Financial Reform Legislation Does Not Eliminate Too Big To Fail

Betting That Cutting Spending Won’t Derail Recovery: The world’s rich countries are now conducting a dangerous experiment. They are repeating an economic policy out of the 1930s — starting to cut spending and raise taxes before a recovery is assured — and hoping today’s situation is different enough to assure a different outcome. In effect, policy makers are betting that the private sector can make up for the withdrawal of stimulus over the next couple of years. If they’re right, they will have made a head start on closing their enormous budget deficits. If they’re wrong, they may set off a vicious new cycle, in which public spending cuts weaken the world economy and beget new private spending cuts.  Today, no wealthy country is an obvious candidate to be the world’s growth engine, and the simultaneous moves have the potential to unnerve consumers, businesses and investors,  “The world may be making a mistake, and it may turn out to make things worse rather than better,”

Who Will Fight for the Unemployed?, Editorial, NY Times: Without doubt, the two biggest threats to the economy are unemployment and the dire financial condition of the states, yet lawmakers have failed to deal intelligently with either one.  Federal unemployment benefits began to expire nearly a month ago. Since then, 1.2 million jobless workers have been cut off. The House passed a six-month extension … in May, but the Senate, despite three attempts, has not been able to pass a similar bill. The majority leader, Harry Reid, said he was ready to give up after the third try last week when all of the Senate’s Republicans and a lone Democrat, Ben Nelson of Nebraska, blocked the bill. Meanwhile, the states face a collective budget hole of some $112 billion, but neither the House nor the Senate has a plan to help. The House stripped a provision for $24 billion in state fiscal aid from its earlier spending bill. The Senate included state aid in its ill-fated bill to extend unemployment benefits; when that bill failed, the promise of aid vanished as well. As a result, 30 states that had counted on the money to help balance their budgets will be forced to raise taxes even higher and to cut spending even deeper in the budget year that begins on July 1. That will only worsen unemployment… Worsening unemployment means slower growth, or worse, renewed recession.

Taleb and Roubini on Government Intervention – While we were interviewing America’s two most prominent doomsters a few weeks ago, Nassim "Black Swan" Taleb and Nouriel "housing crisis" Roubini, the two got into an argument. It was friendly enough — they admire each other — but vigorous, and it concerned the great economic debate of the moment: more government stimulus, or less?  We thought viewers would be interested in their take on the issue and so we edited a relevant segment of our interview for the web. Here it is: (Watch a larger version of the video.)

Some Excellent New Deal 2.0 Posts on Social Security – New Deal 2.0 has been running some excellent Social Security commentary over the past couple weeks. They ran a series of articles under the heading Social Security Fiscal Fitness which included contributions by Robert Kuttner: The Stealth Attack on America’s Best-Loved Program and Greg Anrig: How Social Security Can Gain Without Much Pain.Two specific posts I want to extra encourage you to check out. First is a post, Deficits, Social Security, and the American Public, based on a Roosevelt Institute working paper, Understanding Public Opinion On Deficits and Social Security, by noted scholars Benjamin I. Page and Lawrence I. Jacobs. I also want to point out this post, Social Security’s Family Benefits and the Fiscal Commission by Yung-Ping Chen. He makes the point, one I don’t hear often, that instead of simply using this opportunity to slash benefits, you could actually reorganize the way benefits are paid out to reflect the way the American population is changing

The Financial Reform Bill: A Very Limited Step Forward – The final compromise bill approved by the conference committee on Friday will improve regulation in the financial sector. However, given the severity of the economic crisis caused by past regulatory failures, the public had the right to expect much more extensive reform. On the positive side, the creation of a strong independent consumer financial products protection bureau stands out as an important accomplishment. The requirement that most derivatives be either exchange traded or passed through clearinghouses is also an important improvement in regulation. However, important exceptions remain, which the industry will no doubt exploit to their limit. The creation of resolution authority for large non-bank financial institutions is also a positive step, although the fact that no pre-funding mechanism was put in place is a serious problem.On the negative side, there is little in this legislation that will fundamentally change the way that Wall Street does business. The rules on derivative trading will still leave the bulk of derivatives to be traded directly out of banks rather than separately capitalized divisions of the holding company. The Volcker rule was substantially weakened by a provision that will still allow banks to risk substantial sums in proprietary trading.

A Bank Fee Is Cut From Financial Overhaul Bill – NYTimes— Congressional negotiators briefly reopened the conference proceedings on a sweeping financial regulatory bill on Tuesday after Senate Republicans who had supported an earlier version of the measure threatened to block final approval unless Democrats removed a proposed tax on big banks and hedge funds. Conference negotiators voted to eliminate the proposed tax and adopted a new plan to pay the projected five-year, $20 billion cost of the legislation. The new plan would bring an early end to the Troubled Asset Relief Program, the mammoth financial system bailout effort enacted in 2008, and redirect about $11 billion toward heightened regulation of the financial industry.  The conferees also voted to increase the reserve ratio of the Federal Deposit Insurance Corporation, but specified that small depository institutions — those with less than $10 billion in consolidated assets — be exempt from paying any increase.

Cleveland Fed: It’s Not Looking Good – The Cleveland Fed has launched a new website that will provide on a monthly basis estimates of expected inflation over various horizons. These estimates are supposed to be cleaner than those coming from Treasury inflation-protected securities (TIPS) which are contaminated by risk premia. The model that is the basis for these estimates can also be used to derive real interest rates and an inflation risk premium. This is a great addition to the universe of online economic data and the Cleveland Fed should be commended for providing it to the public. The numbers for June 2010 are not pretty. Here is the lead paragraph: The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.84 percent. In other words, the public currently expects the inflation rate to be less than 2 percent on average over the next decade. It gets worse. This 1.84% is down from the previous month as is all yearly horizons of inflation expectations.. This figure shows the expected inflation over maturities ranging from 1 to 30 years:


Financial Reform Legislation Does Not Eliminate Too Big To Fail – This bill is not going to end the problem of too big to fail. If the banking system is threatened, then one way or the other it will be bailed out. The consequences to the economy would be too large to do otherwise. Thus, banks that are big enough to pose a systemic risk enjoy an advantage over other banks. Banks that pose a systemic risk will be assumed to be safer than other banks due to the implicit government guarantee. This gives large banks an advantage over smaller banks that do not, on their own, threaten the financial system if they fail. In addition, the implicit guarantee gives large banks the incentive to take on too much risk, and this is a reason to regulate the amount of risk they can take (and I don’t think the proposed legislation does enough in this regard).So two things are needed. One is to ensure that the banks that operate under the implicit guarantee cannot take on excessive risk, and the other is to eliminate the advantage that the implicit guarantee gives to bigger banks.

First-Time Homebuyer Traffic Nose-Dive  -First-time buyers purchased 46% of existing home sales in May, down from 49% in April.We all knew that first-time home buyers activity was going to fade after the tax credit expired. But there was not much of a way to quantify exactly what the impact would be beforehand. We could wait for subsequent monthly sales data to reflect that weakness — but that is hardly much of a solution. Enter the Campbell/Inside Mortgage Finance Monthly Survey of Real Estate Market Conditions, a proprietary survey of 1,500 real estate agents nationwide. The results of the first survey are out, and not surprisingly, it indicates that first-time “homebuyer traffic dropped sharply in May. This drop implies fewer signed contracts in June and fewer closed transactions in July and August.

Adam Posen: One Fiscal Size Does Not Fit All – a Korean lesson for Spain – Twelve years ago, the Asian Financial Crisis hit.  The International Monetary Fund took a common approach across the crisis countries, prioritizing fiscal austerity.  In retrospect, outside observers and the Fund itself came to the conclusion that this was a mistake – while appropriate for Indonesia, the ‘It’s Mostly Fiscal’ approach made the situation worse than it needed to be in South Korea, with negative spillovers for the rest of the region.  The euro area governments, under pressure from Berlin and Brussels, are repeating this mistake.    European politicians, particularly in Germany, are visibly sick of Americans and others telling them that imposing uniform austerity beyond Greece and Portugal is in error.  But facts are facts, and it is an error.  The experience of the Asian Financial Crisis is directly relevant, and the willingness of the IMF to reconsider its position in the time since would be a good example to follow.  What matters is getting policies right, not adhering to a foolish consistency, either in policy recommendations across countries or in publicly taken positions.

Ryan Avent: Austerity: A healing pain? – Positive experiences with budget cuts are almost always associated with devaluations, which are off the table for euro area members. They’re usually combined with structural reforms, but Ireland has already rid itself of much of the burdensome economic rules that held back its economy in earlier decades. Austerity can also boost growth by reducing interest rates, but this isn’t helpful when markets shrug off the cost-cutting (as they have where Ireland is concerned) or when rates are already low (as they are in America and Britain)… it’s far from clear that austerity can ultimately lead to growth in an environment where global demand remains weak and many countries are simultaneously making fiscal (or other economic) adjustments. Economists observed high debt levels and market panic and seemed to assume that austerity for every country with a big deficit was the right prescription. That may well prove to have been a big mistake.


Financial Reform Bill Breakdown, Lucy and the Football – It looks like Scott Brown for certain, and possibly Collins and Snowe, are worried about a $20 billion dollar fee that the financial reform bill would add, and are now going to not vote for the bill. First off, as Ryan Avent notes, this shows how completely not serious Republicans are about the deficit: Also as Dave Dayen points out: If this isn’t a Lucy-with-the-football moment, I don’t know what is. Brian Beutler reports that Hill aides told him President Obama’s Treasury Department sided with Scott Brown in the waning moments of the Wall Street reform conference committee, favoring his loophole for the Volcker rule designed to help asset management companies in Massachusetts. In the process they shot a giant hole through the efforts to stop the mega-banks from investing in private equity or hedge funds, allowing them to use up to 3% of Tier One Capital…So the White House put all their eggs in the Scott Brown basket to ensure passage, and now he’s wavering.

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