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There’s a sad truth about the fate of financial regulation: It’s almost certain to be outmoded by the time it’s introduced. This was as true of Glass-Steagall in 1933 as it is of Dodd-Frank today. This month we begin the third year since the Dodd-Frank Wall Street reform act passed, with the struggle over its shape ongoing. It’s a still-unmolded toddler, and already on the fast track to fossilization. Does the most ambitious finance legislation in decades carry the DNA to successfully cope with the next crisis? In a word, no. The take-away from this challenge doesn’t have to be cynicism, inaction, or laissez-faire tirades. To be ready for the next shock rather than the last one, though, we need to reset our thinking. Dodd-Frank is based on the idea that financial markets are normally stable, with the exception of the occasional alarming “event.” The New Deal’s Glass-Steagall Act and the Clinton-era Gramm-Leach-Bliley “Modernization” shared those assumptions. All of these efforts were conceived as system-wide overhauls. In reality, though, they were designed only to remedy random, ad hoc crises; shocks like the 2008 meltdown, sometimes called “Minsky Moments.” Ironically, the late economist Hyman Minsky actually believed that these “moments” were anything but. At the Levy Institute, we share his view that instability is central to the genome of modern finance…. Read More

With yesterday’s quarterly BLS data release on “usual weekly earnings” out, I have once again constructed some “alternative” measures of real wages, based on price indexes for food commodities at the wholesale level. The commodity-based indexes are depicted in the figure above with lines in various colors. Compared to the more typical measure of real, or inflation-adjusted, earnings, which is seen in black, the food-commodity wages may be of interest in different contexts: for consumers who spend relatively large portions of their budgets on food, for example, or to those following the debate over the unfortunate SNAP (food stamp) cuts in the farm bills recently passed by the Senate and the House Agriculture Committee (see this earlier post). Inflation at the wholesale level is sometimes a harbinger of similar trends in prices paid by consumers at retail stores, so the series shown above may be most helpful as indicators of possible future trends in the standard of living.  Along these lines, the Financial Times reports that prices for food commodities will be higher this decade than last, according to two major forecasters.  The cited reasons for the expected rise in food-commodity prices include an expected upward trend in the price of oil, climate-related crop failures, and demand from emerging economies. It is best, given that the data are not seasonally… Read More

Correlation is not causation, of course, but I’m beginning to suspect that there might be some operational relationship between the frequency with which you hear people complaining about the crippling burden of government debt, and a fall in the cost of government borrowing. Last week the Financial Times reported that investors had accepted “the lowest yields ever for 10-year paper in a US Treasury auction.”  Right on schedule, the Washington Post announced yesterday that a shiny new campaign, organized by former politicians and business leaders, has been put together to tackle the clear and present dangers of government debt, advocating “a far-reaching plan to raise taxes, cut popular retirement programs and tame the national debt.” To be fair, it seems there is always a new campaign being announced for taming the national debt (this particular initiative features some plucky newcomers named Erskine Bowles and Alan Simpson).  But there are problems with the projections underlying these arguments about the long-term unsustainability of federal debt.  And in the short run, it’s becoming increasingly difficult to understand what problem is supposed to be solved by decreasing government borrowing. Thankfully, the conventional wisdom is beginning to solidify around the belief that we need to avoid the “fiscal cliff,” but this justified fear of the huge fiscal contraction scheduled for 2013 has so far not… Read More

Local government officials in San Bernardino county have apparently heard enough about how the overhang of mortgage debt is holding back the recovery, and they’re considering taking matters into their own hands.  Reuters‘ Matthew Goldstein and Jennifer Ablan report on the background discussions leading up to a proposal that is being considered by officials in San Bernardino, California—a county where almost half of all mortgages are “underwater.”  The general idea is to use eminent domain as a kind of mortgage debt forgiveness program:  principal reduction would be achieved by forcing the sale of mortgages that have been packaged into securities; the mortgages would then be restructured on more favorable terms.  Homeowners with underwater mortgages who are current on their payments would be able to participate. Randall Wray and Paul McCulley are quoted in the piece, with the latter describing the program as “[a] legal system-midwifed, modern-day jubilee.”  Read the article here.

From the announcement of a new joint research project by Mariana Mazzucato and the Levy Institute’s Randall Wray (“Financing Innovation: an Application of a Keynes-Schumpeter-Minsky Synthesis”): The purpose of this project is to integrate two research paradigms that have strong policy relevance in understanding the degree to which financial markets can be reformed in order to nurture value creation and ‘capital development’, rather than value extraction, and destruction.  The first one might be called the Keynes-Minsky vision that puts effective demand front and center of economic analysis, and the second is the Schumpeter-Minsky vision that places innovation at the center of competition theory, rather than relegated to the periphery of imperfect competition. The project will bring the two visions together to provide rigorous analysis of competition in the financial sphere and how it interacts with competition in the industrial sphere. The new framework will help us better understand the difference between creative destruction and destructive creation, and its applicability to new periods of economic growth such as that which will hopefully result from the green technology revolution.

When the European Monetary Union was set up, member-states adopted what was essentially a foreign currency (the euro) but were left in charge of their own fiscal policy.  Dimitri Papadimitriou and Randall Wray explain in a new Policy Note (“Euroland’s Original Sin“) why this basic structural defect was always bound to tear the eurozone apart.  The solvency crises and the bank runs afflicting Spain, Greece, and Italy were entirely foreseeable (and as Papadimitriou and Wray point out, entirely foreseen).  Unless something is done to remedy this design flaw, the EMU will continue to crumble. The banking crises laid bare what happens when you try to separate fiscal policy from a sovereign currency:  “banks were freed to run up massive debts that would ultimately need to be carried by governments that, because they had abandoned currency sovereignty, were in no position to bear the burden,” say Papadimitriou and Wray.  Inasmuch as they are users rather than issuers of a currency, EMU nations are essentially in the same position as US states—but the difference is that US states can rely on the currency-issuing firepower of the federal government (when Texas was hit with the S&L crisis in the 1980s, the federal government picked up the tab; a tab that was about one quarter the size of Texas’ entire GDP).  And the problem… Read More

As the Center on Budget and Policy Priorities (CBPP) has reported in several recent postings, cuts to SNAP—formerly known as the food stamp program—now being considered in Washington would impose severe hardship on millions of people who use SNAP benefits to buy groceries in retail stores. For example, the Center released a report a few days ago on cuts to the program contained in the farm bill recently proposed by House Agriculture Committee leaders. These three points, quoted from the report, summarize the impact of the proposed cuts: The bill would terminate SNAP eligibility to several million people.  By eliminating categorical eligibility, which over 40 states have adopted, the bill would cut 2 to 3 million low-income people off food assistance. Several hundred thousand low-income children would lose access to free school meals.  According to the Congressional Budget Office (CBO), 280,000 children in low-income families whose eligibility for free school meals is tied to their receipt of SNAP would lose free meals when their families lost SNAP benefits. Some working families would lose access to SNAP because they own a modest car, which they often need to commute to their jobs.  Eliminating categorical eligibility would cause some low-income working households to lose benefits simply because of the value of a modest car they own.  These families would be forced to… Read More

A few months ago we wondered why it was that business groups hadn’t been pushing harder for more stimulus.  My proposed (unoriginal) explanation had to do with inequality and decoupling; Paul Krugman suggested social pressures might also play a part.  But as it turns out, there’s another answer:  they are pushing!  The National Association of Manufacturers (NAM) recently endorsed expanding a government program with the intent to directly and indirectly create one million jobs. Bruce Bartlett (former Treasury Secretary in the Reagan administration) highlights the fact that the influential NAM has released a report detailing how the defense spending cuts scheduled for 2013 as a result of the Budget Control Act (the debt ceiling deal from last summer) will harm employment and growth.  So technically this isn’t really an example of pushing for more stimulus; we’re just talking about preserving levels of funding and preserving jobs.  But the logic of the NAM position goes a long way. For instance, they argue that the knock-on effects of restoring the public spending cuts would create a substantial net number of jobs in the private sector.  In other words, they have implicitly abandoned the argument that increasing government spending or public job creation (above scheduled 2013 levels) would “crowd out” private spending and job creation, embracing instead some version of a multiplier effect. … Read More

Alan Greenspan is apparently writing a book to determine why economic models (all of them, he says) failed to sniff out the financial crisis and ensuing recession. “While the models themselves capture the nonfinancial part of the economy rather well,” says Greenspan, “they’ve been wholly inadequate in understanding how the complex financial system works, both in the United States and globally.” As it happens, the Levy Institute’s Hyman P. Minsky Summer Seminar just finished up, and last week Gennaro Zezza presented on the stock-flow consistent model used here at the Institute.  The approach embedded in this model, originally inspired by Wynne Godley and still being refined and expanded, is notable for the manner in which it looks at the relationship between finance and the real economy.  For an explanation of its contours and to see how it differs from some of the more orthodox models Greenspan presumably has in mind, this paper by Zezza (“Fiscal Policy and the Economics of Financial Balances”) is a good place to start.  As the paper illustrates, the model has had a pretty good track record. Godley and Marc Lavoie’s “Monetary Economics” (recently discussed by Lavoie in a two–part interview with Philip Pilkington) describes some of the early challenges with obtaining good data on the financial flows that are part of this approach (pp. 24-25). … Read More

Brad Plumer reports that a Texas-based bank and a pair of conservative advocacy groups have filed suit against the Consumer Financial Protection Bureau, claiming that the agency is unconstitutional (the agency was created by the Dodd-Frank Act and was a longtime cause of senatorial candidate Elizabeth Warren, who had a hand in setting it up). Normally, this is the sort of story that wouldn’t merit a pause.  But given the fact that we’re now patiently waiting for the Supreme Court to rule on the constitutionality of the Affordable Care Act (“Obamacare”), with many expecting that the Court will strike down some portion of the law—a scenario very few people took seriously when the law passed—anyone interested in financial regulatory reform should probably start paying attention to this lawsuit.  (Plumer has posted a copy of the suit, which also targets FSOC, the Financial Stability Oversight Council.) Despite the numerous flaws in the regulatory approach taken by Dodd-Frank, many of which have been highlighted by Levy Institute scholars (see, for instance, here, here, and here), Randall Wray and Yeva Nersisyan argued (in a paper written when the law was being put together) that the idea of the CFPB was “the best part of the proposal put forward by Washington.” According to a CFPB spokesperson cited by Plumer, “this lawsuit appears to dredge… Read More

In my last post, I quoted Joan Robinson, the renowned Cambridge University economist, on the determinants of long-term interest rates. The mention of Robinson was made in the context of a comment on the Fed open market committee meeting earlier this week and Chairman Ben Bernanke’s press conference on Wednesday. For those who might be curious, here is the “cheap money” scenario from Robinson that I mentioned in the earlier post; astute readers will notice parallels in recent Fed history: The first move in the campaign is for the Central Bank to dose the banks with cash, by open market purchases. The amount of advances the banks can make is limited by the demand from good borrowers. The demand is very inelastic (though it shifts violently up and down with the state of trade), so the banks, between whom competition is highly imperfect, see no advantage in cheapening their price. The redundant cash reserve must go into bills. Any rate of return is better than none. The banks with redundant cash find themselves in much the same position as a group of firms with surplus capacity and zero prime costs. If perfect competition prevailed, the bill rate would go to next to nothing and the banks could not cover their costs. They therefore fix up a gentlemen’s agreement which keeps… Read More

As I write, markets are wondering what Fed Chairman Ben Bernanke will say about interest rates in a press conference taking place this afternoon. Many economists, including some on the Federal Reserve’s rate-setting committee, are arguing that the Chairman is courting inflation with his policies of keeping interest rates low. He has been using three main approaches to this task: (1) keeping short-term interest rates low through open market operations; (2) buying and holding medium- and long-term bonds in a direct bid to keep longer-term rates low; and (3) saying that it is likely to keep the federal funds rate near zero for an extended period of time. Task (1) has been the usual approach of the Fed in modern times (since the early 1950s perhaps); task (2) has been important since the Fed’s response to the financial crisis beginning in 2008 or so. The current version of task (2) consists largely of a “twist” operation in which short-term securities are sold to pay for purchases of long-term securities. Task (3) is a commitment of sorts about short-term rates that helps to keep longer-term rates down. Tasks (2) and (3) are the most directly relevant to mortgage and auto loan rates, which are longer-term rates. Economists, including critics of the Fed’s expansionary policies, sometimes refer to this three-pronged approach as… Read More