Category: Commentary

Good-Bye, Vanilla Option

I realized I didn’t say anything about the death of the vanilla option from the Consumer Financial Protection Agency proposal. I was going to right something targeted and biting, but it ended up as a much broader column for the Washington Post about the Obama Administration’s commitment to regulatory reform.

Mike Konczal, fortunately, has two good posts on the topic: one a eulogy for plain vanilla, one on the underlying problems that plain vanilla would have helped solve. He also points out at least three ways the federal government can achieve some of the same goals through other means:

  • Banning prepayment penalties on mortgages
  • (Citing Alyssa Katz): using the government’s historically large and now even bigger influence in the secondary market to encourage plain vanilla mortgages
  • (Citing Steve Waldman): a government charge card (think “public option”)

All of those posts are worth reading. If we’re not going to have plain vanilla, we need other new ideas about how to channel innovation into things that provide consumer benefit and put a floor under the quality offered by the private sector. More disclosure won’t work (that already failed).

Update: The Raven compares the Obama administration to the Johnson administration, each with its “devil’s bargain.”

By James Kwak

Back-Door Resolution Authority

Tyler Cowen quotes from Robert Pozen’s yet-to-be-released book:

“In my view, the adverse repercussions of Lehman’ failure could have been substantially reduced if the federal regulators had made clear that they would protect all holders of Lehman’s commercial paper with a maturity of less than 60 days and guaranteed the completion of all trades with Lehman for that period.”

Back when people cared about these things, I wrote a couple of posts on the issue of selective protection of creditors.

Continue reading “Back-Door Resolution Authority” →

The G20, The IMF, And Legitimacy

Strong advocates of our new G20 process are convinced that it will bring legitimacy to international economic policy discussions, rule-making, and crisis interventions.  Certainly, it’s better than the G7/G8 pretending to run things – after all, who elected them?

But who elected the G20?  The answer is: No one.  And, in case you were wondering, there is no application form to join the G20 (although you can crash the party if you have the right friends, e.g., Spain).  The G20 has appointed themselves as the world’s “economic governing council” (to quote Gordon Brown).

Is this a good idea? Continue reading “The G20, The IMF, And Legitimacy” →

More on Bank of America

Last Wednesday I wrote a highly critical post about the agreement between Bank of America(BAC)  and the government (Treasury, the Fed, and the FDIC) to terminate BAC’s asset guarantee agreement in exchange for a payment of $425 million. I’ve learned some more about this and I think I can reconstruct the government’s perspective on this issue, with the help of someone knowledgeable about the transaction.

Continue reading “More on Bank of America” →

Robert Shiller and the Danger of Metaphors

Financial commentators use metaphors* all the time. Derivatives are “financial weapons of mass destruction,” for example. Actually, people use metaphors all the time. But what is the substantive content of a metaphor? More technically, if A is (like) B, then why should we believe that A has some attribute that B has?

I’ve been meaning to write about this for a while, but then Robert Shiller handed me a perfect example in the Financial Times, in his “defense of financial innovation:”

“The advance of civilisation has brought immense new complexity to the devices we use every day. A century ago, homes were little more than roofs, walls and floors. Now they have a variety of complex electronic devices, including automatic on-off lighting, communications and data processing devices. People do not need to understand the complexity of these devices, which have been engineered to be simple to operate.

“Financial markets have in some ways shared in this growth in complexity, with electronic databases and trading systems. But the actual financial products have not advanced as much. We are still mostly investing in plain vanilla products such as shares in corporations or ordinary nominal bonds, products that have not changed fundamentally in centuries.

“Why have financial products remained mostly so simple? I believe the problem is trust. People are much more likely to buy some new elec­tronic device such as a laptop than a sophisticated new financial product. People are more worried about hazards of financial products or the integrity of those who offer them.”

Continue reading “Robert Shiller and the Danger of Metaphors” →

When a Nudge Becomes a Shove

Richard Thaler, co-author of Nudge, wrote an op-ed in The New York Times this weekend arguing that we should change the default option for organ donation. Reading the article helped crystallize for me a vague concern I’ve had with all this behavioral economics-inspired, benevolent-paternalistic behavior modification that has gotten so much attention lately among the smart set. But I’m getting ahead of myself.

Continue reading “When a Nudge Becomes a Shove” →

Escape from Punchbowlism

This post was written by StatsGuy, a regular commenter here and very occasional guest contributor. We asked him to expand on the ideas he put forward in this comment on the relationships between monetary policy, international capital flows, and bank capital requirements.

Former Fed Chairman William McChesney Martin is most famous for his notorious quip that the job of the Fed is to “take away the punchbowl just as the party gets going.” It seems this has evolved into a full fledged theory of monetary management.

Unfortunately, structural problems – like trade imbalances, inadequate capital ratios, and weak financial regulation – severely constrain Fed monetary policy options by impacting currency flows and the value of the dollar. (Some specific mechanisms are listed in the previous comment.)

Why does this matter? Because it means the Fed cannot use monetary policy as effectively to keep the country going at full throttle and avoid a prolonged fall in utilization rates (unemployment and idle machines).  How can it be that capacity utilization is still lower than at the bottom of the 81/82 recession and we’re ALREADY raising the bubble/inflation alarm? (Paul Krugman discusses this here, and the answer is that the output gap is itself defined against neutral inflation, not just capacity utilization.)

Continue reading “Escape from Punchbowlism” →

Was The G20 Summit Actually Dangerous?

It is easy to dismiss the G20 communique and all the associated spin as empty waffle.  Ask people in a month what was accomplished in Pittsburgh and you’ll get the same blank stare that follows when you now ask: What was achieved at the G8 summit in Italy this year?

Perhaps just having emerging markets at the table will bring the world closer to stability and more inclined towards inclusive growth, but that seems unlikely.  Should we just move on – back to our respective domestic policy struggles?

That’s tempting, but consider for a moment the key way in which the G20 summit has worsened our predicament. Continue reading “Was The G20 Summit Actually Dangerous?” →

The IMF Should Move To Europe

The headline news from the G20 summit in Pittsburgh is that progress has been made on “IMF reform,” meaning increased voting power for emerging markets relative to rich countries – remember that West Europeans are greatly overrepresented at the IMF for historical reasons.  But further change in a sensible direction is being blocked by the UK and France – because they have figured out that this logic implies they would lose their individual seats on the IMF’s executive board.

The way to break this impasse is (1) for the European Union to consolidate into a single seat or membership, and (2) for the Union to assert its right to be the headquarters of the IMF (under the Articles of Agreement: “The principal office of the Fund shall be located in the territory of the member having the largest quota…”). Continue reading “The IMF Should Move To Europe” →

Neal Wolin And The Bankers

Deputy Treasury Secretary Neal Wolin addressed the Financial Services Roundtable today.  His prepared remarks included the following key paragraphs,

“The days when being large and substantially interconnected could be cost-free – let alone carry implicit subsidies – should be over.  The largest, most interconnected firms should face significantly higher capital and liquidity requirements. 

“Those prudential requirements should be set with a view to offsetting any perception that size alone carries implicit benefits or subsidies.  And they should be set at levels that compel firms to internalize the cost of the risks they impose on the financial system.    Continue reading “Neal Wolin And The Bankers” →

The G20 Summit in Pittsburgh: Should You Care?

On Thursday evening and all day Friday, heads of government from countries belonging to the G20 will meet in Pittsburgh.  On paper, this looks important – 90 percent of world economic output and 67 percent of world population will be at the table: the G7 (US, Canada, Japan, UK, Germany, France, and Italy), plus the European Union, the largest emerging market countries (including China, India, Brazil, Mexico, and South Africa) and a few others.  And unlike the G7, which is really a club for rich industrialized countries, every continent and almost all income levels are represented in the G20. Continue reading “The G20 Summit in Pittsburgh: Should You Care?” →

Bank of America $4 Billion, Taxpayers $425 Million

I’m trying to figure out if I should be infuriated about the agreement allowing Bank of America to walk away from the asset guarantees it got as part of its January bailout in exchange for a payment of $425 million. I can piece together part of the story from The New York Times, Bloomberg, and NPR, but the complete story is a bit hazy.

The initial deal was that Treasury, the FDIC, and the Fed would guarantee losses on a $118 billion portfolio of assets; B of A would absorb the first $10 billion and 10% of any further losses, so the government’s maximum exposure would be about $97 billion. Part of that guarantee was a non-recourse loan commitment from the Fed, basically meaning that the Fed would loan money to B of A, take the assets as collateral, and agree to keep the assets in lieu of being paid back at B of A’s option. In exchange, the government would get:

(a) An annual fee of 20 basis points on the Fed’s loan commitment, even when undrawn (if B of A drew down the loan, which it didn’t, it would pay a real interest rate). The loan commitment could be interpreted to be only $97 billion, so this comes to $194 million per year.

(b) $4 billion of preferred stock with an 8% dividend. That’s a dividend of $320 million per year; B of A can buy back the preferred stock by paying $4 billion.

(c) Warrants on $400 million of B of A stock. B of A was at $7.18 the day the bailout was announced and yesterday it closed at $17.61, so if Treasury had gotten an exercise price of $7.18, those warrants would be worth about $580 million now.

Continue reading “Bank of America $4 Billion, Taxpayers $425 Million” →

The Good Part of the Baucus Bill

I’ve been generally critical of the Baucus Bill, primarily because of the reduced subsidies, which I see as an increased tax on the currently uninsured middle class. But luckily Ezra Klein has been providing detailed coverage of what’s good about it – notably, the proposed reforms to the health care delivery system. See his interview with Peter Orszag and his post about Chris Jennings and most of his other posts from yesterday. On my reading, the Baucus Bill will kick off a number of initiatives that will test different ways of reducing costs or improving quality, such as ways of linking payments to outcomes.

I think this is promising because, as I’ve said before, even though we have a general idea of what the problem is – economic incentives that are cut loose from outcomes – we’re not sure how to solve it. As a result, any master plan to reduce costs without sacrificing quality is easy to attack, and given the political dynamics people will be eager to attack it. The answer is that, in the medium term, we have to figure out what does work, and the way to do that is to try lots of different things. This is exactly what a smart business would do, so it’s good to see the government doing it.

By James Kwak

G20 Thinking: “In The Medium Run We Are All Retired”

It looks like the G20 on Friday will emphasize its new “framework” for curing macroeconomic imbalances, rather than any substantive measures to regulate banks, derivatives, or any other primary cause of the 2008-2009 financial crisis.

This is appealing to the G20 leaders because their call to “rebalance” global growth will involve no immediate action and no changes in policy – other than in the “medium run” (watch for this phrase in the communiqué).

When exactly is the medium run? Continue reading “G20 Thinking: “In The Medium Run We Are All Retired”” →