Tag: financial crisis

Two Cheers for the U.S. Economy

Two articles in today’s Wall Street Journal deal with the housing sector.  They complement each other. Journal reporters note that “Industry Speeds Recovery, And Housing Slows It Down.”  The story notes that that “ground-breaking for new homes and applications for building permits both plunged last month.”  Meanwhile, U.S. industrial output showed strong growth in May.

Bravo for both numbers, which are inter-related.  The headline (over which reporters have no control) reflects conceptual confusion.  U.S. industrial production is strong at least in part because construction of new homes is weak.   The bloated home sector is no longer absorbing a disproportionate share of economic resources.  The new homeowners tax credit has mercifully expired, ending that bit of misguided stimulus.

David Wessel’s article, “Rethinking Home Ownership,” further clarifies the reallocation of resources taking place in the U.S. economy.  Beginning in the 1990s, the federal government adopted a number of policies to stimulate home ownership.  As Wessel makes clear, it was a bipartisan effort.  Home ownership rates rose from around 65% to a peak of 69.4% in 2004.  It was an unsustainable policy, a true asset bubble.

Home ownership rates have now fallen back to where they began, or even below.  The experience of the 1990s and early 2000s in housing demonstrates why government stimulus is not a permanent source of demand, nor the path to sustainable economic growth. Lest we forget, the folly of these programs is measured not just in housing numbers, but in shattered dreams and hopes and ruined lives. And the terrible financial crisis to which these programs contributed

Congress to Expand Deposit Insurance

While I never had much hope that this Congress would actually fix the real causes of the financial crisis - loose monetary policy, Fannie/Freddie - I had hoped that they wouldn’t do a lot to make an already bad situation worse.  Boy, was that hope naive.

Take the area of federally provided deposit insurance.  There is a massive amount of scholarly work, much of it empirical, that demonstrates that expanding the level and scope of deposit insurance results in more frequent and severe financial crises.  So what is Congress considering?  Yes, you guessed it:  expanded deposit insurance.

Recall during the financial crisis Congress raised the coverage limit to $250,000 - forget that there were never any premiums charged ahead of time for this coverage.  The FDIC also, without any basis in law, offered unlimited coverage to non-interest bearing accounts, targeted mostly at business customers.  While these expansions may have brought the system some short term stability, they come at the cost of considerable long term instability.

Congress is also making the misguided change of basing  insurance premiums on total assets rather than total deposits.  This will punish banks for relying on sources of funding other than deposits, giving banks an incentive to shift their funding toward deposits, putting the taxpayer ultimately at even greater risk.

So why all these expanded bank guarantees? Smaller banks view these as changes that would give them a competitive advantage relative to larger banks.  After all community and regional banks are far more dependent on deposits as a source of funds.  And while big banks are damaged politically, the smaller banks, despite their higher failure rates, have managed to maintain their political ability to shift the costs of their risk-taking onto the backs of the taxpayer.

Congress Begins Conference on Financial Regulation

Today begins the televised political theatre that Barney Frank has been waiting months for:  the first public meeting of the House and Senate conferees on the two financial regulation bills.  While there are a handful of important differences between the House and Senate bills, these differences are overshadowed by what the bills have in common.  The most important, and tragic, commonality is that both bills ignore the real causes of the financial crisis and focus on convenient political targets.

As our financial system was brought to its knees by an exploding housing bubble, fueled by government mandates and distortions, one would think, just maybe, that Congress would roll back these distortions.  Despite their role in contributing to the crisis and the size of their bailout, however, neither bill barely mentions Fannie Mae and Freddie Mac.   Except, of course, to continue their favored and privileged status, such as their exemption from a proposed new “consumer protection” agency.  What we really need is a new “taxpayer protection” agency.

Nor will either bill change the government’s meddling in what is probably the most important price in the economy:  the interest rate.  Given the overwhelming evidence that loose monetary policy was a direct cause of the housing bubble, one might expect Congress to spend time and effort preventing the Fed from creating another bubble.  Not only does Congress ignore the issue, the Senate won’t even allow GAO to look at the Fed’s conduct of monetary policy.

Instead of spending the next few weeks gazing into the camera, Congress should stop and gaze into the mirror.  This was a crisis conceived and born in Washington DC.  The Rayburn building serving as the proverbial back-seat of the housing bubble.

‘Make Wall Street traders and CEOs fear for their lives, or at least for their freedom to travel.’

Recall the unionists’ siege of the Maryland banker’s home the other day? Perhaps it was inspired in part by this screed on the world financial crisis that appeared a little while back on the blog New Deal 2.0, published by the left-leaning Franklin and Eleanor Roosevelt Institute. Other advice in the same piece on how to handle execs from Goldman Sachs and similar investment banks: “Build some Guantanamo-like facility to hold these enemy financial combatants until they can be tried, convicted, and properly punished.” And: “Post the names of all managers and traders on Interpol. Arrest anyone who tries to board a plane, train, or boat; confiscate their passports; revoke their visas and work permits; and put a hold on their bank accounts until culpability can be assessed.”

Tongue in cheek-ism, evidence of a genuine impulse to dispense with the rule of law, or some of both? Well, judge for yourself, bearing in mind what sorts of rhetoric serve in accusing, say, the Tea Party movement of extremism and worse. The “braintrusters” roster of the Roosevelt Institute, incidentally, boasts such respectables as Jonathan Alter, Hendrik Hertzberg, appeals court nominee Goodwin Liu, Joseph Stiglitz and Sean Wilentz.

As part of a symposium the other day, the recently launched blog Think Tanked asked me to help define what a think tank is and what it should do. My advice on the latter was to “let ‘em rip” – the scholars and thinkers, that is – but maybe in the case of the Roosevelt Institute I’d advise making an exception.

Topics:

The IMF Is Urging Governments to Impose Regulatory and Tax Cartels to Benefit Politicians

Price fixing is illegal in the private sector, but unfortunately there are no rules against schemes by politicians to create oligopolies in order to prop up bad government policy. The latest example comes from the bureaucrats at the International Monetary Fund, who are conspiring with national governments to impose higher taxes and regulations on the banking sector. The pampered bureaucrats at the IMF (who get tax-free salaries while advocating higher taxes on the rest of us) say these policies are needed because of bailouts, yet such an approach would institutionalize moral hazard by exacerbating the government-created problem of “too big to fail.”

But what is particularly disturbing about the latest IMF scheme is that the international bureaucracy wants to coerce all nations into imposing high taxes and excessive regulation. The bureaucrats realize that if some nations are allowed to have free markets, jobs and investment would flow to those countries and expose the foolishness of the bad policy being advocated elsewhere by the IMF. Here’s a brief excerpt from a report in the Wall Street Journal:

Mr. Strauss-Kahn said there was broad agreement on the need for consensus and coordination in the reform of the global financial sector. “Even if they don’t follow exactly the same rule, they have to follow rules which will not be in conflict,” he said. He said there were still major differences of opinion on how to proceed, saying that countries whose banking systems didn’t need taxpayer bailouts weren’t willing to impose extra taxation on their banks now, to create a cushion against further financial shocks. …Mr. Strauss-Kahn said the overriding goal was to prevent “regulatory arbitrage”—the migration of banks to places where the burden of tax and regulation is lightest. He said countries with tighter regulation of banks might be able to justify not imposing new taxes.

I’ve been annoyingly repetitious on the importance of making governments compete with each other, largely because the evidence showing that jurisdictional rivalry is a very effective force for good policy around the world. I’ve done videos showing the benefits of tax competition, videos making the economic and moral case for tax havens, and videos exposing the myths and demagoguery of those who want to undermine tax competition. I’ve traveled around the world to fight the international bureaucracies, and even been threatened with arrest for helping low-tax nations resist being bullied by high-tax nations. Simply stated, we need jurisdictional competition so that politicians know that taxpayers can escape fiscal oppression. In the absence of external competition, politicians are like fiscal alcoholics who are unable to resist the temptation to over-tax and over-spend.

This is why the IMF’s new scheme should be rejected. It is not the job of international bureaucracies to interfere with the sovereign right of nations to determine their own tax and regulatory policies. If France and Germany want to adopt statist policies, they should have that right. Heck, Obama wants America to make similar mistakes. But Hong Kong, Switzerland, the Cayman Islands, and other market-oriented jurisdictions should not be coerced into adopting the same misguided policies.

SEC vs. Goldman Sachs: Legislation by Demonization

The Obama administration thinks it has discovered the perfect formula to cram legislation through in a hurry:  Demonize some prominent firm within an industry you plan to redesign, and then pass a law that has nothing to do with the accusation against the demonized firm.  They did this with health insurance and now they’re trying it with finance.

With health insurance, the demon was Anthem Blue Cross Blue Shield of California, which Obama accused of raising premiums by “anywhere from 35 to 39 percent.” Why didn’t some curious reporter interview a single person who actually paid 39% more, or quote from a letter announcing such an increase?  Because it didn’t happen.  Insurance premiums are regulated by the states, and California wouldn’t approve such a boost.  Yet the media’s uncritical outrage over that 39% rumor helped to enact an intrusive, redistributive health bill that has nothing to do with health insurance premiums (which remain regulated by the states).

Today, the new demon de jour is Goldman Sachs, a handy scapegoat to promote hasty financial rejiggering schemes  The SEC’s suspiciously-timed civil suit against Goldman looks as flimsy as the last month’s health insurance story.  It also looks unlikely to win in court.

As Washington Post columnist Sebastian Mallaby explains, “This is a non-scandal. The securities in question, so-called synthetic collateralized debt obligations, cannot exist unless somebody is betting that they will lose value.”  In such a zero-sum contest, big investors who went long knew perfectly well that other investors had to be taking the other side of the bet.  Goldman lost $90 million by betting this CDO would go up; John Paulson went short.

Columnists have moralized about the unfairness of the short investor (Paulson) negotiating the terms of this deal with a long investor, ACA Management, which had the last word. This too, notes Mallaby, “is another non-scandal.  An investor who wants to bet against a bundle of mortgages is entitled to suggest what should go into the bundle. The buyer is equally entitled to make counter-suggestions.  As the SEC’s complaint states clearly, the lead buyer in this deal, a boutique called ACA that specialized in mortgage securities, did precisely that.”

Like the earlier fuming about Anthem California, this new SEC publicity stunt is likewise irrelevant to the pending legislation.  Congress hopes to get standardized derivatives traded on an exchange. But synthetic collateralized debt obligations dealing with a customized bundle of securities could not possibly be traded on an exchange, and would therefore be untouched by reform.

Losses sustained by a few financial speculators on one exotic derivative had nothing to do with starting a global recession in December 2007 or the related financial crisis of September 2008. The core of the latter crisis was mortgage-backed securities per se, yet Goldman was only the 12th largest private MBS issuer in 2007.  Fannie Mae and Freddie Mac were and are the biggest risk; any reform that excludes them is a fraud.

The SEC’s dubious civil suit against Goldman is a wasteful diversion at best. It has nothing to do with the Obama administration’s suicidal impulse to impose more tough regulations and taxes on banks to encourage them to lend more.

[Cross-posted at NRO’s The Corner]

Now Is the Time to End the Mortgage Interest Deduction

If there is one, almost universal, point of agreement on drivers of the financial crisis, it is that our financial system simply had way too much leverage.  Much of that discussion has focused on financial institutions, leading many to suggest increased capital standards, so that banks have more equity and less debt.  Often lost in the mix is the excessive leverage on the part of home owners.

We know, for instance, that the number one predictor of mortgage default is whether the borrower has equity or not.  And while that should lead us to debate appropriate downpayment requirements, at least when the government backs the mortgage, we should not forget that our tax code encourages excessive leverage on the part of home buyers.  And there’s no bigger incentive to get a bigger mortgage than the mortgage interest deduction.

Some might say we can’t risk removing any props from the housing market.  My friends at the National Association of Realtors, for instance, have in the past argued that full removal would decrease home prices by up to 15 percent.  Such an estimate depends on the level of interest rates (the higher are mortgage rates, the higher the value of the deduction and the greater the impact on house prices).  With the current low level of mortgage rates, the negative price impact should be around 5 percent.

Given the already close to 30% national decline in prices, a further 5% would be less noticeable now than at a time when prices start to rise again.  In addition, a 5% decline would attract more buyers into the market.  Housing is just like any other good – when there’s too much, the best way to clear the market, perhaps the only way, is to drop prices.  Getting rid of the deduction would make housing all the more affordable.  And given current low mortgage rates,there would be far less distortions to do so now.  Of course, all of this should be done in a budget neutral manner, lowering marginal tax rates across the board, which would have its own benefits to the economy.