My modestly-informed guess is that Hurricane Maria and Puerto Rico will appear in history textbooks right next to Katrina and New Orleans. Puerto Rico’s unique territorial status and institutional constraints make the federal government’s response very difficult. And as I shall suggest in a subsequent post, the hurricane has greatly exacerbated Puerto Rico’s profound debt burden and development challenges. Yet one has to wonder why we are fanning the flames.
There is an opportunity for 1 or 2 Republican Senators to be 21st century Profiles in Courage. A Senator who stands up to his or her party and casts the decisive vote against the Cassidy Graham health legislation will be seen by history as a hero.
Cassidy Graham is the cruelest and most misguided piece of consequential legislation proposed so far in the 21st century. It is far worse than the “repeal and replace” bills that Congress has so far voted down. Cassidy Graham is much more dangerous than previous bills both because it goes further in eliminating critical parts of the ACA and because it savages the pre-ACA Medicaid safety net.
Speaking at an event organized by Robert Greenstein, the President of the Center for Budget and Policy Priorities, I argued last week that unless our values have changed profoundly in an antigovernment direction, the balance of pressures from economic change will lead to an expansion of the federal budget relative to GDP. This was also the conclusion of a paper released by Paul Van de Water of the Center. Excellent summaries were provided by Al Hunt and David Leonhardt.
Stan Fischer announced yesterday that he is leaving his position as Vice Chair of the Fed. The Fed and the international monetary system will be weaker for his departure from official responsibility. It is the end of an era.
Stan’s has been a singular career. As an MIT professor he coauthored, with his close friend Rudi Dornbusch, the macro textbook that defined the basics of the field for a generation. With Olivier Blanchard, he wrote the treatise that defined the state of the art for graduate students. His lectures were models of lucid exposition and balanced judgement. My view of monetary economics was shaped by my experience auditing his class in the Fall of 1978. Legions of central banking greats, starting with Ben Bernanke and Mario Draghi, were not just his students but his disciples. continue
Given recent controversies, I was interested to read NEC chair Gary Cohn’s answer to a “why are you staying?” question put by Stuart Varney of Fox Business Network last week. To his credit Cohn did not back away from his reservations about the President’s response to Charlottesville. He said “Look, tax cuts are really important to me. I think it’s a once-in-a-lifetime opportunity. We haven’t done tax cuts in 31 years. So, to be a part of an Administration that gets something done that hasn’t been done for 31 years is enormously challenging, enormously interesting to me.”
The problem with this statement is how utterly wrong it is. Taxes were not cut 31 years ago. A central point of the 1986 Tax Reform Act was that it was revenue neutral. And since that time, taxes were cut in 1997, 2001, 2003, 2009 and 2015. continue
I will not be attending Jackson Hole this year but I will be thinking about some of the issues under discussion. As I have written recently, I think the period going forward will be more challenging for central banks than the preceding few years. I will sleep best at night if Janet Yellen is reappointed.
Even though the Fed has raised rates more than I would have preferred and done far more signaling of future rate hikes than has seemed reasonable to me or for that matter to markets, it could have been much worse. I do not see a case for a further rate increase on current facts and remain very concerned that macroeconomic policy has inadequately internalized all the aspects of large declines in the neutral real rate and secular stagnation risks. continue
President Trump, recognizing the inevitable, has disbanded his Business Advisory Councils in order to preempt the tidal wave of resignations that was in the offing. Given my long standing views about CEOs lending legitimacy to the Trump administration, I was delighted that a group of CEOs forced this step.
It is a stunning development with more to come. Who could have imagined that the CEO world would be actively stepping away from a Republican President whose economic program is centered on business tax cuts and regulatory relief? Or that an incoming President could take his popularity down to 34 percent within 7 months. Considering polling data, legislative relations and connections or lack thereof to elites, I think it is safe to say that President Trump is more bereft of support than any President since Nixon in the months before his resignation. continue
I have since Inauguration Day been troubled by abdication of moral responsibility on the part of business who have lent their reputations to President Trump. So congratulations to Merck CEO Ken Frazier on his resignation from Trump’s American Manufacturing Council over the President’s manifestly inadequate response to Charlottesville. Interestingly, the President lashed out by tweet at Frazier, who is African American, for resigning. He did not lash out at Disney CEO Robert Iger or Tesla CEO Elon Musk, who are white, when they resigned from his Strategic and Policy Forum because of the President’s decision to pull out of the Paris climate accord.
Andrew Ross Sorkin gets it absolutely right when he asks why there have not been more resignations from Trump’s various Advisory Councils. As I’ve discussed before, the President has again and again traduced American values of international cooperation, of integrity in government, and of human decency. No advisor committed to the bipartisan American traditions of government can possibly believe he or she is being effective at this point. And all should feel ashamed for complicity in Trump’s words and deeds. I sometimes wonder how they face their children. continue
President Trump’s Poland speech articulating his foreign policy principles has generated much comment and would have generated more but for all the Russia scandal news. It’s an important window into the President’s gestalt as he views the world. As I wrote recently, I don’t care for the “West against the Rest” as a paradigm US foreign policy because it risks becoming a self-fulfilling prophecy, a point Martin Wolf makes powerfully in his column today.
Certainly, there is an argument for the President’s invocation of Western Civilization. Unlike many of my friends and colleagues in American universities, I sympathize with the concern that contemporary educational norms pass too lightly over the accomplishments of America and the West in favor of a fashionable multiculturalism. Indeed I have joked after reading multiple issues of its flagship journal that the American Studies Association should be renamed the anti-American Studies Association since it sees America largely through its sins towards minority groups.
In the run-up to the ongoing G20 meeting in Hamburg, I was interviewed by the G20 Research Group about its significance. I argued that the only really important issue was whether the United States would at last be induced to signal a commitment to the idea of a global community or would it double down on atavism.
As I write Saturday morning (US time), things seem to be running below my already low expectations. On the philosophical and policy questions regarding United States’ willingness to continue supporting a rules based international system, there is no progress to observe.
While I do not believe the Fed made a serious mistake Wednesday in raising rates, I believe that the “preemption of inflation based on the Phillips curve” paradigm within which it is operating is highly problematic. Much better would be a “shoot only when you see the whites of the eyes of inflation” paradigm of the kind I have advocated for the past several years.
Such a paradigm would be more credible, more likely to result in the Fed’s satisfying its dual mandate, reduce risks of recession, and increase the economy’s resilience when recession comes. continue
We tend in modern economies to take progress for granted and debate only its pace. This is not true with respect to air travel times. A look at airline time tables reveals that today the 8:26 a.m. flight from Boston to Washington National took 103 minutes. The 8:15 a.m. flight in 1982 took 82 minutes. The difference is similar, if not greater, on other routes. For example, flights from Boston to Charlotte typically took 125 minutes in the early 1980s compared to 160+ today.
At the risk of beating a dead horse, here are some thoughts on the Trump administration’s 3 percent growth forecast. Zero interest rates seemed inconceivable 15 years ago, and yet they happened. Almost no one forecast the productivity boom that took place in the United States between 1995 and 2005 or the magnitude of the 2008 financial crisis. So any statement that a given forecast is inconceivable is unwarranted.
It is, though, reasonable to use history to try to gauge the likelihood of possible outcomes. I do not see how any examination of U.S. history could possibly support the Trump forecast as a reasonable expectation.
The events of the last week have crowded out reflection on economic policy. But things have been happening. Commerce Secretary Wilbur Ross described the trade deal reached with China earlier this month as “pretty much a herculean accomplishment….This is more than has been done in the history of U.S.-China relations on trade.”
Past a certain point, exaggeration and hype become dishonesty and deception. In economic policy, as in almost everything else, the Trump Administration is way past that point.
The trade deal is a “nothing burger” that a serious Administration committed to helping American workers would likely not have accepted, and surely would not have hyped.
Details of President Trump’s first budget have now been released. Much can and will be said about the dire social consequences about what is in it and the ludicrously optimistic economic assumptions it embodies. My observation is that there appears to be a logical error of the kind that would justify failing a student in an introductory economics course.
Apparently, the budget forecasts that US growth will rise to 3.0 percent because of the Administration’s policies—largely its tax cuts and perhaps also its regulatory policies. Fair enough if you believe in tooth-fairies and ludicrous supply-side economics.
Then the Administration asserts that it will propose revenue neutral tax cuts with the revenue neutrality coming in part because the tax cuts stimulate growth! This is an elementary double count. You can’t use the growth benefits of tax cuts once to justify an optimistic baseline and then again to claim that the tax cuts do not cost revenue. At least you cannot do so in a world of logic.
The Trump team prides itself on its business background. This error is akin to buying a company assuming that you can make investments that will raise profits, but then, in calculating the increased profits, counting the higher revenues while failing to account for the fact that the investments would actually cost some money to make. The revenue generated by the investments might exceed their cost (though the same is almost never true of tax cuts), but that doesn’t change the fact that the investment has a cost that must be included in the accounting.
This is a mistake no serious business person would make. It appears to be the most egregious accounting error in a Presidential budget in the nearly 40 years I have been tracking them.
Who knew what when? I have no doubt that there are civil servants in OMB, Treasury and CEA who do know better than this mistake. Were they cowed, ignored or shut out? How could the Secretary of Treasury, Director of OMB and Director of the NEC allow such an elementary error? I hope the press will ferret all this out.
The President’s personal failings are now not just center stage but whole stage. They should not blind us to the manifest failures of his economic team. Whether it is Secretary Mnuchin’s absurd claims about tax cuts not favoring the rich, Secretary Ross’s claim that the small squib of a deal negotiated last week with China was the greatest trade result with China in history, NEC Director Cohn’s ludicrous estimate of the costs of Dodd Frank, or today’s budget, the Trump administration has not yet made a significant economic pronouncement that meets a minimal standard of competence and honesty.
Several weeks ago I gave a talk based on my Brookings paper with Natasha Sarin at the Atlanta Fed’s annual research conference. Here are the video and slides. I continue to be puzzled by gap between what is widely believed and my reading of market evidence.
I began by highlighting three facts that seem to me to be in substantial tension with the widespread view that banks are far safer now than they used to be because they are far better capitalized. Mark Carney’s statement that “The capital requirements of our largest banks are now ten times higher than before the crisis. . . . This substantial capital and huge liquidity give banks the flexibility they need to continue to lend…even during challenging times” is typical.
First, there is distressingly little evidence in favor of the proposition that banks that are measured as better capitalized by their regulators are less likely to fail than other banks. Andrew Haldane suggests the absence of a relationship looking across banks before the 2008 crisis. Òscar Jordà and coauthors suggest the absence of such a relationship historically, using data for many countries. Jeremy Bulow and Paul Klemperer note that for banks whose crisis failure resulted in FDIC losses, the FDIC typically had to inject an amount in excess of 15 percent of their assets, suggesting that they in fact had substantial negative capital positions.
Second, financial logic embodied in the celebrated Modigliani Miller theorem and suggested by common sense holds that substantial reductions in leverage, if achieved, should be associated with reduced volatility, reduced sensitivity to shocks and lower risk premiums. Our paper examines a comprehensive suite of volatility measures including actual volatility, volatility implied by option pricing, beta, credit default spreads, preferred stock yields and earnings price ratios. While each indicator has associated ambiguities, it is striking that none suggest a major reduction in leverage for the largest US financial institutions, large global institutions or midsize domestic institutions.
Third, the ratio of the market value of bank’s common equity to its risk weighted assets provides a market based measure of its leverage. Of course, the market value of equity overstates true capital because of limited liability: if assets rise in value there is no limit to how much shareholders can ultimately receive; but there is a zero lower bound on what shareholders receive. Still, as Haldane and others have documented, this market measure has historically proven useful in predicting bank distress. The data suggest that on a market value of equity basis, major financial institutions are no less levered than they were over the period before the crisis—even excluding the couple of years before the crisis when there was plausibly a bubble element in market pricing.
I am more confident that these observations need to be reckoned with in thinking about financial stability than I am in any particular set of explanations much less policy conclusions. Here though are some observations suggested by our findings.
First, it is essential to take a dynamic view of capital. The health of a financial institution depends critically on the profits it can expect to generate in the future. I suspect that the decline in the ratio of the market value of bank equity to assets reflects declines in expected future profits, and that this declining franchise value, other things equal, causes banks to be more levered.
The stress tests introduced by the regulatory community represent a welcome recognition of the need to take a dynamic view of capital. However I am inclined to agree with Jeremy Bulow who noted in commenting on the our paper that recent stress tests estimate that if GDP drops 6.25 percent, unemployment doubles, the stock market halves, and real estate falls by 25 to 30 percent, then capital losses would be insufficient to trigger “prompt corrective action.” Bulow wonders—and we do as well—if this is not more of a comment on the inadequacies of the stress test procedures, than on the soundness of the banks.
Second, a crucial challenge for financial regulation going forward is assuring prompt responses to deteriorating conditions that do not set off vicious cycles. Markets were sending clear signals of major problems in the financial sector well in advance of the events of the fall of 2008 but the regulatory community did not even limit bank dividend payouts, even after the experience at Bear Stearns, which had been deemed very well capitalized even as it was failing. Current experiences in Europe where some institutions have a price-to-book ratio of barely 0.35 and have not yet been forced to raise capital are not encouraging about lessons learned.
Third, regulators need to be attentive to franchise value. It goes without saying that banks should not be permitted to take excessive risks or treat customers unfairly in order to raise their franchise value. Nor would it be wise public policy to undermine competition in banking in order to raise franchise values. On the other hand, it is not just an issue of cost, but financial stability as well when regulators impose needless burdens on banks. This point was brought home to me not long ago when I heard about the legal contortions one big bank felt it had to go through when I recommended a student for a job. Would hiring the student be doing me an impermissible favor? Would not hiring the student be unfair? The debates surrounding my well-intentioned suggestion consumed hours of time on behalf of the bank’s compliance team. And I am sure such abundance of caution is commonplace at most large financial institutions. On a random Tuesday, there are hundreds of federal government employees going to work at each of our major banks, some of which have more than 10,000 people engaged in compliance activity.
Regulatory costs are an especially large issue for smaller banks since there are almost certainly economies of scale in compliance functions. There is also the crucial point that incomplete regulation which discriminates against banks in favor shadow banks may by undermine financial stability in two ways. First, shadow banks may become loci of instability. Second, weakening the franchise value of regulated institutions may make their insolvency more likely.
Fourth, bankers may be more right in their concerns about increased costs of capital and its effect on lending than economists usually suggest. Economists like Anat Admati normally rely on Modigliani-Miller considerations to argue that enhanced regulation does not raise capital costs, because it makes equity safer. If as our results suggest equity is not safer, there is every reason to suppose that bank capital costs have increased as a consequence of regulation, and that this may to some extent have reduced credit flows.
Fifth, it is high time we move beyond a sterile debate between more and less regulation. No one who is reasonable can doubt that inadequate regulation contributed to what happened in 2008 or suppose that market discipline is sufficient to contain excessive risk-taking in the financial industry. At the same time, not all regulatory expansions are desirable and in some contexts tougher regulation can be counterproductive for financial stability if it reduces profitability without offsetting benefit, if interferes with bank diversification, or if it causes regulators to become overly identified within regulated institutions. Neither the approach that holds that all increases in measured capital and other regulation are attractive, nor the one that holds that capital and other regulations should be completely scaled back is likely to prevent or contain the next financial crisis.
Last week I suggested that I felt sorry for Treasury Secretary Steven Mnuchin. He found himself forced by circumstance and his president to say and do things that undermined his and Treasury’s credibility.
I wish there was an external force that could be blamed for the secretary’s comments on Monday, but they look from the outside like unforced errors.
At Michael Milken’s annual conference for investment professionals, he crowed to the bankers present that “you should all thank me for your bank stocks doing better.” I cannot conceive of any of the 11 other secretaries I have known making such a statement. Leave aside the question of whether whatever credit is to be claimed should be claimed on behalf of the president. Since when is the stock price of banks the objective or the standard of success for economic policy? And when, as will inevitably occur, bank stock prices decline, will the secretary accept the blame?
It was quite a day.
The secretary also doubled down on his surprising statements of last week by predicting that within years the economy will be regularly growing at above 3 percent. This is not the view of mainstream forecasters, and in light of the very slow growth in the adult population, and reduced immigration along with low unemployment, it would require a productivity growth miracle. He cited no evidence in favor of his views.
The secretary claimed that President Trump’s tax cuts will be the largest in history. Relative to any relevant denominator, like total tax collections or GDP, President Ronald Reagan’s were far larger.
Usually treasury secretaries try to stay out of the president’s personal politics. Yet Mnuchin has made the claim that the president has given more financial disclosure than anybody else. This is ludicrous. Hundreds of officials from presidents on down have made their tax returns available to members of Congress as part of the confirmation process. And for 40 years all presidents have released their tax returns. President Trump has been not the most but the least transparent president in the last 50 years.
There will likely come a time when the secretary of the treasury will need to invoke his credibility to support confidence in the economy, to stabilize markets, or to mitigate an international crisis. Let’s hope that when the moment comes Mnuchin will retain some credibility. This will require an end to days like yesterday.
I had a keynote conversation last week with my friend Markus Brunnermeier on fintech and the future of finance at a conference he held at Princeton. Markus got me to think about a number of different aspects of fintech that I hadn’t fully considered before. Some of the main points I tried to make were:
- Fintech is ultimately about taking away frictions. I gave as examples of frictions that are kind of shocking in the 21st century the huge premiums people pay for title insurance every time they refinance a mortgage, the inability of major banks to enable even major private bank customers to automatically pay down their credit line whenever they have cash inflows, and the $40 billion-plus in credit and debit card interchange each year.
- I guessed that 10 years from now, the odds that there would be a fintech company with the kind of $250 billion market cap that some big American banks have was about 25 percent. I did not expect that in the foreseeable future fintech would have the kind of existential impact on banks that Netflix has had on Blockbuster. I do think in some areas fintech companies are likely to have the kind of impact that Skype has had on major telephone companies — forcing drastic reductions in pricing and profit margins on some key products.
- I surprised Markus a bit by being skeptical of the idea that one of the big technology players like Apple, Google, Facebook and Amazon would become big players in financial services. I noted the traditional American aversion to combinations of banking and commerce and also noted that I thought privacy rules would preclude their using their massive data troves to drive lending activity.
- I was quite serene about the impact of fintech on financial stability. In general it seems to me that prevailing understandings of financial crises put too much emphasis on financial innovation and too little on age-old rapid oscillation between greed and fear, on real estate lending and real estate bubbles, on excessive leverage especially related to implicit government guarantees, and on illiquidity phenomena.
- Fintech, by providing for faster settlements, more transparency and diversification, is likely to have as many stabilizing as destabilizing effects.
If the large banks of today are not as large five or 10 years from now, I think it is more likely to be because of bad lending, heavy regulation or market pressures to break up because the whole is valued less than the sum of the parts than it will be because of disruption from fintech. I say this because much of what fintech does depends on the banking system and because I doubt that over this horizon banks can be completely disrupted.
- I argued that financial regulation should be directed at functions and at institutions not at particular financial instruments noting that most instruments could be synthesized in multiple ways and suggesting that all might have similar impacts.
The video of our full conversation can be watched here.
My overall conclusion was that fintech is likely to make a substantial contribution by removing frictions. Policymakers should be slow to accede to demands from incumbents for heavy regulation of new fintech entrants. At the same time, they should assure that when fintech companies succeed, it is on the basis of genuine efficiencies and not because of regulatory avoidance.
President Trump’s tax proposals were rolled out yesterday by Treasury Secretary Mnuchin and NEC Director Cohn. For reasons of long run budget health, fairness, and economic impact I think they are extraordinarily ill-advised. I am certain that the substantive concerns I have will be extensively addressed in the debates to come.
As I read about the proposals and thought back over the tax discussions of the last year, I found myself feeling sympathetic to Secretary Mnuchin. Some of the most difficult moments for any cabinet officer comes when the President fails to respect his Department’s desire to do serious policy work, when political circumstance forces the repudiation of his major past statements, and when he has to out of loyalty support absurd propositions. All three of these things happened to Secretary Mnuchin this week.
By all accounts the Treasury was on a path working with other agencies to come forth by June with a set of tax reform proposals. Treasury officials were shocked when the President, speaking in the Treasury building, announced last Friday that the Administration would unveil its tax plan today. There was no time for specification of a proposal, let alone consultation on its merits, estimates of its revenue impact, or evaluations of its economic impact. Instead the Treasury Secretary was asked to lend his prestige and that of his Department to a one page document that would have been judged skimpy on detail if it were a campaign proposal. I can only imagine how demoralized the Treasury tax staff-a group that rightly prides itself on its professionalism and analytic seriousness – must be.
Mnuchin has stated on multiple occasions that the Administration’s tax proposals would not favor the rich. Whatever its other virtues, distributional neutrality is not a feature of the plan announced yesterday. Indeed, between massive corporate rate cutting, big tax cuts for the highest income individual taxpayers, elimination of the estate tax, and other incentives it is a certainty that the vast majority of the benefits of the plan will go to a very small fraction of tax payers.
Secretary Mnuchin also stated last week, in what appeared to be a scripted interview, that tax cuts would be so good for growth that they would come very close to paying for themselves. This of course is the famous Laffer curve idea. In the context of an economy with 4.5 percent unemployment, it is absurd. Ronald Reagan asserted that tax cuts could pay for themselves during his campaign but his Treasury Department was far too serious to ever make such a statement. His Administration recognized that large tax cuts would raise deficits unless offset by spending cuts. So did the George W. Bush Administration. So have House and Senate Republicans. So has every reputable economist who has addressed the subject in the last several decades.
The Treasury Secretary’s credibility is an important national asset that could be needed at any moment. I am very sorry to see it squandered on behalf of a set of tax reform proposals that are at best a bargaining position.