Archive for the ‘Finance, Banking & Monetary Policy’ Category
It Was the Republican Banker on the Fed Board Raising Concern about Housing
If you’ve followed Obama’s nominations to the Federal Reserve, he’s been pretty consistent, displaying a strong preference for coastal academics or politicos. Not one of his nominations came from the private sector (or “flyover country”), despite the very clear requirements of the Federal Reserve Act.
Recently released Fed transcripts reveal an interesting fact: it wasn’t the all-knowing, impartial Ivy League academics (like Bernanke and Yellen) or the long-term bureaucrats (like Geithner) that expressed concern about the housing and mortgage markets, it was the Republican banker from Tennessee, Susan Bies. Unfortunately it appears that the academics and bureaucrats on the Board treated Governor Bies’s concerns with their usual contempt for anyone who’s actually had to make payroll (or didn’t do their graduate work at Harvard or Yale).
In Obama’s defense, we are talking about the Federal Reserve Board as it existed in 2006. Bush was almost as bad about filling important economic positions with either New Keynesian academics (Mankiw, Bernanke) or Wall Street insiders (Paulson). Bush, however, did occasionally bow to some voices outside the Cambridge-Wall Street-Washington echo chamber, with Fed appointments such as Bies and the current Fed governor Duke.
The relevance for public policy choices facing us today? First, while a Board is no panacea, it does mean alternative voices are at least heard before they are dismissed (think the Consumer Financial Protection Bureau) and second, having a bunch of arrogant (and ignorant of real markets) academics run our economy is a recipe for disaster. And I’m not suggesting we turn our government over to corporate America, I’m suggesting we return our economy to the control and choices of free individuals.
The New Yorker Misunderstands Ron Paul (Again)
In the New Yorker, Nicholas Lemann frets over Ron Paul’s “hostility to government” in an article titled “Enemy of the State.” I wonder if Lemann, who is both a long-time writer at a great magazine and the dean of a great school of journalism, would think “Enemy of the State” was red-baiting or otherwise inappropriate language if it was applied to some other candidate.
But I was especially struck by this comment in Lemann’s lament about all the government programs Paul would repeal:
As for the financial crisis, Paul would have countenanced no regulation that might have prevented it, no government stabilization of the financial system after it happened, and no special help for working people hurt by it. This is where the logic of government-shrinking leads.
The famous New Yorker editing process seems to have broken down here. Here’s how the paragraph should have read:
As for the financial crisis, Paul would have countenanced none of the regulation that helped to cause it, no government creation of cheap money that created the unsustainable boom, and no special help for Wall Street banks when the bubble collapsed. He would have seen that that was where the logic of government-expanding leads.
If the ‘Volcker Rule’ Is So Great, Why Exempt Treasuries and Agencies?
One of the more controversial provisions of the Dodd-Frank Act is its restrictions on proprietary trading, contained in Section 619. Setting aside the fact that even Paul Volcker has said the provision would have done little to avoid to the recent crisis, the Act’s various exemptions illustrate the confusion and hypocrisy underlying the rule.
Foremost among these exemptions is the allowance of proprietary trading when the financial instrument in question is either a U.S. Treasury bill/bond or a security issued by Fannie Mae and Freddie Mac. These instruments are actually the bulk of proprietary trading. Remember the failed hedge fund Long Term Capital Management? Their signature trade was arbitraging on-the-run and off-the-run Treasuries. Ever hear of Bear Stearns? The largest single asset in Maiden Lane I, those Bear Stearn assets guaranteed by the New York Federal Reserve, were Fannie and Freddie securities.
Countries around the World, such as Japan and Canada, have already raised concerns that if their government debt is subject to the Volcker rule, the result will be less liquidity and higher funding costs. But then one has to suspect that former senator Chris Dodd (D-CT) and Rep. Barney Frank (D-MA) understood this, as they allowed an exemption for Treasuries and Agencies (Fannie/Freddie). While I’m no expert on trade policy, this may very well raise World Trade Organization questions since the Volcker rule, as proposed, favors U.S. debt over foreign debt. Of greater concern should be that the Volcker rule favors non-productive investment, that of the U.S. government and Fannie/Freddie, over productive investment, such as corporate paper.
As in so many other areas, Dodd-Frank does leave the actual decision-making to the bank regulators. (Is it too much to ask Congress to actually legislate?) Section 619 is very clear that regulators may exempt Treasuries and Agencies, which implies they also may not. The first best solution would be to just scrap the Volcker rule, but if we are going to have it, then apply it to everyone and all asset classes. Otherwise, one is just introducing additional distortions into our financial markets, some of the same distortions that actually lead to the financial crisis.
Commerce Clause Issues in the Regulation of Non-Bank Financials
If you believe that the Constitution’s Commerce Clause empowers Congress to do pretty much anything it wants (that is, if you believe that me scratching my nose impacts interstate commerce), then you can stop reading now—you’re beyond help.
If, however, one follows both the history of banking law and the wording of the Commerce Clause, which in Article I, Section 8 in listing the powers of Congress reads “To regulate Commerce with foreign Nations, and among the several States, and with the Indian tribes,” then there arises the possibility that Congress lacks the authority to regulate non-bank financials, such as payday lenders, in the manner envisioned by the Consumer Financial Protection Bureau (CFPB), as created by the Dodd-Frank Act.
After you spend over a decade reading federal consumer finance laws, as I have, you notice a trend. Terms like “federally related mortgage loan,” which appears in, among other places, the Real Estate Settlement Procedures Act, or “national bank,” which appears in lots of places, like the Home Owners’ Loan Act or the Federal Deposit Insurance Act, or “housing creditor” as defined under the Alternative Mortgage Transaction Parity Act, appear repeatedly. The commonality of these terms? They always tie back to deposit insurance or some sort of federal guarantee, such as those made by the Federal Housing Administration or Fannie Mae and Freddie Mac.
The structure of federal consumer finance laws has historically gotten around the Commerce Clause by tying said laws to the acceptance of some federal benefit. In the case of banks, the bargain is, Banks get deposit insurance, which is ultimately backed by the taxpayer, and in exchange they get stuck with a whole host of regulations, some relating to safety and soundness, many others not. This scheme has been expanded by trying similar restrictions to the ability to sell a loan to Fannie or Freddie.
While I think this arrangement has been a Faustian bargain for the banks, the fact is they don’t have to take deposit insurance or ask for any other type of bailout.
What is truly revolutionary (in a bad way) about the CFPB’s new powers over non-banks is that they go beyond this traditional framework. I assume, and hope, we aren’t going to start bailing out payday lenders or check-cashers or give them any sort of federal insurance scheme. So if there is no “bargain” here, as there is with federal depositories, then where exactly is the federal nexus? The vast majority of payday loan transactions, for instance, do not cross state lines. The states already have full power to regulate these activities, and already do. There’s no national marketplace for most of these products.
So if non-bank financials lack a federal nexus (due to the absence of any federal guarantee) and are not interstate commerce, then where exactly is the authority (or the need) to regulate them?
Now, I’m not a lawyer, but it’s hard for me to see how the regulation of activities like payday lending meet the three categories spelled out in United States v. Lopez. So in addition to the Appointments Clause challenges to the CFPB, I wouldn’t be surprised to also see a Commerce Clause challenge.
Private Equity, A Capitalist Bane?
Motivated by Newt Gingrich’s assertions — which cast a cloud over private equity operations by characterizing Mitt Romney as a predatory capitalist who destroyed jobs during his tenure at Bain Capital — the chattering classes are playing fast and loose with the facts. If they want the facts, a recently released National Bureau of Economic Research paper authored by Steven J. Davis (University of Chicago), John C. Haltiwanger (University of Maryland), Ron S. Jarmin (U.S. Census Bureau), Josh Lerner (Harvard Business School) and Javier Miranda (U.S. Census Bureau) is just what the Doctor ordered. It’s time for the private equity critics to stop talking and start reading.
Unconstitutional Recess Appointments Haven’t Helped Obama in the Polls
It has just been over a week since President Obama made his “recess” appointments to the Consumer Financial Protection Bureau and the National Labor Relations Board. I suggested last week that this might turn out to be Obama’s “Court-Packing” moment, where he begins to discover that (some) Americans actually do care about the Constitution. While its clearly too early to say anything with certainty, it appears I may have been correct.
On January 3th, the day before the appointments, Obama’s job approval ratings, according to RealClearPolitics, averaged 47.2 approval and 47.8 disapproval. Basically a tie.
Today, his job approval is at 44.5 and disapproval is 50.3. Moving over the course of a week from a tie to a spread of almost 6 percentage points.
Usually we have not seen such large changes over the course of a week. Now obviously one cannot contribute all this decline to the recess appointments, but there were no other big Presidential announcements or even big economic news over the last week that could account for such a slide in support. So while this doesn’t prove anything, it does suggest these appointments, even if they are making his base happy, are coming at the expense of the support of independents.
Mitt Romney and Bain Capital Were Right to Utilitize So-Called Tax Havens
I’m not a big fan of Mitt Romney. I hammered him the day before Christmas for being open to a value-added tax, and criticized him in previous posts for his less-than-stellar record on healthcare, his weakness on Social Security reform, his anemic list of proposed budget savings, and his reprehensible support for ethanol subsidies.
But I also believe in being intellectually honest, so I’ll defend a politician I don’t like (even Obama) when they do the right thing or when they get attacked for the wrong reason.
In the case of Romney, some of his GOP opponents are criticizing him for job losses and/or bankruptcies at some of the companies in which he invested while in charge of Bain Capital. But I don’t need to focus on that issue, because James Pethokoukis of AEI already has done a great job of debunking that bit of anti-Romney demagoguery.
In this post, I want to focus on the issue of tax havens.
Regular readers know that I’m a big defender of these low-tax jurisdictions, for both moral and economic reasons, and I guess that reporters must know that as well because I’ve received a couple of calls from the press in recent weeks. But I suspect I”m not being called because reporters want to understand international tax policy. Instead, based on the questions, it appears that the establishment media wants to hit Romney for utilizing tax havens as part of his work at Bain Capital.
As far as I can tell, none of these reporters have come out with a story. And I’m also not aware that any of Romney’s political rivals have tried to exploit the issue.
But I think it’s just a matter of time, so I want to preemptively address this issue. So let’s go back to 2007 and look at some excerpts from a story in the Los Angeles Times about the use of so-called tax havens by Romney and Bain Capital.
While in private business, Mitt Romney utilized shell companies in two offshore tax havens to help eligible investors avoid paying U.S. taxes, federal and state records show. Romney gained no personal tax benefit from the legal operations in Bermuda and the Cayman Islands. But aides to the Republican presidential hopeful and former colleagues acknowledged that the tax-friendly jurisdictions helped attract billions of additional investment dollars to Romney’s former company, Bain Capital, and thus boosted profits for Romney and his partners. …Romney was listed as a general partner and personally invested in BCIP Associates III Cayman, a private equity fund that is registered at a post office box on Grand Cayman Island and that indirectly buys equity in U.S. companies. The arrangement shields foreign investors from U.S. taxes they would pay for investing in U.S. companies. …In Bermuda, Romney served as president and sole shareholder for four years of Sankaty High Yield Asset Investors Ltd. It funneled money into Bain Capital’s Sankaty family of hedge funds, which invest in bonds and other debt issued by corporations, as well as bank loans. Like thousands of similar financial entities, Sankaty maintains no office or staff in Bermuda. Its only presence consists of a nameplate at a lawyer’s office in downtown Hamilton, capital of the British island territory. … Investing through what’s known as a blocker corporation in Bermuda protects tax-exempt American institutions, such as pension plans, hospitals and university endowments, from paying a 35% tax on what the Internal Revenue Service calls “unrelated business income” from domestic hedge funds that invest in debt, experts say. …Brad Malt, who controls Romney’s financial trust, said Bain Capital organized the Cayman fund to attract money from foreign institutional investors. “This is not Mitt trying to do something strange,” he said. “This is Bain trying to raise some number of billions from investors around the world.”
There are a couple of things worth noting about these excerpts.
1. Nobody has hinted that Romney did anything illegal for the simple reason that using low-tax jurisdictions is normal, appropriate, and intelligent for any business or investor. Criticizing Romney for using tax havens would be akin to attacking me for living in Virginia, which has lower taxes than Maryland.
2. Jurisdictions such as Bermuda and the Cayman Islands are good platforms for business activity, which is no different than a state like Delaware being a good platform for business activity. Indeed, Delaware has been ranked as the world’s top tax haven by one group (though American citizens unfortunately aren’t able to benefit).
3. America’s corporate tax system is hopelessly anti-competitive, so it is quite fortunate that both investors and companies can use tax havens as vehicles to profitably invest in the United States. This helps protect the economy and American workers by attracting trillions of dollars of investment to the U.S.
These three points are just the tip of the iceberg. Watch this video for more information about the economic benefit of tax havens.
Last but not least, here’s a prediction. I think it’s just a matter of time until Romney gets attacked for utilizing tax havens, though the press may wait until after he gets the GOP nomination.
But when those attacks occur, I’m extremely confident that the stories will fail to mention that prominent Democrats routinely utilize tax havens for business and investment purposes, including as Bill Clinton, John Kerry, John Edwards, Robert Rubin, Peter Orszag, and Richard Blumenthal.
It’s almost enough to make you think this cartoon is correct and that the establishment press is biased.
There Was No Nomination of Cordray before the Senate…
Last week President Obama made the “recess” appointment of Richard Cordray to head the Consumer Financial Protection Bureau, created under the Dodd-Frank Act. I’ve already discussed some of the various problems with this so-called recess appointment.
Another, perhaps ultimately more critical, problem is that at the time of this action, January 4th, 2012, there was not a pending nomination of Richard Cordray before the Senate. By the unanimous agreement of the Senate, his nomination was returned to the President on January 3rd, 2012, which for all purposes extinguishes said nomination. Per Paragraph 6 of Senate Rule XXXI, the President would have to re-submit Cordray’s nomination in order for it to be considered by the Senate.
But then I guess if one doesn’t really believe the Senate was in session on January 3rd, despite marking the beginning of a new session, then I guess one might also not believe the Senate could have conducted any business that day, such as returning nominations to the President.
Ironically enough, had the President made the appointment two days earlier, he would be on much stronger, if not still shaky ground. The President’s own attempt at being clever, by trying to gain another year of service for his nominations, may be what ultimately dooms said nominations.
If indeed there was no pending Cordray nomination on January 4th, then following the decision of US District Court for DC in Olympic Federal Savings and Loan Association v. Director, Office of Thrift Supervision, it would seem pretty clear that Cordray’s appointment was unconstitutional. But then I’m no lawyer, so we will see.
A Fed Bailout for Europe
I had an op-ed in the December 28th Wall Street Journal titled “The Federal Reserve’s Covert Bailout of Europe.” It generated a lot of discussion. Yesterday (January 5th), the Journal printed a letter from William C. Dudley, president of the New York Fed, responding to my piece.
In my op-ed, I focus on the currency swaps between the Fed and other central banks. The largest amount is with the European Central Bank (ECB). The Fed “swaps” dollars to the ECB and receives a like amount of euros in return as collateral. The ECB promises to return the dollars in the future at a fixed exchange rate. In the meantime, the ECB lends the dollars to European banks of its choosing. The Fed does not even know their identity.
Among other things, I point out that, thanks to prior Fed policy actions, there is no shortage of dollars in the world. The ECB could lend euros to their banks and the banks could then purchase however many dollars they needed on foreign-exchange markets.
I conclude that “the Fed is, working through the ECB, bailing out European banks and, indirectly, spendthrift European governments.” (The banks are major lenders to governments.)
President Dudley’s letter is non-responsive to the arguments of my op-ed. He never addresses my observation that there is no shortage of dollars in the world. He gives the game away in the following passage: “Banks with surplus dollars are more likely to lend to banks in need of dollars if they know that the borrowing bank will be able to obtain the dollars it needs to repay the loan, if necessary, from its central bank.”
Dudley is not describing a dollar shortage, but another reality. The reason one bank becomes reluctant to lend to another bank is that the potential lender has doubts about the solvency of the would-be borrower. The reality in Europe today is that banks have good reason to doubt the solvency of other banks because they know their own condition is none too strong.
By implication, Dudley’s letter acknowledges my main point: there is a Fed-financed bailout of European banks in progress. The Fed is implementing it through currency swaps because swaps obscure the nature of the transaction, which is in reality a loan. (The Greek government used currency swaps to hide the size of its fiscal deficits.)
It was widely reported that, in a December 14th meeting with Republican senators, Fed Chairman Ben Bernanke told them that he neither intended nor did he have the authority to bail out Europe. A reasonable person would see a conflict between the chairman’s words and those of the New York Fed president. Moreover, the swap arrangement is non-transparent and at odds with Bernanke’s promise of greater openness within the Fed. That is why I call for congressional hearings on it in my op-ed, and I repeat that call here.
A Response to Konczal on Cordray Recess Appointment
”When I use a word,” Humpty Dumpty said, in a rather scornful tone, “it means just what I choose it to mean – neither more nor less.”
“The question is,” said Alice, “whether you can make words mean so many different things.”
“The question is,” said Humpty Dumpty, “which is to be master – that’s alls.” – Lewis Carroll
Apparently some took issue with my concern, expressed yesterday, that President Obama’s “recess” appointment of Richard Cordray to head the Consumer Financial Protection Bureau, might have some legal and constitutional issues. One of the concerned was my friend Mike Konczal at the Roosevelt Institute.
I’ve always been impressed with Mike Konczal’s ability to say so little in so many words. His basic claim is that this is no different than any other recess appointment because Section 1011 of Dodd-Frank states the appointment is subject to the “advice and consent of the Senate” which he sees as meaningless boilerplate. He cites a Congressional Research Service report as saying that a recess appointee has the same powers as a regular appointee. On its face, that is correct. Had there already been a Senate confirmed Director in place, with the additional powers over non-banks in place, then any future recess appointee would have those same powers.
The problem with that line of thought is that these powers are not already in place, something not addressed in the CRS report. This is very real issue (not a “zombie” as Konczal would claim). During my service on the Senate Banking Committee, when we were drafting language to create the new regulator for Fannie and Freddie, we were very aware of this danger, as it had been a problem when the OTS and FHFB were created out of the FHLBB. We didn’t wish to have a similar problem, so we crafted language to avoid it (see Section 1101 of HERA). The problem is that Dodd-Frank did not include such language (one of many drafting errors in the bill).
Now it’s never enough for Konczal to just disagree, he also has to be disagreeable when doing so (I assume it plays well to the nasty echo-chamber that is New York Liberalism). He snidely says, ”I like how libertarians at Cato are all about the Constitution, with grants the President the power to fill up vacancies, until they aren’t.” Well to help him out, I am all about the Constitution as it is written. And the Constitution’s Article 2, Section 2 clearly says “President shall have Power to fill up all Vacancies that may happen during the Recess of the Senate”. Did the vacancy of the CFPB director happen during a recess? Not under the clear language of the Constitution (Mike, I’d be happy to send you a Pocket Copy).
So there you have it. Konczal’s argument boils down to two issues, that in Konczalian Newspeak “advice and consent of the Senate” really means “unilateral action by the President” and that “may happen during the Recess” actually means “whenever the President decides.” Now one has to remember that Konczalian Newspeak changes when the President is a Republican.
Obama’s Constitutional Gamble on Consumer Finance Nomination
President Obama is announcing today that despite the fact that the Senate is not in recess, he’s going to recess appoint Richard Cordray to be the head of the Consumer Financial Protection Bureau (CFPB), created under the Dodd-Frank Act.
Of course the President is actually claiming that the Senate isn’t in session and that its “pro forma” sessions are just a “gimmick”. Funny I don’t remember then Senator Obama complaining about gimmicks when the Senate used the sames tactics to block Bush recess appointments. But then again this is the guy who signs a bill allowing indefinite detention of American citizens after having campaigned on shutting down Guantanamo. Only a former constitutional law professor could be so creative with the Constitution.
More importantly the “recess” appointment of Cordray doesn’t solve the President’s problem. The Dodd-Frank Act is very clear, even a law professor can probably understand this section, that authorities under the Act remain with the Treasury Secretary until the Director is “confirmed by the Senate”. A recess appointment is not a Senate confirmation. Now don’t ask me why Dodd and Frank included such unusual language, they could have just given the Bureau the new authorities, but they didn’t. So even with this appointment, the CFPB won’t be able to go after all those non-banks, like the pay-day lenders and check-cashiers that caused the financial crisis (oh wait, those industries didn’t have anything to do with the crisis).
This appointment also guarantees that Obama, even if he gets a second term, is unlikely to ever get a CFPB Director past the Senate. Maybe not such a big deal for Cordray since the rumor has always been this is just a political stepping stone so he can go back to Ohio and run for office. The real harm is that Obama has decided to take a gamble with the Constitution, risk the further erosion of the Senate’s advise and consent powers, solely to have another campaign issue. So he can try to paint Republicans as captive to Wall Street, all despite the fact the new agency exempts Wall Street (who will continue under the ever effective oversight of the SEC). Maybe he can have Geithner and the various Goldman alum in the Administration stand next to him to help remind us how hard he is fighting for the middle class.
Do Free Markets Tend Toward Concentration? The Case of Banking
Perhaps the most significant difference between my own views and those of my progressive friends is on the relationship between business and government, especially “big business”. I’ve on more than one occasion heard that government needs to be there to off-set the power of big business. That without government, corporations would just continue to grow. Well to me that sounds like an empirical question.
Thanks to the Economic Freedom of the World report, we have some good indicators of just how free-market oriented a country is. What we need are measures of concentration. Unfortunately, these are a little harder to come by. Fortunately, the Office of the Comptroller of the Currency (OCC) did a survey about a decade ago (1999), the data for which are reported in Barth, Caprio, and Levine’s Rethinking Bank Regulation. The measure of concentration is the percent of deposits accounted for by the five largest banks. One could argue for a better measure, but it’s all we have.
The results? It would appear that the freer an economy, the less concentrated its banking system. The chart below offers a scatter diagram, along with a regression line. The vertical Y axis measures concentration and the X axis economic freedom (the higher the number, the freer the economy). Admittedly, the relationship is not a strong one, with a correlation of only -0.11, but it is negative. If anyone knows of comparable measures for other industries, I would encourage them to either send me the data or reproduce this analysis for other industries.
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