I really wish the Bush administration was over, now. Here we have the Treasury secretary calling for the nation’s central bank, which already has internal tensions in its charter (preserving the soundness of the banking system, keeping inflation low and stable, and maintaining full employment) to also be in charge of financial stability:
Mr. Paulson appears to agree with the broad principle. “We should quickly consider how to most appropriately give the Fed the authority to access necessary information from highly complex financial institutions and the responsibility to intervene in order to protect the system, so they can carry out the role our nation has come to expect — stabilizing the overall system when it is threatened,” Mr. Paulson will say.
Since when does “the nation” expect the Fed to ride in to the rescue? That’s Wall Street’s fond wish, but in Bush Administration logic, the desires of the financial services industry are identical with the national interest.
The article notes that this speech by Paulson (to be made tomorrow) reaffirms his vision of consolidation of banking and securities regulation under the Fed’s aegis. and also promotes the idea of the central bank as a financial stability regulator. That was a grand (one might say overreaching) idea from a Treasury secretary with less than a year remaining in office. But rather than act like an adult and recognize that this program will fall to his successors, who will decide which if any elements to adopt, Paulson has decided to try to push it forward, with emphasis on expanding the Fed’s purview.
It hasn’t done very well on any of its current responsibilities. Absent some seasonal adjustments that BreakingViews($) deemed “dubious” the last three months inflation would have reached an annualized rate of 8.3%. Similarly, many analysts have started looking past headline unemployment, and find the trends in broader measures even worse. U-6, the broadest measure of unemployment, stands at 9.7%, up from 8.3% a year ago (while U-3, the official unemployment rate, was 5.5% this May versus 4.5% the May prior). And we don’t need to discuss the health, or rather, the flagging-even-while-on-life-support status of the banking system.
But no, the latest Bush proposal is to expand the mandate of the very body that had a large role in creating the mess we are in, via overly lax monetary policies and a distaste for its supervisory responsibilities, and officially put it in charge of stability.
And what does financial stability extend to, exactly? The stock market? The commodities market? Why don’t we simply officially declare the end of capitalism and make the government the underwriter of all risk. We might as well be honest about what’s afoot.
In fact, one can argue that our financial distress is the result of the central bank’s mission creep. As one former Fed economist friend observed, Greenspan’s big problem was that he needed to be liked. Another former Fed economist, Richard Alford, described at some length how the Fed compromised its independence by throwing its weight behind various Administration policy initiatives, when true independence would dictate remaining silent. Greenspan backed the Clinton deficit reduction, the Bush ownership society (by talking up ARMs) and its Social Security reform program.
And Greenspan took an undue, unprecedented interest in the stock market. A May 2000 Wall Street Journal front page story reveled the then-called Maestro not only pouring over market-related data himself, but putting Fed economist on the task as well. Similarly, the Fed’s orchestration of the rescue of LTCM was controversial at the time. It isn’t clear that an LTCM collapse would have been a systemic event, and the central bank leaned on firms over which it had no formal jurisdiction. In retrospect, had LTCM failed, even if it produced considerable dislocation, it would have led to new-found caution and respect for risk, particularly counterparty exposures.
In fact, a financial stability role conflicts with tough oversight. Shuttering weak firms creates worries; sweeping problems under the rug and hoping they go away keeps confidence high. And markets are all about confidence.
Think that is an exaggeration? Consider another Wall Street Journal story today with the misleading headline, “Banks Find New Ways To Ease Pain of Bad Loans.” A more accurate title would be “Banks Play Accounting Tricks To Disguise How Bad Things Really Are”:
In January, Astoria Financial Corp. told investors that its pile of nonperforming loans had grown to about $106 million as of the end of last year. Three months later, the thrift holding company said the number was just $68 million.
How did Astoria do it? By changing its internal policy on when mortgages are classified on its books as troubled. The Lake Success, N.Y., company now counts home loans as nonperforming when the borrower misses at least three payments, instead of two….
From lengthening the time it takes to write off troubled mortgages, to parking lousy loans in subsidiaries that don’t count toward regulatory capital levels, the creative maneuvers are perfectly legal….
“Spending all the time gaming the system rather than addressing the problems doesn’t reflect well on the institutions,” said David Fanger, chief credit officer in the financial-institutions group at Moody’s Investors Service, a unit of Moody’s Corp. “What this really is about is buying yourself time. … At the end of the day, the losses are likely to not be that different.”….
At Wells Fargo & Co., the fourth-largest U.S. bank by stock-market value, investors and analysts are jittery about its $83.6 billion portfolio of home-equity loans, which is showing signs of stress as real-estate values tumble throughout much of the country.
Until recently, the San Francisco bank had written off home-equity loans — essentially taking a charge to earnings in anticipation of borrowers’ defaulting — once borrowers fell 120 days behind on payments. But on April 1, the bank started waiting for up to 180 days…..
BankAtlantic Bancorp Inc., which is based in Fort Lauderdale, Fla., earlier this year transferred about $100 million of troubled commercial-real-estate loans into a new subsidiary.
That essentially erased the loans from BankAtlantic’s retail-banking unit. Since that unit is federally regulated, BankAtlantic eventually might have faced regulatory action if it didn’t substantially beef up the unit’s capital and reserve levels to cover the bad loans.
Now one can argue that the Fed isn’t the only banking regulator (true) and that regulators can’t do much if banks exploit loopholes (particularly if they drop their federal charters become state-chartered banks and are no longer under the purview of the Fed or the OCC). Nevertheless, there is plenty a regulator can do to discourage behavior that it technically permitted but it dislikes (beyond changing the regs). A simple tactic is to make clear that banks that engage in skirting-at-the-margin practices will be subject to far more aggressive supervision and audit. It’s possible to make audits punitive (one ploy of the Japanese Ministry of Finance). But as the subprime mess attests, the OCC used its authority to put some limits on subprime lending, while the Fed cast a blind eye.
Having said that, if we must have a stability regulator, it most certainly should not be the Fed. England has some division of roles, with the FSA having supervisory responsibilities, and the Bank of England tasked with monetary policy and financial markets stability. Yet Sir John Gieve, the Deputy Governor of the Bank of England who was responsible for stability, suddenly resigned, presumably over the handling of the Northern Rock meltdown. Yet the Bank of England is more of an old-fashioned central bank, concerned with probity and moral hazard, so Gieve’s departure may serve as proof of the difficulty of having the two roles sit under the same roof.
One of the most successful elements of the American political system is its system of checks and balances (which sadly is eroding as imperial presidents chip away at the other two branches). Having one body responsible for both monetary policy and market stability is too much power, and with conflicting objectives. Despite the example of the Greenspan and Bernanke Fed, a central bank should have a bias towards tight credit and a sound currency, while a stability-minded regulator will want to break glass and increase liquidity at the first sign of trouble. Much better to split the roles and let independent bodies duke it out.
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You make several cogent points here. I would only add that today’s grotesquely imbalanced financial arrangement is in DESPERATE need of policy solutions extending beyond mere monetarism. Indeed, we seem to be fast approaching a moment in time when the remaining choices will be but two: all out war or the American System of Political Economy.
Having said that, there simply is no reason whatsoever to wax eloquent for Mother England. She is, after all, a gardener of carrots grown in the Caymans, the Bahamas, Bermuda, the Isle of Man and other unregulated financial havens … who fattened her children on Wall Street to such an obese state as has made their caretaker vulnerable to suffering a fatal heart attack…
Very Good Post …
I would only add one item. That is the that the Fed should be made a completely public institution. It is all too clear that the banks and especially their investment arms are using the privately owned and operated Federal Reserve to pursue their own interests at the expense of the public, great expense I might add.
The member banks are the shareholders of the Fed and they are now pushing to retain the interest earned at the Fed and disburse it to their members! That’s pretty bold stuff but not out of character for the current egos that masquerade as bank CEOs and Fed Board Members.
Re: “financial stability regulator”
This is just an extension of PPT mentality, to save Wall Street from having to play by fair and legal rules and then protect criminal actions under the guise of financial stability regulation, also known as bailing out and socializing casino gambling which occurs as a result of gross mis-management throughout our financial system.
The reason we have a systemic meltdown is because of crooks like Paulson that are in positions to take mafia-like agendas and shove them at retarded Americans — too dumb to wake up from The Bush Era!
The Fed has demonstrated such rare ability supervising and examining bank holding companies such as Citicorp, National City, and Countrywide Financial, haven’t they. Let’s give them more to oversee.
I agree 100% Steve!
Think of the latest PR and hype from FDIC which indicates the potential systemic failure of over 200 American banks; look @ WaMu, look @ LEH, look at any bank out there and the corrupt collusion connected to willful lack of oversight, lack of regulation, lack of respect for America, lack of brain power, and then think about that stuttering retard Paulson that wants more banks to Fu-K up!
http://www.washingtonpost.com/wp-dyn/content/article/2008/06/18/AR2008061803225.html?hpid=topnews
“WaPo” writes
“Paulson’s recommendations go beyond those contained in a blueprint for financial regulation that he unveiled shortly after the Bear Stearns rescue. That document, which had been in the works for more than a year, proposed an enhanced role for the Fed in preempting financial crises but offered few details. Today’s speech will elaborate, calling for the Fed to be given explicit power to step in whenever a firm poses risks to the system and the authority to demand information from financial institutions so it can better anticipate emerging threats.”
Demand information from financial institutions?! Is this to suggest that the stuff we get from the earnings announcements and 10-Qs aren’t information? Are they suggesting there are 2 sets of books?
“…stabilizing the overall system when it is threatened,” Mr. Paulson will say.
Since when does “the nation” expect the Fed to ride in to the rescue?
Um… How about since it has been in their mission statement?
. maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
Neno.
That is a very helpful and simultaneously very troubling item.
I don’t have time now to track this down, but I am pretty certain that that item in the mission statement is no where in any of the legislation passed by Congress regarding the Fed’s duties. Most commentators (and I mean the Serious Economist cohort) talk about a dual mandate: full employment and price stability; that language (probably longer form, I’ve read it but my memory is not exact) comes from Congress. The stability bit comes from the Fed’s original charter, which referred to the stability of the banking system.
Plus if you know corporations, “mission statements” are internal vision statements. So this is an external declaration by the Fed, I suspect not authorized by Congress, of what it thinks its job is. And the idea that the Fed takes responsibility for the “financial system” over which it has very limited supervision, is telling.
Oh, but look, the politcos _need_ a fall guy to point to when things go bad, so that the electorate has a scapegoat. Forget the humble title of ‘Chairman,’ such a macrofinancial supremo should be dubbed His Exigency, with a new motto for the Fed, “We break it, you bought it.”
I’ve said before but I’ll repeat, primary financial regulation should be in the hands explictly of a body other than the Fed, which already has too many conflicting mandates most of which leave it captive to the institutions which it is nominally supposed to supervise.
Yves,
reg. Bank of England. Your “comparative optimism” does not look well placed today.
As Hank Paulson talks, Alistair Darling walks:
http://www.bloomberg.com/apps/news?pid=20601102&sid=aYNiSWz46dJk&refer=uk
Enlargment of CB mandates combined with some personal change ? To me it looks as if Darling wants to make sure that UK rates do not go up before Labour gets thrown out…….
Any Brits here with some thoughts?
A town where the local Mafia owns the police Chief is
a place where it’s a good idea to keep your head down, keep quiet and just go about your business. Oh, and don’t fall behind on your “protection”.
Yves,
BOE King is out saying that he is willing to risk living standards to combat inflation. Retial sales up 3.5% better than expected in May (UK) but no price vs. volume breakout of course.
There is a sort of cognitive dissonace that has happened in the market over the past decade – like the games in Rome…While the rest of the world is trying desperately to deal with the US debt export machine, the US gov’t and its enablers at the Fed are burying their head in the sand. Can you imagine a policy maker in the US coming out and saying the US will have a lower living standard, maybe just one SUV per houshold. No chance.
Look at this prosecution of these guys at BS. You have to love their defense, which is to say if you think we were wrong what about LEH and the rest of the banking sector that has repeatedly mislead investors and continues to do so. If we go so does Fuld. hard to argue. The whole show trial gives you a sense of just ow desperate the PR machine has become. Populism and ignorance coupled by insider dealing makes for a toxic brew. These BS dudes will rue the day being on the other side of that trade.
Paulson is over in China begging them to dereg the financial sector. if you were China would you begiving away your financial complex in the wke of the US disaster, not to mention the margin potential — beats 7% on rubber soles. This comes on the heels of the hat in hand mission to the GCC.
The entire US policy complex needs a new generation of thinkers, not the government come academic come governement retreads that engineered the current system ad hoc. The core conflict is between constantly shifting foreign policy objectives and economic principles. The past tradeoffs are turning out to be about as sound as the option arm portfolios. Interesting times ahead.
Yves, do you have any doubt now that this was just a big sham to bring the economy to a fascist one?
This is how a fascist economy works(from Wikipedia, for lack of time to find a proper source):
Fascists opposed what they believe to be laissez-faire or quasi-laissez-faire economic policies dominant in the era prior to the Great Depression.[34] People of many different political stripes blamed laissez-faire capitalism for the Great Depression, and fascists promoted their ideology as a “third way [disambiguation needed]” between capitalism and Marxian socialism.[35] Their policies manifested as a radical extension of government control over the economy without wholesale expropriation of the means of production. Fascist governments nationalized some key industries, managed their currencies and made some massive state investments. They also introduced price controls, wage controls and other types of economic planning measures.[36] Fascist governments instituted state-regulated allocation of resources, especially in the financial and raw materials sectors.
Other than nationalization of certain industries, private property was allowed, but property rights and private initiative were contingent upon service to the state.[37] For example, “an owner of agricultural land may be compelled to raise wheat instead of sheep and employ more labor than he would find profitable.”[38][38] According to historian Tibor Ivan Berend, dirigisme was an inherent aspect of fascist economies.[39] The Labour Charter of 1927, promulgated by the Grand Council of Fascism, stated in article 7:
“The corporative State considers private initiative, in the field of production, as the most efficient and useful instrument of the Nation,” then goes on to say in article 9 that: “State intervention in economic production may take place only where private initiative is lacking or is insufficient, or when are at stakes the political interest of the State. This intervention may take the form of control, encouragement or direct management.”
Wow, you packed a lot into this post. The comments are also pretty useful. In the end don’t we have to create some system that pins responsibility upon elected officials. If the new regime invests power in institutions that are not subject to review by the electorate then the more cynical commentors are right; we will be on the road to fascism. It might be wise to start with broad principles and derive a regulatory structure consistent with those principles.
Yves —
Thank you for your reply.
I am not sure about the Fed as a “general stability regulator”, but their role certainly goes beyond encouraging maximum employment and stable prices. At least since Bagehot’s time, it has been well-understood that a central bank has the role of “lender of last resort” during a panic. To that end, the Fed has substantial authority to make loans, essentially to anyone they like on any terms they want and against any collateral they choose. And they have had this authority at least since the 30s.
The Fed’s assistance for the Bear Stearns / JPM bail-out was technically structured as a loan. Of course, when you lend at almost no interest for a term of 10 years, you start to cross the line between a “loan” and a purchase…
Bagehot’s dictum for the lender of last resort is to “lend freely against good collateral at a penalty rate”. The Fed’s discount window is supposed to be the mechanism for implementing that dictum. Except they seem to have forgotten the bits about “good collateral” and (especially) “penalty rate”. I would have no problem with extending the discount window to investment banks if the Fed would simply follow Bagehot’s advice. No additional regulation would be needed, because accessing the discount window would be expensive.
As it is, we are now allowing the geniuses at the investment banks — whose entire existence is devoted to identifying and exploiting arbitrage opportunities — to present garbage collateral to the Fed for low-interest loans (via the TSLF and PDCF). We also now have a precedent where the Fed will push to the very edge of its lending authority in order to bail out any firm that is “too big to fail”. If this is to continue — and I do not think it should, but what do I know — then some sort of additional regulation is clearly necessary. So if not the Fed itself, then who? FDIC?
P.S. I agree it would be an interesting exercise to compare the statutes to the mission statement.
Yves,
Nice discussion. I will be interested to see what you and others find relative to statutory authority for the Fed “maintaining the stability of the financial system and containing systemic risk….”
I have a simple (or not) question for you. You say that “a central bank should have a bias towards tight credit and a sound currency”. Why? And how does one define a “sound currency” amid today’s geopolitics? I just looked up “sound currency” and found a definition that disallows for inflation. Do you believe that ought to be the Fed’s policy?
I believe that a central bank ought to have a bias toward a relatively stable currency, but I can’t effectively argue against those who see, say, 2-3 percent inflation to be well within the bounds of “stable”. I believe that credit ought to be tight, loose, or somewhere in between depending on circumstances as economic systems wander amid chaos around various islands of transient equilibria. Maybe I need to re-read Minsky/Keynes before I carry this further.
I agree that the “W” Bush Administration has really screwed things up, and maybe on purpose, but I am by no means heartened by what went on just before during the Clinton Administration. In this I side with Minsky disciples who also argue that it is time (past time really) to rethink economics as we re-regulate “structured finance”.
Nemo,
Sorry for misspelling your handle earlier. A frequent failing of mine.
I will see if I can track down what the Fed’s official mandate is. Check back over the weekend.
You are absolutely correct re Bagehot; that’s implicit in the “soundness of the banking system” construct. But pray tell, what exactly does “stability of the financial system” mean? That is treading on Newspeak. I worry that it includes the stock market, (even if the Fed won’t fess up to that publicly, it’s still a dangerous bit of mission creep).
Dave Iverson,
Although there were good reasons fixed rates had to go, FX markets where currency values often change dramatically over the course of a year makes planning for any company that has international business very difficult.
Economic orthodoxy calls for an inflation rate of 2-3%. The big reason, I believe, is that if things get bad, the monetary authority can cut short rates and not go into zero/negative rate land.
The problem is that collective memory seems to extend not more than a half a generation these days. The Volcker exercise was so painful as to create a good deal of fear for a decade plus about increasing inflation. Clinton got a huge break due to the end of the Cold War; he used the peace dividend to cut the federal deficit, which was anti-stimulatory. In the absence of that bit of good luck, the 1990s might have looked very different.
And as most readers know, although it has continued with Bush, it was Clinton who cut the budget for government statistics and endorsed things like the Boskin Commission, which tweaked the calculation of CPI so as to produce lower numbers.
A simple… but not so timely alternative…
If the “next guy” is Obama and gets his way, regulation will come from a democratic party that’s already hostile to wealth creation.
Agree with him or not… From his perspective it’s far better that regulation get’s put in the hands of a bunch of economists who tend to be both rational about controls and, in the bigger picture, right leaning.
Not that it changes your outrage by any means… but it certainly changes the story to a mundanely rational effort.