Monthly Archives: June 2014
“Given the clear trajectory of U.S. (monetary) policy, the turmoil in emerging-market currency and bond markets over the past year should spur more effective collective action to defend the global financial system against future Fed-induced whiplash…
…The U.S. dollar plays a unique role in the global economy. Although the United States accounts for only 23 percent of global economic output, most of the world’s trade outside the eurozone and 60 percent of foreign exchange reserves are denominated in U.S. dollars. Particularly for developing countries, economic interaction with the rest of the world takes place overwhelmingly in U.S. dollars. Changes in U.S. monetary policy can therefore have immediate and significant global effects, expanding or constricting the flow of capital into and out of developing nations and whipsawing the value of their currencies against the dollar, which can in turn dramatically alter local inflation rates and export volumes. As a result, for many such countries monetary sovereignty is nothing more than an unattainable ideal.”, Ben Steil, “Taper Trouble: The International Consequences of Fed Policy”, Foreign Affairs, July/August 2014
The International Consequences of Fed Policy
BENN STEIL is a Senior Fellow and Director of International Economics at the Council on Foreign Relations. He is the author, most recently, of The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order .
In April 2013, Ukraine was sporting a massive current account deficit of eight percent, and it badly needed dollars to pay for vital imports. Yet on April 10, President Viktor Yanukovych’s government rejected terms set by the International Monetary Fund (IMF) for a $15 billion financial assistance package, choosing instead to continue financing the gap between its domestic production and its much higher consumption by borrowing dollars privately from abroad. So a week later, Kiev issued a ten-year, $1.25 billion eurobond, which cash-flush foreign investors gobbled up at a 7.5 percent yield.
Everything seemed to be going swimmingly, until May 22, when the U.S. Federal Reserve’s then chair, Ben Bernanke, suggested that the Fed might, if the U.S. economy continued improving, soon begin to pare back, or “taper,” its monthly purchases of U.S. Treasury and mortgage-backed securities. The Fed had begun the purchases the previous September in order to push down long-term interest rates and encourage private lending; their end would mean higher yields on longer-maturity U.S. bonds, making developing markets decidedly less attractive. Investors in Ukrainian bonds therefore reacted savagely to the taper talk, dumping them and sending their yields soaring to near 11 percent, a level at which they would remain for most of the rest of the year.
Ukraine’s financial problems had been mounting over many years, but it was the mere prospect of the Fed pumping fewer new dollars into the market each month that pushed the cost of rolling over its debt — that is, paying off old obligations with new bonds — beyond Kiev’s capacity to pay. Had the Fed stayed dovish, Ukraine could have at least delayed its financial crisis, and a crisis delayed can be a crisis averted. Yanukovych ultimately turned for help to Moscow, which successfully demanded that he abandon an association agreement with the European Union in return. Ukrainians took to the streets — and the rest is history.
But that history has, until now, overlooked the role that the Fed’s taper talk played in the toppling of Yanukovych and the chaos that followed. And this insight becomes even more worrisome when you consider that Ukraine is but one of a great many fragile, dollar-dependent countries with markets that can be sent spinning wildly at the mere suggestion of a change in Fed policy.
DOLLAR FOR DOLLAR
The U.S. dollar plays a unique role in the global economy. Although the United States accounts for only 23 percent of global economic output, most of the world’s trade outside the eurozone and 60 percent of foreign exchange reserves are denominated in U.S. dollars. Particularly for developing countries, economic interaction with the rest of the world takes place overwhelmingly in U.S. dollars. Changes in U.S. monetary policy can therefore have immediate and significant global effects, expanding or constricting the flow of capital into and out of developing nations and whipsawing the value of their currencies against the dollar, which can in turn dramatically alter local inflation rates and export volumes. As a result, for many such countries monetary sovereignty is nothing more than an unattainable ideal. Recognizing this, a few of them, such as Ecuador and El Salvador, have in recent decades gone so far as to eliminate their national currencies entirely, adopting the U.S. dollar for use at home as well as abroad.
Ukraine was, following Bernanke’s taper talk last May, only one of many developing nations suffering massive selloffs in their bond and currency markets, as investors sought to repatriate funds for safer investments in the United States. The selling was not indiscriminate, however. The countries hit hardest — Brazil, India, Indonesia, South Africa, and Turkey — had all been running large current account deficits, which needed to be financed with imported capital. Their markets recovered modestly following the Fed’s unexpected decision in September to delay the taper but faltered again in December when the Fed announced that it would move forward with its plans.
As these markets tanked, many leaders of the worst-hit countries criticized Washington for its selfishness and tunnel vision. “International monetary cooperation has broken down,” said an angry Raghuram Rajan, the governor of India’s central bank, following another selloff in his country’s currency and bond markets in January. The Fed and others in the rich world, he said, can’t just “wash their hands off and say, we’ll do what we need to and you do the adjustment.”
In trying to understand what Rajan had expected from the Fed and why he was so angry, the recently released transcripts of the October 2008 Federal Open Market Committee meeting are illuminating. They show that the committee’s members were acutely aware of the global nature of the growing crisis, yet they were focused not on stopping its spread through emerging markets generally but on limiting blowback into the United States. The members agreed that the Fed’s swap lines with emerging-market central banks, whereby the Fed would lend them dollars against their own currencies as collateral, should be temporary and limited to those countries that they considered large and important to the U.S. financial system: Brazil, Mexico, Singapore, and South Korea, all of whose problems could potentially spread directly to U.S. markets. For example, Donald Kohn, then a member of the Fed’s Board of Governors, expressed concern about the potential for large-scale foreign selling of Fannie Mae and Freddie Mac mortgage-backed securities to “feed back on [U.S.] mortgage markets,” pushing up borrowing rates. Certain countries might go down that route, he argued, if they lacked less disruptive means of accessing dollars, such as Fed swap lines. And “it would not be in our interest” for them to do so, Kohn observed.
That year, the Fed privately rebuffed swap-line requests from Chile, the Dominican Republic, Indonesia, and Peru. And two years later, when the U.S. economy had become much less vulnerable to foreign financial instability, the Fed allowed its swap lines with Brazil, Mexico, Singapore, and South Korea to expire. Two years after that, in 2012, the Fed denied a swap-line request from India — thus explaining Rajan’s anger.
Just as the Fed was criticized for causing foreign currencies to plunge with its taper talk in 2013, so had it been condemned for doing the opposite, causing foreign currencies to spike by initiating quantitative easing, in 2010. Many countries’ export competitiveness was hurt as a result. As Zhu Guangyao, China’s vice finance minister, complained at the time, the Fed had “not fully taken into consideration the shock of excessive capital flows to the financial stability of emerging markets.” Brazil’s finance minister, Guido Mantega, was more colorful, accusing the Fed of starting a “currency war.”
Yet expecting the Fed to act otherwise, however desirable it might have been for other countries, was unrealistic: the Fed’s primary objectives — ensuring domestic price stability and maximum employment — are set by law, and the Fed is not authorized to subordinate them to foreign concerns. Unsurprisingly, it has not shown any inclination to do so since the financial crisis erupted six years ago.
FROM BRETTON WOODS TO BITCOIN
It is easy to see why other governments have begun looking for an alternative to the current dollar-dominated global financial architecture — one in which U.S. monetary policy would be less disruptive abroad. In 2009, China’s central bank governor, Zhou Xiaochuan, echoed John Maynard Keynes’ call in the 1940s for the creation of a genuine supranational currency, under the management of the IMF, which would take over the outsized international role of the U.S. dollar. In fact, the fund’s Special Drawing Rights, which represent potential claims on the currencies of IMF members, could already play that role. Yet currently, no private-sector invoicing, borrowing, or lending takes place in SDRs. And until that changes, there is little incentive for central banks to hold much more of them than they currently do — a total of around three percent of global currency reserves.
Back when SDRs were created, in the late 1960s, Jacques Rueff, then the primary economic adviser to French President Charles de Gaulle, famously dismissed them as “nothingness dressed up as currency.” Keynes had detailed how the supply of an IMF currency could be expanded, but never how it could be contracted. Rueff believed that SDRs therefore had a built-in inflationary bias that no bureaucracy would be able to control. He called instead for a return to the gold standard of the late nineteenth century, which had allowed a multilateral trading system to flourish without generating the global imbalances that cause crises. The system had done this, he explained, by automatically raising interest rates in deficit countries and lowering them in surplus countries.
The idea of returning to some form of gold standard still has some well-known backers today, such as Ron Paul, the former Republican congressman from Texas, and the businessman and writer Lewis Lehrman. Yet particularly given the extreme hardship endured by southern member states of the eurozone since 2008, it is not surprising that proposals for governments to reduce their active management of national monetary affairs — whether through the creation of new international currencies, such as the euro, or through a return to some form of commodity backing for money — are more widely seen by policymakers as dangerous steps backward. Of course, the digital currency Bitcoin has shown that something with the properties of transnational money doesn’t necessarily have to be created by policymakers. Yet in the wake of the chaotic collapse of Mt. Gox, once the largest Bitcoin exchange, the Bitcoin market is also the last place anyone would look to minimize volatility and avoid a crisis.
Many still point to the Bretton Woods era of fixed exchange rates, from 1946 to 1971, in which global trade and output grew robustly, as an example of the type of international monetary cooperation to emulate. But other initiatives in the immediate aftermath of World War II, such as the 1948 Marshall Plan and the 1950 European Payments Union, deserve much more of the credit for kick-starting trade and growth. Furthermore, the monetary system that the IMF was set up to oversee could not actually be said to have started until 1961, 15 years after the fund was inaugurated, when the first nine European countries made their currencies convertible into U.S. dollars. And by this time, the system was already coming under stress, as France and others began demanding that the United States redeem their excess dollars for gold.
Today, a road map for cooperative monetary reform appears out of reach politically. Bretton Woods was, in essence, a deal between two nations whose policies were critical to global financial stability: the United States, the world’s dominant creditor, and the United Kingdom, its largest debtor. The former agreed to assist countries struggling with current account deficits, and the latter to forswear competitive currency devaluation. Today, China is the world’s largest creditor, and the United States its largest debtor. Yet both seem unwilling to cede any measure of control — Beijing over its currency exchange rate and Washington over dollar interest rates — even if doing so might theoretically serve the global good.
All of this suggests that the world economy is condemned to remain reliant for some time on what the Stanford economist Ronald McKinnon has called “the unloved dollar standard.” But McKinnon and his colleague John Taylor think there are steps that the Fed could take to regain some love abroad. Taylor has argued that the United States should unilaterally return to a more rules-based, less discretionary approach to monetary policy, since that would lead to less volatile capital flows and economic conditions abroad.
Taylor is surely right in arguing that predictability in U.S. monetary policy has historically been a factor in helping stabilize global markets. Yet the relative unpredictability of such policy today is a direct result of the damage done to the U.S. economy by the financial crisis, which drove short-term interest rates down to zero and obliged the Fed to improvise. It should hardly be surprising that views on what such improvisation should comprise, not least within the Fed, are many, varied, and shifting. Never before have economists and policymakers disagreed so much about what the right rules for monetary policy are and under what conditions a given rule should be followed, modified, or abandoned. And unless these rules are codified, central bank officials will each devise their own preferred ones and, periodically, simply change their minds about them. Indeed, they have been doing so ever since 2010, when the Fed made its first forays into unconventional monetary policy, such as large-scale asset purchases.
Last June, for example, Bernanke tried to steer market expectations by suggesting that the Fed’s asset purchases would end once unemployment got down to around seven percent; yet the Fed only began a modest monthly tapering of such purchases in January, by which time unemployment had already dropped well below that level, to 6.6 percent. In some cases, the Fed has tried to convince the public that it will not do certain things, such as raising interest rates, until a certain distant date (mid-2015). Meanwhile, it has said that it will calibrate other interventions, such as asset purchases, to monthly data on employment and the like, which are typically volatile and therefore suggest frequent changes in the Fed’s behavior. No wonder markets have at times been on edge.
But can’t developing countries take actions on their own to protect themselves, without cooperation from the United States? Indeed, they can. A recent study published by the IMF concluded that countries whose economies have been more resilient in the face of unconventional U.S. monetary policy since 2010 have three characteristics: low foreign ownership of domestic assets, a trade surplus, and large foreign exchange reserves. This has clear policy implications: in good times, emerging-market governments should keep their countries’ imports and currencies down and their exports and dollar reserves up.
Unfortunately, many in the United States see such policies as unfair currency manipulation, harming U.S. exporters. To prevent foreign governments from taking such steps, some influential American economists, such as C. Fred Bergsten, supported by major U.S. corporations, have called on the White House to insert provisions against currency manipulation into future trade agreements. Others, including the economists Jared Bernstein and Dean Baker, have gone so far as to call for Washington to impose taxes on foreign holdings of U.S. Treasuries and slap tariffs on imports from alleged manipulators.
Such suggestions are misguided; they would only raise global trade tensions and political conflict. But the very fact that prominent commentators are calling for these actions illustrates how the functioning, or malfunctioning, of the global financial and monetary system can encourage a spiral of damaging policy actions. China’s recent agreements with Brazil, Japan, Russia, and Turkey to move away from dollar-based trade, for example, could undermine the multilateral trading system. The U.S. dollar plays a critical role in this system, as countries are willing to export more than they are compensated for in imports only because they believe that the money they accumulate in the process — U.S. dollars — will retain its global purchasing power over time. Take the dollar out of the picture and countries will erect trade barriers to prevent bilateral imbalances from emerging, since they won’t want to stockpile one another’s less credible currencies (a fair bet for Brazil, Russia, and Turkey). And if everyone followed suit, the result would be the kind of trade wars that spread the Depression globally in the 1930s.
The U.S. Federal Reserve was created a century ago to end domestic banking panics. The devastation wreaked on British finances by two world wars elevated the Fed above the Bank of England to its current, privileged role at the center of the global monetary system. But even as the power of the Fed increased, it never adopted the same sense of global stewardship as its British counterpart had in the nineteenth century. The U.S. Congress has never shown any desire to change this, and it is hard to imagine it changing its mind anytime soon.
Given the clear trajectory of U.S. policy, the turmoil in emerging-market currency and bond markets over the past year should spur more effective collective action to defend the global financial system against future Fed-induced whiplash. Most emerging-market countries lack the resources to protect themselves individually. But they could build sufficient currency reserves if they acted in concert. In Asia, for example, the Chiang Mai Initiative Multilateralization of 2010 allows the 13 nations involved to tap their $240 billion of combined reserves in the event of a balance-of-payments crisis.
Unfortunately, however, there is much less here than meets the eye. The Chiang Mai countries have not actually pooled the money they have pledged, and members can call on significant funds only if they are under an IMF program and therefore subject to the fund’s surveillance and conditionality — a status that carries a heavy stigma. In reality, governments in the region remain hesitant to extend credit to one another during crises, which is the only time it is actually needed. Meanwhile, the 2013 announcement by the BRICS countries (Brazil, Russia, India, China, and South Africa) that they would create their own development bank is equally long on promise and short on prospects for meaningful action. Neither initiative has yet provided a penny of mutual assistance, nor do they appear likely to do so in the future.
All of this goes to show that it is as easy to bemoan a lack of U.S. financial leadership as it is difficult to substitute for it, even when the resources required to do so are readily available. Given its mandate, the Fed has little choice but to continue pursuing domestic objectives, irrespective of the consequences for those countries that cannot credibly threaten to export economic instability to the United States. But if Washington can’t lead, it should at least get out of the way by abjuring calls to apply anti-currency-manipulation measures against countries taking legitimate steps to bolster their defenses against future Fed-induced shocks. For as the ongoing crisis in Ukraine suggests, nasty financial crises tend to become even worse political ones — and the world is likely to see plenty of both in the years ahead.
“The overall, somewhat gloomy message from the central bankers was that the world is drunk on easy money and has already forgotten the lessons of recent years.”, New York Times
“This is more than a little “rich” coming from the Bank for International Settlements (an organization representing the world’s main central banks). The central bankers themselves have been the world’s brewer and bartender (when it comes to easy money) and now they are complaining that the markets have gotten too drunk off their own brew?”, Mike Perry, former Chairman and CEO, IndyMac Bank
Central Bankers, Worried About Bubbles, Rebuke Markets
By Jack Ewing
FRANKFURT — An organization representing the world’s main central banks warned on Sunday that dangerous new asset bubbles were forming even before the global economy has finished recovering from the last round of financial excess.
Investors, desperate to earn returns when official interest rates are at or near record lows, have been driving up the prices of stocks and other assets with little regard for risk, the Bank for International Settlements in Basel, Switzerland, said in its annual report published on Sunday.
Recovery from the financial crisis that began in 2007 could take several more years, Jaime Caruana, the general manager of the B.I.S., said at the organization’s annual meeting in Basel on Sunday. The recovery could be especially slow in Europe, he said, because debt levels remain high.
“During the boom, resources were misallocated on a huge scale,” Mr. Caruana said, according to a text of his speech, “and it will take time to move them to new and more productive uses.”
The B.I.S. provides financial services to national central banks and also acts as a setting where central bankers can discuss monetary policy and other issues like financial stability or bank regulation. The board of directors includes Janet L. Yellen, chairwoman of the Federal Reserve; Mario Draghi, president of the European Central Bank; and the heads of central banks from Japan, China, India and many other countries.
The organization, which reflects a widespread view among central bankers that they are bearing more than their share of the burden of fixing the global economy, often uses its annual reports to send a message to political leaders, commercial bankers and investors. But the B.I.S.’s language in the 2014 edition was unusually direct, as was its warning that the world could be hurtling toward a new crisis.
“There is a disappointing element of déjà vu in all this,” Claudio Borio, head of the monetary and economic department at the B.I.S., said in an interview ahead of Sunday’s release of the report.
He described the report “as a call to action.”
The organization said governments should do more to improve the performance of their economies, such as reducing restrictions on hiring and firing. The report also urged banks to raise more capital as a cushion against risk and to speed efforts to deal with past problems. Countries that are growing quickly, like some emerging markets, must be alert to the danger of overheating, the group said.
“The signs of financial imbalances are there,” Mr. Borio said. “That’s why we are emphasizing it is important to take further action while the time is still there.”
The B.I.S. report said debt levels in many emerging markets, as well as Switzerland, “are well above the threshold that indicates potential trouble.”
Yet investors show no sign of being deterred. This month, for example, investors snapped up $1.5 billion worth of bonds sold by the government of Kenya. The debt paid an interest rate of 6.875 percent, very low for a country that has deep economic problems and has been rocked by terrorist bombings.
In contrast to many economists and analysts, the B.I.S. played down the risk of deflation, a downward spiral in prices that can have devastating economic effects. When deflation takes hold, people stop spending because they expect prices to fall further. Company profits slump, and unemployment rises.
In Europe, an intense debate has taken place about whether the region could slip into deflation, and whether the European Central Bank should be pumping more money into the euro zone economy as a countermeasure.
Mr. Borio said it was unlikely that there would be a repeat of the kind of catastrophic deflation that occurred during the Great Depression. He noted that prices have been falling in Switzerland for several years, but the country has continued to grow, and unemployment is low.
“We are not saying deflation is not a problem,” Mr. Borio said. “But we would like to try to take a little bit of the emotion out of the debate.”
The organization also had harsh words for corporations, which it said were not taking advantage of booming stock markets to step up investment. That is one reason that gains in productivity — the foundation of sustained economic growth — have slowed in most advanced economies, the bank said.
“Despite the euphoria in financial markets, investment remains weak,” the B.I.S. said. “Instead of adding to productive capacity, large firms prefer to buy back shares or engage in mergers and acquisitions.”
The overall, somewhat gloomy message from the central bankers was that the world is drunk on easy money and has already forgotten the lessons of recent years.
“The temptation to postpone adjustment can prove irresistible, especially when times are good and financial booms sprinkle the fairy dust of illusory riches,” the report said. “The consequence is a growth model that relies too much on debt, both private and public, and which over time sows the seeds of its own demise.”
A version of this article appears in print on June 30, 2014, on page B2 of the New York edition with the headline: Central Bankers, Worried About Bubbles, Rebuke Markets.
“The narrative proceeds…to John Law, the 18th-century Scotsman who, as banker to the French court, gave quantitative easing a try 300 years before Ben Bernanke ran with the idea. Lots of paper credit is the thing, Law contended. Who needed gold? The experiment ended with exploding asset bubbles…
…governments printed currency and levied taxes to fight wars….Customarily, sound finance resumed with the peace. What’s new is that, starting about 1919, the taxing and inflating has kept right on going even after the shooting stopped…. the dollar commands but 1/1,300th of an ounce of gold today, as compared with the 1/20th of an ounce on the eve of World War I…. Money has become an instrument of public policy. Central banks create it with a tap, or snap, to effect desired economic and financial outcomes. They use it in attempts to raise the rate of inflation or the level of the stock market or the numbers of employed workers. They use it to make broke banks solvent. They are goals that, if achieved, are bought at the expense of the integrity of money itself….If the printing press (or computer keypad) seems an improbable means to lasting prosperity, it is because it has never worked before….Since year-end 2007, the Federal Reserve has created more than $3 trillion from the thinnest of air. Over the same span of years, America’s public debt has jumped to $17.6 trillion from $9.2 trillion.”, James Grant, excerpt from WSJ review of “War and Gold”
Book Review: ‘War and Gold’ by Kwasi Kwarteng
Why gold? Because it’s money, or used to be money, and will likely one day be money again.
By James Grant
In the past 12 months alone, the world’s top five central banks have conjured up $1.4 trillion. They called it into existence as a sorcerer might summon the spirits. No wand, no printing press was required; taps on a keyboard did the heavy lifting.
“War and Gold” is a chronicle of fiscal ruination and redemption, with the emphasis on the former. In ages past, observes the historian and politician Kwasi Kwarteng, governments printed currency and levied taxes to fight wars. Now they materialize the money on computer screens to jolt their underachieving and overindebted economies back to life (so far without notable success). Customarily, sound finance resumed with the peace. What’s new is that, starting about 1919, the taxing and inflating has kept right on going even after the shooting stopped.
Money is as old a story as the historian cares to make it. Mr. Kwarteng begins his chronicle with the 16th-century Spaniards, who ripped gold and silver from the hands of the Incas and Aztecs and hauled it back to Seville, making that inland port “one of the great financial centers of the world.” “It is no accident,” the author relates, “that four of the most widely performed operas of the modern era— Mozart’s The Marriage of Figaro and Don Giovanni, Rossini’s Barber of Seville and Bizet’s Carmen—are set in this city.”
The narrative proceeds from the conquistadors to John Law, the 18th-century Scotsman who, as banker to the French court, gave quantitative easing a try 300 years before Ben Bernanke ran with the idea. Lots of paper credit is the thing, Law contended. Who needed gold? The experiment ended with exploding asset bubbles. Mr. Kwarteng next shifts his focus to America and France in the Age of Revolution (both sets of revolutionaries overdid the money printing) and on to Britain at the high noon of empire and back to America for the Gilded Age.
The author concludes his tale—”A 500-Year History of Empires, Adventures, and Debt,” as the subtitle has it—with chapters on the oil-soaked 1970s, Ronald Reagan and Margaret Thatcher, the dawn of the euro, the great Japan levitation, the even more spectacular China levitation, the millennial debt spree and the sorrows of 2007-09.
Are you waiting for the punchline? Mr. Kwarteng arrives at the not especially gob-smacking conclusion that gold may appeal to any who doubt the institution of paper money. Not that the doubters have much practical standing, he suggests: “The gold standard will never formally return, but movements in the price of gold may well suggest that investors, in their lack of faith in paper money, have informally adopted one.” And that is that.
Exasperatingly, the author, a University of Cambridge Ph.D. in history and a British parliamentarian, refuses to render historical judgment. He doesn’t exactly decry the world’s descent into “too big to fail” banking, occult-style central banking and tiny, government-issued interest rates. Neither does he precisely support those offenses against wholesome finance. He is neither for the dematerialized, non-gold dollar nor against it. He is a monetary Hamlet.
He does, at least, ask: “Why gold?” I would answer: “Because it’s money, or used to be money, and will likely one day become money again.” The value of gold is inherent, not conferred by governments. Its supply tends to grow by 1% to 2% a year, in line with growth in world population. It is nice to look at and self-evidently valuable. It is indestructible, hard to find and hard to claw out of the earth. You have to explain the meaning of bitcoin. With gold, it’s comprehension at first sight.
Shelley wrote lines of poetry to protest the deflation that attended Britain’s return to the gold standard after the Napoleonic wars. Mr. Kwarteng quotes them: “Let the Ghost of Gold / Take from Toil a thousandfold / More than e’er its substance could / In the tyrannies of old.” The author seems to agree with the poet. I myself hold the gold standard blameless. The source of the postwar depression was rather the decision of the British government to return to the level of prices and wages that prevailed before the war, a decision it enforced through monetary means (that is, by reimposing the prewar exchange rate). It was an error that Britain repeated after World War I.
The classical gold standard, in service roughly from 1815 to 1914, was certainly imperfect. What it did deliver was long-term price stability. What the politics of the gold-standard era delivered was modest levels of government borrowing. What the British bankers of the gold-standard era delivered (with the rare exception) was solvency.
The author lightly praises these achievements. I would have been fulsome. If Victorian finance had a “latent fragility,” as Mr. Kwarteng contends, so does the finance of most eras. It falls to the reader to decide what to make of the interesting historical facts that Mr. Kwarteng sprinkles on his pages. For instance: “At least four out of eight Governors of the Bank of England between 1833 and 1847 . . . suffered the humiliation of personal bankruptcy.”
I would say that this fact speaks well of the Victorians and of their central bank. The Janet Yellens of that time had day jobs, in the course of which they took commercial and financial risks. More than taking risks, the gentlemen personally bore them. How much better ordered our finances would be if the personnel of the Federal Open Market Committee had a more intimate understanding of success and failure in the workaday world. Out of the 10 voting members on the 2014 FOMC, only four have substantial professional experience outside academe or government.
Progress is the rule, the Whig theory of history teaches, but the old Whigs never met the new bankers. Ordinary people live longer and Olympians run faster than they did a century ago, but no such improvement is evident in our monetary and banking affairs. On the contrary, the dollar commands but 1/1,300th of an ounce of gold today, as compared with the 1/20th of an ounce on the eve of World War I. As for banking, the dismal record of 2007-09 would seem inexplicable to the financial leaders of the Model T era. One of these ancients, Comptroller of the Currency John Skelton Williams, predicted in 1920 that bank failures would soon be unimaginable. In 2008, it was solvency you almost couldn’t imagine.
Mr. Kwarteng rightly observes that human monetary arrangements oscillate between “order and chaos.” If order characterized the gold standard, which he allows, then our present-day setup must be counted chaotic.
The nature of 21st-century money alone would seem to make it so. Undefined, literally insubstantial, the dollar is no longer a weight or a measure, as it was until the Nixon administration stopped converting dollars to gold at a fixed rate in 1971. Money has become an instrument of public policy. Central banks create it with a tap, or snap, to effect desired economic and financial outcomes. They use it in attempts to raise the rate of inflation or the level of the stock market or the numbers of employed workers. They use it to make broke banks solvent.
They are goals that, if achieved, are bought at the expense of the integrity of money itself. Seeing that the monetary mandarins are forever inclined to pull chestnuts from fires, the bankers and the speculators continue to play with matches. Then, too, the up-tempo emission of weightless dollars sows well-founded doubts about the buying power of money. Sooner or later, once-trusting consumers may choose to stockpile merchandise rather than to save George Washingtons. If the printing press (or computer keypad) seems an improbable means to lasting prosperity, it is because it has never worked before.
Since year-end 2007, the Federal Reserve has created more than $3 trillion from the thinnest of air. Over the same span of years, America’s public debt has jumped to $17.6 trillion from $9.2 trillion. “It is perhaps timely to reflect,” Mr. Kwarteng comments, “that paper money was almost always a wartime expedient, introduced as a means of extraordinary financing in extraordinary times.” No longer. Paper money is what the politicians and central bankers wheel out to address the failures of finance—failures chargeable to prior episodes of inflation and overlending.
Mr. Kwarteng, a heroic reader, has compiled a wonderful bibliography and gathered a colorful grouping of monetary characters to people his chapters. Among my favorites is the indomitable Francis W. Hirst (1873-1953), an editor of the Economist who had no truck with John Maynard Keynes, that astringent, Cambridge-educated champion of the state and its latter-day wampum.
The author gives away his politics in his reverential quoting of Keynes and in his characterization of a certain senior U.S. Treasury official during the administration of George W. Bush. “A committed free-market Republican,” quoth Mr. Kwarteng, “he was reluctant to approve any measures which could in any way be interpreted as constituting excessive government interference.” How much bigger might the bank bailout have been if Hank Paulson had not been so selflessly devoted to the ideals of the free market?
—Mr. Grant is the editor of Grant’s Interest Rate Observer. His history of the self-healing slump of 1920-21, “The Forgotten Depression,” will be published in November.
“During my Wall Street days, the individual was never talked about.” (For example, patients often don’t know how much a procedure at a doctor’s office costs ahead of time.) “That’s why I felt we had to drive this revolution where an individual had more of a say in health care.” , Anne Wojcicki, CEO, 23andMe
“Krugman’s anti private markets views on healthcare are completely wrong. Marketplaces like healthcare have become so “screwed up” precisely because they are not organized as free and competitive markets, where customers negotiate (transparent) fees for the services provided among lots of capable and competing providers. Because healthcare can have a catastrophic financial risk to consumers and because we want to provide lower-income individuals with subsidized health care, a free market for healthcare services has been horribly distorted by health insurance (both public and private). While consumer health insurance is a tremendous innovation and protection for all Americans, it has an important negative side-effect. The consumers of healthcare services don’t negotiate prices and make few healthcare payments that correspond (in any direct, material way) to the services received. In other words, because of the un-intended consequences of health insurance (both public and private), healthcare services in America are not a free and competitive marketplace. The solution, in my view, is to continue to provide subsidized coverage to the poor and lower-income individuals and families (probably more directly and not “buried” in insurance rates, which distorts economic decisions) and catastrophic coverage to the rest, yet institute more of a free market system; where we inform consumers and they (or smaller groups of them) negotiate for their services and pay a percent of the cost (probably based on income and net worth) of the services they use. If we want cost-efficient, quality healthcare our government should be encouraging lot of private market competition and innovation. Startups (and other private firms) like 23andMe should be embraced. Yet today, firms like 23andMe are stifled by government bureaucrats and often unnecessary regulations.”, Mike Perry, former Chairman and CEO, IndyMac Bank
Anne Wojcicki’s Quest for Better Health Care
The 23andMe CEO on the promise of genetics and the future of health care
By Alexandra Wolfe
Anne Wojcicki Winni Wintermeyer for The Wall Street Journal
Anne Wojcicki, chief executive of 23andMe, is determined to overturn the way traditional health care works in the U.S. It hasn’t been easy. Last year, the Food and Drug Administration shut down sales of her genetics company’s personalized health reports—one of its main sources of revenue. But Ms. Wojcicki (pronounced wo-JIT-ski) isn’t backing down.
It has been more than six years since 23andMe’s splashy appearance at the World Economic Forum in Davos, Switzerland. On their way out of the annual Google party at 3 a.m., heads of state and CEOs stumbled down the hallways of the Steigenberger Belvédère Hotel to be greeted by lines of 23andMe’s “spit coaches.” (The coaches got them salivating by asking them to imagine favorite foods: “Think of pizza, chocolate, french fries!”) In return, participants later got their own reports, with details like their genetic risk for heart disease and melanoma. Before the FDA stepped in last November, the company offered those reports to consumers for $99.
The FDA contended that genetic results aren’t always accurate and can mislead consumers. Officials feared that, without the supervision of a physician, users of the service might have unnecessary elective surgery based on inconclusive genetic information. 23andMe can still send ancestry information and raw data—lists of genetic codes that are indecipherable to nonscientists but could be sent for analysis to other health information providers.
Today, toned and tan and wearing a form-fitting gray dress, the 40-year-old Ms. Wojcicki is the picture of health. She’s adjusted her own lifestyle based on what she’s found in her genes. She says that she has a higher risk for breast cancer, so she doesn’t drink much alcohol, which could add to her risk, according to well-established research.
She knows that she’s a carrier for a rare disorder called Bloom’s syndrome—though her husband, Google co-founder Sergey Brin, isn’t, so their 5-year-old son and 2-year-old daughter didn’t inherit it. (The couple separated last year but have remained friends and see each other often with their children.) She also has a gene that makes her more susceptible to heroin addiction.
Her company is working with the FDA on getting its reports approved for direct delivery to consumers. Before the FDA’s warning letter, 23andMe had 550,000 customers. Now it has 700,000, though growth has slowed. Based in Mountain View, Calif., the 140-employee company has raised a total of $126 million from investors, including $50 million in the latest installment in December 2012.
Ms. Wojcicki’s ultimate goal is for people to be in control of their own health care. Part of that agenda entails getting more studies done on the connection between health and genetics. Motion sickness, for example, seems to run in families, she says, but there isn’t much research about it.
To that end, the company uses its genetic data (with customers’ consent) for research. It has published 16 studies in the past three years on its website, on topics ranging from Parkinson’s disease to allergies to nearsightedness. In 2012, 23andMe published a paper in the peer-reviewed journal BMC Medical Genetics showing that women with larger breasts had an increased risk for breast cancer. Ms. Wojcicki says knowing this kind of information will help consumers prevent disease.
Born in San Mateo County, Calif., Ms. Wojcicki became interested in science at a young age. Her father was a physics professor at Stanford University, and her mother was a schoolteacher. She graduated from Yale University, where she majored in biology, and worked on Wall Street investing in health-care companies for 10 years. She came up with the idea for 23andMe in 2006, a year before she married Mr. Brin.
“Biotech companies were always failing, so we did a lot of shorting of biotech,” she says of her days as an investor. At the time, she had been pessimistic about the state of health care until she started hearing about the growing field of genetics.
“I kept hearing about how robust the technology was and how cheap it was getting,” she remembers. “For the first time, we were actually going to be able to unlock all our genetic information at a massive scale.” Though deciphering the first human genome cost $3 billion, the price fell quickly and dramatically.
Yet the system was still geared toward institutions. “During my Wall Street days, the individual was never talked about,” she says. For example, patients often don’t know how much a procedure at a doctor’s office costs ahead of time. “That’s why I felt we had to drive this revolution where an individual had more of a say in health care.”
The field is starting to change, as evidenced by the rise of personal health trackers like Fitbit. Still, Ms. Wojcicki worries that patients don’t realize that they own their own data. “You own your tumor,” she says. “Part of our goal was to circumvent the whole system and say you actually own all the information, and you should make choices.” Knowing personal genetic risks for problems ranging from lactose intolerance to cancer will make it possible, she argues, for individuals to take more effective action.
Another problem, Ms. Wojcicki says, is that conducting studies aimed at prevention isn’t in the interest of the health-care industry. “The reality is [that] if you become diabetic, I can make money lots of different ways, but if you don’t become diabetic, I don’t make money off you,” she says, from the point of view of a pharmaceuticals company. “So who’s working on nobody becoming diabetic?” She says there is a disconnect between what the health-care system offers and what the individual wants. As a patient herself, “I found people making decisions for me hugely insulting,” she says. “I guess I’m just fiercely independent.”
Ms. Wojcicki remains optimistic about the future of the industry. “If we had all the data in the world, it would just totally revolutionize health care,” she says. “If the tech is actually cheap enough and electronic medical records are ubiquitous, you could see why you could just marry that.” Going forward, she thinks that this “explosion of information” will spur a growth in personalized medicine as patients and their doctors learn more about which therapies and drugs might work best for them.
She is heartened by the way the retail industry has begun to cater to consumers’ health, such as Wal-Mart adding health-care clinics to some of their stores. And when it comes to understanding genetics, “it would be an amazing thing if you went to the doctor, and the doctor was like, ‘Hey, you might be five years away from having diabetes or these other problems.’ ”
As Ms. Wojcicki wades through the FDA’s approval process, she’s focusing on new genetic research and getting her business back on track. “Our mission as a company has not changed,” she says. “Actually, we’re doubling down on it.”
“If you’re self-employed, you’re hosed. If you just started a job, you’re hosed. If you get a bonus, you’re hosed. Just got a severance payment? Can’t count that. I don’t have to do a lot to be a lender. I just have to be normal. Banks have forgotten that (mortgage) loans are collateralized by the home itself.” William D. Dallas
“Banks haven’t forgotten how to be common sense home lenders. Government banking regulators, led by the Consumer Financial Protection Bureau, have forced them to abandon their common sense and good business judgment and follow a rules-based approach (based on form-over-substance compliance). I would summarize it as follows: “We are from the federal government and we know what’s best for consumer borrowers and you don’t, because you are a greedy, for-profit private lender and can’t be trusted”.” Mike Perry, former Chairman and CEO, IndyMac Bank
In Home Loans, Subprime Fades as a Dirty Word
By SHAILA DEWANJUNE 28, 2014
When no bank would give them a mortgage, Martin and Cindy Arroyo bought their home in Los Gatos, Calif., with a subprime loan from Athas Capital. CreditRamin Talaie for The New York Times
CALABASAS, Calif. — Martin and Cindy Arroyo knew they were not ideal candidates for a home loan.
She had gone through a foreclosure after losing her job, and he was finishing his M.B.A. and had not yet found his current position. But they had managed to put together a down payment of more than $550,000, or three-quarters of the asking price for a four-bedroom house in Los Gatos, and thought they would find a bank willing to lend the rest. They didn’t.
So the Arroyos found an alternative: a subprime mortgage.
Despite the notoriety that subprime loans gained as a prime cause of the financial crisis, they are re-emerging, under much more careful control, as one answer to the tight lending standards that have shut out millions of would-be homeowners.
“We call it the sane subprime,” said Brian O’Shaughnessy, chief executive of the Athas Capital Group, which gave the Arroyos their loan.
Subprime loans, which accounted for about 15 percent of all new home loans in 2005 and 2006, are now a tiny sliver of the mortgage market. Only a handful of lenders are offering them, at interest rates from 8 to 13 percent (compared with about 4 percent for conventional loans to highly rated borrowers).
Brian O’Shaughnessy, chief executive of the Athas Capital Group.CreditAnn Johansson for The New York Times
Mr. O’Shaughnessy said his underwriting standards, while more flexible, are tougher in some cases than those of the Federal Housing Administration, which permits down payments as small as 3.5 percent. According to the Athas rate sheet, borrowers with low credit scores, between 550 and 600, must put at least 35 percent down and will get an interest rate ranging from 8.99 to 12.99 percent.
Subprime loans have a thoroughly unsavory reputation — for good reason. But the loans started out with a legitimate purpose: giving people with less-than-stellar credit the ability to buy a home, as long as they paid a premium to compensate for the higher risk.
Traditionally, any loan to someone with a credit score below about 640 (the highest possible score is 850) has been considered subprime. During the housing bubble, when lenders were hungry for loans to package into securities for resale, the subprime label expanded to describe all manner of schemes, including loans with low or no down payments, “liar loans” with no proof of income and loans with a monthly payment so low that the principal actually increased over time.
Those exotic products are now virtually extinct. Governed by an encyclopedia’s worth of new regulations, Athas’s loans generally require down payments of at least 20 percent and documentation of income or assets, as well as an assessment of the borrower’s ability to make the payments. Athas does not offer teaser rates, pick-a-payment options or interest-only payments. But it does offer loans to people whose records are marred by a recent foreclosure or who lack a steady income.
And it is doing just what many economists and consumer groups have urged: making credit more widely available. “Not all subprime lending is abusive. It just happened that all of the abuses happened in the subprime space,” said Nikitra Bailey, an executive vice president of the Center for Responsible Lending. “The regulators now have to be really vigilant to make sure people are getting appropriate loans and they don’t allow the subprime market to get back out of hand.”
Marketed by some lenders as “second-chance mortgages,” only about 0.5 percent of new home loans are subprime today, according to Black Knight Financial Services, a research firm for lenders. That is not enough to bundle into securities for sale to investors, which means the lenders, largely financed by private investors, are for the most part keeping the loans on their books or selling them one by one, an incentive to keep the quality high.
But the lenders say it is only a matter of time before the market for subprime-mortgage-backed securities rebounds.
According to mortgage data from Zillow, the number of lenders responding to inquiries from subprime borrowers started to catch up to the number responding to prime borrowers beginning in the fourth quarter of last year. Large banks are also looking at subprime borrowers because rising mortgage rates have killed off much of their refinancing business. In February, Wells Fargo announced that it would lower the minimum credit score for a home loan to 600, from 640.
More than 12.5 million people who might have qualified for a home loan before the crash have been shut out of the market, Mark Zandi, the chief economist for Moody’s Analytics, estimates. Members of minority groups have especially suffered; blacks and Hispanics are rejected by mortgage lenders far more often than whites.
Despite the new regulations, there is much that is familiar about the new subprime lenders. Athas is based in Calabasas, the Southern California city that was once the home of perhaps the most infamous subprime lender, Countrywide Financial. Athas’s chief competitor, the Citadel Servicing Corporation, is in Orange County, another onetime hotbed of subprime lenders.
Many of the players are the same, too. Mr. O’Shaughnessy met his partner, Alim Kassam, during the bankruptcy of Quality Home Loans, which had bought Mr. O’Shaughnessy’s previous company, Bankers Express Mortgage.
But the vocabulary has changed. Because new federal regulations have created something called a qualified mortgage, or Q.M., which must conform to strict requirements, future lending is likely to be categorized as Q.M. or non-Q.M. rather than prime or subprime. Non-Q.M. lenders will have both more flexibility and more liability, but not all non-Q.M. loans will be subprime.
Among the lenders preparing to make non-Q.M. loans is New Leaf Lending, a division of the Skyline Financial Corporation, based in Calabasas and run by William D. Dallas. In 2007, Mr. Dallas was a subprime lender who told The New York Times that investors had pushed him to make risky loans. “The market is paying me to do a no-income-verification loan more than it is paying me to do the full-documentation loans,” he said. “What would you do?”
Now, he says, the pendulum has swung too far the other way. “If you’re self-employed, you’re hosed,” Mr. Dallas said. “If you just started a job, you’re hosed. If you get a bonus, you’re hosed. Just got a severance payment? Can’t count that. I don’t have to do a lot to be a lender. I just have to be normal.” Banks have forgotten that loans are collateralized by the home itself, he said.
In the case of the Arroyos, for example, the house would have to lose 75 percent of its value for the lender to be at risk. “They just have a formula, and they decide whether or not you qualify without looking at what’s logical,” Ms. Arroyo said of conventional mortgage lenders.
Some employees of conventional banks might agree. Barry Boston, for example, recently left one of those banks for a job at Athas, frustrated by having to turn down so many perfectly fine borrowers and because of the endless paperwork involved in closing a loan. “I couldn’t stand it anymore,” he said. “The wind had been completely sucked out of my sails.”
A version of this article appears in print on June 29, 2014, on page A1 of the New York edition with the headline: In Home Loans, Subprime Fades as a Dirty Word.
“From 2003 to 2005, however, the Fed kept interest rates lower than such a rules-based approach would imply. This contributed mightily to the housing bubble and the risk-taking search for yield…
…The Fed’s discretionary policies since the financial crisis—particularly the large-scale purchases of mortgage-based securities—have continued and have also set a dangerous precedent, according to John Cochrane of the University of Chicago. “Once the central bank is in the business of supporting particular sectors, housing—and homeowners at the expense of home buyers—why not others? Cars? Farmers? Exporters?…. (Lee Ohanian of UCLA) concluded that “economic growth would have been higher had the Fed stuck to policy rules.”….. In my view more is needed. The big swings between discretion and rules that have characterized Fed history—and the damage this has led to—leads me to favor legislation requiring the Fed to adopt rules for setting policy on the interest rate or the money supply.”, John Taylor, “The Fed Needs to Return to Monetary Rules”, Wall Street Journal, June 27, 2014
The Fed Needs to Return to Monetary Rules
The economic outcomes when the central bank plays it by ear have not been good, especially in the last decade.
By JOHN B. TAYLOR
June 26, 2014 6:57 p.m. ET
As the Federal Reserve’s large-scale bond purchases wind down, financial markets and policy makers now are focused on when the Fed will move to increase interest rates. There is a more fundamental question that needs to be answered: Will the central bank continue its highly interventionist and discretionary monetary policies, or will it move to a more rules-based approach?
A conference last month at Stanford’s Hoover Institution brought top Fed policy makers and staff together with monetary experts and financial journalists to discuss this crucial question.
David Papell of the University of Houston used a statistical analysis to determine objectively when the central bank followed rules-based policies. The periods when it did—such as in much of the 1980s and ’90s—coincided with good economic performance: price stability, steady employment and output growth. Using a different approach based on his research of the Fed’s 100-year history, Carnegie Mellon University’s Allan Meltzer concluded as well that “following a rule or quasi rule in 1923-28 and 1986-2002 produced two of the best periods in Federal Reserve history.”
From 2003 to 2005, however, the Fed kept interest rates lower than such a rules-based approach would imply. This contributed mightily to the housing bubble and the risk-taking search for yield. The Fed’s discretionary policies since the financial crisis—particularly the large-scale purchases of mortgage-based securities—have continued and have also set a dangerous precedent, according to John Cochrane of the University of Chicago. “Once the central bank is in the business of supporting particular sectors, housing—and homeowners at the expense of home buyers—why not others? Cars? Farmers? Exporters?”
Digging deeper into history, Lee Ohanian of UCLA found that the Fed’s deviations from rules that would produce low and stable inflation during periods of large changes in regulatory policies—such as the National Industrial Recovery Act of the 1930s—often harmed the economy. He concluded that “economic growth would have been higher had the Fed stuck to policy rules.”
Michael Bordo of Rutgers noted another central-banking responsibility that the Fed has discharged in an ad hoc and discretionary manner: to act as a lender-of-last-resort. This, he wrote, has led to instability throughout the Fed’s history, most recently in 2008 when it bailed out Bear Stearns and AIG but let Lehman Brothers go under. Mr. Bordo recommends that the central bank adopt a rule to govern when it will make loans of last resort, and make it publicly known. This could mitigate or even prevent future crises of the sort precipitated by the ad-hoc policies of 2008.
Marvin Goodfriend of Carnegie Mellon University also noted that uncertainty about which creditors would be bailed out by the Fed created confusion among policy makers and led to a botched rollout of the Troubled Asset Relief Program in 2008. He recommends a new “Fed-Treasury Credit Accord” which would require “Treasurys only” asset-acquisition policy with exceptions in specific emergency situations.
There were dissenting views. Andrew Levin, a former special adviser to the Federal Reserve now on leave at the International Monetary Fund, emphasized that the parameters of policy rules shift over time making them less reliable. Indeed, the long-run average level of the federal-funds rate—central to any Fed interest-rate policy rule—could change. Mr. Levin did not recommend throwing out rules-based policy altogether, however. Rather, if a key interest-rate rule must change the Fed should communicate the reasons clearly.
The clear implication of the monetary ideas presented at the conference is that the Fed should transition to a more rules-based policy. Richard Clarida of Columbia University showed that these same ideas apply globally and would have beneficial effects for the entire international monetary system. A start, suggested by Charles Plosser, president of the Federal Reserve Bank of Philadelphia, would be for the Fed to report publicly the estimated impacts of the reference policy rules that it uses internally. An open discussion, in press conferences and congressional testimony, would lead to questions and answers about why the Fed deviates from such rules and thereby create more accountability.
In my view more is needed. The big swings between discretion and rules that have characterized Fed history—and the damage this has led to—leads me to favor legislation requiring the Fed to adopt rules for setting policy on the interest rate or the money supply. The Fed, not Congress, would choose the rule. But the rule would be public. If the Fed deviated from it, the Fed chair would be obligated to explain why, in writing and congressional testimony.
Although it is likely to resist such legislation, the Fed could make it work to a good end. The Fed has already adopted a 2% inflation target, which is the value embedded in the rule-like policy advocated by many at the conference at Stanford. In addition, the forecasts for the terminal or equilibrium federal-funds rate by the members of the Federal Open Market Committee now average about 4%, which was also built into the rule-like policies discussed by many at the conference.
Fed Chair Janet Yellen has expressed agreement that the Fed should eventually “adopt such a rule as a guidepost to policy,” though she adds that the time is not yet ripe because the economy is not yet back to normal. So the main debate now is about when, not whether, a rules-based policy should be adopted. Based on recent research, the sooner the better.
Mr. Taylor, a professor of economics at Stanford University and a senior fellow at the Hoover Institution, served as Treasury undersecretary for international affairs from 2001 to 2005.Copyright 2014 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com
“In any event, the limitation upon the President’s appointment power is there not for the benefit of the Senate, but for the protection of the people; it should not be dependent on Senate action for its existence…
…The real tragedy of today’s decision is not simply the abolition of the Constitution’s limits on the recess appointment power and the substitution of a novel framework invented by this Court. It is the damage done to our separation-of-powers jurisprudence more generally….”, Supreme Court Justice Antonin Scalia, concurring in judgment only on NLRB v. Canning
Notable & Quotable: Scalia on NLRB v. Canning
Supreme Court Justice Antonin Scalia, concurring in judgment only, says the court’s NLRB v. Noel Canning ruling does serious damage to separation-of-powers jurisprudence.
June 26, 2014 6:53 p.m. ET
Supreme Court Justice Antonin Scalia concurring in judgment only in the court’s June 26 unanimous decision in NLRB v. Noel Canning that President Obama’s recess appointments to the National Labor Relations Board were invalid:
The majority replaces the Constitution’s text with a new set of judge-made rules to govern recess appointments. Henceforth, the Senate can avoid triggering the President’s now-vast recess-appointment power by the odd contrivance of never adjourning for more than three days without holding a pro forma session at which it is understood that no business will be conducted. Ante, at 33–34. How this new regime will work in practice remains to be seen. Perhaps it will reduce the prevalence of recess appointments. But perhaps not: Members of the President’s party in Congress may be able to prevent the Senate from holding pro forma sessions with the necessary frequency, and if the House and Senate disagree, the President may be able to adjourn both “to such Time as he shall think proper.” U. S. Const., Art. II, §3. In any event, the limitation upon the President’s appointment power is there not for the benefit of the Senate, but for the protection of the people; it should not be dependent on Senate action for its existence.
The real tragedy of today’s decision is not simply the abolition of the Constitution’s limits on the recess appointment power and the substitution of a novel framework invented by this Court. It is the damage done to our separation-of-powers jurisprudence more generally. It is not every day that we encounter a proper case or controversy requiring interpretation of the Constitution’s structural provisions. Most of the time, the interpretation of those provisions is left to the political branches—which, in deciding how much respect to afford the constitutional text, often take their cues from this Court. We should therefore take every opportunity to affirm the primacy of the Constitution’s enduring principles over the politics of the moment. Our failure to do so today will resonate well beyond the particular dispute at hand. Sad, but true: The Court’s embrace of the adverse-possession theory of executive power (a characterization the majority resists but does not refute) will be cited in diverse contexts, including those presently unimagined, and will have the effect of aggrandizing the Presidency beyond its constitutional bounds and undermining respect for the separation of powers.
I concur in the judgment only.Copyright 2014 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com
“The average rate for such (subprime credit card) customers was 21.1% in the first quarter, up from 20.2% a year earlier, according to research firm CardHub.com. In contrast, the highest-quality borrowers paid 12.9% on average in the first quarter, virtually unchanged from a year earlier…
…Subprime borrowers are typically defined as those with FICO or Equifax Risk credit scores below 660 on scales that top out at 850. Such borrowers often have missed payments on debt, suffered foreclosures, filed for bankruptcy protection or have no credit history.”, AnnaMaria Andriotis And Robin Sidel, Credit Cards For Riskiest Customers Roar Back,” Wall Street Journal, June 27, 2014
“21.1% when today’s prime rate is just 3.25%!!! Really, how different is subprime credit card lending by the major banks, than the much-derided payday loans? At the financial/economic crisis peak, these credit card lenders had annual default rates and losses that far-exceeded the default rates and credit losses on nonconforming, FHA, and other subprime home loans. But the home lenders (and mortgage investors) couldn’t “pay” for these increased losses by abruptly raising rates on all of their paying (non-delinquent) customers and cancelling undrawn lines of credit, like the credit card lenders did. And yet, it was the mortgage lenders were the bad guys? Clearly, there needs to be greater competition in consumer finance to drive subprime credit card rates down for these lower-income Americans, but the Consumer Financial Protection Bureau does the opposite. By increasing the cost of regulation and compliance significantly (all form over substance…because the only thing that really matters is the actual economic terms received…), they inadvertantly protect the entrenched players and make it very hard for innovative new entrants to compete with the Too Big to Fail Banks.”, Mike Perry, former Chairman and CEO, IndyMac Bank
Credit Cards For Riskiest Customers Roar Back
By AnnaMaria Andriotis And Robin Sidel
Lenders are courting risky credit-card borrowers more aggressively than they have since the financial crisis in a bid to jolt revenue in a period of sluggish growth and tight regulation.
Banks and other lenders issued 3.7 million credit cards to so-called subprime borrowers during the first quarter, a 39% jump from a year earlier and the most since 2008, according to data provided exclusively to The Wall Street Journal by credit bureau Equifax Inc.
About one-third of all credit cards issued in that period were to subprime customers, the biggest share in six years, according to Equifax.
“Lenders in general have really saturated the higher-credit-quality market, so it is only natural that as they look for growth opportunities, they expand downward,” said Randy Hopper, vice president of consumer lending at Navy Federal Credit Union, an institution based in Vienna, Va., that is the largest credit union in the U.S.
At a time when many other revenue engines are sputtering, subprime borrowers are especially attractive to banks because they tend to pay higher interest rates and generate more revenue as long as they don’t stop making their minimum required payments.
The average rate for such customers was 21.1% in the first quarter, up from 20.2% a year earlier, according to research firm CardHub.com. In contrast, the highest-quality borrowers paid 12.9% on average in the first quarter, virtually unchanged from a year earlier.
Subprime borrowers are typically defined as those with FICO or Equifax Risk credit scores below 660 on scales that top out at 850. Such borrowers often have missed payments on debt, suffered foreclosures, filed for bankruptcy protection or have no credit history.
Stephanie Sannar said she and her husband, Toby, of Colorado Springs, Colo., sold their home for less than they owed on their mortgage in 2012. Mrs. Sannar, 42 years old, an emergency-room nurse, said her credit score fell to about 650 following this process since the mortgage was in her name.
Still, the couple has been receiving many credit-card offers in the mail, and Mrs. Sannar said she recently signed up for a Citigroup Inc. credit card with a credit limit of about $15,000.
“I was surprised they’d give so much,” she said. “The credit-card offers come every week.”
“When evaluating potential customers we consider a number of factors, and FICO is just one dimension,” said a Citigroup spokeswoman. The bank said it focuses on “high-quality acquisitions and loan growth” and that its subprime acquisitions have been consistently down on a year-over-year basis.
U.S. banks posted a 4% decline in net operating revenue for the first quarter from a year earlier, according to the Federal Deposit Insurance Corp. The fall in revenue has been driven by plunging mortgage lending and a drop in trading activity.
In the credit-card business, new regulations make it harder for lenders to pursue certain practices that historically have generated billions of dollars in revenue. Among other things, the Credit Card Accountability Responsibility and Disclosure Act of 2009 makes it more difficult for issuers to jack up interest rates on existing balances.
Bank executives said part of their goal is to reach out to consumers who fell on hard times in the financial crisis but now are in a more stable position.
Richard Fairbank, chief executive of Capital One Financial Corp., a financial holding company based in McLean, Va., said at an investor conference last month that many card companies target subprime customers. He referred to some of them as “fallen angels” and “the accidental subprime.”
During the last recession, rising unemployment led to a surge in late payments, and banks nearly shut off lending to borrowers with less-than-stellar credit records. Now, however, borrowers of all stripes are having an easier time repaying their debts, reducing the risk of subprime lending and emboldening banks to venture back in. According to the Equifax report, which excludes credit cards that can only be used at retail store chains, the portion of card accounts that were 60 days or more past due fell below 1% in May, the lowest rate since 2005.
Charge-offs, or losses from unpaid credit-card debt that banks have declared uncollectable, fell 13% to $27.7 billion in 2013 from a year earlier, according to data from the Federal Reserve compiled by CardHub.com. At the peak in 2009, charge-offs totaled $85.4 billion.
It isn’t clear how long banks will keep wooing subprime borrowers. The Fed’s April survey of senior loan officers found lenders anticipate growth in outstanding loans to their most creditworthy customers this year, but only “a smaller net fraction” of banks expect more growth in loans to nonprime borrowers.
Wells Fargo & Co., the fourth-largest U.S. bank by assets, had more than $2.1 billion in credit-card balances with borrowers whose FICO scores ranged from 600 to 639 in the first quarter, up 9% from a year earlier and 18% from two years earlier, according to company filings. A spokeswoman said these balances account for 8% of the bank’s credit-card balances, a figure that hasn’t changed from the end of 2011.
Capital One, a major subprime credit-card lender and the ninth-largest U.S. commercial bank by assets, has reported that about one-third of its U.S. credit-card balances belonged to borrowers with FICO scores of 660 or lower or who had no score by the end of the first quarter, according to company filings.
A Capital One spokeswoman said the bank lends to all types of consumers and its strategy is to provide reasonable access to credit with safety measures to help cardholders stay on track and build their credit.
“You’re starting to see an environment where issuers are feeling more comfortable to extend credit,” said Jason Kratovil, vice president of government affairs for payments at the Washington-based Financial Services Roundtable, which represents financial-services institutions. “Even though [those borrowers] could be considered subprime, they’re still creditworthy.”
“But as interest rates began their long fall, pension funds faced a dilemma. Staying heavily invested in bonds would force governments either to set aside more cash upfront or to cut pension promises. So instead, pension funds radically changed their investment strategies, embracing investments that produce higher returns but also involve more risk. This shift has replaced an explicit cost with a hidden one…
…that lawmakers will have to divert more tax dollars into pension funds, cut back on benefits or both when stock market crashes cause pension fund asset values to decline……Plunging returns on safe investments over the last few years are a sign of broadly increased investment risk and tepid prospects for economic growth. It won’t be impossible for pension funds to meet a return target of 7 to 8 percent in that environment, but doing so will involve taking on a lot of risk — which means the next stock market crash is likely to also bring another round of exacerbated state fiscal crises and cuts to pension benefits. It’s the way we’re paying for what looks like a free lunch of high investment returns on stocks. A return to boring pension funds that invest mostly in bonds would make the cost of pensions explicit and upfront, and would not subject governments to pension crises when the economy goes bad.”, Josh Barro, “Why Government Pension Funds Became Addicted to Risk”, New York Times
“Again, this NYT’s article makes clear that investors…whether they are private, for-profit institutional investors or public pension funds….are knowingly taking on significant risks to meet either investor expectations for higher returns or to avoid painful actions (like cutting pension benefits or increasing pension plan contributions). These economic and political decisions fuel demand for riskier, higher-yielding assets. Just like they fueled demand for trillions of dollars in private MBS and other higher-yielding, but riskier securities in the period before the 2008 financial crisis. These investors have never been fooled by the increased risks inherent in these securities (as some claim). I believe that the important risks are and were (pre-crisis), for the most part, fairly and properly disclosed. I also believe that for securities markets to work, private and public investors have to be responsible for the consequences of their own decisions (to significantly increase their investment risk appetite in order to earn superior returns). Private securities markets won’t work in the long run if these investors claim (and are lauded for) the superior profits of increased risk-taking during good economic times, but disown the extraordinary losses that occur during bad economic times as a result of their increased risk-taking. And even worse, they and the securities regulators like the SEC inappropriately blame others (the lenders and securities issuers and underwriters) for their own decisions and losses. (I believe this also has resulted in a poor understanding of the root, economic and political causes of the financial crisis.)” Mike Perry, former Chairman and CEO, IndyMac Bank
Why Government Pension Funds Became Addicted to Risk
By Josh Barro
A public pension fund works like this: The government promises to make payments to its employees after they retire; it invests money now and uses those investments, and the returns on them, to make those promised payments later.
Back when interest rates were high, this was fairly simple to do. Pension funds could buy bonds — ideally bonds that would mature around the time they would need the money to pay pensioners — and use the interest on those bonds to fund the payouts. In 1972, more than 70 percent of pension fund investment portfolios consisted of bonds and cash, according to a new analysis from the Pew Charitable Trusts and the Laura and John Arnold Foundation.
But as interest rates began their long fall, pension funds faced a dilemma. Staying heavily invested in bonds would force governments either to set aside more cash upfront or to cut pension promises. So instead, pension funds radically changed their investment strategies, embracing investments that produce higher returns but also involve more risk. This shift has replaced an explicit cost with a hidden one: that lawmakers will have to divert more tax dollars into pension funds, cut back on benefits or both when stock market crashes cause pension fund asset values to decline.
The shift began with pension funds’ adoption of portfolios consisting mostly of stocks, with only about a quarter of their investments in bonds. Then, in the last few years, they rapidly expanded their use of “alternative” asset classes like hedge funds, private equity, commodities and real estate. As of 2012, the typical pension fund investment portfolio was about half stocks, a quarter bonds and cash, and a quarter alternative investments.
The shift has allowed public pension funds to adjust to a sharp drop in bond interest rates. Between 1992 and 2012, the yield on 30-year Treasury bonds fell 4.75 percentage points; on average, large government pension funds cut their investment return targets by just 0.7 of a percentage point over that period.
And the shift has been, in one sense, a success: Pension funds continue to hit their target returns, on average. After the stock market crash of 2008-9, pension funds’ typical goals of annual returns around 8 percent were often criticized as unrealistic, but the National Association of State Retirement Administrators notes that public pension funds have earned annual returns of 9 percent on average over the last 25 years, despite falling interest rates and gyrating stock prices.
The key caveat in that statement is “on average.” While the old bond-heavy investment strategy produced steady, stable returns, a pension fund that is full of risky investments will swing heavily, soaring in value when the economy is strong and tanking when it is weak. The recent fashion for investing in managed investment funds, like private equity funds, has also put taxpayers in the position of paying management fees for services of dubious value.
Advocates of public pension funds typically say state and local governments are in a good position to absorb investment risk and can effectively create value by investing in high-return stocks and using the expected returns to make bondlike promises. “A pension fund, unlike individuals, does not need to be concerned about the stock market’s short-term fluctuations,” according to Dean Baker, co-director for the Center for Economic and Policy Research.
But if this were true — if governments were indifferent, or nearly indifferent, to investment risk — then they would have an enormous arbitrage opportunity on their hands. They could borrow money on the bond market at low rates and invest it in the stock market for high expected returns, using the proceeds to finance not just pension payouts but all kinds of government operations.
The reason governments don’t do this is that they are not actually indifferent to investment volatility. When asset values fall, governments come under pressure (and, in some states, court order) to increase their annual contributions to pension funds to shore them up. Typically, those stock price declines come at the same time that a weak economy is pushing tax receipts down and demand for government services up. A government that does not make those shoring-up contributions can end up in a downward spiral, where the pension fund’s investment projections rely on investments that do not exist, and the pension system’s funding gap continues to grow indefinitely.
In the last few years, the need to shore up pension funds has been a key stressor on state and local budgets. In some places this has led lawmakers to cut back on pension benefits, while in others, the benefits are protected by constitutional provisions or the political power of public employees. On the other hand, periods of excellent returns on pension fund stock investments can create political pressure for pension benefit increases, which many jurisdictions handed out as stock prices soared in the late 1990s — and then came to regret as the tech stock bubble burst.
The volatility of stock returns is why pension funds invested in bonds in the first place. And it’s most likely a driver of the recent rush toward alternative investments, which went from 11 percent of pension portfolios in 2006 to 23 percent in 2012, according to Pew; nearly the entire shift has come at the expense of stocks.
The theory with alternatives is that they earn a premium return in exchange for the difficulty of investing in them. Small investors lack easy access to these asset classes, and the investments are often illiquid: You can’t call up your broker and sell an office building in 15 minutes to raise cash. As a result, by investing in alternatives, pension funds should be able to get either returns similar to those of equities at a lower risk, or higher returns at a similar level of risk.
That’s the theory. The evidence on alternative investments is considerably more mixed. Hedge funds are supposed to pursue equity-like returns with lower levels of risk. But as Antti Ilmanen of the investment manager AQR Capital Management describes in his guide “Expected Returns on Major Asset Classes,” the historical returns of hedge funds are most likely overstated because of reporting biases. Hedge funds don’t have to report their performance to public databases, and are more likely to do so when returns are good.
They often engage in strategies that produce modest regular returns at the expense of rare catastrophic losses, which may make their track records look misleadingly strong. And though skilled fund managers can identify opportunities for above-normal returns without increased risk, a rush of investment capital into hedge funds has pushed those average “alpha” returns (that is, returns after adjustment for risk) down over time.
While Mr. Ilmanen provides a mixed verdict on hedge funds, his verdict on private equity is negative. “The typical PE manager is skillful enough to outperform public indices on a gross basis, but the benefits of these skills accrue primarily to the manager and not to the investor,” he writes, because management fees exceed the excess gross returns generated by private equity funds.
Big management fees are something that private equity and hedge funds have in common, unlike stocks and bonds, which pension systems can generally manage on their own. So it’s no surprise that, as pension funds doubled their allocation to alternatives between 2006 and 2012, their spending on management fees also rose sharply, from 0.28 percent of assets to 0.37 percent, again according to Pew.
A rise of 0.09 of a percentage point may not sound like much, but since public pension funds manage approximately $3 trillion in investments, that means an additional $3 billion a year being spent on management fees — in the case of fees to private equity managers, probably not in exchange for much.
Plunging returns on safe investments over the last few years are a sign of broadly increased investment risk and tepid prospects for economic growth. It won’t be impossible for pension funds to meet a return target of 7 to 8 percent in that environment, but doing so will involve taking on a lot of risk — which means the next stock market crash is likely to also bring another round of exacerbated state fiscal crises and cuts to pension benefits.
It’s the way we’re paying for what looks like a free lunch of high investment returns on stocks. A return to boring pension funds that invest mostly in bonds would make the cost of pensions explicit and upfront, and would not subject governments to pension crises when the economy goes bad.The Upshot provides news, analysis and graphics about politics, policy and everyday life.
“The American colonial slogan “No Taxation Without Representation” described our grievance with Britain and led to our Country’s founding. Shouldn’t the inverse also be true; “No Representation Without Taxation”? With Mississippi getting $3 from the federal government for every $1 they send in (a situation that has occurred for years), should its citizens continue to have voting representatives in Congress or is there some other way to address this flaw inherent in our beautiful U.S. democracy?”, Mike Perry
“Instead of racing to the right, Cochran ran on his talents as a collector of federal money…. He spreads a wide net, from cotton subsidies to food stamps to military contracts to special education in public schools….. Nobody came straight out and said: “Look, Mississippi gets three bucks back from the federal government for every dollar we send in. Don’t kill the golden goose.” But the message was pretty clear, and in some ways a little revolutionary. Like voters in many poor, conservative states, Mississippians have spent decades happily deluding themselves that they’re victims of Washington rather than its top beneficiaries.”, Gail Collins, “Mississippi Goes for the Money”, New York Times OpEd The Opinion Pages | Op-Ed Columnist |NYT Now
Mississippi Goes for the Money
How Did Brett Favre Help Thad Cochran in His Senate Race
Gail Collins Mississippi has sent us a message. I believe it boils down to: We Want Our Stuff. Big election night! As you no doubt have heard, Senator Thad Cochran, a Republican who specializes in sending billions of dollars in federal pork back into his state, defeated a Tea Party challenger who ran against government spending. It wasn’t easy. Cochran’s fierce and energetic opponent, Chris McDaniel, forced him into a primary runoff. To survive, Cochran turned to Democrats, who took advantage of Mississippi’s open primary laws and tossed Thad a vote. Or at least turned out to give McDaniel a kick in the shin. “We are not prone to surrender, we Mississippians,” McDaniel declaimed once the results were announced. “A strong and sturdy people we are. A brave people we are!” He appeared to either be planning to demand an investigation or try out for a role in the next Hobbit sequel. “Those guys are not good losers,” mused Curtis Wilkie, a journalism professor at the University of Mississippi. The runoff was kind of fascinating. Cochran, who is something less than a fireball orator, rambled on at one event about his childhood visits to a farm and doing “all kinds of indecent things with animals.” One of the many, many political action committees involved in the campaign put that in a McDaniel ad, along with a rant about Obamacare and a demand that voters “tell Thad Cochran you’re no farm animal.” Meanwhile, McDaniel got support on the stump from former “The Dating Game” host Chuck Woolery and the parents from the reality show “19 Kids and Counting.” I am not sure how all these thoughts merge together, but as you can see, it was way more interesting than your average Senate primary. These days, when a Republican politician gets into primary trouble, his first move is usually to leap farther right, assuring voters that he is capable of being even angrier and crazier than his opponent. That’s what gives the Tea Party its power. To use a zombie metaphor — and who among us does not love a zombie metaphor? — the Tea Party (Dead But Undead) wins not by killing its opponents but by turning them into drooling, staggering replicas of itself. Cochran is plenty conservative on most issues, except the one the Tea Party cares most about. He’s a true believer in the power of the federal government to use tax dollars to improve the lives of its citizens. He spreads a wide net, from cotton subsidies to food stamps to military contracts to special education in public schools. Instead of racing to the right, Cochran ran on his talents as a collector of federal money. When Mississippians turned on their TVs, there was former Senator Trent Lott, warning voters that without Cochran, Mississippi might lose the Stennis Space Center. Or football hero Brett Favre, reminding people that Cochran got them a ton of help for rebuilding after Katrina. Or an announcer thanking Thad for “our aerospace industry, shipbuilding, military bases, research and development, agricultural breakthroughs.” Nobody came straight out and said: “Look, Mississippi gets three bucks back from the federal government for every dollar we send in. Don’t kill the golden goose.” But the message was pretty clear, and in some ways a little revolutionary. Like voters in many poor, conservative states, Mississippians have spent decades happily deluding themselves that they’re victims of Washington rather than its top beneficiaries. You could argue that Thad Cochran staged an intervention for his state’s residents, in which he pierced, at least temporarily, their veil of denial. McDaniel played right into the old fantasy world, assuring voters that they could eliminate federal spending on education, which amounts to a quarter of Mississippi’s public school budget, without suffering any financial damage. He seemed shocked when it didn’t work. In his refuse-to-concede speech, he denounced Cochran for “once again, reaching across the aisle” a practice he seems to find as offensive as federal aid to education. McDaniel blamed his defeat on “liberal Democrats.” Actually, most of Cochran’s support came from Republicans, but since he won by less than 7,000 votes, you could definitely argue that Democratic Mississippians — most of whom are black — were the ones who saved his bacon. “First time in my life I ever voted in a Republican primary,” said Wilkie, 73. Cochran will almost certainly be re-elected in November. When he gets back to Washington he’ll be 77, starting a new six-year term. With nothing to lose and scores to settle. Really, he could do anything. March in a gay pride parade. Announce that an angel had appeared to him in a dream and told him that God wants us to increase the gas tax to combat global warming. Or at least maybe someday, if the president needs a vote, Cochran will remember who gave him a hand, and return the favor.