Lehman, PSI and the consequences of credit policy: The third lever of macroeconomics

May 2nd 2013, 19:20  by G.I. | WASHINGTON, D.C.

ECONOMICS undergrads learn early on about two levers to manage the macroeconomy: fiscal policy and monetary policy. Events of the last five years make clear that there is a third lever that while poorly understood and difficult to model, it is at times critical: credit policy.

By credit policy (or banking policy or financial policy) I mean anything that affects how the financial system influences aggregate demand. Of course, we’ve always known aggregate demand depends on both the central bank’s policy rate and the spread over that rate paid by households and firms. But before the cirisis the relationship between the policy rate and what borrowers paid was assumed to be either constant, or endogenous to monetary policy or the business cycle.

Regulation, trade and job creation: Defining the state

The role of government intervention in the economy is perhaps the starkest difference between the candidates

Oct 6th 2012 | from the print edition

[Greg Ip] THIS year’s election carries big implications for economic policy well beyond the budget and taxes. Barack Obama and Mitt Romney have very different ideas about regulation, monetary policy, international trade and labour markets, although their rhetoric sometimes exaggerates the distance between their positions.

In his first term Mr Obama presided over a big increase in the number of major newregulations (as measured by their economic impact), from air-cargo screening to fuel efficiency in trucks. On top of those come thousands of pages of new rules implementing his financial-regulation and health-care reforms (see article). The White House claims that the benefits of the new regulations easily exceed the costs, although some economists contest the way the benefits are measured.

Too big to fail: Fright simulator

How to deal with a collapsing bank under the Dodd-Frank rules

Nov 12th 2011 | NEW YORK | from the print edition

[Greg Ip] OF ALL the questions unleashed by the bankruptcy of MF Global, a broker, the most important is whether America is prepared to deal with a bigger collapse, on the scale of another Lehman Brothers. The Dodd-Frank reform law creates an alternative to letting a systemically important firm go bankrupt, known as “resolution”. But it also prohibits bail-outs: shareholders and creditors must bear losses.

The Economist simulated the failure of a global bank at its Buttonwood Gathering on October 27th in New York (a video can be seen here). Larry Summers, a former treasury secretary and once Barack Obama’s top economic adviser, was joined by five other ex-officials and a prominent bank lawyer to play the parts of officials at the Treasury, the White House and regulatory agencies on a Friday afternoon in April 2013. The group was confronted with a teetering, $1 trillion bank-holding company called New Jefferson. Without their intervention, it would not open on Monday, an event guaranteed to send markets into free fall.

Fannie Mae and Freddie Mac: Self harm

The twins still watch their bottom line, to the economy’s detriment

Sep 3rd 2011 | WASHINGTON, DC | from the print edition

[Greg Ip]

AS BARACK OBAMA casts around for ways to bolster the American economy, one area of focus is a still-moribund housing market. He could start by taking a closer look at Fannie Mae and Freddie Mac, America’s housing-finance giants.

When the two government-sponsored entities (GSEs) were listed companies, they acquired or stamped guarantees on millions of loans that in retrospect were far too risky. Those bad loans drove them to the brink of collapse in 2008, forcing their regulator to take them over. The Treasury has since injected some $140 billion into them to keep them solvent. That matters. In the first half of this year the two guaranteed roughly 70% of all new loans. They have also helped 1.7m homeowners through loan modifications and other measures. Yet although the GSEs are ostensibly government-controlled, they still try to maximise profits and minimise losses.

The entire article is linked here.

Central banks: A More Complicated Game

The West’s financial crisis has shaken public confidence in its leading central banks. Yet it has also led to an expansion of their duties and powers

Feb 17th 2011 | WASHINGTON, DC | from the print edition

[Greg Ip] IN TWO days, two prominent central bankers, one on each side of the Atlantic, headed for the exit. Few people were surprised when Kevin Warsh tendered his resignation from the Federal Reserve on February 10th. Rather more people were taken aback when rumours started to fly that Axel Weber would stand down as president of Germany’s Bundesbank and thus rule himself out as the next president of the European Central Bank (ECB), a job for which he had been the front-runner. The rumours were confirmed on February 11th.

The timing was coincidental. Yet the two men have something in common. Both were uneasy about changes in the way that central banks conduct themselves—specifically, about the unprecedented forays into financial markets by the Fed and the ECB. Mr Weber publicly opposed the ECB’s decision last May to start buying the bonds of member countries’ governments. His colleagues, he believed, were intruding dangerously into fiscal policy. Mr Warsh, similarly though more quietly, fretted that the Fed’s policy of quantitative easing (QE)—the purchase of government bonds with newly printed money—was fomenting new imbalances in the global economy and steering the Fed into treacherous political waters.

Since the financial crisis in 2007 central banks have expanded their remits, either at their own initiative or at governments’ behest, well beyond conventional monetary policy. They have not only extended the usual limits of monetary policy by buying government bonds and other assets (see chart). They are also taking on more responsibility for the supervision of banks and the stability of financial systems. Their new duties require new “macroprudential” policies: in essence, this means regulating banks with an eye on any dangers for the whole economy. And their old monetary-policy tasks are not getting any easier to perform. Central banking is becoming a more complicated game.

The entire article is linked here.

The legacy of Larry Summers

Dec 13th 2010, 22:10 by G.I. | WASHINGTON

[Greg Ip] FOR two years the Obama Administration’s economic policy has been caricatured from the right as an invasive expansion of government and from the left as a cowardly capitulation to Wall Street free market fundamentalism.

How can it be both things at once? It helps to understand the philosophy of the man who most embodies that policy, Larry Summers, who today delivered perhaps his final public speech as Barack Obama’s National Economic Council director. The “Summers Doctrine” fuses microeconomic laissez faire with macroeconomic activism. Markets should allocate capital, labour and ideas without interference, but sometimes markets go haywire, and must be counteracted forcefully by government.

Fannie Mae and Freddie Mac: Unfinished business

Can the American mortgage market survive without taxpayer support?

Jul 22nd 2010 | Washington, dc

[Greg Ip] THE hefty financial overhaul that Barack Obama signed into law on July 21st (pictured) left behind one big piece of unfinished business. In 2008 Fannie Mae and Freddie Mac, mortally wounded from losses on loans acquired during the bubble, were placed in “conservatorship”, a halfway house between bankruptcy and outright nationalisation. There they remain, their losses duly covered with new injections of capital by the Treasury—$145 billion so far. Tim Geithner, the treasury secretary, has promised to address the matter of Fannie and Freddie by early next year but so far he has no answers, only questions (literally so: in April he asked the public to comment on seven of them).

Financial reform in America: A decent start

A somewhat clumsy bill is hardly a panacea, though it fixes some important things

Jul 1st 2010

IT IS touted as the biggest overhaul of American finance since the Great Depression. The 2,319-page Dodd-Frank Wall Street Reform and Consumer Protection Act, now nearing the end of its odyssey through Congress, tackles almost every aspect of American finance from municipal bonds to executive pay. Its success, however, rests on a simple question: does it make another crisis significantly less likely?

 

Procyclicality everywhere

Jul 1st 2010, 13:02 by G.I. | WASHINGTON, DC

FISCAL austerity in a time of near recession is a bad idea when monetary policy is helpless as Brad DeLong has been pointing out for oh, several years now. Let’s broaden this debate about procyclicality beyond fiscal and monetary policy. As we saw during the crisis, both regulatory policy (forbearance) and credit policy (bail-outs and liquidity) can also be used for macroeconomic stimulus. How are they doing now: still stimulating? Unfortunately, no: they are showing symptoms of the same inchoate procyclicality as fiscal policy.

Central banks under scrutiny: Prometheus bound

May 20th 2010 | WASHINGTON, DC
From The Economist print edition

Financial reform will make the Fed more powerful and less independent

THE decision of the European Central Bank to start buying government bonds follows a path trodden by the Federal Reserve in 2008 and 2009. Both entered politically charged territory to save the financial system at great risk to their reputations. For the Fed, one consequence is that the big financial-reform bill making its way through the Senate—a vote was expected after The Economist went to press—will leave it more powerful but more beholden to Washington, DC.

The Fed has fought for, and kept, its supervision of banks. It acquires important new powers to regulate big non-bank financial companies and even to break up firms deemed a threat to the financial system. Its only significant loss of turf is direct oversight of consumer protection. The Fed keeps its emergency-lending powers, though it needs the Treasury’s approval to use them (it has usually sought such approval anyway). It cannot lend to failing firms because that job now sits with the Federal Deposit Insurance Corporation under the bill’s new resolution authority.

The price of these powers, though, is to be drawn closer into politicians’ embrace. Since its birth the Fed’s governance has reflected a mix of political and financial influences. Monetary policy is the joint responsibility of governors in Washington, DC, appointed by the president and confirmed by the Senate, and presidents of the reserve banks, some of whose directors are, or are appointed by, bankers.

Critics have long seen the bankers’ role in the running of the Fed as an affront to democracy. Under the reform bill the president will now nominate and the Senate will confirm the New York Fed president (the most important of the regional governors). Fed-supervised banks will lose any say in the governance of the reserve banks. Barney Frank, the chairman of the House Financial Services Committee, wants to go further, either stripping all reserve-bank presidents of their votes on monetary policy or making them more accountable.

Such changes have some worried that the Fed will adopt a looser monetary stance. In the near term, these fears are overdone. The economic environment remains deflationary. Excluding food and energy, inflation fell to a 49-year low of 0.9% in April. Political pressure for more expansionary policy has also been surprisingly slight. Opponents of Ben Bernanke’s confirmation to a second term as Fed chairman in January were more likely to criticise lax policy before the crisis and the Fed’s interventions during it, not its failure to maintain full employment. Inside the Fed, the pressure is also for tighter policy. Some officials are pressing for a quick sale of its holdings of mortgage-backed securities, although minutes of its April meeting suggest that will not happen before the Fed begins raising short-term rates.

The greater risk to Fed independence is not pressure from outside, but the temptation from inside to broaden its macroeconomic remit as the lines between regulatory and monetary policy blur. Financial stability has been formally added to the Fed’s duties, alongside full employment and price stability. More governors will be chosen for regulatory and legal expertise; one will be designated vice-chairman for supervision. If Barack Obama’s latest nominees are approved, only three of the seven governors will be economists; two will be lawyers. Decisions on which financial firms to regulate, which to support and which to liquidate will increasingly be made with an eye on the broader economy. Interest-rate decisions will more heavily consider the impact on the financial system. A hard job has got harder.

The original story is linked here.