Topic: Finance, Banking & Monetary Policy

Dishonest by Definition: Barclays and LIBOR

By
Mark A. Calabria

“We are therefore being dishonest by definition and are at risk of damaging our reputation in the market and with the regulators.” - Barclays staff responsible for LIBOR submission, email December 4, 2007.

By now you’ve undoubtedly heard about Barclays’ manipulation of its submissions to the calculation of the London Interbank Offer Rates (LIBOR), or rather rates. The Barclays employee quoted above obviously understood the ramifications of the bank’s actions on the banks, unfortunately what he missed was something more important, the extent to which such actions would undermine the public’s support for both markets and finance, two key ingredients for a wealthy society. This I fear will be the more long-lasting impact of the LIBOR scandal and those of us who support free-market should be among the loudest condemning Barclays’ behavior.

It is not that I believe Barclays (or banks in general) is any more dishonest than say government politicians and bureaucrats, because in fact I believe bankers to generally be more honest than your typical politician (a low standard I know), but because banking is a business fundamentally built on trust. As we learned so painfully from the financial crisis, all the credit scores and data in the world does not guarantee that someone will honor the contract they’ve signed their name to. One of my greatest concerns is this loss of trust among market participants that makes any society function. The truth is that rules, courts and regulations are always going to be costly ways to monitor society. Trust is one of the great economizers of transactions costs. When we lose it on a broad scale, society is immensely poorer.

Of course trust alone is often insufficient. Incentives should be aligned so as to reduce misbehavior. As it relates to LIBOR, my first suggestion would be to move away from survey based borrowing measures, like LIBOR, and instead rely on market measures, based upon actual transactions, which are less subject to manipulation. Perhaps surprisingly, market measures are likely to be more volatile than surveys (compare the daily LIBOR and federal funds rates for instance), but such volatility would be a more honest assessment of market conditions. In fact one of the ironies, at least to me, is that looking at the various manipulations presented by the FSA, it isn’t clear, pre-crisis, that Barclays was even able to move the market with its false submissions. Of course it isn’t the result here that matters, but the intent. And if our intent is to have a freer and wealthier society, then those who abuse our trust should be held to account.

Topics: 
Finance, Banking & Monetary Policy

How Crony Capitalism Works

By
David Boaz

Tad DeHaven summed up the congressional report on Countrywide Financial’s VIP loan for members of Congress and other Beltway players.

 

 

 

 

 

But I was struck by this point in a Bloomberg report, about Countrywide CEO Angelo Mozilo’s close relationship with Fannie Mae chief executive Jim Johnson, former top aide to Vice President Walter Mondale and chairman of both the Brookings Institution and the Kennedy Center. Instructing his staff to give a discount mortgage loan to Johnson, Mozilo wrote in an email:

Jim Johnson continues to be a source of many loans for our company and this is just a small token of appreciation for the business that he sends to us.

Note that Jim Johnson didn’t favor Countrywide with his personal business. He didn’t invest in Countrywide. He didn’t sell houses and send the buyers to Countrywide. No, he sent loans backed by taxpayers’ money to Countrywide, and was rewarded with personal benefits. That’s crony capitalism.

This was kind of a stunning detail:

Jim Johnson, chief executive officer of Fannie Mae from 1991 to 1998, earned $100 million during his time at the company. Nonetheless, Countrywide employees expressed concern about giving him a loan because he didn’t pay his bills regularly and had a low credit score, according to e-mails published in Issa’s report.

Given his credit report, Countrywide underwriters didn’t want to sign off on a loan to Johnson. But Mozilo, who knew the business Countrywide was really in, told them not only to approve the loan but to give Johnson a discounted rate.

And that, kiddies, is how being involved with a highly respected politician can get you a job in Washington that pays $100 million, backed by the full faith and credit of the American taxpayers, as well as extra perks from other companies tied into the crony corporatist state.

More on Johnson, Fannie, and Mozilo here.

Topics: 
Finance, Banking & Monetary Policy, Government and Politics

A Modest Proposal to Improve Federal Reserve Bank Governance

By
Mark A. Calabria

Recent losses at JP Morgan, and Jamie Dimon’s position on the board of the New York Federal Reserve Bank, have renewed debates as to who should be eligible to sit on the boards of the twelve regional Federal Reserve Banks. In yesterday’s on-line New York Times, Simon Johnson raises additional, and important, questions as to the appropriateness of Dimon’s presence on the NY Fed’s board.

Senator Bernie Sanders (I-VT) has also introduced a bill, S. 3219, that would remove bankers from the regional Fed boards. Representative Barney Frank (D-MA) would go as far as removing the regional bank presidents from the Federal Open Market Committee (FOMC)—although I suspect this has more to do with wanting inflation than anything else. Frank has even proposed replacing those members with additional members appointed by the president of the United States, as if the current Fed is not already too aligned with the White House.

Rep. Frank has called his proposal to pack the Fed with White House loyalists “increased democratization” of the Fed. Frank is, of course, correct to say that regional Fed presidents who sit on the FOMC “… are not subject to a confirmation process by elected officials, and instead are chosen by regional Federal Reserve Bank directors who effectively are appointed by large commercial banks in each region.” [Emphasis in original.]

Here’s my modest proposal to “increase democratization” at the Fed, but to do so in a manner that actually gives more voice to the American public: have the governors of states within the various Fed regions appoint some, or even all, of the board members of the regional Feds. In districts, such a Philadelphia or Cleveland, the governors could appoint multiple members, with over-lapping terms, so that board would have a reasonable minimum size.

To truly increase the “democratization” of the Fed, we should also remove the various vetoes that the DC-based Federal Reserve Board has over regional Fed Bank governance. For instance, Section 4-4 of the Federal Reserve Act requires approval of the DC board of regional bank president appointments.  That allows the Fed to reject anyone who might challenge the status quo. Under any circumstances, having the Fed Board appoint a third of the directors (class C) of the regional banks is also problematic.  Rather then represent Washington’s interests, all regional directors should be either appointed or elected within the region, and without the need for Washington’s approval.

These modest changes could improve the accountability of the Fed, helping the break the dominance of the current Cambridge-Wall Street-Washington group-think that has so badly undermined the Fed. Of course none of this should deter us from exploring alternatives to the Fed.

Topics: 
Finance, Banking & Monetary Policy

Big Government Cripples Incentives to Save, Promotes Risky Culture of Immediate Gratification

By
Daniel J. Mitchell

America’s political elite is nauseating for many reasons, but perhaps most of all when they blame others for problems that are caused by misguided government policies. A stark example is the way they attacked the Facebook billionaire who moved to Singapore because of punitive taxation and class-warfare policy.

Today, let’s look at an example that affects almost everybody rather than just a handful of rich people. Many people in Washington sanctimoniously say that American households and businesses are too focused on the short term and that we don’t save enough.

But as I explain in this CBNC interview, tax and spending policies from Washington have undermined the incentive to save.

Allow me to elaborate on three of my examples.

1. Look at this post comparing the red ink from America’s bankrupt Social Security system with the huge levels of private savings generated by Australia’s system of personal retirement accounts.

Good politicians would respond by copying Australia and reforming Social Security. But good politicians are like unicorns.

2. Or look at this chart showing the extensive double taxation in our tax code, as well as these international comparisons of how America over-taxes dividends and capital gains.

Good politicians would respond by junking the tax code and adopting a flat tax, which has no double taxation of income that is saved and invested. But good politicians are like the Loch Ness Monster.

3. And consider the fact that the Obama Administration has just imposed a regulation that will discourage foreigners from depositing money in American banks, thus driving capital from the U.S. economy.

Good politicians would minimize the damage of anti-savings policies by keeping America a haven for foreign capital. But good politicians are like Bigfoot.

The moral of the story, just in case you haven’t picked up on the theme, is that bad things happen because politicians can’t resist expanding the burden of government when they should be doing the opposite. Which is why this poster is funny, but in a painful way.

P.S. I should have mentioned that some politicians think that we can boost savings by imposing a value-added tax! This is not only a perverse example of Mitchell’s law, but it’s also completely illogical.

A VAT does not change the incentive to save since current consumption and future consumption are equally taxed. But it does reduce the amount of money people have, thus reducing both private consumption and private savings.

Statists would argue that a new tax will reduce the budget deficit and thus reduce the amount of private savings that is being used to finance government debt. That’s only true, though, if you’re naive enough to think politicians won’t spend the new revenue. Good luck with that.

Topics: 
Finance, Banking & Monetary Policy, General, Political Philosophy, Social Security, Tax and Budget Policy

Senate Poised to Reform Flood Insurance

By
Mark A. Calabria

As I’ve written elsewhere, the National Flood Insurance Program (NFIP) has to rank as one of the most misguided and destructive federal programs.  In addition to subsidizing the destruction of the environment, it also encourages families to live in harm’s way.  The solution should be to end it and let the private market appropriately price the risk.  If Congress chooses not to end the NFIP, it should at least reduce the subsidies behind the program.  Surprisingly enough, S. 1940, currently on the Senate floor, does just that.

Over the next 9 years, S. 1940 would increase revenues under the NFIP by $4.7 billion, as estimated by CBO.  This is $4.7 billion that wouldn’t have to be paid by the taxpayer but instead would be paid by those who benefit from flood insurance.  My estimate is that this represents about half of the program’s current subsidies.  Such a major reduction in subsidies would also allow the private sector to have some chance at actually competing.

There have been some complaints raised that S. 1940 expands the program and “gasp” actually includes an “individual mandate” like ObamaCare.  Such misunderstands the nature of the NFIP.  The core nature of NFIP is that if a community wants to be eligible for federal disaster assistance, then it must participate in the NFIP and borrowers, in said community, with a federal mortgage, who live in the 100 year floodplain, must buy flood insurance.  S. 1940 extends that requirement, over a number of years, to homes with federal mortgages that exist behind dams, levees and other man-made structures.  As Hurricane Katrina taught us, having a levee is no absolute protection for either the homeowner or the taxpayer.  While dams and levees can reduce the frequency of flood loss, they do so at the cost of increasing the severity when it does happen.

The important point is that the current program and “residual risk” provisions of S.1940 do not require anyone to do anything.  Every community in America is free to leave the program.  Also homes within communities that stay can avoid the purchase requirement by not getting a federal mortgage (which the taxpayer stands behind).  If this encourages an expansion of a mortgage market not backed by the taxpayer, then all the better.  S.1940 also exempts small dollar premiums from the residual risk requirement.  The residual risk provisions would also incorporate into the premium pricing any real reduction in flood risk that results from a dam or levee.

Again the ultimate solution is to eliminate the NFIP, so that free individuals can choose which risk they take and which they pay others to bear.  Until then, reducing federal subsidies and forcing federal programs to more actually price risk will not only help protect the taxpayer, but also improve the functioning of our mortgage market.  S.1940, along with its residual risk requirements, is a step in that direction (and considerably better than the House version, which does actually increase the taxpayers’ exposure).

Topics: 
Finance, Banking & Monetary Policy, Government and Politics

New Bank Regulations Spawn Doom Loop

By
Steve H. Hanke

Politicians have a genius for creating unintended consequences with each of their new firefighting measures.  Just consider bank regulations.  Today, reportage by Brooke Masters in the Financial Times informs us that the bill for new bank regulations in the EU could balloon to 50 billion euros.  These regulations are intended to make banks “safe.”  But, alas, they will suppress the money supply and economic activity.  In consequence, new bank regulations, in the middle of an economic slump, promise to make banks less, not more, “safe” – a doom loop.  Now is not the time to send in the Boy Scouts.

Topics: 
Finance, Banking & Monetary Policy, General

Did My Student Loan Rate Rise? I Barely Noticed

By
Neal McCluskey

We should all be so lucky as to have our crises be like the looming interest rate change on some student loans. Yes, the rate on subsidized federal loans will double on July 1 absent congressional action, but that needs to be put into context to see that it’s a potential “crisis” – as I heard it described on a radio news report last Friday – akin to your yacht sinking. Your toy, bathtub yacht.

Starting July 1, rates on subsidized loans – a subset of federal loans in which taxpayers eat beginning interest payments as well as bearing non-repayment risk – are set to rise from 3.4 percent to 6.8 percent.

That might sound bad, but note that the rates have only been at 3.4 percent for a year. A 2007 law set them on a gradual decline from 6.8 percent to 3.4 percent over five years. So it’s not like 3.4 percent has been the norm for decades…or even two years.

Next, the rate increase will only affect loans originated after July 1. People with existing loans won’t suddenly see the rates on all their subsidized loans double.

Third, while a rate doubling sounds big, the practical effect according to the White House’s own calculations will be to add about $1,000 to an average loan over its lifetime, which is about ten years. That translates into an additional $8.33 per month – less than the cost of a DC movie ticket.

Finally, freezing the rate for another year will do almost nothing for currently suffering middle-class families, unlike what the White House intimated in President Obama’s most recent weekly address. The large majority of loans originated after July 1 won’t even begin to be repaid for at least another year-and-a-half, after rising seniors have graduated and gone through the six-month repayment grace period.

It’s well known that a crisis is extremely useful for affecting political change – just ask Chicago’s mayor – but it often translates into bad policy. And that’s exactly the kind of policy that creating artificially cheap student loans is. They help fuel skyrocketing college prices, subsidize massive college waste, and contribute to millions of people enrolling who either never complete their studies or who finish largely worthless degrees.

All those consequences are problems that Washington really should worry about. But that’s the other thing about a crisis: It’s usually only embraced when it means giving stuff away to buy lots of votes.

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

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