James Pethokoukis

Politics and policy from inside Washington

More reasons to mock the Fed’s plan to regulate Wall Street pay

Sep 18, 2009 17:29 UTC

My Reuters amigo Christopher “Black” Swann goes after the Fed plan to curb Wall Street pay — with a vengeance. Here is a bit, but read the whole thing. Your brain will thank you:

1. The Fed is certain to be outmatched. In one corner you have a central bank that has been notoriously spineless on regulatory matters. The institution is crammed with officials who have traditionally seen themselves as defenders of the banking system and advocates of laissez faire. … In the opposing corner you have heavy-weight Wall Street institutions with armies of lawyers dedicated to gaming the regulatory system.

2. There is a deeper objection to the Fed’s effort. The real problem is not the structure of bank pay but its scale. The received wisdom remains that longer-term incentives will curb risk taking. Lock up bonuses in stock and you will tame bankers. The experience of the 2008 financial crisis screams otherwise. In the case of Lehman Brothers and Bear Stearns, leading bankers were major shareholders. Richard Fuld was heavily invested in Lehman stock and saw the bulk of his fortune evaporate when the firm collapsed. Ownership does not seem to lower risk.

3. The key, then, is to curb the overall amount of risk that banks can take on. The main tool for doing this is by insisting on much larger capital reserves. This kills two birds with one stone. Tighter capital rules will increase the stability of the financial system and limit the exposure of taxpayers in the event of failure. In addition, tighter capital rules are the most reliable way of bringing down overall bank pay.


Let’s all say this together – “socialism”. Very good boys and girls, now practice it every day until you get it down pat.

Posted by Frank | Report as abusive

A terrible week for financial regulatory reform

Sep 18, 2009 16:32 UTC

After a big speech by the POTUS and the leak of a Fed proposal to monitor and curb Wall Street pay (really, pay at thousands of banks), what has changed about Too Big Too Fail, erratic Fed monetary policy and U.S. housing policy? They’re the true villains of the financial crisis. You want to limit leverage and raise capital requirement? Fine.  But the WH is taking its eye off the ball, I think …

The Fed’s dangerous plan to regulate Wall Street pay

Sep 18, 2009 16:22 UTC

The Obama administration wants the Federal Reserve to be the maximum regulator of the American financial system. As Treasury Secretary Timothy Geithner told the Senate Banking Committee, “The Federal Reserve is best positioned to play that role. It already supervises and regulates bank holding companies, including all major U.S. commercial and investment banks.”

The problem, of course, is that most informed observers have concluded that the Fed failed to adequately supervise and regulate banks during the lead-up to the financial crisis. Count Senator Chris Dodd, chairman of the Senate Banking Committee, in that camp. “There’s not a lot of confidence in the Fed at this point,” Dodd said right after the White House released its financial reform proposal.

This is where Daniel Tarullo makes his appearance. The newest member of the Federal Reserve has apparently authored a plan to have the central bank approve compensation policies potentially But previous to joining the Fed, Tarullo was an influential economic adviser in the Obama presidential campaign.

So now what we have, I think, is Obama’s man at the Fed pushing a politically savvy plan that could bolster the Fed’s standing as a tough regulator in the eyes of Congress and deflect some of the criticism of the central banks past failings. Score one for the White House in its push to make the Fed super-regulator.

Surely, the timing couldn’t be better. Not only has the administration been refocusing attention on passing financial reform – witness the president’s tough Wall Street speech – but next week’s G-20 meeting will include extensive discussion about banker pay issues.

But this is a case where good short-term politics makes for bad long-term bad policy. The greater the Fed involvement in the regulatory process, the greater attention it will receive from Congress – and the greater the threat to its cherished independence.

As it is, the Fed’s historic efforts to rescue the financial system have raised concerns on Capitol Hill that it has too much power with too little oversight. That’s why Rep. Ron Paul’s bill to audit the Fed, according to Financial Services Committee Chairman Barney Frank, will pass the House this year. (Indeed, what Paul really wants to do is end, not mend the Fed.)

Really, could anyone possibly believe that having the Fed become the pay czar at 5,000 banks would lessen congressional interest in its activities, including monetary policy? Not to mention that a better solution to excessive financial risk taking is the restoration of market discipline on Wall Street.

Better that Wall Street understand the consequences of poorly incentivized pay structures. “Too big too fail” remains the biggest threat to America’s fragile financial system.



Posted by charles bowen | Report as abusive

Should the Fed determine pay at 5,000 banks?

Sep 18, 2009 13:23 UTC

Talk about a phenomenally bad idea. According to the WSJ:

Policies that set the pay for tens of thousands of bank employees nationwide would require approval from the Federal Reserve as part of a far-reaching proposal to rein in risk-taking at financial institutions. … Under the proposal, the Fed could reject any compensation policies it believes encourage bank employees — from chief executives, to traders, to loan officers — to take too much risk. Bureaucrats wouldn’t set the pay of individuals, but would review and, if necessary, amend each bank’s salary and bonus policies to make sure they don’t create harmful incentives.

Me: Team Obama wants the Fed to be the super-regulator of the financial system. Sen. Chris “I have no confidence in the Fed” Dodd, chairman of the Senate Banking Committee, would prefer a new, separate entity. A now here we have a plan that would see the Fed doing the kind of thing a super-regulator might do. It is like the Fed is saying, “Hey, we know we dropped the ball before. We get it.  Now we are getting tough. Trust us.”  And don’t ignore the fact that the guy pushing this is Daniel Tarullo, a Fed governor and Obama economic adviser. This is like a joint Fed-WH operation. Also don’t forget that this is coming right before the G-20 meeting where there are expected to be calls to get tough on banker pay. So one could view this as a PR ploy by a WH that is less enthused about pay restrictions than Europe.

Of course, this is a lousy idea. Banker pay didn’t cause the financial crisis. The government should not be micromanaging private-sector compensation. Also, the more the Fed is involved in the regulatory process, the more it is open to political scrutiny.  Yves Smith seems to think this will tamp down support for Ron Paul’s Fed audit bill. Actually, I think this increases support for the bill since the more powerful the Fed seems, the greater the attractiveness of increased oversight and congressional meddling.


Ritesh -
I assume by a 90% tax on bonuses over $1 million, you meant a 90% tax only on the portion over $1 million (ie, the 90% rate would apply to $200,000 of a 1.2 million bonus). Other wise you’re effectively capping pay at $999,999.99. Making a dollar over that would decrease your income by 90%.

One superregulator to rule them all

Sep 1, 2009 18:43 UTC

What is the case, really, for the Fed being the superregulator of the US financial system? I mean, what is the record of achievement in either regulating banks or detecting systemic crises? Not to mention that by expanding the Fed portfolio de jure, you are opening it up to increased political interference. It is already operating as a quasi fourth branch of government. It doesn’t need any more authority. I realize that Bair’s Justice League of Regulators may be unwieldy in a crisis, but let’s not get into a TBTF position to begin with. Raise capital requirements that increase by a greater percentage than assets and be done with it, no wild swings in rates, and make sure accounting rules don’t magnify cyclicality.


I think you mean the quasi fifth branch of government.

Media is the 4th estate. ;)

Do we need a Fiscal Fed for fiscal policy?

Aug 31, 2009 14:05 UTC

Long after the American economy returns to growth mode, the national debt will continue to soar. According to the Congressional Budget Office, the national debt — as low as 33 percent of GDP in 2001 — will reach 54 percent of GDP this year and grow to at least 68 percent by 2019. Beyond that, the increasing cost of mandatory social insurance spending will certainly push the U.S. debt-to-GDP ratio ever higher in the decades ahead.

So how will policymakers deal with the debt? Well, at some point they will raise taxes and cut spending. (No inflating away the debt, right? Promise?) Indeed, the inevitability of such actions seems an article of faith among bond investors who continue to lend cheaply to America. But uncertainties remain. Which taxes will be raised? Which programs will be cut? And by how much? And when?

For all the talk about the need for transparency in monetary policy, there is precious little in the area of fiscal policy. And this is most unfortunate. Eric Leeper, an economics professor at Indiana University, argues in a new paper that enhanced fiscal transparency “can help anchor expectations of fiscal policy and make fiscal actions more predictable and effective … Fiscal policy is too important to be left to the vagaries of the political process.”

Of course, the political process is tough to escape in a democracy. Any budgetary limits Congress imposes on itself eventually can and likely will be evaded. But imagine, if you will, an amped-up version of the Congressional Budget Office. Like the Federal Reserve, the chairman and members of this “fiscal council” would be nominated by the president. And they would explicitly be tasked with the authority to recommend, or even set, deficit and debt targets.

The head of the council would regularly testify before Congress, as does the Fed chairman, on the nation’s fiscal soundness and whether particular new policies would make things better or worse. Leeper notes that in 2007 Sweden established an eight-member Fiscal Policy Council that offers an independent, no-holds-barred analysis of whether the government’s fiscal policy objectives are being met and are sustainable over the long term.

A U.S. version, for instance, might testify as to whether Congress is ignoring pay-as-you-go budget rules. Or it might actually set a debt target that Congress would have to vote up or down on. The key here is to create an institution with as high a profile as the Fed’s that can highlight current fiscal policy and its real-world budgetary impacts, as well as solutions.

And if the budget situation continues to deteriorate, the council might even be given the power to set some broad budgetary parameters, such as federal spending increases being limited to population growth plus inflation.

And who would be the first chairman of the Fiscal Council? You could do a lot worse than master communicator, legendary tightwad and respected financier Warren Buffett.


I would like to clarify one important point. The term “Fiscal Fed,” though catchy and alliterative, appears nowhere in my paper and I find it to be counterproductive. Dedemocratizing fiscal policy is not my intent. And suggestions to do so bring to a screeching halt precisely the conversation I’d like to encourage.

The remainder of your column is constructive and does get to the heart of the issues I have tried to raise.

Study: possible to predict stock market crashes

Aug 28, 2009 11:40 UTC

The most obvious way to predict a stock market crash is to find out when I go all in. But there may be another, says New Scientist:

Now a team of physicists and financiers have bucked the trend by successfully predicting a steep fall in the Shanghai Stock Exchange. …  The idea is that if a plot of the logarithm of the market’s value over time deviates upwards from a straight line, it’s a clear warning that people are investing simply because the market is rising rather than paying heed to the intrinsic worth of companies. By projecting the trend, the team can predict when growth will become unsustainable and the market will crash.

Sornette, Zhou and colleagues applied their model to the Shanghai Composite Index, which tracks the combined worth of all companies listed on the Shanghai Stock Exchange, the world’s second largest. Early this year, the index gained 50 per cent in just four months. In July, the team predicted that the index would start to fall sharply by 10 August. The index duly began to slide on 4 August, falling almost 20 per cent in the subsequent two weeks.

Me: I assume this would also work with individual stocks. Econophysicist Didier Sornette has a paper that puts his approach in a bit more context.


This is a very interesting development! I figured there was a way to predict steep drops based on an accelerating upward trend, kind of like an asymptote. This could prove invaluable in the future.

However, I did not need a logarithm to predict that the Shanghai index would fall. All the news surrounding the Chinese economy points to an inflated stock market based on inflated real estate and excessive risky lending.

Personally, I think the Shanghai index is a lagging indicator, and it will likely fall precipitously sometime this fall/winter. I dont believe that China is immune to the world financial crisis, it just hasnt caught up with the rest of us yet. It will be very interesting to see the consequences of this situation.

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Around the horn

Aug 25, 2009 19:17 UTC

Stuff I read today that you should, too!

Bernanke’s out of control! Russell Roberts thinks Bernanke has gone overboard in reacting to the Great Recession. He might be right, though as the man who jumped out of the burning airplane with no parachute said, “First things first!”

Kicking healthcare, Massachusetts style. Kurt Brouwer  finds fault aplenty with RomneyCare.

Words Bernanke wishes he hadn’t said. My pal John Carney of Clusterstock has a must-read (and must-view) photo gallery of some Bernanke misses. But what about his chitchat with Maria Bartiromo!

How to pay for real economic stimulus. Ed Harrison had the same idea I did. Cut entitlements tomorrow create fiscal space today.

Another vote for Bernanke. Right-of-center economist Greg Mankiw likes the Bernanke reappointment.

Trillion dollar stimulus. Donald Marron notices that the Obama’s fiscal stimulus plan may cost $900 billion.


I joked about Obama appointing a Fed Czar, effectively keeping a popular choice – Bernanke, but undercutting him. Basically, no one seems to be talking about the two appointments for the Governors board that have been vacant due to hold ups for confirmantion during the Bush years. This plus other retirements would provide the current administration with a majority on Fed voting decisions. Nifty.

I’m a litttle disappointed that nobody has brought up this permutation.

http://www.bloomberg.com/apps/news?pid=2 0601087&sid=aO3Cyu_.OHD4

“…….Federal Reserve Chairman Ben S. Bernanke, nominated today for a second four-year term at the helm of the central bank, will be working with a reshaped team.

President Barack Obama, who nominated Bernanke for a second term beginning in February, still must fill two other vacancies on the Fed’s Board of Governors, which has operated without its full seven-member complement since April 2006. On top of that, Vice Chairman Donald Kohn’s term expires in June, and Gary Stern, the longest-serving policy maker, will retire when a replacement is named.

The turnover means Obama will be able to appoint a majority of governors in his first year. Bernanke will have to convince the Fed’s new members to concentrate on maintaining the economic recovery and put aside concerns about a revival of inflation, said former Fed Governor Lyle Gramley…….”

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Obama to renominate Bernanke as Federal Reserve chairman: a few thoughts

Aug 25, 2009 11:36 UTC

And once more, another person in Washington involved with helping create the financial crisis gets to keep his job. In a bit of a  summertime surprise,  President Obama has renominated Ben Bernanke as Fed chairman.

1) So not only does the White House release its new budget forecast on the same day as the Congressional Budget Office releases its forecast so there aren’t two separate days of terrible stories, it also drops this bomb to further dilute the impact. The news might even generate a nice stock market reaction Smart politics.

2) I am mildly surprised. Although, Bernanke seemed to have the backing of Wall Street, the politics were not as clear. What president would not rather have his own pick in the post? And while most economists praise the Fed’s efforts to keep the recession from becoming a depression, politicians in both parties have attacked the Fed’s big bailouts, as well as its handling of the BofA-Merrill merger. Plus, Bernanke terribly underestimated the potential severity of the financial crisis in its early days. If Obama wanted to make a switch, there was enough there to justify it.

3) Bernanke got lucky with the timing. If his term was up in January of 2011 instead, he might get more of the blame for a lackluster economic rebound. As it is, he gets credit for engineering the rebound — and given the mood six months ago, any rebound is a good rebound. But another year of high unemployment might alter those views.

4) I think Obama should get credit for not picking an obvious dove like Janet Yellen, but I am not sure she was really a ever a viable option. I think Larry Summers was viewed as both too independent and too outspoken, a real wildcard. Bernanke is a known quantity in the position who has worked with the White House every step of this crisis.

Political woes could push Obama to nix Bernanke

Aug 21, 2009 13:35 UTC

The great Andy Busch of BMO Capital Markets draws up a scenario that could see Ben Bernanke get pushed toward the exits:

David Wessel in his book, “In Fed We Trust: Ben Bernanke’s War on the Great Panic” said this, “But in what would prove a colossal mistake, they (Bernanke, Paulson, Geithner) hadn’t come prepared with a plan to prevent a bankruptcy if they couldn’t sell Lehman as they had managed to sell Bear Stearns.” This ability to see the danger and yet not being prepared to stop it is truly troubling.

However, this is not why Ben Bernanke may lose his job. It will be due to someone taking the fall for the crisis and for why the unemployment rate remains above 9.5%. This is Bernanke’s Mendoza Line. This is what Moody’s John Lonski and I agreed upon last night on the Kudlow Report: Bernanke can be the fall guy for a weak US economy.

Envision a political world for President Obama in which he’s not getting his major pieces of legislation through Congress. Imagine then, he’s also got an economy that is not rebounding enough to generate job gains and an economy that may be experiencing a strange form of commodity inflation leading to higher gasoline prices. Something has to change and that change could cost Bernanke his job.

If we’ve learned anything from last fall, we know that what was once deemed rock solid can crumble away amidst the pressure of an outside force.