Don't Set Speed Limits on Trading. By ARTHUR LEVITT JR.
Why penalize efficiency? It creates deep and liquid markets.
WSJ, Aug 18, 2009
The debate over high-frequency trading may seem remote and irrelevant to small investors. After all, they may think, if you're only buying and selling stocks and mutual funds occasionally, what difference does it make whether some traders are able to move quickly in and out of those same stocks, squeezing an extra penny or two of profit here and there?
But this debate is not just about the rarified world of high-frequency traders, dominated by superfast computing and trading by advanced algorithms. It's fundamentally about the competitiveness and health of U.S. markets, and the ease with which all investors are able to find willing buyers and sellers. Small investors may never directly use a high-frequency trading strategy in their lives, but they have a very large stake in whether such strategies are regulated out of existence, as is now urged by some in Congress, the media and Wall Street.
High-frequency trading is, in many respects, just the next stage in the ongoing technological innovation of financial markets. Just as paper tickets for trades were replaced by computer orders, and the trading floor seen on television was made largely irrelevant by electronic exchanges, so has high-frequency trading revolutionized the way most U.S. stocks and related investment products are priced and sold.
High-frequency trading occurs when traders position very fast computers as close as possible to the stock market's computer servers to minimize the distance and time it takes for an order to pass through telecom lines. The traders then program those computers to analyze and react to incoming market data in mere fractions of a second.
Those fractions of a second translate into only slightly better margins in executing trades, but if done in large enough volume they add up to significant value. Because of that, roughly two-thirds of all U.S. daily stock volume is generated by high-frequency traders.
Due to the rise of high-frequency trading, investors both large and small enjoy a deeper pool of potential buyers and sellers, and a wider variety of ways to execute trades. There are today more than 30 execution venues—ranging from established global exchanges to a plethora of specialized markets—catering to the particular trading needs of institutions and individuals. Choice abounds, and investors now enjoy faster, more reliable execution technology and lower execution fees than ever before. All of that contributes significantly to market liquidity, a critical measure of market health and something all investors value.
Normally, this revolution in trading would be welcomed, but the practice of "flash trading," which has recently garnered negative headlines and regulatory action, has led some market observers to condemn high-frequency trading as a whole. This is a mistake. While I support the move to ban flash orders because they have the potential to undermine the goals of market competition, that does not mean we should demonize or regulate out of existence all high-frequency trading.
Some in Congress have suggested a tax on all trades of up to 25 basis points per trade, which would raise the per-transaction price on the purchase of a $20 stock to five cents from less than a penny now. Such a tax has been tried before—from 1914 to 1966, there was a transfer tax set at 0.2% on stock trades. But that expense was simply passed on to investors. Today, a tax on each stock transaction would probably drive high-frequency traders, and the liquidity they bring, to foreign markets.
Others simply assert that all high-frequency trading has no moral or underlying economic value, and that high-frequency trading is simply a game for those who want to profit from getting access to data a split-second ahead of someone else. The Securities and Exchange Commission should ignore these complaints and the caricature that has developed of high-frequency traders.
These traders have developed systems to allow them to beat the competition to displayed quotes. They have taken available space near the markets' data servers to squeeze time out of every transaction. These traders continuously look for inefficiencies, and by exploiting them, correct them. I see nothing sinister or unfair about the advantages that come out of their investments and efforts.
We should not set a speed limit to slow everyone down to the pace set by those unwilling or unable to compete at the highest levels of market activity. Investors large and small have always been served well by those looking to build the deepest possible pool of potential buyers and sellers, make trades at a better price, and all as quickly as possible.
More liquidity, better pricing and faster speeds are the building blocks of healthy and transparent markets, and we must always affirm those goals.
Mr. Levitt was chairman of the Securities and Exchange Commission from 1993 to 2001.
Tuesday, August 18, 2009
Monday, August 17, 2009
We Don't Spend Enough on Health Care
We Don't Spend Enough on Health Care. By CRAIG S. KARPEL
It's crazy to adopt a bean-counting mentality amid revolutionary, albeit expensive, advances in medicine.
WSJ, Aug 16, 2009
Americans are being urged to worry about the nation spending 17% of its gross domestic product each year on health care—a higher percentage than any other country. Addressing the American Medical Association in June, Barack Obama said, "Make no mistake: The cost of our health care is a threat to our economy." But the president is mistaken. Japan spends 8% of its GDP on health care—the same as Zimbabwe. South Korea and Haiti both spend 6%. Monaco spends 5%, which is what Afghanistan spends. Do all of these countries have economies that are less "threatened" than that of the U.S.?
No. So there must be other factors that affect the health of a nation's economy.
Mr. Obama has said that "the cost of health care has weighed down our economy." No one thinks the 20% of our GDP that's attributable to manufacturing is weighing down the economy, because it's intuitively clear that one person's expenditure on widgets is another person's income. But the same is true of the health-care industry. The $2.4 trillion Americans spend each year for health care doesn't go up in smoke. It's paid to other Americans.
The basic material needs of human beings are food, clothing and shelter. The desire for food and clothing drove hunter-gatherer economies and, subsequently, agricultural economies, for millennia. The Industrial Revolution was driven by the desire for clothing. Thus Richard Arkwright's water frame, James Hargreaves's spinning jenny, Samuel Crompton's spinning mule, Eli Whitney's cotton gin and Elias Howe's sewing machine.
Though it hasn't been widely realized, the desire for shelter was a major driver of the U.S. economy during the second half of the 20th century and the first several years of the 21st. About one-third of the new jobs created during the latter period were directly or indirectly related to housing, as the stupendous ripple effect of the bursting housing bubble should make painfully obvious.
Once these material needs are substantially met, desire for health care—without which there can be no enjoyment of food, clothing or shelter—becomes a significant, perhaps a principal, driver of the economy.
A little-noticed feature of the current recession is the role of the health-care industry as a resilient driver of the general economy. Health-care now accounts for 10.4% of nonfarm employment. Health-care employment grew by 19,600 jobs in July 2009, on a par with the average monthly gain for the first half of 2009, which was down from an average monthly increase of 30,000 in 2008. Remarkably, these gains occurred in a period during which total employment shrank by 6.7 million.
The U.S. health-care economy should be viewed not as a burden but as an engine of growth. Medical and orthopedic equipment exports increased by 65.1% from 2004 through 2008. Pharmaceutical exports were up 74.6%. The unprecedented advances expected to come out of American stem cell, nanotechnology and human genome research—which other countries' constricted health sectors cannot support—will send these already impressive figures skyward.
A study by Deloitte LLP has found that more than 400,000 non-U.S. residents obtained medical care in the U.S. in 2008, and it forecasts an annual increase of 3%. Some 3.5% of inpatient procedures at U.S. hospitals were performed on international patients, many of them escaping from Canada's supposedly superior health system.
"Inbound medical tourism," Deloitte stated, "is primarily driven by the search for high-quality care without extensive waiting periods. Foreign patients are willing to pay more for care within the United States if these two factors play a large role." The deficiencies of the foreign health-care systems the Obama administration wishes to emulate can be counted on to generate ever-increasing revenues for U.S. providers and employment for Americans.
In a 2007 study, Stanford University economists Robert E. Hall (who will take office next year as president of the American Economic Association) and Charles I. Jones reported that modeling they've conducted has found that mid-21st century U.S. health-care expenditures would optimally amount to 30% of GDP or more. They wrote:
"We examine the allocation of resources that maximizes social welfare in our model. We abstract from the complicated institutions that shape spending in the United States and ask a more basic question: from a social welfare standpoint, how much should the nation spend on health care, and what is the time path of optimal health spending? . . .
"Viewed from every angle, our results support the proposition that both historical and future increases in the health spending share are desirable. . . . [W]e believe it likely that maximizing social welfare in the United States will require the development of institutions that are consistent with spending 30 percent or more of GDP on health by the middle of the century."
The administration's health-care plan is biased toward bean-counting rather than designed to maximize American physical and mental well-being. We need to ask ourselves whether there is truly anything more valuable to us than our loved ones and our own health and longevity.
In the signature radio sketch of Jack Benny, whose performing persona was laughably frugal, actor Eddie Marr snarled at him, "Don't make a move—this is a stickup. Now, come on: Your money or your life." Benny didn't respond. The "robber" said, "Look, bud—I said your money or your life!" Whereupon Benny shot back, "I'm thinking it over!"
Confronted for the first time in history with a constant stream of medical innovations that are marvelously effective but tend to be very expensive, our legislative representatives—in particular, the Blue Dog Democrats—would do well to stop "thinking it over" and to commit themselves to action that will preserve the ability of Americans to choose life over money.
Mr. Karpel is the author of "The Retirement Myth" (HarperCollins, 1995).
It's crazy to adopt a bean-counting mentality amid revolutionary, albeit expensive, advances in medicine.
WSJ, Aug 16, 2009
Americans are being urged to worry about the nation spending 17% of its gross domestic product each year on health care—a higher percentage than any other country. Addressing the American Medical Association in June, Barack Obama said, "Make no mistake: The cost of our health care is a threat to our economy." But the president is mistaken. Japan spends 8% of its GDP on health care—the same as Zimbabwe. South Korea and Haiti both spend 6%. Monaco spends 5%, which is what Afghanistan spends. Do all of these countries have economies that are less "threatened" than that of the U.S.?
No. So there must be other factors that affect the health of a nation's economy.
Mr. Obama has said that "the cost of health care has weighed down our economy." No one thinks the 20% of our GDP that's attributable to manufacturing is weighing down the economy, because it's intuitively clear that one person's expenditure on widgets is another person's income. But the same is true of the health-care industry. The $2.4 trillion Americans spend each year for health care doesn't go up in smoke. It's paid to other Americans.
The basic material needs of human beings are food, clothing and shelter. The desire for food and clothing drove hunter-gatherer economies and, subsequently, agricultural economies, for millennia. The Industrial Revolution was driven by the desire for clothing. Thus Richard Arkwright's water frame, James Hargreaves's spinning jenny, Samuel Crompton's spinning mule, Eli Whitney's cotton gin and Elias Howe's sewing machine.
Though it hasn't been widely realized, the desire for shelter was a major driver of the U.S. economy during the second half of the 20th century and the first several years of the 21st. About one-third of the new jobs created during the latter period were directly or indirectly related to housing, as the stupendous ripple effect of the bursting housing bubble should make painfully obvious.
Once these material needs are substantially met, desire for health care—without which there can be no enjoyment of food, clothing or shelter—becomes a significant, perhaps a principal, driver of the economy.
A little-noticed feature of the current recession is the role of the health-care industry as a resilient driver of the general economy. Health-care now accounts for 10.4% of nonfarm employment. Health-care employment grew by 19,600 jobs in July 2009, on a par with the average monthly gain for the first half of 2009, which was down from an average monthly increase of 30,000 in 2008. Remarkably, these gains occurred in a period during which total employment shrank by 6.7 million.
The U.S. health-care economy should be viewed not as a burden but as an engine of growth. Medical and orthopedic equipment exports increased by 65.1% from 2004 through 2008. Pharmaceutical exports were up 74.6%. The unprecedented advances expected to come out of American stem cell, nanotechnology and human genome research—which other countries' constricted health sectors cannot support—will send these already impressive figures skyward.
A study by Deloitte LLP has found that more than 400,000 non-U.S. residents obtained medical care in the U.S. in 2008, and it forecasts an annual increase of 3%. Some 3.5% of inpatient procedures at U.S. hospitals were performed on international patients, many of them escaping from Canada's supposedly superior health system.
"Inbound medical tourism," Deloitte stated, "is primarily driven by the search for high-quality care without extensive waiting periods. Foreign patients are willing to pay more for care within the United States if these two factors play a large role." The deficiencies of the foreign health-care systems the Obama administration wishes to emulate can be counted on to generate ever-increasing revenues for U.S. providers and employment for Americans.
In a 2007 study, Stanford University economists Robert E. Hall (who will take office next year as president of the American Economic Association) and Charles I. Jones reported that modeling they've conducted has found that mid-21st century U.S. health-care expenditures would optimally amount to 30% of GDP or more. They wrote:
"We examine the allocation of resources that maximizes social welfare in our model. We abstract from the complicated institutions that shape spending in the United States and ask a more basic question: from a social welfare standpoint, how much should the nation spend on health care, and what is the time path of optimal health spending? . . .
"Viewed from every angle, our results support the proposition that both historical and future increases in the health spending share are desirable. . . . [W]e believe it likely that maximizing social welfare in the United States will require the development of institutions that are consistent with spending 30 percent or more of GDP on health by the middle of the century."
The administration's health-care plan is biased toward bean-counting rather than designed to maximize American physical and mental well-being. We need to ask ourselves whether there is truly anything more valuable to us than our loved ones and our own health and longevity.
In the signature radio sketch of Jack Benny, whose performing persona was laughably frugal, actor Eddie Marr snarled at him, "Don't make a move—this is a stickup. Now, come on: Your money or your life." Benny didn't respond. The "robber" said, "Look, bud—I said your money or your life!" Whereupon Benny shot back, "I'm thinking it over!"
Confronted for the first time in history with a constant stream of medical innovations that are marvelously effective but tend to be very expensive, our legislative representatives—in particular, the Blue Dog Democrats—would do well to stop "thinking it over" and to commit themselves to action that will preserve the ability of Americans to choose life over money.
Mr. Karpel is the author of "The Retirement Myth" (HarperCollins, 1995).
Tuesday, August 11, 2009
Arizona’s Budget Breakthrough - An alternative to California’s tax and spend model
Arizona’s Budget Breakthrough. WSJ Editorial
An alternative to California’s tax and spend model.
WSJ, Aug 11, 2009
Perhaps states are starting to learn the right fiscal lessons from the red-ink blowouts in high-tax California and New York. Today, the legislature in Arizona will vote on a tax reform designed to entice more employers and high-income taxpayers to the state. Sponsored by Republican Governor Jan Brewer, the plan would cut state property taxes, the corporate tax and personal income taxes, in exchange for a temporary rise in the sales tax.
Most economic studies agree that states have more jobs and higher income growth when they tax consumption rather than savings, investment and business profits. This explains why most of the nine states with no income tax at all—such as Texas, Florida and Tennessee—have been economic high-flyers in recent decades.
Ms. Brewer’s proposal reflects this economic logic. Effective January 1, 2011, her plan would reduce the state’s corporate income tax rate to 4.86% from 6.97%, which would be one of the largest business tax cuts in the nation in recent years. The proposal also cuts all personal income tax rates by 6.6%, thus lowering the top marginal rate to 4.24% from 4.54%. A hated statewide tax on commercial and residential property would also be abolished.
Arizona has been hit especially hard by the housing slump, and its budget woes were compounded thanks to former Governor Janet Napolitano’s spending spree before she joined the Obama cabinet. On her watch the budget grew by more than 50% in five years—to $10.2 billion from $6.5 billion in 2004. The state now has a $1 billion budget gap, and to close it the legislature will also vote on a one percentage point increase in the sales tax to 6.6% in 2010 and 2011; in the third year the sales tax would fall to 6.1%, and in the fourth year would revert to its current 5.6% rate.
We’d rather see the legislature cut more spending than raise the sales tax, but on the other hand the sales tax would only take effect if it is approved on the November ballot. The political class is giving voters a say in the matter. The sales tax increase also has the advantage of a built-in expiration date, while the tax cuts are permanent.
Democratic opponents are calling this a tax giveaway to big business. But lawmakers needn’t apologize for trying to retain Arizona’s status as a business-friendly state—particularly when jobs are so scarce. Small employers also benefit from the lower property tax rates and the personal income tax reductions. Lower tax payments will enable them to reinvest more in their enterprises.
The opponents should consult a new study of state business taxes by former U.S. Treasury economist Robert Carroll for the Tax Foundation. He examined 50 states and found that states with lower corporate tax rates have higher wage gains and more productivity over time. This tax cut sounds like a high-return investment.
Republicans control both houses of the Arizona legislature, and as we went to press the main obstacle to passing the reform was the Arizona Senate’s antitax conservatives. They oppose the higher sales tax. These Republicans should look to one of the triumphs of the Reagan Presidency, the 1986 tax reform, which broadened the tax base but substantially lowered tax rates and thus sustained the 1980s expansion.
Arizona has the chance to be the anti-California, closing the budget deficit by growing the economy, not by raising taxes. We hope legislators don’t blow it, because the U.S. desperately needs an alternative to the tax, spend and tax again philosophy of Sacramento and Albany.
An alternative to California’s tax and spend model.
WSJ, Aug 11, 2009
Perhaps states are starting to learn the right fiscal lessons from the red-ink blowouts in high-tax California and New York. Today, the legislature in Arizona will vote on a tax reform designed to entice more employers and high-income taxpayers to the state. Sponsored by Republican Governor Jan Brewer, the plan would cut state property taxes, the corporate tax and personal income taxes, in exchange for a temporary rise in the sales tax.
Most economic studies agree that states have more jobs and higher income growth when they tax consumption rather than savings, investment and business profits. This explains why most of the nine states with no income tax at all—such as Texas, Florida and Tennessee—have been economic high-flyers in recent decades.
Ms. Brewer’s proposal reflects this economic logic. Effective January 1, 2011, her plan would reduce the state’s corporate income tax rate to 4.86% from 6.97%, which would be one of the largest business tax cuts in the nation in recent years. The proposal also cuts all personal income tax rates by 6.6%, thus lowering the top marginal rate to 4.24% from 4.54%. A hated statewide tax on commercial and residential property would also be abolished.
Arizona has been hit especially hard by the housing slump, and its budget woes were compounded thanks to former Governor Janet Napolitano’s spending spree before she joined the Obama cabinet. On her watch the budget grew by more than 50% in five years—to $10.2 billion from $6.5 billion in 2004. The state now has a $1 billion budget gap, and to close it the legislature will also vote on a one percentage point increase in the sales tax to 6.6% in 2010 and 2011; in the third year the sales tax would fall to 6.1%, and in the fourth year would revert to its current 5.6% rate.
We’d rather see the legislature cut more spending than raise the sales tax, but on the other hand the sales tax would only take effect if it is approved on the November ballot. The political class is giving voters a say in the matter. The sales tax increase also has the advantage of a built-in expiration date, while the tax cuts are permanent.
Democratic opponents are calling this a tax giveaway to big business. But lawmakers needn’t apologize for trying to retain Arizona’s status as a business-friendly state—particularly when jobs are so scarce. Small employers also benefit from the lower property tax rates and the personal income tax reductions. Lower tax payments will enable them to reinvest more in their enterprises.
The opponents should consult a new study of state business taxes by former U.S. Treasury economist Robert Carroll for the Tax Foundation. He examined 50 states and found that states with lower corporate tax rates have higher wage gains and more productivity over time. This tax cut sounds like a high-return investment.
Republicans control both houses of the Arizona legislature, and as we went to press the main obstacle to passing the reform was the Arizona Senate’s antitax conservatives. They oppose the higher sales tax. These Republicans should look to one of the triumphs of the Reagan Presidency, the 1986 tax reform, which broadened the tax base but substantially lowered tax rates and thus sustained the 1980s expansion.
Arizona has the chance to be the anti-California, closing the budget deficit by growing the economy, not by raising taxes. We hope legislators don’t blow it, because the U.S. desperately needs an alternative to the tax, spend and tax again philosophy of Sacramento and Albany.
The Next Fannie Mae: Ginnie Mae and FHA are becoming $1 trillion subprime guarantors
The Next Fannie Mae. WSJ Editorial
Ginnie Mae and FHA are becoming $1 trillion subprime guarantors.
The Wall Street Journal, p A16, Aug 11, 2009
Much to their dismay, Americans learned last year that they “owned” Fannie Mae and Freddie Mac. Well, meet their cousin, Ginnie Mae or the Government National Mortgage Association, which will soon join them as a trillion-dollar packager of subprime mortgages. Taxpayers own Ginnie too.
Only last week, Ginnie announced that it issued a monthly record of $43 billion in mortgage-backed securities in June. Ginnie Mae President Joseph Murin sounded almost giddy as he cheered this “phenomenal growth.” Ginnie Mae’s mortgage exposure is expected to top $1 trillion by the end of next year—or far more than double the dollar amount of 2007. (See the nearby table.) Earlier this summer, Reuters quoted Anthony Medici of the Housing Department’s Inspector General’s office as saying, “Who would have predicted that Ginnie Mae and Fannie Mae would have swapped positions” in loan volume?
Ginnie’s mission is to bundle, guarantee and then sell mortgages insured by the Federal Housing Administration, which is Uncle Sam’s home mortgage shop. Ginnie’s growth is a by-product of the FHA’s spectacular growth. The FHA now insures $560 billion of mortgages—quadruple the amount in 2006. Among the FHA, Ginnie, Fannie and Freddie, nearly nine of every 10 new mortgages in America now carry a federal taxpayer guarantee.
Herein lies the problem. The FHA’s standard insurance program today is notoriously lax. It backs low downpayment loans, to buyers who often have below-average to poor credit ratings, and with almost no oversight to protect against fraud. Sound familiar? This is called subprime lending—the same financial roulette that busted Fannie, Freddie and large mortgage houses like Countrywide Financial.
On June 18, HUD’s Inspector General issued a scathing report on the FHA’s lax insurance practices. It found that the FHA’s default rate has grown to 7%, which is about double the level considered safe and sound for lenders, and that 13% of these loans are delinquent by more than 30 days. The FHA’s reserve fund was found to have fallen in half, to 3% from 6.4% in 2007—meaning it now has a 33 to 1 leverage ratio, which is into Bear Stearns territory. The IG says the FHA may need a “Congressional appropriation intervention to make up the shortfall.”
The IG also fears that the recent “surge in FHA loans is likely to overtax the oversight resources of the FHA, making careful and comprehensive lender monitoring difficult.” And it warned that the growth in FHA mortgage volume could make the program “vulnerable to exploitation by fraud schemes . . . that undercut the integrity of the program.” The 19-page IG report includes a horror show of recent fraud cases.
If housing values continue to slide and 10% of FHA loans end up in default, taxpayers will be on the hook for another $50 to $60 billion of mortgage losses. Only last week, Taylor Bean, the FHA’s third largest mortgage originator in June with $17 billion in loans this year, announced it is terminating operations after the FHA barred the mortgage lender from participating in its insurance program. The feds alleged that Taylor Bean had “misrepresented” its relationship with an auditor and had “irregular transactions that raised concerns of fraud.”
Is anyone on Capitol Hill or the White House paying attention? Evidently not, because on both sides of Pennsylvania Avenue policy makers are busy giving the FHA even more business while easing its already loosy-goosy underwriting standards. A few weeks ago a House committee approved legislation to keep the FHA’s loan limit in high-income states like California at $729,750. We wonder how many first-time home buyers purchase a $725,000 home. The Members must have missed the IG’s warning that higher loan limits may mean “much greater losses by FHA” and will make fraudsters “much more attracted to the product.”
In the wake of the mortgage meltdown, most private lenders have reverted to the traditional down payment rule of 10% or 20%. Housing experts agree that a high down payment is the best protection against default and foreclosure because it means the owner has something to lose by walking away. Meanwhile, at the FHA, the down payment requirement remains a mere 3.5%. Other policies—such as allowing the buyer to finance closing costs and use the homebuyer tax credit to cover costs—can drive the down payment to below 2%.
Then there is the booming refinancing program that Congress has approved to move into the FHA hundreds of thousands of borrowers who can’t pay their mortgage, including many with subprime and other exotic loans. HUD just announced that starting this week the FHA will refinance troubled mortgages by reducing up to 30% of the principal under the Home Affordable Modification Program. This program is intended to reduce foreclosures, but someone has to pick up the multibillion-dollar cost of the 30% loan forgiveness. That will be taxpayers.
In some cases, these owners are so overdue in their payments, and housing prices have fallen so dramatically, that the borrowers have a negative 25% equity in the home and they are still eligible for an FHA refi. We also know from other government and private loan modification programs that a borrower who has defaulted on the mortgage once is at very high risk (25%-50%) of defaulting again.
All of which means that the FHA and Ginnie Mae could well be the next Fannie and Freddie. While Fan and Fred carried “implicit” federal guarantees, the FHA and Ginnie carry the explicit full faith and credit of the U.S. government.
We’ve long argued that Congress has a fiduciary duty to secure the safety and soundness of FHA through common sense reforms. Eliminate the 100% guarantee on FHA loans, so lenders have a greater financial incentive to insure the soundness of the loan; adopt the private sector convention of a 10% down payment, which would reduce foreclosures; and stop putting subprime loans that should have never been made in the first place on the federal balance sheet.
The housing lobby, which gets rich off FHA insurance, has long blocked these due-diligence reforms, saying there’s no threat to taxpayers. That’s what they also said about Fan and Fred—$400 billion ago.
Ginnie Mae and FHA are becoming $1 trillion subprime guarantors.
The Wall Street Journal, p A16, Aug 11, 2009
Much to their dismay, Americans learned last year that they “owned” Fannie Mae and Freddie Mac. Well, meet their cousin, Ginnie Mae or the Government National Mortgage Association, which will soon join them as a trillion-dollar packager of subprime mortgages. Taxpayers own Ginnie too.
Only last week, Ginnie announced that it issued a monthly record of $43 billion in mortgage-backed securities in June. Ginnie Mae President Joseph Murin sounded almost giddy as he cheered this “phenomenal growth.” Ginnie Mae’s mortgage exposure is expected to top $1 trillion by the end of next year—or far more than double the dollar amount of 2007. (See the nearby table.) Earlier this summer, Reuters quoted Anthony Medici of the Housing Department’s Inspector General’s office as saying, “Who would have predicted that Ginnie Mae and Fannie Mae would have swapped positions” in loan volume?
Ginnie’s mission is to bundle, guarantee and then sell mortgages insured by the Federal Housing Administration, which is Uncle Sam’s home mortgage shop. Ginnie’s growth is a by-product of the FHA’s spectacular growth. The FHA now insures $560 billion of mortgages—quadruple the amount in 2006. Among the FHA, Ginnie, Fannie and Freddie, nearly nine of every 10 new mortgages in America now carry a federal taxpayer guarantee.
Herein lies the problem. The FHA’s standard insurance program today is notoriously lax. It backs low downpayment loans, to buyers who often have below-average to poor credit ratings, and with almost no oversight to protect against fraud. Sound familiar? This is called subprime lending—the same financial roulette that busted Fannie, Freddie and large mortgage houses like Countrywide Financial.
On June 18, HUD’s Inspector General issued a scathing report on the FHA’s lax insurance practices. It found that the FHA’s default rate has grown to 7%, which is about double the level considered safe and sound for lenders, and that 13% of these loans are delinquent by more than 30 days. The FHA’s reserve fund was found to have fallen in half, to 3% from 6.4% in 2007—meaning it now has a 33 to 1 leverage ratio, which is into Bear Stearns territory. The IG says the FHA may need a “Congressional appropriation intervention to make up the shortfall.”
The IG also fears that the recent “surge in FHA loans is likely to overtax the oversight resources of the FHA, making careful and comprehensive lender monitoring difficult.” And it warned that the growth in FHA mortgage volume could make the program “vulnerable to exploitation by fraud schemes . . . that undercut the integrity of the program.” The 19-page IG report includes a horror show of recent fraud cases.
If housing values continue to slide and 10% of FHA loans end up in default, taxpayers will be on the hook for another $50 to $60 billion of mortgage losses. Only last week, Taylor Bean, the FHA’s third largest mortgage originator in June with $17 billion in loans this year, announced it is terminating operations after the FHA barred the mortgage lender from participating in its insurance program. The feds alleged that Taylor Bean had “misrepresented” its relationship with an auditor and had “irregular transactions that raised concerns of fraud.”
Is anyone on Capitol Hill or the White House paying attention? Evidently not, because on both sides of Pennsylvania Avenue policy makers are busy giving the FHA even more business while easing its already loosy-goosy underwriting standards. A few weeks ago a House committee approved legislation to keep the FHA’s loan limit in high-income states like California at $729,750. We wonder how many first-time home buyers purchase a $725,000 home. The Members must have missed the IG’s warning that higher loan limits may mean “much greater losses by FHA” and will make fraudsters “much more attracted to the product.”
In the wake of the mortgage meltdown, most private lenders have reverted to the traditional down payment rule of 10% or 20%. Housing experts agree that a high down payment is the best protection against default and foreclosure because it means the owner has something to lose by walking away. Meanwhile, at the FHA, the down payment requirement remains a mere 3.5%. Other policies—such as allowing the buyer to finance closing costs and use the homebuyer tax credit to cover costs—can drive the down payment to below 2%.
Then there is the booming refinancing program that Congress has approved to move into the FHA hundreds of thousands of borrowers who can’t pay their mortgage, including many with subprime and other exotic loans. HUD just announced that starting this week the FHA will refinance troubled mortgages by reducing up to 30% of the principal under the Home Affordable Modification Program. This program is intended to reduce foreclosures, but someone has to pick up the multibillion-dollar cost of the 30% loan forgiveness. That will be taxpayers.
In some cases, these owners are so overdue in their payments, and housing prices have fallen so dramatically, that the borrowers have a negative 25% equity in the home and they are still eligible for an FHA refi. We also know from other government and private loan modification programs that a borrower who has defaulted on the mortgage once is at very high risk (25%-50%) of defaulting again.
All of which means that the FHA and Ginnie Mae could well be the next Fannie and Freddie. While Fan and Fred carried “implicit” federal guarantees, the FHA and Ginnie carry the explicit full faith and credit of the U.S. government.
We’ve long argued that Congress has a fiduciary duty to secure the safety and soundness of FHA through common sense reforms. Eliminate the 100% guarantee on FHA loans, so lenders have a greater financial incentive to insure the soundness of the loan; adopt the private sector convention of a 10% down payment, which would reduce foreclosures; and stop putting subprime loans that should have never been made in the first place on the federal balance sheet.
The housing lobby, which gets rich off FHA insurance, has long blocked these due-diligence reforms, saying there’s no threat to taxpayers. That’s what they also said about Fan and Fred—$400 billion ago.
Corporate Earnings Are No Sign of Recovery
Corporate Earnings Are No Sign of Recovery. By ZACHARY KARABELL
WSJ, Aug 09, 2009
Despite grim predictions, most major U.S. companies have reported positive earnings for the second quarter of 2009. Given how wrong past predictions have been, the fact that earnings have blown away expectations shouldn’t be so surprising. Still, the numbers are genuinely impressive: More than 73% of the companies that have reported so far have beaten earnings estimates—and stocks have rightly rallied.
Yes, profits are down sharply from a year ago, but this is in the context of an overall global economy that is shrinking. If a company made $30 million on $100 million in revenue a year ago, and made “only” $20 million this quarter, it’s accurate to have a headline that says its profits fell 33%. But making $20 million, or a 20% margin, in an economy that contracted is nonetheless startling, or should be.
The same Wall Street culture that failed to anticipate the tipping point in the financial system is just as prone to a herd mentality of negativity. Having overlooked the gaping fissures in the system last year, most analysts went to the other extreme in their analysis of what would happen this year. A similar process occurred in 2002 and 2003, as views whipsawed from unrealistic optimism to irrational pessimism.
This time, the slew of better earnings has also led to the conviction that the worst of the economic travails are behind us. As the stock market has soared, many have declared the recession either over or ending. These voices range from public officials at the Federal Reserve to notable pessimists such as New York University economist Nouriel Roubini. This rosy view assumes a connection between how listed companies are fairing and how the national economy will fair. That assumption is wrong.
The delinkage of the fate of corporate profits from that of the overall economy is not new. Beginning earlier in this decade, profits began to accelerate far in excess of either global or U.S. economic growth.
In 2004, for instance, earnings for the S&P 500 grew 22%; in 2005 and 2006 they grew just under 20%. Those same years global growth barely exceeded 3%. As we now know, some of those elevated earnings were due to the leverage-fueled profits of the financial-service industry. And there’s little doubt that mortgage-laced derivatives artificially elevated growth. But even discounting those factors, the growth of corporate profits would have substantially exceeded the expansion of national economies.
Then, in the second half of last year and the first months of this year, profits plunged along with U.S. and global economic activity. That gave succor to the belief that companies can only grow as much as the economies in which they function grow. For years, most analysts argued that if there was too wide a variance between the two, something had to give. Either profits had to descend or national economic growth had to accelerate. As profits shrank over the past nine months, those who argued that a reversion to the mean was inevitable seemed to be vindicated. But that belief is wrong. Companies are increasingly less constrained by any national economy, and their success is no harbinger of national economic growth or sustained economic health for the United States.
First, companies have been profiting because they can cut costs aggressively. It’s not as if demand in the U.S. or Europe has picked up. Take Starbucks, which reported a surprising surge in profits. Little of that was due to American consumers suddenly becoming comfortable with $5 grande mocha lattes. Instead, it was because Starbucks—faced with weak demand and sluggish sales—closed stores and laid off workers. That has been a trend across industries.
Second, many larger companies have been profiting because they can focus on where the growth is around the globe. Companies such as Intel, Caterpillar, Microsoft and IBM now derive a majority of their revenues from outside the U.S., with the dynamic economies of the Asian rim and above all China assuming an ever-larger role. Companies are thriving in spite of economic activity in the U.S., not because of it.
That suggests the connection between corporate profits and robust economic recovery in the U.S. is tenuous at best. In fact, the financial crisis hastened the trend toward efficiencies, toward leaner inventories, and towards integrating both technology and global supply chains that has been taking place over the past decade.
That has led to severe pressure on the American working class and eroding employment. As these companies profit from global expansion and greater efficiency, they have little or no reason to rehire fired workers, or to expand their work force in a U.S. that is barely growing. If you are a global company, you want to hire and expand where the most dynamic growth is. Unfortunately for Americans, that’s not the U.S.
So we are facing a conundrum: Companies can grow by leaps and bounds—by double-digits—and yet unemployment can skyrocket and remain high. There is nothing on the horizon that would lead one to expect a turnaround in the employment picture.
Job losses slowed slightly last month as the unemployment rate fell to 9.4% in July from 9.5% in June, but that’s a far cry from any sign of job creation. The weight of more than 20 million marginally employed or unemployed, combined with the increasing pace of economic activity outside the U.S., presents the prospect of permanent change in the American economic landscape: high unemployment, moderate to weak growth, and soaring corporate profits.
The ability of companies—large ones especially, but even more modest ventures that assemble and source globally—to become more efficient and go where the growth is has never been greater. This is undoubtedly good for stocks and positive for investors, but it is also a challenge for American society that we have not even begun to confront.
Mr. Karabell is president of River Twice Research. His new book, “Superfusion: How China and America Became One Economy and Why the World’s Prosperity Depends on It,” will be published by Simon & Schuster in October.
WSJ, Aug 09, 2009
Despite grim predictions, most major U.S. companies have reported positive earnings for the second quarter of 2009. Given how wrong past predictions have been, the fact that earnings have blown away expectations shouldn’t be so surprising. Still, the numbers are genuinely impressive: More than 73% of the companies that have reported so far have beaten earnings estimates—and stocks have rightly rallied.
Yes, profits are down sharply from a year ago, but this is in the context of an overall global economy that is shrinking. If a company made $30 million on $100 million in revenue a year ago, and made “only” $20 million this quarter, it’s accurate to have a headline that says its profits fell 33%. But making $20 million, or a 20% margin, in an economy that contracted is nonetheless startling, or should be.
The same Wall Street culture that failed to anticipate the tipping point in the financial system is just as prone to a herd mentality of negativity. Having overlooked the gaping fissures in the system last year, most analysts went to the other extreme in their analysis of what would happen this year. A similar process occurred in 2002 and 2003, as views whipsawed from unrealistic optimism to irrational pessimism.
This time, the slew of better earnings has also led to the conviction that the worst of the economic travails are behind us. As the stock market has soared, many have declared the recession either over or ending. These voices range from public officials at the Federal Reserve to notable pessimists such as New York University economist Nouriel Roubini. This rosy view assumes a connection between how listed companies are fairing and how the national economy will fair. That assumption is wrong.
The delinkage of the fate of corporate profits from that of the overall economy is not new. Beginning earlier in this decade, profits began to accelerate far in excess of either global or U.S. economic growth.
In 2004, for instance, earnings for the S&P 500 grew 22%; in 2005 and 2006 they grew just under 20%. Those same years global growth barely exceeded 3%. As we now know, some of those elevated earnings were due to the leverage-fueled profits of the financial-service industry. And there’s little doubt that mortgage-laced derivatives artificially elevated growth. But even discounting those factors, the growth of corporate profits would have substantially exceeded the expansion of national economies.
Then, in the second half of last year and the first months of this year, profits plunged along with U.S. and global economic activity. That gave succor to the belief that companies can only grow as much as the economies in which they function grow. For years, most analysts argued that if there was too wide a variance between the two, something had to give. Either profits had to descend or national economic growth had to accelerate. As profits shrank over the past nine months, those who argued that a reversion to the mean was inevitable seemed to be vindicated. But that belief is wrong. Companies are increasingly less constrained by any national economy, and their success is no harbinger of national economic growth or sustained economic health for the United States.
First, companies have been profiting because they can cut costs aggressively. It’s not as if demand in the U.S. or Europe has picked up. Take Starbucks, which reported a surprising surge in profits. Little of that was due to American consumers suddenly becoming comfortable with $5 grande mocha lattes. Instead, it was because Starbucks—faced with weak demand and sluggish sales—closed stores and laid off workers. That has been a trend across industries.
Second, many larger companies have been profiting because they can focus on where the growth is around the globe. Companies such as Intel, Caterpillar, Microsoft and IBM now derive a majority of their revenues from outside the U.S., with the dynamic economies of the Asian rim and above all China assuming an ever-larger role. Companies are thriving in spite of economic activity in the U.S., not because of it.
That suggests the connection between corporate profits and robust economic recovery in the U.S. is tenuous at best. In fact, the financial crisis hastened the trend toward efficiencies, toward leaner inventories, and towards integrating both technology and global supply chains that has been taking place over the past decade.
That has led to severe pressure on the American working class and eroding employment. As these companies profit from global expansion and greater efficiency, they have little or no reason to rehire fired workers, or to expand their work force in a U.S. that is barely growing. If you are a global company, you want to hire and expand where the most dynamic growth is. Unfortunately for Americans, that’s not the U.S.
So we are facing a conundrum: Companies can grow by leaps and bounds—by double-digits—and yet unemployment can skyrocket and remain high. There is nothing on the horizon that would lead one to expect a turnaround in the employment picture.
Job losses slowed slightly last month as the unemployment rate fell to 9.4% in July from 9.5% in June, but that’s a far cry from any sign of job creation. The weight of more than 20 million marginally employed or unemployed, combined with the increasing pace of economic activity outside the U.S., presents the prospect of permanent change in the American economic landscape: high unemployment, moderate to weak growth, and soaring corporate profits.
The ability of companies—large ones especially, but even more modest ventures that assemble and source globally—to become more efficient and go where the growth is has never been greater. This is undoubtedly good for stocks and positive for investors, but it is also a challenge for American society that we have not even begun to confront.
Mr. Karabell is president of River Twice Research. His new book, “Superfusion: How China and America Became One Economy and Why the World’s Prosperity Depends on It,” will be published by Simon & Schuster in October.
Monday, August 10, 2009
USAID Partners With Chevron To Promote Agricultural Development in Angola
USAID Partners With Chevron Corporation and the CLUSA To Promote Agricultural Development in Angola.
USAID
The U.S. Agency for International Development (USAID) has signed a memorandum of understanding with the Chevron Corporation and the Cooperative League of the United States of America (CLUSA) to assist Angola in diversifying its economy by revitalizing small and medium scale commercial farming, and promoting agricultural development that is environmentally friendly, socially just and economically sustainable.
Benefits of Implementation
The partnership between USAID, Chevron and the CLUSA will enable farmers to develop and improve the commercial viability of their products and services. The mechanisms the partnership will use to assist Angola in reaching its agricultural sector development include:
To build on the successes of this partnership, USAID, Chevron and CLUSA will coordinate technical assistance and research to promote environmentally friendly resource management agricultural and agribusiness practices and will serve as the facilitators of "best practices" to country-level partners. They will work together to monitor the impact, effectiveness, and sustainability of their support to agricultural activities.
USAID
The U.S. Agency for International Development (USAID) has signed a memorandum of understanding with the Chevron Corporation and the Cooperative League of the United States of America (CLUSA) to assist Angola in diversifying its economy by revitalizing small and medium scale commercial farming, and promoting agricultural development that is environmentally friendly, socially just and economically sustainable.
Benefits of Implementation
The partnership between USAID, Chevron and the CLUSA will enable farmers to develop and improve the commercial viability of their products and services. The mechanisms the partnership will use to assist Angola in reaching its agricultural sector development include:
- Providing finance, business and training support to small and medium scale farmers and related agricultural enterprises;
- Strengthening the capacity of agrarian schools;
- Providing assistance to non-governmental organizations that deliver savings and credit products to small and medium scale farmers and related agricultural enterprises;
- Technical assistance to commercial banks providing wholesale lending to rural finance institutions; and
- Financing and support to private sector-based agricultural initiatives that promote sustainable, integrated value chains that link producers, input suppliers, financiers, buyers and other agribusinesses.
To build on the successes of this partnership, USAID, Chevron and CLUSA will coordinate technical assistance and research to promote environmentally friendly resource management agricultural and agribusiness practices and will serve as the facilitators of "best practices" to country-level partners. They will work together to monitor the impact, effectiveness, and sustainability of their support to agricultural activities.
Friday, August 7, 2009
US Air Force and Naval forces could do serious damage to Tehran’s nuclear facilities if diplomacy fails
There Is a Military Option on Iran. By CHUCK WALD
U.S. Air Force and Naval forces could do serious damage to Tehran’s nuclear facilities if diplomacy fails.
WSJ, Aug 07, 2009
In a policy address at the Council on Foreign Relations last month, Secretary of State Hillary Clinton said of Iran, “We cannot be afraid or unwilling to engage.” But the Iranian government has yet to accept President Obama’s outstretched hand. Even if Tehran suddenly acceded to talks, U.S. policy makers must prepare for the eventuality that diplomacy fails. While there has been much discussion of economic sanctions, we cannot neglect the military’s role in a Plan B.
There has been a lack of serious public discussion of the military tools available to us. Any mention of them is either met with accusations of warmongering or hushed with concerns over sharing sensitive information. It is important to discuss, within legal limits, such a serious issue as openly as possible. Discussion strengthens our democracy and dispels misinformation.
The military can play an important role in solving this complex problem without firing a single shot. Publicly signaling serious preparation for a military strike might obviate the need for one if deployments force Tehran to recognize the costs of its nuclear defiance. Mr. Obama might consider, for example, the deployment of additional carrier battle groups and minesweepers to the waters off Iran, and the conduct of military exercises with allies.
If such pressure fails to impress Iranian leadership, the U.S. Navy could move to blockade Iranian ports. A blockade—which is an act of war—would effectively cut off Iran’s gasoline imports, which constitute about one-third of its consumption. Especially in the aftermath of post-election protests, the Iranian leadership must worry about the economic dislocations and political impact of such action.
Should these measures not compel Tehran to reverse course on its nuclear program, and only after all other diplomatic avenues and economic pressures have been exhausted, the U.S. military is capable of launching a devastating attack on Iranian nuclear and military facilities.
Many policy makers and journalists dismiss the military option on the basis of a false sense of futility. They assume that the U.S. military is already overstretched, that we lack adequate intelligence about the location of covert nuclear sites, and that known sites are too heavily fortified.
Such assumptions are false.
An attack on Iranian nuclear facilities would mostly involve air assets, primarily Air Force and Navy, that are not strained by operations in Iraq and Afghanistan. Moreover, the presence of U.S. forces in countries that border Iran offers distinct advantages. Special Forces and intelligence personnel already in the region can easily move to protect key assets or perform clandestine operations. It would be prudent to emplace additional missile-defense capabilities in the region, upgrade both regional facilities and allied militaries, and expand strategic partnerships with countries such as Azerbaijan and Georgia to pressure Iran from all directions.
Conflict may reveal previously undetected Iranian facilities as Iranian forces move to protect them. Moreover, nuclear sites buried underground may survive sustained bombing, but their entrances and exits will not.
Of course, there are huge risks to military action: U.S. and allied casualties; rallying Iranians around an unstable and oppressive regime; Iranian reprisals be they direct or by proxy against us and our allies; and Iranian-instigated unrest in the Persian Gulf states, first and foremost in Iraq.
Furthermore, while a successful bombing campaign would set back Iranian nuclear development, Iran would undoubtedly retain its nuclear knowhow. An attack would also necessitate years of continued vigilance, both to retain the ability to strike previously undiscovered sites and to ensure that Iran does not revive its nuclear program.
But the risks of military action must be weighed against those of doing nothing. If the Iranian regime continues to advance its nuclear program despite the best efforts of Mr. Obama and other world leaders, we risk Iranian domination of the oil-rich Persian Gulf, threats to U.S.-allied Arab regimes, the emboldening of radicals in the region, the creation of an existential threat to Israel, the destabilization of Iraq, the shutdown of the Israel-Palestinian peace process, and a regional nuclear-arms race.
A peaceful resolution of the threat posed by Iran’s nuclear ambitions would certainly be the best possible outcome. But should diplomacy and economic pressure fail, a U.S. military strike against Iran is a technically feasible and credible option.
Gen. Wald (U.S. Air Force four-star, retired) was the air commander for the initial stages of Operation Enduring Freedom in Afghanistan and deputy commander of the U.S. European Command. He was also a participant in the Bipartisan Policy Center’s project on U.S. policy toward Iran, “Meeting the Challenge.”
U.S. Air Force and Naval forces could do serious damage to Tehran’s nuclear facilities if diplomacy fails.
WSJ, Aug 07, 2009
In a policy address at the Council on Foreign Relations last month, Secretary of State Hillary Clinton said of Iran, “We cannot be afraid or unwilling to engage.” But the Iranian government has yet to accept President Obama’s outstretched hand. Even if Tehran suddenly acceded to talks, U.S. policy makers must prepare for the eventuality that diplomacy fails. While there has been much discussion of economic sanctions, we cannot neglect the military’s role in a Plan B.
There has been a lack of serious public discussion of the military tools available to us. Any mention of them is either met with accusations of warmongering or hushed with concerns over sharing sensitive information. It is important to discuss, within legal limits, such a serious issue as openly as possible. Discussion strengthens our democracy and dispels misinformation.
The military can play an important role in solving this complex problem without firing a single shot. Publicly signaling serious preparation for a military strike might obviate the need for one if deployments force Tehran to recognize the costs of its nuclear defiance. Mr. Obama might consider, for example, the deployment of additional carrier battle groups and minesweepers to the waters off Iran, and the conduct of military exercises with allies.
If such pressure fails to impress Iranian leadership, the U.S. Navy could move to blockade Iranian ports. A blockade—which is an act of war—would effectively cut off Iran’s gasoline imports, which constitute about one-third of its consumption. Especially in the aftermath of post-election protests, the Iranian leadership must worry about the economic dislocations and political impact of such action.
Should these measures not compel Tehran to reverse course on its nuclear program, and only after all other diplomatic avenues and economic pressures have been exhausted, the U.S. military is capable of launching a devastating attack on Iranian nuclear and military facilities.
Many policy makers and journalists dismiss the military option on the basis of a false sense of futility. They assume that the U.S. military is already overstretched, that we lack adequate intelligence about the location of covert nuclear sites, and that known sites are too heavily fortified.
Such assumptions are false.
An attack on Iranian nuclear facilities would mostly involve air assets, primarily Air Force and Navy, that are not strained by operations in Iraq and Afghanistan. Moreover, the presence of U.S. forces in countries that border Iran offers distinct advantages. Special Forces and intelligence personnel already in the region can easily move to protect key assets or perform clandestine operations. It would be prudent to emplace additional missile-defense capabilities in the region, upgrade both regional facilities and allied militaries, and expand strategic partnerships with countries such as Azerbaijan and Georgia to pressure Iran from all directions.
Conflict may reveal previously undetected Iranian facilities as Iranian forces move to protect them. Moreover, nuclear sites buried underground may survive sustained bombing, but their entrances and exits will not.
Of course, there are huge risks to military action: U.S. and allied casualties; rallying Iranians around an unstable and oppressive regime; Iranian reprisals be they direct or by proxy against us and our allies; and Iranian-instigated unrest in the Persian Gulf states, first and foremost in Iraq.
Furthermore, while a successful bombing campaign would set back Iranian nuclear development, Iran would undoubtedly retain its nuclear knowhow. An attack would also necessitate years of continued vigilance, both to retain the ability to strike previously undiscovered sites and to ensure that Iran does not revive its nuclear program.
But the risks of military action must be weighed against those of doing nothing. If the Iranian regime continues to advance its nuclear program despite the best efforts of Mr. Obama and other world leaders, we risk Iranian domination of the oil-rich Persian Gulf, threats to U.S.-allied Arab regimes, the emboldening of radicals in the region, the creation of an existential threat to Israel, the destabilization of Iraq, the shutdown of the Israel-Palestinian peace process, and a regional nuclear-arms race.
A peaceful resolution of the threat posed by Iran’s nuclear ambitions would certainly be the best possible outcome. But should diplomacy and economic pressure fail, a U.S. military strike against Iran is a technically feasible and credible option.
Gen. Wald (U.S. Air Force four-star, retired) was the air commander for the initial stages of Operation Enduring Freedom in Afghanistan and deputy commander of the U.S. European Command. He was also a participant in the Bipartisan Policy Center’s project on U.S. policy toward Iran, “Meeting the Challenge.”
Thursday, August 6, 2009
How Japan Restored Its Financial System - The focus was on better risk controls, not higher capital reserves
How Japan Restored Its Financial System. By KATSUNORI NAGAYASU
The focus was on better risk controls, not higher capital reserves.
WSJ, Aug 06, 2009
Regulatory authorities around the world are currently discussing ways to prevent another financial crisis. One idea is to mandate higher levels of capital reserves. Japan’s banking reform shows that a comprehensive solution would work better.
After our bubble economy collapsed in the 1990s, it took policy makers many years to address the real issue: the health of our financial system. When they did, they injected public funds into large Japanese banks across the board, enhanced deposit insurance safety nets, and accelerated the disposal of nonperforming assets based on strict risk assessments. The market selected which banks could survive under a system of multiple regulatory requirements, not just a capital requirement. Many banks were absorbed into larger entities.
Japan also avoided moral hazard by studiously avoiding the classification of any bank as “too big to fail.” Regulators instead put more emphasis on improving banks’ risk controls and did not require them to have excess capital. The financial system soon regained its health and the economy enjoyed seven consecutive years of uninterrupted growth, starting in 2001.
Today’s regulatory dialogue in the United States and Europe has implicitly assumed that large financial institutions are “too big to fail.” This assumption may encourage banks to take excessive risks, resulting in potentially more bank bailouts. It has also skewed the regulatory debate toward a focus on requiring banks to hold higher levels of “going concern capital,” such as common equity.
This is a dangerous path to follow. If regulators mandate higher capital requirements for banks, there is no guarantee that banks will be able to raise that capital in equity markets. They may have to shrink their balance sheets to meet the requirements, potentially curtailing their capacity to lend and support economic growth. A narrowly defined approach to capital regulation would also reduce banks’ options for raising other types of capital when they need it. This could result in systemic risk when another financial crisis hits.
A better regulatory framework must combine capital regulations with other tools, including a resolution mechanism for financial institutions that fail, a retail deposit insurance system, and a prompt corrective action system that allows regulators to force a bank to take action before it fails. As long as the regulators can effectively control systemic risk by taking such a multifaceted approach, banks should also be allowed to absorb losses, raising capital other than common equity. It should be acceptable to allow banks to fail, and there should be no need for excessive capital requirements.
A new regulatory framework must also distinguish between banks whose main business is deposit taking and lending—the vast majority of banks world-wide—and banks that trade for their own account. The recent financial crisis demonstrated that balance sheet structure matters. Trusted banks with a large retail deposit base continued to provide funds to customers even in the depths of the crisis, whereas many banks that relied heavily on market funding or largely trading for their own account effectively failed. Investment banks with higher risk businesses by nature should be charged a higher level of capital requirement—otherwise, sound banking will not be rewarded.
Higher capital requirements attempt to rectify market or systemic failure by denying the market mechanism, where banks that take too much risk fail, and those that don’t, survive. Excessive regulation will stifle healthy competition in banking.
Policy makers instead should learn from Japan’s experience by improving the range of regulatory rules available and setting reasonable capital rules for banks based on their actual business models. That’s the best way to ensure banks perform their essential role at the lowest long-term cost to taxpayers, customers and shareholders.
Mr. Nagayasu is president of Bank of Tokyo-Mitsubishi UFJ and chairman of the Japanese Bankers Association.
The focus was on better risk controls, not higher capital reserves.
WSJ, Aug 06, 2009
Regulatory authorities around the world are currently discussing ways to prevent another financial crisis. One idea is to mandate higher levels of capital reserves. Japan’s banking reform shows that a comprehensive solution would work better.
After our bubble economy collapsed in the 1990s, it took policy makers many years to address the real issue: the health of our financial system. When they did, they injected public funds into large Japanese banks across the board, enhanced deposit insurance safety nets, and accelerated the disposal of nonperforming assets based on strict risk assessments. The market selected which banks could survive under a system of multiple regulatory requirements, not just a capital requirement. Many banks were absorbed into larger entities.
Japan also avoided moral hazard by studiously avoiding the classification of any bank as “too big to fail.” Regulators instead put more emphasis on improving banks’ risk controls and did not require them to have excess capital. The financial system soon regained its health and the economy enjoyed seven consecutive years of uninterrupted growth, starting in 2001.
Today’s regulatory dialogue in the United States and Europe has implicitly assumed that large financial institutions are “too big to fail.” This assumption may encourage banks to take excessive risks, resulting in potentially more bank bailouts. It has also skewed the regulatory debate toward a focus on requiring banks to hold higher levels of “going concern capital,” such as common equity.
This is a dangerous path to follow. If regulators mandate higher capital requirements for banks, there is no guarantee that banks will be able to raise that capital in equity markets. They may have to shrink their balance sheets to meet the requirements, potentially curtailing their capacity to lend and support economic growth. A narrowly defined approach to capital regulation would also reduce banks’ options for raising other types of capital when they need it. This could result in systemic risk when another financial crisis hits.
A better regulatory framework must combine capital regulations with other tools, including a resolution mechanism for financial institutions that fail, a retail deposit insurance system, and a prompt corrective action system that allows regulators to force a bank to take action before it fails. As long as the regulators can effectively control systemic risk by taking such a multifaceted approach, banks should also be allowed to absorb losses, raising capital other than common equity. It should be acceptable to allow banks to fail, and there should be no need for excessive capital requirements.
A new regulatory framework must also distinguish between banks whose main business is deposit taking and lending—the vast majority of banks world-wide—and banks that trade for their own account. The recent financial crisis demonstrated that balance sheet structure matters. Trusted banks with a large retail deposit base continued to provide funds to customers even in the depths of the crisis, whereas many banks that relied heavily on market funding or largely trading for their own account effectively failed. Investment banks with higher risk businesses by nature should be charged a higher level of capital requirement—otherwise, sound banking will not be rewarded.
Higher capital requirements attempt to rectify market or systemic failure by denying the market mechanism, where banks that take too much risk fail, and those that don’t, survive. Excessive regulation will stifle healthy competition in banking.
Policy makers instead should learn from Japan’s experience by improving the range of regulatory rules available and setting reasonable capital rules for banks based on their actual business models. That’s the best way to ensure banks perform their essential role at the lowest long-term cost to taxpayers, customers and shareholders.
Mr. Nagayasu is president of Bank of Tokyo-Mitsubishi UFJ and chairman of the Japanese Bankers Association.
A new database tracks emerging threats to trade
Protectionism Exposed. By CHAD P. BOWN
A new database tracks emerging threats to trade.
WSJ, Aug 06, 2009
In May, the United States slapped new tariffs on steel pipe imports from China. In June, China imposed new barriers on U.S. and European Union exports of adipic acid, an industrial chemical used to make nylon and polyester resin. In July, the EU also decided to restrict imports of steel pipe from China.
The important question now is, do these events foreshadow spiraling protectionism and tit-for-tat retaliation that threaten a global trade war? Or is trade policy always like this, and we’re just noticing more now, given the global slowdown and heightened fears of Smoot-Hawley-style protectionism?
A new set of data on protectionism can help answer that question. The World Bank’s newly updated Global Antidumping Database, which I help organize, displays in almost real time emerging trends in this form of protectionism in more than 20 of the largest economies in the World Trade Organization. Some of the numbers are worrying.
The count of newly imposed protectionist policies like antidumping duties and other “safeguard” measures increased by 31% in the first half of 2009 relative to the same period one year ago, which itself is not an alarming number. But many governments take more than a year to make final decisions on such policies after receiving the initial request for protection from a domestic industry. The fact that industry requests for new import restrictions were 34% higher in 2008 relative to 2007 is a worrying trend even though 2007 saw a historical low in such requests. And with the recession continuing, requests for new import restrictions were 19% higher in the first half of 2009 relative to 2008.
This suggests a wave of new protectionist measures may be on the way. While leaders of the Group of 20 large economies unanimously pledged not to resort to protectionism at a Washington summit last November and reaffirmed this in London in April, virtually all of them have slipped at least a little bit.
Nor is it just the U.S., EU and China: Since the beginning of 2008, Indian companies alone are responsible for roughly 25% of all requests for new trade barriers, attacking a range of imports that include steel, DVDs, yarn, tires and a variety of industrial chemicals. While it is too early to know the final resolution of these new investigations, Indian policy makers have imposed at least preliminary barriers on more than 20 different products being investigated.
The burden of this protectionism is not uniformly distributed among exporting countries. In the first half of this year, China’s exporters were specifically named in more than 75% of these economies’ newly initiated investigations. In the second quarter, China’s exporters were targeted in all 17 of the cases in which new trade barriers were imposed around the world.
Despite all this bad news, there is a silver lining. The fact that countries may be resorting to antidumping actions and safeguards in lieu of other protectionist policies, such as across-the-board tariff increases or a proliferation of “Buy-America”-type provisions in national stimulus packages, is a partial sign of the strength and resilience of the rules-based WTO system. It is important to have a reliable trading system that allows for the transparency necessary to clearly see the new trade barriers, because industry demands for protectionism are somewhat inevitable in a recession.
That’s encouraging because “little” acts of protectionism could add up to a big problem. Having accurate data on the extent of the problem is important, but the only solution is for policy makers to recognize the dangers of the path they’re headed down.
Mr. Bown, an economics professor at Brandeis University and fellow at the Brookings Institution, is author of “Self-Enforcing Trade: Developing Countries and WTO Dispute Settlement” (Brookings Press, 2009).
A new database tracks emerging threats to trade.
WSJ, Aug 06, 2009
In May, the United States slapped new tariffs on steel pipe imports from China. In June, China imposed new barriers on U.S. and European Union exports of adipic acid, an industrial chemical used to make nylon and polyester resin. In July, the EU also decided to restrict imports of steel pipe from China.
The important question now is, do these events foreshadow spiraling protectionism and tit-for-tat retaliation that threaten a global trade war? Or is trade policy always like this, and we’re just noticing more now, given the global slowdown and heightened fears of Smoot-Hawley-style protectionism?
A new set of data on protectionism can help answer that question. The World Bank’s newly updated Global Antidumping Database, which I help organize, displays in almost real time emerging trends in this form of protectionism in more than 20 of the largest economies in the World Trade Organization. Some of the numbers are worrying.
The count of newly imposed protectionist policies like antidumping duties and other “safeguard” measures increased by 31% in the first half of 2009 relative to the same period one year ago, which itself is not an alarming number. But many governments take more than a year to make final decisions on such policies after receiving the initial request for protection from a domestic industry. The fact that industry requests for new import restrictions were 34% higher in 2008 relative to 2007 is a worrying trend even though 2007 saw a historical low in such requests. And with the recession continuing, requests for new import restrictions were 19% higher in the first half of 2009 relative to 2008.
This suggests a wave of new protectionist measures may be on the way. While leaders of the Group of 20 large economies unanimously pledged not to resort to protectionism at a Washington summit last November and reaffirmed this in London in April, virtually all of them have slipped at least a little bit.
Nor is it just the U.S., EU and China: Since the beginning of 2008, Indian companies alone are responsible for roughly 25% of all requests for new trade barriers, attacking a range of imports that include steel, DVDs, yarn, tires and a variety of industrial chemicals. While it is too early to know the final resolution of these new investigations, Indian policy makers have imposed at least preliminary barriers on more than 20 different products being investigated.
The burden of this protectionism is not uniformly distributed among exporting countries. In the first half of this year, China’s exporters were specifically named in more than 75% of these economies’ newly initiated investigations. In the second quarter, China’s exporters were targeted in all 17 of the cases in which new trade barriers were imposed around the world.
Despite all this bad news, there is a silver lining. The fact that countries may be resorting to antidumping actions and safeguards in lieu of other protectionist policies, such as across-the-board tariff increases or a proliferation of “Buy-America”-type provisions in national stimulus packages, is a partial sign of the strength and resilience of the rules-based WTO system. It is important to have a reliable trading system that allows for the transparency necessary to clearly see the new trade barriers, because industry demands for protectionism are somewhat inevitable in a recession.
That’s encouraging because “little” acts of protectionism could add up to a big problem. Having accurate data on the extent of the problem is important, but the only solution is for policy makers to recognize the dangers of the path they’re headed down.
Mr. Bown, an economics professor at Brandeis University and fellow at the Brookings Institution, is author of “Self-Enforcing Trade: Developing Countries and WTO Dispute Settlement” (Brookings Press, 2009).
Autocracy and the Decline of the Arabs
Autocracy and the Decline of the Arabs. By FOUAD AJAMI
The Arab world is plagued by despots. But don’t expect the U.N. to give President Bush any credit for challenging this order.
WSJ, Aug 06, 2009
‘It made me feel so jealous,” said Abdulmonem Ibrahim, a young Egyptian political activist, of the recent upheaval in Iran. “We are amazed at the organization and speed with which the Iranian movement has been functioning. In Egypt you can count the number of activists on your hand.” This degree of “Iran envy” is a telling statement on the stagnation of Arab politics. It is not pretty, Iran’s upheaval, but grant the Iranians their due: They have gone out into the streets to contest the writ of the theocrats.
In contrast, little has stirred in Arab politics of late. The Arabs, by their own testimony, have become spectators to their history. A struggle rages between the Iranian theocracy and the Pax Americana for primacy in the Persian Gulf and the Levant. The Arabs have the demography—360 million people by latest count—and the wealth to balance Iran’s power. But they have taken a pass in the hope that America—or Israel, for that matter—would shatter the Iranian bid for hegemony.
We are now in the midst of one of those periodic autopsies of the Arab condition. The trigger is the publication last month of the Arab Human Development Report 2009, the fifth of a series of reports by the by the United Nations Development Program (UNDP) on the state of the contemporary Arab world.
The first of these reports, published in 2002, was treated with deference. A group of Arab truth-tellers, it was believed, had broken with the evasions and the apologetics to tell of the sordid condition of Arab society—the autocratic political culture, the economic stagnation, the cultural decay. So all Arabs combined had a smaller manufacturing capacity than Finland with its five million people, and a vast Arabic-speaking world translated into Arabic a fifth of the foreign books that Greece with its 11 million people translates. With all the oil in the region, tens of millions of Arabs were living below the poverty line.
Little has altered in the years separating the first of these reports from the most recent. A huge oil windfall came into the region, and it was better handled, it has to be conceded, than earlier oil windfalls. But on balance the grief of the Arabs has deepened, and the autocracies are yet to be brought to account. They remain unloved, but they remain in the saddle.
In a clever turn of phrase, The Economist recently wrote of an Arab Rip Abu Winkle awakening from a slumber into which he had fallen in the early 1980s to marvel at how little has changed. He would find Hosni Mubarak still at the helm in Cairo, the policeman Zine el-Abidine Ben Ali in Tunisia, and Moammar Gadhafi in Libya. He would miss Hafez Assad in Damascus, but he would be reassured that his son Bashar had inherited his father’s dominion. He would of course find the same dynasties in Jordan and in the Arab states of the Peninsula and the Gulf.
Wily rulers, the men at the helm may have failed their peoples. They may have denied them decent educational systems. They may not have figured out a way into the modern world economy. But they have mastered the art of political survival. “He who eats the sultan’s bread, fights with the sultan’s sword,” goes an Arabic maxim. The economic dominance of the rulers, the absence of the countervailing power of property and the private sector, has increased the awesome power of the governments and their security establishments.
It is no mystery, this sorrowful decline of the Arabs. They have invested their hopes in states, and the states have failed. According to the UNDP’s report, government revenues as percentage of GDP are 13% in Third World Countries, but they are 25% in the Middle East and North Africa. The oil states are a world apart in that regard: the comparable figures are 68% in Libya, 45% in Saudi Arabia, and 40% in Algeria, Kuwait and Qatar. Oil is no panacea for these lands. The unemployment rates for the Arab world as a whole are the highest in the world, and no prophecy could foresee these societies providing the 51 million jobs the UNDP report says are needed by 2020 to “absorb young entrants to the labor force who would otherwise face an empty future.”
The simple truth is that the Arab world has terrible rulers and worse oppositionists. There are autocrats on one side and theocrats on the other. A timid and fragile middle class is caught in the middle between regimes it abhors and Islamists it fears.
Indeed, the technocrats and intellectuals associated with these development reports are themselves no angels. On the whole, they are unreconstructed Arab nationalists. The patrons of these reports are the likes of the Algerian diplomat Lakhdar Brahimi and the Palestinian leader Hanan Ashrawi, intellectuals and public figures whose stock-in-trade is presumed Western (read American) guilt for the ills that afflict the Arabs. Anti-Americanism suffuses this report, as it did the earlier ones.
There is cruelty and plunder aplenty in the Arab world, but these writers are particularly exercised about Iraq. “This intervention polarized the country,” they say of Iraq. This is a myth of the Arabs who are yet to grant the Iraqis the right to their own history: There had been a secular culture under the Baath, they insist, but the American war begot the sectarianism. To go by this report, Iraq is a place of mayhem and plunder, a land where militias rule uncontested.
For decades, it was the standard argument of the Arabs that America had cast its power in the region on the side of the autocrats. In Iraq in 2003, and then in Lebanon, an American president bet on the freedom of the Arabs. George W. Bush’s freedom agenda broke with a long history and insisted that the Arabs did not have tyranny in their DNA. A despotism in Baghdad was toppled, a Syrian regime that had all but erased its border with Lebanon was pushed out of its smaller neighbor, bringing an end to three decades of brutal occupation. The “Cedar Revolution” that erupted in the streets of Beirut was but a child of Bush’s diplomacy of freedom.
Arabs know this history even as they say otherwise, even as they tell the pollsters the obligatory things about America the pollsters expect them to say. True, Mr. Bush’s wager on elections in the Palestinian territories rebounded to the benefit of Hamas. But the ballot is not infallible, and the verdict of that election was a statement on the malignancies of Palestinian politics. It was no fault of American diplomacy that the Palestinians, who needed to break with a history of maximalist demands, gave in yet again to radical temptations.
Now the Arabs are face to face with their own history. Instead of George W. Bush there is Barack Hussein Obama, an American leader pledged to a foreign policy of “realism.” The Arabs express fondness for the new American president. In his fashion (and in the fashion of their world and their leaders, it has to be said) President Obama gave the Arabs a speech in Cairo two months ago. It was a moment of theater and therapy. The speech delivered, the foreign visitor was gone. He had put another marker on the globe, another place to which he had taken his astounding belief in his biography and his conviction that another foreign population had been wooed by his oratory and weaned away from anti-Americanism.
The crowd could tell itself that the new standard-bearer of the Pax Americana was a man who understood its concerns, but the embattled modernists and the critics of autocracy knew better. There is no mistaking the animating drive of the new American policy in that Greater Middle East: realism and benign neglect, the safety of the status quo rather than the risks of liberty. (If in doubt, the Arabs could check with their Iranian neighbors. The Persians would tell them of the new mood in Washington.)
One day an Arab chronicle could yet be written, and like all Arab chronicles, it would tell of woes and missed opportunities. It would acknowledge that brief interlude when American power gave Arab autocracies a scare, and when a despotism in Baghdad and a brutal “brotherly” occupation in Beirut were laid to waste. The chroniclers would have to be an honest lot. They would speak the language of daily life, and the truths that Arabs have seen and endured in recent years. On that day, the “human development reports” would be discarded, their writers seen for the purveyors of double-speak and half-truths they were.
Mr. Ajami, a professor at the School of Advanced International Studies at Johns Hopkins University and an adjunct fellow at Stanford University’s Hoover Institution, is the author, among other books, of “The Arab Predicament: Arab Political Thought and Practice since 1967 (Cambridge University Press, 1981).
The Arab world is plagued by despots. But don’t expect the U.N. to give President Bush any credit for challenging this order.
WSJ, Aug 06, 2009
‘It made me feel so jealous,” said Abdulmonem Ibrahim, a young Egyptian political activist, of the recent upheaval in Iran. “We are amazed at the organization and speed with which the Iranian movement has been functioning. In Egypt you can count the number of activists on your hand.” This degree of “Iran envy” is a telling statement on the stagnation of Arab politics. It is not pretty, Iran’s upheaval, but grant the Iranians their due: They have gone out into the streets to contest the writ of the theocrats.
In contrast, little has stirred in Arab politics of late. The Arabs, by their own testimony, have become spectators to their history. A struggle rages between the Iranian theocracy and the Pax Americana for primacy in the Persian Gulf and the Levant. The Arabs have the demography—360 million people by latest count—and the wealth to balance Iran’s power. But they have taken a pass in the hope that America—or Israel, for that matter—would shatter the Iranian bid for hegemony.
We are now in the midst of one of those periodic autopsies of the Arab condition. The trigger is the publication last month of the Arab Human Development Report 2009, the fifth of a series of reports by the by the United Nations Development Program (UNDP) on the state of the contemporary Arab world.
The first of these reports, published in 2002, was treated with deference. A group of Arab truth-tellers, it was believed, had broken with the evasions and the apologetics to tell of the sordid condition of Arab society—the autocratic political culture, the economic stagnation, the cultural decay. So all Arabs combined had a smaller manufacturing capacity than Finland with its five million people, and a vast Arabic-speaking world translated into Arabic a fifth of the foreign books that Greece with its 11 million people translates. With all the oil in the region, tens of millions of Arabs were living below the poverty line.
Little has altered in the years separating the first of these reports from the most recent. A huge oil windfall came into the region, and it was better handled, it has to be conceded, than earlier oil windfalls. But on balance the grief of the Arabs has deepened, and the autocracies are yet to be brought to account. They remain unloved, but they remain in the saddle.
In a clever turn of phrase, The Economist recently wrote of an Arab Rip Abu Winkle awakening from a slumber into which he had fallen in the early 1980s to marvel at how little has changed. He would find Hosni Mubarak still at the helm in Cairo, the policeman Zine el-Abidine Ben Ali in Tunisia, and Moammar Gadhafi in Libya. He would miss Hafez Assad in Damascus, but he would be reassured that his son Bashar had inherited his father’s dominion. He would of course find the same dynasties in Jordan and in the Arab states of the Peninsula and the Gulf.
Wily rulers, the men at the helm may have failed their peoples. They may have denied them decent educational systems. They may not have figured out a way into the modern world economy. But they have mastered the art of political survival. “He who eats the sultan’s bread, fights with the sultan’s sword,” goes an Arabic maxim. The economic dominance of the rulers, the absence of the countervailing power of property and the private sector, has increased the awesome power of the governments and their security establishments.
It is no mystery, this sorrowful decline of the Arabs. They have invested their hopes in states, and the states have failed. According to the UNDP’s report, government revenues as percentage of GDP are 13% in Third World Countries, but they are 25% in the Middle East and North Africa. The oil states are a world apart in that regard: the comparable figures are 68% in Libya, 45% in Saudi Arabia, and 40% in Algeria, Kuwait and Qatar. Oil is no panacea for these lands. The unemployment rates for the Arab world as a whole are the highest in the world, and no prophecy could foresee these societies providing the 51 million jobs the UNDP report says are needed by 2020 to “absorb young entrants to the labor force who would otherwise face an empty future.”
The simple truth is that the Arab world has terrible rulers and worse oppositionists. There are autocrats on one side and theocrats on the other. A timid and fragile middle class is caught in the middle between regimes it abhors and Islamists it fears.
Indeed, the technocrats and intellectuals associated with these development reports are themselves no angels. On the whole, they are unreconstructed Arab nationalists. The patrons of these reports are the likes of the Algerian diplomat Lakhdar Brahimi and the Palestinian leader Hanan Ashrawi, intellectuals and public figures whose stock-in-trade is presumed Western (read American) guilt for the ills that afflict the Arabs. Anti-Americanism suffuses this report, as it did the earlier ones.
There is cruelty and plunder aplenty in the Arab world, but these writers are particularly exercised about Iraq. “This intervention polarized the country,” they say of Iraq. This is a myth of the Arabs who are yet to grant the Iraqis the right to their own history: There had been a secular culture under the Baath, they insist, but the American war begot the sectarianism. To go by this report, Iraq is a place of mayhem and plunder, a land where militias rule uncontested.
For decades, it was the standard argument of the Arabs that America had cast its power in the region on the side of the autocrats. In Iraq in 2003, and then in Lebanon, an American president bet on the freedom of the Arabs. George W. Bush’s freedom agenda broke with a long history and insisted that the Arabs did not have tyranny in their DNA. A despotism in Baghdad was toppled, a Syrian regime that had all but erased its border with Lebanon was pushed out of its smaller neighbor, bringing an end to three decades of brutal occupation. The “Cedar Revolution” that erupted in the streets of Beirut was but a child of Bush’s diplomacy of freedom.
Arabs know this history even as they say otherwise, even as they tell the pollsters the obligatory things about America the pollsters expect them to say. True, Mr. Bush’s wager on elections in the Palestinian territories rebounded to the benefit of Hamas. But the ballot is not infallible, and the verdict of that election was a statement on the malignancies of Palestinian politics. It was no fault of American diplomacy that the Palestinians, who needed to break with a history of maximalist demands, gave in yet again to radical temptations.
Now the Arabs are face to face with their own history. Instead of George W. Bush there is Barack Hussein Obama, an American leader pledged to a foreign policy of “realism.” The Arabs express fondness for the new American president. In his fashion (and in the fashion of their world and their leaders, it has to be said) President Obama gave the Arabs a speech in Cairo two months ago. It was a moment of theater and therapy. The speech delivered, the foreign visitor was gone. He had put another marker on the globe, another place to which he had taken his astounding belief in his biography and his conviction that another foreign population had been wooed by his oratory and weaned away from anti-Americanism.
The crowd could tell itself that the new standard-bearer of the Pax Americana was a man who understood its concerns, but the embattled modernists and the critics of autocracy knew better. There is no mistaking the animating drive of the new American policy in that Greater Middle East: realism and benign neglect, the safety of the status quo rather than the risks of liberty. (If in doubt, the Arabs could check with their Iranian neighbors. The Persians would tell them of the new mood in Washington.)
One day an Arab chronicle could yet be written, and like all Arab chronicles, it would tell of woes and missed opportunities. It would acknowledge that brief interlude when American power gave Arab autocracies a scare, and when a despotism in Baghdad and a brutal “brotherly” occupation in Beirut were laid to waste. The chroniclers would have to be an honest lot. They would speak the language of daily life, and the truths that Arabs have seen and endured in recent years. On that day, the “human development reports” would be discarded, their writers seen for the purveyors of double-speak and half-truths they were.
Mr. Ajami, a professor at the School of Advanced International Studies at Johns Hopkins University and an adjunct fellow at Stanford University’s Hoover Institution, is the author, among other books, of “The Arab Predicament: Arab Political Thought and Practice since 1967 (Cambridge University Press, 1981).
Wednesday, August 5, 2009
Vegetables don’t want to be eaten and other lessons from Britain's organic food war
Vegetables don’t want to be eaten and other lessons from Britain's organic food war. By Trevor Butterworth
STATS.org, August 4, 2009
A major British study recently turned conventional wisdom on organic food on its head, triggering a war between science writers, reporters, activists and chefs. Was it a “myth” that organic produce was nutritionally superior to conventional food – or did an agency with an agenda cook up some flawed science to appease big agribusiness?
Bad Science, a book by Ben Goldacre, has become an unusual bestseller in the British Isles, powering its way into the higher reaches of nationally and locally compiled bestseller lists since its publication in the Fall of 2008. Goldacre is a doctor for Britain’s National Health Service (though he plays this down on the grounds that arguments from positions of expertise are often self-defeating with the public), and the book is a continuum of a column by the same name he writes for the left-leaning Guardian newspaper. The Royal Statistical Society awarded him first prize in their inaugural 2007 award for statistical excellence in journalism, and the British Medical Journal, in reviewing “Bad Science,” declared that Goldacre “is fighting what sometimes seems like a one man battle against a tide of pseudoscience and an army of quacks,” and that the country was lucky to have him.
The book’s popularity seems to speak to increasing consumer frustration with information promoted as “scientific,” whether in news stories, government pronouncements, or advertisements for pills and panaceas, and to the hopeful sign that people want to know – or want someone to examine on their behalf – the underlying principles that determine whether such research claims can be considered reliable or unreliable.
These principles came to the forefront in Britain last week – and the rest of the world – with the publication of a new study claiming that there was no reliable evidence that organically-produced food was better, nutritionally, than conventionally-produced food.
The study, “Nutritional quality of organic foods: a systematic review,” was funded by Britain’s Food Standards Agency (FSA), and conducted by researchers from the Nutrition and Public Health Intervention Research Unit at the Department of Epidemiology and Population Health, London School of Hygiene & Tropical Medicine; it was published in the peer-reviewed American Journal of Clinical Nutrition.
Senior reporter Karen McVeigh told readers of the Guardian in the opening paragraph of its news report on June 30 that the review’s “conclusions have been called into question by experts and organic food campaigners,” and more than half of the article focused on criticisms of the study, namely that the researchers had been “selective in the extreme,” used “questionable methodology, were contradicted by numerous other studies, and neglected to mention the risks of pesticides and fertilizers in conventional farming. As Peter Melchett, policy director at the Soil Association, the non-profit that advocates for and certifies organic farming in Britain, told the paper, “The review rejected almost all of the existing studies of comparisons between organic and non-organic nutritional differences.”
Given the way the story was reported, with the validity of the study immediately questioned in the opening paragraph (and with the paper being home to Goldacre’s column), readers could have been forgiven for concluding that the FSA had indeed funded some dodgy research, peer-review notwithstanding.
But at the Guardian’s sister, Sunday paper, The Observer, science editor, Robin McKie, defended the study. “[I]t is certainly not the work of dogmatic and intractably hostile opponents of the cause,” he wrote before weighing in on one of the key criticisms of the study, namely, that it did not take pesticide and fertilizer residues on conventional food into consideration.
“For a start, the idea that organic fruit and veg contain no harmful chemicals compared with non-organic produce is simply wrong, scientists argue. Certainly, there are pesticide residues in the latter but there is no evidence these are cumulatively harmful.
More to the point, organic crops - because they are untreated with chemicals - have correspondingly high levels of natural fungal toxins. Thus they balance out: artificial pesticide residues in non-organic crops, natural fungal toxins in organic.”
As Professor Ottoline Leyser, a molecular biologist at York University told McKie:
“People think that the more natural something is, the better it is for them. That is simply not the case. In fact, it is the opposite that is the true: the closer a plant is to its natural state, the more likely it is that it will poison you. Naturally, plants do not want to be eaten, so we have spent 10,000 years developing agriculture and breeding out harmful traits from crops. ‘Natural agriculture’ is a contradiction in terms.”
Over at the Times of London, science editor Mark Henderson took a similar position, as well as noting that
“Research that appears to support health claims for organic food also suffers from a quality problem. Many studies lack proper controls or fail to detail the organic regime and crop variety being evaluated or the analytical techniques used for assessment.
Studies that fail to meet these standards cannot provide useful evidence and are rightfully excluded from systematic reviews. It is no coincidence that the school had to throw out about two thirds of the available literature.”
The Times also noted that previous reviews by the French and Swedish food standards agencies had come to the same conclusion as this new study.
But as the Observer called into question the thrust of the Guardian’s initial news report, so the Times sister paper, The Sunday Times seemed to question the daily paper’s characterization of the study.
“We dig out the facts from the manure,” said the article’s sub head, but as reporter Chris Gourlay dug away, he seemed less convinced by the FSA’s evidence: The new study’s findings were “controversial” and the Food Standards Agency “claimed a comprehensive review,” but as Carlo Leifert, Professor of Ecological Agriculture at Newcastle University told Gourlay, the researchers “have ignored all the recent literature as well as new primary research which show the health advantages of organic.” He added that he intended “to rip their study apart in scientific journals.”
Other newspapers, such as the Daily Mail, warned that “studies have found” that children born to farmers in summer, when pesticide use was highest, were “less intelligent.” One columnist rued the focus on nutrition in the Daily Telegraph noting that “All food is nutritious; having no food is what kills. The wider benefits of organic foods are still worth pursuing. It is what food does not contain and the effects that it does not have that really matter.” The Telegraph’s gossip columnist warned that the pro-organic produce Prince Charles had reportedly taken a dim view of the FSA study and was girding for battle.
One notable pattern emerged in the coverage: If the reporter specialized in science, they thought the study well done and conclusive; if the reporter was a generalist, the study was flawed and controversial. So what did the scourge of bad science make of the review and the media coverage?
Goldacre began his column by noting that news coverage had given organic advocates a blanket right of reply to the study. This, he said, was “testament to the lobbying power of this £2bn [$3.38 billion dollars] industry, and the cultural values of people who work in the media.”
He pointed out one of the salient aspects of the study, namely, that it was only about the nutritional content of organic and conventional food, and not about any other kind of benefit. Critics of the study, however, only wanted to talk about other kinds of benefits to prove that the study was flawed; this was, he said, “gamesmanship.” And it was gamesmanship that worked to undermine the public’s understanding and ability to engage in a debate on the evidence by claiming that key evidence was ignored by the FSA.
“The accusation is one of ‘cherry-picking’, and it is hard to see how it can be valid in the kind of study conducted by the FSA, because in a ‘systematic review’, before you begin collecting papers, you specify how you will search for evidence, what databases you will use, what types of studies you will use, how you will grade the quality of the evidence (to see if it was a ‘fair test’), and so on.
What is it that the FSA ignored which so angered the Soil Association? As an example, from their press release, they are ‘disappointed that the FSA failed to include the results of a major European Union-funded study involving 31 research and university institutes and the publication, so far, of more than 100 scientific papers, at a cost of €18m [$25.9 million dollars], which ended in April this year’. They gave the link to qlif.org.
I followed this link and found the list of 120 papers. Almost all are irrelevant. The first 14 are on ‘consumer expectations and attitudes’, which are correctly not included in a systematic review of the evidence on food composition. Then there are 22 on ‘effects of production methods’: here you might expect to find more relevant research, but no.
The first paper (‘The effect of medium term feeding with organic, low input and conventional diet on selected immune parameters in rat’), while interesting, will plainly not be relevant to a systematic review on nutrient content. The same is true of the next paper, ‘Salmonella infection level in Danish indoor and outdoor pig production systems measured by antibodies in meat juice and fecal shedding on-farm and at slaughter’: it is not relevant.
Furthermore, the overwhelming majority of these are unpublished conference papers, and some of them are just a description of the fact that somebody made an oral presentation at a meeting. The systematic review correctly looked only at good-quality data published in peer-reviewed academic journals.”
This is a devastating indictment, not just of the Soil Association’s position, but the degree to which reporters did little more than act as stenographers to its criticisms of the FSA study. [Yes, we too followed the link to http://www.qlif.org/ and found that Goldacre was correct in his categorization of the research]. Readers of the Guardian may have been forgiven for wondering why they bothered to read the initial news story, given that the reporter’s focus on what was wrong with the study turned out to be more spin than science.
The uncomfortable question for the media – and the Guardian in particular – is to what degree would Goldacre’s rearguard defense of science be needed if the journalists who reported on the latest data did a better job of analysis before presenting it to the public?
STATS.org, August 4, 2009
A major British study recently turned conventional wisdom on organic food on its head, triggering a war between science writers, reporters, activists and chefs. Was it a “myth” that organic produce was nutritionally superior to conventional food – or did an agency with an agenda cook up some flawed science to appease big agribusiness?
Bad Science, a book by Ben Goldacre, has become an unusual bestseller in the British Isles, powering its way into the higher reaches of nationally and locally compiled bestseller lists since its publication in the Fall of 2008. Goldacre is a doctor for Britain’s National Health Service (though he plays this down on the grounds that arguments from positions of expertise are often self-defeating with the public), and the book is a continuum of a column by the same name he writes for the left-leaning Guardian newspaper. The Royal Statistical Society awarded him first prize in their inaugural 2007 award for statistical excellence in journalism, and the British Medical Journal, in reviewing “Bad Science,” declared that Goldacre “is fighting what sometimes seems like a one man battle against a tide of pseudoscience and an army of quacks,” and that the country was lucky to have him.
The book’s popularity seems to speak to increasing consumer frustration with information promoted as “scientific,” whether in news stories, government pronouncements, or advertisements for pills and panaceas, and to the hopeful sign that people want to know – or want someone to examine on their behalf – the underlying principles that determine whether such research claims can be considered reliable or unreliable.
These principles came to the forefront in Britain last week – and the rest of the world – with the publication of a new study claiming that there was no reliable evidence that organically-produced food was better, nutritionally, than conventionally-produced food.
The study, “Nutritional quality of organic foods: a systematic review,” was funded by Britain’s Food Standards Agency (FSA), and conducted by researchers from the Nutrition and Public Health Intervention Research Unit at the Department of Epidemiology and Population Health, London School of Hygiene & Tropical Medicine; it was published in the peer-reviewed American Journal of Clinical Nutrition.
Senior reporter Karen McVeigh told readers of the Guardian in the opening paragraph of its news report on June 30 that the review’s “conclusions have been called into question by experts and organic food campaigners,” and more than half of the article focused on criticisms of the study, namely that the researchers had been “selective in the extreme,” used “questionable methodology, were contradicted by numerous other studies, and neglected to mention the risks of pesticides and fertilizers in conventional farming. As Peter Melchett, policy director at the Soil Association, the non-profit that advocates for and certifies organic farming in Britain, told the paper, “The review rejected almost all of the existing studies of comparisons between organic and non-organic nutritional differences.”
Given the way the story was reported, with the validity of the study immediately questioned in the opening paragraph (and with the paper being home to Goldacre’s column), readers could have been forgiven for concluding that the FSA had indeed funded some dodgy research, peer-review notwithstanding.
But at the Guardian’s sister, Sunday paper, The Observer, science editor, Robin McKie, defended the study. “[I]t is certainly not the work of dogmatic and intractably hostile opponents of the cause,” he wrote before weighing in on one of the key criticisms of the study, namely, that it did not take pesticide and fertilizer residues on conventional food into consideration.
“For a start, the idea that organic fruit and veg contain no harmful chemicals compared with non-organic produce is simply wrong, scientists argue. Certainly, there are pesticide residues in the latter but there is no evidence these are cumulatively harmful.
More to the point, organic crops - because they are untreated with chemicals - have correspondingly high levels of natural fungal toxins. Thus they balance out: artificial pesticide residues in non-organic crops, natural fungal toxins in organic.”
As Professor Ottoline Leyser, a molecular biologist at York University told McKie:
“People think that the more natural something is, the better it is for them. That is simply not the case. In fact, it is the opposite that is the true: the closer a plant is to its natural state, the more likely it is that it will poison you. Naturally, plants do not want to be eaten, so we have spent 10,000 years developing agriculture and breeding out harmful traits from crops. ‘Natural agriculture’ is a contradiction in terms.”
Over at the Times of London, science editor Mark Henderson took a similar position, as well as noting that
“Research that appears to support health claims for organic food also suffers from a quality problem. Many studies lack proper controls or fail to detail the organic regime and crop variety being evaluated or the analytical techniques used for assessment.
Studies that fail to meet these standards cannot provide useful evidence and are rightfully excluded from systematic reviews. It is no coincidence that the school had to throw out about two thirds of the available literature.”
The Times also noted that previous reviews by the French and Swedish food standards agencies had come to the same conclusion as this new study.
But as the Observer called into question the thrust of the Guardian’s initial news report, so the Times sister paper, The Sunday Times seemed to question the daily paper’s characterization of the study.
“We dig out the facts from the manure,” said the article’s sub head, but as reporter Chris Gourlay dug away, he seemed less convinced by the FSA’s evidence: The new study’s findings were “controversial” and the Food Standards Agency “claimed a comprehensive review,” but as Carlo Leifert, Professor of Ecological Agriculture at Newcastle University told Gourlay, the researchers “have ignored all the recent literature as well as new primary research which show the health advantages of organic.” He added that he intended “to rip their study apart in scientific journals.”
Other newspapers, such as the Daily Mail, warned that “studies have found” that children born to farmers in summer, when pesticide use was highest, were “less intelligent.” One columnist rued the focus on nutrition in the Daily Telegraph noting that “All food is nutritious; having no food is what kills. The wider benefits of organic foods are still worth pursuing. It is what food does not contain and the effects that it does not have that really matter.” The Telegraph’s gossip columnist warned that the pro-organic produce Prince Charles had reportedly taken a dim view of the FSA study and was girding for battle.
One notable pattern emerged in the coverage: If the reporter specialized in science, they thought the study well done and conclusive; if the reporter was a generalist, the study was flawed and controversial. So what did the scourge of bad science make of the review and the media coverage?
Goldacre began his column by noting that news coverage had given organic advocates a blanket right of reply to the study. This, he said, was “testament to the lobbying power of this £2bn [$3.38 billion dollars] industry, and the cultural values of people who work in the media.”
He pointed out one of the salient aspects of the study, namely, that it was only about the nutritional content of organic and conventional food, and not about any other kind of benefit. Critics of the study, however, only wanted to talk about other kinds of benefits to prove that the study was flawed; this was, he said, “gamesmanship.” And it was gamesmanship that worked to undermine the public’s understanding and ability to engage in a debate on the evidence by claiming that key evidence was ignored by the FSA.
“The accusation is one of ‘cherry-picking’, and it is hard to see how it can be valid in the kind of study conducted by the FSA, because in a ‘systematic review’, before you begin collecting papers, you specify how you will search for evidence, what databases you will use, what types of studies you will use, how you will grade the quality of the evidence (to see if it was a ‘fair test’), and so on.
What is it that the FSA ignored which so angered the Soil Association? As an example, from their press release, they are ‘disappointed that the FSA failed to include the results of a major European Union-funded study involving 31 research and university institutes and the publication, so far, of more than 100 scientific papers, at a cost of €18m [$25.9 million dollars], which ended in April this year’. They gave the link to qlif.org.
I followed this link and found the list of 120 papers. Almost all are irrelevant. The first 14 are on ‘consumer expectations and attitudes’, which are correctly not included in a systematic review of the evidence on food composition. Then there are 22 on ‘effects of production methods’: here you might expect to find more relevant research, but no.
The first paper (‘The effect of medium term feeding with organic, low input and conventional diet on selected immune parameters in rat’), while interesting, will plainly not be relevant to a systematic review on nutrient content. The same is true of the next paper, ‘Salmonella infection level in Danish indoor and outdoor pig production systems measured by antibodies in meat juice and fecal shedding on-farm and at slaughter’: it is not relevant.
Furthermore, the overwhelming majority of these are unpublished conference papers, and some of them are just a description of the fact that somebody made an oral presentation at a meeting. The systematic review correctly looked only at good-quality data published in peer-reviewed academic journals.”
This is a devastating indictment, not just of the Soil Association’s position, but the degree to which reporters did little more than act as stenographers to its criticisms of the FSA study. [Yes, we too followed the link to http://www.qlif.org/ and found that Goldacre was correct in his categorization of the research]. Readers of the Guardian may have been forgiven for wondering why they bothered to read the initial news story, given that the reporter’s focus on what was wrong with the study turned out to be more spin than science.
The uncomfortable question for the media – and the Guardian in particular – is to what degree would Goldacre’s rearguard defense of science be needed if the journalists who reported on the latest data did a better job of analysis before presenting it to the public?
Tuesday, August 4, 2009
The SEC vs. CEO Pay
The SEC vs. CEO Pay. By RUSSELL G. RYAN
The agency stretches the law to confiscate a bonus.
WSJ, Aug 05, 2009
A lawsuit filed on July 22 by the Securities and Exchange Commission (SEC) should send a mid-summer chill down the spine of every chief executive and chief financial officer of a U.S. public company.
Exploiting an ambiguously worded phrase in Sarbanes-Oxley, the agency has for the first time claimed that it may under that law “claw back”—some might say confiscate—bonus money and stock sale proceeds from CEOs and CFOs even when it lacks evidence to charge them with wrongdoing.
Sarbanes-Oxley was rushed through Congress in the summer of 2002 in reaction to public outrage over notorious corporate accounting failures at Enron, WorldCom and other companies. As is often the case with such far-reaching and hastily conceived legislation, many of its details were half-baked, poorly worded, and riddled with ambiguity.
A prime example was the so-called clawback feature of Section 304, which was designed to prevent crooked CEOs and CFOs from taking home big bonuses and cashing out company stock while they were knowingly defrauding shareholders. It empowered the SEC to force these executives to reimburse their companies for all bonuses and stock sale proceeds received during any financial period for which their company was later required to restate its financial statements due to “misconduct.”
But in its haste to “do something” about the scandal of the day, Congress muddied the question of whether the “misconduct” required for such a clawback had to be committed by the executive himself (or at least known to him), or could be that of a subordinate, completely unbeknownst to the executive.
Many executives and legal advisers have cautiously assumed that bonuses and stock proceeds were at risk only for executives who actually engaged in misconduct themselves—or at least were aware of it and acquiesced. In fact, the SEC itself has rarely used this feature of Sarbanes-Oxley at all, and had done so only in cases where it alleged personal misconduct by the targeted chief executives or chief financial officers. A prominent example was the agency’s stock-option backdating case against Dr. William McGuire, the former CEO of UnitedHealth Group.
But the SEC has abruptly changed course. It has sued Maynard Jenkins, the former CEO of CSK Auto Corporation, an auto-parts company that had previously settled with the agency on charges of accounting fraud after restating three years’ worth of financial statements.
Several subordinate executives have been charged with both civil and criminal securities law violations. But the SEC has never accused Mr. Jenkins of any wrongdoing. In a press release announcing this case, the agency highlighted its novel position that no such accusation—much less proof—was necessary to claw back his bonuses and stock sale proceeds for the three years in question, which totaled more than $4 million.
Mr. Jenkins is contesting the lawsuit, and he has grounds for optimism. On a visceral level, it seems shocking that a U.S. law enforcement agency could take more than $4 million from any citizen without so much as an accusation of personal misconduct, or at least knowing acquiescence in someone else’s misconduct. Indeed, according to a report by Bloomberg, two of the SEC’s five commissioners voted not to file the lawsuit at all.
In an unrelated case earlier this year, the SEC unsuccessfully argued an equally aggressive interpretation of Section 304. Stretching the law’s wording that clawbacks are appropriate only when a company is “required to prepare an accounting restatement,” the agency argued that Section 304 also allows clawbacks when no restatement is actually prepared, so long as the SEC later concluded the company should have done so.
A federal judge in St. Louis rejected that theory and threw out the charge. In recent years, courts have similarly rejected the agency’s overly aggressive interpretations of laws preventing “selective disclosure,” insider trading, aiding and abetting, and other violations.
The irony is this. Despite all the recent criticism the SEC has taken for supposed laxity in its enforcement program, the agency has in fact consistently taken very aggressive positions in its enforcement cases, such as with laws concerning foreign bribery, market timing of mutual funds, and many forms of insider trading.
For the most part, investors expect the SEC to push the envelope to protect their interests. But the wisdom and fairness of pursuing no-fault clawbacks from unaccused executives is dubious at best.
Mr. Ryan is a securities lawyer and was an assistant director of the Securities and Exchange Commission’s division of enforcement from 2000-2004.
The agency stretches the law to confiscate a bonus.
WSJ, Aug 05, 2009
A lawsuit filed on July 22 by the Securities and Exchange Commission (SEC) should send a mid-summer chill down the spine of every chief executive and chief financial officer of a U.S. public company.
Exploiting an ambiguously worded phrase in Sarbanes-Oxley, the agency has for the first time claimed that it may under that law “claw back”—some might say confiscate—bonus money and stock sale proceeds from CEOs and CFOs even when it lacks evidence to charge them with wrongdoing.
Sarbanes-Oxley was rushed through Congress in the summer of 2002 in reaction to public outrage over notorious corporate accounting failures at Enron, WorldCom and other companies. As is often the case with such far-reaching and hastily conceived legislation, many of its details were half-baked, poorly worded, and riddled with ambiguity.
A prime example was the so-called clawback feature of Section 304, which was designed to prevent crooked CEOs and CFOs from taking home big bonuses and cashing out company stock while they were knowingly defrauding shareholders. It empowered the SEC to force these executives to reimburse their companies for all bonuses and stock sale proceeds received during any financial period for which their company was later required to restate its financial statements due to “misconduct.”
But in its haste to “do something” about the scandal of the day, Congress muddied the question of whether the “misconduct” required for such a clawback had to be committed by the executive himself (or at least known to him), or could be that of a subordinate, completely unbeknownst to the executive.
Many executives and legal advisers have cautiously assumed that bonuses and stock proceeds were at risk only for executives who actually engaged in misconduct themselves—or at least were aware of it and acquiesced. In fact, the SEC itself has rarely used this feature of Sarbanes-Oxley at all, and had done so only in cases where it alleged personal misconduct by the targeted chief executives or chief financial officers. A prominent example was the agency’s stock-option backdating case against Dr. William McGuire, the former CEO of UnitedHealth Group.
But the SEC has abruptly changed course. It has sued Maynard Jenkins, the former CEO of CSK Auto Corporation, an auto-parts company that had previously settled with the agency on charges of accounting fraud after restating three years’ worth of financial statements.
Several subordinate executives have been charged with both civil and criminal securities law violations. But the SEC has never accused Mr. Jenkins of any wrongdoing. In a press release announcing this case, the agency highlighted its novel position that no such accusation—much less proof—was necessary to claw back his bonuses and stock sale proceeds for the three years in question, which totaled more than $4 million.
Mr. Jenkins is contesting the lawsuit, and he has grounds for optimism. On a visceral level, it seems shocking that a U.S. law enforcement agency could take more than $4 million from any citizen without so much as an accusation of personal misconduct, or at least knowing acquiescence in someone else’s misconduct. Indeed, according to a report by Bloomberg, two of the SEC’s five commissioners voted not to file the lawsuit at all.
In an unrelated case earlier this year, the SEC unsuccessfully argued an equally aggressive interpretation of Section 304. Stretching the law’s wording that clawbacks are appropriate only when a company is “required to prepare an accounting restatement,” the agency argued that Section 304 also allows clawbacks when no restatement is actually prepared, so long as the SEC later concluded the company should have done so.
A federal judge in St. Louis rejected that theory and threw out the charge. In recent years, courts have similarly rejected the agency’s overly aggressive interpretations of laws preventing “selective disclosure,” insider trading, aiding and abetting, and other violations.
The irony is this. Despite all the recent criticism the SEC has taken for supposed laxity in its enforcement program, the agency has in fact consistently taken very aggressive positions in its enforcement cases, such as with laws concerning foreign bribery, market timing of mutual funds, and many forms of insider trading.
For the most part, investors expect the SEC to push the envelope to protect their interests. But the wisdom and fairness of pursuing no-fault clawbacks from unaccused executives is dubious at best.
Mr. Ryan is a securities lawyer and was an assistant director of the Securities and Exchange Commission’s division of enforcement from 2000-2004.
‘Blue Dogs’ or Corporate Shills?
‘Blue Dogs’ or Corporate Shills? By Thomas Frank
WSJ, Aug 05, 2009
Capitalism is said to be in terrible trouble these days, with the profit motive suffering rampant badmouthing. Entrepreneurs are facing criticism, damnable criticism. And this criticism must stop.
If we don’t watch what we say, some warn, the supermen who shoulder the world will soon grow tired of our taunting, will shrug off their burden and walk righteously away, leaving us lesser mortals to stew in our resentment and envy.
So far have things gone that the editors of the Washington Post, ever vigilant against deteriorating public morals, apparently decided last week that Americans required a strong dose of instruction in the basic principles of their old-time economic religion. Stephen L. Carter, the famous law professor from Yale University, took the pulpit. And from the heights of the Post’s op-ed page, he instructed us to cheer whenever we discovered that someone was making money.
“High profits are excellent news,” he intoned. “The only way a firm can make money is to sell people what they want at a price they are willing to pay.”
Since that’s the one and only way a firm can make a profit—fraud isn’t a problem, I guess, nor are subsidies or cherry-picking or price-fixing or conflicts of interest—profit is a foolproof sign of civic uprightness.
Professor Carter’s essay was supposed to be a word of caution in a dark, anticapitalist time. But if you read your newspaper closely, it’s not hard to spot glimmers of profit-taking here and there. For example, while some see the city of Washington as a stage for anticorporate posturing, in fact it is ingeniously entrepreneurial.
Consider the “Blue Dog” Democrats, whose money-making ways were the subject of a page-one story in the Washington Post on the very day after Mr. Carter’s sermon. The Blue Dogs, as the world knows, are the caucus of conservative House Democrats who have been much in the news of late for their role in weakening the Obama administration’s plans for a public health-insurance option.
Much of the writing about the Blue Dogs revolves around the question of why they do what they do. What makes the Dogs run? Where did they get their peculiar name? And why do they chase this car but not that one?
The Blue Dogs’s official caucus Web site answers with rhetorical tail-chasing in which “centrism” is so exalted that it justifies any position the centrist takes by virtue of the label itself. The slightly more sophisticated explanation currently in vogue with the media—the Dogs come from heartland districts where the culture wars are a big deal—helps even less.
As the syndicated columnist David Sirota pointed out last week on the OpenLeft blog, having constituents who care deeply about, say, gun rights doesn’t really have anything to do with the pro-corporate stands on mortgage modification and health insurance that have made the Blue Dogs famous.
Friday’s page-one Post story about the Blue Dogs suggests a far simpler explanation: Entrepreneurship. In addition to everything else, the Dogs are champion fund raisers. Individual Dogs do far better than garden-variety Democrats when it comes to bringing in contributions from folks with business before Congress, like the insurance industry and the medical industry. According to CQ, their political action committee is the only Democratic PAC to rival the big Republican dogs; in 2009 fund raising it has been bested only by Mitt Romney’s gang.
So this is the Blue Dogs’ day, with games of fetch down on K Street that had me reminiscing, as I read the Post’s description, about the times when Tom DeLay and his pack did their own tricks for industry’s table scraps.
My guess is that the Blue Dogs, like Jack Abramoff’s Republicans before them, are more keenly attuned than their colleagues to that force of universal goodness, the profit motive. Theirs is simply a less ferocious version of what we had before, with cuddly bipartisan righteousness replacing the fierce red-state righteousness of DeLay’s dogs. But the master is the same as ever, and surely we can still count on the profit motive to deliver the very best in public policy.
Still, there remains the problem of the senseless moniker, “Blue Dog.” In the interests of improved political nicknames, let me propose an alternative. Back in 1932, the future Illinois Sen. Paul Douglas advised progressives not to expect too much from the Democratic Party. It was, he wrote, “maintained by the business interests” as a kind of “lifeboat.” Whenever the GOP ship sprung a leak—whenever Republicans were no longer willing or able to do business’s bidding—the interests simply piled into the other party and made their escape.
The Democrats have improved considerably since those days, at least from a progressive standpoint. But there are still branches of the party willing to carry out the ancestral mission. Let’s call them what they are: the lifeboat caucus.
WSJ, Aug 05, 2009
Capitalism is said to be in terrible trouble these days, with the profit motive suffering rampant badmouthing. Entrepreneurs are facing criticism, damnable criticism. And this criticism must stop.
If we don’t watch what we say, some warn, the supermen who shoulder the world will soon grow tired of our taunting, will shrug off their burden and walk righteously away, leaving us lesser mortals to stew in our resentment and envy.
So far have things gone that the editors of the Washington Post, ever vigilant against deteriorating public morals, apparently decided last week that Americans required a strong dose of instruction in the basic principles of their old-time economic religion. Stephen L. Carter, the famous law professor from Yale University, took the pulpit. And from the heights of the Post’s op-ed page, he instructed us to cheer whenever we discovered that someone was making money.
“High profits are excellent news,” he intoned. “The only way a firm can make money is to sell people what they want at a price they are willing to pay.”
Since that’s the one and only way a firm can make a profit—fraud isn’t a problem, I guess, nor are subsidies or cherry-picking or price-fixing or conflicts of interest—profit is a foolproof sign of civic uprightness.
Professor Carter’s essay was supposed to be a word of caution in a dark, anticapitalist time. But if you read your newspaper closely, it’s not hard to spot glimmers of profit-taking here and there. For example, while some see the city of Washington as a stage for anticorporate posturing, in fact it is ingeniously entrepreneurial.
Consider the “Blue Dog” Democrats, whose money-making ways were the subject of a page-one story in the Washington Post on the very day after Mr. Carter’s sermon. The Blue Dogs, as the world knows, are the caucus of conservative House Democrats who have been much in the news of late for their role in weakening the Obama administration’s plans for a public health-insurance option.
Much of the writing about the Blue Dogs revolves around the question of why they do what they do. What makes the Dogs run? Where did they get their peculiar name? And why do they chase this car but not that one?
The Blue Dogs’s official caucus Web site answers with rhetorical tail-chasing in which “centrism” is so exalted that it justifies any position the centrist takes by virtue of the label itself. The slightly more sophisticated explanation currently in vogue with the media—the Dogs come from heartland districts where the culture wars are a big deal—helps even less.
As the syndicated columnist David Sirota pointed out last week on the OpenLeft blog, having constituents who care deeply about, say, gun rights doesn’t really have anything to do with the pro-corporate stands on mortgage modification and health insurance that have made the Blue Dogs famous.
Friday’s page-one Post story about the Blue Dogs suggests a far simpler explanation: Entrepreneurship. In addition to everything else, the Dogs are champion fund raisers. Individual Dogs do far better than garden-variety Democrats when it comes to bringing in contributions from folks with business before Congress, like the insurance industry and the medical industry. According to CQ, their political action committee is the only Democratic PAC to rival the big Republican dogs; in 2009 fund raising it has been bested only by Mitt Romney’s gang.
So this is the Blue Dogs’ day, with games of fetch down on K Street that had me reminiscing, as I read the Post’s description, about the times when Tom DeLay and his pack did their own tricks for industry’s table scraps.
My guess is that the Blue Dogs, like Jack Abramoff’s Republicans before them, are more keenly attuned than their colleagues to that force of universal goodness, the profit motive. Theirs is simply a less ferocious version of what we had before, with cuddly bipartisan righteousness replacing the fierce red-state righteousness of DeLay’s dogs. But the master is the same as ever, and surely we can still count on the profit motive to deliver the very best in public policy.
Still, there remains the problem of the senseless moniker, “Blue Dog.” In the interests of improved political nicknames, let me propose an alternative. Back in 1932, the future Illinois Sen. Paul Douglas advised progressives not to expect too much from the Democratic Party. It was, he wrote, “maintained by the business interests” as a kind of “lifeboat.” Whenever the GOP ship sprung a leak—whenever Republicans were no longer willing or able to do business’s bidding—the interests simply piled into the other party and made their escape.
The Democrats have improved considerably since those days, at least from a progressive standpoint. But there are still branches of the party willing to carry out the ancestral mission. Let’s call them what they are: the lifeboat caucus.
Germany’s Recession vs. America’s: Doing Worse, but Feeling Better
Germany’s Recession vs. America’s: Doing Worse, but Feeling Better. By Douglas J. Elliott, Fellow, Economic Studies, Initiative on Business and Public Policy
The Brookings Institution, Jul 28, 2009
The world recession that began in the U.S. is hitting Germany much harder than us, due to a collapse in world trade that has damaged an economy that Germans constantly refer to as “the World Export Champion.” Their economy will have shrunk by about 8% by the time it bottoms, whereas America’s GDP should fall less than 4% from its peak. Intriguingly, the German public and elites feel much better about their situation than Americans do about ours. The key question is whether this represents: a justified faith in a system that works well for them; government measures that delay the pain; German complacency; or some combination of these factors.
I spent a week in Germany recently meeting with dozens of policymakers, academics, journalists, and policy analysts, as a guest of the Konrad Adenauer Foundation[1], a German public policy institute. The overwhelming impression I received was of a fundamental disconnect between the horrible recession and the calmness with which the Germans were facing it. This paper will briefly explore that disconnect, but is not intended as an overall criticism of Germany and its economy. An American observer should be humble indeed in these times about giving economic advice to other countries. However, it still seems to me that the extraordinary recent decline of the German economy should foster more serious questioning than has occurred to date. There seem to be three principal factors behind the phlegmatic German reactions.
First, the public has yet to feel the pain directly and is unlikely to do so until after the Federal elections on September 27th that will determine the make-up of the new parliament. Government programs are providing major subsidies to keep redundant employees on the payroll, at substantially reduced hours. This still has some cost for businesses, but they generally do not want to lay off significant numbers of employees prior to the elections, both out of a desire to support the more business-friendly parties and because they would not wish to be singled out by the politicians in the frenzy of a close election campaign. The clear consensus of those with whom we spoke was that there would be a massive spike in unemployment starting in the Fall.
I was told that a private poll found that only 6% of respondents had felt a significant direct effect from the recession. Another 20-30% had close friends or relatives who were affected, which still left a clear majority who just were not seeing the impact. In fact, about a third of respondents did not think they would ever see significant harm to themselves or others close to them from the recession. In addition to the delayed reaction caused by the temporary unemployment measures, the level of anxiety is almost certainly reduced by Germany’s generous social safety net, which provides a considerable degree of cushioning for those who do end up unemployed.
These polling figures contrast sharply with those for American attitudes. Here, fear is widespread, in part because unemployment has risen sharply already and is poised to go higher still. We have also been struck by the housing crisis that affects tens of millions of Americans directly or indirectly and which does not plague Germany. (Germany had a massive construction bubble after Reunification. The bursting of that bubble played a major role in preventing them from following in the over-optimistic path of the U.S., the U.K., and Spain in recent times.)
Second, Germans have great faith in their overall economic model. There is a very widespread belief, across the great middle ground of the political landscape, that their “social market” system is right for Germany. The term is amorphous, but refers to a consensus approach in which business is allowed to operate in a fundamentally capitalist manner, but with high levels of taxes/social contributions and a number of operating limitations. These limitations include such things as restricted opening hours for shops and a requirement that many corporate decisions are approved by a Supervisory Board that includes union representation.
Equally importantly, Germany is justifiably proud of its prowess in exports, particularly industrial machinery and automobiles. Somewhere between 40% and 50% of Germany’s GDP comes from exports, depending on when and how you measure it. This is more than three times that of the U.S., although it is important to note that Germany is a considerably smaller country and is closely integrated with its European neighbors, who are the largest importers of German products. (If the U.S. counted sales from the Northeast to California as exports, our figure would be sharply higher than it is.) Germans view their trade surplus as a sign of virtue and the source of overseas investments that will carry the country through a future in which their aging population cuts back on output and necessarily lives more on the fruits of past labor.
Third, Germans are somewhat puzzled when pushed by outsiders to make changes to their overall model. They believe it has worked extremely well for them and consequently were resistant in the past to all but the most compelling changes when foreigners were lecturing them about rigidities in their system, even though those foreigners were then enjoying better growth and lower unemployment than Germany. Now that it appears to Germans that the advice was coming from people who have massively messed up their own systems, they are even less inclined to change. In addition, I believe that there is a sense of resignation about being able to change very much while staying consistent with the social market approach and the reality of their business systems.
The largest vulnerability of the German economy is their heavy reliance on exports. However, there is great resistance to changing this. Germans often seem to interpret the suggestion to do so as a call to do a worse job of exporting, which would indeed be a mistake. The real advice is to free up their service sector more and to reduce the disincentives to consume. If domestic consumption and the service sector grew, Germans would become less dependent on the success of their manufacturing exports.
It seems ironic to an American that Germans, generally so careful, would build an economy so exposed to a single factor. There appears to be an almost unconscious belief that since the world crisis was not their fault, there is no need to change their model. However, this ignores the likelihood that other major countries will have problems in the future. Germany will remain exposed to the mistakes of others as long as exports dominate their economy. Even a great German driver in one of their best cars is exposed to the risks posed by drunk drivers on the road, which is one reason for the many safety features built into their autos.
In sum, the German views can be over-simplified, indeed caricatured, as follows. The U.S. and the U.K. created a catastrophe in the financial system, leading to a severe recession in those countries, which then spread around the world. The global recession created an “export shock” for Germany as world trade fell by about a quarter. The effects of that one-time shock should stabilize soon, allowing Germany to find its feet and then shift to growth, albeit slow growth. The economy will be 8% smaller at the bottom, but the basic German model of export orientation and a social market will remain intact and provide a good future. It makes sense for Germany to make a few changes around the edges, such as somewhat tougher financial regulation, but there is no need to pursue anything more sweeping.
To an American ear, it sounds unreasonable to be so little inclined to examine your core assumptions at a time when your economy is suffering twice as badly as the supposedly severely mismanaged U.S. economy and your experience is significantly worse than anything since the trauma of World War II and the immediate post-war period. It does not make it any more understandable that the only other major economy suffering so badly is Japan, which has been struggling for many years to find its way economically.
Of course, the Germans could be right in their two core premises: (a) the German way of doing things provides them the right balance of security and growth over the long haul and (b) the export shock will pass soon and they will be able to gradually move back to their pre-crisis growth rates. Only time will tell.
However, if I were a betting man, I would put my money on a significantly less complacent Germany in six months to a year. By that point, the Germans are likely to have discontinued their expensive labor subsidies, given their horror of budget deficits. That horror is exemplified by a recent constitutional amendment to phase them out over time. Unemployment will have shot up by at least a million people, largely undoing one of the proud achievements of the current government in bringing unemployment down from about 5 million to well under 4 million. This unemployment shock should bring home the magnitude of the crisis to most Germans, even with the strong safety net available to protect the unemployed. All of this will be worse still if, as I fear, the rest of the world does not resume its imports of German cars and machinery as quickly as is hoped. A slowdown in consumption could hold auto purchases down more than expected and it is likely that parts of the world over-invested in industrial machinery in the recent past and will take some time to resume buying in volume.
The German economy has done extremely well in some respects, particularly in exports, and the Germans have shown an admirable thrift. However, all economic models should be re-examined periodically and a period of extreme stress such as today seems an especially good time to review one’s assumptions.
[1] The Konrad Adenaeur Foundation is closely associated with the Christian Democratic Union, the party of Chancellor Angela Merkel. However, I do not believe this created a significant bias in the messages that we heard. The meetings included a wide range of people in and out of politics and the views expressed about the economy were consistent with media accounts of German views
The Brookings Institution, Jul 28, 2009
The world recession that began in the U.S. is hitting Germany much harder than us, due to a collapse in world trade that has damaged an economy that Germans constantly refer to as “the World Export Champion.” Their economy will have shrunk by about 8% by the time it bottoms, whereas America’s GDP should fall less than 4% from its peak. Intriguingly, the German public and elites feel much better about their situation than Americans do about ours. The key question is whether this represents: a justified faith in a system that works well for them; government measures that delay the pain; German complacency; or some combination of these factors.
I spent a week in Germany recently meeting with dozens of policymakers, academics, journalists, and policy analysts, as a guest of the Konrad Adenauer Foundation[1], a German public policy institute. The overwhelming impression I received was of a fundamental disconnect between the horrible recession and the calmness with which the Germans were facing it. This paper will briefly explore that disconnect, but is not intended as an overall criticism of Germany and its economy. An American observer should be humble indeed in these times about giving economic advice to other countries. However, it still seems to me that the extraordinary recent decline of the German economy should foster more serious questioning than has occurred to date. There seem to be three principal factors behind the phlegmatic German reactions.
First, the public has yet to feel the pain directly and is unlikely to do so until after the Federal elections on September 27th that will determine the make-up of the new parliament. Government programs are providing major subsidies to keep redundant employees on the payroll, at substantially reduced hours. This still has some cost for businesses, but they generally do not want to lay off significant numbers of employees prior to the elections, both out of a desire to support the more business-friendly parties and because they would not wish to be singled out by the politicians in the frenzy of a close election campaign. The clear consensus of those with whom we spoke was that there would be a massive spike in unemployment starting in the Fall.
I was told that a private poll found that only 6% of respondents had felt a significant direct effect from the recession. Another 20-30% had close friends or relatives who were affected, which still left a clear majority who just were not seeing the impact. In fact, about a third of respondents did not think they would ever see significant harm to themselves or others close to them from the recession. In addition to the delayed reaction caused by the temporary unemployment measures, the level of anxiety is almost certainly reduced by Germany’s generous social safety net, which provides a considerable degree of cushioning for those who do end up unemployed.
These polling figures contrast sharply with those for American attitudes. Here, fear is widespread, in part because unemployment has risen sharply already and is poised to go higher still. We have also been struck by the housing crisis that affects tens of millions of Americans directly or indirectly and which does not plague Germany. (Germany had a massive construction bubble after Reunification. The bursting of that bubble played a major role in preventing them from following in the over-optimistic path of the U.S., the U.K., and Spain in recent times.)
Second, Germans have great faith in their overall economic model. There is a very widespread belief, across the great middle ground of the political landscape, that their “social market” system is right for Germany. The term is amorphous, but refers to a consensus approach in which business is allowed to operate in a fundamentally capitalist manner, but with high levels of taxes/social contributions and a number of operating limitations. These limitations include such things as restricted opening hours for shops and a requirement that many corporate decisions are approved by a Supervisory Board that includes union representation.
Equally importantly, Germany is justifiably proud of its prowess in exports, particularly industrial machinery and automobiles. Somewhere between 40% and 50% of Germany’s GDP comes from exports, depending on when and how you measure it. This is more than three times that of the U.S., although it is important to note that Germany is a considerably smaller country and is closely integrated with its European neighbors, who are the largest importers of German products. (If the U.S. counted sales from the Northeast to California as exports, our figure would be sharply higher than it is.) Germans view their trade surplus as a sign of virtue and the source of overseas investments that will carry the country through a future in which their aging population cuts back on output and necessarily lives more on the fruits of past labor.
Third, Germans are somewhat puzzled when pushed by outsiders to make changes to their overall model. They believe it has worked extremely well for them and consequently were resistant in the past to all but the most compelling changes when foreigners were lecturing them about rigidities in their system, even though those foreigners were then enjoying better growth and lower unemployment than Germany. Now that it appears to Germans that the advice was coming from people who have massively messed up their own systems, they are even less inclined to change. In addition, I believe that there is a sense of resignation about being able to change very much while staying consistent with the social market approach and the reality of their business systems.
The largest vulnerability of the German economy is their heavy reliance on exports. However, there is great resistance to changing this. Germans often seem to interpret the suggestion to do so as a call to do a worse job of exporting, which would indeed be a mistake. The real advice is to free up their service sector more and to reduce the disincentives to consume. If domestic consumption and the service sector grew, Germans would become less dependent on the success of their manufacturing exports.
It seems ironic to an American that Germans, generally so careful, would build an economy so exposed to a single factor. There appears to be an almost unconscious belief that since the world crisis was not their fault, there is no need to change their model. However, this ignores the likelihood that other major countries will have problems in the future. Germany will remain exposed to the mistakes of others as long as exports dominate their economy. Even a great German driver in one of their best cars is exposed to the risks posed by drunk drivers on the road, which is one reason for the many safety features built into their autos.
In sum, the German views can be over-simplified, indeed caricatured, as follows. The U.S. and the U.K. created a catastrophe in the financial system, leading to a severe recession in those countries, which then spread around the world. The global recession created an “export shock” for Germany as world trade fell by about a quarter. The effects of that one-time shock should stabilize soon, allowing Germany to find its feet and then shift to growth, albeit slow growth. The economy will be 8% smaller at the bottom, but the basic German model of export orientation and a social market will remain intact and provide a good future. It makes sense for Germany to make a few changes around the edges, such as somewhat tougher financial regulation, but there is no need to pursue anything more sweeping.
To an American ear, it sounds unreasonable to be so little inclined to examine your core assumptions at a time when your economy is suffering twice as badly as the supposedly severely mismanaged U.S. economy and your experience is significantly worse than anything since the trauma of World War II and the immediate post-war period. It does not make it any more understandable that the only other major economy suffering so badly is Japan, which has been struggling for many years to find its way economically.
Of course, the Germans could be right in their two core premises: (a) the German way of doing things provides them the right balance of security and growth over the long haul and (b) the export shock will pass soon and they will be able to gradually move back to their pre-crisis growth rates. Only time will tell.
However, if I were a betting man, I would put my money on a significantly less complacent Germany in six months to a year. By that point, the Germans are likely to have discontinued their expensive labor subsidies, given their horror of budget deficits. That horror is exemplified by a recent constitutional amendment to phase them out over time. Unemployment will have shot up by at least a million people, largely undoing one of the proud achievements of the current government in bringing unemployment down from about 5 million to well under 4 million. This unemployment shock should bring home the magnitude of the crisis to most Germans, even with the strong safety net available to protect the unemployed. All of this will be worse still if, as I fear, the rest of the world does not resume its imports of German cars and machinery as quickly as is hoped. A slowdown in consumption could hold auto purchases down more than expected and it is likely that parts of the world over-invested in industrial machinery in the recent past and will take some time to resume buying in volume.
The German economy has done extremely well in some respects, particularly in exports, and the Germans have shown an admirable thrift. However, all economic models should be re-examined periodically and a period of extreme stress such as today seems an especially good time to review one’s assumptions.
[1] The Konrad Adenaeur Foundation is closely associated with the Christian Democratic Union, the party of Chancellor Angela Merkel. However, I do not believe this created a significant bias in the messages that we heard. The meetings included a wide range of people in and out of politics and the views expressed about the economy were consistent with media accounts of German views
Reducing Systemic Risk in the Financial Sector
Reducing Systemic Risk in the Financial Sector. By Alice M. Rivlin, Senior Fellow, Economic Studies. Testimony: House Committee on Financial Services & Senate Committee on Banking, Housing and Urban Affairs
July 21, 2009 —
Mr. Chairman and members of the Committee: I am happy to be back before this Committee to give my views on reducing systemic risk in financial services. I will focus on changes in our regulatory structure that might prevent another catastrophic financial meltdown and what role the Federal Reserve should play in a new financial regulatory system.
It is hard to overstate the importance of the task facing this Committee. Market capitalism is a powerful system for enhancing human economic wellbeing and allocating savings to their most productive uses. But markets cannot be counted on to police themselves. Irrational herd behavior periodically produces rapid increases in asset values, lax lending and over-borrowing, excessive risk taking, and out-sized profits followed by crashing asset values, rapid deleveraging, risk aversion, and huge loses. Such a crash can dry up normal credit flows and undermine confidence, triggering deep recession and massive unemployment. When the financial system fails on the scale we have experienced recently the losers are not just the wealthy investors and executives of financial firms who took excessive risks. They are average people here and around the world whose jobs, livelihoods, and life savings are destroyed and whose futures are ruined by the effect of financial collapse on the world economy. We owe it to them to ferret out the flaws in the financial system and the failures of regulatory response that allowed this unnecessary crisis to happen and to mend the system so to reduce the chances that financial meltdowns imperil the world’s economic wellbeing.
Approaches to Reducing Systemic Risk
The crisis was a financial “perfect storm” with multiple causes. Different explanations of why the system failed—each with some validity—point to at least three different approaches to reducing systemic risk in the future.
The highly interconnected system failed because no one was in charge of spotting the risks that could bring it down. This explanation suggests creating a Macro System Stabilizer with broad responsibility for the whole financial system charged with spotting perverse incentives, regulatory gaps and market pressures that might destabilize the system and taking steps to fix them. The Obama Administration would create a Financial Services Oversight Council (an interagency group with its own staff) to perform this function. I think this responsibility should be lodged at the Fed and supported by a Council.
The system failed because expansive monetary policy and excessive leverage fueled a housing price bubble and an explosion of risky investments in asset backed securities. While low interest rates contributed to the bubble, monetary policy has multiple objectives. It is often impossible to stabilize the economy and fight asset price bubbles with a single instrument. Hence, this explanation suggests stricter regulation of leverage throughout the financial system. Since monetary policy is an ineffective tool for controlling asset price bubbles, it should be supplemented by the power to change leverage ratios when there is evidence of an asset price bubble whose bursting that could destabilize the financial sector. Giving the Fed control of leverage would enhance the effectiveness of monetary policy. The tool should be exercised in consultation with a Financial Services Oversight Council.
The system crashed because large inter-connected financial firms failed as a result of taking excessive risks, and their failure affected other firms and markets. This explanation might lead to policies to restrain the growth of large interconnected financial firms—or even break them up—and to expedited resolution authority for large financial firms (including non-banks) to lessen the impact of their failure on the rest of the system. Some have argued for the creation of a single consolidated regulator with responsibility for all systemically important financial institutions. The Obama Administration proposes making the Fed the consolidated regulator of all Tier One Financial Institutions. I believe it would be a mistake to identify specific institutions as too big to fail and an even greater mistake to give this responsibility to the Fed. Making the Fed the consolidated prudential regulator of big interconnected institutions would weaken its focus on monetary policy and the overall stability of the financial system and could threaten its independence.
The Case for a Macro System Stabilizer
One reason that regulators failed to head off the recent crisis is that no one was explicitly charged with spotting the regulatory gaps and perverse incentives that had crept into our rapidly changing financial structure in recent decades. In recent years, anti-regulatory ideology kept the United States from modernizing the rules of the capitalist game in a period of intense financial innovation and perverse incentives to creep in.
Perverse incentives. Lax lending standards created the bad mortgages that were securitized into the toxic assets now weighting down the books of financial institutions. Lax lending standards by mortgage originators should have been spotted as a threat to stability by a Macro System Stabilizer—the Fed should have played this role and failed to do so—and corrected by tightening the rules (minimum down payments, documentation, proof that the borrow understands the terms of the loan and other no-brainers). Even more important, a Macro System Stabilizer should have focused on why the lenders had such irresistible incentives to push mortgages on people unlikely to repay. Perverse incentives were inherent in the originate-to-distribute model which left the originator with no incentive to examine the credit worthiness of the borrower. The problem was magnified as mortgage-backed securities were re-securitized into more complex instruments and sold again and again. The Administration proposes fixing that system design flaw by requiring loan originators and securitizers to retain five percent of the risk of default. This seems to me too low, especially in a market boom, but it is the right idea.
The Macro System Stabilizer should also seek other reasons why securitization of asset-backed loans—long thought to be a benign way to spread the risk of individual loans—became a monster that brought the world financial system to its knees. Was it partly because the immediate fees earned by creating and selling more and more complex collateralized debt instruments were so tempting that this market would have exploded even if the originators retained a significant portion of the risk? If so, we need to change the reward structure for this activity so that fees are paid over a long enough period to reflect actual experience with the securities being created.
Other examples, of perverse incentives that contributed to the violence of the recent perfect financial storm include Structured Investment Vehicles (SIV’s) that hid risks off balance sheets and had to be either jettisoned or brought back on balance sheet at great cost; incentives of rating agencies to produce excessively high ratings; and compensation structures of corporate executives that incented focus on short-term earnings at the expense the longer run profitability of the company.
The case for creating a new role of Macro System Stabilizer is that gaps in regulation and perverse incentives cannot be permanently corrected. Whatever new rules are adopted will become obsolete as financial innovation progresses and market participants find ways around the rules in the pursuit of profit. The Macro System Stabilizer should be constantly searching for gaps, weak links and perverse incentives serious enough to threaten the system. It should make its views public and work with other regulators and Congress to mitigate the problem.
The Treasury makes the case for a regulator with a broad mandate to collect information from all financial institutions and “identify emerging risks.” It proposes putting that responsibility in a Financial Services Oversight Council, chaired by the Treasury, with its own permanent expert staff. The Council seems to me likely to be cumbersome. Interagency councils are usually rife with turf battles and rarely get much done. I think the Fed should have the clear responsibility for spotting emerging risks and trying to head them off before it has to pump trillions into the system to avert disaster. The Fed should make a periodic report to the Congress on the stability of the financial system and possible threats to it. The Fed should consult regularly with the Treasury and other regulators (perhaps in a Financial Services Oversight Council), but should have the lead responsibility. Spotting emerging risks would fit naturally with the Fed’s efforts to monitor the state of the economy and the health of the financial sector in order to set and implement monetary policy. Having explicit responsibility for monitoring systemic risk—and more information on which to base judgments would enhance its effectiveness as a central bank.
Controlling Leverage. The biggest challenge to restructuring the incentives is: How to avoid excessive leverage that magnified the upswing and turned the downswing into a rout? The aspect of the recent financial extravaganza that made it truly lethal was the over-leveraged superstructure of complex derivatives erected on the shaky foundation of America’s housing prices. By itself, the housing boom and bust would have created distress in the residential construction, real estate, and mortgage lending sectors, as well as consumer durables and other housing related markets, but would not have tanked the economy. What did us in was the credit crunch that followed the collapse of the highly leveraged financial superstructure that pumped money into the housing sector and became a bloated monster.
One approach to controlling serious asset–price bubbles fueled by leverage would be to give the Fed the responsibility for creating a bubble Threat Warning System that would trigger changes in permissible leverage ratios across financial institutions. The warnings would be public like hurricane or terrorist threat warnings. When the threat was high—as demonstrated by rapid price increases in an important class of assets, such as land, housing, equities, and other securities without an underlying economic justification--the Fed would raise the threat level from, say, Three to Four or Yellow to Orange. Investors and financial institutions would be required to put in more of their own money or sell assets to meet the requirements. As the threat moderated, the Fed would reduce the warning level.
The Fed already has the power to set margin requirements—the percentage of his own money that an investor is required to put up to buy a stock if he is borrowing the rest from his broker. Policy makers in the 1930s, seeking to avoid repetition of the stock price bubble that preceded the 1929 crash, perceived that much of the stock market bubble of the late 1920s had been financed with money borrowed on margin from broker dealers and that the Fed needed a tool distinct from monetary policy to control such borrowing in the future.
During the stock market bubble of the late 1990s, when I was Vice Chair of the Fed’s Board of Governors, we talked briefly about raising the margin requirement, but realized that the whole financial system had changed dramatically since the 1920s. Stock market investors in the 1990s had many sources of funds other than borrowing on margin. While raising the margin requirements would have been primarily symbolic, I believe with hindsight that we should have done it anyway in hopes of showing that we were worried about the bubble.
The 1930’s legislators were correct: monetary policy is a poor instrument for counteracting asset price bubbles; controlling leverage is likely to be more effective. The Fed has been criticized for not raising interest rates in 1998 and the first half of 1999 to discourage the accelerating tech stock bubble. But it would have had to raise rates dramatically to slow the market’s upward momentum—a move that conditions in the general economy did not justify. Productivity growth was increasing, inflation was benign and responding to the Asian financial crisis argued for lowering rates, not raising them. Similarly, the Fed might have raised rates from their extremely low levels in 2003 or raised them earlier and more steeply in 2004-5 to discourage the nascent housing price bubble. But such action would have been regarded as a bizarre attempt to abort the economy’s still slow recovery. At the time there was little understanding of the extent to which the highly leveraged financial superstructure was building on the collective delusion that U.S. housing prices could not fall. Even with hindsight, controlling leverage (along with stricter regulation of mortgage lending standards) would have been a more effective response to the housing bubble than raising interest rates. But regulators lacked the tools to control excessive leverage across the financial system.
In the wake of the current crisis, financial system reformers have approached the leverage control problem in pieces, which is appropriate since financial institutions play diverse roles. However the Federal Reserve—as Macro System Stabilizer—could be given the power to tie the system together so that various kinds of leverage ratios move in the same direction simultaneously as the threat changes.
With respect to large commercial banks and other systemically important financial institutions, for example, there is emerging consensus that higher capital ratios would have helped them weather the recent crisis, that capital requirements should be higher for larger, more interconnected institutions than for smaller, less interconnected ones, and that these requirements should rise as the systemic threat level (often associated with asset price bubbles) goes up.
With respect to hedge funds and other private investment funds, there is also emerging consensus that they should be more transparent and that financial derivatives should be traded on regulated exchanges or at least cleared on clearinghouses. But such funds might also be subject to leverage limitations that would move with the perceived threat level and could disappear if the threat were low.
One could also tie asset securitization into this system. The percent of risk that the originator or securitizer was required to retain could vary with the perceived threat of an asset price bubble. This percentage could be low most of the time, but rise automatically if Macro System Stabilizer deemed the threat of a major asset price bubble was high. One might even apply the system to rating agencies. In addition to requiring rating agencies to be more transparent about their methods and assumptions, they might be subjected to extra scrutiny or requirements when the bubble threat level was high.
Designing and coordinating such a leverage control system would not be an easy thing to do. It would require create thinking and care not to introduce new loopholes and perverse incentives. Nevertheless, it holds hope for avoiding the run away asset price exuberance that leads to financial disaster.
Systemically Important Institutions
The Obama Administration has proposed that there should be a consolidated prudential regulator of large interconnected financial institutions (Tier One Financial Holding Companies) and that this responsibility be given to the Federal Reserve. I think this is the wrong way to go.
It is certainly important to reduce the risk that large interconnected institutions fail as a result of engaging in highly risky behavior and that the contagion of their failure brings down others. However, there are at least three reasons for questioning the wisdom of identifying a specific list of such institutions and giving them their own consolidated regulator and set of regulations. First, as the current crisis has amply illustrated, it is very difficult to identify in advance institutions that pose systemic risk. The regulatory system that failed us was based on the premise that commercial banks and thrift institutions that take deposits and make loans should be subject to prudential regulation because their deposits are insured by the federal government and they can borrow from the Federal Reserve if they get into trouble. But in this crisis, not only did the regulators fail to prevent excessive risk-taking by depository institutions, especially thrifts, but systemic threats came from other quarters. Bear Stearns and Lehman Brothers had no insured deposits and no claim on the resources of the Federal Reserve. Yet when they made stupid decisions and were on the edge of failure the authorities realized they were just as much a threat to the system as commercial banks and thrifts. So was the insurance giant, AIG, and, in an earlier decade, the large hedge fund, LTCM. It is hard to identify a systemically important institution until it is on the point of bringing the system down and then it may be too late.
Second, if we visibly cordon off the systemically important institutions and set stricter rules for them than for other financial institutions, we will drive risky behavior outside the strictly regulated cordon. The next systemic crisis will then likely come from outside the ring, as it came this time from outside the cordon of commercial banks.
Third, identifying systemically important institutions and giving them their own consolidated regulator tends to institutionalize ‘Too Big to Fail’ and create a new set of GSE-like institutions. There is a risk that the consolidated regulator will see its job as not allowing any of its charges to go down the tubes and is prepared to put taxpayer money at risk to prevent such failures.
Higher capital requirements and stricter regulations for large interconnected institutions make sense, but I would favor a continuum rather than a defined list of institutions with its own special regulator. Since there is no obvious place to put such a responsibility, I think we should seriously consider creating a new financial regulator. This new institution could be similar to the UK’s FSA, but structured to be more effective than the FSA proved in the current crisis. In the US one might start by creating a new consolidated regulator of all financial holding companies. It should be an independent agency but might report to a board composed of other regulators, similar to the Treasury proposal for a Council for Financial Oversight. As the system evolves the consolidated regulator might also subsume the functional regulation of nationally chartered banks, the prudential regulation of broker-dealers and nationally chartered insurance companies.
I don’t pretend to have a definitive answer to how the regulatory boxes should best be arranged, but it seems to me a mistake to give the Federal Reserve responsibility for consolidated prudential regulation of Tier One Financial Holding Companies, as proposed by the Obama Administration. I believe the skills needed by an effective central bank are quite different from those needed to be an effective financial institution regulator. Moreover, the regulatory responsibility would likely grow with time, distract the Fed from its central banking functions, and invite political interference that would eventually threaten the independence of monetary policy.
Especially in recent decades, the Federal Reserve has been a successful and widely respected central bank. It has been led by a series of strong macro economists—Paul Volcker, Alan Greenspan, Ben Bernanke—who have been skillful at reading the ups and downs of the economy and steering a monetary policy course that contained inflation and fostered sustainable economic growth. It has played its role as banker to the banks and lender of last resort—including aggressive action with little used tools in the crisis of 2008-9. It has kept the payments system functioning even in crises such as 9/11, and worked effectively with other central banks to coordinate responses to credit crunches, especially the current one. Populist resentment of the Fed’s control of monetary policy has faded as understanding of the importance of having an independent institution to contain inflation has grown—and the Fed has been more transparent about its objectives. Although respect for the Fed’s monetary policy has grown in recent years, its regulatory role has diminished. As regulator of Bank Holding Companies, it did not distinguish itself in the run up to the current crisis (nor did other regulators). It missed the threat posed by the deterioration of mortgage lending standards and the growth of complex derivatives.
If the Fed were to take on the role of consolidated prudential regulator of Tier One Financial Holding Companies, it would need strong, committed leadership with regulatory skills—lawyers, not economists. This is not a job for which you would look to a Volcker, Greenspan or Bernanke. Moreover, the regulatory responsibility would likely grow as it became clear that the number and type of systemically important institutions was increasing. My fear is that a bifurcated Fed would be less effective and less respected in monetary policy. Moreover, the concentration of that much power in an institution would rightly make the Congress nervous unless it exercised more oversight and accountability. The Congress would understandably seek to appropriate the Fed’s budget and require more reporting and accounting. This is not necessarily bad, but it could result in more Congressional interference with monetary policy, which could threaten the Fed’s effectiveness and credibility in containing inflation.
In summary, Mr. Chairman: I believe that we need an agency with specific responsibility for spotting regulatory gaps, perverse incentives, and building market pressures that could pose serious threats to the stability of the financial system. I would give the Federal Reserve clear responsibility for Macro System Stability, reporting periodically to Congress and coordinating with a Financial System Oversight Council. I would also give the Fed new powers to control leverage across the system—again in coordination with the Council. I would not create a special regulator for Tier One Financial Holding Companies, and I would certainly not give that responsibility to the Fed, lest it become a less effective and less independent central bank.
Thank you, Mr. Chairman and members of the Committee.
July 21, 2009 —
Mr. Chairman and members of the Committee: I am happy to be back before this Committee to give my views on reducing systemic risk in financial services. I will focus on changes in our regulatory structure that might prevent another catastrophic financial meltdown and what role the Federal Reserve should play in a new financial regulatory system.
It is hard to overstate the importance of the task facing this Committee. Market capitalism is a powerful system for enhancing human economic wellbeing and allocating savings to their most productive uses. But markets cannot be counted on to police themselves. Irrational herd behavior periodically produces rapid increases in asset values, lax lending and over-borrowing, excessive risk taking, and out-sized profits followed by crashing asset values, rapid deleveraging, risk aversion, and huge loses. Such a crash can dry up normal credit flows and undermine confidence, triggering deep recession and massive unemployment. When the financial system fails on the scale we have experienced recently the losers are not just the wealthy investors and executives of financial firms who took excessive risks. They are average people here and around the world whose jobs, livelihoods, and life savings are destroyed and whose futures are ruined by the effect of financial collapse on the world economy. We owe it to them to ferret out the flaws in the financial system and the failures of regulatory response that allowed this unnecessary crisis to happen and to mend the system so to reduce the chances that financial meltdowns imperil the world’s economic wellbeing.
Approaches to Reducing Systemic Risk
The crisis was a financial “perfect storm” with multiple causes. Different explanations of why the system failed—each with some validity—point to at least three different approaches to reducing systemic risk in the future.
The highly interconnected system failed because no one was in charge of spotting the risks that could bring it down. This explanation suggests creating a Macro System Stabilizer with broad responsibility for the whole financial system charged with spotting perverse incentives, regulatory gaps and market pressures that might destabilize the system and taking steps to fix them. The Obama Administration would create a Financial Services Oversight Council (an interagency group with its own staff) to perform this function. I think this responsibility should be lodged at the Fed and supported by a Council.
The system failed because expansive monetary policy and excessive leverage fueled a housing price bubble and an explosion of risky investments in asset backed securities. While low interest rates contributed to the bubble, monetary policy has multiple objectives. It is often impossible to stabilize the economy and fight asset price bubbles with a single instrument. Hence, this explanation suggests stricter regulation of leverage throughout the financial system. Since monetary policy is an ineffective tool for controlling asset price bubbles, it should be supplemented by the power to change leverage ratios when there is evidence of an asset price bubble whose bursting that could destabilize the financial sector. Giving the Fed control of leverage would enhance the effectiveness of monetary policy. The tool should be exercised in consultation with a Financial Services Oversight Council.
The system crashed because large inter-connected financial firms failed as a result of taking excessive risks, and their failure affected other firms and markets. This explanation might lead to policies to restrain the growth of large interconnected financial firms—or even break them up—and to expedited resolution authority for large financial firms (including non-banks) to lessen the impact of their failure on the rest of the system. Some have argued for the creation of a single consolidated regulator with responsibility for all systemically important financial institutions. The Obama Administration proposes making the Fed the consolidated regulator of all Tier One Financial Institutions. I believe it would be a mistake to identify specific institutions as too big to fail and an even greater mistake to give this responsibility to the Fed. Making the Fed the consolidated prudential regulator of big interconnected institutions would weaken its focus on monetary policy and the overall stability of the financial system and could threaten its independence.
The Case for a Macro System Stabilizer
One reason that regulators failed to head off the recent crisis is that no one was explicitly charged with spotting the regulatory gaps and perverse incentives that had crept into our rapidly changing financial structure in recent decades. In recent years, anti-regulatory ideology kept the United States from modernizing the rules of the capitalist game in a period of intense financial innovation and perverse incentives to creep in.
Perverse incentives. Lax lending standards created the bad mortgages that were securitized into the toxic assets now weighting down the books of financial institutions. Lax lending standards by mortgage originators should have been spotted as a threat to stability by a Macro System Stabilizer—the Fed should have played this role and failed to do so—and corrected by tightening the rules (minimum down payments, documentation, proof that the borrow understands the terms of the loan and other no-brainers). Even more important, a Macro System Stabilizer should have focused on why the lenders had such irresistible incentives to push mortgages on people unlikely to repay. Perverse incentives were inherent in the originate-to-distribute model which left the originator with no incentive to examine the credit worthiness of the borrower. The problem was magnified as mortgage-backed securities were re-securitized into more complex instruments and sold again and again. The Administration proposes fixing that system design flaw by requiring loan originators and securitizers to retain five percent of the risk of default. This seems to me too low, especially in a market boom, but it is the right idea.
The Macro System Stabilizer should also seek other reasons why securitization of asset-backed loans—long thought to be a benign way to spread the risk of individual loans—became a monster that brought the world financial system to its knees. Was it partly because the immediate fees earned by creating and selling more and more complex collateralized debt instruments were so tempting that this market would have exploded even if the originators retained a significant portion of the risk? If so, we need to change the reward structure for this activity so that fees are paid over a long enough period to reflect actual experience with the securities being created.
Other examples, of perverse incentives that contributed to the violence of the recent perfect financial storm include Structured Investment Vehicles (SIV’s) that hid risks off balance sheets and had to be either jettisoned or brought back on balance sheet at great cost; incentives of rating agencies to produce excessively high ratings; and compensation structures of corporate executives that incented focus on short-term earnings at the expense the longer run profitability of the company.
The case for creating a new role of Macro System Stabilizer is that gaps in regulation and perverse incentives cannot be permanently corrected. Whatever new rules are adopted will become obsolete as financial innovation progresses and market participants find ways around the rules in the pursuit of profit. The Macro System Stabilizer should be constantly searching for gaps, weak links and perverse incentives serious enough to threaten the system. It should make its views public and work with other regulators and Congress to mitigate the problem.
The Treasury makes the case for a regulator with a broad mandate to collect information from all financial institutions and “identify emerging risks.” It proposes putting that responsibility in a Financial Services Oversight Council, chaired by the Treasury, with its own permanent expert staff. The Council seems to me likely to be cumbersome. Interagency councils are usually rife with turf battles and rarely get much done. I think the Fed should have the clear responsibility for spotting emerging risks and trying to head them off before it has to pump trillions into the system to avert disaster. The Fed should make a periodic report to the Congress on the stability of the financial system and possible threats to it. The Fed should consult regularly with the Treasury and other regulators (perhaps in a Financial Services Oversight Council), but should have the lead responsibility. Spotting emerging risks would fit naturally with the Fed’s efforts to monitor the state of the economy and the health of the financial sector in order to set and implement monetary policy. Having explicit responsibility for monitoring systemic risk—and more information on which to base judgments would enhance its effectiveness as a central bank.
Controlling Leverage. The biggest challenge to restructuring the incentives is: How to avoid excessive leverage that magnified the upswing and turned the downswing into a rout? The aspect of the recent financial extravaganza that made it truly lethal was the over-leveraged superstructure of complex derivatives erected on the shaky foundation of America’s housing prices. By itself, the housing boom and bust would have created distress in the residential construction, real estate, and mortgage lending sectors, as well as consumer durables and other housing related markets, but would not have tanked the economy. What did us in was the credit crunch that followed the collapse of the highly leveraged financial superstructure that pumped money into the housing sector and became a bloated monster.
One approach to controlling serious asset–price bubbles fueled by leverage would be to give the Fed the responsibility for creating a bubble Threat Warning System that would trigger changes in permissible leverage ratios across financial institutions. The warnings would be public like hurricane or terrorist threat warnings. When the threat was high—as demonstrated by rapid price increases in an important class of assets, such as land, housing, equities, and other securities without an underlying economic justification--the Fed would raise the threat level from, say, Three to Four or Yellow to Orange. Investors and financial institutions would be required to put in more of their own money or sell assets to meet the requirements. As the threat moderated, the Fed would reduce the warning level.
The Fed already has the power to set margin requirements—the percentage of his own money that an investor is required to put up to buy a stock if he is borrowing the rest from his broker. Policy makers in the 1930s, seeking to avoid repetition of the stock price bubble that preceded the 1929 crash, perceived that much of the stock market bubble of the late 1920s had been financed with money borrowed on margin from broker dealers and that the Fed needed a tool distinct from monetary policy to control such borrowing in the future.
During the stock market bubble of the late 1990s, when I was Vice Chair of the Fed’s Board of Governors, we talked briefly about raising the margin requirement, but realized that the whole financial system had changed dramatically since the 1920s. Stock market investors in the 1990s had many sources of funds other than borrowing on margin. While raising the margin requirements would have been primarily symbolic, I believe with hindsight that we should have done it anyway in hopes of showing that we were worried about the bubble.
The 1930’s legislators were correct: monetary policy is a poor instrument for counteracting asset price bubbles; controlling leverage is likely to be more effective. The Fed has been criticized for not raising interest rates in 1998 and the first half of 1999 to discourage the accelerating tech stock bubble. But it would have had to raise rates dramatically to slow the market’s upward momentum—a move that conditions in the general economy did not justify. Productivity growth was increasing, inflation was benign and responding to the Asian financial crisis argued for lowering rates, not raising them. Similarly, the Fed might have raised rates from their extremely low levels in 2003 or raised them earlier and more steeply in 2004-5 to discourage the nascent housing price bubble. But such action would have been regarded as a bizarre attempt to abort the economy’s still slow recovery. At the time there was little understanding of the extent to which the highly leveraged financial superstructure was building on the collective delusion that U.S. housing prices could not fall. Even with hindsight, controlling leverage (along with stricter regulation of mortgage lending standards) would have been a more effective response to the housing bubble than raising interest rates. But regulators lacked the tools to control excessive leverage across the financial system.
In the wake of the current crisis, financial system reformers have approached the leverage control problem in pieces, which is appropriate since financial institutions play diverse roles. However the Federal Reserve—as Macro System Stabilizer—could be given the power to tie the system together so that various kinds of leverage ratios move in the same direction simultaneously as the threat changes.
With respect to large commercial banks and other systemically important financial institutions, for example, there is emerging consensus that higher capital ratios would have helped them weather the recent crisis, that capital requirements should be higher for larger, more interconnected institutions than for smaller, less interconnected ones, and that these requirements should rise as the systemic threat level (often associated with asset price bubbles) goes up.
With respect to hedge funds and other private investment funds, there is also emerging consensus that they should be more transparent and that financial derivatives should be traded on regulated exchanges or at least cleared on clearinghouses. But such funds might also be subject to leverage limitations that would move with the perceived threat level and could disappear if the threat were low.
One could also tie asset securitization into this system. The percent of risk that the originator or securitizer was required to retain could vary with the perceived threat of an asset price bubble. This percentage could be low most of the time, but rise automatically if Macro System Stabilizer deemed the threat of a major asset price bubble was high. One might even apply the system to rating agencies. In addition to requiring rating agencies to be more transparent about their methods and assumptions, they might be subjected to extra scrutiny or requirements when the bubble threat level was high.
Designing and coordinating such a leverage control system would not be an easy thing to do. It would require create thinking and care not to introduce new loopholes and perverse incentives. Nevertheless, it holds hope for avoiding the run away asset price exuberance that leads to financial disaster.
Systemically Important Institutions
The Obama Administration has proposed that there should be a consolidated prudential regulator of large interconnected financial institutions (Tier One Financial Holding Companies) and that this responsibility be given to the Federal Reserve. I think this is the wrong way to go.
It is certainly important to reduce the risk that large interconnected institutions fail as a result of engaging in highly risky behavior and that the contagion of their failure brings down others. However, there are at least three reasons for questioning the wisdom of identifying a specific list of such institutions and giving them their own consolidated regulator and set of regulations. First, as the current crisis has amply illustrated, it is very difficult to identify in advance institutions that pose systemic risk. The regulatory system that failed us was based on the premise that commercial banks and thrift institutions that take deposits and make loans should be subject to prudential regulation because their deposits are insured by the federal government and they can borrow from the Federal Reserve if they get into trouble. But in this crisis, not only did the regulators fail to prevent excessive risk-taking by depository institutions, especially thrifts, but systemic threats came from other quarters. Bear Stearns and Lehman Brothers had no insured deposits and no claim on the resources of the Federal Reserve. Yet when they made stupid decisions and were on the edge of failure the authorities realized they were just as much a threat to the system as commercial banks and thrifts. So was the insurance giant, AIG, and, in an earlier decade, the large hedge fund, LTCM. It is hard to identify a systemically important institution until it is on the point of bringing the system down and then it may be too late.
Second, if we visibly cordon off the systemically important institutions and set stricter rules for them than for other financial institutions, we will drive risky behavior outside the strictly regulated cordon. The next systemic crisis will then likely come from outside the ring, as it came this time from outside the cordon of commercial banks.
Third, identifying systemically important institutions and giving them their own consolidated regulator tends to institutionalize ‘Too Big to Fail’ and create a new set of GSE-like institutions. There is a risk that the consolidated regulator will see its job as not allowing any of its charges to go down the tubes and is prepared to put taxpayer money at risk to prevent such failures.
Higher capital requirements and stricter regulations for large interconnected institutions make sense, but I would favor a continuum rather than a defined list of institutions with its own special regulator. Since there is no obvious place to put such a responsibility, I think we should seriously consider creating a new financial regulator. This new institution could be similar to the UK’s FSA, but structured to be more effective than the FSA proved in the current crisis. In the US one might start by creating a new consolidated regulator of all financial holding companies. It should be an independent agency but might report to a board composed of other regulators, similar to the Treasury proposal for a Council for Financial Oversight. As the system evolves the consolidated regulator might also subsume the functional regulation of nationally chartered banks, the prudential regulation of broker-dealers and nationally chartered insurance companies.
I don’t pretend to have a definitive answer to how the regulatory boxes should best be arranged, but it seems to me a mistake to give the Federal Reserve responsibility for consolidated prudential regulation of Tier One Financial Holding Companies, as proposed by the Obama Administration. I believe the skills needed by an effective central bank are quite different from those needed to be an effective financial institution regulator. Moreover, the regulatory responsibility would likely grow with time, distract the Fed from its central banking functions, and invite political interference that would eventually threaten the independence of monetary policy.
Especially in recent decades, the Federal Reserve has been a successful and widely respected central bank. It has been led by a series of strong macro economists—Paul Volcker, Alan Greenspan, Ben Bernanke—who have been skillful at reading the ups and downs of the economy and steering a monetary policy course that contained inflation and fostered sustainable economic growth. It has played its role as banker to the banks and lender of last resort—including aggressive action with little used tools in the crisis of 2008-9. It has kept the payments system functioning even in crises such as 9/11, and worked effectively with other central banks to coordinate responses to credit crunches, especially the current one. Populist resentment of the Fed’s control of monetary policy has faded as understanding of the importance of having an independent institution to contain inflation has grown—and the Fed has been more transparent about its objectives. Although respect for the Fed’s monetary policy has grown in recent years, its regulatory role has diminished. As regulator of Bank Holding Companies, it did not distinguish itself in the run up to the current crisis (nor did other regulators). It missed the threat posed by the deterioration of mortgage lending standards and the growth of complex derivatives.
If the Fed were to take on the role of consolidated prudential regulator of Tier One Financial Holding Companies, it would need strong, committed leadership with regulatory skills—lawyers, not economists. This is not a job for which you would look to a Volcker, Greenspan or Bernanke. Moreover, the regulatory responsibility would likely grow as it became clear that the number and type of systemically important institutions was increasing. My fear is that a bifurcated Fed would be less effective and less respected in monetary policy. Moreover, the concentration of that much power in an institution would rightly make the Congress nervous unless it exercised more oversight and accountability. The Congress would understandably seek to appropriate the Fed’s budget and require more reporting and accounting. This is not necessarily bad, but it could result in more Congressional interference with monetary policy, which could threaten the Fed’s effectiveness and credibility in containing inflation.
In summary, Mr. Chairman: I believe that we need an agency with specific responsibility for spotting regulatory gaps, perverse incentives, and building market pressures that could pose serious threats to the stability of the financial system. I would give the Federal Reserve clear responsibility for Macro System Stability, reporting periodically to Congress and coordinating with a Financial System Oversight Council. I would also give the Fed new powers to control leverage across the system—again in coordination with the Council. I would not create a special regulator for Tier One Financial Holding Companies, and I would certainly not give that responsibility to the Fed, lest it become a less effective and less independent central bank.
Thank you, Mr. Chairman and members of the Committee.
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