James Pethokoukis

Politics and policy from inside Washington

The Fantastic Four … Fed presidents against the Dodd bill

Apr 26, 2010 17:14 UTC

ffAgain, it isn’t just Republicans making the charge that the Dodd bill does not end Too Big To Fail. So are a quartet of regional Fed bank presidents:

1) Thomas Hoenig of the KC Fed (in a chat with the Huffington Post):

As for Dodd’s treatment of Too Big To Fail, Hoenig said the bill puts too much power in the hands of regulators. “What I worry about [is] if you have a large institution, and it got into very serious trouble and you only have a weekend to take care of it, the procedures under the Dodd bill would make that very difficult,” Hoenig said. “Let’s say you were coming into Monday morning and you didn’t have the ability to get to the judges in time to get this thing approved, and you had to get to another day. What you would tend to do is lend to that institution — if it were not a commercial bank, you would even use the [Fed's] so-called 13-3 authority… and you would lend to it,” he said in a reference to the legal authority that the Fed claimed gave it the power to lend taxpayer money to AIG. “So you would still have it as an operating bank, you would not have taken control of it, not put it in receivership yet, and yet you would be bailing it out. That’s what we have to avoid.
“There’s still this desire to leave discretion in the hands of the Secretary of the Treasury, and while I understand that desire — because you never know what the circumstance is going to be — the problem is in those circumstances you always take the path of least resistance because of the nature of the crisis.

“You don’t want to be the person responsible for the meltdown, so you take the exception and you move it through.

“But if you had a good firm rule of law, and the markets knew… there were no exceptions… you would be in the long run much better off. It does affect behavior,” he said.

2) Richard Fisher of the Dallas Fed (in a speech):

The dangers posed by TBTF banks are too great. To be sure, having a clearly articulated “resolution regime” would represent steps forward, though I fear they might provide false comfort in that a special resolution treatment for large firms might be viewed favorably by creditors, continuing the government-sponsored advantage bestowed upon them. Given the danger these institutions pose to spreading debilitating viruses throughout the financial world, my preference is for a more prophylactic approach: an international accord to break up these institutions into ones of more manageable size—more manageable for both the executives of these institutions and their regulatory supervisors.

3) Jeffrey Lacker of the Richmond Fed (in a CNBC interview with Steve Liesman):

Lacker: The issue of our time has to do with the government safety net for financial firms. And it’s grown tremendously, and containing that, establishing clear boundaries of that, is the number one priority. As I read the Dodd bill and the mechanism it sets up for the resolution authority, it doesn’t strike me that it’s likely to help us there. And in fact, it seems to me like a major danger is that there’s going to be more instability in financial markets instead of less.

Liesman: The Dodd bill allows for a three-bankruptcy judge panel to declare insolvency. It allows losses to go to unsecured creditors; it allows management to be replaced and shareholders to be wiped out. How much clearer could the government be in this bill that there will be real losses to investors?

Lacker: It allows those things, but it does not require them. Moreover, it provides tremendous discretion for the Treasury and FDIC to use that fund to buy assets from the failed firm, to guarantee liabilities of the failed firm, to buy liabilities of the failed firm. They can support creditors in the failed firm. They have a tremendous amount of discretion. And if they have the discretion, they are likely to be forced to use it in a crisis.

4) Charles Plosser of the Philly Fed:

In order to end TBTF, we must have a way that credibly convinces large financial firms and the markets that firms on the verge of failure will, in fact, be allowed to fail. If the resolution mechanism is either too vague or allows for too much discretion by regulators or Congress to rescue firms through subsidies or bailouts, then troubled firms will surely argue that the risks of failure are so severe and systemic that they must be bailed out. This is what we saw in the recent crisis. A credible commitment by government not to intervene or bail out firms must be the centerpiece of the resolution mechanism.

I believe the best approach to making such a credible commitment and thus ending TBTF is amending the bankruptcy code for nonbank financial firms and bank holding companies, rather than expanding the bank resolution process under the FDIC Improvement Act (FDICIA). While the Senate bill has tightened up the proposal with a stronger bias toward liquidating a troubled firm, the bill would still give a great deal of discretion to policymakers to avoid the discipline of a bankruptcy court. I recognize that the current bankruptcy code does not adequately address the inherent challenges in liquidating large financial institutions without risks to the market, but I believe a modified bankruptcy process would eliminate discretion and strengthen market discipline, by permitting creditors as well as regulators to place the firm into bankruptcy when it is unable to meet its financial obligations.

Becker vs. Posner on the VAT

Apr 26, 2010 14:35 UTC

The online conversation between Gary Becker and Richard Posner is one of my favorite things on the web. Currently they are taking on the the idea of the US implementing a value-added tax. First a bit from Becker, as excerpted by me:

1) A flat VAT tax would be more efficient for two reasons than a progressive income tax that raises the same revenue: it does not discourage savings relative to consumption, and it induces fewer distortions on other behavior because it has flat rather than rising tax rates. A flat income tax eliminates the effects of rising tax rates, but still distorts savings behavior.

2) The downside of a value added tax to anyone concerned about growing government spending and taxing is very much related to its upside; namely, that a VAT is a more efficient and relatively painless tax. … For example, the VAT rate in Europe started low but now ranges from 15 to 25%, and averages about 20%. In Denmark, for example, the VAT rate was 9% in 1962, but quickly rose to 25% by 1992, and has remained at that level.

3) However, the problems is that a VAT would be introduced not as a partial or full substitute for personal and corporate income taxes, but rather as an additional tax. This would make it much easier to close the fiscal gap by maintaining or increasing government spending and overall tax levels.

4) Since high taxes and high levels of government spending would discourage economic growth and raise rather than lower the overall distortions in an economy, I am highly dubious about introducing a VAT into the federal tax system unless accompanied by a major overall of this system. One big improvement that does not involve a VAT would be to flatten the present income tax rates and greatly reduce the various exemptions, so that the tax basis is widened. Even then it is necessary to be vigilant about combating the incentives government officials have to increase flat taxes over time, whether they are flat income taxes or flat value added taxes.

Now Posner:

1) Because (assuming no exemptions) the tax base for a VAT is so broad—all goods and services—a VAT can generate enormous tax revenues at a low tax rate, which reduces the distortionary effect of the tax. … The VAT also avoids the double taxation of savings under a corporate plus individual income tax system, further encourages savings by making consumption more costly, and reduces the disincentive effects of heavy income taxation. … Of course the benefits of the VAT are greatest if it is substituted for income taxes and other inefficient taxes rather than being added to the existing tax system to generate additional tax revenues.

2) Becker’s main objection to the adoption of the VAT by the federal government, which is similar to the objection to taxes on Internet sales and indeed any new taxes that do not merely replace existing taxes, is that by increasing government revenues it will increase the size of government relative to the private economy, and if (as is doubtless true) government is less efficient, the result will be a reduction in economic welfare. … I agree but on the other side of the issue is our awful fiscal situation.

3) In light of the nation’s fiscal bind, the imposition of a federal VAT becomes a more attractive prospect. One immediate beneficial effect, provided that the VAT was not entirely additive to existing taxes but was coupled with some reduction in corporate and payroll taxes, would be a reduction in export prices and therefore an increase in exports and hence a reduction in our trade deficit, which is a contributor to our public debt. The General Agreement on Tariffs and Trade permits VAT to be rebated on exports, thus lowering the cost to the foreign buyers.

4) More important, the VAT would increase federal tax revenues with minimal distortion because it is an efficient tax. To the extent (even if modest) that it replaced less efficient taxes, it would increase economic efficiency and thus increase the rate of economic growth. Most important, by discouraging consumption in favor of savings, a VAT would reduce the interest rate on our public debt and the Treasury’s dependence on foreign lenders.

American job insecurity

Apr 26, 2010 14:11 UTC

Two interesting polls from Gallup show why a few ticks in the unemployment rate here and there are really besides the point. (Thanks to Jim Geraghty of NR.)  This downturn has scarred the American psyche. The first chart shows how worried workers are about finding a comparable job if they ever lose their current one. The second chart shows that they are still pretty worried about losing their existing job.

gallup2

gallup1

COMMENT

Last night when Fu Bo appeared at the venue next, “Legal Evening News” reporter noted that is different from the previous game in his dress, a black suit, a dark grey cashmere scarf, this has been a sportswear based coach, in such a way that the game for his meaning something different

The state of play for financial reform

Apr 26, 2010 13:53 UTC

A few observations, comments and highlights:

1) Three things can happen today, as I see it: a) Chris Dodd and Richard Shelby reach a deal; b) Dems pick off a few Rs, get cloture, and the debate on the bill proceeds; or c) no deal, Rs stay unified and negotiations continue. Of those “c’ is the likely option — and that will eventually lead to a bill that may be getting tougher by moment. On Good Morning America today, Shelby seemed supportive of tougher derivatives language. And although it will not be in the bill, Kent Conrad’s comments that a bank tax is coming is reflective of the growing anti-Wall Street mood on Capitol Hill.

2) An interesting piece in The American by economist Phil Swagel, formerly of the Paulson Treasury Department, on whether the Dodd bill is a “bailout bill.” Read the whole thing, but in this bit he uses Lehman Brothers as an example:

In the fall of 2008, the Lehman Brothers bankruptcy was followed by severe negative effects as short-term credit markets shut down. This is sometimes taken as evidence that bankruptcy is not a tenable outcome for a large financial firm. This is wrong. The disruptions that followed Lehman’s collapse were greatly magnified by the idiosyncratic problem that a large money-market mutual fund broke the buck as a result of losses on Lehman debt. This sparked a panicked flight out of money-market mutual funds, which led commercial paper markets to seize up and in turn begat TARP. This situation would have been prevented only by guaranteeing Lehman debt—that is, by a bailout that the administration says would not be allowed to occur under its financial regulatory reform proposals. This means that either the administration intends to allow bailouts or that its approach would not in fact solve the problem of Lehman’s collapse—it cannot be both ways. In fact, the Dodd bill allows two forms of a bailout, since the government can put cash directly into a failing firm or guarantee its debt. The Dodd proposal is a bailout bill, plain and simple.

3) Here is Charles Plosser, head of the Philly Fed, on Dodd and TBTF:

I believe the best approach to making such a credible commitment and thus ending TBTF is amending the bankruptcy code for nonbank financial firms and bank holding companies, rather than expanding the bank resolution process under the FDIC Improvement Act (FDICIA). While the Senate bill has tightened up the proposal with a stronger bias toward liquidating a troubled firm, the bill would still give a great deal of discretion to policymakers to avoid the discipline of a bankruptcy court.

The Senate bill’s proposal to restrict the Federal Reserve’s supervisory authority to about 35 of the largest financial firms with $50 billion or more in assets further undermines the effort to end TBTF. The markets will likely interpret this provision as signaling that these firms are unique and will continue to be treated as TBTF. Many would assume that the language in the resolution section that emphasizes bankruptcy would not apply to these firms. This provision would, de facto, make the Federal Reserve supervisor of the firms deemed TBTF.

In addition, restricting the Federal Reserve’s supervisory authority to these large firms would focus the Federal Reserve’s attention more toward Wall Street and less on Main Street.

COMMENT

Dodd needs a job on Wall Street upon retirement, so he can’t be too aggressive

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