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March 8, 2013

Latest Posts from Economist's View


Latest Posts from Economist's View


Posted: 26 Feb 2013 11:11 AM PST
We are, as they say, live:
Our Real Worry Isn't the Debt, It's Our Politicians
The political environment, particularly today's Republican Party, is the biggest threat to future economic growth.
Posted: 26 Feb 2013 12:03 AM PST
Posted: 25 Feb 2013 03:23 PM PST
Tim Duy:
ECB Should Pledge to Not Do Anything Stupid, by Tim Duy: Market participants were rattled today by the election news out of Italy, as it looks like the economically-challenged nation is now politically adrift. But what exactly might worry investors? I pulled this quote from Bloomberg:
"We don't want to see more chaos out of Europe," Bruce McCain, chief investment strategist at the private-banking unit of KeyCorp in Cleveland, said in a phone interview. His firm oversees more than $20 billion. "Any question about whether or not Italy would be committed to austerity measures after the elections gets investors concerned."
Why should we be concerned that Italy backslides on its commitment to austerity? After all, evidence of the economic damage wrought by such policies continues to mount. If anything, a reversal of recent austerity should be welcome.
I suspect, however, that it is not the austerity that worries market participants. It is the fear that European Central Bank head Mario Draghi will threaten to pull his pledge to do whatever is takes to save the Euro in the face of Italian intransigence. The fear that European policymakers are about to partake in another grand game of chicken that once again will bring the sustainability of the single currency back into question. In short, I think that market participants fear tight monetary policy much more than loose fiscal policy.
I am very much hoping that the ECB will keep calm and not do anything that encourages market participants to once again doubt the central bank's commitment to the Euro. Otherwise, this spring and summer will look much like last year's. And the year before that. And the year before that.
Posted: 25 Feb 2013 01:40 PM PST
This is from a St. Louis Fed write-up of the following Dialogue:
St. Louis Fed economist William Emmons led the Dialogue, titled "Robo-signing, the London Whale and Libor Rate-Rigging: Are the Largest Banks Too Complex for Their Own Good?" Joining Emmons for the Q&A that followed were Mary Karr, senior vice president and general counsel of the St. Louis Fed; Steven Manzari, senior vice president of the New York Fed's Complex Financial Institutions unit; and Julie Stackhouse, senior vice president of Banking Supervision and Regulation at the St. Louis Fed. See the videos and Emmons' presentation slides at www.stlouisfed.org/dialogue.
Here's the last part of the write-up on dealing with the too big to fail problem:
The Big Banks: Too Complex To Manage?, Central Banker, Winter 2012, FRB St. Louis:
... How To (Maybe) End "Too Big To Fail"
So, how will we deal with the megabanks? Emmons outlined two basic approaches: radical and incremental. The radical approach involves structural changes imposed on the banks themselves or the creation of a different legal definition of what a bank is and what it can do. Radical proposals include:
  • Reduce their complexity and size – Revive the 1933 Glass-Steagall Act (partially repealed by the 1999 Gramm-Leach-Bliley Act) prohibiting combining commercial banking with investment banking or insurance underwriting. Also, reduce their size by placing limits on banks' assets or deposits. However, Emmons said this proposal likely wouldn't succeed because combining commercial and investment banking was not the main source of problems; in fact, many of the "too-big-to-fail" institutions that caused problems during the crisis would have been allowed to operate under Glass-Steagall.
  • Create "narrow banks" – Separate payments functions from all other financial activities. Such a bank would take deposits and make payments but not make loans except those that have very little default risk. Emmons said this proposal wouldn't be successful either because such banks are not likely to be viable. Narrow banks likely would seek to make riskier loans to improve their profitability, while non-narrow banks would seek to enter the payments business in one way or another.
"In fact, we have chosen not to pursue radical approaches to solving the 'too-big-to-fail' problem," he said. "Instead, we're implementing incremental—albeit significant—reforms of the existing legal, regulatory and governance frameworks in which banks operate." Meanwhile, bankers, regulators and legislators won't know whether the regulatory reform efforts will actually work until they are actually used. Those efforts, which have sparked a lot of profound debate throughout the financial industry, include:
  • The 2010 Dodd-Frank Act – The law includes living wills for orderly dissolution, capital requirements, stress tests, risk-based assessments on deposit insurance, FDIC orderly liquidation authority, the Volcker Rule and investor protections. "These are all pushing banks to be more effective in internal discipline," Emmons said.
  • Basel III Accord – The third round of the Basel Accords is looking to improve the quality of bank capital and make other changes related to capital so that big banks demonstrate that they "have more skin in the game," Emmons said.
Emmons also offered another proposal: Make a strictly enforced "death penalty" regime, a law mandating that any bank requiring government assistance would be nationalized, with a plan to sell it back to new shareholders at some point in the future. "The crux of the matter would be carrying through this pledge to re-privatize the institution," he said. "It should reduce the incentives to take risk because the 'death penalty' is such a severe penalty that it would act as a deterrent." Emmons noted that TARP (the Troubled Asset Relief Program) was a half-step in this direction, in which the federal government took noncontrolling equity positions in megabanks—preferred instead of common equity—and didn't wipe out shareholders or management.
"It's not so radical of a proposal because we did impose a 'death penalty' on Fannie Mae and Freddie Mac: Their shareholders and management were wiped out. General Motors and Chrysler were forced into bankruptcy, and AIG was effectively nationalized," he said.
"If this were to be the plan, we would need (to continue the metaphor) an undertaker standing by—an institution that would be ready to exact this discipline on the firms," he said, pointing to other nations' permanent "sovereign wealth funds" that can take equity positions in firms.
The Jury Is Still Out
While investigations and lawsuits continue, regulations are written for new laws, and the industry wrestles with proposed capital and other standards, the question remains: Will any of this solve "too big to fail," successfully rein in systemic risk or prevent future "misbehaviors"? Simply put, we don't know yet.
"I think it's really important to realize that these are the early days in terms of the reform efforts for the financial system, and many firms still have to navigate a pretty complex set of changes to the regulatory landscape, how the world is unfolding and how they're going to generate profits," Manzari said during the Q&A portion.
Stackhouse noted that of the 400 or so regulations and rules required by the Dodd-Frank Act, only about one-third are actually in place. "The financial community, large banks in particular—those with over $50 billion in assets—have a lot ahead of them," she said. "The Dodd-Frank Act right now is the mechanism on the table to deal with these very large firms. The jury is still out on how that particular rule making will take place and how effective it will be."
A strictly enforced "death penalty" sounds good to me, but I'd also like to reduce the ability of large financial institutions to influence politicians and regulators. The discussion does note that:
The revelations of recent controversies such as robo-signing, the London Whale and Libor rate-rigging—explored in the "Big Bank Misbehaviors" sidebar at the bottom—as well as other problems not mentioned here indicate that something critical was lacking in the discipline of large, complex banks.
But the regulatory capture aspect of large banks isn't addressed.
I mostly wanted to highlight this slide from the presentation because it answers a question I've been asking for a long time, how big do banks need to be in order to reach the minimum efficient scale?
Frbstl1
And from another slide, the size of the largest banks:
Frbstl2
Some summary measures:
Frbstl3
The conclusion seems obvious to me.
Posted: 25 Feb 2013 09:00 AM PST
Dean Baker:
Fix the Economy, Not the Deficit, by Dean Baker, The American Prospect: It's hard to be happy about the prospect of the sequester ... going into effect at the end of the week. Not only will it will mean substantial cuts to important programs; it will be a further drag on an already weak economy, shaving 0.6 percentage points off our growth rate. ...
Of course, it could be worse. Half of the cuts are on the military side. This will help to bring our bloated military sector closer to its pre-September 11 share of the economy, and going forward, the principle that domestic cuts be matched by cuts in defense spending is certainly better than the idea of attacking domestic spending alone. In addition, the most important programs in the budget—Social Security, Medicare, and Medicaid—have been largely spared the ax—an important victory in the 2011 negotiations. ...
The next step at that point is unclear. President Obama has explicitly offered cuts in Social Security and Medicare if the Republicans will go along with higher taxes. For those who oppose cuts to these programs, the generous view of this maneuver is that he knows that the Republicans won't budge on taxes; by offering a compromise, he is simply making them look unreasonable. The less  generous view is that he is actually willing to make cuts in these programs, sharing the view of Washington Post-centrist types that seniors are living too high on the hog. 
While the odds are against a "grand bargain" that couples tax increases with cuts to Medicare, Medicaid, and Social Security, it remains a possibility. However, it's more likely that President Obama and Congress will agree to some scaled-down version of the sequester... This will have the deficit hawks yelling and screaming, but that would be the best plausible outcome from the standpoint of the economy. ...
My view is of the less generous variety. I think Obama is quite willing to make these cuts.
Posted: 25 Feb 2013 12:03 AM PST

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