Category: Commentary

Required Intellectual Capital

By Simon Johnson

At one level, the pursuit of higher and more robust capital requirements for banks is not going well. The US Treasury insisted, throughout the year-long financial reform debate, that capital should be the focus – increasing the loss-absorbing buffers that banks must carry – and that they (and other regulators) needed to negotiate this is through the Basel Committee process.

But Basel has some under great pressure from the banking lobby, which argues that any increase in capital requirements would limit lending and slow global growth (see this useful background by Doug Elliott). The Institute of International Finance (IIF) – a lobby group for big banks – issued an influential “report” along these lines and the European stress test results strongly suggest that Euroland politicians do not want to press more capital into their financial system – “just enough” would be fine with them.

However, at another level – in terms of the analytical consensus around these issues – there is a great deal of progress in the right direction. In particular, an important new paper by Samuel Hanson, Anil Kashyap, and Jeremy Stein, “A Macroprudential Approach to Financial Regulation” pulls together the best recent thinking and makes three essential points. (This is a nontechnical paper written for the Journal of Economic Perspectives – it’s a “must read” for anyone interested in financial sector issues but requires some effort and a little jargon does creep in.) Continue reading “Required Intellectual Capital” →

Yet Another Reason to Like Elizabeth Warren

By James Kwak

Bob Lawless points me to this 2006 blog post by Elizabeth Warren. Warren describes a first-year contracts class on the case that upheld a fine-print forum selection clause (a clause saying that if you want to sue us, you have to sue us in X jurisdiction–Florida, in this case) on the back of a cruise ship ticket.

Warren’s entire class (Harvard, let me say for the record) insists that, as a factual matter, this decision is good for consumers because . . . well, regular readers of this blog should be able to fill in stock Mickey Mouse economistic hand-waving as well as any first-year law school student. Of course! Forcing people to sue in Florida (or to accept binding arbitration in the forum of the company’s choice) deters frivolous lawsuits and lowers costs for the company, and it can pass those savings onto consumers. Why does it pass those savings onto consumers instead of putting them into shareholders’ (or managers’) pockets? Because in a perfect competitive market, if Alpha Cruise Lines doesn’t, then Beta Cruise Lines will, and Beta will underprice Alpha, . . . Consumers will read the fine print and can make an informed choice between the lower price with the forum selection clause and the higher price without the forum selection clause.

Continue reading “Yet Another Reason to Like Elizabeth Warren” →

Banking Under the Dodd-Frank Act

By Simon Johnson

President Obama’s signing of the financial reform bill yesterday does not end our intense debates over banking – rather it just moves them to a new sphere. Instead of arguing about legislation, the next arena is the action (and perhaps inaction) of regulators.

Those pushing for more effective regulation of the financial system are looking for progress along three potential dimensions. The first two – raising capital standards and appointing new regulators – are the most discussed, but powerful interests are blocking real change. The third – tougher and smarter congressional oversight – holds great promise. Continue reading “Banking Under the Dodd-Frank Act” →

Hope

By James Kwak

A number of people have asked me what I think about the financial reform bill that was finally passed by the Senate. I don’t think I have much to add to what I’ve said already, but here’s one more angle.

“We can’t legislate wisdom or passion. We can’t legislate competency. All we can do is create the structures and hope that good people will be appointed who will attract other good people.”

That’s what Christopher Dodd said about the bill, as quoted by The New York Times. It’s become a commonplace observation by now that the reform bill, instead of making structural changes to the financial sector, instead increases regulators’ discretionary powers to constrain — or not constrain — the behavior of the industry.

As a result, the success of reform, in the words of its supposed architect, depends on hoping that presidents will appoint good people and that that will be enough to attract people to being regulators.

Continue reading “Hope” →

Treasury Makes A Mistake – Claiming They Are Not Blocking Elizabeth Warren

By Simon Johnson

It’s one thing to block Elizabeth Warren from heading the new Consumer Financial Protection Bureau.

It’s quite another thing to deny in public, for the record, that any such blocking is going on (e.g., see this report; Michael Barr apparently said something quite similar today).

There is a strong groundswell of opinion on this issue from the left – see the BoldProgressives petition. But the center also feels strongly that, given everything Treasury has said and done over the past few months, it would be a complete travesty not to put the strongest possible regulator in change of protecting consumers. (See Ted Kaufman on the NYT’s DealBook, giving appropriate credit to the SEC, and apply the same points to broader customer issues going forward.)

This can now go only one of two ways. Continue reading “Treasury Makes A Mistake – Claiming They Are Not Blocking Elizabeth Warren” →

Tim Geithner’s Ninth Political Life

By Simon Johnson

In modern American life, Treasury Secretary Tim Geithner stands out as amazingly resilient and remarkably lucky – despite presiding over or being deeply involved in a series of political debacles, he has gone from strength to strength. After at least eight improbably bounce backs, he might seem unassailable. But his latest mistake – blocking Elizabeth Warren from heading the new Consumer Financial Protection Bureau – may well prove politically fatal.

Geithner was a junior but key member of the US Treasury team that badly mishandled the early days of the Asian financial crisis in 1997 and received widespread criticism (Life #1). He was promoted as a result and thereafter enjoyed a meteoric rise.

As President of the New York Federal Reserve from 2003, and de facto head of the government’s financial intelligence service, he completely failed to spot the problems developing in and around the country’s financial markets; nothing about this embarrassing track record has since stood in his way (Life #2). He subsequently became Hank Paulson’s Wall Street point person for one of the most comprehensively bungled bailouts of all time – the Troubled Asset Relief Program, TARP, which in fall 2008 first appalled Congress with its intentions and then wasn’t used at all as advertised (Life #3). Continue reading “Tim Geithner’s Ninth Political Life” →

The Future of Finance: International Edition

By Simon Johnson

Bankers and hedge fund managers are fond of saying, “if you place restrictions on our activities in New York, we’ll just move elsewhere – like London.” This makes attitudes towards the financial sector in other countries – particularly the UK – highly relevant for American public policy debate on this issue.

Is it the case that the new found skepticism about modern finance and its effects on the real economy is confined to the United States? Or is there a broader shift in thinking around the world, including in other leading financial centers?

A new book out this week from the London School of Economics, “The Future of Finance and The Theory That Underpins It”, suggests that a profound shift in the consensus is well underway. Continue reading “The Future of Finance: International Edition” →

The New Antitrust – For Banks

Just over a hundred years ago, the United States led the world in terms of rethinking how big business worked – and when the power of such firms should be constrained. In retrospect, the breakthrough legislation – not just for the US, but also internationally – was the Sherman Antitrust Act of 1890.

The Dodd-Frank Financial Reform Bill, which is about to pass the US Senate, does something similar – and long overdue – for banking.

[To read the rest of this post, click here – which takes you to Project Syndicate’s site; no fees or advertizing involved]

David Axelrod’s Talking Points

By Simon Johnson

David Axelrod was on the Diane Rehm show this morning – a great opportunity to connect with listeners who will actually stop what they are doing and pay attention, at least for a short while. He was awful.

He had even the most basic facts wrong – it’s not “8 million people have lost their jobs” but rather “more than 8 million jobs have been lost” since December 2007. He rambled – it was hard to see his point, particularly in the introduction. But most of all, there was no narrative – why exactly did we have a recession, why has it been so bad, and why aren’t the jobs coming back?

Without a narrative, how can anyone make sense of the past 18 months? Continue reading “David Axelrod’s Talking Points” →

Why Agencies Get Things Terribly Wrong

By James Kwak

There has been a lot of criticism of regulatory agencies in the past couple of years, from the Office of Thrift Supervision and the Securities and Exchange Commission (Madoff who?) to the Minerals Management Service. But most of the people in these agencies are not evil; on the contrary, I believe (without a ton of evidence in support at the moment) that a majority are conscientious, hard-working, and civic-minded, and a significant minority are actually quite good at what they do. So why do they get things so wrong?

A few days ago, Leslie Kaufman of The New York Times wrote an article describing how the Fish and Wildlife Service “signed off on the Minerals Management Service’s conclusion that deepwater drilling for oil in the Gulf of Mexico posed no significant risk to wildlife.” This sounds like classic incompetence, or corruption, or both.

But the report itself, it seems, was not so far off, at least in its details. The report assessed spills of up to 15,000 barrels of oil. As Kaufman paraphrases,

“In its 71-page biological assessment, the Minerals Management Service concluded that the chances of oil from a spill larger than 1,000 barrels reaching critical habitat within 10 days could be more than 1 in 4 for the piping plover and the bald eagle, as high as 1 in 6 for the brown pelican and almost 1 in 10 for the Kemp’s ridley sea turtle. When the model was extended to 30 days, the assessment predicted even higher likelihoods of habitat pollution. . . .

“‘Heavily oiled birds are likely to be killed,’ the assessment said.”

Fifty-one days after the well explosion, the amount of oil spilled is probably somewhere between one and three million barrels.

Continue reading “Why Agencies Get Things Terribly Wrong” →

The Kanjorski Surprise – Now It Gets Interesting

By Simon Johnson

The bank lobbyists, it turns out, missed one. They and their congressional allies were able to gut the Volcker Rule, the Lincoln Amendment, and almost everything else that could have had a meaningful effect on the industry.

But, as I point out in a Bloomberg column today, they couldn’t get at (or didn’t sufficiently understand?) the Kanjorski Amendment. This Amendment was originally proposed by Congressman Paul Kanjorski (chair of an important House subcommittee on capital markets) during the fall. Against the odds, it survived in the final House bill and now – probably because it has stayed mostly below the radar – remains in the reconciled legislation.

Kanjorski gives federal regulators the power and the responsibility to limit the activities or even break up big banks if they pose a “grave risk” to the financial system. Continue reading “The Kanjorski Surprise – Now It Gets Interesting” →

One Paragraph on the Financial Reform Bill

By James Kwak

From Mike Konczal:

“Examples? Off the top of my head, ones with a paper trail: [Treasury] fought the Collins amendment for quality of bank capital, fought leverage requirements like a 15-to-1 cap, fought prefunding the resolution mechanism, fought Section 716 spinning out swap desks, removed foreign exchange swaps and introduced end user exemption from derivative language between the Obama white paper and the House Bill, believed they could have gotten the SAFE Banking Amendment to break up the banks but didn’t try, pushed against the full Audit the Fed and encouraged the Scott Brown deal.”

(By the way, if you’re missing your financial commentary fix during my self-imposed hiatus, I recommend Mike’s blog highly–not that that’s news to anyone anymore.)

Continue reading “One Paragraph on the Financial Reform Bill” →

Bad Software

By James Kwak

Planet Money did a story this week on the problems with medical billing. This is something I’ve been vaguely interested in for a long time; nine years ago, we seriously thought about it as a business opportunity for our company.

The Planet Money team said that there is $7 billion in waste in the medical billing process per year, which sounds like a lot until you realize that it isn’t. (Total healthcare costs in the United States are on the order of $2 trillion, I believe.) But the story had a great example of the problems with enterprise software that I’ve written about before.

Continue reading “Bad Software” →

State Banking, Globally

By Simon Johnson

A standard refrain from U.S. banking industry lobbyists is “you cannot put us at a disadvantage relative to our overseas competitors.” The Obama administration has largely bought into this line and cites it in public and private as one reason for opposing size caps on our largest banks and preventing Congress from raising capital requirements.

The US Treasury puts its faith instead in the Basel Committee on Banking Supervision process, a somewhat murky convocation of bank regulators from various countries that has a weak track record in terms of setting sufficient prudential standards (also the assessment of Dan Tarullo, now an influential Federal Reserve governor; disclosure, I have a part-time position at the Peterson Institute, which published his book). But, the official US reasoning goes, the crisis of 2007-08 was so traumatic, our European counterparts will now want to be more careful. Continue reading “State Banking, Globally” →

The G20’s China Bet

By Simon Johnson

The G20 communiqué, released after the Toronto summit on Sunday, made it quite clear that most industrialized countries now have budget deficit reduction fever (see this version, with line-by-line comments by me, Marc Chandler and Arvind Subramanian). The US resisted the pressure to cut government spending and/or raise taxes in a precipitate manner, but the sense of the meeting was clear – cut now to some extent and cut more tomorrow.

This makes some sense if you think that the global economy is in robust health and likely to grow at a rapid clip – say close to 5 percent per annum – for the foreseeable future. With high global growth, it will matter less that governments are cutting back and unemployment will come down regardless. Taking this into account, the IMF is actually predicting (as cited prominently by the G20) that budget “consolidation” actually raise growth over a five-year horizon.

There is no question that some weaker European countries, such as Greece, Portugal, and Ireland, had budget deficits that were out of control. Particularly if they are to pay back all their foreign borrowing – a controversial idea that remains the conventional wisdom – these countries need some austerity. But what about those larger countries, which remain creditworthy, such as Germany, France, the UK, and the US? If these economies all decide to reduce their budget deficits, what will drive global growth? Continue reading “The G20’s China Bet” →