Archive for the ‘Finance, Banking & Monetary Policy’ Category
Tim Geithner: The Forrest Gump of World Finance
One almost feels sorry for Treasury Secretary Tim Geithner.
He’s a punchline in his own country because he oversees the IRS even though he conveniently forgot to declare $80,000 of income (and managed to get away with punishment that wouldn’t even qualify as a slap on the wrist).
Now he’s becoming a a bit of a joke in Europe. Earlier this month, a wide range of European policy makers basically told the Treasury Secretary to take a long walk off a short pier when he tried to offer advice on Europe’s fiscal crisis.
And the latest development is that the German Finance Minister basically said Geithner was “stupid” for a new bailout scheme. Here’s an excerpt from the UK-based Daily Telegraph.
Germany and America were on a collision course on Tuesday night over the handling of Europe’s debt crisis after Berlin savaged plans to boost the EU rescue fund as a “stupid idea” and told the White House to sort out its own mess before giving gratuitous advice to others.German finance minister Wolfgang Schauble said it would be a folly to boost the EU’s bail-out machinery (EFSF) beyond its €440bn lending limit by deploying leverage to up to €2 trillion, perhaps by raising funds from the European Central Bank.”I don’t understand how anyone in the European Commission can have such a stupid idea. The result would be to endanger the AAA sovereign debt ratings of other member states. It makes no sense,” he said.
All that’s missing in the story is Geithner channeling his inner Forrest Gump and responding that “Stupid is as stupid does.”
...at birth?
Separated...
This little spat reminds me of the old saying that there is no honor among thieves. Geithner wants to do the wrong thing. The German government wants to do the wrong thing. And every other European government wants to do the wrong thing. They’re merely squabbling over the best way of picking German pockets to subsidize the collapsing welfare states of Southern Europe.
But that’s actually not accurate. German politicians don’t really want to give money to the Greeks and Portuguese.
The real story of the bailouts is that politicians from rich nations are trying to indirectly protect their banks, which – as shown in this chart – are in financial trouble because they foolishly thought lending money to reckless welfare states was a risk-free exercise.
Europe’s political class claims that bailouts are necessary to prevent a repeat of the 2008 financial crisis, but this is nonsense – much as American politicians were lying (or bamboozled) when they supported TARP.
It is a relatively simple matter for a government to put a bank in receivership, hold all depositors harmless, and then sell off the assets. Or to subsidize the takeover of an insolvent institution. This is what America did during the savings & loan bailouts 20 years ago. Heck, it’s also what happened with IndyMac and WaMu during the recent financial crisis. And it’s what the Swedish government basically did in the early 1990s when that nation had a financial crisis.
But politicians don’t like this “FDIC-resolution” approach because it means wiping out shareholders, bondholders, and senior management of institutions that made bad economic choices. And that would mean reducing moral hazard rather than increasing it. And it would mean stiff-arming campaign contributors and protecting the interests of taxpayers.
Heaven forbid those things happen. After all, as Bastiat told us, “Government is the great fiction, through which everybody endeavors to live at the expense of everybody else.”
Cochrane’s Kinky Curves
The doctrine that inflation can cure unemployment, implicit in the Obama administration’s spending blowout, goes way back.
The modern version originated with William Phillips, a New Zealand-born economist who, in 1958, wrote a paper modestly titled “The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861‑1957.” Phillips suggested that when inflation went up, unemployment went down. Keynesian economists Paul Samuelson and Robert Solow popularized Phillips’ idea as a reason to ratchet up government spending and inflate the money supply. That’s what the Kennedy and Johnson administrations did during the 1960s.
In 1967, Milton Friedman expressed a skeptical view about what had come to be known as the Phillips Curve, launching an extended debate. Then in 1973, President Richard Nixon, who had famously declared “I am now a Keynesian,” leaned hard on Fed Chairman Arthur Burns to inflate the money supply and drive down unemployment, hopefully to improve Nixon’s prospects for re-election. Well, as those of us who were around back then recall, both inflation and unemployment went up! This was a bit of a problem for Phillips Curve aficionados.
As if the stubborn stagflation of the 1970s wasn’t bad enough, subsequent efforts by new Fed Chairman Paul Volcker and President Ronald Reagan to stop inflation cold delivered another hammer blow against the Phillips Curve: both inflation and unemployment went down!
Now fast-forward to January 2009: President Obama levitated the Phillips Curve from the dead when he repeatedly declared that it was urgent to enact his $825 billion stimulus bill so unemployment would go down. But both spending and unemployment went up! It became harder to deny that the stimulus spending flopped, though the New York Times’ Keynesian columnist Paul Krugman tried valiantly. He claimed stimulus spending flopped because Obama didn’t spend enough. Accordingly, several weeks ago, Obama proposed still more stimulus spending to fight unemployment, and he begged people to support it: “If you love me, pass this bill!”
There shouldn’t have been any surprise about Obama’s flop, since the underlying idea – the Phillips Curve – proved to be a dud long ago. This would be a good time to review experience with the Phillips Curve.
Thankfully, Cato Adjunct Scholar John H. Cochrane, the AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business, has done just that. He focused on the period from 1966 to the present. That year, President Lyndon Johnson was going full bore, promoting runaway spending on new entitlement programs and on the Vietnam war simultaneously, and inflation reared its ugly head.
Cochrane charted what happened year-by-year to inflation and unemployment. The result wasn’t a nice smooth curve dreamed about by Keynesians. Rather, there was a kinky curve. One year, inflation went up, and unemployment went down. Next year, inflation went up again, and unemployment went up. Then when inflation went down, unemployment went up again. On and on as if we followed a drunk stumbling around a street. Since a single chart would have become an unreadable tangle if it tried to cover the entire 45-year period, Cochrane developed two charts, 1966-1984 and 1985-2011. Clearly, what we see is a random relationship between inflation and unemployment, that makes the Phillips Curve worthless as a policy tool.
The charts appear in an insightful article Cochrane wrote, published in the Fall 2011 National Affairs. The article is important quite apart from the Phillips Curve charts. Although the prevailing view seems to be that high inflation is most likely to occur if and when the Fed increases the money supply, Cochrane warns high inflation could occur as a consequence of soaring government debt. Such inflation would amount to a default. It would be triggered by a run on dollar-denominated assets, if and when investors conclude that the government cannot pay its debts. Runs occur without warning, often after a succession of events have undermined investor confidence.
On A Rental Solution to the Foreclosure Crisis
Dealing with the large overhang of foreclosed homes has been an issue vexing both policy-makers and real estate professionals, especially since both continue to resist the obvious solution of letting prices fall to their market-clearing levels. The latest “solution” is to increase the demand for excess housing by converting said homes to rental properties.
My first reaction to the proposal was maybe, but then are not the housing markets with excess owner units the same markets with a glut of apartments? Shifting a unit wouldn’t seem to impact the overall excess supply in a given market. Given my general willingness to subject my suspicions to empirical testing, off to the Census Bureau’s Housing Vacancy Survey I did go.
It seems my first reaction was half-right. If one compares owner vacancy rates with rental vacancy rates across metro areas, you do indeed find a positive correlation, but only about .5, which leaves considerable room for variation. Interestingly enough, that correlation, while still positive, becomes considerably smaller (.26) if one looks at just housing markets with above average owner vacancy rates.
The bottom line, in some markets like Portland OR or Seattle WA, the rental market is not so glutted that it could likely absorb a significant amount of vacant homes. In other markets, like Jacksonville FL, Dayton OH Phoenix, AZ or Las Vegas, NV, there is both a surplus of owner and rental properties. This implies that such homes would not be quickly rented or would have to rent at a considerable discount. Unsurprisingly these double glut markets are where the foreclosure crisis is centered.
Of course none of this changes the fact that the best way to get the housing market moving is to have the government stop meddling and allow market fundamentals to drive prices, instead of using government to pretend the bubble never ended.
The Federal Reserve, the ‘Twist,’ Inflation, QE3, and Pushing on a String
In a move that some are calling QE3, the Federal Reserve announced yesterday that it will engage in a policy called “the twist” — selling short-term bonds and buying long-term bonds in hopes of artificially reducing long-term interest rates. If successful, this policy (we are told) will incentivize more borrowing and stimulate growth.
I’ve freely admitted before that it is difficult to identify the right monetary policy, but it certainly seems like this policy is — at best — an ineffective gesture. This is why the Fed’s various efforts to goose the economy with easy money have been described as “pushing on a string.”
Here are two related questions that need to be answered.
1. Is the economy’s performance being undermined by high long-term rates?
Considering that interest rates are at very low levels already, it seems rather odd to claim that the economy will suddenly rebound if they get pushed down a bit further. Japan has had very low interest rates (both short-run and long-run) for a couple of decades, yet the economy has remained stagnant.
Perhaps the problem is bad policy in other areas. After all, who wants to borrow money, expand business, create jobs, and boost output if Washington is pursuing a toxic combination of excessive spending and regulation, augmented by the threat of higher taxes.
2. Is the economy hampered by lack of credit?
Low interest rates, some argue, may not help the economy if banks don’t have any money to lend. Yet I’ve already pointed out that banks have more than $1 trillion of excess reserves deposited at the Fed.
Perhaps the problem is that banks don’t want to lend money because they don’t see profitable opportunities. After all, it’s better to sit on money than to lend it to people who won’t pay it back because of an economy weakened by too much government.
The Wall Street Journal makes all the relevant points in its editorial.
Read the rest of this post »
Should the Federal Reserve Supervise Banks?
For about all of 5 minutes during the deliberations of the Dodd-Frank Act (to the extent there were deliberations) proposals were offered to separate the conduct of monetary policy from the regulation of banks. That is, remove the Federal Reserve’s supervision of banks and transfer such authority to another agency. Given the close relationship between Treasury, who was negotiating the bill for the White House, and the Fed, this was never a real possibility.
But would we have been better off removing the Fed’s supervision authorities? A recent NBER working paper by Barry Eichengreen and Nergiz Dincer suggest we would be. The authors examine 140 countries and analyze whether the combination or separation of monetary policy and bank regulation had any influence on the banking sector.
Their results: 1) Relative to countries that combine monetary policy and banking regulation, those countries that separate the two have fewer nonperforming loans as a percent of GDP; 2) They also have lower bank capital requirements, presumably because they have less need to protect against bad loans; 3) savers enjoy higher deposit rates; and 4) there is some weak evidence that separated systems have fewer systemic banking crises. These all seem like worthwhile goals to me.
Given the renewed, and much deserved, attention the Fed is now getting in political circles, we might actually have the opportunity, under a new President, for reform of our banking and monetary systems that would reduce bailouts and financial crises, rather than increase them.
Ackermann and Dimon 1; Bernanke and Geithner 0
My last blog on bank capital requirements concluded that the push to implement Basel III, which mandates increases in bank capital-asset ratios, is a deadly cocktail to ingest in the middle of an economic slump.
Shortly after, the Chairman of Deutsche Bank Josef Ackermann weighed in during a Frankfurt speech with a blistering attack on raising capital-asset ratios in the middle of a slump. He was armed with heavy artillery – namely, “The Cumulative Impact on the Global Economy of Changes in the Financial Regulatory Framework,” a 123 page Institute of International Finance report that was hot off the press.
Today, the Financial Times reports that Jamie Dimon, Chief Executive of JPMorgan, has gone even further than Ackermann. Indeed, Dimon suggests that the new Basel III capital requirements are “anti-American” and that the U.S. should consider pulling out of the Bank for International Settlements in Basel, Switzerland.
Both Ackermann and Dimon are right. The cheerleaders for the imposition of higher bank capital requirements in the middle of a slump – like U.S. Treasury Secretary Timothy Geithner and Fed Chairman Ben Bernanke – are wrong.
We can demonstrate the validity of this conclusion with ease. Higher capital-asset ratios are “deflationary.” If we hold the level of a bank’s capital constant, an increase in its capital-asset ratio requires that the level of its assets must fall. This, in turn, implies that the banking system’s liabilities – demand deposits – must contract. Since the money supply consists of demand deposits, among other things, the money supply must, therefore, contract.
Alternatively, if we hold assets constant, an increase in the capital-asset ratio requires an increase in capital. This destroys money. When an investor purchases newly-issued bank shares, for example, the investor exchanges funds from a bank deposit for the new shares. This reduces deposit liabilities in the banking system and wipes out money.
It’s no surprise that Sir John Hicks – a high priest of economic theory and 1972 Nobelist – thought there was nothing more important than a balance sheet.
If Geithner, Bernanke and other members of the official chattering classes insist on higher bank capital-asset ratios, the U.S. might, unfortunately, revisit 1937. It’s time to listen to Ackermann and Dimon.
Kinks in Obama’s Home Refinancing Plans
In the president’s electioneering lecture to Congress, Mr. Obama said, “To help responsible homeowners, we’re going to work with federal housing agencies to help more people refinance their mortgages at interest rates that are now near 4 percent. . . . I know you guys must be for this, because that’s a step that can put more than $2,000 a year in a family’s pocket, and give a lift to an economy still burdened by the drop in housing prices.”
Unfortunately, it is not quite that simple. Because using the leverage of Fannie Mae, Freddie Mac, or the Federal Housing Administration to promote riskier standards for refinancing would benefit only those homeowners who stay put in houses they already own, the unintended effect on sales of new or existing homes could be negative. Moreover, gains to borrowers would be offset by potentially larger losses to investors in mortgage-backed securities (MBSs) — the “toxic assets” that provoked so much financial mischief in 2008.
As it happens, the Congressional Budget Office just released an “An Evaluation of Large-Scale Mortgage Refinancing Programs” by two CBO staffers and Deborah Lucas, a first-rate economist on loan from M.I.T.
Here are some key points:
We analyze a stylized large-scale mortgage refinancing program that would relax current income and loan-to-value restrictions for borrowers who wish to refinance and whose mortgages are currently insured by Fannie Mae, Freddie Mac, or the Federal Housing Administration. The analysis relies on an estimate of the volume of incremental refinancing that would occur and an estimate of how future default and prepayment behavior would be affected by such refinancing. Relative to the status quo, the specific program analyzed here is estimated to cause an additional 2.9 million mortgages to be refinanced, resulting in 111,000 fewer defaults on those loans and estimated savings for the GSEs and FHA of $3.9 billion on their credit guarantee exposure, measured on a fair-value basis. Offsetting those savings, federal investors in MBSs, including the Federal Reserve, the GSEs, and the Treasury, would experience an estimated fair-value loss of $4.5 billion. . . .
We also discuss the impact of this program on various stakeholders, including homeowners, non-federal mortgage investors, mortgage lenders, mortgage service providers, private mortgage insurers, and subordinated mortgage holders. For example, non-federal investors would experience an estimated fair-value loss of $13 to $15 billion; most of that wealth would be transferred to borrowers. . . .
In aggregate, the fair-value loss to both federal and non-federal investors is equivalent to the gain experienced by borrowers from the decline in their interest payments. . . Nevertheless, because a significant share of investors is composed of foreigners and the U.S. government, and because private investors would be expected to reduce spending in response their losses by less than the increase in spending by borrowers in response to their lower interest payments as well as their lower mortgage principal payments, the net effect would be an economic stimulus . . . but it is likely to be small relative to GDP.
With respect to the housing market, the overall impact of the program is also small; the 111,000 homeowners saved from foreclosure by virtue of lower monthly mortgage payments will have a minor impact on the path of future home prices. Because this program is directed toward current homeowners, it would do little to alleviate the tighter underwriting standards and increased credit pricing for purchase loans. In addition, it would not create much demand for homes, because all of its participants would already have at least one property.
If You Like Obama’s Economic Team, You’ll Love Romney’s…
Just when you thought Keynesian economics was finally dead among Republicans, Mitt Romney announces two prominent New Keynesian academics, Greg Mankiw and Glenn Hubbard, as the heart of his economic team. So if you loved how Obama has managed to continue the flawed economics of the Bush administration*, you’ll feel pretty safe with Romney.
Sadly the real problem goes beyond Romney and Obama. The financial crisis and the government’s response to it illustrate the failure of much of mainstream macroeconomics. Yes, the Romney team would have had its stimulus proposal tilted more toward temporary tax cuts, but it still would have made efforts at government fine-tuning of the economy. In the grand scheme of things, there is not a dime’s worth of difference between Mankiw, Bernanke, and Romer.
Romney’s announcement does, however, give the other Republican candidates an opportunity to appoint someone outside the failed New Keynesian consensus that rules macroeconomics.
*In the interest of full disclosure: I spent 11 months with the Bush administration, leaving once I figured how there was no real commitment to free markets.
Are Tax Havens Moral or Immoral?
Being the world’s self-appointed defender of so-called tax havens has led to some rather bizarre episodes.
For instance, the bureaucrats at the Organization for Economic Cooperation and Development threatened to have me thrown in a Mexican jail for the horrible crime of standing in the public lobby of a hotel and giving advice to low-tax jurisdictions.
On a more amusing note, my efforts to defend tax havens made me the beneficiary of grade inflation and I was listed as the 244th most important person in the world of global finance — even higher than George Soros and Paul Krugman.
But if that makes it seem as if the battle is full of drama and (exaggerated) glory, that would be a gross exaggeration. More than 99 percent of my time on this issue is consumed by the difficult task of trying to convince policymakers that tax competition, fiscal sovereignty, and financial privacy should be celebrated rather than persecuted.
Sort of like convincing thieves that it’s a good idea for houses to have alarm systems.
And it means I’m also condemned to the never-ending chore of debunking left-wing attacks on tax havens. The big-government crowd viscerally despises these jurisdictions because tax competition threatens the ability of politicians to engage in class warfare/redistribution policies.
Here’s a typical example. Paul Vallely has a column, entitled “There is no moral case for tax havens,” in the UK-based Independent.
To determine whether tax havens are immoral, let’s peruse Mr. Vallely’s column. It begins with an attack on Ugland House in the Cayman Islands.
There is a building in the Cayman Islands that is home to 12,000 corporations. It must be a very big building. Or a very big tax scam.
As I’ve already explained in a post about a certain senator from North Dakota, a company’s home is merely the place where it is chartered for legal purposes. A firm’s legal domicile has nothing to do with where it does business or where it is headquartered.
Why Congressional Budget Office Estimates and Policy Options Are Taken Much Too Seriously
Coercive redistribution and diversity in the interests of its constituent groups are essential features of the modern welfare state. Disagreement over perceived consequences of social policy creates the demand for publicly justified “objective” evaluations. If there were no coercion, redistribution and intervention would be voluntary activities and there would be no need for public justification for voluntary trades.
−James J. Heckman (winner of the 2000 Nobel Prize in Economics), “Accounting for Heterogeneity, Diversity and General Equilibrium in Evaluating Social Programs,” National Bureau of Economic Research Working Paper No. 7230, July 1999.
Three Strikes and You’re Out
When the Wall Street Journal, the Financial Times and the New York Times agree on the merits of a policy, readers will understandably be confused.
At the annual rendezvous of central bankers in Jackson Hole, Wyoming this past weekend, the IMF’s new managing director Christine Lagarde asserted that Europe’s banks should be recapitalized. This, she claimed, would make the banks “safer” and improve the chances for European growth.
On August 29th, I wrote that Ms. Lagarde had misdiagnosed Europe’s banking problems and is confused. Indeed, her prescription would be deflationary and put more stress on Europe’s fragile economies.
On August 30th, I criticized the Wall Street Journal‘s editorial which praised Ms. Lagarde’s recapitalization ideas. Strike one.
On August 31st, I commented on the F.T.‘s effusive endorsement of Ms. Lagarde’s recapitalization proposals. Strike two.
With the New York Times, we have strike three. Ms. Lagarde’s recapitalization ideas are out.
Recapitalizing banks in the middle of economic troubles is a dangerous and unwise course. For more on this issue, I recommend Prof. Tim Congdon’s book Money in a Free Society which Encounter Books will release in October. Prof. Congdon’s book is profound and I am pleased that its dust jacket will carry my endorsement:
Prof. Tim Congdon, one of the world’s most eminent monetarists, employs his multiple talents and experience – as a first-rate scholar, market economist and financial journalist – to unravel the mysteries of modern money and banking systems. His most careful and anxious attention to the arguments proffered in the great canonical works and debates of the past is unmatched. This, coupled with his mastery of the tricky intricacies of modern money, will ensure that readers of “Money in a Free Society” are richly rewarded. Among other things, they will learn that Nobelist Paul Krugman and the Chairman of the Federal Reserve Ben S. Bernanke have a tenuous grasp on both economic theory and reality, rendering their analyses of the current crisis wrong and/or irrelevant.
Ed DeMarco: A Rare Public Servant
I spend a lot of time pointing out government gone wrong. Sadly it doesn’t take that much effort. But occasionally you come across someone actually doing their job and trying to protect the taxpayer. As illustrated in today’s Wall Street Journal, Edward DeMarco, the acting director of the Federal Housing Finance Agency (FHFA), which regulates Fannie Mae and Freddie Mae, is such a person.
Mr. DeMarco has continued to push back against repeated plans by the Obama Administration to use Fannie and Freddie as off-budget slush-funds (they seem to have forgotten such was one of the reasons we are in our current economic mess).
As I explained yesterday, by pushing back DeMarco is simply carrying out the law as it was both written and intended. It is particularly sad to see a former Obama Administration official, who now “teaches” law, complain about DeMarco missing the big picture. As if somehow the “big picture” empowers DeMarco to ignore the law. DeMarco showed his integrity by saying, “”If we’re not authorized to do it, that’s a dangerous place to be.” He’s absolutely correct. Although he should have just stopped at “not authorized to do it.”
After the lawlessness practiced by various financial regulators in 2008, it is commendable to see a true public servant reminding us that legislative decisions are the province of legislators, not regulators. If more regulators behaved this way, we would have avoided some of the mess we are now in.
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