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“Taking On Too Big To Fail”: Financial Reform Is About To Catch A Second Wind And Elizabeth Warren Is Ready To Ride It

Financial reformers seeking new rules beyond the range of the Dodd-Frank law haven’t had much to cheer about this year. The chances of Congress passing new regulations—OK, passing anything—look bleak, and the Obama Administration wants to simply finish implementing the last set of reforms. But reformers are playing a longer game, biding their time until the conditions are ripe for a dam burst. That could happen sooner than you think. High-profile champions for reform are gradually bending regulators to their will, and a pile-up of big bank abuses have eroded Wall Street’s reputation in Washington. Most importantly, a new report detailing the extraordinary largesse granted banks during the financial crisis, and questioning whether Dodd-Frank would prevent a rerun, could set off a fresh spark.

An unlikely bipartisan duo, Senators Sherrod Brown and David Vitter, have tried all year to focus attention in Congress on ending “too big to fail,” the perception that large financial institutions will inevitably receive government bailouts if they run into trouble. This allows banks to take on outsized risks with implicit government support, and receive a de facto subsidy, with lower borrowing costs than their smaller competitors, because investors believe a backstopped institution will always pay them back. Brown and Vitter introduced legislation earlier this year to significantly raise capital requirements, which they say will reduce reliance on bailouts by forcing banks to pay for their own losses.

Brown and Vitter commissioned a study from the Government Accountability Office (GAO) to quantify the public subsidy bestowed on banks, which could give them powerful evidence to rally support for their legislation. GAO released the first part of the study last week. It mostly looks backward at the “extraordinary support” given to banks from 2007-2009 to weather the financial crisis, and whether the Dodd-Frank financial reform law ended this tendency toward bailouts. The more controversial part of the study, on how much the government subsidizes big banks considered too big to fail, isn’t due until next year.

But the report still contains some explosive material. It details how banks received trillions of dollars in capital injections, emergency lending and debt guarantees during the financial crisis, offered with more favorable terms than they could have found in the private market, and secured by junk collateral that non-government lenders would never accept. Some debt guarantees given by government agencies to banks were up to 10 percent cheaper than private alternatives, saving the banks billions of dollars. Banks with over $50 billion in assets used the crisis-era programs nearly twice as much as their smaller counterparts. Outside of the broadly available emergency programs, JPMorgan Chase received a $30 billion loan from the New York Federal Reserve (then run by Timothy Geithner) for its purchase of Bear Stearns, and both Citigroup and Bank of America received special direct assistance of $20 billion each. According to a summary released by Brown and Vitter, those three banks, the U.S.’s largest, would have been insolvent without the government support provided during the crisis. Since the biggest banks are even bigger today (the report states that the nation’s four largest banks are $2 trillion larger than they were in 2007), it’s hard to believe that similar support wouldn’t be granted if needed.

Dodd-Frank’s architects claim the law would prevent future bailouts. At least some of the market is convinced it would; the rating agency Moody’s downgraded the debt of major U.S. banks last week, after determining they would not have the advantage of future government support in a crisis (it’s worth noting that rating agencies receive the majority of their funding through the structured finance deals of these same big banks). But the GAO report concludes that Dodd-Frank “implementation is incomplete and the effectiveness of some provisions remains uncertain.”

The best example of this is the Federal Reserve’s Section 13(3) authority, a primary vehicle for emergency lending during the crisis. Dodd-Frank prevents the Federal Reserve from using section 13(3) to assist an individual institution, restricts even broad-based 13(3) programs from lending to insolvent firms, and adds other requirements and limitations. But the Fed has not written any 13(3) regulations yet, nor has it set any time frames for doing so. GAO recommended that the Fed establish a timeline for drafting 13(3) procedures, and the board accepted that recommendation.

The report comes at an interesting moment. Readers of this magazine may have heard of a certain Massachusetts senator named Elizabeth Warren. She has also taken on too big to fail, as an antecedent to her agenda of building an economy that works for ordinary Americans, rather than using them as giant wealth-extraction machines. And Warren has something Brown and Vitter don’t—a national platform, with the ability to shape and transform the national debate. She has already used this power to provoke incremental changes, mostly because regulators would rather be on her side than in her crosshairs. Nobody is better positioned to put this new set of facts from the GAO to use than the Warren wing of the Democratic Party.

To see this attitude change in real time, simply review the Senate Banking Committee confirmation hearings for Janet Yellen, nominated to take over the chair of the Federal Reserve. In 2009, Ben Bernanke sought confirmation for the same position, and when he was questioned about the Fed’s failures in financial regulation before the crisis, he vociferously defended the institution’s actions. Yellen, right in her opening statement, added financial regulation to the Fed’s core responsibilities, along with full employment and price stability—a huge shift. During questioning from Warren, Yellen agreed that the Board of Governors should reinstate regular principals meetings on financial supervision for the first time in 20 years, instead of relegating the decision-making to the staff level.

 

By: David Dayen, The New Republic, November 21, 2013

November 25, 2013 Posted by | Big Banks, Financial Reform | , , , , , , , | 2 Comments

“Give Jobs A Chance”: To Err Is Human, But To Err On The Side Of Growth Is Wise

This week the Federal Reserve’s Open Market Committee — the group of men and women who set U.S. monetary policy — will be holding its sixth meeting of 2013. At the meeting’s end, the committee is widely expected to announce the so-called “taper” — a slowing of the pace at which it buys long-term assets.

Memo to the Fed: Please don’t do it. True, the arguments for a taper are neither crazy nor stupid, which makes them unusual for current U.S. policy debate. But if you think about the balance of risks, this is a bad time to be doing anything that looks like a tightening of monetary policy.

O.K., what are we talking about here? In normal times, the Fed tries to guide the economy by buying and selling short-term U.S. debt, which effectively lets it control short-term interest rates. Since 2008, however, short-term rates have been near zero, which means that they can’t go lower (since people would just hoard cash instead). Yet the economy has remained weak, so the Fed has tried to gain traction through unconventional measures — mainly by buying longer-term bonds, both U.S. government debt and bonds issued by federally sponsored home-lending agencies.

Now the Fed is talking about slowing the pace of these purchases, bringing them to a complete halt by sometime next year. Why?

One answer is the belief that these purchases — especially purchases of government debt — are, in the end, not very effective. There’s a fair bit of evidence in support of that belief, and for the view that the most effective thing the Fed can do is signal that it plans to keep short-term rates, which it really does control, low for a very long time.

Unfortunately, financial markets have clearly decided that the taper signals a general turn away from boosting the economy: expectations of future short-term rates have risen sharply since taper talk began, and so have crucial long-term rates, notably mortgage rates. In effect, by talking about tapering, the Fed has already tightened monetary policy quite a lot.

But is that such a bad thing? That’s where the second argument comes in: the suggestions that there really isn’t that much slack in the U.S. economy, that we aren’t that far from full employment. After all, the unemployment rate, which peaked at 10 percent in late 2009, is now down to 7.3 percent, and there are economists who believe that the U.S. economy might begin to “overheat,” to show signs of accelerating inflation, at an unemployment rate as high as 6.5 percent. Time for the Fed to take its foot off the gas pedal?

I’d say no, for a couple of reasons.

First, there’s less to that decline in unemployment than meets the eye. Unemployment hasn’t come down because a higher percentage of adults is employed; it’s come down almost entirely because a declining percentage of adults is participating in the labor force, either by working or by actively seeking work. And at least some of the Americans who dropped out of the labor force after 2007 will come back in as the economy improves, which means that we have more ground to make up than that unemployment number suggests.

How misleading is the unemployment number? That’s a hard one, on which reasonable people disagree. The question the Fed should be asking is, what is the balance of risks?

Suppose, on one side, that the Fed were to hold off on tightening, then learn that the economy was closer to full employment than it thought. What would happen? Well, inflation would rise, although probably only modestly. Would that be such a bad thing? Right now inflation is running below the Fed’s target of 2 percent, and many serious economists — including, for example, the chief economist of the International Monetary Fund — have argued for a higher target, say 4 percent. So the cost of tightening too late doesn’t look very high.

Suppose, on the other side, that the Fed were to tighten early, then learn that it had moved too soon. This could damage an already weak recovery, causing hundreds of billions if not trillions of dollars in economic damage, leaving hundreds of thousands if not millions of additional workers without jobs and inflicting long-term damage as more and more of the unemployed are perceived as unemployable.

The point is that while there is legitimate uncertainty about what the Fed should be doing, the costs of being too harsh vastly exceed the costs of being too lenient. To err is human; to err on the side of growth is wise.

I’d add that one of the prevailing economic policy sins of our time has been allowing hypothetical risks, like the fiscal crisis that never came, to trump concerns over economic damage happening in the here and now. I’d hate to see the Fed fall into that trap.

So my message is, don’t do it. Don’t taper, don’t tighten, until you can see the whites of inflation’s eyes. Give jobs a chance.

 

By: Paul Krugman, Op-Ed Columnist, The New York Times, September 15, 2013

September 17, 2013 Posted by | Economic Recovery, Economy | , , , , , , , | Leave a comment

“Defining Prosperity Down”: At This Point, It’s Clear That Monetary Hawkery Is Mainly A Form Of Puritanism

Friday’s employment report wasn’t bad. But given how depressed our economy remains, we really should be adding more than 300,000 jobs a month, not fewer than 200,000. As the Economic Policy Institute points out, we would need more than five years of job growth at this rate to get back to the level of unemployment that prevailed before the Great Recession. Full recovery still looks a very long way off. And I’m beginning to worry that it may never happen.

Ask yourself the hard question: What, exactly, will bring us back to full employment?

We certainly can’t count on fiscal policy. The austerity gang may have experienced a stunning defeat in the intellectual debate, but stimulus is still a dirty word, and no deliberate job-creation program is likely soon, or ever.

Aggressive monetary action by the Federal Reserve, something like what the Bank of Japan is now trying, might do the trick. But far from becoming more aggressive, the Fed is talking about “tapering” its efforts. This talk has already done real damage; more on that in a minute.

Still, even if we don’t and won’t have a job-creation policy, can’t we count on the natural recuperative powers of the private sector? Maybe not.

It’s true that after a protracted slump, the private sector usually does find reasons to start spending again. Investment in equipment and software is already well above pre-recession levels, basically because technology marches on, and businesses must spend to keep up. After six years during which hardly any new homes were built in America, housing is trying to stage a comeback. So yes, the economy is showing some signs of healing itself.

But that healing process won’t go very far if policy makers stomp on it, in particular by raising interest rates. That’s not an idle worry. A Fed chairman famously declared that his job was to take away the punch bowl just as the party was really warming up; unfortunately, history offers many examples of central bankers pulling away the punch bowl before the party even starts.

And financial markets are, in effect, betting that the Fed is going to offer another such example. Long-term interest rates, which mainly reflect expectations about future short-term rates, shot up after Friday’s job report — a report that, to repeat, was at best just O.K. Housing may be trying to bounce back, but that bounce now has to contend with sharply rising financing costs: 30-year mortgage rates have risen by a third since the Fed started talking about relaxing its efforts about two months ago.

Why is this happening? Part of the reason is that the Fed is constantly under pressure from monetary hawks, who always want to see tighter money and higher interest rates. These hawks spent years warning that soaring inflation was just around the corner. They were wrong, of course, but rather than change their position they have simply invented new reasons — financial stability, whatever — to advocate higher rates. At this point it’s clear that monetary hawkery is mainly a form of Puritanism in H. L. Mencken’s sense — “the haunting fear that someone, somewhere may be happy.” But it remains dangerously influential.

Unfortunately, there’s also a technical issue that plays into the prejudices of the monetary hawks. The statistical techniques policy makers often use to estimate the economy’s “potential” — the maximum level of output and employment it can achieve without inflationary overheating — turn out to be badly flawed: they interpret any sustained economic slump as a decline in potential, so that the hawks can point to charts and spreadsheets supposedly showing that there’s not much room for growth.

In short, there’s a real risk that bad policy will choke off our already inadequate recovery.

But won’t voters eventually demand more? Well, that’s where I get especially pessimistic.

You might think that a persistently poor economy — an economy in which millions of people who could and should be productively employed are jobless, and in many cases have been without work for a very long time — would eventually spark public outrage. But the political science evidence on economics and elections is unambiguous: what matters is the rate of change, not the level.

Put it this way: If unemployment rises from 6 to 7 percent during an election year, the incumbent will probably lose. But if it stays flat at 8 percent through the incumbent’s whole term, he or she will probably be returned to power. And this means that there’s remarkably little political pressure to end our continuing, if low-grade, depression.

Someday, I suppose, something will turn up that finally gets us back to full employment. But I can’t help recalling that the last time we were in this kind of situation, the thing that eventually turned up was World War II.

 

By: Paul Krugman, Op-Ed Columnist, The New York Times, July 7, 2013

July 8, 2013 Posted by | Economic Recovery, Economy | , , , , , , | Leave a comment

“The Big Shrug”: A Combination Of Complacency And Fatalism By Fiscal Policy Makers That Nothing Need Be Done Or Can Be Done

I’ve been in this economics business for a while. In fact, I’ve been in it so long I still remember what people considered normal in those long-ago days before the financial crisis. Normal, back then, meant an economy adding a million or more jobs each year, enough to keep up with the growth in the working-age population. Normal meant an unemployment rate not much above 5 percent, except for brief recessions. And while there was always some unemployment, normal meant very few people out of work for extended periods.

So how, in those long-ago days, would we have reacted to Friday’s news that the number of Americans with jobs is still down two million from six years ago, that 7.6 percent of the work force is unemployed (with many more underemployed or forced to take low-paying jobs), and that more than four million of the unemployed have been out of work for more than six months? Well, we know how most political insiders reacted: they called it a pretty good jobs report. In fact, some are even celebrating the report as “proof” that the budget sequester isn’t doing any harm.

In other words, our policy discourse is still a long way from where it ought to be.

For more than three years some of us have fought the policy elite’s damaging obsession with budget deficits, an obsession that led governments to cut investment when they should have been raising it, to destroy jobs when job creation should have been their priority. That fight seems largely won — in fact, I don’t think I’ve ever seen anything quite like the sudden intellectual collapse of austerity economics as a policy doctrine.

But while insiders no longer seem determined to worry about the wrong things, that’s not enough; they also need to start worrying about the right things — namely, the plight of the jobless and the immense continuing waste from a depressed economy. And that’s not happening. Instead, policy makers both here and in Europe seem gripped by a combination of complacency and fatalism, a sense that nothing need be done and nothing can be done. Call it the big shrug.

Even the people I consider the good guys, policy makers who have in the past shown real concern over our economic weakness, aren’t showing much sense of urgency these days. For example, last fall some of us were greatly encouraged by the Federal Reserve’s announcement that it was instituting new measures to bolster the economy. Policy specifics aside, the Fed seemed to be signaling its willingness to do whatever it took to get unemployment down. Lately, however, what one mostly hears from the Fed is talk of “tapering,” of letting up on its efforts, even though inflation is below target, the employment situation is still terrible and the pace of improvement is glacial at best.

And Fed officials are, as I said, the good guys. Sometimes it seems as if nobody in Washington outside the Fed even considers high unemployment a problem.

Why isn’t reducing unemployment a major policy priority? One answer may be that inertia is a powerful force, and it’s hard to get policy changes absent the threat of disaster. As long as we’re adding jobs, not losing them, and unemployment is basically stable or falling, not rising, policy makers don’t feel any urgent need to act.

Another answer is that the unemployed don’t have much of a political voice. Profits are sky-high, stocks are up, so things are O.K. for the people who matter, right?

A third answer is that while we aren’t hearing so much these days from the self-styled deficit hawks, the monetary hawks — economists, politicians and officials who keep warning that low interest rates will have dire consequences — have, if anything, gotten even more vociferous. It doesn’t seem to matter that the monetary hawks, like the fiscal hawks, have an impressive record of being wrong about everything (where’s that runaway inflation they promised?). They just keep coming back; the arguments change (now they’re warning about asset bubbles), but the policy demand — tighter money and higher interest rates — is always the same. And it’s hard to escape the sense that the Fed is being intimidated into inaction.

The tragedy is that it’s all unnecessary. Yes, you hear talk about a “new normal” of much higher unemployment, but all the reasons given for this alleged new normal, such as the supposed mismatch between workers’ skills and the demands of the modern economy, fall apart when subjected to careful scrutiny. If Washington would reverse its destructive budget cuts, if the Fed would show the “Rooseveltian resolve” that Ben Bernanke demanded of Japanese officials back when he was an independent economist, we would quickly discover that there’s nothing normal or necessary about mass long-term unemployment.

So here’s my message to policy makers: Where we are is not O.K. Stop shrugging, and do your jobs.

By: Paul Krugman, Op-Ed Columnist, The New York Times, June 9, 2013

June 10, 2013 Posted by | Economy, Jobs | , , , , , , , | 1 Comment

“Why We Regulate”: The Arrogance Of Wall Street And The Lessons Of History

One of the characters in the classic 1939 film “Stagecoach” is a banker named Gatewood who lectures his captive audience on the evils of big government, especially bank regulation — “As if we bankers don’t know how to run our own banks!” he exclaims. As the film progresses, we learn that Gatewood is in fact skipping town with a satchel full of embezzled cash.

As far as we know, Jamie Dimon, the chairman and C.E.O. of JPMorgan Chase, isn’t planning anything similar. He has, however, been fond of giving Gatewood-like speeches about how he and his colleagues know what they’re doing, and don’t need the government looking over their shoulders. So there’s a large heap of poetic justice — and a major policy lesson — in JPMorgan’s shock announcement that it somehow managed to lose $2 billion in a failed bit of financial wheeling-dealing.

Just to be clear, businessmen are human — although the lords of finance have a tendency to forget that — and they make money-losing mistakes all the time. That in itself is no reason for the government to get involved. But banks are special, because the risks they take are borne, in large part, by taxpayers and the economy as a whole. And what JPMorgan has just demonstrated is that even supposedly smart bankers must be sharply limited in the kinds of risk they’re allowed to take on.

Why, exactly, are banks special? Because history tells us that banking is and always has been subject to occasional destructive “panics,” which can wreak havoc with the economy as a whole. Current right-wing mythology has it that bad banking is always the result of government intervention, whether from the Federal Reserve or meddling liberals in Congress. In fact, however, Gilded Age America — a land with minimal government and no Fed — was subject to panics roughly once every six years. And some of these panics inflicted major economic losses.

So what can be done? In the 1930s, after the mother of all banking panics, we arrived at a workable solution, involving both guarantees and oversight. On one side, the scope for panic was limited via government-backed deposit insurance; on the other, banks were subject to regulations intended to keep them from abusing the privileged status they derived from deposit insurance, which is in effect a government guarantee of their debts. Most notably, banks with government-guaranteed deposits weren’t allowed to engage in the often risky speculation characteristic of investment banks like Lehman Brothers.

This system gave us half a century of relative financial stability. Eventually, however, the lessons of history were forgotten. New forms of banking without government guarantees proliferated, while both conventional and newfangled banks were allowed to take on ever-greater risks. Sure enough, we eventually suffered the 21st-century version of a Gilded Age banking panic, with terrible consequences.

It’s clear, then, that we need to restore the sorts of safeguards that gave us a couple of generations without major banking panics. It’s clear, that is, to everyone except bankers and the politicians they bankroll — for now that they have been bailed out, the bankers would of course like to go back to business as usual. Did I mention that Wall Street is giving vast sums to Mitt Romney, who has promised to repeal recent financial reforms?

Enter Mr. Dimon. JPMorgan, to its — and his — credit, managed to avoid many of the bad investments that brought other banks to their knees. This apparent demonstration of prudence has made Mr. Dimon the point man in Wall Street’s fight to delay, water down and/or repeal financial reform. He has been particularly vocal in his opposition to the so-called Volcker Rule, which would prevent banks with government-guaranteed deposits from engaging in “proprietary trading,” basically speculating with depositors’ money. Just trust us, the JPMorgan chief has in effect been saying; everything’s under control.

Apparently not.

What did JPMorgan actually do? As far as we can tell, it used the market for derivatives — complex financial instruments — to make a huge bet on the safety of corporate debt, something like the bets that the insurer A.I.G. made on housing debt a few years ago. The key point is not that the bet went bad; it is that institutions playing a key role in the financial system have no business making such bets, least of all when those institutions are backed by taxpayer guarantees.

For the moment Mr. Dimon seems chastened, even admitting that maybe the proponents of stronger regulation have a point. It probably won’t last; I expect Wall Street to be back to its usual arrogance within weeks if not days.

But the truth is that we’ve just seen an object demonstration of why Wall Street does, in fact, need to be regulated. Thank you, Mr. Dimon.

 

By: Paul Krugman, Op-Ed Columnist, The New York Times, May 13, 2012

May 16, 2012 Posted by | Financial Crisis | , , , , , , , , | Leave a comment

   

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