Topic: Finance, Banking & Monetary Policy

Major Whistleblower Provisions in Financial Regulation Bill

When Congress passes major new regulatory laws, it nowadays routinely throws in provisions authorizing lawsuits on behalf of so-called whistleblowers at regulated businesses. Lawmakers do this despite frequent complaints that such provisions encourage discontented employees to seize on borderline conduct and label it fraud or rule-breaking, enrich some persons who themselves took part in questionable practices, and interfere with companies’ own internal compliance efforts, to name a few presumably unintended consequences.

One reason these provisions are added with such regularity despite their at-best-mixed record is that they are lobbied for avidly by two groups of lawyers, the so-called qui tam bar (which collects a percentage of the sometimes enormous informant bounties provided by statute) and the plaintiff’s employment bar, for whom the laws (especially “anti-retaliation” provisions) can provide valuable leverage in negotiating on behalf of terminated employees even if no bounty is available.

While it has not been a major focus of bill opponents, the Dodd-Frank financial regulation bill is loaded with major new extensions of whistleblower law into the economy’s financial sector. Michael Fox at Jottings By An Employer’s Lawyer has more, and links to a more detailed account at an understandably jubilant plaintiff’s-lawyer site. I covered the issue a few weeks ago at Overlawyered, where there is also background on qui tam and whistleblower matters more generally.

Senate Bill Sows Seeds of Next Financial Crisis

With Majority Leader Harry Reid’s announcement that Democrats have the 60 votes needed for final passage of the Dodd-Frank financial bill, we can take a moment and remember this as the moment Congress planted the seeds of the next financial crisis.

In choosing to ignore the actual causes of the financial crisis – loose monetary policy, Fannie/Freddie, and never-ending efforts to expand homeownership – and instead further expanding government guarantees behind financial risk-taking, Congress is eliminating whatever market discipline might have been left in the banking industry.  But we shouldn’t be surprised, since this administration and Congress have consistently chosen to ignore the real problems facing our country – unemployment, perverse government incentives for risk-taking, massive fiscal imbalances – and instead pursued an agenda of rewarding special interests and expanding government.

At least we’ll know what to call the next crisis: the Dodd-Frank Crash.

Show Me the Money

A number of economists have been warning about the Federal Reserve’s easy-money policy, but defenders of the central bank often ask, “if there’s an easy money policy, why isn’t that showing up in the form of higher prices?” Thomas Sowell has an answer to this question, explaining that people and businesses are sitting on cash because anti-business policies have dampened economic activity.

Not only has all the runaway spending and rapid escalation of the deficit to record levels failed to make any real headway in reducing unemployment, all this money pumped into the economy has also failed to produce inflation. The latter is a good thing in itself but its implications are sobering. How can you pour trillions of dollars into the economy and not even see the price level go up significantly? Economists have long known that it is not just the amount of money, but also the speed with which it circulates, that affects the price level. Last year the Wall Street Journal reported that the velocity of circulation of money in the American economy has plummeted to its lowest level in half a century. Money that people don’t spend does not cause inflation. It also does not stimulate the economy. …Banks have cut back on lending, despite all the billions of dollars that were dumped into them in the name of “stimulus.” Consumers have also cut back on spending. For the first time, more gold is being bought as an investment to be held as a hedge against a currently non-existent inflation than is being bought by the makers of jewelry. There may not be any inflation now, but eventually that money is going to start moving, and so will the price level.

I do my best to avoid monetary policy issues and certainly am not an expert on the subject, so I asked a few people for their thoughts and was told that perhaps the strongest evidence for Sowell’s hypothesis comes from the Federal Reserve’s data on “Aggregate Reserves of Depository Institutions” - specifically the figures on excess reserves. This is the money that banks keep at the Federal Reserve voluntarily because they don’t have any better options. As you can see from the chart, excess reserves shot up during the financial crisis. But what’s important is that they did not come back down afterwards. Some people refer to this as “money on the sidelines” and Sowell clearly is worried that it will have an impact on the price level if banks start circulating it. That doesn’t sound like good news. On the other hand, it’s not exactly good news that banks are holding money at the Fed because there are not enough profitable opportunities.

What this really tells us is that the combination of easy money and big government isn’t working any better today than it did in the 1970s.

Why Limits On Banker Bonuses Are Meaningless

The European parliament has just approved a measure that would limit bonus payments and other aspects of compensation for bankers. National finance ministers are expected to approve the measure next week, and it will take effect Jan. 1. The goal of the legislation is to limit banker incentives to take risk, since this was allegedly a major cause of the recent financial crisis.

The key question about compensation limits is why shareholders and creditors have not imposed these on bank executives already. If the possibility of large bonuses indeed generates excessive risk-taking, then bank stakeholders have ample incentive to adopt such limits without government coercion.

The answer is that bank risk-taking was not necessarily excessive from the perspective of the bank stakeholders, since banks were living in a world with private gains but public losses.  Stakeholders stood to earn large returns when times were good, and they knew taxpayers would cushion the losses – via deposit insurance or accomodative monetary policy – when times went bad.

Since events of the past two years have done nothing but reinforce the view that major banks are too big to fail, the incentive to pile on risk is stronger than ever.

So limits on bank compensation are fighting an uphill battle, and bankers will find ways around them via creative accounting and clever compensation packages. The limits are therefore just political pandering to populist outrage over banker excesses. That outrage is understandable, but limiting compensation will not prevent the next blow up.

C/P at

Active Government, Passive Economy

Today, Politico Arena asks a second question:

What does Obama need to do on jobs?

My response:

What does Obama need to do on jobs? Asked about that in his Arena interview today, Rep. Rob Andrews (D-N.J.) answers, “The best thing we could do is encourage banks to lend money.” Encourage them? Banks don’t need to be encouraged: if they can make money by lending it, they will. But that’s just the problem. The regulatory climate under Obama is so uncertain that capital isn’t moving. Andrews adds that “we need to stimulate,” as if we hadn’t already massively stimulated with little to show but massive debt.  And he says that “the Wall Street reform bill will help.” Apparently he hasn’t read Stanford economist John B. Taylor’s analysis in yesterday’s Wall Street Journal, which concludes: “People may be waking up to the fact that the bill does not do what its supporters claim. It does not prevent future financial crises. Rather, it makes them more likely and in the meantime impedes economic growth.”

Stimulus Now, Restraint Later?

Journalists have been repeating lately that “economists say” that we need yet more government spending now to keep on goosing the economy, even though – to be sure – we will need to cut back on spending at some point in the undefined future, to avoid the fate of Greece. Well, maybe some economists. But I’m sure this “economists agree” claim is no more true today than it was a year ago. Here’s one example, from NYU economist Mario J. Rizzo, coauthor with Cato senior fellow Gerald P. O’Driscoll Jr. of The Economics of  Time and Ignorance:

But let’s look at the arguments made by the opponents of fiscal stimulus.

Some have argued that, as deficits increase, people now offset the putative stimulus by increasing their savings in anticipation of future tax increases. So there is no stimulus now.

Others have argued that, for example, extending unemployment insurance (again) to those unemployed for more than six months will increase the length of unemploymentnow (by subsidizing it) while failing to stimulate.

The stimulus failure is due to the relatively small increase in spending induced by non-permanent increases in income (as unemployment insurance is certainly not permanent source of income). Even more, producers know that the spending is non-permanent so it is unlikely to result in increased employment of labor. Thus, there is no stimulus now; in fact if unemployment continues there is a kind of anti-stimulus now.

Austrians have argued that failing to allow the housing market to adjust by both fiscal and monetary propping-up measures, worsens the situation now by prolonging the inevitable adjustment to a bubble sector. As the adjustment is dragged out and the rest of the economy suffers the dampening effectsnow. This must include the uncertainty as to when (in calendar time) the market will be allowed to adjust.

In empirical work, John Taylor finds that to the extent there was some effect of the fiscal stimulus it was very small and lasted only a matter of two or three months for each major injection. So I guess the long run is four or five months by this reckoning:

Compared with the 2008 stimulus, the 2009 stimulus was larger, but the amount paid in checks was smaller and more drawn out. Nevertheless, there is still no noticeable effect on consumption. I also show the timing of the “Cash for Clunkers” program in Figure 7; it did encourage some consumption, but did not last and cannot be considered an effective method to stimulate the economy. In addition, my analysis of the government spending part of the stimulus is that it too had little positive impact.

Even frameworks that stress future consequences of current stimulus need not be long-run theories in the calendar sense. For example, if the anticipated taxes required to pay off or service current deficits consist of rises in marginal income tax rates, output will be considerably lower and the real interest rates higher in a matter of a couple of years than without stimulus.

The upshot of all of this is that the anti-stimulus economists are not claiming we must trade off benefits now for some long-term pie-in-the-sky benefits. Most are saying: The stimulus route leads to (almost) no benefits now as well as costs later.

Re. Ezra Klein: Did State and Local Anti-stimulus Nullify Federal Stimulus?

A recent Washington Post column by Ezra Klein dreamed up a new excuse for the conspicuous failure of Obama’s so-called stimulus plan.   Klein argues that the stimulus of federal spending has been offset by the “anti-stimulus” of fiscal austerity by state and local governments.  For proof he quotes Bruce Bartlett, who is fast becoming the favorite go-to guy for liberals seeking conservative allies in their endless quest for more spending and taxes. 

Bartlett says, “When the history of the current crisis is written, much of the blame will be placed on the sharp fiscal contraction of state and local governments.  I think economists will view this as a preventable error equivalent to the Fed’s passive shrinkage of the money supply in the early 1930s.”

A historian himself, Bartlett imagines this to be a question that will have to be pondered by historians in the distant future.   But it is easy to identify each sector’s direct contribution to the overall growth rate of real GDP from a St. Louis Fed publication, “National Economic Trends.” 

State and local government spending was rising during the first three quarters of the recession, and the drop in the fourth quarter of 2008 accounted for just 0.25% of the 5.37% annualized decline in GDP.  In the first quarter of 2009, state and local spending subtracted  just 0.19% from real GDP, but federal spending subtracted more (0.33%) due to cuts in defense spending.  Government obviously made only a minor contribution to the 6.4% drop in overall GDP.
In the second quarter of 2009, state and local spending was way up (by 0.48%), as was federal spending (0.85%).  But the private economy did not begin expanding until the third quarter – when government spending stopped diverting so many resources to unproductive uses.
The table shows that government spending on goods and services had nothing to do with the recovery (transfer payments don’t contribute to GDP).  

As a matter of simple accounting, the state and local sector has been a very minor negative force −scarcely comparable to the Fed’s inaction in 1930-32

Federal purchases, whether for heavily-subsidized ”green jobs” or shovel-ready pork, have been virtually irrelevant during the last two quarters.

Contributions to Real GDP Growth
……………………..  3rd…… 4th…… 1st qtr

Real GDP              2.2         5.6             3.0%
Private                   1.6         5.8             3.4
Federal                  0.6        0.0            0.1
State & Local     -0.1      -0.3           -0.5