Tag: finance

Osborne Risks a Triple-Dip for the UK

U.K. Chancellor of the Exchequer George Osborne has resumed his saber-rattling over raising capital requirements for British banks. Most recently, Osborne has fixated on alleged problems with banks’ risk-weighting metrics that, according to him, have left banks undercapitalized. Regardless of Osborne’s rationale, this is just the latest wave in a five-year assault on the U.K. banking system – one which has had disastrous effects on the country’s money supply. The initial rounds of capital hikes took their toll on the British economy – in the form of a double-dip recession. Now, Osborne appears poised to light the fuse on a triple-dip recession.

Even before the Conservative, Osborne, took the reins of Her Majesty’s Treasury, hiking capital requirements on banks was in vogue among British regulators. Indeed, it was under Gordon Brown’s Labour government, in late 2007, that this wrong-headed idea took off.

In the aftermath of his government’s bungling of the Northern Rock crisis, Gordon Brown – along with his fellow members of the political chattering classes in the U.K. – turned his crosshairs on the banks, touting “recapitalization” as the only way to make banks “safer” and prevent future bailouts.

It turns out that Mr. Brown attracted many like-minded souls, including the central bankers who endorsed Basel III, which mandates higher capital-asset ratios for banks. In response to Basel III, banks have shrunk their loan books and dramatically increased their cash and government securities positions, which are viewed under Basel as “risk-free,” requiring no capital backing. By contrast, loans, mortgages, etc. are “risk-weighted” – meaning banks are required by law to back them with capital. This makes risk-weighted assets more “expensive” for a bank to hold on its balance sheet, giving banks an incentive to lend less as capital requirements are increased. 

Five years later, Osborne is attempting to ratchet up the weights on these assets. Indeed, he is taking another whack at banks’ balance sheets – and the result will be the same as when the U.K. Financial Services Authority first took aim at the banking system (under Gordon Brown). As the accompanying chart shows, the first round of capital requirement hikes (in 2008) dealt a devastating blow to the U.K. money supply. Indeed, it tightened the noose on the supply of bank money – the portion of the total money supply produced by the banking system, through deposit creation.

Not surprisingly, this sent the British economy spiraling into its first recessionary dip. The second hit to the money supply came shortly after the Bank for International Settlements announced the imposition of capital hikes under the Basel III accords, in October 2010. Despite numerous infusions of state money (reserve money) via the Bank of England’s quantitative easing schemes, these first two squeezes on bank money have put the squeeze on the U.K.’s total money supply.

This is the case because state money makes up only 16.3% of the U.K.’s total money supply. The remaining 83.7% of the money supply is made up of bank money. In consequence, the Bank of England would have to undertake a massive expansion of state money, via quantitative easing, to offset the U.K.’s bank money squeeze.

It is doubtful, however, that the British pound sterling would be able to withstand such a move. Indeed, there are more storm clouds brewing over Threadneedle Street. The sterling recently touched a 15-month low against the euro, and it has fallen 8% against the euro since late July. For the time being, at least, the pound’s tenuous position will likely put a constraint on any further significant expansion of state money, through quantitative easing. It appears markets simply wouldn’t tolerate it.

Accordingly, the only viable option to jumpstart the faltering U.K. economy is to release the banking system from the grips of the government-imposed bank-money squeeze. Alas, Osborne’s most recent initiative on bank recapitalization goes in exactly the wrong direction.

Congressional Insider Trading: Is It Legal?

Washington has been buzzing for the past 48 hours over revelations that some of Capitol Hill’s best-known lawmakers have been making fortunes speculating in the stocks of companies affected by official actions, typically while in possession of market-moving inside information. Rep. John Boehner (R-OH), Senatorial wife Teresa Kerry and others made bundles trading in health companies’ stocks shortly before Congressional or executive-branch action affecting the companies’ fortunes. After closed-door 2008 meetings in which Fed chairman Ben Bernanke briefed Congress on the gravity of the financial collapse, some lawmakers dumped their own stockholdings or even placed bets that the market would fall. Rep. Nancy Pelosi (D-CA) got access to highly desirable IPO (initial public offering) stock placements, some in companies with business before Congress. And so on. Studies have found that lawmakers as a group reap far above-average returns on their investments—suggesting either that these politicians are among the world’s cleverest investors, or else that they are profiting from inside information. All this has been turned into a front-page issue thanks to Throw Them All Out, a book by Hoover fellow Peter Schweizer, whose findings were showcased the other night on 60 Minutes.

So the question is: is all this legal? While there’s some difference of opinion on the issue among law professors, the proper answer to that question is most likely going to be, “Yes, it’s legal.” As UCLA’s Stephen Bainbridge points out, existing insider trading law, developed by way of a long series of contested cases under the Securities and Exchange Commission’s Rule 10b-5, assigns liability to persons who are not corporate insiders if they are violating a recognized duty of loyalty to those for whom they work. As applied to the investment whizzes of the Hill, this implies that trading on inside information might be a violation if done by Congressional staffers (since they owe a duty of loyalty to higher-ups) but not when done by members of Congress themselves.

It is tempting to approach the new revelations the way an ambitious prosecutor might, trying to stitch together a test-case indictment from, say, the penumbra of the mail and wire fraud statutes bulked up with a bit of newly hypothesized fiduciary duty here and a little “honest services” there. But that’s not how criminal law is supposed to work: for the sake of all of our liberties, prohibited behavior needs to be clearly marked out as prohibited in advance, not afterward once we realize it doesn’t pass a smell test. But we are still free to deplore the hypocrisy of a Congress that has long been content to criminalize for the private sector—often with stiff jail sentences—behavior not much different from what lawmakers are happy to engage in themselves.

Do We Need China to Fund Our Mortgage Market?

Earlier this week I repeatedly heard the claim that if the federal government does not guarantee credit risk in the mortgage market, foreigners won’t buy U.S. mortgage-related debt.  Before we test whether that claim is true, let’s first determine just how important are foreign investors in the U.S. mortgage market.

For the most part, foreign investors do not hold U.S. mortgages directly, but either hold Fannie and Freddie debt and mortgage-backed securities (MBS) or hold private-label MBS.  As the private-label securities lack a government guarantee, we can ignore that segment of the market.  The chart below depicts the percentage share of foreign ownership of these securities in recent years:

The chart illustrates that, at times (particularly around the peak of the recent housing bubble), foreign investors have been large providers of capital to the GSEs.  In 2007, over 20% of GSE debt was held outside the United States, double the percentage from only a few years earlier.  The increase was driven almost exclusively by purchases by foreign governments (mostly central banks for the purpose of currency manipulation).  In 2007, this amounted to just over $1.5 trillion. 

However, if we went back and looked at a year prior to the super-heated housing market — say 2003 — then this total is about $650 billion.  Given that U.S. commercial banks now have about $1 trillion in cash sitting on their balance sheets, it appears that domestic sources could completely fund the U.S. mortgage market without any foreign funds.

But let’s say we want to keep the option of living beyond our means and have the rest of the world fund a large part of our mortgage market.  Would they?  Given that foreign investors currently hold over $5.4 trillion in U.S. corporate bonds and equities (not all guaranteed by the U.S. taxpayer), I think it’s fair to assume that these foreign investors have some appetite for U.S.  assets. 

Now does that mean foreigners would buy the debt of massively leveraged, mismanaged mortgage companies subject to constant political-cronyism, without some guarantee?  Probably not.  But then, it strikes me that a better way to attract foreign investment into the U.S. mortgage market is to deal with those issues, rather than paper over those problems with a taxpayer-funded guarantee. 

It is also worth noting that when we most needed foreign support for the U.S. mortgage market, in 2008, foreign investors were dumping Fannie and Freddie debt in significant amounts.  And obviously I think we’d prefer that the Chinese Central Bank stop using the purchase of Fannie and Freddie debt to depress the value of their own currency.

Federal Government Is a Lucrative ‘Industry’

The Bureau of Economic Analysis latest release of industry compensation levels shows that the average federal worker ranks up at the top along with employees in the finance and energy industries. That’s not exactly popular company these days.

The BEA presents compensation data for 72 industries that span the U.S. economy. Figure 1 shows the 20 industries with the highest levels of average compensation, which includes wages and benefits. It also shows the average for all U.S. private industries and the average for the industry with the lowest compensation. (The names of the industries have been simplified in some cases).

Federal civilian workers have the sixth highest average compensation of the 72 industries:

As yesterday’s post showed, federal employee compensation has exploded over the course of the decade. Figure 2 shows that this federal employee compensation growth has been the fifth highest of the 72 industries measured by the BEA: