Posts Tagged ‘Helwege’

Glass-Steagall Redux

Wednesday, October 21st, 2009

The New York Times reports today that former Fed Chair Paul Volcker’s call to forbid commercial banks from mixing with investment banks is falling on deaf ears within the Obama administration.  Volcker, head of the president’s Economic Recovery Advisory Board, believes keeping banks from owning and trading securities will keep them out of the trouble they have experienced in the current recession.

According to Smeal’s Jean Helwege, Volcker’s plan would likely make future economic crises less costly than this most recent one, however, it won’t keep the Fed from spending taxpayer dollars to bail out poorly run banks in the future.

More from Helwege:

Paul Volcker, former Federal Reserve chairman and adviser to President Obama, recommends that we go back to the good old days when commercial banks and investment banks were kept separate. The logic now, as it was in the 1930s when Glass-Steagall was enacted, is that investment banking is too risky a business to mix with consumer deposits. In a speech earlier this fall Volcker stated, “I do not think it reasonable that public money—taxpayer money—be indirectly available to support risk-prone capital market activities simply because they are housed within a commercial banking organization.” Volcker recognizes that his views are hardly “progressive,” noting that “people say I’m old-fashioned and banks can no longer be separated from nonbank activity.”  But he points out, “That argument brought us to where we are today.”

The $64,000 question is whether we would be where we are today had we pursued different regulatory policies leading up to this recession. Whatever the policies regarding mergers of banks and investment houses, we would have experienced a housing bubble and it would still have popped, bringing massive losses to homeowners across the nation and a retrenchment in homebuilding that would last years. Fannie Mae and Freddie Mac would still be in conservatorship, having overleveraged themselves to peddle the American dream of home ownership. Investors would still have lost money on mortgage-backed securities built on subprime mortgages. Those losses would still have led to concerns that safer mortgages might default, expanding the breadth of losses in the MBS market. We would be in a deep recession as a result of the housing downturn regardless of whether banking activities are segregated.

However, Volcker’s arguments are more geared toward preventing the next near-Great Depression and redefining the policy responses to such crises. If we still had Glass-Steagall, we would not have seen the merger of JPMorgan Chase (a bank) with Bear Stearns (an investment bank) in 2008, which might have prevented people from expecting a similar deal with Lehman and some other commercial bank and thus the fallout when Lehman was dropped like a stone from the list of firms “too big to fail.” If we still had Glass-Steagall, Goldman would never have decided to convert to a bank holding company and potentially would not have received the largesse it did. Nor would Bank of America have had its arm twisted into acquiring Merrill Lynch. Bringing back Glass-Steagall might bring us back to the days of more narrowly defined policy responses by the Federal Reserve. And it might mean that the next crisis will not be worse than today’s now that the investment banks are so strongly encased in the regulatory womb of the Federal Reserve.

Reinstating Glass-Steagall is a simple response to a complex issue.  While simple may be all we can swallow, it remains the case that the Federal Reserve has not been successful in striking a balance between helping out the economy and condoning bad behavior by financial firms.  The Fed identified AIG as strong enough to get a loan (i.e., the Fed was sure it would get paid back) and Lehman as incapable of repaying new funds. It deemed CIT too unimportant to deserve aid but was willing to help out the entire money market mutual fund industry. The Fed’s willingness to extend its hand to all manner of poorly run firms is a concern and Volcker’s efforts to rein in this independent agency may help, but unfortunately it’s more likely that the Fed will find another way to expand its role as lender of last resort regardless of whether we revert to Glass-Steagall.

Tags: Banking, Economic Crisis, Finance, Helwege, Politics
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Audit the Fed?

Tuesday, September 1st, 2009

Rep. Ron Paul told The Wall Street Journal that Rep. Barney Frank, chairman of the House Financial Services Committee, backs Paul’s legislation that would give Congress new authority to audit the monetary policy operations of the Federal Reserve.

Smeal’s Jean Helwege argues that the monetary policy work of the Fed should be independent from second-guessing by Congress, however, she says that Fed Chairman Ben Bernanke needs to maintain the Fed’s impartiality and put an end to its picking and choosing winners and losers in the capital markets:

Rep. Ron Paul has been pushing to rein in the Federal Reserve and has proposed a bill to give the General Accounting Office (GAO) powers to audit it. The Fed is already subject to audit by the GAO when it comes to consumer protection laws and banking regulation, but not with regard to monetary policy. This bill would change that situation, although not so dramatically that the Fed would lose its independence (it’s not clear what the penalty is for any agency failing to live up to a GAO audit, but the Fed would surely get away with even more than the typical government group). Recently, Rep. Barney Frank, who surely is as far along the spectrum away from Ron Paul as any politician can get, voiced support for expanding the GAO’s powers to more thoroughly audit the Fed.

The Fed has pumped billions into financially distressed firms in the last year as part of its effort to revive the economy. These actions clearly fall under the category of monetary policy, not banking regulation, even though most of the money went to banks. Because the Fed traditionally sends more than 95 percent of its revenues to the U.S. government (i.e., it is a source of revenue on the U.S. Treasury budget), any money lost on firms like AIG is truly money spent by the U.S. taxpayer. For that reason, Ron Paul would like to see less of it spent in ways that seem wasteful and bad for the economy in the long run. I suspect that Barney Frank is on board with the plan because he wants some reassurance that the money going to AIG is not being paid out in the form of bonuses to the higher-ups there. 

In contrast, Fed Chair Ben Bernanke would argue that, as part of monetary policy, the Fed, through the FOMC, should be allowed to pursue whatever policies are most helpful toward maintaining price stability and economic growth. He undoubtedly would argue that whatever waste and distaste is associated with AIG, the payoff to society is worth the relatively minor cost. Bernanke believes Americans should trust the Fed chairman to do what is best for the U.S. economy, even if some of it seems illogical or annoys those who want to punish the people who got us into this mess.

Bernanke is right to fight for Fed independence on monetary policy. Determining where the economy is at and how best to maintain low price inflation is a difficult job that is not made any easier by having the public or Congress second-guess the decisions that are ultimately made by the Fed. However, Bernanke’s form of monetary policy involves a tremendous amount of policy that essentially picks winners and losers in the capital markets. By choosing to bail out AIG and not bail out Lehman; by choosing to drag its feet with regard to GM and CIT but to propel Bear Stearns at lightning speed into the arms of JP Morgan Chase; and by choosing to slowly offer assistance at the discount window to insurers but to immediately open it up to investment banks are all decisions that most Americans would rather not leave to Ben Bernanke or any other Fed chairman. These decisions seem capricious and poorly justified in terms of monetary policy and this perception is not at all helped by the e-mails regarding the merger of Bank of America and Merrill Lynch. Either the Fed strictly maintains its independence and avoids bailing out specific institutions or it should expect the people ultimately footing the bill to take notice when several hundred billion dollars are showered on what appear to be worthless ventures.

Tags: Banking, Economic Crisis, Economy, Helwege
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Financial Oversight Overhaul

Wednesday, June 17th, 2009

President Obama today unveiled a new financial regulatory structure aimed at preventing future economic meltdowns. Below, Smeal’s Jean Helwege explains the impetus for the new oversight rules and explores the regulatory strengths and weaknesses of the Fed and the FDIC:

A prominent element of President Obama’s plan is to create a systemic risk regulator. The idea is that one agency will be charged with regulating financial entities that pose a risk threat to the economy as a whole. This agency will ensure that firms that fit into the “too big to fail” category will be more prudent and thus taxpayers in the future will not be asked again to pony up billions to bail out reckless financial firms.  

The idea of a systemic risk regulatory really embodies two major reforms: consolidation of depository regulators and creation of a new body to focus on systemic risk. Our current system allows financial firms that offer deposits to choose one of several regulators: The Federal Reserve is the regulator for bank holding companies, such as Citigroup; the Office of the Comptroller of the Currency (OCC) is the regulator for nationally chartered banks;  and the Office of Thrift Supervision (OTS) is the regulator for savings and loans, which surprisingly is the charter chosen by AIG, American Express, and several other behemoths that are not typically thought of as depository institutions.

While AIG is mainly an insurance company and its insurance subsidiaries are regulated by state insurance commissioners, AIG finds it convenient to offer checking accounts to its customers, and therefore has a thrift charter. All of these deposits are insured by the Federal Deposit Insurance Corporation (FDIC), which became the single regulator for deposit insurance in the 1990s for most checking and savings accounts (except those offered by credit unions). If you open a checking or savings account in this country, the firm offering you the account could be operating under the regulatory authority of the Fed, the OCC, the OTS, or it could be an account at a state-chartered bank that has no federal oversight. Moreover, the regulator of your bank is not assigned randomly—firms choose the charter they want, which means they effectively can shop for the regulator they view as most appealing. Frequently, they choose the regulator they believe is the most incompetent and therefore the least likely to exercise any authority. Since its inception in the late 1980s, that regulator has consistently been the OTS. Among the many sweeping changes in the proposed plan of reform is the intent to eliminate the OTS.  If no other part of the plan is passed, this part should be.

(more…)

Tags: Economic Crisis, Finance, Helwege, Politics
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Bank Detox Halted

Thursday, June 4th, 2009

“The Federal Deposit Insurance Corporation indefinitely postponed a central element of the Obama administration’s bank rescue plan on Wednesday, acknowledging that it could not persuade enough banks to sell off their bad assets,” according to The New York Times. The Times reports that the cancellation confirmed many oberservers’ suspicions that the program may not work.

Among those skeptical of the plan at the outset was Smeal’s Jean Helwege, who wrote for Business Casual in March that the plan’s success depended on how well the Obama administration pressured the banks into writedowns.

From Helwege’s March 26 entry:

A critical part of the Treasury plan to remove the toxic assets is participation by the banks.  One has to wonder why these assets, which have been weighing them down for well over a year, have not yet been sold. One potential problem is a lack of liquidity: Few financial institutions have the funds available to buy them. Thus the Treasury has moved to provide financing in its auction. However, another possibility is that banks are reluctant to sell the assets. Bank regulations provide perverse incentives to troubled banks: Even when the banks and the market know the true value of a bad loan, banks resist writing down their assets to avoid having to raise more capital to secure deposits.

As long as few toxic assets are trading, bank regulators cannot easily prove that banks are operating with faulty balance sheets. Suppose a bank makes a $100 loan that subsequently goes bad. If the bank reappraises the loan at $60, it must find an additional $40 in capital to maintain its regulatory net worth. As bad as that sounds, a Treasury-sponsored auction that reveals a value of only $30 would be even worse, as it might indicate insolvency and thus lead regulators to take over the bank. Some banks would rather not participate in any plan to clean up toxic assets if the asset values they record in their books are still far from the true market values.  Instead, they will prefer to wait for recovery, no matter how slow.

Whether the plan works or not depends crucially on banks’ incentives to participate, and this in turn depends crucially on how well bank regulators have succeeded in pressuring banks to write down assets to reflect the true losses. Treasury efforts to entice buyers with subsidies and loan guarantees will help bring them to the auctions, but their profits from buying cheap toxic loans will not materialize if the banks stay away. As infuriating as these subsidies are to American taxpayers, things could be worse if banks refused to cough up the assets on which Wall Street vultures hope to profit.

Tags: Banking, Economic Crisis, Finance, Helwege
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New Derivatives Regulations

Friday, May 15th, 2009

The Obama Administration on Wednesday announced a proposal to regulate the credit derivatives market as part of an effort to avoid another financial crisis.  According to Smeal’s Jean Helwege, “The lynchpin of the plan is the requirement that all credit default swaps (CDS) contracts trade on a regulated exchange so that they involve a reasonable amount of capital and to increase the transparency of the market.”

But, Helwege says, “The plan to require a CDS exchange misses the crux of the crisis, as it does almost nothing to reform the current setup.” She says the country would be better served by focusing reforms in the mortgage market, specifically targeting Fannie Mae and Freddie Mac.

More from Helwege:

The motivation for this reform is the failure of the giant insurance company, A.I.G., which became financially distressed as a result of writing hundreds of billions of CDS contracts (essentially offering insurance on bonds). 

The plan to require a CDS exchange misses the crux of the crisis, as it does almost nothing to reform the current setup.  If the requirement is extremely onerous to Wall Street, the CDS as we know it will cease to exist and the bankers will invent a new contract that evades the regulations but includes the essence of a CDS contract.  If the regulation is not onerous, the CDS will start to trade on the exchange and two changes will occur that President Obama believes are very important. 

First, the trades will be written down in a central place so that regulators can observe the depth of the market and understand the prices involved in these transactions.  While this sounds like a major innovation, regulators can and do buy data on the CDS market from a vendor whose coverage is quite comprehensive. 

Second, the CDS exchange will require that sellers maintain a margin account and put up more cash as the CDS premium increases.  The market already requires that CDS sellers put up more cash as bond default probabilities increase. Indeed, this is the source of AIG’s cash crunch—their trading partners were requiring more and more collateral as the economy collapsed and corporate bond prices declined.  Putting this requirement into writing as part of a CDS exchange would not have made AIG more or less vulnerable to losses surrounding CDS contracts.

(more…)

Tags: Economic Crisis, Finance, Helwege, Politics
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Not Too Big to Fail

Wednesday, April 15th, 2009

Washington regulators have justified several recent interventions in the financial realm by warning that firms like Bear Stearns and AIG are too big to fail (TBTF). However, according to new research by Smeal’s Jean Helwege, the U.S. economy would be better served by letting failing firms file for bankruptcy. She argues that the two most often cited consequences of allowing TBTF firms to fail—domino effects and fire sales—are unlikely to pose major risks to the financial system.

More on Helwege’s research is available here. A draft copy of her complete report is online here.

Tags: Economic Crisis, Economy, Finance, Helwege
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Treasury Detox

Thursday, March 26th, 2009

Treasury Secretary Timothy Geithner this week unveiled the Obama Administration’s plan to “liberate the nation’s banks from a toxic stew of bad home loans,” as The New York Times puts it. Smeal’s Jean Helwege says the plan may be what the financial system needs, but cautions that banks may not automatically play along.

More from Helwege:

The Treasury plan to auction banks’ toxic assets to private investors may be just the catalyst the financial system needs. In the past, when banks have been overburdened with bad loans—for example, in the Latin American debt crisis of the early 1980s, the savings and loan crisis of the late 1980s, or the so-called Lost Decade experienced by Japan in the 1990s—allowing banks to operate under the cloud of bad assets has been destructive to the economy.
 
While it may seem like a shell game to move assets from one part of the financial system to another, removing bad assets from bank balance sheets seems to help. In the Latin American crisis, toxic assets were removed via the Brady Plan, which packaged bad loans as bonds and sold them to investors such as insurance companies and mutual funds. Because these investors had no exposure to the emerging markets and were able to buy the bonds cheaply, they did not suffer any stigma by acquiring the assets and the banks were able to clean up their images. Likewise, the S&Ls’ bad assets were moved into the Resolution Trust Corporation (RTC) and auctioned off to private equity investors. In contrast, the Lost Decade went on as long as it did because Japan did not remove the bad assets from their banks, with the result being that they operated as “zombie” banks for years. 

A critical part of the Treasury plan to remove the toxic assets is participation by the banks.  One has to wonder why these assets, which have been weighing them down for well over a year, have not yet been sold. One potential problem is a lack of liquidity: Few financial institutions have the funds available to buy them. Thus the Treasury has moved to provide financing in its auction. However, another possibility is that banks are reluctant to sell the assets. Bank regulations provide perverse incentives to troubled banks: Even when the banks and the market know the true value of a bad loan, banks resist writing down their assets to avoid having to raise more capital to secure deposits.

As long as few toxic assets are trading, bank regulators cannot easily prove that banks are operating with faulty balance sheets. Suppose a bank makes a $100 loan that subsequently goes bad. If the bank reappraises the loan at $60, it must find an additional $40 in capital to maintain its regulatory net worth. As bad as that sounds, a Treasury-sponsored auction that reveals a value of only $30 would be even worse, as it might indicate insolvency and thus lead regulators to take over the bank. Some banks would rather not participate in any plan to clean up toxic assets if the asset values they record in their books are still far from the true market values.  Instead, they will prefer to wait for recovery, no matter how slow. 

Whether the plan works or not depends crucially on banks’ incentives to participate, and this in turn depends crucially on how well bank regulators have succeeded in pressuring banks to write down assets to reflect the true losses. Treasury efforts to entice buyers with subsidies and loan guarantees will help bring them to the auctions, but their profits from buying cheap toxic loans will not materialize if the banks stay away. As infuriating as these subsidies are to American taxpayers, things could be worse if banks refused to cough up the assets on which Wall Street vultures hope to profit.

Tags: Banking, Economic Crisis, Finance, Helwege
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Smeal on the Radio

Tuesday, March 24th, 2009

Smeal’s Jean Helwege is scheduled to be on WRTA-AM in Altoona, Pa., around 3 p.m. EDT on Wednesday. She will be discussing the financial crisis and the Obama Administration’s plan to buy up toxic mortgage assets.

Listen live online here.

Tags: Helwege, Media
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