How Big Is Too Big?

As legislation on restructuring the banking industry moves forward, attention on Capitol Hill is increasingly drawn to the issue of bank size. Should our biggest banks be made smaller?

Senator Bernard Sanders, an independent from Vermont, introduced the “Too Big To Fail Is Too Big to Exist” bill in early November; this helped focus attention. Since then, in the legislative trenches where the detailed crafting takes place, Representative Paul E. Kanjorski — the Pennsylvania Democrat who is chairman of the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises — proposed an amendment to the Financial Stability Improvement Act (currently before the House Financial Services Committee) that

would empower federal regulators to rein in and dismantle financial firms that are so large, inter-connected, or risky that their collapse would put at risk the entire American economic system, even if those firms currently appear to be well-capitalized and healthy.

In a major step forward, this passed the committee on Nov. 18. Continue reading “How Big Is Too Big?” →

Is It 1999 All Over Again?

The New York Times’ Bits blog has a post on Trefis, a Web 2.0 startup that apparently makes it easy for you to create your own valuation model for public companies. They give you starter models using public information, and you can then tweak the assumptions to come up with your own valuation. The pitch is that this puts the tools used by research analysts and professional investors in the hands of the retail investor. “Perhaps these new tools will put some added pressure on the sell-side professionals – many of whom are notorious for creating overly optimistic takes on the companies they follow.”

Or maybe they will make retail investors think they have an advantage that they really don’t. Advantages in stock valuation have to be based on superior information, which you can get by doing lots of market research (like some old-fashioned hedge funds do) or by having privileged access to company insiders. Superior information can include superior forecasting ability, so if you have some ability to predict the market size for routers better than anyone else, you can make money from it. But neither of these are things you get from models; they are things you plug into models. I’m sure the founders of Trefis don’t see it this way, but this feels to me like a great way to lure people into individual stock-picking, and thereby a boon to stock brokers everywhere.

Continue reading “Is It 1999 All Over Again?” →

More on Goldman and AIG

Thomas Adams, a lawyer and former bond insurer executive, wrote a guest post for naked capitalism on the question of why AIG was bailed out and the monoline bond insurers were not (wow, is it really almost two years since the monoline insurer crisis?). He estimates that the monolines together had roughly the same amount of exposure to CDOs that AIG did; in addition, since the monolines also insured trillions of dollars of municipal debt, there were potential spillover effects. (AIG, by contrast, insured tens of trillions of non-financial stuff — people’s lives, houses, cars, commercial liability, etc. — but that was in separately capitalized subsidiaries.)

The difference between the monolines and AIG, Adams posits, was Goldman Sachs.

Continue reading “More on Goldman and AIG” →

Data on the Debt

So far, my foray into the world of the national debt has consisted of this:

One of the curious things about the debt scare that is building in the media is that it is happening at a moment when long-term interest rates are very low. In other words, it’s based on a theory that the market is wrong in its collective assessment of the debt situation. I’ve heard this blamed on “non-economic actors” (that is, foreign governments that buy U.S. Treasuries not as a good investment, but for political reasons), or on a “carry trade” where investors are exploiting the steep yield curve (free short-term money, positive long-term interest rates), as Paul Krugman discusses here.

Menzie Chinn crunches some numbers. He takes a model that he and Jeff Frankel created several years ago to estimate the impact on interest rates of inflation, the future projected national debt, the output gap (economic output relative to potential), and foreign purchases of Treasuries. That last term is important, because the oft-heard fear is that foreign governments will suddenly stop buying our debt.

Continue reading “Data on the Debt” →

What’s on TV

Frontline has a program on tonight about the credit card industry, which may be a useful accompaniment to the regulatory reform debate. They include this juicy paragraph in their press release:

“They’re lower-income people-bad credits, bankrupts, young credits, no credits,” Mehta [former CEO of Providian] says. Providian also innovated by offering “free” credit cards that carried heavy hidden fees. “I used to use the word ‘penalty pricing’ or ‘stealth pricing,'” Mehta tells FRONTLINE. “When people make the buying decision, they don’t look at the penalty fees because they never believe they’ll be late. They never believe they’ll be over limit, right? … Our business took off. … We were making a billion dollars a year.”

Rings true to me.

By James Kwak

Morgan Stanley Speaks: Against Relying On Capital Requirements

Just when momentum was starting to build for increased capital requirements as the core element of an approach that will reign in reckless risk-taking, Morgan Stanley effectively demolishes the idea.

In “Banking – Large & Midcap Banks: Bid for Growth Caps Capital Ask,” (no public link available) Betsy Graseck, Ken Zorbo, Justin Kwon, and John Dunn of Morgan Stanley Research North America dissect the coming demands for more bank capital. 

“In short, we think the demand for growth and access to credit will trump desire for unprofitable capital levels…

For the large cap and midcap banks, we expect normalized median common tier-1 ratios to come in at 8.4% and 10.0% respectively.”

That’s less capital than Lehman had just before it failed – 11 percent.  (If you doubt this, read the transcript of the final Lehman conference call – link is in this NYT.com piece or try this direct link; see p.7, for example) Continue reading “Morgan Stanley Speaks: Against Relying On Capital Requirements” →

Blaming It on Obama

Last week I wrote a post about “government debt hysteria” that has gotten a lot of attention because of a link from Paul Krugman. (As Felix Salmon, said, “blogging is a lottery on the individual-blog-entry level.”) The main point of last week’s post was not that it’s wrong to be concerned about the national debt (I think everyone is concerned about it — the question is what to do about it and when), but that it’s irresponsible to title a column “Could America Go Broke?” and talk about hyperinflation without providing some evidence, or at least a logical argument that goes beyond tautology, that hyperinflation is something we should be worrying about it.

Here’s something else that’s irresponsible. In that same column, Robert Samuelson says, “The Congressional Budget Office reckons the Obama administration’s planned budgets would increase the debt-to-GDP ratio from 41 percent in 2008 to 82 percent in 2019″ (emphasis added).

Continue reading “Blaming It on Obama” →

Government Debt Hysteria

I don’t spend a lot of time trying to police the economic news media — Dean Baker and Brad DeLong are much better on that — but I found myself reading a two-week-old Newsweek column by Robert Samuelson that enraged me enough to type this out. (I read it on old-fashioned paper, but here’s the WaPo version.) The title of the WaPo version is “Could America Go Broke?” and here’s the last paragraph:

“Deprived of international or domestic credit, defaulting countries in the past have suffered deep economic downturns, hyperinflation, or both. The odds may be against a wealthy society tempting that fate, but even the remote possibility underlines the precariousness and the novelty of the present situation. The arguments over whether we need more ‘stimulus’ (and debt) obscure the larger reality that past debt increasingly constricts governments’ economic maneuvering room.”

Deep economic downturns! Hyperinflation! “Precariousness and novelty of the present situation!” You’d think there was some actual reason to be afraid.

Continue reading “Government Debt Hysteria” →

The AIG-Maiden Lane III Controversy

As everyone knows by now, Neil Barofsky, special inspector general for TARP, has a new report out on the decision by the Federal Reserve Bank of New York last Fall to make various AIG counterparties (primarily some very big banks with names you know) whole on the the CDS protection they had bought from AIG to cover their risk on some CDOs. The potentially juicy bit has to do with the Maiden Lane III transaction (New York Fed summary here).

Continue reading “The AIG-Maiden Lane III Controversy” →

CRA Bashing, Nth Generation

The Community Reinvestment Act is a law originally passed in 1977 that directed federal regulatory agencies to ensure that the banks they supervised were not discriminating against particular communities in making credit available.The onset of the subprime mortgage crisis triggered a flood of sloppy, lazy attacks on the CRA claiming that since the crisis was created by excess lending to the poor, and the CRA was intended to increase lending to the poor, the CRA must have caused the crisis. These arguments suffered from a mistaken premise (subprime lending had a modest negative correlation with income, but many subprime loans were used by the middle class to buy expensive houses in the suburbs and exurbs of California and Nevada) and a failure to check their facts (“Only six percent of all the higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas, the local geographies that are the primary focus for CRA evaluation purposes.” — Randall Kroszner, former Fed governor appointed by President George W. Bush, in a Federal Reserve study that also found that subprime loan performance was no worse in CRA-covered zip codes than in slightly more affluent zip codes not covered by the CRA.)

Yesterday at a Cato Institute conference, Edward Pinto, chief credit officer at Fannie from 1987 to 1989 and currently a real estate financial services industry consultant (according to recent Congressional testimony), rolled out the new line. The new argument is a curious mirror image of the old argument (which Pinto himself may not have made): now the subprime explosion did not cause the housing bubble, but was caused by the housing bubble and … wait for it … the CRA caused the housing bubble, along with the affordable housing goals of Fannie and Freddie.

Continue reading “CRA Bashing, Nth Generation” →

Written Testimony Submitted To The Congressional Oversight Panel

Testimony submitted to the Congressional Oversight Panel, hearing on “The overall impact of the Troubled Asset Relief Program (TARP) on the health of the financial system and the general U.S. economy,” Thursday, November 19, 2009. (pdf version)

Submitted by Simon Johnson, Ronald Kurtz Professor of Entrepreneurship, MIT Sloan School of Management; Senior Fellow, Peterson Institute for International Economics; and co-founder of http://BaselineScenario.com.

Summary

1)      In the immediate policy response to any major financial crisis – involving a generalized loss of confidence in major lending institutions – there are three main goals:

  1. To stabilize the core banking system,
  2. To prevent the overall level of spending from collapsing,
  3. To lay the groundwork for a sustainable recovery.

2)      IMF programs are routinely designed with these criteria in mind and are evaluated on the basis of: the depth of the recession and speed of the recovery, relative to the initial shock; the side-effects of the macroeconomic policy response, including inflation; and whether the underlying problems that created the vulnerability to panic, are addressed over a 12-24 month horizon.

3)      This same analytical framework can be applied to the United States since the inception of the Troubled Asset Relief Program (TARP).  While there were unique features to the US experience (as is the case in all countries), the broad pattern of financial and economic collapse, followed by a struggle to recover, is quite familiar.

Continue reading “Written Testimony Submitted To The Congressional Oversight Panel” →

Auto Race to the Bottom

This guest post was contributed by Raj Date, head of the Cambridge Winter Center for Financial Institutions Policy and a former McKinsey consultant, bank senior executive, and Wall Street managing director. For further information on the auto dealer exemption, see the recent study by the Cambridge Winter Center.

Over the past several months, Congress has debated ways to strengthen and rationalize consumer protection in financial services.  Central to that debate is the proposed creation of a new agency focused exclusively on this issue, the Consumer Financial Protection Agency (the “CFPA”).

Even among proponents, however, there are varying conceptions of the scope and function of the CFPA.  For example, the CFPA as envisioned by the House Financial Services Committee would exclude auto dealers from the CFPA’s coverage.  The Administration’s original proposal would have included them.  Starting this week, the Senate Banking Committee will have to wrestle with the same question.

They shouldn’t have to wrestle long:  Even by the low analytical standards applied to hastily arranged, crisis-driven corporate welfare initiatives, the exemption of auto dealers from the CFPA appears profoundly ill conceived.  Exempting auto dealers would simultaneously be bad for consumers, bad for industry stability, and bad for what remaining sense of free-market integrity we still have.

Continue reading “Auto Race to the Bottom” →

What Did TARP Do?

This morning, starting at 9:30am, the Congressional Oversight Panel holds a hearing to assess the performance of the Troubled Asset Relief Program (TARP).  The hearing will be streamed live and also archived, featuring testimony from: Dean Baker (Center for Economic and Policy Research), Charles Calomiris (Columbia University), Alex Pollock (American Enterprise Institute), Mark Zandi (Moody’s Economy.com), and me.

In late September 2008, Secretary of the Treasury Henry S. Paulson asked Congress for $700 billion to buy toxic assets from banks, as well as unconditional authority and freedom from judicial review. Many economists and commentators suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands – indeed, that is the only way that buying toxic assets would have helped anything. Perhaps because there was no way to make such a blatant subsidy politically acceptable, that approach was shelved. Continue reading “What Did TARP Do?” →

Slow Cat, Fast Mouse

One of our readers pointed me to a paper by Edward Kane with the unfortunately complicated title “Extracting Nontransparent Safety Net Subsidies by Strategically Expanding and Contracting a Financial Institution’s Accounting Balance Sheet.” The paper is an extended discussion of regulatory arbitrage — not the specific techniques (such as securitization with various kinds of recourse) that banks use to finesse capital requirements, but the larger game played by banks and their regulators. This is how Kane frames the situation:

“Regulation is best understood as a dynamic game of action and response, in which either regulators or regulatees may make a move at any time.  In this game, regulatees tend to make more moves than regulators do.  Moreover, regulatee moves tend to be faster and less predictable, and to have less-transparent consequences than those that regulators make.

“Thirty years ago, regulatory arbitrage focused on circumventing restrictions on deposit interest rates; bank locations; charter powers; and deposit institutions’ ability to shift risk onto the safety net.  Probably because regulatory burdens in the first three areas have largely disappeared, the fourth has become more important than ever.  Today, loophole mining by financial organizations of all types focuses on using financial-engineering techniques to exploit defects in government and counterparty supervision.”

Continue reading “Slow Cat, Fast Mouse” →

Time For Coordinated Capital Account Controls?

This guest post was submitted by Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics.  Arvind is a leading proponent of the view that we need to rethink capital controls – he sees them as central to meaningful macroprudential regulation going forward.  (He also has an op ed in today’s Financial Times, on climate change, economic development, and the basis for an international agreement.)

The Bretton Woods Committee is organizing a panel (today, Wednesday) on the role of the G-20 in coordinating global growth with speakers from the IMF, US Treasury, and the G-24 group of developing countries.  “Global imbalances” (the US current account deficit, the Chinese current account surplus, etc) will be discussed extensively. But I will also raise the question of whether there is a new imbalance in the world economy that threatens emerging markets, and what they should do about it.

Extraordinarily loose monetary policy and the resulting close-to-zero interest rates in many industrial countries are pushing capital out to emerging markets—Brazil, China, and India—whose growth prospects are buoyant and relatively unaffected by the crisis. Brazil’s currency has appreciated by 30 percent this year, India’s stock market soared by 70 percent, and China is once again furiously accumulating foreign exchange reserves, $62 billion in September. Continue reading “Time For Coordinated Capital Account Controls?” →