Profiting from Regulation

Here's Tyler Cowen at Marginal Revolution discussing why simply breaking up the banks may not prevent a future crisis and how they may not actually be the centers of power they are made out to be in the popular imagination:

it's our government deciding to assemble a cooperative ruling coalition - which includes banks -- at the heart of its fiscal core. It's our government deciding who belongs to this coalition and who does not, mostly for reasons of political expediency and also a perception - correct or not -- of what is best for the welfare of American voters....

Ask yourself the simple question: who has both the guns and the money, including the ability to print new money at zero cost? It's Washington, not the private banks.

It's easy, and probably wrong, to simply dismiss such a notion as too conspiratorial. As luck would have it, on the same day I read Cowen's post, my google reader also included blogger Matthew Yglesias discussing the modest profit margin of Wal Mart.

Yglesias compared the profits of Wal Mart to other industries, produced a chart of the comparison and came to this conclusion:

Wal-Mart’s total profits are enormous because the company is so large. But mass-market retail is not a high-margin line of business ...

At any rate, looking at this chart I think it’s hard to avoid the conclusion that Wal-Mart is the last thing we should be worried about. The worrying trend is the domination of the corporate landscape by super-profitable firms in the heavily regulated energy, banking, and telecom sectors.

Maybe Cowen's on to something here.

Got Rent? Raw milk and rent-seeking

Wisconsin resident Sean Scallon at the @TAC blog covers last week's hearing in Eau Claire concerning the sale of raw milk. In the strange bedfellows joined in support of raw milk, Scallon sees a possible manifestation of the "freedom movement" and makes a good point about a split among libertarians, which seems to follow the coastal vs. national interior fault lines that run through so much of our culture.

But it was this item that really stood out for me:

And yet who stands in opposition? Government bureaucrats and the big farmer, big agribusiness dominated Farm Bureau. One wishes to regulate behavior and the other wishes to regulate out of existence a product that may cut in on their business. A state ag department that doesn’t have enough inspectors to monitor large farm operations and the manure finds it does have personnel to go after the little guy and his tank of raw milk on his small farm. [EA]

When business seeks to increase or protect profits through political influence rather than innovation in the marketplace we have rent-seeking. This behavior is absolutely corrosive to a free-market system. It hurts producers by keeping them out or running them out of business. It hurts consumers through fewer choices, less competition, and higher prices.

Any government regulation should be scrutinized in an attempt to determine if it serves some compelling public interest, and not simply the interest of well-connected, and funded, private firms.

Should firms be able to bet with your money?

The White House issued a statement on financial regulatory reform outlining two parts of their proposal. This one in particular seems like a very good idea:

1. Limit the Scope-The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.

Megan McArdle describes it this way:

banks that have access to the discount window will not be able to trade for their own account. That means no prop [proprietary] trading desk. No owning hedge funds or private equity funds. No investments of any kind to make profits for your shareholders. Financial institutions can make profits by servicing clients, or they can make profits by investing for their own book. But they can't do both....

Indeed, if they pass this thing, they should probably call it the Hey Goldman Sachs! You're Not Going to Be So Profitable Any More Act of 2010.

She has reservations as to whether or not such a proposal is enforceable, but if it is then it seems like a positive step.

I still think resolution authority (that is, a way for failed firms to go out of business in an orderly manner) is the key to regulatory reform, but this proposal could compliment that authority.

If firms want to gamble, they should do so with private money. Preventing them from doing so with public money seems like sound policy.

The economy that swallowed a fly

The Obama administration has proposed a new tax on large banks and are promoting it as a way for taxpayers to recover the money lost due to the TARP bailout.

At FoxPolitics.net Jo Egelhoff has all the right reasons as to why this is a bad idea. Among them, the TARP losses primarily stem from AIG and the auto companies, which are NOT subject to the tax and the fact that these banks will simply pass the tax on to consumers.

With another view is Harvard Economist Greg Mankiw. Mankiw is not known as a promoter of higher taxation, so his advocay of the proposal cannot simply be dismissed as promotion of an agenda aimed at government expansion.

We could promise never to bail out financial institutions again. Yet nobody would ever believe us. And when the next financial crisis hits, our past promises would not deter us from doing what seemed expedient at the time.

Alternatively, we can offset the effects of the subsidy with a tax. If well written, the new tax law would counteract the effects of the implicit subsidies from expected future bailouts.

So the tax could be an antidote to the poisonous bailouts that have now become the norm. While Mankiw may be absolutely right on the economic merits, I can't help but find his argument thoroughly unconvincing.

So many in the financial industry conducted themselves recklessly, but were saved from the consequences of their actions by a government bailout. And because of the bailout, we now need to impose a tax on those institutions? When I heard this proposal, I couldn't help but think of the old lady who swallowed the fly, then the spider, then the...well, you know.

Mankiw may simply be arguing for the best solution given the reality of our situation, but there may be an alternative.

We should make it clear that there won't be any more bailouts, but how?

Since many reasonable people believe that letting large financial firms collapse in a chaotic manner would have been even worse than the present conditions, solving that problem becomes key to ending the era of bailouts. Finding a way to let failed firms go into bankruptcy in an orderly manner should be the number one priority of our financial reform efforts. Such a system would not, and could not, ever be perfect. It would just have to be good enough to avoid the catastrophic.

Bailouts are only tolerated when the alternative seems even worse. With a system in place to provide a framework for the dissolution of failed firms, people, and the politicians that represent them, will be far less tolerant of bailouts, and better off in the long run.

The Strange Shape of Senate Financial Reform

Today Senator Chris Dodd unveiled a plan for the Senate version of financial regulatory reform.

The big news is the changes in the power of the Federal Reserve and the FDIC.  The Fed would be restricted in its ability to make loans to financial institutions, which of late has become a major part of its activity.  It also takes away much of the Fed's role in regulating banks.

Dodd is up for re-election in 2010, but he's not running against Ron Paul, so this new found hatred for the Fed seems a bit out of character.

Then there's this:

Mr. Dodd also stepped into a debate about the governance of 12 regional Fed banks. These banks play a role in regulating private banks and have a say in the Fed's decisions on interest rates. Private bankers choose six of the nine directors on the boards of each of these 12 regional Fed banks, which critics say could be a conflict of interest.

The personification of this concern over banks choosing Fed directors is none other than Obama Treasury Secretary Timothy Geithner.  One of the major knocks on Geithner has been his cozy relationship with many of the giant, now failed, financial firms during his time as head of the New York Fed, but as far as I know Dodd has never called on Geithner to step down.

So by Dodd's logic the process of banks choosing Fed directors is so flawed that the Senate and the President need to take over that duty, but overseeing a global financial crisis while at the New York Fed makes you qualified to be Secretary of the Treasury?

With a Senate counterpart like Dodd, Barney Frank has to like his chances to stay in the lead on financial reform regardless of how many times he is present at a pot bust.

TARP on Steroids

That's what Congressman Brad Sherman (D-CA) has called the new resolution authority proposal put forth by Secretary Geithner and the Treasury.

Resolution authority is the ability for the government to take over and somehow deal with failing financial institutions. There seems to be a fair amount of agreement that this was something lacking during the current crisis and that this authority is needed to avoid a repeat of the wave of bailouts the financial industry has been riding of late.

Treasury's proposal though, would be a step in the wrong direction. Here's Congressman Sherman's highlights:

The new Resolution Authority, set forth in Treasury’s 253-page legislative draft of October 27, 2009 provides permanent, unlimited bailout authority....

The Secretary of the Treasury has rejected a $1 Trillion limit on this bailout power...

The chief economic effect of Treasury’s proposed unlimited bailout legislation is to cause creditors to lend money on favorable terms to “systemically important institutions” (the top 10 to 25). If the institution cannot repay those creditors, the Government probably will....

This law will allow those institutions which are clearly systematically important (the top 10 to 25) to borrow at a lower cost. This will help the largest institutions get bigger, so they can pose a greater systemic risk.

I suppose it's too much to ask anyone in government not use a crisis as cover for a huge power grab, but couldn't they at least make a pretense toward improving the situation?

This proposal seems little more than an attempt to put into law the system of business friendly back room deals that have proceeded ad hoc over the last year. If this is the shape "change" then we are in for a whole lot more of the same.

The Shape of Financial Reform

Efforts to develop some type of regulatory response to the financial crisis have begun in earnest.

Legislatively, the House Financial Services Committee is drafting legislation which will be the focus of reform in Congress.

Outside of Congress, though, there are other voices making themselves heard. Most notably Obama advisor and former Fed Chairman Paul Volcker who has recently argued, and been mostly ignored, that we need to break up large financial institutions and reinstitute Glass-Steagall. This is the Depression era legislation that separated commercial banking (taking deposits, making collateralized loans) and investment banking (issuing and selling securities, and speculating with their own money).

These two activities were separated until legislative changes in the early 80's loosened some of the rules and then they were removed completely about 10 years ago.

The House reform includes a council of regulators meant to monitor the so-called systemic risks and a way for regulators to force a company they feel is undercapitalized to enter bankruptcy. This is a form of "resolution authority" in a manner of speaking, but some in the Obama administration have other ideas. For example, using a mechanism similar to what the FDIC currently uses to take over failed banks. This idea has been espoused by current Fed Chairman Bernanke.

So the final form of reform remains unclear, but those on the right should take heart. At least that's what Reihan Salam argues at National Review where he says Republicans:

are surrendering the playing field to the Democrats on the pretty darn important question of whether or not we're going to be a market economy or a government-dominated economy. This is insane. Politics and principle are pushing in the same direction.

House Committee Votes to Create CFPA

The House Financial Services Committee voted to create a Consumer Financial Protection Agency today:

On Thursday, the House Financial Services Committee approved its final version of the Consumer Financial Protection Agency Act of 2009 by a 39 to 29 vote....

The vote largely came down along party lines, with Reps. Walt Minnick of Idaho and Travis Childers of Mississippi the only Democrats to vote against the bill, while Rep. Mike Castle of Delaware was the only Republican to vote in support of it.

The bill (HR3126) will create a new federal agency to regulate consumer financial products. The bill summary indicates that the agency will still have some considerable powers, though two high profile portions were scrapped in committee. The requirement that companies offer a simple ("plain vanilla") version of their products and the ability of states to enact their own tougher regulations. Huffington Post reports:

Democrats also compromised on a keystone reform that would have allowed tougher state laws to act in tandem with new federal regulation. Frank and the White House wanted states to have free rein to get as tough as they chose, while pro-business Democrats and Republicans sought to exempt large national banks from state standards.

So much for states' rights.

Given the recent failures of regulation, I'm skeptical of attempts to prevent a repeat of the current crisis through additional regulation. On the other hand, perhaps regulation that focuses on products rather than on firms could prove to be one part of a revised, and more successful, regulatory regime.

Read more at: http://www.huffingtonpost.com/2009/10/22/house-committee-passes-co_n_330038.html

Why I hate government regulation

The Consumer Product Safety Improvement Act (CPSIA) was a law enacted in the wake of some tainted toy scandals and requires testing of toys for lead and other harmful chemicals.

The law was written so broadly that items like clothing and books would also have to be tested, not just toys for infants, who are most likely to put them in their mouths. This wide net of testing requirements has been a cause of particular concern among second-hand sellers and those that shop at such venues regularly.

Well who would be for such a regulation you ask. Surely not a toymaker, right? Wrong.

So while most small toymakers had no idea this law was coming down the pike until it was too late, Mattel spent $1 million lobbying for a little provision to be included in the CPSIA permitting companies to test their own toys in "firewalled" labs that have won Consumer Product Safety Commission approval.

The million bucks was well spent, as Mattel gained approval late last week to test its own toys in the sites listed above—just as the window for delayed enforcement closed.

Instead of winding up hurting, Mattel now has a cost advantage on mandatory testing, and a handy new government-sponsored barrier to entry for its competitors.

This is the definition of Regulatory Capture. It is the ability of the rich and connected to carve out advantages to themselves within a complex regulatory regime by manipulating a corrupt political system.

I like interstate highways, the Marine Corps, and non-tainted beef, but this kind of thing will never stop as long as we continue to implement unnecessarily complicated regulatory schemes.

An environment where the interests of The State align with those of The Corporation is the least conducive to freedom this side of Stalin's Russia.

Petri/Kucinich Alliance?

OK, not really, but Open Congress reports they agreed on this:

During the House Education & Labor Committee’s mark-up of the health care bill (H.R. 3200) today, Rep. Dennis Kucinich [D, OH-10] proposed and passed an amendment that would remove legal barriers barring a state from creating a Medicare-like single-payer health care system to guarantee insurance for all of their citizens.

Thirteen Republicans voted with Kucinich, including Wisconsin's own Petri.

This would allow states to create their own single payer health care systems.

Recent debates have largely turned on the question of whether or not the federal government should get involved in what is largely private enterprise (autos, banks, health care). There is another question, though, that in my mind is just as important.

We have many other levels of government in this country, some of which might be better suited to address the concerns of the citizenry. Maybe sometimes there is a need for government intervention, that doesn't necessarily mean it has to be the federal government.

Cap & Trade Keeps Getting Better

Senatus reports a new development in the continuing saga of the cap & trade legislation:

A bill (S. 1399) introduced yesterday by Senators Dianne Feinstein (D-CA) and Olympia Snowe (R-ME) would “give the Commodity Futures Trading Commission full authority over markets that buy and sell pollution permits issued to companies as part of a climate change plan to cut greenhouse gas emissions,” Reuters reports.

It’s called the Carbon Market Oversight Act....

A press release issued on the bill states that it “is designed to prevent Enron-like fraud, manipulation and excessive speculation in the new federal, state and regional carbon markets that will be established by such a system.”

There was at least one Enron program that was supposed to be regulated by CFTC, but wasn't due to the ability of Enron to lobby (some would say bribe) powerful people to secure an exemption from oversight. We all know how that turned out, don't we.

Think of the opportunities for enrichment presented to the powerful and connected by a new and complex scheme of government mandated carbon emission levels, combined with government issued emission permits, traded on a governmentally regulated exchange. No doubt the folks at Goldman Sachs have already set up a war room from which to execute their strategy.

This is what is known as Regulatory Capture. For those of us that are doing neither the regulating nor the capturing, the end result isn't good.

Ron Paul's Fed Bill Gaining Momentum

Ron Paul's bill to bring transparency to the actions of the Federal Reserve once seemed an idealistic but unrealistic crusade. Or, at the very best, a remote possibility. Not so any more.

The Open Congress blog reports:

UPDATE 3: The bill has officially reached (and surpassed) majority co-sponsorship status, a just-issued press release from Ron Paul reports:

Audit the Fed Bill Reaches Crucial Benchmark

Washington, D.C. – Congressman Ron Paul’s Federal Reserve Transparency Act, HR 1207, has reached and surpassed the level of 218 cosponsors in the House of Representatives, which means it is now cosponsored by a majority of the members.

The 218th cosponsor was Dennis Kucinich (OH-10), and the bill has since received its 222nd cosponsor.

“The tremendous grass-roots and bipartisan support in Congress for HR 1207 is an indicator of how mainstream America is fed up with Fed secrecy,” said Congressman Paul. “I look forward to this issue receiving greater public exposure.”

Hearings on Federal Reserve transparency are expected within the next month, as part of the Financial Services Committee’s series of hearings on regulatory reform.

This is great news for those that believe the Fed is in need of greater oversight and accountability. If this doesn't include you, watch this video:



Still don't think the Fed needs more oversight?

The Next Bubble?

Scary words from economist Simon Johnson:

By not changing incentives for powerful bank insiders, we are lining ourselves up for another big “moral hazard trade” – think of this as a bailout by the Federal Reserve of everyone, but especially banks. Current and future bank executives will take risk again – but next time it will be risk with the public’s money. A housing bubble led to the current difficulties but the meta-bubble is a rise in financial services as a share of the economy, which has been underway since the 1980s. In the latest manifestation of the ensuing shift in economic and political power towards the financial sector, an unsustainable “Fed bubble” is potentially underway. This may lead to outcomes that are considerably worse than what we have seen so far. [E.A.]

Johnson is a proponent of revised regulation for the financial industry, and he is optimistic that the will exists to make it happen. If there was some way to insure that we implement the correct regulation, rather than just any regulation, I might share some of his zeal for a new regulatory regime.

There are two major hurdles to this outcome. First, it is difficult, if not impossible, to know for certain what the optimal regulatory scheme is. Second, even if it were knowable, the reality of our political system may make implementation impossible.

Given this, I am even more frightened by his warning regarding the existence of a Fed bubble, and what its end might mean for the economy.

NPR's Planet Money Suffers Mental Eclipse

For coverage of the economic crisis you could do a lot worse than the folks at NPR's Planet Money. They host a three times weekly podcast, maintain a blog, and contribute reporting to other public radio programs. On last Friday's podcast, however, correspondent Adam Davidson apparently disengaged his brain when he put on his headphones.

The apparent cause of his sudden onset stupidity was an interview with Congressional Oversight Panel Chair Elizabeth Warren. One would think that a radio reporter on a national news outlet ought to be able to conduct an interview, but not in this case. The interview devolved into what was essentially a shouting match between Davidson and Warren. For the record, Warren got the better of him as Davidson's argument was mostly reduced to stammering and "yeah, buts," at least in the clips they played on the podcast.

Even if Davidson had carried the argument, one can only wonder why on earth any journalist with even the flimsiest pretense of objectivity would allow himself to let an interview turn into such a mess. Remember, this was an interview by a reporter. Davidson was not moderating a debate between persons with differing viewpoints. He started, I think, to inform his listeners about the current state of the COP's work and instead gave us a negative example of how a reporter should act.

His problem with Warren's work as far as I could tell, boiled down to the fact that Warren believes the current economic crisis requires a two-pronged solution. This solution includes a component to address the malfunctioning financial system and a component to address what Warren sees as the attack on the American middle class that has taken place over the last thirty years or so. Warren's views on this are well known, and not always liked; but it isn't as if she discovered her desire to champion the middle class after she began working on TARP issues.

Davidson could easily have done some actual reporting and questioned Warren on her views. The questioning could have even been (gasp!) tough. Instead, he chose to argue against her position himself. His main argument against Warren's economic two-state solution to the problem: It is not widely held by a majority of mainstream economists.

For a reporter to put their journalistic reputation on the line and engage in a partisan argument is already a dicey proposition, to do so when the force of one's argument rests on an appeal to conventional wisdom is lunacy.

I'm not going to search the NPR site for a citation, but I would be willing to bet that many NPR reporters, possibly even Davidson himself, have interviewed many people during this crisis that were widely regarded as fools for their unconventional takes on the approaching economic collapse not that long ago. (Nouriel Roubini or Peter Schiff anyone?) For Davidson to quite literally shout at Warren that she is wrong to think that the solution to this crisis goes through the American middle class simply because this is not a widely held view is just ridiculous.

I guess I owe Megan McArdle an apology since I was wrong to think that she was the only reporter that didn't like Elizabeth Warren. This latest episode makes me wonder if there are any reporters out there that are not so in the thrall of our nation's financial and political elites that they cannot consider, and possibly report on, some alternative view of the facts. Especially a view that has the audacity to be unconventional.

Update: The Confluence has the real reason why Davidson gave Warren the business: Sexism. Here I thought it was just his slavish devotion to dominant memes (uh, I think that means he thinks like everyone else) but I'm a man so what the hell do I know. Frankly I'm not sold on misogyny as the explanation for Davidson's bad behavior. I can't confirm this, but I hear that he once refused the offer of a piece of gum for the sole reason that it had not been recommended by 4 out of 5 dentists! Sorry. I can't help it. It is just so easy in this case.

Fed Up: Why we need small government populism

There's been something of a dust-up over a purchase of Goldman Sachs stock by the Chairman of the New York Federal Reserve; a purchase made while Goldman had business before the Fed, which is also Goldman's regulator.

Over at Slate, Eliot Spitzer has a great piece describing the special place of the New York Fed in our financial system and how it is entirely dominated by the large financial institutions it is supposed to be regulating. Here's the takedown:

So is it any wonder that the N.Y. Fed has been complicit in the single greatest bailout of poorly managed banks in history? Any wonder that it has given—with virtually no strings attached—practically the entire contents of the Treasury to the very banks whose inability to manage risk has brought our economy to its knees? Any wonder that not a single CEO or senior executive of a major bank has been removed as a condition of hundreds of billions of direct cash and guarantees? Any wonder that, despite its fundamental responsibility to preserve the integrity of the banking system, it sat quietly on the sidelines as the leverage beneath the banks exploded and the capital underlying their investments shrank?

It is now clear that there is something even worse than too much regulation, worse, even, than too little regulation. Namely, a public regulatory scheme that is little more than a thin veneer covering a privately controlled system utilized to deliver private gain.

Not illegally mind you, this is strictly above board. It is the use of access and influence to provide maximum value for shareholders, the primary duty of those that run public companies.

There is nothing wrong with trying to deliver value to shareholders, but the means for doing so used to be production of valuable goods and services. If we have entered a time when the means to deliver shareholder value is by having the ear of government officials, we have truly entered the age of decadent capitalism.

This phenomenon highlights the limits of effective regulation. When regulation is complex and carried out in secret, there will be those that will find ways to game the system. Always.

Minimal regulation intended to prevent only the most calamitous outcomes, enforced in full view of the public is the best hope we have of preserving our own welfare and preventing the very real human suffering that results when government serves the interests of business before it serves the interests of the people.

Warren takes on Geithner

Treasury Secretary Geithner will appear before the Congressional Oversight Panel today. (You can watch them live by clicking here.)

For those of you scoring at home the COP is the panel set up by Congress to review and report on the TARP and the other efforts to stabilize the financial system. The panel is headed by Elizabeth Warren.

Ahead of this hearing, Politico has an article indicating that Professor Warren may be wearing out her welcome on Capitol Hill:

While the bubbly and brilliant 59-year-old professor is a darling of Democrats, Warren has become the scourge of conservative Republicans, who question her panel’s exploration of more-liberal approaches such as nationalization and bank liquidation.

Most of the article goes on to describe dissatisfaction with Warren from lobbyists:

Financial services lobbyists, who’ve long disliked Warren for highlighting predatory lending and abusive credit card fees, argue that she’s using her post to push her own, anti-industry agenda.

“A number of people wonder if this is the new Warren commission or the congressional oversight panel,” said Wayne Abernathy, executive director for financial institutions policy at the American Bankers Association. “It’s looking more like the former than the latter.”

Let's see, who should we go with here? The Harvard professor with a no-nonsense reputation and a proven track record of advocating for the middle class; Or, "the smartest guys in the room," who just happened to take the world's biggest economy and reduce it to an absolute shambles, causing tremendous pain for millions of Americans along the way.

Every minute that public officials spend listening to the fools from Wall Street that created so much of this mess (or their paid advocates) rather than considering thoughtful proposals about how to navigate out of this mess from folks like Warren is an absolute affront to average Americans.

My only hope is that this Politico article is just a bit overblown and the only people really against the efforts of the COP are lobbyists. There is no guarantee of this, especially given this item from the article:

In private conversations, even some Democrats complain that Warren’s role as a constant Cassandra could undermine already tenuous public support for the bank, auto industry and other financial rescue programs.

The panel specializes in calculating the kinds of scary numbers that the Obama administration would rather not broadcast too loudly.

If there is anyone on Capitol Hill (from either party) or at Treasury or on Pennsylvania Avenue for that matter, who thinks we can just get through this rough patch and then everything will go back to the way it was, then we are in worse shape than I previously thought.

It's not that things absolutely can't go back to the way they were. We can all pretend that stock prices or home prices or any other asset price that we just pick at random can go up forever and that these inflated prices represent real wealth. I mean, it's not as if the human capacity for self-delusion has been diminished in any meaningful way.

The real fact of the matter is that things shouldn't go back to the way they were. Our behaviors were obviously unsustainable. Unless we want to get into the habit of waking up with an economic bubble hangover with frightening regularity, some things are going to have to change.

It may be the case that the change we really need starts with the work of the COP and Warren.