Author Archive
Moody’s Caves In to Political Pressure on Municipal Bonds
Moody’s has announced that it will change its methods for rating debt issued by state and local governments. Politicians have argued that its current ratings ignore the historically low default rate of municipal bonds, resulting in higher interest rates being paid on muni debt, or so argue the politicians.
First this argument ignores that the market determines the cost of borrowing, not the rating. And while ratings are considered by market participants, one can easily find similarly rated bonds that trade at different yields.
Second, while ratings should give some weight to historical performance, far more weight should be given to expected future performance. Regardless of how say California-issued debt has performed in the past, does anyone doubt that California, or many other municipalities, are in fiscal straights right now?
Last and not least, politicians have no business telling rating agencies how to handle different types of investments. We’ve been down this road before with Fannie Mae and Freddie Mac. During drafting of GSE reform bills in the past, politicians put constant pressure on the rating agencies to maintain Fannie and Freddie’s AAA status.
The gaming over muni ratings illustrates all the more why we need to end the rating agencies govt created monopoly. As long as govt has imposed a system protecting the rating agencies from market pressures, those agencies will bend to the will of politicians in order to protect that status. As Fannie and Freddie have demonstrated, it ends up being the taxpayers and the investors who ultimately pay for this political meddling.
Ban on Short Sales Benefits Banks and Hurts Investors
Today, in what seems like an endless string of 3-2 votes, the SEC moved to restrict the ability of investors to short stocks, claiming that such restrictions would restore stability and protect our financial system. The truth couldn’t be more different. Short sellers have long been the first, and often only, voice raising questions about corporate fraud and mismanagement. For instance, shorts exposed the fraud at Enron, WorldCom and other companies while the SEC largely slept.
Bush’s SEC, lead by former Congressman Chris Cox banned the shorting of various financial industry stocks during the crisis. The SEC then, as now, would have us believe that Bear, Lehman, AIG, Fannie, Freddie and others were not the victims of their own mismanagement, but rather victims of bear raids by short sellers. In another instance of Obama and his appointees reading from the Bush playbook, SEC Chair Mary Shapiro finds ever creative ways to expand Cox’s misguided policies.
Short sellers only profit if they end up being correct. Sadly Washington instead believes in punishing market mechanisms that work and throwing increasingly more money at failed agencies, like the SEC. Rather than attacking short sellers we should applaud them for doing the SEC’s job. But then if we had more short selling, providing greater incentives for investors to root out fraud, we might start to question why we even have the SEC.
Government Program Competes with First-Time Home Buyers
If there should ever be a great time to be a first-time home buyer — it should be now. Mortgage rates are at historic lows. Prices have fallen almost 30% across the country since the peak. Builders continue to add supply into already saturated markets. Yet, as the Wall Street Journal reports, potential first time home buyers are facing stiff competition from investors…and from the government.
Congress has appropriated about $6 billion to local and state governments to buy foreclosed properties. President Obama is proposing to add another $1.5 billion that could be used for similar purposes. The argument is supposed to be that these funds would eliminate the negative impact of foreclosures on communities, while also providing shelter to needy families. Part of the program’s rationale is that local governments’ will select a better group of tenants and purchasers that would private investors (the history of public housing should rebut that assumption).
With the exception of cities like Detroit, Cleveland and Buffalo, many of the country’s boom areas still have significant population and other amenities (like sunny weather). Many people would continue to choose to live in these areas, if only they were more affordable. After all these years of massive subsidies for home-ownership, there seems a great irony in having the government now be one of the largest barriers to families achieving home-ownership — by using tax dollars to bid up and compete away existing homes.
Doubling Down on Failed Policies
Today in Las Vegas, President Obama will take another $1.5 billion in taxpayer money and let it ride another spin on the roulette wheel otherwise known as foreclosure assistance. This time, however, he’s not even bothering to send the money to homeowners; its all going to state governments.
That’s correct, he’s sending a huge check to select state governments to use in almost any manner they choose, as long as it offers some pretense at propping up the housing market.
The assistance will be targeted at those states that have seen at least a 20% decline in home prices. Subsidizing states because their housing markets are getting more affordable almost makes one yearn for the days when we subsidized states because their housing markets were too expensive. What we are really subsidizing is those states whose destructive land-use policies contributed to the magnitude of the housing bubble. Basic economics tells us that as supply becomes more inelastic (think growth boundaries), prices become more volatile. It’s bad enough that most of our housing subsidies, both homeowner and renter, have ended up going to states that have crippled their housing markets, but now we are sending them a big check to reward such behavior.
Washington needs to end its constant attempts to prop up the housing market. The only viable solution to an over-supply of housing is a further decline in prices. Most of the worst-hit areas, such as California, do not lack for families wanting to buy homes. They lack a supply of homes at affordable prices, which would be solved by letting prices fall.
Putting “Holds” on Hold
Recent weeks have witnessed considerable media attention on a fairly obscure Senate practice: that of Senators placing a “hold” on a nomination. Holds are essentially a method for Senators to tell the Majority Leader that if the Leader were to try to move a nomination by unanimous consent, that Senator would object on the Senate floor.
Much of the attention has unsurprisingly come from Democrats, who see the use of holds as obstructing President Obama’s ability to get in place his preferred personnel. Perhaps getting the most attention was Senator Richard Shelby’s placing a hold on 70 some nominations (full disclosure: I spent seven years working for Shelby).
What is missed in the debate over holds is whether the Senate should be moving nominations by unanimous consent in the first place. President Obama’s supporters contend that his nominees deserve an up or down vote. Yet that is exactly what is required by a hold: an up or down vote. Holds do not have to be honored by the Majority Leader (else why doesn’t someone just place a hold on health care?). In fact, nominations are privileged motions, meaning the Majority Leader can bring up a nomination for debate and vote at any time.
Moving a nomination (or even legislation) by unanimous consent all but guarantees that the nomination in question will receive zero deliberation or debate by the full Senate. Whether a particular position is subject to Senate confirmation is almost completely up to Congress. So if Congress decides that a position is important enough to demand the “advice and consent” of the Senate, then one would assume that such a position would also merit deliberation and debate by the Senate. In passing so many nominations (and legislation) by unanimous consent, the Senate fails in its responsibilities.
Congress finds itself in this bind because of its own doing. In desiring to have government intrude in some many aspects of our lives, Congress has decided that thousands of political appointees are needed to run those intrusions. But with so many appointees subject to confirmation, the Senate has no choice by to move nominations without debate for deliberation, for there is not enough time in the day to do so, especially when the Senate prefers to sending its time on grand policies, rather than the business of simply governing.
The solution is not to get rid of holds. The solution is to reduce the involvement of government in our lives, so that the Senate does not have to process thousands of nominations every year.
Fed Governor Starting to Make Sense
Despite still defending the Fed’s bailouts, Fed Governor Kevin Warsh gave a speech this morning offering a few insights about reforming our financial system that seem to be lost on both Obama and Bernanke.
A few highlights:
The mortgage finance system is owed far stricter scrutiny to gather a fuller appreciation of the causes of the crisis. The government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, for example, were given license and direction to take excessive risks.
One has to hope that both Bernanke and Obama are listening. The silence of the Obama administration on fixing Fannie and Freddie is nothing short of shocking and irresponsible. Any commitment to real reform has to include the GSEs.
Granting new powers to resolve failing firms in the discretionary hands of regulators is unlikely, in the near-term, to drive the market discipline required to avoid the recurrence of financial crises.
…Some newly-empowered and untested regulatory structure is not likely — in and of itself — to be sufficient to tackle institutions that are too-big-to-fail, particularly as memories of the crisis fade. Regulation is too important to be left to regulators alone.
I believe these two points cannot be stated more strongly: what we need is more market discipline, rather than less. Putting the entire weight of our financial system on the backs of our financial regulators is a crisis just waiting to happen. Sadly the direction of both President Obama and Congress seems to be in undermining market monitoring of firms and relying solely on regulators to “get it right” – the very same regulators who were asleep at the wheel prior to the last crisis.
Obama Small Business Lending Fund Likely A Bust
President Obama has announced his intention to use $30 billion in TARP funds to create a new small business lending fund. In all likelihood, this is $30 billion the taxpayers will never see returned.
First of all, the problem facing small business, outside of the massive uncertainty being created by Washington, is one of credit availability, not cost. For those who can get credit, its quite cheap, arguably too cheap. So if the president doesn’t intend to lower the cost of credit, the plan must be to lower the quality; using the $30 billion to cover expected credit losses. Of course, we tried throwing lots of taxpayer money at unsustainable homeownership, is there any reason to believe throwing taxpayer money at unsustainable businesses is going to work any better?
Using TARP funds for this program is also somewhat disingenuous. This program adds $30 billion to the deficit regardless of whether it’s funded by TARP or by Congressional appropriations. Taking from the TARP only allows the President to keep treating the TARP as his personal slush fund. Nowhere in the TARP legislation can you find language authorizing the use of funds to cover credit losses on new loans. Being a constitutional scholar, the President should know very well that the spending power rests with Congress, not the President. If we are to have a new small business lending program, it should be designed and funded by Congress, not bureaucrats at the Treasury Department.
Historically the two main sources of small business start-up funding have been home equity and credit cards. Clearly the availability of home equity has declined. Sadly as well, with the passing of credit card “reform” the availability of credit card lending has also declined. If the President truly wants to help small business, then the first thing to do is ask Congress to repeal the credit card bill and then just get out of the way.
Volcker Rule Misses the Mark
Today Paul Volcker appears before the Senate Banking Committee to argue for the separation of proprietary trading and commercial banking. In Mr. Volcker’s own works “what we plainly need are authority and methods to minimize the occurrence of those failures that threaten the basic fabric of financial markets.”
Using his own test, the Volcker Rule fails miserably. Had this rule been in place say five or even ten years ago, we’d most likely be in the same place we are today. It would have not avoided the crisis, and may potentially have made it worse.
First of all the proposal ignores the fact that those institutions at the heart of the crisis, Bear, Lehman, Fannie, Freddie, AIG, were not commercial banks. They were not using federally insured deposits to gamble in our financial markets. Those commercial banks with proprietary trading activities that did fail, such as Wachovia, were sunk not by proprietary trading, but by bad mortgage lending.
Mr. Volcker is correct in arguing for a change in assumptions that institutions and their creditors will not be bailed out. He errs in believing that the House passed financial “reform” bill achieves that. One has to wonder if he’s bother to even read the bill. The House bill explicitly allows for rescuing creditors. The House bill does not reduce the chance of bailouts, it increases them.
While the Obama Administration may have changed the face of its reforms, sadly the substance of its proposals continue to bear little relation to the actual causes of our financial crisis. Nowhere in the President’s proposals do we see any efforts at avoiding future housing bubbles. Perhaps this should come as no surprise given Washington’s continued attempts to re-inflate the last housing bubble.
Obama Bank Tax Is Misguided
Perhaps I am a little confused, but didn’t the Obama Administration tell the American public only months ago that TARP was turning a profit? But now the same administration is proposing to assess a fee on banks to cover losses from the TARP. Maybe President Obama is coming around to the realization that the TARP has indeed been a loser for the taxpayer. He appears, however, to be missing the critical reason why: the bailouts of the auto companies and AIG, all non-banks. This is to say nothing of the bailout of Fannie Mae and Freddie Mac, whose losses will far exceed those from the TARP. Where is the plan to re-coup losses from Fannie and Freddie? Or a plan to re-coup our rescue of the autos?
If the effort is really about deficit reduction, then it completely misses the mark. Any serious deficit reduction plan has to start with Medicare and Social Security. Assessing bank fees is nothing more than a rounding error in terms of the deficit. Let’s put aside the politics and get serious about both fixing our financial system and bringing our fiscal house into order. The problem driving our deficits is not a lack of revenues, aside from effects of the recession, revenues have remained stable as a percent of GDP, the problem is runaway spending.
The bank tax would also miss what one has to guess is Obama’s target, the bank CEOs. Econ 101 tells us (maybe the President can ask Larry Summers for some tutoring) corporations do not bear the incidence of taxes, their consumers and shareholders do. So the real outcome of this proposed tax would be to increase consumer banking costs while reducing the value of bank equity, all at a time when banks are already under-capitalized.
Where’s Our Bailout Vote?
It’s easy to forget that the financial crisis was not simply one of American financial institutions getting into trouble; banks around the world found themselves on the brink of failure. One of the more interesting cases is Landsbankinn, a privately owned bank in Iceland. Landsbankinn also operated a branch in Britain and the Netherlands called “Icesave.” When Icesave failed in 2008, the British government rushed in and covered the deposits of its British savers — a move that was neither requested by Landsbankinn or the government of Iceland. Now the Brits are demanding that Iceland pay them to cover those expenses.
For a brief moment it looked like that was exactly what was going to happen, as the legislature in Iceland passed a bill to pay off the Brits. Sensing the public opposition, Iceland’s president blocked the bill. This is likely to lead to a public vote by the people of Iceland on whether they want to cover the losses of British depositors in Icesave.
Britain had no legal basis for seizing Icesave assets in the UK, nor did depositors in Icesave have any right to have their losses covered. If England wants to bail out its citizens, that is its business. Asking Iceland to foot the tab afterwards sets a dangerous precedent.
But then at least the citizens of Iceland are getting a vote on whether to bail out or not. By comparison, both U.S. Treasury Secretaries Paulson and Geithner have decided that U.S. taxpayers must honor foreign investments in Fannie Mae and Freddie Mac, even if those investments were explicitly not insured by the U.S. government. Perhaps the U.S. could learn a little about democracy and accountability from Iceland.
Did the Fed Buying MBS Make a Difference?
Recent years have witnessed a multitude of new Federal Reserve programs aimed at bringing stability to our financial markets. One of the largest programs has been the Fed’s purchase of Fannie Mae and Freddie Mac guaranteed mortgage-backed securities (MBS). The program was initially announced in November 2008 with the goal of buying up to $500 billion, later expanded to $1.25 trillion. Clearly we are talking a lot of money.
The ultimate objective of the FED MBS purchase program was, in the words of the Fed, to reduce mortgage rates “relative to what they otherwise would have been.” Did the Fed meet this objective? According to a new study by Stanford University Economists Johannes Stroebel and John Taylor the Fed did not.
More specificially, the professors “find that the MBS program has no significant effect. Movements in prepayment risk and default risk explain virtually all of the movements in mortgage spreads.” So while it is clear that mortgage rates declined over the time the Fed has operated the MBS purchase program, those declines were due to factors outside of the Fed’s control.
Professors Stroebel and Taylor only look at the claimed benefits of the Fed’s MBS purchase program, leaving aside the issue of cost. Since any losses on MBS purchased by the Fed reduces the amount of funds transferred from the Fed to Treasury, these losses are ultimately borne by the taxpayer, as that reduction will have to be made up elsewhere. With close to a trillion in purchases, even minor declines in value can result in large losses for the taxpayer. For instance, a 5% loss in value would translate to $50 billion loss to the taxpayer. Another good reason to audit the Fed.
Bernanke Still Doesn’t Get It
Yesterday, at the annual meetings of the American Economic Association, Fed Chairman Ben Bernanke offered a continued defense of the Fed’s monetary policies earlier this decade. Essentially he believes that monetary policy did not contribute to the housing bubble. He also makes clear that he believes that the excessively loose policy stance of the Fed after the dot-com bubble burst was appropriate given the level of unemployment at that time. Given that today’s unemployment level is even worse, Bernanke has offered us a clear indication that monetary policy will remain excessively loose for the foreseeable future, regardless of the Fed’s inability to actually create jobs.
Bernanke’s remarks also illustrate the contradictions in his own thinking. At one point he comments that it would have been inappropriate for the Fed to response to increases in energy prices, because such prices were viewed as temporary; yet elsewhere he indicates that most market participants viewed house price increases as permanent, yet the Fed felt it was appropriate to ignore those, for what reason we do not know. No where in his remarks does he address the impact of ignoring the single largest item behind consumer spending: housing.
Perhaps the weakest link in Bernanke’s arguments is presenting the false choice of either monetary policy or mortgage underwriting standards. How about accepting that both played a role. Sadly when discussing underwriting standards, Bernanke continues to miss the most essential element: downpayment requirements. Nowhere in his discussion of mortgage defaults does he seem to recognize the role of equity.
A Lump of Coal From Treasury
On Christmas Eve, Treasury Secretary Tim Geithner decided that the nation’s taxpayers had been naughty, and accordingly left a big lump of coal in their stockings. More specifically, after Congress had finally left town and health care filled the headlines, Treasury announced in a short press release, that the federal government would cover all of Fannie Mae and Freddie Mac losses between now and 2012.
Previous to this announcement, Treasury had agreed to cover up to $400 billion in Fannie and Freddie losses. Remember this isn’t an investment that will come back to the taxpayer, it is a loss. And a loss that will exceed anything seen under the TARP. As if $400 billion were not a sufficient hit to the taxpayer, Treasury has not decided that additional losses will also be covered. All this without so much as even a press conference; much less a vote of Congress. So much for accountability and transparency.
Of course, Treasury tells us this action is necessary to protect our mortgage markets. Maybe at some point, we will actually decide that we’ve spent enough to protect our mortgage markets. I have a home and a mortgage; yet didn’t feel any more protected by agreeing to cover losses that could run into the trillions.
What Geithner really should have admitted is that we aren’t taking these actions to protect the mortgage market, we are taking these actions to protect Fannie and Freddie’s largest debtholders, among them the Chinese Central Bank. But then if we don’t make good on the Chinese investment in Fannie and Freddie, how can we expect them to continue lending us ever more money to live beyond our means?
It’s the Obama Economy Now
Undoubtedly President Obama inherited an economic mess. Also undoubtedly, he’s made it worse. Barring substantial revisions to recent job loss estimates, we have now crossed the line where as many jobs have been lost during this recession under President Obama as under President Bush. From the start of the recession, in December 2007, until President Obama took the oath of office at the end of January 2009, there have been 3.36 million nonfarm payroll jobs lost. From February 2009 until now there have been about 3.36 million nonfarm payroll jobs lost (estimates from ADP employment report).
Even during the best of times, the economy experiences substantial job loss. However, we consider those times good because the labor market is also creating lots of jobs, so that job losses are offset by job gains. The early parts of a recession are generally characterized by large increases in job losses, with minor declines in job creation. Eventually the job losses moderate and job creation picks up, bringing us out of the recession. We are arguably past the worst of the job losses. What has escaped us is job creation.
And it is on the job creation front that Obama takes ownership of the economy. While there are certainly problems in the credit markets, the major reason behind the lack of job creation is the massive uncertainty being generated by Washington. For any employer today, it is almost impossible to estimate what the future health care costs of new hires will be. It’s impossible to gauge what your environment costs are going to be. Same with the costs of the 90 new workplace rules that the Department of Labor promised would be forthcoming over the next year.
Sadly this administration learned the wrong lesson from the defeat of the Clinton health care plan. The history lesson they should have learned is that Clinton inherited a recession as well (as did Bush for that matter), but that job creation was weak until the Clinton health care plan stalled.
Until employers and investors feel it is safe once again to put their businesses and investments at risk, and Washington ends its war on the productive elements of our society, we will not have significant private sector job growth.
Filed under: Finance, Banking & Monetary Policy; General
Does CRA Undermine Bank Safety?
A recent policy forum here at Cato discussed the role of the Community Reinvestment Act (CRA) in the financial crisis. While the forum focused on the federal push for ever expanding homeownership to marginal borrowers, the analysis did not touch directly upon the question of whether CRA lending undermines bank safety.
Fortunately this is a question that one economist at the Federal Reserve Bank of Dallas bothered to ask. While his research findings were available before the crisis, they were clearly ignored.
In a peer-reviewed published article, appearing in the journal Economic Inquiry, economist Jeff Gunther concludes that there is “evidence to suggest that a greater focus on lending in low-income neighborhoods helps CRA ratings but comes at the expense of safety and soundness.” Specifically he finds an inverse relationship between CRA ratings and safety/soundness, as measured by CAMEL ratings.
In another study Gunther finds that increases in bank capital are associated with an increase substandard CRA ratings. Apparently bank CRA examiners prefer that capital to be lend out, rather than serve as a cushion in times of financial distress.
Given the current attempts in Washington to expand CRA, it seems some people never learn. One can always argue over how CRA should work, but the evidence is quite clear how it has worked, once again proving: there’s no free lunch.
One Thing Greenspan Got Right and Bernanke Didn’t
While both Greenspan and Bernanke merit considerable blame for helping to inflate the housing bubble, it is worth mentioning what Greenspan did get right: bringing to the attention of Congress and the public the risk posed to our financial system from Fannie Mae and Freddie Mac.
During Bernanke’s confirmation hearing last week, Banking Committee Chairman Chris Dodd criticized the Fed for not doing enough to warn Congress on systemic risks facing the economy. Given Dodd’s attendance record, both as Chair and before, he can perhaps be forgiven if he missed one of Greenspan’s many appearances before the Banking Committee.
To help remind us, on Feb. 24, 2004, Greenspan told the Banking Committee:
Concerns about systemic risk are appropriately focused on large, highly leveraged financial institutions such as the GSE’s…to fend off possible future system difficulties, which we assess as likely…preventive actions are required sooner rather than later.” In Greenspanspeak, that translates to “do something now.
Again on April 6, 2005, Greenspan warned the Banking Committee:
When these institutions were small, the potential for such risk, if any, was small. Regrettably, that is no longer the case. From now on, limiting the potential for systemic risk will require the significant strengthening of GSE regulation.
These are just a few of Greenspan’s many warnings to Congress on the risks posed by Fannie and Freddie. In addition, economists at the Fed published numerous studies, during Greenspan’s tenure, on the nature of Fannie and Freddie.
Sadly, upon taking over as Chair of the Federal Reserve, Ben Bernanke scaled back these efforts. Gone was the published economic research on GSEs. Gone was the loud voice of authority from a Fed Chairman on GSE policy. Instead, Bernanke choose to appease the GSE’s protectors in Congress.
While the Federal Reserve does not maintain primary regulatory authority over Fannie and Freddie, the Fed has long been viewed as the most credible voice in Washington on issues of systemic risk. When faced with the choice of protecting the Fed, or protecting the financial system, by raising the pressure on GSE reform, Bernanke punted. How he can be trusted to find the courage to taken on the next “Fannie Mae” is beyond me.
Volcker on Financial Reform and Economic Stimulus
In a recent edition of The Region magazine, published by the Federal Reserve Bank of Minneapolis, retiring Minn. Fed President Gary Stern interviews Paul Volcker on a variety of topics. It’s an interview well worth reading, and reminds one why Volcker is one of the more thoughtful voices on economics and finance, even if he isn’t always right.
Some highlights. On the Obama financial reform plan:
I do not share one part of the general philosophy which seemed to emerge from this, particularly the proposal that the Federal Reserve supervise directly all “systemically important” institutions. I don’t know what “systemically important” institutions are, incidentally, but I’m sure that if you picked them out, people will assume they’re going to be saved, that they’re too big to fail. At the same time, there’d be some that you don’t pick out in advance that you’d want to save under particular circumstances. So I think that is a mistake.
Volcker also express concern that those institutions at the center of the crisis are left out of the reform. Specifically he mentions that Obama Administration officials “haven’t said anything about Fannie Mae or Freddie Mac.”
Volcker also takes issue with the Administration’s proposal to regulate non-banks, including hedge funds and private equity. “I wouldn’t regulate so strictly the nonbanks. I’d like to create the impression…that there’s no automatic bailout of those institutions.”
Volcker also raises important questions about the Administration’s Keynesian stimulus actions. As the stimulus was meant to replace a reduction in private sector demand, Volcker asks “are we really dealing with the underlying pressures in the economy without permitting a relative decline in consumption to proceed?”
Those are just a few of his comments. Here’s to hoping the rest of the Obama Administration is listening. They could do a lot worse than Volcker’s advice.
Remembering the Reporter Who Sued the Fed
With the Washington Post and other mainstream media outlets publishing endless defenses of “Federal Reserve independence” and proclaiming the Fed as savior of our financial system, it is all to easy to dismiss much of the media as simply defenders of the status quo. There were many, however, willing to challenge this orthodoxy. Standing out among them was Mark Pittman, reporter for Bloomberg. It was Mr. Pittman who sued the Federal Reserve, winning a victory on August 24, as the Manhattan Federal Court allowed the suit to proceed. Sadly, Mark Pittman passed away on November 25th.
Mark Pittman and his employer, Bloomberg News, sought details on the Federal Reserve’s numerous special lending facilities. Which firms were getting loans, and for how much and at what terms? These were all details the American public were entitled to, yet were denied by the Federal Reserve. We all remember the Fed’s warnings that if AIG counter-parties were named, there would be market disruptions. Yet, after much public and Congressional pressure, those firms were named, with no adverse market consequences.
While Mark Pittman’s efforts will be greatly missed, his suit continues, as does the efforts by Rep. Ron Paul and others in Congress, to bring transparency to the activities of the Federal Reserve.
Some Facts on Executive Compensation
All too often policy debates regarding executive compensation appear driven more by populist politics than any real basis in fact. In order to add some light to this debate, two professors at New York University’s Stern School of Business, Gian Luca Clementi and Thomas Cooley, recently released a working paper, offering their findings on trends in executive compensation, many of which I found surprising.
First off, Professors Clementi and Cooley measure executive compensation more broadly than just salary, perks and bonuses. They include annual change in value of own company stock and option holdings, as well as the value of own company stock sales and newly awarded securities. This broader measure is intended to give a fuller picture of how closely an executive’s wealth is tied to the performance of their firm. Not too surprising given this broader measure, the professors find that salary and bonuses are actually a small faction of overall compensation. Stock holdings, awards and options are far larger shares of compensation.
Among their other findings: A $1,000 increase in shareholder wealth is associated with about a $35 rise in CEO wealth. One factor behind this relationship is the relatively high own company stock holdings of CEOs. For 2006, about a fourth of CEOs held more than 1% of their company’s stock, while 10% held more than 5%.
A surprisingly finding was that it was quite common for CEOs to actually see negative compensation. For instance in 2002, the professors find that 40% of CEOs lost money, driven many by their own company stock and option losses. These are just a few of the paper’s findings. Hopefully this research, and others, will provide a more factual basis for debates surrounding executive compensation.
Homeownership Myths
In a recent Washington Post op-ed, Professor Joseph Gyourko, chair of the Wharton School’s Real Estate Department, lists what he sees as the five biggest myths about homeownership. Given the central role of federal housing policy, particularly Fannie Mae and Freddie Mac, in our recent financial crisis, it is worth following Professor Gyourko’s suggestion and question whether a national policy of ownership, all the time for everyone, really makes sense.
Professor Gyourko’s five myths:
1. Housing is a great long-term investment.
2. The homebuyer tax credit makes buying a house more affordable.
3. Homeowners are better citizens.
4. It’s safe to buy a house with a very low downpayment.
5. Owning is always cheaper than renting.
You’ll have to read the op-ed to see his explanations. An important qualification on his analysis is that in many cases what can be good for the buyer, such as putting no money down, may not be good for the economy if it results in additional foreclosures.
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