Archive for the ‘Finance, Banking & Monetary Policy’ Category
A Plug for Financial Fiasco
The distinguished Harvard economist Richard N. Cooper, former president of the Federal Reserve Bank of Boston, praises Johan Norberg’s Financial Fiasco: How America’s Infatuation With Homeownership and Easy Money Created the Economic Crisis in Foreign Affairs:
The economic crisis of 2008-9 will no doubt spawn dozens of books. Here are two good early ones….
Norberg, a knowledgeable Swede, provides a much more detailed account of the broader events of 2007-9, from the useful perspective of a non-American. He finds plenty of blame with all the major players in the U.S. financial system: politicians, who thoughtlessly pushed homeownership on thousands who could not afford it; mortgage loan originators, who relaxed credit standards; securitizers, who packaged poor-quality mortgage loans as though these were conventional loans; the Securities and Exchange Commission, which endowed the leading rating agencies with oligopoly powers; the rating agencies, which knowingly overrated securitized mortgages and their derivatives; and investors, who let the ratings substitute for due diligence. Senior management in large parts of the financial community lacked an attribute essential to any well-functioning financial market: integrity. But solutions, Norberg warns, do not lie in greater regulation or public ownership. Politicians and bureaucrats are not immune from the “short-termism” that plagues private firms.
The other book he praises, by the way, is Paul Krugman’s The Return of Depression Economics. And oddly, his list of Norberg’s villains doesn’t include one implied in the title: the Federal Reserve Bank, which issued the “easy money” that allowed the boom to happen. Purchase Financial Fiasco here or on Kindle.
Filed under: Cato Publications; Finance, Banking & Monetary Policy
Fed Opposed by Left and Right
On its front page today, the Washington Times reports that expanded powers for the Federal Reserve are being opposed by “odd allies.” The Fed’s imperial over-reach for additional regulatory powers is being opposed by Democrats and Republicans, and liberals and conservatives alike. As well it should be. As Senator Shelby observed, “Anointing the Fed as the systemic-risk regulator will make what has proven to be a bad bank regulator even worse.”
The regulation of financial services failed conspicuously to prevent the worst financial crisis since the Great Depression. The Fed failed most conspicuously as it was charged with oversight of all the major banks, including notably Citigroup and Bank of America. Bank regulation now functions to insulate banks from the consequences of their own bad acts. The regulatory system enables banks to engage in excessive risk taking.
The Obama Administration and Chairman Barney Frank of the House Financial Services Committee propose that an expanded role for the Fed and generally more of the same will improve matters. Instead, the proposed legislation will worsen the situation by codifying the status of the major financial institutions as “too-big-to-fail.” It would thereby provide them with special legal status. We have all seen this movie and how it ends. Fannie Mae and Freddie Mac had such a status and collapsed. Do we need 20 more such disasters?
Three cheers for all those opposing this destructive piece of legislation. End “too-big-to-fail” instead.
Is the Economy Booming Again?
The lead headline in Friday’s Wall Street Journal proclaims
Economy Snaps Long Slump
But buried on page C10 is a more skeptical view:
If the Obama administration were managing a company, it might have hoped the latest gross-domestic-product numbers would be greeted with cries of “great quarter, guys!”
At least the stock-market obliged, rising on the back of better-than-expected GDP data Thursday morning. But then bulls have become used to looking to Washington for inspiration. Zero rates and stimulus programs boost economic data as well as nudge money toward riskier assets.
Fully 2.2 percentage points of the third quarter’s 3.5% growth figure related to vehicle purchases and residential construction, both juiced by government support. Federal spending added 0.6%.
If these GDP data were company earnings, they would be what analysts euphemistically call “low quality.” Investors buying into the market off the back of them are ignoring weekly unemployment-claims data that came in above 500,000 again on the same day.
The danger is that all these short-term fixes leave the economy dangerously addicted to taxpayer-funded steroids. The circularity in the housing market, whereby Washington provides tax breaks to first-time buyers, guarantees most of the mortgages written, and then buys most of those, beggars belief, and suggests a worrying case of amnesia following the bursting of the housing bubble. (emphasis added)
Johan Norberg warned about the dangers of repeating the very mistakes that created the bubble and bust in the first place in Financial Fiasco: How America’s Infatuation with Homeownership and Easy Money Created the Economic Crisis (available in hardcover, e-book, or Kindle).
Filed under: Cato Publications; Finance, Banking & Monetary Policy
The Fed and Policy Uncertainty
How and when should the Fed unwind the enormous monetary expansion it undertook in response to the financial crisis and recession? The WSJ reports [$]:
As the Federal Reserve’s next meeting approaches in early November, an internal debate is brewing about how and when to signal the possibility of interest-rate increases.
The Fed has said since March that it will keep rates very low for an “extended period.” Long before it raises rates, however, it will need to change that public signal to financial markets.
Because the recovery is so young and is expected to be so weak, many central bank officials are comfortable, for now, keeping rates very low. But they are beginning to strategize about how to walk away from the “extended period” language.
My suggestion is that the Fed announce a path of gradual increases in the federal funds rate, say beginning next year and lasting for two years, until the rate is at some “normal level.”
This approach is different than what the Fed is likely to undertake; it will probably want to maximize “discretion,” the ability to adjust on the fly as conditions unfold.
My approach maximizes predictability and reassurance: it commits the Fed to shrinking the money supply and heading off future inflation. This reassures markets and takes substantial uncertainty out of the picture.
The problem with my approach is the pre-commitment: everyone knows the Fed could abandon a pre-announced path.
But such an announcement might still give markets useful guidance, and the Fed would know that any deviation would itself upset markets, and this might encourage adherence to the pre-commitment.
C/P Libertarianism, from A to Z
Filed under: Finance, Banking & Monetary Policy; General
Crist and Cato
Florida’s airwaves are alive with the sound of Governor Charlie Crist’s radio advertisement trumpeting his grade of “A” on Cato’s “Fiscal Policy Report Card on America’s Governors.”
I am pleased that Gov. Crist values Cato’s ratings because we work hard to make them accurate and nonpartisan. But the radio ad is making many fiscally conservative Floridians scratch their heads because of the governor’s recent policy actions.
The governor earned his Cato grade in last year’s report mainly because of his large property tax cuts and moderate spending approach. The grade was based purely on quantitative data on revenues, general fund spending, and tax rate changes.
However, since I wrote the report in mid-2008, the governor seems to have fallen off the fiscal responsibility horse.
In particular, Crist approved a huge $2.2 billion tax increase for the fiscal 2010 budget, even though he had promised that $12 billion in federal “stimulus” money showered on Florida over three years would obviate the need for tax increases.
About $1 billion of the tax increases are on cigarette consumers, which will particularly harm moderate-income families. The rest of the increases are in the form of higher costs for often mandatory services, such as automobile registration, which is really just a sneaky form of tax increases.
These tax increases will be particularly painful to Floridians in the short-term because of the recession. But Crist has also jeopardized the state’s long-term finances with his expanded subsidies for hurricane insurance. Hurricanes are a major challenge in Florida, but giving big subsidies to coastal property owners, driving private insurers out of the state, and guaranteeing a massive state bailout when the next hurricane hits strikes me as the height of fiscally irresponsibility.
More on the Crist campaign here.
Executive Comp Restrictions Could End Up Costing the Taxpayer
The Obama administration’s announcement this week on cash compensation for those seven institutions receiving “extraordinary assistance” has generated the all-too-predictable responses. Either you think executives at the entities are bad and greedy and should be punished, or you believe this is just the first step in an all-out class war. Sadly the real victim in all these efforts has been, and continues to be, the taxpayer.
Now that the taxpayer is the most significant shareholder in these companies, the top priority for Washington, as representative of the taxpayer, should be to see these companies return to profitability. Quite simply, if these companies are not profitable, that loss will fall on the taxpayer, as shareholder.
And of course, without the ability to retain talent, it is all the more likely that these companies will not maintain profitability. I suspect the competitors of these seven are already eyeing their best talent. And let’s not kid ourselves, leaving these companies stocked with mediocre employees will not help taxpayers get their money back.
In trying to punish the bailed-out companies, we are also punishing ourselves. This is one of the very reasons we should never have bailed them out in the first place: once we are the owners, there fate and ours are linked.
Nothing Good about The Higher Ed Pricing Game
On Tuesday I noted that the College Board had released its annual reports on college prices and student aid. At the time I wrote the post I hadn’t yet been able to download the reports, but was planning to provide a rundown of their major findings once I’d read them. I’ve now done the latter, but it turns out that Ben Miller over at the Quick and the ED has already posted a pretty good summary of the most important findings. Go there if you want the highlights. Don’t go there, though, if you want to know what the highlights mean, at least for anyone other than students. For that, you’ll have to read on here….
The big news is that net college prices — what students pay after aid– have actually decreased over the last 15 years. While sticker prices were rising much faster than incomes and inflation, what students were actually paying dropped. The implication of this is so obvious that Mr. Magoo couldn’t mistake it: Student aid, much of which comes through taxpayers, enables schools to charge ever-higher prices with near impunity.
Back to the Quick and the ED. To some degree, Miller sees declining net price as a triumph for federal aid, making college more affordable even as prices explode:
This story should be encouraging for legislators that fought hard to win Pell Grant increases over the last few years. The steepest decreases in net price occur beginning in the 2007-2008 academic year, the same time Congress began passing legislation that boosted the maximum Pell Grant award several times. This at least suggests that the money spent on the program did play some role in lessening the financial burden for students and was not completely eaten up by sticker price increases.
On the flip side, Miller at least acknowledges that:
The net price figure also lessens the pressure on schools to actually take proactive steps to lower their costs. If the price you list isn’t actually what you charge, then why should anyone care what the listed price is and how high it gets? Net price thus serves as a kind of smokescreen that gets colleges at least partially off fo[r] charging an arm and a leg.
So what’s wrong with this analysis?
Most important is that Miller softpedals the aid effect, suggesting that the main negative consequence of ever-increasing assistance is that it bleeds off a bit of the pressure for schools to lower costs. But it likely has a much more destructive effect than that, not just curbing efficiency pressures, but enabling schools to constantly charge and spend more. It’s a likelihood that student-aid defenders try to dispel by citing studies that cover very short periods of time, or that simply pronounce that we don’t know that it happens. That it probably happens, however, has been borne out empirically, and it’s readily ackowledged by prominent higher educators including former Harvard president Derek Bok, former Stanford vice president William F. Massy, and former University of Iowa president Howard Bowen. Indeed, the latter’s “law” couldn’t be more blunt: “Universities will raise all the money they can and spend all the money they raise.”
Miller’s other major failing is that he completely ignores that all this aid has to come from somwhere, and that “somewhere” is largely taxpayers. (OK, first it’s China.) Just to give you a sense of the impact on taxpayers, College Board data show that between the 1998-99 and 2008-09 academic years, total federal aid — including grant money recipients don’t have to pay back, and loans they (sometimes) do — rose from $61.1 billion to $116.8 billion. Add state aid to that, and the total goes from $66.6 billion to $126.2 billion.
And what are some of the major downsides of these forced third-party payments? Miller mentions a few pricing difficulties for students, but makes no mention of the potentially huge negative consequences for the nation: Encouraging lots of people to attend college who simply aren’t prepared for it; cranking out many more degrees than the job market demands; and potentially slowing economic growth by taking funds from productive uses and giving it to efficiency-averse colleges and students.
The big finding in the latest College Board data, which the Quick and the ED nails, is that net college prices have been going down. The important story, however, is that this is bad news for the country. Unfortunately, the Quick and the Ed misses that almost completely.
Filed under: Education and Child Policy; Finance, Banking & Monetary Policy; Health, Welfare & Entitlements; Tax and Budget Policy
U.S. Cutting Pay for Bailed Out Company Executives
According to reports, executives from bailed out companies Citigroup, Bank of America, GM, Chrysler, GMAC, Chrysler Financial and AIG are going to see major pay cuts this year, which will be enforced by the president’s “pay czar,” Kenneth R. Feinberg. WaPo:
NEW YORK — The Obama administration plans to order companies that have received exceptionally large amounts of bailout money from the government to slash compensation for their highest-paid executives by about half on average, according to people familiar with the long-awaited decision.
The administration will also curtail many corporate perks, including the use of corporate jets for personal travel, chauffeured drivers and country club fee reimbursement, people familiar with the matter have said. Individual perks worth more than $25,000 have received particular scrutiny.
The American people have every right to be upset about generous compensation packages for executives at financial firms that are being kept alive by subsidies and bailouts.
But their ire should be directed at the bailouts, because that is the policy that redistributes money from the average taxpayer and puts it in the pockets of incompetent executives. Unfortunately, rather than deal with the underlying problems of bailouts and intervention, some politicians want to impose controls on salaries. This might be a tolerable second-best (or probably fifth-best) outcome if the compensation limits only applied to companies mooching off the taxpayers, but some politicians want to use the financial crisis as an excuse to regulate compensation at firms that do not have their snouts in the public trough.
This would be a big mistake. So long as rich people make money using non-coercive means, politicians should butt out. It should not matter whether we are talking about Tiger Woods, Brad Pitt, or a corporate CEO. The market should determine compensation, not political deal making. Markets don’t produce perfect outcomes, to be sure, but political intervention invariably produces terrible outcomes.
I debate this further on CNBC:
C/P The Hill
Filed under: Finance, Banking & Monetary Policy; General
What Caused the Crisis?
Last night National Government Radio promoted a documentary on National Government TV about the financial crisis of 2008, which concludes that the problem was . . . not enough government.
If the “Frontline” episode mentioned any of the ways that government created the crisis — cheap money from the central bank, tax laws that encourage debt over equity, government regulation that pressured lenders to issue mortgages to borrowers who wouldn’t be able to pay them back — NPR didn’t mention it.
For information on those causes, take a look at this paper by Lawrence H. White or get the new book Financial Fiasco by Johan Norberg, which Amity Shlaes called “a masterwork in miniature.” Available in hardcover or immediately as an e-book. Or on Kindle!
And for a warning about the dangers lurking in Fannie Mae and Freddie Mac, see this 2004 paper by Lawrence J. White.
Filed under: Cato Publications; Finance, Banking & Monetary Policy
Regulation and Competition among Mortgage Brokers
With the House Financial Services Committee moving forward with a bill to increase the regulation of our consumer credit markets, particularly our mortgage market, it is worth asking the question: what’s the best protection for consumers, regulation or competition?
Let’s take the example of mortgage brokers. They’ve often been targeted as one of the causes of the crisis. The story goes that they just made the loans and passed it along to the lenders and/or Wall Street and so, didn’t care about the quality of the loan.
The response of government, first at the state then the federal level, has been to subject mortgage brokers to increased oversight and licensing, with the intent to keep the “bad actors” out of the marketplace. How well did this all work out?
According to Professor Morris Kleiner and Minn Fed Economist Richard Todd, not exactly the way you’d want. What the economists found was that tighter regulation on who can become a mortgage broker is actually associated ”with higher broker earnings, fewer brokers, fewer subprime mortgages, higher foreclosure rates, and a greater percentage of high-interest-rate mortgages.”
It seems the barrier to entry created by these licensing requirements reduced competition in a manner that caused far more harm to consumer than any protections provided by increasing the “quality” of mortgage brokers.
Sound Money Essay Contest
Our friends at the Atlas Economic Research Foundation are offering prizes for the best essays on sound money by students and young faculty and policy analysts:
The Atlas Economic Research Foundation invites you to participate in its Sound Money Essay Contest, which has a deadline of November 24th, 2009.
The contest is open to students, young faculty, and policy writers who are interested in the cause of sound money. It aims to engage you in thinking about sound money principles with relevance to today’s economic challenges.
The overall winner will receive a cash prize of $5000. Two additional prizes of $1000 each will be given to outstanding essays written by junior faculty, graduate students, or policy writers. And three additional prizes of $500 each will be given to outstanding essays written by undergraduate students.
Essay topics include:
· “Money and the Free Society: Can Money Exist Outside of the State?”
· “The Ethical Implications of Monetary Manipulation”
· “Monetary Policy and the Rule of Law in the United States”
To be eligible, you must be a legal resident of the U.S. or engaged as a full-time student or faculty in the U.S. You must also be no more than 35 years old on the date of the contest deadline (November 24, 2009). Atlas welcomes involvement of older and non-U.S. scholars in its discussions and ongoing work on sound money, but this essay contest is targeted to the audience described above.
For a list of reference materials and writing guidelines, please visit the Atlas website.
And for Cato research on sound money, check here.
Federal Reserve as Cash Cow
Scheduled for consideration before the House Financial Services Committee this week is a draft bill creating a Consumer Financial Protection Agency.
While there is a lot wrong with the bill — after all it is based on the premise that somehow consumers were tricked into not making a downpayment or re-financing thousands out of their homes, and then walking away — perhaps the most important provision, and the least discussed, is funding the agency by a transfer of cash from the Federal Reserve. Section 119 of the bill requires the Federal Reserve to transfer an amount equal to 10 percent of its expenses to the new agency’s Director.
This I believe is the first time in history that Congress is using the Federal Reserve to simply fund another agency. Why stop there, how about have the Fed just prints trillions of dollars to pay for the rest of the government? If Congress believes this agency will benefit the public, then the agency should be funded by the public, by a direct appropriations raised by taxes.
Of course after watching Ben Bernanke turn the Fed’s balance sheet into a slush fund for Wall Street, it was only going to be a matter of time before someone in Congress decided to use that slush fund for their own purposes. So much for transparency in government.
What’s Wrong With Being A Renter?
A recent New York Times piece focusing on the financial health of the Federal Housing Administration (FHA), offered a couple of examples of borrowers who would not have gotten mortgages, but for FHA’s low downpayment and underwriting requirements.
Take for instance a Ms. Shimon, mentioned in the piece. If she had to come up with a larger than 3.5 percent downpayment, she “would still be a renter,” in the words of the New York Times. Yes, my reaction was probably the same as yours; no, not that, not a renter, anything but being a renter. I am trying to remember at what point in our history did being a renter become a social stigma, or some sort of disease to be cured? Of course, the article does not explain why it would be bad if Ms. Shimon had stayed a renter, because apparently the New York Times assumes all decent, upstanding people own their own homes.
Now yes, there are dozens of academic studies that show owning your own home is associated with being a better citizen, better educational and health outcomes for your children, and greater savings on the part of owners. But it is important to remember that none of these studies show that homeownership causes these outcomes, just that on average, homeownership is associated with these outcomes. More importantly, the marginal homeowner, who would not have bought a home without some sort of subsidy, is likely to be quite different than the average homeowner.
Some, like my home-building friends, might justify ever-expanding homeownership because it creates construction jobs. But so does building apartments. If we had a shortage of apartments, then maybe encouraging people to buy homes would relieve pressure on the rental market. But the glut of apartments is almost as big as the glut in homes. Rental vacancy rates are near historic highs in much of the country. Even with declining home prices, in many places it still makes more financial sense to rent.
The federal government’s obsession with homeownership was one of the contributing factors to the financial crisis. It is time we recognized renting as a viable option for many households, and starting treating renters as if they were as equal citizens as anyone else.
Perpetuating Bad Housing Policy
Perhaps the worst feature of the bailouts and the stimulus has been that, whatever their merits as short terms fixes, they have done nothing to improve economic policy over the long haul; indeed, they compound past mistakes.
Here is a good example:
For months, troubled homeowners seeking to lower their mortgage payments under a federal plan have complained about bureaucratic bungling, ceaseless frustration and confusion. On Thursday, the Obama administration declared that the $75 billion program is finally providing broad relief after it pressured mortgage companies to move faster to modify more loans.
Five hundred thousand troubled homeowners have had their loan payments lowered on a trial basis under the Making Home Affordable Program.
The crucial words in the story are “$75 billion” and “pressured.”
No one should object if a lender, without subsidy and without pressure, renegotiates a mortgage loan. That can make sense for both lender and borrower because the foreclosure process is costly.
But Treasury’s attempt to subsidize and coerce loan modifications is fundamentally misguided. It means many homeowners will stay in homes, for now, that they cannot really afford, merely postponing the day of reckoning.
Treasury’s policy is also misguided because it presumes that everyone who owned a house before the meltdown should remain a homeowner. Likewise, Treasury’s view assumes that all the housing construction over the past decade made good economic sense.
Both presumptions are wrong. U.S. policy exerted enormous pressure for increased mortgage lending in the years leading up to the crisis, thereby generating too much housing construction, too much home ownership and inflated housing prices.
The right policy for the U.S. economy is to stop preventing foreclosures, to stop subsidizing mortgages, and to let the housing market adjust on its own. Otherwise, we will soon see a repeat of the fall of 2008.
New Paper: Would a Stricter Fed Policy and Financial Regulation Have Averted the Financial Crisis?
Many commentators have argued that if the Federal Reserve had followed a stricter monetary policy earlier this decade when the housing bubble was forming, and if Congress had not deregulated banking but had imposed tighter financial standards, the housing boom and bust—and the subsequent financial crisis and recession—would have been averted.
In a new study, Cato scholars Jagadeesh Gokhale and Peter Van Doren investigate those claims and dispute them.
Filed under: Cato Publications; Finance, Banking & Monetary Policy
Eyewitness to Government’s Robbery of Chrysler Creditors
Further to Ilya Shapiro’s post this morning, let me also point you to a concise chronology of events culminating in the government’s robbery of Chrysler creditors.
The story is that of Richard Mourdock, Treasurer of the State of Indiana and the man responsible for stewardship of the state’s pension funds, some of which were victimized by the Obama administration’s pre-packaged and then forced-fed bankruptcy deal for Chrysler. I strongly urge you to read Mr. Mourdock’s testimony, which is at once revealing, sobering, compelling and, regrettably, a frightening sign of the times.
Mourdock will be speaking on this very topic at Cato, along with bankruptcy law expert David Skeel, on Thursday, October 15 at noon. Reserve your seat now.
Filed under: Finance, Banking & Monetary Policy; Government and Politics; Law and Civil Liberties
The Government Robbed Chrysler Creditors
In January 2009, Chrysler stood on the brink of insolvency. Purporting to act under the Emergency Economic Stabilization Act, the Treasury extended Chrysler a $4 billion loan using funds from the Troubled Asset Relief Program (TARP). Still in a bad financial situation, Chrysler initially proposed an out-of-court reorganization plan that would fully repay all of Chrysler’s secured debt. The Treasury rejected this proposal and instead insisted on a plan that would completely eradicate Chrysler’s secured debt, hinging billions of dollars in additional TARP funding on Chrysler’s acquiescence.
When Chrysler’s first lien lenders refused to waive their secured rights without full payment, the Treasury devised a scheme by which Chrysler, instead of reorganizing under a chapter 11 plan, would sell its assets free of all secured interests to a shell company, the New Chrysler. Chrysler was thus able to avoid the “absolute priority rule,” which provides that a court should not approve a bankruptcy plan unless it is “fair and equitable” to all classes of creditors.
Cato joined the Washington Legal Foundation, Allied Educational Foundation, and George Mason law professor Todd Zywicki on a brief supporting the creditors’ petition asking the Supreme Court to review the transaction’s validity. We argue that the forced reorganization amounted to the Treasury redistributing value from senior, secured creditors to debtors and junior, unsecured creditors.
The government should not be allowed, through its own self-dealing, to hand-pick certain creditors for favorable treatment at the expense of others who would otherwise enjoy first lien priority. Further, a lack of predictability and consistency with regard to creditors’ expectations in bankruptcy will result in a destabilization of existing and future credit markets.
The Court will be deciding whether to hear the case later this fall. Thanks very much to Cato legal associate Travis Cushman for his help with the brief.
Filed under: Finance, Banking & Monetary Policy; Government and Politics; Law and Civil Liberties
Limitations of Bank Capital Regulation
Politicians and bank regulators across the world have come to the conclusion that excessive leverage, that is too much debt relative to equity, contributed to the depth of our recent financial crisis. Their solution: require banks to have more capital. If only it were so easy.
As Raghuram Rajan points out in a recent piece for the Financial Times, “banks will not be passive in the face of regulatory change.” Indeed, they will not. For instance, if you simply double a bank’s minimum required capital, the bank could respond by doubling the risk of loans on its portfolio. You move capital 8% to 16%, the bank can makes loans that default with expected losses at 16% and you haven’t done anything to reduce the risk in the system.
The problem with excessive leverage in our financial system was not that there was too much debt, but that debt-holders believed they would be bailed-out and hence provided little to no monitoring of bank activities. Reducing leverage does not increase the incentives of debt-holders to monitor, in fact it may reduce it, because debt-holders will now believe there is an even bigger cushion before they take any losses.
Why is it important for debt-holders to monitor the behavior of banks anyway? Because they are the largest piece of a bank’s capital structure. With an 8% equity stake, debt makes up 92% of the capital structure; with even a 16% equity stake, debt is still 84% of the capital structure. If there is no market discipline on debt-holders, then we essentially have no market discipline.
So how then to give debt-holders the appropriate incentives to monitor bank behavior? Quite simple, put them on the hook for losses. Rajan suggests we create “contingent capital” – debt that would convert to equity if capital levels fell below a certain level. While the devil is in the details, providing some system to impose losses on debt-holders is essential if we ever want to have functioning financial markets. Simply raising capital requirements does not solve that problem.
The Czar Will Rule
President Obama’s real czar, “pay czar” Ken Feinberg, who has real power, brushes aside such claims even as he prepares to issue his Gosplan-style edicts on future and even past pay agreements:
The Obama administration’s pay czar says negotiations over executive compensation with the seven companies that received the biggest federal bailouts have been “a consensual process’’ – not a matter of forcing decisions on them.
“I’m hoping I won’t be required to simply make a determination over company objections,’’ veteran Washington attorney Kenneth Feinberg told the Chicago Bar Association in a speech.
But note: he’s “hoping” he won’t have to impose his own view. He’s hoping the companies will accede to his power without complaining. But the fact remains, he doesn’t have to get their consent. He “has sole discretion to set compensation for the top 25 employees of each of those companies,” and his decisions “won’t be subject to appeal.” Or, as Feinberg himself puts it,
The statute provides these guideposts, but the statute ultimately says I have discretion to decide what it is that these people should make and that my determination will be final. The officials can’t run to the Secretary of Treasury. The officials can’t run to the court house or a local court. My decision is final on those individuals.
That’s power. So where is Doonesbury? We need him to update his classic 1970s “energy czar” strips.
Filed under: Finance, Banking & Monetary Policy; General; Government and Politics; Political Philosophy
Credit Card Act Is Affecting the Job Market
Despite the economic stimulus and various financial bailouts, our economy continues to shed jobs. One of the reasons for continued job losses is the decline in new hires, especially the lack of new hiring by small business.
As bank analyst Meredith Whitney discusses in the Wall Street Journal [$], all the major credit programs created by Congress and the Federal Reserve have been targeted at big corporations and Wall Street firms. However, small companies, especially start-ups and partnerships, do not issue bonds in the debt markets, nor do they borrow from Goldman Sachs. So these firms have been left out in the cold, as federal credit inventions have favored corporate America.
Adding insult to injury is that not only has Washington subsidized credit to large firms, it has taken actions that restrict the credit available to small firms and start-ups. The prime example of this is the Credit Card Reform Act signed by President Obama in May.
As Whitney reports, “Credit cards are the most common source of liquidity to small businesses, used by 82 percent as a vital portion of their overall funding.” In restricting the usage of credit cards and reducing the ability to risk-base price, Washington has eliminated the most important source of credit to small business.
Of course, being unable to project their future health care costs, or tax burdens (yes, they are going up, but by how much), many small businesses have either been forced to or chosen to sit on the sidelines of our economy. Washington needs to recognize that Wall Street and corporate American are not the sum of our economy, if we hope to turn the employment situation around.
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