Category Archive for: Regulation [Return to Main]

Friday, September 26, 2014

'Why the Fed Is So Wimpy'

Justin Fox:

Why the Fed Is So Wimpy, by Justin Fox: Regulatory capture — when regulators come to act mainly in the interest of the industries they regulate — is a phenomenon that economists, political scientists, and legal scholars have been writing about for decades.  Bank regulators in particular have been depicted as captives for years, and have even taken to describing themselves as such.
Actually witnessing capture in the wild is different, though, and the new This American Life episode with secret recordings of bank examiners at the Federal Reserve Bank of New York going about their jobs is going to focus a lot more attention on the phenomenon. It’s really well done, and you should listen to it, read the transcript, and/or read the story by ProPublica reporter Jake Bernstein.
Still, there is some context that’s inevitably missing, and as a former banking-regulation reporter for the American Banker, I feel called to fill some of it in. Much of it has to do with the structure of bank regulation in the U.S., which actually seems designed to encourage capture. But to start, there are a couple of revelations about Goldman Sachs in the story that are treated as smoking guns. One seems to have fired a blank, while the other may be even more explosive than it’s made out to be. ...

Thursday, September 18, 2014

'What's So BadAbout Monopoly Power?'

At MoneyWatch:

What's so bad about monopoly power?: Google (GOOG) has been negotiating with European regulatory authorities since 2010 in an attempt to settle an antitrust case concerning its search engine, and its third attempt to settle the case has been rejected. Google may also face new antitrust problems over its Android mobile operating system, and it's not alone in facing tough antitrust scrutiny in Europe. Microsoft (MSFT) has also been the subject of a long-running battle in Europe over market dominance issues. But what's motivating this scrutiny from European regulators? What's so bad about a company amassing monopoly power? ....

[Also, from yesterday, What do economists mean by "slack"?]

Wednesday, September 10, 2014

'The Biggest Lie of the New Century'

Barry Ritholtz:

The Biggest Lie of the New Century: Yesterday, we looked at why bankers weren't busted for crimes committed during the financial crisis. Political corruption, prosecutorial malfeasance, rewritten legislation and cowardice on the part of government officials were among the many reasons.
But I saved the biggest reason so many financial felons escaped justice for today: They dumped the cost of their criminal activities on you, the shareholder (never mind the taxpayer). ... Many of these executives committed crimes; got big bonuses for doing so; and paid huge fines using shareholder assets (i.e., company cash), helping them avoid prosecution.
As for claims, like those of white-collar crime defense attorney Mark F. Pomerantz, that “the executives running companies like Bank of America, Citigroup and JP Morgan were not committing criminal acts,” they simply implausible if not laughable. Consider a brief survey of some of the more egregious acts of wrongdoing: ...

Monday, September 08, 2014

What were they thinking? The Federal Reserve in the Run-Up to the 2008 Financial Crisis

At Vox EU:

What were they thinking? The Federal Reserve in the run-up to the 2008 financial crisis, by Stephen Golub, Ayse Kaya, Michael Reay: Since the Global Crisis, critics have questioned why regulatory agencies failed to prevent it. This column argues that the US Federal Reserve was aware of potential problems brewing in the financial system, but was largely unconcerned by them. Both Greenspan and Bernanke subscribed to the view that identifying bubbles is very difficult, pre-emptive bursting may be harmful, and that central banks could limit the damage ex post. The scripted nature of FOMC meetings, the focus on the Greenbook, and a ‘silo’ mentality reduced the impact of dissenting views.

Have Economists Been Captured by Business Interests?

Justin Fox:

Have Economists Been Captured by Business Interests?: To be an economist, you kind of have to believe that people respond to economic incentives. But when anyone suggests that an economist’s views might be shaped by the economic incentives he or she faces,... it’s actually pretty common to hear economists saying things like — this is from the usually no-nonsense John Cochrane of the University of Chicago — “the idea that any of us do what we do because we’re paid off by fancy Wall Street salaries or cushy sabbaticals at Hoover is just ridiculous.” ...
Happily, Luigi Zingales, a colleague of Cochrane’s at Chicago’s Booth School of Business, is trying to correct his discipline’s blind spot by examining the economics of economists’ opinions. ...
Zingales ... subjects his notions to an empirical test: Are there discernible patterns in what kinds of economists think corporate executives are overpaid and what kinds think they’re paid fairly? ... The answer turns out to be yes. ...
What Zingales doesn’t call for is any kind of blanket retreat by economists from consulting and expert witnessing and board memberships. Which is a good thing, I think. One of the reasons why economics rocketed past the other social sciences in influence and prestige over the past 75 years was because so many economists involved themselves in the worlds they studied. That has surely led to some amount of capture by outside interests, but it also seems to have counteracted the natural academic tendency toward insularity and obscurity. Lots of economists study things of direct relevance to business leaders and government policy-makers. We wouldn’t really want to take away their incentive to do that, would we?

Sunday, August 31, 2014

What Savings Glut?

Joe Stiglitz in a review of Martin Wolf's new book "The Shifts and the Shocks":

... If I have a point of difference with Wolf’s analysis, it is that he ... is insufficiently critical of the “savings glut” hypothesis advanced by former Federal Reserve chairman Ben Bernanke, among others, which presents what used to be a virtue (savings) as a vice, shifting blame to China and (less vocally) to Germany. Yet the investment needs of today are staggering: for infrastructure in the developing world, let alone in the US; for retrofitting the global economy to cope with global warming; even for small and medium-sized enterprises starved of capital in much of the world. This should make it obvious that the problem is not an excess of savings but a financial system that is more fixated on speculation than on fulfilling its societal role of intermediation ... in which scarce savings are allocated to the investments of highest social returns.

The problem goes beyond a "financial system that is more fixated on speculation":

It is striking how much Wolf, like so many advocates of financial reform, focuses on protecting us against the banks: making sure that they don’t engage in excessive risk-taking... Wolf doesn’t dwell much on some of the more antisocial aspects evidenced in the aftermath of the crisis: the market manipulation (as in the Libor and forex scandals), the anti-competitive practices, the predatory and discriminatory lending, the lack of transparency, the fraudulent behavior. Presumably, this is because he believes, or hopes, that even too-big-to-fail and too-big-to-jail banks won’t be politically powerful enough to continue such behavior unimpaired. But he says too little about what might be done to make banks actually fulfill the societal role that they should be playing. ...

Monday, August 04, 2014

Paul Krugman: Obama’s Other Success

Financial reform is working:

Dodd-Frank Financial Reform Is Working, by Paul Krugman, Commentary, NY Times: ...The Dodd-Frank reform bill ... is working a lot better than anyone listening to the news media would imagine. Let’s talk, in particular, about two important pieces of Dodd-Frank: creation of an agency protecting consumers from misleading or fraudulent financial sales pitches, and efforts to end “too big to fail.”
The decision to create a Consumer Financial Protection Bureau shouldn’t have been controversial, given what happened during the housing boom. ...
Of course, that obvious need didn’t stop the U.S. Chamber of Commerce, financial industry lobbyists and conservative groups from going all out in an effort to prevent the bureau’s creation or at least stop it from doing its job, spending more than $1.3 billion in the process. Republicans in Congress dutifully served the industry’s interests...
At this point, however, all accounts indicate that the bureau is in fact doing its job, and well... But what happens if a crisis occurs anyway?
The answer is that, as in 2008, the government will step in to keep the financial system functioning; nobody wants to take the risk of repeating the Great Depression.
But how do you rescue the banking system without rewarding bad behavior? ...
The answer is that the government should seize troubled institutions when it bails them out, so that they can be kept running without rewarding stockholders or bondholders who don’t need rescue. In 2008 and 2009, however, it wasn’t clear that the Treasury Department had the necessary legal authority to do that. So Dodd-Frank filled that gap, giving regulators Ordinary Liquidation Authority, also known as resolution authority, so that in the next crisis we can save “systemically important” banks and other institutions without bailing out the bankers.
Bankers, of course, hate this idea; and Republican leaders like Mitch McConnell tried to help their friends with the Orwellian claim that resolution authority was actually a gift to Wall Street, a form of corporate welfare, because it would grease the skids for future bailouts. ...
Did reform go far enough? No. In particular, while banks are being forced to hold more capital, a key force for stability, they really should be holding much more. But Wall Street and its allies wouldn’t be screaming so loudly, and spending so much money in an effort to gut the law, if it weren’t an important step in the right direction. For all its limitations, financial reform is a success story.

Monday, July 21, 2014

'Truth or Consequences: Ponzi Schemes and Other Frauds'

Cecchetti & Schoenholtz:

... A well-functioning financial system is based on trust. Widespread belief in honesty and integrity are essential for intermediation. That is, when we make a bank deposit, purchase a share of stock or a bond, we need to believe that terms of the agreement are being accurately represented. Yes, the value of the stock can go up and down, but when you think you buy an equity share, you really do own it. Fraud can undermine confidence, and the result will be less saving, less investment, less wealth and less income.
Unfortunately, in a complex financial system, the possibilities for fraud are numerous and the incidence frequent. Most cases are smaller and more mundane than Madoff or Ponzi. But they are remarkably common even today, despite enormous public efforts to prevent or expose them. One website devoted to tracking financial frauds in the United States lists 67 Ponzi schemes worth an estimated $3 billion in 2013 alone. ...

See also: Four years after passage, House keeps trying to kill Dodd-Frank.

Friday, July 18, 2014

'Did the Banks Have to Commit Fraud?'

Dean Baker:

Did the Banks Have to Commit Fraud?: Floyd Norris has an interesting piece discussing Citigroup's $7 billion settlement for misrepresenting the quality of the mortgages in the mortgage backed securities it marketed in the housing bubble. Norris notes that the bank had consultants who warned that many of the mortgages did not meet its standards and therefore should not have been included the securities.
Towards the end of the piece Norris comments:
"And it may well be true that actions like Citigroup’s were necessary for any bank that wanted to stay in what then appeared to be a highly profitable business. Imagine for a minute what would have happened in 2006 if Citigroup had listened to its consultants and canceled the offerings. To the mortgage companies making the loans, that might have simply marked Citigroup as uncooperative. The business would have gone to less scrupulous competitors."
This raises the question of what purpose is served by this sort of settlement. Undoubtedly Norris' statement is true. However, the market dynamic might be different if this settlement were different.
Based on the information Norris presents here, Citigroup's top management essentially knew that the bank was engaging in large-scale fraud by passing along billions of dollars worth of bad mortgages. If these people were now facing years of prison as a result of criminal prosecution then it may well affect how bank executives think about these situations in the future. While it will always be true that they do not want to turn away business, they would probably rather sacrifice some of their yearly bonus than risk spending a decade of their life behind bars. The fear of prision may even deter less scrupulous competitors. In that case, securitizing fraudulent mortgages might have been a marginal activity of little consequence for the economy.
Citigroup's settlement will not change the tradeoffs from what Citigroup's top management saw in 2006. As a result, in the future bankers are likely to make the same decisions that they did in 2006.

Sunday, July 13, 2014

'Why Macroeconomists, Not Bankers, Should Set Interest Rates'

Simon Wren-Lewis:

Why macroeconomists, not bankers, should set interest rates: More thoughts on the idea that interest rates ought to rise because of the possibility that the financial sector is taking excessive risks: what I called in this earlier post the BIS case, after the Bank of International Settlements, the international club for central bankers. I know Paul Krugman, Brad DeLong, Mark Thoma, Tony Yates and many others have already weighed in here, but - being macroeconomists - they were perhaps too modest to draw this lesson. ...

Wednesday, July 09, 2014

'Lifting the Veil on the U.S. Bilateral Repo Market'

Via the Liberty Street Economics blog at the NY Fed, should we worry as much about the bilateral repo market as we do about the tri-party market (which played a key role in the financial crisis and remains vulnerable to another "run on the shadow banking system")?:

Lifting the Veil on the U.S. Bilateral Repo Market, by Adam Copeland, Isaac Davis, Eric LeSueur, and Antoine Martin, Liberty Street Economics: The repurchase agreement (repo), a contract that closely resembles a collateralized loan, is widely used by financial institutions to lend to each other. The repo market is divided into trades that settle on the books of the two large clearing banks (that is, tri-party repo) and trades that do not (that is, bilateral repo). While there are public data about the tri-party repo segment, there is little to no information on the bilateral repo segment. In this post, we update a methodology we developed earlier to estimate the size and composition of collateral posted for bilateral repos, and find that U.S. Treasury securities are the dominant form of collateral for bilateral repos. This new finding implies that the collateral posted for bilateral repos is of higher quality than the collateral posted for tri-party repos. ...

Sunday, July 06, 2014

'Keynesian Yellen versus Wicksellian BIS'

Gavyn Davies:

Keynesian Yellen versus Wicksellian BIS, by Gavyn Davies: The Bank for International Settlements (BIS) caused a splash last weekend with an annual report that spelled out in detail why it disagrees with central elements of the strategy currently being adopted by its members, the major national central banks. On Wednesday, Fed Chair Janet Yellen mounted a strident defence of that strategy in her speech on “Monetary Policy and Financial Stability”. She could have been speaking for any of the major four central banks, all of which are adopting basically the same approach [1].
Rarely will followers of macro-economics have a better opportunity to compare and contrast the two distinct intellectual strands in the subject...
Paul Krugman correctly points out that the BIS has been wrong in the past about the threat of inflation. Furthermore, their supply-led analysis of the real economy probably underestimates the pervasive importance of demand shocks during most economic cycles (see Mark Thoma). But the risk of financial instability is another matter entirely. It is optimistic to believe that macro-prudential policy alone will be able to handle this threat. The contrasting needs of the real economy and the financial sector present a very real dilemma for monetary policy.
The BIS was right about the dangers of risky financial behaviour prior to the crash. That caused the greatest demand shock for a century. Keynesians, including the Chair of the Federal Reserve, should be more ready to recognise that the same could happen again.

Inadequate demand calls for low interest rates to try to stimulate spending, but does the threat of financial instability necessarily call for higher rates? If so, which should prevail? As I see it (1) lack of demand is the bigger threat right now, (2) if financial instability looks like the bigger problem at some point in the future, then macroprudential policy targeted at the specific problem should be the first line of defense, (3) and, if it is "optimistic to believe that macro-prudential policy alone will be able to handle this threat," that is, if macroprudential policy alone is not enough to eliminate the threat, then, and only then, should interest rates by raised beyond where they would be given the state of aggregate demand.

As I said a few days ago:

"I think the macroprudential approach is correct. Using interest rates to deal with pockets of financial instability is too blunt of an instrument, e.g. it hits all industries, not just the ones where the instability is suspected and it may not directly address the particular problem generating the instability. It's much better to target the sectors where the problems exist, and to shape the policies to directly address the underlying problem(s)."

But let me conceded one point. If we wait until we can be sure that a dangerous bubble exists, and to see if macroprudential policy will be sufficient, it may be too late to raise interest rates to try to pop the bubble -- it may be past the point of no return. But I still prefer pricking the bubble with targeted policy rather than raising interest rates and causing a slowdown in a wide variety of markets, almost all of which are not a threat to the economy.

Thursday, July 03, 2014

'The Financial Instability Argument for Raising Rates'

Simon Wren-Lewis responds to calls to raise interest rates to promote financial stability:

The financial instability argument for raising rates: ... Let’s call the proposition that we should raise rates now to avoid financial instability the BIS case, after the Bank of International Settlements who have been making this argument ever since the recession began. ...
I want to begin by conceding a point. Suppose, as a monetary policymaker, you believe a financial crisis is possible, and that by raising rates you may be able to prevent it. Assume, crucially, that there is nothing else you can do to help prevent the financial crisis. In that case, you will consider raising rates, even if inflation is below target. ...
However that is not the end of the story. If you raise rates to prevent financial instability when inflation is below target, inflation will remain below target or may fall even further. You cannot ignore that. So if interest rates are raised today to head off a financial crisis, they will have to be lower in the future to deal with the lower inflation or even deflation you have caused. ... So by raising rates by a modest amount today we might prevent financial instability, but at the cost of delaying the recovery. ...
As Ryan Avent says, we can avoid all these difficulties by adding an extra instrument, which is macroprudential regulation. ... Now, as R.A. notes, those taking the BIS position counter that such measures are untested and may not be effective. Here is a typical example in the FT, where it is stated that “macroprudential policies will fail to stop investors taking irrational risks”.
So we must raise interest rates, and delay the recovery, because nothing else can stop some in the financial system taking excessive risks. To which I can only say, summoning all my academic gravitas, what audacity, what impudence! Not only have we had to suffer the consequences of the Great Recession because of excessive risk taking within a largely unregulated financial system, we now have to cut short our main means of getting out of that recession because they might do it again. I do not know what planet these people are on, but if its mine, can they please get off and play their games elsewhere.

Jane Yellen on how to deal with financial instability:

... Well, I think my main theme here today is that macroprudential policies should be the main line of defense, and I think the efforts that we’re engaged in in the United States but all countries coordinating through the — through Basel, through the Financial Stability Boards — the efforts that we are taking to globally strengthen the resilience of the financial system: more capital, higher quality capital, higher liquidity buffers, stronger and — arrangements for central clearing of derivatives that reduce interconnectedness among systemically important financial institutions, strengthening of the architecture of payments and clearing system dealing with risks we see in areas like tri-party repo. ...
I would also put resolution planning which we’re engaging in actively as among those measures. And, you know, as I mentioned, I think cyclical policies and sector-specific policies that we’re seeing many emerging markets take steps that can be used, particularly when we see problems developing in housing or a particular sector. These are really promising.
I don’t think we yet understand how they work. When they can be effective, how we should use them. I hope this will be an area for the IMF and for us of active research so we can better deploy those tools, capital — countercyclical capital charges.
But I think importantly, I’ve not taken monetary policy totally off the table as a measure to be used when financial excesses are developing because I think we have to recognize that macroprudential tools have their limitations. ... So to me, it’s not a first line of defense, but it is something that has to be actively in the mix. ...

Paul Krugman says "It’s about sadomonetarism, not stability."

I think the macroprudential approach is correct. Using interest rates to deal with pockets of financial instability is too blunt of an instrument, e.g. it hits all industries, not just the ones where the instability is suspected and it may not directly address the particular problem generating the instability. It's much better to target the sectors where the problems exist, and to shape the policies to directly address the underlying problem(s).

Friday, June 27, 2014

'How to Avoid the Next Crash'

From the editors at BloombergView:

How to Avoid the Next Crash: ... Many central banks, led by the U.S. Federal Reserve, have innovated boldly when it comes to monetary policy. They have pumped money into the financial system. They have provided banks with emergency loans. They have started providing "forward guidance" in an attempt to stabilize markets. Some even pay negative interest rates on reserves as a way to encourage private lending. Many countries have overhauled their financial regulatory systems as well.
There is a third category of innovation, however -- known as macroprudential policy -- that has lagged behind. It shouldn’t.
As the name suggests, macroprudential policies are a kind of hybrid: financial regulations attuned to the condition of the system as a whole, rather than the soundness of particular banks or other institutions. ...
Few deny the need for macroprudential policy. If speeches and conferences on the topic were a measure of progress, there'd be no cause for concern. Sadly, they aren't. Governments should develop a sense of urgency before it's too late.

For me, stopping the equivalent of bank runs within the shadow banking system -- a big problem during the financial crisis that has not yet been fully addressed -- is a top priority.

Thursday, June 26, 2014

'Are the Rating Agencies About to Get Their Comeuppance?'

Barry Ritholtz:

Are the Rating Agencies About to Get Their Comeuppance?: This week in encouraging news, we learn that the Securities and Exchange Commission may finally be pursuing one of the prime enablers of the financial crisis — the ratings companies. Previously, it was reported that disclosure violations were on the SEC’s radar, but truth be told, those are minor offenses.
The SEC’s Office of Credit Ratings, a division whose sole purpose is essentially to oversee Moody’s and Standard & Poor’s, seems to be stirring. ... Multiple cases have reportedly been referred to the SEC’s enforcement division, and new regulations are due.
And a welcome change it would be. Of all the players that helped cause the financial crisis, the ratings companies have gotten off scot-free. Banks have had massive fines while many mortgage and derivative underwriters have had their garbage securities put back to them at great cost. Since 2008, there have been 388 mortgage companies that have gone bankrupt. All of that junk paper found its way into AAA-rated securitized products and derivatives. The penalty for Moody’s and S&P has been essentially nil. ...[continue]...

It may be "encouraging news" but why has it taken so long?

Tuesday, May 27, 2014

'Don't Buy the 'Sharing Economy' Hype'

Dean Baker:

Don't buy the 'sharing economy' hype: Airbnb and Uber are facilitating rip-offs: The "sharing economy" – typified by companies like Airbnb or Uber, both of which now have market capitalizations in the billions – is the latest fashion craze among business writers. But in their exuberance over the next big thing, many boosters have overlooked the reality that this new business model is largely based on evading regulations and breaking the law. ...

This downside of the sharing needs to be taken seriously, but that doesn't mean the current tax and regulatory structure is perfect. Many existing regulations should be changed, as they were originally designed to serve narrow interests and/or have outlived their usefulness. But it doesn't make sense to essentially exempt entire classes of business from safety regulations or taxes just because they provide their services over the Internet.

Going forward, we need to ensure that the regulatory structure allows for real innovation, but doesn't make scam-facilitators into billionaires. For example, rooms rented under Airbnb should be subject to the same taxes as hotels and motels pay. Uber drivers and cars should have to meet the same standards and carry the same level of insurance as commercial taxi fleets.

If these services are still viable when operating on a level playing field they will be providing real value to the economy. As it stands, they are hugely rewarding a small number of people for finding a creative way to cheat the system.

Agree about the level playing field, but perhaps it will serve as a catalyst for changing regulations that "were originally designed to serve narrow interests and/or have outlived their usefulness"?

Tuesday, April 29, 2014

'Narrow Banks Won't Stop Bank Runs'

This is from a new blog by Stephen Cecchetti and Kermit Schoenholtz:

Narrow Banks Won't Stop Bank Runs: Every financial crisis leads to a new call to restrict the activities of banks. One frequent response is to call for “narrow banks.” That is, change the legal and regulatory framework in a way that severely limits the assets that traditional deposit-taking banks can hold. One approach would require that all liabilities that are demandable at par be held in the form of deposits at the central bank. That is, accounts that can be withdrawn without notice and have fixed net asset value would face a 100% reserve requirement. The Depression-era “Chicago Plan” had this approach in mind.
In the aftermath of the financial crisis of 2007-09, Lawrence Kotlikoff, Jeremy Bulow and Paul Klemperer, John Kay, and, most recently, John Cochrane, and Martin Wolf have resurrected versions of narrow banking. All of these proposals, both the old and the new, have a common core: banks should be split into two parts, neither of which would supposedly be subject to runs. ...
Naturally, we share the objective of these reformers: preventing bank runs. The key issue is how to do so and at what cost. We suspect that narrow banking would be costly in terms of economic performance, yet unlikely to achieve this goal. ...
We know that a combination of transparency, high capital and liquidity requirements, deposit insurance and a central bank lender of last resort can make a financial system more resilient. We doubt that narrow banking would.

(The original post is much more detailed.)

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.