Topic: Finance, Banking & Monetary Policy

How Not to Spin a Big Drop in Top 1% Incomes

Pre-1944 method of estimating top 1% shares

When Thomas Piketty and Emmanuel Saez release their annual estimates of top 1 percent incomes, you can count on The New York Times to put it in a front page headline with additional hype on the editorial page.  This time, however, the news was that the top 1 percent had suffered a 14.9 percent decline in real income in 2013 if capital gains are included, as they always had been until now.  

The New York Times heroic spin was “The Gains From the Economic Recovery Are Still Limited to the Top One Percent.”  The author, Justin Wolfers of the Peterson Institute wrote, “Emmanuel Saez … has just released preliminary estimates for 2013. The share of total income (excluding capital gains) going to the top 1 percent remains above one ­sixth, at 17.5 percent. By this measure, the concentration of income among the richest Americans remains at levels last seen nearly a century ago.”

I will have more to say about this in another blog post.  For now, I just want to call attention to the artistic way in which the subject was changed.  Since 2008, Saez has been comparing changes in top incomes (for which he has preliminary IRS data) to incomes of the bottom 90 percent (for which IRS data are singularly inappropriate).   He always included realized capital gains because that makes the top 1 percent share both larger and more cyclical.

If We Decide to Keep Fannie Mae Around…

I’ve repeatedly said since 2009 that the further in time we get from the crisis, the greater the probability that Fannie Mae and Freddie Mac would survive in some form.  Such looks like an ever-increasing likelihood.  I’m occasionally asked if there are any reforms that would make Fannie & Freddie acceptable.  I’m tempted to say “no.” 

In the spirit of lively debate, I submit the following changes to address most of the flaws in the government sponsored enterprise (GSE) model that would also allow the companies to survive in some form.  I do emphasize that this is not an argument for keeping the GSEs.  That’s a different question altogether.

1)   Open up the charters to competition.  If we learned anything from the rampant corruption that characterized early 1800s U.S. state banking, it is that legislators shouldn’t give out exclusive charters.  Accordingly, the government should delegate chartering authority to the regulator and allow anyone who can meet the requirements to get a charter.

2)   Increase Capital.  Fannie and Freddie were (and still are) massively leveraged.  Laurie Goodman suggests 4 to 5 percent would be a reasonable minimum capital.  I believe something closer to what insurance companies have–around 8 percent (real, not risk-weighted) would be appropriate.  While I’m not completely in the Admati camp on capital, I do agree with her general point that capital isn’t “dead” –it would be used for lending.  And since GSEs aren’t providing some form of payment medium like banks, I see little cost to requiring higher capital levels. So I’d say 8 percent, if not more.

3)   Ditch loan limits, go with income.  In order to make sure these entities actually serve middle-class America, rather than be a subsidy to the well-off, we should eliminate the loan limits and make mortgage eligibility based on income.  This is similar to the USDA’s Rural Housing Service loans.

4)   Break ‘em up.  This might be the most controversial, but simply allowing other institutions to enter the market is unlikely to guarantee sufficient competition.  We broke up Ma Bell.  Under any antitrust standard, Fannie and Freddie are a duopoly.  Unless we are repealing the Sherman Act, the two companies should be broken into at least 6 pieces each and barred from merging.  Existing shareholders would get shares in the off-spring companies.

5)   Require More Mortgage Insurance.  In order to protect the taxpayer, mortgage insurance companies should take the first 35 percent of loss, instead of the customary 20 percent.

6)   Improve Underwriting Standards.  End the housing goals and require minimum down payments of 5 percent and minimum FICO scores of 700.

7)   End all securities law exemptions.  Subject companies to 1933 & 1934 Act requirements. 

8)   End banking law preferences.  Banks aren’t allowed to hold corporate equity, except for that of GSEs.  We know how that turned out.  For the purposes of all banking regulation, especially capital and asset concentration limits, treat GSE securities as you would any other corporate security.

9)   Limit portfolios.  Allow portfolios to be used for an inventory function only. A minimum of 90 percent of debt issued should be required to be mortgage-backed securities (MBS).

These are just some initial thoughts.  Implementing all of these would go a long way towards bringing competition to our mortgage markets and protecting the taxpayer.  If some remain concerned that this lacks a “catastrophic” backstop, then we can allow the Federal Home Loan Banks to discount advances on the MBS issued by these new and improved GSEs.

Fact Checking the Fed on “Audit the Fed”

With the introduction of bills in both the House (H.R. 24) and Senate (S.264) allowing for a GAO audit of the Federal Reserve’s monetary policy, officials at both the Board and regional Fed banks have launched an attack on these efforts.  While we should all welcome this debate, it should be one based on facts.  Unfortunately some Fed officials have made a number of statements that could at best be called misleading. 

For instance Fed Governor Jerome Powell recently claimed “Audit the Fed also risks inserting the Congress directly into monetary policy decisionmaking”.  I’ve read and re-read every word of these bills and have yet to find such.  H.R. 24/S.264 provide for no role at all for Congress to insert itself into monetary policy, other than Congress’ existing powers.  I would urge Governor Powell to point us to which particular part of the bill he is referring to, as I cannot find it.

Dr. Krugman Meets Dr. Fox

Dr. Paul Krugman, the hyper-productive New York Times columnist and Nobel laureate, has produced a flood of fiscal factoids. He argues that the only way to put the major economies around the world back on track is to “stimulate” them via deficit-financed government spending.

Most recently, Dr. Krugman has weighed in repeatedly on Greece’s travails with his fiscalist snake oil. His column of January 26th, “Ending Greece’s Nightmare,” makes it clear that he thinks he can deliver an elixir.

Not so fast Doctor. A mountain of evidence shows that the elixir is a fiscal factoid. Never mind.

On Greece: Plus Ça Change, Plus C’est la Même Chose

People keep asking me what I think about Europe’s most recent crisis (read: Greece). Well, my sentiments are exactly the same as they were in April 2012, when my Globe Asia column was titled: “China and Greece – Here We Go Again.”

Here’s what I wrote on Greece: “And if you think the political chattering classes in the U.S. are dangerous, take a look at Europe, where the elites are fighting economic reality with all their might — a fight they will lose. Indeed, they have built an economic doomsday machine. And when it comes to Greece, don’t fool yourselves into believing that the recent huge debt restructuring exercise will allow Europe’s politicos to pull their chestnuts out of the fire. Greece’s annual broad money (M3) growth rate has been in negative territory for every month since February 2010, and it is currently contracting at a fantastic 17.5%. In the words of former President George W. Bush (not Yogi Berra): ‘This sucker is going down.’ You can forget all the calculations and soothing noises coming from Europe.”

Yes. Plus ça change, plus c’est la même chose.

Loan Loss Only Part of Financial Crisis Story

With the release of Peter Wallison’s new book, Hidden in Plain Sight, debates about the role of Fannie Mae and Freddie Mac in the financial crisis have heated up again. As I’ve written elsewhere, I believe there’s a lot more to the story than the GSEs’ housing goals. While there are a number of omissions in Peter’s otherwise fine book, I want to address a particular criticism of his work that strikes me as simply confused and mistaken.

I’ve often heard that Fannie and Freddie couldn’t have been a cause of the crisis because their loan loss rates (and totals) were far below those of banks. Robert VerBruggen recently repeats this in his review of Peter’s book. 

For this claim, Robert relies on loss estimates by David Min and Mark Zandi. The latter repeated this criticism at an AEI event for Peter’s book, and you can find Zandi’s estimates here (page 8, table 1). Zandi states that as a percent of debt, the GSEs witnessed a loss rate of 2.7 percent on their holdings of residential mortgages. Combined with the Federal Housing Administration’s losses, this comes to around $206 billion. In contrast, depositories (banks & thrifts) had a loss rate of 5.8 percent for a total of $217 billion—both the rate and total are obviously greater than that for the GSEs and FHA.  

So far, so good; I don’t disagree with any of the above. But Zandi’s estimates suffer from a massive omission: the other side of the balance sheet—equity. If you think losses are all that matter, consider that the dot.com bubble erased about $8 trillion in wealth, whereas losses on mortgages, according to Zandi, were just under $1 trillion. So if losses are the issue, why wasn’t the dot.com bubble so much worse than the subprime crisis? Because of leverage.

Yes, the GSEs’ losses on mortgages were less than that for depositories, but the differences in capital were far greater. The GSEs had far less shareholder money to fall back on if mortgages started to sour. Again bear in mind that total losses were similar between the GSEs and the depositories. In the 4th quarter of 2007, Fannie and Freddie held about $70 billion in shareholder equity, behind $1.7 trillion in assets and around $5 trillion in debt and guaranteed mortgage-backed securities. By contrast, depositories held $1.3 trillion in shareholder equity, or about 19 times the equity of the GSEs. Mortgage losses were not enough to sink the entire banking system, even if some banks did sink, whereas the GSEs were toast because of their low levels of capital. 

Why does that matter? Because it takes insolvencies to drive a financial crisis. The banking system, as a whole, was not driven to insolvency, but the GSEs where. Losses (and loss rates) only make sense relative to the capital ready to absorb those losses. And of course the failure of the GSEs was magnified through the system in a uniquely harmful manner. 

Did other banks hold Citibank equity?  Of course not, but they did hold GSE preferred shares. This all isn’t to say that the GSEs were the only cause of the crisis; they weren’t. It is to say that loss rates presented out of context are meaningless and could even be misleading.

Bitcoin Regulation: “Assume the Existence of Public Interest Benefits!”

You’ve probably heard some version of the joke about the chemist, the physicist, and the economist stranded on a desert island. With a can of food but nothing to open it, the first two set to work on ingenious technical methods of accessing nutrition. The economist declares his solution: “Assume the existence of a can opener!”…

There are parallels to this in some U.S. state regulators’ approaches to Bitcoin. Beginning with the New York Department of Financial Services six months ago, regulators have put proposals forward without articulating how their ideas would protect Bitcoin users. “Assume the existence of public interest benefits!” they seem to be saying.

When it issued its “BitLicense” proposal last August, the New York DFS claimed “[e]xtensive research and analysis” that it said “made clear the need for a new and comprehensive set of regulations that address the novel aspects and risks of virtual currency.” Yet, six months later, despite promises to do so under New York’s Freedom of Information Law, the NYDFS has not released that analysis, even while it has published a new “BitLicense” draft.

Yesterday, I filed comments with the Conference of State Bank Supervisors (CSBS) regarding their draft regulatory framework for digital currencies such as Bitcoin. CSBS is to be congratulated for taking a more methodical approach than New York. They’ve issued an outline and have called for discussion before coming up with regulatory language. But the CSBS proposal lacks an articulation of how it addresses unique challenges in the digital currency space. It simply contains a large batch of regulations similar to what is already found in the financial services world.