Black swans
The Financial Times has a debate over recent Congressional attempts to loosen bank regulation. Hal Scott supports looser regulation:
The Fed’s stress tests are effectively the binding constraint on bank capital and thus lending. They require banks to prove they could survive extreme adverse scenarios while still complying with global capital requirements. The process has two major deficiencies.
First, the Fed’s adverse scenarios are extreme to the point of incredulity. For example, the latest stress test assumes an increase of the unemployment rate from 4.1 to 10 per cent over seven quarters. That has not happened in the 70 years since today’s measure for unemployment was adopted. There is no open consultation with experts, industry or the general public as to whether these scenarios make sense.
Do we really want banks to hold enough capital to survive events that have no US historical precedent? If such an extreme economic event did occur, would any amount of capital be enough to withstand the panic it could trigger?
We absolutely do want to have banks be able to survive a recession that pushes unemployment up to 10%. The unemployment rate hit 10% in 1982 and again in 2009 (albeit from a higher base than today.) In the early 1930s, it rose from 3% to 25%. After what happened in 2008, how can anyone seriously claim that we don’t want our banking system to be able to survive a recession that leads to 10% unemployment? That makes no sense.
I don’t know enough about bank regulation to have an informed opinion on stress tests, but this argument actually makes me more likely to support the other side. I didn’t even have to read the arguments made by Lisa Donner, in opposition to loosening regulations.
Ideally we’d have a laissez faire banking regime. But until we get rid of the GSEs, FDIC and TBTF, we probably need some sort of capital requirements and/or stress tests. Since neither party favors removing moral hazard from banking, we are unfortunately stuck with regulation.
Off Topic: The clown show continues:
Gary D. Cohn, the director of the National Economic Council, had been lobbying for months alongside others, including Defense Secretary James Mattis and Rob Porter, the staff secretary who recently resigned under pressure from the White House, to kill, postpone, or at least narrow the scope of the measures, people familiar with the discussions said.
But in recent weeks, a group of White House advisers who advocate a tougher posture on trade has been in ascendance, including Robert Lighthizer, the country’s top trade negotiator, and Peter Navarro, a trade skeptic who had been sidelined but is now in line for a promotion.
The departure of Mr. Porter, who organized weekly trade meetings and coordinated the trade advisers, and the breakdown of the typical trade advisory process has helped create a chaotic situation in which those opposing factions are no longer kept in check. The situation had descended into utter chaos and an all-out war between various trade factions, people close to the White House said.
Trump just stabbed US manufacturers in the back.
Tags:
1. March 2018 at 08:59
Scott,
I am completely unfamiliar with this issue, but why is FDIC a bad thing?
1. March 2018 at 09:46
Keenan, It encourages excessive risk taking by banks. It was a major factor in both the 1980s and the 2008 banking crises.
1. March 2018 at 11:35
“The Fed’s stress tests are effectively the binding constraint on bank capital and thus lending.”
This just isn’t correct. Money that comes from new stock issuances is as green as money from liabilities. Both are lent out. Liquidity reserves are not lent out, but the Fed should offset a lower V with a higher M.
The Fed paper she linked to actually says optimal capital ratios range from 13% to 26%. There is a cost to higher bank capital, but it’s far from clear that lower cost on TBTF deposits is a good thing. Venezuelans probably don’t mind having 30 cent gas instead of $2 gas, but that doesn’t make subsidized gas a good thing.
1. March 2018 at 12:09
Matthew. Yes, I agree. Because of moral hazard there’s a bias toward too much bank lending, not enough of other forms of finance.
1. March 2018 at 12:41
Hi Scott,
As usual, I’m inclined to agree with you. However, why do we need such vast and complex regulatory apparatuses if we just want to be sure banks have enough capital?
Why not just enforce a 30% capital requirement, and then repeal Dodd Frank and allow the Fed to focus on Monetary Policy?
1. March 2018 at 12:44
Charlie, I’d be happy with a 20% capital requirement, if we repealed Dodd-Frank.
1. March 2018 at 12:49
I see. Thanks for the response Scott!
1. March 2018 at 13:00
Hello Mr. Sumner,
My apologies as this is not entirely related to your blog post. I was wondering if there were any studies you know about which reflected an empirical measurement of expectations and shown how they effect business decisions (mergers, entrepreneurship, etc)?
1. March 2018 at 13:28
The Minneapolis Fed says that the capital requirement should be 23.5%. I have no idea how they can be so precise.
1. March 2018 at 14:17
The issue with simple capital requirements is bank assets can be structured with more volatility to offset the capital requirement. For a really simple example, let’s say a bank issues $1mil in mortgages. The bank can tranche the bottom 50% at a lower rate and keep the top 50%. They sell the bottom 50% on the market and keep the top 50%, with higher risk and higher return.
So capital ratios aren’t just equity/assets. They’re equity/(risk-weighted assets). A claim on a AAA sovereign has a 0% risk-weighting, which means that Treasury purchases can be financed 100% with deposits. Publicly traded stocks have a 300% risk-weighting, say when used as collateral. So to meet a 10% capital requirement, stock purchases have to be funded with 70%/30% liabilities/equity.
https://www.fdic.gov/news/news/financial/2012/fil12027.html
Sorry if the risk-weighted-assets was implicit in “20% capital requirements.” I just wanted to point out capital ratio is not a simple or straightforward calculation. The RWA mechanism was gamed a lot by broker-dealers under SEC’s supervision.
http://insurancejournal.org/wp-content/uploads/2011/12/Rosato.pdf
2. March 2018 at 02:42
Keenan,
Another argument against the FDIC is that it is backed by an entity with an infinitely deep pocket: i.e. the government, which can grab limitless amounts of money from taxpayers. That is not a natural or free market type of insurer.
It wouldn’t be too bad if the insurer was run on strictly commercial lines, but it just isn’t. E.g. the Fed loaned roughly $600bn to banks for roughly 18 months during the crisis at an approximately zero rate of interest. Of course the Fed is not the same as FDIC, but it’s doing the same job, i.e. getting banks out of trouble.
That near zero rate of interest compares to the 10% that Warren Buffet charged Goldman Sachs during the crisis, which is presumably more like the realistic free market rate.
And same goes for the UK: government has for decades provided deposit insurance for free up to very recently.
2. March 2018 at 03:01
Charlie,
Anat Admati and Martin Wolf (chief economics correspondent at the Financial Times) advocate about 25%. Then there are the advocates of full reserve banking (e.g. Milton Friedman) who advocate 100%.
Scott,
Re your desire for a laissez faire bank system, there is a problem there, which is that banks (central and commercial) are into the money creation business, but “money is a creature of the state” as the saying goes. I.e. there has to be general agreement as to what the nation’s currency shall be, and who should produce it. That general agreement equals economic planning of a sort, rather than laissez faire.
However, like you, I favor as free a market as possible. To that end, I object to the fact that private banks can create money, whereas non-bank corporations cannot. That’s not a level playing field. I therefor back Milton Freidman’s full reserve system which makes it impossible for private banks to create money: only the Fed can do that.
2. March 2018 at 05:26
I dunno. Large publicly held banks nave boards of directors, who should be representing shareholders. If a bank fails, the shareholders are wiped out, even if the Feds step in and bail out the bank.
There is plenty of real-world financial hazard for shareholders, and there should be.
I would like to see a mandatory fat layer of convertible bonds issued by banks, say 20% of loans outstanding (or 23.5%), but no other regs.
Then shareholders would lose everything if a bank failed, and convertible bondholders would be at risk to right the ship. In practice, convertible bondholders would form committees to protect their interests and make sure certain covenants are honored, etc. When the covenants were broken they would end up owning the bank.
Depositors? Listen, you don’t want to see bank runs.
Free markets? Well, maybe. Remember the private-sector free-market idea of financial insurance was AIG. They insured bonds for sophisticated institutional buyers of bonds. They collapsed, and were bailed out. Whether true or not, people were screaming we would all burn in financial hell for decades if AIG was not propped up. Would make the Great Depression look like a picnic. AIG’s collapse was an “extinction-level financial event.”
Gives one a caution.
2. March 2018 at 08:28
Yellen and Bernanke chat;
https://www.brookings.edu/events/a-fed-duet-janet-yellen-in-conversation-with-ben-bernanke/
2. March 2018 at 08:30
‘The Minneapolis Fed says that the capital requirement should be 23.5%. I have no idea how they can be so precise.’
It’s what happens when a political hack gets named President of a Fed bank.
2. March 2018 at 08:35
In that chat between Yellen and The Ben;
————quote———–
“…We supervised Countrywide for a while and looked at their mortgage business which was growing enormously. I met pretty regularly with Angelo Mozilo. And the San Francisco Fed was quite concerned about what was going on. We tried to insist on tighter risk controls.
“And one day Angelo came up and we had our regular quarterly meeting and he said to me, Janet, I have to tell you, it’s been terrific to be supervised by you. You guys are really on top of your game and we really appreciate all of the valuable advice that you’ve given us. But, you know, we’ve realized that we don’t actually need to be a bank holding company. We realized it would be okay to be a thrift holding company. And so we’re changing our charter. And indeed they did so and decided it would be nice to be supervised by the Office of Thrift Supervision that is no more.
————endquote———-
Which ought to give Kashkari and others who think increasing capital requirements is the answer, pause. Not that anything would.
2. March 2018 at 08:50
Also in the Big Fed conversation, The Janet says;
————–quote————
“And initially, at meetings we would have a lot of options on the table and there would be go-arounds and people would express their views. The options–there were people who would favor options that didn’t get a lot of support and they would tend to see that. You know, I love Option Number 9, but I was pretty much alone in doing that. And what I found was it was great. Over time people who favored options for which there wasn’t a lot of support tended to shift their support to options where there was greater support. And gradually, we narrowed things down to one and got complete agreement.
“So I guess what I do is I often compare the job of managing the committee to the issue a designer would have to face who is trying to decide what’s the right color to paint a room. You have 19 people around the table, and you want to come up with a decision we can all live with on what color to paint the room. And we’d go around the table. Ben, what would you like? You think baby blue is just absolutely ideal. David, what do you think? Chartreuse you think is a lovely color. (Laughter) And we go around the room like that. And the question is, are we ever going to converge?
“I would feel my job is get everybody to see that off-white is not a bad alternative. (Laughter) As brilliant as your choice was, maybe you could live with off-white, and it’s not so bad. And we can converge on that and it’s going to function just fine and maybe we can agree. So I felt I was often trying to get the committee to coalesce and decide. We’d come up with a good option that we could all agree on.”
————endquote————-
Which is probably how Ben came to abandon his belief that interest rates aren’t a reliable indicator of monetary policy.
This is all courtesy of Tim Taylor, the editor of the JEP, and The Conversable Economist (whom everyone ought to be reading as a matter of course);
http://conversableeconomist.blogspot.com/
2. March 2018 at 09:18
Yes, there is a black swan, it’s called a Federal Debt downgrade or maybe even the demise of Wells Fargo.
It’s not about bank capital cushions. The problem is with monetary policy. Every recession since the Great Depression has been entirely the Fed’s fault.
And DFIs do not loan out existing deposits, saved or otherwise, or the equity of bank owners. From a system’s perspective, DFIs acquire earning assets through the creation of new money. When DFIs make loans to, or buy securities from, the private non-bank sector, new money, demand deposits, are created somewhere in the banking system.
The use or non-use of savings held by the commercial banks is a function of the velocity, not the volume, of their deposit liabilities. The parameters of economics are not those of mathematics – the whole is much larger than the sum of its parts. The decisions of the public to invest their bank-held savings will not, per se, change the aggregate liabilities, or the existing assets, of the payment’s system. The expansion of time “saved” deposits adds nothing to N-gDp.
The aggregate lending capacity of the payment’s system is determined by the monetary policy of Federal Reserve authorities. It is in no way dependent on the savings practices of the public. People could cease to hold any savings in the member banks & the legal lending capacity of the payment’s system, given our current institutional arrangements, would be unimpaired.
The way to force savings out of the banking system, risk on, is to lower FDIC coverage, and cap deposit rates – and gradually lower them until the member banks are completely out of the savings business. This would make both the DFIs and NBFIs more profitable (size isn’t synonymous with profitability). It would lower inflation. It would lower long-term interest rates. It would raise R-gDp.
Savings flowing through the non-banks never leaves the payment’s system. The expansion of savings/investment accounts or interest bearing accounts, adds nothing to total member bank liabilities, assets, or earning assets. The source of time deposits, is demand deposits, directly or indirectly via the currency route (never more than a short run situation), or thru the bank’s undivided profits accounts.
Bank-held-savings have a zero payment’s velocity. Unlike with the NBFIs, there is no transfer of ownership between counterparties within the payment’s system.
Whether the public saves, dis-saves, chooses to hold their savings in the commercial banks, or to transfer them to non-banks will not, per se, alter the total assets or liabilities of the commercial banks, nor alter the forms of these assets and liabilities.
However, all bank-held savings are lost to any type of payment or expenditure until their owners spend/invest directly/indirectly. Bank-held savings are un-used and un-spent. This is the sole source of secular strangulation.
If the public would shift into other types of earning assets outside of the payment’s system, then savings would have an income velocity. If a transfer in the ownership of commercial bank deposits takes place, this becomes a velocity of one when the funds are spent/invested.
2. March 2018 at 09:36
Black Swans are a totally normal species of swan in Australia and they make great gag gifts for the economist in your family. If you don’t have room to keep one alive, maybe they’d make a good Thanksgiving dinner?
https://en.wikipedia.org/wiki/Black_swan
2. March 2018 at 10:45
Scott,
I find your qualified support for regulation unoersuasive. Regulation and/or higher capital requirements may indeed reduce the likelihood of recession, but they also have costs. The question is, if we take the business cycle for granted, how much growth in the long run are we willing to sacrifice to reduce the risk of recession by some amount. It isn’t self evident (its manifestly incorrect I’d say) that we should be as risk averse as Nassim Taleb wants us to be. The occasional recession may be less costly than the regulation necessary to prevent it.
And of course, the idea that regulation is effective at constraining the excesses of banks is dubious to begin with. The SEC and Fed can (and often have, and will continue to do so) simply selectively enforce or not enforce whatever rules it’s politically convenient to at the time. Some regulations (recourse rule, mark to market accounting, etc.) help cause recessions.
In short, as pessimistic as you are about the possibility of doing away with federal deposit insurance etc, I’m about as pessimistic about the possibility of regulations (especially Dodd-Frank) doing what they’re designed to do.
2. March 2018 at 11:25
“Re your desire for a laissez faire bank system, there is a problem there, which is that banks (central and commercial) are into the money creation business”
IMO, the “money creation cycle” is one of the worst things in conventional economic teachings. Banks don’t create money. They create legal and accounting liabilities. Legally, contract law does not have a distinction between a bank deposit contract, a bond covenant or a net/30 invoice. They’re all enforced under contractual law, UCC, etc.
Bank liabilities only have enduring equivalence to money when there is a government backstop. In Panics prior to the federal reserve, banks had to suspend conversion of deposits to specie. The Money Market Fund/Commercial Paper shadow banking system didn’t last either. All investment banks went bankrupt or became Fed members with access to the discount window.
A truly laissez faire banking system would mean no FDIC or Fed discount window. Pre-Fed was not exactly laissez faire either, as national banks could issue notes with backing of Treasury.
Ideally, under laissez faire, savers would have to honestly match the maturity of their savings and the assets ultimately backing the savings. The fear would be less sophisticated savers would be too enticed by lower costs if some banks still offered maturity mismatched deposits. Or the savers are agents working for less sophisticated principles, such as pension, insurance, CFO’s, endowments, etc. Some regulation would likely need to shift, emphasizing maturing matching.
2. March 2018 at 11:38
Ralph, Central banks create base money, banks create credit.
Salmo, There are so many mistakes there I won’t even attempt to address them all. But a good place to start is real and nominal variables—please don’t mix them up. The central bank influences the nominal size of the banking industry (and indeed all industries), the public (and regulators) determines the real size of the industry.
Mark, First, I oppose Dodd-Frank, so I don’t know if your comment is addressed at me. Second, there are no “costs of regulations” if they are good second best policies. When moral hazard creates excessive lending, capital controls can be an efficient response. There’s no guarantee they are efficient, but they may well be.
Third, this is not about preventing recessions—banking problems do not cause recessions, tight money does.
If we had a laissez-faire banking system, I would oppose all bank regulation.
We have a socialist banking system in America, thus any “regulation is bad” talk is meaningless unless you explain whether it will make our socialist banking system more or less efficient. As long as we have FDIC, doing nothing is not an option.
Here’s my question. Where is the GOP plan to reform our banking system, to overcome the problems created by moral hazard? Let me guess, the same GOP plan as they are implementing to hold down Medicare costs.
2. March 2018 at 11:46
“Free markets? Well, maybe. Remember the private-sector free-market idea of financial insurance was AIG. They insured bonds for sophisticated institutional buyers of bonds. They collapsed, and were bailed out. Whether true or not, people were screaming we would all burn in financial hell for decades if AIG was not propped up. Would make the Great Depression look like a picnic. AIG’s collapse was an “extinction-level financial event.””
It should be much more emphasized that it wasn’t only AIG that was bailed out in Sep. 2008. Essentially the whole shadow banking system was backstopped overnight as the Fed guaranteed all money market funds.
However, an AIG failure was particularly sudden and nobody really knew the consequences. AIG bonded a lot of construction sites for example. With AIG’s bankruptcy, the lenders would require the construction to stop. A new bond would only be issued after the existing work was inspected.
AIG’s personal lines would have been protected by guaranty funds, but much of AIG’s insurance business was long-tail, commercial business. A business with an asbestos or workers comp liability would have those long-tail liabilities shift to them. They could only make claims through the liquidation proceedings.
It’s not clear how segregated the insurance companies were or how a receivership process with New York’s Insurance Commissioner would have shaken out. Despite all the possible collateral effects, I would have preferred AIG run its course *IF* monetary policy could truly meet NGDP/inflation level targets no matter what. The ZLB was key predicate of making bailouts probably necessary to prevent a Great Depression.
2. March 2018 at 12:25
I’ve made no accounting errors. You have learned your Keynesian catechisms. You, and everyone else, obviously have never studied the system’s T-accounts.
All the outside factors that affect bank deposits are peripheral to the creation of new money. And the commercial banks have not been reserve bound since 1995. Bank lending today simply depends upon on bankable opportunities and credit worthy borrowers.
All savings originate within the confines of the payment’s system. Saver-holders never transfer their savings outside the payment’s system unless they hoard currency or convert to other national currencies. The only way to activate voluntary savings is for the saver holder (owner) to invest his funds directly or indirectly.
Some liquid assets (time/savings deposits) have a direct one-to-one, relationship to the volume of demand / transaction deposits (DDs), while others affect only the velocity of DDs. The former requires direct regulation; the latter simply is important data for the Fed to use in regulating the money supply.
It is axiomatic macro accounting. All savings which are “attracted” are derived from other member banks. This is not a zero-sum game, one bank’s gain by attracting more “core” or “derivative” deposits, is less than the losses sustained by other banks in the system. The whole (the forest), is not the sum of its parts (the trees), in the money creating process.
You have a money illusion. Whether money is neutral or robust, nominal or real, depends upon the monetary fulcrum, the wedge of inflation, whether it’s falling, neutral, or rising.
So, whether interest rates fall or rise, given a monetary injection of liquidity, depends upon money flows. This is clearly demonstrated by monetary flows, volume X’s velocity, which have been mathematical constants for over 100 years. *Nominal* or idle reserves, and *real* newly created money, are spurious economic distinctions.
2. March 2018 at 12:55
“laissez faire banking”, however desirable, is not a policy option, i.e. it’s impossible to credibly commit to it. Stop worrying and learn to love regulation.
2. March 2018 at 13:23
The expiration of the FDIC’s unlimited transaction deposit insurance is prima facie evidence, hence my Dec. 15th 2012 market zinger forecast:
(1) “Posts:203 Re: QE3 = nuttin’ honey (on iTulip.com)
“We’re close to seeing the real power of OMOs. R-gDp is likely to accelerate earlier & faster than anyone now expects. The roc in M*Vt before any new stimulus is already above average. With low inflation (given some deficit resolution), Jan-Apr could be a zinger”
Then we had a “taper tantrum”.
“market zinger” forecast (zinger = a surprise, shock, or piece of electrifying news).
(2) 12-16-12, 01:50 PM #1 flow5 “We’re close to seeing the real power of OMOs. R-gDp is likely to accelerate earlier & faster than anyone now expects. The roc in M*Vt before any new stimulus is already above average. With low inflation (given some deficit resolution), Jan-Apr could be a zinger”
Ergo, the infamous “taper tantrum” (simply putting idled, flight-to-bank-held savings, back to work, based on the U.S. Golden Era in economics, the continuous and orderly flow of savings into real-investment, a non-inflationary velocity relationship).
The smartest Ph.Ds. in economics get this backwards.
See the universal error:
“Before the financial crisis, accounts were insured up to the first $100,000 by the FDIC. That limit kept enormous sums in the shadow banking system. After the crisis, the FDIC raised the insured account limit to $250,000. But trillions of dollars still sate outside the traditional banking system. The “safe” money had no place to go expect money market mutual funds and government securities, leading to a shortage of T-Bills and a corresponding drop in yield.” –Danielle Dimartino Booth’s book: “Fed Up”, pg. 218
Unless savings are expeditiously activated (perpetual motion of income redistribution, the circuit income and transactions velocity of funds), and put back to work, a dampening economic impact is exerted.
Historical FDIC’s insurance coverage deposit account limits:
• 1934 – $2,500
• 1935 – $5,000
• 1950 – $10,000
• 1966 – $15,000
• 1969 – $20,000
• 1974 – $40,000
• 1980 – $100,000
• 2008 – $unlimited
• 2013 – $250,000 (caused taper tantrum)
The U.S. Golden Era in economics was where pooled savings were gov’t insured and put back to work, largely thru the S&Ls, MSBs, and CUs. Then the DIDMCA transformed these thrifts into commercial banks (which created the S&L crisis).
DFI’s Time deposits vs. demand deposits:
1939……..15~~~~~~ 33
1954……..47~~~~~ 121
1964……126~~~~~ 156
1974……421~~~~~ 274
1979……676~~~~~ 401
1986…1,215~~~~~ 491
1996…1,271~~~~~ 420
2006…3,696~~~~~ 317
2016…8,222~~~~1,233
2017…
Ratio of TD/DD in 1939 = 0.45
Ratio of TD/DD in 2016 = 6.67
2. March 2018 at 13:37
As Professor Lester V. Chandler originally theorized in 1961, viz., that in the beginning: “a shift from demand to time “savings” accounts involves a decrease in the demand for money balances, and that this shift will be reflected in an offsetting increase in the velocity of money”. Therefore no dampening effect existed. However, this caused stagflation (as Pritchard predicted before the word was coined).
Chandler’s conjecture was correct up until 1981 – up until the plateau of financial innovation for commercial bank deposit accounts (the “monetization” of time “savings” deposits, the elimination of gate-keeping restrictions, etc., and the widespread introduction of ATS, NOW, and MMDA accounts).
The saturation of DD Vt according to Marshall D. Ketchum (Chicago School) in 1961: “It seems to be quite obvious that over time the demand for money cannot continue to shift to the left as people buildup their savings deposits; if it did, the time would come when there would be no demand for money at all”.
Thus, as Professor emeritus Dr. Leland James Pritchard, Ph.D., Economics, Chicago, 1933, MS, Statistics, Syracuse, predicted in May 1980 issue of IMTRAC (a publication by Dr. Christopher Y. Thomas, a cardiac surgeon), began the secular decline in money velocity (and the accompanying secular strangulation) as money velocity climaxed in the 1st qtr. 1981 (reached a permanently high plateau), from the “time” bomb (the time bomb was predicted), resulting in a 19.1 % 1st qtr. 1981 N-gNp figure:
http://bit.ly/2sW5vGi
http://bit.ly/29rPfCj
http://bit.ly/2h2KbrD
Note esp. that the 1981 “time bomb”, as predicted, denigrates all the velocity naysayers. Professor Pritchard never minced his words, and in May 1980 pontificated that:
“The Depository Institutions Monetary Control Act will have a pronounced effect in reducing money velocity”. And the rest is history.
As Dr. Leland James Pritchard proposed in the late 1950’s:
“Savings require prompt utilization if the circuit flow of funds is to be maintained and deflationary effects avoided”…”The growth of commercial bank-held time “savings” deposits shrinks aggregate demand and therefore produces adverse effects on gDp”…”The stoppage in the flow of funds, which is an inexorable part of time-deposit banking, would tend to have a longer-term debilitating effect on demands, particularly the demands for capital goods.” Circa 1960
The point is that Philip George validates Leland Pritchard’s ideas on commercial banks vs. financial intermediaries.
2. March 2018 at 17:14
Professor Sumner,
I think the argument might have been the speed with which the unemployment rate spikes to 10 percent. As I think you’ve noted, there was not substantial rise in the unemployment rate around December 2007 even as housing prices began to fall: it rose rather gradually and peaked by the end of 2009. (Ironically, if monetary policy were too tight in 2008, this is actually consistent with policy lags of about a year.)
With that said, I have no objection to incredibly rigorous stress tests. I do think some form of streamlining could perhaps lessen the burdens associated with compliance. I’ve read that institutions sometimes have to shell out millions to comply with these, hire vast numbers of people, etc. There’s almost surely excessive bureaucracy, though that need not mean the tests themselves are too harsh.
3. March 2018 at 06:36
A bank is liquid when it is able to exchange its assets for cash rapidly enough to meet the demands made upon it for cash and payments. A bank is solvent when the realizable value of its assets is at least sufficient to cover all its liabilities. A bank at any given time could meet a current test of liquidity and not be solvent, and it could be solvent and not have sufficient current liquidity.
In terms of balance sheet, net worth is the margin between solvency and insolvency, but a forced and hasty liquidation of assets might result in a bank being insolvent whose condition ordinarily could be regarded as sound.
My question is whether Wells Fargo is solvent.
3. March 2018 at 07:00
‘Here’s my question. Where is the GOP plan to reform our banking system, to overcome the problems created by moral hazard?’
Phil Gramm is a Republican. You wanted him to have the Nobel Prize for his plan;
http://econlog.econlib.org/archives/2015/11/could_gramm_lea.html
‘So the law that provided the flexibility Bernanke needed to deal with the 2008 banking crisis, also suggested a policy reform that might have prevented the crisis entirely. Maybe Phil Gramm deserves a Nobel Prize in economics.’
3. March 2018 at 07:09
‘Remember the private-sector free-market idea of financial insurance was AIG.’
Wrong. AIG’s problems only eventuated AFTER Eliot Spitzer effectively confiscated it from its found Hank Greenberg. It was the regulators fault. Had Greenburg been left unmolested to run his company it never would have gotten into trouble.
https://www.amazon.com/dp/B00AZ64YUG/ref=dp-kindle-redirect?_encoding=UTF8&btkr=1
3. March 2018 at 07:14
‘The question is, if we take the business cycle for granted, how much growth in the long run are we willing to sacrifice to reduce the risk of recession by some amount. It isn’t self evident (its manifestly incorrect I’d say) that we should be as risk averse as Nassim Taleb wants us to be.’
Exactly, Mark Z. Just add Neel Kashkari’s name of those ignoring the Dead Weight Loss 25% capital requirements would entail
3. March 2018 at 14:04
Patrick,
No, AIGFP willingly underwrote all of those CDS’s, and made a good bit of money doing it before the market crashed. Maybe Hank Greenberg would have stopped it, or maybe not. He says he would have, but nobody really knows.
It’s so absurdly tortured to blame Spitzer for AIGFP underwriting CDS’s, like other tortured arguments for blaming government for the subprime mortgages (i.e. CRA).
3. March 2018 at 15:25
Matthew, You said:
“Remember the private-sector free-market idea of financial insurance was AIG.”
Not even close. There is nothing at all “free market” about our financial system, including AIG. It’s riddled with moral hazard.
Salmo, You said:
“The aggregate lending capacity of the payment’s system is determined by the monetary policy of Federal Reserve authorities.”
and then:
“Bank lending today simply depends upon on bankable opportunities and credit worthy borrowers.”
Make up your mind.
Fred, I have no opinion on stress tests, I just think the argument about unemployment not rising to 10% in 7 quarters is nuts. It most certainly could happen.
Patrick, Phil Gramm has nothing to do with the modern GOP, which is the party of corporate cronyism, the party of Trump.
3. March 2018 at 16:48
Scott,
I was quoting Benjamin Cole above me.
3. March 2018 at 20:39
Matthew, Sorry, I missed that.
15. March 2018 at 01:45
@Scott:
I don’t think these two claims are mutually exclusive.
“The aggregate lending capacity of the payment’s system is determined by the monetary policy of Federal Reserve authorities.”
and then:
“Bank lending today simply depends upon on bankable opportunities and credit worthy borrowers.”
The first one simply refers to the upper limit (i.e. the maximum supply constraint set by the central bank), whereas the second one refers to the actual amount of extended credit under current conditions (i.e. the demand for credit).
Salmo’s comments are barely comprehensible due to his writing style but I would love to read your opinion on his ideas. he’s essentially saying that different monetary regimes produce different real outcomes even in the very long run, i.e. there is no money neutrality even in the very long run. There is some very basic evidence pointing to that direction. Changes in monetary regimes over the past 100 years really seem to have had lasting and material impact on real interest rates in the respective countries.
Same goes for the design of the banking system and its regulation. It may affect the type of investments towards which credit is geared (acquisition of already existing assets vs. creation of new assets,e.g. buying to let vs. building new homes).