Topic: Finance, Banking & Monetary Policy

A Victory for Bitcoin Users

On July 25, Miami-Dade Florida circuit judge Teresa Pooler dismissed money-laundering charges against Michell Espinoza, a local bitcoin seller. The decision is a welcome pause on the road to financial serfdom. It is a small setback for authorities who want to fight crime (victimless or otherwise) by criminalizing and tracking the “laundering” of the proceeds, and who unreasonably want to do the tracking by eliminating citizens’ financial privacy, that is, by unrestricted tracking of their subjects’ financial accounts and activities. The US Treasury’s Financial Crimes Enforcement Network (FinCEN) is today the headquarters of such efforts.

As an Atlanta Fed primer reminds us, the authorities’ efforts are built upon the Banking Secrecy Act (BSA) of 1970. (A franker label would be the Banking Anti-Secrecy Act). The Act has been supplemented and amended many times by Congress, particularly by Title III of the USA PATRIOT Act of 2001, and expanded by diktats of the Federal Reserve and FinCEN. The laws and regulations on the books today have “established requirements for recordkeeping and reporting of specific transactions, including the identity of an individual engaged in the transaction by banks and other FIs [financial institutions].”  These requirements are collectively known as Anti-Money-Laundering (AML) rules.

In particular, banks and other financial institutions are required to obey “Customer Identification Program” (CIP) protocols (aka “know your customer”), which require them to verify and record identity documents for all customers, and to “flag suspicious customers’ accounts.” Banks and financial institutions must submit “Currency Transaction Reports” (CTRs) on any customers’ deposits, withdrawals, or transfers of $10,000 or more. To foreclose the possibility of people using unmonitored non-banks to make transfers, FinCEN today requires non-depository “money service businesses” (MSBs) – which FinCEN defines to include “money transmitters” like Western Union and issuers of prepaid cards like Visa – also to know their customers. Banks and MSBs must file “Suspicious Activity Reports (SARs)” on transactions above $5000 that may be associated with money-laundering or other criminal activity. Individuals must also file reports. Carrying $10,000 or more into or out of the US triggers a “Currency or Monetary Instrument Report” (CMIR).” Any US citizen who has $10,000 or more in foreign financial accounts, even if it never moves, must annually file “Foreign Bank and Financial Accounts Reports (FBARs).”

Basel’s Liquidity Coverage Ratio: Redux

Last summer I contributed a post about the Liquidity Coverage Ratio (LCR), a new regulation that is part of the latest international Basel Accords (Basel III) and that is being imposed on U.S. banks and other financial institutions. As I explained in that post, the LCR requires banks to hold “high quality liquid assets” (HQLA) sufficient to cover potential net cash outflows over 30 days. Both George Selgin and I have pointed out that the LCR probably contributes to the continuing desire of banks to maintain such a high level of reserves.

Two economists who have severely criticized the LCR are Gary Gorton, noted for his work on bank panics, and his co-author, Tyler Muir. Earlier this year they published online a short version of a much longer unpublished paper that scrutinizes the potential impact of the LCR. Whereas my post, appropriately entitled “Reserve Requirements Basel Style,” compared the LCR to the traditional but now largely abandoned reserve requirements imposed on banks, Gorton and Muir compare it to the bond-collateral (or bond-deposit) requirement of the national banking era, prevailing from the Civil War until creation of the Federal Reserve. They conclude that the LCR will cause the same sorts of problems that, ironically, the Fed was supposed to solve.

Italy’s Renzi Goes Toe-to-Toe with the EU over Italy’s Troubled Banks

Only 17 percent of Italy’s money supply (M3) is accounted for by State money produced by the European Central Bank (ECB). The remaining 87 percent is Bank money produced by commercial banks through deposit creation. So, Italy’s banks are an important contributor to the money supply and, ultimately, the economy.

In anticipation of poor results from the Italian banks’ stress tests (which will be reported on July 29th), Italy’s Prime Minister, Matteo Renzi, has indicated that his government will unilaterally pump billions of euros into Italy’s troubled banks to recapitalize them, so that they can continue to extend credit and contribute to the growth of Italy’s broad money supply. There is a problem with this approach: it is not allowed under new EU rules. These rules require that bank bondholders take losses (a bail-in) before government bailout money can be deployed. But, in Italy, a big chunk of bank debt (bonds) is held by retail investors. These retail investors vote in large numbers. So, the EU bail-in regulation, if invoked, will certainly put Renzi’s neck on the chopping block. And that will come sooner rather than later because the Prime Minister has called for a referendum on Italy’s constitution in October and stated that he’ll resign if the referendum is voted down.

It’s no surprise that Renzi has his eye on banks. It’s also easy to see why he is worried and ready to pull the trigger on a state-sponsored bank bailout. The accompanying chart on non-performing loans should be cause for concern.

To put the non-performing loans into perspective, there is nothing better than the Texas Ratio (TR). The TR is the book value of all non-performing assets divided by equity capital plus loan loss reserves. Only tangible equity capital is included in the denominator. Intangible capital — like goodwill — is excluded.

So, the denominator is the defense against bad loans wiping the bank out, forcing it into insolvency. A TR over 100 percent means that a bank is skating on thin ice. Indeed, if the non-performing loans were written off, a bank with a TR in excess of 100 percent would be wiped out. All of the five big Italian banks in the accompanying table — including the Banca Monte dei Paschi di Siena (BMPS), the world’s oldest bank — fall into this ignominious category.

They need to be recapitalized. This could be done by issuing new shares on the market. But, all these banks’ shares are trading well below their book values. BMPS’ price is only about 10 percent of its book value, and Intesa Sanpaolo (the best of the lot) is only about 66 percent. In consequence, any new shares issued on the market would dilute existing shareholders and be unattractive. This is why an Italian state rescue is the most attractive source for the recapitalization.

Financial Deregulation? Don’t Bank on Brexit

On June 23, Britain voted by a margin of 52 to 48 percent to leave the European Union (EU). Much ink has already been spilled on the policy implications of that vote and, indeed, its long-run consequences may prove quite profound. When it comes to financial regulation, however, it is difficult to see any significant changes emerging in the short- to medium-term. There are a couple of fundamental reasons for this.

The first stems from the fact that the British financial sector is desperate to maintain its current access to the European Economic Area (EEA), also known as the “single market.” As things stand, a process known as “passporting” allows British financial firms to do business throughout the single market, whether on a cross-border basis or by establishing branches, without having to get separate regulatory approval in every jurisdiction. This arrangement is important to the industry and — given that financial services produce 8 percent of the UK’s output — the British government is likely to make its continuation after Brexit a priority.

But how can they bring that about? The most straightforward path is for Britain to leave the EU, but remain a member of the EEA. This approach, often referred to as the “Norway option,” would see Britain exit the EU’s centralized political institutions, while still participating fully in its “four freedoms” — that is, the free movement of goods, services, capital, and people. There is much to commend such a settlement, as I’ve written before. But if it did come to pass, Britain’s financial sector would clearly be subject to EU rules in much the same way as it is now.

There’s also a political problem with EEA membership: namely, it wouldn’t allow the British government to pursue its stated aim of controlling immigration from the EU. That suggests that the obvious alternative — a bilateral, post-Brexit trade treaty — might be the more likely outcome of Britain’s eventual withdrawal. Such a treaty could, theoretically, protect the British financial sector’s passporting rights. However, the quid pro quo for market access of that sort would undoubtedly be regulatory equivalence — that is, the European Commission would have to deem British regulation equivalent to EU rules before any passporting could take place. The handful of existing EU directives that provide “third country” financial firms access to the single market work in precisely this way. Ultimately, then, there are unlikely to be any major reforms to British financial regulation so long as the British financial services industry maintains access to the single market.

Paul Romer as Chief Economist of the World Bank Is Great News

Paul Romer becoming chief economist at the World Bank looks quite promising for economic development. 

In a 1990 explanation of new growth economics, Paul Romer and Robert Barro wrote, “If government taxes or distortions discourage the activity that generates growth, growth will be slower.” 

Speaking about the “Mauritian Miracle” at a 1992 World Bank conference, Romer emphasized that  “income and corporate tax rates were halved in 1983 (from about 70 to about 35 percent).” He also noted that free-trade zones allowed “unrestricted, tariff-free imports of machinery and materials, no restriction on ownership or repatriation of profits, [and] a ten-year income tax holiday for foreign investors.”  

Romer’s new growth economics should prove quite compatible with a timely rediscovery of the many global success stories with supply-side reductions in marginal tax rates and tariffs in the 1980s and 1990s in countries as diverse as Botswana, India, Chile, New Zealand, China, Ireland, Singapore, Mexico and more recently Turkey and Eastern Europe.  

A Monetary Policy Primer, Part 6: The Reserve-Deposit Multiplier

In my last post in this series, I observed that an economy’s “base” money serves as the “raw material” that commercial banks and other private-market financial intermediaries employ in “producing” deposits of various kinds that can themselves serve as means of exchange.

Multiplier2If they could do so profitably, these private intermediaries would, by making their substitutes more attractive than base money itself, collectively gain possession of every dollar of base money in existence. In some past monetary arrangements, most notably that of Scotland before 1845, banks came very close to achieving this ideal, thanks to the their freedom to supply their customers with circulating paper banknotes as well as with deposits, and to the fact that between them these two substitutes could serve every purpose coins might serve, and do so more conveniently than coins themselves.

All save a handful of commercial banks today are, in contrast, able to supply deposits only, so that only base money itself can serve as currency, that is, circulating money. The extent to which national money stocks have been “privatized,” in the sense of being made up mainly of private IOUs of various kinds rather than officially-supplied base money, has been correspondingly limited, as has the extent to which private money holdings have served as a source of funding for bank loans.