The Two Likeliest Political Outcomes for Mubarak

The Two Likeliest Political Outcomes for Mubarak. By Stephen J. Hadley
Egyptian society needs time to prepare for free elections and to remediate years of government oppression.
WSJ, Jan 31, 2011
http://online.wsj.com/article/SB10001424052748703833204576114252976824050.html


All eyes are now on Egypt and an Obama administration struggling to find its footing. The truth is that once revolutionary fervor emerges and a situation descends into crisis, any administration is largely hostage to events and the dilemmas are acute. Do we desert a longstanding ally, only to raise doubts about our staying power in the minds of other longstanding allies? Do we remain loyal to a longstanding ally even after he has clearly lost public support, only to alienate a people struggling to win their freedom? In the midst of a crisis like this, the options are few.

Before the current crisis, there were good options. They were urged on the Egyptian government by a series of American administrations—including especially the administration of George W. Bush, in which I served. The United States pressed President Hosni Mubarak publicly and privately to encourage the emergence of non-Islamist political parties. Our calls for action were generally ignored and non- Islamist parties were persecuted and suppressed.

The result was a political landscape that offered the Egyptian people just two choices: the government party (the National Democratic Party or NDP) and the underground Islamist Muslim Brotherhood. This sad outcome was President Mubarak's own creation. He did it in part so that he could argue to successive U.S. administrations and his own people that the only alternative to his rule was an Islamist state. But it didn't have to be this way.

Some critics argue that no U.S. administration went far enough in pressing President Mubarak—including the administrations in which I served. As important as the "freedom agenda" was to President Bush, there were other issues—terrorism, proliferation, the Israeli-Palestinian conflict, to name a few—that required us to deal with the Egyptian government. Perhaps as important, the Egyptians are a proud people. No nation wants to be seen to be giving in to public pressure from another state—even a close ally. In the end, the decision was President Mubarak's. He made it, and he is now facing the consequences.

At present, the two most probable outcomes of the current crisis are a lame-duck Mubarak administration or a Mubarak departure from power in favor of a transitional government backed by the Egyptian military.

Under the first outcome, President Mubarak rides out the current crisis. Presidential elections are expected in September of this year. It seems unlikely that either President Mubarak or his son Gamal will conclude that under current circumstances they can run and win. That will leave President Mubarak presiding over a lame-duck administration. The issue will be whether he seeks to transfer power to another authoritarian strongman backed by the army or dramatically changes course and uses the upcoming presidential election to create a democratic transition for his country.

The precedents for this latter outcome are few but not nonexistent. It is essentially the role that the Bush administration urged on Pakistani President Pervez Musharraf, which he played successfully in 2008. The resulting government is admittedly a weak one that continues to cause the U.S. real problems in Afghanistan. But it is a democratic government, and by its coming to power we avoided the kind of Islamist regime that followed the fall of the Shah of Iran and that has provoked three decades of serious confrontation with the U.S. and totalitarian oppression of the Iranian people.

Under the second outcome, President Mubarak surrenders power and is replaced by a transitional government supported by the Egyptian military. The presidential elections then become the vehicle for transferring power to a government whose legitimacy comes from the people.

Either way, Egyptian society needs time to prepare for these elections and to begin to remediate the effects of years of government oppression. The Egyptian people should not have to choose only between the government-backed NDP and the Islamist Muslim Brotherhood. Non-Islamist parties need an opportunity to emerge to fill in the intervening political space. Time is short even if the presidential elections go forward as expected in September. The U.S. should resist the temptation to press for an accelerated election schedule. Hopefully wise heads in Egypt will do the same.

Time and a full array of political alternatives are critical in the upcoming presidential election and the parliamentary elections that undoubtedly will follow. If given an array of choices, I believe that the Egyptian people will choose a democratic future of freedom and not an Islamist future of imposed extremism. While the Muslim Brotherhood, if legalized, would certainly win seats in a new parliament, there is every likelihood that the next Egyptian government will not be a Muslim Brotherhood government but a non-Islamist one committed to building a free and democratic Egypt.

Such a government would still pose real challenges to U.S. policy in many areas. But with all eyes in the region on Egypt, it would be a good outcome nonetheless. With a large population and rich cultural heritage, Egypt has always been a leader in the Middle East. Now it has the opportunity to become what it always should have been—the leader of a movement toward freedom and democracy in the Arab world.

Mr. Hadley was national security adviser to President George W. Bush.

Databases

* ABI/Inform

ABI/INFORM is a database covering business, management, economics and a wide range of related fields. It provides abstracts of material from 1971 onwards and over 2,000 titles in full text, from 1987 onwards.

* Academic Search Complete

Updated daily, Academic Search Complete is a multi-disciplinary database with full text coverage of almost 4,700 scholarly publications, including full text coverage of over 3,600 peer-reviewed journals dating as far back as 1975.

* Business Source Premier

Full text coverage of nearly 7,600 business publications, including full text coverage of over 1,100 peer-reviewed, scholarly journals. Coverage back to 1922 in some cases.

* Cambridge Journals Online

Cambridge University Press publishes a prestigious list of scholarly journals, ranging across the humanities, social sciences and STM displines, made available electronically through the Cambridge Journals online service.

* Dawsons E-Book Collection

The Online Library has purchased several core text books in electronic format, and the collection is constantly growing. Please note that not all your required textbooks can be provided but we consider all your suggestions.

* Economic and Social Data Service (ESDS)

Brings together a broad range of social and economic data, both qualitative and quantitative.

* EndNote Bibliographic Software

EndNote and Reference Manager Bibliographic software enables you to record and store references to books or journal articles - with additional options such as the facility to generate bibliographies.

* HeinOnline

Hein Online has four major full text collections: the Law Journal Library, covering over 650 titles (including older issues of journals), the Federal Register Library (1936-1998), the Treaties and Agreements Library, and the U.S. Supreme Court Library.

* IngentaConnect |IngentaConnect offers one of the most comprehensive collections of academic and professional research articles online - some 4 million articles from 11,000 publications.

* Journal of Regional Analysis and Policy Full text available from 1971 to present

* JSTOR

A digital archive collection of core scholarly journals. It is unique in that complete archives of these journals have been digitised, starting with the very first issues, many of which were published as far back as the nineteenth century.

* Lexis®Library

Full-text case-law and legislation for the UK, US (Federal and State), EU and other jurisdictions. It also provides access to a large number of full-text legal journals, local and national newspapers and business information, again both from the UK and the rest of the world.

* PsycARTICLES

PsycARTICLES provides full-text scholarly and scientific articles in psychology. The database contains more than 40,000 articles from 56 journals - 45 published by the American Psychological Association (APA) and 11 from allied organizations. It includes all journal articles, letters to the editor and errata from each journal. Coverage spans 1985 to present.

* PsycEXTRA

PsycEXTRA, produced by the American Psychological Association (APA), is a bibliographic and full-text companion to the scholarly PsycINFO database. The document types included are technical, annual and government reports, conference papers, newsletters, magazines, newspapers, consumer brochures and more.

* SAGE Journals Online

SAGE Journals Online is the delivery platform that provides online access to the full text of individual SAGE journals.

* Science Direct

FulL text access to over 70 peer reviewed journals in a wide range of subject areas, including education health, business & management and the social sciences. Abstracts for over 1800 journals can be searched, but full text access is limited to those titles we have selected and paid for.

* Web of Knowledge

ISI Web of Knowledge delivers easy access to high quality, scholarly information in the sciences, social sciences, and arts and humanities.

* Westlaw

Full text UK case law and journals. Also includes UK Civil Procedures, EU cases, treaties and directives, daily alerting service and some material for other jurisdictions such as the USA

* Wiley Online Library

Access an extensive range of quality journals, reference works and Current Protocols online, covering a range of scientific, medical, technical and professional disciplines.

Press Briefing

Press Briefing

World Economic Forum: Global Risks 2011
http://bit.ly/gDhGcO

Kaplan on Tunisia, or, defending autocratic stability
http://themoornextdoor.wordpress.com/2011/01/23/kaplan-on-tunisia-or-autocratic-stability/

MLK Day Refelctions http://goo.gl/fb/b6vkv
 
The Vice President & First Lady Honor Sargent Shriver http://goo.gl/fb/QH2HL

Video: A State of the Union Preview http://goo.gl/fb/3D39k

Find a State of the Union Watch Party Near You http://goo.gl/fb/x9QrM

Weekly Address: "We Can Out-Compete Any Other Nation" http://goo.gl/fb/wdLhQ

Seniors and the Affordable Care Act http://goo.gl/fb/gkh5g


Rush Limbaugh on President Obama's state dinner for Hu Jintao
Radio show, Jan. 20, 2011
http://online.wsj.com/article/SB10001424052748704754304576095892416479506.html

The moral code, the moral compass of the state-controlled media is something to behold. Now, some of you may not know the 2009 Nobel Peace Prize winner hosted a state dinner last night for Hu Jintao of China. Hu Jintao is holding the 2010 Nobel Peace Prize winner in prison in China. Not making it up. The 2009 Nobel Peace Prize winner hosted a dinner for the guy holding the 2010 Nobel Peace Prize winner in prison, and the media does not get the irony of this at all. They're too busy running around chasing Sarah Palin and radio talk show hosts over "civility."

Four of every 10 rows of U.S. corn now go for fuel, not food

Please see commentary at TradeFlow21.com

Amber Waves of Ethanol. WSJ Editorial
Four of every 10 rows of U.S. corn now go for fuel, not food.
WSJ, Jan 22, 2011
http://online.wsj.com/article/SB10001424052748703396604576088010481315914.html

The global economy is getting back on its feet, but so too is an old enemy: food inflation. The United Nations benchmark index hit a record high last month, raising fears of shortages and higher prices that will hit poor countries hardest. So why is the United States, one of the world's biggest agricultural exporters, devoting more and more of its corn crop to . . . ethanol?

The nearby chart, based on data from the Department of Agriculture, shows the remarkable trend over a decade. In 2001, only 7% of U.S. corn went for ethanol, or about 707 million bushels. By 2010, the ethanol share was 39.4%, or nearly five billion bushels out of total U.S. production of 12.45 billion bushels. Four of every 10 rows of corn now go to produce fuel for American cars or trucks, not food or feed.

This trend is the deliberate result of policies designed to subsidize ethanol. Note the surge in the middle of the last decade when Congress began to legislate renewable fuel mandates and many states banned MTBE, which had competed with ethanol but ran afoul of the green and corn lobbies.

This carve out of nearly half of the U.S. corn corp to fuel is increasing even as global food supply is struggling to meet rising demand. U.S. farmers account for about 39% of global corn production and about 16% of that crop is exported, so U.S. corn stocks can influence the world price. Chicago Board of Trade corn March futures recently hit 30-month highs of $6.67 a bushel, up from $4 a bushel a year ago.

Demand from developing nations like China is also playing a role in rising prices, and in our view so is the loose monetary policy of the U.S. Federal Reserve that has increased the price of nearly all commodities traded in dollars.

But reduced corn food supply undoubtedly matters. About 40% of U.S. corn production is used to produce feed for animals. As corn prices rise, beef, poultry and other prices rise, too. The price squeeze has already contributed to the bankruptcy of companies like Texas-based Pilgrim's Pride Corp. and Delaware-based poultry maker Townsends Inc. over the past few years.

This damage coincides with a growing consensus that ethanol achieves none of its alleged policy goals. Ethanol supporters claim the biofuel reduces U.S. dependence on foreign oil and provides a cleaner source of energy. But Cornell University scientist David Pimentel calculates that if the entire U.S. corn crop were devoted to ethanol production, it would satisfy only 4% of U.S. oil consumption.

The Environmental Protection Agency has found that ethanol production has a minimal to negative impact on the environment. Even Al Gore, once an ethanol evangelist, now says his support had more to do with Presidential politics in Iowa and admits the fuel provides little or no environmental gain.

Not that this has changed the politics of ethanol. When consumers didn't buy enough gas last year to meet previous ethanol mandates, the Obama Administration lifted the cap on how much ethanol may be mixed into gasoline to 15% from 10%. Presto! More ethanol "demand." On Friday the EPA greatly expanded the number of cars approved to use the 15% blend. Last month, Congressmen whose constituents benefit from this largesse tucked into the tax bill an extension of the $5 billion tax credit for blending ethanol into gasoline.

At a time when the world will need more corn and grains, it makes no sense to devote scarce farmland to make a fuel that exists only because of taxpayer subsidies and mandates. If food supplies tighten and prices keep rising, such a policy will soon become immoral.

Iranians adjust to increases in fuel – diesel costs 837% more than a month ago

Please see commentary on this and other subjects at TradeFlow21.com

Iranians adjust to increases in fuel – diesel costs 837% more than a month ago

You can request the full WSJ report in the link above.

Press Briefing

Press Briefing

Video: President Obama on the 50th Anniversary of JFK's Inauguration http://goo.gl/fb/AOdS1

Top Tips for Hosting a State of the Union Watch Party http://goo.gl/fb/lNZWi
 
Promises Kept: Civil Rights http://goo.gl/fb/ivYl9
 
Promises Kept: Education http://goo.gl/fb/2F1wK

Promises Kept: National Security http://goo.gl/fb/GcS3c
 
Press Briefing by Press Secretary Robert Gibbs, 1/20/2011 http://goo.gl/fb/k7OcI

First Lady Michelle Obama to Surprise Visitors on White House Tour at 10:45 AM ET… http://goo.gl/fb/Eifi5

Remarks by President Obama and President Hu of the People's Republic of China in an… http://goo.gl/fb/qdNrA

U.S. & China: Building a Positive, Cooperative, and Comprehensive Relationship http://goo.gl/fb/EjIZ8


The Ruling Ad-Hocracy
So much for Dodd-Frank's promise of no more bailouts.
The Wall Street Journal, Friday, January 21, 2011
http://online.wsj.com/article/SB10001424052748704590704576092422321704498.html


Federal regulators have made it official: The 2010 Dodd-Frank law to reform Wall Street has already failed on its most fundamental promise. That was quick.

Over the last week, the new overseers of American finance have confirmed that there could be more "exceptional" market interventions and that regulators will continue to exercise their own discretion to identify "systemic risks." Regulators will also be able to discriminate among creditors and bail out short-term lenders to too-big-to-fail firms, which will be protected from bankruptcy.

A new report from Neil Barofsky, Special Inspector General for the Troubled Asset Relief Program (TARP), underlines the fact-free analysis behind the bailout judgments of 2008. Focusing on one of the biggest of the too-big-to-fail firms, Mr. Barofsky reports that the process by which federal officials decided that Citigroup had to be saved in late 2008 "was strikingly ad hoc. While there was consensus that Citigroup was too systemically significant to be allowed to fail, that consensus appeared to be based as much on gut instinct and fear of the unknown as on objective criteria."

One could make a case that Citigroup was too big to fail, but nobody seems to have made it. Before voting on November 23, 2008 to recommend that Treasury invoke the systemic-risk exception, which allows the Federal Deposit Insurance Corporation to assist an open bank, the FDIC board seems to have relied largely on the judgment of others.

Mr. Barofsky quotes FDIC Chairman Sheila Bair: "We were told by the [Federal Reserve Bank of New York] that problems would occur in the global markets if Citi were to fail. We didn't have our own information to verify this statement, so I didn't want to dispute that with them."

Office of Thrift Supervision Director John Reich voted along with the rest of the FDIC board to help Citi and agreed that it was "obviously a systemic risk situation," but he expressed concern that there had been "some selective creativity exercised in the determination of what is systemic and what's not."

As a result of the FDIC vote and similar judgments at the Fed and Treasury, Citigroup received its second round of federal aid in the space of two months. Having received $25 billion via TARP in October, the company in November received a federal guarantee on some $300 billion of its toxic assets plus another $20 billion from TARP.

Why $20 billion? The company had only asked for the asset guarantee, not the new TARP funds. Henry Paulson, then Secretary of the Treasury, told Mr. Barofsky that he made the decision but "stated that he did not perform any analysis specific to Citigroup in arriving at the $20 billion figure. Rather, he took into consideration the limited amount of TARP funds still available, as well as the prospect that another bank could soon need assistance."

But that was 2008, when according to the Beltway narrative, seat-of-the-pants judgments were needed because regulators had insufficient powers to manage crises. Surely Dodd-Frank fixed all that, right?

Well, not necessarily, according to current Treasury Secretary Tim Geithner, who told Mr. Barofsky that, "In the future we may have to do exceptional things again if we face a shock that large. You just don't know what's systemic and what's not until you know the nature of the shock. It depends on the state of the world—how deep the recession is. We have better tools now, thanks to Dodd-Frank. But you have to know the nature of the shock."

Taxpayers may notice that this message has evolved since last July, when President Obama signed Dodd-Frank and proclaimed, "There will be no more tax-funded bailouts—period."

It's not merely a shift in rhetoric. The new old ad-hocracy was also on display this week in two regulatory decisions. The new Financial Stability Oversight Council chaired by Mr. Geithner once again refused to define exactly what it means to be a systemically significant firm.

In a draft rule, the council said it will take into account things like the size, leverage and "interconnectedness" of firms, but didn't say how big or how leveraged, or what a high degree of interconnectedness means. Oh, and "In addition, the Council would consider any other risk-related factors that the Council deems appropriate, either by regulation or on a case-by-case basis . . ."

So systemically risky will be whatever unelected officials say it is. A financial market in need of bright lines will get only more shades of regulator gray.

Over at the FDIC, meanwhile, the regulators enacted an "interim final" rule on how to manage the failure of systemically significant firms. "Interim" means the FDIC will still accept comments about it from the public, but "final" means the rule is now binding. And the final decision is that when too-big-to-fail firms are handed over to the FDIC instead of to a bankruptcy court, the FDIC can discriminate among creditors and can keep payments flowing to short-term creditors that the agency believes are essential to the operation of the firm.

We think Mr. Barofsky is performing a public service by excavating these 2008 bailout ruins because the time to tighten the rules on too-big-to-fail firms is when the market is calm, not amid a panic. Dodd-Frank was supposed to reduce the odds of back-pocket rescue decisions, but now even its main promoters are admitting that the law gives them enormous discretion to do it all over again, based on little more than their own ad-hoc judgments.

Any Republicans tempted to accept Dodd-Frank as settled law should dig into the details and work to restore the freedom to fail in American finance.

Beijing's leaders have concluded that the U.S. is in decline and that now is the time to seek more global influence

The New Era of U.S.-China Rivalry. By Aaron Friedberg
Beijing's leaders have concluded that the U.S. is in decline and that now is the time to seek more global influence.
WSJ, Jan 17, 2011
http://online.wsj.com/article/SB10001424052748704323204576085013620618774.html

When he meets with President Barack Obama this week, China's paramount leader Hu Jintao will probably be looking to soothe concerns over his country's recent behavior. The last two years have seen a marked increase in tensions between the two Pacific powers, as well as between China and many of its Asian neighbors. In the past 12 months alone Beijing has:

• Shielded North Korea from tough international sanctions, despite Pyongyang's unprovoked sinking of a South Korean naval vessel and deadly shelling of a small island;

• Intensified its long-standing claim to virtually all of the resource-rich South China Sea by suggesting that the region was a "core national interest," a term previously used to refer only to areas (like Tibet and Taiwan) over which China is willing to go to war.

• Declared publicly that, when it comes to resolving competing claims over this region "China is a big country and other countries are small countries, and that's just a fact."

• Threatened for the first time to impose sanctions on U.S. companies that participate in arms sales to Taiwan.

• Conducted unprecedentedly large and complex naval exercises in the waters of the Western Pacific.

• Revealed the existence of a new stealth fighter aircraft.

• Begun initial deployments of a new antiship ballistic missile targeting U.S. aircraft carriers in the Western Pacific.


Not surprisingly, all of this activity has stirred anxiety across Asia, and it has begun to provoke responses from the United States as well. President Obama's recent swing through Asia included stops in India, Indonesia, South Korea and Japan, but it pointedly excluded Beijing. American and Japanese defense officials have since announced their intention to devote more resources to counter China's rising power, and the U.S. and South Korea have enhanced their military cooperation. Despite a history of animosity, Seoul and Tokyo have taken steps in the same direction.

Beijing's behavior has thus triggered reactions that could make it harder to achieve its long-term goal of re-establishing China as the dominant power in East Asia. A well-timed campaign of "smile diplomacy" could help.

But how meaningful will any of this week's theater be? The answer depends in large part on what lies behind China's recent assertiveness. Some Western analysts have sought to explain it away as an incidental by-product of political infighting in the run-up to the planned 2012 leadership succession, or a passing outburst of belligerence by some elements of the People's Liberation Army. Cooler heads have now prevailed, we are told, and they are now trying to put the country back on the less confrontational path it has followed for the past three decades.

Unfortunately, the problem is more deeply rooted than these reassuring assertions suggest. While Chinese leaders may disagree on questions of tactics and timing, there is no reason to believe they differ over fundamental questions of strategy. Beijing may be willing to dial back its rhetoric, but it is not going to abandon its goal of regional preponderance.

Since the start of the 2008-09 financial crisis, many Chinese strategists have concluded that the U.S. is declining, while China is rising much faster than expected. Belief that this is the case has fed an already powerful nationalism that appears to be increasingly widespread, especially among the young.

In this view it is time for China to "stand up," to right some of the wrongs suffered when the country was relatively weak, and to reclaim its rightful role in Asia and the world. Such sentiments are not the exclusive preserve of the military, although it may seek to tap them for its own ends. The rising generation of Chinese leaders cannot afford to ignore these views, and they may well share them.

If this assessment is correct, then the last two years are not a temporary deviation but a portent. Rather than signaling the start of a new interval of cooperation and stability, Hu Jintao's visit may mark the end of an era of relatively smooth relations between the U.S. and China.

Mr. Friedberg is a professor at Princeton University. His new book, "A Contest for Supremacy: China, America and the Struggle for Mastery in Asia" is forthcoming from W.W. Norton.

Can We Boost Demand for Rainfall Insurance in Developing Countries?

Can We Boost Demand for Rainfall Insurance in Developing Countries?
Wold Bank, Jan 05, 2011
http://blogs.worldbank.org/allaboutfinance/node/634

Ask small farmers in semiarid areas of Africa or India about the most important risk they face and they will tell you that it is drought. In 2003 an Indian insurance company and World Bank experts designed a potential hedging instrument for this type of risk—an insurance contract that pays off on the basis of the rainfall recorded at a local weather station.

The idea of using an index (in this case rainfall) to proxy for losses is not new. In the 1940s Harold Halcrow, then a PhD student at the University of Chicago, wrote his thesis on the use of area yield to insure against crop yield losses. In the past two decades the market to hedge against weather risk has grown, especially in developed economies: citrus farmers can insure against frost, gas companies against warm winters, ski resorts against lack of snow, and couples against rain on their wedding day.

Rainfall insurance in developing countries is typically sold commercially before the start of the growing season in unit sizes as small as $1. To qualify for a payout, there is no need to file a claim: policyholders automatically qualify if the accumulated rainfall by a certain date is below a certain threshold. Figure 1 shows an example of a payout schedule for an insurance policy against drought, with accumulated rainfall on the x-axis and payouts on the y-axis. If rainfall is above the first trigger, the crop has received enough rain; if it is between the first and second triggers, the policyholder receives a payout, the size of which increases with the deficit in rainfall; and if it is below the second trigger, which corresponds to crop failure, the policyholder gets the maximum payout. This product has inspired development agencies around the world, and today at least 36 pilot projects are introducing index insurance in developing countries.



Figure 1. Example of a Payout Schedule for an Insurance Policy against Drought

DTheredespite the potentially large welfare benefits, take-up of the product has been disappointingly low. Explanations for this low demand abound. The first and obvious reason is that the product is too expensive relative to the risk coping strategies now used by the farmers. After all, when it is not heavily subsidized (as it is in several states in India), average payouts, which are based on historical rainfall data, amount to about 30–40 percent of the premiums. In a recent paper several coauthors and I estimate that if insurance could be offered with payout ratios similar to those of U.S. insurance contracts, demand would increase by 25–50 percent. But even if prices were close to actuarially fair, demand would not come close to universal participation. So the price cannot be the whole story.

Another explanation is based on liquidity constraints: farmers purchase insurance at the start of the growing season, when there are many competing uses for the limited cash available. In the same paper we randomly assign certain households enough cash to buy one policy and find that this increases take-up by 150 percent of the baseline take-up rate. This effect is several times as large as the effect of cutting the price of the product by half and is concentrated among poor households, which are likely to have less access to the financial system.

In addition, potential buyers may not fully trust the product. Unlike credit, which requires that the lender trust the borrower to repay the loan, insurance requires that the client trust the provider to honor its promise in case of a payout. We measure the importance of trust by varying whether or not the insurance educator visiting households is endorsed by a trusted local agent during the visit. Demand is 36 percent higher when the insurance is offered by a source the household trusts. Trust may be particularly important because many households have only limited numeracy and financial literacy, which is likely to reduce their ability to independently evaluate the insurance.

These results point to several possible improvements in contract design. For example, the trust issue might be overcome by designing a product that pays often initially, since it is easier to sell insurance where a past payout has occurred. Liquidity constraints might be eased by ensuring that payouts are disbursed quickly or by offering loans to pay the premium. Finally, agricultural loans could be bundled with insurance, creating what is in effect a contingent loan, with the amount to be repaid depending on the amount of rainfall. This product was tested in a pilot in Malawi, and to our surprise demand for the bundled loan (17.6 percent uptake) was lower than that for a regular loan (33 percent). The reason may have been that the lender’s inability to penalize defaulting borrowers (in part, because of lack of collateral) was already providing implicit insurance and so farmers did not value the insurance policy.

What is remarkable about the Malawi experience is that after the pilot the lenders decided to bundle all agricultural loans with insurance. In their view, rainfall insurance had proved to be an attractive way to reduce the risk of credit default and had the potential to increase access to agricultural credit at lower prices.

The insurance covers only the loans. But informal discussions with borrowers suggest that they remain largely unaware that the loans are insured. Banks may not be telling borrowers about the insurance, however—because if they did, borrowers would need to know the exact amount of the payout (if any) to compute what they need to repay to the bank. In other words, uncertainty about the payout can undermine the culture of repayment. This happened in the Malawi pilot. One region of the pilot experienced a mild drought that triggered only a small payout. But because farmers were told that there had been a payout, they assumed that it covered the entire repayment amount and thus defaulted on their loans.

This example suggests that where financial literacy and understanding of the product are limited, insurance policies could instead be targeted to a group—such as an entire village, a producer group, or a cooperative—rather than to individuals. The decision to purchase insurance would be made by the group’s managers, who are likely to be more educated and more familiar with financial products than other group members and may also be less financially constrained. The group could then decide ahead of time how best to allocate funds among its members in case of a payout.

Further reading

Giné, X., R. M. Townsend, and J. Vickery. 2007. “Statistical Analysis of Rainfall Insurance Payouts in Southern India.” American Journal of Agricultural Economics 89 (5): 1248–54.

Giné, X., R. Townsend, and J. Vickery. 2008. “Patterns of Rainfall Insurance Participation in Rural India.” World Bank Economic Review 22 (3): 539–66.

Giné, X., and D. Yang. 2009. “Insurance, Credit, and Technology Adoption: Field Experimental Evidence from Malawi.” Journal of Development Economics 89 (1): 1–11.

Cole, S., X. Giné, J. Tobacman, P. Topalova, R. Townsend, and J. Vickery. 2010. “Barriers to Household Risk Management: Evidence from India.” Policy Research Working Paper 5504, World Bank, Washington, DC.

A New Model for Corporate Boards - Companies have too many directors, and not enough of them have experience in the firm's main line of business

A New Model for Corporate Boards. By ROBERT C. POZEN
Companies have too many directors, and not enough of them have experience in the firm's main line of business.
The Wall Street Journal, Thursday, December 30, 2010
http://online.wsj.com/article/SB10001424052748703581204576033430665661032.html


In 2002, Congress passed the Sarbanes-Oxley Act to prevent corporate governance debacles like Enron and WorldCom from happening again. But six years later, many of the largest U.S. institutions had to be rescued by massive federal assistance. All of these institutions were Sarbox-compliant: Most members of their boards were independent, and their auditors' reports showed no material weaknesses in internal controls. So why were the reforms so ineffective?

I believe that the problem is the current structure of corporate boards. In short, they are too big, members often don't have enough relevant experience, and they put too much emphasis on procedure. Complex global companies need a new model. Boards should be comprised of a small group of people with enough pertinent experience and sufficient time to hold management accountable.

The average board size for companies in the S&P 500 was almost 11 in 2009. In groups this large, individual members engage in what psychologists call "social loafing." Instead of taking personal responsibility for the group's actions, they rely on others to take the lead.

Psychologists such as Harvard's Richard Hackman suggest that groups of six or seven are the most effective at decision-making. Groups of this size are small enough for all members to take personal responsibility for the group's actions. They also can take decisive action more quickly than a large board.

Although the Citigroup board in 2007 was filled with many luminaries, only one of the independent directors had ever worked for a financial-services firm. Of course, every board needs a generalist to provide a broad perspective and an accounting expert to head the audit committee. But the rest should have experience in the company's main line of business.

Most boards meet in person every other month for one day, plus conference calls between meetings. That simply isn't enough time to keep abreast of the global operations of a large company. An effective outside director should spend at least two days per month on company business between board meetings. Accordingly, independent directors should be restricted to serving on just two boards of public companies.

In all three respects, this model represents a significant departure from current board practice. Here are some pre-emptive answers to questions that will likely arise from my proposal:

When it comes to finding people with relevant experience, those most qualified to be professional directors often are working for the company's competitors. They obviously couldn't serve on a competitor's board due to conflicts of interest and antitrust concerns. As a result, most independent directors will have to be retired company executives (but not of the company in question). Many executives retire around age 60 in good health and want to continue to work, preferably on a part-time basis. They should serve as directors as long as they are capable, without a requirement for mandatory retirement at 70.

The average compensation of directors in S&P 500 companies is currently $213,000 per year. In this new model, professional directors would be putting in roughly twice the hours, so their total compensation should be approximately $400,000 per year.

To align the interests of professional directors with those of long-term shareholders, these directors should receive 75% of their total compensation in shares, subject to two conditions. First, these shares would vest in equal parts over four years. Second, at least half of the shares would have to be held until retirement.

Since professional independent directors will be more active in supervising the business of the company, will they become subject to increased legal liabilities? For example, if the head of a particular company's audit committee learns a lot about that company's finances, will he or she be personally liable if its financial statements contain material misrepresentations? No. Under federal securities laws, unless the audit head knew of these misrepresentations or recklessly disregarded them, he or she would not be liable.

Under state laws, state courts will override the business judgment of independent directors only if they do not act "in good faith." Because professional directors will be more diligent than today's norm, they will be in a particularly strong position to show that they acted "in good faith."

The most serious objection to my proposed model will probably be the concern that it could blur the distinction between the roles of the board and management. A board of directors has specific duties such as selecting the CEO, plus more general duties such as setting strategic goals. But the board is not supposed to get involved in day-to-day company management.

Although the new model will give greater power to professional directors, it would not empower them to cross the line into the day-to-day operations. Between board meetings, for example, professional directors would talk with managers to better understand the key decisions underlying the company's financial statements and the actual impact of its compensation policies. These sessions wouldn't amount to micromanagement. Instead, they would ensure that critical issues were fully addressed by the relevant board committees.

This new model could get adopted in several ways. First, bank regulators could use their "safety and soundness" authority to force troubled banks to elect professional directors. Second, activist shareholders might join together to pressure a poorly performing company into adopting this model. Finally, a few boards of large companies might be willing to try it out and see how it works.

Regulators, investors and directors should recognize that we do not need more procedures for corporate boards. Instead, we need more expert directors who view their board services as their primary profession—not an avocation.

Mr. Pozen is chairman emeritus of MFS Investment Management and a senior lecturer at Harvard Business School. This op-ed was adapted from an article appearing in the December 2010 issue of the Harvard Business Review.

Press Briefing

Jan 13, 2011

Video: President Obama: Memorial in Arizona http://goo.gl/fb/VcCCk

Remarks by Vice President Biden and Prime Minister Gilani of Pakistan http://goo.gl/fb/f57o3

Readout of the President's Meeting with Prime Minister Hariri of Lebanon http://goo.gl/fb/jGBNc

Readout of the President’s call to King Abdullah of Saudi Arabia http://goo.gl/fb/n215n

Letter from the President regarding the Cuban Liberty and Democratic Solidarity http://goo.gl/fb/f4usj

Statement by President Barack Obama on the One Year Anniversary of the Earthquake in Haiti http://goo.gl/fb/ykrE0

Remarks by Vice President Biden and President Karzai of Afghanistan After Meeting http://goo.gl/fb/EnTsi

Special Inspector General for Afghanistan Reconstruction Submits Resignation http://goo.gl/fb/oxwyx

President Obama on Tucson, Grief & Courage http://goo.gl/fb/unDA1

Remarks by President Obama and President Sarkozy of France after Bilateral Meeting http://goo.gl/fb/tIAOX


Gulf Political Spill. WSJ Editorial
Obama's commission indicts an industry, without evidence.
WSJ, Jan 13, 2011
http://online.wsj.com/article/SB10001424052748703791904576076012106308644.html

President Obama's drilling commission released its 398-page report on the causes of the Gulf oil spill this week, and talk about a lost opportunity. After six months of hearings and interviews, the commission still doesn't know what caused the accident but does think it knows enough to condemn all and sundry.

The disaster, we are told, was primarily the result of "overarching failure of management" by BP, Transocean and Halliburton—which is hardly news to anyone who's been paying attention. Yet the commission didn't stop with the companies that managed the Macondo well, going on to blame the highly unusual blowout on a "system-wide problem" of failed regulation and a complacent industry that requires "significant reform."

These sweeping conclusions are remarkable from a commission that admits to knowing so little. The report cites several questionable decisions made by Macondo drillers as the "immediate causes" of the blowout, only to acknowledge it can't say which, if any, were the cause:

• "It is not clear whether the decision to use a long string well design contributed directly to the blowout."

• "The evidence to date does not unequivocally establish whether the failure to use 15 additional centralizers was a direct cause of the blowout."

•"Whether . . . 'unconverted' float valves contributed to the eventual blowout, has not yet been, and may never be, established with certainty."

Unable to name what definitely caused the well failure, the commission resorts to a hodgepodge of speculations. Adding to the confusion, it acknowledges it could find no evidence that BP or its contractors "consciously chose a riskier alternative because it would cost the company less money." The commission didn't even wait to get an autopsy of the failed blowout preventer, which is rusting on a Louisiana dock.

The report's one firm conclusion boils down to this: In the hours preceding the explosion, crew members missed "critical signs" that something was wrong. "The crew could have prevented the blowout—or at least significantly reduced its impact—if they had reacted in a timely and appropriate manner." This is called human error, in this case with tragic consequences to those who erred.

Yet it's hardly evidence that the entire drilling industry is an accident waiting to happen, as the commission insists. Its section "The Root Causes: Failures in Industry and Government" uses questionable decisions made by the Macondo players to suggest, with no evidence, that such behavior is the industry norm.

The report fails to reconcile this indictment with the industry's prior safety record, or with the fact that many countries have modeled their drilling technology and practices on those of the Gulf. For a better account of how unusual the Macondo practices were, we recommend the June 11, 2010 letter to the editor in this newspaper from Terry Barr, the president of Samson Oil and Gas.

The commission nonetheless offers an array of recommendations, most of which would severely restrict oil and gas drilling. Despite President Obama's promises that the new Bureau of Ocean Management (formerly the Minerals and Management Service) is now a shipshape regulator, the commission recommends that Congress create another agency to supervise drilling. Now, there's a new idea—another layer of bureaucracy to supervise the bureaucracy that failed.

The report also advocates toughening the National Environmental Policy Act to make it harder for companies to obtain drilling leases. Another section doubts it is possible ever to drill safely in Alaska or the Arctic—a hardy perennial of the anti-oil lobby.

This was all too predictable given the political history of commission members. Former Democratic Senator Bob Graham fought drilling off Florida, William Reilly is the former head of the antidrilling World Wildlife Fund, and Frances Beinecke ran the Natural Resources Defense Council, which is opposed to carbon fuels. Not a single member was a drilling engineer or expert in oil exploration technology or practices.

Compare this to the Rogers Commission, which investigated the Challenger space shuttle disaster of 1986. Led by former Secretary of State William P. Rogers, that group included theoretical and solar physicists, engineers and aeronautics specialists. The commission located the exact cause of the disaster (failed O-rings) and prescribed precise safety changes. The preface of the Rogers report states that the only way to deal with such a failure is to investigate, correct and "continue the program with renewed confidence and determination."

***

The unbalanced, tendentious nature of the commission report vindicates those who suspected from the start that this was all a political exercise. The White House has been pounded on the left for agreeing to ease drilling restrictions before the spill, and now it is looking for support to walk that back. Though the Administration officially lifted its Gulf drilling moratorium and issued new safety rules two months ago, it has refused to permit a single new well.

U.S. gasoline prices are now above $3 a gallon, and the decline in Gulf drilling will not help supply. Forecasters predict domestic production will fall at least 13% this year due in part to the Gulf lockdown. Meanwhile, last week the British Parliament rejected a drilling moratorium in U.K. waters on grounds it would cause "expertise to migrate," decrease "security of supply" and harm the British economy.

The BP spill was a tragedy that should be diagnosed with a goal of preventing a repeat, not in order to all but shut down an industry that is vital to U.S. energy supplies and the livelihood of millions on the Gulf Coast.

Amy Chua: Why Chinese Mothers Are Superior

_                               ---advertisement---

Please check commentary at TradeFlow21.com

_                               ---advertisement---



Why Chinese Mothers Are Superior. BY AMY CHUA
Can a regimen of no playdates, no TV, no computer games and hours of music practice create happy kids? And what happens when they fight back?The Wall Street Journal Life & Culture, Saturday, January 8, 2011
http://online.wsj.com/article/SB10001424052748704111504576059713528698754.html

A lot of people wonder how Chinese parents raise such stereotypically successful kids. They wonder what these parents do to produce so many math whizzes and music prodigies, what it's like inside the family, and whether they could do it too. Well, I can tell them, because I've done it. Here are some things my daughters, Sophia and Louisa, were never allowed to do:

• attend a sleepover

• have a playdate

• be in a school play

• complain about not being in a school play

• watch TV or play computer games

• choose their own extracurricular activities

• get any grade less than an A

• not be the No. 1 student in every subject except gym and drama

• play any instrument other than the piano or violin

• not play the piano or violin.

I'm using the term "Chinese mother" loosely. I know some Korean, Indian, Jamaican, Irish and Ghanaian parents who qualify too. Conversely, I know some mothers of Chinese heritage, almost always born in the West, who are not Chinese mothers, by choice or otherwise. I'm also using the term "Western parents" loosely. Western parents come in all varieties.

All the same, even when Western parents think they're being strict, they usually don't come close to being Chinese mothers. For example, my Western friends who consider themselves strict make their children practice their instruments 30 minutes every day. An hour at most. For a Chinese mother, the first hour is the easy part. It's hours two and three that get tough.

Despite our squeamishness about cultural stereotypes, there are tons of studies out there showing marked and quantifiable differences between Chinese and Westerners when it comes to parenting. In one study of 50 Western American mothers and 48 Chinese immigrant mothers, almost 70% of the Western mothers said either that "stressing academic success is not good for children" or that "parents need to foster the idea that learning is fun." By contrast, roughly 0% of the Chinese mothers felt the same way. Instead, the vast majority of the Chinese mothers said that they believe their children can be "the best" students, that "academic achievement reflects successful parenting," and that if children did not excel at school then there was "a problem" and parents "were not doing their job." Other studies indicate that compared to Western parents, Chinese parents spend approximately 10 times as long every day drilling academic activities with their children. By contrast, Western kids are more likely to participate in sports teams.

What Chinese parents understand is that nothing is fun until you're good at it. To get good at anything you have to work, and children on their own never want to work, which is why it is crucial to override their preferences. This often requires fortitude on the part of the parents because the child will resist; things are always hardest at the beginning, which is where Western parents tend to give up. But if done properly, the Chinese strategy produces a virtuous circle. Tenacious practice, practice, practice is crucial for excellence; rote repetition is underrated in America. Once a child starts to excel at something—whether it's math, piano, pitching or ballet—he or she gets praise, admiration and satisfaction. This builds confidence and makes the once not-fun activity fun. This in turn makes it easier for the parent to get the child to work even more.

Chinese parents can get away with things that Western parents can't. Once when I was young—maybe more than once—when I was extremely disrespectful to my mother, my father angrily called me "garbage" in our native Hokkien dialect. It worked really well. I felt terrible and deeply ashamed of what I had done. But it didn't damage my self-esteem or anything like that. I knew exactly how highly he thought of me. I didn't actually think I was worthless or feel like a piece of garbage.

As an adult, I once did the same thing to Sophia, calling her garbage in English when she acted extremely disrespectfully toward me. When I mentioned that I had done this at a dinner party, I was immediately ostracized. One guest named Marcy got so upset she broke down in tears and had to leave early. My friend Susan, the host, tried to rehabilitate me with the remaining guests.

The fact is that Chinese parents can do things that would seem unimaginable—even legally actionable—to Westerners. Chinese mothers can say to their daughters, "Hey fatty—lose some weight." By contrast, Western parents have to tiptoe around the issue, talking in terms of "health" and never ever mentioning the f-word, and their kids still end up in therapy for eating disorders and negative self-image. (I also once heard a Western father toast his adult daughter by calling her "beautiful and incredibly competent." She later told me that made her feel like garbage.)

Chinese parents can order their kids to get straight As. Western parents can only ask their kids to try their best. Chinese parents can say, "You're lazy. All your classmates are getting ahead of you." By contrast, Western parents have to struggle with their own conflicted feelings about achievement, and try to persuade themselves that they're not disappointed about how their kids turned out.

I've thought long and hard about how Chinese parents can get away with what they do. I think there are three big differences between the Chinese and Western parental mind-sets.

First, I've noticed that Western parents are extremely anxious about their children's self-esteem. They worry about how their children will feel if they fail at something, and they constantly try to reassure their children about how good they are notwithstanding a mediocre performance on a test or at a recital. In other words, Western parents are concerned about their children's psyches. Chinese parents aren't. They assume strength, not fragility, and as a result they behave very differently.

For example, if a child comes home with an A-minus on a test, a Western parent will most likely praise the child. The Chinese mother will gasp in horror and ask what went wrong. If the child comes home with a B on the test, some Western parents will still praise the child. Other Western parents will sit their child down and express disapproval, but they will be careful not to make their child feel inadequate or insecure, and they will not call their child "stupid," "worthless" or "a disgrace." Privately, the Western parents may worry that their child does not test well or have aptitude in the subject or that there is something wrong with the curriculum and possibly the whole school. If the child's grades do not improve, they may eventually schedule a meeting with the school principal to challenge the way the subject is being taught or to call into question the teacher's credentials.

If a Chinese child gets a B—which would never happen—there would first be a screaming, hair-tearing explosion. The devastated Chinese mother would then get dozens, maybe hundreds of practice tests and work through them with her child for as long as it takes to get the grade up to an A.

Chinese parents demand perfect grades because they believe that their child can get them. If their child doesn't get them, the Chinese parent assumes it's because the child didn't work hard enough. That's why the solution to substandard performance is always to excoriate, punish and shame the child. The Chinese parent believes that their child will be strong enough to take the shaming and to improve from it. (And when Chinese kids do excel, there is plenty of ego-inflating parental praise lavished in the privacy of the home.)

Second, Chinese parents believe that their kids owe them everything. The reason for this is a little unclear, but it's probably a combination of Confucian filial piety and the fact that the parents have sacrificed and done so much for their children. (And it's true that Chinese mothers get in the trenches, putting in long grueling hours personally tutoring, training, interrogating and spying on their kids.) Anyway, the understanding is that Chinese children must spend their lives repaying their parents by obeying them and making them proud.

By contrast, I don't think most Westerners have the same view of children being permanently indebted to their parents. My husband, Jed, actually has the opposite view. "Children don't choose their parents," he once said to me. "They don't even choose to be born. It's parents who foist life on their kids, so it's the parents' responsibility to provide for them. Kids don't owe their parents anything. Their duty will be to their own kids." This strikes me as a terrible deal for the Western parent.

Third, Chinese parents believe that they know what is best for their children and therefore override all of their children's own desires and preferences. That's why Chinese daughters can't have boyfriends in high school and why Chinese kids can't go to sleepaway camp. It's also why no Chinese kid would ever dare say to their mother, "I got a part in the school play! I'm Villager Number Six. I'll have to stay after school for rehearsal every day from 3:00 to 7:00, and I'll also need a ride on weekends." God help any Chinese kid who tried that one.

Don't get me wrong: It's not that Chinese parents don't care about their children. Just the opposite. They would give up anything for their children. It's just an entirely different parenting model.

Here's a story in favor of coercion, Chinese-style. Lulu was about 7, still playing two instruments, and working on a piano piece called "The Little White Donkey" by the French composer Jacques Ibert. The piece is really cute—you can just imagine a little donkey ambling along a country road with its master—but it's also incredibly difficult for young players because the two hands have to keep schizophrenically different rhythms.

Lulu couldn't do it. We worked on it nonstop for a week, drilling each of her hands separately, over and over. But whenever we tried putting the hands together, one always morphed into the other, and everything fell apart. Finally, the day before her lesson, Lulu announced in exasperation that she was giving up and stomped off.

"Get back to the piano now," I ordered.

"You can't make me."

"Oh yes, I can."

Back at the piano, Lulu made me pay. She punched, thrashed and kicked. She grabbed the music score and tore it to shreds. I taped the score back together and encased it in a plastic shield so that it could never be destroyed again. Then I hauled Lulu's dollhouse to the car and told her I'd donate it to the Salvation Army piece by piece if she didn't have "The Little White Donkey" perfect by the next day. When Lulu said, "I thought you were going to the Salvation Army, why are you still here?" I threatened her with no lunch, no dinner, no Christmas or Hanukkah presents, no birthday parties for two, three, four years. When she still kept playing it wrong, I told her she was purposely working herself into a frenzy because she was secretly afraid she couldn't do it. I told her to stop being lazy, cowardly, self-indulgent and pathetic.

Jed took me aside. He told me to stop insulting Lulu—which I wasn't even doing, I was just motivating her—and that he didn't think threatening Lulu was helpful. Also, he said, maybe Lulu really just couldn't do the technique—perhaps she didn't have the coordination yet—had I considered that possibility?

"You just don't believe in her," I accused.

"That's ridiculous," Jed said scornfully. "Of course I do."

"Sophia could play the piece when she was this age."

"But Lulu and Sophia are different people," Jed pointed out.

"Oh no, not this," I said, rolling my eyes. "Everyone is special in their special own way," I mimicked sarcastically. "Even losers are special in their own special way. Well don't worry, you don't have to lift a finger. I'm willing to put in as long as it takes, and I'm happy to be the one hated. And you can be the one they adore because you make them pancakes and take them to Yankees games."

I rolled up my sleeves and went back to Lulu. I used every weapon and tactic I could think of. We worked right through dinner into the night, and I wouldn't let Lulu get up, not for water, not even to go to the bathroom. The house became a war zone, and I lost my voice yelling, but still there seemed to be only negative progress, and even I began to have doubts.

Then, out of the blue, Lulu did it. Her hands suddenly came together—her right and left hands each doing their own imperturbable thing—just like that.

Lulu realized it the same time I did. I held my breath. She tried it tentatively again. Then she played it more confidently and faster, and still the rhythm held. A moment later, she was beaming.

"Mommy, look—it's easy!" After that, she wanted to play the piece over and over and wouldn't leave the piano. That night, she came to sleep in my bed, and we snuggled and hugged, cracking each other up. When she performed "The Little White Donkey" at a recital a few weeks later, parents came up to me and said, "What a perfect piece for Lulu—it's so spunky and so her."

Even Jed gave me credit for that one. Western parents worry a lot about their children's self-esteem. But as a parent, one of the worst things you can do for your child's self-esteem is to let them give up. On the flip side, there's nothing better for building confidence than learning you can do something you thought you couldn't.

There are all these new books out there portraying Asian mothers as scheming, callous, overdriven people indifferent to their kids' true interests. For their part, many Chinese secretly believe that they care more about their children and are willing to sacrifice much more for them than Westerners, who seem perfectly content to let their children turn out badly. I think it's a misunderstanding on both sides. All decent parents want to do what's best for their children. The Chinese just have a totally different idea of how to do that.

Western parents try to respect their children's individuality, encouraging them to pursue their true passions, supporting their choices, and providing positive reinforcement and a nurturing environment. By contrast, the Chinese believe that the best way to protect their children is by preparing them for the future, letting them see what they're capable of, and arming them with skills, work habits and inner confidence that no one can ever take away.

—Amy Chua is a professor at Yale Law School and author of "Day of Empire" and "World on Fire: How Exporting Free Market Democracy Breeds Ethnic Hatred and Global Instability." This essay is excerpted from "Battle Hymn of the Tiger Mother" by Amy Chua, to be published Tuesday by the Penguin Press, a member of Penguin Group (USA) Inc. Copyright © 2011 by Amy Chua.

Macro-prudential regulation and the false promise of Basel III

Financial regulation goes global - Risks for the world economy
Legatum Institute
http://www.li.com/attachments/20101228_LegatumInstitute_FinancialRegulationGoesGlobal.pdf
Dec 29, 2010

Excerpts with footnotes:

4. How internationalised regulation can lead to a new crisis

We are witnessing a movement towards tighter regulation of world financial markets and also towards regulation that is more closely harmonised across the leading industrial economies. That is no accident, as the G20 communiqué pledged that:

“We each agree to ensure our domestic regulatory systems are strong. But we also agree to establish the much greater consistency and systematic cooperation between countries, and the framework of internationally agreed high standards, that a global financial system requires.”

Policymakers seem to believe that insufficient regulation, not just ineffective regulation, is to blame for the financial crisis. Moreover, they also want regulations to be more consistent across different countries and intend to further internationalise financial regulation.

However, there are a number of weaknesses, in principle and practice, with the regulations that have been proposed, that might mean they exacerbate future periods of boom and bust.

4.1 Global regulations create global crises

The central argument in favour of supranational regulation is the possibility of financial contagion. Policymakers do not want their own financial systems put at risk by regulatory failures elsewhere. However, with the present crisis emerging in major developed economies, it is hard to justify the sudden focus on the possibility of contagion. Many countries, such as Canada, did maintain stable financial systems despite collapses elsewhere. The contagion from the subprime crisis in the United States was a serious problem only because financial sectors in other major economies had made similar mistakes and become very vulnerable.

To be sure, an economy will suffer if its trading partners get into trouble. There will be a smaller market for their exports, imports might become more expensive or more difficult to get hold of, and supply chains can be disrupted. But that can happen for a range of reasons: a bad harvest, war, internal political strife, a recession not driven by a financial crisis. The financial sector is not unique in that regard.

There is also concern about a “race to the bottom”. As Stephen G. Cecchetti – Economic Adviser and Head of Monetary and Economic Department at the Bank for International Settlements – wrote, it is felt to be necessary to “make sure national authorities are confident that they will not be punished for their openness”.18 Concerns that countries will be punished for proper regulation are overblown. There are powerful network effects in financial services that mean many institutions are located in places like New York, London and Frankfurt despite those locations having high costs. While smaller institutions like hedge funds may move more lightly, big banks and other systemically important institutions need to be located in a major financial centre. At the same time, they do attach some importance to a reliable financial system. Countries are more likely to be punished for bad policy – e.g. the new 50 percent top tax rate in the United Kingdom – than for measures genuinely necessary to ensure financial stability.

At the same time, the coordination of regulatory policies creates new risks and exacerbates crises.  Common capital adequacy rules, while increasing transparency, also encourage homogeneity in investment strategy and undertaking of risk, leading to a high concentration of risk. That means that global regulations can be dangerous because they increase the amplitude of global credit cycles. If every country is in phase, systemic risk is higher than in situations where there are offsetting, out of phase, credit booms and busts in individual countries. The situation is akin to a monoculture, a lack of diversity makes the whole crop more vulnerable.

The Basel rules use a similar risk assessment framework across a broad range of institutions which encourages them to hold similar assets and respond in similar ways in a crisis.19 Consequently, instead of increasing diversification of assets and minimising risk, herd behaviour is amplified.20

The recession that followed the financial crisis was undoubtedly sharper because it was global. That meant countries were hit simultaneously by their own crisis and a fall in global demand hurting export industries. There were also more simultaneous pressures on global financial institutions. Global regulations, reducing diversity in investment decisions and behaviour in a crisis, will tend to produce global crises when they go wrong. As a result, internationalising regulations increases the danger to the world economy.

The objective should be to strike a proper balance between standardisation and diversity in regulations. Unfortunately, there are reasons why politicians might go too far in standardising regulations. Politicians in countries with burdensome regulations are tempted to force others into adopting equally burdensome measures, in order to prevent yardstick competition and limit the ability of firms and individuals to vote with their feet. A well known example of this is attempts to curb tax competition by organisations such as the OECD and the European Union. Finally, for some, international summits are more comfortable than messy, democratic domestic politics.

4.2 Macro-prudential regulation and the false promise of Basel III

The economic profession’s understanding of the role of financial regulation is shifting from an insistence on micro-prudential regulation to measures which take into account the systemic risks involved in finance.  The new paradigm suggests that a policy approach that tries to make the system safe by making each of the individual financial institutions safe is doomed to fail because of the endogenous nature of risk and because of the interactions between different financial institutions.21

Many of the proposed regulatory changes seem to be inspired – at least in part – by the idea that macro-prudential regulation will require a move away from a regulatory regime that does not take into account the endogenous nature of risk. Unfortunately, the form that the international harmonisation of regimes of financial regulation is taking fails to mitigate excessive leverage in good economic times.

A related question is whether the endogenous nature of risk enables this new regulatory paradigm to succeed at all. Most importantly, caring about systemic risk requires the regulator to identify – explicitly or implicitly – those financial institutions that are systemically important – either individually or in “herds”. Provided that this information can be discovered by the banks or becomes common knowledge, systemically important institutions will know that they will not be allowed to fail.  This would create a large moral hazard problem and could represent a key structural flaw that compromises the whole idea of macro-prudential financial regulation.

At the same time, there might be no need for shifting regulations in the macro-prudential direction, especially if the crisis is the result of regulatory and policy failure as set out in Section 1. Policymakers would just need to abstain from policies similar to those that fuelled the boom leading to this crisis. Of course, a greater need for macro-prudential policy and avoiding specific regulatory and policy failure are not mutually exclusive. It is easy to imagine a regulatory environment that combines more attention to the macroeconomic dimension of financial markets; a more prudent monetary policy that becomes contractionary during periods of rapid economic expansions, and sectoral policies that do not encourage asset bubbles.22

However, the regulation of financial markets is taking a path that could exacerbate future booms and busts – in sharp contrast both to the declared intentions of policymakers and to the underlying idea of macro-prudential regulation.

Our criticism of the Basel rules and of the harmonisation of financial regulation needs to be distinguished sharply from the concerns raised by the banking community, which usually point out the costs that would be involved in raising capital adequacy standards. The Institute of International Finance, for instance, has conducted a study of the effects of likely regulatory reform on the broader economy.23 The models used by the study are based on a relatively simple logic. Higher capital ratios require banks to raise more capital, putting an upward pressure on the cost of capital. In turn, this increases lending rates and reduces the aggregate supply of credit to the economy, lowering aggregate employment and GDP.

On that basis, the paper estimates the costs of adopting a full regulatory reform at an average of about 0.6 percentage points of GDP over the period 2011-2015 and an average of about 0.3 percentage points of GDP for the ten year period, 2011-2020. With a different set of assumptions, the Basel Committee estimates the costs to be much smaller. But whether this is a cost worth bearing depends on what the regulatory reform would achieve. If the output gap is a price to pay for an adequate reduction in the likelihood of future crises – and a reduction in the amplitude of business cycles – then it might be worth paying. Unfortunately, the regulatory reform which we are likely to get is unlikely to achieve that.

Firstly, in spite of claims to the contrary, much of the re-regulation simply increases the procyclicality which was characteristic of banking regulation under Basel II. Indeed, Basel III increases the requirements for tier 1 capital to a minimum of 6 percent and the share of common equity to a total of 7.0 percent.  And on top of that it introduces a countercyclical buffer of 0-2.5 percent. Yet, that buffer cannot offset the procyclical effect of the increased capital requirements.

We should stress that the problem with Basel III rules is not the absolute size of capital adequacy requirements but the fact that they are based on the borrower’s default risk. Hence, riskier assets need to be backed by a larger capital buffer than less risky ones. During times of crisis, the overall riskiness of extending loans increases and banks will therefore have an incentive to increase the amount of capital which they are holding relative to the total size of their risk-weighted assets. An extreme reaction to economic downturn would thus consist of dumping the riskier assets on the financial market, in the hope of restoring the required capital adequacy ratio, exacerbating the economic downturn and possibly triggering a credit crunch. Conversely, in good economic times, when the measured riskiness of individual loans has decreased, banks will be tempted to hold less capital relative to their other assets and will thus be tempted to fuel a potential lending boom.

A related issue is that current measures of risk – which are used as the basis for the risk-weighted capital adequacy rules – are highly imperfect. In a nutshell, highly-rated assets can be leveraged much more heavily than riskier assets, which is a problem if those ratings are not necessarily accurate. Lending to triple- A-rated sovereigns still carries a risk-weight of zero. As the present fiscal crisis in Europe suggests, exposure to triple-A-rated debt is certainly not risk free.  Basel III complements the capital adequacy rules by simple – not risk weighted – leverage ratio limits.  However, looking at the past data, there is little reason to believe that these will be effective in preventing future crises. In fact, risk-adjusted and simple balance sheet leverage ratios both show stable bank leverage until the onset of the crisis.24

Similarly, mark-to-market valuation practices are very problematic for assets where markets have become illiquid, and yield valuations that are both very low and uncertain. In times of crisis, this can give rise to serious consequences for companies that report mark-to-market valuations on their balance sheets. For that reason, mark-to-market valuations can exacerbate the effects of economic downturns.

Furthermore, Basel III will contain new, stricter, definitions of common equity, Tier 1 capital and capital at large. In principle, there is nothing wrong with being pickier when selecting the capital assets to use as a buffer when running a bank. It might indeed be prudent to use only common stock and not preferred stock and/or debt-equity hybrids that are permissible under Basel II. However, imposing a common notion of capital on banks and financial institutions worldwide is more likely to make their por tfolios similar and will therefore increase the co-movement existing between their liquidity – or lack thereof – at any given point in time.

A common definition of capital and a similar composition of bank capital across the world will also create incentives for regulators to synchronise monitoring. Such moves are already on their way within the EU – especially in the light of the establishment of common institutions for financial regulation – in spite of the fact that the business cycles in different parts of Europe are not synchronised.

Finally, we should recognise that tighter financial regulation has its unintended consequences. In the past, we have witnessed companies’ moving complex, highly leveraged, instruments off their balance sheets. Much of the financial activity moved – both geographically and sector-wise – to areas which were less heavily regulated. This included moving activities away from the banking industry into, say, hedge funds. And this also includes moving financial activities to jurisdictions that are friendlier to the financial industry. According to the Financial Times25, in the past two years, almost 1,000 hedge fund employees moved from the UK to Swiss cantons, seeking regulatory and fiscal predictability.  Insofar as the move towards harmonised financial regulation is imperfect – and so long as there remain jurisdictions and areas of finance that are regulated less heavily – there will be a relocation of financial activities towards these jurisdictions and areas of activity. The corollary is that overly tight regulation can create a situation in which much of the actual financial activity is taking place outside of the government supervision which is intended to curb their alleged excesses.

4.3 Crisis as alibi, symbolic politics

Many of the measures that are part of the G20 agenda are completely irrelevant to any ambition one could possibly have to mitigate systemic risks in the world economy. For instance, the idea that “tax havens” and banking secrecy are among the issues that contributed to the financial crisis is completely unfounded. If anything, tax competition could curb some of the excesses of the big, fiscally irresponsible, welfare states by making it difficult for governments to impose too onerous fiscal burdens on mobile tax bases. It is thus clear that for politicians in high-tax countries, the present crisis has served as an alibi to push forward a variety of measures which they have demonstrated an interest in implementing but lacked a plausible justification.26

In many respects, regulating short-selling is similar. Short-selling cannot be blamed for the financial crisis, just as it cannot be blamed for the Greek debt crisis that occurred earlier this year. Indeed, short-selling is critical in reflecting new, often pessimistic, information about the asset in question into a market price. Enabling European regulators to prohibit short-selling in specific situations – presumably in situations when doubts arise about the ability of a European country to repay its debt obligations – will do nothing to address the underlying problems of fiscal irresponsibility. It is just an illustration of a mentality that pretends that shooting the messenger is an appropriate response to the fiscal problems of the Eurozone. The direct cost of this policy is that it will introduce noise into the functioning of financial markets and will make them process new information less efficiently.

Besides taxation and short-selling, there have been coordinated moves to regulate hedge funds, both in the United States and in Europe. While this might make sense from a macro-prudential perspective, particularly if it is the case that some of the hedge funds are of systemic importance, we should recognise that hedge funds were the victim, not the perpetrator, in the recent crisis.  There have been a series of measures that governments have been eager to take for a long time and for which the crisis provided a convenient ad hoc justification, that are now part of the coordinated re-regulation of financial markets in the United States and in Europe. This includes, for instance, the creation of systemic risk boards – as if creation of such institutions would in itself be an improvement over the present situation. Creating a new bureau does not endow the regulators with a superior model of the economy and certainly does not mean that they will be able to do better forecasts than the regulators of the past.

Likewise, the creation of consumer protection boards is unlikely to have a significant effect, besides creating a false sense of security among the general public. After all, the crisis was not caused by uninformed consumers’ falling prey to – say – credit card companies. While instances of individuals making bad decisions regarding their indebtedness certainly exist, they were in most cases a rational response to the wider institutional environment in which they were operating, and which made it worthwhile, for instance, to use one’s house as a piggybank. Furthermore, there is evidence that some of the measures aiming at protecting consumers can in fact exacerbate moral hazard and strengthen the incentives for irresponsible behaviour.27

Finally, the issue of executive pay is high on the list of priorities for policymakers across the globe, again without a credible explanation of how that would contribute to the prevention of future crises. Major proponents of macroprudential regulation – such as the authors of the Geneva report – argue that there is very little reason for regulators to get involved in the decisions of private firms over executive compensation. Rather, as Charles Wyplosz says, “macro-prudential regulation will push banks to develop incentive packages that are more encouraging of longer-term behaviour.”28



Footnotes:

18 Cecchetti, S. G. “Financial reform: a progress report.” Remarks prepared for the Westminster Economic Forum, National Institute of Economic and Social Research, 4 October 2010.
19 Eatwell, J. The New International Financial Architecture: Promise or Threat? Cambridge Endowment for Research in Finance, 22 May 2002.
20 Daníelsson, J. & J.-P. Zigrand. What Happens when You Regulate Risk? Evidence from a Simple Equilibrium Model. April 2003.
21 For an exposition of the ideas behind this approach to financial regulation see Hanson, Kashyap and Stein (2010): “A Macroprudential Approach to Financial Regulation.” Journal of Economic Perspectives, forthcoming.
22 In this endeavour, targeting nominal GDP instead of inflation might be instrumental, as Scott Sumner, David Beckworth, George Selgin and others have argued.
23 IIF (2010). Interim Report on the Cumulative Impact on the Global Economy of Proposed Changes in the Banking Regulatory Framework. http://www.ebf-fbe.eu/uploads/10-Interim%20NCI_June2010_Web.pdf
24 See Joint FSF-CGFS Working Group (2009). The role of valuation and leverage in procyclicality. http://www.bis.org/publ/cgfs34.htm
25 FT. “Hedge funds managers seek predictability.” October 1, 2010. Available at: http://www.ft.com/cms/s/0/557f55d4-cd93-11df-9c82-00144feab49a.html
26 Indeed, the OECD has been running its program on harmful tax practices since 1998.
27 We discuss the specific case of the CARD Act in the United States in Rohac, D. (2010). “The high costs of consumer protection.” The Washington Times, September 3, 2010.
28 Wyplosz, C. (2009). “The ICMB-CEPR Geneva Report: ‘The future of financial regulation.’” VoxEU, January 27, 2009. http://www.voxeu.org/index.php?q=node/2872