New Fed bank rules will solve nothing

Financial Review

PUBLISHED: 23 Jun 2012

Anna Bernasek 

Come into the time machine. I’ll set the dial for September 2008. The world – the financial world at any rate – has just ended. Credit markets have stopped working. Every major US financial institution is essentially bankrupt. Fear and panic prevail.

Let’s turn the dial forward to 2009. The world didn’t end; not even the financial world ended, since it received infinite backing from the US Treasury. But still, nobody’s happy. The economy is in the tank. So is the stockmarket. There’s no lending to speak of. Reform of the global financial system is the talk of the day.

Another twist of the dial and we’re in November 2010. The G20 has just made a bold promise: in two years, sweeping changes to strengthen global bank capital requirements will be adopted by major countries.

Step out of the time machine with me, back to June 2012. The US Federal Reserve just unveiled its plan to meet the G20 timetable. The new bank regulations are here!

Fed chairman Ben Bernanke hailed it as a model for the rest of the world. “I think this may well be the standard against which other capital regimes around the world may be measured going forward, and I hope that other countries, other jurisdictions, will meet this standard,” he bragged.

But after two weeks, banks and lawyers are still trying to figure out what those standards really mean.

Maybe that’s because the Fed’s proposal is 800 pages long. A once-through read took one bank’s team of experts three days. Bankers, lawyers, and lobbying groups continue to diligently comb through every page. So far they only agree on one thing: the complexity is awe-inspiring. Which should give one pause.

Every serious review of systemic failures leading up to the collapse cited excessive complexity as a major cause. Some view complexity as the whole problem. A month – even a day! – before Lehman Brothers collapsed, there was no way for investors or the public to assess if it was fully solvent or worthless. There were lots of rules and disclosures, but none was worth a damn.

Four years later, the vaunted fix for what was condemned as overly complex and therefore unsafe is more complexity. If the devil lurks in the details, in 800 pages he’s surely got plenty of places to hide.
“The irony is when this is done there will be less uniformity than before because of all the complexity”, says someone close to the process.

The level of complexity makes a mockery of public disclosure. The banks will say their capital is “x per cent”. But how in heaven’s name can anybody get a commonsense picture of what’s really going on? Only the bank (at least one hopes so) and perhaps the Fed have a prayer of gaining insight into bank risk.

So will these new rules change anything? They certainly include lots of new categories and definitions as the Fed plays catch-up to financial “innovators”. But if the new rules don’t curtail innovation, how long do you think it will take to devise something risky to shoehorn into an unforeseen (maybe intentional) linguistic gap?

Bankers and experts are trying to understand the differences globally. “The whole notion of whether we will have a level playing field is very high on people’s minds,” says Tom McGuire, head of Barclays Capital capital advisory group in New York.

After a historic financial crisis, US regulators have missed the mark.

Enter online sites at your own risk

Financial Review

PUBLISHED: 16 Jun 2012

Anna Bernasek 

The saying “don’t trust anyone over 30” came into vogue almost half a century ago. Perhaps now it should be “don’t trust anyone under 30”.

The custodians of our digital lives, the internet’s newly minted billionaires, are shockingly young. But while novel social media and purveyors of big data explode on the internet scene, age-old concerns about individual rights and liberties have not yet been addressed.

A glance at the sharemarket shows how large the impact has been on business. But longer-term effects on society and politics may be even more profound.

No one questions the cleverness of Facebook’s Mark Zuckerberg or Groupon’s Andrew Mason for instance. But as each new wave of twenty-somethings pushes technology into areas never before explored, who is thinking about the long term? Data security looks like an early warning sign.

Earlier this month LinkedIn, a respected professional networking site, reported the theft of more than 6 million user passwords. In itself that’s not too big a shock. Getting hacked is par for the course for many companies these days. The thing about stolen passwords, though, is that many people use the same password for lots of things. An errant message on LinkedIn is one thing, but a financial or medical intrusion would be quite another. And in LinkedIn’s case what surprised the experts was a minimal approach to data security.

Since the theft, LinkedIn says it has upgraded security. Many of the costs arising from the glitch won’t be borne by LinkedIn, though. LinkedIn’s users and the websites and businesses they frequent are poised to spend countless hours sorting out a potential mess.

LinkedIn isn’t alone. Other social networking sites, such as the online dating site eHarmony, have also reported bulk password theft. The internet is an ecosystem based on trust, so a problem in one area can affect many others.

Then there’s Facebook. A disastrous initial public offering left the company and its top managers looking greedy. The ensuing scrutiny put the company under a bigger spotlight and cracks are showing.

Facebook’s day-to-day business practices are raising eyebrows. Some users are getting an unwelcome surprise when they click the “like” button connected to a product. They find their name and photo appearing in an online ad promoting somebody else’s business. Had they read the Facebook user agreement, of course, this would have been no surprise. But show me someone who has the time to read the online user agreements they sign up for.

Even reading those agreements might not help. You’d probably need a lawyer to understand them. So, even if you read it, the user agreement would still be a farce, since it’s not as if you can change it.
In the long run, of course, these things tend to work out. Unreasonable user agreements will eventually give way to customer-friendly ones. But to be useful today, the agreements need to be clear and understandable, which they’re generally not.

With hundreds of networking, search and email sites, the problem is multiplied. The ever-expanding web of legal rights and relationships is too complex for an individual to cope with. Users simply don’t understand what they are getting into. Some have even found themselves in physical danger.

The latest case involves Skout, a social networking app designed for “flirting” between adults. When Skout figured out that children were using its site, they developed a separate service restricted to 13 to 17-year-olds. But adults managed to pose as teenagers, and now there are three cases of child rape associated with Skout.

The internet is nothing if not dynamic, with thousands of social experiments happening in real time. But the business model followed by many internet entrepreneurs raises red flags. It works something like this. First, figure out how to apply technology to something people want. Next, offer it for free with seemingly no strings attached. Then, after you build up millions of followers, spring the trap. Hold their data and relationships hostage as you exploit their trust for your commercial gain.

If you are lucky enough to get to critical mass, most users won’t leave because they don’t know how to get everyone else to go with them. Companies build up just enough trust to hook people in, but then they start consuming that asset. In many ways the internet looks like a get-rich-quick scheme where some prosper but leave much of the hard work to others.

So far internet companies have had a free pass on some big issues. Whether it’s sales tax, ownership of sensitive information, or data security, internet companies aren’t paying all their freight. Yet until the public and policymakers catch up, users are practically on their own. Maybe sites should be required to come with a warning: enter at your own risk.

Policy paralysis a horror show

Financial Review

PUBLISHED: 09 Jun 2012

Anna Bernasek 

Conservatives in the United States have argued for years that the government should get out of the business of managing the economy. A prominent Republican presidential candidate even wrote a book in 2009 entitled End the Fed. Now it looks like conservatives have gotten their way.

The signs couldn’t be any clearer that the US economy is slowing to a crawl. A mere 69,000 jobs were created in May with monthly jobs growth averaging only 96,000 in the past three months. At that rate, employment growth is too weak to keep up with population growth. Economic growth was also revised down in the first quarter to an annual rate of 1.9 per cent.

What’s more, the European crisis and incipient recession combined with the slowdown in China and India are all but certain to weigh on the US economy. Chief executives here express their concern about the outlook and some say they are putting hiring and investment plans on hold.

At best, the US economy is going nowhere. Yet policymakers have indicated they won’t do anything unless it gets a lot worse. Does that surprise you? It should. Until recently American policy was to make pre-emptive corrections when needed to fight a potential downturn or unwelcome change in inflation before it took hold.

But now, even as it’s readily apparent that we’re facing a major global downside risk, policymakers have painted themselves into a corner. On both the fiscal and monetary policy front, decision makers have effectively tied their own hands. Willingly or not, we have embarked on an historic experiment in laissez-faire economics.

Take a look at what’s happening at America’s deeply divided Fed. This week, several top officials spoke publicly about their positions. James Bullard, president of the St Louis Federal Reserve Bank, and Richard Fisher, president of the Dallas Fed dismissed the need for greater economic stimulus.

“The outlook for 2012 has not changed significantly so far,” Bullard said at a conference. “A change in US monetary policy at this juncture will not alter the situation in Europe.” And Fisher remarked: “Short of an implosion, I cannot support further quantitative easing.”

On the other hand, Charles Evans, the President of the Chicago Fed said this week: “We should be providing more accommodation.”

The problem for the Fed though is that with interest rates already as low as they can go, its main policy instrument, official interest rates, is simply not available or effective. While official rates are close to zero, the yield on 10-year Treasury bills fell to a record low of 1.44 per cent after May’s disappointing jobs numbers were released.

About the best the Fed can do is keep official rates near zero. But it’s already done that, promising rates will stay where they are until 2014.

What about quantitative easing? Much has been made about it as a radical way to stimulate the economy. The problem is that even if QE drives market rates lower, unless lots of borrowing ensues, the Fed hasn’t done a thing except energise its critics. That’s the thing about a liquidity trap. Policies that drive rates down ever lower lose their effectiveness.

There’s another thing the Fed can do. It could nudge up inflation expectations. But a deep ideological chasm divides not only politicians but American economists. There’s no sign – at all – of a purposeful increase in inflation.

So with the Fed effectively out of commission, that leaves things up to Congress and the President. Which isn’t much help because each party is hoping to gain in November’s election. Neither Democrats nor Republicans look to compromise now and potentially lose support from their base. Short of a full-blown financial crisis, don’t expect action from Washington.

Even worse, profound divisions in Europe have created a similar paralysis. That means the major chunk of the developed world is sitting on its hands at a time when prudence counsels action.

Welcome to a world we thought was a thing of the past. Forget about managing the global economy this year. It’s both terrible and fascinating to watch.

The analyst who's rarely wrong

Financial Review

 
PUBLISHED: 02 Jun 2012

Anna Bernasek

The most influential economist in America isn’t Fed chairman Ben Bernanke, or Alan Krueger on President Barack Obama’s staff. It’s a newspaper columnist named Paul Krugman.

Writing twice weekly for The New York Times, Krugman is without peer as a popular analyst of economic and fiscal matters. It’s not luck, of course. Krugman has enviable credentials, including a prestigious chair at Princeton and a not-yet-dusty Nobel Prize. But those credentials aren’t what make him unique.

Krugman’s widespread influence comes from just how well he’s been doing his job. Since he started writing for a general readership in the 1990s, Krugman has forcefully taken each of the Clinton, Bush and Obama administrations to task on economic policy matters. And, as one observer put it, his record has been “uncannily right”.

With the release of his latest book, End This Depression Now!, Krugman has launched an all-out attack against fiscal austerity and inserted himself in the middle of a battle for the future prosperity of the US and Europe.

Typically caricatured as an “arch-liberal” by political and academic opponents, when read fairly Krugman has been a moderate but fearless critic of politicians and policymakers of all stripes. He leaped to national prominence in the run-up to the 2000 election, laying bare the intellectual void behind then candidate George W. Bush’s economic plans.

Since filing his first Times column in 2000, Krugman has hammered away at Bush’s war-mongering, tax cuts and fiscal profligacy, and more recently at President Obama’s triangulations to appease a divided electorate.

And he hasn’t been shy about criticising the Fed under Alan Greenspan or Bernanke (a friend and fellow Princetonian).

Putting his analysis above personal loyalties has earned him a reputation as a polarising figure and making him a lightning rod for public opinion. To a degree usually reserved for the politically powerful, one either loves Krugman him or hates him. There’s not much middle ground.

But to the dismay of his many critics, the columnist’s record has become pretty impressive. In 12 years of writing two columns a week plus books and blog posts, virtually everything Krugman says has been dissected and debated. In all that time mistakes and wrong calls have been few.

More important, he’s been dead right on the most critical issues. The Bush economic plan did turn out to be intellectually bankrupt; his tax cuts did turn out to be irresponsible and corrosive. And Obama’s stimulus did turn out to be too small.

It’s not unusual to hear fellow economists remark that they started out disagreeing with Krugman on one issue or another, only to grudgingly admit he was right later on.

So what is Krugman saying now?

As a specialist on global trade and currencies, his opinion on the European Union and the euro was sought from the start.

And he has not been optimistic about the future of the euro. He consistently warned that a common currency among such diverse countries, without a strong political union, would eventually self-destruct.

In Krugman’s view the only way to save the euro (he thinks it’s already too late to save Greece) is to raise inflation targets and stimulate growth through spending. And he believes Germany needs to take on a bit of inflation and spend more.

While Germany still seems a long way off accepting that proposition, international opinion seems to be shifting Krugman’s way. The IMF, some G8 leaders and the OECD have quietly dropped their austerity language and called on Europe to adopt policies promoting growth, rather than retrenchment.

In the US, Krugman argues that years of slow growth and stubbornly high unemployment are completely unnecessary. All it would take is for the government to start spending again.

He identifies several areas where spending and the boost to the economy would be quick and provide long-lasting benefits: rehire millions of teachers who have been laid off across the country, invest in road, rail and water infrastructure, and provide real relief for homeowners saddled with bloated mortgages.

The trouble Krugman runs into is that, while in the long run it’s in the interest of us all to promote growth, in the short run potent interests are determined to preserve the status quo.

Despite his persuasive arguments, there’s still a big hill to climb politically. But judging from Krugman’s record, it won’t turn out well for those who ignore him.