Topic: Finance, Banking & Monetary Policy

Volcker on Financial Reform and Economic Stimulus

In a recent edition of The Region magazine, published by the Federal Reserve Bank of Minneapolis, retiring Minn. Fed President Gary Stern interviews Paul Volcker on a variety of topics.  It’s an interview well worth reading, and reminds one why Volcker is one of the more thoughtful voices on economics and finance, even if he isn’t always right.

Some highlights.  On the Obama financial reform plan:

I do not share one part of the general philosophy which seemed to emerge from this, particularly the proposal that the Federal Reserve supervise directly all “systemically important” institutions. I don’t know what “systemically important” institutions are, incidentally, but I’m sure that if you picked them out, people will assume they’re going to be saved, that they’re too big to fail. At the same time, there’d be some that you don’t pick out in advance that you’d want to save under particular circumstances.  So I think that is a mistake.

Volcker also express concern that those institutions at the center of the crisis are left out of the reform.  Specifically he mentions that Obama Administration officials “haven’t said anything about Fannie Mae or Freddie Mac.”

Volcker also takes issue with the Administration’s proposal to regulate non-banks, including hedge funds and private equity.  “I wouldn’t regulate so strictly the nonbanks.  I’d like to create the impression…that there’s no automatic bailout of those institutions.”

Volcker also raises important questions about the Administration’s Keynesian stimulus actions.  As the stimulus was meant to replace a reduction in private sector demand, Volcker asks “are we really dealing with the underlying pressures in the economy without permitting a relative decline in consumption to proceed?”

Those are just a few of his comments.  Here’s to hoping the rest of the Obama Administration is listening.  They could do a lot worse than Volcker’s advice.

Remembering the Reporter Who Sued the Fed

With the Washington Post and other mainstream media outlets publishing endless defenses of “Federal Reserve independence” and proclaiming the Fed as savior of our financial system, it is all to easy to dismiss much of the media as simply defenders of the status quo.  There were many, however, willing to challenge this orthodoxy.  Standing out among them was Mark Pittman, reporter for Bloomberg.  It was Mr. Pittman who sued the Federal Reserve, winning a victory on August 24, as the Manhattan Federal Court allowed the suit to proceed.  Sadly, Mark Pittman passed away on November 25th. 

Mark Pittman and his employer, Bloomberg News, sought details on the Federal Reserve’s numerous special lending facilities.  Which firms were getting loans, and for how much and at what terms?  These were all details the American public were entitled to, yet were denied by the Federal Reserve.  We all remember the Fed’s warnings that if AIG counter-parties were named, there would be market disruptions.  Yet, after much public and Congressional pressure, those firms were named, with no adverse market consequences. 

While Mark Pittman’s efforts will be greatly missed, his suit continues, as does the efforts by Rep. Ron Paul and others in Congress, to bring transparency to the activities of the Federal Reserve.

They Never Learn

The town of Truckee, CA is an upscale community nestled in the Sierra Nevadas near Donner Summit off I-80. Housing is expensive.  Truckee’s origins were as a railroad town, so there is older housing.  In Truckee, however, downscale is funky and comes with upscale prices.  The Truckee Town Council has decided to provide “downpayment assistance” with loans at interest rates as low as 2 percent.

Those who work in Truckee often cannot afford to live there and the Truckee Town Council hopes to make housing affordable for them.  The program is thus paved with good intentions, but we know where that road leads.  Cato’s Randall O’Toole and Hoover’s Thomas Sowell have shown that land-use restrictions and zoning are principal causes of high-priced housing.  The recent housing boom and bust demonstrated how efforts to make housing “more affordable” largely made it more expensive.  And they ended up putting many into homes that they could not ultimately afford.

There are no reports that the Truckee Town Council is planning to ease land-use restrictions.  So they have done nothing to address the problem of pricey homes.  It’s supply and demand, and the Council is working the wrong side of the equation.

Federal Housing Subsidies Are Insane

A New York Times report on the Federal Housing Administration’s subsidies for higher-priced real estate reveals the insanity of federal housing policies. The 2008 stimulus package signed by President Bush temporarily doubled the maximum loan the FHA insured to $729,750 on single-family homes. Coverage on multi-family units can exceed $1 million.

The article starts in San Francisco in early 2009:

In January, Mike Rowland was so broke that he had to raid his retirement savings to move here from Boston. A week ago, he and a couple of buddies bought a two-unit apartment building for nearly a million dollars. They had only a little cash to bring to the table but, with the federal government insuring the transaction, a large down payment was not necessary. ‘It was kind of crazy we could get this big a loan,’ said Mr. Rowland, 27. ‘If a government official came out here, I would slap him a high-five.’

If you’re thinking to yourself that this is the sort of government-induced behavior that helped create the housing bubble, go to the head of the class.

With government finances already under great strain, the policy expansions are creating new risks for American taxpayers. The Internal Revenue Service is giving tax rebates to first-time buyers, and soon to move-up buyers, in a program beset by accusations of fraud. And the government agency that issues mortgage insurance, the Federal Housing Administration, is underwriting loans at quadruple the rate of three years ago even as its reserves to cover defaults are dwindling. On Thursday, the Mortgage Bankers Association said more than one in six FHA borrowers was behind on payments.

It has been widely reported that the FHA might need a taxpayer bailout as a result of its head-first dive into riskier mortgages. HUD’s inspector general says the higher loan limits add additional risk to the FHA’s already dicey situation. But the FHA’s commissioner, David H. Stevens, says he isn’t worried because these mortgages “are for shelter. They aren’t speculative-type investments.”

Mr. Stevens is willfully ignoring the fact that the FHA’s ridiculously low minimum downpayment requirements mean homebuyers have little skin in the game. In a down housing market this increases the chances of homeowners being “underwater” on their mortgages, which can lead to them walking away and sticking FHA with the bill.

And as Richard Pozen pointed out in a Wall Street Journal op-ed yesterday, the $8,000 homebuyer tax credit can mean no downpayment at all:

Here’s how the credit allows buyers to avoid putting their own money at risk. Suppose a couple making $60,000 annually buys a home worth $200,000. They can get an FHA-insured loan if they put down 3.5% of the purchase price, about $7,000. The couple will also need to come up with another $1,000 in closing costs, for a total of $8,000. The couple can either dip into savings or borrow that money from relatives or somewhere else on a temporary basis. After closing, the couple can quickly obtain the $8,000 refundable tax credit to pay off their temporary loan (or replenish their savings). In effect, they will have bought a home without putting any of their own money at risk. Owners who don’t sink their own money into a house are much more likely to default on the mortgage.

So will Congress be bringing this insanity to a halt anytime soon?  Not according to the Times:

A few weeks ago, Congress extended the higher lending limits for another year. Representative Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee, said in an interview that he planned to introduce legislation next year raising the maximum FHA loan by $100,000, to $839,750. His bill would make the new limits permanent.

I guess being Barney Frank means never having to say you’re sorry.

Some Facts on Executive Compensation

All too often policy debates regarding executive compensation appear driven more by populist politics than any real basis in fact.   In order to add some light to this debate, two professors at New York University’s Stern School of Business, Gian Luca Clementi and Thomas Cooley, recently released a working paper, offering their findings on trends in executive compensation, many of which I found surprising.

First off, Professors Clementi and Cooley measure executive compensation more broadly than just salary, perks and bonuses.  They include annual change in value of own company stock and option holdings, as well as the value of own company stock sales and newly awarded securities.  This broader measure is intended to give a fuller picture of how closely an executive’s wealth is tied to the performance of their firm.   Not too surprising given this broader measure, the professors find that salary and bonuses are actually a small faction of overall compensation.  Stock holdings, awards and options are far larger shares of compensation.

Among their other findings:  A $1,000 increase in shareholder wealth is associated with about a $35 rise in CEO wealth.  One factor behind this relationship is the relatively high own company stock holdings of CEOs.  For 2006, about a fourth of CEOs held more than 1% of their company’s stock, while 10% held more than 5%.

A surprisingly finding was that it was quite common for CEOs to actually see negative compensation.  For instance in 2002, the professors find that 40% of CEOs lost money, driven many by their own company stock and option losses.  These are just a few of the paper’s findings.  Hopefully this research, and others, will provide a more factual basis for debates surrounding executive compensation.

Pelosi Eyeing Global Tax on Financial Transactions

Imagine if the government got to pick your pocket every time you engaged in a financial transaction? That nightmare scenario is a distinct possibility now that senior Democrats have joined with European politicians and urged that such a tax be applied on a worldwide based. Reuters has the disturbing details:

Any tax imposed on financial transactions would have to take effect internationally to keep Wall Street jobs and related business from moving overseas, U.S. House of Representatives Speaker Nancy Pelosi said on Thursday.

“It would have to be an international rule, not just a U.S. rule,” Pelosi said at a news conference. “We couldn’t do it alone, we’d have to do it as an international initiative.”

Several House Democrats have proposed a Wall Street tax to pay for job-creating legislation they plan to pass in December. The tax, which could raise $150 billion per year, would tap into widespread public outrage at Wall Street in the wake of the financial crisis.

…The No. 4 Democrat in the House, Representative John Larson, said his proposal to impose a 0.25 percent tax on over-the-counter derivatives transactions would apply internationally. “Part of our proposal would include that it would be international,” Larson told Reuters after meeting with other lawmakers about the jobs package. Democratic Representative Peter DeFazio said his separate proposal, which would tax a wider array of trading activity, would cover all U.S. corporations and individuals no matter where their trades took place.

…Britain urged other governments earlier this month to consider a bank tax as a way to fund future bailouts, and France and Germany have also called for a bank tax. The International Monetary Fund is studying the idea.

This issue reveals the value of tax competition – but also its limitations. Pelosi and other collectivists realize that economic activity will migrate to friendlier jurisdictions if if they unilaterally impose this punitive tax. This externally-imposed discipline is why tax competition is a liberalizing force. But competition can be undermined if governments create a cartel, which is exactly what American and European statists would like to see.

Congress Grows Fed Up

The Wall Street Journal reported that Congress likes Fed Chairman Bernanke, but not the institution that he heads. There is growing consensus that the Fed needs to be reformed and restructured.  Most notably, there are calls to strip the Fed of its supervisory authority.  In practice, the new sentiment reflects the failure of the Fed to rein in risk taking by the largest banks.

The Fed is pushing back.  One reserve bank president said that removing the Fed’s supervisory authority “would affect our ability to conduct monetary authority effectively.” He went on to say that without the supervisory authority, the Fed wouldn’t know enough about risks brewing in the economy.  This argument is shop worn. The Fed had the authority. It fueled the housing boom with its monetary policy and failed to head off the banking crisis with its supervisory powers. And let us not forget the regional banking crises of the 1990s; the fallout of the Latin American debt crisis for Citibank; and others (e.g., the failure of Continental Illinois National Bank).  All on the Fed’s watch.

Around the world, some central banks have supervisory authority over banks and some do not.  There is no clear pattern for either monetary policy or bank regulation with respect to how the powers are structured and distributed.  Other factors seem to matter much more. It would be useful to identify what they are.

Congress is moving a few deck chairs around as the ship sinks. No fundamental rethinking of bank regulation is occurring. The Fed is probably being made a scapegoat for Congress’s own failings.  But that is how Washington works.