Bank Resolution Costs, Depositor Preference, and Asset Encumbrance

Bank Resolution Costs, Depositor Preference, and Asset Encumbrance. By Daniel C. Hardy
IMF Working Paper No. 13/172
July 18, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40799.0

Summary: Depositor preference and collateralization of borrowing may reduce the cost of settling the conflicts among creditors that arises in case of resolution or bankruptcy. This net benefit, which may be capitalized into the value of the bank rather than affect creditors’ expected returns, should result in lower overall funding costs and thus a lower probability of distress despite increasing encumbrance of the bank’s balance sheet. The benefit is maximized when resolution is initiated early enough for preferred depositors to remain fully protected.


Conclusions and next steps (edited)


Bank resolution, like bankruptcy and debt restructuring generally, inherently involves a great deal of negotiation and uncertainty; these are situations in which contracts are far from complete. Experience from many sectors, most notably the financial sector, suggest that the attendant conflicts among claimants can add substantially to costs and delays in resolution.

The prospective costs attached to such conflicts, which should depend on the magnitude of residual assets, can influence the optimal composition and conditions of financing, and, in particular, motivate the introduction of provisions that make some claims “bankruptcy remote.” Bankruptcy remoteness can be achieved through statute and policy, as when depositors enjoy preferred status as a matter of law, or through private agreements, as when banks issue covered bonds backed by a pool of high-quality assets. The asset encumbrance that results from either mechanism can be desirable insofar as it reduces bankruptcy costs, and, through lower overall funding costs, lowers the probability of distress. This substantive effect from the composition of financing is not due to asymmetric information or related mechanisms, but to the gain from containing conflict resolution costs.

In the first instance, the gain should be capitalized into the value of the bank, which enjoys an overall reduction in funding costs. The extension of preferred status to some creditors (including a DGS) need not make them better off. Nor need non-secured borrowers be disadvantaged in expectational terms: they earn more when the bank survives but bear larger net losses in case of resolution (though they spend less contending for their claims). Granting preferred status to (some) depositors need not provoke increased collateralization of other credits: from the point of view of the borrowing bank, collateralization and statutory depositor preference are near substitutes, with the difference that collateralization can be increased at the bank’s initiative, albeit at an increasing marginal cost. However, the achievement of full benefits and their distribution will depend on pricing being risk-sensitive; the probability of distress might not be reduced if those that benefit from collateralization demand an interest rate that ignores the reduction in LGD that collateralization should achieve.

For these measures to be valuable, a high degree of legal certainty of their implementation must be achieved, and it is important that the resolution process starts when the borrowing bank still has enough residual assets that preferred or collateralized claims can be met. If, ex post, these conditions are not met, conflict may be intensified. Hence, bank stability might be enhanced by limiting total asset encumbrance (preferred deposits plus collateralized borrowing) to below the likely minimum level of residual assets. Authorities that are willing and able to take early corrective action, and therefore rarely have to deal with banks left with scant residual assets, can be more sanguine about asset encumbrance.

The analysis presented here lead on to other questions of practical relevance, which may be addressed in further research using an extension of the framework. Some of these questions include the following:

• What systematic evidence might be examined to determine whether and how bankruptcy costs depend on the intensity of conflict over residual assets? Some anecdotal evidence indicates that bankruptcy proceedings and bank resolutions are characterized by intensive lobbying in various forms, which considerably inflate the costs to all concerned. There is also some statistical evidence that bankruptcy costs and delays are related to the complexity of the affected corporation, and complexity is plausibly connected to the number of interest groups and thus expenditure on lobbying. But it would be worthwhile to investigate also who bears costs and receives benefits ex ante, as measured, for example, by the reaction of market prices to relevant regulatory innovations.

• Why is information on bank asset encumbrance not more readily available? Appropriate pricing of both collateralized and non-collateralized borrowing depends on making good estimates of probability of failure and of loss given default facing different creditors, and thus of the degree of outstanding asset encumbrance. Yet it is difficult to obtain current or detailed, bank-by-bank information: one may use published accounts to quantify a bank’s deposit base—if deposits enjoy preferential status—and the volume of covered bonds that it has issued, but typically one cannot know the volume of assets pledged in the interbank market, to the central bank, in liquidity swap and derivative deals, etc. Presumably a bank in a weak position is afraid to reveal that fact and face a “squeeze” on its position. However, there seem to be incentives for strong banks to disclose information, and thus to force others to reveal more. To some extent this occurs: many banks repaid as early as possible financing from the ECB’s Long-Term Refinancing Operation, presumably to demonstrate their strength. If banks do not volunteer much information on encumbrance, there could be grounds for imposing greater transparency through regulation, but national authorities have traditionally reserved the right to provide central bank refinancing on a confidential basis. [The European Systemic Risk Board recently issued recommendations to enhance prudential oversight of asset encumbrance and related market transparency, but explicitly prohibits the revelation of data on assets encumbered to central banks (see "Recommendations of European Systemic Risk Board of 20 December 2012 on funding of credit institutions" (ESRB/2012/2), available at http://www.esrb.europa.eu/pub/pdf/recommendations/2012/ESRB_2011_2.en.pdf?e622821b9c3171124f1d85f3a1b4d40e ).]

• What are the implications for funding behavior and stability of heterogeneity among creditors in their litigating/lobbying ability and incentives? Welch (1997) has initiated a discussion of the question, with a focus on a non-financial corporate facing a dominant bank creditor, but the situation of banks, with many retail and wholesale counterparties, may be rather different. The interests of those most effective in lobbying may not coincide with those of society or the prudential regulator. One advantage of depositor preference is that it protects the interests of a large number of creditors with a substantial portion of claims for whom, however, it is individually relatively expensive to defend those claims in case of resolution; the weak atomistic depositors are molded into one dominant creditor. In this connection, differences in lobbying ability could account for aspects of market segmentation: those with low costs might specialize in the holding of certain instruments, and those with high costs (or funding constraints) might want to concentrate on holding secured, bankruptcy-remote assets.

• In what ways would statutory bail-in of unsecured creditors be symmetric to the granting depositors preferred status, and in what ways would contingent capital (“CoCos”) be symmetric to collateralized credit?

The framework would need to be extended to analyze how different forms of asset encumbrance might affect bank liquidity risk, taking into account the availability of other liquidity buffers and interaction with solvency risk. Indeed, liquidity and solvency risk are deeply connected, especially for banks. Furthermore, illiquidity, like bankruptcy, is “a situation in which existing claims are inconsistent,” and so suited to an analysis based on costly resolution of conflict, rather than the application of predetermined rules and contracts. In all cases, one category of claimant is assigned a special status in case of bankruptcy or resolution—some are assigned an especially weak position, others an especially strong one. The incentives for, and ability of the different claimants to lobby for larger compensation is therefore affected. For example, those clearly subject to a statutory bail-in would not devote resources to contesting claims with those in a clearly superior position, and thus bankruptcy costs could be reduced. Holders of bail-in-able securities or CoCos would presumably demand higher yields to compensate for this risk, which in itself may increase risk of distress, but there could be some net benefit.

Conspiracy Theories Permeate Pakistani Society

Pakistan Taliban Lambastes Schoolgirl for U.N. Speech. By Saeed Shah
Anti-Western View Shown in Verbal Attack Permeates Pakistani Society
The Wall Street Journal, July 18, 2013, on page A7
For full article: http://online.wsj.com/article/SB10001424127887323309404578612173917367976.html

ISLAMABAD—Malala Yousafzai, a teenage campaigner for girls' education who was nearly killed by Pakistani militants, was feted at the United Nations last week. Here at home, however, she has been widely portrayed as part of a Western conspiracy against Islam and the developing world.

A 1,800-word open letter in imperfect English by Adnan Rasheed, one of the most feared Taliban leaders in Pakistan, outlined these conspiracy theories Wednesday, describing the type of secular education that Ms. Yousafzai championed as "satanic" and arguing that the U.N. wanted to "enslave the world."

Even as the 16-year-old girl is celebrated abroad as a hero, such radical views are becoming mainstream in Pakistani society, where even commentators hostile to the Taliban widely portray Ms. Yousafzai as a pawn of the West or even a CIA agent.

While Pakistanis usually condemn the violence of the Taliban, the paranoid worldview of the group has soaked deep into society, making the fight against extremism much more difficult. Many in the country, for example, still refuse to believe that Osama bin Laden was found living here in 2011.

"Public opinion is confused about the Malala issue. Many people hate Malala," said Zubair Torwali, a newspaper columnist from her home valley of Swat. "Anything here in Pakistan related to the West or America becomes a thing of conspiracy. The Taliban's ideology is flourishing in Pakistan. It is victorious."

Pakistani society is also influenced by the support that the military has long given to jihadist groups. More recently, the backlash over nearly a decade of U.S. drone strikes, and over the unilateral American raid to kill bin Laden deep inside Pakistan, has created a virulently anti-Western culture that sees spies everywhere.

Ms. Yousafzai narrowly survived an assassination attempt by the Pakistani Taliban in October last year, when she was shot in the head from point-blank range.

When aged just 11, Ms. Yousafzai became a powerful voice against the Taliban through a diary she kept of the extremists' takeover of Swat Valley, in northwest Pakistan. The diary was broadcast by BBC radio in 2009. Following the shooting in Swat, she was airlifted for treatment in England, where she now lives with her family.

Ms. Yousafzai, brought to the U.N. headquarters in New York to mark her 16th birthday, said in a speech Friday that "extremists are afraid of books and pens."

Mr. Rasheed's open letter to Ms. Yousafzai was the first reaction to these remarks by the Taliban leadership.

Mr. Rasheed began the letter by saying that he wishes that the attack on her had "never happened." Then, however, he went on to justify it with detailed arguments, showing, if there were any doubt, the dangers that Ms. Yousafzai would face if she returned home.

"Taliban believe that you were intentionally writing against them and running a smearing campaign to malign their efforts to establish Islamic system in Swat and your writings were provocative," he wrote.

Mr. Rasheed denied that the Taliban were against education—though he went on to spell out the movement's opposition to the "satanic or secular curriculum," which is a "conspiracy of tiny elite who want to enslave the whole humanity for their evil agendas in the name of new world order."

He advised Ms. Yousafzai to return to Pakistan and enroll in a madrassah, or Islamic seminary.

"Your propaganda was the issue and what you are doing now, you are using your tongue on the behest of the others and you must know that if the pen is mightier than the sword then tongue is sharper…In the wars tongue is more destructive than any weapon," the letter said.

When the shooting happened, there was an unprecedented outpouring of public sympathy for Ms. Yousafzai, and anger against the Taliban, inside Pakistan.

However, since then, opinion has hardened against the girl. Last week, on the local Pakistani language versions of the BBC website, in the national language Urdu and the Pashto spoken in her native Swat, the majority of comments were venomously against the schoolgirl. Some even described her as a "prostitute."

Detractors seized on the assistance and attention Ms. Yousafzai received from Western governments and media after the attack. Her appearance at the United Nations seemed to confirm the view that she was somehow working on a Western agenda.

Even Shahbaz Sharif, chief minister of the largest Punjab province and brother of Prime Minister Nawaz Sharif, issued an oblique criticism of Ms. Yousafzai's speech, posting on his Twitter account that it "seemed to be written for global consumption."

IMF Papers on Macroprudential Policies and Systemic Risk Monitoring

1  The Macroprudential Framework: Policy Responsiveness and Institutional Arrangements

Author/Editor:     Cheng Hoon Lim ; Ivo Krznar ; Fabian Lipinsky ; Akira Otani ; Xiaoyong Wu

IMF Working Paper No. 13/166, July 17, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40789.0

Summary: This paper gauges if, and how, institutional arrangements are correlated with the use of macroprudential policy instruments. Using data from 39 countries, the paper evaluates policy response time in various types of institutional arrangements for macroprudential policy and finds that the macroprudential framework that gives the central bank an important role is associated with more timely use of macroprudential policy instruments. Policymakers may also tend to use macroprudential instruments more quickly if the ability to conduct monetary policy is somehow constrained. This finding points to the importance of coordination between macroprudential and monetary policy.




2  Evaluating the Net Benefits of Macroprudential Policy: A Cookbook

Author/Editor:     Nicolas Arregui ; Jaromir Benes ; Ivo Krznar ; Srobona Mitra ; Andre Santos

IMF Working Paper No. 13/167, July 17, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40790.0

Summary: The paper proposes a simple, new, analytical framework for assessing the cost and benefits of macroprudential policies. It proposes a measure of net benefits in terms of parameters that can be estimated: the probability of crisis, the loss in output given crisis, policy effectiveness in bringing down both the probability and damage during crisis, and the output-cost of a policy decision. It discusses three types of policy leakages and identifies instruments that could best minimize the leakages. Some rules of thumb for policymakers are provided.



3   Systemic Risk Monitoring ("SysMo") Toolkit—A User Guide

Author/Editor:     Nicolas R. Blancher ; Srobona Mitra ; Hanan Morsy ; Akira Otani ; Tiago Severo ; Laura Valderrama

IMF Working Paper No. 13/168, July 17, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40791.0

Summary: There has recently been a proliferation of new quantitative tools as part of various initiatives to improve the monitoring of systemic risk. The "SysMo" project takes stock of the current toolkit used at the IMF for this purpose. It offers detailed and practical guidance on the use of current systemic risk monitoring tools on the basis of six key questions policymakers are likely to ask. It provides "how-to" guidance to select and interpret monitoring tools; a continuously updated inventory of key categories of tools ("Tools Binder"); and suggestions on how to operationalize systemic risk monitoring, including through a systemic risk "Dashboard." In doing so, the project cuts across various country-specific circumstances and makes a preliminary assessment of the adequacy and limitations of the current toolkit.

Bhidé and Phelps: Central Banking Needs Rethinking: The Fed's monetary policy is hazardous, its bank supervision ineffectual

Bhidé and Phelps: Central Banking Needs Rethinking. By Amar Bhidé and Edmund Phelps
The Fed's monetary policy is hazardous, its bank supervision ineffectual.
The Wall Street Journal, July 16, 2013, on page A15
http://online.wsj.com/article/SB10001424127887324879504578597721920923596.html

The Federal Reserve did well to supply liquidity after Lehman Brothers failed in September 2008 and the world was plunged into financial crisis. But since then the Fed's monetary policy has been increasingly hazardous and bank supervision by the Fed and other regulators dangerously ineffectual.

Monetary policy might focus on the manageable task of keeping expectations of inflation on an even keel—an idea of Mr. Phelps's in 1967 that was long influential. That would leave businesses and other players to determine the pace of recovery from a recession or of pullback from a boom.

Nevertheless, in late 2008 the Fed began its policy of "quantitative easing"—repeated purchases of billions in Treasury debt—aimed at speeding recovery. "QE2" followed in late 2010 and "QE3" in autumn 2012. Fed Chairman Ben Bernanke said in November 2010 that this unprecedented program of sustained monetary easing would lead to "higher stock prices" that "will boost consumer wealth and help increase confidence, which can also spur spending."

It is doubtful, though, that quantitative easing boosted either wealth or confidence. The late University of Chicago economist Lloyd Metzler argued persuasively years ago that a central-bank purchase, in putting the price level onto a higher path, soon lowers the real value of household wealth—by roughly the amount of the purchase, in his analysis. (People swap bonds for money, then inflation occurs, until the real value of money holdings is back to where it was.)

True, stock prices did rise in real terms in 2009-10. But surely that rebound in share prices from the panic of 2008 was mainly due to a stunning rise in after-tax corporate profits, much of it overseas. Stock markets did not begin their recent breakout until late 2012, by which time other factors were at work, such as Washington's heightened concern over continuing fiscal deficits on top of already high public debt and entitlements. Had Fed purchases raised stock prices to levels that caught the eye of business owners, the purchases might have prompted accelerated business investment, a powerful creator of jobs. But the rise was evidently too little and too late to hasten markedly the recovery.

Moreover, the Fed's quantitative easing appears not to have increased confidence and may have reduced it. No one—the Fed included—knows how much more it will buy or how much of its mountain of Treasurys will be sold back to the market. The Fed said it would end easing at serious signs of faster inflation. But as the housing bubble that preceded the financial crisis showed, imprudent speculation can be destructive without high inflation. Today we have banks, insurance companies and pension funds leveraging their assets and loading up on credit risks because prudence cannot provide acceptable returns.

The cost of this uncertainty can be considerable. An attendant foreboding may lie behind some of the depression in business investment—even if myopic traders in bonds and currencies are impervious to it and too-big-to-fail banks go on making one-way bets. Also, the time and money that businesses give to innovation and efficiency gains are squeezed if the businesses are distracted by the uncertainties surrounding monetary policy.

This ambiguity notwithstanding, President Obama commends Mr. Bernanke for "helping us recover much stronger than, for example, our European partners." Sure, the European Central Bank did not adopt quantitative easing. But the delay in Europe's recovery plausibly derives from the severity of its fiscal and banking problems and its structural disadvantages, such as inflexible labor markets and lack of institutions for early renegotiation of debts.

The Fed attributes persistent joblessness in the U.S. to a deficiency of aggregate demand, which the Fed blames on foreigners' thrift. But if the West's problem were simply that, it long ago would have increased its money supply to meet the increases demanded and would have invested in businesses at an increased pace to take advantage of the cheap credit.

Households have maintained their strong propensity to consume, persuaded that their retirement incomes will be topped up with entitlements. But consumer-goods production—giant machines needing only a guard and a dog, as some wag put it—is generally not labor-intensive enough to provide high employment at normal wages. A central bank's monetary policy, no matter how ambitious, cannot solve this structural problem.

What we do need from the Fed is reform of the ways banks are regulated and supervised. Tough, on-the-ground examination of individual banks not only helps keep them solvent, such scrutiny can also prevent out-of-control money growth without suppressing productive lending. Similarly, rules that discourage banks from relying on yield-chasing hot money will limit the runs and panics the Fed has to fight.

Unfortunately, over the past couple of decades, bank regulation, like the Fed's macro-interventions, has become more top-down and formulaic.

Until the 1980s, for instance, bank examiners would assess how large a capital buffer each bank should have, taking into account its specific risks instead of relying on internationally standardized ratios.

Dysfunctional rules have also sustained the growth of monolithic megabanks that have little interest in traditional productive lending.

Unsurprisingly, the Fed's aggressive monetary easing has helped large companies already flush with cash issue bonds at low rates, while small businesses have struggled to secure working-capital loans.

In a modern economy some areas of top-down control are likely to be unavoidable. But that does not mean we should settle for institutions that are less participatory or accountable. It is not desirable that seven people on the Federal Open Market Committee have the power to intervene on a massive scale based on theories that may or may not be right and do not reflect a popular consensus.

America has a constitutional takings clause, as well as checks and balances on the state's power of eminent domain. Such matters as tax laws and budgets are subject to votes rather than being left to "experts." These arrangements are as much about legitimacy and consent of the governed as they are about economic efficiency.

Congress passed the Federal Reserve Act in 1913 mainly to forestall and contain panics, discourage speculation and improve the supervision of banks, not to steer the economy. Indeed, the Federal Reserve System was set up as 12 more-or-less independent reserve banks to assuage concerns about centralized control and capture by financial interests.

Restoring the modest foundational aims and diffused governance of the Fed would be good for our economy and good for our democracy.

Mr. Bhidé, a professor at Tufts University's Fletcher School, is the author of "A Call for Judgment: Sensible Finance for a Dynamic Economy" (Oxford, 2010). Mr. Phelps, the 2006 Nobel laureate in economics and director of Columbia University's Center on Capitalism and Society, is the author of "Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge and Change," forthcoming from Princeton University Press.

Trevor Butterworth's Fad Food Nation

Fad Food Nation. By Trevor Butterworth
A skeptical survey of the claims being made about food, health and the environment.
The Wall Street Journal, July 16, 2013, on page A13
online.wsj.com/article/SB10001424127887323823004578593943760620664.html  

Excerpts:

Not so long ago, I spoke to a chef who ministers to children attending some of the most elite and expensive schools in America. Why, I asked him, was his company's website larded with almost comical warnings about the lethality of eating genetically modified (GM) food? Did he actually believe this as scientific fact or was he catering to his clientele's spiritual fears? It was simply for the mothers, he said, candidly. They ate it up—or, rather, they had swallowed so many apocalyptic warnings about genetically modified food that he had no choice but to echo their terror. How could they entrust their children to him otherwise? The downside of such dogma, he explained, was cost. Many of the mothers wouldn't agree to their children eating anything less than 100% organic, even if organic food required flying in, as he put it, "apples from Cuba."

Mr. Butterworth is a contributor at Newsweek and editor at large for STATS.org.

The Financial Instability Council - Regulators want to make insurers too big to fail. Uh-oh.

The Financial Instability Council
Regulators want to make insurers too big to fail. Uh-oh.
The Wall Street Journal, July 16, 2013, on page A14
http://online.wsj.com/article/SB10001424127887324634304578537490141477314.html

There's finally a healthy discussion in Washington about how to end too-big-to-fail banks. But before the government can start getting rid of taxpayer-backed behemoths, it first has to stop creating them.

The 2010 Dodd-Frank law classified all banks with more than $50 billion in assets as systemically important, and the federal Financial Stability Oversight Council (FSOC) is considering which non-banks should also be deemed too big to fail. Last year the board of regulators slapped the systemic tag on eight "financial market utilities," including clearinghouses, which means taxpayers now stand behind derivatives trading. Congratulations.

And last week the council, chaired by Treasury Secretary Jack Lew, declared that GE Capital, the finance arm of General Electric, GE and AIG are also officially important. Now the council is trying to designate insurer Prudential as systemic, and perhaps MetLife too.

GE Capital was rescued in the 2008 panic and thus deserves the systemic label. AIG seems to welcome the designation, perhaps because its current mix of businesses means that it will face a lighter regulatory burden than some competitors. But taxpayers should be cheered to learn that Prudential and MetLife are resisting membership in the too-big-to-fail club, and for good reason. It's a giant and counterproductive leap to conclude that the insurance business presents a systemic risk to the financial system.

AIG was a giant insurer when it failed, but its disastrous housing bets largely occurred outside its traditional insurance businesses, which have always been regulated by the states. The company's catastrophic wagers on the mortgage market were overseen by the U.S. Treasury's Office of Thrift Supervision. So of course Treasury's solution is to expand federal regulation to the businesses that weren't overseen by the department and didn't fail. Makes perfect Beltway sense.

But this logic should give taxpayers pause. Along with the "systemic" designation comes regulation that was created for banks, not for insurance companies, and that will create problems for taxpayers and policyholders. Any firm dubbed "systemically important" will be regulated by the Federal Reserve. This will likely mean heavy new capital requirements designed to prevent problems that generally don't exist at an insurer.

Banks accept short-term liabilities in the form of deposits and use them to fund long-term loans. This "maturity transformation" has wonderful economic benefits but carries the risk of failure if lots of depositors suddenly want to withdraw their funds. To address this risk, banks are required to maintain capital cushions and liquidity to meet deposit withdrawals that can occur at any time.

Insurers, by contrast, match long-term liabilities with long-term assets. Premiums to cover some event likely to occur decades in the future are invested in assets of a similar duration. There is little risk of a "run on the bank" because policyholders, unlike depositors, typically cannot demand the face value of their policies in cash. Tornadoes, car accidents and terminal cancer do occur, but they don't occur everywhere at once, and they are not triggered by a panic in financial markets.

Insurers can fail, but since customers cannot immediately demand their money the way bank depositors can, the failures tend to play out slowly over many years. States also typically require insurers to contribute to a fund to make up for the shortfall if one of them fails and its assets and liabilities don't match. Without the same immediate demands for cash as at a bank that's heading south, there is less risk of an asset fire sale that could roil markets.

Treating insurers like banks would also raise costs substantially at insurers as they scramble to comply with the new burdens. This means higher premiums for customers. MetLife hired consultant Oliver Wyman to calculate the consumer costs of bank regulation if applied to several insurers that could potentially fall under federal bank rules. The industrywide estimate: $5 billion to $8 billion a year.

If companies can't pass along these higher costs to customers and stay competitive, they are likely to exit the business, especially the capital-intensive life insurance market. That would mean less competition.

The other big risk is that the systemic risk designation could turn out to be self-fulfilling. If an insurer has to accept bank regulation, it might as well consider expanding into bank businesses. If it has to pay the regulatory costs of holding short-term liabilities, then the natural next step is to consider relying more on short-term funding, which almost everyone agrees was a key vulnerability leading into the 2008 crisis. Insurers may become riskier institutions than they now are, which means more risks for taxpayers.

This is no idle fear because the only certainty about financial regulation is that it never prevents the next crisis. Yet in order to reinforce the illusion of effective regulation, and vindicate the folly of Dodd-Frank, regulators are about to force insurance companies and customers who didn't cause the last crisis to pay more while encouraging firms to pursue riskier business thanks to an implied federal backstop. They should have called it the Financial Instability Council.

Riot after Chinese teachers try to stop pupils cheating. By Malcolm Moore

Riot after Chinese teachers try to stop pupils cheating. By Malcolm Moore
What should have been a hushed scene of 800 Chinese students diligently sitting their university entrance exams erupted into siege warfare after invigilators tried to stop them from cheating. The Telegraph, Jun 20, 2013
www.telegraph.co.uk/news/worldnews/asia/china/10132391/Riot-after-Chinese-teachers-try-to-stop-pupils-cheating.html

The relatively small city of Zhongxiang in Hubei province has always performed suspiciously well in China's notoriously tough "gaokao" exams, each year winning a disproportionate number of places at the country's elite universities.

Last year, the city received a slap on the wrist from the province's Education department after it discovered 99 identical papers in one subject. Forty five examiners were "harshly criticised" for allowing cheats to prosper.

So this year, a new pilot scheme was introduced to strictly enforce the rules.

When students at the No. 3 high school in Zhongxiang arrived to sit their exams earlier this month, they were dismayed to find they would be supervised not by their own teachers, but by 54 external invigilators randomly drafted in from different schools across the county.

The invigilators wasted no time in using metal detectors to relieve students of their mobile phones and secret transmitters, some of them designed to look like pencil erasers.

A special team of female invigilators was on hand to intimately search female examinees, according to the Southern Weekend newspaper.

Outside the school, meanwhile, a squad of officials patrolled the area to catch people transmitting answers to the examinees. At least two groups were caught trying to communicate with students from a hotel opposite the school gates.

For the students, and for their assembled parents waiting outside the school gates to pick them up afterwards, the new rules were an infringement too far.

As soon as the exams finished, a mob swarmed into the school in protest.

"I picked up my son at midday [from his exam]. He started crying. I asked him what was up and he said a teacher had frisked his body and taken his mobile phone from his underwear. I was furious and I asked him if he could identify the teacher. I said we should go back and find him," one of the protesting fathers, named as Mr Yin, said to the police later.

By late afternoon, the invigilators were trapped in a set of school offices, as groups of students pelted the windows with rocks. Outside, an angry mob of more than 2,000 people had gathered to vent its rage, smashing cars and chanting: "We want fairness. There is no fairness if you do not let us cheat."

According to the protesters, cheating is endemic in China, so being forced to sit the exams without help put their children at a disadvantage.

Teachers trapped in the school took to the internet to call for help. "We are trapped in the exam hall," wrote Kang Yanhong, one of the invigilators, on a Chinese messaging service. "Students are smashing things and trying to break in," she said.

Another of the external invigilators, named Li Yong, was punched in the nose by an angry father. Mr Li had confiscated a mobile phone from his son and then refused a bribe to return the handset.

"I hoped my son would do well in the exams. This supervisor affected his performance, so I was angry," the man, named Zhao, explained to the police later.

Hundreds of police eventually cordoned off the school and the local government conceded that "exam supervision had been too strict and some students did not take it well".

Additional reporting by Adam Wu

Discussion on balancing risk sensitivity, simplicity and comparability within the Basel capital standards initiated by the Basel Committee

Discussion on balancing risk sensitivity, simplicity and comparability within the Basel capital standards initiated by the Basel Committee
July 8, 2013
http://www.bis.org/press/p130708.htm

The Basel Committee on Banking Supervision today released a Discussion Paper on the balance between risk sensitivity, simplicity and comparability within the Basel capital standards.

In response to the financial crisis, the Basel Committee introduced a range of reforms designed to substantially raise the resilience of the banking system against shocks. In addition to these reforms, during 2012 the Committee commissioned a small group of its members (the Task Force on Simplicity and Comparability) to undertake a review of the Basel capital framework. The goal of the Task Force was to identify opportunities to remove undue complexity within the framework, and improve the comparability of its outcomes. The creation of the Task Force acknowledged that the framework has steadily grown over time as risk coverage has been expanded and more sophisticated risk measurement methodologies have been introduced.

The paper being released today discusses the reasons behind the evolution of the current framework, and outlines the potential benefits and costs that arise from a more risk sensitive methodology. The paper also discusses ideas that could possibly be explored to further reform the framework with the objective that it continues to strike an appropriate balance between the complementary goals of risk sensitivity, simplicity and comparability.

The purpose of the discussion paper is to seek views on this critical issue so as to help shape the Committee's thinking. At this stage, the Committee has not made a decision to pursue any of the ideas presented; the paper is being published to elicit comments and feedback from interested stakeholders, which will help the Committee refine its thinking in this area. Furthermore, the Committee remains firmly of the view that full, timely and consistent implementation of Basel III remains fundamental to building a resilient financial system, maintaining public confidence in regulatory ratios and providing a level playing field for internationally active banks. Adopting the Basel III reforms (higher and better quality capital, improved risk coverage, capital buffers, and liquidity and funding requirements) in accordance with the internationally-agreed transition period deadlines is itself an important step in improving the consistency of bank regulation globally.

Mr Stefan Ingves, Chairman of the Basel Committee and Governor, Sveriges Riksbank said: "The Committee is keenly aware of the current debate concerning the complexity of the current regulatory framework. For that reason, the Committee set up a Task Force last year to look at this issue in some depth. The Committee believes that it would benefit from further input on this critical issue before deciding on the merits of any specific changes to the current framework. The paper being released today is designed to encourage discussion amongst, and solicit views from, a broad set of stakeholders."

The Committee welcomes views on the issues outlined in this paper. Comments should be submitted by Friday 11 October 2013 by e-mail to baselcommittee@bis.org. Alternatively, comments may be sent by post to: Secretariat of the Basel Committee on Banking Supervision, Bank for International Settlements, CH-4002 Basel, Switzerland. All comments may be published on the website of the Bank for International Settlements unless a respondent explicitly requests confidential treatment.

Lord Morris of Borth-y-Gest Memorial Lecture. By Michael Howard, MP. July 6, 2006

Lord Morris of Borth-y-Gest Memorial Lecture. By Michael Howard, MP
http://web.archive.org/web/20070505062753/http://www.michaelhowardmp.com/speeches/lampeter060706.htm
July 6, 2006


It is a great privilege to have been invited to give this lecture.

Lord Morris of Borth-y-Gest – or John Willie as I recall him being almost universally referred to – was one of the giants of the law when I studied it at Cambridge and during the years when I was making my way as a Junior Member of the Bar.

Superficially we had quite a few things in common. We were, of course, both Welsh. We were both members of the Inner Temple. We had both been Presidents of the Cambridge Union. And we both, and this may be particularly encouraging to some, took second-class degrees in law.

But there, I fear, the similarities come to an end. I could not hope, even to begin to match the distinction of John Willie’s attainments at the Bar, on the Bench and as one of our great appeal judges. Nor, let’s be frank about this, could I aspire to his hallmarks of gentleness, patience and universal popularity.

He was a legend in the land. And not just, of course, for what he achieved in his legal career. At the outbreak of war in 1914, at the age of 17 he joined the Royal Welsh Fusiliers, saw service in France, reached the rank of Captain and was awarded the Military Cross. And it is said that, after being appointed a Law Lord in 1960 he walked down Whitehall to the House of Lords every day, lifting his hat as he passed the cenotaph.

Sadly I never had the honour of appearing before him. But I did meet him. When I was an undergraduate at Cambridge he came to see us to encourage us to go to the Bar.

I cannot pretend that this was a decisive influence on my own career because I had already made up my mind that that was what I wanted to do. So none of the blame for my subsequent career can be laid at John Willie’s door.

The Dictionary of National Biography, in describing his judicial characteristics, says that he was 'vigilant in protecting the freedom of the individual when threatened by the executive' and adds that 'he exhibited judicial valour consistently and in full measure.'

These statements are justified. But they must be interpreted in the spirit and context of their time. Thirty years ago judges were also conscious of the constraints which were imposed on their role.

Since then, that role has been greatly expanded, first as a consequence of the enlargement of judicial review, more recently as a result of the Human Rights Act. It is to that trend, its implications and its consequences that I intend to devote the rest of my remarks this evening.

Over thirty years ago, on a visit to Philadelphia, I fell into conversation with a woman who had recently been given a parking ticket. She had been incensed, so incensed that she decided to go to Court to challenge it.

When she appeared in Court she was rather surprised when the magistrate called all the defendants who were due to appear that day to the bar of the Court. He told them his name and asked them to remember it. Then he said, “All cases dismissed.”

The astonishment of my acquaintance at this development was tempered somewhat when she discovered that a few days later the regular election of magistrates in the city was due to take place. The magistrate before whom she had appeared, albeit rather briefly, was re-elected with the biggest majority in the history of the Philadelphia magistracy.

When I was told that story I reacted, I am sorry to say, with a rather superior disdain. “What can you expect” I asked, “if you elect magistrates and judges? We in Britain would never contemplate any such step.”

Thirty years on I am much less sure. The truth is that during that time the power of judges in this country was increased, is increasing and will increase further, if nothing is done to change things.

For the most part this increase in power has been at the expense of elected Governments and elected Parliaments. Our judges, of course, are unelected. They are unaccountable. They cannot be dismissed, save in the most extreme circumstances, and in practice never are.

Moreover they are appointed without regard to their political background and views are without any public scrutiny, parliamentary or otherwise. I believe that this has, in the past, been one of the great strengths of our judiciary. But as they move, increasingly, to the centre of the political stage how long can this state of affairs continue?

It would be wrong to suggest that this shift in power is entirely new or that it is entirely due to the coming into force of the Human Rights Act.

The Courts have traditionally had the power to curb the illegal, arbitrary or irrational exercise of power by the Executive. But, traditionally this power was exercised with restraint.

The Courts would be careful not to quash decisions because they disagreed on the merits with the decisions under challenge.

There is common consent that during the last 50 years this restraint has been eroded. As the previous Lord Chancellor, Lord Irvine put it, in his 1995 Address to the Administrative Law Bar Association:
“The range of circumstances in which decisions may be struck down has been extended beyond recognition.”

That address was essentially a plea for judicial restraint. Indeed in it the future Lord Chancellor referred to what he described as the “constitutional imperative of judicial self-restraint.”

He gave three reasons for it. First he referred to the constitutional imperative – the fact that Parliament gives powers to various authorities, including Ministers, for good reasons and in reliance on the level of knowledge and experience which such authorities possess. Secondly, he referred to the lack of judicial expertise which, he said, made the Courts ill-equipped to take decisions in place of the designated authority. Thirdly, and most pertinently, he referred to what he called the democratic imperative – the fact that elected public authorities derive their authority in part from their electoral mandate.

It is worth quoting his words in full: “The electoral system,” he said, “also operates as an important safeguard against the unreasonable exercise of public powers, since elected authorities have to submit themselves, and their decision-making records, to the verdict of the electorate at regular intervals.”

With respect to Lord Irvine, I couldn’t have put it better myself.

Remarkably enough he even prayed in aid, as one of his arguments against judicial intervention, the fact that it would strengthen objections to the incorporation of the European Convention on Human Rights into our law – the very Human Rights Act which he did so much to introduce.

Rightly describing it as a step which would hugely enhance the role and significance of the judiciary in our society he said this:- “The traditional objection to incorporation has been that it would confer on unelected judges powers which naturally belong to Parliament. That objection, entertained by many across the political spectrum, can only be strengthened by fears of judicial supremacism.”

Lord Irvine was right. My essential objection to the Human Rights Act is that it does involve a very significant shift in power from elected representatives of the people to unelected judges. Members of Parliament, and Ministers are, except for Ministers in the House of Lords like the Lord Chancellor, answerable to their electorates. As I know only too well they can be summarily dismissed by the electorate. They are directly accountable. Judges, as I have already pointed out, are unelected, unaccountable and cannot be dismissed.

The reason why this difficulty arisesin such acute form as a result of the Human Rights Act is because so many of the decisions which our judges now have to make under it are, essentially, political in nature.

Just this week, Charles Clarke, the former Home Secretary, complained that, and I quote:- “One of the consequences of the Human Rights Act is that our most senior judiciary are taking decisions of deep concern to the security of our society without any responsibility for that security.”

What on earth did he expect?

Of course that is one of the consequences of the Human Rights Act. It is an inevitable consequence. It is what the Human Rights Act obliges the senior judiciary to do. It is not the fault of the judges if they perform, as conscientiously as they can, duties which the Government has placed on them.

And it is not as though the Government were not warned.

To select a quote almost at random Appeal Court Judge Sir Henry Brooke predicted that judges would be drawn into making “much more obviously political decisions.” He pointed out that under the Act “for the first time judges would have to decide whether government interference with a human right was 'necessary in a democratic society.’ – and that, of course, is clearly a political value judgement.

How does this arise? In a nutshell the Act requires our courts to apply the European Convention on Human Rights in every decision they make. The rights which the Convention seeks to protect are framed in very wide terms. The Convention was drawn up in the aftermath of the Second World War. Its authors saw it as a safeguard against any revival of Nazism or any other form of totalitarian tyranny. I suspect that many of them would turn in their graves if they were able to see the kind of cases which are being brought in reliance on it today.

None of these rights can be exercised in isolation. Any decision to uphold one right may well infringe someone else’s right. Or it may conflict with the rights of the community at large.

The example that has most recently hit the headlines well illustrates the difficulties that arise.

As David Cameron pointed out in his recent speech on this subject life in the globalised twenty first century world presents two great challenges to governments. The first is to protect our security. The second is protecting our liberty.

We would, I suspect, all agree with his view that 'it is vital that free societies do all they can to maintain people’s human rights and civil liberties, not least because a free society is, in the long term, one of the best protections against terrorism and crime.”

As he said, “The fundamental challenge is to strike the right balance between security and liberty.”

The fundamental question is who is ultimately responsible for striking that balance: elected members of Parliament or unelected judges?

In the cases on terrorism, Parliament twice, after much anxious consideration by both Houses, reached its view. It was not always a view with which I agreed. But it was the view of Parliament.

Yet twice the Judges have held that Parliament got the balance wrong. They thought the balance should be struck differently.

And in doing so they were not deliberately seeking to challenge the supremacy of Parliament. They were simply doing what Parliament has asked them to do.

There are countless other examples. In his recent speech on the subject David Cameron discussed the way in which the Human Rights Act has made the fight against crime harder.

He cited the example of the Assets Recovery Agency, which was set up to seize the assets of major criminals.

The agency has been forced to spend millions of pounds fighting legal challenges brought by criminals under the Human Rights Act.

This has had bogged down cases for years, and the backlog in the courts has grown to 146 uncompleted claims.

The Director of the Agency has directly blamed the human rights “bandwagon” for thwarting its efforts.

He referred to the case of the convicted rapist, Anthony Rice, who was wrongly released on licence and then murdered Naomi Bryant.

The bridges Report set up to investigate the case makes clear that one of the factors that influenced the thinking of officials in dealing with Rice was a concern that he might sue them under the Human Rights Act.

As David Cameron acknowledged there were other elements in the case that had no connection to human rights.

And it is true that any legal challenge by Rice might well have failed.

But it remains the case that officials sought to protect themselves rather than risk defeat in the courts.

The Rice case illustrates a wider trend.

Even without actual litigation, some public bodies are now so frightened of being sued under the Human Rights Act that they try to protect themselves by making decisions that are often absurd and occasionally dangerous.

We saw this recently when the police tried to recapture foreign ex-prisoners who should have been deported and had instead gone on the run.

The obvious thing to do would have been to issue “Wanted” posters but police forces across the country refused to do so on the grounds that it would breach the HRA.

The Association of Chief Police officers says in its guidance to forces: “Article 8 of the Human Rights Act gives everyone the right to respect for their private and family life.....and publication of photographs could be a breach of that.”

According to ACPO, photographs should be released only in “exceptional circumstances”, where public safety needs to override the case for privacy.

These were criminals who had been convicted of very serious offences and who shouldn’t even have been in the UK.

Yet the Metropolitan Police said, “We will use all the tools in our tool box to try and find them without printing their identity – that’s the last recourse.”

Perhaps the most ludicrous recent example occurred a few weeks ago when a suspected car thief clambered onto the roof tops after a high speed chase and began pelting the police who had tried to follow him with roof tiles.

It ended with a siege that would waste the time of 50 police officers, close the street until 9.40pm and culminate in the spectacle of the suspect being handed a bucket of KFC chicken, a two litre bottle of Pepsi and a packet of cigarettes at tax payers expense – all apparently to preserve his “human rights.”

Of course there are examples of cases where the Act has led to results most of us would applaud. But we have to ask whether those results could not have been achieved by effective lobbying of our elected Parliament or a change of Government following an Election.

The Human Rights Act requires the Courts to interpret legislation so that it complies with the Convention if that is at all possible. If in the Court’s view any secondary legislation – passed after due consideration by both Houses of Parliament – is incompatible with the Convention that legislation can be struck down by the Court.

If any primary legislation is held to be incompatible there is a fast-track procedure which would enable the Government to short-circuit the normal processes of parliamentary scrutiny in order to amend or repeal any such legislation.

This surely a direct threat to the very democratic imperative on which the then Lord Chancellor waxed so eloquent 5 years ago.

One of the consequences of this is likely to be the increasing politicisation of judges.

How long, if the Act remains in force, will our present system of selection of judges survive? How long before the political backgrounds of candidates for judicial office become subject to Parliamentary scrutiny? How long before we see demands that these judges submit themselves for election?

The most common argument in favour of the Act is that it 'brings rights home.’ By that its supporters mean that since the Act could in any event be relied upon in an appeal from the English Courts to the European Court of Human Rights it is much better to allow English judges to apply it themselves. Indeed in presenting this argument the impression is sometimes given that the new jurisdiction of the English Courts will in some way replace the jurisdiction of the European Court of Human Rights. This is of course quite untrue. The right to appeal to the ECHR will remain.

I would concede that the previous situation was not ideal.

The ECHR does sometimes reach decisions which are very difficult to understand and sometimes cause considerable frustration.

But there is a remedy for this which the last Government was pursuing. The ECHR recognises the existence of what it calls a 'margin of appreciation.’ By that it means that will make some allowance, in applying the Convention, for the local circumstances and traditions of the country from which the appeal is brought. The last Government had embarked on a campaign to increase this margin of appreciation so that the Court would give greater leeway to countries to decide things for themselves.

Now the very future of the margin of appreciation is uncertain. Academic controversy rages on to whether our courts will apply it. And the ECHR is much less likely to apply it to decisions of our Courts than to decisions of administrative bodies.

It is in this context that David Cameron’s proposal for a British Bill of Rights should be considered.

As Mr Cameron expressly said the existence of a clear and codified British Bill of Rights will tend to lead the European Court of Human Rights to apply, and I would add to enhance, the “margin of appreciation.”

This seems to me to be the key to the continuing application and acceptance of the European Convention. It was intended to be a backstop to ensure that there was no repetition in Western European of Nazi atrocities and to minimise, as far as possible, the danger of future totalitarian outrages. It was not intended to strike down carefully considered judgements by democratically elected authorities of where the balance should be struck between legitimate but competing interests.

The route to this more limited role for the Convention and the Court which adjudicates on it lies through an enhanced margin of appreciation. A British Bill of Rights may well help us to reach this very desirable destination.

It is of course true, as Mr Cameron himself acknowledged, that the drafting of such a Bill would represent a formidable challenge. But this is true of all charters of this kind. If it helps us to achieve a workable solution to our relationship with the European Convention the effort will be well worth while.

And if it also enables us to scrap the discredited Human Rights Act it would be doubly welcome.

As the distinguished Scottish judge, Lord McCluskey predicted, the Act has become:- “A field day for crackpots, a pain in the neck for judges and a goldmine for lawyers.”

It is an experiment that has failed. It should go.

Report on the regulatory consistency of risk-weighted assets in the banking book issued by the Basel Committee

Report on the regulatory consistency of risk-weighted assets in the banking book issued by the Basel Committee
http://www.bis.org/press/p130705.htm
BCBS, Jul 5, 2013

The Basel Committee on Banking Supervision has today published its first report on the regulatory consistency of risk-weighted assets (RWAs) for credit risk in the banking book. This study is a part of its wider Regulatory Consistency Assessment Programme (RCAP), which is intended to ensure consistent implementation of the Basel III framework. The study draws on supervisory data from more than 100 major banks, as well as additional data on sovereign, bank and corporate exposures collected from 32 major international banks as part of a portfolio benchmarking exercise.

There is considerable variation across banks in average RWAs for credit risk in the banking book. The study published today finds that most of the variation in RWAs can be explained by broad differences in the composition of banks' assets, reflecting differences in risk preferences as intended under the risk-based capital framework. However, there is also material variation driven by diversity in bank and supervisory practices.

Through a portfolio benchmarking exercise, the study found a high degree of consistency in banks' assessment of the relative riskiness of obligors. That is, there was a high correlation in how banks rank a portfolio of individual borrowers. Differences exist, however, in the levels of estimated risk, as expressed in probability of default (PD) and loss-given-default (LGD), that banks assign. These differences drive the variation in risk weights attributable to individual bank practices, and could result in the reported capital ratios for some outlier banks varying by as much as 2 percentage points from a 10% risk-based capital ratio benchmark (or 20% in relative terms) in either direction, although the capital ratios for most banks fall within a narrower range.

Notable outliers are evident in each asset class, with the corporate asset class showing the tightest clustering of banks around a central tendency, and the sovereign asset class showing the greatest variation. The low-default nature of the benchmark portfolios and the consequent challenges in obtaining appropriate data for risk estimation may be one factor contributing to differences across banks, especially for banks' estimates of LGDs in the sovereign and bank asset classes.

The report also includes a preliminary discussion of potential policy options that the Committee could pursue in seeking to minimise excessive practice-based variations. The Committee is conscious of the need to ensure that the capital framework retains its risk sensitivity, while at the same time promoting improved comparability of regulatory capital calculations by banks.

Commenting on the report, Stefan Ingves, Chairman of the Basel Committee and Governor of Sveriges Riksbank, said: "While some variation in risk weightings should be expected with internal model-based approaches, the considerable variation observed warrants further attention. In the near term, information from this study on the relative positions of banks is being used by national supervisors and banks to take action to improve consistency. In addition, the Committee is using the results as part of its ongoing work to improve the comparability of the regulatory capital ratios and to enhance bank disclosures. The Committee will be considering similar exercises to monitor consistency in capital outcomes and assess improvement over time."

On Mr Lafe Solomon's, National Labor Relations Board's acting general counsel, letter to Cablevision

The Lord of U.S. Labor Policy. By Kimberley Strassel
Lafe Solomon, acting general counsel of the National Labor Relations Board, defies Congress and the courts on behalf of Big Labor.The Wall Street Journal, July 4, 2013, on page A9
http://online.wsj.com/article/SB10001424127887323899704578583671862397166.html

For a true expression of the imperious and extralegal tendencies of the Obama administration, there is little that compares with the Wisdom of Solomon. Lafe Solomon, that is, the acting general counsel of the National Labor Relations Board.

Mr. Solomon's wisdom was on revealing display this week, in the form of a newly disclosed letter that the Obama appointee sent to Cablevision in May. The letter was tucked into Cablevison's petition asking the Supreme Court this week to grant an emergency stay of NLRB proceedings against it. The Supremes unfortunately denied that request, though the exercise may prove valuable for shining new light on the labor board's conceit.

A half-year has passed since the D.C. Circuit Court of Appeals ruled in Noel Canning that President Obama's appointments to the NLRB were unconstitutional, and thus that the board lacks a legal quorum. In May, the Third Circuit affirmed this ruling. Yet the NLRB—determined to keep churning out a union agenda—has openly defied both appeals courts by continuing to issue rulings and complaints.

Regional directors in April filed two such unfair-labor-practice complaints against Cablevision. The company requested that Mr. Solomon halt the proceedings, given the NLRB's invalid status. It is Mr. Solomon's refusal, dated May 28, that provides the fullest expression of the NLRB's insolence.

The acting general counsel begins his letter by explaining that the legitimacy of the board is really neither here nor there. Why? Because Mr. Solomon was himself "appointed by the President and confirmed by the Senate"—and therefore, apparently, is now sole and unchecked arbiter of all national labor policy.

This is astonishing on many levels, the least of which is that it is untrue. Mr. Solomon is the acting general counsel precisely because the Senate has refused to confirm him since he was first nominated in June 2011. Nor will it, ever, given his Boeing BA +1.38% escapades.

Then there is the National Labor Relations Act, which created the NLRB. The law clearly says that the general counsel acts "on behalf of the Board"—a board that is today void, illegitimate, null, illegal. Mr. Solomon admits the "behalf" problem in his letter, though he says he's certain Congress nonetheless meant for him to be "independent" of the board. He says.

The acting general counsel naturally rushes to explain that—his omnipotence aside—the NLRB still has every right to ignore the courts. His argument runs thus: Because a decade ago the 11th Circuit issued an opinion that upholds recess appointments (though it didn't deal with Mr. Obama's breathtaking reading of that power), there exists a "split" in the circuit courts. The NLRB is therefore justified in ignoring any courts with which it disagrees until the Supreme Court has "resolved" the question.

What Mr. Solomon fails to note is the extremes the NLRB has gone to in order to suggest court confusion. The agency has deviated from past procedures, and it refused to ask either the D.C. Circuit or the Third Circuit to "stay" their opinions. Why? Because to do so—and to be rebuffed—would put the NLRB under enormous pressure to acknowledge that those courts have authority over its actions.

The board has likewise ignored the fact that the D.C. Circuit hears more NLRB decisions than any other, and is also the pre-eminent court for reviewing federal agency decisions. This ought to entitle that court, and its Noel Canning ruling, respectful deference from the labor board.

The most revealing part of Mr. Solomon's letter is the section cynically outlining why the NLRB continues to operate at a feverish pace. Mr. Solomon notes that this isn't the first time the board has operated without a quorum.

The NLRB issued 550 decisions with just two board members before the Supreme Court's 2010 ruling in New Process Steel that the NLRB must have a three-person board quorum to operate. Mr. Solomon brags that of these 550, only about 100 were "impacted" by the Supreme Court's ruling—which, he writes, proves that the NLRB is justified in continuing to operate even at times when its "authority" has been challenged.

Mr. Solomon is in fact celebrating that of the 550 outfits harassed by an illegal, two-member board, only about 100 later decided they had the money, time and wherewithal to spend years relitigating in front of the labor goon squad. The NLRB is counting on the same outcome in Cablevision and other recent actions.

The board will push through as many rulings and complaints against companies as it can before the Supreme Court rules on its legitimacy. And it will trust that the firms it has attacked and drained will be too weary to then try for reversals. This is why the Obama administration waited so long to petition the Supreme Court to reverse Noel Canning. The longer this process takes, the more damage the NLRB can inflict on behalf of its union taskmasters.

Right now, the NLRB is the only weapon the administration can wield on behalf of Big Labor. The need to placate that most powerful special interest was behind Mr. Obama's decision to install his illegal recess appointments in the first place, and it explains the NLRB's continuing defiance of courts and Congress. Mr. Solomon's wisdom is the Obama philosophy of raw power, in all its twisted glory.

Credit and growth after financial crises, by Elod Takats and Christian Upper

Credit and growth after financial crises, by Előd Takáts and Christian Upper
BIS Working Papers No 416
July 2013
http://www.bis.org/publ/work416.htm

We find that declining bank credit to the private sector will not necessarily constrain the economic recovery after output has bottomed out following a financial crisis. To obtain this result, we examine data from 39 financial crises, which - as the current one - were preceded by credit booms. In these crises the change in bank credit, either in real terms or relative to GDP, consistently did not correlate with growth during the first two years of the recovery. In the third and fourth year, the correlation becomes statistically significant but remains small in economic terms. The lack of association between deleveraging and the speed of recovery does not seem to arise due to limited data. In fact, our data shows that increasing competitiveness, via exchange rate depreciations, is statistically and economically significantly associated with faster recoveries. Our results contradict the current consensus that private sector deleveraging is necessarily harmful for growth.

Keywords: creditless recovery, financial crises, deleveraging, household debt, corporate debt

JEL classification: G01, E32


Conclusion
We find that bank lending to the private sector and economic growth are essentially uncorrelated after those financial crises that were preceded by credit booms. This result is relevant for the major advanced economies recovering from the financial crisis, since the current crisis was also preceded by a credit boom. Our results suggest that the ongoing deleveraging in advanced economies might not be as harmful for the recovery as many fear.

We also find that depreciating real exchange rates are statistically and economically significantly associated with substantially stronger economic growth.  This finding on real exchange rates shows that the price channel for external adjustment can contribute to stronger economic activities. Consequently, if crisis hit countries can generate substantial real effective exchange rate depreciation, either via nominal exchange rate depreciation or internal cost adjustments, this could hasten their recovery. However, given the global nature of the current crisis this solution might not be available for all countries at the same time.

Furthermore, we find some weak negative association between public debt ratios and recoveries: increasing public debt seems to lead to somewhat weaker recoveries. This might cast doubt on the claims that fiscal stimulus is the appropriate answer to fasten the recovery now.

While we are aware that these results come with caveats, we believe that our results provide a useful contribution to the creditless recovery literature. We hope that these finding would elicit debates and further research to understand debt dynamics, financial crises and how recoveries work.

Opening a New Era in U.S.-Iraq Relations - We Iraqis, grateful for America's sacrifice, now seek an economic partner

Opening a New Era in U.S.-Iraq Relations. By Lukman Faily
We Iraqis, grateful for America's sacrifice, now seek an economic partner.
The Wall Street Journal, July 3, 2013, on page A13
http://online.wsj.com/article/SB10001424127887324436104578579212252109642.html

Last week, the United Nations Security Council voted unanimously to lift international trade and financial sanctions on Iraq that have been in effect since Saddam Hussein invaded Kuwait in the 1990s. Iraq's exit from Chapter VII of the U.N. Charter—and the substantial progress it has made with Kuwait—is a major accomplishment, and one of several recent developments we Iraqis are celebrating.

Though most Americans probably believe that Iraqis are fed up with the U.S., the truth is that Iraqis appreciate what the U.S. has done and are looking for more U.S. involvement—not more sacrifice of blood and treasure, but more diplomatic, political, trade, investment and economic partnership.

The next clear step is for the U.S. and Iraq to fully implement the Strategic Framework Agreement, signed prior to the 2011 withdrawal of U.S. forces, which defines the overall political, economic, cultural and security ties between our two countries. Americans should see this agreement not as a ticket out of Iraq, but as the foundation for a long-term partnership with the people and government of Iraq.

At a time of profound change in the Middle East, the implementation of the agreement has so far been slow and uneven. While security coordination through military sales and financing programs continues, an expedited delivery of promised sales, better intelligence sharing, and stepped-up assistance in counterterrorism and training is essential for Iraq's fight against terrorism—a clear national security interest of the U.S. Implementing this agreement should not be linked to regional issues, such as the conflict in Syria.

As we look forward to full implementation of the Strategic Framework Agreement, the legacy of the past 10 years is something to build on. After decades of dictatorship, three disastrous wars, international isolation, economic sanctions, the displacement of more than a million Iraqis and the deaths of tens of thousands more, Iraq has begun to build a multiethnic, multiparty democracy with respect for the rule of law.

It hasn't been easy. But Iraqis are making progress towards creating a democratic system. All the political parties have accepted elections as a method of power-sharing and peaceful change. Terrible as it is, the current violence in Iraq is primarily caused by terrorism, not civil war. As the recent provincial elections affirmed, Iraqis are developing a culture of democracy—something that many of our neighbors do not yet have.

With Iraq taking its place as a partner, not a protectorate, Americans can help by providing political, diplomatic and security assistance, in addition to technical know-how and investment capital.

On the political front, the U.S. can serve as an honest broker among Iraqi factions that are learning to work with each other. Americans are seen as mature partners who have proven their commitment to Iraq, and their involvement is not perceived as a threat to our sovereignty or national interest.

On the diplomatic front, Iraq has rejoined the international community by exiting Chapter VII, and it has done important work with the International Monetary Fund, World Bank and the Arab League. Looking ahead, Iraq and the U.S. can cooperate to resolve broader regional challenges.

Now that Iraq is moving toward a market economy friendly to foreign investment, Americans can provide what our nation needs: expertise on energy technologies, engineering, design, construction and financial services. Iraq offers tremendous investment opportunities for developing and servicing telecommunications, health care, education, water treatment, and bridges and highways, to name a few.

Meanwhile, oil production has increased by 50% since 2005, and our economy is expected to grow by at least 9.4% annually through 2016. Iraq expects to increase oil production to 4.5 million barrels per day by the end of 2014 and nine million barrels a day by 2020—a 157% increase from our current production levels. With the goal of diversifying our economy beyond energy, Iraq plans to invest these oil revenues in education and critical development projects, including restoring electrical power and rebuilding our transportation system.

Moreover, Iraq is in the process of purchasing over $10 billion worth of military equipment, paid for with our own revenues, and we are eager to buy this hardware from the U.S. Iraq's recent purchase of 30 Boeing BA +1.40% planes for our national carrier testifies to our potential as a market for U.S. goods and services.

Iraqis will be forever grateful to Americans for sacrificing alongside us to overthrow Saddam's brutal tyranny. We now look forward to working together to build a strong and prosperous democracy in Iraq and to cement a strategic partnership between our nations.

Mr. Faily is the newly appointed ambassador of Iraq to the United States.

Basel Committee consults on derivatives-related reforms to capital adequacy framework

Basel Committee consults on derivatives-related reforms to capital adequacy framework
BCBS, June 28, 2013

The Basel Committee today released two consultative papers on the treatment of derivatives-related transactions under the capital adequacy framework.

1  Capital treatment of bank exposures to central counterparties - consultative document
http://www.bis.org/publ/bcbs253.htm
PDF of full document: http://www.bis.org/publ/bcbs253.pdf

The Basel Committee on Banking Supervision, in cooperation with the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO), is seeking views on potential changes to the capital treatment of banks' exposure to central counterparties (CCPs). The Basel Committee published an interim standard in July 2012 and noted at that time that additional work was needed to improve the capital framework. Introduction of the interim standard represented an important step towards ensuring appropriate measurement, monitoring and management of banks' exposures to CCPs, exposures which had previously attracted no regulatory capital charge.

The proposed changes to the interim standard seek to establish a capital treatment that ensures banks' exposures to central counterparties are adequately capitalised, while also preserving incentives for central clearing. They promote robust risk management by banks and CCPs, including by encouraging CCPs to satisfy the CPSS-IOSCO Principles for financial market infrastructures (PFMIs). The proposed changes respond to evidence that application of the interim rules could lead both to instances of very little capital being held against exposures to some CCPs, and potentially in certain cases, to capital charges that are higher than for bilateral (non-centrally-cleared) transactions. There was also concern that, in some cases, the interim capital treatment might not create the appropriate incentives for maintaining generous default funds. [my emphasis] These outcomes are potentially inconsistent with the Committee's objectives and the changes set out in the consultative paper seek to address those concerns. 

In parallel to this consultation, the Committee will also conduct a quantitative impact study. Any amendments to the proposed standard will be based on feedback on this consultative document, evidence from the quantitative impact study that will be conducted alongside this consultation, and further consultation with CPSS and IOSCO. The Committee is not proposing any change to the capital treatment of exposures to non-qualifying CCPs. Nor does this consultative paper consider any changes to the rules on capital treatment of clearing member exposures to clients. 

2  The non-internal model method for capitalising counterparty credit risk exposures - consultative document
http://www.bis.org/publ/bcbs254.htm
PDF of full document: http://www.bis.org/publ/bcbs254.pdf

The Basel Committee's consultative paper The non-internal model method for capitalising counterparty credit risk exposures outlines a proposal to improve the methodology for assessing the counterparty credit risk associated with derivative transactions. The proposal would, when finalised, replace the capital framework's existing methods - the Current Exposure Method and the Standardised Method. It improves on the risk sensitivity of the Current Exposure Method by differentiating between margined and unmargined trades. The proposed non-internal model method updates supervisory factors to reflect the level of volatilities observed over the recent stress period and provides a more meaningful recognition of netting benefits. At the same time, the proposed method is suitable for a wide variety of derivatives transactions, reduces the scope for discretion by banks and avoids undue complexity.

The Basel Committee will conduct a quantitative impact study in order to inform the final formulation of the non-internal model method and to assess the difference in exposure and overall capital requirements under this proposal as compared to other measures of counterparty credit risk under the Basel framework. In addition to replacing the Current Exposure Method and the Standardised Method, the  non-internal model method may also be used with respect to the leverage ratio, large exposures, and exposures to central counterparties (CCPs).

Contradictory rules are putting bankers in a bind and threatening the housing recovery. By Frank Keating

Regulators Have Created a Mortgage Minefield. By Frank Keating
Contradictory rules are putting bankers in a bind and threatening the housing recovery.
The Wall Street Journal, June 27, 2013, on page A19
http://online.wsj.com/article/SB10001424127887324183204578567993734188214.html

Bankers will soon step into a mortgage minefield—a no-win landscape in which every move will be fraught with peril, and in which the ultimate casualties will be the nascent housing recovery and the American home buyer.

This minefield—a set of incompatible, contradictory regulations—is a creation of the federal government. The first regulation came from the Department of Housing and Urban Development in March, and it said that mortgage lenders can be liable for violations of the 1968 Fair Housing Act if their lending decisions have a so-called "disparate impact" on minorities. No evidence of discriminatory intent or action is required, merely statistical variance in a bank's lending outcomes.

Bankers support equal housing opportunity, but this represents a radical shift in how the government enforces fair housing law. The text of the law prohibits discrimination "because of" race, religion, sex and other protected classes, which means that the lender must have intended to discriminate. This is how we understood the law during the first Bush administration, when I enforced fair housing laws as general counsel and acting deputy secretary atHUD.

The Supreme Court recently agreed to hear the Mount Holly v. Mt. Holly Gardens Citizens in Action case to review whether disparate impact creates liability under the Fair Housing Act. But in the meantime, lenders are facing lawsuits and prosecutions even if they have done nothing wrong.

That's bad enough, but on Jan. 10, the Consumer Financial Protection Bureau's "ability to repay" rule will take effect. This Dodd-Frank mandated rule exposes lenders to risk of litigation if borrowers default on a mortgage—unless the loan falls into a legal "safe harbor" under the CFPB's qualified-mortgage, or QM, guidelines. For example, a loan in which the borrower's total monthly debt payments exceed 43% of his income would presumably fall outside the QM safe harbor.

Even when lenders can prove they have done their best to serve consumers outside the safe harbor, the expected costs of defenses—and delays in resolving defaults—will be passed on to all consumers. This will make lending, even to many creditworthy borrowers, too costly.

Many banks have said that they plan to loan only within the QM guidelines, and Fannie Mae and Freddie Mac —the taxpayer-backed companies that undergird the secondary mortgage market—will buy only qualified mortgages. Thus, the QM will be the primary mortgage product available to home buyers.

The QM requirements will result in an immediate tightening of credit, with banks substituting a one-size-fits-all federal mandate for their own good judgment and sound underwriting. Many creditworthy borrowers who are on the cusp of meeting the requirements—and who may qualify before Jan. 10—will be cut off from the dream of home ownership.

Many of these aspirational home buyers—those who have solid financial futures but who don't fit the QM box—are members of minorities. Moreover, the poverty gap that exists along many racial lines virtually guarantees that tightened mortgage standards will mean that members of some races will be denied credit at a higher rate than others—and voila, disparate impact.

Bankers will be damned if they do and damned if they don't. If they follow the QM guidelines and thus tighten credit, they will run afoul of the novel disparate-impact interpretation of housing laws. If they loosen lending standards to ensure that lending outcomes are identical for every protected group, then they expose themselves to risk of litigation if some of those loans end up in default.

The end result will be confusion and uncertainty. Some banks will stop making mortgage loans altogether, which will further cut access to credit, reduce competition and drive up costs for all home buyers.

Raj Date, the former deputy director of the Consumer Financial Protection Bureau who wrote a large portion of the qualified-mortgage guidelines, now runs a startup venture and mortgage lender that he says will offer loans outside the QM guidelines. As he recently told this newspaper: "It is just way too hard for good, responsible people to get good mortgages today."

We agree. To get people into "good mortgages," the government needs to clear the minefield it created.

Mr. Keating, a former governor of Oklahoma and HUD general counsel, is president and CEO of the American Bankers Association.

Revised Basel III leverage ratio framework and disclosure requirements - consultative document

Revised Basel III leverage ratio framework and disclosure requirements - consultative document
BIS, June 2013
http://www.bis.org/publ/bcbs251.htm

An underlying feature of the financial crisis was the build-up of excessive on- and off-balance sheet leverage in the banking system. The Basel III reforms introduced a simple, transparent, non-risk based leverage ratio to act as a credible supplementary measure to the risk-based capital requirements. The leverage ratio is intended to:

• restrict the build-up of leverage in the banking sector to avoid destabilising deleveraging processes that can damage the broader financial system and the economy; and
• reinforce the risk-based requirements with a simple, non-risk-based "backstop" measure.

The Basel Committee is of the view that a simple leverage ratio framework is critical and complementary to the risk-based capital framework and that a credible leverage ratio is one that ensures broad and adequate capture of both the on- and off-balance sheet leverage of banks.

Implementation of the leverage ratio requirement has begun with bank-level reporting to supervisors of the leverage ratio and its components from 1 January 2013, and will proceed with public disclosure starting 1 January 2015. Any final adjustments to the definition and calibration of the leverage ratio will be made by 2017, with a view to migrating to a Pillar 1 treatment on 1 January 2018 based on appropriate review and calibration.

The Basel Committee's consultative paper The revised Basel III leverage ratio framework is set out in the remainder of this document, along with the public disclosure requirements starting 1 January 2015. In summary, revisions to the framework relate primarily to the denominator of the leverage ratio, the Exposure Measure. The major changes to the Exposure Measure include:

• specification of a broad scope of consolidation for the inclusion of exposures;
• clarification of the general treatment of derivatives and related collateral;
• enhanced treatment of written credit derivatives; and
• enhanced treatment of Securities Financing Transactions (SFTs) (eg repos).

In parallel with the consultation on the proposals, the Committee will also undertake a Quantitative Impact Study to ensure that the calibration of the leverage ratio, and its relationship with the risk-based framework, remains appropriate.

Comments on this consultative report should be submitted by 20 September 2013 by email to baselcommittee@bis.org. Alternatively, comments may be sent by post to: Secretariat of the Basel Committee on Banking Supervision, Bank for International Settlements, CH-4002 Basel, Switzerland. All comments may be published on the website of the Bank for International Settlements unless a contributor specifically requests confidential treatment.

Cochrane: Regulating the riskiness of bank assets is a dead end. Instead, fix the run-prone nature of bank liabilities

Stopping Bank Crises Before They Start. By John Cochrane
Regulating the riskiness of bank assets is a dead end. Instead, fix the run-prone nature of bank liabilitiesThe Wall Street Journal, June 24, 2013, on page A19
http://online.wsj.com/article/SB10001424127887324412604578513143034934554.html

In recent months the realization has sunk in across the country that the 2010 Dodd-Frank financial-reform legislation is a colossal mess. Yet we obviously can't go back to the status quo that produced a financial catastrophe in 2007-08. Fortunately, there is an alternative.

At its core, the recent financial crisis was a run. The run was concentrated in the "shadow banking system" of overnight repurchase agreements, asset-backed securities, broker-dealers and investment banks, but it was a classic run nonetheless.

The run made the crisis. In the 2000 tech bust, people lost a lot of money, but there was no crisis. Why not? Because tech firms were funded by stock. When stock values fall you can't run to get your money out first, and you can't take a company to bankruptcy court.

This is a vital and liberating insight: To stop future crises, the financial system needs to be reformed so that it is not prone to runs. Americans do not have to trust newly wise regulators to fix Fannie Mae and Freddie Mac, end rating-agency shenanigans, clairvoyantly spot and prick "bubbles," and address every other real or perceived shortcoming of our financial system.

Runs are a pathology of financial contracts, such as bank deposits, that promise investors a fixed amount of money and the right to withdraw that amount at any time. A run also requires that the issuing institution can't raise cash by selling assets, borrowing or issuing equity. If I see you taking your money out, then I have an incentive to take my money out too. When a run at one institution causes people to question the finances of others, the run becomes "systemic," which is practically the definition of a crisis.

By the time they failed in 2008, Lehman Brothers and Bear Stearns were funding portfolios of mortgage-backed securities with overnight debt leveraged 30 to 1. For each $1 of equity capital, the banks borrowed $30. Then, every single day, they had to borrow 30 new dollars to pay off the previous day's loans.

When investors sniffed trouble, they refused to roll over the loans. The bank's broker-dealer customers and derivatives counterparties also pulled their money out, each also having the right to money immediately, but each contract also serving as a source of short-term funding for the banks. When this short-term funding evaporated, the banks instantly failed.

Clearly, overnight debt is the problem. The solution is just as clear: Don't let financial institutions issue run-prone liabilities. Run-prone contracts generate an externality, like pollution, and merit severe regulation on that basis.

Institutions that want to take deposits, borrow overnight, issue fixed-value money-market shares or any similar runnable contract must back those liabilities 100% by short-term Treasurys or reserves at the Fed. Institutions that want to invest in risky or illiquid assets, like loans or mortgage-backed securities, have to fund those investments with equity and long-term debt. Then they can invest as they please, as their problems cannot start a crisis.

Money-market funds that want to offer better returns by investing in riskier securities must let their values float, rather than promise a fixed value of $1 per share. Mortgage-backed securities also belong in floating-value funds, like equity mutual funds or exchange-traded funds. The run-prone nature of broker-dealer and derivatives contracts can also be reformed at small cost by fixing the terms of those contracts and their treatment in bankruptcy.

The bottom line: People who want better returns must transparently shoulder additional risk.

Some people will argue: Don't we need banks to "transform maturity" and provide abundant "safe and liquid" assets for people to invest in? Not anymore.

First, $16 trillion of government debt is enough to back any conceivable demand for fixed-value liquid assets. Money-market funds that hold Treasurys can expand to enormous size. The Federal Reserve should continue to provide abundant reserves to banks, paying market interest. The Treasury could offer reserves to the rest of us—floating-rate, fixed-value, electronically-transferable debt. There is no reason that the Fed and Treasury should artificially starve the economy of completely safe, interest-paying cash.

Second, financial and technical innovations can deliver the liquidity that once only banks could provide. Today, you can pay your monthly credit-card bill from your exchange-traded stock fund. Tomorrow, your ATM could sell $100 of that fund if you want cash, or you could bump your smartphone on a cash register to buy coffee with that fund. Liquidity no longer requires that anyone hold risk-free or fixed-value assets.

Others will object: Won't eliminating short-term funding for long-term investments drive up rates for borrowers? Not much. Floating-value investments such as equity and long-term debt that go unlevered into loans are very safe and need to pay correspondingly low returns. If borrowers pay a bit more than now, it is only because banks lose their government guarantees and subsidies.

In the 19th century, private banks issued currency. A few crises later, we stopped that and gave the federal government a monopoly on currency issue. Now that short-term debt is our money, we should treat it the same way, and for exactly the same reasons.

In the wake of Great Depression bank runs, the U.S. government chose to guarantee bank deposits, so that people no longer had the incentive to get out first. But guaranteeing a bank's deposits gives bank managers a huge incentive to take risks.

So we tried to regulate the banks from taking risks. The banks got around the regulations, and "shadow banks" grew around the regulated system. Since then we have been on a treadmill of ever-larger bailouts, ever-expanding government guarantees, ever-expanding attempts to regulate risks, ever-more powerful regulators and ever-larger crises.

This approach will never work. Rather than try to regulate the riskiness of bank assets, we should fix the run-prone nature of their liabilities. Fortunately, modern financial technology surmounts the economic obstacles that impeded this approach in the 1930s. Now we only have to surmount the obstacle of entrenched interests that profit from the current dysfunctional system.

Mr. Cochrane is a professor of finance at the University of Chicago Booth School of Business, a senior fellow at the Hoover Institution, and an adjunct scholar at the Cato Institute.