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The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.


April 13, 2011


How has the financial system changed? (And what to do about it)

The subject of this post's title was, in essence, the centerpiece of the most recent edition of the Atlanta Fed's annual Financial Markets Conference, convened this year in Stone Mountain, Ga. (just outside Atlanta). In terms of formal papers, the conference was bookended by work that came to very similar conclusions but from very different angles. From the vantage point of recent developments in micro banking structure, Arnoud Boot offered this diagnosis:

"A fundamental feature of more recent financial innovations is their focus on augmenting marketability. Marketability has led to a strong growth of transaction-oriented banking (trading and financial market activities). This is at least in part facilitated by the scalability of this activity (contrary to relationship banking activities). It is argued that the more intertwined nature of banks and financial markets induces opportunistic decision making and herding behavior. In doing so, it has exposed banks to the boom and bust nature of financial markets and has augmented instability."

Taking the very long view, Moritz Schularick presented (from a paper co-authored with Alan Taylor) pretty compelling evidence that the ongoing shift from relationship banking to transactions-based banking has fundamentally altered the nature of financial developments on real activity in modern economies:

"We first document and discuss our newly assembled dataset on money and credit, aligned with various macroeconomic indicators, covering 14 developed countries and the years from 1870 to 2008. This new dataset allows us to establish a number of important stylized facts about what we shall refer to as the 'two eras of finance capitalism.' The first financial era runs from 1870 to 1939. In this era, money and credit were volatile but over the long run they maintained a roughly stable relationship to each other, and to the size of the economy measured by GDP. The only exception to this rule was the Great Depression period: in the 1930s money and credit aggregates collapsed. In this first era, the one studied by Friedman and Schwartz, the 'money view' of the world looks entirely plausible. However, the second financial era, starting in 1945, looks very different. With the banking sector progressively more leveraged in the second financial era, particularly towards the end, the divergence between credit supply and money supply offers prima facie support for the credit view as against a pure money view; we have entered an age of unprecedented financial risk and leverage, a new global stylized fact that is not fully appreciated."

If there was agreement on increasing threats to financial stability, what to do about it (unsurprisingly) was somewhat more controversial. On the microprudential front, several conference participants—Viral Acharya, for example—looked to greater capital buffers as a key to greater financial stability. Others—George Kaufman commenting on Boot's paper, for instance—were more inclined to rely on market solutions. Boot, for his part, was highly skeptical of the self-correcting market forces and, while sympathetic to greater reliance on bank capital, believes much more is required:

"What we have also argued is that market discipline might be rather ineffective. We described this as a paradox. When particular strategies have momentum in financial markets, the market as a whole may underestimate the risks that these entail. How then can we expect market discipline to work? It appears to us that market discipline might not be present when banks follow financial market inspired strategies. Things are even worse because these strategies will lead to a high correlation in actual exposures between financial institutions because all see the same opportunities and hence herding occurs. Systemic risk would then be considerable and not checked by market discipline."

Earlier in the paper, Boot puts forward:

"We believe that heavy handed intervention in the structure of the banking industry—building on the Volcker Rule—might ultimately be an inevitable part of the restructuring of the industry. It could address complexity but also help in containing market forces that might run orthogonal to what prudential concerns would dictate (as the insights on market discipline in section 6 suggest). For now, the structural interventions in the banking industry are rather tentative. Other measures such as higher capital and liquidity requirements are clearly needed. But these primarily focus on individual institutions while a more system-orientation is crucial to identify externalities and interlinkages (Goodhart, 2009; and Calomiris, 2009). Anti-cyclical capital surcharges and other measures and surcharges depending on the degree of interconnectedness are needed as well to add some further comfort. We tend to subscribe to John Kay's (2009) notion of redundancy: having comfort in the stability of the financial sector dictates building redundancy into the regulatory and supervisory structures of banking."

With respect to "system-oriented" signals, Schularick was clear where he and his co-author think their research leads:

"These new results from long-run data, if they pass scrutiny, inform the current controversy over macroeconomic policy practices in developed countries. Specifically, the pre-2008 consensus argued that monetary policy should follow a 'rule' based only on output gaps and inflation, but a few dissenters thought that credit aggregates deserved to be watched carefully and incorporated into monetary policy. The influence of the credit view has certainly advanced after the 2008–09 crash, just as respect has waned for the glib assertion that central banks could ignore potential financial bubbles and easily clean up after they burst."

Credit and bank capital—along with sound fiscal policy and a little good luck—do appear to have been key to how well different economies fared during the recent financial crisis. At least that is the conclusion reached in a study by Stephen Cecchetti and his co-authors from the Bank of International Settlements:

"The macroeconomic performance of individual countries varied markedly during the 2007–09 global financial crisis.… Better-performing economies featured a better-capitalised banking sector, a current account surplus, high foreign exchange reserves and low private sector credit-to-GDP. In other words, sound policy decisions and institutions reduced their vulnerability to the financial crisis. But these economies also featured a low level of financial openness and less exposure to US creditors, suggesting that good luck played a part."

As we seek to shore up our financial timber to avoid a repeat of recent history, it is appropriate to remember that, while it is good to be lucky, fortune is probably not arbitrary in choosing where it will shine.


Photo of Dave Altig By Dave Altig
senior vice president and research director at the Atlanta Fed



April 13, 2011 in Financial System, Money Markets | Permalink

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Banking is one of many oligopolies that are government ignores.

"People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices." (Adam Smith, The Wealth of Nations, 1776).

What does the American auto industry, the health care industry, wall street firms and the banking industry all have in common; other than they were all on the brink of failure?

These are industries where the production side of the industry is no longer a free market with many producers competing head-to head to earn the business of consumers, or customers, of the industry. Instead each of these industries are controlled by a relatively small number of very large corporations that have transformed these markets into oligopolies.

Adam Smith when he discussed “rational self interest” and competitive markets in his book Wealth of Nations, envisioned many consumers buying goods and services from many producers with everyone looking out for their self-interest. By keeping markets “free”, producers pursue their rational self-interest and this best meets the needs of the consumers and the citizens of our country, who are also looking out for their self-interest. Under this system, what is in the producers self interest is to provide the best product possible to the consumer, while striving to be a low cost producer for their niche.

This consolidation of markets began in the late 1960's early 1970's in the auto industry when it was transformed from a free market to an industry that was controlled by three giant corporations and one union. As this transformation was occurring the auto company's and auto union's self-interest became separated from what the consumer wanted and/or needed. Competition between the companies broke down and this gave an opening for foreign competition to enter our markets and the beginning of the end of the American auto industry as we knew it.

Other industries saw what was happening in the auto industry and saw that government was not objecting so naturally they followed the same path with little concern on any ones part that we were losing our free market system to a more centralized market system of oligopolies. As a result we now have major markets where the producing entities self-interest is not always in line with the self-interest of the consumer. What is in the self-interest of the entities in these industries is to keep the oligopoly alive. Thus the creation of special interests and lobbyists.

These oligopolies have bought the protection of our representatives in Washington and state capitals. I am always baffled by the fact that corporations and unions cannot vote in this country, however they are allowed to buy votes with their contributions.

We lost track of a key ingredient that Adam Smith identified as necessary in order for “rational self interest” to work. There must be many producers. In too many industries, the number of producers has shrunk and the ones remaining have gotten “too big to fail”. This is true in the auto industry, the banking industry, wall street, health care and will soon be true in the computer software industry.

When discussing the health insurance industry proponents for this specific oligopoly site the fact that the bigger the insured pool, the lower insurance premiums can be. However, I submit that this "bigger pool savings" is more than offset by the fact that the rational self-interest of the companies is not totally aligned with the rational self interest of the insured. The insurance industries self-interest is to keep the oligopoly alive. The self-interest of the insured is to have as many insurance companies as possible clawing to get his business and thus ringing out all excessive cost, including unconscionable salaries for top executives, to earn the consumers business.

The liberals are right that regulation is required and conservatives are right that a free market is the best way to meet the needs and wants of our citizens. The common ground is that regulation is essential to make our markets more free. We have too many industries where companies have too much power, their self interest is not aligned with the citizens of this country and they are too big to fail.

It is time that our politicians breakaway from the shackles of oligopolies, special interests groups and lobbyists. Use antitrust legislation to bring back free markets.http://freeourfreemarkets.org

Posted by: sbanicki | April 13, 2011 at 04:31 PM

A very good post, thank you.

Transactions-oriented banking would seem to require a transactions-oriented regulatory tool-kit modeled after what is done in best-of-breed trading houses today: transactions that increase corporate risk get capital charges, and transactions that decrease it get capital credits. Note that this policy is applied to *transactions*. The balance-sheet provides the direction and intensity of the charges, but the charge is applied to the transaction.

While the details are certainly profoundly complicated, it does seem that transactions-oriented capital regulation has the potential to remediate liquidity problems. The expectations of late-entrants into a crowding market will be dampened by the higher capital charges. Momentum-trading will be less profitable. Counter-cyclic trade charges are a correction to the distribution of expectations of return that are proportional to market depth. It will decrease liquidity demand at precisely the time when liquidity is drying up.

If successful this policy allocates the costs of liquidity risk to the late-comers who actually cause the problem, and it protects the capital of the early-adopters who are the innovators in the market.

The downside is that this will tend to slow price competition in financial services. But in an industry that experiences 35% annual decline in profit margins, that might actually be a good thing. Extreme volatility in the profitability of financial services has the potential of rather spectacularly bad outcomes, as we have seen.

Posted by: Alan King | April 17, 2011 at 10:40 AM

Moritz Schularick's comments on "the divergence between credit supply and money supply" are interesting.

But the "divergence" is only the result of an error in measuring money supply, and this in turn is the result of viewing money not as the sum of credit plus currency but as cash balances. The error of viewing money as cash balances is an error common to the Austrians, the monetarists and the Keynesians. So far as I know only one economist has not agreed with this view: Joseph Schumpeter. And unfortunately, Schumpeter did not do any serious work on money.

In an era when currency is only about 50% of M1, a completely new model of money is required, one that views money as credit plus currency, not cash balances.

I have developed a complete model of money as credit but understanding it calls for unlearning a lifetime's thinking of money as cash balances.

In any case the end result, a graph showing what I call Corrected Money Supply from 2001 to 2011 can be viewed at http://www.philipji.com/Mc2001-2011.gif

If the fact that it accurately tracks the rise of money supply until the beginning of 2006 when housing starts ceased to grow, the contraction of money during the recession and its rise to dangerous levels in recent months is interesting, the logic behind the article can be seen at http://www.philipji.com/riddle-of-money/

In the absence of an accurate monetary aggregate any attempt to identify and prevent bubbles is impossible.

Posted by: Philip George | April 17, 2011 at 11:34 AM

I really like this concept. I just want to know as it consists of how many templates. Better-performing economies featured a better-capitalized banking sector, a current account surplus, high foreign exchange reserves and low private sector credit-to-GDP. In other words, sound policy decisions and institutions reduced their vulnerability to the financial crisis. But these economies also featured a low level of financial openness and less exposure to US creditors, suggesting that good luck played a part. Thanks for sharing this great post.

Posted by: home business | April 18, 2011 at 05:09 AM

Great article, short and precise. What bothers me although is the fact that the jury is impressed by a presentation like this. This just proves that the application of law often does not have anything to do with justice, but more so with who's better at presenting. While the details are certainly profoundly complicated, it does seem that transactions-oriented capital regulation has the potential to remediate liquidity problems. The expectations of late-entrants into a crowding market will be dampened by the higher capital charges. Momentum-trading will be less profitable. Counter-cyclic trade charges are a correction to the distribution of expectations of return that are proportional to market depth. It will decrease liquidity demand at precisely the time when liquidity is drying up. What bothers me although is the fact that the jury is impressed by a presentation like this. This just proves that the application of law often does not have anything to do with justice, but more so with "who's better at presenting".

Posted by: Business Plan | April 19, 2011 at 07:45 AM

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May 13, 2010


Regulatory reform via resolution: Maybe not sufficient, certainly necessary

This macroblog post is the first of several that will feature the Atlanta Fed's 2010 Financial Markets Conference. Please return for additional information.

On Tuesday and Wednesday the Federal Reserve Bank of Atlanta hosted its annual Financial Markets Conference, titled this year Up From the Ashes: The Financial System After the Crisis. Much of the first day was devoted to conversations about rating agencies and their role in the economy, for better and worse. The second day was absorbed by the issues of too-big-to-fail, macroprudential regulation, and regulatory reform.

One theme that ran throughout the second day's conversations related to the two aspects of regulatory reform highlighted by Chairman Bernanke in his recent congressional testimony on lessons from the failure of Lehman Brothers:

"The Lehman failure provides at least two important lessons. First, we must eliminate the gaps in our financial regulatory framework that allow large, complex, interconnected firms like Lehman to operate without robust consolidated supervision… Second, to avoid having to choose in the future between bailing out a failing, systemically critical firm or allowing its disorderly bankruptcy, we need a new resolution regime, analogous to that already established for failing banks."

Though those two aspects of reform are in no way mutually exclusive, there is, I think, a tendency to lean to one or the other as the first most important contributor to avoiding a repeat of our recent travails. To put it in slightly different terms, there are those that would place greatest emphasis on reducing the probability of systemically important failures and those that would put greatest emphasis on containing the damage when a systemically important failure occurs.

I offered my views last month at the Third Transatlantic Economic Dialogue, hosted by Johns Hopkins University's Center for Transatlantic Relations.

"…the best chance for durable reform is to start with the assumption that failure will happen and construct a strategy for dealing with it when it does…

"In a world with the capacity for rapid innovation, rule-writers have a tendency to perpetually fight the last war…

"I am not arguing that … the 'Volcker rule,' derivative exchanges, trading restrictions, or any of the specific regulatory reform proposals in play are necessarily bad ideas. I am arguing that we should assume that, no matter what proposed safeguards are put in place, failure of some systemically important institution will ultimately occur—somewhere, somehow. And that means priority has to be given to the development of resolution procedures for institutions that are otherwise too big to fail."

At our conference this week, University of Florida professor Mark Flannery expressed concerns that, placed in an international context, a truly robust resolution process for failed institutions may be tough to construct:

"In principle, a non-bankruptcy reorganization channel for SIFIs [systemically important financial institutions] makes a lot of sense. But the complexity of SIFIs' organizational structures introduces some serious problems. Not only do SIFIs operate with a bewildering array of subsidiaries… but they generally operate in many countries. Without very close coordination of resolution decisions across jurisdictions, a U.S. government reorganization would likely set off a scramble for assets of the sort that bankruptcy is meant to avoid. Rapid asset sales could generate downward price spirals… with systemically detrimental effects. Second, supervisors would have to assure that SIFIs maintain the proper sort and quantity of haircut-able liabilities outstanding. Once a firm has been identified as systemically important, this may be a relatively straightforward requirement to impose, but there remains the danger that 'shadow' institutions will become systemically important, before they are properly regulated. (This is not a danger unique to the question of resolution.)

"I conclude that the international coordination required to make prompt resolution feasible for SIFIs is a long way off, if it can be achieved at all."

Not an encouraging note, and the point is very well taken. Flannery concludes that we would be better served by focusing on changes that lie on the "avoiding failure" end of the reform spectrum: standardized derivative contracts, tying supervisory oversight to objective market-based metrics on the health of SIFIs, limitations on risky activities, and higher capital standards.

As I noted above, I am certainly not hostile to these ideas, and the answer to the question "should reform strategies be rules-based or resolution-based?" is surely "all of the above." But even if it will take a long time to develop better resolution procedures to address the types of problems that emerged in the past several years, I strongly argue that development of such procedures are necessary for the long-term, and work on these procedures should begin. And here, I have a relatively modest proposal, returning to my remarks:

"…there is a pretty obvious way to vet proposals that are offered. We have a couple of real-world case studies—Bear Stearns, Lehman, AIG. One test for any proposed resolution process would be to illustrate how that plan would have been implemented in each of those cases. This set of experiments can't be started too soon, and I think should move it to the top of our reform priorities."

Whether it be the specific provisions of reform bills winding their way through Congress or the "living will" idea championed this week by the Federal Deposit Insurance Corporation, I think we would do well to let the stress testing of those proposals begin.

By Dave Altig, senior vice president and research director at the Atlanta Fed

May 13, 2010 in Banking, Financial System, Regulation | Permalink

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My thoughts on this are posted at my blog, www.pointsandfugures.com. To summarize them, we need a drastic change in the structure of the cash equity marketplace. We need to look at the role of each marketplace in the economy, and eliminate some traditional practices.

As far as OTC, we certainly should clear many of them. But there is not any way to safely clear all of them. Let the market decide.

Posted by: Jeff | May 15, 2010 at 06:33 PM

Does anyone at the Fed or within the banking system have a thought on the system as a whole?

We've been "at" capitalism now for a few hundred years. Seems odd that now, in 2010, we need some regulation that some previous authoritative body overlooked.

I'm hinting that the problem is not legal, it's physical. Our current manifestation of economy may in-itself be dying.

3 major crashes in one decade, and we almost went down again last week. What is "law" really going to do?

Posted by: FormerSSResident | May 15, 2010 at 07:04 PM

I genuinely do not understand why this is such a problem. The share price of any institution that fails ought to be zero, in which case, the institution can be taken into the temporary ownership of the government for, say, one cent per share. The government are then free, as the new owners, to dispose of the business as they see fit, either through an orderly liquidation or recapitalisation and sale. In that way, any systemic shock can be avoided. Except for petty political prejudice against nationalisation, which it ought to be possible to set aside in an emergency, what is the problem with that solution?

Posted by: RebelEconomist | May 16, 2010 at 02:57 PM

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May 11, 2010


Return of the swap lines

As the European Union jumped into crisis resolution mode with both feet and the European Central Bank (ECB) responded to the "exceptional circumstances" with measures to address severe tensions in financial markets, the Federal Reserve has made its own contribution to global economic stability by announcing the reestablishment of temporary U.S. dollar swap facilities with the ECB, Bank of Canada, Bank of England, Swiss National Bank, and (later) the Bank of Japan.

Swap lines are not new tools for central banks. In fact, we covered the basics of swap arrangements in September 2008, explaining the rationale at that time for the facilities thus:

"An underlying aspect of a currency swap is that banks (and businesses) around the world have assets and liabilities not only in their home currency, but also in dollars. Thus, banks in England need funding in U.S. dollars as well as in pounds.

"However, banks recently have been reluctant to lend to one another. Some observers believe this reluctance relates to uncertainty about the assets that other banks have on their balance sheets or because a bank might be uncertain about its own short-term cash needs. Whatever the cause, this reluctance in the interbank market has pushed up the premium for short-term U.S. dollar funding and has been evident in a sharp escalation in LIBOR rates.

"The currency swap lines were designed to inject liquidity, which can help bring rates down."

Yesterday's online edition of The Wall Street Journal's Real Time Economics blog makes note of a more recent, and very nice, primer from the Federal Reserve Bank of New York, co-authored by Michael Fleming and Nicholas Klagge. The Fleming-Klagge article describes a Libor-based measure of stress that was particularly acute in nondollar countries during the worst of the crisis that began in 2007.

"Because foreign banks secure much of their dollar funding through interbank loans, they can expect to face greater funding pressures during times of market stress. One way to measure such pressures involves examining the individual borrowing rates of the sixteen banks that make up the Libor survey 'panel.' The difference between the average borrowing rate of the panel's thirteen non-U.S. banks and the average borrowing rate of its three U.S. banks provides a rough proxy for the increased difficulty foreign banks face in trying to borrow dollars."

Did the currency swaps help bring this spread down? Here's a little informal evidence:

051110
enlarge

That's not proof, but it is not too hard to see why the New York Fed article would conclude with this answer to the WSJ's answer to the question "Did it Work?":

"Early evidence suggests that the swap lines were successful in smoothing disruptions in overseas dollar funding markets. Swap line announcements and operations were associated with improved conditions in these markets: Although measures of dollar funding pressures remained high throughout the crisis period, they tended to moderate following large increases in dollars lent under the swap line program. Moreover, the sharp decline in swap line usage as the crisis ebbed suggests that the pricing of funds offered through swap lines gave institutions an incentive to return to private sources of funding as market conditions improved."

You can find more information about the Federal Reserve's previous swap facilities here.

By Dave Altig, senior vice president and research director at the Atlanta Fed

May 11, 2010 in Federal Reserve and Monetary Policy, Financial System | Permalink

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Nice piece. The swap lines will also tend to limit dollar appreciation, which may not help the economies in the euro area.

Posted by: don | May 13, 2010 at 01:45 PM

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April 29, 2010


Consumer credit: More than meets the eye

A lot has been made (here, for a recent example) of the idea that banks have shown a surprising amount of reluctance to extend credit and to start making loans again. Indeed, the Fed's consumer credit report, which shows the aggregate amount of credit extended to individuals (excluding loans secured by real estate), has been on a steady downward trend since the fall of 2008.

Importantly, that report also provides a breakdown that shows how much credit the different types of institutions hold on their books. Commercial banks, which are the single largest category, accounted for about a third of the total stock in consumer credit in 2009. The two other largest categories—finance companies and securitized assets—accounted for a combined 45 percent. While commercial banks have been the biggest source of credit, they have not been the biggest direct source of the decline.

042910a
(enlarge)

The chart above highlights a somewhat divergent pattern among the big three credit holders. This pattern mainly indicates that credit from finance companies and securitized assets has been on a relatively steady decline since the fall of 2008 while credit from commercial banks has shown more of a leveling off. These details highlight a potential misconception that commercial banks are the primary driver behind the recent reduction in credit going to consumers (however, lending surveys certainly indicate that standards for credit have tightened).

To put a scale on these declines, the aggregate measure of consumer credit has declined by a total of 5.7 percent since its peak in December 2008 through February 2010. Over this same time period, credit from finance companies and securitizations declined by 16.2 percent and 12.4 percent, respectively, while commercial bank credit declined by 5.5 percent. Admittedly, securitization and off-balance sheet financing are a big part of banks' activity as they facilitate consumers' access to credit. The decline in securitized assets might not be that surprising given that the market started to freeze in 2007 and deteriorated further in 2008 as many investors fled the market. Including banks' securitized assets that are off the balance sheet would show a steeper decline in banks' holdings of consumer credit.

A significant factor in evaluating consumer credit is the pace of charge-offs, which can overstate the decline in underlying loan activity (charge-offs are loans that are not expected to be paid back and are removed from the books). Some (here and here) have made the point that the declines in credit card debt, for example, reflect increasing rates of charge-offs rather than consumers paying down their balances.

How much are charge-offs affecting the consumer credit data? Unfortunately, the Fed's consumer credit statistics don't include charge-offs. However, we can look at a different dataset that includes quarterly data on charge-offs for commercial banks to get an approximation. We can think of the change in consumer loan balances roughly as new loans minus loans repaid minus net loans charged off:

Change in Consumer Loans = [New Loans – Loan Repayments] – Net Charge-Offs

Adding net charge-offs to the change in consumer loans should give a cleaner estimate of underlying loan activity:

  042910c

If the adjusted series is negative, loan repayments should be greater than new loans extended, which would lend support to the idea that loans are declining because consumers are paying down their debt balances. If the adjusted series is positive, new loans extended should be greater than loan repayments and adds support to the hypothesis that part of the decline in the as-reported loans data is from banks removing the debt from their books because of doubtful collection. Both the as-reported and adjusted consumer loan series are plotted here:

042910b
enlarge

Notably, year-over-year growth in consumer loans adjusted for charge-offs has remained positive, which contrasts the negative growth in the as-reported series. That is, the net growth in new loans and loan repayments shows a positive (albeit slowing) growth rate once charge-offs are factored in. Over 2009, this estimate of charge-offs totaled about $27 billion while banks' average consumer loan balances declined by about $25 billion. Thus, a significant portion of the recent decline in consumer loan balances is the result of charge-offs.

Nevertheless, in an expanding economy, little or no credit growth implies a declining share of consumption financed through credit. Adjusting consumer loans for charge-offs suggests that the degree of consumer deleveraging across nonmortgage debt is somewhat less substantial than indicated by the headline numbers.

All in all, the consumer credit picture is a bit more complicated than it appears on the surface. A more detailed look suggests that banks haven't cut their consumer loan portfolios as drastically as sometimes assumed. The large run-up in charge-offs has also masked the underlying dynamics for loan creation and repayment. Factoring in charge-offs provides some evidence that a nontrivial part of consumer deleveraging is coming through charge-offs.

By Michael Hammill, economic policy analysis specialist in the Atlanta Fed's research department

April 29, 2010 in Banking, Capital Markets, Financial System, Saving, Capital, and Investment | Permalink

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Very nice.

One can get a slightly broader data set by using FDIC statistics on all insured institutions (http://www2.fdic.gov/SDI/SOB/). It doesn't seem the results are substantially different: For end 2009 vs end 2008, an unadjusted drop of $29bn, vs an adjusted rise of $34bn.

Paul Kasriel recently did the same analysis for bank lending overall (full disclaimer - he mentions my website). http://web-xp2a-pws.ntrs.com/content//media/attachment/data/econ_research/1004/document/ec042910.pdf

Posted by: Jim Fickett | May 01, 2010 at 07:31 PM

you could have boiled off a lot of filler here and had quite a nice compact post
regardless well worth reading thanx

Posted by: paine | May 02, 2010 at 01:56 PM

A question: when there are charge-offs, do they include the late-payment penalties and other fees or only original principal?

Posted by: Daniil | May 03, 2010 at 10:21 AM

Two other general observations: First, although clearly implied by the post above, some readers commenting around the net have not noticed that we DON'T KNOW what the net growth in new consumer loans is, overall. Since charge-off data are available only for FDIC-insured institutions, we can't make the second graph above for the other categories of lending.

Second, and related, Felix Salmon did a post in March, linked to above, in which he concluded that consumers were not paying their cards down; in fact they were borrowing more. But the data he used, from CardHub, was mistaken -- it did not make the distinctions made in the post above, and applied the Fed charge-off rate, which is only for commercial banks, to the full revolving debt balance, from all sources. Many people are still under the impression of what Salmon wrote, but in fact we do not know whether it is true.

@Daniil: charge-offs are only principal. The accounting, in which the principal balance of loans outstanding is reduced by charge-offs, would not make sense otherwise.

Posted by: Jim FIckett | May 03, 2010 at 11:43 PM

@Jim My question is not about that. It's the following. There's a balance of $1000. I miss 3 payments and the bank assesses $200 worth of late charges and resets the interest rate after first missed payment so that after 3 months (let's say that's when the bank charges off the loan) my loan to the bank is $1300. So my total debt goes up. I don't know what's on banks books as a result of this. Do they discharge the 1000? 1300?
And even if 1300, then the total 'borrowing' might still be going up not because people are borrowing, but because they are falling behind.

Posted by: Daniil | May 05, 2010 at 04:54 PM

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April 06, 2010


Breaking up big banks: As usual, benefits come with a side of costs

Probably the least controversial proposition among an otherwise very controversial set of propositions on which financial reform proposals are based is that institutions deemed "too big to fail" (TBTF) are a real problem. As Fed Chairman Bernanke declared not too long ago:

As the crisis has shown, one of the greatest threats to the diversity and efficiency of our financial system is the pernicious problem of financial institutions that are deemed "too big to fail."

The next question, of course, is how to deal with that threat. At this point the debate gets contentious. One popular suggestion for dealing with the TBTF problem is to just make sure that no bank is "too big." Two scholars leading that charge are Simon Johnson and
James Kwak (who are among other things the proprietors at The Baseline Scenario blog). They make their case in the New York Times' Economix feature:

Since last fall, many leading central bankers including Mervyn King, Paul Volcker, Richard Fisher and Thomas Hoenig have come out in favor of either breaking up large banks or constraining their activities in ways that reduce taxpayers' exposure to potential failures. Senators Bernard Sanders and Ted Kaufman have also called for cutting large banks down to a size where they no longer pose a systemic threat to the financial system and the economy.

…We think that increased capital requirements are an important and valuable step toward ensuring a safer financial system. We just don't think they are enough. Nor are they the central issue…

We think the better solution is the "dumber" one: avoid having banks that are too big (or too complex) to fail in the first place.

Paul Krugman has noted one big potential problem with this line of attack:

As I argued in my last column, while the problem of "too big to fail" has gotten most of the attention—and while big banks deserve all the opprobrium they're getting—the core problem with our financial system isn't the size of the largest financial institutions. It is, instead, the fact that the current system doesn't limit risky behavior by "shadow banks," institutions—like Lehman Brothers—that carry out banking functions, that are perfectly capable of creating a banking crisis, but, because they issue debt rather than taking deposits, face minimal oversight.

In addition to that observation—which is the basis of calls for a systemic regulator that spans the financial system, and not just specific classes of financial institutions—there is another, very basic, economic question: Why are banks big?

To that question, there seems to be an answer: We have big banks because there are efficiencies associated with getting bigger—economies of scale. David Wheelock and Paul Wilson, of the Federal Reserve Bank of St. Louis and Clemson University, respectively, sum up what they and other economists know about economies of scale in banking:

…our findings are consistent with other recent studies that find evidence of significant scale economies for large bank holding companies, as well as with the view that industry consolidation has been driven, at least in part, by scale economies. Further, our results have implications for policies intended to limit the size of banks to ensure competitive markets, to reduce the number of banks deemed "too-big-to-fail," or for other purposes. Although there may be benefits to imposing limits on the size of banks, our research points out potential costs of such intervention.

Writing at the National Review Online, the Cato Institute's Arnold Kling acknowledges the efficiency angle, and then dismisses it:

There's a long debate to be had about the maximum size to which a bank should be allowed to grow, and about how to go about breaking up banks that become too large. But I want to focus instead on the general objections to large banks.

The question can be examined from three perspectives. First, how much economic efficiency would be sacrificed by limiting the size of financial institutions? Second, how would such a policy affect systemic risk? Third, what would be the political economy of limiting banks' size?

It is the political economy that most concerns me…

If we had a free market in banking, very large banks would constitute evidence that there are commensurate economies of scale in the industry. But the reality is that our present large financial institutions probably owe their scale more to government policy than to economic advantages associated with their vast size.

I added the emphasis to the "probably" qualifier.

The Wheelock-Wilson evidence does not disprove the Kling assertion, as the estimates of scale economies are obtained using banks' cost structures, which certainly are impacted by the nature of government policy. But if economies of scale are in some way intrinsic to at least some aspects of banking—and not just political economy artifacts—the costs of placing restrictions on bank size could introduce risks that go beyond reducing the efficiency of the targeted financial institutions. If some banks are large for good economic reasons, the forces that move them to become big would likely emerge with force in the shadow banking system, exacerbating the very problem noted by Krugman.

I think it bears noting that the argument for something like constraining the size of particular banks implicitly assumes that it is not possible, for reasons that are either technical or political, to actually let failing large institutions fail. Maybe it is so, as Robert Reich asserts in a Huffington Post item today. And maybe it is in fact the case that big is not beautiful when it comes to financial institutions. But in evaluating the benefits of busting up the big guys, we shouldn't lose sight of the possibility that this is also a strategy that could carry very real costs.

By Dave Altig, senior vice president and research director at the Atlanta Fed

April 6, 2010 in Banking, Financial System, Regulation | Permalink

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I understand Krugman's argument, but doesn't it emphasise the importance of dealing with the TBTF problem for all types of financial institutions - whether deposit-taking or not? I agree that dealing with the TBTF problem only for depositary institutions is pointless - after all, the big failures of the current crisis were all non-banks (Bear Stearns, Lehman Brothers, AIG...) - but why should that be the end of the story? If PIMCO or Blackrock create systemic risk, that should be regulated - including structural remedies if necessary - just as it should if the culprit is Citi or Bank of America.

Posted by: Carlomagno | April 06, 2010 at 04:00 PM

Higher capital requirements might be one way to establish a driving force for reducing the size of a bank. Another one could be higher fees to pay for being a big bank, like an insurance premiums: because the damage of a bank failure would increase over proportionally with the size of the bank, the insurance payments should increase also with size and much more than linearly. If a bank wants to get bigger, to do some things better, it pays the price and is allowed to grow.

Posted by: Peter T | April 06, 2010 at 07:11 PM

The most obvious "economy of scale" associated with large banks is ability to influence the regulator. This is bad, not good, for the system even if it is good for bank profits.

The other key reason why banks might grow large is diversification -- but increased securitization should have reduced, not increased, the correlation between size and diversification. Computing power is even less plausible. Cross-selling never was plausible except to the extent that it involved the potential for profiting from breaches of client confidentiality.

Posted by: D Greenwood | April 08, 2010 at 09:07 AM

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March 05, 2010


In the beginning, there was a lender of last resort

Steven Pearlstein, business columnist for the Washington Post, asks and answers the question "should the Fed stay out of the bank supervision business?"

"As the Senate begins to focus on how to fix financial regulation, one of the remaining unresolved issues is what role the Federal Reserve should have in supervising banks.

"The correct answer? None at all."

One of the centerpieces of the Pearlstein argument is this:

"The reality is that the Fed's primary focus is and will always be on monetary policy. Bank supervision will continue, as it has been, as a secondary activity that not only receives less attention from the top but will be sacrificed at those rare but crucial moments when the two missions might conflict. Indeed, by arguing that the Fed needs the insights gleaned from bank supervision to be more effective in making monetary policy, the Fed essentially acknowledges this hierarchy in its priorities. Bank supervision is important enough that it ought to be somebody else's top priority."

If you might allow me a moment of personal indulgence, there was a time when I had some sympathy with the sentiment that the "Fed's primary focus is and always will be on monetary policy." I, of course, knew the story of the creation of the Fed, motivated by the need to provide an elastic currency to avoid disruptive fluctuations in prices and a lender of last resort to stop liquidity stress from becoming a full-blown financial crisis. But that was a story from the past. The modern world began in 1935 with the statutory creation of the Federal Open Market Committee, which would eventually evolve, with its central bank brethren in the rest of the world, into the institution described by Pearlstein as being primarily focused on monetary policy.

I felt that way until Sept. 11, 2001. On an average day in the week ending Sept. 5 of that year, the Federal Reserve extended $21 million in discount loans to banks, a reasonably representative volume. On Sept. 12, discount loans amounted to over $45 billion. As a result, the U.S. financial system did not collapse.

The horrible circumstances of 9/11 have been thankfully unique, but there is a case to be made for the proposition that the most important role of the central bank in the recent financial crisis was not in the realm of traditional monetary policy but in the exercise of variations on the lender-of-last-resort function. In fact, in times of acute financial stress, this role must always be so. Witness this remark by Alan Greenspan on Oct. 20, 1987:

"… in a crisis environment, I suspect we shouldn't really focus on longer-term policy questions until we get beyond this immediate period of chaos."

Which brings us to the question of the Fed's role in bank supervision. More precisely, it brings us to comments from Atlanta Fed President Dennis Lockhart, who delivered remarks on Wednesday to the New York Association for Business Economics:

"… the Fed must play a central role in a defense structure designed to prevent or manage future crises. My key argument is the indivisibility of monetary authority, the lender-of-last-resort role, and a substantial direct role in bank supervision. Only the Fed can act as lender of last resort because only the monetary authority can print money in an emergency. To make sound decisions, the lender of last resort needs intimate hard and qualitative knowledge of individual financial institutions, their connectedness to counterparties, and the capacity of management.

"There is sentiment in Washington that would separate these tightly linked functions that are so critical in responding to a financial crisis. Removing the central bank from a supervision role designed to provide totally current, firsthand knowledge and information will weaken defenses against recurrence of financial instability. Flawed defenses could be calamitous in a future we cannot see."

If this advice goes unheeded, I fear we might discover its wisdom in the worst possible circumstances.

By Dave Altig, senior vice president and research director at the Atlanta Fed

March 5, 2010 in Federal Reserve and Monetary Policy, Financial System, Monetary Policy, Regulation | Permalink

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Dave, is the Federal Reserve taking action to strengthen its level of expertise in banking and financial intermediation and risk management ? The argument has been made that its academic staff were very good at doing 1001 variations on the Taylor rule but lacked the human capital necessary to understand financial developments. I don't know if that was true, but it would explain the Fed's dereliction of duty in the latter years of Greenspan tenure.

Posted by: PE | March 05, 2010 at 06:08 PM

The best banking system in the world (Canada) separates the two functions.

Posted by: JKH | March 06, 2010 at 11:11 AM

Indeed, if this crisis demonstrates nothing else, it is that monetary policy is indivisible from regulation. Loose regulation is a form of loose monetary policy.

Since virtually all innovation has eventually come around to the Fed to backstop, one would wish the Fed would get out in front to decide what it can and cannot defend. We suspect it is too late.

Posted by: Alan Harvey | March 06, 2010 at 06:13 PM

What of the argument that it was the Fed's failed supervision and regulation that in part caused the crisis? If the Fed hadn't failed in S&R, then maybe we wouldn't have needed all the new liquidity facilities in the first place. Perhaps a somehow more effective regulatory body could have avoided the current crisis? The question seems to come down to "who can do it better?" Perhaps the answer is noone.

Also, for 9/11, I wonder what the counterfactual would have been if the Fed didn't have bank regulatory powers. That is, would the Fed still have opened the liquidity spigot without the "hard and qualitative knowledge of individual financial institutions..."?

Posted by: MH | March 09, 2010 at 10:45 AM

The best banking system in the world (Australia) separates the two functions.

Nevertheless, this rule is necessary but not sufficient.

Posted by: Thomas Esmond Knox | March 15, 2010 at 03:26 AM

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February 19, 2010


Should the Fed stay in regulation?

One of the central issues in the postcrisis effort to reform our regulatory infrastructure is who should do the regulating. The answer to some in Congress is none of the above:

"… under consideration is a consolidated bank regulator, one aide [to Alabama Senator Richard Shelby] said. The idea is supported by [Connecticut Senator Christopher] Dodd, who proposed eliminating the Office of Thrift Supervision and Office of the Comptroller of the Currency, and moving their powers, along with the bank-supervision powers of the Federal Reserve and the Federal Deposit Insurance Corp., to the new agency.

"Negotiators are still deciding how to monitor firms for systemic risk, including how to define and measure it, what authorities to give a regulator and which agency is best suited to get the power, a Shelby aide said."

As reported in The New York Times:

"The Senate and the Obama administration are nearing agreement on forming a council of regulators, led by the Treasury secretary, to identify systemic risk to the nation's financial system, officials said Wednesday…"

Though the idea of a council to provide regulatory and supervisory oversight is still contentious (the Times article offers multiple opinions from Federal Reserve officials) the formation of a council is not necessarily the same thing as removing the central bank from boots-on-the-ground, or operational, supervisory responsibility. In other words, there is still the question of how to monitor systemic risk and which agency is best suited to get the power.

Earlier this week I made note of a new International Monetary Fund (IMF) paper by Olivier Blanchard, Giovanni Dell'Aricca, and Paulo Mauro, taking some issue with the proposal that central banks consider raising their long-run inflation objectives. Though that part of the paper seemed to attract almost all of the attention in the media and blogosphere, the discussion in the IMF article expanded well beyond that inflation target issue. Included among the many proposals of Blanchard et al. was this, on systemic risk regulation and the role of the central bank:

"If one accepts the notion that, together, monetary policy and regulation provide a large set of cyclical tools, this raises the issue of how coordination is achieved between the monetary and the regulatory authorities, or whether the central bank should be in charge of both.

"The increasing trend toward separation of the two may well have to be reversed. Central banks are an obvious candidate as macroprudential regulators. They are ideally positioned to monitor macroeconomic developments, and in several countries they already regulate the banks. 'Communication' debacles during the crisis (for example on the occasion of the bailout of Northern Rock) point to the problems involved in coordinating the actions of two separate agencies. And the potential implications of monetary policy decisions for leverage and risk taking also favor the centralization of macroprudential responsibilities within the central bank."

Consistent with the even-handedness of the Blanchard et al. paper, the authors did not come to this conclusion without noting the legitimate issues of those who would separate regulatory authority from the central bank:

"Against this solution, two arguments were given in the past against giving such power to the central bank. The first was that the central bank would take a 'softer' stance against inflation, since interest rate hikes may have a detrimental effect on bank balance sheets. The second was that the central bank would have a more complex mandate, and thus be less easily accountable. Both arguments have merit and, at a minimum, imply a need for further transparency if the central bank is given responsibility for regulation."

But, they conclude:

"The alternative, that is, separate monetary and regulatory authorities, seems worse."

I wonder, then: Would a regulatory council of which the Federal Reserve is a member, combined with operational supervisory responsibilities housed within the central bank, be a tolerably good response to Blanchard's and his colleagues' admonitions?

By Dave Altig, senior vice president and director of research at the Atlanta Fed

February 19, 2010 in Banking, Financial System, Regulation | Permalink

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The Fed is ill suited to a regulatory role. Regardless of the general trend, we have to deal with this Fed in this country, not central banks in general.

Why?

First, the Fed utterly dropped the ball on AIG which it had regulatory authority over. It had a reputation at the time for lax regulation and nothing has happened to change this impression. The Fed simply isn't set up to be a regulator in the same way as other bank regulatory agencies.

Second, few agencies are dispositionally less suited to monitor systemic risk. No federal government player is more focused on the short term here and now concerns of the economy. The Fed is a day to day, month to month participant in and manager of the markets. It does so in a very stylized, through, predictable way. It is all about the trees.

Systemic risk monitoring is fundamentally a long run, see the forest operation. Systemic risk is particularly likely to be hiding precisely where entities like the Fed are not out there collecting data. It is hiding off the books and in novel relationships.

Third, systemic risk regulation is a voice in the wilderness job. The regulator needs to zig when everyone else zags and defy the conventional wisdom of the establishment. The Fed is the establishment. The Fed uses mainstream economic models. The Fed's actions establish conventional wisdom. The Fed is at its most inept when the usual tools stop working in the usual ways (see stagflation). Putting systemic risk regulation in the Fed is to doom that regulator to group think and ideological capture.

Posted by: ohwilleke | February 19, 2010 at 07:14 PM

Do councils in regulatory authorities work? Any examples of where this works today? Seems like an excuse to meet X times a year and yet do nothing.

And, I wish Shelby good luck with defining exactly what all constitutes risk. That could be everything from CDS to police on the street. I think what they mean is "Banking system risk". That's only one part of this apparatus.

Posted by: FormerSSResident | February 21, 2010 at 11:22 AM

I think that regulators need to pay much closer attention to market structure rather than writing rules. For example, in the cash equity markets, they allow dark pools of liquidity, delayed price and volume reporting, payment for order flow, internalization of order flow. These things lead to distortions in the marketplace.

Just wrote a piece on fungibility at pointsandfigures.com.

Posted by: Jeff | February 21, 2010 at 01:13 PM

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December 23, 2009


Change the bathwater, keep the baby

What have we learned from the experience of the last two years? The Wall Street Journal offers up one discouraging conclusion:

"For much of the past century, America has served as the global model for the power of free markets to generate prosperity…

"In the 2000s, though, the U.S. quickly went from being the beacon of capitalism to a showcase for some of its flaws…

"But one thing is certain: America's success or failure over the next decade will go a long way toward defining what the world's next economic model will be."

One of the article's implied alternatives for the world's next economic model seems a bit of a stretch:

"The troubles in the U.S. stand in sharp contrast to the relative success of other countries, notably China. With a system that is at best quasi-capitalist, China's economic output per person grew an inflation-adjusted 141% over the decade, and hardly paused for the global crisis, according to estimates from the International Monetary Fund. That compares with 9% growth in the U.S. over the same period."

Let's put that comparison to rest right away:

122209

The theory of economic growth is rich, interesting, and somewhat unsettled, but it stands to reason that emerging economies, where the fruit hangs low, can for a time grow much faster than advanced, fully developed countries. Furthermore, I find it reasonable to assume that, contrary to representing an alternative economic model, the Chinese experience over the past decade is itself evidence that even incomplete movements in the direction of free markets can pay large dividends. But even if you doubt that interpretation, the gap between the material circumstances of the average American and Chinese citizen is so large as to make comparisons about the success of the respective economic models premature by several decades.

In fact, the picture above nicely illustrates what I believe is a more on-the-mark observation in the WSJ article:

"At least twice in the past century, the U.S. has re-emerged from deep crises to reinvent capitalism. In the 1930s, the Depression compelled Franklin Roosevelt to introduce Social Security, deposit insurance and the Securities and Exchange Commission.

"After the brutal stagflation of the 1970s and early 1980s, then-Federal Reserve Chairman Paul Volcker demonstrated the ability of an independent central bank to get prices under control, ushering in an age in which powerful, largely autonomous central banks became the norm throughout the developed world."

So what, then, is the alternative model waiting in the wings to replace the current one? It's not given a name, but the features are clear in the article:

"Policy makers' focus now, though, is on the financial sector that failed so spectacularly. Progress has been slow, and key pieces are missing, but the contours of a new system are taking shape. Banks will face stricter limits on their use of borrowed money, or 'leverage,' to boost returns. The Fed will keep a closer eye on markets during booms, and possibly step in to curb excessive risk-taking—a U-turn from its previous policy of mopping up after bubbles burst.

"Such changes would amount to a grand bargain: Give up some of the growth and dynamism of the U.S. economy for a safer, more equitable brand of capitalism—one that could avoid the kind of busts that turned the 2000s into such a disaster."

OK, but here is the central question: How can we be sure that the "new system" will be an improvement on the one it replaces? Some of the most significant failures of the last couple of years occurred in highly regulated industries. So the absence of regulation is not really at issue, but rather what kind of regulation we will have, and how it will be implemented. And there is the obvious point that regulatory change is not really reform if it undermines a system's existing strength. Some of the reform proposals on the table, for example, have the potential to seriously compromise "the ability of an independent central bank to get prices under control," the very feature of our current system that the article identifies as an historical source of resilience.

I worry about a regulatory change that commences from the proposition that we must "give up some of the growth and dynamism of the U.S. economy for a safer, more equitable brand of capitalism." In their introduction to a comprehensive set of reform proposals from New York University's Stern School of Business, professors Viral Acharya and Matthew Richardson have this to say:

"There are many cracks in the financial system, some of which we now know, others no doubt we will discover down the road.… A common theme of our proposals notes that fixing all the cracks will shore up the financial house but at great cost. Instead, by fixing a few major ones, the foundation can be stabilized, the financial structure rebuilt, and innovation and markets can once again flourish."

One of those major cracks is the "too-big-to-fail" distortion. Is it important to remember that too-big-to-fail is itself a creation of regulation, not markets? I think so.

By David Altig, senior vice president and research director at the Atlanta Fed

December 23, 2009 in Financial System, Regulation | Permalink

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This was very interesting, but I think you made the question too narrow.

"Too-big-to-fail" is not a creation of either regulation or markets per se. It was created by cornering the market for regulation. The new model involves changing the regulations in this meta-market, via campaign finance and other procedural reforms to our democracy.

Posted by: capax | December 23, 2009 at 05:15 PM

Yes, Yes, Yes, all of us know what the term regulatory capture means. Who's gonna regulate the regulators? Have fun chewing on that one..

The fact is so very few people really understand how the machine works. I won't even pretend I do. The history of the machine is that when it breaks, it's like the human body. Doctors rush in to prescribe this and that, but often it self heals.

So, take two aspirin and call us in the morning would be my advise.

However I do thing something structurally did change. What it is, I do not yet know. But I see it's sign and footprint all over California.

Posted by: FormerSSresident | January 03, 2010 at 10:41 AM

"too-big-to-fail is itself a creation of regulation" HUH? This is preposterous!

Posted by: bailey | January 03, 2010 at 11:17 PM

I see Ben Bernanke said that he thinks regulation is the answer for the current economic problem. It leads me to think this is because they haven't allowed people to fail.

Failure is regulation in and of itself provided an understood framework exists for the particpants.

Now what I suspect is Goldman Inc and such will shift thier burden of responsibility to some gov agent.

Indeed dare I say this could eventually lead to some new form of finance capitalism as people seek to get around the government BS.. Venture backed mortgages I guess..

Posted by: FormerSandySpringsResident | January 04, 2010 at 11:10 AM

I would suggest Wall St. needs to make a decision about whether it wants to be a hedge fund or a bank, but not both. Banking should be boring.

And the government must rid itself of the GSE's.

We can talk about whether anyone is smart enough to control interest rates later:)

Posted by: jim | January 05, 2010 at 07:09 AM

Great post. As far as regulation of the financial sector, I think that the fix supplied by both Congressional committees, and the thoughts of the Treasury Secretary are misguided.

They are not changing anything.

I would rather see regulation based on function in the marketplace. For example, many activities the SEC deems "legal" are very anti-competitive and anti-free market. For example, payment for order flow and the internalization of order flow. These two practices don't make the market more efficient, but certainly line the pockets of the big banks that can practice them.

I'd like to see a ban on dual trading. If you want to be a broker, then get paid to broker your customers' order. Otherwise, take risk and be a trader. There is a huge conflict of interest that has been exploited by specialists, investment banks and others for years. Secondly, I'd ban payment for order flow, and internalization. Also, the reporting of trades is nebulous. A block trade is reported late. They should be reported in real time to give better information to the market.

All the proposed trading taxes working their way through Congress will hurt markets as well.

I certainly can sympathize with the Americans who decry the greed on Wall St. However, the regulations currently in place don't allow for markets to nip a lot of that greed in the bud, and the new proposed regulations will do nothing to curb it either. We are rebuilding the same house of cards.

Posted by: Jeff Carter | January 06, 2010 at 10:35 AM

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December 08, 2009


Another rescue plan comes in below the original price tag

Though the tab to taxpayers could still be substantial when all is said and done, it now appears the taxpayer cost of the Troubled Asset Relief Program (TARP) will be substantially lower than was thought not too long ago:

"The Obama administration expects the cost of the Troubled Asset Relief Program to be $200 billion less than projected, helping to reduce the size of the budget deficit, a Treasury Department official said yesterday.

"The administration forecast in August that the TARP would ultimately cost $341 billion, once banks had repaid the government for capital injections and other investments. Congress authorized $700 billion for the program in October 2008."

There is precedent for such good news. Travel back for a moment to the formation and operation of the Resolution Trust Corporation (RTC), the agency formed to purchase and sell the "toxic assets" of failed financial institutions following the savings and loan crisis of the 1980s. As noted in a postmortem by Timothy Curry and Lynn Shibut of the Federal Deposit Insurance Corporation (FDIC), the cost projections for the RTC ballooned in the early days of its operations:

"Reflecting the increased number of failures and costs per failure, the official Treasury and RTC projections of the cost of the RTC resolutions rose from $50 billion in August 1989 to a range of $100 billion to $160 billion at the height of the crisis peak in June 1991..."

In the end, however, the outcome, though higher than the very first projections, came in well below the figures suggested by the worst case scenario:

"As of December 31, 1999, the RTC losses for resolving the 747 failed thrifts taken over between January 1, 1989, and June 30, 1995, amounted to an estimated $82.7 billion, of which the public sector accounted for $75.6 billion, or 91 percent, and the private sector accounted for $7.1 billion, or 9 percent."

While people may debate the approaches taken, it is heartening to see evidence that TARP, like the RTC before it, is ultimately costing considerably less than estimated.

By David Altig, senior vice president and research director of the Atlanta Fed

December 8, 2009 in Deficits, Federal Debt and Deficits, Financial System, Fiscal Policy | Permalink

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TARP should be judged on the basis of its effects on the financial system, and not its cost. So far looks like its working.

Visit econdashboards.com

Posted by: ZZ | December 08, 2009 at 10:56 PM

Since the expressed purpose was to 'save Main Street' by handing out the future to Wall Street, the plan has decidedly not worked. Main Street has been pulled through the knothole anyway, and paid for the experience.

Posted by: wally | December 09, 2009 at 09:25 AM

Please. Give us a break. What about trillions of dollars in guarantees given to various institutions. How about junk MBS paper bought by the federal reserve and GSE's. Lets not pretend that the cost to tax payer is going to be minimal. This is going to end badly but only for the tax payers. The banks will make out like bandits.

Posted by: sartre | December 10, 2009 at 01:10 AM

Interesting. An interview I read with Kashkarian had him stating that "700 billion" was a number pulled out of thin air. They had no idea how much to ask, so they decided to ask for as large a number as they could get.

I am glad they didn't go over it. However, I am dismayed at the outcomes learned. The government now wants to create more bureaucracy to oversee the financial system. The TARP has created even more concentration-bringing with it anti-competitive oligopolies.

We need to restructure the marketplace, not re or over regulate it.

Posted by: jeff | December 10, 2009 at 11:41 AM

You're omitting the other expenditures by the government to ensure that these loans would be repaid.

At the time TARP was authorized, they didn't envision spending 850 billion dollars to stimulate the economy and 1.8 trillion dollars to inflate asset prices.

The cost is going to be much higher over time because the Federal government will be running trillion dollar deficits for some time.

Posted by: Les | December 14, 2009 at 09:31 AM

You are ignoring a couple of *extremely* important facts:

The banks are "healthier" and able to buy their way out of TARP (perhaps only for awhile - a disgusting TARP II is not beyond belief) because:

1) The Fed (backed by the Treasury) has bought a trillion dollars worth of crappy MBS assets from the banks - at insanely inflated prices given their risks.

The default risks have therefore been transferred to the taxpayers - who will bleed out for years to come in order to transfuse degenerate banks.

Some success.

2) Savers have had the present value of their savings expropriated due to the zero interest rate policies pursued to save our scummy banks.

Again, some success.

Posted by: cas127 | December 15, 2009 at 08:43 AM

The banks also received massive tax breaks in the stimulus which are inflating the value of the shares that were exchanged for cash from the government. There's a good article in todays Washington Post.

http://www.washingtonpost.com/wp-dyn/content/article/2009/12/15/AR2009121504534.html

Posted by: Les | December 15, 2009 at 09:20 PM

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November 12, 2009


Small businesses, small banks, big problems?

In a speech on Tuesday, Federal Reserve Bank of Atlanta President Dennis Lockhart drew some connections between the current commercial real estate (CRE) problems and the prospects for a small business-led recovery.

The starting point was an observation made in an earlier macroblog post that identified the important role small businesses have traditionally played in job creation in the economy and how they had been disproportionately negatively affected in this recession.

What are the connections between CRE and small business? An obvious direct link running from small businesses to CRE is that small businesses are an important source of demand for many types of commercial space. A link from CRE to small businesses is that CRE problems in banks could potentially affect credit availability for small businesses.

CRE pressures
The problems currently facing the CRE industry have been building for some time for both property owners and the holders of CRE debt:

  • The income generated by nonresidential/nonowner-occupied CRE has generally been falling as vacancy rates on commercial space rose, and capitalization rates–the ratio of income to valuation–have climbed sharply.
  • The decline in CRE valuations has created a significant amount of "rollover risk" when CRE loans and mortgages mature and need to be refinanced (about $340 billion in CRE debt is estimated to mature in 2010 and 2011). At the same time, delinquency rates on CRE loans have been increasing sharply, especially for CRE lending for residential construction and development purposes.

This recent Cleveland Fed report captures some of the dimensions of the banking systems exposure to CRE, as does this Wall Street Journal piece from March.

Small business lending
Banks have already responded to the generally weakened economic conditions and reduced creditworthiness of borrowers by raising credit standards for all types of lending, including commercial loans, credit cards, and home equity. But there is a risk that additional bank problems, such as the realization of substantial CRE losses, could further constrain bank lending right at the time when credit is needed to support economic growth.

President Lockhart draws the connection between further bank problems and the prospects for small business-led recovery by observing that small businesses depend significantly on the banking sector as a source of financing. (A 2003 Federal Reserve survey of financial services used by small business showed over 50 percent of small businesses had a credit line or bank loan. In addition about half of small businesses use a personal or business credit card.)

The dependence of small businesses on banks is particularly problematic if the banks facing the most severe CRE problems also are a significant source of loans to small businesses.

It turns out that much of the CRE exposure is concentrated among the set of 6,880 or so smaller banking institutions (banks with total assets under $10 billion). Based on the June 2009 Bank Call Report data, these banks represented 20 percent of total commercial bank assets in the United States but hold almost half of the CRE loans.

It seems reasonable to assume that the banks with high exposure to CRE (say, those with CRE exposure as measured by a CRE loan book that is more than three times their tier one capital) are likely to take a conservative approach toward additional loan growth. The bad news is that the banks with the highest CRE exposure also account for about 40 percent of all commercial loans under $1 million–the types of loans most likely used by small businesses.

It is important to recognize that this analysis does not automatically imply small businesses will not be able to get needed funding when demand increases. For instance, even if banks with high CRE exposure are unable to expand lending as demand increases, it is possible that other banks that are less constrained will be able to step in to provide the needed financing. Also, small businesses depend a lot on other sources of financing, such as credit cards, and the large card issuers tend to have low CRE exposure.

Today, the number one challenge for small businesses remains poor sales rather than access to credit. But tomorrow, it will be important that small businesses also have access to funding if they are going to play their traditional role as an engine of growth.

By John Robertson, a vice president in the Atlanta Fed’s research department

November 12, 2009 in Banking, Financial System, Labor Markets | Permalink

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Comments

This may not be the appropriate place for this but I figured I'd give it a shot.

I was wondering how the fed permanently withdraws liquidity? I believe reverse repos are only for a temporary duration.

Posted by: cubguy99 | November 14, 2009 at 02:41 AM

CRE pressure is exactly what I'm writing a paper about. Thanks for sharing this.

Posted by: Debt Consolidation Companies | November 15, 2009 at 01:03 AM

Interesting that you identify the number one problem as poor sales.
Mega corporations reported earnings this week, top line revenue growth was poor. Earnings increased via cuts in expenditures.

Expectations going forward will be the driver of growth. Consumers today value cash over anything else. They know taxes are going up in 2010, and they also intuitively know that when government gets aggressive in regulatory matters, it gets expensive to do business.

Posted by: Jeff | November 16, 2009 at 07:43 AM

I have to admit I am very impressed with the quality of your blog. It is certainly a pleasure to read as I do enjoy your posts.

Posted by: Dental Seattle | May 18, 2011 at 06:51 AM

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