Topic: Finance, Banking & Monetary Policy

Will Congress extend the ‘TAG’ Bank Bailout?

By
Mark A. Calabria

Looking back on the events of 2007-9, it’s easy to lose track of the various assistance programs instituted by our financial regulators.

For instance, there were at least 14 different Federal Reserve programs created.  A lot of criticisms can be leveled against those programs, but at least they had some basis in law.  The Federal Deposit Insurance Corporation, by constrast, created a couple of programs out of thin air, without any statutory authority.

One of those was the Transaction Account Guarantee (TAG) program.  Under TAG, the usual cap on per-account deposit insurance (currently $250,000) is lifted if the account pays no interest.  In today’s interest rate environment, it’s not hard for banks to offer zero-interest deposit accounts.

By the end of the first quarter of 2012, the TAG program backed over $1.5 trillion in deposits, accounting for much of the increase in insured U.S. deposits, from just under $5 trillion in Q1 2009 to over $7 trillion Q1 2012.  Most of the program is concentrated in the largest banks.  The 19 largest banks, each with assets in excess of $100 billion, hold two-thirds of TAG deposits, more than the remaining 7,288 U.S. banks combined.  Perhaps even more shocking is that the average TAG account is for over $2 million.

Maybe it’s just the circles I travel in, but I don’t know anyone with over $2 million in bank deposits.  This is a massive handout to the banks, businesses, and wealthy individuals.  Given that there are actual systems of private deposit insurance in the United States (for one example, see here), TAG is not only a government giveaway, but an unnecessary one at that.

Instead of letting the program expire (or better yet, punishing the FDIC for its illegal behavior), Section 343 of the Dodd-Frank Act extends TAG until January 1, 2013.  But as the Federal Reserve Bank of St. Louis points out out, “The TAG program has lost money because current premiums have not covered the losses the FDIC has incurred when a bank fails and the agency has to pay out deposits in excess of the $250,000 coverage limit.”

Despite the losses, the banking industry is lobbying for the extension of TAG.  If we are ever to restore market discipline to the banking industry and end the bailouts, Congress would be wise to let TAG expire.

Topics: 
Finance, Banking & Monetary Policy

Break Up the Banks? Be Careful of What You Ask For

By
Mark A. Calabria

One of the architects of today’s big banks, Sandy Weill, who helped build Citibank into the behemoth it is today, has come out and called for breaking up the largest banks “so that the taxpayer will never be at risk, the depositors won’t be at risk.”

If only it were so simple.

Weill should remember the savings & loan crisis of the late 1980s and early 1990s. That crisis mostly involved small institutions, yet it cost taxpayers a lot and did significant harm to depositors. Perhaps Weill believes the 400+ small banks that have failed in the current crisis had little effect on the economy. While I admittedly haven’t run the numbers, it’s hard for me to believe that 400+ bank failures did not have some negative macroeconomic effects, in addition to being very expensive for the Federal Deposit Insurance Corporation.

In fact, I would argue that the single largest problem facing the banking industry before this crisis was a lack of geographic diversification. Our long history of extensive branch banking restrictions kept banks small and extremely vulnerable to local and regional downturns. Fortunately, we deregulated that area in 1994. The result has been a more stable financial system.  Would Wells Fargo even be standing today if it had been limited to the California housing market (where Wells Fargo got its start)?

Weill needs to tell us, if we were to break up the banks, where exactly will that risk go?  It isn’t going to just disappear.  As I’ve argued elsewhere, one result of our small, fragmented 1920s banking system was the creation of Fannie Mae, the Federal Housing Administration, and the Federal Home Loan Banks.  Need I remind Weill that the current bailout of Fannie and Freddie is at least $180 billion and counting, far exceeding the costs of all other rescues in the recent financial crisis combined?  If we’d had bigger banks in the 1930s, we could have avoided the creation of such disasters as Fannie and Freddie and the FDIC (witness the stability of Canada’s diversified banking system, both in the 1930s and recently).

The most effective solution to risk-taking by big banks, as I’ve argued elsewhere, is to stop trying to micromanage what risk banks are taking and start pulling back their safety net. It is largely the moral hazard created by various government guarantees protecting “Too-Big-To-Fail” banks that caused the most recent crisis. It’s time to start reducing, if not eliminating, those guarantees. Ultimately, Too-Big-To-Fail is a political problem, not an economic one. The solution is to be found in limiting government, not the banks.

Topics: 
Finance, Banking & Monetary Policy

How to Increase the Money Supply, Without Increasing the Government’s Debt

By
Steve H. Hanke

In my August 2012 Globe Asia column, “Money, Where’s the Money?”, I explained why the global economy is still sputtering, and proposed a partial solution. In short, I called for governments (not central banks) to engage in debt market operations – a way to increase the money supply directly, without increasing the overall level of government debt. A number of readers have since contacted me with questions about the specific example I discussed in my column. The most frequent question was:

“Isn’t your proposal just the same as the Fed’s Operation Twist, where the Fed purchases long-term government securities from the public and increases high-powered money?”

The answer is, in short, no – and here’s why:

The first thing that should be noted is that both a central bank and a government can conduct debt market operations. Debt market operations constitute either central bank, or government, transactions with non-banks, which change the bank deposits held by those non-banks. There are many combinations of such operations that can be employed, but with all debt market operations of the type I am envisioning, long-dated debt is replaced with short-dated debt (and so, in one sense, there would be some similarity with Operation Twist).

In my Globe Asia example, however, the government would conduct the debt market operations with no involvement by the central bank. The government would borrow from private banks and purchase outstanding long-dated government debt from the public, and then cancel the debt that had been purchased. The result would be an increase in the money supply, with no change in the monetary base. If the government were instead to borrow from the central bank, both base money and broad money would increase – a fundamental difference.

The central bank could engage directly in debt market operations (and several have done so in recent QE operations). But, in this case, the long-dated bonds purchased by the central bank would end up on the central bank’s balance sheet. The debt would not be canceled out, as it would be if the government was to conduct debt market operations. It is this fact that defines one of the fundamental differences between debt market operations conducted by a central bank and those conducted by a government. A central bank engaged in debt market operations would be left with holdings of long-dated government debt and be exposed to interest rate risk on those securities. It could incur large accounting losses if interest rates were to rise. This would not be the case if the government conducted debt market operations.

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

Federal Irony Alert!

By
Neal McCluskey

The nation’s biggest subprime student lender–your federal government!—has just called out private “subprime” lenders.

This morning the Consumer Financial Protection Bureau and U.S. Department of Education released a report examining private student loans. It concludes that private lenders were out of control, just like all of Wall Street, before the “Great Recession” hit, a fact largely evidenced by high default rates. It was, the report argues, a part of the overall subprime lending debacle and it hurt innocent students.

“Subprime-style lending went to college and now students are paying the price,” said U.S. Education Secretary Arne Duncan in a release accompanying the report.

What’s the report’s solution to the problem? Push people into federal loans to the maximum extent possible. After all, those loans have low, taxpayer-backed interest rates; generous repayment terms, including speedy forgiveness for anyone going into “public service”; and essentially no requirement that borrowers offer evidence of creditworthiness.

Wait—essentially no evidence of creditworthiness? Isn’t that subprime lending in its very purest form? Indeed it is, which is perhaps why the report offers no comparison of default rates on private and federal loans.

Basically, the report is pushing for even greater subprime lending, only with taxpayers on the hook rather than voluntary investors.

The report tries to further portray the fate of private lending as part of an exclusively Wall Street-driven recession by arguing  that a big drop in private lending between the 2007-08 and 2008-09 academic years was  entirely the result of private lenders suffering from the collapse of credit markets. No doubt that had a significant role, but the report somehow manages to not discuss numerous changes to federal law in the 2007-2010 time frame that pushed private lenders out of the way, including:

  • The College Cost Reduction and Access Act (2007), which set federal subsidized-loan interest rates on their halving path from 6.8 percent to the current 3.4 percent.
  • The Ensuring Continued Access to Student Loans Act (2008), which increased unsubsidized loan maximums, reduced eligiblity criteria for PLUS loans (the only loans requiring some demonstration of creditworthiness), and offered federal money when guaranteed lending participants couldn’t get it through capital markets.
  • The reauthorized Higher Education Act (2008), which increased Pell Grant maximums, authorized forgiveness of up to $10,000 in debt for anyone working in an area of “national need,” and added new regulations for private lending.
  • The Student Aid and Fiscal Responsibility Act (2010), which ended federal guaranteed lending in favor of federal lending directly from the U.S. Treasury

Fully private lending probably was reined in thanks to the recession, which is a good thing, with private lenders taking less risk when it didn’t pay off. But it is no doubt also important that Washington enacted many laws that made it much harder for private lenders to compete. The fact is the Feds can subprime-lend without any major concern about losing big bucks. It’s only taxpayer money, after all, and there’s always more of that! Plus the political dividends are sizable, enabling politicians to heartily and repeatedly congratulate themselves for “making sure everyone can go to college!”

That gets us to the next critical point: In addition to reinforcing the utterly discredited notion that the recession was all the fault of “greedy Wall Street fat cats,” a report focusing on private lending is just a distraction from the 800-pound gorilla in higher education: the federal government. At their peak in 2007-08, private loan originations were less than one-third the size of federal loans, and about one-fifth the size of all federal aid. Today they are slightly more than one-20th the size of federal loans, and about one-30th the size of all federal aid.

In other words, private loans are but bit players in a student-aid show dominated by Washington. It is super-abundant federal aid, not private lending, that signficantly fuels tuition inflation, enables dreadful college completion rates, and fosters a glut of degree holders. Yet it’s those same federal lenders who dare scold private companies and warn us about their subprime failures.

Oh, the irony!

Topics: 
Education and Child Policy, Finance, Banking & Monetary Policy

Europe’s Crisis Is Because of Too Much Government, Not the Euro Currency

By
Daniel J. Mitchell

The mess in Europe has been rather frustrating, largely because almost everybody is on the wrong side.

Some folks say they want “austerity,” but that’s largely a code word for higher taxes. They’re fighting against the people who say they want “growth,” but that’s generally a code word for more Keynesian spending.

So you can understand how this debate between higher taxes and higher spending is like nails on a chalkboard for someone who wants smaller government.

And then, to get me even more irritated, lots of people support bailouts because they supposedly are needed to save the euro currency.

When I ask these people why a default in, say, Greece threatens the euro, they look at me as if it’s the year 1491 and I’ve declared the earth isn’t flat.

So I’m delighted that the Wall Street Journal has published some wise observations by a leading French economist (an intellectual heir to Bastiat!), who shares my disdain for the current discussion. Here are some excerpts from Prof. Salin’s column, starting with his common-sense hypothesis.

…there is no “euro crisis.” The single currency doesn’t have to be “saved” or else explode. The present crisis is not a European monetary problem at all, but rather a debt problem in some countries—Greece, Spain and some others—that happen to be members of the euro zone. Specifically, these are public-debt problems, stemming from bad budget management by their governments. But there is no logical link between these countries’ fiscal situations and the functioning of the euro system.

Salin then looks at how the artificial link was created between the euro currency and the fiscal crisis, and he makes a very good analogy (and I think it’s good because I’ve made the same point) to a potential state-level bankruptcy in America.

The public-debt problem becomes a euro problem only insofar as governments arbitrarily decide that there must be some “European solidarity” inside the euro zone. But how does mutual participation in the same currency logically imply that spendthrift governments should get help from the others? When a state in the U.S. has a debt problem, one never hears that there is a “dollar crisis.” There is simply a problem of budget management in that state.

He then says a euro crisis is being created, but only because the European Central Bank has surrendered its independence and is conducting backdoor bailouts.

Because European politicians have decided to create an artificial link between national budget problems and the functioning of the euro system, they have now effectively created a “euro crisis.” To help out badly managed governments, the European Central Bank is now buying public bonds issued by these governments or supplying liquidity to support their failing banks. In so doing, the ECB is violating its own principles and introducing harmful distortions.

Last but not least, Salin warns that politicians are using the crisis as an excuse for more bad policy - sort of the European version of Mitchell’s Law, with one bad policy (excessive spending) being the precursor of an additional bad policy (centralization).

Politicians now argue that “saving the euro” will require not only propping up Europe’s irresponsible governments, but also centralizing decision-making. This is now the dominant opinion of politicians in Europe, France in particular. There are a few reasons why politicians in Paris might take that view. They might see themselves being in a similar situation as Greece in the near future, so all the schemes to “save the euro” could also be helpful to them shortly. They might also be looking to shift public attention away from France’s internal problems and toward the rest of Europe instead. It’s easier to complain about what one’s neighbors are doing than to tackle problems at home. France needs drastic tax cuts and far-reaching deregulation and labor-market liberalization. Much simpler to get the media worked up about the next “euro crisis” meeting with Angela Merkel.

This is a bit of a dry topic, but it has enormous implications since Europe already is a mess and the fiscal crisis sooner or later will spread to the supposedly prudent nations such as Germany and the Netherlands. And, thanks to entitlement programs, the United States isn’t that far behind.

So may as well enjoy some humor before the world falls apart, including this cartoon about bailouts to Europe from America, the parody video about Germany and downgrades, this cartoon about Greece deciding to stay in the euro, this “how the Greeks see Europe” map, and this cartoon about Obama’s approach to the European model.

P.S. Here’s a video narrated by a former Cato intern about the five lessons America should learn from the European fiscal crisis.

Topics: 
Finance, Banking & Monetary Policy, General, Government and Politics, International Economics and Development, Tax and Budget Policy

What, Us Worry about Paying for College?

By
Neal McCluskey

Listen to the media and you might think every American is scared silly about paying for college, and  public aid is stretched micron thin to help just the neediest of students. A new report analyzing what and how Americans paid for higher education last year, however, puts the lie to that image.

How America Pays for College: 2012, from Sallie Mae and Ipsos Public Affairs, offers an interesting breakdown of who pays what and how for college, and furnishes some welcome contextual data. I’m not sure there is a unifying message in the numbers – other than people seem to be economizing a bit since the 2009-10 academic year – but some of the potential lessons are striking.

The first lesson is don’t believe that government aid is just for the poor. Families making $100,000 or more used federal loans, tax-incentivized savings programs, and federal, state, and school-based grants – which do not include scholarships – to cover 27 percent of their total cost of attendance.

Next, don’t get caught up in the overblown controversy over private student loans. It’s a diversion from the much bigger impact of government aid. Only 1 percent of the total cost of attendance last year was covered by private loans, versus 4 percent by federal Parent PLUS loans, 13 percent by other federal loans, 1 percent by federal work-study, and 16 percent by federal, state, or school-based grants. And don’t forget: much of the cost of public institutions is borne by taxpayers before the tuition bills even go out.

Perhaps most interesting, it appears that even though the sticker price of college has risen at astronomical rates, most people aren’t sufficiently concerned that they plan ahead for how they’ll pay. 50 percent of respondents either “somewhat” or “strongly” disagreed with the statement that “before my child/I enrolled, our family created a plan for paying for all years of college.” Only 39 percent somewhat or strongly agreed with the statement.

What does this tell us? Potentially many things, but one might be that many people assume someone, no matter what, will ensure that they or their child will be able to go to college. Unfortunately, that “someone” often ends up being the American taxpayer.

Topics: 
Education and Child Policy, Finance, Banking & Monetary Policy, General

Where Was Geithner During LIBOR Suppression?

By
Mark A. Calabria

Perhaps the most interesting turn of events in the ongoing LIBOR scandal is the potential involvement of financial regulators,  both in the United Kingdom and the United States.  We know that on at least one occurrence, an October 2008 phone call between Bank of England (BoE) deputy governor Paul Tucker and Barclays CEO Robert Diamond, a BoE official indicated that he was ”concerned” with Barclays’ high LIBOR submissions.  While there is so far no evidence that the BoE requested Barclays to lower its submissions, there seems to be some strong suggestions that the BoE would have welcomed a lower number.

From an American perspective, an interesting fact revealed in the UK’s Financial Services Authority investigation was that on a number of occasions the Federal Reserve Bank of New York, then headed by current Treasury Secretary Tim Geithner, was informed by Barclays of its concerns about LIBOR manipulation by other banks as well as Barclays’ own approach to submitting LIBOR.  Or as the FSA puts it:

Barclays discussed liquidity issues with external entities such as the FSA, the Bank of England and the Federal Reserve Bank of New York during the financial crisis in routine liquidity calls. At times information about Barclays’ liquidity position was relayed to the FSA on a daily basis. During certain of these liquidity calls, between November 2007 and October 2008, Barclays described to these external entities its perception that other banks appeared to be understating their LIBOR submissions. On occasion Barclays made comments about its own approach to submitting LIBOR. Barclays had similar conversations with the BBA [British Bankers Association] and believed that it had disclosed its approach to the BBA.

The FSA also notes that:

On 17 April 2008, Manager D made comments in a liquidity call to the FSA indicating that Barclays had been understating its LIBOR submissions: “we did stick our head above the parapet last year, got it shot off, and put it back down again. So, to the extent that, um, the LIBORs have been understated, are we guilty of being part of the pack? You could say we are. We’ve always been at the top end and therefore one of the four banks that’s been eliminated. Um, so I would, I would sort of express us maybe as not clean clean, but clean in principle”. Barclays made similar comments to the BBA and the Federal Reserve Bank of New York.

While UK regulators appear to be at the heart of the discussions, it is appropriate to ask what exactly did the New York Fed know and what did it say?  Perhaps if we ever get a real audit of the Fed, we can learn whether Geithner and his crew at the NY Fed signed off on Barclays’ suppression of LIBOR rates.

Topics: 
Finance, Banking & Monetary Policy

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