Topic: Finance, Banking & Monetary Policy

Are State Regulators A Source of Systemic Risk?

The Dodd-Frank Act creates the Financial Stability Oversight Council (FSOC).  One of the primary responsibilities of the FSOC is to designate non-banks as “systemically important” and hence requiring of additional oversight by the Federal Reserve.  Setting aside the Fed’s at best mixed record on prudential regulation, the intention is that additional scrutiny will minimize any adverse impacts on the economy from the failure of a large non-bank.  The requirements and procedures of FSOC have been relatively vague.  We have, however, gained some insight into the process since MetLife has chosen to contest FSOC’s designation of MetLife as systemically important.

Driverless Money

Last week I happened to be contemplating a post having to do with driverless cars when, wouldn’t you know it, I received word that the Bank of England had just started a new blog called Bank Underground, the first substantive post on which had to do with — you guessed it — driverless cars.

As it turned out, I needn’t have worried that Bank Underground had stolen my fire. The post, you see, was written by some employees in the Bank of England’s General Insurance Supervision Division, whose concern was that driverless cars might be bad news for the insurance industry. The problem, as the Bank of England’s experts see it, is that cars like the ones that Google plans to introduce in 2020 are much better drivers than we humans happen to be — so much better, according to research cited in the post, that “the entire basis of motor insurance, which mainly exists because people crash, could … be upended.” Driverless cars therefore threaten to “wipe out traditional motor insurance.”

It is of course a great relief to know that the Bank of England’s experts are keeping a sharp eye out for such threats to the insurance industry. (I suppose they must be working as we speak on some plan for addressing the dire possibility — let us hope it never comes to this — that cancer and other diseases will eventually be eradicated.) But my own interest in driverless cars is rather different. So far as I’m concerned, the advent of such cars should have us all wondering, not about the future of the insurance industry, but about the future of…the Bank of England, or rather of it and all other central banks. If driverless cars can upend “the entire basis of motor insurance,” then surely, I should think, an automatic or “driverless” monetary system ought to be capable of upending “the entire basis of monetary policy” as such policy is presently conducted.

And that, so far as I’m concerned, would be a jolly good thing.

The Mercantilists Are Marching onto War

Senator Lindsey Graham likes to march onto war, and off into economic swamps, as well. Recently, Senator Graham mounted a counter attack on fellow Republicans who opposed the reauthorization of the Export-Import Bank. Indeed, the Senator said “…I’m not going to unilaterally disarm.” Yes, it is clear that the senator has mounted a surge.

The Export-Import Bank (Ex-Im) provides financing and loan guarantees at below-market rates to foreign purchasers looking to buy products from American exporters. For example, if Emirates Air wants to buy planes from Boeing, Ex-Im can provide a loan guarantee, reducing the interest rate Emirates will pay, and thus incentivizing Emirates to buy from Boeing rather than Airbus.

Ex-Im’s supporters claim that these subsidies create jobs and finance domestic economic growth. But, they fail to consider the ensuing downstream effects. As Cato scholar Daniel Ikenson makes clear, every dollar Ex-Im provides to subsidize foreign purchasers of U.S.-produced products discriminates against U.S. consumers of the same products. For example, when Emirates receives a subsidy for planes because it is a foreign company, Emirates gets a leg up on Delta.

An edifying account of how this system works was presented many years ago by the late Prof. Yale Brozen in his foreword to Prof. Leland Yeager’s classic Proposals for Government Credit Allocation (1977):

Whom you know and with whom you have influence becomes more important in obtaining capital than how productively you can use it. Capital is diverted from more productive uses to politically determined applications […]. The national income pie shrinks as an increasing proportion of our capital is allocated by the political process – not only because of its diversion from more productive uses but also because more and more of our resources are devoted to winning political influence, as that becomes the road to access to available capital and subsidies.

For the record, Ex-Im isn’t small potatoes. In FY 2015, Ex-Im’s loans and loan guarantees will total $30.9 billion, or 6.7% of all non-housing federal credit programs. The Ex-Im’s total cumulative loans and guarantees outstanding (read: credit exposure) currently sits at $112 billion. Because the loans are granted at below-market rates, the Ex-Im does not receive fair compensation for the $112 billion of risk it takes on.

Instead of adopting a policy that makes a few U.S. exporters winners at the expense of many losers, there is a way to make all U.S. firms more competitive: just lower the grueling corporate tax rate. Yes, according to the Organization for Economic Co-operation and Development (OECD), the U.S. has the highest corporate tax rate of the 34 OECD member countries.

There is clearly a better way to unburden U.S. corporations and make them more competitive internationally than to sponsor a “bank” in which politicians and bureaucrats, not capital markets, choose winners and losers. It is time to move away from a mercantilist view of trade towards one that puts the market back in control.

The Three M’s: Milosevic, Mugabe, and Maduro

What do Slobodan Milosevic, Robert Mugabe, and Nicolás Maduro have in common? The Communist Manifesto and inflation.

At 480% per annum, Venezuela’s inflation is currently the world’s highest. The Bolivarian Revolution is pushing prices up at a rate of 36% per month. Will these punishing inflation numbers spell the end of President Nicolás Maduro’s reign? Maybe not. Milosevic’s Yugoslavia and Mugabe’s Zimbabwe witnessed much higher inflation rates, and both hung on for many years.

Slobodan Milosevic was in the saddle when inflation gutted the rump Yugoslavia. Milosevic’s inflationary madness reached its peak in January 1994, when the monthly inflation rate hit 313,000,000% – almost nine million times greater than Venezuela’s current monthly rate. Nonetheless, Milosevic retained his grip on what was left of Yugoslavia for another six years.

Court Finds Government Actions in AIG Bailout Were Illegal

Ask any first year law student “what did you learn in school today” and you’ll probably get some version of the answer: “duty-breach-causation-harm.”  While this applies specifically to tort claims, it seems axiomatic, even for non-lawyers, that you can’t sue someone who hasn’t hurt you.  Or can you?

Former AIG CEO Hank Greenberg caused a ripple of shock in late 2011 when he filed suit against the U.S. government, alleging that the government’s 2008 bailout and subsequent take-over of AIG was unlawful, and claiming $40 billion in damages.  Despite skepticism throughout the legal community, the case not only survived dismissal, but went on to a full trial, during which such heavyweights as Tim Geithner, Hank Paulson, and Ben Bernanke took the stand. 

Throughout the trial, Judge Thomas Wheeler seemed sympathetic to the claims that Greenberg brought on behalf of Starr International Company, an AIG shareholder.  Few believed that AIG had any alternative to the government’s money, except bankruptcy.  In bankruptcy, shareholders (like Starr) are paid last out of whatever remains after all the company’s debts are paid.  Which typically (and most likely in AIG’s case) means not paid at all.  Would the judge really grant Starr a $40 billion judgment – against the U.S. government – when the alternative was bankruptcy?

No.  But that doesn’t mean the government got off scot free either.  Judge Wheeler found that the federal government committed an illegal exaction.  That is, it took something it had no right to take.  (This, the judge carefully notes, is not the same as a “takings” under the Fifth Amendment.  When there is a takings, the government lawfully uses its authority to take private property for public use and then must pay the owner “just compensation” for that property.  An illegal exaction means the government took properly unlawfully.) 

Why the IMF Is Playing Hardball with Greece

Under normal conditions, the IMF is supposed to be limited to lending up to 200% of a country’s quota (each country’s capital contribution made to the IMF) in a single year and 600% in cumulative total. However, under the IMF’s “exceptional access” policy there are, in principle, virtually no limits on lending. The exceptional access policy, which was introduced in 2003, opened the door for Greece to talk its way into IMF credits worth an astounding 1,860% of Greece’s quota – a number worthy of an entry in the Guinness Book of World Records.

The IMF’s over-the-top largesse towards Greece explains why the IMF has been forced to play hardball with Greece’s left-wing Syriza government. The IMF’s imprudent over-commitment of funds to Greece leaves it no choice but to pull the plug on Athens. That is why the IMF’s negotiators packed their bags last week and returned to Washington, and that is why it will probably remain uncharacteristically immovable.

Doc Selgin’s QE Eye Test

Some weeks ago, I made some critical observations concerning the Fed’s contribution to  the recovery.  In particular, I complained that, despite the decidedly mixed and ambiguous results of empirical assessments thus far, the view that Quantitative Easing has been a smashing success seemed well on its way to becoming official dogma, if not a more generally-held article of faith.

Even so, I was taken aback by the off-hand manner in which Fed Vice Chairman Stanley Fischer declared a QE victory, in the course of a speech given two weeks ago at the International Monetary Conference in Toronto.   Did the Fed’s policies work?  According to Fischer, “The econometric evidence says yes.  So does the evidence of one’s eyes” (my emphasis).

In fact, as I’ve already noted, the econometric evidence concerning the effectiveness of QE is hardly decisive.  For one thing, most studies have looked only at the interest-rate effects of the Fed’s purchases, without troubling to ask whether those effects translated into any definite changes in spending, output, and employment.  For another, the interest-rate effect estimates are themselves not to be trusted.   A fairly recent IMF study on “Foreign Investor Flows and Sovereign Bond Yields in Advanced Economies,” for example, notes — en passant as it were — that, controlling for such flows, the Fed’s large-scale asset purchases resulted, not in the 90-200 basis point decline in long-term rates reported in various other studies, but in a decline of just thirty basis points, which is peanuts.  Other studies may, in other words, have conflated the effects of the Fed’s asset purchases with those of concurrent “flights” from lower-quality Eurozone securities to higher-quality Treasuries.

But why bother with fancy econometrics when one can simply refer, as Vice Chairman Fischer did, to the “evidence of one’s eyes”?   Fischer, apparently, found in that evidence compelling proof that QE worked wonders.  Fischer actually mentions only one piece of evidence, to wit: the fact that “the recent inauguration of the ECB’s QE policy seemed to have an immediate effect not only on European interest rates, but also on longer-term rates in the United States.”  But here, as with other inferences drawn by looking at interest-rate movements, connecting the dots isn’t nearly as easy as Fischer supposes.

Evidence that some good has come from the ECB ‘s belated easing is, in any event, not evidence that the Fed’s easing did any good.  Try as I might, I just can’t seem to get my eyes to focus on any clear and unambiguous evidence that it did.  Has Fischer, I wonder, been looking at the same things I’ve looked at?  If so, is he perhaps looking through rose-colored glasses, or is it my own vision or prescription that’s faulty?

With such questions in mind, I decided to put the matter to a test.  Call it Doc Selgin’s QE Eye Test, or Eye QE Test, or whatever else you wish to call it.  The instructions are simple: eyeball the following charts, gathered from various internet sources, recording all sorts of basic information pertaining to Quantitative Easing on one hand and the post-2008 recovery on the other.  Then decide for yourself whether the evidence of your eyes agrees with Mr. Fischer’s relatively sunny impression, or with my own much gloomier one.