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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.


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April 22, 2013


Too Big to Fail: Not Easily Resolved

As Fed Chairman Ben Bernanke has indicated, too-big-to-fail (TBTF) remains a major issue that is not solved, but “there’s a lot of work in train.” In particular, he pointed to efforts to institute Basel III capital standards and the orderly liquidation authority in Dodd-Frank. The capital standards seek to lower the probability of insolvency in times of financial stress, while the liquidation authority attempts to create a credible mechanism to wind down large institutions if necessary. The Atlanta Fed’s flagship Financial Markets Conference (FMC) recently addressed various issues related to both of these regulatory efforts.

The Basel capital standards are a series of international agreements on capital requirements reached by the Basel Committee on Banking Supervision. These requirements are referred to as “risk-weighted” because they tie the required amount of bank capital to an estimate of the overall riskiness of each bank’s portfolio. Put simply, riskier banks need to hold more capital under this system.

The first iteration of the Basel requirements, known as Basel I, required only 30 pages of regulation. But over time, banks adjusted their portfolios in response to the relatively simple risk measures in Basel I, and these measures became insufficient to characterize bank risk. The Basel Committee then shifted to a more complex system called Basel II, which allows the most sophisticated banks to estimate their own internal risk models subject to supervisory approval and use these models to calculate their required capital. After the financial crisis, supervisors concluded that Basel II did not require enough capital for certain types of transactions and agreed that a revised version called Basel III should be implemented.

At the FMC, Andrew Haldane from the Bank of England gave a fascinating recap of the Basel capital standards as a part of a broader discussion on the merits of complex regulation. His calculations show that the Basel accords have become vastly more complex, with the number of risk weights applied to bank positions increasing from only five in the Basel I standards to more than 200,000 in the current Basel III standards.

Haldane argued that this increase in complexity and reliance on banks’ internal risk models has unfortunately not resulted in a fair or credible system of capital regulation. He pointed to supervisory studies revealing wide disparities across banks in their estimated capital requirements for a hypothetical common portfolio. Further, Haldane pointed to a survey of investors by Barclays Capital in 2012 showing, not surprisingly, that investors do not put a great deal of trust in the Basel weightings.

So is the problem merely that the Basel accords have taken the wrong technical approach to risk measurement? The conclusion of an FMC panel on risk measurement is: not necessarily. The real problem is that estimating a bank’s losses in unlikely but not implausible circumstances is at least as much an art as it is a science.

Til Schuermann of Oliver Wyman gave several answers to the question “Why is risk management so hard?” including the fact that we (fortunately) don’t observe enough bad events to be able to make good estimates of how big the losses could become. As a result, he said, much of what we think we know from observations in good times is wrong when big problems hit: we estimate the wrong model parameters, use the wrong statistical distributions, and don’t take account of deteriorating relationships and negative feedback loops.

David Rowe of David M. Rowe Risk Advisory gave an example of why crisis times are different. He argued that the large financial firms can absorb some of the volatility in asset prices and trading volumes in normal times, making the financial system appear more stable. However, during crises, the large movements in asset prices can swamp even these large players. Without their shock absorption, all of the volatility passes through to the rest of the financial system.

The problems with risk measurement and management, however, go beyond the technical and statistical problems. The continued existence of TBTF means that the people and institutions that are best placed to measure risk—banks and their investors—have far less incentive to get it right than they should. Indeed, with TBTF, risk-based capital requirements can be little more than costly constraints to be avoided to the maximum extent possible, such as by “optimizing” model estimates and portfolios to reduce measured risk under Basel II and III. However, if a credible resolution mechanism existed and failure was a realistic threat, then following the intent of bank regulations would become more consistent with the banks’ self-interest, less costly, and sometimes even nonbinding.

Progress on creating such a mechanism under Dodd-Frank has been steady, if slow. Arthur Murton of the Federal Deposit Insurance Corporation (FDIC) presented, as a part of a TBTF panel, a comprehensive update on the FDIC’s planning process for making the agency’s new Orderly Liquidation Authority functional. The FDIC’s plans for resolving systemically important nonbank financial firms (including the parent holding company of large banks) is to write off the parent company’s equity holders and then use its senior and subordinated debt to absorb any remaining losses and recapitalize the parent. The solvent operating subsidiaries of the failed firm would continue in normal operation.

Importantly, though, the FDIC may exercise its new power only if both the Treasury and Federal Reserve agree that putting a firm that is in default or in danger of default into judicial bankruptcy would have seriously adverse effects on U.S. financial stability. And this raises a key question: why isn’t bankruptcy a reasonable option for these firms?

Keynote speaker John Taylor and TBTF session panelist Kenneth Scott—both Stanford professors—argued that in fact bankruptcy is a reasonable option, or could be, with some changes. They maintain that creditors could better predict the outcome of judicial bankruptcy than FDIC-administered resolution. And predictability of outcomes is key for any mechanism that seeks to resolve financial firms with as little damage as possible to the broader financial system.

Unfortunately, some of the discussion during the TBTF panel also made it apparent that Chairman Bernanke is right: TBTF has not been solved. The TBTF panel discussed several major unresolved obstacles, including the complications of resolving globally active financial firms with substantial operations outside the United States (and hence outside both the FDIC and the U.S. bankruptcy court’s control) and the problem of dealing with many failing systemically important financial institutions at the same time, as is likely to occur in a crisis period. (A further commentary on these two obstacles is available in an earlier edition of the Atlanta Fed’s Notes from the Vault.)

Thus, the Atlanta Fed’s recent FMC highlighted both the importance of ending TBTF and the difficulty of doing so. The Federal Reserve continues to work with the FDIC to address the remaining problems. But until TBTF is a “solved” problem, what to do about these financial firms should and will remain a front-burner issue in policy circles.

Photo of Paula Tkac By Paula Tkac, vice president and senior economist, and

Photo of Larry Wall Larry Wall, director of the Center for Financial Innovation and Stability, both in the Atlanta Fed’s research department

April 22, 2013 in Capital and Investment, Capital Markets, Financial System | Permalink

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Yes, solving the Too Big to Fail problem is really, really difficult if the people making policy don't want to solve it, as they evidently don't. Clearly, the political influence of such organizations is at work impeding the process. Sadly, the regulators/enablers (both international and domestic) are terrified of imposing the kind of "dumb but simple" workable solution that would drastically impact the business models of these very politically powerful organizations. No, let's keep putting increasingly sophisticated band aids on tumors--that's the spirit, fellows!

Posted by: William Meyer | April 23, 2013 at 09:37 AM

Nice summary of the problems here. In addition to the problems you mention, I worry about a couple of others. One was noted recently by Sarah Gordon in the FT. She writes:


There is a compelling body of evidence suggesting that the people most likely to go into the riskier areas of financial services are precisely those least suited to judging risk. Susan Cain’s recently published book Quiet cites a series of studies that suggest that extroverts tend to be attracted to the high-reward environments of investment banking, deals and trading. And, troublingly, these outgoing people also tend to be less effective at balancing opportunity and risk than some of their more introverted peers. (http://www.ft.com/intl/cms/s/0/a917de18-abef-11e2-9e7f-00144feabdc0.html#axzz2Rxxxb9nc)

A second thing that makes me nervous is the fact, as you point out, that the FDIC an exercise its new powers to resolve a systemically important institution only if the Fed and the Treasury agree to let it do so. Would the Treasury really be able to resist political pressures and make such a decision objectively? Even the Fed, independent though it is, might find it hard to do so.

Posted by: Ed Dolan | April 30, 2013 at 12:56 PM

There is waiting in the Platonic cave a critically important paper that derives Campbell's Law and Goodhart's Law from Goedel's incompleteness theorem. As long as we allow a financial system to exist in which ever more complex debt instruments are allowed to be created, then for every control regime devised by some Basel XXXIV or whatever, there will be a new class of derivatives that escapes those regulations and destabilizes the system.

There are three possible ways to escape this endless escalation of risk-creating games: (1) impose a formal language for creating financial instruments that has been proven to be sub-Turing in its expressive power, (2) implement institution-scale TBTF, preventing any single institution or implicit consortium of institutions from acquiring enough significance to endanger the system as a whole, or (3) implement sovereign TBTF, preventing the failure of any nation-state from endangering the financial systems of others. It's not too late to start considering mechanisms to allow the Eurozone to spin off disruptive members in the same way that a lizard sheds its tail when in mortal danger. Cyprus is almost there already.

Unfortunately the US cannot spin off insolvent states, much as some of them might wish to leave. If only we could let North Carolina go, and take the Bank of America with it!

Good luck!

Posted by: George McKee | April 30, 2013 at 10:04 PM

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April 16, 2013


Improvement in the Outlook? The BIE Panel Thinks So

Earlier this month, Dennis Lockhart, the Atlanta Fed’s top guy, gave his assessment of the economy and monetary policy to the Kiwanis Club of Birmingham, Alabama. Here’s the essential takeaway:

There are encouraging developments in the economy, to be sure, but the evidence of sustainable momentum that will deliver “substantial improvement in the outlook for the labor market” is not yet conclusive. ... How will I, as one policymaker, determine that the balance has shifted and the time for a policy change has come? Well, one key consideration is the array of risks to the economic outlook and my degree of confidence in the outlook.

To help the boss assess the risks to the outlook, we reached out to our Business Inflation Expectations (BIE) panel to get a sense of how they view the outlook for their businesses and, notably, how they assess the risks to that outlook. Specifically, we asked:

Projecting ahead, to the best of your ability, please assign a percent likelihood to the following changes to UNIT SALES LEVELS over the next 12 months.

The table below summarizes the answers and compares them to the responses we got to this statement last November.

First, the business outlook of our panel has improved decidedly since last November. On average, our panel sees unit sales growth averaging 1.8 percent. OK, not a spectacular number, but, to our eyes at least, much improved from the 1.2 percent the group was expecting when we queried five months ago.

And how about the assessment of the risks President Lockhart indicated was also a key consideration? Here again, the sentiment in our panel appears to have shifted favorably. Last November, our panel put the likelihood that their year-ahead unit sales growth would be 1 percent or less at 50 percent. The group now puts the chances of a downshift in business activity at 37 percent. Meanwhile, the upside potential for their sales has grown. Last November, the panel put the chances of a “significant” improvement in unit sales at about 20 percent; this month, the group thinks the likelihood is 30 percent.

And this improved sentiment isn’t centered in just a few industries—it’s spread across a wide swath of the economy. Firms in construction and real estate, which were, on average, projecting 12-month unit sales growth of 1.1 percent last November, now put that growth number at 1.8 percent. The average sales outlook of general-services firms has risen from 1 percent to 2.2 percent; finance and insurance companies went from 0.5 percent to 1.3 percent; and retailers/wholesalers’ unit sales projections rose from 1.5 percent to 2 percent. And manufacturers, who posted relatively strong expectations last November, reported about the same sales outlook this month as they did five months ago.

To be clear, President Lockhart’s recent comments—and the Federal Open Market Committee statement on which they are based—indicate he is looking for a substantial improvement in the outlook for the labor market, not sales. But we’re going to assume that it’s unlikely to have one without the having the other. And is our panel’s unit sales forecast “substantially” improved? Well, what constitutes “substantial” is in the eye of the beholder, but if this isn’t a substantial improvement in the outlook, it’s certainly a move in that direction.

Photo of Mike BryanBy Mike Bryan, vice president and senior economist, and

Photo of Nick ParkerNick Parker, economic research analyst, both in the Atlanta Fed’s research department

April 16, 2013 in Business Inflation Expectations, Economics, Inflation, Inflation Expectations | Permalink

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April 12, 2013


Higher Education: A Deflating Bubble?

There are at least two sides to every debate, but it’s becoming clearer by the day that the debate over the cost of higher education is being won by people like University of Tennessee law professor Glenn Reynolds.

A frequent writer and lecturer, and even more frequent blogger, Reynolds visited the Atlanta Fed recently to share his views with local community leaders. He reported that total student loan debt now stands at over $1 trillion—more than total credit card debt and auto loan debt combined. As these charts from the New York Fed show, the increase in total student debt over the past eight years is a result of greater numbers of students and families taking on educational debt as well as higher debt balances per student. 

One can argue that this trend is not necessarily a bad thing. Education is an investment in human capital, and if those newly acquired skills are valued highly by employers, then going to college can be a positive net present value project, even with debt financing.

And wage data reveal that these skills are indeed valuable. As this Cleveland Fed article and chart show, the median wage for a worker with a bachelor’s degree was about 30 percent higher than that of a worker with only a high school diploma in the late 1970s and grew to more than 60 percent higher by the early 2000s. However, the data also show that over the last decade the value of a college degree measured by wages has stagnated.

Wage Premium by Terminal Degree

And here begins the crux of Reynolds’s concern. The cost of attending college has continued to grow, and grow rapidly. Between the 2000–01 and 2010–11 academic school years, the cost of undergraduate tuition, room, and board rose 42 percent at public institutions and 31 percent at private not-for-profit institutions, after adjusting for inflation, according to the National Center for Education Statistics.

A stagnant wage premium with rising costs of attendance suggests that, at least on average, the value proposition of going to college is deteriorating. To make matters worse, Reynolds described students graduating with significant levels of student loan debt who often cannot find jobs that pay enough to cover the loan payments. Moreover, unlike credit card debt, student loans are not dischargeable in bankruptcy, meaning that there is no opportunity to get out from under the debt burden other than through full repayment. Reynolds told of individuals whose high levels of student debt are limiting their career choices, ability to obtain mortgages, and save for retirement. He even went on to say that student loans are affecting a much more personal market—the marriage market. After all, he says, “Who wants to marry someone with huge amounts of unpayable debt?”

Reynolds contends that ”something that can’t go on forever, won’t,” and he believes that seeing friends or family members having financial problems because of student loans is leading college students to become more cost conscious. Additionally, he notes that more and more of today’s students are focusing on majors that seem likely to offer a strong salary over time. The chart on 2009 enrollment and wage premiums by major show some support for that notion.

Wage Premiums for Four-Year and Advanced Degrees in Categories of Majors

Large fractions of students are enrolled in majors with relatively higher wage premiums, including business and engineering, but there are also substantial enrollments in education, psychology, and the humanities. For Reynolds it is not so much about seeking out the highest-wage major; instead, his advice is, “Don’t go to a college that will require you to borrow a lot of money.”

What’s the endgame? Well, he expects that when the bubble bursts, there will be less “dumb money” to be gained, students will demand a higher return on investment, and schools will ultimately be forced to adapt. According to Reynolds, colleges have two different strategic choices: increase the value of the education for the current cost, or lower the cost of providing the current level of value. And he expects the most common response will be the latter, likely involving technology such as MOOCs (massive open online courses) and other innovations in teaching methods.

When any bubble bursts, there are some casualties. In this case, it may be that some colleges do not survive once market discipline has been unleashed. Given the statistics above, you might think that it would be the small liberal arts colleges that will suffer the most, but in this video, shot during the visit to Atlanta, Reynolds argues that these colleges may actually gain from the coming shakeout.

Reynolds indicated that there is change in the air, but it’s coming slowly. The bubble may not have burst, but he sees it deflating. He noted, “A lot of people hope it will pass. They’ll muddle through without dramatic changes. And frankly I hope they’re right. But I don’t think they are.”

Photo of Paula TkacBy Paula Tkac, vice president and senior economist in the Atlanta Fed research department and

Photo of Michael ChrisztMichael Chriszt, vice president and community relations officer in the Atlanta Fed’s public affairs department

April 12, 2013 in Economics, Education | Permalink

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A bubble is when people are willing to pay more than fundamental value for an asset because they expect to be able to sell it for still more. This is a weird metaphor to use to describe the problems in higher education.

The problem in higher education is two fold. First, the state and federal governments, which used to be key financing sources, have cut back their funding radically.

Second, universities, now forced to rely on students for more of their funding, have gotten locked into a dangerous competitive game that they believe requires them to expend ever increasing sums on highly visible (and expensive) amenities, including nicer dorms and many more student services.

All this is compounded by the unconscionable changes in student loans. Currently the US profits even from so-called "subsidized" student loans, charging far more than its cost of funds. The high interest rate charged students functions as an excise tax on education. Making these loans non-dischargeable puts increasing numbers of students, especially those who've been scammed by for-profit institutions masquerading as trade schools, into a form of debt peonage that is a disgrace to a civilized country.

The solution, if we are a civilized country, is simple enough. Student loans should be, as they once were, at rates below the US government's borrowing rate, and they should be dischargeable in bankruptcy like any other debt. This alone would cut the cost of higher education dramatically for students who need to borrow.

Then, our governments should shift some of the astonishing resources they have devoted to building prisons and supporting the military-industrial complex to, instead, building our future.

There is no need to turn our state universities into online trade schools -- we could, instead, act like the richest country in the world and fund them adequately.

Posted by: GeneralWelfare1776 | April 12, 2013 at 05:44 PM

you point out that "the median wage for a worker with a bachelor’s degree was about 30 percent higher than that of a worker with only a high school diploma in the late 1970s and grew to more than 60 percent higher by the early 2000s"; but there's no counterfactual; it may be that those more intelligent & focused individuals would have commanded the same premium had they not gone to college...

Posted by: rjs | April 12, 2013 at 06:26 PM

I just did a quick back-of-the-envelope estimate regarding my daughter's college cost at a state university (paying in-state tuition).
It costs her roughly $53 for every hour she sits in a classroom. (Roughly 18K/yr in tuition, housing, etc plus what she could have made on a minimum wage job during that time).

What does the university deliver that is worth her paying that much?

Until universities can answer that question without bumbling, blushing, or bullshitting, they will continue to be at existential risk going forward.

Posted by: JS | April 15, 2013 at 01:46 PM

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April 05, 2013


Labor Market Update: Muddy Waters Continue to Run Deep

Earlier this week, Atlanta Fed President Dennis Lockhart gave a speech in Birmingham, Alabama, focused on labor markets, risks to the outlook, and current monetary policy. One of the things President Lockhart noted was that the picture for the labor market remained muddy. Specifically:

"The fact is that conditions in the broad labor market are quite mixed. While some indicators of labor market health have improved a lot since the recession, others have not improved much at all or have even worsened. As I said, net job creation is picking up. Initial claims for unemployment insurance have fallen. But the official rate of unemployment remains high, many discouraged workers have left the labor force, and there are many people working part-time jobs who want to work full time."

Today's labor report did little to clarify improvement in labor market conditions, with March payrolls estimated to have grown by a much less than expected 88,000 workers and the jobless rate falling one-tenth of a percent, to 7.6 percent, on the back of a decline of 496,000 in the size in the labor force. Updated with today's data, below is the spider chart we have previously offered as one way to simultaneously track and visualize "conditions in the broad labor market."


As a reminder, we've taken the approach of dividing a set of 13 indicators of labor market conditions into four segments:

  • Employer Behavior includes indicators related to the hiring activities of employers.
  • Confidence includes indicators of employer and worker confidence in the labor market.
  • Utilization includes measures related to available labor resources.
  • Leading Indicators shows data that typically provide insight into the future direction of overall labor market activity.

The circle at the perimeter of this chart represents labor market conditions that existed just before the recession. We have dated this as late 2007. The inner circle represents the state of affairs when payroll employment reached its trough in late 2009. The oddly shaped red figure inside the perimeter depicts where each of the indicators was in March 2011 relative to the benchmarks. The purple figure depicts the state of the labor market in March 2012. Finally, the blue figure shows where the indicators were as of March 2013. All of the indicators are scaled so that outward movement represents improvement. The progression of these point-in-time snapshots provides us with a picture of how labor market conditions have evolved over the past four years.

As you can see, substantial improvement has arguably been achieved in the leading indicator series. As a group, these data points are approaching their prerecession levels. Employer hiring behavior and confidence are slowly moving outward but remain quite weak relative to their prerecession benchmarks. Finally, the labor utilization measures are very weak and, notably, have hardly improved at all over the past two years.

In the macroblog post that introduced the spider chart, we noted that there are a couple of immediate issues that arise in using this graphic to interpret market improvement, substantial or otherwise:

First, a variable such as the level of payroll employment will eventually exceed its pre-recession level, and grow consistently over time as the population grows. A variable like "hiring plans"—which is the net percentage of firms in the National Federation of Independent Business survey expecting to hire employees in the next three months—cannot grow without bound....

Second, it is not obvious that 2007:IVQ levels are necessarily the best benchmarks for all (or even any) of the variables we are monitoring [in the spider chart].

Of these two issues, the second one is potentially the more problematic. The spider chart invites you to think of the inner circle as the starting point and the outer circle as the "goal," or a representation of "normal" labor market conditions. In assessing improvement in variables such as payroll employment, using the prerecession level as a reference point makes some sense as a minimal standard. But for some, "minimal" may be the operative word. If we are interested in questions of how employment is doing relative to some concept of "full employment," it might be appropriate to assess the data relative to some measure of trend. For example, payroll employment is still about 3 million below the prerecession peak, but the labor force, despite the drop in March, is by about 1 million higher than before the recession. When measured relative to the size of the labor market, progress on employment is less impressive than it would appear by just looking at growth in employment itself.

One way to address both of the caveats noted above is to scale variables that involve numbers of jobs or people—such as payroll employment or the number of unemployed—by the size of the population or the labor force. Doing so ensures that variables measured in numbers of jobs or people do not grow without bound. It also helps in assessing progress in these variables relative to a (back-of-the-envelope) measure of the trend in labor resources.

We take this approach in the following chart, which reproduces the spider chart but divides the variables that are counts of people by the size of the labor force. (The labor force has grown more slowly than the population since the end of the recession, but a generally similar picture emerges if the variables are instead deflated by the population.)


Not surprisingly, for most of the indicators, labor market progress is a bit more subdued relative to postrecession growth in the labor force than growth in the indicators alone would suggest. These adjustments definitely would not alter our view that the labor market picture is "quite mixed." President Lockhart's recent comments on CNBC—in which he said he would like to see more positive data before declaring that sustained improvement has taken hold—seem especially prescient in light of today's job numbers:

Photo of John RobertsonBy John Robertson, vice president and senior economist in the Atlanta Fed's research department, and

 

Photo of Dave AltigDave Altig, executive vice president and research director of the Atlanta Fed

 

April 5, 2013 in Employment, Labor Markets | Permalink

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