Tuesday, 2 September 2014

New bank rules make short selling more difficult - shock horror.

Front page story in today’s Financial Times is that banks are complaining that new funding rules for banks proposed by the Basel Committee on Banking Supervision will make it more expensive for banks to engage in short selling and similar dodgy practices.

Well boo hoo. I’m devastated.

The basic and socially useful purpose of banks is to supply people with mortgages and lend to business. If the new rules make short selling more difficult, I don’t give a monkey’s whatsit. I don’t give a toss. Let me put that in plainer English: I don’t give a f*ck.

Monday, 1 September 2014

John Cochrane advocates full reserve banking, sort of.

John Cochrane (economics prof in Chicago) more or less advocates full reserve banking (FR). In line with Milton Friedman, James Tobin, Laurence Kotlikoff and other advocates of FR he advocates that institutions that advertise their deposit accepting facilities as being totally safe should invest depositors’ money only in base money or short term government debt.
As to entities / banks which lend to mortgagors, businesses etc Cochrane suggests a 30% capital ratio rather than the 100% ratio favoured by Friedman, Tobin etc. Certainly the REALLY BIG improvement in bank safety comes from upping the ratio from the ridiculous pre-crisis 3% to 30%, while relatively little improvement is gained from taking that right up to 100%. However there are some good arguments for the 100% ratio, which are briefly as follows.
1. The 100% ratio costs nothing because of Modigliani Miller.
2. As long as there is ANY SORT of bank subsidy or guarantee offered by government (deposit insurance, lender of last resort at favourable rates of interest, etc) then private banks are being subsidised, and subsidies misallocate resources and reduce GDP.
Now what sort of capital ratio would induce governments to make it clear that NO SORT OF backing for commercial banks is available? 30%? 50%?
Say it’s 50%. But there’s a catch: in that scenario if anything DID GO seriously wrong with a bank, then depositors and bondholders might be in for a hair cut. That is, they’d be shareholders of a sort. So why not just cut all the shilly-shally and make it 100%?
3. 100% is a nice simple number: it’s a clear line in the sand. Anything less than 100%, and you can bet that over the years bankster-liars will bribe and cajole politicians and regulators into cutting the percentage down to 3% or so. Roll on the next crisis.

MMT for beginners.

At least this is my version of MMT. Hopefully other MMTers will agree.
1. Private sector spending varies with the stock of what MMTers call “Private Sector Net Financial Assets” (PSNFA): that’s the stock of base money plus national debt.
I.e. in plain English, the more money (or near money, which is what government debt is) that people hold, the more they tend to spend.
2. If aggregate spending, i.e. aggregate demand is inadequate, the state should spend more (and/or cut taxes). I.e. the state should “net spend”. The state can do that (as pointed out by Keynes) either by spending borrowed money or by spending freshly created money.
4. Borrowing money when you can print the stuff is pointless. Only a lunatic would do that. Ergo the government should simply print money and spend it (and/or cut taxes) when AD is insufficient. Certainly Warren Mosler (leading MMTer)  advocated that government should borrow nothing, as did Milton Friedman in a 1948 paper. Personally I agree with them.
5. Most so called “professional” economists are lunatics.
6. The reason Keynes emphasised borrowing rather than printing money so as to fund government spending was that he was a clever man who was surrounded by people who, relatively speaking, were Neanderthals. That’s “Neanderthal” as in “go ballistic whenever the words “print” and “money” appear in the same sentence”.
7. Where the state creates new money and spends it, the effect comes via two channels. First, the fact of spending (e.g. on roads, education or whatever) employs more people (on repairing / building roads, in schools, etc). Second, the increased stock of base money / PSNFA in private hands increases private sector spending.
8. If the state funds the extra spending via borrowing, the net effect per dollar spent is significantly reduced, which is an additional reason for thinking that borrowing money when you can print the stuff is a sign of lunacy.
9. If the state prints and spends too much, the private sector will end up with an excess stock of base money, and excess AD and excess inflation will ensue. The best cure for that is to cut down on the amount of money printing, or even reverse it: e.g. raise taxes and "unprint" the money collected. But an additional possible tool is for the state to borrow back some of that money.  Borrowing (to repeat) is pointless. Though in emergencies, that borrowing is probably justified so as to damp down AD. However, the long term aim should be zero government borrowing.
10. One of the many defects in the latter borrowing is that the interest is funded by ordinary taxpayers and ends up in the pockets of those with an excess stock of money, the rich. And that’s a third reason for thinking that government borrowing is lunacy (except as stated above as an emergency measure for damping down AD).
11. A state which issues its own money (e.g. the US, Japan, UK, etc) can pay any rate of interest it likes on its debt. If the existing rate is a bit on the high side, all such a state has to do is print money and buy back the debt (or cease rolling it over). That equals QE. As to any excess stimulatory or inflationary effect that has, that can be negated by increased taxes or reduced government spending. However, the NET EFFECT on AD is zero (assuming the latter “negating” effect exactly equals the stimulatory effect). Thus there needn’t be any effect on numbers employed or GDP from the latter “interest reducing” exercise (at least in the case of a closed economy).
In the case of an OPEN economy, i.e. where some government debt is in the hands of foreigners, the latter debt reduction exercise will obviously result in funds being withdrawn from the country in question, which will reduce the value of its currency on forex markets, which will hit living standards in the country in question.
12. The above is all way beyond the comprehension of most so called “professional” economists, but it should be within the grasp of the average intelligent fifteen year old. Certainly there isn't a cat in Hell’s chance of Rogoff or Reinhart ever understanding the above.
13. Forget all about “monetary policy”, “fiscal policy”, “fiscal consolidation” etc. That’s all boll*cks.
14. David Hume spelled out the REAL REASON for government borrowing over 200 years go: as he pointed out, borrowing enables incumbent politicians to ingratiate themselves with voters. That is (as pointed out above) cutting government debt in an open economy involves a finite but temporary standard of living hit.  Conversely, increased borrowing temporarily increases living standards, and thus the number of votes that incumbent politicians get.

Saturday, 30 August 2014

Regulatory revenge.

Gillian Tett devoted an entire article in the Financial Times on Friday to making the point that the $100bn of fines imposed on banks in the US recently is largely fatuous because it fails to punish those responsible. Second, the ACTUAL PEOPLE punished, i.e. shareholders are not guilty. And third, much the biggest effect will be to raise the return demanded in future by bank shareholders. After all, if you’re going to have to pay billions in fines for the crimes of others, you’ll want a reward for doing so.
That point of Gillian Tett’s is hardly original. Sundry economics bloggers have already made that point. E.g. me here.
However, I do like the phrase “regulatory revenge”.

Wednesday, 27 August 2014

Modigliani & Miller are right on bank capital.

I argued yesterday that the cost of raising bank capital requirements to 25% or even 100% was zero, because that’s what the Modigliani Miller (MM) theory says. I also pointed out that criticisms of MM are feeble.
After a bit of Googling and rummaging around, I now find that the criticisms are even more feeble that I thought. Details as follows.
Lev Ratnovski in a Voxeu paper entitled “How much capital should banks have” suggests just two possible weaknesses in MM. One, (para starting “There are two ways…) is that if you ASSUME the return on bank capital is 15% and the return on bank debt is 5%, then the more capital there is, the higher the cost of funding the bank. Well of course, but it’s PRECISELY the latter sort of 15%/5% assumption that MM proved to be a nonsense. Ratnovski’s point there is a bit like saying “assuming the Earth is flat we wouldn’t be able to have weather satellites”.
The second possible weakness in MM that Ratnovski cites is the taxation point I referred to yesterday, and which, as I explained yesterday, is nonsense. Plus Ratnovski cites another paper on MM (by Anil Kashyap and others). But that paper ALSO has no criticism of MM other than the latter flawed tax point (see p.4 in particular).
MM passes the test with flying colours.
The conclusion is that while the PROCESS of raising bank capital may involve temporary or transient costs, a permanent and higher capital ratio (25%, 50% or even 100%) is costless.
Or to be more exact, it brings net benefits in that bank subsidies and state support for banks is removed.

Tuesday, 26 August 2014

An answer to Martin Wolf’s question.

He wrote an article in the Financial Times some time ago entitled “Seven Ways to Clean up our Banking Cess-pit”. See here or here. He advocated a HUGE increase in bank capital ratios: up from the present 3-6% to about 25%: quite right.
However, he argued AGAINST raising that still further to 100%, which would amount to full reserve banking. And his reason was:
“I accept that leverage of 33 to one, as now officially proposed is frighteningly high. But I cannot see why the right answer should be no leverage at all. An intermediary that can never fail is surely also far too safe.”
The answer to that is: “it all depends on the cost of attaining total and complete safety”. If the costs are zero, then total and complete safety makes sense.
And in the case of banks, the costs of total and complete safety ARE ZERO, and for reasons spelled out by Messers Modigliani and Miller. As M&M correctly pointed out, the costs of funding a given bank which engages in a given set of activities and hence takes given risks is a GIVEN. Thus the charge made by those covering the risk is a given. Thus if the charge is spread over a larger number of “risk carriers” i.e. shareholders rather than a smaller number, there’ll be no change in the TOTAL CHARGE made for covering the risk. Thus moving from 25% to 100% involves no costs.
The M&M theory HAS BEEN criticised, but I’m not impressed by the criticisms. About the most popular criticism seems to be that the tax treatment of bank capital and bank debt is different, thus, so the argument goes, M&M does not work out in the real world in the same way as it does in theory. For example that is the first criticism listed in a paper by three Bank of England authors entitled “Optimal Bank Capital” (p.9).
However, that “tax” criticism is feeble. Reason is that tax is an entirely ARTIFICIAL imposition. Thus for the purposes of gauging REAL costs and benefits, tax should be ignored.
The second criticism of M&M in the latter paper is that the charge made for deposit insurance may not reflect the risk.  Well the answer to that is much the same as the answer to the above “tax” criticism: for the purposes of gauging REAL costs and benefits, any “incorrect” or artificial charges should be ignored. That is, in such cost / benefit calculations or arguments, correct or accurate charges should be assumed, even if those are not the charges that obtain in the real world.
Game set and match to M&M.