Tag: banks

The Audacity of Hypocrisy

By
Edward H. Crane

In his ongoing effort to micromanage the U.S. economy President Obama used his Dec. 12 weekly radio address to promote his proposed Consumer Financial Protection Agency.  It will be filled with bureaucrats second-guessing entrepreneurs and is sure to improve the performance of our financial institutions – much in the manner of the SEC’s bureaucrats alertly nailing Bernie Madoff just 30 years into his Ponzi scheme.  Never mind that the federal government had much more to do with the financial meltdown than the banks did, the real knee-slapper in his address was his claim that the CFPA “would bring new transparency and accountability to the financial markets…” This, from a man demanding passage of a 2000-page health care reform bill that no one, including Mr. Obama, has read.  So much for transparency and accountability.

Topics: 
Finance, Banking & Monetary Policy, Government and Politics

Volcker Unloads on Bankers

By
Gerald P. O'Driscoll Jr.

As reported in today’s Wall Street Journal, Paul Volcker, who is a former Fed Chairman and current adviser to President Obama, challenged bankers to produce a “shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy.”  Yet some of these innovative financial products brought the economy to “the brink of disaster.”   Profits in banking are being restored in part by playing financial brinkmanship once again.

How can this be?  Volcker focuses in on public policies that back excessive risk taking by bankers.  They and their stockholders garner the profits, but, through bailouts and government guarantees, manage to socialize the losses. That process is what economists call moral hazard.

He questions whether improved regulation can resolve the problems without serious structural change.  He repeats his longstanding policy of separating traditional commercial banking from what has been aptly termed casino banking. Casino banks must not be protected by the government.

Here is my suggestion for a start.  Hedge funds can serve a very useful function in the economy. But banks taking insured deposits should not be permitted to operate hedge funds in their institutions.  Most proprietary trading by banks amounts to an in-house hedge fund.  Separate the activity from banking.

Topics: 
Finance, Banking & Monetary Policy

The Cost of Government Guarantees

By
Jagadeesh Gokhale

John Kay’s column in yesterday’s Financial Times criticizes government guarantees to banks because they involve hidden but large costs. According to Kay:

  • Such guarantees distort competition: sheltered banks outperform rivals not because of greater efficiency, but because capital becomes cheaper to obtain.
  • Sheltered banks gain too-big-to-fail status, which creates barriers to entry for smaller, more efficient banks.
  • Relief from business risk leads to more risk taking, AKA moral hazard.
  • Cheaper private risk management incentives are reduced within and outside the bank.

Other kinds of government guarantees, such as social insurance, also involve large hidden costs. Social Security and Medicare’s guarantee of a paid holiday with medical care for the rest of retirees’ lives generates the same types of costs:

  • Labor competition is reduced because the programs induce early worker retirements, which leads to higher wage costs, on average, and lower national output.
  • Workers who believe they will receive Social Security and Medicare will engage in lower personal saving, which means less capital formation and lower economic efficiency.
  • Retirement income guarantees induce riskier personal savings portfolios, AKA moral hazard.
  • Guaranteed retirement income means poorer financial knowledge and poorer risk management.

And now, retiree political power is too big to fail as well!

How come when Kay writes about market distortions from government guarantees for banks, he gets published; but when I do the same about government guarantees for people, I get the cold shoulder from editorial page editors?

Topics: 
Finance, Banking & Monetary Policy, Government and Politics, Health Care

Tuesday Links

  • Twenty inaccurate claims in Obama’s speech to Congress on health care. “If [members of Congress] yelled out every time President Obama said something untrue about health care, they would quickly find themselves growing hoarse.”
  • Political tensions decreasing between Taiwan and China.
  • How Americans misunderstand war: “America’s biggest mistake in Afghanistan and Iraq was to think its modern military would make winning easy.”
  • Always read the fine print: There is a dangerous provision in the Senate Finance Committee’s health care bill that could deny crucial health treatments for Medicare patients.
Topics: 
Cato Publications, General

Taking Over Everything

By
David Boaz

“My critics say that I’m taking over every sector of the economy,” President Obama sighed to George Stephanopoulos during his Sunday media blitz.

Not every sector. Just

This president and his Ivy League advisers believe that they know how an economy should develop better than hundreds of millions of market participants spending their own money every day. That is what F. A. Hayek called the “fatal conceit,” the idea that smart people can design a real economy on the basis of their abstract ideas.

This is not quite socialism. In most of these cases, President Obama doesn’t propose to actually nationalize the means of production. (In the case of the automobile companies, he clearly did.) He just wants to use government money and government regulations to extend political control over all these sectors of the economy. And the more political control achieves, the more we can expect political favoritism, corruption, uneconomic decisions, and slower economic growth.

Topics: 
Finance, Banking & Monetary Policy, Tax and Budget Policy

The Legacy of TARP: Crony Capitalism

By
Jeffrey A. Miron

When Treasury Secretary Hank Paul proposed the bailout of Wall Street banks last September, I objected in part because the TARP meant that government connections, not economic merit, would come to determine how capital gets allocated in the economy. That prediction now looks dead on:

As financial firms navigate a life more closely connected to government aid and oversight than ever before, they increasingly turn to Washington, closing a chasm that was previously far greater than the 228 miles separating the nation’s political and financial capitals.

In the year since the investment bank Lehman Brothers collapsed, paralyzing global markets and triggering one of the biggest government forays into the economy in U.S. history, Wall Street has looked south to forge new business strategies, hew to new federal policies and find new talent.

“In the old days, Washington was refereeing from the sideline,” said Mohamed A. el-Erian, chief executive officer of Pimco. “In the new world we’re going toward, not only is Washington refereeing from the field, but it is also in some respects a player as well… . And that changes the dynamics significantly.”

Read the rest of the article; it is truly frightening. We have taken a huge leap toward crony capitalism, to our peril.

Topics: 
Finance, Banking & Monetary Policy, Government and Politics

For Financial Stability, Fix the Tax Code

By
Mark A. Calabria

There seems to be near universal agreement that the excessive use of debt among both corporations, particularly banks, and households contributed to the severity of the financial crisis.  However, other than the occasional refrain that banks should hold more capital, there has been little discussion over why corporations choose to be so highly leveraged in the first place.  But then such a discussion might lead us to the all too obvious answer – the federal government, via the tax code, encourages, even heavily subsidizes corporate leverage.

Cato scholar and banking analyst Bert Ely has estimated that the subsides for debt have historically resulted in an after tax cost of debt of 3 to 5 percent, compared to an after tax cost of equity of 12 to 15 percent.  With differences of this magnitude, it should not be surprising that financial companies and corporations in general become highly leveraged.

For corporations, this massive difference in cost between debt and equity financing results primary from the ability to deduct interest expenses on debt, while punishing equity due to the double-taxation of dividends along with taxing capital gains. 

If we are going to use the tax code to subsidize debt and tax equity, we shouldn’t act surprised when firms load up on the debt and reduce their use of equity – making financial crises all too frequent and severe.

Topics: 
Finance, Banking & Monetary Policy

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