Should We Break Up the Banks?
When it comes to banking policy, there are few people I respect more than Jonathan Macey and Arnold Kling; so when these two, independently, argue that we should be breaking up the largest banks, it is idea that merits consideration. Yet I still have my doubts.
First, lets start with what we are fairly certain of. There is a large empirical literature that suggest most US mega-banks are beyond their efficient size. There is a good survey of the literature by former Fed Economist Allen Berger . So, at a minimum, the academic literature suggests the largest banks are beyond a size that is justified by the social benefits.
However, there is also a small literature that suggests more concentrated banking systems are more stable, and less prone to crisis. Some of this literature has grown out of research efforts by the World Bank. While this literature is largely cross-country comparisons, recalling our own banking history gives several examples - the savings & loan crisis, the mass of small banks failures in the 1920s and 1930s, and current day Georgia – where lots of small bank failures have been associated with significant economic damage. So, at minimum, there is some question of whether breaking up the largest banks would give us a more stable, less crisis-prone system. In fact, there is considerable evidence to suggest that breaking up the banks would make our financial system more fragile.
To some extent, the debate over breaking up the large banks is about reducing political power. The argument is that, because of their vast resources, these large banks unduly influence and capture our political system. Undoubtedly, I believe the largest banks have substantial influence over both our legislative and regulatory systems. However, so do smaller banks. From my seven years as staff on the Senate Banking Committee, I would definitely argue that the Independent Community Banks Association (ICBA), as a group, has far more pull than does say Bank of America, as a single company. One need only witness the various exemptions for small banks in the Dodd bill, for instance from the consumer protection bureau, to illustrate the lobbying power of small bankers. One could also argue that the economic history of progressive era legislation, like the Sherman Act, is one of smaller, organized interests winning against larger sized firms. Despite its appeal, the assertion that bigger is always better in politics is just an assertion. Yet this is at heart an empirical argument, and perhaps one that can be tested. Until then, I still have my doubts.
Did the IMF Deliberately Exaggerate the 2008 Financial Crisis?
This month, two vice-presidents of the Czech National Bank (CNB) have made very serious allegations against the International Monetary Fund. Below is the summary of their claims so far:
- Speaking to the Austrian daily newspaper Der Standard on April 2, Mojmir Hampl, the vice-president of the CNB, said that the IMF under Dominique Strauss-Kahn “wanted to expand its role in Eastern Europe and obtain new financial resources.” Hampl claimed that the IMF exaggerated problems with the financial systems in Eastern Europe. “We have always emphasized that the instability of the financial system [in 2008] was a Western European problem. That proved correct… According to a recent EU report, only nine out of 27 EU member states did not have to introduce any financial stabilization measures [during the crisis]. All nine were new [mostly Eastern European] member states.”
- Hampl’s claim was echoed by his colleague, CNB vice-president Miroslav Singer, in today’s edition of the Czech daily Hospodarske Noviny. According to Singer, “I cannot say nice things about the IMF’s role in the 2008 crisis.” The Financial Times, Singer continued, carried a lot of nonsensical stories about the state of the Czech financial sector prior to the crisis. Instead of dispelling those stories, the IMF produced a study about the Czech Republic based on incorrect data and then leaked it to the Financial Times. “It is difficult to be certain… that the IMF wanted to harm the Czechs, Slovaks or Poles on purpose… More likely it was a combination of panic, lack of expertise and a desire to see problems everywhere.”
If true, these claims raise troubling questions about the incentives behind the largest increase of resources in the Fund’s history.
Ban on Short Sales Benefits Banks and Hurts Investors
Today, in what seems like an endless string of 3-2 votes, the SEC moved to restrict the ability of investors to short stocks, claiming that such restrictions would restore stability and protect our financial system. The truth couldn’t be more different. Short sellers have long been the first, and often only, voice raising questions about corporate fraud and mismanagement. For instance, shorts exposed the fraud at Enron, WorldCom and other companies while the SEC largely slept.
Bush’s SEC, lead by former Congressman Chris Cox banned the shorting of various financial industry stocks during the crisis. The SEC then, as now, would have us believe that Bear, Lehman, AIG, Fannie, Freddie and others were not the victims of their own mismanagement, but rather victims of bear raids by short sellers. In another instance of Obama and his appointees reading from the Bush playbook, SEC Chair Mary Shapiro finds ever creative ways to expand Cox’s misguided policies.
Short sellers only profit if they end up being correct. Sadly Washington instead believes in punishing market mechanisms that work and throwing increasingly more money at failed agencies, like the SEC. Rather than attacking short sellers we should applaud them for doing the SEC’s job. But then if we had more short selling, providing greater incentives for investors to root out fraud, we might start to question why we even have the SEC.
State of the Union Fact Check
Cato experts put some of President Obama’s core State of the Union claims to the test. Here’s what they found.
THE STIMULUS
Obama’s claim:
The plan that has made all of this possible, from the tax cuts to the jobs, is the Recovery Act. That’s right — the Recovery Act, also known as the Stimulus Bill. Economists on the left and the right say that this bill has helped saved jobs and avert disaster.
Back in reality: At the outset of the economic downturn, Cato ran an ad in the nation’s largest newspapers in which more than 300 economists (Nobel laureates among them) signed a statement saying a massive government spending package was among the worst available options. Since then, Cato economists have published dozens of op-eds in major news outlets poking holes in big-government solutions to both the financial system crisis and the flagging economy.
CUTTING TAXES
Obama’s claim:
Let me repeat: we cut taxes. We cut taxes for 95 percent of working families. We cut taxes for small businesses. We cut taxes for first-time homebuyers. We cut taxes for parents trying to care for their children. We cut taxes for 8 million Americans paying for college. As a result, millions of Americans had more to spend on gas, and food, and other necessities, all of which helped businesses keep more workers.
Back in reality: Cato Director of Tax Policy Studies Chris Edwards: “When the president says that he has ‘cut taxes’ for 95 percent of Americans, he fails to note that more than 40 percent of Americans pay no federal incomes taxes and the administration has simply increased subsidy checks to this group. Obama’s refundable tax credits are unearned subsidies, not tax cuts.”
Visit Cato’s Tax Policy Page for much more on this.
SPENDING FREEZE
Obama’s claim:
Starting in 2011, we are prepared to freeze government spending for three years.
Back in reality: Edwards: “The president’s proposed spending freeze covers just 13 percent of the total federal budget, and indeed doesn’t limit the fastest growing components such as Medicare.
“A better idea is to cap growth in the entire federal budget including entitlement programs, which was essentially the idea behind the 1980s bipartisan Gramm-Rudman-Hollings law. The freeze also doesn’t cover the massive spending under the stimulus bill, most of which hasn’t occurred yet. Now that the economy is returning to growth, the president should both freeze spending and rescind the remainder of the planned stimulus.”
Plus, here’s why these promised freezes have never worked in the past and a chart illustrating the fallacy of Obama’s spending claims.
JOB CREATION
Obama’s claim:
Because of the steps we took, there are about two million Americans working right now who would otherwise be unemployed. 200,000 work in construction and clean energy. 300,000 are teachers and other education workers. Tens of thousands are cops, firefighters, correctional officers, and first responders. And we are on track to add another one and a half million jobs to this total by the end of the year.
Back in reality: Cato Policy Analyst Tad Dehaven: “Actually, the U.S. economy has lost 2.7 million jobs since the stimulus passed and 3.4 million total since Obama was elected. How he attributes any jobs gains to the stimulus is the fuzziest of fuzzy math. ‘Nuff said.”
Obama Bank Tax Is Misguided
Perhaps I am a little confused, but didn’t the Obama Administration tell the American public only months ago that TARP was turning a profit? But now the same administration is proposing to assess a fee on banks to cover losses from the TARP. Maybe President Obama is coming around to the realization that the TARP has indeed been a loser for the taxpayer. He appears, however, to be missing the critical reason why: the bailouts of the auto companies and AIG, all non-banks. This is to say nothing of the bailout of Fannie Mae and Freddie Mac, whose losses will far exceed those from the TARP. Where is the plan to re-coup losses from Fannie and Freddie? Or a plan to re-coup our rescue of the autos?
If the effort is really about deficit reduction, then it completely misses the mark. Any serious deficit reduction plan has to start with Medicare and Social Security. Assessing bank fees is nothing more than a rounding error in terms of the deficit. Let’s put aside the politics and get serious about both fixing our financial system and bringing our fiscal house into order. The problem driving our deficits is not a lack of revenues, aside from effects of the recession, revenues have remained stable as a percent of GDP, the problem is runaway spending.
The bank tax would also miss what one has to guess is Obama’s target, the bank CEOs. Econ 101 tells us (maybe the President can ask Larry Summers for some tutoring) corporations do not bear the incidence of taxes, their consumers and shareholders do. So the real outcome of this proposed tax would be to increase consumer banking costs while reducing the value of bank equity, all at a time when banks are already under-capitalized.
Geithner Ignores Bailout History
Perhaps the biggest problem with the Obama plan to “reform” our financial system is the impact it would have on the market perception surrounding “too big to fail” institutions. In identifying some companies as “too big to fail” holders of debt in those companies would assume that they would be made whole if those companies failed. After all, that is what we did for the debt-holders in Fannie, Freddie, AIG, and Bear. Both former Secretary Paulson and Geithner appear under the impression that moral hazard only applies to equity, despite debt constituting more than 90% of the capital structure of the typical financial firm.
Geithner believes he’s found a way to solve this problem – he’ll just tell everyone that there isn’t an implicit subsidy, and there won’t be a list of “too big to fail” companies. Great, why didn’t I think of that. After all, the constant refrain in Washington over the years that Fannie and Freddie weren’t getting an implicit subsidy really prepared the markets for their demise.
Even more bizarre is Geithner’s assertion that the government can force these institutions to hold higher capital, maintain more liquidity and be subjected to greater supervision, all without anyone knowing who exactly these companies are. Does the Secretary truly believe that these companies’ securities disclosures won’t include the amount of capital they are holding? Whether there is an official list or not is besides the question, market participants will be able to infer that list from publicly available information and the actions of regulators.
One has to wonder whether Geithner spent any of his time at the NY Fed actually watching how markets work. Before we continue down the path of financial reform, maybe it would be useful for our Treasury Secretary to take a few weeks off to study what got us into this mess. We’ve already been down this road of denying implicit subsidies and then providing them after the fact. Maybe it’s time to try something different.
CAP’s Proposal to Add ‘Public Members’ to Corporate Boards Is Flawed
Today the Center for American Progress rolled out its proposal that we add “public directors” to the boards of companies that have been bailed out by the government. CAP scholar Emma Coleman Jordan argues that “public directors will provide a corrective to the boards of the financial institutions that helped cause the crisis.”
One has to wonder whether Ms. Jordan has ever heard of Fannie Mae and Freddie Mac. If she had, she might recall that a substantial number of the board members of Fannie and Freddie were so-called “public” members appointed by the President. Perhaps she can ask CAP adjunct scholar and former Fannie Mae executive Ellen Seidman to review the history of those companies for her.
Monday Links
- Obama spoke on Wall Street today about increasing regulation of the American financial system. But did deregulation really cause the financial crisis?
- Burnt rubber: Obama’s decision to slap a 35 percent tariff on Chinese tires whiffs of senseless protectionism.
- According to the Economic Freedom in the World report, the U.S. was ranked the second-freest economy in 2000. It has fallen to 6th place this year.
- A bold exit strategy for Afghanistan.
- Why it’s time for the U.S. to start doing less abroad.
- Podcast: China’s economy is on track to be larger than the U.S. economy in a few years. Trade expert Dan Griswold says, “So what?”
AFL-CIO Wants to Tax Stock Trades…to Stop Speculation
Earlier this week, the AFL-CIO, building upon a suggestion made last week in the UK, proposed that the federal government impose a 1/10 of 1 percent tax of all stock trades. The union group argues that such a tax would reduce non-productive speculative activity in the stock market.
First of all, we have all sorts of transfer taxes on housing, and yet we still had a housing bubble. So much for small taxes stopping speculative activity. If an investor expected to double his money, it seems quite a stretch to believe that such a small tax would discourage him.
More importantly, our recent financial crisis was not triggered by too much equity (like stocks) but by too much debt. In taxing stock transactions, we only add to the already favorable treatment of debt compared to equity, encouraging even greater leverage in our financial system.
The real purpose of this tax on speculation becomes apparent when the AFL-CIO suggests what the money should be used for…building new infrastructure that would require the hiring of unionized workers. The AFL-CIO should stop hiding behind the spin of stopping speculation and directly engage in the real debate: the massive size of our federal government and the unsustainable fiscal path we are on.
Timmy Throws a Temper-Tantrum
As reported in yesterday’s Wall Street Journal, Treasury Secretary Tim Geithner called fellow bank regulators, included Fed Chair Ben Bernanke and FDIC Chair Sheila Bair, over for an obscenity-laced rant about their audacity in raising questions about his scheme to fix our financial system.
Reportedly the Secretary told regulators that “enough is enough” and that they’ve been heard, so the time for debate is over. This sounds eerily like the President’s previous comments about including Republicans in the talks over the stimulus – you’ve been heard, so you were “included,” now shut up. The shouting down of debate is becoming all too much a signature of this Administration.
The Secretary apparently also told the regulators in attendance that it was the administration and the Congress that sets policy. Perhaps next he’ll tell us that the power of the purse lies with the Treasury and the Congress. Secretary Geithner has no more constitutional authority to set policy than do any of the bank regulators. It is the job of Congress to make laws, not the Treasury Secretary’s. He can offer his opinion, just as they can, and should, offer theirs.
Of course, Secretary Geithner’s frustrations are understandable, given that his regulatory proposals have hit a brick-wall with both Congress and the Public. He has made no effort to explain to either Congress or the public how exactly his plan will stop future bailouts. Instead, any reasonable read of his proposal would lead to the conclusion that we will have more bailouts, rather than less, under the Obama-Geithner plan. Instead of directing his energies at anger, he should put them toward coming up with solutions that actually increase the stability of our financial system.
We were all told during his confirmation process that we must overlook such facts as his failure to pay taxes, because Tim Geithner was the “boy-wonder” who would save our financial system. As his recent out-bursts demonstrate, “boy-wonder” is only half-right.
Bailouts Could Hit $24 Trillion?
ABC News reports:
“The total potential federal government support could reach up to $23.7 trillion,” says Neil Barofsky, the special inspector general for the Troubled Asset Relief Program, in a new report obtained Monday by ABC News on the government’s efforts to fix the financial system.
Yes, $23.7 trillion.
“The potential financial commitment the American taxpayers could be responsible for is of a size and scope that isn’t even imaginable,” said Rep. Darrell Issa, R-Calif., ranking member on the House Oversight and Government Reform Committee. “If you spent a million dollars a day going back to the birth of Christ, that wouldn’t even come close to just $1 trillion — $23.7 trillion is a staggering figure.”
Granted, Barofsky is not saying that the government will definitely spend that much money. He is saying that potentially, it could.
At present, the government has about 50 different programs to fight the current recession, including programs to bail out ailing banks and automakers, boost lending and beat back the housing crisis.
We used to complain that George W. Bush had increased spending by ONE TRILLION DOLLARS in seven years. Who could have even imagined new government commitments of $24 trillion in mere months? These promises could make the implosion of Fannie Mae and Freddie Mac look like a lemonade stand closing.
Too Big to Fail
One of the most pernicious public policies aggravating the financial crisis is that of “too big to fail.” The doctrine states that some banks (now financial institutions generally) are so large that their failure would incur “systemic risk” for the financial system. That sounds terrible and it is intended to. Financial services regulators and Treasury secretaries use it to frighten small children and congressmen. How can an elected official vote to incur systemic risk? He must vote to approve the bank bailout of the day. In fact, people who use the term cannot even agree among themselves as to what it means, much less what causes it and, therefore, what the appropriate response would be. I suggest the reader substitute the phrase “too politically connected to fail” whenever he sees “too big to fail.” What follows will then be rendered intelligible.
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