Economist's View

Hillary Clinton: How I’d Rein In Wall Street

Hillary Clinton's plan for Wall Street:

Hillary Clinton: How I’d Rein In Wall Street: Seven years ago, the financial crisis sent our economy into a tailspin. ...

Under President Obama, our economy has come a long way back. ... And we have tough new rules on the books, including the Dodd-Frank Act, that protect consumers and curb recklessness on Wall Street.

But not everyone sees that as a good thing. Republicans, both in Congress and on the campaign trail, are dead-set on rolling back critical financial protections. ...

President Obama and congressional Democrats should do everything they can to stop these efforts. But it’s not enough simply to protect the progress we have made. As president, I would not only veto any legislation that would weaken financial reform, but I would also fight for tough new rules, stronger enforcement and more accountability that go well beyond Dodd-Frank. ...

'Fed Emergency Lending'

Ben Bernanke:

Fed emergency lending: Earlier this week, the Federal Reserve’s Board of Governors approved a rule implementing restrictions on its emergency lending powers that were mandated by Congress in the 2010 Dodd-Frank Act. On the whole, the rule is a sensible compromise which clarifies the procedures for Fed lending in a panic while responding to critics’ concerns. ... Going forward, however, we should be wary of any further changes that might have the effect of deterring financial firms from borrowing from the Fed during a financial panic. ...

In a financial panic, providers of short-term funding to financial institutions refuse to renew their lending, out of fear that an institution might fail. ... When banks or other financial firms cannot obtain funding, they ... stop extending credit to households and businesses, which can bring the economy to a halt.

The most important tool that central banks (like the Fed) have for fighting financial panics is their ability to serve as a lender of last resort... Crucially, the Fed retains the authority to lend freely in a panic. ...

My biggest concern about the collective impact of the reforms is related to what economists call the stigma of borrowing from the central bank. For lender-of-last resort policies to work, financial institutions have to be willing to avail themselves of the central bank’s loans. If they fear that by doing so that they will be identified by the marketplace as weak, and thus subject to even more pressure from creditors and counterparties, then they will see borrowing from the Fed as counterproductive and will stay away. This is the stigma problem... Deprived of access to funding, financial firms will instead hoard cash, dump assets, cut credit, and call in loans, with bad effects on the whole economy.

We faced a serious stigma problem during the recent crisis, and, collectively, the reforms to the Fed’s lending authorities have probably made the problem worse. An example is the effect of new reporting requirements. Dodd-Frank requires that the identities of all borrowers (including non-emergency borrowers through the discount window) be disclosed... These provisions serve the important purposes of advancing transparency, accountability, and democratic legitimacy, and I am not advocating that they be changed. But we should be aware that, by increasing the risk of early disclosure of borrowers’ identities, these requirements will probably reduce the willingness of firms to borrow from the Fed in a panic... 

I don’t see an easy remedy for this problem. As is often the case, policymakers must trade off competing goals. However, in contemplating possible future changes to the Fed’s authorities, we should be very careful to avoid anything that might worsen further the stigma problem...

Paul Krugman: Democrats, Republicans and Wall Street Tycoons

Financial tycoons broke up with Democrats. Now they ♥ Republicans (or maybe they are just using them with their money):

Democrats, Republicans and Wall Street Tycoons, by Paul Krugman, Commentary, NY Times: Hillary Clinton and Bernie Sanders had an argument about financial regulation during Tuesday’s debate — but it wasn’t about whether to crack down on banks. Instead, it was about whose plan was tougher. The contrast with Republicans like Jeb Bush or Marco Rubio, who have pledged to reverse even the moderate financial reforms enacted in 2010, couldn’t be stronger.

For what it’s worth, Mrs. Clinton had the better case. ... But is Mrs. Clinton’s promise to take a tough line on the financial industry credible? Or would she ... return to the finance-friendly, deregulatory policies of the 1990s? ...

To understand the politics of financial reform and regulation, we have to start by acknowledging that there was a time when Wall Street and Democrats got on just fine. Robert Rubin of Goldman Sachs became Bill Clinton’s most influential economic official; big banks had plenty of political access; and the industry by and large got what it wanted, including repeal of Glass-Steagall.

This cozy relationship was reflected in campaign contributions, with the securities industry splitting its donations more or less evenly between the parties, and hedge funds actually leaning Democratic.

But then came the financial crisis of 2008, and everything changed.

Many liberals feel that the Obama administration was far too lenient on the financial industry in the aftermath of the crisis. ... But the financiers didn’t feel grateful for getting off so lightly. ... Financial tycoons loom large among the tiny group of wealthy families that is dominating campaign finance this election cycle — a group that overwhelmingly supports Republicans. Hedge funds used to give the majority of their contributions to Democrats, but since 2010 they have flipped almost totally to the G.O.P. ... Wall Street insiders take Democratic pledges to crack down on bankers’ excesses seriously. And it also means that a victorious Democrat wouldn’t owe much to the financial industry.

If a Democrat does win, does it matter much which one it is? Probably not. Any Democrat is likely to retain the financial reforms of 2010, and seek to stiffen them where possible. But major new reforms will be blocked until and unless Democrats regain control of both houses of Congress, which isn’t likely to happen for a long time.

In other words, while there are some differences in financial policy between Mrs. Clinton and Mr. Sanders, as a practical matter they’re trivial compared with the yawning gulf with Republicans.

'Monopolies Don't Give Us Nice Things'

I've been arguing we need to take a more active approach to reducing market power for many years, without much traction, so it's always nice to see others joining in (it hasn't been enough, but the Obama administration has been better than the Bush administration on this front). This is from Barry Ritholtz:

Monopolies Don't Give Us Nice Things: ...There is little intelligent discussion about the costs of too much regulation on the one hand, and the excesses of capitalism on the other. That is a shame, because both sides of those issues create real economic frictions with substantial societal costs. ...

I would like to address ... how poor a job the U.S. does in regulating industries to which it grants monopoly or oligopoly status. ...

As a nation we do a very poor job of managing competition and adopting the needed standards to improve market efficiency. Television services are just one example. ...

It seems impossible, however, to have a serious conversation about this as long as rich companies buy off elected officials who grant special tax breaks, dispensations and exemptions. You can pretty much name any intractable problem in the U.S. and you can trace it back to the money corrupting the political process. ...

Wanted: Independent Evaluations of Government Programs

In case you are feeling Moody:

Timothy Geithner and the Auditors, by Dean Baker: Eduardo Porter had a good piece in the NYT pointing out the importance of having independent evaluations of government programs. The point is that the agencies undertaking a program have a strong incentive to exaggerate its benefits. ...

One of the areas noted by Porter is in the rating of mortgage backed securities (MBS). During the housing bubble years, the bond-rating agencies routinely gave investment grade ratings to MBS that were stuffed with junk mortgages. They ignored the quality of the mortgages because they wanted the business. They knew if they gave honest ratings, the investment banks would take away their business.

While Porter notes this is a problem with the issuer pays model (the banks pay the rating agencies), there actually is a very simple solution. In the debate on Dodd-Frank, Senator Al Franken proposed an amendment which would have the Securities and Exchange Commission pick the rating agency, instead of the issuer. The bank would still pay the fee, but since they were no longer controlling who got the work, it eliminated the conflict of interest problem. The amendment passed the senate 65-34, with considerable bi-partisan support.

Unfortunately, as Geithner indicated in his autobiography, the Obama administration apparently did not like the dismantling of the perfect system we have today. The Franken amendment was removed in the conference committee and the existing structure was left in place. This was possible because the bond-rating agencies and the banks have real lobbies, whereas the folks who like honest evaluations don't. Of course the news media didn't help much, giving the issue very little coverage. And what attention it did get largely reflected the views of the financial industry.

Anyhow, this is a good example of the difficulties in putting in place the sort of independent auditing process that Porter seeks.

Bank Panics and the Next 30 Years

The end of an essay by David Warsh:

... Many regulators and bankers contend that the thousand-page Dodd Frank Act complicated the task of a future panic rescue by compromising the independence of the Fed. Next time the Treasury Secretary will be required to sign off on emergency lending.

Bank Regulators?  Some economists, including Gorton, worry that by focusing on its new “liquidity coverage ratio” the Bank for International Settlements, by now the chief regulator of global banking, will have rendered the international system more fragile rather than less by immobilizing collateral.

Bankers?  You know that the young ones among them are already looking for the Next New Thing.

Meanwhile, critics left and right in the US Congress are seeking legislation that would curb the power of the Fed to respond to future crises.

So there is plenty to worry about in the years ahead. Based on the experience of 2008, when a disastrous meltdown was avoided, there is also reason to hope that central bankers will once again cope. Remember, though, as the Duke of Wellington said of the Battle of Waterloo, it was a close-run thing.

Update: See Brad Delong's reply.

Paul Krugman: Dewey, Cheatem & Howe

Republicans can't help but side with business, but there are very good reasons for the recent increase in regulatory oversight:

Dewey, Cheatem & Howe, by Paul Krugman, Commentary, NY Times: Item: The C.E.O. of Volkswagen has resigned after revelations that his company committed fraud on an epic scale, installing software on its diesel cars that detected when their emissions were being tested, and produced deceptively low results.

Item: The former president of a peanut company has been sentenced to 28 years in prison for knowingly shipping tainted products that later killed nine people and sickened 700.

Item: Rights to a drug used to treat parasitic infections were acquired by Turing Pharmaceuticals, which specializes not in developing new drugs but in buying existing drugs and jacking up their prices. In this case, the price went from $13.50 a tablet to $750. ...

There are, it turns out, people in the corporate world who will do whatever it takes, including fraud that kills people, in order to make a buck. And we need effective regulation to police that kind of bad behavior... But we knew that, right?

Well, we used to know it... But ... an important part of America’s political class has declared war on even the most obviously necessary regulations. ...

A case in point: This week Jeb Bush, who has an uncanny talent for bad timing, chose to publish an op-ed article in The Wall Street Journal denouncing the Obama administration for issuing “a flood of creativity-crushing and job-killing rules.” Never mind his misuse of cherry-picked statistics, or the fact that private-sector employment has grown much faster under President Obama’s “job killing” policies than it did under Mr. Bush’s brother’s administration. ...

The thing is, Mr. Bush isn’t wrong to suggest that there has been a move back toward more regulation under Mr. Obama, a move that will probably continue if a Democrat wins next year. After all, Hillary Clinton released a plan to limit drug prices at the same time Mr. Bush was unleashing his anti-regulation diatribe.

But the regulatory rebound is taking place for a reason. Maybe we had too much regulation in the 1970s, but we’ve now spent 35 years trusting business to do the right thing with minimal oversight — and it hasn’t worked.

So what has been happening lately is an attempt to redress that imbalance, to replace knee-jerk opposition to regulation with the judicious use of regulation where there is good reason to believe that businesses might act in destructive ways. Will we see this effort continue? Next year’s election will tell.

'Rational Drug Pricing'

Should we rationally expect rational drug pricing?:

Rational Drug Pricing, by Jeff Sachs: Drug pricing has taken center stage in U.S. politics, and it's high time that it should. ...

Drug pricing is not like the pricing of apples and oranges, clothing, or furniture that well and good should be left to the marketplace. There are two major reasons. First, the main cost of drug production is not the cost of manufacturing the tablet but the cost of producing the knowledge embedded in the tablet. Second, there is often a life-and-death stake in access to the drug, so society should take steps to ensure that the drug is affordable and accessible.

To ensure that financial resources flow to scientists to produce the knowledge embedded in the tablet, the government does two things. First, the government pays directly for a substantial part of the research and development (R&D). ... Second, the government grants patent rights for drug discovery. ...

It's a basic insight of economics that patent rights are a "second-best" solution to drug pricing, not an optimal solution. A patent creates an artificial monopoly to incentivize R&D. Yet it also reduces access to the product, perhaps with unacceptable and immoral life-and-death consequences. Rational drug pricing would get the best of the patent system but ensure that it is compatible with access to the life-saving drugs.

Unfortunately, the current rules of the game in the U.S. pharmaceutical sector do not compensate for the weaknesses of patents. They amplify them. ... What should be done? Here are three key principles.

First, private R&D should certainly be protected by patents but only enough to elicit the needed R&D, not to produce outlandish profits. ...

Second, when the U.S. government pays for much of the R&D, it should share in the property rights. This should be a no-brainer, but in fact the NIH simply gives away most or all the intellectual property that it has financed, so the taxpayer pays part of the R&D bills but the returns are fully captured by private companies.

Third, when companies ... make profits from their U.S.-based research and U.S.-based production and sales, they should certainly pay U.S. taxes on their profits. The fact that the IRS lets them hide their profits in overseas tax havens is scandalous and without any logical justification whatsoever.

'Jeb Bush Has No Clue About Business Regulation'

Kevin Drum is not impressed with Jeb Bush's plan for regulation, or his justification for it:

Jeb Bush Has No Clue About Business Regulation: Jeb Bush today in the Wall Street Journal:

To understand what is wrong with the regulatory culture of the U.S. under President Obama, consider this alarming statistic: Today, according to the World Bank—not exactly a right-wing think tank—the U.S. ranks 46th in the world in terms of ease of starting a business. That is unacceptable. Think what the U.S. could be and the prosperity we could have if we rolled back the overregulation that keeps us from ranking in the top 10.

My goodness. That does sound unacceptable. Still, it never hurts to check up on these presidential candidates... So let's click the link ... and see what it says: "The rankings of economies with populations over 100 million are based on data for 2 cities." Hmmm. It turns out the World Bank is ranking the US based on starting up a business in New York City. That seems to tip the scales a wee bit, no? ...

Now I get it. This isn't about getting a business up and running. It's solely about registering a new business. And it's got nothing to do with any of Obama's regulations. It's all about state and local stuff. ... I'm not sure what Jeb Bush thinks he's going to do to streamline this. Bottom line: this is completely meaningless. ...

But wait! There's more. The World Bank does have a broader "Ease of Doing Business" rank that takes into account the things you need to do to get up and running: construction permits, electricity, credit, paying taxes, enforcing contracts, etc. As it happens, the bulk of this stuff is still state and local, and has nothing to do with Obama or the federal government. Still, let's take a look since Jeb chose not to share it with us for some reason...

The World Bank has us in 7th place. We're already in the top ten that Jeb is aiming for. Mission accomplished! ...

As for the outrageous regulations he promises to repeal on Day One, this would mostly just benefit big campaign donors, not the yeoman entrepreneurs he claims to be sticking up for. No big surprise there, I suppose.

'The Evolution of Scale Economies in U.S. Banking'

This is a question I have wanted to see an answer to for a long time. What is the minimum efficient scale for financial institutions? This is an important question with respect to breaking up large banks into smaller entities. Some have argued, based on very little compelling evidence as far as I can tell, that breaking up big banks would be costly because large banks are able to exploit economies of scale. Others disagree, but again evidence for either point of view is unclear. I don't mean there is no evidence at all, the existing research is described in the introduction to this paper, but the results do not point strongly in any particular direction. Hopefully, more work on the topic will shift the weight of the evidence in one direction or another:

The Evolution of Scale Economies in U.S. Banking, by David C. Wheelock and Paul W. Wilson, August 2015: Abstract Continued consolidation of the U.S. banking industry and general increase in the size of banks has prompted some policymakers to consider policies to discourage banks from getting larger, including explicit caps on bank size. However, limits on the size of banks could entail economic costs if they prevent banks from achieving economies of scale. The extent of scale economies in banking remains unclear. This paper presents new estimates of returns to scale for U.S. commercial banks based on nonparametric, local-linear estimation of bank cost, revenue and pro t functions. We present estimates for both 2006 and 2012 to compare the extent of scale economies in banking some four years after the financial crisis and two years after enactment of the Dodd-Frank Act with scale economies prior to the crisis. We find that most banks faced increasing returns to scale in cost in both years, though results for the very largest banks in 2012 are somewhat sensitive to specification. Further, most banks faced decreasing returns in revenue in both years, though nearly all banks could still increase revenue and pro t by becoming larger.

[As I've written many, many times, I do not think that breaking up big banks will do a lot to reduce our susceptibility to bank crises. After all, we had a financial crisis about every 20 years in the 1800s, and this continued through the Great Depression, and at that time banks were relatively small. Thus, it seems that crises have more to do with the diversity of activity and connectedness than bank size. I favor breaking up the biggest banks to reduce their political power, which I believe is excessive, and to reduce their economic power. If the above results had shown that the minimum efficient scale was much smaller than the typical large, systemically important bank, breaking them up would be an easy call. But that's not what the results imply. Thus, in this case, there is a tradeoff between the benefit or reducing political and economic power versus losing economies of scale (not sure how steep the cost function is at the existing size -- if it's relatively flat the loss of scale economies could be small). The other alternative is to treat them along the lines of a public utility. We allow them to be large to exploit scale economies, then regulate pricing and other behavior. However, this is where the political power of the large banks matters, and it's not clear that a policy of "large but with regulatory oversight" is the best option to pursue.]

Financial Regulation: Which Reform Strategy is Best?

Today is the 5th anniversary of the Dodd-Frank financial reform bill. When the bill was being debated, I was torn on which strategy is best, to strike while the iron is hot -- to implement financial reform legislation as soon as possible -- or to take a patient approach that allows careful consideration and study of proposed regulatory changes:

Kashyap and Mishkin ... may be right that now is not the time to change regulations because it could create additional destabilizing uncertainty in financial markets, and that waiting will give us time to see how the crisis plays out and to consider the regulatory moves carefully. But as we wait, passions will fade, defenses will mount, the media will respond to the those opposed to regulation by making it a he said, she said issue that fogs things up and confuses the public as well as politicians. By the time it is all over there's every chance that legislation will pass that is nothing but a facade with no real teeth that can change the behaviors that go us into this mess.

More and more, I think doing what you can while passions are inflamed, and then defending the legislation as much as possible when the inevitable attack from the industry comes is the best strategy. For example, in the WSJ two days ago, there was an opinion piece with the title "After Five Years, Dodd-Frank Is a Failure," and the sub-header "The law has crushed small banks, restricted access to credit, and planted the seeds of financial instability."

There is a problem with small banks. Here's an email I received earlier this year (last March, in response to an article of mine at CBS MoneyWatch on the decline in the number of small banks and how that could harm smaller buinesses):

Mr. Thoma,

I am a regular reader of your columns, and lean more to the left than virtually any banker I know, but I have to tell you that you are on to something with the decline in the number of small banks, and regulations. As the Chairman of a small bank in [state omitted], the shear amount of regulations that have come out since the banking crisis started are incredible. I know of banks in the area which have simply had to hire a full time staff person to help with compliance. Our bank has had to hire the CPA firm [omitted] to have them come in once a quarter to help us keep up with the compliance. Obviously, this crimps our profits, as does the ZLB which we have had to deal with for six years now, through no fault, at all, of our own.

Don't get me wrong, I understand why all these regulations have been put in place, but unfortunately for us, most of these have little to do with our small bank. They seem to be designed to keep the behemoths out of trouble, and we got dragged along. There needs to be a different set of rules for banks under a certain size. Banks like ours, who keep all our loans in house, and aren't a threat to the economy as a whole, have never been ones to "screw" our customers, or write "bogus" loans, and sell them. Our loan losses since 2008 have been minimal to say the least, because we try very hard to make loans that are going to be repaid. Our total losses over the last six or seven years are not any worse than, and probably, better than they were before the banking crisis arrived.

We, as a board of the bank, have talked on numerous occasions in the last few years on what to do about this problem, and have brought it up with the federal regulators at our last two exams, but have really gotten no where as far as coming up with any ideas on what to do to try and alleviate these burdens on small banks. Any suggestions, or publicity regarding the issue, would be greatly appreciated.

The point I'm trying to make is this. There are two choices when trying to fix a financial system after a crisis. The first is to move fast while the politics are supportive, and put as many of the needed rules and regulations in place as possible. Then, over time, *carefully* adjust the rules to overcome unforeseen problems (while resisting attempts to rollback needed legislation, a delicate balance). The second is to proceed slowly and deliberately and "consider the regulatory moves carefully" before implementing legislation. But by the time this deliberate procedure has been completed, it may very well be that the politics have changed and nothing will be done at all. So I'd rather move fast, if imperfectly, and then fix problems later instead of waiting in an attempt to put near perfect legislation in place and risk doing very little, or nothing at all.

Did Dodd-Frank Fix Too Big To Fail?

Gara Afonso and João Santos at the NY Fed's Liberty Street Economics blog:

What Do Bond Markets Think about “Too-Big-to-Fail” Since Dodd-Frank?: In our previous post, we concluded that, in rating agencies’ views, there is no clear consensus on whether the Dodd-Frank Act has eliminated “too-big-to-fail” in the United States. Today, we discuss whether bond market participants share these views.

As we discussed in our post on Monday, the Dodd-Frank Act includes provisions to address whether banks remain “too big to fail.” Title II of the Act creates an orderly liquidation mechanism for the Federal Deposit Insurance Corporation (FDIC) to resolve failed systemically important financial institutions (SIFIs). ...

Since the Dodd-Frank Act makes it easier to intervene at the holding company level, we predict that, relative to the pre-Dodd-Frank era, investors’ perceptions of the risk of holding bonds of a parent company would have increased relative to the risk of holding bonds of its subsidiary bank. To test this hypothesis, we compared how bond spreads evolved for a matched pair of bonds—one issued by the parent company and one by its subsidiary bank. This approach lets us isolate any differential effect of the new resolution procedure on the parent company relative to its subsidiary. A downside, though, is that there are only a few cases where both the parent and the subsidiary have the same bonds traded in financial markets.

Contrary to our hypothesis, the difference in option-adjusted spreads to Treasuries of the parent companies and their subsidiary banks ... has not widened since the Dodd-Frank Act was enacted. ...

Our previous post demonstrated that rating agencies do not have a unanimous view of the current level of government support of U.S. commercial banks and their holding companies. The results here indicate that market participants’ perceptions of the relative risk have not increased as one would have expected given the new resolution framework introduced by the Dodd-Frank Act. ...

Together the evidence suggests that rating agencies and market participants may have some doubts about the ability, so far, of the Dodd-Frank Act to deal with “too big to fail.” However, some observers have argued that once all provisions of the Dodd-Frank Act are implemented, any remaining expectations of government support will disappear. Time will tell.

'Bailout Barometer: How Large is the Financial Safety Net?'

John Cochrane points to this from the Richmond Fed (he has a few additional comments):

Bailout Barometer: How Large is the Financial Safety Net?: ...The Bailout Barometer is our estimate of the share of financial system liabilities for which the federal government provides protection from losses. In addition to protection from explicit government guarantee programs, our estimate includes implicit protection that people are likely to infer from past government actions and statements. Despite efforts to end ad hoc bailouts, the financial safety net that protects certain firms remains large under current government policies.

How large is it?

Our latest estimate shows that the financial safety net covers 60 percent of the financial sector. This estimate also includes a breakdown by sector. These measures, compiled in March 2015, use data as of December 31, 2013. Our Bailout Barometer has grown considerably since our first estimate in 1999.

Why does it matter?

When creditors expect to be protected from losses, they will overfund risky activities, making financial crises and bailouts like those that occurred in 2007-08 more likely. An extensive safety net also creates a need for robust supervision of firms benefitting from perceived protection. Over time, shrinking the financial safety net is essential to restore market discipline and achieve financial stability. Doing so requires credible limits on ad hoc bailouts. Read more on our perspective.

Want to learn more?

• Methodology used to calculate Bailout Barometer
• History of Bailout Barometer, including previous estimates
• Frequently asked questions
• Related research on the financial safety net and the "too big to fail" problem

'Free-Market Dogma has Jacked Up our Electricity Bills'

David Cay Johnston

Free-market dogma has jacked up our electricity bills: A new analysis shows that people pay 35 percent more for electricity in states that abandoned traditional regulation of monopoly utilities in the 1990s compared with states that stuck with it. ....

You might think that the higher prices in the 15 states with markets would encourage investment, creating an abundance of new power plants. That, at any rate, is what right-wing Chicago School economic theories on which the electricity markets were created say should happen. The validity of these theories, and flaws in how they were implemented, matter right now because Congress is considering a raft of energy supply bills that include some expansion of the market pricing of wholesale electricity. ...

Yet just 2.4 percent of new electric generating capacity in 2013 “was built for sale into a market,” electricity-market analyst Elise Caplan showed in a study last fall... The rest were built in states with traditional regulation or under long-term supply contracts that essentially guaranteed repayment of loans to build the plants.

Here’s another measure of failure: Areas covered by electricity markets have 60 percent of America's generating capacity, but enjoyed just 6 percent of new generation built in 2013.

If unregulated markets are invariably better, as the Chicago School holds, why was 94 percent of new generating capacity built in traditionally regulated jurisdictions? ...

'Wyoming’s War on Microbiology'

Mike the Mad Biologist:

Wyoming’s War on Microbiology: Well, they’re not calling it that, but this Wyoming law is definitely not going to make our water cleaner, or stop the spread of antibiotic resistance genes...:

…the new law makes it a crime to gather data about the condition of the environment across most of the state if you plan to share that data with the state or federal government. The reason? The state wants to conceal the fact that many of its streams are contaminated by E. coli bacteria, strains of which can cause serious health problems, even death. ... Rather than engaging in an honest public debate about the cause or extent of the problem, Wyoming prefers to pretend the problem doesn’t exist. And under the new law, the state threatens anyone who would challenge that belief by producing information to the contrary with a term in jail...

The new law is of breathtaking scope. It makes it a crime to “collect resource data” from any “open land,” meaning any land outside of a city or town, whether it’s federal, state, or privately owned. The statute defines the word collect as any method to “preserve information in any form,” including taking a “photograph” so long as the person gathering that information intends to submit it to a federal or state agency. In other words, if you discover an environmental disaster in Wyoming, even one that poses an imminent threat to public health, you’re obliged, according to this law, to keep it to yourself.

While this law will probably be ruled unconstitutional, its intent is horrendous...

For me personally, the timing is ironic, as I’ve spent the last week involved in various agriculture-related microbiology meetings, and the constant refrain was “we need more data on what people are doing” (e.g., how are they using antibiotics?). In the areas of food and water safety, we desperately need more data. ...

'An Open Letter to Bill McNabb, CEO of Vanguard Group'

Stephen G. Cecchetti and Kermit L. Schoenholtz (sort of a follow up on the claim that financial reform is working -- perhaps -- but as noted in the post below this one there is more to do):

An Open Letter to Bill McNabb, CEO of Vanguard Group: Dear Mr. McNabb,

We find your WSJ op-ed (Wednesday, May 6) misleading, short-sighted, self-serving, and very disappointing.

Vanguard has been in the forefront of providing low-cost, reliable access to U.S. and global capital markets to millions of customers, including ourselves. Following the financial crisis of 2007-2009, the firm naturally should be a leader in promoting a more resilient financial system. Your op-ed sadly goes in the opposite direction.

Let’s start with the most stunning example: your defense of money market mutual funds. MMMFs are simply banks masquerading as professionally managed investment products. Like banks, they engage in liquidity and maturity transformation. Like banks, they faced runs in 2008 that ended only when the federal government provided a guarantee that put taxpayers at risk. Even with that guarantee, the government still had to support many healthy U.S. corporations with household names that – having previously relied on MMMF purchases of their commercial paper – suddenly faced a severe credit crunch. And, to limit a fire sale amidst the crisis, the Federal Reserve had to provide special funding to buyers to help MMMFs unload their assets.

Unsurprisingly, fund sponsors and their clients – both creditors and borrowers – want to keep these opaque federal subsidies (especially the implicit guarantees that only become explicit and transparent in a crisis). Like them, you make the false, but popular claim that power-hungry regulators (who wish to limit the subsidies that make future crises more likely) are attacking (taxing!) Main Street instead of Wall Street.

In fact, the investment company industry captured its primary regulator long ago, and hasn’t let go. The Securities and Exchange Commission’s 2014 “reform” of MMMFs is exhibit A. It almost surely makes these funds more, not less, liable to runs (see here and here). And – what a surprise – Congress seems to find protecting U.S. taxpayers from contingent liabilities (like implicit financial guarantees to your industry) less attractive than the largesse of financial lobbyists. Even the voluminous Dodd-Frank Act didn’t address MMMFs! ...

After quite a bit more, they conclude with:

As the CEO of one of the largest mutual fund companies in the world that is dedicated to serving and protecting small investors, you should be in the vanguard of advocating reforms that enhance stability.

Instead of complaining about regulation under the guise of protecting Main Street, you should highlight the vulnerabilities in our financial system and make the case for efficient regulation that treats all activities equally. You should also promote investment vehicles that are likely to prove robust in a crisis, while warning about existing products that probably won’t be.

Only greater resilience in the system can make investors confident that capital markets here and elsewhere will remain strong. That is in Vanguard’s interest, too.

Sincerely,

Stephen G. Cecchetti and Kermit L. Schoenholtz

Paul Krugman: Wall Street Vampires

Financial reform seems to be working:

Wall Street Vampires, by Paul Krugman, Commentary, NY Times: Last year the vampires of finance bought themselves a Congress. I know it’s not nice to call them that, but I have my reasons, which I’ll explain in a bit. For now, however, let’s just note that these days Wall Street, which used to split its support between the parties, overwhelmingly favors the G.O.P. And the Republicans who came to power this year are returning the favor by trying to kill Dodd-Frank, the financial reform enacted in 2010.

And why must Dodd-Frank die? Because it’s working. ...

For one thing, the Consumer Financial Protection Bureau — the brainchild of Senator Elizabeth Warren — is, by all accounts, having a major chilling effect on abusive lending practices. And early indications are that enhanced regulation of financial derivatives — which played a major role in the 2008 crisis — is having similar effects, increasing transparency and reducing the profits of middlemen.

What about the problem of ... “too big to fail”? There, too, Dodd-Frank seems to be yielding real results, in fact, more than many supporters expected. ...

All of this seems to be working: “Shadow banking,” which created bank-type risks while evading bank-type regulation, is in retreat. ...

But the vampires are fighting back.

O.K., why do I call them that? Not because they drain the economy of its lifeblood, although they do: there’s a lot of evidence that oversize, overpaid financial industries — like ours — hurt economic growth and stability. Even the International Monetary Fund agrees.

But what really makes the word apt in this context is that the enemies of reform can’t withstand sunlight. Open defenses of Wall Street’s right to go back to its old ways are hard to find. When right-wing think tanks do try to claim that regulation is a bad thing that will hurt the economy, their hearts don’t seem to be in it. ...

Republicans would love to undo Dodd-Frank, but they are, rightly, afraid of the glare of publicity that defenders of reform like Senator Warren — who inspires a remarkable amount of fear in the unrighteous — would shine on their efforts.

Does this mean that all is well on the financial front? Of course not. Dodd-Frank is much better than nothing, but far from being all we need. And the vampires are still lurking in their coffins, waiting to strike again. But things could be worse.

'An Overwhelming Argument for Draconian Bank Regulation'

Paul Krugman on John Taylor's claim that deviations from his Taylor Rule caused the financial crisis:

...if it’s really that easy for monetary errors to endanger financial stability — if a deviation from perfection so small that it leaves no mark on the inflation rate is nonetheless enough to produce the second-worst financial crisis in history — this is an overwhelming argument for draconian bank regulation. Modest monetary mistakes will happen, so if you believe that these mistakes caused the global financial crisis you must surely believe that we need to do whatever it takes to make the system less fragile. Strange to say, however, I don’t seem to be hearing that from Taylor or anyone else in that camp.

'Are We Kidding Ourselves on Competition?'

This seems implausible to me, yet there seems to be evidence for it:

Are we kidding ourselves on competition?, by Joshua Gans: ...Consider a situation where there are 10 firms in a market and they compete with one another. Now suppose that all shareholders — say because they are following the dicta of diversification — allocate their wealth in equal proportion across those 10 firms. That means that each owner of the firm — even if there are thousands of these — cares equally about each firm’s profits.

So ask yourself: when those shareholders vote on the composition of boards or the management of the firm, or, importantly how the management of the firm is compensated, are they going to vote for managers who will care only about the profits of the firm they manage or about the profits more broadly? The answer is obvious: they will look to managers who manage in the interest of shareholders and so that means they care about all firm profits and not just the one of their own firm.

In a world where shareholders can get what they want, we won’t have competition in this outcome but, more likely, a collusive outcome. What is more, the firms won’t have to go to all the difficulty of violating antitrust laws to obtain this outcome, they will do it unilaterally. There are no laws against that. ...

Now this isn’t just speculation. Jose Azar, an economist now at Charles River Associates, did his Princeton PhD on this topic. His theory paper is here and it builds on others including Gordon (1990), Hansen and Lott (1995) and O’Brien and Salop (2000). Frank Wolak and I came up with a similar set of issues related to cross-ownership and hedging in electricity markets (for vertical ownership) and verified anti-competitive consequences arising from this. But Azar, along with Martin Schmalz and Isabel Tecu have demonstrated that cross-ownership has anti-competitive impacts on the US airline industry. They find that cross ownership increases US airline prices 3–5%. When they use the event whereby BlackRock acquired Barclays Global Investors (a merger changing the shares of common ownership in airlines), they found such ownership could indicate 10% bumps in pricing with US airline ticket prices rising by 0.6% as a result of that merger alone. ...

The point here is that we cannot really ignore this issue as economists or as policy-makers. We have “known” about it for decades. Now’s the time to take it seriously.

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

'No More Cheating: Restoring the Rule of Law in Financial Markets'

Simon Johnson:

No More Cheating: Restoring the Rule of Law in Financial Markets, by Simon Johnson: ... In a speech on Wednesday, Senator Elizabeth Warren (D., MA) laid out a vision for better financial markets. This is not a left-wing or pro-big government agenda. Senator Warren’s proposals are, first and foremost, pro-market. She wants – and we should all want – financial firms and markets that work for customers, that encourage innovation, and that do not build up massive risks which can threaten the financial system and bring down the economy.

Senator Warren puts forward two main sets of proposals. The first is to more strongly discourage the deception of customers. This is hard to argue against. Some parts of the financial sector are well-run, providing essential services at reasonable prices and with sound ethics throughout. Other parts of finance have drifted, frankly, into deceiving people – on fees, on risks, on terms and conditions – as a primary source of profits. We don’t allow this kind of cheating in the non-financial sector and we shouldn’t allow it in finance either.

The unfortunate and indisputable truth is that our rule-making and law-enforcement agencies completely fell asleep prior to 2008 with regard to protecting borrowers and even depositors against predation. Even worse, since the financial crisis, the Securities and Exchange Commission, the Justice Department, and the Federal Reserve Board of Governors proved hard or near impossible to awake from this slumber.

We need simple, clear rules that ensure transparency and full disclosure in all financial transactions – and we need to enforce those rules. This is what was done with regard to securities markets after the debacle of the early 1930s. ...

The second proposal is to end the greatest cheat of all – the implicit subsidies received by the largest financial institutions, structured so as to encourage excessive and irresponsible risk-taking. These consequences of these subsidies have already caused massive macroeconomic damage – this is why our crisis in 2008-09 was so severe and the recovery so slow. Yet we have made painfully little progress towards really ending the problems associated with some very large financial firms – and their debts – being viewed by markets and policymakers as being too big to fail. ...

'Labor Market Regulation Does Not Hamper Long-Term Performance'

Speaking of "Gloomy European Economist" Francesco Saraceno' (see post below this one):

What Structural Reforms?, by Francesco Saraceno: I am ready to bet that the latest IMF World Economic Outlook ... will make a certain buzz for a box. It is box 3.5, at page 36 of chapter 3, which has been available on the website for a few days now. In that box, the IMF staff presents lack of evidence on the relationship between structural reforms and total factor productivity, the proxy for long term growth and competitiveness. (Interestingly enough people at the IMF tend to put their most controversial findings in boxes, as if they wanted to bind them).

What is certainly going to stir controversy is the finding that while long term growth is negatively affected by product market regulation, excessive labour market regulation does not hamper long term performance.

It is not the first time that the IMF surprises us with interesting analysis that goes against its own previous conventional wisdom. I will write more about this shortly. Here I just want to remark how these findings are relevant for our old continent.

The austerity imposed to embraced by eurozone crisis countries has taken the shape of expenditure cuts and labour market deregulation, whose magic effects on growth and competitiveness have been sold to reluctant and exhausted populations as the path to a bright future. I already noted, two years ago, that the short-run pain was slowly evolving into long-run pain as well, and that the gain of structural reforms was nowhere to be seen. The IMF tells us, today, that this was to be expected.

The guy who should be happy is Alexis Tsipras; he has been resisting since January pressure from his peers (and the Troika, that includes IMF staff!) to further curb labour market regulations, and recently presented a list of reforms that mostly pledges to reduce crony capitalism, tax evasion and product market rigidities. Exactly what the IMF shows to be effective in boosting growth. ...

This happens in Washington. Problem is, Greece, and Europe at large, seem to be light years away from the IMF research department. We already saw, for example with the mea culpa on multipliers, that IMF staff in program countries does not necessarily read what is written at home. Let’s see whether the discussion on Greece’s reforms will mark a realignment between the Fund’s research work and the prescriptions they implement/suggest/impose on the ground.

'The Mythic Quest for Early Warnings'

Cecchetti & Schoenholtz:

The mythic quest for early warnings: Economists and policymakers are on a quest. They are looking for the elixir that will protect their economies from financial crises. Their strategy is to find an indicator that provides an early warning of collapse, and then respond with preventative measures.

We think the approach of waiting for warnings is seriously flawed. The necessary information may never be in our grasp. And even if it were, our ability to respond rapidly and effectively is far from clear. Rather than treating the symptoms of illness after they start to develop, we believe the better strategy is early immunization: the more resilient the financial system, the less reliance we will have on faulty or nonexistent warnings.

To back up a bit, there are now an abundance of indices designed to measure financial system stress. ... [reviews work on scores of indicators] These findings are compelling. They tell us that forecasting systemic stress is extremely difficult and that ordinary financial market indicators efficiently summarize what information there is. ...

We do not mean to strike too harsh a tone. Having accurate measures of where we stand is extremely useful. ...

Will researchers eventually develop measures that tell us not just where we stand, but where we are going? Is the quest for early warning indicators destined to succeed? It’s possible that with more detailed data on what is going on in both financial institutions and financial markets that we will be able to anticipate big risks on the horizon. We hope so, but shouldn’t plan on it: there are important grounds for skepticism. ...

Where does this leave us?  Our answer is that we have yet another reason to be skeptical of time-varying, discretionary regulatory policy. In an earlier post, we noted that the combination of high information requirements, long transmission lags and significant political resistance made it unlikely time-varying capital requirements will be effective in reducing financial vulnerabilities. Our conclusion then, which we reiterate now, is that the solution is to build a financial system that is safe and resilient all of the time, since we really never know what is coming. That means a regulatory system based on economic function, not legal form, with sufficient capital buffers to guard against all but the very worst possibilities.

In the end, a financial system that relies on an early warning indicator of imminent financial collapse seems destined to fail.

I don't think we should stop trying to find indicators that would be useful to regulators (and neither do they), just because we haven't found them yet doesn't mean no such indicators exist -- they may. But I fully agree that regulation should be based upon the state of the art, and presently we haven't found reliable indicators of forthcoming problems in financial markets.

'The Real Cost of Coal'

David Hayes and James Stock:

The Real Cost of Coal, NY Times: Congress long ago established a basic principle governing the extraction of coal from public lands by private companies: American taxpayers should be paid fair value for it. They own the coal, after all.... Studies by the Government Accountability Office, the Interior Department’s inspector general and nonprofit research groups have all concluded that taxpayers are being shortchanged.

This is no small matter. In 2013, approximately 40 percent of all domestic coal came from federal lands. ... Headwaters Economics estimates that various reforms to the royalty valuation system would have generated $900 million to $5.6 billion more overall between 2008 and 2012.

This failure by the government to collect fair value for taxpayer coal is made more troubling by the climate-change implications of burning this fossil fuel. ... The price for taxpayer-owned coal should reflect, in some measure, the added costs associated with the impacts of greenhouse gas emissions. ...

Industry is sure to oppose this, even though coal is the planet’s most carbon-intensive energy source. Others will argue that an across-the-board carbon tax is a more efficient way to account for climate impacts. With no near-term prospects for such legislation, however, the Interior Department should set a royalty that provides fair value to taxpayers by addressing the climate costs of burning coal. ...

'We’re Frighteningly in the Dark About Student Debt'

Susan Dynarski:

We’re Frighteningly in the Dark About Student Debt, NY Times: ...The ... United States government ... has a portfolio of roughly $1 trillion in student loans, many of which appear to be troubled. The Education Department, which oversees the portfolio, is ... neither analyzing the portfolio adequately nor allowing other agencies to do so.

These loans are no trivial matter... Student loans are now the second-largest source of consumer debt in the United States, surpassed only by home mortgages. In a major reversal, they now constitute a larger portion of household debt than credit cards or car loans. ...

The frightening reality, however, is that we are remarkably ignorant about student debt..., we can’t quantify the risks that student debt places on individual households and the economy as a whole. ...

Over at the Federal Reserve and consumer bureau, as well as outside the government, highly trained analysts are eager for data. A sensible solution would be for the Education Department to put it in their hands and let them get to work.

An additional longer-term solution is to move the loan program out of the Education Department entirely — either into an existing agency that has the statistical expertise or a new student-loan authority. ...

An even better solution would be to stop saddling students with so much debt.

'Finance Is Great, But It Can Be A Real Drag, Too'

If the financial sector gets too big or grows too fast, it's bad for growth:

Finance is great, but it can be a real drag, too: When we were college students in the mid-1970s, some of our friends wanted to change the world and our understanding of it. They worked on things like galactic structures, superconductors, computer algorithms, subcellular mechanisms, and genetic coding. Their work aimed at providing cheap energy, improving information technology, curing cancer, and generally making our lives and our appreciation of the world around us better.

By the 1990s, attitudes had changed. Many top students, including newly-minted Ph.D.s, moved from natural science and engineering to finance. Their goal was to get high-paying jobs.

Would we be better off today if some of these financial wizards had focused instead on inventing more efficient solar cells or finding ways to forestall dementia?  The older we get, the more we think so (especially when it comes to dementia). And, believe it or not, there is now notable, cross-country evidence buttressing this view.

For the past few years, one of us (Steve) has been studying the relationship between economic growth and finance. The results are striking. They come in two categories. First, the financial system can get too big – to the point where it drags productivity growth down. And second, the financial system can grow too fast, diminishing its contribution to economic growth and welfare.

Just to get this on the record: we really like finance. Without efficient financial services, there would be no prosperous economies today. Intermediaries and financial markets both mobilize and channel savings to those who can use capital most productively; they also allocate risk to those persons who are most able to bear it. Despite its recently tarnished reputation, financial innovation greatly improves people’s lives (see here). As a result, when finance is properly harnessed, it makes economies more productive, enhancing employment and growth, and makes the world a better place.

So, we badly need efficient finance. But how much do we really need? And, should we be concerned if financial sector growth sharply outpaces the growth in the rest of the economy? ...

After answering these questions, explaining the results, and discussing how finance can lower growth, they conclude:

... Many observers (especially the largest financial intermediaries themselves) are critical of the increased regulation of the financial sector following the crisis of 2007-2009, arguing that it will slow economic growth. We, too, can think of some misdirected regulatory efforts that may diminish long-run efficiency without reducing systemic risk (see, for example, our take on raising the maximum loan-to-value ratio for mortgages to 97%).

But, we strongly support the authorities’ efforts to raise capital requirements in order to make the financial system safer. If anything, the research on finance and economic growth strengthens that view, suggesting that there will be little, if any, cost in terms of economic growth even if further increases in capital requirements were to lead to some shrinkage of the size of the financial sector in the advanced economies.

'Connections in the Modern World: Network-Based Insights'

Research on networks could be very helpful in determining when financial systems are under the type of stress that could lead to a major collapse:

Connections in the modern world: Network-based insights, by Matthew O. Jackson, Brian Rogers, and Yves Zenou, Vox EU: There have been 24 outbreaks of the Ebola virus since it first appeared in 1976. Most were limited to dozens of cases, or at most hundreds – but the 2014 outbreak reached tens of thousands (Global Alert and Response, World Health Organization 2014). Although this latest outbreak now appears to be contained, the world may have dodged a dangerous bullet. If the disease had gotten a toehold in one of the many large urban slums throughout the world, the toll could have been dramatically larger. The same year saw an outbreak of measles in the US unlike any in decades, as a combination of complacency and fears of side effects led to lapses in vaccinations that allowed for susceptibility to contagion. Indeed, even small percentages of unvaccinated people – especially children – can lead small seeds of a very virulent disease to snowball into widespread infection. 

The combination of world population growth and an increasingly interconnected society is producing new dynamics. Of course, deadly pandemics are not new. The Black Death (bubonic plague) wiped out tens of millions of people between the 14th and 19th centuries. Modern medicine and especially vaccinations have helped the world mitigate and even prevent many such catastrophes. But a changing world brings new challenges. Social distances between individuals currently average less than five degrees (Ugander et al. 2011) so that it is typically possible to go from one person via a friend to another friend, and another – and within five steps or so reach much of the rest of the world.

Historical data suggest that this closeness is indeed a modern phenomenon. For instance, using data from the spread of the bubonic plague, Marvel et al. (2013) estimate that in the Middle Ages average social distances between people were many times higher than they are today. The plague spread relatively slowly from one area to the next, taking four years to travel across Europe at a pace of less than a thousand kilometers per year, as people interacted mostly in limited local patterns. In contrast, modern travel means that a healthcare worker exposed to Ebola in a village in Sierra Leone can easily be in London or New York before showing symptoms. A child who catches measles in Anaheim, California can board a plane and bring it home thousands of miles away. Increased mobility combined with tightly clustered interactions (e.g. children in schools), mean that small pockets of vaccination lapses can generate heavy outbreaks. Limiting the terrible costs that can be imposed by contagious diseases including Ebola, measles, HIV, and many others, remains an important priority. What are the most effective ways to employ preventative measures, treatment for the ill, and barriers to contagion – including travel bans and the like? Properly addressing such questions requires understanding the complex networks of interactions that govern transmission, and a systematic framework for trading off the costs and benefits of policies. 

Disease is but one example of diffusion through connections. As we have seen recently, despite the advantages of modern financial systems they are susceptible to systemic failures – a downturn in one country can lead to cascading downturns in others. In the EU the largest 50 or so banking institutions are now highly connected, with interbank exposures exceeding one trillion euros, more than their total Tier 1 capital (Alves et al. 2013). While disease and financial contagion share certain similarities, they differ in fundamental respects. Financial contagion is less well studied and the challenge of how to ‘vaccinate’ an institution without slowing the economy is significant. How can we identify which institutions are really ‘too connected to fail’? Which financial institutions require regulation and how should regulatory policy be guided? Should financial integration be encouraged or discouraged? Again, answering these questions necessitates a network-based approach.

'Washington Strips New York Fed’s Power'

I wasn't aware of this, apparently for good reason:

Washington Strips New York Fed’s Power, by Jon Hilsenrath, WSJ: The Federal Reserve Bank of New York, once the most feared banking regulator on Wall Street, has lost power... The Fed’s center of regulatory authority is now a little-known committee run by Fed governor Daniel Tarullo , which is calling the shots in oversight of banking titans such as Goldman Sachs Group Inc. and Citigroup Inc .

The new structure was enshrined in a previously undisclosed paper written in 2010 known as the Triangle Document. ... The power shift, initiated after the financial crisis and slowly put in place over the past five years, is more than a bureaucratic change. ...

During internal debates on a range of issues ... New York Fed examiners have been challenged by Washington. At times they have been shut out of policy meetings and even openly disparaged by Mr. Tarullo for failing to stem problems at banks...

The Fed undertook the reorganization with little disclosure about what was taking place...

Officials in Washington say centralizing regulatory authority in D.C. gives the Fed a broader view of risks across the whole system and a more evenhanded oversight approach. ...

'Can Competition Fix Net Non-Neutrality?'

Joshua Gans:

Can competition fix net non-neutrality?: Short answer: it isn’t obvious that it can.

Let me back up a second and explain why I am revisiting this issue again. Tim Harford published an article a few days ago that took his masterful econsplaining skills to the issue of net neutrality. But in providing his characteristically clear exposition, he crystallised where many economists (including Tim) slip up on the issue of whether broadband competition would get rid of net non-neutrality and make net neutrality regulations redundant. ...

The problem here is that we believe that competition is designed to provide consumers with more of what they want. So if your claim is that they want fast and slow lanes to management network traffic, then moving from monopoly to competition won’t stop that from happening. It will likely enhance it even if, at the same time, it delivers lower prices to consumers. Indeed, in my own work (that just appeared in the Journal of Regulatory Economics), I found that it could be a vehicle for that even if net non-neutrality is not just about network management but something more sinister — like content provider hold-up.

The broader argument that I have made many times is that, in fact, solving the main problem with net non-neutrality — content provider hold-up — can be done with net neutrality while using less intrusive pricing schemes and product design to solve network management issues. In other words, I think we can have our cake and eat it too and net neutrality regulation is a good place to start.

On the issue of broadband competition, there is a political economy reason why net neutrality regulations might turn out to be bad for this: they now provide an excuse to allow things like the Comcast-Time Warner merger to proceed on the basis that net neutrality regulations curb a negative effect of that. My argument here is that I am far from convinced that the two things are related. However, I guess we will see if the political economy issues assist the merger’s regulatory chances. As Tim Harford noted, cable company stocks rose after last week’s announcement by the FCC so things are not looking too good on that front.

How Safe is the Financial System?

Part of an interview with Tim Geithner:

... The really important distinction to make in terms of both diagnosing the risks of a crisis and of thinking about how to respond is to try to determine when your system is vulnerable to a truly systemic disruption and when it is not. If there is a lot of dry tinder, you are more vulnerable and even a modest shock can risk tipping you over into a more systemic panic. You want to make your system resilient to such shocks. So, the most important thing is to ask yourself: where today do we face the kinds of vulnerabilities, the kinds of conditions – the dry tinder – that might make us more vulnerable to a more cataclysmic kind of shock that would be very damaging to the economy?

For systems to face that kind of threat you really need to have had a long boom in credit financed either through the banking system or through the financial system in ways that create a classic vulnerability to a run. That is, you need to have a set of long-dated assets that are illiquid, are vulnerable to a loss, and are funded short. We don’t face that sort of vulnerability in the financial system today. In many ways, the crisis is still too recent. The memory is too fresh for us to have had that long build up in borrowing through the banking system that makes you susceptible to systemic panic. Since the crisis, credit growth has been very modest while financial reforms have produced a system that is much better capitalized.

The one exception I would make to that general view is that Europe is vulnerable for different reasons to a kind of classic run or panic. They don’t have the institutions that would allow them to defend themselves credibly against such an event. For them to build that kind of arsenal (like what we eventually built in 2008-2009 to break a panic) they would have to do a whole range of things – creating institutions that aren’t in place today.

Beyond that, there is a familiar set of risks out there. But they are not risks on a scale like those that made the world vulnerable to a panic in 2008-2009. ...

We should probably remember that he has an incentive to say that the things he helped to do during the financial crisis have made the system safer today.

'Nominate A Qualified Undersecretary Of Domestic Finance Now'

This is from Simon Johnson (I didn't follow the debate over the qualifications of Antonio Weiss, the administration's nominee for Undersecretary for Domestic Finance, as closely as I should have, so I don't have much to say about that part of what is said below. But I very much agree with the need to find someone who will stand up for financial reform):

Nominate A Qualified Undersecretary Of Domestic Finance Now: The Obama administration urgently needs to nominate a qualified individual as Undersecretary for Domestic Finance at the Treasury Department. ...

The ... White House pushed hard for the confirmation of a Wall Street executive, Antonio Weiss, as Undersecretary for Domestic Finance. (In mid-January, in the face of continuing legitimate questions about his qualifications, Mr. Weiss withdrew himself from consideration. ...) ...

The House Republicans show every sign of doing what they can to help Citigroup, JP Morgan Chase, and others remove all effective restrictions on megabanks’ ability to take on large amounts of risk. The big banks want to return to the days of executives getting the upside when things go well and the taxpayer left holding the bag whenever disaster strikes.

The Treasury Department urgently needs to focus intellectual and administrative attention on the substance of defending Dodd-Frank, including shoring up support with Democrats, resisting the political onslaught led by House Republicans, and reaching out to senators of both parties who are willing to help. A key piece of becoming properly organized – intellectually and in terms of liaison with Congress – involves appointing a credible, qualified Undersecretary for Domestic Finance who hits the ground running and really knows what he or she is talking about. ...

Mr. Weiss’s principal problem was simple: he ... did not have the relevant general domain expertise and also lacked a sufficiently convincing grasp of the economic and political details surrounding financial regulation.

The search now should be quite straightforward. Find someone with relevant experience and a good track record – including statements and actions that are on the public record and that demonstrate willingness to challenge the megabanks’ worldview. ...

Nominating a credible Undersecretary for Domestic Finance quickly is an essential step towards helping the Treasury Department most effectively serve the American people – and towards preventing the collapse of financial reform.

Interview of Donald Kohn

From an interview of Donald Kohn by Cecchetti & Schoenholtz:

Interview: Donald Kohn: ... Where should we be looking now for financial stability risks given this experience?

Vice Chairman Kohn: The response of the authorities to the crisis has concentrated on banks, especially large banks, and other systemically important financial institutions, including insurance companies, investment banks, etc. I think those financial institutions that have been the target of the authorities’ attention are in much better shape, and I don’t think they constitute a risk to financial stability today. So I don’t think that what nearly brought the system down before, a Lehman Brothers kind of collapse, is currently a risk.

There could be mispriced bonds. People have pointed to junk bonds and dollar-denominated emerging market bonds and asked whether the risk in those bonds has been accurately valued by the market.  With regard to the consequences of a price adjustment, I would contrast the dot-com boom and bust with the housing boom and bust. The difference was the participation of intermediaries. Most price adjustments are fine. There could be quite a bit of volatility in the market as prices adjust. But I don’t see it having the same kind of risk characteristics that the subprime market had in the United States. ... I would look at ... the markets and the pricing of risks, including liquidity risks...

Also, I would look at what remains of the shadow banks. In the tri-party RP [repurchase] markets, the money markets funds and other cases, there have been some fixes. But I do think we need to be careful that – as we put more restrictions on banks and other systemically important institutions – if their activity migrates to other places, it doesn’t do so in a way that has systemic risk associated with it. I don’t see that today, but I think it’s something we have to be careful about in the future.

Tri-party repo (where we saw a run on the shadow banking system during the crisis, a vulnerability that still exists) is what worries me the most.

'Republican Assault on Dodd-Frank Act Intensifies'

Is anyone surprised?:

Republican assault on Dodd-Frank act intensifies, by Barney Jopson, FT: Republicans are intensifying an assault on the Dodd-Frank financial reform act in the second week of a new Congress...

Under attack in the House on Wednesday was part of the so-called Volcker rule, a provision of the reforms that limits bank risk taking.

Lawmakers voted 271-154 to delay from 2017 to 2019 a ban on banks holding securitised debt that has been packaged into collateralised loan obligations, with 29 Democrats supporting the postponement along with Republicans. ...

Because the Masters of the Universe need years and years to adjust to this change (Dodd-Frank was passed nearly *five* years ago). Or maybe they are simply hoping to delay and delay until they can get repeal? The president has said he will veto this if it also gets through the Senate, but they will likely try to attach it to other legislation to make a veto much harder.

I don't think the repeal of Glass-Steagall caused the financial crisis. But that doesn't mean the Volcker rule has no value, only costs. Repeal of Glass-Steagall sets up a vulnerability that could cause a crisis in the future, so it's worth fixing via the Volcker rule.

'Conflicts of Interest in Finance'

Cecchetti & Schoenholtz:

Conflicts of Interest in Finance: ...Financial corruption ... is ... widespread... The corruption exposed in recent years is breathtaking in its scale, scope, and resistance to remedy. We have seen traders collude to manipulate LIBOR ... and the foreign exchange (FX) market... We have seen firms facilitate tax evasion and money laundering. We have seen financial behemoths taking concentrated risks that undermine their capital and their funding, threatening the financial system as a whole until they are bailed out by public support. And we have witnessed what are arguably the largest Ponzi schemes in history (see our earlier post).

The policy response also has been wide-ranging. Congress enacted the most far-reaching financial reform since the 1930s. Regulators leaned on financial firms to diminish risk-taking incentives in their compensation schemes. Prosecutors, regulators and private litigants obtained ever-larger pecuniary settlements – the total since 2009 is now approaching $200 billion.

Previously frustrated by the “too big to jail” taboo (following the 2002 collapse of Arthur Andersen), in 2014 prosecutors again moved beyond simply seeking monetary settlement without admission of guilt and charged a bank with criminal behavior. They are also pursuing individual traders in the LIBOR and FX scandals in the criminal courts. Finally, leading regulators are openly warning the largest U.S. institutions that a failure to improve their ethical culture could lead policymakers to seek a dramatic downsizing of their firms to ensure financial stability.

So far, the most obvious response from the financial sector has been on the employment side: firms have hired or will hire thousands of compliance officers and risk managers to police the behavior of their employees (see here, here, and – if you have Wall Street Journal access – here).

We will be delighted if these reforms work to reduce corruption dramatically, but we remain skeptical. ... What to do? The only major alternatives we see are either to break up large institutions into smaller ones with restricted scope, to hold individuals more accountable, or some mix of both. ... Our preferred approach emphasizes a version of the second remedy: hold managers collectively more accountable for the actions of their firm. ...

One can hope that with their financial solvency really at stake, managers would become more aggressive in policing behavior inside of their organizations. Either that, or they will simply refuse to engage in activities where conflicts are most likely to arise. So much the better.

Unfortunately, there exists no panacea for containing conflicts of interest. ...

[I cut quite a bit from the original.]

Do Safer Banks Mean Less Economic Growth?

At MoneyWatch:

Do safer banks mean less economic growth?: One reason the financial crisis was so severe was that banks were highly leveraged. That is, they relied heavily on borrowed funds to acquire risky financial assets. This left them highly vulnerable when those assets' prices collapsed and the banks were unable to raise the funds they needed to pay off their loans.

In response, regulators have increased the capital requirements for banks. This limits the amount of leverage they can use and provides a safety buffer against losses. But banks protest that these more stringent capital requirements interfere with their ability to provide the financing the economy needs to function optimally, and hence this will slow economic growth.

However, recent research calls this into question. ...

Regulation of the Financial Industry

Is the financial industry is winning the war over regulation?:

Volcker lambasts Wall Street lobbying, FT: Paul Volcker, the former Federal Reserve chairman, has lambasted the "eternal lobbying" of Wall Street after regulators granted the industry more time to comply with a rule designed to prevent them from owning hedge funds.

In a withering statement ... Mr Volcker said: “It is striking, that the world's leading investment bankers, noted for their cleverness and agility in advising clients on how to restructure companies and even industries however complicated, apparently can't manage the orderly reorganization of their own activities in more than five years.”

“Or, do I understand that lobbying is eternal, and by 2017 or beyond, the expectation can be fostered that the law itself can be changed?”

The Fed and its fellow regulators this week gave the banks until 2017 to comply... Banks had been supposed to comply by next year. The law containing the Volcker rule was passed in 2010. ...

'Wall Street Salivating Over Further Destruction of Financial Reform'

Surprise! Or not (more concerned with this than whether the Fed changed a few words in its Press Release following the FOMC meeting):

Wall Street Salivating Over Further Destruction of Financial Reform, by Kevin Drum: Conventional pundit wisdom suggests that Wall Street may have overreached last week. Yes, they won their battle to repeal the swaps pushout requirement in Dodd-Frank, but in so doing they unleashed Elizabeth Warren and brought far more attention to their shenanigans than they bargained for. They may have won a battle, but ... they're unlikely to keep future efforts to weaken financial reform behind the scenes, where they might have a chance to pass with nobody the wiser.

Then again, maybe not. Maybe it was all just political theater and Wall Street lobbyists know better than to take it seriously. Ed Kilgore points to this article in The Hill today:

Banks and financial institutions are planning an aggressive push to dismantle parts of the Wall Street reform law when Republicans take control of Congress in January. ...

Will Democrats in the Senate manage to stick together and filibuster these efforts to weaken Dodd-Frank? ... I'd like to think that Elizabeth Warren has made unity more likely, but then again, I have an uneasy feeling that Wall Street lobbyists might have a better read on things than she does. Dodd-Frank has already been weakened substantially in the rulemaking process, and this could easily represent a further death by a thousand cuts. ...

Higher capital requirements: The jury is in

A follow up to this:

Higher capital requirements: The jury is in, by Stephen Cecchetti, Vox EU: Summary Regulators forced up capital requirements after the Global Crisis – triggering fears in the banking industry of dire effects. This column – by former BIS Chief Economist Steve Cecchetti – introduces a new CEPR Policy Insight that argues that the capital increases had little impact on anything but bank profitability. Lending spreads and interest margins are nearly unchanged, while credit growth remains robust everywhere but in Europe. Perhaps the requirements should be raised further. 

'Higher Capital Requirements Didn't Slow the Economy'

Cecchetti & Schoenholtz:

Higher capital requirements didn't slow the economy: During the debate over the 2010 Basel III regulatory reform, one of the biggest concerns was that higher capital requirements would damage economic growth. Pessimists argued that forcing banks to increase their capitalization would lower long-run growth permanently and that the transitional adjustment would impose an extra drag on the recovery from the Great Recession. Unsurprisingly, the private sector saw catastrophe, while the official sector was more positive.

The Institute of International Finance’s (IIF) 2010 report is the most sensational example of the former and the Macroeconomic Assessment Group (MAG) one of the most staid cases of the latter. The IIF concluded that banks would need to increase capital levels dramatically and that this would drive lending rates up, loan volumes down and result in an annual 0.6-percentage-point hit to GDP growth in the United States, the euro area and Japan. By contrast, the MAG reported that the implied increase in capital would drive lending rates up only modestly, loan volumes down a bit, and result in a decline in growth of only 0.05 percentage point per year for five years – one-twelfth the IIF’s estimate.

Four years on we can start to take stock, and our reading of the evidence is that the optimistic view was correct. Since the crisis, capital requirements and capital levels have both gone up substantially. Yet, outside the still-fragile euro area, lending spreads have barely moved, bank interest margins have fallen and loan volumes are up. To the extent that more demanding capital regulations had any macroeconomic impact, it would appear to have been offset by accommodative monetary policy. ...

[There is much, much more in the post.]

Paul Krugman: Wall Street’s Revenge

The battle over financial reform is far from over:

Wall Street’s Revenge, by Paul Krugman, Commentary, NY Times: On Wall Street, 2010 was the year of “Obama rage,” in which financial tycoons went ballistic over the president’s suggestion that some bankers helped cause the financial crisis. They were also, of course, angry about the Dodd-Frank financial reform, which placed some limits on their wheeling and dealing.

The Masters of the Universe, it turns out, are a bunch of whiners. But they’re whiners with war chests, and now they’ve bought themselves a Congress. ...

Wall Street overwhelmingly backed Mitt Romney in 2012, and invested heavily in Republicans once again this year. And the first payoff to that investment has already been realized. Last week Congress passed a ... rollback of one provision of the 2010 financial reform.

In itself, this rollback is significant but not a fatal blow to reform. But it’s utterly indefensible. ... One of the goals of financial reform was to stop banks from taking big risks with depositors’ money. ... If banks are free to gamble, they can play a game of heads we win, tails the taxpayers lose. ...

Dodd-Frank tried to limit this kind of moral hazard in various ways, including a rule barring insured institutions from dealing in exotic securities, the kind that played such a big role in the financial crisis. And that’s the rule that has just been rolled back. ...

What just went down isn’t about free-market economics; it’s pure crony capitalism. And sure enough, Citigroup literally wrote the deregulation language that was inserted into the funding bill.

Again, in itself last week’s action wasn’t decisive. But it was clearly the first skirmish in a war to roll back much if not all of the financial reform. And if you want to know who stands where in this coming war, follow the money: Wall Street is giving mainly to Republicans for a reason. ...

Meanwhile, it’s hard to find Republicans expressing major reservations about undoing reform. You sometimes hear claims that the Tea Party is as opposed to bailing out bankers as it is to aiding the poor, but there’s no sign that this alleged hostility to Wall Street is having any influence at all on Republican priorities.

So the people who brought the economy to its knees are seeking the chance to do it all over again. And they have powerful allies, who are doing all they can to make Wall Street’s dream come true.

'Citigroup Will Be Broken Up'

Simon Johnson:

Citigroup Will Be Broken Up: Citigroup is a very large bank that has amassed a huge amount of political power. Its current and former executives consistently push laws and regulations in the direction of allowing Citi and other megabanks to take on more risk, particularly in the form of complex highly leveraged bets. Taking these risks allows the executives and traders to get a lot of upside compensation in the form of bonuses when things go well – while the downside losses, when they materialize, become the taxpayer’s problem.

Citigroup is also, collectively, stupid on a grand scale. The supposedly smart people at the helm of Citi in the mid-2000s ran them hard around – and to the edge of bankruptcy. A series of unprecedented massive government bailouts was required in 2000-09 – and still the collateral damage to the economy has proved enormous. Give enough clever people the wrong incentives and they will destroy anything.

Now the supposedly brilliant people who run Citigroup have, in the space of a single working week, made a series of serious political blunders with long-lasting implications. Their greed has manifestly proved Elizabeth Warren exactly right about the excessive clout of Wall Street, their arrogance has greatly strengthened a growing left-center-right coalition concerned about the power of the megabanks, and their public exercise of raw power has helped this coalition understand what it needs focus on doing – break up Citigroup. ...

If we can't stop Citigroup from inserting changes to Dodd-Frank it desires into the "Cromnibus", then how, exactly -- with that sort of political influence -- does it get broken up?

'What is Congress Trying to Secretly Deregulate in Dodd-Frank?'

And so it begins:

What is Congress Trying to Secretly Deregulate in Dodd-Frank?, by Mike Konczal: There are concerns that the budget bill under debate in Congress will eliminate Section 716 of Dodd-Frank, using language previously drafted by Citigroup. So what is this all about?

Section 716 of Dodd-Frank says that institutions that receive federal insurance through FDIC and the Federal Reserve can’t be dealers in the specialized derivatives market. Banks must instead “push out” these dealers into separate subsidiaries that don’t benefit from the government backstop. They can still trade in many standardized derivatives and hedge their own risks, however. This was done because having banks act as swap dealers put taxpayers at risk in the event of a sudden collapse. That’s it.

Why would you want a regulation like this? The first is that it acts as a complement to the Volcker Rule. ...

A second reason is 716 will also prevent exotic derivatives from being subsidized by the government’s safety net. ...

The third reason is for the sake of financial stability. ...

Stiglitz reiterated this point today, saying “Section 716 facilitates the ability of markets to provide the kind of discipline without which a market economy cannot effectively function. I was concerned in 2010 that Congress would weaken 716, but what is proposed now is worse than anything contemplated back then.”

Now many on Wall Street would argue that this rule is unnecessary. However, their arguments are not persuasive. ...

We should be strengthening, not weakening, financial reform. And removing this piece of the law will not benefit this project.

See also Barney Frank Criticizes Planned Roll-Back of Namesake Financial Law.

'Maths and Morals, Economics and Greed'

Tim Johnson, "a mathematician who works on financial problems":

Maths and morals, economics and greed: ... Mathematics has always been part of finance but with the re-introduction of derivatives markets in the 1970s and their growth in the nineties, ‘quants’, trained in engineering, physics and mathematics, came to dominate the ‘casino banking’ that is widely criticised. My concern is that the quants are not amenable to questions of morality, and so the problems of finance are going to be difficult to resolve without finding the right way of communicating with the bankers who see themselves as scientists. ...

The Chartered Institute of Bankers are working on Professional Standards but are struggling to engage with the quants, who operate the casino branch of banking, because the quants believe science is value neutral; it delivers truths beyond morality. ...

This brings to mind Alasdair MacIntyre's ‘disquieting suggestion’ that modern society has completely lost the ability to make moral judgements and I see it as the brick wall that most attempts to reform banking will crash into.

I believe the brick wall can be dismantled relatively easily: by recognising that many of the practices of contemporary finance associated with ‘casino banking’ were widespread before the eighteenth century. Unlike today, they were undertaken in the context not of consequentialist or deontological ethics, but of virtue ethics that focuses on good practice. It might seem surprising that I suggest this is a relatively easy approach. What make it easy is that rather than criticising modern finance on the basis that it is degraded from a mythic golden age of finance, the starting point is the doux-commerce thesis that finance is civilising. Rather than characterising bankers as amoral spivs, they are presented as paragons of rational morality and the approach gives the bankers the opportunity to carry on their activities while, critically, reconstructing their own ethos.  I developed this representation in my paper Reciprocity as a Foundation of Financial Economics.

The hurdle this approach needs to cross is that of the dominant ideologies of markets. The market ideology holds that the market mechanism will deliver optimal solutions to society, while anti-market ideology argues that profits are degrading and markets are destructive. The hurdle can be crossed by ignoring both these ideologies and analysing the role that money and markets have played in forming both Western science and democracy. We need to represent markets as centres of communication and deliberation, not as competitive arenas driven by profit maximisation. The clue is in the word forum, which defined both the market place and the political centre of a Roman city.

As I noted after a speech by William Dudley on the same topic, I am not so sure this will work, but it's interesting how much of the recent commentary on the problems in financial markets are focused on changing the ethics of the financial industry. I'd rather focus on regulation and enforcement -- real regulation and real enforcement, not what we had before the financial crisis -- and more importantly putting circuit breakers in place that will limit the damage should problems reoccur, as they surely will at some point now matter how much we regulate or what ethical structure is in place (e.g. limits on leverage and interconnectedness).

'It's the Leverage, Stupid!'

Cecchetti & Schoenholtz

It's the leverage, stupid!: In the 30 months following the 2000 stock market peak, the S&P 500 fell by about 45%. Yet the U.S. recession that followed was brief and shallow. In the 21 months following the 2007 stock market peak, the equity market fell by a comparable 52%. This time was different: the recession that began in December 2007 was the deepest and longest since the 1930s.

The contrast between these two episodes of bursting asset price bubbles ought to make you wonder. When should we really worry about asset price bubbles? In fact, the biggest concern is not bubbles per se; it is leverage. And, surprisingly, there remain serious holes in our knowledge about who is leveraged and who is not. ...

All of this leads us to draw two simple conclusions. First, investors and regulators need to be on the lookout for leverage; that’s the biggest villain. In the United States and many other countries, mortgage borrowing has been at the heart of financial instability, and it may be so again in the future. But we should not be lulled into a sense of security just because banks’ real estate exposure has declined. If leverage starts rising in real estate or elsewhere – on or off balance sheet – then we should be paying attention.

'Will the Big Banks Ever Clean Up Their Act?'

I am not convinced that telling the kids to be good or else -- when there's a history of not doing much to enforce the request -- will work:

Will the big banks ever clean up their act?, by Mark Thoma: Federal Reserve Bank of New York President William Dudley delivered a stern warning to the largest banks in a speech earlier this week. Either clean up your illegal and unethical behavior through "cultural change" from within, he said, or be broken into smaller, more manageable pieces.

In his conclusion, the warning was direct and explicit:

"...if those of you here today as stewards of these large financial institutions do not do your part in pushing forcefully for change across the industry, then bad behavior will undoubtedly persist. If that were to occur, the inevitable conclusion will be reached that your firms are too big and complex to manage effectively. In that case, financial stability concerns would dictate that your firms need to be dramatically downsized and simplified so they can be managed effectively. It is up to you to address this cultural and ethical challenge."

How can the needed change be accomplished? ...

Will this work? Will large financial firms take the threat that they might be broken up seriously? Will they even bother to implement the many suggestions Dudley made?

Regulators have been reluctant to break up big banks in the past out of fear that it might undercut their ability to finance very large projects and hurt their competitiveness in international markets. And given that this behavior is so pervasive and has endured for so long, regulators haven't been as tough as they could be in stopping it.

Maybe this time is different. Maybe financial firms believe regulators are serious, and they will change the culture that has allowed these problems to exist. Perhaps the threat to break up the banks if they continue to prove they are "too big to manage" is real.

Let's hope so, because the financial instability that can occur when large banks behave unethically or when they fail to comply with existing regulations can be very costly for the nation's economy.

But, again, I doubt asking banks to change their culture will be enough, they will need to be persuaded through other, stronger means. (If it was up to me, I would have broken them into smaller pieces long ago. I do not beleive the minimum efficient scale is anywhere near as large as the largest banks, their political and economic power is too strong, and they pose a risk for the economy when they misbehave or make big mistakes. Smaller banks don't solve all these problems, there can still be widespread, cascading bank failures for example, but it does reduce the risks.)

'Shadow Banking: U.S. Risks Persist'

I've noted this several times in the past, but it's worth pointing out again. The problems in the shadow banking sector are still present for the most part. From Tim Taylor:

Shadow Banking: U.S. Risks Persist: ...A "shadow bank" is any financial institution that gets funds from customers and then in some way lends the money to borrowers. However, a shadow bank doesn't have deposit insurance. And while the shadow bank often faces some regulation, it typically falls well short of the detailed level of risk regulation that real banks face. In this post in May, I tried to explain how shadow banking works in more detail. Many of the financial institutions at the heart of the financial crisis were "shadow banks." ...

Five years past the end of the Great Recession, how vulnerable is the U.S. and the world economy to instability from shadow banking? ... The IMF devotes a chapter in its October 2014 Global Financial Stability Report to "Shadow Banking Around the Globe: How Large, and How Risky?" ...

It is discomforting to me to read that for the U.S., shadow banking risks are "slightly below precrisis levels." In general, the policy approach here is clear enough. As the IMF notes: "Overall, the continued expansion of finance outside the regulatory perimeter calls for a more encompassing approach to regulation and supervision that combines a focus on both activities and entities and places greater emphasis on systemic risk and improved transparency."

Easy for them to say! But when you dig down into the specifics of the shadow banking sector, not so easy to do. 

'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. ...

'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"?]

'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: ...

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?