Enforce the regulations that we already have

Republicans and Democrats are arguing over how many regulations we should add—or remove—from the financial services industry.  Before we think about altering the regulations, we should think about enforcing the ones we currently have.

Ever since the sub-prime meltdown erupted during 2008, politicians on both sides of the aisle have taken aim at the rules and regulations under which the financial system operates.

Democrats argue that the crisis resulted from the under-regulation of the financial system.  In response, the Democrats enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.  Dodd-Frank constituted the most extensive expansion of financial regulation since the reforms enacted in the aftermath of the Great Depression.

Republicans counter that the financial crisis was largely the result of too much government involvement in the financial system.  They blame the crisis on government sponsored entities like Fannie Mae and Freddie Mac, as well as, in the words of Republican presidential candidate Mitt Romney, “Washington mis- and over-regulation.”

During his State of the Union address last month, President Obama took up a slightly different theme, arguing that during the run-up to the crisis, “Regulators had looked the other way, or didn’t have the authority to stop the bad behavior.”

Evidence published last week by the New York Times suggests that, in fact, regulators did look the other way.

The Times story focused on the Securities and Exchange Commission (S.E.C.), which has jurisdiction over securities markets, including the authority to file fraud cases against financial firms.  In addition to monetary fines, firms that are found guilty of, or settle fraud charges are liable to be denied preferential treatment by the S.E.C.  This restriction is costly for firms that are so penalized, making it more expensive for them to raise money and, theoretically, harder to commit the same violations again.

The Times found that the S.E.C. routinely waived the non-monetary penalties for Wall Street firms, issuing at least 344 waivers during the last decade.

This not the first time that S.E.C. permissiveness has led to trouble.  In 2004, the five member commission voted unanimously to allow the largest Wall Street firms to judge for themselves how much capital to hold.  Since it is cheaper to borrow than to raise capital, the debt levels of these firms skyrocketed. When the subprime market collapsed, these heavily indebted giants either collapsed or required a government bailout.

Nor is the S.E.C. the only culprit.  During the savings and loan (S&L) debacle of the 1980s, the crisis was made more severe because deposit insurance authorities routinely granted regulatory forbearance—that is, allowed S&Ls to remain open long after their balance sheets revealed them to be lost causes.  Instead of giving troubled institutions  time to work their way out of trouble, regulatory forbearance gave these S&Ls more time to rack up larger losses that would eventually be borne by the taxpayer.

The debate between Republicans and Democrats over how much regulation is necessary will—and should–continue.  Before we worry too much about what regulations to enact, however, we should make sure that regulators enforce the regulations that we have.

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Three cheers for the IMF, the EU, and the ratings agencies!!!

Hungary’s new constitution came into force on January 1.  This was not good news.

Engineered by Prime Minister Viktor Orbán’s Fidesz party, the new constitution has a number of unsavory elements.

The Constitutional Court, which serves as a check on government power, has been weakened in several ways (e.g., packing it with new judges, having its jurisdiction curtailed, and restricting access to it).  The ordinary court system has also been assaulted by lowering the retirement age from 70 to 62, allowing the government to fill the judiciary with judges favorable to its views, as well as allowing the government to decide which judges hear which cases.  According to Princeton’s Kim Lane Scheppele: “The independence of the judiciary is over when a government puts its own judges onto the bench, moves them around at will, and then selects which ones get particular cases to decide.”

Other elements of the constitutional changes include:

  • Reforming the elections commission and parliamentary redistricting–both with the intent of securing the dominance of the Fidesz party.
  • Lengthening terms of important officials, including the public prosecutor, the head of the state audit office, the head of the national judicial office, and the head of the media board–all currently filled by Fidesz loyalists.
  • Requiring a two thirds super-majority in parliament, making it difficult to reverse these new rules.
  • Enacting a conservative religious social doctrine, even though the country is overwhelmingly secular (only 21 percent of the population attend any kind of church services), and deregistering over 348 of the previously recognized  362 religious communities (including those of the Methodists, Pentecostals, Adventists, Reform Jews, the Salvation Army, Jehovah’s Witnesses, Muslims, Buddhists, and Hindus).

The domestic opposition, human rights groups, and Secretary of State Clinton (among others) have protested; however, it is not clear how effective these moves will be.

Interestingly, the aspect of the Fidesz putsch that has been most effectively countered is the attempt to run roughshod over the central bank, the Hungarian National Bank.  The Fidesz measure would have merged the central bank with the national financial regulator and placed both under the head of the amalgamated agency.  This would have effectively demoted head of the previously independent central bank, András Simor.

It has long been accepted wisdom that monetary policy is too important to be left to the politicians.  The reason for this is that because monetary policy could be used for political purposes, such as lowering interest rate just before an election to help the governing party, it is best left to non-partisan officials.

Although international opposition to the non-economic aspects of the constitutional putsch have been appropriate, the response to the attempts to meddle with the central bank have been even more effective.  Hungarian loans from international agencies, needed to prop up the currency, have been endangered and Hungary’s credit rating has been downgraded to junk status.  These moves appear to have forced Orbán to back off  of his attempt to strangle the central bank.

The response was so swift and so effective because money was at stake. With lots of dubious European sovereign debt already floating around, nobody–including the IMF–is going to lend money to a country that is on the point of destroying a vital national institution.  Nor are the ratings agencies going to certify such countries as good credit risks.

Let’s hope that internal and external pressure will help to overturn the rest of Orbán’s putsch.

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Unfortunately, in Greece statistics is a combat sport

The Financial Times reports that Andreas Georgiou, the head of the independent Greek statistical agency Elstat, is facing a criminal investigation for allegedly inflating the scale of the country’s fiscal crisis and “acting against the Greek national interest.”

Georgiou, who worked at the International Monetary Fund for 20 years, was appointed in 2010 by agreement with the fund and the European Commission to clean up Greek statistics after years of unreliable reporting by the finance ministry.

The source of the accusations against Georgiou is a former member of the statistical agency’s board who was fired recently.  The specific allegation is that the 2009 deficit was exaggerated by Elstat “so it would become larger than that of Ireland and Greece would be forced to adopt painful austerity measures.”

Two observations:

First, it is a little hard to see what benefit a veteran international civil servant–brought in to clean up the national accounts–would receive by exaggerating the budget deficit.

Second, the charge should serve as a reminder of the importance of accurate economic data for making sound policy decisions.  Although Greece’s economic trouble cannot be laid solely at the feet of fudged books, dishonest statistics contributed to the mess.

It is a difficult to see how prosecuting the guy who is supposedly cleaning up the mess in in Greece’s national interest.

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Where will the new capital come from?

Writing in Thursday’s Financial Times, Pimco chief executive and chief investment officer Mohamed El-Erian argues that Europe’s first order of business should be to recapitalize its banks.

It is hard to argue with this prescription.  With the finances of Greece, Portugal, Spain, and Italy in dire straits and banks across the continent up to their eyeballs in the sovereign debt of other countries, the question is how will the recapitalization be financed.

According to El-Erian:  “Where private funding is not forthcoming, which should now be the presumption for a growing number of banks, recapitalization must be imposed, in return for fundamental changes in the way financial institutions operate and burdens are shared.”

Swell, but with so many European sovereigns having difficulty borrowing it is hard to see where the money will come from for this recapitalization.  The only plausible sources seem to be the European Central Bank and the International Monetary Fund, neither of which has a clear mandate to act.

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Glenn Hubbard ignores some inconvenient facts

Writing in today’s Wall Street Journal about how to reduce government spending, Columbia University economist and former chairman of George W. Bush’s Council of Economic Advisors R. Glenn Hubbard chooses to disregard some important facts.

According to Hubbard, “President Obama’s answer is higher taxes.”

Well, not exactly.  What President Obama proposed was a combination of tax increases (primarily falling upon those with higher incomes), plus cuts in government programs, including cuts in such sacred cows as the social safety net.  Although Hubbard may disagree with the relative size of tax increases and spending cuts suggested by the president, it is wrong to characterize the president as saying that the answer lies only in higher taxes.

Hubbard continues: “The obvious place to begin is repealing ObamaCare and its expansion of spending.”  If by ObamaCare Hubbard means the Patient Protection and Affordable Care Act–which is what most critics mean when they talk about ObamaCare–Hubbard is mistaken.  According to the Congressional Budget Office(CBO), ObamaCare should reduce the government budget deficit.

When the new Republican majority took over the House this past January, they immediately introduced H.R. 2, the Repealing the Job-Killing Health Care Law Act (nice title!).  The CBO’s preliminary analysis of that stated: “Because CBO and JCT estimated that the March 2010 health care legislation would reduce budget deficits over the 2010–2019 period and in subsequent years, we expect that repealing that legislation would increase budget deficits.”

There are some useful ideas when you go further into the Hubbard op-ed.  I disagree with a lot of them, but they should certainly be part of the debate on how to attack our budget deficit.  Nonetheless, Hubbard should be able to motivate his arguments and stay closer to the facts.

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Great minds think alike

Apparently, the Economist agrees with my emphasis on the rise of technocracy.

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Send in the technocrats!

Winston Churchill said that democracy is the worst form of government except all those other forms that have been tried. The financial crisis has tested Churchill’s assertion.

In Greece, the austerity measures imposed on the country by the EU and the ensuing domestic unrest led Prime Minister George Papandreou to call for a referendum to approve the terms of the bailout that he had just negotiated.  In seeking public approval for the package, Papandreou drew the ire of the main proponents of the bailout–President Nicolas Sarkozy of France and Chancellor Angela Merkel of Germany.  Their threats to withdraw the deal if it was not speedily approved led Papandreou to resign.

Typically, in parliamentary democracies, when one party loses the confidence of the parliament, it becomes necessary to form a new government.  A new government can be formed under the outgoing leadership, under the leadership of the opposition, or new elections can be called.

Sadly, even though the major parties recognized that the bailout was necessary, none had the guts to take the blame for taking the deal.  The result was the appointment of a non-political European civil servant–former European Central Bank Vice President Lucas Papademos–to accept the deal.

In Italy, Silvio Berlusconi….Well, let’s just say that Berlusconi was a problematic leader on a number of levels.  He certainly demonstrated his inability to undertake the necessary reforms in a timely manner (he was, after all, prime minister on and off since 1994).

The solution?  Mario Monti, a former EU Commissioner and president of Bocconi University: another non-politician brought into an inherently political job to do what the politicians could not.

Here in the United States, democratic institutions and the politicians in charge on them are having trouble achieving important public policy goals.  Congress appears incapable of dealing with the budgetary situation through normal channels.  Instead, they found it necessary to appoint a super-committee (I have a hard time imagining Washington or Jefferson uttering the term “super-committee”). The outcome of that group’s deliberations is very much in doubt.

The super-committee framework isn’t the same thing as appointing a non-political “technocrat”, but it does suggest that the politicians are incapable of doing the people’s business unless they are somehow protected from voters who will be angry at them for making  unpopular, but necessary, decisions.

I wonder what Churchill would have thought of a technocracy.

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Penny wise and pound foolish

The institutions of government and the politicians who run them have–rightly–been criticized for many mistakes during the past few years.   The Congressional budget deadlock this past summer is a case in point.  The mismanagement at Walter Reed Army Medical Center, first publicized by the Washington Post in 2007, is another.

No wonder why Gallup reports that trust in the government is low–so low that the national mood can probably be summed up by paraphrasing the Robin Williams’ character in Good Morning, Vietnam: “If it is being done correctly, here or abroad, it’s probably not being done by the government.”

The government actually does a number of things quite well.  Among the things it does superbly well is collect economic data.

Is hard to overstate the importance of accurate and comprehensive data for conducting economic analysis.

Without good data, it is impossible to assess where the economy has been, how it is currently doing, and to make concrete recommendations for economic policy.

Which is why it was so disappointing to read in yesterday’s Wall Street Journal that cuts to the Census Bureau budget proposed by House Republicans may endanger the Bureau’s Economic Census.

The Economic Census, which takes place every five years, is scheduled to survey five million US firms starting in late 2012.  This survey provides a gold mine of data on the size, location, and competitiveness of US business.  It provides, in the Census Department’s words, “consistent, comparable, and comprehensive measures” of business activity by region and industry.

It also provides important benchmark data for constructing a host of important indices of economic activity, including GDP.  According to Steve Landefeld, director of the Bureau of Economic Analysis, without the census, “You would find that the GDP estimates would get progressively off.”

Economists have been rightly criticized for our performance during the financial and economic meltdown of the past few years.

We won’t do any better if the data get worse.

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Alan Meltzer’s straw “Keynesian”

Remember when “liberal” became the insult of choice among Republicans?

Apparently, “Keynesian” has now taken on that status for Republican economists.  Never mind that Keynesian is ill-defined (old Keynesian?  new Keynesian?  the Keynesian part of the neoclassical synthesis?)–making Keynesian a dirty word and applying it to those with whom you disagree has become the tactic of choice among Republican economists.

Take Friday’s Wall Street Journal opinion piece by Alan Meltzer of Carnegie Mellon University and–because WSJ‘s op-ed page seems to require that a quota of their opinion piece be penned by someone from it–the Hoover Institution.

A couple of  this op-ed’s shakier assertions:

“Those who heaped high praise on Keynesian policies have grown silent as government spending has failed to bring an economic recovery.  Except for a few diehards who want still more government spending, and those who make the unverifiable claim that the economy would have collapsed without it, most now recognize that more than a trillion dollars of spending by the Bush and Obama administrations has left the economy in a slump and unemployment hovering above 9%.”

In fact, there is a considerable body of evidence to suggest that the fiscal stimulus did have a positive effect on the economy.  Fellow Hoover Institution denizen Ed Lazear is willing to credit the stimulus with boosting GDP by 3 percent–and if you can get 3 percent further away from the edge of a cliff, I am all for it.  Even the fiscally conservative Economist magazine seems to think that there is room for additional stimulus.

Meltzer continues: “…Keynesian models totally ignore the negative effects of the stream of costly new regulations that pour out of the Obama bureaucracy…”  The solution?  “…announce a five-year moratorium on new regulations.”

Talk about unverifiable claims! The author is railing against reforms that have not yet been fully implemented (health care and Dodd-Frank).

Although we do have a number of silly and costly regulations (my personal favorite is Florida’s licensing requirements for interior designers) which should be eliminated, many make valuable contributions to societal welfare.  If the government had done a better job of using regulation to moderate some of the excesses of the financial industry, we might have mitigated some of the worst consequences of the financial crisis.

According to the World Bank the US ranked fourth out of 183 countries in ease of doing business.  Claiming that America’s businessmen suffer from the burdens of over-regulation–and erroneously blaming it on Keynesian economics–is a mistake.

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