Topic: Finance, Banking & Monetary Policy

The Bipartisan Push to Fully Restore the Export-Import Bank

Export-Import Bank supporters are back at it again. According to a document from the Office of Management and Budget, the administration is reportedly asking lawmakers to include a provision restoring the agency’s full lending authority as part of the continuing resolution that needs to be passed in order to keep the government functioning after September 30th. It was just a few weeks before his election in 2008 that Obama said it had “become little more than a fund for corporate welfare,” and cited it as an example of why he wasn’t someone “who believes we can or should defend every government program just because it’s there.” What a difference eight years can make.

Opponents of cheered last year when Congress let the bank’s charter lapse, only for it to be reauthorized months later when a provision was attached to the highway bill in December to reauthorize the agency through September 2019.

The agency, which provides financing and loan guarantees for U.S. export transactions, has since been limited in the scope of its lending authority, as the Senate has declined to approve the administration’s nominee to its board of directors. With three of five board seats vacant, quorum rules prevent the bank from approving any transactions over $10 million until the vacancy is filled.

This latest request from the administration is the culmination of a concerted effort on both sides of the aisle to restore full authority to the agency, without which it cannot approve the larger deals that would benefit the bigger companies that receive so much of the bank’s support. This is hardly a partisan affair, as earlier this year Republican Rep. Charlie Dent introduced an amendment to the State and Foreign Operations Appropriations Bill that would achieve the same objective.

Has the Fed Been Breaking the Law?

No, I don’t mean sections 8 and 10 of the Constitution’s first article — though goodness knows a case can be made (and has been made recently, and most eloquently, by CMFA Adjunct Scholar Dick Timberlake), that it hasn’t adhered to the letter of that law, either. I’m referring to the law authorizing the Fed to pay interest on depository institutions’ reserve balances, or IOR, for short.

You see, according to Title II of the 2006 “Financial Services Regulatory Relief Act” — that law that originally granted the Fed authority, commencing October 1, 2011, to begin paying IOR — the Fed is allowed to pay interest, not at any old rate it chooses, but “at a rate or rates not to exceed the general level of short-term interest rates.”

As the name of the 2006 Act suggests, its purpose was to relieve financial institutions of unnecessary regulatory burdens. The fact that depository institutions’ reserve balances at the Fed, including minimum balances they were required to hold, bore no interest, had long been regarded as one such unnecessary burden. So long as reserve balances paid no interest, reserve requirements amounted to a distortionary tax on bank deposits subject to them. In the words of then Fed Governor Donald Kohn, who testified in favor of IOR back in 2004, the payment of interest on reserves, and on required reserves especially, would result in improvements in efficiency that “should eventually be passed through to bank borrowers and depositors.”

Since the original intent of IOR was to remove an implicit tax on deposits, and not to have the Fed subsidize those deposits, it’s easy to understand the law’s insistence that the Fed pay IOR only at “a rate or rates not to exceed the general level of short-term interest rates.” It also easy to see why most economists, including the Fed’s own experts, treat the federal funds rate as an appropriate proxy for the opportunity cost of reserve holding, and hence as one of the short-term rates that the rate of interest on bank reserves ought “not to exceed.” Indeed, because overnight lending involves some risk and transactions costs, while banks would earn IOR effortlessly and without bearing any risk, the IOR rate should logically be strictly below, rather than below or equal to, the federal funds rate.

Miami Vice

The City of Miami has come up with an ingenious plan: raise revenue without asking for a dime from taxpayers and make Wall Street banks pay for it, all under the auspices of fighting racial discrimination. Actually, it would be unfair to give Miami full credit for the idea: so far, it’s only one of more than a dozen cities, counties, and school districts that have tried the same scheme.

The plan works by engaging the services of plaintiffs’ counsel (who typically work on a contingency fee, requiring the city to pay nothing out of pocket) to sue mortgage lenders under the Fair Housing Act (FHA). The city claims that it has suffered from a diminished tax base, in addition to an increase in the need for its services, all thanks to lenders’ alleged discriminatory practices.

While this is an interesting theory, it falls well outside the problems the FHA was designed to address. It seems the Supreme Court may also question whether the FHA permits this type of suit as it has granted certiorari in the case Bank of America v. City of Miami. On Monday, the Cato Institute filed a brief in support of Bank of America and its co-defendant, Wells Fargo.

Thomas Paine, Advocate of Sound Money and Banking

Between writing his well-known revolutionary liberal tracts Common Sense (1776) and The Rights of Man (1791), Thomas Paine contributed knowledgeably to a 1785-6 debate over money and banking in Pennsylvania. Paine defended the Bank of North America’s charter and it operations in a number of lengthy letters to Philadelphia newspapers during 1786, followed by a December monograph that summarized his case, Dissertations on Government; The Affairs of the Bank; and Paper Money.[1]

Paine argued that to repeal the bank’s charter violated both the rule of law and the maxims of sound economic policy. His writings show that he well understood the benefits of banking. Although proponents of the repeal accused Paine, publicly known to be in dire financial shape, of being paid by the BNA’s proprietors for defending it (one called him “an unprincipled author, who lets his pen out for hire”), Paine vociferously denied the charge, and historians (such as Philip S. Foner, who edited an anthology of Paine’s works), have found no evidence to support the accusation. Prima facie evidence for Paine’s sincerity is found in his marshalling of serious arguments that were consistent with the classical liberal principles of his earlier writings.

The Fed Is Overestimating Economic Growth

In her speech yesterday at the Federal Reserve’s annual conference in Jackson Hole, Wyoming, Fed Chair Janet Yellen stated that “the case for an increase in the federal funds rate has strengthened in recent months.” She based that view on “the continued solid performance in the labor market” and “our outlook for economic output and inflation.”

As documented by Jon Hilsenrath in yesterday’s Wall Street Journal,the Fed has consistently overestimated economic growth since 2004. The Fed’s economic model is wrong and there is no reason to believe it will suddenly produce reliable predictions. The model also does poorly in predicting inflation, though it does not show such a bias one way or another. Continuing to rely on the Fed’s flawed model to determine policy would be foolish.

Characterizing the labor market as “solid” is misleading in the extreme. Much of the decline in the unemployment rate to which Yellen directs our attention has been due to the decline in the civilian labor market participation rate. If people give up on the labor market, they are not counted as unemployed. Far from being a sign of strength, a fall in the unemployment rate for that reason is arguably a sign of weakness in labor markets. Since the unemployment rate is no longer a reliable indicator of labor market conditions, it should be dropped as a policy gauge.

For these and other reasons, I stand by my post of August 9th that the Fed will not be able to raise rates. My only hedge on that prediction is that Yellen is putting the Fed’s credibility on the line with her continued predictions of raising interest rates. Loss of face is a poor justification for raising interest rates, but the human factor cannot be dismissed in policy making.

MetLife v. Financial Stability Oversight Council

Under Dodd-Frank, the new Financial Stability Oversight Council (FSOC) has the authority to designate companies as “systemically important financial institutions” or “SIFIs.” By identifying and branding these companies as systemically important, we’ve been told, the government will end “too big to fail.” Dodd-Frank’s supporters claim bailouts like the one we saw in 2008 are a thing of the past, in part because of the heightened oversight of SIFIs. Except FSOC hasn’t fully thought through the whole SIFI designation concept. In March, a court found that FSOC’s designation of insurance giant MetLife failed to consider the impact the designation would have on MetLife and the U.S. financial system as a whole and therefore was “arbitrary and capricious,” that is, unlawful.

FSOC was created by Dodd-Frank and, as an agency of the federal government, it exists to “further some public interest or policy which [Congress] has embodied in law.” This interest, Dodd-Frank tells us, is to “promote the financial stability of the United States…to end too big to fail, [and] to protect the American taxpayer by ending bailouts[.]” Whether FSOC  is capable of any of these things and whether the legislation that created it will ultimately promote anything like stability is not the point (although our vote on these questions is “no”). The point is that, in exercising this delegated authority, FSOC must always act to forward the goal of promoting the financial stability of the United States.

It is surprising, then, that in determining whether MetLife should be designated as a SIFI, FSOC not only failed but flat out refused to consider whether the cost of compliance with this increased burden might actually weaken the company. If FSOC designates a company as a SIFI it means that FSOC has determined that “material financial distress” at the company “could pose a threat to the financial stability of the United States.” That is, that anything that weakens it would undermine the express goal of Dodd-Frank. It seems clear that FSOC should at least ask the question: would complying with these new rules make the company stronger or weaker?

And yet FSOC claimed that this question, which goes to the very heart of its authorizing statute, is not one it has to ask. Following its loss in the district court, FSOC appealed the case to the D.C. Circuit Court. On Monday, Cato filed an amicus brief arguing that it was unreasonable for FSOC to fail to consider whether its action in designating MetLife as a SIFI promoted or instead frustrated the goal of Dodd-Frank in promoting financial stability in the U.S. Cato also argued that, far from reducing the risk of bailout, designating MetLife as a SIFI could in fact increase the likelihood of taxpayer-funded rescue.

Ultimately the question is whether an agency must grapple with the possible negative effects of its actions, or whether it may simply wave these costs away, saying “that’s not our concern.” We hope the court decides that federal agencies, like everyone else, must consider the costs of their actions.

[Cross-posted from Alt-M.org]

The Fiscal Theory of the Price Level: True and False

There are two versions of the fiscal theory of the price level (FTPL); one true, the other false.  The true version holds that if the fiscal authority dominates the policy space, then fiscal deficits could be monetized by the central bank. This version is consistent with the quantity theory of money, because inflation is ultimately determined by excess growth in the money supply.  If money growth were constant, inflation could not occur—that is, there could not be a sustained rise in the average level of money prices. In this sense, Milton Friedman’s dictum that “inflation is always and everywhere a monetary phenomenon” cannot be refuted (Friedman 1970: 11).

The second version of the FTPL, the so-called strong version, holds that even if the money supply is held constant, inflation can occur if the fiscal authority is passive.[1] All that is needed is for the public to expect prices to rise. People will then spend their given money balances at a faster rate — increasing the velocity of money — and prices will rise until expectations change. If the fiscal authority is passive, velocity can explode, producing hyperinflation (see McCallum and Nelson 2005). This feature of the strong version is referred to as “speculative inflation” and is independent of monetary policy (Tutino and Zarazaga 2014: 3). The strong version also implies that fiscal action—not monetary reform—is the primary tool for ending a hyperinflation. This version of the FTPL is false: it ignores historical evidence that shows the determining factor in generating hyperinflations is explosive growth in the money supply (or the expectation that such growth will occur); and it fails to recognize that stabilization  results from credible monetary reform.[2]

Expectations about future inflation don’t appear like manna from heaven — businesses and households know that excess money growth causes inflation. They also know that large unfunded government liabilities and budget deficits risk having the central bank monetize debt. Although the strong version of the FTPL assumes away that possibility, history does not.