Making The Volcker Rule Work

By Simon Johnson.  This is the text of a letter (about 2,000 words) submitted on Friday to the Financial Stability Oversight Council, in response to their request for comments on the Volcker Rule.  The full letter is here and on regulations.gov.  If you would like more background on the Volcker Rule and its political importance, please see this post and the links it provides.

Dear Members of the Financial Stability Oversight Council:

Thank you for the opportunity to submit these comments on the study regarding implementation of Section 619 of the Dodd-Frank Act, also known as the Merkley-Levin provisions on proprietary trading and conflicts of interest or as the Volcker Rule.

Summary

I would like to offer three main comments. 

  1. Mismanagement of risks that involved effectively betting the banks’ own capital was central to the financial crisis of 2008; this is why our largest banks failed or almost failed.  The Merkley-Levin Volcker Rule, properly defined, would significantly reduce systemic financial risks looking forward.  Congressman Bachus’s comment to contrary (as submitted to the FSOC, as part of the Public Input for this Study, dated November 3, 2010) is completely at odds with the facts.
  2. Trades need to be scrutinized in a detailed and high frequency fashion.  It is not enough to rely on relatively infrequent and “high level” inspections – or the established supervisory process.  The comments provided to you in this regard by Senator Harkin (dated October 20, 2010) – and also by Senators Merkley and Levin (dated November 4, 2010) – are exactly on target.
  3. The separation between banks and the funds they sponsor, in any fashion, needs to be complete.  The argument offered by State Street and other “Custodian Banks” in their comment to you (dated October 27, 2010) is worrying and potentially dangerous, because it ignores the basic economics that leads to bank failure.

The remainder of this letter expands on these points. Continue reading “Making The Volcker Rule Work” →

B of A Doublespeak

By James Kwak

Investors are claiming that Bank of America’s servicing operations are milking delinquent mortgages to earn fees rather than either foreclosing or modifying the mortgages. Bank of America’s defense?

“We have no financial incentive to keep mortgages on the books longer. Isn’t it better to modify the loan and keep people in their homes rather than foreclosing?”

I’m glad you feel that way. Then why do you have the second-lowest permanent modification rate of the seventeen servicers and two other servicer categories whose data have been released by Treasury?

Is This What You Voted For?

By James Kwak

In What’s the Matter with Kansas? Thomas Frank described how the Republican Party was able to take advantage of the conservative, values-focused, evangelical-driven movement to come to power–and then paid lip service to the priorities of the “base,” instead pursuing policies that helped established business interests and the rich. On a national scale, this was one major reason why conservatives became so disillusioned with George W. Bush.

It’s no surprise to anyone that this is happening again, only substituting “Tea Party” for “evangelical conservatives” and “United States” for “Kansas.”

Spencer Bachus, the likely new chair of the House Financial Services Committee, has announced that he is planning to use whatever powers he can to gut the Dodd-Frank financial reform bill. Why? According to the Financial Times, Bachus “expressed concern that shareholders of Goldman Sachs and JPMorgan Chase will be hurt because the banks will be less profitable.”

So one major effect of the Tea Party movement will be to further enrich Wall Street banks and the bankers who work there. (Which, I guess, is consistent with the common Tea Party insistence on reducing taxes for the rich.)

Is this what you voted for?

(If not, Mike Konczal reminds us that tomorrow is the deadline to submit comments on the implementation of the Volcker Rule.)

Panel with Blogging Luminaries

By James Kwak

For those of you lucky enough to live in Western Massachusetts, the Political Economy Research Institute is hosting a panel tomorrow (Friday) from noon to 1:30 with not one, not two, but three prominent econobloggers: Doug Henwood of Left Business Observer, Mike Konczal of Rortybomb, and Yves Smith of naked capitalism. And your humble blogger will be moderating. It’s at the University of Massachusetts, on the third floor of Gordon Hall.

Paul Ryan Is Not A Fiscal Conservative

By Simon Johnson

Writing in the Financial Times today, Paul Ryan – the incoming chair of the House Budget Committee – presents himself as a fiscal conservative, primarily focused on bringing the budget deficit and government debt under control.  He is not.

Only in American could self-styled “fiscal conservatives” say that “America is eager for an adult conversation on the threat of debt,” but then decline to discuss the first order problem that has brought us here and threatens us going forward: Dangerous systemic risk brought on by the reckless behavior of big banks.  No “fiscal conservatives” showed up for the legislative fight to rein in big banks – none, and now Spencer Bachus (presumptive incoming chair of House Financial Services) says that restrictions on big banks should be further lifted (quoted in the FT today, p.15).

We can reasonably draw only one conclusion: Paul Ryan and his colleagues are not real fiscal conservatives.  This is further confirmed by the following: Continue reading “Paul Ryan Is Not A Fiscal Conservative” →

Will the Volcker Rule Survive The Midterm Elections?

By Simon Johnson

The Obama administration saved the deeply troubled megabanks in the United States in early 2009 with a bundle of rescue measures that, compared with similar financial crises elsewhere, stands out as extraordinarily generous – particularly to the bankers at the epicenter of the disaster.

The banks responded to this magnanimity with – by all accounts – extraordinarily generous support for the Republicans leading up to this week’s midterm elections. Why would they do this?

The answer is straightforward: The Republicans have promised generally not to tighten restrictions on the financial sector, which means specifically that they will seek to make the recent Dodd-Frank financial regulatory legislation less effective. Continue reading “Will the Volcker Rule Survive The Midterm Elections?” →

The White House Needs Elizabeth Warren, Now More Than Ever

By Simon Johnson

The White House today is under pressure, with insiders asking: After the strong showing of the Republicans in the midterm elections, should the president move to the right or to the left?

This is entirely the wrong way to think about the problem – the administration needs to get beyond its mental framework of early 2009, which led it sadly astray with regard to the financial sector.  The President needs to find people and themes capable of cutting across the political spectrum; specifically he needs to promote strongly the ideas of Elizabeth Warren – what we need in financial services, above all else, is much more transparency.

The premise – and central mistake – of the Obama administration in 2009-10 can be summed up in what the president said to leading bankers on that fateful day, March 27, 2009: “My administration is the only thing between you and the pitchforks”. Continue reading “The White House Needs Elizabeth Warren, Now More Than Ever” →

Interview in The Straddler

By James Kwak

The Straddler, an online interdisciplinary publication, has an extended interview with me, of all people, so you can see what I talk like.

This is one section I’m proud of:

“Middle class wages have been declining for ten years and stagnant for thirty years, and if you have a financial system that allows people making $15,000 a year to take out $400,000 mortgages, I don’t think that’s the fault of the guy making $15,000.  I think it’s the fault of the financial system.

“But, let’s say I’m a guy who makes $15,000 a year.  I realize, wow, I can get a $400,000 mortgage and I can live in this house for a few years, and if housing prices go up, I can flip it and I can actually make a couple hundred thousand dollars.  And let’s say I’m really clever, and I say, if housing prices go down, I’ll just walk away and I will have gotten to live in a really nice house for three years at no cost to myself.  I mean, that’s the worst, most cynical spin you can put on it, right?  But this is exactly what people on Wall Street do.  The person who is criticizing the janitor for doing this is the same person who thinks that businesses should exploit every legal opportunity to make profits.  So even if you attribute the worst possible state of mind to the guy making $15,000, he’s still just doing what any businessman should do under the circumstances.  But our national ideology somehow doesn’t allow us to think about it in those terms.”

Enjoy.

Phony “Fiscal Conservatives” – In The Midterms And Beyond

By Simon Johnson

Should we take seriously people who, in the current US political debate, argue that they are “fiscal conservatives”?  No.

These self-labeled conservatives are very far from even being willing to discuss the real issues – let alone make proposals that would have significant effects.  As Peter Boone and I argue on Bloomberg this morning, US “fiscal hawks” are just pretending.  Perhaps this will prove effective in the midterm elections, but then they will face the music – what exactly will they put on the table that will make any difference at all?

Unless and until you are ready to really reform the financial sector, you cannot be taken seriously in the fiscal space.  It’s the big banks that blew up the economy, caused a devestating recession, and pushed up debt by 40 (forty) percentage points relative to GDP. 

None of today’s “fiscal conservatives” showed up to work hard on constraining global megabanks over the past 18 months.  They have repeatedly and explicitly earned the right not to be taken seriously.

Here’s the full Bloomberg link: http://www.bloomberg.com/news/2010-11-01/u-s-fiscal-hawks-turning-french-commentary-by-peter-boone-simon-johnson.html

Foreign Money, National Security, And The Midterm Elections

By Simon Johnson

Campaign contributions by non-citizens are a huge issue lurking behind the midterm elections; they will be even more important in 2012.  Think about the economic dynamics:

  1. Americans have a long-standing and well-founded aversion to foreign involvement in their politics, and it is well-established that this can happen in part through corporate “commercial” structures.  Thomas Jefferson objected to Alexander Hamilton’s plan for a national bank in part because he feared this would become a stalking horse for the British in some form (see Chapter 2 of 13 Bankers for the context).  Dubai Ports World was not allowed to invest in the United States – for reasons of perceived national security.  You may or may not think that case was handled well, but we have the CFIUS process to vet foreign direct investment for good reason.
  2. The Supreme Court has determined that corporations can make political contributions virtually without limit, apparently not understanding or not caring that (a) management has a fiduciary responsibility to shareholders, (b) globalization means more foreign shareholders on average (for privately held companies and funds, as well as publicly traded companies), and (c) at the margin, key strategic shareholders – the people who provide extra capital when the chips are down – increasingly tend to be foreign.  Think about the role of Sovereign Wealth Funds in providing funds to our banking system in 2007-08, or the fact that Citigroup goes cap-in-hand to Saudi Arabia every decade or so.
  3. During the Reagan years and again, even more, under the Second President Bush, the US ran a large current account deficit – reaching 6 percent of GDP before the 2008 crisis (and still around 3 percent of GDP).  You may think this a technical detail that is largely irrelevant to the political process, but you would be wrong.  We finance our current account deficit with capital inflows from abroad or, to put that more plainly: Foreigners buy and hold financial assets in the United States.  Some of those assets are US government obligations but traditionally and increasingly non-US people have also acquired claims on corporate entities – including common or preferred stock. Continue reading “Foreign Money, National Security, And The Midterm Elections” →

Telecom Tech Support

By James Kwak

I’ve recently been making you suffer through my struggles with the telecom industry. To show that I appreciate your patience, I wanted to recommend to you a brilliant cartoon on telecom tech support, from the inimitable XKCD. I would reproduce it here, but that seems like it would violate fair use, so you’ll have to go over there.

Don’t forget to check out the mouseover (place your pointer over the cartoon and wait for a few seconds).

Who’s In Charge Here? Not The G20

By Simon Johnson

Most accounts of the ministerial meeting last weekend of the Group of 20 — 19 nations plus the European Union that represent the world’s wealthiest economies —implied that it continued to perform sterling service – heading off currency wars, keeping explicit protectionism under control and deftly managing the process of reforming governance at the International Monetary Fund.

Post-financial crisis, middle-income countries continue to rise in economic importance, and the recent shift in global leadership from the Group of 7 (the United States, Canada, Britain, Italy, France, Germany and Japan) to the G-20 is commonly supposed to accommodate the growing claims of “emerging markets” on the world stage.

This interpretation is correct as far as it goes, but it also misses the main story, which is that emerging markets have two primary goals that are increasingly at odds with each other. These goals – to hold large stocks of American dollars and to stave off a flow of capital from abroad – add up to wanting to retain the emerging markets’ recently achieved status of collective net creditors (i.e., being owed more than they owe). Unfortunately, this contributes to the serious vulnerability of the world economy as we head into the next credit cycle. Continue reading “Who’s In Charge Here? Not The G20” →

Beyond Crazy

By James Kwak

Daniel Hamermesh points out a Wall Street Journal article on how colleges and universities are trying to increase accountability and productivity by measuring costs and benefits quantitatively. The “star” example is Texas A&M, which created a report showing a profit-and-loss summary for each professor or lecturer, where revenues are defined as external grants plus a share of tuition (if you teach one hundred students, you are credited with ten times as much revenues as someone who teaches ten students).

Let’s not argue about whether our colleges and universities are doing a good job. Let’s not even argue about whether we need more transparency and accountability in higher education. Assuming we do, this is just about the most idiotic way of doing it that I could imagine. No, wait; there’s no way I could have imagined something this stupid.

Continue reading “Beyond Crazy” →

Shape-Shifting Deficit Hawks

By James Kwak

We appear to be a week way from an election that, while really about persistent high unemployment, on the talking-point level is largely about deficits, with the Republicans continuing their usual posturing about cutting deficits without raising taxes or explaining what spending programs they are going to cut. Robert Pollin has contributed an analysis of the deficit hawks’ argument that is valuable for pointing out that there actually four deficit hawk arguments. In his words:

“1. The traditional view. Large fiscal deficits will cause high interest rates, large government debts, and inflation.

“2. Declining business confidence is the real danger. Even if the current deficits have not caused high interest rates and inflation, they are eroding business confidence. When business confidence is low, the economy is highly vulnerable to small changes in conditions, what some economists call ‘non-linearities.’

“3. Fiscal stimulus policies never work. New Classical economists, Robert Barro most notably, have long argued that the multiplier for fiscal stimulus policies is zero or thereabouts.

“4. A long-term fiscal train-wreck is coming. Regardless of short-term considerations, we are courting disaster in the long-run with structural deficits that the recession has only worsened.

Pollin also has the grace to point out that, for the deficit hawks to be correct, only one of these arguments has to be correct.

Continue reading “Shape-Shifting Deficit Hawks” →

Food and Finance

By James Kwak

I just read Michael Pollan’s book, In Defense of Food, and what struck me was the parallels between the evolution of food and the evolution of finance since the 1970s. This will only confirm my critics’ belief that I see the same thing everywhere, but bear with me for a minute.

Pollan’s account, grossly simplified, goes something like this. The dominant ideology of food in the United States is nutritionism: the idea that food should be thought of in terms of its component nutrients. Food science is devoted to identifying the nutrients in food that make us healthy or unhealthy, and encouraging us to consume more of the former and less of the latter. This is good for nutritional “science,” since you can write papers about omega-3 fatty acids, while it’s very hard to write papers about broccoli.

Continue reading “Food and Finance” →