Tag: Yellen

Some Preliminary Thoughts on the New “Final” Volcker Rule

There was only one way that the five regulatory agencies tasked with drafting the Volcker Rule–the provision of Dodd-Frank limiting proprietary trading by banks–were ever going to meet the year-end deadline and give meat to a poorly drafted statutory provision. That was if they retained maximum ex post facto discretion to decide whether bank activity is permissible or not under the rule. Unsurprisingly, this appears to be exactly what they have done.

I have some particular concerns:

The rule will require a “maze of regulators” (via the Wall Street Journal)

You thought the debate over the extraterritorial application of cross border derivatives (i.e., the fight between the Securities and Exchange Commission and the Commodities Futures Trading Commission)was contentious? Volcker is going to be five times worse. The rule still requires ongoing monitoring and enforcement by FIVE separate agencies and, as Wayne Abernathy of the American Bankers Association noted, there is still no mechanism for coordination built into the rule.

The rule lacks “bright line distinctions” (per Janet Yellen)

Basically banks won’t know if they’re in compliance or not until their regulator determines it. Ominously, SEC chairman Mary Jo White said that the regulators would be available to add “clarification.” Needless to say, a final rule should not need clarification.

The devil is in the enforcement

Several of the regulators noted that the key to “successful” implementation of the rule is ongoing monitoring and enforcement. But how do you monitor and enforce a rule that doesn’t have a bright line? So much for the rule of law.

The rule contains an exception for sovereign debt

In other words, banks can trade in as much sovereign debt as they want for their own account, but if they were to engage in similar activity with respect to investment grade corporate debt–Exxon Mobil for example–this will be illegal proprietary trading. (I feel safer already!)

Much of the “new final” rule does not have the benefit of public input

The two SEC commissioners who voted against the rule both complained they did not have sufficient time to review the contents–one labeled the year-end deadline “wholly political”–and were concerned that many of the new provisions did not have the benefit of public comment. They are correct that, at the very least, the rule should have been re-proposed as a draft.

For a full transcript of the final rule and Volcker related materials, see here.

Yellen and the Fed

The Senate Banking Committee just voted 14 to 8 to confirm Janet Yellen’s nomination to be the new Chair of the Federal Reserve. She will likely go on to be confirmed by the full Senate.

Much of the coverage has focused on Yellen as a person, when the real story is on the Fed as an institution. Sometimes individuals have profound influence on Fed policy, such as Paul Volcker  in the late 1970s and 1980s. Over time, however, the institutional structure of the central bank and the incentives facing policymakers matter more.

The Federal Reserve famously has a dual mandate of promoting maximum employment and price stability. The Federal Open Market Committee, which sets monetary policy, has great discretion in weighting the two policy goals. As a practical matter, the vast majority of the time, full employment receives the greater weight. That is because the Fed is subject to similar pressures as are the members of Congress to which the Fed must report. In the short run, voters want to see more job creation. That is especially true today. The United States is experiencing weak growth with anemic job creation.

Never mind that the Fed is not capable of stimulating job creation, at least not in a sustained way over time. It has a jobs mandate and has created expectations that it can stimulate job growth with monetary policy. The Fed became an inflation-fighter under Volcker only when high inflation produced strong political currents to fight inflation even at the cost of recession and job creation.

The Federal Reserve claims political independence, but it has been so only comparatively rarely. Even Volcker could make tough decisions only because he was supported by President Carter, who appointed him, and President Reagan, who reappointed him. Conventionally defined inflation is low now, so the Fed under any likely Chair would continue its program of monetary stimulus. Perhaps Yellen is personally inclined to continue it longer than might some other candidates. But all possible Fed chiefs’ would face the same pressures to “do something” to enhance job growth, even if its policy tools are not effective.

The prolonged period of low interest rates has made the Fed the enabler of the federal government’s fiscal deficits. Low interest rates have kept down the government’s borrowing costs, at least compared to what they would have been under “normal” interest rates of 3-4 percent.

Congress and the president have been spared a fiscal crisis, and thus repeatedly punted on fiscal reform. They are likely to continue doing so until rising interest rates precipitate a crisis. How long that can be postponed remains an open question.

Does Janet Yellen Know What a Bubble Looks Like?

With Larry Summers withdrawing from the race for Federal Reserve chair, current Fed vice chair Janet Yellen has pulled into the lead to become Ben Bernanke’s replacement. Previous to her current appointment, Yellen served as president of the San Francisco Federal Reserve Bank  The SF Fed’s district includes three of the worst states in the housing crisis – California, Arizona and Nevada.  I think its fair to say that without the housing boom and bust in these states we wouldn’t have had a mortgage crisis.  Given that Yellen was the top banking regulator for this geography, one has to wonder whether she was asleep at the wheel.  

This issue wasn’t ignored at her confirmation hearing for Fed vice chair.  Here’s a little of her exchange with Sen. Richard Shelby (R-Ala.):

SHELBY: And regarding your tenure as president of the 12th District, I have two questions. First, what role do you believe a breakdown in regulatory oversight played in the failure of the institutions in your district? And secondly, were you raising any warning flags with respect to speculative excesses or lax monetary policy during that period?

YELLEN: So the first question was to the breakdown – to the breakdown in…

SHELBY: Do you believe a breakdown in regulatory oversight – what role do you believe that a breakdown in regulatory oversight played in the failure of the institutions in your district?

YELLEN: Working with other regulators, I think that our regulatory oversight was careful and appropriate, but I believe that the…

SHELBY: Well, excuse me. You say it’s careful and appropriate, and you – most people believe…

YELLEN: Given the…

SHELBY: … it was lax and inappropriate.

YELLEN: Well, I – in the institutions that have failed in my district are mainly community banks with high exposure to commercial real estate.


YELLEN: And when I say careful and appropriate, I mean that as early as 2001…


YELLEN: … people in the Federal Reserve System, and particularly in my bank, were at the forefront of focusing on high concentrations that existed in the banks we supervised in commercial real estate. We saw that these exposures and concentrations could be a source of vulnerability, and we monitored this carefully throughout.

Interestingly enough she never touches on the topic of monetary policy and its impact on housing prices.  When the Fed hasn’t been complicit in generating bubbles, they’ve generally just turned a blind eye to them.  If one cannot from the perch of San Francisco identify the perverse impact of loose money on housing prices, then you’re likely to miss it from D.C. as well.

If you think bubbles are a great avenue for wealth creation, then Yellen is the Fed chair for you.  If you, however, suspect bubbles are damaging to our economy, then you might rightly be concerned that she repeats her San Francisco performance on a national level.