Topic: Finance, Banking & Monetary Policy

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

The Road to Ruin

By
Steve H. Hanke

I have often warned against the dangers associated with conventional wisdom. With the onset of the financial crisis and the corresponding plunge in asset prices, I noted that people who were wealthy or who were close to retirement were the ones getting clobbered. New evidence now confirms this: Americans nearing retirement took the biggest hit after the financial crisis.

The sad truth is that their road to ruin was, in many cases, paved by conventional wisdom about investing.

That wisdom had many believing that, over the long run, stocks produce the highest returns; that a diversified stock portfolio protects you against loss; and that the risk of owning stocks is small, if you hold them for a long time.

While the number of decades in which U.S. equities underperform other asset classes may be small, the size of the shortfalls, when they occur, can be huge. For those who are near retirement, the shortfalls can be devastating. As a recent study from the Pew Research Center shows, the plunge in asset prices that followed the financial crisis has resulted in “a lost decade of the middle class,” with the median real net worth in America now resting roughly where it was in 1983.

And if that’s not bad enough, those folks might not ever get a shot at making up the loss in their lifetimes. As Catherine Rampell’s recent reporting in the New York Times shows, median household income has fallen most sharply among 55–64 year olds, since June 2009.

Diversification is useful, in varying degrees, most of the time. But there are occasions when all stocks dive simultaneously, and in these cases a diversified stock portfolio won’t save you.

Beware of conventional economic wisdom. Some 95% of what you read in the financial press is either wrong or irrelevant.

Topics: 
Finance, Banking & Monetary Policy, International Economics and Development, Social Security

Hey RNC, There Already Was a Gold Commission

By
Mark A. Calabria

The rumor is that Republicans, at their upcoming convention, will call for a government commission to study the feasibility of returning to a gold monetary standard.  The platform would also call for a policy audit of the Federal Reserve, a proposal that has passed the House but is currently stuck in the Senate (and apparently opposed by the Obama White House).

First let’s recognize that a GOP gold standard plank isn’t all that novel. Republican platforms in the past have often alluded to “a dependable monetary standard,” as both the 1980 and 1984 platforms made some reference to monetary matters.  In fact, the 1980 election did result in the creation of a Gold Commission. Cato recently republished the commission’s minority report, The Case for Gold, as a free ebook.  So if Republicans want to consider some sort of gold standard, there is already a significant amount written on the topic.  Cato also published a paper in 2008 by George Mason University professor Larry White on the economics of the gold standard.

On a broader level, what these platform additions truly represent is a dissatisfaction with the Federal Reserve, and not only its current monetary policies, but also its role in the numerous bailouts of 2008-9 and the extent to which its obsession with deflation contributed to the creation of a massive housing bubble.  If Republicans truly want to take on the Fed (something I’m not all that convinced of), then exposing the Fed’s repeated rescues and support of Wall Street would likely be far more effective.  I’ve long been puzzled by how President Obama manages to talk tough on Wall Street while he stands next to Tim Geithner.  If Mitt Romney wants to distinguish himself from the current president, the best thing he could do is call for Geithner to resign.

Republicans would also be wise to talk about the relationship between inflation and unemployment in the long run, which appears positive, rather than negative as the proponents of more Fed easing would have us believe.  The single-minded focus on gold is likely to serve more as a distraction than anything else.  I have about as much faith in the federal government picking the correct gold-dollar parity as I do in the Fed picking the correct interest rate.  And of course, who is to say that gold is the correct commodity to use in the first place? But then, this concern is less about gold and more about the Fed.  And while Republicans have regularly talked tough on the Fed, the truth is that it has usually amounted to little more than talk.

Topics: 
Finance, Banking & Monetary Policy

Terminating the Small Business Administration - Reader Response

By
Tad DeHaven

It’s always nice to hear from readers in the “real world” who deal with government programs first hand. I recently received an email from a credit analyst with a commercial bank who read my essay with Veronique de Rugy on terminating the Small Business Administration. I think it’s worth sharing (name withheld):

I commend you for your excellent piece on “terminating the SBA.”  As a credit analyst for a commercial bank based in DC, I’m in a special position to see the tragedy of it.

In addition to everything you cited, it’s also worth noting that the SBA will not sign on to loans if the guarantor is too strong (on the theory that such a guarantor already has access to credit).  This policy necessarily means that the SBA only guarantees high-risk loans.  Next, the SBA mandates low interest-rate ceilings (in the name of aiding its Borrowers), meaning that the loans are low-reward from an SBA income standpoint.  You put that together and what you have is the SBA is putting the taxpayer’s money into a portfolio that is high-risk, low-reward by design, and further burdens us with a massive overhead of nationwide offices and 2,000+ employees.  (One also might wonder about the opportunity cost we pay when 2,000 people who could presumably be producing bona fide goods and services are instead taking from our limited resources and redirecting them into operations with an unusually high failure rate).

I’m convinced that nearly all of the good loans made with the SBA’s guarantee would have been made anyway, and we would have been spared most of the bad ones and a whole lot of headache.

The reader’s name had to be withheld, of course, because the bank probably wouldn’t appreciate one of its own publicly acknowledging that SBA loan guarantees are an unnecessary handout.

Topics: 
Finance, Banking & Monetary Policy, Tax and Budget Policy

Geithner Favors Fannie Mae Debtholders over Taxpayers … Again

By
Mark A. Calabria

You have to give Treasury Secretary Tim Geithner some credit for spin: today the Treasury announced “Further Steps to Expedite Wind Down of Fannie Mae and Freddie Mac.” The only problem is that the steps announced largely put the taxpayer at greater risk in order to protect holders of Fannie and Freddie debt.

Essentially, the Treasury has amended its agreements with Fannie and Freddie so that the companies no longer have to pay a fixed dividend to the U.S. taxpayer, but instead “every dollar of profit” from the companies to the taxpayer. The problem is that the Government Sponsored Enterprises (GSE) have never had a year where their profits would have covered the dividend payments, so while we can debate if the taxpayer will recover anything from the GSEs, shifting to just collecting profits definitely means the taxpayer’s potential recoupment is lower.

The GSE’s regulator, the Federal Housing Finance Agency (FHFA) was at least a little more honest in its announcement of the changes, stating that, “as Fannie Mae and Freddie Mac shrink, the continued payment of a fixed dividend could have called into question the adequacy of the financial commitment contained in the PSPAs.”  Read “financial commitment” to mean protecting debtholders from loss.

How does the change protect debtholders over taxpayers? It reduces the ability of FHFA to place Fannie or Freddie into a receivership, under which FHFA could impose losses on creditors. Under Section 1145 of the Housing and Economic Recovery Act, FHFA has the discretion of appointing a receiver if one the GSEs displays an “inability to meet obligations,” which would include dividend payments. By essentially taking away that lever from FHFA, Treasury has greatly reduced any chance of a receivership. Sadly, I believe a receivership was the only thing that would force Congress to also deal with Fannie and Freddie. Treasury’s actions have been a massive win for the broken status quo.

Don’t let the rest of the Treasury announcement fool you. Yes, Treasury has both agreed to reduce the GSEs’ portfolios and to require the GSEs to submit an “annual taxpayer protection plan,” but both of these efforts are little more than fig-leafs to cover Treasury’s protection of GSE creditors at the expense of taxpayers. After all, the first commandment in the Geithner bible, as witnessed during the 2008 bailouts, is that debtholders shall take no losses, regardless of the expense to the taxpayer.

Topics: 
Finance, Banking & Monetary Policy

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