We shouldn’t dread the debt limit
“Have a drink out there, folks, and just know that your kids and grandkids will be out there picking grit with the chickens,” says former U.S. Senator Alan Simpson in the video above. Simpson’s quip is the best summary I’ve ever heard of the public’s lack of understanding of the severity of the nation’s fiscal crisis. The federal government is currently borrowing 42 cents of every dollar that it spends. Thanks to the Federal Reserve’s quantitative easing and the strong global demand for U.S. Treasury debt, the nation has been able to borrow heavily at low interest rates to cover its budget shortfalls.
But the debt is piling up so high that the country might face a borrowing shock if there were a black swan event or if bond vigilantes forced higher interest rates. It’s not a question of whether rates will rise – they certainly will. What we don’t know is when it will happen. The same politicians who created this fiscal quagmire have now tasked themselves with fixing it. Despite numerous proposals on how to get our debt under control, the political dynamics of the issue make it likely that nothing will be resolved in Congress until after November’s election. The Washington Post reports:
But once the election is over … the issue of the debt will quickly rise to the top of the agenda – and not just because of the debt limit. In January, policymakers also will be facing the first round of harsh, across-the-board spending cuts adopted last summer, as well as the expiration of a host of tax cuts that benefit every American household. Unless Congress agrees on an alternative deficit-reduction strategy, the policies threaten to deliver a fiscal shock that could throw the nation back into recession.
Earlier this week at the Peterson Foundation’s Fiscal Summit 2012, House Speaker John Boehner gave a speech in which he laid out his plans for tax reform and vowed not to increase the borrowing limit:
Any sudden tax hike would hurt our economy, so this fall – before the election — the House of Representatives will vote to stop the largest tax increase in American history [the expiration of the Bush tax cuts]. This will give Congress time to work on broad-based tax reform that lowers rates for individuals and businesses while closing deductions, credits, and special carveouts. Eyebrows go up all over town whenever I talk about this, but when I say ‘broad-based’ tax reform, I mean it. We need to do it all … deal with the whole code, personal and corporate it’s fairer and more productive for everyone.
Meanwhile the Senate Republicans found an obscure Senate rule that allowed them to take control of the Senate for a day and hold a series of votes on their proposed budgets. From Bloomberg:
Troubles in Volcker land?
My post last week about ditching the Volcker Rule and returning to some form of Glass-Steagall got a lot of positive responses. Back then I wrote that the Volcker Rule, which requires regulators to cleave risky trading for a bank’s house account from deposits insured by the FDIC, is immensely complex and that it will never be properly defined or enforced. Several regulators in the past week have agonized publicly over the need to get the rule “right.”
First among them was Fed Chairman Ben Bernanke. In the three minutes of C-Span video above, Bernanke says: “We are going to try and do our best to clarify the distinction between proprietary trading and market making.” It’s clear that even to our top banking regulator, defining Volcker properly is nearly impossible.
SEC Chairman Mary Schapiro had this to say on Volcker, via The Hill:
When asked by Rep. Mario Diaz-Balart (R-Fla.) if regulators would be better off scrapping the proposal and starting over, Schapiro was noncommital.
“Whether we start right from the beginning again or not, I can tell you we will and are reviewing all the comments letters carefully and rethinking how we should approach the statutory requirement,” she said. “We have a lot of issues to work through.”
And here’s SEC Commissioner Dan Gallagher, via Reuters:
Dan Gallagher, a Republican commissioner at the U.S. Securities and Exchange Commission, said on Monday that a quick review of the thousands of [Volcker] comment letters revealed widespread fears about the rule’s potential impact.
“These comments provide powerful evidence that the benefits the proposed rule was designed to provide may come at an unacceptably high cost,” Gallagher said in prepared remarks for a speech at the Institute of International Bankers conference in Washington.
He said regulators must be willing to re-examine their initial efforts and “if necessary” go back to the drawing board on the proposal.
. . . “Prior to joining SIFMA, Mr. Ryan was Vice Chairman, Financial Institutions and Governments, at J.P. Morgan where he was a member of the firm’s senior leadership” . . you know – prior to 2009 . . .
No doubt Tim Ryan has the US taxpayer top of mind when he provides his “deep concerns” . . . time to enforce the rules before the next SH*T SHOW!
Forget Volcker — bring back Glass-Steagall
Imagine you are a financial regulator whose agency is underfunded, understaffed and under-trained and that firms under your jurisdiction are likely to pick off your best employees by offering them triple the salary you pay them.
Furthermore, imagine that Congress has written an 800-page law that instructs you to write and enforce new regulations on banks and securities firms to ensure financial stability for the system. The most complex part of this new law, the Volcker Rule, would require you to cooperate with three other agencies to jointly issue a 530-page Proposed Rule that asks 1,300 questions.
Now imagine that in the course of honing this rule, 17,000 comment letters will flow into your agency, the majority of which promote the status quo.
After going through this thought experiment, you’d probably say: “What a headache! Why can’t we just bring back Glass-Steagall and split up banks into risky trading machines and safe depository institutions? This monstrosity of a regulatory fiat will never be properly defined or adequately enforced.”
The Volcker Rule is supposed to isolate the risk of a bank trading its own assets and separate that from depositors’ assets. In other words, the Volcker Rule should isolate the risk of a big derivatives or fixed-income loss on the house account from the cash savings of retired teachers and other customers of the bank. By design, it is aimed at the heart of the nation’s largest banks, the five institutions that use their enormous staffs and FDIC-insured balance sheets to dominate trading and commercial banking.
Take JPMorgan Chase, for instance. Tuesday it released the employee headcount of its investment bank: 2,500 salespeople and 2,000 traders on 110 trading desks in 20 trading centers, in addition to its 2,000 investment bankers. JPMorgan trades securities in 12 asset classes using its risk-weighted assets of $467 billion. Although JPMorgan and other banks are less leveraged than they were prior to the financial crisis, they are still pumped up trading engines attached to slow-moving, deposit-taking banks. In the derivative space alone JP Morgan’s total credit exposure was 285 percent of its risk-based capital in Q3 2011, according to the Office of the Comptroller of the Currency (graph 5A).
The core issue in attempting to define the Volcker Rule is that federal securities and banking regulators have never really supervised the fixed-income and derivatives markets. Dodd-Frank has many provisions for the regulation of derivatives but entirely skips over any requirement to regulate bond trading. The SEC heavily regulates stock trading but conducts little to no oversight of bond markets. Bonds are an enormous, dark market that few people understand, hence all the laments that eliminating prop trading of bonds will dry up liquidity — a ridiculous idea. If there are larger profits in bond trading because the five major banks are limited, new entrants will expand into the market to capture those profits and provide liquidity.
It’s true that there aren’t quote reporting requirements in the bond markets like there are in the stock markets. But that’s because there are literally millions of distinct bonds outstanding versus around 8,000 equities. It is impossible to quote all bonds actively as is done with equities. Dealers only provide bond quotes when their customers ask. And, there are detailed FINRA and MSRB markup and fair pricing rules that apply to the prices dealers dealers can charge for bonds. Moreover, the rules related to price transparency are completely unrelated to Gramm Leach Bliley and wouldn’t change if Glass Stegall came back. The GLBA had practically nothing to do with regulating the bond markets.
Even more important, there are extensive regulations that apply to almost all aspects of the bond markets. The SEC, FINRA and the MSRB all have thick rule books that relate to the bond business, and those rule books are getting thicker as Dodd-Frank is implemented. It simply isn’t the case that regulators conduct “little to no oversight of bond markets.”
Finally, under Glass-Stegall before the GLBA, banks were heavily involved in the fixed income markets. Government, agency, mortgage-backed and most municipal securities were all “bank eligible,” meaning that commercial banks could underwrite and trade them. Bringing back Glass-Stegall as it was before the GLBA wouldn’t keep banks out of the fixed income business.
The ability to think and generate new ideas
The research department of the Federal Reserve Bank of New York released an interesting paper this week entitled “How Colleges and Universities Can Help Their Local Economies” (the video above is a good summary). The work centers on two ideas: 1) graduates can join the region’s educated workforce and contribute to economic growth; and 2) “human capital” is expanded when institutions team up with local business, or attract new businesses, to commercialize technology developed at the school.
I think these are good observations and help justify public support of higher education, but the analysis overlooks some big ways for institutions to drive economic growth more broadly. For example, Stanford University’s Engineering School is offering some of its most popular classes free of charge to students and educators around the world.
Here’s the best thinking from the New York Fed paper (page 2):
Higher levels of human capital in a region can contribute to higher levels of economic activity for several reasons. Human capital increases individual-level productivity and the generation of ideas. By extension, a region having more people with higher levels of human capital should have greater economic activity overall.
However, the total effect of higher levels of human capital on economic activity is larger than the sum of its parts. The geographic concentration of human capital facilitates what economists refer to as “knowledge spillovers”—the transfer of knowledge and skills from one individual to another. One person may, through observation and communication, learn skills from another; alternatively, the sharing of ideas among individuals may generate new insights that increase the knowledge of the group. When people increase their knowledge in these ways, they create a secondary pathway that increases human capital, which can further enhance regional productivity, encourage innovation, and promote growth.
The overall tone of this is right, but when the researchers say that the “geographic concentration of human capital facilitates what economists refer to as ‘knowledge spillovers’,” they miss a very important paradigm shift in American culture and economic activity. It’s as likely that we are facilitating knowledge spillovers with others who may not even live in our state or nation. If you search a little you can see the prevalence of this type of mission expansion by our great universities. Here’s a list of 400 free online university classes, and here are 10 university collections on YouTube. This is just the vanguard of progressive, first-class universities, and it mirrors how white-collar work is increasingly becoming virtual for many.
The challenge for the economists at the New York Fed and elsewhere is how to capture the value to economic growth this type of activity brings. There are no known quantifiables. But imagine the gain to human capital if workers were able to learn new skills virtually. There are actually few limits to virtual knowledge transfer. It’s happening, and we should nurture and measure it. America needs every possible tool to help it grow.
Muniland: the big picture (part 1)
A lot of municipal bond reporting zooms in on particular issuers or sectors and assumes that the reader understands the broader market. But the municipal bond market is foreign to most people, and I thought that it might be useful to sketch out the bigger picture. Here are some quick bullet points:
1. As of the third quarter of 2011 the size of the municipal bond market was $3.733 trillion. To put that into perspective, as of Jan. 25 there was $15.236 trillion of U.S. Treasury debt outstanding.
Source: Federal Reserve Flow of Funds (page 92)
2. Municipal bonds issued by state and local governments predominate, but there are also large amounts issued by nonprofits (think hospitals) and industrial revenue bonds (think sewer and water systems).
Source: Federal Reserve Flow of Funds (page 92)
When home prices and property taxes diverge
The latest S&P/Case-Shiller Home Price Index, released yesterday, wasn’t pretty. Housing values continued to fall, their 5th consecutive year-on-year decline. (You can download the data here). The Federal Reserve Bank of Cleveland had this to say about the release:
According to today’s [Case-Shiller] report, the fourth quarter started with broad-based declines in home prices… On an annual basis, the 10-city composite is down 3 percent and the 20-city composite is down 3.4 percent, and eighteen of the 20 MSAs are also in negative territory.
Basically, there’s blood on the streets everywhere.
The Federal Reserve Board reports in its Flow of Funds data (line 4) that the value of household real-estate assets has declined from $22.7 trillion in 2006 to $16.1 trillion in the third quarter of 2011. That’s a loss of 30 percents. Have revenues from property taxes, which are supposed to reflect the property valuations, mirrored the same decline?
Thankfully not (yet). As we can see in the U.S. Census data graphed below, property taxes have mostly marched steadily northward. We see a slight flattening in 2009, but nothing to match the 30 percent decline in property values. Local governments should see this as a gift from increasingly stretched taxpayers. There may be room to raise tax rates in some places but there will also have to be local belt-tightening as declines in property values feed into declines in tax collections.
what do you mean “thankfully not yet”? Do you see it as a positive thing that homeowners, having lost up to or over 30% of their home’s value are getting shafted by overpaying property taxes, which in many places were high to the point of thievery before home values dropped? I’m sure struggling homeowners are very “thankful” when they get the tax bill for property value that doesn’t even exist anymore.
Found: $840 billion in municipal bonds
The Federal Reserve has quietly admitted they had undercounted about $840 billion of municipal bonds. Bloomberg reports on this new pile of assets:
The U.S. municipal-bond market is 28 percent larger than reported in June, according to a quarterly Federal Reserve release, which used new data showing individuals own more state and local-government debt.
[...]
“The estimate of household holdings of municipal securities and loans is revised up by about $840 billion, on average, from 2004 forward,” according to the Fed’s Flow of Funds Accounts report for the third quarter.
The Federal Reserve may not have intended to bury the news, but I couldn’t find an official press release acknowledging the adjustment to their data. The massive adjustment only appeared as text in the quarterly flow of funds release.
The Fed’s data snafus
Most everyone knows that the Federal Reserve Board is responsible for making monetary policy, handling prudential oversight of many of the nation’s banks and keeping the clearing and payment system flowing. But the Fed has another fundamental function that often goes unnoticed: collecting financial and economic data.
Good policymaking flows from having fresh and accurate data. From my little experience with the Fed they are not doing very well at this task.
Reuters is reporting that Fed Governor Elizabeth Duke believes that household debt has declined since the financial crisis of 2008 and that this reduction in household balance sheets will position families to participate in the recovery when conditions tick up. From Reuters:
Households’ caution about taking on debt and spending will stand them in good stead when the economic recovery becomes more robust, a top Federal Reserve official said on Saturday.
Household debt-to-income ratios skyrocketed during 2001-2007, but households cut debt and spending significantly during the financial crisis that began in 2007, [Fed Governor Elizabeth] Duke said.
Governor Duke is making some large assertions about household behavior. It’s hard to confirm her viewpoint because there has been a lot of confusion surrounding the data sets that the Fed is using to model household balance sheets.
The Federal Reserve publishes two major public datasets for household finances: the Survey of Consumer Finance (SCF) and the more recent “Consumer Credit Panel” (CCP). The SCF is conducted as a survey every three years by interviewing approximately 4,400 households who self report their debt and assets. The results of this data are then extrapolated to the nation’s 130 million households. In contrast the CCP is constructed by compiling a dataset of approximately 38 million credit reports and projecting those findings onto the general population. The CCP began publishing data in 2010 and updates its numbers every quarter.
What makes you think that the Fed is interested in printing the truth? See http://www.bloomberg.com/news/2011-10-23 /bank-of-america-too-much-of-behemoth-t o-fail-commentary-by-simon-johnson.html#
. . kinda makes Chinese economic data integrity look like a “pre-game” skate?!?
Vermont rebuilds while Congress fights
The state of Vermont is struggling to gather funds to repair the flood damage from Hurricane Irene, the state’s worst natural disaster since the floods of 1927. Generally the state would rely on support from the federal government to replace and repair this infrastructure, but the U.S. Congress is locked in a fight over funding the Federal Emergency Management Agency as part of a larger fiscal battle that could shut down the federal government. From CBS News:
Congress is headed for a showdown over disaster relief funding that could bring the government to the brink of a government shutdown again.
House Speaker John Boehner has scheduled a vote tomorrow on a bill that would keep the government operating through Nov. 18. If the Senate and the House do not approve the stopgap measure, known as a continuing resolution, before the fiscal year ends Sept 30, the government would be forced to shutdown.
The House bill includes $1 billion in immediate funding for the Federal Emergency Management Agency and $2.65 billion for next year, but the Republican measure also includes a provision to offset the FEMA funds with cuts to the Energy Department’s Advanced Technology Vehicles Manufacturing Loan Program.
Meanwhile up north Vermont is scrambling to make repair funds available from a variety of sources. VTDigger.org reports:
In the meantime, the state [Vermont] is setting up loan programs to ensure that communities aren’t tapped out as they wait for federal reimbursement money.
Vermont banks, the Vermont Municipal Bond Bank and the state Treasurer’s Office announced a financial assistance package to help ease the financial stress on municipalities as they rebuild over the coming year.
The state will advance $24 million in payments that are already slated for town highway aid ($6.2 million), current use ($12.3 million) and payment in lieu of taxes ($5.8 million).
Local banks will “immediately” open lines of credit worth several hundred thousand dollars to millions of dollars to cash-strapped municipalities. In the event that a municipality reaches the lending cap, the originating bank will turn to a “loan pool,” in which other banks offer more capital.
In the short-term, banks that have exhausted other avenues can turn to the Vermont Municipal Bond Bank for cash to meet short-term municipal needs, according to John Valenti, chair of the bond bank board.
I think the lesson here is that states need to plan for less support from the federal government for emergency funding, or at least have back-up plans in place to tide themselves over. Imagine if this crisis had happened in Illinois, a state with limited borrowing capacity which doesn’t have enough cash to cover its current payables. I suppose the repair work would have to wait until members of Congress fought their ideological battles. Battle by battle we are seeing the federal structure weaken. The states must strengthen themselves.
New York Times hot on Cuomo bank
Muniland holds steady
Municipal bond ownership has remained relatively steady over the past year, according to the Federal Reserve’s latest Flow of Funds data, which was released yesterday (Fed’s L.211 Municipal Securities and Loans page 92). The data paints a different picture than the one we typically hear from the media of large outflows from retail investors and mutual funds following Meredith Whitney’s prediction of massive municipal defaults. Essentially the whole municipal bond market has increased slightly in size, growing from $2.842 trillion in 2Q 2010 to $2.886 trillion in 2Q 2011. Ownership for all categories has remained pretty steady.
The puzzling part is that the Federal Reserve continues to maintain that muniland is about $2.8 trillion in size. Back in June my colleguage Daniel Berger of Thomson Reuters Municipal Market Data kicked up a dust storm when he began to question the overall size of the municipal bond market. George Friedlander of Citigroup got on the story too and wrote the following:
After considerable conversation with Federal Reserve staff and recalculation based upon separate sources, we have concluded that the Fed’s data dramatically understates the amount of outstanding municipals. We now estimate that there is a sum total of roughly $3.7 trillion in state and local debt outstanding, in comparison with the $2.925 trillion reported by the Fed for year-end 2010. While the Fed may modify its data at some point, we felt that it was important to present this modified picture of the size and mix of holdings on a timely basis.
It would be useful if the Federal Reserve was able to verify the size of the muni bond market, especially as President Obama and the Congress make proposals to alter the tax treatment of these bonds. It would certainly help policy-making if there were accurate baseline data.
Moodys: Defaults and bankruptcies to remain “rare”
Reuters reports that the rating agency Moodys continues to see stress on state and local government finances but predicts few defaults or bankruptcies for municipal bonds. From Reuters:
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Resident Muniland expert
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It’s not the debt limit people fear, it’s the politicizing of the debt limit. Neither Dems nor GOP will give one inch to the other in this battle, both wanting to achieve their own agenda.
Fear the results of a broken, entrenched political system trying to agree on anything.