Dammit Janet, I love you!*

I am very pleased with the president’s nomination of Janet Yellen to be the next Federal Reserve Chair. Ms. Yellen has impeccable credentials, the best economic forecasting record of any recent Fed official, and appears to take the regulator part of the Fed Chair job seriously.

This last part is important. Larry Summers, the original front-runner for the job, helped push through the key deregulation of the late Clinton years, has dismissed the idea that it contributed to the bubble or crash, and has basically never admitted a mistake in this area. Alan Greenspan was essentially hostile to financial regulation, and bears as much responsibility as anyone for the housing bubble of the 2000s. Ben Bernanke has acknowledged that the Fed failed as a regulator during the housing bubble, but he was a Fed governor for most of that bubble and Chair for the last two years of it. Economist Bill Black finds Bernanke to have been sorely lacking as a regulator. The Fed’s main regulatory task is to try to detect and reduce systemic risk, i.e., risky activities that threaten the larger financial system and economy. Granted, Yellen told the Financial Crisis Inquiry Commission in 2010 that she failed to see several of those risks (securitization, credit rating agencies, Special Investment Vehicles) when she was San Francisco Fed President in 2004-2010, but on the other hand she was among the first at the Fed to publicly call attention to the housing bubble

Granted, monetary policy, not financial regulation, is the main part of the job. I agree with those who have said she will probably be very similar to Bernanke as far as that goes, and I’d call that a good thing. The Fed needs to do what it can to pull us out of this Little Depression, and since interest rates cannot fall below zero, additional measures like buying long-term bonds and mortgage-backed securities (i.e., quantitative easing, or QE) make sense, as long as they work. Yellen is often stereotyped as a “dove” because in recent years she favored expansionary policy and did not state that inflation was an imminent risk, but those recent years were the Little Depression that began in 2008. When unemployment is not the nation’s biggest problem, Yellen is more concerned about inflation. Such as in the roaring 1990s, when Yellen was Clinton’s Chair of the Council of Economic Advisers and then a Fed governor. With unemployment down to its lowest levels in decades, Yellen was an inflation “hawk,” as Matthew O’Brien details.

Whether the Senate is capable of that much nuance as it considers her nomination remains to be seen. I expect she’ll win majority support, including a handful of Republicans, and that Republicans will resist the temptation to filibuster her nomination. The right-leaning American Enterprise Institute offers several reasons why an anti-Yellen filibuster would be a disaster. Then again, flirting with disaster seems to be the Congressional Republicans’ game plan of late.

PS Here is a recent (Nov 2012) interview with Janet Yellen.

* Title stolen from EconoMonitor, who of course got it from Rocky Horror:

Ask what you can do for the banks

Spencer Bachus, Alabama Republican and incoming chairman of the House Financial Services Committee, lets us know who’s his daddy:

“In Washington, the view is that the banks are to be regulated, and my view is that Washington and the regulators are there to serve the banks.”

The honesty’s too much.

Hat tip and emphasis: Matt Yglesias.

Financial reform bill: Better than nothing

This week the Senate passed a financial reform bill that’s at least a bit tougher than looked possible a couple weeks ago.  Paul Krugman has a concise rundown on it right here:

“What’s good? Resolution authority, which was sorely lacking last year; consumer protection; derivatives traded through clearinghouses; ratings reform, thanks to Al Franken; tighter capital standards for big players, although with too much discretion to regulators.

“What’s missing? Hard leverage limits; size caps; not much in the way of restoring Glass-Steagall. If you think that too big to fail is the core problem, it’s disappointing; if you think that shadow banking is the core, as I do, not too bad.”

Dean Baker has some additional words here on Al Franken’s credit-rating-agencies reform amendment, which would eliminate the huge grades-for-sale conflict of interest of having companies being rated pay the rating agency for their work.  Instead, the Securities and Exchange Commission will assign the rating agency for each new securities issue.

The Senate bill also includes a Consumer Financial Protection Agency, which will be technically independent, as reformers had been pushing for and industry had been furiously opposing.  However, the agency will be housed within the Federal Reserve, which reformers had opposed because of the Fed’s dismal track record on consumer protection over the past decade.  Supposedly the agency will not have to answer to the Fed’s leadership, but we’ll have to see how that works out in practice.  I have not yet seen any word on whether the fabulous Elizabeth Warren, the Harvard Law professor who had been advocating for this agency, would still be interested in heading it.

All told, the bill still leaves much to be desired — Simon Johnson and James Kwak at The Baseline Scenario decry its lack of hard capital requirements or bank size restrictions — but looks a whole lot better than nothing:

Too big, too bad, too late: Greenspan speaks

Simon Johnson has yet another fine post on the need to break up the biggest banks, for the sake of financial stability.  Unfortunately, he notes, it looks like it ain’t gonna happen, that the SAFE Banking Act sponsored by Sens. Sherrod Brown (D-OH) and Ted Kaufman (D-DE) won’t make it anywhere near the Senate floor.*

The post includes a remarkable quote by Alan Greenspan, who now seems to get it:

“For years the Federal Reserve had been concerned about the ever larger size of our financial institutions. Federal Reserve research had been unable to find economies of scale in banking beyond a modest-sized institution. A decade ago, citing such evidence, I noted that ‘megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail.’ Regrettably, we did little to address the problem.”

Now, Greenspan is a bit like the Bible, Shakespeare, or Adam Smith — comb through all his words and you can probably find something to support your position, whatever it is.  But it is striking that he acknowledges the lack of economies of scale brought by big banks and their potential for systemic damage.  His regret at not addressing the problem would be more constructive if he could find a concrete proposal to support, like Sen. Kaufman’s bill, for example.  (I’m reminded of the old quote A little knowledge that acts is worth infinitely more than much knowledge that is idle.)

* Update:  The Brown-Kaufman SAFE Banking Amendment did make it to the Senate floor on May 6, but it was voted down, 33-61.  The roll call vote is here.  About two-thirds of Democrats voted for it, along with three Republicans.  Among the Democrats voting No were Senate Banking Committee Chairman Christopher Dodd and New York’s Chuck Schumer and Kirsten Gillibrand.

Too big

The NYT has a good piece on the prospects for federal breakups of the big banks.  It’s not part of the financial reform bill that the Senate Finance Committee just passed, or the one the House passed earlier, but a group of Democratic senators including Sherrod Brown of Ohio and Ted Kaufman of Delaware just introduced such a measure.

Some numbers to sink your teeth into, from the article:

The banking industry has become much more concentrated as it has grown in recent years. In 1995, the assets of the six largest banks were equivalent to 17 percent of G.D.P.; now they amount to 63 percent of G.D.P. Meanwhile, the share of all banking industry assets held by the top 10 banks rose to 58 percent last year, from 44 percent in 2000 and 24 percent in 1990.

UPDATE: Simon Johnson likes the Kaufman-Brown bill and discusses it at length here.  A longer post here about the specious arguments by two senators and Larry Summers in favor of preserving the size of the big banks.

Mitch McConnell voted for the bank bailout

The Senate Minority Leader has been talking tough lately about how the best way to reform the financial sector is with just three words:  No. More. Bailouts.

Two main drawbacks to this Three Word Game:

(1) The collateral damage to the rest of the economy, notably the credit markets,  is likely to be huge if financial behemoths fail;

(2) Politicians and policy makers know that and will tend to choose a bailout over colossal damage to the economy, no matter what they say.

One such politician is the senior Republican senator from Kentucky, who voted for the financial bailout of 2008, along with 74 other senators.  (The party breakdown was 39-9 in favor among Democrats, 34-15 among Republicans.)

Senator McConnell, I call bullshit.

Exiled From Main St. / Start Breaking Up

Thomas Hoenig, president of the Kansas City Fed and one of the most incisive critics of the “too big to fail” policy, has an op-ed in today’s NYT about the current financial reform bill before Congress.  He says it does far too little to end “too big to fail” — while it sets up a mechanism for big failing financial institutions to be put under FDIC receivership, those financial institutions would still have the political clout to snag a bailout instead.

This may be true, but it seems to be a drawback in any financial reform bill that doesn’t call for the biggest financial institutions to be broken up into smaller ones that are not too big to fail, i.e., which can go bankrupt without significant systemic risk to the economy.  Koenig has spoken elsewhere on the need to break up the biggest banks.  It’s a position that finds favor among many liberal economists,including James Kwak of the Baseline Scenario (see previous link).  Rep. Paul Kanjorski of Scranton, PA has proposed an amendment to give the government power to preemptively break up any financial institution whose failure would impose giant costs on the U.S. economy, but the Senate Banking Committee apparently has nothing like that on the table yet.  Alas, the political clout of the big banks may well be enough to make bank size restrictions a non-starter in the Senate.  Simon Johnson of The Baseline Scenario says much the same thing here.

Hoenig says that another provision of the bill actually makes things worse by narrowing the Fed’s supervisory role to just the nation’s 12 largest banks, most of which are headquartered in NYC.  I do not know what the logic of this provision is, and Hoenig doesn’t say; maybe the idea is for the other banks to be supervised by the FDIC and/or other agencies instead.  Whatever it is, Hoenig thinks the Fed needs to give just as much attention to the other 6,700 as to the top 12.  As he points out, that would seem to be the whole point of having 11 regional Fed banks besides the one in New York.

UPDATE:  Simon Johnson puts it a lot more plainly right here.  For the record, Paul Krugman has his doubts that breaking up the banks would help much — see the last three paragraphs of this recent column.  I’m with Simon Johnson here.  By all means, crack down on fraudulent finance at institutions large and small, but I don’t see how you limit the power of the big banks without limiting their size, too.

The problem with banker pay

Krugman’s latest column is a gem.  The problem, he says, is not the level of financial-industry pay but its asymmetry — lavish rewards for short-term profits, no responsibility for long-term losses or systemic damage — and the perverse incentives that result.  Once again, it’s a case of “privatize the profits, socialize the losses.”

Judging from the quote from President Obama, it doesn’t look like this administration is going to do anything about it, though.  Sigh.

Where credit ain’t due: The rating agencies

For once, I agree wholeheartedly with a Wall Street Journal editorial.  (OK, I could do without the mixed sports metaphor in the title (“A Triple-A Punt.” How bush league).  The piece raps the Obama Administration’s new financial reform plan for giving the credit rating agencies a free pass.  Some key excerpts:

‘The government-anointed judges of risk at Standard & Poor’s, Moody’s and Fitch inflicted upon investors the AAA-rated subprime mortgage-backed security. They also inflicted upon the world’s nest eggs the even more opaque AAA-rated collateralized debt obligation (CDO). Without the ratings agency seal of approval — required by SEC, Federal Reserve and state regulation for many institutional investors — it would have been nearly impossible to market the structured financial products at the heart of the crisis. Yet Team Obama suggests only that regulators reduce the agencies’ favored role “wherever possible.”. . .