Category Archive for: Regulation [Return to Main]

Thursday, April 17, 2014

'Antitrust in the New Gilded Age'

Robert Reich:

Antitrust in the New Gilded Age, by Robert Reich: We’re in a new gilded age of wealth and power similar to the first gilded age when the nation’s antitrust laws were enacted. Those laws should prevent or bust up concentrations of economic power that not only harm consumers but also undermine our democracy — such as the pending Comcast acquisition of Time-Warner. ...
In many respects America is back to the same giant concentrations of wealth and economic power that endangered democracy a century ago. The floodgates of big money have been opened...
Remember, this is occurring in America’s new gilded age — similar to the first one in which a young Teddy Roosevelt castigated the “malefactors of great wealth, who were “equally careless of the working men, whom they oppress, and of the State, whose existence they imperil.”
It’s that same equal carelessness toward average Americans and toward our democracy that ought to be of primary concern to us now. Big money that engulfs government makes government incapable of protecting the rest of us against the further depredations of big money.
After becoming President in 1901, Roosevelt used the Sherman Act against forty-five giant companies, including the giant Northern Securities Company that threatened to dominate transportation in the Northwest. William Howard Taft continued to use it, busting up the Standard Oil Trust in 1911. 
In this new gilded age, we should remind ourselves of a central guiding purpose of America’s original antitrust law, and use it no less boldly. 

Monday, April 14, 2014

Paul Krugman: Three Expensive Milliseconds

 What is the "true cost of our bloated financial industry"?:

Three Expensive Milliseconds, by Paul Krugman, Commentary, NY Times: Four years ago ... Spread Networks finished boring its way through the Allegheny Mountains of Pennsylvania. Spread’s tunnel was ... a fiber-optic cable that would shave three milliseconds — three-thousandths of a second — off communication time between the futures markets of Chicago and the stock markets of New York. ...
Who cares about three milliseconds? The answer is, high-frequency traders, who make money by buying or selling stock a tiny fraction of a second faster than other players. ...
Think about it..., spending hundreds of millions of dollars to save three milliseconds looks like a huge waste. And that’s part of a much broader picture, in which society is devoting an ever-growing share of its resources to financial wheeling and dealing, while getting little or nothing in return.
How much waste are we talking about? A paper by Thomas Philippon of New York University puts it at several hundred billion dollars a year. ...
What are we getting in return for all that money? Not much, as far as anyone can tell. ...
But if our supersized financial sector isn’t making us either safer or more productive, what is it doing? One answer is that it’s playing small investors for suckers, causing them to waste huge sums in a vain effort to beat the market. Don’t take my word for it — that’s what the president of the American Finance Association declared in 2008. Another answer is that a lot of money is going to speculative activities that are privately profitable but socially unproductive. ...
 It’s ... hard ... to see how the three-millisecond advantage conveyed by the Spread Networks tunnel makes modern America richer; yet that advantage was clearly worth it to the speculators.
In short, we’re giving huge sums to the financial industry while receiving little or nothing — maybe less than nothing — in return. Mr. Philippon puts the waste at 2 percent of G.D.P. Yet even that figure, I’d argue, understates the true cost of our bloated financial industry. For there is a clear correlation between the rise of modern finance and America’s return to Gilded Age levels of inequality.
So never mind the debate about exactly how much damage high-frequency trading does. It’s the whole financial industry, not just that piece, that’s undermining our economy and our society.

Saturday, April 12, 2014

Have We Repaired Financial Regulations Since Lehman?

"The 2008 financial crisis led to the worst recession in the developed world since the Great Depression. Governments had to respond decisively on a large scale to contain the destructive impact of massive debt deflation. Still, several large financial institutions and thousands of small-to-medium-sized institutions collapsed or had to be rescued, numerous non-financial businesses closed, and millions of households lost their savings, jobs, and homes. Five years later, we are still feeling these effects. Will the financial reforms introduced since the onset of the crisis prevent another catastrophe? This keynote panel titled 'Have We Repaired Financial Regulation Since Lehman' at the Institute for New Economic Thinking's "Human After All" conference in Toronto."

Featured speakers: Anat Admati, Richard Bookstaber, Andy Haldane, and Edward Kane, moderated by Martin Wolf.

Thursday, March 13, 2014

'The Free Market’s Weak Hand'

James Kwak:

The Free Market’s Weak Hand, by James Kwak:

“Except where market discipline is undermined by moral hazard, owing, for example, to federal guarantees of private debt, private regulation generally is far better at constraining excessive risk-taking than is government regulation.”

That was Alan Greenspan back in 2003. This is little different from another of his famous maxims, that anti-fraud regulation was unnecessary because the market would not tolerate fraudsters. It is also a key premise of the blame-the-government crowd (Wallison, Pinto, and most of the current Republican Party), which claims that the financial crisis was caused by excessive government intervention in financial markets.

Market discipline clearly failed in the lead-up to the financial crisis. ... However, one thrust of post-crisis regulation has been to attempt to strengthen market discipline. This is consistent with the overall Geithner-Summers doctrine that markets generally work close to perfectly, and that regulation should mainly attempt to nudge markets in the right direction.

David Min (the lead rebutter of Wallison and Pinto’s theory of subprime mortgages, which relied on a made-up definition of “subprime”) has a new paper explaining why this is likely to fail. ...

Ultimately, one of Min’s suggestions is that we simply cannot rely heavily on market discipline as a means of constraining risk-taking by financial institutions. This leaves us with relatively unfashionable tools like higher capital requirements and structural reforms (size and complexity limits). But that’s not nearly sophisticated enough for the Geithner-Summers-Bernanke crew.

Thursday, March 06, 2014

'Why DRM'ed Coffee-Pods May be Just the Awful Stupidity We Need'

Speaking of anti-competitive behavior, here's Cory Doctorow:

Why DRM'ed coffee-pods may be just the awful stupidity we need, by Cory Doctorow: I've been thinking about the news that Keurig has added "DRM" to its pod coffee-makers since the story first started doing the rounds a couple of days ago. I've come to the conclusion that while the errand is a foolish one, and the company deserves nothing but contempt for such an anti-competitive move, that there might be a silver lining to this cloud. As I've written recently, there's not a lot of case-law on Section 1201 of the Digital Millennium Copyright Act (DMCA), the law that prohibits "circumventing...effective means of access control" to copyrighted works. In the past, we've seen printer companies and garage door opener manufacturers claim that the software in their devices was a "copyrighted work" and that anyone who made a spare part for their products was thus violating 1201. But that was 10 years ago, and it's been a while since there was someone stupid and greedy enough to try that defense.
I think Keurig might just be that stupid, greedy company. The reason they're adding "DRM" to their coffee pods is that they don't think that they make the obviously best product at the best price, but want to be able to force their customers to buy from them anyway. So when, inevitably, their system is cracked by a competitor who puts better coffee at a lower price into the pods, Keurig strikes me as the kind of company that might just sue. And not only sue, but keep on suing, even after they get their asses handed to them by successive courts. With any luck, they'll make some new appellate-level caselaw in a circuit where there's a lot of startups -- maybe by bringing a case against some spunky Research Triangle types in the Fourth Circuit.
Now, this is risky. Hard cases made bad law. A judge in a circuit where copyright claims are rarely heard might just buy the idea of copyright covering pods of coffee. The rebel forces that Keurig sues might be idiots (remember Aimster?). But of all the DRM Death Stars to be unveiled, Keurig's is a pretty good candidate for Battle Station Most Likely to Have a Convenient Thermal Exhaust Port.

[Boing Boing is licensed under a Creative Commons License permitting non-commercial sharing with attribution.]

'Did Robert Bork Understate the Competitive Impact of Mergers?'

I have argued again and again that we aren't concerned enough about the concentration of economic power:

Did Robert Bork Understate the Competitive Impact of Mergers? Evidence from Consummated Mergers, by Orley C. Ashenfelter, Daniel Hosken, and Matthew C. Weinberg, NBER: In The Antitrust Paradox, Robert Bork viewed most mergers as either competitively neutral or efficiency enhancing. In his view, only mergers creating a dominant firm or monopoly were likely to harm consumers. Bork was especially skeptical of oligopoly concerns resulting from mergers. In this paper, we provide a critique of Bork’s views on merger policy from The Antitrust Paradox. Many of Bork’s recommendations have been implemented over time and have improved merger analysis. Bork’s proposed horizontal merger policy, however, was too permissive. In particular, the empirical record shows that mergers in oligopolistic markets can raise consumer prices.

Wednesday, February 26, 2014

Fed Watch: Tarullo on Monetary Policy and Financial Stability

Tim Duy is helping to fill the void -- thanks Tim:

Tarullo on Monetary Policy and Financial Stability, by Tim Duy: Federal Reserve Governor Daniel Tarullo tackled the issue of financial stability in a speech that I think is well worth the time to read. The starting point is that many lessons have been learned over the past two cycles, including the perils of ignoring financial stability issues. But how should such concerns be incorporated into the policymaking process? Tarullo:

While few today would take the pre-crisis view common among central bankers that financial stability should not be an explicit concern of monetary policy, there is considerable disagreement over--among other things--the weight that financial stability concerns should carry compared with traditional monetary policy goals of price stability and maximum employment.

Tarullo begins with a brief overview of the financial crisis and the Fed's response, declaring partial victory:

...while the recovery has been frustratingly slow and remains incomplete, there has been real progress, despite the fact that in the past couple of years a restrictive fiscal policy has been working at cross-purposes to monetary policy, and that balance sheet repair and financial strains in Europe have made it more difficult for the economy to muster much self-sustaining momentum.

As Tarullo notes, the Fed's actions have not come without backlash. Of much focus is the size of the balance sheet, and the likelihood of unwinding the resulting liquidity should inflation rear its head. Tarullo quickly dismisses this concern as no longer of major concern given the expansion of the Fed's toolkit. He turns his attention toward bigger game:

The area of concern about recent monetary policy that I want to address at greater length relates to financial stability. The worry is that the actual extended period of low interest rates, along with expectations fostered by forward guidance of continued low rates, may be incentivizing financial market actors to take on additional risks to boost margins, thereby contributing to unsustainable increases in asset prices and a consequent buildup of systemic vulnerabilities. Indeed, in the years preceding the crisis, a few prescient observers swam against the tide of conventional wisdom to argue that a sustained period of low rates was inducing investors to "reach for yield" and thereby endangering the financial system.

Policymakers currently anticipate the Fed will hold interest rates near zero into 2015, followed by only a gradual path of tightening. The concern is that such a long period of low rates will spawn an asset bubble, or bubbles, similar to the process that many feel fueled the housing boom last decade. The eventual unwinding of any bubbles would likely be unpleasant. But, presumably, the period of low rates occurred for a reason - to support economic activity. Therein lies the conundrum for policymakers:

The very accommodative monetary policy that contributed to the restoration of financial stability could, if maintained long enough in the face of slow recovery in the real economy, eventually sow the seeds of renewed financial instability. Yet removal of accommodation could choke off the recovery just as it seems poised to gain at least a bit more momentum.

So how can the Federal Reserve protect against financial instability? Tarullo here makes a point I think the Fed will frequently reiterate:

As a preliminary matter, it is important to note that incorporating financial stability considerations into monetary policy decisions need not imply the creation of an additional mandate for monetary policy. The potentially huge effect on price stability and employment associated with bouts of serious financial instability gives ample justification.

By addressing financial instability risks, they are attempting to minimize deviations in inflation and unemployment. In effect, they might slow the pace of activity on the upside in return for minimizing the downside. This, however, is easier said then done, as it is difficult to sell delaying progress on the real problems of low inflation and high unemployment to fight against a phantom downturn:

Of course, this preliminary observation underscores the fact that the identification of systemic risks, especially those based on the putative emergence of asset bubbles, is not a straightforward exercise. The eventual impact of the bursting of the pre-crisis housing bubble on financial stability went famously underdiagnosed by policymakers and many private analysts. But there would be considerable economic downside in reacting with policy measures each time a case could be made that a bubble was developing.

The Fed is actively paying attention to markets in the search for stability risks. Tarullo reports the outcome of the Fed's new macroprudential efforts:

At present, our monitoring does find some evidence of increased duration and credit risk, but the increases appear relatively moderate to date--particularly at the largest banks and life insurers. Moreover, valuations for broad categories of assets such as real estate and corporate equities remain within historical norms, suggesting that valuation pressures, if present, are confined to narrower segments of assets. For example, valuations do appear stretched for farmland, although recent data are suggesting some slowing, and for the equity prices of some small technology firms.

No broad-based concerns such as the equity surge of the 1990s or the housing boom of the 2000s. Just pockets of issues here and there. That said, all is not perfect:

Still, there are areas where investors appear to have been very sanguine regarding certain types of exposure and modest in their demands for compensation to assume such risk. High-yield corporate bond and leveraged loan funds, for instance, have seen strong inflows, reflecting greater investor appetite for risky corporate credits, while underwriting standards have deteriorated, raising the possibility of large losses going forward.

Weak underwriting for risky, leveraged assets that investors seem eager to acquire for unusually little reward. This is the kind of situation, especially with leveraged assets, that will repeatedly gain the Fed's attention going forward. What action has the Fed taken? Tarullo:

In these circumstances, it has to date seemed appropriate to rely on supervisory responses. For example, in the face of substantial growth in the volume of leveraged lending and the deterioration in underwriting standards, the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued updated guidance on leverage lending in March 2013. This guidance outlined principles related to safe and sound leveraged lending activities, including the expectation that banks and thrifts originate leveraged loans using prudent underwriting standards regardless of their intent to hold or distribute them.

In addition, the Federal Reserve, alongside other regulators, has been working with the firms we supervise to increase their resilience to possible interest rate shocks...Our analysis to this point (undertaken outside of our annual stress test program) suggests that banking firms are capitalized to withstand the losses in asset valuations that would arise from large spikes in rates, which, moreover, would see an offset from the increase in the value of bank deposit franchises. This finding is consistent with the lack of widespread stress during the period of May through June 2013 when interest rates increased considerably. The next set of stress-test results, which we will release next month, will provide further insight on this point, both to regulators and to markets.

Some enhanced guidance and additional stress tests. I think it would be reasonable to describe this response as underwhelming. Would "additional guidance" have deterred lending activity during the housing bubble? I somehow doubt it. Indeed, Tarullo has his doubts:

While ad hoc supervisory action aimed at specific lending or risks is surely a useful tool, it has its limitations. First, it is a bit too soon to judge precisely how effective these supervisory actions--such as last year's leveraged lending guidance--have been. Second, even if they prove effective in containing discrete excesses, it is not clear that the somewhat deliberate supervisory process would be adequate to deal with a more pervasive reach for yield affecting many areas of credit extension. Third, and perhaps most important, the extent to which supervisory practice can either lean against the wind or increase the overall resiliency of the financial system is limited by the fact that it applies only to prudentially regulated firms. This circumstance creates an incentive for intermediation activities to migrate outside of the regulated sector.

The last point is critical. Increased regulatory activity might just push more activity into the shadow banking realm. There the threat of financial instability might increase exponentially, but without a regulator as a backstop. I think this issue will tend to restrain the Fed's interest in heavy-handed regulatory activity.

Tarullo follows with a discussing of time-varying policies, citing the example of increased loan-to-value requirements for mortgages as lending accelerates. This is an area to watch, as Tarullo sees value in this approach:

...I would devote particular attention to policies that can act as the rough equivalent of an increase in interest rates for particular sources of funding. Such policies would be more responsive to problems that were building quickly because of certain kinds of credit, without regard to whether they were being deployed in one or many sectors of the economy...

Such policies could slow the progress of an asset bubble and, as Tarullo points out, provide additional time for policymakers to determine if the situation requires a change in overall monetary policy. Ultimately, however, Tarullo is a realist. He doesn't intent to put all his eggs in the macroprudential basket:

The foregoing discussion has considered the ways in which existing supervisory authority and new forms of macroprudential authority may allow monetary policymakers to avoid, or at least defer, raising interest rates to contain growing systemic risks under circumstances in which policy is falling well short of achieving one or both elements of the dual mandate. However, as has doubtless been apparent, I believe these alternative policy instruments have real limitations.

As he later says, this means that the Fed should not take the direct monetary policy action "off the table" when it comes to addressing financial instability. What does that mean for policy in the near term? Tarullo:

As I noted earlier, I do not think that at present we are confronted with a situation that would warrant a change in the monetary policy we have been pursuing...

Not terribly surprising. After all, given that policymakers expect a long period of low rates, they obviously are not expecting sufficient financial instability to justify changing that outcome. But expect more talk about the topic:

...But for that very reason, now is a good time to consider these issues more actively. One useful step would be development of a framework that would allow us to make a more analytic, less instinctual judgment on the potential tradeoffs between enhanced financial stability and reduced economic activity. This will be an intellectually challenging exercise, but in itself does not entail any changes in policy.

Bottom Line: The Fed continues to explore the role of monetary policy in addressing asset bubbles. But engaging such concerns head on with tighter policy remains a secondary option. The first option is a variety of macroprudential tools. Moreover, policymakers believe they have the time to explore such tools, much as they have had time to consider managing their expanded balance sheet. They will also remain cautious to act out fear of increasing the risk of instability by driving activity out from under their purview. At this point, my gut reaction is that by the time the Fed feels they are left with no other option but to tighten policy to limit financial instability risks, the damage will already have been done.

Friday, February 21, 2014

'What Do Obamacare and the EITC Have in Common with Cap-and-Trade?'

Jeff Frankel has a follow-up to a post I highlighted a few days ago:

What Do Obamacare and the EITC Have in Common with Cap-and-Trade?: My preceding blog post described how market-oriented mechanisms to address environmentally damaging emissions, particularly the cap-and-trade system for SO2 in the United States, have recently been overtaken by less efficient regulatory approaches such as renewables mandates. One reason is that Republicans — who originally were supporters of cap-and-trade — turned against it, even demonized it.
One can draw an interesting analogy between the evolution of Republican political attitudes toward market mechanisms in the area of federal environmental regulation and hostility to the Affordable Care Act, also known as Obamacare. ... One can trace through the parallels between clean air and health care. ... A third example is the Earned-Income Tax Credit. ...

Wednesday, February 19, 2014

'The Rise and Fall of Cap-and-Trade'

Jeff Frankel:

The Rise and Fall of Cap-and-Trade: ...the political tide on both sides of the Atlantic has been against “cap and trade” over the last five years. In the United States, the highly successful trading system for allowances in emissions of SO2 (sulfur dioxide) has all but died since 2012.  In the European Union as well, the Emissions Trading System was in effect overtaken by other kinds of regulation in 2013.
Cap-and-trade was originally considered a Republican idea.  Market-friendly regulation was pushed by those who thought of themselves as pro-market, rather than by those who thought of themselves as pro-regulation.  Most environmental organizations were opposed to the novel approach;  many of them thought it immoral for corporations to be able to pay for the right to pollute. The pioneering use of the cap-and-trade approach to phase out lead from gasoline in the 1980s was a policy of Ronald Reagan’s Administration.  Its successful use to reduce SO2 emissions from power plants in the 1990s was a policy of George H.W. Bush’s administration.  The proposal to use cap-and-trade to reduce SO2 and other emissions further was a policy of George W. Bush’s administration ten years ago under, first, the Clear Skies Act proposed in 2002 and then the Clean Air Interstate Rule of 2005. (See Schmalensee and Stavins, 2013, pp.103-113.) ... Senator John McCain, had sponsored US legislative proposals to use cap-and-trade to address emissions of carbon dioxide and other greenhouse gases responsible for global warming. ...
Republican politicians have now forgotten that this approach was ever their policy.  To defeat the last major climate bill in 2009, they worked themselves into a frenzy of anti-regulation rhetoric.  ... The Republican rhetoric successfully stigmatized cap-and-trade.  Schmalensee and Stavins (p.113) sum it up: “It is ironic that conservatives chose to demonize their own market-based creation.”
This stance left in its place alternative approaches that are less market-friendly (Stavins, 2011)... The non-market alternatives, such as “command and control” regulation requiring that particular energy sources or particular technologies be used, are less efficient.    Nonetheless they are again the dominant regime.   ...
There is nothing inevitable or irreversible about the recent trend away from cap-and-trade.  ... Even in the US, where it began, there is still grounds for hope. ...

Saturday, February 15, 2014

'Time to Get Real on Comcast-Time Warner'

On the proposed Comcast Time-Warner merger:

Paul Krugman:

Monoposony Begets Monopoly, And Vice Versa: Nothing to see here, folks, says Comcast. The cable giant’s defenders insist that its already awesome market power won’t be increased if it acquires Time Warner, because they serve (i.e., are local monopolists in) different geographical areas...
But elsewhere in the business section, we see clear evidence that this is nonsense. Comcast’s size gives it monopsony as well as monopoly power — it is able to extract far more favorable deals from content providers than smaller rivals. And if it’s allowed to acquire Time Warner, it will be even more advantaged...
This would, in turn, make it even harder for potential competitors to enter markets served by ComcastTimeWarner, strengthening its monopoly position.
What possible justification could there be for approving this scheme?

Joshua Gans:

Time to get real on Comcast-Time Warner, by Joshua Gans: ... with every potential harm to the public benefit is also opportunity. What would happen if, as part of the conditions to approve this merger (a) content assets were divested; and (b) Net Neutrality was enshrined? That may remove more structural impediments to competition and guarantee that this is a long-term win for consumers. It would be nice if someone were to propose that.

In general, I don't think that we pay enough attention to the problems that are associated with market power.

Monday, February 03, 2014

'Silicon Valley Billionaires Believe in the Free Market, as Long as They Benefit'

Dean Baker:

Silicon Valley billionaires believe in the free market, as long as they benefit, by Dean Baker, theguardian.com: Last week, Mark Ames published an article ... on a court case that alleges that Apple, Google, and other Silicon Valley powerhouses actively conspired to keep their workers' wages down. According to documents filed in the case, these companies agreed not to compete for each others' workers dating at least as far back as 2005. ... This means not only that they broke the law, and that they acted to undermine the market, but that they really don't think about the market the way libertarians claim to think about the market. ...

The classic libertarian view of the market is that we have a huge number of people in the market actively competing..., there is so much competition that no individual or company can really hope to have much impact on market outcomes.

This point is central to their argument that the government should not interfere with corporate practices. For example, if we think our local cable company is charging too much..., our libertarian friends will insist that the phone company, satellite television or other competitors will step in to keep prices in line. They would tell the same story if the issue were regulating the airlines, banks, health insurance, or any other sector where there is reason to believe that competition might be limited. ...

The ... Silicon Valley non-compete agreements show that this is not how the tech billionaires believe the market really works. This is just a story they peddle to children and gullible reporters. ... The fact the Silicon Valley honchos took the time to negotiate and presumably enforce these non-compete agreements was because they did not think that there were enough competitors to hire away their workers. They believed that they had enough weight on the buy-side of the market for software engineers ... to ... keep their wages down. ...

Tuesday, January 14, 2014

'Capital Markets Balkanization Should Not Prevent Regulation'

Adair Turner:

Adair Turner: Capital Markets Balkanization Should Not Prevent Regulation, by The Institute for New Economic Thinking: “Don’t worry about the balkanisation of global capital markets” – Adair Turner
Fears that bank regulation or capital controls could lead to a “balkanisation” of global capital markets are overstated and should not constrain policy action to address the problems created by volatile short term capital flows and excessive credit creation, says Adair Turner, Senior Fellow at the Institute for New Economic Thinking and former chairman of the United Kingdom Financial Services Authority.
Speaking at a conference in Delhi sponsored by the Reserve Bank of India, Turner focused on the links between the international monetary system and domestic financial stability. [For the text of the speech and presentation please see below.] ...
Ultimately, Turner rejected the idea that this would lead to a harmful fragmentation of global capital markets.
“Talk of such policies is often met by objections that this will lead to a dangerous ‘balkanisation’ of global capital markets, preventing the free flow of capital and stymieing its allocative efficiency benefits,” he said. “But since the evidence for the benefits of financial integration is at best elusive and ambiguous, some ‘balkanisation’ of short term international debt markets could be a good thing”.

Monday, December 09, 2013

'What Obama Left Out of His Inequality Speech: Regulation'

Thought I'd highlight this piece from today's links:

What Obama Left Out of His Inequality Speech: Regulation, by Thomas McGarity, Commentary, NY Times: President Obama’s speech on inequality last Wednesday was important in several respects. He identified the threat to economic stability, social cohesion and democratic legitimacy posed by soaring inequality of income and wealth. He put to rest the myths that inequality is mostly a problem afflicting poor minorities, that expanding the economy and reducing inequality are conflicting goals, and that the government cannot do much about the matter.
Mr. Obama also outlined several principles to expand opportunity: strengthening economic productivity and competitiveness; improving education, from prekindergarten to college access to vocational training; empowering workers through collective bargaining and antidiscrimination laws and a higher minimum wage; targeting aid at the communities hardest hit by economic change and the Great Recession; and repairing the social safety net.
But there’s a crucial dimension the president left out: the revival, since the mid-1970s, of the laissez-faire ideology that prevailed in the Gilded Age, roughly the 1870s through the 1910s. It’s no coincidence that this laissez-faire revival — an all-out assault on government regulation — has unfolded over the very period in which inequality has soared to levels not seen since the Gilded Age. ...[continue]...

See here for more.

Friday, November 15, 2013

'Actually, Economists Can Predict Financial Crises'

I've argued for some time that we need new measures of systemic risk in financial markets -- we won't know if we can find reliable measures or not until we try -- so as it says below, recent "efforts to develop measures of systemic risk are encouraging":

Actually, Economists Can Predict Financial Crises, by Mark Buchanan, Commentary, Bloomberg: ... In recent years, an inconsistency has emerged in the economics profession. Many, including some Nobel Prize winners, maintain that crises are by their very nature unpredictable. At the same time, others -- aided by engineers, physicists, ecologists and computer scientists -- are developing ways to detect and quantify systemic risks, including measures that regulators could use to identify imbalances or vulnerabilities that might result in a crisis. ...
The challenge for economists is to find those indicators that can provide regulators with reliable early warnings of trouble. ...
Work is racing ahead. In the U.S., the newly formed Office of Financial Research has published various papers on topics such as stress tests and data gaps -- including one that reviews a list of some 31 proposed systemic-risk measures. The economists John Geanakoplos and Lasse Pedersen have offered specific proposals on measuring the extent to which markets are driven by leverage, which tends to make the whole system more fragile.
One problem has been “physics envy” -- a longing for certainty and for beautiful, timeless equations that can wrap up economic reality in some final way. Economics is actually more like biology, with perpetual change and evolution at its core. This means we’ll have to go on discovering new ways to identify useful clues about emerging problems as finance changes and investors jump into new products and strategies. Perpetual adaptation is part of living in a complex world.
The efforts to develop measures of systemic risk are encouraging. ...

Thursday, October 31, 2013

'Why Bankers Still Aren't Chastened'

From Spiegel:

Why Bankers Still Aren't Chastened, by Martin Hesse and Anne Seith, Spiegel: ... At 1:45 on the morning of Oct. 19, Italian police arrested the 53-year-old [Raoul Weil, once one of the most influential executives at Swiss bank UBS] ... and brought him to ... Dozza prison. The reason: US authorities had indicted Weil, the former head of wealth management at UBS, for allegedly helping American clients hide their assets from US tax authorities on Swiss bank accounts.
Weil's arrest was only one of a series of reminders last week that bankers around the globe are no longer the admired elite of the business world. Public prosecutors, financial regulators and politicians everywhere now suddenly seem to be striving to condemn all of the industry's excesses in fast forward.
British authorities recently hit the financial sector with record penalties. Last week, on the other side of the Atlantic, a US court found Bank of America and a former manager guilty of fraud because of a scheme involving shoddy home loans. Shortly before that, Jamie Dimon, CEO of JPMorgan,reluctantly negotiated a record settlement of $13 billion (€9.45 billion) to at least put a stop to civil claims that his bank knowingly sold toxic US mortgage-backed securities. ...
The truth is, spectacular coups like Weil's arrest are little more than symbolic gestures. The fines and settlements paid by many financial institutions are akin to the indulgences sold by the medieval Catholic Church. The sins of the past may now be forgiven -- but there are no guarantees of improvement in the future.
Regulatory agencies and politicians have not set effective controls on banks and bankers, and although their reputation may be tarnished, their power remains unbroken. ...

Monday, October 21, 2013

Predatory Lending and the Subprime Crisis

From the NBER:

Predatory Lending and the Subprime Crisis, by Sumit Agarwal, Gene Amromin, Itzhak Ben-David, Souphala Chomsisengphet, Douglas D. Evanoff, NBER Working Paper No. 19550 Issued in October 2013: We measure the effect of an anti-predatory pilot program (Chicago, 2006) on mortgage default rates to test whether predatory lending was a key element in fueling the subprime crisis. Under the program, risky borrowers and/or risky mortgage contracts triggered review sessions by housing counselors who shared their findings with the state regulator. The pilot cut market activity in half, largely through the exit of lenders specializing in risky loans and through decline in the share of subprime borrowers. Our results suggest that predatory lending practices contributed to high mortgage default rates among subprime borrowers, raising them by about a third.

Monday, September 30, 2013

'World Leaders Must Act Faster on Climate Change'

Speaking of the GOP undermining of the public's faith in the government's ability to solve important problems. This is from Nicholas Stern:

World leaders must act faster on climate change, by Nicholas Stern, Commentary, Financial Times: Governments and businesses should be left in no doubt about the dangers of delaying further cuts in greenhouse gas emissions following the publication of the new assessment report by the Intergovernmental Panel on Climate Change. ... [W]e are seeing fundamental changes to the world’s climate, which could soon be ... causing mass migration and endless conflict. This should focus minds...
But all governments must recognise that they themselves potentially pose the biggest threat. There is a danger that, through vacillation and confusion, they will create policy risk that undermines the confidence of the companies largely responsible for delivering the transition to low-carbon economic growth and development. ...
Some politicians will still seek to deny the science and downplay the risks. Many of them have vested financial interests in protecting the status quo, or ideological beliefs that mean they cannot acknowledge the logic of correcting market failures ... to strengthen the role of markets... Although they are small in number, they still have the power to create confusion and slow action.
But everywhere evidence is emerging of opportunities afforded by new energy sources that are more efficient and less polluting. No investor should fail to be impressed by how rapidly the costs of solar photovoltaics and other technologies are falling. ...
The new IPCC report should now convince all world leaders to accelerate their efforts to tackle climate change and create a safer and more prosperous world.

Given the (intentionally created) political climate surrounding attempts to address this problem, it's hard for me to imagine anything of significance happening anytime soon.

Wednesday, September 25, 2013

Understanding the 'Economic' Arguments Against Dealing with Global Warming

Brad DeLong:

"But We Must Do the Wrong Thing!": Understanding the "Economic" Arguments Against Dealing with Global Warming: The market-based economics that I was brought upon had four principles:

  1. It is important to get the distribution of wealth right, or as right as you can, so that household willingness-to-pay properly represent social marginal values.
  2. It is important to get aggregate demand right--for the government to create the right amount of safe and of liquid assets to match shifting private sector demand and so make Say's Law true in practice if not in theory--so that the problems economic policy is dealing with are Harberger Triangles and not Okun Gaps.
  3. Then you can let the competitive market rip--as long, that is, as...
  4. You have also imposed the right Pigovian taxes and bounties to deal with externalities.

"But the Coase Theorem" you say? The Coase Theorem is three things:

  1. An injunction to carve property rights at the joints--to bundle powers, rights, obligations so that you have to impose as little in the way of Pigovian taxes and bodies as possible.
  2. A powerful way of thinking about whether the proper Pigovian taxes and bounties are best imposed through Article I processes (legislation) or Article III processes (adjudication).
  3. A thought experiment that, as Ronald Coase complained until the day he died, was seized by George Stigler for his own purposes and is much more often misinterpreted than applied.

The self-deluded who don't know what they're doing and the vested interests that fear they would be impoverished when we to do the right thing dealing with global warming are still holding on to their first line of defense: that global warming is not happening. They have, however, built a second line of defense: that global warming was happening until 1995, but then something stopped it, and it will not resume. And behind that is the third line of defense that they are now building which we are here to think about today: that we cannot afford to do the right Pigovian tax-and-bounty thing, for dealing with global warming will cost jobs and incomes.

This is the fifth policy-relevant case I have seen in recent years of the political right that claims to love the market system denying and abandoning the basic principles that underpin the technocrat judgment that the market system can and often is a wonderful social economic calculation, allocation, and distribution mechanism. It is almost as if their previous advocacy of the technocratic case for the market system was simply a mask for their vested interests. We have seen this in opposition to doing the right thing in financial regulation; in the management of aggregate demand; in the provision of the right level of social insurance in the long run; and in shifting the policy mix to partially offset the medium-run rapid rise in inequality. Milton Friedman and George Stigler always used to say that you were better off relying on market contestability rather than capture of old regulatory bureaucracies like the interstate commerce commission to deal with the market failures created by private monopoly, but the problems like excessive inequality and poverty on the one hand and pollution on the other required government action--a negative income tax in the first case, and a market-based antipollution policy via Pigovian taxes and bounties in the second. That is now, largely, out the window.

It is important to recognize what is going on here. ...

There's much, much more in the full post.

Sunday, September 22, 2013

'Lehman Was Not Alone – Measuring System Risk in the 2008 Crisis'

Robert Engle at the INET blog:

Lehman Was Not Alone – Measuring System Risk in the 2008 Crisis, by Robert Engle: On September 15, 2008, Lehman Brothers filed for bankruptcy and ushered in the worst part of the recent financial crisis. Today, we still discuss whether taxpayer money should have been used to rescue Lehman. My colleagues at NYU and I have developed measures of systemic risk, and this fifth anniversary affords us a good opportunity to look at what these measures would have indicated to Treasury Secretary Paulsen if they had been available at that time.
The answer is quite surprising. ... On the website, you can go back to August 29, 2008, to see the ranking of U.S. firms based on SRISK.  . Was Lehman at the top of the list in 2008? No. In fact, it was Number 11. ...

Wednesday, September 18, 2013

'DeLong: The Lehman Disaster was Foreseeable'

Brad DeLong:

... The uncontrolled bankruptcy of Lehman was a disaster.
Lehman was a systemically-important financial institution, and it was foreseeable that an uncontrolled bankruptcy would be a disaster--the only surprise was that it turned out to be a much bigger disaster than Paulson, Bernanke, Geithner were expecting at the time.
There is a date--April 15, 2008, say--at which Lehman Brothers was "solvent" in the sense that the Bush Treasury and the Bernanke-Geithner Fed would have been willing to lend to it massively as they near-extinguished the claims of its equity holders, closed down the institution, and distributed some of its risk to the Federal Reserve and some of its risk to other financial institutions.
There was a date--September 15, 2008--at which the Bush Treasury and the Bernanke-Geithner Fed were unwilling to do that, and let Lehman go.
By continuity, in between there is a last date at which Lehman can still be resolved in an orderly fashion--a date on which their special assistants walk into Paulson's, Bernanke's, and Geithner's offices, and say: "Today may be our last chance to close down Lehman in an orderly fashion. If things go badly for Lehman on the markets today, by tomorrow it will be so clearly insolvent that we will not be able to lend to it to grease its shutdown."
When Paulson, Bernanke, and Geithner heard that, they should immediately have huddled, and then called Lehman and said: "You need to do a deal today, because tonight we are going to announce that our judgment is that you are on the edge of insolvency."

Saturday, September 14, 2013

'Ronald Coase, a Pragmatic Voice for Government’s Role'

Robert Frank:

Ronald Coase, a Pragmatic Voice for Government’s Role, by Robert Frank, Commentary, NY Times: ... Nobel Memorial Prize in Economic Science [winner] ... Ronald H. Coase ... spent most of his career at the University of Chicago, where he was revered by its many free-market enthusiasts as the world’s foremost authority on ... negative externalities... He became their champion because they thought his framework provided the most cogent arguments for limiting government’s role in economic life.
That belief was profoundly mistaken. In time, I predict, Mr. Coase’s framework will instead be seen as providing not only the best explanation for why governments regulate..., but also the best advice on how they might regulate more effectively. ...
Mr. Coase’s work cannot be read as a case for minimal government. On the contrary, his message was more purely pragmatic: Because we can’t negotiate efficient private solutions most of the time, we must ask whether laws and other institutions can help steer us toward solutions we would have chosen if negotiation had been practical. ...
Because population density has been rising, behaviors with harmful side effects have been growing steadily more important. Our continued prosperity ... will require thinking clearly about how to mitigate the resulting damage. Mr. Coase has pointed the way forward.

Thursday, September 12, 2013

'Remembering Ronald Coase’s Contributions'

In his post Remembering Ronald Coase’s Contributions, Robert Stavins notes a big surprise, the Wall Street Journal's editorial page being less than forthright (he is summarizing a statement in "an effective essay" by Severin Borenstein on "the effect that Coase’s thinking had decades ago on his own intellectual development"):

the Wall Street Journal in its ... tribute to Coase ... twisted the implications of his work to fit the Journal’s view of the world

Stavins goes on to discuss "The Coase Theorem and the Independence Property":

... In our article, “The Effect of Allowance Allocations on Cap-and-Trade System Performance,” Hahn and I took as our starting point a well-known result from Coase’s work, namely, that bilateral negotiation between the generator and the recipient of an externality will lead to the same efficient outcome regardless of the initial assignment of property rights, in the absence of transaction costs, income effects, and third party impacts. This result, or a variation of it, has come to be known as the Coase Theorem.
We focused on an idea that is closely related to the Coase theorem, namely, that the market equilibrium in a cap-and-trade system will be cost-effective and independent of the initial allocation of tradable rights (typically referred to as permits or allowances). That is, the overall cost of achieving a given emission reduction will be minimized, and the final allocation of permits will be independent of the initial allocation, under certain conditions (conditional upon the permits being allocated freely, i.e., not auctioned). We called this the independence property. It is closely related to a core principle of general equilibrium theory (Arrow and Debreu 1954), namely, that when markets are complete, outcomes remain efficient even after lump-sum transfers among agents.
The Practical Political Importance of the Independence Property
...The reason why this property is of such great relevance to ... public policy is that it allows equity and efficiency concerns to be separated. In particular, a government can set an overall cap of pollutant emissions (a pollution reduction goal) and leave it up to a legislature to construct a constituency in support of the program by allocating shares of the allowances to various interests, such as sectors and geographic regions, without affecting either the environmental performance of the system or its aggregate social costs. Indeed, this property is a key reason why cap-and-trade systems have been employed and have evolved as the preferred instrument in a variety of environmental policy settings.
...Does the Property Always Hold?
...Hahn and I ... carried out an empirical assessment of the independence property in past and current cap-and-trade systems...
I hope some of may find time to read our article, but a quick summary of our assessment is that we found modest support for the independence property in the seven cases we examined (but also recognized that it would surely be useful to have more empirical research in this realm).
Political Judgments
That the independence property appears to be broadly validated provides support for the efficacy of past political judgments regarding constituency building through legislatures’ allowance allocations in cap-and-trade systems. Governments have repeatedly set the overall emissions cap and then left it up to the political process to allocate the available number of allowances among sources to build support for an initiative without reducing the system’s environmental performance or driving up its cost.
This success with environmental cap-and-trade systems should be contrasted with many other public policy proposals for which the normal course of events is that the political bargaining that is necessary to develop support reduces the effectiveness of the policy or drives up its overall cost. So, the independence property of well-designed and implemented cap-and-trade systems is hardly something to be taken for granted. It is of real political importance and remarkable social value. It is just one of many lasting contributions of Ronald Coase.

Saturday, August 31, 2013

A Carbon Tax That America Could Live With?

I expected Greg Mankiw's latest column to be about sales of his textbook. That's important news everyone should know about. But in a complete surprise, he talked about carbon taxes instead:

A Carbon Tax That America Could Live With: ... If the government charged a fee for each emission of carbon, that fee would be built into the prices of products and lifestyles. When making everyday decisions, people would naturally look at the prices they face and, in effect, take into account the global impact of their choices. In economics jargon, a price on carbon would induce people to “internalize the externality.”
A bill introduced this year by Representatives Henry A. Waxman and Earl Blumenauer and Senators Sheldon Whitehouse and Brian Schatz does exactly that. Their proposed carbon fee — or carbon tax, if you prefer — is more effective and less invasive than the regulatory approach that the federal government has traditionally pursued.
The four sponsors are all Democrats, which raises the question of whether such legislation could ever make its way through the Republican-controlled House of Representatives. The crucial point is what is done with the revenue raised by the carbon fee. If it’s used to finance larger government, Republicans would have every reason to balk. But if the Democratic sponsors conceded to using the new revenue to reduce personal and corporate income tax rates, a bipartisan compromise is possible to imagine. ...

Mankiw once said that economists shouldn't consider the political realities of policy, they should just recommend the best policy:

Politics aside: I have finally gotten around to reading the new Ebenstein biography of Milton Friedman. Here is a quotation from Milton that I particularly like:

“The role of the economist in discussions of public policy seems to me to be to prescribe what should be done in light of what can be done, politics aside, and not to predict what is ‘politically feasible’ and then to recommend it.”

So now, when I advocate raising gasoline taxes and cutting income taxes, and my conservative friends tell me that the plan is politically unrealistic, that the government will just keep the extra revenue instead of cutting income taxes, I can quote Milton....

I get that Mankiw really wants his personal taxes to be lowered, he seems to hate the idea of paying a fair share in taxes from what he makes from the textbook he hawks at every opportunity. But why, from an economic standpoint, is lowering his personal taxes (corporate taxes too) the best option (as opposed to simply trying to find something that is politically acceptable to the right)? Has he made that argument? The revenue could be used to help low income households that would be hurt by the tax, for deficit reduction without cutting programs, there are all sorts of ways the revenue could be used and it's not at all clear that his recommendation is, from an economic rather than a political view, the best way to use the revenue from a carbon tax.

Wednesday, August 28, 2013

'Regulators Repeat What They Did During the Last Housing Boom'

James Kwak is not happy:

Regulators Repeat Exactly What They Did During the Last Housing Boom, by James Kwak: The Dodd-Frank Act was supposed to require securitizers to retain 5 percent of the credit risk of the mortgage-backed securities that they issued, in order to reduce the risk of a repeat of the last housing bubble. Today, the federal financial regulators said, “Whatever,” and ignored that requirement. In particular, they created an exemption that would have covered at least 98 percent of all mortgages issued last year.

Why? Because

“adding additional layers of regulation would have contracted credit for first time home buyers and borrowers without large down payments, and prevented private capital from entering the market.”

That’s according to the head of the Mortgage Bankers Association.

This is the exact same argument that was made in favor of deregulation during the two decades prior to the last financial crisis, without the slightest hint of irony. It’s further proof that everyone has either forgotten that the financial crisis happened or is pretending that it didn’t happen because, well, maybe it won’t happen again?

Even leaving aside the specific merits of this decision, the worrying thing is that the intellectual, regulatory, and political climate seems to be basically the same as it was in 2004: no one wants to to anything that might be construed as hurting the economy, and no one wants to offend the housing industry.

Monday, August 26, 2013

The Single Most Effective Way of Avoiding Another Financial Crisis

Simon Wren-Lewis:

... The single most effective way of avoiding another financial crisis is to reduce the political influence of the banking sector.

'Rethinking Investment Risk'

A new paper in the QJE shows that financial innovation raises portfolio risks:

Rethinking investment risk, by Peter Dizikes, MIT News: Financial innovation is supposed to reduce risk -- in theory, at least. Yes, new financial instruments based on the housing market helped cause the financial crisis of 2008. But in the abstract, those same instruments have the potential to spread risk more evenly throughout the marketplace by making it possible to trade debt more extensively, rather than having it concentrated in a relatively few hands.
Now a paper published by MIT economist Alp Simsek makes the case that even in theory, financial innovation does not lower portfolio risk. Instead, it raises portfolio risks by creating situations in which parties sit on opposing sides of deep disagreements about the value of certain investments.
"In a world in which investors have different views, new securities won't necessarily reduce risks," says Simsek, an assistant professor in MIT's Department of Economics. "People bet on their views. And betting is inherently a risk-increasing activity."
In a paper published this month in the Quarterly Journal of Economics, titled "Speculation and Risk Sharing with New Financial Assets," Simsek details why he thinks this is the case. The risk in portfolios, he argues, needs to be divided into two categories: the kind of risk that is simply inherent in any real-world investment, and a second type he calls "speculative variance," which applies precisely to new financial instruments designed to generate bets based on opposing worldviews.
To be clear, Simsek notes, financial innovation may have other benefits -- it may spread information around world markets, for instance -- but it is not going to lead to lower risks for investors as a whole.
"Financial innovation might be good for other reasons, but this general kind of belief that it reduces the risks in the economy is not right," Simsek says. "And I want people to realize that." ...

[There's quite a bit more explanation in the original post.]

Paul Krugman: The Decline of E-Empires

The biggest companies eventually become complacent and lose their leading role in the marketplace. Does that mean we shouldn't worry about their monopoly power?:

The Decline of E-Empires, by Paul Krugman, Commentary, NY Times: Steve Ballmer’s surprise announcement that he will be resigning as Microsoft’s C.E.O. ... has me thinking about network externalities and Ibn Khaldun. ...
First, about network externalities: Consider the state of the computer industry circa 2000... By all accounts, Apple computers were better than PCs... Yet the vast majority of desktop and laptop computers ran Windows. Why?
The answer, basically, is that everyone used Windows because everyone used Windows. ... Software was designed to run on PCs; peripheral devices were designed to work with PCs. That’s network externalities in action, and it made Microsoft a monopolist. ...
The trouble for Microsoft came with the rise of new devices whose importance it famously failed to grasp. “There’s no chance,” declared Mr. Ballmer in 2007, “that the iPhone is going to get any significant market share.”
How could Microsoft have been so blind? ... Ibn Khaldun ... was a 14th-century Islamic philosopher... Desert tribesmen, he argued, always have more courage and social cohesion than settled, civilized folk, so every once in a while they will sweep in and conquer lands whose rulers have become corrupt and complacent. They create a new dynasty — and, over time, become corrupt and complacent themselves, ready to be overrun by a new set of barbarians.
I don’t think it’s much of a stretch to apply this story to Microsoft, a company that did so well with its operating-system monopoly that it lost focus, while Apple — still wandering in the wilderness after all those years — was alert to new opportunities. And so the barbarians swept in from the desert. ...
Anyway, the funny thing is that Apple’s position in mobile devices now bears a strong resemblance to Microsoft’s former position in operating systems. ...Apple ... products ... are, by most accounts, little if any better than those of rivals, while selling at premium prices.
So why do people buy them? Network externalities: lots of other people use iWhatevers, there are more apps for iOS... Meet the new boss, same as the old boss.
Is there a policy moral here? ... Microsoft was a monopolist, it did extract a lot of monopoly rents, and it did inhibit innovation. Creative destruction means that monopolies aren’t forever, but it doesn’t mean that they’re harmless while they last. This was true for Microsoft yesterday; it may be true for Apple, or Google, or someone not yet on our radar, tomorrow.

Monday, August 19, 2013

'Safe Banks Need not Mean Slow Economic Growth'

Banks are objecting to a proposal from regulators to reduce their leverage ratios through higher capital standards. One of the arguments is that it would reduce lending and slow economic growth, but Thomas Hoenig says the evidence doesn't support this claim:

Safe banks need not mean slow economic growth, by Thomas Hoenig, Commentary, FT: ... The largest banks are raising objections designed to scare the public and force a retreat from good public policy. ...
One of the more frequent objections asserts that the proposed increase in equity capital will force banks to curtail lending in the short term and thereby inhibit the recovery. This is false. ... The public should not accept the liability associated with a highly leveraged banking industry as the price of credit and economic growth. A review of real-world data since 1999 on the relationship between equity and loan levels for the eight US globally systemic banks found no evidence that higher capital leads to lower loan volumes over the long run. Indeed, banks with thick capital cushions are better able to maintain lending during a crisis – a key factor influencing the speed of the recovery.
It is also often suggested that higher equity requirements would put US banks on an uneven playing field versus their global peers. I have seen no credible evidence to substantiate this concern. ...

He also explains why some of the other objections banks are trying to use to block this change in regulation have little merit.

Saturday, August 03, 2013

'A Republican Case for Climate Action'

Republican administrators of the E.P.A under Presidents Richard Nixon, Ronald Reagan, George Bush and George W. Bush try to convince other Republicans that climate change is real, and that we need to do something about it now, not later:

A Republican Case for Climate Action, by William D. Ruckelshaus, Lee M. Thomas, William K. Reilly, and Christine Todd Whitman, Commentary, NY Times: Each of us took turns over the past 43 years running the Environmental Protection Agency. We served Republican presidents, but we have a message that transcends political affiliation: the United States must move now on substantive steps to curb climate change, at home and internationally.
There is no longer any credible scientific debate about the basic facts: our world continues to warm... The costs of inaction are undeniable. ... And the window of time remaining to act is growing smaller: delay could mean that warming becomes “locked in.”
A market-based approach, like a carbon tax, would be the best path to reducing greenhouse-gas emissions, but that is unachievable in the current political gridlock in Washington. Dealing with this political reality, President Obama’s June climate action plan lays out achievable actions that would deliver real progress. He will use his executive powers to require reductions in the amount of carbon dioxide emitted by the nation’s power plants... The president also plans to use his regulatory power to limit the powerful warming chemicals known as hydrofluorocarbons...
Rather than argue against his proposals, our leaders in Congress should endorse them and start the overdue debate about what bigger steps are needed and how to achieve them — domestically and internationally.
As administrators of the E.P.A under Presidents Richard M. Nixon, Ronald Reagan, George Bush and George W. Bush, we held fast to common-sense conservative principles — protecting the health of the American people, working with the best technology available and trusting in the innovation of American business and in the market to find the best solutions for the least cost.
That approach helped us tackle major environmental challenges to our nation and the world: the pollution of our rivers... The solutions we supported worked, although more must be done. ...
We can have both a strong economy and a livable climate. All parties know that we need both. The rest of the discussion is either detail, which we can resolve, or purposeful delay, which we should not tolerate. ... The only uncertainty about our warming world is how bad the changes will get, and how soon. What is most clear is that there is no time to waste.

Thursday, July 18, 2013

'Magnifying the Risk of Fire Sales in the Tri-Party Repo Market'

[One more quick one, and then I am out of here for a bit -- gone fishing (actually hiking) -- back later.]

The fragility of the tri-party repo market was a key part of the financial crisis, and it's problem that is not yet fully resolved:

Magnifying the Risk of Fire Sales in the Tri-Party Repo Market, Leyla Alkan, Vic Chakrian, Adam Copeland, Isaac Davis, and Antoine Martin, Liberty Street Economics: The fragility inherent in the tri-party repo market came to light during the 2008-09 financial crisis. One of the main vulnerabilities is the risk of fire sales, which can be enhanced by the response of some investors to stress events. Money market mutual funds (MMFs) and the agents investing cash collateral obtained from securities lending (SLs) are thought to behave, in times of stress, in ways that exacerbate fire-sale risks in the tri-party repo market. Based on detailed investor data, we find that MMFs and SLs constitute almost half of the investor market, making it crucial for tri-party repo participants and regulators to account for MMF and SL investment behavior when considering how to mitigate the risk of fire sales. ...

Sunday, July 14, 2013

'Remember Citigroup'

Simon Johnson:

Remember Citigroup,  by Simon Johnson: On Thursday of last week, four senators unveiled the 21st Century Glass Steagall Act. The pushback from people representing the megabanks was immediate but also completely lame – the weakness of their arguments against the proposed legislation is a major reason to think that this reform idea will ultimately prevail.
The strangest argument against the Act is that it would not have prevented the financial crisis of 2007-08. This completely ignores the central role played by Citigroup. ...

My argument on this has always been that it doesn't matter whether the repeal of Glass-Steagall was a factor in the financial crisis, what's important is whether it creates the potential for a future crisis (though arguments that it was a factor in the current crisis make the argument even more compelling). If the repeal of Glass-Steagall makes a crisis more likely and more severe, as I believe it does, then it ought to be reinstated.

Wednesday, July 10, 2013

Apple Found Guilty of Price Fixing

Joshua Gans with "initial thoughts":

Apple found guilty of price fixing: Initial thoughts, by Joshua Gans: Apple have been found guilty of price fixing in the US. Judge Cote found that Apple and five publishers had conspired to raise the price of eBooks. Basically, Apple used the iPad launch to “solve” the publisher’s problem with Amazon’s $9.99 retail pricing by assisting and, perhaps, insisting, that they engage in a coordinated move to an agency model with a most-favoured nation clause that would prevent retail price competition against Apple’s new iBookstore. The case was unusual because Apple was, in fact, a new entrant into a retail space with a dominant incumbent player, Amazon. But it was the way they entered that Judge Cote took issue with.
I have to admit that I was sceptical the DOJ would be able to amass the evidence to find price fixing in this case. From the judgment, even without the presence of Steve Jobs, there was enough. Is it believable that Apple knew and understood how it was helping the publishers here? Absolutely. I just wondered about satisfying a burden of proof without a key conspirator being able to be cross-examined. ...
This judgment is very interesting. ...

He goes on to describe it in detail.

Friday, June 28, 2013

'What to Do with the Hypertrophied Financial Sector?'

Brad DeLong:

... Over the past year and a half, in the wake of Thomas Philippon and Ariel Resheff's estimate that 2% of U.S. GDP was wasted in the pointless hypertrophy of the financial sector, evidence that our modern financial system is less a device for efficiently sharing risk and more a device for separating rich people from their money--a Las Vegas without the glitz--has mounted. Bruce Bartlett points to Greenwood and Scharfstein, to Cechetti and Kharoubi's suggestion that financial deepening is only useful in early stages of economic development, to Orhangazi's evidence on a negative correlation between financial deepening and real investment, and to Lord Adair Turner's doubts that the flowering of sophisticated finance over the past generation has aided either growth or stability.
Four years ago I was largely frozen with respect to financial sophistication. It seemed to me then that 2008-9 had demonstrated that our modern sophisticated financial systems had created enormous macroeconomic risks, but it also seemed to me then that in a world short of risk-bearing capacity with an outsized equity premium virtually anything that induced people to commit their money to long-term risky investments by creating either the reality or the illusion that finance could, in John Maynard Keynes's words, "defeat the dark forces of time and ignorance which envelop our future". ...
But the events and economic research of the past years have demonstrated ... I should ... have read a little further in Keynes, to "when the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done". And it is time for creative and original thinking--to construct other channels and canals by which funding can reach business and bypass modern finance with its large negative alpha.

Thursday, June 20, 2013

'Corrupted Credit Ratings'

I was working on this post Tuesday morning when the phone rang and, to use Paul Krugman's phrase, life intervened. I had something to say about it, but I don't know what it was at this point. Anyway, may as well post it now (posts from me will continue to be sparse/absent for awhile -- immense thanks for the outpouring of support):

Corrupted Credit Ratings: S&P’s Lawsuit and the Evidence by Matthias Efing, Harald Hau, Vox EU: In its civil lawsuit against Sta)ndard & Poor's, the US Department of Justice accuses the credit-rating agency to have defrauded federally insured financial institutions... The US complaint alleges that Standard & Poor’s presented overly optimistic credit ratings as objective and independent when, in truth, Standard & Poor’s downplayed and disregarded the true extent of credit risk...

According to the plaintiff, Standard & Poor’s catered rating favors in order to maintain and grow its market share and the fee income generated from structured debt ratings. In support of these allegations, the complaint lists internal emails in which Standard & Poor’s analysts complain that analytical integrity is sacrificed in pursuit of rating favors for the issuer banks.

Standard & Poor’s files for dismissal of the case

Standard & Poor’s denies issuing inflated ratings and any possible conflict of interest... That some of Standard & Poor’s very own employees appealed to their colleagues and superiors to withdraw inflated ratings is dismissed as "internal squabbles" and interpreted as a "robust internal debate among Standard & Poor’s employees"...

Statistical evidence on rating bias in structured products

While the US Department of Justice did not give any statistical evidence in its deposition, our new research (Efing and Hau 2013) suggests that rating favors were indeed systematic and pervasive in the industry.

In a sample of more than 6,500 structured debt ratings produced by Standard & Poor’s, Moody's and Fitch, we show that ratings are biased in favor of issuer clients that provide the agencies with more rating business. This result points to a powerful conflict of interest, which goes beyond the occasional disagreement among employees.

The beneficiaries of this rating bias are generally the large financial institutions that issue most structured debt; they in turn provide the rating agencies with most of their fee income. Better ratings on different components (so-called tranches) of the debt-issue amount to a lower average yield at issuance – a cost reduction pocketed by the issuer bank. ...[presents evidence]...

The evidence also suggests that the two other rating agencies, Moody’s and Fitch were no less prone to rating favors towards their largest clients than was Standard & Poor’s. ...

Still more evidence on rating bias in bank ratings

Additional evidence for rating bias emerges for bank ratings. Hau, Langfield and Marques-Ibanes (2012) show in a paper forthcoming in Economic Policy that rating agencies gave their largest clients also more favorable overall bank credit ratings. ...

Hau, Langfield and Marqués-Ibañez (2012) also show that large banks profited most from rating favors. ... The rating process for banks may have contributed to substantial competitive distortions in the banking sector, thus fostering the emergence of the too-big-to-fail banks.

Ironies of the case

It is hard to read some of the legal arguments without being struck by a sense of irony.

In its defense, Standard & Poor’s argues (without admitting any rating bias) that it has never made a legally binding promise to produce objective and independent credit ratings. ... For an agency whose business model is based on its reputation as an impartial 'gatekeeper' of fixed income markets, this defense is most remarkable.

But the accusation has its own oddities: Standard & Poor’s argues that it is impossible to defraud financial institutions about "the likely performance of their own products". Standard & Poor’s points out the irony "that two of the supposed 'victims,' Citibank and Bank of America – investors allegedly misled into buying securities by Standard & Poor’s fraudulent ratings – were the same huge financial institutions that were creating and selling the very CDOs at issue"...

In many cases the victim-view on institutional investors may indeed be questionable: Large banks often issued complex securities and at the same time invested in them. It is hard to believe that the asset management division of a bank was ignorant of the dealings by the structured product division with the rating agencies. ... It is difficult to figure out where exactly the border between complicity and victimhood runs.

What could be done?

The lawsuit against Standard & Poor’s highlights the conflicts of interest inherent in the rating business, but can do little to resolve them. If new and complex regulation and supervision of rating agencies provides a remedy is unclear and remains to be seen. However, three alternative policy measures could make the existing conflicts much less pernicious:

  • Similar to US bank regulation under the Dodd-Frank act, Basel III should abandon (or at least decrease) its reliance on rating agencies for the determination of bank capital requirements.
  • As forcefully argued by Admati, DeMarzo, Hellwig and Pfleiderer (2011), much larger levels of bank equity as required under Basel III could reduce excessive risk-taking incentives and ensure that future failures in bank-asset allocation do not trigger another banking crisis.
  • More bank transparency in the form of a full disclosure of all bank asset holdings at the security level would create more informative market prices for bank equity and debt, with positive feedback effects on the quality of bank governance and bank supervision.

Our reliance on bank ratings could thus be greatly reduced. ...

Sunday, June 16, 2013

Wall Street is Winning the War against Regulation

Wall Street is successfully resisting attempts to regulate the financial industry:

Wall Street is winning the long war against post-crash regulation, by Heidi Moore, guardian.co.uk: ...There are no such things as borders in the world of finance; it's an integrated whole. ... That's why it's so baffling that the House of Representatives came down, this week, on the side of ignoring abuses of US-made derivatives – known as swaps – as soon as they're wired overseas. These swaps were at the heart of the London Whale trading debacle...
The House voted overwhelmingly to let the measure – labeled the London Whale Loophole Act by critics – pass. It's one of several measures that the House has taken to weaken oversight of derivatives; the other two will come up for debate soon.
It will surprise no cynic that there is a financial connection between the members of Congress who approve these measures and the industry they are supposed to regulate. According to MapLight:
"On average, House agriculture committee members voting for HR 992 [one of the derivatives bills] have received 7.8 times as much money from the top four banks as House agriculture committee members voting against the bill."
It's no surprise, of course – given the well-known influence of Wall Street in writing and influencing the bills that regulate Wall Street. Citigroup lobbyists infamously drafted 70 lines of an 85-line amendment that protected a large acreage of derivatives from regulation.
There is more to add. ... [adds more] ...
All of this is part of the process of killing off the one flailing, pathetic attempt at financial reform: the Dodd-Frank Act. Dodd-Frank, bloated and vague from the beginning, was never a threat to Wall Street. Big banks thought they could wait out the outrage, then start undermining the intent of the law.
They were right, this time. But when they're wrong – and when those derivatives cause another crisis – it'll be Americans who pay the price.

Tuesday, May 28, 2013

'China and the Environmental Kuznets Curve'

Tim Taylor:

China and the Environmental Kuznets Curve: The original Kuznets curve posited, back in 1955, that inequality of incomes would follow an inverted-U pattern as a nation's economy developed, first rising, and then declining. In 1955, this looked reasonable! The "environmental Kuznets curve" suggests that pollution may follow an inverted-U pattern as a nation's economy develops. Pollution first rises as a low income nation industrializes with few limitations on pollution. But then the nation becomes better-off and more able and willing to pay the costs of limiting pollution, and the nation's economy shifts from industry to services, and pollution levels fall. For a useful overview article, Susmita Dasgupta, Benoit Laplante, Hua Wang, and David Wheeler wrote on "Confronting the Environmental Kuznets Curve" in the Winter 2002 issue of the Journal of Economic Perspectives. (Like all articles in JEP, it is freely available online compliments of the American Economic Association. Full disclosure: I've been the Managing Editor of JEP for the last 26 years.)
Of course, the environmental Kuznets curve is a theory that needs to be supported or refuted with evidence... And the experience of China, with its burgeoning economy and extraordinary environmental issues, is at the center of the debate. ...
The conventional environmental Kuznets is that emissions of pollutants rise up until some level between about $5000 and $8000 in per capita income, and then fall after that point. There is some historical evidence to support this claim. ...
According to the World Bank, China's per capita GDP was $5,445 in 2011, so it is just reaching the levels where its pollution should first start to level off, and then to decline. ...
Interestingly, there are signs that for some pollutants, the level of pollution is no longer rising with the growth of China's economy. For example, here's a figure about air pollution. The top line shows the growth of GDP. Emissions of sulfur dioxides and soot have not been rising with GDP, and even emissions of carbon dioxide have been lagging behind the rise in GDP in the last few years.
Here's a similar figure for water pollution. Chemical oxygen demand (COD) measures the level of organic pollutants in water. Both that measure and wastewater are at least not rising at the same pace as GDP.
It remains true that China's amount of pollution relative to its economic output is high by the standards of high income countries. ...
The policy prescription for reducing pollution in China is clear enough: close down older facilities, and make sure their replacements have up-to-date anti-pollution equipment; keep building sewage treatment facilities; put a price on polluting activities to encourage conservation; and so on. Sam Hill's paper has details.
But ultimately, China's path along the environmental Kuznets curve will be determined by politics and public pressure, and public pressure in China does seem to be building for stronger environmental protection. The (wonderfully named) Elizabeth C. Economy at the Council of Foreign Relations recently wrote a brief piece on "China’s Environmental Politics: A Game of Crisis Management," which notes the growing number of environmental public protests in China. In a society under such a high degree of government control, environmental protests can become a place where those discontented with government have a semi-safe space for dissent.

Tuesday, May 21, 2013

'The Climate Skeptics Have Already Won'

Martin Wolf:

Humanity has decided to yawn and let the real and present dangers of climate change mount. ... Judged by the world’s inaction, climate skeptics have won..., however rational it may be to seek to lower the risk of catastrophic outcomes, this is not what is happening now or seems likely to happen in the foreseeable future. ...

The attempt to shift our choices away from the ones now driving ever-rising emissions has failed. It will, for now, continue to fail. The reasons for this failure are deep-seated. Only the threat of more imminent disaster is likely to change this and, by then, it may well be too late. This is a depressing truth. It may also prove a damning failure.

As he says, it's not too late, "Unless the most apocalyptic scenario happens, humanity may be able to curb emissions and buy itself time," but the clock is running and it's hard to see how meaningful change will come about without substantial changes in the political environment. Gridlock favors the skeptics.

Thursday, May 02, 2013

Global Financial Regulation

In case this is of interest:

Global Financial Regulation

Speakers:

  • James Barth, Senior Finance Fellow, Milken Institute; Lowder Eminent Scholar in Finance, Auburn University
  • Bob Corker, U.S. Senator
  • Carey Lathrop, Managing Director and Head of Global Credit Markets, Citi
  • Kevin Lynch, Vice Chairman, BMO Financial Group
  • Thomas Perrelli, Partner, Jenner & Block; Former Associate U.S. Attorney General
Moderator: Jaret Seiberg, Managing Director and Senior Policy Analyst, Guggenheim Partners
As countries implement new regulations in response to the global financial crisis, will safer and sounder markets be the result? Or just more burdens and costs? What impact can we expect on financial institutions, lending, the flow of capital around the world and, eventually, the global economy? Has the too-big-to-fail problem been solved, or should the giants simply be broken up? Is there a place for a global financial regulator? And what should be done about the shadow banking system - the institutions that wield influence but go largely unregulated? Our panel will delve into whether there are more effective ways to oversee financial markets than current methods.

Monday, April 29, 2013

Have Blog, Will Travel: Milken Global Conference

I am here today (Milken Global Conference 2013).

One quick first impression based upon the schedule of sessions. In the last few years, two or three years ago more so than last year, there were quite a few "soul-searching" sessions from the financial industry. How did financial markets fail, how can they be fixed, etc. That's not to say that there wasn't a lot of resistance to regulation from the industry, but they were at least dealing with the main issues, there was an attempt at an honest appraisal from many, and there were quite a few sessions on the topic.

There are sessions on regulation this year -- I'm currently in one called "Global Financial Regulation" (usual TBTF discussion so far, just turning to leverage) -- but compared to previous years the main concern now appears to be where we are headed in the next few years, opportunities for investment, etc. I suppose that's good news for the economy, but for financial stability? There's still a lot of work to be done, and an eroding will to do it.

Wednesday, April 17, 2013

'Financial Stability Monitoring'

In order to stabilize the financial system, there are two recommendations that I would definitely make. One is to reduce the chance of runs in the shadow banking system -- a key factor behind the financial crisis. As noted below, the Dodd-Frank Act "does not address structural problems in wholesale short-term funding markets, such as the susceptibility of money market funds to investor runs or the inherent fragility of repo markets." Regulators have been working on fixes for this problem, but it's not fixed yet and that should be a bit more alarming than it seems to be.

The other change is to develop a better early warning system for financial crises. Dean Baker would say just call me, but I'd like to go beyond that and develop new tools, statistics, etc. that can help us do a better job of identifying risks before they become destructively large. I won't be satisfied with the excuse that we can't predict bubbles reliably until we have done the work of trying to find better leading indicators for problems.

Those two changes are far from exhaustive, reducing leverage, for example, should be on the list as well. But they are key issues that need to be addressed and it's nice to see that the Fed recognizes this and is trying to develop a "broad and forward-looking monitoring program" (the problem of bank runs in the shadow banking system isn't directly addressed, the idea is to prevent problems through early detection coupled with a policy response to relieve the pressure in the market).

Before moving on to the paper, given recent developments surrounding the work of Reinhart and Rogoff, I should probably remind people of this:

NOTE: Staff working papers in the Finance and Economics Discussion Series (FEDS) are preliminary materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of Governors.

Here's the abstract and introduction (on the continuation page) to the preliminary paper:

Financial Stability Monitoring, by Tobias Adrian, Daniel Covitz, and Nellie Liang, FRB Working Paper: Abstract While the Dodd Frank Act (DFA) broadens the regulatory reach to reduce systemic risks to the U.S. financial system, it does not address some important risks that could migrate to or emanate from entities outside the federal safety net. At the same time, it limits the types of interventions by financial authorities to address systemic events when they occur. As a result, a broad and forward-looking monitoring program, which seeks to identify financial vulnerabilities and guide the development of pre-emptive policies to help mitigate them, is essential. Systemic vulnerabilities arise from market failures that can lead to excessive leverage, maturity transformation, interconnectedness, and complexity. These vulnerabilities, when hit by adverse shocks, can lead to fire sale dynamics, negative feedback loops, and inefficient contractions in the supply of credit. We present a framework that centers on the vulnerabilities that propagate adverse shocks, rather than shocks themselves, which are difficult to predict. Vulnerabilities can emerge in four areas: (1) systemically important financial institutions (SIFIs), (2) shadow banking, (3) asset markets, and (4) the nonfinancial sector. This framework also highlights how policies that reduce the likelihood of systemic crises may do so only by raising the cost of financial intermediation in non-crisis periods.

Continue reading "'Financial Stability Monitoring'" »

Thursday, April 11, 2013

Did the Fed Cause the housing Bubble?

According to research by Ambrogio Cesa-Bianchi and Alessandro Rebucci, the housing bubble was caused by "regulatory rather than monetary-policy failures":

Is the Federal Reserve breeding the next financial crisis?, by Ambrogio Cesa-Bianchi and Alessandro Rebucci: Many economists think that the US Federal Reserve’s loose monetary stance in the 2000s fuelled the US housing bubble. Is the Fed thus responsible for the Global Crisis? This column discusses evidence suggesting that monetary policy was, in fact, not to blame. Rather, it was the absence of an effective regulatory function that created the mess we’re in now. It is not fair to blame the Great Recession only on the Fed’s monetary-policy stance nor is the Fed now breeding the next US financial crisis. ...
In the context of our model and according to this evidence, regulatory rather than monetary-policy failures are largely to blame for the occurrence and the severity of the Great Recession. Only by assuming that the Fed was the sole institutional guardian of financial stability, or at least the main one, is it possible to contend that monetary policy is to blame for the 2007-09 financial crisis and the ensuing Great Recession. ...

Tuesday, April 09, 2013

Solow: Has Financialization Gone Too Far?

Robert Solow has an essay that begins with lots of praise for Ben Bernanke:

How to Save American Finance from Itself: Has financialization gone too far?, by Robert Solow, TNR: Central banking is not rocket science, but neither is it a trivial pursuit. ... Running a central bank is in one way a little bit like flying a plane or sailing a boat: much of the time standard responses and small adjustments will do just fine, but every so often a situation arises in which fundamental understanding, knowledge of history, and good judgment can make the difference between riding out the storm and crashing. There was no such person in charge in 1929, and the result was disaster. There was one in 2008.
In his earlier scholarly life, Ben Bernanke, the chairman of the Federal Reserve Board, had been a careful student of the general interaction between the financial system and the real economy and especially of its working out in the Great Depression of the 1930s. So he had done his homework. His decisive and innovative actions at the Fed saved our economy from free fall with a possibly catastrophic end. ...

He goes on to review a book of four lectures Ben Bernanke gave on the role of the Fed:

In March 2012, George Washington University invited Bernanke to give four lectures as part of a course devoted to the role of the Federal Reserve in the economy. The lectures are now reproduced in book form, apparently from lightly edited transcripts. Each lecture ends with half a dozen questions from anonymous “students” and Bernanke’s answers. Some of the questions are smart, some less so, in which case Bernanke exhibits the professorial skill of seamlessly answering a slightly different question. ...
The lectures are consistently lucid and informal—maybe a little too anecdotal, but illustrated with many clear and informative slides—and above all intelligent and interesting. There are no revelations or recantations; even if Bernanke had any in mind, this would not be the place for them. A short book such as this has no room for a play-by-play account of the crisis. But it would be difficult to find a better short and not very technical account of what went wrong, and of how the Fed (and the Treasury) managed to keep it from getting much worse. ...

He then goes through a long, detailed discussion of the issues Bernanke addresses in these lectures, but I want to pick it up again near the end:

Bernanke's ... preferred answer is better and more system-oriented regulation. One has to ask then why regulation failed to see the crisis of 2007–2008 coming and take action to head it off. Bernanke suggests that regulators were lulled into inattention by the so-called Great Moderation...
For safeguarding financial stability in the future, Bernanke seems to count heavily on the provision in Dodd-Frank that establishes a committee of regulators charged with keeping an eye on “systemically important” financial institutions, whatever they look like, in order to warn them away from dangerously risky behavior and/or impose extra capital requirements. We will have to see how that works out...
He touches on it only obliquely in these lectures, but Bernanke has lingering worries that the size, the complexity, and the interconnectedness of today’s financial system strain the capacity of even improved risk-management techniques to protect the system against its inherent vulnerabilities. ...
All of which leads to a broader issue... Any complicated economy needs a complicated financial system: to allocate dispersed capital to dispersed productive uses, to provide liquidity, to do maturity and risk transformation, and to produce market evaluations of uncertain prospects. If these functions are not performed adequately, the economy cannot produce and grow with anything like efficiency. Granted all that, however, the suspicion persists that financialization has gone too far.
What would that mean? It would mean that the last x percent of financial activity absorbs more resources (especially intellectual resources) and creates more potential instability than its additional efficiency-benefits can justify. This charmingly subversive suggestion is easy to make, but it is extremely difficult to validate. Yes, it is hard to imagine that the Hedge Fund Operator of the Year does anything that is remotely socially useful enough to justify the enormous (and lightly taxed) compensation that results; but that is not really an argument. Much more significant is the fact that the bulk of incremental financial activity is trading, and trading, while it may provide a little useful public information about market opinion, is largely a way to transfer wealth from those with inferior information and calculation ability to those with more. There is no enhancement of economic efficiency to speak of. This is, you might say, the $64 trillion question. Maybe I shouldn’t wish it on Ben Bernanke. 

Given his worries about financial stability, I have to wonder if the praise for Bernanke shouldn't be a bit more qualified. I agree that the Fed did a pretty good job responding the the recession. It could have done better -- it was frequently too late and too timid, especially during the first few years -- but it also could have done a whole lot worse. But what we don't yet know is how well we have been insulated from future shocks. Is Bernanke's view correct about what is needed on the regulatory front, and has it been implemented? In my view, significant vulnerabilities remain within the shadow banking system (and I'm far from alone). If that's true and we do have another crisis down the road, then the effusive praise for Bernanke will diminish much as happened with Greenspan (anointed as the best Fed Chair ever only to have housing bubble crash dramatically change the view of his record). As Robert Solow says about Bernanke's views on safeguarding financial stability in the future, "We will have to see how that works out.

'Let the Punishment Fit the Crime of the Recession'

We are, as they say, live:

Let the Punishment Fit the Crime of the Recession, by Mark Thoma: As Paul Krugman observed recently,  “the urge to see depression as a necessary and somehow even desirable punishment for past sins, while inveighing against any attempt to mitigate suffering — is as strong as ever.”  Many of those who see our economic problems in these terms believe the sin we committed is too much debt fueled consumption and government spending. According to this view punishments such as austerity and high levels of unemployment provide a moral lesson that helps to prevent us from making the same mistakes again.
This is bad economics and it has the moral lesson all wrong. ...

Thursday, April 04, 2013

Thinking Straight About Debt

Paul Krugman on something I emphasized in a recent post, the danger of "excessive leverage":

Thinking Straight About Debt: A heads-up: I’m doing This Week this week. Also on the panel: David Stockman. This should be, um, interesting.
So, a few more thoughts on debt and what it does and doesn’t signify. ...
This is how you want to think about debt: it’s not a burden on the nation’s resources, because it’s mainly money we owe to ourselves, and it’s a problem not because we have to tighten our belt but because debt is currently leading to spending that’s less than we need to maintain full employment.
I would add that ... the ... debt of financial intermediaries ... is a big part of the real story and if anything bears even less resemblance to the notion of debt as a consequence of national overspending; to a large extent it’s just an accounting issue, because old-fashioned deposits aren’t counted as debt even though they are.
Maybe a short way to put all this is to say that we have a real problem with excessive leverage; that’s not at all the same thing as the nation being deeply in hock to some external player or players. And failing to understand that difference is a way to get both the nature of our crisis and the shape of appropriate policies totally wrong.

'Don’t Panic – Financial Reform is Coming'

Barney Frank is confident that new financial regulation "will be completed in time to prevent the type of crises that they are intended to prevent":

Don’t panic – financial reform is coming to America, by Barney Frank, Commentary, Financial Times: We are going to sort out the US financial system. This might seem a bold statement when, two and a half years after the Dodd-Frank Act was signed into law, much necessary regulation is still not on the books. But with the re-election of Barack Obama, I have no doubt that the necessary new rules will be in place in good time. ... Some of the factors responsible for the pace were inherent in the task. ...
This brings us to the set of obstacles to filling out the rule book... First, the SEC and the CFTC receive vast amounts of comments for each proposed rule, which they must process. Meanwhile, the Republican House appropriations committee starves them of money. ...
This is where the DC courts come in. Not only do these agencies have to go through comments, the court then grades their work... On several occasions, DC courts have struck down SEC and CFTC rules, not because of any constitutional problem, but because the conservative judges think the agencies have given too little deference to the financial industry’s arguments.
Documenting decisions to the degree that the court requires would be difficult in any circumstance. Doing so with ... Republican underfunding is impossible. This was, in part, what was at stake when the Republican Senate minority filibustered to death an Obama appointee to the DC circuit. ...
The rules will be completed in time to prevent the type of crises that they are intended to prevent, but later than they should be. But the fault for that will rest with Republican appropriators withholding adequate funding and Republican senators filibustering to maintain the DC circuit as a rightwing bastion.

I am not as confident as he is that we will get the rules we need. In addition, notice that he talks about preventing financial crisis. However, we can never fully prevent a financial collapse, only make it less likely. Thus, there is another aspect of regulation that is just as important as trying to prevent problems from occurring, building systems that are robust to shocks. Leverage is a good example. Limiting leverage can limit the "unwind" that occurs with large negative financial shocks and thus limit the downside risk.

The recent financial collapse surely illustrated that we need better regulation to reduce the chances of financial collapse, but it also illustrated -- starkly -- that the sorts of shock absorbers we should have in place are missing. Yes, things like limiting leverage will be resisted mightily by the industry and the politicians in the financial industry's pocket, but this type of protection for the system is just as important as trying to prevent problems in the first place.

Joel Waldfogel's Ambilavence about Amazon’s Acquisition of Goodreads

Joel Waldfogel on the economics of Amazon's purchase of Goodreads:

Am I the Only One Ambivalent about Amazon’s Acquisition of Goodreads?, by Joel Waldfogel: The New York Times reported recently that Amazon’s buying Goodreads, the largest book review site online. It’s easy to see the appeal of Goodreads to Amazon. Goodreads apparently has 10 million ratings and reviews of over 700,000 titles. ...
But when I think about Amazon’s sources of market power in book retailing, one of the first things that comes to mind is the indirect network effects: Amazon’s existing collection of user-contributed book ratings and reviews provide lots of information to potential buyers. The more customers who use Amazon, the more information they make available, and the higher the quality of subsequent customer experience at Amazon. In short, the more that people use Amazon, the more that additional people will want to use Amazon. This source of market power is fairly gained, I guess, although the customer/reviewers who create all of this information might want more compensation than the words “top-rated reviewer” after their names.
Buying Goodreads substantially increases the amount of information at Amazon’s disposal. Given how adroit Amazon is at using information, we can expect them to find a way to improve the customer experience. Some part of me is actually excited about that.
But Amazon’s acquisition of Goodreads will also enhance the market position of the market’s largest player. If Amazon owns Goodreads, then no other book retailer does. It seems entirely possible that some other book retailer could have combined with Goodreads to offer Amazon some serious competition. If this is a done deal, we’ll never know.

Tuesday, April 02, 2013

'Dark Pool Trading'

Hmmm: -- anyone want to convince me this is not something regulators should worry about?:

... The portion of all stock trading taking place away from the public exchanges hit new highs over the last few weeks, amounting to close to 40 percent on several days, up from an average of 16 percent in 2008 ...

'Olivier Blanchard’s Five Lessons for Economists From the Financial Crisis'

Long, long travel day today (and not sure if I'll have an internet connection), so -- for now -- a few quick ones (between here and today's links). First, Brad Delong sends us to David Wessel, who sends us to Olivier Blanchard (I've shortened the five points):

Olivier Blanchard’s Five Lessons for Economists From the Financial Crisis: ...Here are Mr. Blanchard's five lessons in his own words, lightly edited by The Wall Street Journal’s David Wessel:
1. Humility is in order: The Great Moderation ... convinced too many of us that the large-economy crisis -­ a financial crisis, a banking crisis ­- was a thing of the past. It wasn’t going to happen again... My generation ... knew how to do things better, not only in economics but in other fields as well. What we have learned is that's not true. History repeats itself. We should have known.
2. The financial system matters — a lot: It’s not the first time that we¹re confronted with ... “unknown unknowns”... There is another example in macro-economics: The oil shocks of the 1970s... It took a few years, more than a few years, for economists to understand what was going on. After a few years, we concluded that we could think of the oil shock as yet another macroeconomic shock. We did not need to understand the plumbing. We didn’t need to understand the details of the oil market. ...
This is different. What we have learned about the financial system is that the problem is in the plumbing and that we have to understand the plumbing..., it's very clear that the details of the plumbing matter.
3. Interconnectedness matters: This crisis started in the U.S. and across the ocean in a matter of days and weeks. Each crisis, even in small islands, potentially has effects on the rest of the world. The complexity of the cross border claims by creditors and by debtors clearly is something that many of us had not fully realized..., which countries are safe havens, and when and why? Understanding this has become absolutely essential. What happens in one part of the world cannot be ignored by the rest of the world. ...

It’s also true on the trade side. ... One absolutely striking fact of the crisis is the collapse of trade in 2009. Output went down. Trade collapsed. Countries which felt they were not terribly exposed through trade turned out to be enormously exposed.
4. We don’t know if macro-prudential tools work: It’s very clear that the traditional monetary and fiscal tools are just not good enough to deal with the very specific problems in the financial system. This has led to the development of macro-prudential tools... [Macroprudential tools allow a central bank to restrain lending in specific sectors without raising interest rates for the whole economy, such as increasing the minimum down payment required to get a mortgage, which reduces the loan-to-value ratio.] ... If there is a problem somewhere you can target the tool at the problem and not use the policy interest rate, which basically is kind of an atomic bomb without any precision.
The big question here is: How reliable are these tools? How much can they be used? The answer ... is this: They work but they don’t work great. People and institutions find ways around them. In the process of reducing the problem somewhere you tend to create distortions elsewhere.
5. Central bank independence wasn’t designed for what central banks are now asked to do: ... One of the major achievements of the last 20 years is that most central banks have become independent of elected governments. Independence was given because the mandate and the tools were very clear. The mandate was primarily inflation... The tool was some short-term interest rate that could be used by the central bank to try to achieve the inflation target. In this case, you can give some independence to the institution in charge of this because the objective is perfectly well defined, and everybody can basically observe how well the central bank does.
If you think now of central banks as having a much larger set of responsibilities and a much larger set of tools, then the issue of central bank independence becomes much more difficult. Do you actually want to give the central bank the independence to choose loan-to-value ratios without any supervision from the political process. Isn’t this going to lead to a democratic deficit in a way in which the central bank becomes too powerful? I'm sure there are ways out. Perhaps there could be independence with respect to some dimensions of monetary policy -­ the traditional ones — and some supervision for the rest or some interaction with a political process.

Friday, March 29, 2013

'Is 'Intellectual Property' a Misnomer?'

Tim Taylor:

Is "Intellectual Property" a Misnomer?, by Tim Taylor: The terminology of "intellectual property" goes back to the eighteenth century. But some modern critics of how the patent and copyright law have evolved have come to view the term as a tendentious choice. One you have used the "property" label, after all, you are implicitly making a claim about rights that should be enforced by the broader society. But "intellectual property"  is a much squishier subject than more basic applications of property, like whether someone can move into your house or drive away in your car or empty your bank account. ...
Is it really true that using someone else's invention is the actually the same thing as stealing their sheep? If I steal your sheep, you don't have them any more. If I use your idea, you still have the idea, but are less able to profit from using it. The two concepts may be cousins, but they not identical. 

Those who believe that patent protection has in some cases gone overboard, and is now in many industries acting more to protect established firms than to encourage new innovators, thus refer to "intellectual property as a "propaganda term." For a vivid example of these arguments, see "The Case Against Patents," by Michele Boldrin and David K. Levine, in the Winter 2013 issue of my own Journal of Economic Perspectives. (Like all articles in JEP back to the first issue in 1987, it is freely available on-line courtesy of the American Economic Association.)

Mark Lemley offers a more detailed unpacking of the concept of "intellectual  property" in a 2005 article he wrote for the Texas Law Review called "Property, Intellectual Property, and Free Riding" Lemley writes: ""My worry is that the rhetoric of property has a clear meaning in the minds of courts, lawyers and commentators as “things that are owned by persons,” and that fixed meaning will make all too tempting to fall into the trap of treating intellectual property just like “other” forms of property. Further, it is all too common to assume that because something is property, only private and not public rights are implicated. Given the fundamental differences in the economics of real property and intellectual property, the use of the property label is simply too likely to mislead."

As Lemley emphasizes, intellectual property is better thought of as a kind of subsidy to encourage innovation--although the subsidy is paid in the form of higher prices by consumers rather than as tax collected from consumers and then spent by the government. A firm with a patent is able to charge more to consumers, because of the lack of competition, and thus earn higher profits. There is reasonably broad agreement among economists that it makes sense for society to subsidize innovation in certain ways, because innovators have a hard time capturing the social benefits they provide in terms of greater economic growth and a higher standard of living, so without some subsidy to innovation, it may well be underprovided.

But even if you buy that argument, there is room for considerable discussion of the most appropriate ways to subsidize innovation. How long should a patent be? Should the length or type of patent protection differ by industry? How fiercely or broadly should it be enforced by courts? In what ways might U.S. patent law be adapted based on experiences and practices in other major innovating nations like Japan or Germany? What is the role of direct government subsidies for innovation in the form of government-sponsored research and development? What about the role of indirect government subsidies for innovation in the form of tax breaks for firms that do research and development, or in the form of support for science, technology, and engineering education? Should trade secret protection be stronger, and patent protection be weaker, or vice versa? 

These are all legitimate questions about the specific form and size of the subsidy that we provide to innovation. None of the questions about "intellectual property" can be answered yelling "it's my property." 

The phrase "intellectual property" has been around a few hundred years, so it clearly has real staying power and widespread usage  I don't expect the term to disappear. But perhaps we can can start referring to intellectual "property" in quotation marks, as a gentle reminder that an overly literal interpretation of the term would be imprudent as a basis for reasoning about economics and public policy. 

Monday, March 25, 2013

'Did the Iraq War Cause the Great Recession?'

Via Henry Farrell:

Did the Iraq War Cause the Great Recession?, Henry Farrell: Thomas Oatley thinks that it very plausibly did. His argument draws upon an interesting article (should be ungated) in the new issue of Perspectives on Politics, where he, Kindred Winecoff, Andrew Pennock and Sarah Bauerle Danzman argue that international political economy scholars pay too little attention to the structural characteristics of international politics. By concentrating too much on states as unitary actors, they fail to recognize the importance of the network connections between them. The network topology – the shape of the network – can have consequences – networks where no node gets very much more links than any other node are quite different in their consequences from networks where one or a couple of nodes receive a lot more links than others. This has implications for financial contagion – if contagion spreads across links, network topology will have important consequences for the likelihood of spread. As it turns out, there is strong reason to believe that the international financial system is one of the latter kinds of networks rather than one of the former. On two measures of financial ties, most countries on the periphery of the network have few links to other peripheral countries, but pretty well everyone has links to the US, and many have links to the UK too. ...[more]...

I'm not fully convinced by this theory that the Iraq war caused the recession, but it does bring up some important issue about network connectivity. Are highly interconnected networks better at dispersing risk? It depends upon the type of risk. Suppose a toxin hits a network. If diluting the toxin across the network also dilutes its effects to practically nothing, then we want the network to be as large and interconnected as possible. When shocks hit they will be quickly diluted and rendered relatively harmless. But for toxins that are deadly in minute doses, toxins that kill whatever they touch even when they are highly diluted, we want the infected node on the network to be isolated as much as possible.

Optimally, then, assuming that most shocks are not toxic if they are dispersed across a large network, we want the network to be large and highly interconnected so that risks can be diversified across the network to practically nothing. But we also want the ability to quickly disconnect nodes that become infected with toxins that don't lose their potency as they are diluted. And that's the problem, identifying when such a toxin hits a network is difficult -- there will always be denial if disconnecting nodes in the financial system costs people money -- and it may not be easy to quickly disconnect nodes from the network so that problem nodes can be isolated/quarantined before the toxin spreads.

We have been told that problems in places like Cyprus have been walled off -- nodes in the network have been isolated -- but so long as a few isolated connections still exist that are difficult to cut, highly toxic shocks can pollute the rest of the network. In addition, as we saw today when "Jeroen Dijsselbloem, the current head of the Eurogroup, held a formal, on-the-record joint interview with Reuters and the FT today, saying that the messy and chaotic Cyprus solution is a model for future bailouts" and financial markets reacted negatively (the statement is being walked back), some connections -- those involving expectations -- cannot be severed in any case.

Highly interconnected networks are highly desirable so long as (1) we can quickly identify trouble, and (2) nodes can be quickly and effectively isolated. But when those conditions are not present, the occasional highly toxic shock will cause quite a bit of damage.