Category: Commentary

Traditional Chicago Economics Under Pressure: Beyond The Thaler-Posner Debate

Richard Posner is against the proposed new Consumer Financial Protection Agency (CFPA).  This is, of course, not a surprise.  Posner has always been an articulate advocate of the view most often associated with economics at the University of Chicago: market-based outcomes are invariably better than the alternatives, and anything that interferes with consumer choice is a bad idea. 

Posner wraps this opposition to the CFPA into an odd attack (near the end of his WSJ op ed) on the personal decision-making abilities of Richard Thaler – a leading economist on consumer choice, misperceptions, and mistakes. (More on Thaler here.)

Thaler, also of the University of Chicago, hit back hard yesterday.  He is right that Posner mischaracterizes the CFPA proposal, and points out that his agenda – and that of Cass Sunstein, formerly of Chicago and now a czar in the adminstration – is simply to provide consumers with a framework for better decisions.  He implies that Posner defends defective baby cribs and their equivalent.

I would go further. Continue reading “Traditional Chicago Economics Under Pressure: Beyond The Thaler-Posner Debate” →

Jeb Hensarling, George Orwell

The debate over re-regulation of the financial sector has finally, and irreversibly, turned partisan.  This helps define issues in ways that may be more familiar and thus easier to understand.

In the blue corner we have Treasury Secretary Tim Geithner.  Secretary Geithner’s overall banking policy continues to be problematic, and his broader re-regulation effort is hampered by all the free passes he gave to bank CEOs earlier this year.  But on consumer protection he has the right message and he delivered it forcefully to Congress last week: we need a Consumer Financial Protection Agency (CFPA) and we need it now.

In the red corner, Representative Jeb Hensarling is rapidly emerging as a leader.  A member of the Congressional Oversight Panel and the senior republican on the House Financial Services subcommittee on Financial Institutions and Consumer Credit, he wrote last week in the Washington Timesthat the CFPA is “Orwellian”, because it would strip consumers of their rightful choices.

Mr. Hensarling seems dangerously close to slipping into double think. Continue reading “Jeb Hensarling, George Orwell” →

Secretary Geithner’s China Strategy: A Viewer’s Guide

On Monday and Tuesday of this week, Treasury Secretary Geithner – and Secretary of State Clinton – meet with a high-level Chinese delegation.  (Could someone please update the Treasury’s schedule of events? At 7am on Monday it still shows last week’s agenda; update, 9am, this is now fixed – thanks).

According to official previews (i.e., the apparent contents of background briefings given to wire services), the economic topics are China’s concerns about the value of the dollar (i.e., their investments in the U.S.) and the amount of debt that the U.S. will issue this year.

This is absurd. Continue reading “Secretary Geithner’s China Strategy: A Viewer’s Guide” →

Health Insurance “Innovation”

The This American Life crew, once again proving that they can cover any topic they want better than anyone else in the media,* has a segment in this weekend’s episode on rescission of health insurance policies – insurers’ established practice of looking for ways to invalidate policies once it turns out that the insured actually needs significant medical care. (The segment is around the 30-minute mark; audio should be available on that page sometime on Monday.) The story describes a couple of particularly egregious cases, such as a woman who was denied breast cancer surgery because she had been treated for acne in the past, and a person whose policy was rescinded because his insurance agent had incorrectly entered his weight on the application form.

Continue reading “Health Insurance “Innovation”” →

Soaking Customers as a Form of Prudential Regulation

Good for Deputy Treasury Secretary (and YLS alumnus) Neal Wolin for wading into the American Bankers Association to defend the Consumer Financial Protection Agency. According to FinReg21’s article:

Wolin firmly rejected the argument made by American Bankers Association chief executive Ed Yingling in recent congressional testimony that responsibility for consumer protection should not be separated from the responsibility for safety and soundness. . . .

The industry has argued that prudential regulators are careful to preserve a profit margin on financial products, to keep financial institutions sound.

Continue reading “Soaking Customers as a Form of Prudential Regulation” →

After Peak Finance: Larry Summers’ Bubble

There are three kinds of “bubbles” –  a term often used loosely when asset prices rise a great deal and then fall sharply, without an obvious corresponding shift in “fundamentals“.

  1. A short-run bubble.  Think about 17th century Dutch Tulip Mania: spectacular, probably disruptive, but not a major reason for the decline of the Netherlands as a global power. 
  2. A distorting bubble.  In this case, the increase in asset prices contributes to a reallocation of resources across sectors.  Think of the Dot-com Bubble: fortunes were made and lost, the collapse was scary to many, and – at the end of the day – you’ve built the Internet and some good companies.
  3. A political bubble.  Here rising asset prices generate resources that can be fed into the political process, through bribes, building politicians’ careers, and lobbying of all kinds.  Bubbles in Emerging Markets often generate resources that impact the political process, sometimes in good ways – but most often in bad ways, which eventually contribute to a collapse.

Larry Summers seems to think we are dealing with the consequences of bubble type #1.  In his speech last week, “the bubble” is a modern deus ex machina – it explains why we have a crisis, but there is no explanation of where this bubble came from, what exactly was bubbling, and what changes this bubble brought to the real economy or to our politics. Continue reading “After Peak Finance: Larry Summers’ Bubble” →

Mixed Messages

David Wessel seems to be doing the impossible: his book, In Fed We Trust, is getting mentions from all over the Internet, even before its publication, despite competition from what seem like dozens of other crisis books. That’s what a good PR campaign (and a good review from Michiko Kakutani) will do for you.

I obviously haven’t read the book yet, but I was interested in this description in Bloomberg:

None of the senior government policy makers anticipated the credit-market collapse that followed Lehman’s bankruptcy filing in the early hours of Sept. 15, according to Wessel’s book. . . .

On a conference call the previous week, Paulson, Bernanke, Securities and Exchange Commission Chairman Christopher Cox, and senior staff members from those agencies had agreed that companies and investors who did business with Lehman had learned from Bear Stearns and would have acted to protect themselves from a Lehman failure, Wessel wrote.

What were they supposed to learn from Bear Stearns? That they should be very, very afraid of a major bank failure and take steps to protect themselves? Or that the government would step in, so that even if shareholders were largely wiped out, counterparties would be protected? It seems like more of them drew the latter conclusion, even though Paulson, Bernanke, et al. wanted them to draw the former conclusion.

This seems to me an illustration of the fact that you can never be sure what message you are sending. Perversely, even letting Lehman fail ultimately convinced market participants that the government would step in the next time – because the damage done by Lehman’s collapse was so great. One-off intervention are a crude and risky way of communicating policy and creating incentives.

By James Kwak

Bernanke And The Lobbies: Confidence Illusion

Ben Bernanke is opposed to the creation of a new Consumer Financial Protection Agency.  Disregarding his organization’s disappointing track record in this regard, he claims that the Fed can handle this issue perfectly well going forward.

He thus adds his voice to the cacophony of financial sector lobbyists favoring the status quo.

At the same time, Bernanke and the lobbyists talk about the importance of consumer confidence for the recovery.  But how can you expect anyone to have confidence enough to spend and borrow when so many people have been so badly treated by the financial sector in recent years? Continue reading “Bernanke And The Lobbies: Confidence Illusion” →

S&P Revises Expectations for the Economy Downward

Calculated Risk reports that S&P is increasing its forecasts for losses on subprime mortgages again. As I’ve said before, in principle this means that their expectations about the economy are worse today than they were yesterday. They’re not just saying that defaults will go up; they’re saying that they will go up by more than they thought before today.

I previously discussed why I think this is weird, and there are a number of good comments to that earlier post. My theory that they are trying to spread out the deterioration of their forecasts over several months to save face got some support. q and others explained that rating agencies lag the economy because they base their forecasts on published economic data. That may be true, and it may be the best explanation for what is going on, but if so it seems like a condemnation of the rating agencies, since their job is to estimate the likelihood of default, and one of the inputs to their models should be the economic situation. (Or maybe their job is to estimate default likelihood assuming “normal” economic conditions, and it’s up to the investor to adjust accordingly.)

Note that these are their macroeconomic forecasts, not revisions to ratings of specific bonds, so the bond-rating schedule isn’t the driving factor here.

By James Kwak

What Are You (Or Barney Frank) Going To Do About It?

At a hearing of the House Financial Services Committee yesterday, Barney Frank nicely summarized where we are with regard to re-regulation of our largest financial institutions: some of them are definitely “too big to fail”, with the potential to present the authorities with what Larry Summers calls the “collapse or bailout” choice, but what exactly should be done about it?

On a five-person panel, I had the middle seat (as usual) and found myself agreeing with points made both to my left and to my right.  Alice Rivlin is correct that we need to control leverage as well as increase capital requirements, and the Fed’s tools vis-à-vis leverage need modernization – your grandparents’ margin requirements would not suffice.  Peter Wallison, a member of the new financial crisis investigation commission, stresses that capital requirements should be higher for larger banks.  Paul Mahoney wants to change the bankruptcy code, to make it easier for courts to handle large financial firms in quick time; recent CIT Group events suggest this is a good idea.

And Mark Zandi was persuasive on the point that households had no idea what they were signing up to with option ARMs – even he has trouble with those spreadsheets.  Effective consumer protection – including a new consumer safety commission – would definitely contribute to financial system stability.

What will Barney Frank and his committee do?  There will be no “Tier 1 Holding Company” category of firms, if Frank has anything to do with it; this is too much like creating an implicit government guarantee. Frank is clearly drawn towards higher capital requirements or more insurance payments from firms that pose more system risk.  I suggested total assets of 1% of GDP as a threshold, but we agree this should be essentially a progressive drag on profits – creating the strong market-based incentive for the biggest firms to downsize.

Other than that, watch this space.

My written testimony submitted to the committee is below. Continue reading “What Are You (Or Barney Frank) Going To Do About It?” →

Much Ado About Bernanke

There has been a lot of talk recently about Ben Bernanke, he of the Wall Street Journal op-ed and the multiple Congressional appearances. (Hey, can anyone put me in touch with his agent?*) At the risk of seeming ignorant (or revealing myself to be ignorant), I must say I don’t really understand what the fuss is about.

The question seems to be whether the Fed will be able to tighten monetary policy fast enough when necessary to dampen the potential inflationary effect of its current expansive monetary policy (Fed funds rate at zero, buying long-term securities, etc.). My read on the situation is as follows:

  1. Almost everyone agrees that expansive monetary policy has been appropriate during the crisis and recession to date.
  2. Everyone agrees that at some point monetary policy will have to be tightened.
  3. No one knows when that will happen.
  4. Everyone agrees that because policy has been so expansionary recently, tightening monetary policy when necessary will be more difficult than usual.
  5. Everyone agrees more or less on what tools will be available to the Fed.
  6. No one is certain the Fed will or will not be successful, because there are no relevant datapoints to compare it to.
  7. No matter what Bernanke actually thought, he would still have to say exactly what he is saying this week.

I don’t see much in there worth arguing about.

As Catherine Rampell says, a more interesting question is when the Fed will start tightening policy. This is the kind of thing that can set the Fed against the administration, as stereotypically one focuses on inflation and the other on unemployment. But since most people think it is too early to start now, that debate would be purely speculative at the moment.

* He does need a grammar checker, though. His first sentence – “The depth and breadth of the global recession has required a highly accommodative monetary policy” – contains an error in subject-verb agreement.

By James Kwak

The Problem with Federalism

Paul Krugman and many others have been talking about the “fifty little Hoovers” – state governments forced by balanced-budget rules to cut spending and raise taxes in the face of a recession, eliminating services when they are most needed and deepening the economic downturn. James Surowiecki (hat tip Matthew Yglesias) expands the attack by arguing that federalism (the idea that power is balanced between the national and state governments) in general is a problem, at least in these economic circumstances. In addition to counter-cyclical state fiscal policy, he cites political issues such as the disproportionate allocation of road spending to areas with few people and coordination problems such as the difficulty building national transportation or energy networks.

It may seem as if the balance is tilted heavily in favor of the national government – it has an army, it prints money, and so on – but the Constitution leans more toward protecting state autonomy (see the principle that the federal government is one of enumerated powers, and the Tenth Amendment), and the trend of the Reagan Revolution and the Rehnquist Court was to favor states’ rights. (Of course, “states’ rights” are not necessarily a Republican or a Democratic issue, but tend to be favored by whichever side finds the argument convenient at the moment.)

When I was young (like in high school) I thought states were silly and we should just have a national government, like in France, where the departments are mainly just administrative units. When I got a little older and became a qualified fan of Edmund Burke, I decided that the current system worked well enough most of the time that it would have to be seriously broken to justify a major structural change.

I’m not sure it qualifies as seriously broken at the moment, but I think the current recession counts as evidence that it sure isn’t the system you would design if you were starting from scratch.

By James Kwak

Three Myths about the Consumer Financial Product Agency

This guest post was contributed by Elizabeth Warren, chair of the Congressional Oversight Panel and the Leo Gottlieb Professor of Law at Harvard University. (Update: more on the case for a CFPA in her YouTube video, released yesterday.)

I’ve written a lot about the creation of a new Consumer Protection Financial Agency (CFPA), starting with an article I wrote in the Democracy Journal in the summer of 2007. My writing has helped me work through the idea and has advanced a conversation about what kind of changes in financial products would be most effective. A couple of weeks ago, I testified before the House Financial Services Committee about why I think a new consumer agency is so important, and I’ve argued the case many times.

Today, though, I’d like to post specifically about some of the push back that has developed on this issue.  In particular, I’d like to focus on three big myths – myths designed to protect the same status quo that triggered the economic crisis. Continue reading “Three Myths about the Consumer Financial Product Agency” →

CEO Psychology

If you need more reasons to dislike former Bear Stearns CEO Jimmy Cayne, apparently William Cohan’s new book about the fall of Bear gives you plenty more. I’m just judging from the excerpts in Malcolm Gladwell’s new article in The New Yorker, which is really about the tendency toward overconfidence among the people who rise to the top on Wall Street, but also quotes Cayne saying that people he doesn’t like are gay – and he doesn’t mean it in a nice way.

Gladwell tries to position psychology as an alternate explanation of the financial crisis:

Since the beginning of the financial crisis, there have been two principal explanations for why so many banks made such disastrous decisions. The first is structural. Regulators did not regulate. Institutions failed to function as they should. Rules and guidelines were either inadequate or ignored. The second explanation is that Wall Street was incompetent, that the traders and investors didn’t know enough, that they made extravagant bets without understanding the consequences. But the first wave of postmortems on the crash suggests a third possibility: that the roots of Wall Street’s crisis were not structural or cognitive so much as they were psychological.

I think this is a bit much. The fact that some Wall Street actors were megalomaniacs does not change the facts that regulators did not regulate, or that rules and guidelines were inadequate. Nor is overconfidence inconsistent with incompetence.

But Gladwell is probably right that overconfidence was a factor in the terrible decisions made by so many people. The problem, Gladwell argues, is that overconfidence is a useful trait to have in many settings – perhaps even an evolutionary adaptation. But then we fall into the trap:

“I’m good at that. I must be good at this, too,” we tell ourselves, forgetting that in wars and on Wall Street there is no such thing as absolute expertise.

In addition, the business world tends to breed overconfidence in CEOs. There is dumb luck in everything. But people who are successful tend to think that their success is a product of their own abilities, which leads them to overestimate those abilities. The sycophantic nature of the corporate culture at most large companies only reinforces this delusion. Then there is the insistence by the media, analysts, and institutional investors that CEOs project constant, Herculean confidence. If a CEO were to say the truth on an earnings call – “I’m pretty happy about how we did last quarter; we got lucky and closed a couple of big deals we might not have won; if things go well next quarter we’ll meet our targets, but any number of things could go wrong” – investors would fall over themselves trying to dump his or her stock.

But all of these problems are endemic to modern American capitalism, not just Wall Street banks (although Wall Street trading floors are particularly fertile breeding grounds for overconfidence, given the nature of trading gains and losses, and the amount of money being made). I would tend to put it more in the category of problems that will always be with us than the category of specific causes of the financial crisis. Maybe the specific problem here was that megalomaniacs ascended to be head of systemically important banks that could bring down the entire financial system, rather than running airlines, telecom companies, private equity firms, high-tech companies, baseball teams, or other organizations whose collapse would not have such dire consequences.

By James Kwak