Topic: Finance, Banking & Monetary Policy

Where’s All the TAG Bank Lending?

The Senate is poised to vote on extending FDIC’s Transaction Account Guarantee (TAG) program, which offers government deposit insurance for bank accounts over $250,000.  I’ve written elsewhere why this program is a big bank bailout that benefits mainly large account-holders.

I suspect the banks that are lobbying for an extension of TAG are offering all sorts of claims that not extending TAG would hurt the economy by reducing lending.  Unfortunately for those banks there is little evidence that TAG resulted in any new net lending.

Before TAG was created, federal depositories (banks and thrifts), held about $8.2 trillion in total deposits.  They also held about $7.6 trillion in net loans and leases.  This makes for a ratio of about 93%.  Today that ratio is just above 70% (see chart).  While deposits increased during the crisis, and after the creation of TAG, by over $2 trillion, net loans and leases actually fell in $7.4 trillion.  Whatever banks are doing with all these extra deposits, one thing they aren’t do is much new net lending.

For the most part banks are using TAG deposits to either play in the derivatives market (think JP’s London Whale) or to purchase large amounts of Treasuries and Fannie/Freddie securities.  We would be far better off if this lending flowed to businesses rather than government.  Banks have also used TAG to reduce their subordinated debt, further decreasing market discipline.

Much of TAG came at the expense of the money market mutual funds (MMMF).  One of the reasons for Treasury’s MMMF guarantee program was actually to off-set the impact of TAG.  Now that the (explicit) guarantee of MMMF is gone, we should end TAG.  Shifting funds from MMMF to TAG has also resulted in significant disruptions to the commercial paper market, furthering harming business investment.  We should start eliminating the various government guarantees of the banking system, starting with TAG.

It Is The Same Banks that Repeatedly Get in Trouble

When the December issue of the Journal of Finance landed on my desk, it was almost like Christmas had come early.   Among the articles was an interesting examination of banks which failed (or were rescued) during the recent financial crisis (for a non-pay-wall working paper version see here).  The authors set out to ask a simple question:  how well does the performance of individual banks in 1998 predict their performance in the recent crisis? 

Recall in 1998 Russia defaulted on some of its debts.  It was generally believed (erroneously) that nuclear powers did not default.  Market participants did not take the news well, with a resulting flight to quality and spike in lending spreads.  Then Treasury Secretary Robert Rubin called it “the worst financial crisis in the last 50 years” (sounds a little familiar).

While the authors find that other factors, such as leverage and reliance on short-term funding, were significant predictors of failure, 1998 performance predicted well which banks got in trouble this past crisis.  This effect is likely capturing a variety of bank specific characteristics, such a firm culture, risk tolerance and management style. 

One of the central debates about financial crises is to what extent are shocks contagious, like a disease that spreads from one bank to another, or rather do shocks, such as recessions, separate weak firms from strong firms?  If the former then broad-based Geithner-Bernanke style rescues might be appropriate.  If however failures are limited to weak firms, then rescues keep these weak firms, with their dysfunctional cultures around. 

The results of this paper suggest to me the importance of allowing firms to fail, rather than resorting to bailouts.  One of the fundamental problems of our current bank regulatory regime is that it is subject to its own flawed theory of intelligent design.  If only enlightened regulators are given sufficient power, they can design the best system.  I believe reality is quite different.  Only by allowing the evolutionary sorting of banks, and their firm cultures, can we improve the stability and efficiency of our financial system.

Tarullo: No Return to Glass-Steagall

Finally, a senior banking regulator has acknowledged the so-called repeal of Glass-Steagall had nothing to do with the 2008 financial crisis. In a recent speech, Fed governor Daniel Tarullo noted that most firms at the center of the financial crisis in 2008 were either stand-alone commercial banks or investment banks, and therefore would not have been affected by the repeal. Tarullo also expressed concern that a reinstatement of Glass-Steagall would be costly for banks and their clients and would result in less product diversification.

Of all the myths underpinning the response to the 2008 financial crisis, one of the most persistent is that the repeal of Glass-Steagall was a major contributing factor. So Tarullo’s comments are heartening. But still, he misses out one key piece of the puzzle, namely, that multifunctional, diversified financial firms are not just more efficient and cost-effective than their more specialized counterparts; they are frequently more stable.

The banks that got into trouble in 2008 did so because they concentrated their risk in one kind of asset. The firms that did comparatively well throughout the crisis avoided this particular mistake and were able to come to the rescue, admittedly with some government assistance, of their ailing counterparts—think Wells Fargo or JPMorgan. Firms fail when they make bad investment decisions, regardless of their structure.

North Korea’s Hyperinflation Legacy, Part II

Following North Korean supreme leader Kim Jong-il’s death last December, many around the world had high hopes that his successor (and son), Kim Jong-un, would launch much-needed economic and political change. Unfortunately, in the months since the new supreme leader assumed power, little has changed for North Koreans outside of the small, communist upper class. The failed communist state has not delivered on its advertised economic reforms.

One thing it has delivered, however, is weapons, which have flowed through its illegal arms-trafficking pipelines. And, if that’s not enough, North Korea is planning another missile test  in the near future. But, as it turns out, the only thing that is certain to blast off is inflation.

In my recent blog post, I pointed out that one of North Korea’s communist legacies is hyperinflation (in addition to starvation). Indeed, hyperinflation may soon plague North Korea once again.

From what little data are available, it would appear that, in the span of six months, the price of rice has increased by nearly 130%. This is par for the course in North Korea, where the price of rice has increased by roughly 28,500% over the last three years (see the chart below).

 

 While the North Korean government worries about rocket launches and how to supply Syria with weapons, and while its archaeologists “discover” ancient unicorn lairs, its citizens’ food bowls are becoming quite expensive to fill. The supreme leader’s priorities, it would seem, are supremely out of whack.

Teachers — and Unions — Like Profits, Too

By now you’ve probably seen the economically ignorant, Ed Asner-narrated polemic from the California Federation of Teachers that “explains” how the rich hurt everyone because they are just so darn greedy. At one point in the original version the already loathsome Richy Rich actually goes so far as to relieve himself on the middle- and lower-class people above whom he rises  on his pile of cash. Don’t look for that “trickle down” visual now, though. It seems the CFT has edited it out after getting, shall we say, less than positive reviews for it. The rest of the tedious allegory, however, isn’t much more subtle.

It’s the reality-denying hypocrisy of it all, though, that is so grating. You see, teachers and unions want to profit just as much as reviled “Wall Street fat cats.”

“What?!” I can hear the teachers reading this scream. “I don’t do this for the money! How dare you, sir!”

Mr. and Mrs. Teacher, please bear with me for a moment.  I mean you no harm.

First, undertsand what profit is. Basically, it is making more from providing something than it costs to produce it. So if you are a teacher and use your earnings to buy food, housing, cable television, garden gnomes, airplane tickets, plastic surgery – anything – you are making a profit. And on an hourly basis likely a good profit, outpacing accountants and auditors, insurance underwriters, registered nurses, and other professionals. And that is without considering quite generous benefit packages public school employees often get.

Those concrete things, though, are not the compensation limits. There’s also substantial job security that comes with tenure, and in conjunction with teaching not being especially hard to break into, relatively little personal risk. Contrast that to entrepreneurs – you know, people who sometimes become fat cats – who often risk much of what they have to try new things that often end in failure. Such risk is a huge cost teachers simply don’t deal with.

In addition, while working with children is often very challenging, it can also be very rewarding. Who doesn’t get a kick out of the antics, questions, and comments of little kids? (I mean, they say the darndest things, right?) Or enjoy seeing their smiling faces. And when they get older, it can be very gratifying to guide them or inspire them as they contemplate what they want to do with their lives. In contrast, running a business  involves often stultifying detail work such as running payroll, securing office space, keeping “the books,” dealing with detailed government regulations, etc.

Finally, and perhaps most importantly, there is nothing wrong with making a profit! Indeed, being profitable is generally the key to knowing that what you are doing is in demand – that you are providing something that makes other people better off – and, because you are earning more than the cost of production, you are doing something sustainable. So teachers, don’t disdain profits – embrace them!

Perhaps, though, be concerned about how you are getting them.

While there is far too much crony capitalism at work – businesses enriching themselves through government and politics – in general, companies can only make profits by earning the voluntary business of customers. In other words, they have to provide something people want, at a cost they are willing to pay. Payers have to feel they are better off.

Not so for public school teachers. Rather than getting paid by voluntary customers, they are ultimately paid with money extracted through government. Whether taxpayers like it or not, they are forced to pay for public schools. Which is, of course, why teachers’ unions are so deeply involved in politics.  They want to take people’s money no matter what.

The real irony is that many teachers could probably get paid more – in Korea some get MUCH more – were free enterprise rather than socialism allowed to reign. But we have a government monopoly, which is ripe for union control. One system, without any real competition, is best suited to have one employee rep. Allow people to freely choose among autonomous schools, however, and schools would have big incentives to pay the best teachers well because providing a great service – not throwing around political weight – would be the key to success.

Teachers, ultimately, are human beings, and on the whole almost certainly enjoy profit as much as anyone else. That’s not a problem. The problem is how they – and much worse, their unions – make it.

Sports ‘Donations’ a Flagrant College Foul

I love me some Georgetown University basketball, and am happy to pay for the privilege of possessing season tickets. (Well, that is when the Hoyas win pretty regularly and don’t deliver too many abominations like this one.) I’m also more than willing to make the hoops club “donation” that’s required to secure my seats. But it’s high time to end the ludicrous college sports scam—especially in light of our fast-approaching rendezvous with the “fiscal cliff”—that is the tax deduction for ticket-securing “charitable” donations.

My forced giving, to be honest, is pretty small: $100 per seat for some decent, lower bowl (though not center court) seats. But it’s not like I’m spending the dough to support, say, a new science center, or endow a professorship. No, it’s going to support big-time, constantly televised, money-making sports entertainment. And, of course, it is the fun of being an in-person fan—not my selfless desire to, say, engineer mitochondria to better serve humanity—that is animating my “charity.” Nonetheless, 80 percent of my donation is tax deductible.

At many big-time sports schools, and for better seats than mine, such forced philanthropy can be much pricier. At some institutions, such as the University of Texas and the University of North Carolina, it is impossible to nail down just how much people have to donate per seat beyond sticker prices because one accumulates donation points over time. Just to make it onto the UT benefits chart, however, you have to donate at least $150, and the top-line is $25,000. Texas A&M lets you know that for “priority” football tickets you’ll have to give between $45 and $3,900 per seat. And for most of the lower-bowl seats at the University of Kentucky’s Rupp Arena, basketball season tickets require donations of between $850 and $5,000. But don’t worry—part of the price can be handled by corporate matching funds!

If people want to donate generously to college sports programs—including cash-cow football and basketball—that’s fine. And I don’t want government getting any more money than it already has … and flushes down noble-sounding toilets. But giving favored tax status to forced donations for season tickets, as if one were donating to famine relief or cancer research? Even without the nation facing a $16 trillion—and growing—debt, that’s ridiculous.

Cross-posted from SeeThruEdu.com

The UK’s Capital Obsession

Last Thursday, Mervyn King, the outgoing governor of the Bank of England, called for yet another round of recapitalization of the major UK banks. For some time, I have warned that higher bank capital requirements, when imposed in the middle of an economic slump, are wrong-headed because they put a squeeze on the money supply and stifle economic growth. So far, bank recapitalization efforts, such as Basel III, have resulted in financial repression – a credit crunch. It is little wonder we are having trouble waking up from the current economic nightmare.

So why would Mr. King want to saddle the UK banking system  with another round of capital-requirement increases, particularly when the UK economy is teetering on the edge of a triple-dip recession? Is King simply unaware of the devastating unintended consequences this would create?

In reality, there is more to this story than meets the eye. To understand the motivation behind the UK’s capital obsession, we must begin with infamous Northern Rock affair. On August 9, 2007, the European money markets froze up after BNP Paribas announced that it was suspending withdrawals on two of its funds that were heavily invested in the US subprime credit market. Northern Rock, a profitable and solvent bank, relied on these wholesale money markets for liquidity. Unable to secure the short-term funding it needed, Northern Rock turned to the Bank of England for a relatively modest emergency infusion of liquidity (3 billion GBP).

This lending of last resort might have worked, had a leak inside the Bank of England not tipped off the BBC to the story on Thursday, September 13, 2007. The next morning, a bank run ensued, and by Monday morning, Prime Minister Gordon Brown had stepped in to guarantee all of Northern Rock’s deposits.

The damage, however, was already done. The bank run had transformed Northern Rock from a solvent (if illiquid) bank to a bankrupt entity. By the end of 2007, over 25 billion GBP of British taxpayers’ money had been injected into Northern Rock. The company’s stock had crashed, and a number of investors began to announce takeover offers for the failing bank. But, this was not to be – the UK Treasury announced early on that it would have the final say on any proposed sale of Northern Rock. Chancellor of the Exchequer Allistair Darling then proceeded to bungle the sale, and by February 7, 2008, all but one bidder had pulled out. Ten days later, Darling announced that Northern Rock would be nationalized.

Looking to save face in the aftermath of the scandal, Gordon Brown – along with King, Darling and their fellow members of the political chattering classes in the UK – turned their crosshairs on the banks, touting “recapitalization” as the only way to make banks “safer” and prevent future bailouts.

In the prologue to Brown’s book, Beyond the Crash, he glorifies the moment when he underlined twice “Recapitalize NOW.” Indeed, Mr. Brown writes, “I wrote it on a piece of paper, in the thick black felt-tip pens I’ve used since a childhood sporting accident affected my eyesight. I underlined it twice.”

I suspect that moment occurred right around the time his successor-to-be, David Cameron, began taking aim at Brown over the Northern Rock affair.

Clearly, Mr. Brown did not take kindly to being “forced” to use taxpayer money to prop up the British banking system. But, rather than directing his ire at Mervyn King and the leak at the Bank of England that set off the Northern Rock bank run, Brown opted for the more politically expedient move – the tried and true practice of bank-bashing.

It turns out that Mr. Brown attracted many like-minded souls, including the central bankers who endorsed Basel III, which mandates higher capital-asset ratios for banks. In response to Basel III (and Basel III, plus), banks have shrunk their loan books and dramatically increased their cash and government securities positions (both of these “risk free” assets are not covered by the capital requirements imposed by Basel III and related capital mandates).

In England, this government-imposed deleveraging has been particularly disastrous. As the accompanying chart shows, the UK’s money supply has taken a pounding since 2007, with the money supply currently registering a deficiency of 13%.

 

How could this be? After all, hasn’t the Bank of England employed a loose monetary policy scheme under King’s leadership? Well, state money – the component of the money supply produced by the Bank of England – has grown by 22.3% since the Bank of England began its quantitative easing program (QE) in March 2009, yet the total money supply, broadly measured, has been shrinking since January 2011.

The source of England’s money-supply woes is the all-important bank money component of the total money supply. Bank money, which is produced by the private banking system, makes up the vast majority – a whopping 97% – of the UK’s total money supply. It is bank money that would take a further hit if King’s proposed round of bank recapitalization were to be enacted.

As the accompanying chart shows, the rates of growth for bank money and the total money supply have plummeted since the British Financial Services Authority announced its plan to raise capital adequacy ratios for UK Banks.

 

In fact, despite a steady, sizable expansion in state money, the total money supply in the UK is now shrinking, driven by a government-imposed contraction in bank money. So, contrary to popular opinion, monetary policy in the UK has been ultra-tight, thanks to the UK’s capital obsession.

Despite wrong-headed claims to the contrary by King, raising capital requirements on Britain’s banks will not turn around the country’s struggling economy – any more than it will un-bungle the Northern Rock affair. Indeed, this latest round of bank-bashing only serves to distract from what really matters – money.