While the US Congress is busy preparing to battle a timid proposal to reform health insurance (not health care) and attacking one of the key public officials that prevented a new Depression, an article published last week by BoB herbert in the NY Times commenting on a new study ‘The suburbanization of poverty: trends in Metropolitan America, 2000 to 2008’ by the Brookings Institution provides a stark reminder of is going on in the real economy.
According to the study, from 2000 to 2008, the number of poor people in the U.S. grew by 5.2 million, reaching nearly 40 million. That represented an increase of 15.4% in the poor population, which was more than twice the increase in the population as a whole during that period. In 2008 alone, a startling 91.6 million people – more than 30 percent of the entire U.S. population - fell below 200 percent of the federal poverty line, which is a meager $21,834 for a family of four.
The authors point that while poverty has grown on the whole, the most recent data also makes clear that American poverty is becoming an increasingly suburban phenomenon. Little explanations are advanced on why poverty as a whole increased during that period and why suburbs are increasingly affected – the authors only mention that ‘since the late 1990’s jobs in almost every major metro area have continued to shift away from the urban core toward the metropolitan fringe, regardless of industry or whether the regional job was expanding or contracting – arguing that metro areas with higher levels of employment decentralization over this decade also exhibit a greater suburbanization of poverty’.
A few other arguments might also be useful in explaining such trends…Bush anyone?
Tuesday, January 26
ex post facto
In reviewing yet another book on the financial crisis, Edward Cahncellor adds to the typical causes mentioned, the failing of academic economists for failing to warn of pending bubles. He cites an American provost that complains of having an 'entire department of economists who can provide a brilliant ex post facto explanation of what happened - and not a single one saw it coming'.
Friday, January 22
The Volcker Rule
As GS was reporting the most profitable year in its history, Obama introduced the ‘Volcker Rule’: a call for a return to a Glass-Steagall type of separation between commercial and investment banking activities. The proposal aimed at addressing some on the implicit moral hazards currently existent in the US financial system.
Bank holding companies with government-insured deposits and access to cheap financing from the Federal Reserve should not be allowed to engage in proprietary trading or co-invest and sponsor riskier alternative investment vehicles such as hedge funds or private equity types of structures;
Firms that underwrite new issues of stocks and bonds and act as broker-dealers for their institutional clients should not be allowed to trade for their own accounts;
Such proposals would probably be more effective at constraining profits and resolving moral hazard issues than actually addressing the structural problems that almost brought the entire financial system to a halt in 2008.
Bank holding companies with government-insured deposits and access to cheap financing from the Federal Reserve should not be allowed to engage in proprietary trading or co-invest and sponsor riskier alternative investment vehicles such as hedge funds or private equity types of structures;
Firms that underwrite new issues of stocks and bonds and act as broker-dealers for their institutional clients should not be allowed to trade for their own accounts;
Such proposals would probably be more effective at constraining profits and resolving moral hazard issues than actually addressing the structural problems that almost brought the entire financial system to a halt in 2008.
Thursday, January 21
Financial crisis for beginners
The blog 'Baseline scenario' provides a wide range of very useful resources on the origins and implications of the financial crisis, and even have their own integrated presentation.
A must read.
A must read.
Big Banks Subsidy
Expanding on my previous post on the implicit public subsidy provided by modern monetary policy, it is worth mentioning the much talked about study by Dean baker and Travis McArthur of The Center for Economic and Policy Research ‘The Value of the “Too Big to Fail” Big Bank Subsidy’ published in September of 2009.
In essence, the study attempts to quantify the value of the US government policy of implicitly guaranteeing the debts of major financial institutions in case of possible defaults.
The authors quantify the value of this implicit public insurance as the difference in the spread between the average cost of funds for smaller banks and institutions with assets in excess of $100 billion before and after the passing of the ‘Troubled Asset Relief Program’ (TARP).
Between the first quarter of 2000 through the fourth quarter of 2007 before the collapse of Bear Sterns that spread averaged 0.29 percentage points. In the period from the fourth quarter of 2008 through the second quarter of 2009, the gap had widened to an average of 0.78 points.
While is it disputable the extent to which the increased gap is attributable to the government policy, is hard to argue against the impact that it has had on the ability of larger banks to borrow at much lower costs than smaller banks not backed by government protection.
The authors point out that the increase of 0.49 percentage points in the gap means that the larger banks have saved $34.1 billion a year in borrowing costs – a significant public subsidy to the 18 banking holding companies with more than $100 billion in assets. When represented as a percentage of bank profits, Tyler Durden in Zero Hedge points out that it accounts for nearly 50% of all bank profits.
With banks currently announcing the size of their bonus pools, it would be interesting to determine how much of it is directly funded by the big bank public subsidy…
In essence, the study attempts to quantify the value of the US government policy of implicitly guaranteeing the debts of major financial institutions in case of possible defaults.
The authors quantify the value of this implicit public insurance as the difference in the spread between the average cost of funds for smaller banks and institutions with assets in excess of $100 billion before and after the passing of the ‘Troubled Asset Relief Program’ (TARP).
Between the first quarter of 2000 through the fourth quarter of 2007 before the collapse of Bear Sterns that spread averaged 0.29 percentage points. In the period from the fourth quarter of 2008 through the second quarter of 2009, the gap had widened to an average of 0.78 points.
While is it disputable the extent to which the increased gap is attributable to the government policy, is hard to argue against the impact that it has had on the ability of larger banks to borrow at much lower costs than smaller banks not backed by government protection.
The authors point out that the increase of 0.49 percentage points in the gap means that the larger banks have saved $34.1 billion a year in borrowing costs – a significant public subsidy to the 18 banking holding companies with more than $100 billion in assets. When represented as a percentage of bank profits, Tyler Durden in Zero Hedge points out that it accounts for nearly 50% of all bank profits.
With banks currently announcing the size of their bonus pools, it would be interesting to determine how much of it is directly funded by the big bank public subsidy…
Wednesday, January 20
Financial Innovation
'The most important financial innovation that I have seen in the past 20 years is the automatic teller machine... How many other innovations can you tell me of that have been as important to the individual?'
by Paul Volckner
by Paul Volckner
Subsidized profits
Currently writing a book about the financial crisis, David Stockman, director of the Office of Management and Budget under President Ronald Reagan published today on the NY Times a surprisingly tough attack on the nation’s largest financial institutions as well as on the actions of the Federal Reserve to save them and its current monetary policy.
For Stockman, the Fed’s purchase of $1.5 trillion of Treasury bonds and other securities held by these banks bringing short-term interests rates to near zero is a ‘vast and capricious reallocation of national income’ in which ‘the savers of America are taking a $250 billion annual haircut in lost interest income’ (bringing down the banks cost of production) while rates on bank loans have not came down accordingly.
The result has a been a steeply sloped yield curve which has allowed financial institutions to report record profits that represented ‘the fruits of hyperactive gambling in the Fed’s monetary casino – a place where the inside players obtain their chips at no cost from the Fed-controlled money markets, and are warned well in advance, by obscure wording changes in the Fed’s policy statements, about any pending shift in the gambling odds.
While reality is vastly more complex, Stockman argument is useful in making clearer the extent to which behind the banks results there is a huge public subsidy which is being provided at the expense of the ordinary saver and taxpayer.
Warren Buffet might not see a rationale for bank fees, but if that subsidy is going to end up as bonuses, it seems only fair that part of it should recouped by the government in the form of a tax on the nations’ largest financial institutions.
For Stockman, the Fed’s purchase of $1.5 trillion of Treasury bonds and other securities held by these banks bringing short-term interests rates to near zero is a ‘vast and capricious reallocation of national income’ in which ‘the savers of America are taking a $250 billion annual haircut in lost interest income’ (bringing down the banks cost of production) while rates on bank loans have not came down accordingly.
The result has a been a steeply sloped yield curve which has allowed financial institutions to report record profits that represented ‘the fruits of hyperactive gambling in the Fed’s monetary casino – a place where the inside players obtain their chips at no cost from the Fed-controlled money markets, and are warned well in advance, by obscure wording changes in the Fed’s policy statements, about any pending shift in the gambling odds.
While reality is vastly more complex, Stockman argument is useful in making clearer the extent to which behind the banks results there is a huge public subsidy which is being provided at the expense of the ordinary saver and taxpayer.
Warren Buffet might not see a rationale for bank fees, but if that subsidy is going to end up as bonuses, it seems only fair that part of it should recouped by the government in the form of a tax on the nations’ largest financial institutions.
Tuesday, January 19
The revolution in equity ownership
In an important opinion article in the Wall Street Journal, the founder of the Vanguard Group John C. Bogle documents the impressive transformation in the US public capital markets that took place in the last half of the 20th century - no less than a ‘revolution in equity ownership’.
In the mid-1950s, institutional investors held less than 10% of all U.S. stocks. This number increased to 35% in 1975, 53% a decade ago and now institutional investors own and control almost 70% of the shares of US corporations.
With the rise in equity ownership by institutional investors, the US financial system widened the range of investment opportunities available to the nation’s pool of savings. This steady rise not only improved the ability of the economy as a whole to allocate capital to its most productive uses, but also made the higher returns of equity markets available to the wider public.
At a corporate level, the availability of public capital markets to fund the growth of companies increased the transparency of the corporate system, increasing the attractiveness of US markets to investment. Also, the increased liquidity compressed bid-ask spreads and allowed capital and risk to be more efficiently priced.
No doubt such advances in its financial system contributed to the growth and general success that overall the US economy enjoyed in the last part of the 20th century.
Still, the shortcomings of the system that John Bogle describes speak to the some of the reasons of why economic growth in Western economies has been persistently punctuated by periods of drastic contractions and recessions.
Annual stock turnover was barely 21% 30 years ago. It increased to 78% a decade ago and appears to have been 250% in 2009. As Bogle argues, economic fundamentals and company prospects alone cannot justify ownership stakes in corporations to change hands two and a half times on average in one year.
Only short-term expectations of generating returns unrelated to fundamentals and fees generated from trading activity can justify such high turnovers.
Focus on short term gains has increased the volatility of prices and with it the intensity of business cycles – with period of overvaluation of equities being followed by drastic and sudden divestments originating significant financial losses as well as contractions in economic output.
Increases in financial intermediation costs has siphon part of the increased returns on the nation savings to the financial industry at the expense of investors – while fundamentally changing the GDP composition of cities and nations of such services were located, making them increasingly dependent on the industry’s revenues.
The separation of ownership from management that the access to public capital markets entailed also seems to have weakened corporate control systems. The focus on share price as the preferred measure of performance and board of directors agency fundamentally misaligned the interests of shareholders and management. Accounting and reporting tricks became common and senior management compensation relative to the average worker rose drastically (from 42 times in 1980 to close to 400 times in 2009).
John Bogle proposes tax devices to incentivize long-term holding of public equities – granting long term extra voting rights and/ or higher dividends; and a tax on short-term realized capital gains.
Such strategies would seem to address some of the shortcomings described – by incentivizing investors to focus on long term strategies, equity prices would tend to better reflect underlying fundamentals as well as increasing the accountability of senior management to boards of directors by realigning its economic interests in the company’s performance.
Given the vast vested interests dependent on the profitability of the industry, such proposals seem to have little chances of successfully being enacted. Nevertheless they are certainly worth of being included in the financial stability plan being elaborated by the current administration.
In the mid-1950s, institutional investors held less than 10% of all U.S. stocks. This number increased to 35% in 1975, 53% a decade ago and now institutional investors own and control almost 70% of the shares of US corporations.
With the rise in equity ownership by institutional investors, the US financial system widened the range of investment opportunities available to the nation’s pool of savings. This steady rise not only improved the ability of the economy as a whole to allocate capital to its most productive uses, but also made the higher returns of equity markets available to the wider public.
At a corporate level, the availability of public capital markets to fund the growth of companies increased the transparency of the corporate system, increasing the attractiveness of US markets to investment. Also, the increased liquidity compressed bid-ask spreads and allowed capital and risk to be more efficiently priced.
No doubt such advances in its financial system contributed to the growth and general success that overall the US economy enjoyed in the last part of the 20th century.
Still, the shortcomings of the system that John Bogle describes speak to the some of the reasons of why economic growth in Western economies has been persistently punctuated by periods of drastic contractions and recessions.
Annual stock turnover was barely 21% 30 years ago. It increased to 78% a decade ago and appears to have been 250% in 2009. As Bogle argues, economic fundamentals and company prospects alone cannot justify ownership stakes in corporations to change hands two and a half times on average in one year.
Only short-term expectations of generating returns unrelated to fundamentals and fees generated from trading activity can justify such high turnovers.
Focus on short term gains has increased the volatility of prices and with it the intensity of business cycles – with period of overvaluation of equities being followed by drastic and sudden divestments originating significant financial losses as well as contractions in economic output.
Increases in financial intermediation costs has siphon part of the increased returns on the nation savings to the financial industry at the expense of investors – while fundamentally changing the GDP composition of cities and nations of such services were located, making them increasingly dependent on the industry’s revenues.
The separation of ownership from management that the access to public capital markets entailed also seems to have weakened corporate control systems. The focus on share price as the preferred measure of performance and board of directors agency fundamentally misaligned the interests of shareholders and management. Accounting and reporting tricks became common and senior management compensation relative to the average worker rose drastically (from 42 times in 1980 to close to 400 times in 2009).
John Bogle proposes tax devices to incentivize long-term holding of public equities – granting long term extra voting rights and/ or higher dividends; and a tax on short-term realized capital gains.
Such strategies would seem to address some of the shortcomings described – by incentivizing investors to focus on long term strategies, equity prices would tend to better reflect underlying fundamentals as well as increasing the accountability of senior management to boards of directors by realigning its economic interests in the company’s performance.
Given the vast vested interests dependent on the profitability of the industry, such proposals seem to have little chances of successfully being enacted. Nevertheless they are certainly worth of being included in the financial stability plan being elaborated by the current administration.
Subscribe to:
Comments (Atom)
Posts
