Congressman Ron Paul’s bill to audit the Federal Reserve, HR 1207, seems to have generated quite a bit of concern amongst the Fed that monetary policy would somehow be jeopardized by its passage. In recent congressional testimony, Fed Vice Chairman Donald Kohn stated that “permitting GAO audits of monetary policy also could cast a chill on monetary policy deliberations”, meaning that members of the Fed Open Market Committee (FOMC) and other committees might be more reluctant to openly discuss ideas in private if the actual discussions were subject to congressional scrutiny, and not just the final conclusions of the discussions such as target interest rates.
How justified are the Fed’s concerns? Would passage of HR 1207 somehow threaten the Fed’s independence with respect to conducting monetary policy? To begin with, the tools the Fed has at its disposal to conduct monetary policy, such as open-market operations, reserve requirements and the discount window, are codified in Title 12 of the U.S. Code, whereas HR 1207 would only amend Title 31 of the code. None of the legal provisions which authorize the Fed to conduct monetary policy would be altered in the slightest if HR 1207 is to be passed in its current form, and those provisions maintain a degree of independence for the Fed by not requiring its Board of Governors to obtain congressional approval for adjustments in the conduct of monetary policy.
But Mr. Kohn hinted that additional audits of the Fed might implicitly force its members to focus more on short-term gains, rather than on sound long-term monetary policy, without expressly changing the Fed’s legal authority to conduct monetary policy. In Mr. Kohn’s statements, he indicates that members of the FOMC might be reluctant to express ideas freely in private sessions, if those members are aware that their remarks might be later revealed to the GAO and the Congress, and that could have the effect of preventing meaningful ideas from being expressed which lead to sound policy. This is a most curious observation, since during the hearing Mr. Kohn acknowledged that the Fed is obligated to pursue the goals established for it by Congress. If members of the Fed are genuinely focused on those goals, should not their remarks in private sessions reflect those goals? Of course members might disagree on the best course of action to reach those goals, balancing short-term and long-term objectives, but given that the results of monetary policy are publicly announced and columnists from the Wall Street Journal and other publications frequently comment on the potential ramifications of the Fed’s actions, any member of the Fed who is qualified to hold such position should have to fortitude to stand by their remarks. By comparison, in addition to Supreme Court decisions being publicized, many opinions delivered by Supreme Court justices concerning its decisions have offered glimpses into how certain justices perceive the law, but those revelations have not threatened the Court’s independence.
It is more likely that the Fed is using concern over monetary policy as a distraction, to prevent the curious eyes of Congressman Paul from discovering which institutions the Federal Reserve has been bailing out through its emergency loan program. The Fed’s bailout program is not granted by the Congress in the Federal Reserve Act, and raises questions about how the Fed is conducting itself in all areas. While it is true that the central bank should have a measure of political independence to ensure long-term prosperity, Mr. Kohn failed to mention the effect HR 1207 would have in allowing Congress to discover which banks the Fed has been favoring – either he is somehow unaware of that implication, or the omission was deliberate. Furthermore, during his entire oratory about how the Fed has increased its transparency, Mr. Kohn apparently “forgot” about how certain senators have inquired to Fed Chairman Ben Bernanke concerning which banks have received the bailouts – with no response from Mr. Bernanke. Congressman Paul’s proposed bill would do nothing to remove the monetary policy tools available to the Fed under Title 12, and given concerns over the recent bailout activities it is prudent that the additional audits occur.
Saturday, August 29, 2009
Wednesday, August 5, 2009
Geithner should be upset with himself, not regulators
According to the New York Times, Treasury Secretary Tim Geithner held a meeting last Friday with top regulatory officials (http://dealbook.blogs.nytimes.com/2009/08/04/geithner-said-to-lose-his-cool-at-regulators-meeting/?scp=2&sq=geithner&st=cse). According to the article, Mr. Geithner is upset because President Obama’s financial regulatory reform is encountering resistance among regulators, including the plan to expand the Federal Reserve’s powers. The article states that “Mr. Geithner told attendees that the administration and Congress set policy”.
To begin with, the regulatory policy established by Congress and past administrations specifically give regulators a measure of independence from Congress and the White House. For example, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) each have five commissioners, of which not more than three may be of the same political party by law. Additionally, the laws which grant the SEC and CFTC authority also grant those agencies power to establish regulations in certain areas, without prior approval from Congress or the White House. So, not only is Mr. Geithner’s assessment not compatible with the traditional U.S. law, he is assuming far too much power because the Congress HAS NOT passed President Obama’s regulatory reform measures – for which Mr. Geithner was undoubtedly the key author. And with tirades such as those, growing public mistrust with the Federal Reserve, and Mr. Geithner's previous toxic asset plan, it is more and more likely that Mr. Geithner’s agenda will not receive congressional support.
Additionally, Mr. Geithner himself is jointly responsible for the atmosphere in which regulators are pessimistic about his new reforms. Senator Bernie Sanders, an independent from Vermont, has stated on numerous occasions that the Federal Reserve has loaned at least $2.2. trillion to banks, without permission from the Congress or president. And Ron Paul, a Republican from Texas, has received tremendous support for his House bill to audit the Fed. Because it is likely that those loans began while Mr. Geithner was head of the New York Fed, Mr. Geithner at least implicitly gave his approval of those loans which have given free money to bank executives without freeing the credit markets. And now his reform plan includes expanding the powers of the Federal Reserve, at the same moment when Congress is pressing the Fed to release disclose who received the loans and demand additional accountability by auditing the Fed.
The article also states that “Ms. Schapiro (chairwoman of the SEC) and Ms. Bair (chairwoman of the FDIC) have argued that more authority should be shared among a council of regulators”. Considering that the Federal Reserve has no regulatory authority to assist commercial banks which are near insolvency, such power is instead given to the FDIC, it would seem that Ms. Schapiro and Ms. Bair should be demanding that Mr. Geithner uphold the laws which have been passed by Congress and prior administrations and that Mr. Geithner and the Federal Reserve cease interfering with their respective agencies. The bailout policies which began with the Federal Reserve while Mr. Geithner was leading the New York Fed are not only legally questionable, but have also been an unmitigated disaster – this is why Mr. Geithner should be upset with himself and not with other regulators. Or perhaps he realizes how liable he is for the present situation, and is seeking to shed culpability inasmuch as possible.
To begin with, the regulatory policy established by Congress and past administrations specifically give regulators a measure of independence from Congress and the White House. For example, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) each have five commissioners, of which not more than three may be of the same political party by law. Additionally, the laws which grant the SEC and CFTC authority also grant those agencies power to establish regulations in certain areas, without prior approval from Congress or the White House. So, not only is Mr. Geithner’s assessment not compatible with the traditional U.S. law, he is assuming far too much power because the Congress HAS NOT passed President Obama’s regulatory reform measures – for which Mr. Geithner was undoubtedly the key author. And with tirades such as those, growing public mistrust with the Federal Reserve, and Mr. Geithner's previous toxic asset plan, it is more and more likely that Mr. Geithner’s agenda will not receive congressional support.
Additionally, Mr. Geithner himself is jointly responsible for the atmosphere in which regulators are pessimistic about his new reforms. Senator Bernie Sanders, an independent from Vermont, has stated on numerous occasions that the Federal Reserve has loaned at least $2.2. trillion to banks, without permission from the Congress or president. And Ron Paul, a Republican from Texas, has received tremendous support for his House bill to audit the Fed. Because it is likely that those loans began while Mr. Geithner was head of the New York Fed, Mr. Geithner at least implicitly gave his approval of those loans which have given free money to bank executives without freeing the credit markets. And now his reform plan includes expanding the powers of the Federal Reserve, at the same moment when Congress is pressing the Fed to release disclose who received the loans and demand additional accountability by auditing the Fed.
The article also states that “Ms. Schapiro (chairwoman of the SEC) and Ms. Bair (chairwoman of the FDIC) have argued that more authority should be shared among a council of regulators”. Considering that the Federal Reserve has no regulatory authority to assist commercial banks which are near insolvency, such power is instead given to the FDIC, it would seem that Ms. Schapiro and Ms. Bair should be demanding that Mr. Geithner uphold the laws which have been passed by Congress and prior administrations and that Mr. Geithner and the Federal Reserve cease interfering with their respective agencies. The bailout policies which began with the Federal Reserve while Mr. Geithner was leading the New York Fed are not only legally questionable, but have also been an unmitigated disaster – this is why Mr. Geithner should be upset with himself and not with other regulators. Or perhaps he realizes how liable he is for the present situation, and is seeking to shed culpability inasmuch as possible.
Saturday, May 30, 2009
Federal Reserve lacks adequate oversight
When Congress passed the stimulus bill in February, there were plenty of detractors of the bill. Unlike the Federal Reserve, however, the votes of individual representatives and senators can used to hold elected officials accountable at the ballot box. Should the stimulus bill not work as expected, and the economy not recover in a timely manner, voters will have an opportunity to elect new leadership.
Congress and the President, however, are apparently not the only branches of government which can finance expensive ventures. According to Senator Bernie Sanders of Vermont, the Federal Reserve has given a total of $2 trillion to various businesses since the AIG mess began last year, without any approval from either Congress or President Obama. To whom the money was given and under what conditions remains a mystery, since Fed chairman Ben Bernanke has declined to provide such information to either Congress or to the public.
How is the Federal Reserve legally able to carry out such operations? According to the Office of the Inspector General for the Federal Reserve (http://www.federalreserve.gov/oig/), which is tasked with auditing and overseeing the actions of the Fed, the answer lies in Title 12 of the United States Code, Section 343 paragraph 2. For a PDF download of Title 12, go to http://uscode.house.gov/pdf/2007/ and click on the 2007usc12.pdf link. On page 112 of that document, look for paragraph 2 of Section 343 in the upper right-hand corner. If you can decipher the maze of legalese, you’ll realize that Congress has granted the Fed unlimited access to printing money and handing it out to whomever it pleases, so long as five members of the Board of Governors of the Federal Reserve concur. This authority is not subject to either presidential or congressional oversight – in effect, both the executive and legislative branches have agreed to turn a blind eye to the Fed’s actions and hope for a speedy end to the recession.
Members of both parties in Congress are aware of this issue, and have reported that there has been significant debate over how to properly regulate the Fed. And yet there is strangely little mention of this problem in either Republican or Democrat press releases, which is unusual in that both parties excel in criticizing the policies of the other. What better opportunity for Republicans to denounce Democrats when the Fed has given away $2 trillion, especially considering that the entire stimulus bill was “only” $787 billion? Could it be that big banks line the pockets of all congressional delegates, in order to ensure easy access to free money? Or is it that there is uncertainty concerning the proper method to regulate the Fed’s authority while not causing concern in the private sector?
One possible solution has been presented by Congressman Ron Paul, R-Texas, who has introduced house bill H.R. 779 to abolish the Federal Reserve System. Given the bank panics and failures of the early 1930s, this would seem to be an extreme measure which would prevent the federal government from insuring deposits and could lead to consumer fears over losing their deposits in a bank failure. But Congressman Paul is correct in raising concerns about the operation of the Fed, and of the notion of a central bank in general. Although a central bank is required in order to secure the full faith and credit of the United States, and to promote a healthy monetary policy, recent events have demonstrated a need for proper congressional oversight of the Fed and to restrict its role to regulating the healthy operation of commercial banks, not in acting as a regular bank in its own right.
Congress and the President, however, are apparently not the only branches of government which can finance expensive ventures. According to Senator Bernie Sanders of Vermont, the Federal Reserve has given a total of $2 trillion to various businesses since the AIG mess began last year, without any approval from either Congress or President Obama. To whom the money was given and under what conditions remains a mystery, since Fed chairman Ben Bernanke has declined to provide such information to either Congress or to the public.
How is the Federal Reserve legally able to carry out such operations? According to the Office of the Inspector General for the Federal Reserve (http://www.federalreserve.gov/oig/), which is tasked with auditing and overseeing the actions of the Fed, the answer lies in Title 12 of the United States Code, Section 343 paragraph 2. For a PDF download of Title 12, go to http://uscode.house.gov/pdf/2007/ and click on the 2007usc12.pdf link. On page 112 of that document, look for paragraph 2 of Section 343 in the upper right-hand corner. If you can decipher the maze of legalese, you’ll realize that Congress has granted the Fed unlimited access to printing money and handing it out to whomever it pleases, so long as five members of the Board of Governors of the Federal Reserve concur. This authority is not subject to either presidential or congressional oversight – in effect, both the executive and legislative branches have agreed to turn a blind eye to the Fed’s actions and hope for a speedy end to the recession.
Members of both parties in Congress are aware of this issue, and have reported that there has been significant debate over how to properly regulate the Fed. And yet there is strangely little mention of this problem in either Republican or Democrat press releases, which is unusual in that both parties excel in criticizing the policies of the other. What better opportunity for Republicans to denounce Democrats when the Fed has given away $2 trillion, especially considering that the entire stimulus bill was “only” $787 billion? Could it be that big banks line the pockets of all congressional delegates, in order to ensure easy access to free money? Or is it that there is uncertainty concerning the proper method to regulate the Fed’s authority while not causing concern in the private sector?
One possible solution has been presented by Congressman Ron Paul, R-Texas, who has introduced house bill H.R. 779 to abolish the Federal Reserve System. Given the bank panics and failures of the early 1930s, this would seem to be an extreme measure which would prevent the federal government from insuring deposits and could lead to consumer fears over losing their deposits in a bank failure. But Congressman Paul is correct in raising concerns about the operation of the Fed, and of the notion of a central bank in general. Although a central bank is required in order to secure the full faith and credit of the United States, and to promote a healthy monetary policy, recent events have demonstrated a need for proper congressional oversight of the Fed and to restrict its role to regulating the healthy operation of commercial banks, not in acting as a regular bank in its own right.
Monday, March 30, 2009
The President's role in restructuring GM
If General Motors is going to receive more financial aid from the federal government, it is apparently going to have to achieve new concessions from creditors, unions and retirees. Former GM CEO Rick Wagoner and other directors have reportedly lost their jobs as a condition for the White House to provide any more funding to the U.S. auto industry giant.
All this raises questions about what the government's role in private industry should be, and how to apply that power across different industries. For example, although the executives at some banks have been replaced and certain FDIC members placed under government control, there are also financial firms which have received bailouts but have not been forced to restructure. Meanwhile, President Obama and Treasury Secretary Geithner have been calling for a plan under which the taxpayers would assume control of the banking industry's toxic assets - a far cry from forcing a restructuring deal.
To begin with, does President Obama or "the government" actually have the authority to force GM into bankruptcy, even if it is a short-lived "prepackaged bankruptcy"? Actually, yes - prepackaged bankruptcies are allowed under Chapter 11 restructuring bankruptcies, and certain creditors can force a company into an involuntary bankruptcy under Section 303 of the bankruptcy code. So because the government is a creditor to GM, and not simply an investor owning common or preferred stock, it would be permissible under certain circumstances for the government to force GM into bankruptcy.
But another question also looms: what is the definition of "the government"? When it is said that "the government" is a GM creditor, does that refer to the President, Congress, or the Treasury? Or is there even a written definition for this particular circumstance? Certainly the government should not be interfering with private industry except as authorized by law, but all these bailouts and questions as to which firms are "too big to fail" has left us in a situation not seen in over 70 years, so there is little experimental evidence to go on as to how we should proceed. And since there are economic and social differences between modern times and the Great Depression, from the loss of the manufacturing industry to the social safety net programs such as unemployment benefits, what would have been effective int the 1930s will not necessarily work now.
When any company, from a bank to GM to AIG, requests government assistance, that firm should expect to have changes imposed on it. After all, if the company had been healthy and prosperous to begin with, there would have been no need for any bailout. Furthermore, the possibility of government intervention following a bailout would hopefully provide incentive for companies to NOT seek government assistance, but rather would convince both the company and its creditors that a mutually acceptable restructuring with no government interference would be in their best interests.
Alas, there have already been billions of dollars spent in assisting U.S. firms, with the possibility of much more on the way. So while we should strive to minimize or eliminate all government funding to private businesses, there should also be a system in place in case such action is deemed necessary by both the public and private sectors in order to minimize abuses to the system. For example, when the government becomes a creditor to a private company, perhaps there should be a clause in the bankruptcy code in which only a joint congressional resolution would place that company into involuntary bankruptcy, or perhaps that power should reside with the President or the Treasury Secretary. Point is, there is no such legal provision, so while the President's actions may be with the best intent and for the protection of the taxpayers, the fact that there is currently no legal framework for what is happening could very well be setting a dangerous precedent. Of course, any mere legal framework in and of itself cannot prevent abuses from either private industry or the government, nor could such framework even guarantee positive results. But at least a legal framework would have to be agreed upon by both Congress and the President in the typical legislative process, and hopefully that would ensure greater accountability in the hopefully rare instance that bailouts are deemed necessary.
All this raises questions about what the government's role in private industry should be, and how to apply that power across different industries. For example, although the executives at some banks have been replaced and certain FDIC members placed under government control, there are also financial firms which have received bailouts but have not been forced to restructure. Meanwhile, President Obama and Treasury Secretary Geithner have been calling for a plan under which the taxpayers would assume control of the banking industry's toxic assets - a far cry from forcing a restructuring deal.
To begin with, does President Obama or "the government" actually have the authority to force GM into bankruptcy, even if it is a short-lived "prepackaged bankruptcy"? Actually, yes - prepackaged bankruptcies are allowed under Chapter 11 restructuring bankruptcies, and certain creditors can force a company into an involuntary bankruptcy under Section 303 of the bankruptcy code. So because the government is a creditor to GM, and not simply an investor owning common or preferred stock, it would be permissible under certain circumstances for the government to force GM into bankruptcy.
But another question also looms: what is the definition of "the government"? When it is said that "the government" is a GM creditor, does that refer to the President, Congress, or the Treasury? Or is there even a written definition for this particular circumstance? Certainly the government should not be interfering with private industry except as authorized by law, but all these bailouts and questions as to which firms are "too big to fail" has left us in a situation not seen in over 70 years, so there is little experimental evidence to go on as to how we should proceed. And since there are economic and social differences between modern times and the Great Depression, from the loss of the manufacturing industry to the social safety net programs such as unemployment benefits, what would have been effective int the 1930s will not necessarily work now.
When any company, from a bank to GM to AIG, requests government assistance, that firm should expect to have changes imposed on it. After all, if the company had been healthy and prosperous to begin with, there would have been no need for any bailout. Furthermore, the possibility of government intervention following a bailout would hopefully provide incentive for companies to NOT seek government assistance, but rather would convince both the company and its creditors that a mutually acceptable restructuring with no government interference would be in their best interests.
Alas, there have already been billions of dollars spent in assisting U.S. firms, with the possibility of much more on the way. So while we should strive to minimize or eliminate all government funding to private businesses, there should also be a system in place in case such action is deemed necessary by both the public and private sectors in order to minimize abuses to the system. For example, when the government becomes a creditor to a private company, perhaps there should be a clause in the bankruptcy code in which only a joint congressional resolution would place that company into involuntary bankruptcy, or perhaps that power should reside with the President or the Treasury Secretary. Point is, there is no such legal provision, so while the President's actions may be with the best intent and for the protection of the taxpayers, the fact that there is currently no legal framework for what is happening could very well be setting a dangerous precedent. Of course, any mere legal framework in and of itself cannot prevent abuses from either private industry or the government, nor could such framework even guarantee positive results. But at least a legal framework would have to be agreed upon by both Congress and the President in the typical legislative process, and hopefully that would ensure greater accountability in the hopefully rare instance that bailouts are deemed necessary.
Friday, March 27, 2009
President Obama needs more decisiveness in dealing with bank execs
Today, President Obama met with the CEOs of 15 major banks at the White House to encourage cooperation with the administration’s new plan to free up the credit and lending markets. The bank executives appear optimistic about the initial proposal but would also like further details.
Apparently, the plan to partner with private investors, the Federal Reserve and the FDIC to buy as much as $1 trillion in toxic assets from the banks to encourage lending is still on the table. As mentioned before, can we really trust the same banks whose dealings led to those toxic assets with that amount of capital, while simply HOPING the plan will free up lending but not actually require it? Or will even $1 trillion not be enough to cover all of the toxic assets, in which case the lending crisis will remain as it is now, only with more accumulation to the national debt?
Although the President should definitely make overtures to bank executives to encourage their cooperation in an economic recovery plan, the President also has considerable leverage in the matter and should not be afraid to use it if absolutely necessary – but hopefully the mere possibility of such action would convince banks to accept an alternative solution. Since most, if not all, of the major banks are members of the FDIC, the Federal Deposit Insurance Act allows the FDIC to step in and assume control of those institutions under certain conditions, including “unsafe or unsound condition” and “losses”. If the FDIC were to assume control of the banks, those toxic assets could be renegotiated, with a corresponding loss of economic income and prestige to both the banks and their counterparties in the toxic assets.
However, it is not in the best interest of the economy at large or the banks for the FDIC to take such initiative. But it should be sufficient incentive for the banks to accept an alternative plan to the outright purchase of the toxic assets by the government and private investors: no-interest loans provided by the Treasury and Federal Reserve to the banks UNDER THE WRITTEN CONDITION THAT THOSE FUNDS BE USED IN EXTENDING LOANS TO PRIVATE BUSINESSES. A written agreement will prevent another AIG scandal, as the bank executives would be criminally liable if the conditions of the agreement were broken. And even though the banks would still hold the toxic assets, they would benefit from the interest earned on the business loans, while the counterparties in the toxic assets wouldn’t be paid immediately but also would not see the assets diminish in value as a result of FDIC action. Finally, the government would benefit not only from the economic stimulation of loans to businesses, but also by not holding onto those toxic assets and eventually being repaid by the banks to minimize the impact on the national debt.
President Obama is taking the correct approach in being diplomatic with the bank executives and soliciting their cooperation in the economic recovery plan. But he also needs to keep in mind the leverage he has in this particular situation, and use that to his advantage in putting forth a plan which will first and foremost stimulate the economy while also allowing the banks to gradually eliminate their toxic assets. This plan will also allow the Congress time to debate and establish the new regulatory measures before all the toxic assets are removed and the wheeling and dealing begins with renewed vigor.
After all, if the President is willing to spend upwards of $1 trillion in the HOPE that banks will begin lending again, why not spend less than that amount in a plan which ENSURES that the money go towards stimulating the economy?
Apparently, the plan to partner with private investors, the Federal Reserve and the FDIC to buy as much as $1 trillion in toxic assets from the banks to encourage lending is still on the table. As mentioned before, can we really trust the same banks whose dealings led to those toxic assets with that amount of capital, while simply HOPING the plan will free up lending but not actually require it? Or will even $1 trillion not be enough to cover all of the toxic assets, in which case the lending crisis will remain as it is now, only with more accumulation to the national debt?
Although the President should definitely make overtures to bank executives to encourage their cooperation in an economic recovery plan, the President also has considerable leverage in the matter and should not be afraid to use it if absolutely necessary – but hopefully the mere possibility of such action would convince banks to accept an alternative solution. Since most, if not all, of the major banks are members of the FDIC, the Federal Deposit Insurance Act allows the FDIC to step in and assume control of those institutions under certain conditions, including “unsafe or unsound condition” and “losses”. If the FDIC were to assume control of the banks, those toxic assets could be renegotiated, with a corresponding loss of economic income and prestige to both the banks and their counterparties in the toxic assets.
However, it is not in the best interest of the economy at large or the banks for the FDIC to take such initiative. But it should be sufficient incentive for the banks to accept an alternative plan to the outright purchase of the toxic assets by the government and private investors: no-interest loans provided by the Treasury and Federal Reserve to the banks UNDER THE WRITTEN CONDITION THAT THOSE FUNDS BE USED IN EXTENDING LOANS TO PRIVATE BUSINESSES. A written agreement will prevent another AIG scandal, as the bank executives would be criminally liable if the conditions of the agreement were broken. And even though the banks would still hold the toxic assets, they would benefit from the interest earned on the business loans, while the counterparties in the toxic assets wouldn’t be paid immediately but also would not see the assets diminish in value as a result of FDIC action. Finally, the government would benefit not only from the economic stimulation of loans to businesses, but also by not holding onto those toxic assets and eventually being repaid by the banks to minimize the impact on the national debt.
President Obama is taking the correct approach in being diplomatic with the bank executives and soliciting their cooperation in the economic recovery plan. But he also needs to keep in mind the leverage he has in this particular situation, and use that to his advantage in putting forth a plan which will first and foremost stimulate the economy while also allowing the banks to gradually eliminate their toxic assets. This plan will also allow the Congress time to debate and establish the new regulatory measures before all the toxic assets are removed and the wheeling and dealing begins with renewed vigor.
After all, if the President is willing to spend upwards of $1 trillion in the HOPE that banks will begin lending again, why not spend less than that amount in a plan which ENSURES that the money go towards stimulating the economy?
Wednesday, March 25, 2009
New regulatory framework for financial institutions
Treasury Secretary Timothy Geithner is petitioning Congress for a set of new regulatory powers which would enable the federal government to seize certain financial companies which are near insolvency, similar to powers the FDIC has in taking control of troubled banks. The idea is to prevent another bailout disaster similar to AIG, but is such drastic new legislation really necessary, or could a more moderate increase in federal regulatory powers serve to fulfill the same purpose?
Let’s review the bank situation Mr. Geithner is attempting to draw a parallel with. The Federal Deposit Insurance Act, which created the FDIC, contains provisions under which that entity can take over certain troubled banks, including conditions of “assets insufficient for obligations”, “unsafe or unsound condition”, “cease and desist orders”, “violations of law”, and “losses”. This Act was passed soon after FDR took office in the early 1930s, when bank failures were commonplace, and provided a mechanism for the government to take early action to prevent catastrophic failure of a critical component of the economy. Since bank failures can suppress economic growth and lead directly to both short and long-term distress for bank account holders, there is a good basis for this law even today.
But even with the public outrage over the AIG situation, is there a more moderate approach to handling new regulatory measures for non-banks? First off, both President Bush and a Democratic Congress failed to expressly write conditions under which AIG should use the bailout funds, so public outrage should first and foremost be directed at the federal government. If you give a bunch of crooks some money without police escort, what would you expect?
Alas, we could play the political blame game to infinity without achieving any significant progress, so here is a solution to the regulatory problem which will allow some level of government intervention when appropriate while allowing non-banks to function in a manner deemed appropriate by their directors: amend the Investment Company Act of 1940. An “investment company” is one whose primary business is in investment, i.e. trading stocks and bonds and other securities and derivatives to achieve profit. AIG currently does not qualify as an investment company because its primary business is insurance, not investing. And yet, poor investing is what put this insurance giant into distress. So why not amend the Investment Act of 1940 to require certain publicly-traded companies, i.e. firms required to register under the Securities Act of 1933 or Securities Exchange Act of 1934, as investment companies? There could be an exception for companies who only invest extra cash into savings accounts or other publicly-traded companies, but otherwise if a publicly traded company (1) engages primarily in investing, (2) has a subsidiary engaged primarily in investing (i.e., AIG Financial Products) or (3) invest cash in anything other than demand deposits or other publicly-traded securities, that company would also have to register as an investment company.
What intervention authority should the federal government have over investment companies? For starters, companies classified as “investment companies” under provision (2) or (3) above should have more stringent and frequent reporting requirements so both investors and federal authorities would be more likely to catch any particular trouble spots. This would exclude firms such as hedge funds and other companies engaged primarily in investing activities from these reporting requirements. And federal authorities should then be allowed to file for a cease and desist order in federal bankruptcy court to prevent dangerous activities by those companies, but not for the government to simply take over those companies. The companies could then either play ball and cooperate with the government, or appeal the order first in bankruptcy court then in district court. In this manner, more consumer and overall economic protection would be provided without allowing the government too much control over the daily operations of non-banking private companies.
Let’s review the bank situation Mr. Geithner is attempting to draw a parallel with. The Federal Deposit Insurance Act, which created the FDIC, contains provisions under which that entity can take over certain troubled banks, including conditions of “assets insufficient for obligations”, “unsafe or unsound condition”, “cease and desist orders”, “violations of law”, and “losses”. This Act was passed soon after FDR took office in the early 1930s, when bank failures were commonplace, and provided a mechanism for the government to take early action to prevent catastrophic failure of a critical component of the economy. Since bank failures can suppress economic growth and lead directly to both short and long-term distress for bank account holders, there is a good basis for this law even today.
But even with the public outrage over the AIG situation, is there a more moderate approach to handling new regulatory measures for non-banks? First off, both President Bush and a Democratic Congress failed to expressly write conditions under which AIG should use the bailout funds, so public outrage should first and foremost be directed at the federal government. If you give a bunch of crooks some money without police escort, what would you expect?
Alas, we could play the political blame game to infinity without achieving any significant progress, so here is a solution to the regulatory problem which will allow some level of government intervention when appropriate while allowing non-banks to function in a manner deemed appropriate by their directors: amend the Investment Company Act of 1940. An “investment company” is one whose primary business is in investment, i.e. trading stocks and bonds and other securities and derivatives to achieve profit. AIG currently does not qualify as an investment company because its primary business is insurance, not investing. And yet, poor investing is what put this insurance giant into distress. So why not amend the Investment Act of 1940 to require certain publicly-traded companies, i.e. firms required to register under the Securities Act of 1933 or Securities Exchange Act of 1934, as investment companies? There could be an exception for companies who only invest extra cash into savings accounts or other publicly-traded companies, but otherwise if a publicly traded company (1) engages primarily in investing, (2) has a subsidiary engaged primarily in investing (i.e., AIG Financial Products) or (3) invest cash in anything other than demand deposits or other publicly-traded securities, that company would also have to register as an investment company.
What intervention authority should the federal government have over investment companies? For starters, companies classified as “investment companies” under provision (2) or (3) above should have more stringent and frequent reporting requirements so both investors and federal authorities would be more likely to catch any particular trouble spots. This would exclude firms such as hedge funds and other companies engaged primarily in investing activities from these reporting requirements. And federal authorities should then be allowed to file for a cease and desist order in federal bankruptcy court to prevent dangerous activities by those companies, but not for the government to simply take over those companies. The companies could then either play ball and cooperate with the government, or appeal the order first in bankruptcy court then in district court. In this manner, more consumer and overall economic protection would be provided without allowing the government too much control over the daily operations of non-banking private companies.
Monday, March 23, 2009
New Obama plan similar to AIG bailouts?
While final details are still a little sketchy, the Obama administration has proposed a plan to provide both public and private investment in removing toxic assets from bank balance sheets in an attempt to improve the credit markets. Although improving unemployment should remain the priority at this stage of the economic recovery, there is little or no doubt that the financial markets need to be strengthened so that viable companies which actually have a demand for their products can obtain credit in order to obtain more inventory and increase payrolls. So, will this plan actually strengthen the financial system?
The proposed plan will involve the purchase, by both the government and private investors, of both troubled securities and loans currently on bank balance sheets. While purchasing the loans may prevent some foreclosures and therefore steady the housing markets, there should be more than a little skepticism about purchasing troubled securities – most of which are tied into the housing market. Under the current plan, the government (including the Federal Reserve) will hold upwards of 93% of the toxic securities. It is important to note that this plan will NOT improve the market for such securities - that will only occur when and if the housing market returns to its pre-2007 high water mark. The plan simply assumes that, by removing these toxic assets from the banks, the banks will have incentive to once again provide loans and hopefully raise the GDP.
One problem (amongst many potential issues): what is the total amount of “toxic” assets that we are talking about? The initial plan seems to call for a grand total of anywhere between one half and one trillion dollars in total relief. But what if the total amount of the assets in question exceeds the amount provided by the federal government? In that case this would resemble the AIG bailout, with government (and a little private) funds going to banks to purchase the securities, the government left with the toxic assets and hoping their value rises over time, the banks paying off the investment banks or other parties they are currently indebted to, and not enough capital left over to provide for credit consumers. If any estimate of the total amount of toxic assets is available, I have yet to see one in any of the press releases.
Instead of simply paying off the investment bankers in the hopes that credit will start flowing again, why not provide the relief to banks in the form of zero-interest loans with a five-year maturity under the condition that the funds be used in extending credit? That is the surest way to get loans out to businesses which are willing to expand and provide more jobs. It doesn’t solve the toxic asset problem anytime soon, but it does get credit flowing, and by improving the unemployment rate and stimulating the economy the impact of those toxic assets can eventually be either be lessened or completely negated, and there will be a stronger base for the U.S. economy going forward. Besides, by making economically sound loans and earning interest, the banks can gradually fulfill their prior obligations and thereby remove the toxic assets.
The proposed plan will involve the purchase, by both the government and private investors, of both troubled securities and loans currently on bank balance sheets. While purchasing the loans may prevent some foreclosures and therefore steady the housing markets, there should be more than a little skepticism about purchasing troubled securities – most of which are tied into the housing market. Under the current plan, the government (including the Federal Reserve) will hold upwards of 93% of the toxic securities. It is important to note that this plan will NOT improve the market for such securities - that will only occur when and if the housing market returns to its pre-2007 high water mark. The plan simply assumes that, by removing these toxic assets from the banks, the banks will have incentive to once again provide loans and hopefully raise the GDP.
One problem (amongst many potential issues): what is the total amount of “toxic” assets that we are talking about? The initial plan seems to call for a grand total of anywhere between one half and one trillion dollars in total relief. But what if the total amount of the assets in question exceeds the amount provided by the federal government? In that case this would resemble the AIG bailout, with government (and a little private) funds going to banks to purchase the securities, the government left with the toxic assets and hoping their value rises over time, the banks paying off the investment banks or other parties they are currently indebted to, and not enough capital left over to provide for credit consumers. If any estimate of the total amount of toxic assets is available, I have yet to see one in any of the press releases.
Instead of simply paying off the investment bankers in the hopes that credit will start flowing again, why not provide the relief to banks in the form of zero-interest loans with a five-year maturity under the condition that the funds be used in extending credit? That is the surest way to get loans out to businesses which are willing to expand and provide more jobs. It doesn’t solve the toxic asset problem anytime soon, but it does get credit flowing, and by improving the unemployment rate and stimulating the economy the impact of those toxic assets can eventually be either be lessened or completely negated, and there will be a stronger base for the U.S. economy going forward. Besides, by making economically sound loans and earning interest, the banks can gradually fulfill their prior obligations and thereby remove the toxic assets.
Subscribe to:
Posts (Atom)