Decision Time: Has the President Abandoned Paul Volcker’s Ideas On Financial Reform?

By Simon Johnson

The official reconciliation process between Senate and House reform bills will get underway next week, but the behind-the-scenes maneuvering (and intense lobbying) is already well underway.  The main remaining question is whether the final legislation will ultimately make the financial system at all safer than it was in the run up to the crisis of September 2008.

How do big banks repeatedly get themselves into so much trouble?  Dangerous banking in today’s world involves banks trading securities and, in that context, taking positions – i.e., betting their own capital.  For example, almost all the profits made by big banks in 2009 came from securities trading.  When market conditions are favorable and traders get lucky, the people running these banks (and hopefully their shareholders) get tremendous upside.  But when this same risk-taking behavior results in big losses, the major negative impact is felt in terms of a major recession, raising government debt, and sharply lower employment.

“Wall Street gets the upside, and society gets the downside” is an old saying that is now more relevant than ever.  This asymmetry in incentives explains how smart people with concentrated financial power can cause so much damage – according to, for example, the Bank of England’s analysis. Continue reading “Decision Time: Has the President Abandoned Paul Volcker’s Ideas On Financial Reform?” →

Can the Buy Side Take on the Sell Side?

By James Kwak

The Economist did not like 13 Bankers: “A broader perspective would have led to more nuanced conclusions. The origins of America’s financial ‘oligarchy’, for instance, might have more to do with campaign-finance rules and political appointees than banks’ size. The faith that Messrs Johnson and Kwak put in merely capping the size of banks is misplaced.”*

But a reader pointed us to the Economist columnist who goes by the name of Buttonwood (the site of the founding of the New York Stock Exchange), who seems a bit more favorable. In a recent column criticizing the rent-seeking of the financial sector, Buttonwood seems to tell broadly the same story:

“Something has clearly changed within the past 40 years. Banking and asset management used to be perceived as fairly dull jobs, which did not attract a significant wage premium. But after 1980, financial wages started to climb much more quickly than those of engineers, another profession that ought to have benefited from technological complexity.

“Around the same time, banks became more profitable.”

He even nods toward breaking up the banks:

“At the moment, governments are wading in with all kinds of levies and regulations, which will probably have unintended consequences. Rather than tackle the big problem (for example, by breaking up the banks), they waste their time on populist measures like banning short-selling.”

Continue reading “Can the Buy Side Take on the Sell Side?” →

The Perils of Studying Economics

By James Kwak

Patrick McGeehan at the New York Times recently wrote about a New York Fed study finding that studying economics makes you a Republican. The headline conclusion is that the more economics classes you take, the more likely you are to be a Republican. Majoring in economics or business is also more likely to make you a Republican. (See Table 2 in the original paper.) The study is based on thousands of observations of undergraduates at four large universities over three decades, so it is focused on undergraduate-level economics.

Studying economics also affects your position on several public policy issues. Of seven issues, economics courses were significantly associated with the five following positions (Table 6):

  • Tariffs are bad.
  • Trade deficits are not so bad.
  • The government should not cap oil prices in response to a supply shock.
  • Raising the minimum wage increase unemployment for low-wage workers.
  • Income distribution should not be more equal.

These are all pro-free market, anti-government intervention positions.

Continue reading “The Perils of Studying Economics” →

Investment Banks and the World Cup

By James Kwak

A reader alerted me to the World Cup forecasting competition, which includes links to the predictions made by several major investment banks’ models, and some data you can use if you want to give it a shot. The predictions:

  • JPMorgan Chase: England
  • UBS: Brazil (UBS also has South Africa as the team most likely to make the second round, which seems surprising.)
  • Goldman: Brazil
  • Danske Bank: Brazil

I typically root for France, because I started following soccer while living in France back in the early 1990s, but I don’t think I can this time because (a) they don’t deserve to be in the World Cup Finals, having beaten Ireland on an obvious hand ball and (b) I can’t stand their coach, who has managed to transform an incredibly talented group of players into a mediocre team.

As for who will win, I would go with Nate Silver (who recently signed with the Times for three years) if he made a prediction, but I don’t think he has.

Enjoy.

Richard Fisher (Federal Reserve Bank Of Dallas): Larry Summers, The G20, And Financial Dementia

By Simon Johnson, co-author of 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown

Richard Fisher, president of the Dallas Fed, has long been a proponent of serious financial sector reform.  As a former commercial banker, he sees quite clearly that the legislation now headed into “reconciliation” between House and Senate versions amounts to very little.  He also knows that pounding away repeatedly on this theme is the best way to influence his colleagues within the Fed and across the policy community more broadly.

He is now taking his game to a new, higher level.  Couched in the diplomatic language of senior officials, his speech on June 3 to the SW Graduate School of Banking was both a carefully calibrated assault on the administration’s general “softly, softly” approach to the big banks and a direct refutation of arguments put forward by Larry Summers in particular. 

As the title of Mr. Fisher’s speech implies, if the legislation is not real financial reform (and it is not, according to him), then our current policy trajectory amounts to facilitating further rounds of financial dementia. Continue reading “Richard Fisher (Federal Reserve Bank Of Dallas): Larry Summers, The G20, And Financial Dementia” →

French Connection: The Eurozone Crisis Worsens Sharply

By Peter Boone and Simon Johnson

The big news is France.  With sentiment worsening across Europe, France has lost its relative safe haven status – credit default swap spreads on French government debt were up sharply today.

The trigger – oddly enough – was Hungary’s announcement that its budget is worse than expected (blaming the previous government; this is starting to become the European pattern) and in the current fragile environment discussed yesterday, this relatively small piece of news spooked investors.  But these developments only reinforced a trend that was already in place. Continue reading “French Connection: The Eurozone Crisis Worsens Sharply” →

The Maginot Line Illusion

By Peter Boone and Simon Johnson

Many commentators suggest Spain is now the euro zone’s Maginot line.  The argument is clear:  Spain, with GDP over $1.3 trillion (8th largest in the world; 5th largest in Europe) and its large outstanding bank and public debt, is simply too big to fail without causing irreparable harm to the euro zone financial system.  If we dig in here, the reasoning goes, eurozone market upheavals can be stopped.

Just as Germany did in 1940, in past weeks global market forces circumvented this new Maginot line without serious resistance.  The events that shook equity markets were not just in Spain; they were everywhere in the world.  The cost of protecting against default on India’s largest private bank rose 79BP, or 44%, and the cost of protecting against major Korean banks’ default similarly rose 45%.  Oil prices collapsed and emerging markets found their access to credit markets dried up.  The interest rate for lending between banks in US dollars (LIBOR) shot up, and investors piled funds into their currently perceived “safe-havens” driving down the yields of German, French, and US bonds.

This pattern reflects the core problem facing world markets today.  Investors have already begun to extrapolate from eurozone problems to understand that the world remains a highly dangerous place.  The latent dangers include our overreliance on rapid Asian growth that might falter, the pressure for sharp fiscal tightening in nations with high deficits (other than in the world’s “safe havens”), and highly leveraged banks that continue to own toxic real estate, weak sovereign debt, and other assets.  If world financial markets once again decide their risk appetite is again low, there are many unsustainable leveraged institutions and governments that are in for a tough ride. Continue reading “The Maginot Line Illusion” →

Eugene Fama: “Too Big To Fail” Perverts Activities and Incentives

By Simon Johnson, co-author of 13 Bankers

In our continuing financial debate, one of the central myths – put about by big banks and also not seriously disputed by the administration – is that reining in “too big to fail” banks is in some sense an “anti-market” approach.

Speaking on CNBC at the end last week, Gene Fama – probably one of the most pro-market economists left standing – pointed out that this view is nonsense. (The clip is here, and also on Greg Mankiw’s blog; TBTF is the focus from about the 5:50 minute mark.)

Having banks that are Too Big To Fail, according to Fama, is “perverting activities and incentives” in financial markets – giving big financial firms,

“a license to increase risk; where the taxpayers will bear the downside and firms will bear the upside.” Continue reading “Eugene Fama: “Too Big To Fail” Perverts Activities and Incentives” →

Summer “Vacation”

By James Kwak

Tomorrow I am beginning my summer internship (for those who don’t know, I’m a law student between my second and third years). I’m going to be working in death penalty defense.

Sometimes people ask me how I find the time to write this blog. The answer is that being a student at the Yale Law School takes a good deal less time than a real job. (You can, of course, make yourself very busy with clinics, journals, and other activities, but you don’t have to.) But this summer will be like a real job, and I intend to spend the time that I’m not working with my family, which means that I will be cutting way, way back on blogging this summer. I’m guessing that I’ll write about two posts per week, but I would not be too surprised if I don’t even manage that, and there’s a small chance I won’t have time for anything at all.

I expect that I’ll get back to something close to my usual frequency in late August or early September.

Thank you for taking the time to read the blog.

The Future of Personal Computing, Part 2

By James Kwak

(This is Part 2 of 2; Part 1 covers the shift in personal computing from the age of the standalone PC to the age of cloud computing.)

We left off with the idea that personal computing was inexorably, though slowly shifting toward a Web-based model in which our computers’ main purpose is to run browsers and we spend most of our time on the Internet. A decade ago when this idea became popular it was not particularly practical, because you simply couldn’t do very interesting things in a browser; it was originally designed, after all, for reading static web pages. But in the past decade, web sites have become much richer and interactive — think about something like Gmail, with its automatic refreshing and keyboard shortcuts, or Google Documents, which allows multiple people to edit a document at the same time — to the point where most of what people do most of the time can be done in a browser.

But then there was Apple.

Continue reading “The Future of Personal Computing, Part 2” →

Regulatory Capture Underground and At Sea

By James Kwak

First there was the financial crisis. Then there was the West Virginia mine explosion. Now we have the BP oil leak. In each case, we were treated to news stories about the cozy relationships between the industry and the regulators who were supposed to be regulating it. (Here’s the latest New York Times story on how the Minerals Management Service was captured by industry — a problem that has existed for a long time, but that the Obama administration apparently did little to fix.)

Occasionally people say that the story we tell in 13 Bankers is really the same in every industry. That would not surprise me. I do think that the financial sector is unusual for a couple of reasons. One is that the interconnections between the major financial institutions make each one too big to fail in a way that, say, Enron was not. Another is that modern finance is so complex that it makes it easier for industry lobbyists to run roughshod over congressional opponents. But the problem of regulatory capture is obviously not restricted to finance, and it is a problem that we are seeing all over.

I’ve been meaning to write about this, but I haven’t had and won’t have the time. Arianna Huffington wrote an article on the parallels between the financial crisis and the West Virginia mine disaster. Lawrence Baxter has two recent posts (on his new blog) on regulatory capture and the role of regulation. Obviously this problem is not easily solved, especially in the wake of the Citizens United decision, which gave corporations even more influence over our political life. But hopefully the BP oil leak will produce a wave of anger — and a demand for answers — similar to what the financial crisis gave rise to.

The Future of Personal Computing, Part 1

By James Kwak

This week, Apple passed Microsoft to become the most valuable technology company in the world (measured by the market value of its stock).* I’ve been wondering about Apple and, in particular, why “apps” — which at first glance struck me as a giant step backward in computing technology — have gotten so much buzz in the media. Then I bought an iPad, and while I understand apps a little better, I’m still perplexed. But since this isn’t a particularly technology-savvy audience, this is going to take some setting up. The background is here in Part 1; Part 2 will be coming shortly.

(Note that here I’m talking about personal computing, which is what people like you and I do on our own; enterprise computing is something very different that I’ve written about before, and still largely takes place on mainframe computers.)

A Little Background

Rather than recap the entire history of computing (hilarious synopsis here, hat tip Brad DeLong), I’ll start in the early 1990s. At this point, many people had personal computers, but for the most part they weren’t connected to anything except maybe a printer. (Actually, in the early 1980s my father brought home one of those primitive modems where you actually placed your phone receiver into a socket to communicate, so we could log into the mainframe at his university, but that was the exception.)

Continue reading “The Future of Personal Computing, Part 1” →

The Consensus On Big Banks Shifts, But Not At Treasury

By Simon Johnson, co-author 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown

Attitudes towards big banks are changing around the world and across the political spectrum.  In the UK, the new center-right government is looking for ways to break them up:

“We will take steps to reduce systemic risk in the banking system and will establish an independent commission to investigate the complex issue of separating retail and investment banking in a sustainable way; while recognising that this will take time to get right, the commission will be given an initial time frame of one year to report.”

The European Commission, among others, signals that a bank tax is coming; presumably, as suggested by the IMF, this will have higher rates for bigger banks and for banks with less capital.  And other European officials are increasingly worried by the lack of capital in German banks, by the recent reckless lending sprees in Ireland and Spain, and by the dangers posed by banks that are much bigger than their home countries (e.g., Switzerland).

Yet top Obama administration officials refuse to change their opinions in the slightest; they have dug in behind the idea that they represent the moderate center on banking policy.  This is a weak position; it is simply a myth with no factual basis – the people who pushed effectively for more reform over the past few months were the center, not the left, of the Democratic party. Continue reading “The Consensus On Big Banks Shifts, But Not At Treasury” →

Is The SEC Still Working For Wall Street?

By Simon Johnson

The Securities and Exchange Commission (SEC) under Mary Shapiro is trying to escape a difficult legacy – over the past two decades, the once proud agency was effectively captured by the very Wall Street firms it was supposed to regulate.

The SEC’s case against Goldman Sachs may mark a return to a more effective role; certainly bringing a case against Goldman took some guts.  But it is entirely possible that the Goldman matter is a one off that lacks broader implications.  And in this context the SEC’s handling of concerns about “high frequency trading” (HFT) – following the May 6 “flash crash”, when the stock market essentially shut down or rebooted for 20 minutes – is most disconcerting.  (See yesterday’s speech by Senator Ted Kaufman on this exact issue; short summary.) Continue reading “Is The SEC Still Working For Wall Street?” →

Good Government vs. Less Government

Or: Why the Heritage Freedom Index is a Damned Statistical Lie

This guest post was contributed by StatsGuy, a frequent commenter and occasional guest on this blog. It shows how quickly the headline interpretation of statistical measures breaks down once you start peeking under the covers.

Recently, a controversy raged in the blogosphere about whether neo-liberalism has been a bane or a boon for the world economy. The argument is rather coarse, in that it fails to distinguish between the various elements of neo-liberalism, or moderate deregulation vs. extreme deregulation. But if we take the argument at face value, one of the major claims of neoliberals is that countries in the world which are more neoliberal are more successful (because they are more neoliberal). I disagree.

My disagreement is not with the raw correlation between the Heritage Index and Per Capita GDP. A number is a number. My disagreement is with the composition of the index itself, and interpreting this correlation as causation between neo-liberalism and ‘good things.’

My primary contention below is that many of these measures used in the composite Heritage Index have nothing to do with less government, and a lot more to do with good government. It is these measures of good government that correlate to economic growth and drive the overall correlation between the “Freedom Index” and positive outcomes. Secondarily, I will argue that many of the other items in the index (like investment freedom) are not causes of growth, but rather outcomes of growth.

Continue reading “Good Government vs. Less Government” →