A Short Question For Senior Officials Of The New York Fed

At the height of the financial panic last fall Goldman Sachs became a bank holding company, which enabled it to borrow directly from the Federal Reserve. It also became subject to supervision by the Federal Reserve Board (with the NY Fed on point) – hence the brouhaha over Steven Friedman’s shareholdings.

Goldman is also currently engaged in private equity investments in nonfinancial firms around the world, as seen for example in its recent deal with Geely Automotive Holdings in China (People’s Daily; CNBC). US banks or bank holding companies would not generally be allowed to undertake such transactions – in fact, it is annoyed bankers who have asked me to take this up. Continue reading “A Short Question For Senior Officials Of The New York Fed” →

Fed Chest-Thumping for Beginners

I generally avoid writing about monetary policy, since every economics course I’ve taken since college has been a micro course, and besides Simon is a macroeconomist, among other things. But since just about everyone in my RSS feed has been linking to Tim Duy’s recent article on the Fed, I thought I would try to put in context for all of us who don’t understand Fed-speak.

Duy takes as his starting point a series of statements by Fed governors and bank presidents indicating “hawkishness,” which in central banker jargon means caring primarily about inflation, not economic growth. (“Doves” are those who care more about economic growth and jobs, although, just like in the national security context, no one likes to be known as a dove. This itself is a disturbing use of language, since it implicitly justifies beating up on poor people, but let’s leave that for another day.)

Continue reading “Fed Chest-Thumping for Beginners” →

Too Connected To Fail

Over on the Economist Roundtable, my colleague Daron Acemoglu makes several important points.

We now have some financial institutions (and perhaps nonfinancial firms also) that have such strong and deep political connections, they will not be allowed to go bankrupt. This is a reality we must face.
Assuming that we can address such a deep political problem with a tweak of our regulatory arrangements is a dangerous illusion. Continue reading “Too Connected To Fail” →

The Economics of Models

Economic and financial models have come in for a lot of criticism in the context of the global financial crisis, much of it deserved. One of the primary targets is models that financial institutions widely used to (mis)estimate risk, such as Value-at-Risk (VaR) models for measuring risk exposures (which we’ve discussed elsewhere) or the Gaussian copula function for quantifying the risk of a pool of assets.

In September, the Subcommittee on Oversight and Investigations of the House Science and Technology Committee held a hearing on the role of risk models in the financial crisis and how they should be used by financial regulators, if at all. The hearing focused largely on VaR models, which attempt to quantify the amount that a trader (or an entire bank) stands to lose on a given day, with a certain confidence level. (For example, a one-day 1% VaR of $10 million means that on 99% of days you will lose less than $10 million.) Continue reading “The Economics of Models” →

How to Waste 45 Minutes (Like I Just Did)

Start here. Then keep reading. It has nothing to do with economics, but a lot to do with statistics.

Or don’t, if you need to get something done this morning.

Update: One reader writes in:

“I beg to differ that this link has nothing to do with economics: The same technique it uses to detect possible making-up of poll numbers was used in a recent paper to detect possible making-up of National Accounts statistics in some developing countries in a widely used economic dataset:

http://www.bepress.com/bejm/vol7/iss1/art17/.”

By James Kwak

Good-Bye, Vanilla Option

I realized I didn’t say anything about the death of the vanilla option from the Consumer Financial Protection Agency proposal. I was going to right something targeted and biting, but it ended up as a much broader column for the Washington Post about the Obama Administration’s commitment to regulatory reform.

Mike Konczal, fortunately, has two good posts on the topic: one a eulogy for plain vanilla, one on the underlying problems that plain vanilla would have helped solve. He also points out at least three ways the federal government can achieve some of the same goals through other means:

Banning prepayment penalties on mortgages
(Citing Alyssa Katz): using the government’s historically large and now even bigger influence in the secondary market to encourage plain vanilla mortgages
(Citing Steve Waldman): a government charge card (think “public option”)

All of those posts are worth reading. If we’re not going to have plain vanilla, we need other new ideas about how to channel innovation into things that provide consumer benefit and put a floor under the quality offered by the private sector. More disclosure won’t work (that already failed).

Update: The Raven compares the Obama administration to the Johnson administration, each with its “devil’s bargain.”

By James Kwak

Back-Door Resolution Authority

Tyler Cowen quotes from Robert Pozen’s yet-to-be-released book:

“In my view, the adverse repercussions of Lehman’ failure could have been substantially reduced if the federal regulators had made clear that they would protect all holders of Lehman’s commercial paper with a maturity of less than 60 days and guaranteed the completion of all trades with Lehman for that period.”

Back when people cared about these things, I wrote a couple of posts on the issue of selective protection of creditors.

Continue reading “Back-Door Resolution Authority” →

Real Problems, No Easy Solutions

On Monday I wrote a post criticizing the sloppy way that Robert Shiller argued for financial innovation, which focused primarily on the use of metaphor and secondarily on the use of a valid example (people are overly cautious about some financial products) to make an invalid general point (people are overly cautious about all financial products. Then I threw in a sloppy paragraph, because I wanted to get to the end of a long post:

“From there, the article actually gets better, because Shiller gives us examples of areas where he thinks financial innovation would be good. And here I don’t really disagree with him that much. I agree with him that reliance on housing as an investment vehicle is bad. I don’t really agree that target-date mutual funds are such a good idea (since as far as I can tell the conventional wisdom about switching from stocks to bonds as you age is the equivalent of an old wives’ tale), but they are probably better than many of the things people are currently invested in. Retirement annuities, another thing he recommends, would definitely be useful if you could get them at a decent price. (I believe now they suffer from a significant adverse selection problem.)

“For the sake of argument, I am willing to concede that these are useful innovations that would make people better off.”

Felix Salmon rightly points out that I shouldn’t have conceded it for the sake of argument. Really, what I should have said was that I agreed with Shiller that people face real problems — relying on housing for investment is bad, and it “would definitely be useful” if you could get inflation-adjusted annuities for retirement. (I don’t like target-date funds, and I said so.) But since I had already made my main point (the one about metaphor), I didn’t look into the specific innovations that Shiller was proposing to solve these problems. Salmon points out accurately that the proposed solutions rely on embedded options that ordinary consumers are likely to get screwed by. I recommend reading his post.

By James Kwak

The G20, The IMF, And Legitimacy

Strong advocates of our new G20 process are convinced that it will bring legitimacy to international economic policy discussions, rule-making, and crisis interventions. Certainly, it’s better than the G7/G8 pretending to run things – after all, who elected them?

But who elected the G20? The answer is: No one. And, in case you were wondering, there is no application form to join the G20 (although you can crash the party if you have the right friends, e.g., Spain). The G20 has appointed themselves as the world’s “economic governing council” (to quote Gordon Brown).

Is this a good idea? Continue reading “The G20, The IMF, And Legitimacy” →

More on Bank of America

Last Wednesday I wrote a highly critical post about the agreement between Bank of America(BAC) and the government (Treasury, the Fed, and the FDIC) to terminate BAC’s asset guarantee agreement in exchange for a payment of $425 million. I’ve learned some more about this and I think I can reconstruct the government’s perspective on this issue, with the help of someone knowledgeable about the transaction.

Continue reading “More on Bank of America” →

Robert Shiller and the Danger of Metaphors

Financial commentators use metaphors* all the time. Derivatives are “financial weapons of mass destruction,” for example. Actually, people use metaphors all the time. But what is the substantive content of a metaphor? More technically, if A is (like) B, then why should we believe that A has some attribute that B has?

I’ve been meaning to write about this for a while, but then Robert Shiller handed me a perfect example in the Financial Times, in his “defense of financial innovation:”

“The advance of civilisation has brought immense new complexity to the devices we use every day. A century ago, homes were little more than roofs, walls and floors. Now they have a variety of complex electronic devices, including automatic on-off lighting, communications and data processing devices. People do not need to understand the complexity of these devices, which have been engineered to be simple to operate.

“Financial markets have in some ways shared in this growth in complexity, with electronic databases and trading systems. But the actual financial products have not advanced as much. We are still mostly investing in plain vanilla products such as shares in corporations or ordinary nominal bonds, products that have not changed fundamentally in centuries.

“Why have financial products remained mostly so simple? I believe the problem is trust. People are much more likely to buy some new electronic device such as a laptop than a sophisticated new financial product. People are more worried about hazards of financial products or the integrity of those who offer them.”

Continue reading “Robert Shiller and the Danger of Metaphors” →

When a Nudge Becomes a Shove

Richard Thaler, co-author of Nudge, wrote an op-ed in The New York Times this weekend arguing that we should change the default option for organ donation. Reading the article helped crystallize for me a vague concern I’ve had with all this behavioral economics-inspired, benevolent-paternalistic behavior modification that has gotten so much attention lately among the smart set. But I’m getting ahead of myself.

Continue reading “When a Nudge Becomes a Shove” →

Escape from Punchbowlism

This post was written by StatsGuy, a regular commenter here and very occasional guest contributor. We asked him to expand on the ideas he put forward in this comment on the relationships between monetary policy, international capital flows, and bank capital requirements.

Former Fed Chairman William McChesney Martin is most famous for his notorious quip that the job of the Fed is to “take away the punchbowl just as the party gets going.” It seems this has evolved into a full fledged theory of monetary management.

Unfortunately, structural problems – like trade imbalances, inadequate capital ratios, and weak financial regulation – severely constrain Fed monetary policy options by impacting currency flows and the value of the dollar. (Some specific mechanisms are listed in the previous comment.)

Why does this matter? Because it means the Fed cannot use monetary policy as effectively to keep the country going at full throttle and avoid a prolonged fall in utilization rates (unemployment and idle machines). How can it be that capacity utilization is still lower than at the bottom of the 81/82 recession and we’re ALREADY raising the bubble/inflation alarm? (Paul Krugman discusses this here, and the answer is that the output gap is itself defined against neutral inflation, not just capacity utilization.)

Continue reading “Escape from Punchbowlism” →

Was The G20 Summit Actually Dangerous?

It is easy to dismiss the G20 communique and all the associated spin as empty waffle. Ask people in a month what was accomplished in Pittsburgh and you’ll get the same blank stare that follows when you now ask: What was achieved at the G8 summit in Italy this year?

Perhaps just having emerging markets at the table will bring the world closer to stability and more inclined towards inclusive growth, but that seems unlikely. Should we just move on – back to our respective domestic policy struggles?

That’s tempting, but consider for a moment the key way in which the G20 summit has worsened our predicament. Continue reading “Was The G20 Summit Actually Dangerous?” →

The IMF Should Move To Europe

The headline news from the G20 summit in Pittsburgh is that progress has been made on “IMF reform,” meaning increased voting power for emerging markets relative to rich countries – remember that West Europeans are greatly overrepresented at the IMF for historical reasons. But further change in a sensible direction is being blocked by the UK and France – because they have figured out that this logic implies they would lose their individual seats on the IMF’s executive board.

The way to break this impasse is (1) for the European Union to consolidate into a single seat or membership, and (2) for the Union to assert its right to be the headquarters of the IMF (under the Articles of Agreement: “The principal office of the Fund shall be located in the territory of the member having the largest quota…”). Continue reading “The IMF Should Move To Europe” →