Topic: Finance, Banking & Monetary Policy

The Fed’s New Round of Quantitative Easing

By
William Poole

Last Thursday, the Fed announced its intention to proceed with another round of quantitative easing, or QE3. To summarize my reactions:

  1. By introducing another program to buy MBSs, to the tune of $40 billion per month, the FOMC is supporting the long-standing federal policy of special aid to housing, real estate and mortgage interests. These federal policies were the largest single contributor to the financial crisis. Why would the Federal Reserve want  to encourage continuation of these federal policies? Almost every economist, except those allied with housing interests, agrees that the mortgage-interest and real-estate tax deductions in the federal tax code should be eliminated or scaled back. I’ll wager that almost every Federal Reserve economist shares this view. The Federal Reserve says that it is apolitical but this decision is directly supportive of continuation of the current status of Fannie Mae and Freddie Mac. This action is not monetary policy but fiscal policy, extending credit to a favored industry. This policy is crony capitalism, whether practiced by the federal government or by the Federal Reserve.
  2. The FOMC’s decisions create yet another exit problem for the Fed. If job growth picks up, or inflation rises, before every future FOMC meeting the market will wonder if the Fed will stop buying MBSs. The Fed has refused to offer any genuine guidance as to when the policy will end. Conversely, if job growth remains weak, market participants will wonder before every FOMC meeting whether the Fed will do more, or introduce some new and untried policy.
  3. In his press conference, Chairman Bernanke appropriately emphasizes the need for fiscal policies to stabilize federal finances. Yet, he is promising that the Fed can make a material contribution to bringing down unemployment. That promise reduces the pressure on Congress to act. Why should Congress deal with the tough political issues if the Fed can do the job, even if more slowly than if Congress acted?
Topics: 
Finance, Banking & Monetary Policy, General

The CFPB Gets One Right?

By
Mark A. Calabria

It’s no secret that I’m not a big fan of the Dodd-Frank-created Consumer Financial Protection Bureau (CFPB), mostly because I believe it will not be good for consumers.  So let me acknowledge an instance in which the agency is attempting to do something good.

One thing I dislike more than the CFPB is the practice of many state and local governments to use their “abandoned” property laws to steal the remaining value of a consumer’s gift card.  Here’s how it often works:  Say your favorite aunt gives you an Amazon gift card for your birthday.  Now you don’t know what you want to use it for, so you put it in a drawer in your house.  If you leave it there for more than two years—even considering that it is in your house (that is, in your actual possession)—but you don’t use it, states like Maine consider it “abandoned” and force the merchant (in this case Amazon) who issued it to transfer its outstanding value to the government.  If that’s not theft, I don’t know what is.

The CFPB has issued a notice for comment on whether these laws should be preempted by federal statute.  Now if the CFPB was really doing its job, it would simply cite Article I, Section 10 of the Constitution, which prohibits states from ”impairing the obligation of contracts.” But I suspect that the CFPB doesn’t fundamentally have a problem with states rewriting contracts, at least not when the states claim the rewriting somehow benefits consumers.  Oddly enough in the abandoned gift card instances, however, the states in question are benefiting the merchant. These laws relieve the merchant of his obligation to honor the cards’ promise to the consumer, because the state puts itself in the place of the consumer.

I am withholding final judgment on this CFPB initiative because, after all, this is a notice for comment, not a final rule or preemption. As the CFPB was intentionally structured to be a captive of specific special interests, I worry that once the affected governors and mayors mobilize to protect their ability to steal consumers’ gift cards, the CFPB will fold like a cheap suit.  Here’s hoping the agency gets this one right.

Topics: 
Finance, Banking & Monetary Policy

The Truth about the GM and Chrysler Bailouts

By
Randal O'Toole

Vice presidential candidate Paul Ryan has been accused of lying when he claimed that Obama broke a promise by letting a Wisconsin auto factory close, when in fact the factory closed before Obama took office. Although that isn’t precisely what Ryan said, there is some validity to the accusation that his statement was deceptive.

But numerous Obama supporters are playing just as loose with the facts when they say that, if Obama hadn’t rescued GM and Chrysler, far more factories would have closed permanently. That is simply untrue. While news agencies have fact-checked some of the things being said at the Democratic convention, I haven’t seen any challenges of this claim.

Both GM and Chrysler were headed for bankruptcy. If they had gone bankrupt under chapter 11, most of their factories would have stayed open and they would have continued making and selling cars. Bankruptcy would have allowed the companies to avoid interest and dividend payments for a time, and to renegotiate union contracts. Under bankruptcy laws, stockholders would have lost the value of their stocks, but bond owners–who have first claim to company assets and profits–would have been paid off, if not in whole than at least in part.

Instead of letting the companies declare bankruptcy, Obama decided to “bail them out” by taking them over. Once the administration had control of the companies, it had them file for bankruptcy, just as they would have done without the government takeover. Stockholders still lost everything, but so did Chrysler’s bond holders. Instead of renegotiating union contracts, the administration gave the unions greater say over the companies. In other words, the administration didn’t bail out the companies; it bailed out the unions at the expense of (in Chrysler’s case) the bondholders.

In doing so, the administration created uncertainty in the bond market. Bonds were supposed to be safer investments than stocks. But who would want to invest in long-term bonds if the government could step in at any time and void the legal rights of the bond owners? The result is that bond sellers must be willing to pay more interest to attract buyers.

In short, the Obama auto bailout probably didn’t save many jobs (though it probably did keep worker pay uncompetitively high). Instead, it is more likely that the Obama administration’s action prolonged the recession by discouraging private investment in American industry.

Topics: 
Finance, Banking & Monetary Policy

Theory and Practice in the Austrian School

By
Jason Kuznicki

This month’s Cato Unbound looks at the Austrian school of economics. Specifically, how do Austrian insights apply to the “real” world—not just theory, but economic history and policy?

In his lead essay, Professor Steven Horwitz argues that Austrian economists are making important and under-appreciated empirical contributions. The Austrian school even stands to teach mainstream economics a good deal about how to conduct empirical work and interpret it properly.

To discuss with Horwitz, we have invited three other distinguished economists, each of whom has been influenced by the Austrian school—while ultimately settling elsewhere methodologically: Bryan Caplan, George A. Selgin, and Antony Davies.

As always, Cato Unbound readers are encouraged to take up our themes, and enter into the conversation on their own websites and blogs, or on other venues. We also welcome your letters. Send them to jkuznicki at cato dot org. Selections may be published at the editors’ option.

Topics: 
Cato Publications, Finance, Banking & Monetary Policy, General, Political Philosophy

Waiting for Bernanke

By
David Boaz

Cato senior fellow Gerald P. O’Driscoll Jr. has some advice for the Fed in today’s Wall Street Journal:

Quantitative easing is the Fed’s version of “stimulus,” the complement to fiscal stimulus. The trouble with all forms of temporary spending is that they have no permanent effects. They delay needed adjustments in the economy.

Today’s state and local governments are a case in point. Municipal and state spending was propped up by federal transfers of many billions of dollars in the president’s 2009 stimulus package. But as this federal money has dried up, public payrolls are declining, ironically enough for this administration, close to the presidential election. President Obama received bad advice when he was told that government spending would prime the pump of the economy. Instead it had the effect of temporarily transferring resources from the productive private sector to a bloated public sector.

The Fed’s version of temporary stimulus will likely involve purchasing government bonds. If past is prologue, this will act as a sugar rush to financial markets. There will be equity- and bond-market rallies. Wall Street will rejoice, but none of this will translate into “substantial and sustainable” economic growth, the FOMC’s stated goal….

What would stir the spirits of investors and employers would be some policy certainty, reining-in of out-of-control government spending, stopping ill-advised regulations, and clearing the air of antibusiness rhetoric. No repeat of a one-off round of bond buying by the Fed substitutes for the fundamental and permanent changes needed.

Read it all. And while you’re there, don’t miss Seth Lipsky on “The Gold Standard Goes Mainstream.”

Topics: 
Finance, Banking & Monetary Policy

Swiss Monetary Policy: Dangerous Contradictions

By
Steve H. Hanke

The Swiss National Bank is conducting a bizarre, contradictory, and potentially dangerous set of monetary policies.

During the past year, the SNB has mandated the imposition of super-high bank capital requirements. Indeed, the SNB, in its annual Financial Stability Report, even admonished Credit Suisse for not building up a big enough capital cushion. The Swiss capital mandates have caused the rate of growth in money created by Swiss banks (bank money) to plunge.

As can be seen in the accompanying chart, Swiss bank money was 25 percent lower in July 2012 than it was in July 2011. This should be alarming because bank money is, by far, the biggest component of the total money supply. In fact, since the beginning of 2003, bank money has, on average, constituted 89 percent of the total Swiss money supply.

Bank regulations in Switzerland and elsewhere, have resulted in, you guessed it: very tight bank money.

Not being one to sit on its hands, the SNB has turned on its money pumps. Indeed, Swiss state money—the money produced by the SNB—was 305 percent higher in July 2012 than in July 2011.

This explosion in state money has been more than enough to offset the contraction of the all-important bank money component.

In consequence, Switzerland’s total money supply grew at a 10 percent year-over-year rate in July 2012. With double-digit money supply growth, and overall prices declining, it’s little wonder that prices in certain asset classes, such as housing, are surging in Switzerland.

Topics: 
Finance, Banking & Monetary Policy, General, Government and Politics, International Economics and Development, Regulatory Studies

One of Many Ways the SEC Contributed to the Financial Crisis

By
Mark A. Calabria

I was recently reminded that in its infinite wisdom, the Securities and Exchange Commission (SEC) actually sued banks as the housing bubble was building for putting aside too much money to coverage potential loan losses.  It seems that while many banks were worried that bubble lending could turn out bad, the SEC felt that recent history did not offer banks enough justification for setting aside such funding (after all housing prices were going up).  The most significant example was the SEC suit against SunTrust.  In November 2004 the SEC actually pushed SunTrust to fire its Chief Risk Officer for setting aside too much to cover bad loans, while also pushing SunTrust to reduce its loan loss reserves.

The worst part is that the rest of the banking industry clearly got the message.  Before the SEC’s attacks on SunTrust, commercial banks held loan loss reserves, as a percent of total loans, equal to 1.67% (in 2003 Q1), by the peak of the housing bubble that was down to 1.07% (in 2006 Q4), a decline of over 50 percent.  While I don’t mean to exaggerate the impact of this change, had banks kept their loan loss reserves at pre-SunTrust levels, there would have only been about $30 billion more to absorb losses, I do believe this illustrates just how clueless the financial regulators were as to the risks building behind the housing bubble.  And we are being asked, via Dodd-Frank, to give this same SEC lots more discretionary authority in the vain hope that maybe next time they might get it right?

Topics: 
Finance, Banking & Monetary Policy, Regulatory Studies

Pages