“There is not much evidence that these policies (macroprudential regulations) prevent financial bubbles. But there is great risk in allowing a small group of unelected technocrats to determine the allocation of credit in the U.S. economy…
…Government regulators are no better than private investors at predicting which individual investments are justified and which are folly. The cost of macroprudential regulation in the name of financial stability is almost certainly even slower economic growth than the anemic recovery has so far yielded.”, Paul H. Kupiec , “When Central Bankers Become Central Planners”, Wall Street Journal
When Central Bankers Become Central Planners
Macroprudential regulation is not likely to prevent asset bubbles. But credit allocation will depress growth.
PAUL H. KUPIEC
Sept. 28, 2014 7:01 p.m. ET94 COMMENTS
Stanley Fischer, vice chairman of the Federal Reserve, has been tapped to head the Fed’s new financial stability committee. In recent speeches both Mr. Fischer and Fed Chair Janet Yellen have argued that so-called macroprudential regulation can prevent asset bubbles from erupting while the Fed maintains near-zero interest rates. There is not much evidence that these policies prevent financial bubbles. But there is great risk in allowing a small group of unelected technocrats to determine the allocation of credit in the U.S. economy.
Macroprudential regulation, macro-pru for short, is the newest regulatory fad. It refers to policies that raise and lower regulatory requirements for financial institutions in an attempt to control their lending to prevent financial bubbles.
These policies will not succeed. Consider the most common macroprudential tool: raising or lowering bank minimum capital standards. Academic research—including a recent study I co-authored with Yan Lee of the Federal Deposit Insurance Corp. and Claire Rosenfeld of the College of William and Mary—has found that increasing a bank’s minimum capital requirements by 1% will decrease bank lending growth by about six one-hundredths of a percent.
Other studies have examined the effect on loan growth of raising a bank’s minimum capital requirements by 1%, using data from different countries and different measurement techniques. They have found a similarly minor effect—between seven and 13 basis points. The economic magnitude is trivial.
Banks adjust their lending in response to a host of factors including pressure from bank regulators, changes in their funding cost, losses on their outstanding loans and other factors. Changes in regulatory capital and liquidity requirements have only the weakest detectable effects on lending.
There is also the very real risk that macroprudential regulators will misjudge the market. Banks must cover their costs to stay in business, and in the end bank customers will pay the cost banks incur to comply with regulatory adjustments, regardless of their merit. By the way, when was the last time regulators correctly saw a coming crisis?
Other common macroprudential tools include varying maximum loan-to-value ratios and debt-to-income limits. Yet in aspeech on July 10 Mr. Fischer noted that changing minimum capital requirements and maximum loan-to-value ratios on mortgage loans in Israel had little effect on attenuating a mortgage-lending boom that raised central bank stability concerns beginning in 2010.
When short-term interest rates are low and long-term rates are high, borrowers prefer to use short-term or floating-rate debt to minimize interest payments. And so it was in Israel when a surge in mortgage-lending growth was fueled by mortgages keyed to low short-term interest rates. When higher capital requirements and lower loan-to-value limits did not work, the Bank of Israel reduced the growth in mortgage lending by requiring banks to tie mortgage rates to long-term interest rates, effectively prohibiting cheap variable-rate mortgages.
With Mr. Fischer now heading the Fed’s new financial stability committee, might we soon see regulations requiring product-specific minimum interest rates? Or maybe rules that single out new loan products and set maximum loan maturities and debt-to-income limits to stop banks from lending on activities the Fed decides are too “risky”? None of these worries is an unimaginable stretch.
Since the 2008 financial crisis, U.S. bank regulators have put in place new supervisory rules that limit banks’ ability to make specific types of loans in the so-called leverage-lending market—loans to lower-rated corporations—and for home mortgages. Since there is no scientific means to definitively identify bubbles before they break, the list of specific lending activities that could be construed as “potentially systemic” is only limited by the imagination of financial regulators.
Few if any centrally planned economies have provided their citizens with a standard of living equal to the standard achieved in market economies. Unfortunately the financial crisis has shaken belief in the benefits of allowing markets to work. Instead we seem to have adopted a blind faith in the risk-management and credit-allocation skills of a few central bank officials.
Government regulators are no better than private investors at predicting which individual investments are justified and which are folly. The cost of macroprudential regulation in the name of financial stability is almost certainly even slower economic growth than the anemic recovery has so far yielded.
Mr. Kupiec, a resident scholar at the American Enterprise Institute, has held senior positions at the Federal Deposit Insurance Corp., International Monetary Fund and Federal Reserve Board.