The Right Way to Deregulate Wall Street


The economy has been chugging along at about 2% annual GDP growth ever since the end of the Great Recession in June 2009. Unemployment has been steadily dropping and is now a fairly low 4.4%.  Low wage earners are now even beginning to see bigger gains in pay.
Most people would like to speed up economic growth even more.  Tax reform will help in this regard but so will sensible deregulation.  Barron’s has an excellent article this week about deregulating Wall Street by William D. Cohan.

According to Mr. Cohan:

  • GDP growth is highly correlated with bank lending.
  • The Dodd-Frank Act, passed by Congress in 2010, has disproportionately burdened community banks, despite their having no role in the financial crisis.
  • More than 1700 U.S. banks have disappeared since Dodd-Frank was passed.
  • Senator John Kennedy (R, LA) has introduced a bill which would exempt community banks and credit unions with assets of less than $10 billion from the Dodd-Frank Act.
  • As a result of Dodd-Frank, big banks are now required to have more capital and less leverage. Today a bank’s assets would have to fall about 7% before a bank’s capital would be wiped out, as opposed to only 2% in 2008.  This makes them safer.
  • Prior to 1970 the Wall Street partnership structure ensured that bankers had plenty of skin in the game – essentially their full net worth was on the line every day.
  • Today bankers and traders are rewarded for taking risks with other people’s money. Mr. Cohan recommends that the top 500 traders and executives at every big bank have a significant portion of their net worth on the line.

Conclusion. Mr. Cohan’s program would not only give a big boost to the economy by enabling community banks to lend more freely but would also make our financial system safer by requiring top financiers to have skin in the game.

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The Trump Critics Need to Calm Down


The New York Times editorial page is unremittingly hostile towards Donald Trump. My last post reports on an essay in the Atlantic magazine, “How to Build an Autocracy,”  arguing that Trump will seize dictatorial power if he can get away with it.  Now the foreign policy expert Elliot Cohen, whose work I greatly admire, argues that the Trump regime will probably end in some disastrous calamity such as a terrible global recession or war. This is overreaction.

Several of Trump’s executive orders in the first two weeks are very positive:

  • New Iran Sanctions for conducting ballistic missile tests contrary to agreement. This also implies that the Trump Administration will probably not tear up the Iranian Nuclear Agreement signed in July 2015.
  • Rolling back overly restrictive Dodd-Frank regulations. The financial crisis was not caused by greedy bankers but rather by the bursting of the housing bubble fed by too many government-mandated subprime mortgages. The Dodd-Frank Act is aimed at Wall Street banks but is hurting too many Main Street banks.
  • Federal Regulations. Requiring that at least two regulations be repealed for each new one implemented. This is a gimmick but it is still a move in the right direction.

There are, of course, at least two that are ill conceived:

  • The travel ban to the U.S. from seven predominantly Muslim countries was rushed out without careful vetting but has now been blocked by U.S. District Judge James Robart in Seattle.
  • Revamping the National Security Council by removing the chairman of the Joint Chiefs of Staff and replacing him by his chief strategist Steve Bannon. This gives too much influence to an inexperienced amateur.

Conclusion. The American people are taking a clear risk with such an unconventional populist President. But we have huge problems to solve, especially economic (slow growth) and fiscal (massive debt). A President Clinton would not have addressed them effectively. I am quite confident that President Trump will address them.  Furthermore his supporters and their representatives in Washington are capable of restraining him if necessary.

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The Need for Regulatory Reform


One of my favorite topics is the need for faster economic growth in order to create more jobs and better paying jobs and also to bring in more tax revenue to help shrink our rapidly accumulating national debt.
My last post discusses vivid evidence from the economist John Taylor that slow productivity growth is one of the main culprits holding back our economy.  He suggests several ways of speeding up productivity growth, one of which is regulatory reform.

capture74Two previous posts, here and here, show the increasing size of the regulatory burden as well as how it could be eased significantly for main street banks, for example, by simplifying the Dodd-Frank Act.
A recent study from the Mercatus Center at George Mason University gives a good overall summary of the economic costs of excessive regulation.  In particular:

  • Deterring growth. By distorting the investment choices that lead to innovation, regulation has caused a considerable drag on the economy, amounting to an average reduction of 0.8% in the annual growth rate of the US GDP. This has resulted in an economy which is $4 trillion smaller in 2012 than it could have been without such regulatory accumulation.
  • Increasing prices. Increases in the total volume of regulations are strongly associated with higher prices. This affects lower-income households harder than higher-income households.
  • Distortion of labor market. Regulation adds to costs, increasing prices for regulated goods and services and therefore reducing the amounts being bought and sold. As production declines, so does the demand for workers engaged in production. In addition, more regulation leads to a shift of workers from production to regulatory compliance, reducing overall economic efficiency.
  • Decline in competition. Existing firms benefit from regulation because it deters new market entrants, thereby reducing the number of small firms, which are responsible for most new hiring.

Conclusion. Federal regulations have accumulated over many decades, resulting in a system of duplicative, obsolete, conflicting and even contradictory rules. The consequences to the workers, consumers and job creators who drive economic growth and prosperity are considerable.

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Dodd-Frank Is Hurting the Recovery!


The Federal Reserve Bank plays an important role in our economy by trying to keep inflation low and stable but also by trying to make recessions less severe by increasing the money supply when the unemployment rate is high. My last post, “What the Federal Reserve Can and Can’t Do” emphasizes that, as Ben Bernanke says, “the Fed has little or no control over long term fundamentals,” such as economic growth which depends on increases in productivity which, in turn, are heavily influenced by fiscal and regulatory policy.
Capture8The American Enterprise Institute’s Peter Wallison explains very clearly in “The slow economic recovery explained,” why, for example, the Dodd-Frank Act of 2010 is having a harmful effect on economic growth:

  • Regulatory burdens imposed by Dodd-Frank have been particularly harsh for community banks, with $10 billion or less in assets; 98.5 % of U.S. banks fall into this category. Since Dodd-Frank was enacted in 2010, community banks’ share of banking assets has shrunk by 12%.
  • According to the Small Business Administration, there were approximately 23 million small businesses (with fewer than 500 employees) in 2012, compared to 18,500 firms with more than 500 employees. Large businesses have access to capital markets whereas small businesses rely on local banks for their credit needs.
  • Regulatory costs affect small banks more than large banks because the costs are fixed, independent of size of the institution. When the Consumer Financial Protection Bureau sends out voluminous regulations on mortgage lending, for example, then extensive legal fees, compliance officers and technology retooling must be paid for up front.
  • A recent report from Goldman Sachs, “The Two-Speed Economy,” shows that large firms have grown faster than usual after 2010 while small firms have grown much slower than usual (see chart above).

Conclusion. Monetary policy alone, as conducted by the Federal Reserve, cannot return our economy to good health. This can only be accomplished by increasing productivity which is aided by smart fiscal and regulatory policy. Dodd-Frank is an example of regulatory policy which is hurting economic growth by having a harmful effect on main street banks.                                 

Providing Regulatory Relief for Main Street Banks

The major congressional response to the Financial Crisis was the passage of the Dodd-Frank Act in 2010, putting many restrictions on U.S. financial institutions in hopes of ending “too big to fail.”  The problem is that the new regulations often apply to the many low risk, traditional, main street banks which did not cause the financial crisis.  The new regulations hamper the ability of these smaller banks to lend money to their regular customers, thereby slowing down the economic growth we need for full recovery from the recession.
CaptureThomas Hoenig, Vice Chair of the Federal Deposit Insurance Corporation, has recently made some common sense recommendations for alleviating this problem.
He proposes to provide relief for financial institutions which meet the following criteria:

  • Banks that hold zero trading assets or liabilities.
  • Banks that hold no derivative positions other than interest rate swaps and foreign exchange derivatives.
  • Banks whose total value of all derivative exposures is less than $3 billion.
  • Banks which have a ratio of equity-to-assets of at least 10%. Most community banks meet this criteria and the number is within reach for those which do not.

Of more than 6500 commercial banks, only about 400 do not meet the first three criteria.  None of the banks with more than $100 billion in total assets meet these criteria. Banks which qualify could receive relief such as:

  • Exemptions from Basel capital standards and risk-weighted asset calculations.
  • Allowing for examiner judgment in eliminating requirements to refer “all possible or apparent fair lending violations to Justice” if judged to be de-minimis or inadvertent.
  • Exemptions from appraisal and stress test requirements.
  • Allowing an 18-month examination cycle as opposed to the current 12-month cycle.

Mr. Hoenig’s conclusion: “For the vast majority of commercial banks that stick to traditional banking activities, and conduct their activities in a safe and sound manner with sufficient capital reserves, the regulatory burden would be eased.  For the small handful of firms that have elected to expand their activities beyond commercial banking, the additional regulatory burden is theirs to bear.”

The Financial Crisis IV. Where Do We Go From Here?


“It was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it.                                                                    former Congressman Barney Frank, 2010

“Only by understanding the factors that led to and amplified the crisis can we hope to guard against a repetition.”
                                                   former Federal Reserve Chair, Ben Bernanke, 2010

As I explained in my last post, my views on the financial crisis are most heavily influenced by John Allison, President of the CATO Institute; Sheila Bair, former Chair of the FDIC; and Peter Wallison, a financial policy analyst at the AEI, as follows:

  • The primary cause of the crisis was the affordable housing policy, created by Congress and administered by HUD, under which higher and higher percentages of mortgages acquired by the GSEs Fannie Mae and Freddie Mac had to be made to low and moderate income borrowers. This policy, aided by the very low interest rates maintained by the FED from 2002-2004, created the housing bubble which burst in 2007 leading to an unprecedented number of delinquencies and defaults.
  • Subprime lending abuses could have been avoided if the FED had used the authority it had under the Home Ownership Equity Protection Act of 1994 to require appropriate mortgage lending standards. In other words, lax regulation, but not deregulation, was a major contributor to the crisis.
  • Investment Banks, such as Bear Stearns and Lehman Brothers, magnified the misallocation of credit to the housing market with financial products such as CDOs and derivatives.

Clearly congressional action was needed to address the financial abuses leading up to the crisis.  But the Dodd-Frank Act is an overreaction.  It requires 398 new regulations which are taking a big toll on the economy as shown by the chart below from the American Action Forum.
CaptureDodd-Frank should be scaled back so that its provisions apply only to the very largest financial institutions where the abuses were the greatest.  This can be accomplished with capital requirements which increase proportionally with the size of the institution so that smaller banks are better able to compete with the giants.
Faster economic growth is critical for our future.  It will not only create more jobs and higher paying jobs but will also alleviate our deficit problem by bringing in more tax revenue.  Paring back and streamlining Dodd-Frank would be a big step in the right direction.

The Government’s Mishandling of the Financial Crisis


“If stupidity got us into this mess, why can’t stupidity get us out?”
Will Rogers, 1879 – 1935

The Financial Crisis of 2008 and the subsequent Great Recession, from which we are still slowly emerging, is the greatest shock to our fiscal and economic health since the Great Depression of the 1930s.  There are many explanations available for what happened, the most believable ones being written by the major participants themselves. My favorite reference for these events is the book, “Bull by the Horns,” written by the former Chair of the Federal Deposit Insurance Corporation, Sheila Bair, who held this post from 2006 – 2011.  Ms. Bair could see the crisis coming.  She interacted with all of the prime players but was too late on the scene, and with too little clout, to have a major effect on the outcome.
CaptureAnother persuasive account is provided by Richard Kovacevich, Chairman Emeritus of Wells Fargo, in a recent speech, “The Financial Crisis: Why the Conventional Wisdom Has It All Wrong.”  According to Mr. Kovacevich:

  • Forcing all large banks to take TARP funds, in October 2008, even if they didn’t want or need the funds, was one of the worst economic decisions in the history of the U.S.
  • If Bear Stearns had been allowed to go bankrupt in March 2008, Lehman Brothers would have been sold and the subsequent financial crisis greatly reduced. A total of just 20 financial institutions caused the crisis, half investment banks and half savings and loans, yet 6000 commercial banks are being punished by Dodd-Frank.
  • Dodd-Frank does not address the major causes of the recent crisis and offers few approaches to prevent the next one.
  • Since regulatory agencies are not capable of using the authority they already have to prevent failures, we need a regulatory system which limits the damage of failures. In case of failure, all creditors, other than insured depositors, should take a “haircut”.
  • Requiring excessive levels of capital will only cause financial institutions to take on greater risks. If equity and long term debt, at both the bank and bank holding company levels, is required to be maintained at 30% of assets, it is unlikely that the FDIC will ever incur losses.
  • The quasi-private/public agencies Fannie Mae and Freddie Mac need to be abolished.
  • The Glass-Steagall Act, passed in 1933 and repealed in 1999, should not be reinstated because investment banking is far less risky than commercial banking, and therefore the two forms of banking need not be separated.
  • There are three warning signs when a financial institution is approaching the danger zone: concentration of risk, inadequate liquidity and significant exposure to capital markets. Competent regulators, not Dodd-Frank, are needed to address these risks.

Recoveries from past recessions have been much more vigorous than our anemic 2.2% rate of GDP growth for the past five years. Mr. Kovacevich believes that because of the Dodd-Frank legislation, and the current monetary policies of the Federal Reserve, the bottom 25% of Americans on the economic ladder have restricted access to mortgages and personal loans.  This is inhibiting economic growth and contributing significantly to the inequality gap.


The President Plays Small Ball


As reported in today’s New York Times, ”Personal Tack by Obama in an Effort to Aid Parents”, the President held an all-day conference yesterday for working families, saying that

  • “Family leave, child care, workplace flexibility, a decent wage – these are not frills – they are basic needs.”
  • “There is only one developed country in the world that does not offer paid maternity leave. And that is us. And that is not the list you want to be on by your lonesome.”
  • “We need you to tell Congress, don’t talk about how you support families: actually support families.”


The economic journalist, Robert Samuelson, pointed out in the Washington Post a few days ago, ”The Jobs Mystery”, that even though our unemployment rate has now dropped to 6.3%, there are still 9.8 million officially unemployed people, plus an additional 7 million who would like a job but are not looking.  There are also 7.3 million part-time workers who would like longer hours.  This gives a really quite shocking total of 24.1 million unemployed or underemployed workers.
Granted we had a bad recession which was not the President’s fault, but it ended in June 2009, a full five years ago.  In the meantime his administration has done much to retard economic growth (passing ObamaCare and the Dodd-Frank Act) and little, besides huge deficit spending, to boost it.  He and the Democratic Party should be held responsible for this neglect and they probably will be.
One thing which would do a lot to boost economic growth is apparently contrary to liberal ideology and therefore off the discussion table.  I am referring to fundamental, broad-based tax reform whereby individual tax rates would be lowered across the board, but in a revenue neutral manner, by closing or greatly shrinking the loopholes and deductions which primarily benefit the wealthy.  The two-thirds of Americans who do not itemize their tax deductions would get a big boost in take home pay.  Since they are primarily middle and lower income workers whose wages have been stagnant since the recession began, they will tend to spend this extra income, thereby giving the economy a big boost.
If the President were to sincerely ask the House Republican leadership to work with the Democratic Party to boost economic growth, something along this line could be acted upon.  This is the way to really aid families.  Why doesn’t he do it?