Topic: Finance, Banking & Monetary Policy

Krugtron the Invincible or the Undercover Economist?

If one questions the old-school Keynesian orthodoxy, one risks being accused by Paul Krugman of being complicit in an “anti-scientific revolution” in macroeconomics:

[w]e had a scientific revolution in economics, one that dramatically increased our comprehension of the world and also gave us crucial practical guidance about what to do in the face of depressions. The broad outlines of the theory devised during that revolution have held up extremely well in the face of experience, while those rejecting the theory because it doesn’t correspond to their notion of common sense have been wrong every step of the way.

Yet a large part of both the political establishment and the economics establishment rejects the whole thing out of hand, because they don’t like the conclusions.

Galileo wept.

While there is no question of the importance of Keynesian models in 20th-century economic thinking, the current pluralism of modeling and empirical strategies in macroeconomics is a fact of life. The existence of divergent views on macroeconomics should not be surprising, given by the difficulty of doing clean empirical tests. Krugman does his discipline a disservice by elevating one narrow subset of models to the status of a well-established scientific truth and presenting the views of a large part of what he calls “the economics establishment” – i.e. of numerous other academics – as somehow obviously false and irrelevant.

So when it comes to economic journalism, one can – and should – do better than Krugman. To see a living example, come next Thursday to Cato and listen to Tim Harford (or watch live here if you can’t make it). Harford may disagree with libertarians on many issues but, unlike Krugman, he has always been the epitomy of civility. What is more, his writings demonstrate that one can communicate complicated ideas to wide audiences without falling into tired ideological clichés and self-righteousness.

Inflation and Injustice

More than a few places in this world people are trying to better themselves by saving money. Many people without access to formal financial services (or awareness of their benefits) are trying to amass capital by squirreling away cash. If wariness and luck prevent that money from being stolen, their nest-eggs might provide life-saving health care, seed capital for businesses, the means to move, education for children, and numerous other enhancements to poor people’s well-being. I say good for them. But there are people out there who don’t care if government policy stands in the way.

Unknown to many cash-hoarders—unsophisticated investors who should have our sympathy—official government policy in many countries is to inflate the currency. Under stable conditions, such policies might reduce the value of the existing stock of money at a rate of about 2% per year.

That is a boon to governments, of course, which are typically debtors. The policy quietly reduces real government debt by 2% annually without need of raising official taxes. And whether they spend the money themselves or infuse their banking sectors with liquidity, governments use monetary policy to curry favor with important political constituencies, thus solidifying power.

Bernanke’s View of Fiscal Policy

Federal Reserve chairmen are famous for their opaque but sophisticated-sounding comments designed to make it appear that they know more about the shape of the economy than they really do. But outgoing chairman Ben Bernanke’s direct and transparent assertions yesterday about fiscal policy also left me scratching my head.

In response to a reporter’s question about why the economy has not created more jobs:

Bernanke saw several of the usual reasons: the nature of the financial crisis, the housing bust and trouble in Europe. But he added one more. ‘On the whole, except for in 2009, we’ve had very tight fiscal policy,’ he said. ‘People don’t appreciate how tight fiscal policy has been.’

In the usual (and weird) Keynesian view of the economy, government deficits are stimulative while surpluses are “tight” or destimulative. The following chart (based on CBO) shows that in the four years after 2009, we had $4.4 trillion of federal deficit spending, or supposed Keynesian stimulus. Calling that “very tight fiscal policy” is absurd.

Edwards Chart

Some Preliminary Thoughts on the New “Final” Volcker Rule

There was only one way that the five regulatory agencies tasked with drafting the Volcker Rule–the provision of Dodd-Frank limiting proprietary trading by banks–were ever going to meet the year-end deadline and give meat to a poorly drafted statutory provision. That was if they retained maximum ex post facto discretion to decide whether bank activity is permissible or not under the rule. Unsurprisingly, this appears to be exactly what they have done.

I have some particular concerns:

The rule will require a “maze of regulators” (via the Wall Street Journal)

You thought the debate over the extraterritorial application of cross border derivatives (i.e., the fight between the Securities and Exchange Commission and the Commodities Futures Trading Commission)was contentious? Volcker is going to be five times worse. The rule still requires ongoing monitoring and enforcement by FIVE separate agencies and, as Wayne Abernathy of the American Bankers Association noted, there is still no mechanism for coordination built into the rule.

The rule lacks “bright line distinctions” (per Janet Yellen)

Basically banks won’t know if they’re in compliance or not until their regulator determines it. Ominously, SEC chairman Mary Jo White said that the regulators would be available to add “clarification.” Needless to say, a final rule should not need clarification.

The devil is in the enforcement

Several of the regulators noted that the key to “successful” implementation of the rule is ongoing monitoring and enforcement. But how do you monitor and enforce a rule that doesn’t have a bright line? So much for the rule of law.

The rule contains an exception for sovereign debt

In other words, banks can trade in as much sovereign debt as they want for their own account, but if they were to engage in similar activity with respect to investment grade corporate debt–Exxon Mobil for example–this will be illegal proprietary trading. (I feel safer already!)

Much of the “new final” rule does not have the benefit of public input

The two SEC commissioners who voted against the rule both complained they did not have sufficient time to review the contents–one labeled the year-end deadline “wholly political”–and were concerned that many of the new provisions did not have the benefit of public comment. They are correct that, at the very least, the rule should have been re-proposed as a draft.

For a full transcript of the final rule and Volcker related materials, see here.

“We wouldn’t file a complaint against someone who doesn’t have liability”

A group called the National Fair Housing Alliance has taken the lead in levying sensational bias charges against mortgage lenders, claiming that neglect of REO (real-estate-owned) properties following foreclosure has followed racially discriminatory patterns. It helped negotiate the extraction of $42 million from Wells Fargo, and is pursuing tens of millions in claims against Bank of America and other lenders. NFHA’s claims have routinely been given unskeptical circulation in the press, but now an investigation by Kate Berry and Jeff Horwitz in the American Banker is bringing overdue scrutiny:

The group has disclosed addresses for only a fraction of the properties it alleges the banks have neglected, but a review of those it has released indicates that NFHA regularly misidentified the institution legally responsible for maintaining specific homes. In some cases, it conflated the banks responsible for maintaining properties with those that were simply serving as trustees for mortgage-bond investors. In others, it faulted banks for damage that occurred before they took possession of properties.

Not in dispute is the leverage the NFHA has gained in its dealings with banks from its close ties to supporters in the federal government. Unusual among Washington agencies, the Department of Housing and Urban Development both funds housing discrimination investigations by nonprofits, including by the NFHA, and provides the venue for them to negotiate their claims.

Grants from HUD and Fannie Mae helped get the NFHA and its leader, Shanna Smith, into the profitable business of investigations in the first place. Banks complain without success about Smith’s practice of demanding a deal while withholding the actual identities and addresses of the properties said to be suffering from bank neglect. Now the HUD-brokered Wells Fargo settlement has paid off richly with $30 million+ for the NFHA and its affiliates, the better with which to stir up more complaints. And watch the revolving door spin, amid few qualms arising from conflicts of interest: “Sara Pratt, the HUD official responsible for investigating and resolving the NFHA’s complaints, and who oversaw its settlement with Wells Fargo, is a former NFHA staffer and consultant.” [cross-posted from Overlawyered]

Frank: Nonbank “Designation” Goes Too Far

An interesting op-ed in today’s WSJ echoing my own previous op-eds (http://www.cato.org/publications/commentary/treasury-departments-regulatory-overreach-expands and http://www.cato.org/publications/commentary/too-big-fail-too-foolish-continue). The WSJ quotes former House Financial Services Chairman Barney Frank as saying that he does not favor designating large asset managers such as BlackRock or Fidelity as “systemically important” and that this was not the intent of his law. Those are pretty strong words from one of the chief architects of Dodd-Frank and all the more remarkable since Frank has seldom acknowledged an aspect of the financial sector he didn’t think could use more regulation.

According to the Journal, Frank noted that “overloading the circuits isn’t a good idea” and said that the Financial Stability Oversight Council (FSOC) created by Dodd-Frank “has enough to do regulating the institutions that are clearly meant to be covered—the large banks.”

Implicit in this this statement, is the idea that the FSOC is somewhat out of its depth when it comes to identifying “systemic risks” in the nonbank financial system. Unsurprising, since most of the Council’s staffers are young political appointees with no financial sector experience. Even more fundamental, as Frank alludes to, is the lack of evidence that the industries being targeted in any way contribute to widespread systemic risk. Frank concentrated on the lack of evidence that asset managers transmit risk through the system, but the same logic can be applied to insurers and hedge funds as well.

Absent a full repeal of the Dodd-Frank, and given the growing bipartisan recognition of the dangers of extending bank-like supervision to the nonbank sector, at the very least, Congress should limit the application of Titles I and II of Dodd-Frank to bank holding companies only.

Iran: From Hyperinflation to Stability?

With the announcement on Saturday night that Iran and the P5+1 group reached a tentative deal over the Iranian nuclear program, the Iranian rial appreciated 3.45% against the dollar on the black market. The rial jumped from 30000 IRR/USD on Saturday November 23rd to 29000 IRR/USD on Sunday November 24th. A daily appreciation of this magnitude is rare. In fact, it has occurred fewer than ten times since the beginning of 2013. Indeed, this indicates that the diplomatic breakthrough is having a positive effect on Iranian expectations.

Over a year ago, I uncovered the fact that Iran experienced a period of hyperinflation (in early October 2012), when its monthly inflation rate peaked at 62%. Since then, I have been actively monitoring and reporting on the IRR/USD black market exchange rates and calculating implied inflation rates for the country.

Since Hassan Rouhani took office, on August 3rd, Iranian expectations about the economy have turned less negative. Thus far, it appears Rouhani has been successful in ending the long period of economic volatility that has plagued Iran, since the US imposed sanctions in 2010. This has been reflected in the black-market IRR/USD exchange rate, which

There are three main factors at work here. The first is a concerted effort by the Rouhani administration and the central bank to curb Iran’s inflation. This stands in stark contrast to the previous regime, whose strategy was to simply deny that inflation was a problem.

The second is that that Iran’s economy has proved remarkably “elastic” – meaning that the country has ultimately adapted to the sanctions regime and has found ways to keep its economy afloat in spite of them.

The third factor in the rial’s recent stability is an improvement in Iranian economic expectations. This is where the P5+1 talks come into play. Iranians recognized that easing of the sanctions regime would be a bargaining chip in any nuclear negotiations. In consequence, their economic expectations improved as the talks progressed. Indeed, Saturday’s announcement gave these expectations a shot in the arm.

In light of the rial’s recent stability, I have delisted the rial from my list of “Troubled Currencies,” as tracked by the Troubled Currencies Project. For starters, the rial no longer appears to be in trouble. And, on a technical note, implied inflation calculations are less reliable during sustained periods of exchange rate stability.

That said, we must continue to pay the most careful and anxious attention to the black-market IRR/USD exchange rate in the coming months. Like the P5+1 agreement, Rouhani’s economic progress in Iran is tentative and likely quite fragile. Since the black-market IRR/USD is one of the only objective prices in the Iranian economy – and perhaps the most important one of all – it will continue to serve as an important weather vane, as the diplomatic process continues, and as Iran’s economy gradually moves into a post-sanctions era.