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Archive for the ‘finance’ Category

A casualty of “pro-consumer” financial regulation. John Stossel is on the story:

Today, Americans were told that they must close their Intrade.com accounts. That happened because the federal government agency known as the “Commodity Futures Trading Commission” (CFTC) today sued the prediction market, where people from all over the world bet about things like who will win elections.

Intrade decided all its U.S. customers must now close their accounts and withdraw their money from the site.

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As the economy slowly claws its way out of the financial crisis and the deepest and most prolonged recession since the Great Depression, it is good to know that some of the lending practices that contributed to the collapse are once again being deployed. As Jessica Silver-Greenberg and Tara Siegel explain in today’s NYT:

as financial institutions recover from the losses on loans made to troubled borrowers, some of the largest lenders to the less than creditworthy, including Capital One and GM Financial, are trying to woo them back, while HSBC and JPMorgan Chase are among those tiptoeing again into subprime lending.

Credit card lenders gave out 1.1 million new cards to borrowers with damaged credit in December, up 12.3 percent from the same month a year earlier, according to Equifax’s credit trends report released in March. These borrowers accounted for 23 percent of new auto loans in the fourth quarter of 2011, up from 17 percent in the same period of 2009, Experian, a credit scoring firm, said.

But I thought the new regulations were going to put an end to these practices? No, in fact, they have stimulated their return:

The banks, for their part, are looking to make up the billions in fee income wiped out by regulations enacted after the financial crisis by focusing on two parts of their business — the high and the low ends — industry consultants say. Subprime borrowers typically pay high interest rates, up to 29 percent, and often rack up fees for late payments.

Thankfully, “the push for subprime borrowers has not extended to the mortgage market, which remains closed to all but the most creditworthy.”  My guess: it is only a matter of time until these practices revert to the old normal.

As most accounts of the financial crisis suggest, moral hazard was a significant problem.  Financial institutions assumed that they could act with reckless abandon and assume risk but the costs, should things collapse, would be socialized by the government. The events of the past few years have only reinforced this assumption.

As Solomon remarked:

 “As a dog returns to his vomit, so a fool repeats his folly.”   Proverbs 26:11

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Since the East Asian financial crisis of the late 1990s, a consensus among even free-market economists has been developing: financial liberalization for developing countries usually don’t make sense. The financial crisis of 2008 and the ongoing Eurozone crisis have only fortified this consensus. The mainstream economic position seems to be that, at least for developing countries with smaller markets and poorly trained regulators, restrictions on capital account transactions in liquid portfolio assets often make sense.

Even the usually reliably free-market, pro-globalization economist Jagdish Bhagwati writes in his popular book, In Defense of Globalization, that the East Asian financial crisis

…was a product of hasty and imprudent financial liberalization, almost always under foreign pressure, allowing free international flows of short-term capital without adequate attention to the potentially potent downside of such globalization. There has been no shortage of excuses and strained explanations blaming the victims… [T]he motivation underlying these specious explanations is a desire to continue to maintain ideological positions in favor of a policy of free capital flows or to escape responsibility for playing a central role in pushing for… gung-ho international financial capitalism. (199-200)

Strong words! And then there’s this (more…)

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This working paper is already getting substantial attention, and it’s not hard to see why. They find that banks that lobbied more in the years leading up to the Troubled Asset Relief Program (TARP) of 2008 received more money through TARP. What’s particularly astounding is the rate of return, which they estimate at between $485 and $585 per dollar spent in lobbying.

I suppose there are two ways to look at this. One is to become outraged at the profitability of lobbying and the fact that money buys influence in Washington — but who is really surprised by that? The other way to look at it is that despite the flood of rents available, rent-seeking seems to be far less than theory would predict. Theory predicts that banks should spend up to about 1/2 the amount they could reasonably expect to receive, and that total expenditures on rent-seeking could even be greater than the rents available. Perhaps the reason standard rent-seeking models don’t apply in this case is that a program the size of TARP was unforeseeable until just days before it happened.

In any event, the findings certainly betray the common assertion from political leadership that the program was simply a practical response to the financial crisis aimed at preventing another Great Depression.

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For many libertarians, the single most important policy reform today would be abolishing the Federal Reserve and replacing it with competing currencies issued by unregulated, private banks. Ron Paul has repeatedly introduced bills to abolish the Fed and has made the issue a key theme of his presidential campaigns. Many libertarians get involved in efforts to use silver as a medium of exchange, such as the Liberty Dollar and Shire Silver.

Why do so many libertarians think that abolishing the Fed should take such a high priority? Some economists have explored the history and theory of “free banking,” such as Larry White and George Selgin. But I suspect many libertarians derive their monetary ideas not from reading White or Selgin, but from Ron Paul or lurid, conspiratorial books like The Creature from Jekyll Island. One commonly encounters views such as, “The Fed is creating hyperinflation that will destroy the value of the dollar,” and, “The Fed prints money to fund the government’s war machine.”

It’s important to note that these views are not correct. The main way that the Fed creates money is by (more…)

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Risk-pooling in an era of frequent financial crisis is not as good an argument against Scottish independence as Tyler Cowen thinks it is. First off, bailing out is a policy choice to which there are alternatives. Second, financial governance matters. Who had a worse financial crisis in 2008: the United States (population 300 million) or Canada (population 35 million)? Which set of countries suffered more in the 1997 East Asian financial crisis: South Korea, Thailand, and Indonesia or Singapore, Hong Kong, and Taiwan?

Finally, the European Central Bank and leading European Union member states have shown that they are more than willing to pool risk with weaker members. The SNP favors joining the Eurozone in the event of Scottish independence. Even if the optimal size of nations has gone up with the increased risk of financial crisis, that does not mean that Scotland falls below the optimal size.

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Not long after the ratification of the Constitution, Madison came to have serious doubts about his former Federalist friends. Particularly, he came to suspect the sincerity of many who had asserted that the new government would possess only those powers specifically delegated to it.

The first disappointment came with Hamilton’s championing of the incorporation of the Bank of the United States in 1791. It sparked the formation of the first party system: Federalists who supported the bank versus Republicans (not the modern party by that name) who opposed it. Madison felt especially sensitive to this issue. He remembered that the power of incorporation had come up at the Philadelphia convention. Indeed, he remembered it so well because he had been the one to move for its approval. He also recalled that it had been roundly voted down.

To Madison’s thinking, the power to incorporate was a very particular and peculiar power. At the time he had proposed its inclusion in the Constitution, he was certain it could serve important national purposes, but having been voted down, he was just as certain that no such power had been given to the general government.

Hamilton took a different view. The bank, he argued, would be of such significant utility to the collection of taxes, the paying of obligations, the administration of finance, both public and private, and of the regulation of commerce and the value of coinage, that it achieved the level of an implied power. Its necessity was established by its usefulness, and as such, it was constitutional.

To Madison that way of thinking amounted to no limits at all. By such an assumption, anything deemed useful could be done by the federal government regardless of whether or not it had been specifically written down. Where then was the promise of reserved and delegated powers?

Madison summarized his concern poignantly on the floor of the House: “With all this evidence of the sense in which the con (more…)

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Following yesterday’s meeting, the Fed’s Federal Open Market Committee seems to be relatively optimistic that (1) the recovery is underway (even if employment figures are less than one might hope) and (2) despite rising commodity prices, inflation expectations “remain stable.” As a result, some are predicting that the Fed will not continue quantitative easing past June. Perhaps $600 billion in bond purchases will be enough. See report here and Marc Faber’s far more skeptical prediction here.

Things seem far more complicated, however, and the long-term implications of current and past policy decisions may be rather significant. Consider the question of inflation. As Kelly Evans (WSJ) argues, there is, in fact, evidence that inflationary expectations are growing:

Americans are increasingly worried about the rising cost of living. And who can blame them? The cost of food and fuel, two of the most vital and visible household purchases, has jumped in the past year; gasoline prices in particular have spiked. In turn, consumers polled this month by Reuters and the University of Michigan expect inflation of 4.6% on average over the next year. That is more than double the 2.2% expected in September, when double-dip fears raged. It is also well above the actual inflation rate.

One might expect that a little inflation is a good thing. If consumers expect prices to fall—if they assume a “deflationary mindset”–they may defer purchases until the future, sucking the wind out of an already anemic recovery. Yet, as Evans observes: “Consumers may fear inflation…but are reacting in a deflationary way” (e.g., by reducing discretionary spending in response to increases in fuel costs).

If this is correct, now that the Fed has assumed responsibility for the unemployment rate, will it be able to resist further quantitative easing? And if inflationary expectations translate into higher levels of inflation, what will be the consequences for policy and politics? In short, will another round of quantitative easing be followed by quantitative tightening?
As Irwin Kellner (Marketwatch) explains:

If the central bank decides that the time is fast approaching to take a stand against inflation, it will have to deprive inflation of its fuel — money. Reducing the money supply will cause interest rates to rise, thus cutting into spending and borrowing. This will result in layoffs, thus boosting the already-swollen ranks of the jobless.

Veronique de Rugy (Mercatus Center) has examined the impact of interest rate assumptions on the costs of servicing the national debt. If interest rates return to the levels of the 1980s, “our interest payments would nearly triple from CBO’s projection of $749 billion to $2.0 trillion. Accumulated interest payments over this period would double from their current projected level of $5.7 trillion dollars to $11.0 trillion dollars.” She illustrates the impact with the following chart:

Of more immediate concern to the Left may be the short-term political implications for the 2012 elections. In the words of Mark Tapscott (San Francisco Examiner):

Here’s a political equation that ought to furrow the brows of everybody working to get a second term for President Obama: QE1+QT1=DEFEAT.

The Fed giveth and the Fed taketh away. Unfortunately, it increasingly executes its duties without clear rules to constrain its discretionary authority.

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Guido Fawkes makes the case for letting banks fail, comparing the trajectories of two economies massively damaged by the financial crisis: Iceland and Ireland. Iceland let its banks fail, while Ireland has bailed out its banks, to massive expense:

The Irish bail-out plan will cost €54,800 per Irish household. Ireland’s future thus looks a lot more bleak than Iceland’s path of debt default and a devaluation of 60% two years ago which has the country rebounding: exports and manufacturing are growing by 20%, tourism is back near all-time highs, real wages are rising, unemployment is declining sharply, interest rates fell from 18% to 5.5% and the stock market has rebounded 50% from its lows.

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