Topic: Finance, Banking & Monetary Policy

Really, It’s True: Creditors, Predators Not Same Thing

Between the print version of Rebecca Traister’s August 5 New York magazine profile of Elizabeth Warren, and the version now online, there can be spotted an amusing correction. Print version:

Clip of 8/4/19 NY mag "predators"

Online version

Clip, NY mag 8/4/19 online, "creditors"

Let’s hope editors in the nation’s leading financial center continue to keep in mind that lending money to someone doesn’t necessarily make you a predator. 

How to Flip a Yield Curve

If the recent yield curve panic proves anything, it proves that, in financial markets, what may start out as a mere statistical correlation, and possibly a spurious one, can become a genuine causal relationship. In particular, if enough people subscribe to a post-hoc fallacy, it may not stay a fallacy for long.

A Self-Fulfilling Prophecy

It was, therefore, just a matter of time before the discovery that inverted yield curves often anticipate recessions resulted in the world’s first yield-curve induced panic. And the distance between panic to recession is no great stretch. Knowing that the curve has turned turtle, and anticipating tumbling stock markets and shrinking incomes, the public rushes to trade stocks for more liquid assets, while banks tighten lending standards. Lo and behold, stocks do tumble, and incomes do shrink. A slowdown then threatens. Should the monetary and fiscal authorities fail to avert it, the slowdown can become a contraction. If the contraction lasts, it becomes a recession. And all this because the yield curve went concave. Post hoc ergo propter hoc. Really.

Progressives’ Financial Inclusion Agenda Is Likely to Backfire

In a recent op-ed for CNN, Rep. Rashida Tlaib (D-MI) suggests a plan for improving the financial inclusion of minority households. She believes that reversing the Trump administration’s recent regulatory initiatives on credit discrimination and mortgage reporting legislation would improve matters.

While Rep. Tlaib is right to point out the disproportionate numbers of blacks among those lacking access to financial services, their financial exclusion goes back, not years or months, but decades. Moreover, her recommendations would mainly double down on existing regulations that seem to perpetuate rather than mitigate financial exclusion.

Rep. Tlaib begins with the striking finding that, ostensibly, the black homeownership rate in the second quarter of 2019 was lower than at any time since 1970. At 40.6 percent, it came in six percentage points below the Hispanic homeownership rate and almost a third below that of whites. Tlaib worries that, because black Americans are so much less likely than other racial groups to own their home, they will have a harder time achieving economic stability.

While homeownership is indeed a popular form of wealth accumulation, the share of Americans who own their homes is hardly a straightforward measure of financial security. For example, the homeownership rate among all households hit an all-time high of 69.1 percent at the start of 2005, a time of exceptionally high home prices and extremely loose credit standards. The financial crisis that followed, with foreclosures hitting up to 10 million families, belied the assumption that the new homeowners had achieved financial security.

Black Americans’ low homeownership rate is the product of many causes, notably decades of institutional discrimination that made it difficult or impossible for blacks to gain access to the same job opportunities and schooling as whites. Discrimination caused black households to have persistently lower incomes and greater professional and personal instability, frustrating their attempts to earn and save. Explicit government policies also limited black Americans’ access to credit by designating predominantly black neighborhoods as “hazardous” to prospective lenders. Because banks since the 1930s have sold most of their mortgages to government and government-sponsored entities, an official recommendation against lending in certain areas had the power of a veto.

Rep. Tlaib is right to focus attention on the troubling legacy of redlining, but blaming a recent and marginal reduction in regulation for blacks’ low homeownership rate is highly suspect. For one thing, the most recent quarterly rate of 40.6 percent is only slightly below the 41 to 43 percent range recorded for most quarters since the beginning of 2012. The estimate’s margin of error, at 0.9 percent, is also high. Thus, the record low reported for the last quarter could be a statistical fluke or a short-lived dip. Giving one quarterly result great significance is probably unwise at this stage.

Franco Is Still Dead and the CFPB Is Still Unconstitutional

In Federalist 47, James Madison wrote that “the accumulation of all powers, legislative, executive, and judiciary, in the same hands, whether of one, a few, or many, and whether hereditary, self-appointed, or elective, may justly be pronounced the very definition of tyranny.” Our constitutional structure is thus built on a foundation of the separation of powers. Indeed, as any Schoolhouse Rock aficionado could tell you, the legislative branch is supposed to legislate, the executive branch is supposed to enforce that legislation, and the judicial branch should interpret that legislation. But what happens when Congress places all of those powers in one agency, and then removes all of that agency’s accountability to elected officials? Worse, what happens when the power of such an agency is in the hands of one unelected individual?

This is what Congress did when it created the Consumer Financial Protection Bureau in 2010. First, Congress created a single director as the head of the organization, but insulated that director from presidential removal except “for cause.” This unique structure removes the president’s ability to exert control over the CFPB even though the agency is charged with enforcing laws. Furthermore, since a director serves a five-year term, a president could conceivably never appoint a new director.

Second, Congress eliminated its own power over the CFPB by granting the bureau independent access to Federal Reserve funds. Because the CFPB doesn’t need congressional approval to access these funds, there is no “power of the purse” for Congress to use to control an agency empowered to regulate the financial services industry.

Third, Congress then gave the CFPB almost unlimited power through vague statutory language. The Dodd-Frank Act grants the agency power to punish “unfair”, “deceptive,” and “abusive” practices, but also grants the CFPB’s director full discretion to define those terms. What’s even worse, no director has yet to define them terms, preferring to act on a case-by-case basis. With this vast arbitrary power, the CFPB has investigated, prosecuted, and punished people, a glaring violation of due process.

This is why Cato has filed an amicus brief urging the Supreme Court to rule on the constitutionality of the CFPB, as we have before (we also previously filed twice in the lower courts arguing that it’s not). The high court has an obligation to defend our separation of powers. If the Court allows the CFPB to continue as currently constituted, it will allow major violations of constitutionally protected liberty by a powerful and unaccountable federal agency.

The case is Seila Law LLC v. CFPB. The Court will decide whether to take it up when it returns in September from summer recess.

Fed Watchers Should Keep an Eye on the IOER-SOFR Spread

Regular Alt-M readers are no doubt looking forward to the FOMC’s announcement next Wednesday. But I doubt they’ll be sitting at the edges of their seats between now and then, much less biting their fingernails.

Markets have, after all, been anticipating a modest Fed cut ever since the committee’s last meeting, when the FOMC chose not to cut just yet, but to “wait and see.” During his recent appearances before the House and Senate, Chair Powell only seemed to reinforce the general belief that “wait and see” meant “we’ll cut in July.” Finally, since the relatively dovish Jim Bullard, the lone dissenter in June, who favored a rate cut then, still thinks that a 25 basis point cut should suffice, it hardly seems likely that the Fed will cut its target by more than that amount. In short, it’s no surprise that futures traders now see a quarter-point cut as all but certain.

But it doesn’t follow that next week’s FOMC decision will be altogether free of suspense. On the contrary: there’s still a big question-mark hanging over it. The question isn’t whether the Fed will lower its rate target, and by how much. It’s whether market rates will respond in kind.

Of Libras and Zebras: What Are the True Financial Risks of the Facebook-Led Digital Currency? (Part III: National Security Risk)

At yesterday’s Senate Banking Committee hearing on Libra, the digital currency project led by Facebook with 27 other partners, concerns about its potential to undermine U.S. national security featured prominently. Senators from across the political spectrum, including Arkansas’ Tom Cotton and New Jersey’s Bob Menendez, suggested that Libra might lend itself to the scheming of malicious actors and U.S. strategic foes, a worry expressed the day before by Treasury Secretary Mnuchin.

How vulnerable will Libra be to criminal uses? A careful examination of the digital currency’s mechanics and its likely employment by financial services providers, suggests that policymakers have reacted prematurely. In fact, cryptocurrencies are significantly less useful to criminals than cash, because they leave a public record of transactions. Furthermore, Libra is even less useful than other cryptocurrencies because its management by gatekeepers means that users will not be able to conceal their identity in the limited ways available to users of open-access cryptocurrencies such as Bitcoin.

As with their warnings about systemic risk and monopoly, policymakers’ concerns about the national security risks of Libra lack a firm foundation. This post, the third in a series on Libra, discusses why.

Of Libras and Zebras: What Are the True Financial Risks of the Facebook-Led Digital Currency? (Part II: Monopoly Risk)

Policymakers, in America and around the world, have for the most part responded to the announcement of Libra with skepticism, fear, and not a little bit of loathing. In my last post, I argued that Libra’s association with Facebook and misleading references to it as a cryptocurrency led to an overreaction on the part of the policy elite. Like budding zoologists who think of zebras rather than horses when they hear hoofbeats, government officials are focusing on the memorable (crisis, monopoly, fraud) rather than the probable (an improved payments system) consequences of this innovation.

My previous post showed that warnings about the systemic risk that Libra presents are overblown. In this post, I explore another concern policymakers have expressed about the Facebook-led digital currency project. That is the risk that Libra-based providers, or even Facebook alone, will be able to monopolize payments through the Libra Association. I hope to show that public officials may be letting their imagination run wild, as they have with regard to systemic risk. In fact, Libra appears more likely to increase competition and choice in payments. Such an outcome is not a best-case scenario, but rather what one might expect based on the experience of payment card networks.