Archive for the ‘Finance, Banking & Monetary Policy’ Category
Greece Is Imploding
Money matters. That’s why I have kept my eye on Greece’s money supply (M3). It’s been contracting in an increasing rate since February 2010. Since March 2010, I have concluded that the writing was on the wall and that all the debt sustainability numbers calculated by the International Monetary Fund, the European Union and the Greek government could be thrown in their respective bureaucratic trash cans. Well, even though the Bank of Greece is still behind the curve, it’s catching up. The Bank has just revised its forecast of Greece’s 2012 growth — down from -4.5% to -5.0%. The current annual rate of contraction (-19%) of the Greek money supply guarantees many more eruptions from that Balkan nation.
If Only Politicians Were More Like Good Parents
Sometimes I wish politicians were more like good parents. I know that doesn’t sound very libertarian — the last thing we want is for politicians to become humanity’s moms and dads — but there’s at least one thing good parents do that most politicians constantly avoid: saying “no.”
When kids want their food pyramids to have a base of candy, center of ice cream, and peak of ice cream with candy sprinkles, good parents say “no.”
When young ‘uns want to show off their mumblety-peg skills with the Bowie knife they found in dad’s old camping gear, good parents say “no.”
And when the children want to borrow the family sedan for a little off-road speed competition, good parents say “no.”
Of course, saying no all the time doesn’t make life with the kiddos easy or fun. The kids get angry. Mom and dad fume. “I hate you” may even be uttered. But refusing to help the children seriously endanger their arteries, digits, or worse – even if it makes the parents’ life tougher – is what good parenting is all about.
If only our politicians would exercise the same restraint. But they don’t, with the latest case-in-point being the drive to keep interest rates on subsidized federal student loans at super-low levels. It will be the centerpiece of a three-state presidential tour beginning today.
Currently, interest rates on subsidized loans — loans on which Washington pays the interest while a borrower is in school and for a six-month period after graduation — are at 3.4 percent, a surface-skimming level reached after the College Cost Reduction and Access Act of 2007 cut rates in half over a five year period. Rates are scheduled to return to 6.8 percent in July.
The argument proffered for keeping the rates at 3.4 percent is that interest rates generally are at historic lows, and 6.8 percent would simply be too high. Much more important, though, seems to be the political reality: President Obama appears intent on currying favor with both college students and, frankly, any voters looking at exorbitant college prices and asking “how the heck am I going to pay for that?”
But it’s not just the current president who appears to be playing politics. Mitt Romney, the presumptive GOP challenger to Mr. Obama, yesterday also urged Congress to freeze the rate at 3.4 percent.
World Bank: Anti–Money Laundering Rules Hurt the Poor
I’ve complained many times about the pointless nature of anti–money laundering laws. They impose very high costs and force banks to spy on their customers, but they are utterly ineffective as a weapon against criminal activity. Yet politicians and bureaucrats keep making a bad system worse, and the latest development is a silly scheme to ban $100 bills!
It also seems that poor people are the main victims of these expensive and intrusive laws. According to a new World Bank study, half of all adults do not have a bank account, with 18 percent of those people (click on the chart below for more info) citing documentation requirements—generally imposed as part of anti–money laundering rules—as a reason for being unable to participate in the financial system.
But this understates the impact on the poor. Of those without bank accounts, 25 percent said cost was a factor, as seen in the chart below. One of the reasons that costs are high is that banks incur regulatory expenses for every customer, in large part because of anti–money laundering requirements, and then pass those costs on to consumers.
Time for Me to Defend My Work on Tax Havens
A few days ago, I explained why I’m a big fan of tax competition. Simply stated, we need to subject governments to competitive pressure to at least partially offset the tendency of politicians to over-tax and over-spend.
Tax havens play an important role in this liberalizing process, largely because they do not put themselves under any obligation to enforce the bad tax laws of other jurisdictions. They also use privacy laws to protect their sovereign control of what gets taxed inside their borders (this is what separates a “tax haven” from a more conventional low-tax jurisdiction). This means they are fiscal safe zones, particularly for people who want to protect their assets from the pervasive double taxation that exists in so many nations.
Not everybody agrees with my analysis (gee, what a surprise). To cite one example, the petty bureaucrats at the OECD got so agitated at me in 2009 (when I was offering advice to representatives of so-called tax havens while standing in a public lobby of a public hotel) that they threatened to have me thrown in a Mexican jail.
Now I have a new critic, though hopefully someone who would never consider thuggish tactics to suppress dissent. Ann Hollingshead writes for the Task Force on Financial Integrity and Economic Development, which (notwithstanding the name of the organization) seems to favor bigger government.
Anyhow, she wrote an article specifically criticizing my work on tax havens. So I figured it was time for a fisking, which means a point-by-point rebuttal. Here’s how she begins, and I’ll follow up her points with my responses.
Officially Dan Mitchell is a Senior Fellow at the Cato Institute, a conservative public policy research organization, and a researcher on tax reform. Unofficially, he has (perhaps ironically?) called himself the “world’s self-appointed defender of so-called tax havens.”
No irony on my part. As I have openly stated, tax havens are a key part of tax competition, which is a necessary (though sadly not sufficient) process to restrain the greed of the political class.
Oddly enough, Mitchell and I agree on many of the facts about these havens. We both have observed, for example, that there are buildings in Delaware and the Cayman Islands that house thousands of corporations. Mitchell concludes there is nothing wrong with either; I conclude there is something wrong with both. Mitchell also agrees that the United States“could be considered the world’s largest tax haven.” On that topic, he’s even cited my paper on non-resident deposits in secrecy jurisdictions. In his comment, he does not take issue with my methodology or my results, but rather concludes that my finding that the United States is the largest holder of non-resident deposits “makes the case for pro-market policies.” I, on the other hand, have argued that these findings support across the board reform, rather than that limited to traditional offshore financial centers.
Fair enough. We both recognize that the United States is a big tax haven. But we have different conclusions. I think it is unfortunate that only non-resident foreigners can benefit from these policies, while Ann wants to crack down on small low-tax jurisdictions such as Monaco, Bermuda, Liechtenstein, and the Cayman Islands, as well as big nations such as the United States. Sadly, Ann’s side has somewhat prevailed, and many of the havens have agreed to become deputy tax collectors for nations with bad tax law.
So how is it that two (relatively intelligent?) people can draw such different conclusions? I would argue our differences lie not in our facts, or perhaps even our economics, but in our underlying philosophical and theoretical differences.
I guess I should be happy that she holds out the possibility that I’m “relatively intelligent.”
Revolt of the Irish Tax Slaves
I wrote last year about a backlash from long-suffering Greek taxpayers. These people – the ones pulling the wagon rather than riding in the wagon – are being raped and pillaged by a political class that is trying to protect the greedy interest groups that benefit from Greece’s bloated public sector.
We now have another group of taxpayers who are fighting back against greedy government. My ancestors in Ireland have decided that enough is enough and there is widespread civil disobedience against a new property tax.
Here are the key details from an AP report.
Ireland is facing a revolt over its new property tax. The government said less than half of the country’s 1.6 million households paid the charge by Saturday’s deadline to avoid penalties. And about 5,000 marched in protest against the annual conference of Prime Minister Enda Kenny’s Fine Gael party. Emotions ran raw as police backed by officers on horseback stopped demonstrators from entering the Dublin Convention Centre. …One man mistakenly identified as the government minister responsible for collecting the tax had to be rescued by police from an angry scrum. Kenny said his government had no choice, but to impose the new charge as part of the nation’s efforts to emerge from an international bailout. …The charge this year is a flat-fee €100 ($130) per dwelling, but is expected to rise dramatically next year once Ireland starts to vary the charge based on a property’s estimated value. Anti-tax campaigners have urged the public to ignore the tax demand, arguing that the government doesn’t have the power to collect it.
What makes this new tax so outrageous is that Irish taxpayers already have been victimized with higher income tax rates and a more onerous value-added tax. Yet they weren’t the ones to cause the nation’s fiscal crisis. Ireland is in trouble for two reasons, and both deal with the spending side of the fiscal equation.
1. The burden of government spending exploded last decade, more than doubling in less than 10 years. This wiped out all the gains from fiscal restraint in the 1980s and 1990s.
2. Irish politicians decided to give a bailout not only to depositors of the nation’s failed banks, but also to bondholders. This is a grotesque transfer of wealth from ordinary people to those with higher incomes.
It’s worth nothing that academic studies find that tax evasion is driven largely by high tax rates. This makes sense since there is more incentive to hide money when the government is being very greedy. But there is also evidence that tax evasion rises when people perceive that government is wasting money and being corrupt.
The serfs are fighting back
Heck, no wonder the Irish people are up in arms. They’re being asked to cough up more money to finance a bailout that was both corrupt and wasteful.
Let’s close by looking at American attitudes about tax evasion. Here’s part of a column from Forbes, which expresses surprise that Americans view tax evasion more favorably than behaviors such as shoplifting and littering.
A new survey suggests Americans consider cheating on their taxes more socially acceptable than shoplifting, drunk driving or even throwing trash out the window of a moving car. …only 66% of the participants said they “completely agree” that “everyone who cheats on their taxes should be held accountable” and only 72% completely agreed that “it’s every American’s civic duty to pay their fair share of taxes”–suggesting, as the Shelton study does, that perhaps disapproval of tax evasion is not as strong as, say, disapproval of stealing from private businesses.
I’m not sure, though, why anybody would be shocked by these results. We have a government in Washington that is pervasively corrupt, funneling money to scams like Solyndra.
These same people want higher tax rates, which will further encourage people to protect their income.
If we really want to promote better tax compliance, whether in the U.S., Ireland, or anywhere in the world, there are two simple answers. First, enact a simple and fair flat tax to keep rates low. Second, shrink government to its proper size, which will automatically reduce waste and limit opportunities for corruption.
But none of this is in the interests of the political class, so don’t hold your breath waiting for these reforms.
Do We Need a FDA for Financial Journalists?
The normally insightful Gretchen Morgenson ran a column Saturday that I at first suspected must have been intended for April Fools’ Day. She discusses a paper by University of Chicago professors Eric Posner and E. Glen Weyl that suggests we create an agency like the Food and Drug Administration for financial products.
I haven’t yet read the paper, but given some of the remarks, I am not sure its worth the effort. For instance, Weyl states, ”[w]e tried an experiment with a very radical form of deregulation that has very little basis in sound economic science.” In what universe does one live in to believe our financial system had a “very radical form of deregulation”. Our financial markets are, and have been for a long time, massively regulated. That’s the problem. The moral hazard and perverse incentives created by our existing system of financial regulation should be clear to anyone with a basic understanding of “sound economic science”.
Take the example of credit default swaps (CDS). The good professors posit “[i]magining a credit default swap being brought before a financial protection agency,” Mr. Posner and Mr. Weyl wrote: “We would expect the F.P.A. to treat it skeptically.” Really? CDS were brought before the NY Fed, who signed off on them as a great way for banks to manage their risk (and hence reduce their capital).
We had a massive financial crisis because households, banks, bureaucrats and politicians rationally responded to the perverse incentives they faced. What’s crazy about defaulting on a mortgage when you’ve put nothing down and there’s no recourse. (Let’s not forget it was some politician that decided that recourse was a bad thing). If you want a better system, fix the incentives. Thinking that the same failed regulators who missed, and contributed to, the last crisis are going to fix the next one strikes me as naive, as well as having “very little basis in sound economic science”.
Should A Bank’s CEO also be the Chairman of the Board?
One of the more contentious issues in corporate governance, particularly as it relates to the stability of financial institutions, is whether a company’s CEO should also be the Chairman of the Board of the company. In the case of Goldman Sachs, the union American Federation of State, County and Municipal Employees (Afscme) felt it was needed to separate those two positions.
First, in my humble opinion, this is ultimately an issue for shareholders to decide upon, at least for non-financial companies that don’t receive taxpayer bailouts (let’s set aside the autos). If shareholders believe separating the two enhances value, then as long as it consistent with the terms of the corporate charter, they are welcome to try. If they are wrong the market will correct that error. In this regard the agreement between Goldman and Afscme is a loss for shareholders, as they are being denied the opportunity to vote on the issue.
But Goldman is a bank holding company; therefore able to access the Fed’s discount window and receive other benefits not available to non-banks. So it would seem reasonable to me to place restrictions upon those feeding at the government trough that reduce the likelihood of using said subsidies. By this standard, separating the CEO from the Chairman position is no longer simply a choice for shareholders, but an empirical issue relating to bank safety.
So what does the data suggest? While we are lacking a direct test for Goldman Sachs, or even investment banks in general, a recent study in the April 2012 issue of the peer-reviewed Journal of Banking and Finance does shed some light. The authors go back to the Savings and Loan crisis and ask: did the separation of CEO and Board Chair display any influence on whether a thrift failed or not? The study’s conclusions are:
We find that thrifts were more likely to survive the thrift crisis when their CEO also chaired the firm’s board of directors. On average, chair-holding CEOs undertook less aggressive lending policies than their counterparts who did not chair their boards. Consequently, taxpayer interests were protected by thrifts that bestowed both leadership posts to one person. This is an important policy issue, because taxpayers become the residual claimants for depository institutions that fail as a result of managers adopting risky strategies to exploit underpriced deposit insurance. Our findings corroborate recent evidence that manager-dominated firms resist shareholder pressure to adopt riskier investment strategies to exploit underpriced deposit insurance.
While this is just one study and I don’t expect it to settle the debate, it should make us all a little more modest about pushing corporate changes that may actually make banks less stable rather than more. Or in the words of Yale Law Professor Roberta Romano, we should resist the temptation to rely on “quack corporate governance.”
Interest Rates Impact Both Sides of the Household Balance Sheet
I have some mixed feelings about the good people at USA Today. Yesterday’s paper had a great story on Romney’s support for TARP which quoted me extensively, but under the fold of the front page ran the headline “Low interest rates putting cash in American’s pockets”. While it is true that low interest rates have reduced households’ interest expenses, they have also reduced their interest incomes, as I have noted elsewhere.
The chart below offers my estimates of household interest expenses, based upon Bureau of Economic Analysis data as compiled by the St. Louis Federal Reserve. The overwhelming majority of this expense is mortgage related. Since the start of the recession in December 2007, households’ annual interest payments have declined by about $400 billion. But households’ annual interest incomes have also declined by about $400 billion, meaning the net impact on households has been about zero. So whatever low interest rates may, or may not, be accomplishing, putting lots of money into households’ pockets is not one of them.
Now if you want to argue that the households benefiting are credit-constrained and likely have a higher marginal propensity to consume than the losing households, that’s a plausible argument if one can muster the data to support it. Even if that argument is correct, which is far from clear, spending would only increase by the net impact across households, and not simply by the increased spending of households that benefit.
There are lots of reasons why the current low level of interest rates may or may not be good for the economy. Let’s examine them. Debate them. But let’s not be fooled by simplistic notions that households are receiving massive net direct benefits from these low rates.
The ‘Dodd Rule’ on Nominations
Obama’s recent nomination of Jeremy Stein and Jerome Powell to the Board of Governors of the Federal Reserve System raises an important question: How should the Senate treat nominations whose terms are likely to run beyond the term of the current president? If confirmed, Stein could serve until 2018 and Powell until 2014. Of course this pales in comparison to current governor Janet Yellen, whose term runs until 2024. With or without Stein and Powell, Obama nominations will have control of the Federal Reserve for years to come.
The long terms of Federal Reserve governors are meant to insulate them from political pressure. But that’s after they’ve been confirmed. This structure tells us little about how to handle such appointments during their nomination phase.
In the absence of strong policy or theoretical rationales, we often look to precedent. In this case we have at least one. In December of 2007, almost a year before the November 2008 election, then Senate Banking Committee chair Chris Dodd (D-CT) said, in relation to the nomination of Randall Kroszner to the Federal Reserve, “We’re frankly getting down to less than a year away from the election. On nominations of that length, I’m fairly reluctant.” Senator Dodd acted (or rather failed to act) on that reluctance, and blocked the nomination of Professor Kroszner. His nomination was not an exception, as the nominations of Larry Klane to the Federal Reserve and a couple of nominations to the Securities Investor Protection Corporation were also blocked, for apparently this same reason. Dodd also delayed nominations to the President’s Council of Economic Advisers, although those positions would have ended with the term of President Bush. Also worth noting is that these important economic policy positions were being blocked in the middle of a recession and financial crisis, when one would think you need “all hands on deck.”
Is this “Dodd rule” the correct position? It’s hard to know. I can say I didn’t think it was appropriate at the time. And I am usually not one to believe that “two wrongs make a right.” The correct solution, in my view, would be to have the Senate decide upon the appropriate length of time before a presidential election that it will no longer consider nominations that run beyond the president’s term and incorporate that decision into the Senate rules. Until then operating under the “Dodd Rule” strikes me as fair enough.
Wall Street’s Seat at the Federal Reserve?
Tomorrow the Senate Banking Committee will likely hold a vote on President Obama’s recent nominations to the Federal Reserve Board, Harvard professor Jeremy Stein and former investment banker and Treasury official Jerome Powell. I’ve written elsewhere on how these two fail to meet the statutory requirements for board membership, as it relates to geography. But there is another issue that continues to bother me about these nominations. That is the unwritten assumption that Wall Street gets a seat on the Federal Reserve Board.
As Bloomberg reports Powell “would bring expertise on financial markets to the Fed’s board, filling a void left by Kevin Warsh, a former Morgan Stanley banker.” But this overlooks the fact that the New York Federal Reserve President, currently former Goldman Exec William Dudley, is a permanent member of the Fed’s Federal Open Market Committee (FOMC). As an institutional matter, the Fed already has a line from Wall Street via the New York Fed, where’s the need for another?
The Federal Reserve Act requires the president, when making nominations to the Fed, to give “due regard to a fair representation of the financial, agricultural, industrial, and commercial interests.” As far as I can tell there is zero representation on the Board for “agricultural, industrial and commercial interests” and already one former banker (Duke) on the Board. How is that “fair?” While this “fairness” requirement is not as black and white as the geography issue, I do believe it is one fundamental to the functioning of the Fed. Is this a Fed that represents all sectors and interests in the economy, or is this a Fed that mainly represents Wall Street (and academia, which is never mentioned in the Federal Reserve Act)?
While I do not personally know Mr. Powell, and I have no reason to suspect he is anything other than an honorable and well-intended man, I think we all have reason to believe that the last thing the Fed needs is another New York investment banker.
Stop Ignoring Higher Ed Reality
Like most political discussions, the student aid debate is driven far more by sentiment than reasoned analysis. If we used the latter, we’d be demanding big aid cuts for the sake of students and taxpayers alike.
As I testified to a Senate panel earlier this week, the evidence is powerful that there is massive overconsumption of higher education, and cheap federal aid ultimately fuels the college price skyrocket while encouraging students to tackle programs and debt they often can’t handle.
I won’t go into all the evidence here—you can get much of it in my testimony, and even more in this report—but here are a few of the big points that plead for us to stop the rhetoric and attack the waste:
- Aid and prices have both increased at breakneck speeds over the last several decades. Growing empirical research shows that this is not an accident—colleges raise their prices to capture the aid—though there is a limit to what research can prove. Fortunately, logic can fill in the rest: People who work at colleges are normal human beings and will take every dollar they can get their hands on. They always have something good—either personally or professionally—they think they can do with it.
- Inflation is not explained just by state and local budget cuts. Both public and private colleges have seen decades of rampant inflation; total state and local funding to colleges has not dropped during that time; and on a per-pupil basis public schools have raised tuition revenue by roughly $2 for every $1 lost in appropriations.
- Only 57 percent of first-time, full-time students at four-year colleges finish their programs within six years. Huge numbers of the students we encourage to go to college, including with federal grants and loans, languish there and likely never finish.
- Roughly one-third of people with bachelor’s degrees are in jobs that don’t require them.
- Most of the jobs expected to have the biggest growth in the coming decades will not require college attendance, but on-the-job training.
The list could go on, but the point is unmistakable: Talk all you want about the power of education or the future economy; the public dollars we lavish on higher education—including federal student loans with generous terms and interest rates—are largely being squandered, even if with good intentions. Add all this to the nation’s staggering debt, and it is well past time that we stop all the talk and start dealing with reality.
C/P from the National Journal’s “Education Experts” blog.
On New Fed Nominations: Are There No Keynesians in Flyover Country?
In late January President Obama submitted to the Senate the appointments of Jeremy Stein and Jerome Powell to the Board of Governors of the Federal Reserve System. This past Tuesday the Senate Banking Committee held a nomination hearing for Stein and Powell. None of this really matters, as per Section 10 of the Federal Reserve Act, neither Stein or Powell can serve currently on the Fed’s Board.
Recall that Section 10 requires that in regard to members of the board ”not more than one of whom shall be selected from any one Federal Reserve district”, the President’s selections ”shall have due regard to a fair representation of…geographical divisions of the country.” In plain English, this means you cannot have more than one Fed governor from the same Fed district.
According to his paperwork, submitted to the Senate, Professor Stein is from Massachusetts. Unfortunately current Fed governor Dan Turullo is from Massachusetts. Mr. Powell is from Maryland, as is current governor Raskin. As this was an issue with the failed nomination of Peter Diamond to the Fed, you’d think the White House (or the Fed) would have bothered to read the statute with these nominations.
Don’t get me wrong, this isn’t about personal qualifications, this is about the law. In fact, as far as Democratic academics go, I am hard pressed to think of a better nominee than Jeremy Stein. Much of his work has been on the topics of monetary policy and financial regulation, unlike Professor Diamond. And not only has his work been relevant, it has been thoughtful, insightful and original. Like current governor Turullo, Stein seems to get many of the deep flaws in our current bank capital system. As importantly he also gets the impact of down-payment requirements as they related to housing markets, something outright rejected by many housing advocates on the left. If the Fed was not already packed with academics, he’d be a fine addition.
While I do not agree with the President’s desire to pack the Fed board with easy money advocates and friends of Wall Street (Powell), I do believe that such is his prerogative, as long as he can get the advice and consent of the Senate. I do, however, believe the President has to do so within the bounds of the law. He should take his search for Keynesians to flyover country (maybe on one of his trips to Ohio), which is not currently represented on the Fed Board.
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