Topic: Finance, Banking & Monetary Policy

Uncle Sam: Payday Lender

One of the puzzles of Congressional efforts to “reform” our financial system to avoid future crises is the amount of attention to lenders who had nothing to do with the crisis (almost as puzzling as the inattention to many who did).

Today’s Washington Post, for instance, details the efforts of payday lenders to fight back against both Senator Dodd’s new consumer agency and Senator Hagan’s amendment, that would essentially eliminate the consumer option of payday loans.

In general, any efforts to restrict consumer choice is rarely likely to improve consumer welfare.  This has been repeatedly demonstrated in research on payday lending.  Senator Hagan played a key role in banning such products in North Carolina.  What was the result of that ban?  Don Morgan, at the Federal Reserve Bank of New York, decided to test whether such a ban helped or hurt consumers.  He compares how households in North Carolina fared after payday loan bans.  The results: since the loans were banned in 2005 in North Carolina, compared to states where payday lending is permitted, households in NC have bounced more checks and complained more to FTC about lenders and debt collectors. “The increased credit problems contradicts the debt trap critique of payday lending, but is consistent with the hypothesis that payday credit is preferable to substitutes such as the bounced check protection sold by credit unions and banks or loans from pawnshops” states Morgan.

Where Hagan proposes to ban payday, Dodd proposes to have banks and non-profits directly compete with payday lenders, but with one big, important difference: taxpayers would cover a substantial portion of the credit losses.  Buried at the end of Dodd’s massive bill in Title XII is a grant program that would cover credit losses on “payday” loans made by non-profit community lenders as an “alternative to more costly payday loans.”  Of course the private sector loans will be more costly, as the lender will have to charge a rate that covers its losses.  The difference between Dodd’s proposal and the private sector is that while private sector payday loans may be expense, they are entered into voluntarily, whereas Dodd make the taxpayer an unwilling participant in subsidizing high risk borrowing.  Perhaps Dodd should examine previous efforts to subsidize high cost mortgage lending, before we repeat the same mistakes in payday.

Friedman and Moynihan Agree with Sanders and Paul

Reportage in today’s New York Times (“Consensus For Limits to Secrecy At the Fed” by Sewell Chan) indicates that more auditing of the Fed is probably in the cards.

Prof. Milton Friedman and Senator Daniel Patrick Moynihan would have most certainly agreed with the thrust of the Senate (S. 604) and House (H.R. 1207) bills sponsored by Senator Bernard Sanders and Representative Ron Paul, respectively.  These bills would partially lift the shroud of secrecy draped over the Fed.

Prof. Milton Friedman weighed in on central bank independence in a 1962 essay, “Should There Be an Independent Monetary Authority?”  Prof. Friedman’s conclusion: “The case against a fully independent central bank is strong indeed.”  As for letting in some sunshine, Senator Moynihan had this to say: “Secrecy is for losers.”

Federal Reserve 1, Transparency 0

It is being reported that the Senate has reached a “compromise” on Bernie Sanders’ amendment to audit the Federal Reserve.  This amendment was a companion to Ron Paul’s House bill that would have subjected both the Federal Reserve’s lending facilities and monetary policy to a GAO audit.  The compromise?  Drop the monetary policy audit.  It is hard to match Ron Paul’s reaction:  “Bernie Sanders has sold out.”

Congressmen Paul is 100% right on this.  While it is important to get details on the Fed’s emergency lending facility, those decisions are behind us.  The public has a right to know who benefited from the Fed’s actions, but the reality is that such an audit would change little going forward.  The real action is monetary policy.

After having spent seven years as a staffer on the Senate Banking Committee, I can attest that most senators, congressman and their staff have little understanding of the mechanics of monetary policy.  Just listen to any random appearance of the Fed chairman before Congress and you will immediately know what I mean.  But then, congressman in general don’t understand the workings of most federal programs.  That is one of the purposes of the GAO: to help explain to Congress how programs work and evaluate how well those programs are working.  I can think of no area more in need of such understanding than monetary policy.

Of course, some worry that an audit would undermine the claimed independence of the Fed.  For instance, former Hartford insurance exec, now Obama Treasury official, Neal Wolin praised the compromise, claiming the original language would “threaten the central bank’s independence from Congress.”  Sadly, Mr. Wolin is confused about the nature of the Fed.  If there is a constitutional basis for the Fed, it is Article I, Section 8’s delegation to Congress of the ability “to coin money, regulate the value there of,”  which Congress has delegated to the Fed.  The supposed independence of the Fed is from the Executive branch, not Congress.  And one of the very reasons for an audit is for the public to have a window into the dealings of the Fed with the Executive branch, most importantly the Treasury.  What Mr. Wolin and others are trying to protect is the favored relationship between Treasury and the Fed.  A GAO audit would shift the balance of power over the Fed away from the Executive and back to Congress, who despite its many problems, is directly accountable to the American public.

The gutting of the Sanders’ amendment is a huge win for both Wall Street and the Treasury (is there any longer a difference between the two?), and a massive loss and missed opportunity for the American public, and its representatives in Congress, to regain some control over an agency (the Fed) that has acted as a piggybank for both Presidents Bush and Obama.

Should We Break Up the Banks?

When it comes to banking policy, there are few people I respect more than Jonathan Macey and Arnold Kling; so when these two, independently, argue that we should be breaking up the largest banks, it is idea that merits consideration.  Yet I still have my doubts.

First, lets start with what we are fairly certain of.  There is a large empirical literature that suggest most US mega-banks are beyond their efficient size.  There is a good survey of the literature by former Fed Economist Allen Berger .  So, at a minimum, the academic literature suggests the largest banks are beyond a size that is justified by the social benefits.

However, there is also a small literature that suggests more concentrated banking systems are more stable, and less prone to crisis.  Some of this literature has grown out of research efforts by the World Bank.  While this literature is largely cross-country comparisons, recalling our own banking history gives several examples - the savings & loan crisis, the mass of small banks failures in the 1920s and 1930s, and current day Georgia - where lots of small bank failures have been associated with significant economic damage.  So, at minimum, there is some question of whether breaking up the largest banks would give us a more stable, less crisis-prone system.  In fact, there is considerable evidence to suggest that breaking up the banks would make our financial system more fragile.

To some extent, the debate over breaking up the large banks is about reducing political power.  The argument is that, because of their vast resources, these large banks unduly influence and capture our political system.  Undoubtedly, I believe the largest banks have substantial influence over both our legislative and regulatory systems.  However, so do smaller banks.  From my seven years as staff on the Senate Banking Committee, I would definitely argue that the Independent Community Banks Association (ICBA), as a group, has far more pull than does say Bank of America, as a single company.  One need only witness the various exemptions for small banks in the Dodd bill, for instance from the consumer protection bureau, to illustrate the lobbying power of small bankers.  One could also argue that the economic history of progressive era legislation, like the Sherman Act, is one of smaller, organized interests winning against larger sized firms.  Despite its appeal, the assertion that bigger is always better in politics is just an assertion.  Yet this is at heart an empirical argument, and perhaps one that can be tested.  Until then, I still have my doubts.

Failing Banks: Bankruptcy or Receivership?

In today’s Wall Street Journal Stanford Professor John Taylor argues that resolving failing financial institutions via the bankruptcy process rather than a FDIC style receivership process is the only way to really limit bailouts.  The heart of the argument is that the government is far more likely to inject funds if the process is controlled by political appointees and bureaucrats, rather than a judge.  While this is probably the best reason to use the courts instead of a bureaucratic process, there are many other reasons to consider.

Proponents of administrative receivership often argue that the bankruptcy process is simply too slow to deal with banks and other financial institutions.  “Too slow” sounds like an empirical question to me.  So what does the data say?  An interesting article in the Journal of Finance reports the median time in Chapter 11 to be 28 months and the median time in Chapter 7 to be 22 months.  How does this compares to FDIC bank resolutions?  Surprisingly, not bad.  A Federal Reserve Bank of Chicago study finds the median time for FDIC resolutions to be 28 months, just as long as they typical Chapter 11, but longer than the typical Chapter 7.  It could be argued that bankruptcy is actually quicker, as a Chapter 7 liquidation is more compare to an FDIC receivership than is Chapter 11.

Given that there doesn’t seem much of a time advantage to receivership, is there a cost advantage?  After all, bankruptcy does require all those lawyers.  In regards to bankruptcy, there is good data on costs. The median cost for a Chp 7 is 2.5% of assets, and for Chp 11, 2% of assets.  Interestingly, the largest expense in Chp 11 is administering the creditors committee, which would not be needed in a receivership (as creditors go unrepresented).  Also of interest is that costs, as a percent of assets, decline with size.  For firms above $10 million in assets, median costs are 0.8% of assets.

Unfortunately there is not good public data on the FDIC’s costs.  I have been told, however, that despite my initial suspicions, the $50 billion figure in the Dodd bill was calculated as the cost to resolve an entity like Lehman.  At the time of its failure, Lehman’s assets were around $600 billion.  If we are to take $50 billion as the cost of resolution, that would imply a resolution cost in excess of 8%, considerably above what a comparable Chp 11 would cost.  As the Lehman bankruptcy is resolved, we will have better data, yet at least from the various data points we have, the case for FDIC being a cheaper, or faster, alternative than the courts is far from conclusive, with some evidence suggesting the contrary.

Heating Up the Covert Generational War

My latest book Social Security: A Fresh Look at Reform Alternatives (available here) argues that it’s not just labor quantity — the number of employees who are accruing future Social Security benefits — that will determine the size of Social Security’s future imbalances (and, incidentally, those of Medicare, and the size of deficits for all of government), but also the quality of that labor — the value of the work those employees are doing. 

Declining labor quality (as experienced baby boomers retire) will reduce taxable payrolls faster than is being projected by the Social Security Administration and the Congressional Budget Office.  The result is even more beneficiaries receiving Social Security checks, and lower-wage workers who will be funding those checks.

In the book, I construct a detailed simulation of U.S. demographic and economic forces over the coming decades to estimate how much of a drag declining labor quality will exert on labor productivity, countering the effects of capital accumulation and technological advance.

Now James Heckman has coauthored a study suggesting that the same thing is happening in Europe, traceable in part to public policies promoting less use and low maintenance of worker skills through the early retirement incentives of their public pension, welfare, and health systems. 

So it is quite clear how the developed world (Anglo-Saxon and mainland Europe) will spiral downward.  We’ll all vote to “strengthen” social insurance systems (the U.S. health care “reform” this year being the latest example), only to further weaken incentives for the young to acquire skills, further erode the tax base, which in turn will promote the further “strengthening” of social insurance protections … and so on. 

My old idea of a “covert generational war” is playing out before our very (but fully blind) eyes.

Two months ago, EU officials were even flirting with the idea of a cross-country crisis insurance institution — a European Monetary Fund. 

One ironic element in the ongoing European crisis: Remember how the EU’s erstwhile Stability and Growth Pact included penalties on nations who exceeded the 3 percent fiscal deficit rule?  Turns out, penalties must now be paid by the “successful” countries — mainly Germany and France — by coughing up the aid packages!

Planned Economy, Privacy Problems

If someone asked you what’s wrong with a planned economy, your first answer might not be “privacy.” But it should be. For proof, look no further than the financial regulation bill the Senate is debating. Its 1,400 pages contain strong prescriptions for a government-micromanaged economy—and the undoing of your financial privacy. Here’s a look at some of the personal data collection this revamp of financial services regulation will produce.

The “Office of Financial Research” (sec. 152) will have a “Data Center” (sec. 154) that requires submisson of data on any financial activity that poses a threat to financial stability.

Use your noggin, now: Will government researchers know in advance what might cause financial instability? Will they home in on precisely that? No.

This is government entrée into any financial activities federal bureaucrats suspect might cause instability. It’s carte blanche to examine all financial transactions—including yours. (Confidentiality rules? The better view is that privacy is lost when the government takes data from your control, but we’ll come back to confidentiality.)

The Office of Financial Research is also a sop to industry. Morgan Stanley estimates that it will save the company 20 to 30 percent of its operating costs. The advocates for this bureaucracy want to replace the competitive environment for financial data with a uniform government data platform. Students of technology will instantly recognize what this data monoculture means: If the government’s data and assumptions are bad, everyone’s data and assumptions are bad, and all players in the financial services system fall together. The Office of Financial Research itself poses a threat to financial stability.

But all that’s about money. On with privacy…

The “Bureau of Consumer Financial Protection” (sec. 1011) in the bill is another beetle boring into your personal financial life. Among its mandates is to “gather information … regarding the organization, business conduct, markets, and activities of persons operating in consumer financial services markets” (sec. 1022(c)(4)).

In case you’re wondering, the definition of “person” includes “an individual” (sec. 1002(17)). The Bureau of Consumer Financial Protection can investigate your business conduct and activities.

Come now. All this private data gathering can’t possibly be what they mean to do, can it?

Section 1071(b) requires any deposit-taking financial institution to geo-code customer addresses and maintain records of deposits for at least three years. Think of the government having its own Google map of where you and your neighbors do your banking. The Bureau may “use the data for any other purpose as permitted by law,” such as handing it off to other bureaus, like the Federal Bureau of Investigation.

Still, that’s really not what the Bureau of Consumer Financial Protection is supposed to be about, is it? It can’t be!

It’s not. Nor was the Social Security number about creating a uniform national identifier that facilitates both lawful (excessive) data collection and identity fraud. The construction of surveillance infrastructure doesn’t turn on the intentions of its builders. They’re just giving another turn to the wheels that crush privacy.

Promises of confidentiality and “de-identified” data are not reassuring. It’s getting harder and harder to collect data that are not personally identifiable. Latanya Sweeney’s 2002 “k-anonymity” paper is best known for establishing how anonymous data can be “re-identified,” unraveling promised confidentiality and privacy.

Just a few “anonymous” data points can pick out individuals. Data-driven triangulation on individuals will get easier as data collection grows society-wide. Confidentiality rules in the bill will tend to fail over time, if they’re not simply reversed when some future exigency demands it. If we’re to maintain privacy, government data collection should be shrinking, not growing.

How do you manage an economy from the top? You collect data. Thanks to computing and communications, there are lots of data available nowadays. Maybe the failed Progressive-Era dream of “scientific government” has been revitalized by the idea that data can shore up regulation’s natural defects.

My colleague Mark Calabria has investigated and drawn into question whether it was a lack of consumer protection that caused the financial crisis. But Washington, D.C. has determined that Washington, D.C. should manage the financial services industry. Your personal and private financial affairs will be managed there too.