We hope that you enjoy this reading over Labor Day, our national holiday dedicated to the ethos of hard work and entrepreneurship that has made America great.
BPC’s Financial Regulatory Reform Initiative regularly highlights news articles, papers, and other important work which illuminate current and new thinking within financial regulation. We circulate these articles to provide a full view of cutting edge ideas, reactions and positions. The views expressed in these articles do not necessarily represent the views of the initiative, its co-chairs, task force members, or the Bipartisan Policy Center.
The Paranoid Style in Economics
By Raghuram Rajan
“For economists who actively engage the public, it is hard to influence hearts and minds by qualifying one’s analysis and hedging one’s prescriptions. Better to assert one’s knowledge unequivocally, especially if past academic honors certify one’s claims of expertise. This is not an entirely bad approach if it results in sharper public debate.
“The dark side of such certitude, however, is the way it influences how these economists engage contrary opinions. How do you convince your passionate followers if other, equally credentialed, economists take the opposite view? All too often, the path to easy influence is to impugn the other side’s motives and methods, rather than recognizing and challenging an opposing argument’s points. Instead of fostering public dialogue and educating the public, the public is often left in the dark. And it discourages younger, less credentialed economists from entering the public discourse.” Read the full piece here.
Bedeviled by Dodd-Frank Details
By The Washington Post Editorial Board
“On Monday, President Obama summoned top financial regulators to the White House and told them to get busy finishing implementation of the 2010 Dodd-Frank financial reform law. Mr. Obama’s impatience is understandable. Dodd-Frank is the centerpiece of his efforts to prevent another financial meltdown like the one in 2008. Yet as of July 15, regulators have finalized only 158 of 398 rules called for in the legislation, according to a law firm, Davis Polk, that tracks the process. Regulators have missed 172 of 279 rule-making deadlines, Davis Polk reports.” Read the full article here.
Safe Banks Need Not Mean Slow Economic Growth
By FDIC Vice Chairman Thomas Hoenig
“Recent research found no evidence that higher bank capital leads to lower volumes of loans over the long run, writes Thomas Hoenig.” Read the entire article here. (Subscription to The Financial Times required)
Letter to Chairman Dodd and Chairman Lincoln from April 30, 2010
By Former FDIC Chairman Sheila Bair
“I urge you to carefully consider the underlying premise of this provision – that the best way to protect the deposit insurance fund is to push higher risk activities into the so-called shadow sector. To be sure, there are certain activities, such as speculative derivatives trading, that should have no place in banks or bank holding companies. We believe the Volcker rule addresses that issue and indeed would be happy to work with you on a total ban on speculative trading, at least in the CDS market. At the same time, other types of derivatives such as customized interest rate swaps and even some CDS do have legitimate and important functions as risk management tools, and insured banks play an essential role in providing market-making functions for these products.” Read the full letter here.
Peer Review of the United States on Implementation and Effectiveness of Financial Regulation
By Financial Stability Board
“Good progress has been made by the US authorities in following up on the Financial Sector Assessment Program recommendations, particularly as regards systemic risk oversight arrangements and the supervision and oversight of FMIs. A unifying theme behind all three topics is the complex and fragmented US regulatory and supervisory structure, characterised by multiple agencies at the state and federal levels with closely related (and sometimes overlapping) responsibilities. To a large extent, the reforms analysed in this peer review focus on the need to ensure effective and efficient coordination and information sharing arrangements and to address any overlaps or gaps in the roles and responsibilities of the respective agencies.” Read the full review here.
Global Liquidity: Public and Private
By Jean-Pierre Landau, presented at the Jackson Hole Economic Symposium
“Global liquidity is a cyclical problem in search of a structural solution. In the period to come, obviously, the main challenge will be to manage the consequences of monetary policies, and their evolutions, on cross border liquidity movements. Amplifications, feedback loops and sensitivity to risk perceptions will complicate the task of exit and necessitate very close and constant dialogue and cooperation between Central Banks. They may also justify much more proactive macro prudential policies that would go beyond dampening long‐term credit cycles. The gains from formal coordination should be sought in the regulatory and financial structures areas rather than monetary policies.” Read the full paper here.
Dilemma not Trilemma: The Global Financial Cycle and Monetary Policy Independence
By Hélène Rey, presented at the Jackson Hole Economic Symposium
“At the heart of the transmission mechanism described in this paper is the ability of financial intermediaries, whether banks or shadow banks to leverage up quickly to very high levels when financing conditions are favourable. Credit is excessively sensitive to the financing costs. I start again… with the useful observation that the most dangerous outcome of inappropriately loose global financial conditions is excessive credit growth. Hence, a sensible policy option, whether in addition to or instead of monitoring the cyclical properties of credit growth is to cut structurally the ability of financial intermediaries to be excessively procyclical. One policy lever seems particularly appropriate for doing this: the leverage ratio.” Read the full paper here.
Macroeconomic Impact Assessment of OTC Derivatives Regulatory Reforms
By Bank for International Settlements, Macroeconomic Assessment Group on Derivatives
“In its preferred scenario, the Group found economic benefits worth 0.16% of GDP per year from avoiding financial crises. It also found economic costs of 0.04% of GDP per year from institutions passing on the expense of holding more capital and collateral to the broader economy. This results in net benefits of 0.12% of GDP per year. These are estimates of the long-run consequences of the reforms, which are expected to apply once they have been fully implemented and had their full economic effects.” Read the full paper here.
How Bad Was It? The Costs and Consequences of the 2007-2009 Financial Crisis
By Dallas Federal Reserve staff
“The 2007-09 financial crisis cost the U.S. economy at least 40 to 90 percent of one year’s total goods and services. The estimate depends on what growth would otherwise have been and what it will be in the future. A more comprehensive evaluation of other factors suggests the costs and consequences of the crisis are even greater.” Read the full report here.
Evaluating Early Warning Indicators of Banking Crises: Satisfying Policy Requirements
By Bank for International Settlements staff
“We find that the credit-to-GDP gap and the [debt service ratio] are the best performing [early warning indicators] in terms of our evaluation criteria. Their forecasting abilities dominate those of the other EWIs at all policy-relevant horizons.” Read the full report here.
IMF working paper: Credibility and Crisis Stress Testing
By International Monetary Fund staff
“[Crisis stress tests] must have a clear objective and take action once valuations have fallen to certain levels. At that stage, and before any crisis of confidence becomes firmly entrenched, they must be prepared to transparently conduct a thorough examination of their banking system, take necessary follow-up action(s) based on the findings and have the requisite resources to back them, if the exercise is to serve its purpose of improving sentiment towards the banking system. Otherwise, the effort would likely backfire and exacerbate the loss in market confidence, with potentially devastating consequences for the real economy.” Read the full report here.