What do I think of the Dodd-Frank Financial Reform legislation?
I can't express it better than this:
The Dodd-Frank Financial Reform Act is already "legacy".
Showing posts with label financial reform bill. Show all posts
Showing posts with label financial reform bill. Show all posts
Wednesday, December 8, 2010
Thursday, April 22, 2010
Washington Still Doesn't Get It!
The President and Congress just don’t get it!
Financial reform is in the air! The bad guys did it and they need to be brought to account! Protect Main Street and go after those that are on Wall Street!
Unfortunately, this is not going to produce the results that the President and Congress want.
Unfortunately, we are not going to get helpful results until the President and Congress develop an understanding about finance and what their current philosophies about economic policy are doing.
Unfortunately, I don’t see this happening in the near term.
Just two points this morning, but points that I have made before.
The first point pertains to the understanding…or misunderstanding…of what finance is all about. This misunderstanding is captured in the lead editorial in the New York Times this morning titled “After Goldman” (http://www.nytimes.com/2010/04/22/opinion/22thu1.html?hp). In this editorial we read: “The Goldman deal was nothing more than a bet on the mortgage market…WITHOUT ‘INVESTING’ ANYTHING IN THE REAL ECONOMY.”
Guess what? That is what finance ultimately is. Finance is nothing more than information and millions and millions of people operate with this kind of information every day.
What is your dollar bill? A piece of paper…a piece of information.
Well, but it is legal tender!
Right, according to the government you have to accept a dollar bill in payment for debt. What has this got to do with THE REAL ECONOMY?
And, what about the demand deposit account you have at your commercial bank? It is just 0s and 1s in some computer. What has this got to do with THE REAL ECONOMY?
By the way, you are betting that you will be able to access that money when you need it? Is it safe?
Well, you say, the deposit account has insurance on it, doesn’t it? The Federal Government has guaranteed that you will not lose these funds and will not be inconvenienced by a delay in access to them. You have a promise! But, what has that got to do with THE REAL ECONOMY?
What are loans? Well, they are cash flows. Say, an initial cash outflow to the borrower and then a series of cash inflows back to the lender. Just 0s and 1s through bank accounts.
But, I put up a house to back the loan, didn’t I? The house is a real asset.
Yes, but the loan agreement is in terms of cash flows and the house is there for security in case you don’t pay the returning cash flow. Furthermore, that house is 25% underwater now, another piece of information, so how does this impact the cash flows?
Furthermore, it was the government that showed us how to “slice and dice” cash flows in order to tailor cash flows so that potential purchasers would find those “new” cash flows more attractive and purchase them. The first mortgage-backed security was issued by the Federal Government in 1970. The mortgage market went from playing a zero role in world capital markets to becoming, by the middle of the 1980s, the largest component of world capital markets. (See Michael Lewis’ “Liar’s Poker”.)
Thank you Washington for teaching us that cash flows are just bits of information! No real world
here.
Now Washington wants to bring the herd of cats it has unleashed under control. Good luck!
The second point has to do with government policy and how it creates the environment for all else that goes on in the economy. Some of this discussion can be related to the David Wessel’s column in the Wall Street Journal this morning, “Mapping Fault Lines of Crises,” (http://online.wsj.com/article/SB20001424052748704133804575198080507492968.html#mod=todays_us_page_one). Wessel, in his column, discusses the work of Raghuram Rajan, a professor at the University of Chicago and former chief economist at the International Monetary Fund.
Rajan argues that “The U. S. approach to recession-fighting and its social safety net are geared for fast recoveries of the past, not jobless recoveries now the norm. That puts pressure on Washington to do something: tax cuts, spending increases and very low interest rates. This leads big finance to assume that the government will keep money flowing and will step in if catastrophe occurs.”
This philosophy of government was first incorporated into government policymaking in the early sixties and has continued as the foundation for economic policy ever since. A consequence of this has been that the purchasing power of the dollar has gone from $1.00 in January 1961 to $0.15 in 2010. And, as we know, a sustained inflationary environment is one that produces massive debt creation and increasing financial leverage along with extensive amounts of financial innovation.
This leads us to another part of Rajan’s argument: “As incomes at the top soared (in the last half of the 20th century), politicians responded to middle-class angst about stagnant wages and insecurity over jobs and health insurance. Since they couldn’t easily raise incomes, politicians of both parties gave constituents more to spend by fostering an explosion of credit, especially for housing.” And, Wessel states, Rajan goes back in history to support the fact that this is not an atypical reaction.
The latter move not only contributed to general inflation, but eventually led to asset price bubbles in specific sectors of the market which could not be sustained. Hence the financial crisis!
Finance has never really been connected to THE REAL ECONOMY. Take a look at Niall Ferguson’s book “The Ascent of Money.” (See my review, http://seekingalpha.com/article/120595-a-financial-history-of-the-world.) This is especially true since the growth in finance and financial innovation, historically, has been connected with government’s financing of wars and, in the 20th century, the social system.
Furthermore, finance, in the future, is going to be even more connected with the idea of information and the exchange of information. For example, see the book “The Quants” (http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson). And, this concept is spreading beyond financial markets. An amazing amount of research efforts and publications are connected with “Information Markets” which are not related to financial markets. Bob Shiller of “Irrational Exuberance” has produced a lot in this area: see his books “Macro Markets” and “The New Financial Order.”
The point is, again, that the President and Congress are fighting the last war. But, the last war is history!
Financial reform is in the air! The bad guys did it and they need to be brought to account! Protect Main Street and go after those that are on Wall Street!
Unfortunately, this is not going to produce the results that the President and Congress want.
Unfortunately, we are not going to get helpful results until the President and Congress develop an understanding about finance and what their current philosophies about economic policy are doing.
Unfortunately, I don’t see this happening in the near term.
Just two points this morning, but points that I have made before.
The first point pertains to the understanding…or misunderstanding…of what finance is all about. This misunderstanding is captured in the lead editorial in the New York Times this morning titled “After Goldman” (http://www.nytimes.com/2010/04/22/opinion/22thu1.html?hp). In this editorial we read: “The Goldman deal was nothing more than a bet on the mortgage market…WITHOUT ‘INVESTING’ ANYTHING IN THE REAL ECONOMY.”
Guess what? That is what finance ultimately is. Finance is nothing more than information and millions and millions of people operate with this kind of information every day.
What is your dollar bill? A piece of paper…a piece of information.
Well, but it is legal tender!
Right, according to the government you have to accept a dollar bill in payment for debt. What has this got to do with THE REAL ECONOMY?
And, what about the demand deposit account you have at your commercial bank? It is just 0s and 1s in some computer. What has this got to do with THE REAL ECONOMY?
By the way, you are betting that you will be able to access that money when you need it? Is it safe?
Well, you say, the deposit account has insurance on it, doesn’t it? The Federal Government has guaranteed that you will not lose these funds and will not be inconvenienced by a delay in access to them. You have a promise! But, what has that got to do with THE REAL ECONOMY?
What are loans? Well, they are cash flows. Say, an initial cash outflow to the borrower and then a series of cash inflows back to the lender. Just 0s and 1s through bank accounts.
But, I put up a house to back the loan, didn’t I? The house is a real asset.
Yes, but the loan agreement is in terms of cash flows and the house is there for security in case you don’t pay the returning cash flow. Furthermore, that house is 25% underwater now, another piece of information, so how does this impact the cash flows?
Furthermore, it was the government that showed us how to “slice and dice” cash flows in order to tailor cash flows so that potential purchasers would find those “new” cash flows more attractive and purchase them. The first mortgage-backed security was issued by the Federal Government in 1970. The mortgage market went from playing a zero role in world capital markets to becoming, by the middle of the 1980s, the largest component of world capital markets. (See Michael Lewis’ “Liar’s Poker”.)
Thank you Washington for teaching us that cash flows are just bits of information! No real world
here.
Now Washington wants to bring the herd of cats it has unleashed under control. Good luck!
The second point has to do with government policy and how it creates the environment for all else that goes on in the economy. Some of this discussion can be related to the David Wessel’s column in the Wall Street Journal this morning, “Mapping Fault Lines of Crises,” (http://online.wsj.com/article/SB20001424052748704133804575198080507492968.html#mod=todays_us_page_one). Wessel, in his column, discusses the work of Raghuram Rajan, a professor at the University of Chicago and former chief economist at the International Monetary Fund.
Rajan argues that “The U. S. approach to recession-fighting and its social safety net are geared for fast recoveries of the past, not jobless recoveries now the norm. That puts pressure on Washington to do something: tax cuts, spending increases and very low interest rates. This leads big finance to assume that the government will keep money flowing and will step in if catastrophe occurs.”
This philosophy of government was first incorporated into government policymaking in the early sixties and has continued as the foundation for economic policy ever since. A consequence of this has been that the purchasing power of the dollar has gone from $1.00 in January 1961 to $0.15 in 2010. And, as we know, a sustained inflationary environment is one that produces massive debt creation and increasing financial leverage along with extensive amounts of financial innovation.
This leads us to another part of Rajan’s argument: “As incomes at the top soared (in the last half of the 20th century), politicians responded to middle-class angst about stagnant wages and insecurity over jobs and health insurance. Since they couldn’t easily raise incomes, politicians of both parties gave constituents more to spend by fostering an explosion of credit, especially for housing.” And, Wessel states, Rajan goes back in history to support the fact that this is not an atypical reaction.
The latter move not only contributed to general inflation, but eventually led to asset price bubbles in specific sectors of the market which could not be sustained. Hence the financial crisis!
Finance has never really been connected to THE REAL ECONOMY. Take a look at Niall Ferguson’s book “The Ascent of Money.” (See my review, http://seekingalpha.com/article/120595-a-financial-history-of-the-world.) This is especially true since the growth in finance and financial innovation, historically, has been connected with government’s financing of wars and, in the 20th century, the social system.
Furthermore, finance, in the future, is going to be even more connected with the idea of information and the exchange of information. For example, see the book “The Quants” (http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson). And, this concept is spreading beyond financial markets. An amazing amount of research efforts and publications are connected with “Information Markets” which are not related to financial markets. Bob Shiller of “Irrational Exuberance” has produced a lot in this area: see his books “Macro Markets” and “The New Financial Order.”
The point is, again, that the President and Congress are fighting the last war. But, the last war is history!
Thursday, March 18, 2010
The "Dodd" Financial Reform Bill
Well, there finally is a financial reform bill!
Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System seems to be back in the good graces of the political pros. So much for the independence of the Fed!
The only thing Bernanke seems unhappy about at the present time is that he would like to maintain more regulatory influence over banks that are less than $50 billion in asset size. Otherwise, he seems pretty satisfied.
The important thing is that the Fed and the Chairman of the Fed retain, or even increase, their power.
I have written on the future environment of bank regulation and so I don’t intend to go into that again at this time. This series began on January 25, 2010: see my “Financial Regulation in the Information Age: Part A” (http://seekingalpha.com/article/184153-financial-regulation-in-the-information-age-part-a) which was followed by Part B and Part C. Let me just say that I believe that the regulatory structure that Dodd and Congress is attempting to construct is aimed at “fighting the last war” and that the financial system, especially the part composed of large financial organizations, has already moved beyond what the politicians are fighting for. So, Congress is already behind the times.
Even more important, however, is the fact that the underlying cause of the growth in finance over the past fifty years or so, the financial innovation that took place, and the evolution of financial institutions into structures that are “too big to fail”, is not even being addressed. And, if this cause is not taken into account, any regulatory structure that Congress constructs will be doubly inadequate to handle the problems of the future.
Debt finance thrives in an inflationary environment! Need I mention again that what a dollar bill could purchase in January 1961 has declined to the point that a 2010 dollar could only buy less than twenty cents worth of the same goods and services today? The purchasing power of the dollar has declined by more than 80% since the early 1960s.
The inflationary environment that began in the early 1960s bore fruit by the early 1970s and only spread from there. The Gross Federal debt had increased by more than 40% during this time period, the largest peace-time increase in the government’s debt in history. Commercial banks had innovated to the extent that they could get-around any federal or state regulations that might limit their geographic or asset expansion by creating the ability to “manage liabilities” and hence grow to any size that they desired. The federal government had created a novel new financial innovation called the mortgage-backed security that would, in fifteen years or so, result in the mortgage market becoming the largest component of the capital markets in the world.
And, by August 1971, inflation became such a problem that President Nixon froze wages and prices in the United States and removed the dollar from the gold standard. In addition, Nixon appointed a Fed Chairman that underwrote his re-election and promoted the most expansive monetary growth in the post-World War II period to date. By the end of the 1970s decade, inflation was the number one problem in the United States. In 1978, Congress passed a second full employment bill that secured in law the “Keynesian” economic philosophy that the federal government had to achieve high levels of employment in the economy. And, as they say, with two short exceptions, the rest is history.
There is no better environment for debt and the creation of financial innovation than one that is grounded in inflation. With no constraint on the size of financial institutions, almost all of them became liability managers, banks and other financial organizations could grow and grow and grow. Where there were constraints, the environment was such that ways could be found around the constraints. And, since the constraints didn’t work in such an inflationary environment, the politicians and the regulators were even willing to remove or lessen the constraints that were still on the books. Good-bye Glass-Steagall.
Inflation, usually measured in terms of flow statistics like the Consumer Price Index, spilled over into the prices of assets, like common stocks, houses, and commercial real estate. The consumer inflation of the period before the 1990s became the “bubble” inflations of the 1990s and 2000s, and, the music continued to play.
My point is, of course, that no regulatory structure is going to withstand an economic environment in which the value of the currency declines by more than 80 percent over a period of fifty years. And, the last fifty years was a period in which the Information Age was just in its infancy. The major point in my series of posts on regulation that appeared in January was that the ability of financial institutions to innovate in the next fifty years is ever so much greater than it was in the past fifty years. Thus, the hope to “rein in” the financial system is like smoke that will just swiftly drift away into the atmosphere.
If Congress and the Obama administration want to keep a lid on the financial system they need to clean up their own house first. The attempts they are making to re-regulate this financial system, to me, are hopeless unless they abandon the fundamental philosophy that is the foundation for their economic policies. The “Keynesian” effort to keep employment at high levels in the short run hasn’t worked and it will not work in the future. The “Keynesian” effort to keep employment at high levels creates an inflationary bias in the economy. An inflationary bias produces an incentive to take on more and more debt and leverage oneself into the future. This bias is the engine that drives the excessive risk-taking that can come from accelerating financial innovation. This is story of what occurred over the past fifty years.
In conclusion, then, financial regulation is more than just controlling the behavior of “greedy” bankers!
Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System seems to be back in the good graces of the political pros. So much for the independence of the Fed!
The only thing Bernanke seems unhappy about at the present time is that he would like to maintain more regulatory influence over banks that are less than $50 billion in asset size. Otherwise, he seems pretty satisfied.
The important thing is that the Fed and the Chairman of the Fed retain, or even increase, their power.
I have written on the future environment of bank regulation and so I don’t intend to go into that again at this time. This series began on January 25, 2010: see my “Financial Regulation in the Information Age: Part A” (http://seekingalpha.com/article/184153-financial-regulation-in-the-information-age-part-a) which was followed by Part B and Part C. Let me just say that I believe that the regulatory structure that Dodd and Congress is attempting to construct is aimed at “fighting the last war” and that the financial system, especially the part composed of large financial organizations, has already moved beyond what the politicians are fighting for. So, Congress is already behind the times.
Even more important, however, is the fact that the underlying cause of the growth in finance over the past fifty years or so, the financial innovation that took place, and the evolution of financial institutions into structures that are “too big to fail”, is not even being addressed. And, if this cause is not taken into account, any regulatory structure that Congress constructs will be doubly inadequate to handle the problems of the future.
Debt finance thrives in an inflationary environment! Need I mention again that what a dollar bill could purchase in January 1961 has declined to the point that a 2010 dollar could only buy less than twenty cents worth of the same goods and services today? The purchasing power of the dollar has declined by more than 80% since the early 1960s.
The inflationary environment that began in the early 1960s bore fruit by the early 1970s and only spread from there. The Gross Federal debt had increased by more than 40% during this time period, the largest peace-time increase in the government’s debt in history. Commercial banks had innovated to the extent that they could get-around any federal or state regulations that might limit their geographic or asset expansion by creating the ability to “manage liabilities” and hence grow to any size that they desired. The federal government had created a novel new financial innovation called the mortgage-backed security that would, in fifteen years or so, result in the mortgage market becoming the largest component of the capital markets in the world.
And, by August 1971, inflation became such a problem that President Nixon froze wages and prices in the United States and removed the dollar from the gold standard. In addition, Nixon appointed a Fed Chairman that underwrote his re-election and promoted the most expansive monetary growth in the post-World War II period to date. By the end of the 1970s decade, inflation was the number one problem in the United States. In 1978, Congress passed a second full employment bill that secured in law the “Keynesian” economic philosophy that the federal government had to achieve high levels of employment in the economy. And, as they say, with two short exceptions, the rest is history.
There is no better environment for debt and the creation of financial innovation than one that is grounded in inflation. With no constraint on the size of financial institutions, almost all of them became liability managers, banks and other financial organizations could grow and grow and grow. Where there were constraints, the environment was such that ways could be found around the constraints. And, since the constraints didn’t work in such an inflationary environment, the politicians and the regulators were even willing to remove or lessen the constraints that were still on the books. Good-bye Glass-Steagall.
Inflation, usually measured in terms of flow statistics like the Consumer Price Index, spilled over into the prices of assets, like common stocks, houses, and commercial real estate. The consumer inflation of the period before the 1990s became the “bubble” inflations of the 1990s and 2000s, and, the music continued to play.
My point is, of course, that no regulatory structure is going to withstand an economic environment in which the value of the currency declines by more than 80 percent over a period of fifty years. And, the last fifty years was a period in which the Information Age was just in its infancy. The major point in my series of posts on regulation that appeared in January was that the ability of financial institutions to innovate in the next fifty years is ever so much greater than it was in the past fifty years. Thus, the hope to “rein in” the financial system is like smoke that will just swiftly drift away into the atmosphere.
If Congress and the Obama administration want to keep a lid on the financial system they need to clean up their own house first. The attempts they are making to re-regulate this financial system, to me, are hopeless unless they abandon the fundamental philosophy that is the foundation for their economic policies. The “Keynesian” effort to keep employment at high levels in the short run hasn’t worked and it will not work in the future. The “Keynesian” effort to keep employment at high levels creates an inflationary bias in the economy. An inflationary bias produces an incentive to take on more and more debt and leverage oneself into the future. This bias is the engine that drives the excessive risk-taking that can come from accelerating financial innovation. This is story of what occurred over the past fifty years.
In conclusion, then, financial regulation is more than just controlling the behavior of “greedy” bankers!
Subscribe to:
Posts (Atom)
