The German Finance Minister Needs To Confront Investment Banks

By Simon Johnson

Wolfgang Schauble, German finance minister, has a surprisingly sensible op ed in today’s Financial Times. As we suggested yesterday, first the relevant Europeans should decide if they want to keep the euro – more precisely, who stays in and who leaves the currency union – then policy must be adjusted accordingly.

Mr Schauble is obviously correct that existing economic self-policing mechanisms are badly broken; the eurozone can only survive if there are effective monitors and appropriate penalties for fiscal and financial transgression. He is also right to fear that involving the IMF in Greece would necessarily give the Fund greater rights to kibbitz on European Central Bank monetary policy. Given the fear and loathing expressed for the IMF’s “4 percent inflation solution” (or is it 6 percent?) in eurozone policy circles, you can see why this gives the Greek prime minister some bargaining power – the Germans will do whatever it takes to keep him away from the IMF in the short-term.

But Schauble misses (or holds back for now) on a potentially important point vis-a-vis investment banks. Continue reading “The German Finance Minister Needs To Confront Investment Banks” →

Delaying Tactics On Display

By Simon Johnson

Senator Richard Shelby, ranking Republican on the Senate Banking Committee, today issued the following statement,

“Republicans remain open to finding common ground with Chairman Dodd. If my Democrat colleagues are interested in enacting reforms that protect American taxpayers, promote economic growth, and preserve the competitiveness of our financial markets, there is no reason that we cannot reach an agreement. As long as we remain focused on policy and not politics, an agreement is still very possible. The Republican members of the Committee stand united and ready to work with Chairman Dodd toward that goal.”

This is not a correct or accurate statement with regard to Republican intentions and their work behind the scenes. At this point, leading Senate Republicans are trying hard to prevent any kind of bill from moving forward. Their thinking is that there is not a lot of legislative time remaining in 2010 – a week or two lost now can derail completely opportunity for reform along any dimension.

No doubt we will see an increase in contributions by the financial sector in return for actions and statements that prevent effective consumer protection and that push derivatives regulation towards being even less effective.

The Coming Greek Debt Bubble

By Peter Boone and Simon Johnson

Bubbles are back as a topic of serious discussion, as they were before the financial crisis. The questions are: (1) can you spot bubbles, (2) can policymakers do anything to deflate them gently, and (3) can anyone make money when bubbles get out of control?

Our answers are: Spotting pure equity bubbles may sometimes be hard, but we can always see unsustainable finances supported by cheap credit. But policymakers will not act because all great (and dangerous) bubbles build their own political support; bubbles are invincible, until they collapse. A few investors can do well by betting against such bubbles, but it’s harder than you might think because you have to get the timing right – and that’s much more about luck than skill. Continue reading “The Coming Greek Debt Bubble” →

Business Economists on the CFPA

By James Kwak

The National Association for Business Economics does a semi-annual Economic Policy Survey of its members, who are primarily private-sector economists. The March 2010 survey isn’t up on their site yet, but this is what it has to say about the Consumer Financial Protection Agency:

“A key point of discussion in Congressional deliberations on financial services regulatory reform has been the establishment of an independent agency focused on consumer financial protection. Fifty-four percent of survey respondents feel that creating such an agency would not impair safety and soundness regulation; 25 percent believed it would be detrimental. On a related issue, 43 percent of respondents indicate that a consumer financial protection agency would not impair access to credit while 39 percent believed it would.”

The financial sector has been demanding that any new consumer protection agency be made subservient to the traditional safety and soundness regulators, and has also been threatening that greater regulation will make credit harder to come by. Apparently the business community–a group that is pretty skeptical about government, judging by some of the other survey responses–isn’t buying it.

The Speech For Which We Have Been Waiting

By Simon Johnson

For nearly two years now we have waited for a speech. We need a simple speech and a direct speech – most of all a political speech – about what exactly happened to our financial system, and therefore to our economy, and what we must do to make sure it can never happen again.

President George W. Bush apparently did not consider giving such a speech, and Secretary Paulson could never talk in this way. President Obama seemed, at some moments, close to making things clear – when he talked on Wall Street in September and, most notably, when he launched the Volcker Rules in January. But President Obama has always come up short on the prescriptive part – i.e., what we need to do – and his implementation people still move as if there were lead weights in their shoes.

Without a definitive speech, there is no political reference point, there is no convergence in the debate, and there is not even any clarity regarding what we should be arguing about. Without the right kind of speech, there are just many lobbyists working the corridors and a lot of backroom deals that most people do not understand – by design.

Tomorrow, hopefully, we should finally get the speech. Not – sadly – from the White House, not from anyone in the executive branch, and not even from within the Senate Banking Committee (although Senators Merkley and Levin took a big step today), but rather on the floor of the Senate. Continue reading “The Speech For Which We Have Been Waiting” →

The Volcker Principles Move Closer To Practice

By Simon Johnson

Senators Merkley and Levin, with support from colleagues, are proposing legislation that would apply Paul Volcker’s financial reform principles – actually, much more effectively than would the Treasury’s specific proposals. (Link to the bill’s text.)

Volcker’s original idea, as you may recall, is that financial institutions with government guarantees (implicit or explicit) should not be allowed to engage in reckless risk-taking. At least in part, that risk-taking takes the form of big banks committing their own capital in various kinds of gambles – whether or not they call this proprietary trading.

At the Senate Banking Committee hearing on this issue in early February, John Reed – former head of Citi – was adamant that a restriction on proprietary trading not only made sense, but was also long overdue. Gerald Corrigan of Goldman Sachs and Barry Zubrow of JP Morgan Chase expressed strong opposition, which suggests that Paul Volcker is onto something.

Of course, Goldman – among others – may seek to turn in its (recently acquired) banking license and go back to being “just an investment bank”, not subject to Fed regulation. But raising this possibility is a feature, not a bug of the Volcker-Merkley-Levin approach. Continue reading “The Volcker Principles Move Closer To Practice” →

Good for Bank of America

I think. BofA is eliminating overdraft protection on debit card purchases. Most stories, like in the Times and the Journal, are headlining the elimination of overdraft fees, but it’s not like you’re getting overdrafts for free; actually they are eliminating overdrafts on debit card transactions altogether, starting this summer. (You will still be able to opt in to overdraft protection for debit card transactions, but only if you link your checking account to another account, so the money is being transferred from yourself. You will also be able to opt in to overdraft protection, with fees, for checks and automatic bill payments;* and you will be able to decide on the spot if you want to pay a fee to overdraw your account from an ATM.)

Continue reading “Good for Bank of America” →

Hank Paulson’s Memoir: The Inside Job

By Simon Johnson

If you’ve read, are reading, or plan to read Andrew Ross Sorkin’s Too Big To Fail, you also need to pick up a copy of Hank Paulson’s memoir, On The Brink. Sorkin has the bankers’ story, in sordid yet compelling detail, of how they received the most generous bailout in the world financial history during fall 2008 – and set us up for great problems to come. Paulson tells us why, when, and how exactly he let them get away with this.

Hank Paulson does not, of course, intend to be candid. As I review in detail on The New Republic’s The Book site this morning, On The Brink is actually a masterpiece of misdirection and disinformation.

But still, he gives it all away – and if any details remain obscure, check them in Sorkin. Paulson honestly believes that the financial sector as constructed is productive, makes sense, and should continue to operate in roughly its current form. Continue reading “Hank Paulson’s Memoir: The Inside Job” →

Banks Paying Customers to Take Overdraft Protection

By James Kwak

I saw a bank ad in the subway yesterday. Basically, it said:

If you set up direct deposit the bank will give you $100.
If you set up overdraft protection the bank will give you $25.
If you activate online bill pay the bank will give you $25.

1 makes sense because (a) it gives the bank more cheap deposits, which are its raw material and (b) it increases your switching costs. 3 makes sense because it increases your switching costs; it may also cause you to give the bank more cheap deposits, since you need money in the account to cover your bills.

2 makes sense because . . . the bank expects to get more than $25 in fees out of the average customer. A single overdraft fee typically costs more than $25. Now people will be making an explicit decision: “I want the $25 now because I don’t think I’ll ever pay an overdraft fee.” (To be fair, they might be thinking, “I already value overdraft protection at $35 per occurrence, so the $25 is just a bonus.” But I doubt many people think overdraft protection is worth $35 per transaction when the typical transaction is a lot less than $35.

There’s nothing illegal about this, and arguably it’s a smart business decision. It just makes things perfectly clear: the banks want those fees so much they are willing to pay you for them.

It’s Not That Easy

By James Kwak

Elizabeth Green (hat tip Ezra Klein) discusses the importance of teaching techniques. Here’s one key passage (at least for people like me):

“The testing mandates in No Child Left Behind had generated a sea of data, and researchers were now able to parse student achievement in ways they never had before. A new generation of economists devised statistical methods to measure the ‘value added’ to a student’s performance by almost every factor imaginable: class size versus per-pupil funding versus curriculum. When researchers ran the numbers in dozens of different studies, every factor under a school’s control produced just a tiny impact, except for one: which teacher the student had been assigned to.”

Continue reading “It’s Not That Easy” →

Way Too Big To Save

By Simon Johnson

Listening to US officials, talking to legal experts, and waiting for an intense Senate debate on financial reform to begin, you can easily form the impression that “too big to fail” adequately describes our most serious future systemic banking problems. It does not.

In September 2008, the large banks and quasi-banks at the heart of our financial system faced failure – and they were saved in the most immediate sense through actions taken by the Federal Reserve, but TARP (passed by Congress and run Treasury) also played a significant supporting role.

The Bush administration threw a small fiscal stimulus into the mix in early 2008, hoping to stave off recession; the Obama administration committed a much larger package at the start of 2009, aiming to prevent anything like a Second Great Depression. This fiscal policy response was in direct reaction to problems caused by the overextension and near failure of the financial system

Do not make the mistake – for example of Secretary Geithner, talking to the New Yorker – of thinking (or implying) that “saving the financial system” did not involve spending a lot of taxpayer money to support the real economy. Remember that if the economy crashes, asset prices fall, and banks’ problems become even more severe.

And try to avoid three further mistakes that are currently common. Continue reading “Way Too Big To Save” →

They Saved the Big Banks But Kind Of Lost The Economy Doing It

By Simon Johnson

It would be easy to take relatively cheap shots at the portrayal of Tim Geithner — “we saved the economy but kind of lost the public doing it” — in the New Yorker, out today.

Mr. Geithner is quoted as saying, “Some on the left have fallen into a trap set by the Republicans, allowing voters to mistakenly think that the biggest part of the bank bailout had come under Obama rather Bush.” Mr. Geithner should know – as he spearheaded the saving of banks and other financial institutions under both Bush and Obama. In fact, it’s the continuation of George Bush’s policies by other means that really has erstwhile Obama supporters upset.
“I think there are some in the Democratic Party that think Tim and Larry are too conservative for them and that the President is too receptive to our advice.” Probably this is linked to the fact that Tim Geithner is not a Democrat.
Geithner also suggests that his critics compare government spending on different kinds of programs under President Obama: “By any measure, the Main Street stuff dwarfs the Wall Street stuff.” This insults our intelligence. Wall Street created a massive crisis and we consequently lost 8 million jobs; any responsible government would have tried hard to offset this level of damage with all available means. This includes fiscal measures that will end up increasing out privately held government debt, as a percent of GDP, by around 40 percentage points. It’s not the fiscal stimulus, broadly defined, that is Mr. Geithner’s problem – it’s the lack of accountability for the bankers and politicians who got us into this mess.

But the Geithner issues reflected here run much deeper. The New Yorker’s John Cassidy alludes to these but he may be too subtle. Here’s the less subtle version. Continue reading “They Saved the Big Banks But Kind Of Lost The Economy Doing It” →

European Monetary Fund, Arriving Soon

By Simon Johnson

American officials are annoyed and deeply skeptical – not thinking that this will amount to anything. But the future has finally arrived – or perhaps its arrival has just been announced – in the form of the European Monetary Fund.

Such an institution would represent a major reshaping of global financial architecture, undermining the traditional basis of power for the United States – which would prefer to keep the International Monetary Fund (IMF) paramount. This is a good thing for the world, but also for the IMF and – believe it or not – for the US. Continue reading “European Monetary Fund, Arriving Soon” →

Subsidized Housing

Calculated Risk points out Robert Shiller’s article in the New York Times on the subsidization of homeownership in America. Shiller asks why we should subsidize homeownership, beyond short-term expediencies such as the fact that since we have a lot of unemployed construction workers, we could reduce unemployment by subsidizing homeownership (as long as we can subsidize new home construction as opposed to just trading houses). Of course, the reason we have a lot of unemployed construction workers is that we over-subsidized housing for the past decade and a half; hence Shiller’s question.

Continue reading “Subsidized Housing” →

Current Financial Conditions and Future Economic Activity

By James Kwak

David Leonhardt (hat tip Brad DeLong) discusses the risk of a double-dip recession. For Leonhardt, the main risks are the pending expiration of the fiscal stimulus and some of the Fed’s monetary stimulus measures, as well as continuing de-leveraging by households, which deprives the economy of its usual growth engine.

James Hamilton highlights a new financial conditions index developed by five economists — two from major banks and three from universities. The goal of the index is to estimate the impact of current financial variables on the future trajectory of the economy. For example, the level of current interest rates is likely to influence future economic outcomes. The paper evaluates several existing financial conditions indexes and finds that most of them show financial conditions returning to neutral in late 2009. It then describes a new index comprised of forty-four variables, which tends to do a better job of predicting economic activity than the existing indexes. (The authors admit that this is in part because they have the benefit of living through the recent financial crisis, which has shown the value of certain variables not included in previous indexes.)

So what?

Continue reading “Current Financial Conditions and Future Economic Activity” →