Along came Phil

Gramm, former Senator from the state of Texas to set a few facts straight in the Wall Street Journal about the cause of the financial crisis. I.e., it wasn't deregulation of the banking system;

Regulators also eroded the safety of the financial system by pressuring banks to make subprime loans in order to increase homeownership. After eight years of vilification and government extortion of bank assets, often for carrying out government mandates, it is increasingly clear that banks were more scapegoats than villains in the subprime crisis.

Similarly, the charge that banks had been deregulated before the crisis is a myth. From 1980 to 2007 four major banking laws—the Competitive Equality Banking Act (1987), the Financial Institutions, Reform, Recovery and Enforcement Act (1989), the Federal Deposit Insurance Corporation Improvement Act (1991), and Sarbanes-Oxley (2002)—undeniably increased bank regulations and reporting requirements. The charge that financial regulation had been dismantled rests almost solely on the disputed effects of the 1999 Gramm-Leach-Bliley Act (GLBA).

Prior to GLBA, the decades-old Glass-Steagall Act prohibited deposit-taking, commercial banks from engaging in securities trading. GLBA, which was signed into law by President Bill Clinton, allowed highly regulated financial-services holding companies to compete in banking, insurance and the securities business. But each activity was still required to operate separately and remained subject to the regulations and capital requirements that existed before GLBA. A bank operating within a holding company was still subject to Glass-Steagall (which was not repealed by GLBA)—but Glass-Steagall never banned banks from holding mortgages or mortgage-backed securities in the first place.

Bolds by HSIB in the above. As faithful readers here know, GLBA only repealed two provisions (of 34 original ones) of the Banking Reform Act of 1933 (AKA Glass-Steagall). And the two repealed were numbers 20 and 32--affiliations provisions that had prevented a holding company from owning separately both a commercial and an investment bank--not the actual provisions (16 and 21) defining and separating institutions that offer checking accounts from those underwriting corporate securities.

IOW, Bernie Sanders and his ilk are just flat out wrong to assert otherwise. Also, Sanders is wrong about the dangers of big banks, because elsewhere in his excellent piece, Gramm points out that the large banks were the ones that didn't need bailing out by TARP, because they were better capitalized. It was smaller banks that wouldn't have survived without the actions of Hank Paulsen, Ben Bernanke and Tim Geithner.

The subprime crisis was largely the product of government policy to promote housing ownership and regulators who chose to promote that social policy over their traditional mission of guaranteeing safety and soundness. But blaming the financial crisis on reckless bankers and deregulation made it possible for the Obama administration to seize effective control of the financial system and put government bureaucrats in the corporate boardrooms of many of the most significant U.S. banks and insurance companies.

Again, our bold in the above paragraph.

EuroCoCo, Guy

We again interrupt our blogging hiatus, for another update on banking regulation.

Tuesday, at the Brookings Institution, about 30 minutes into this discussion, retired Fed Board of Governor's member Donald Kohn tells Minneapolis Fed President Neel Kashkari, pretty much what Bentley University macroeconomist Scott Sumner concluded last November: That had contingent convertible bonds, with an explicitly defined trigger been in place years before 2008, the financial crisis may well have been averted.

Kohn's reasoning was that back then the conversion to equity of the long term bonds (CoCos) in the capital structure of stressed firms (such as Bear Stearns and Lehman Bros) would have protected the short term bond holders from runs: That's where the danger was. He then goes on to point to the CoCos in Europe (where such bonds are already in place), as an example. He believes that developments in the last few weeks show that markets believe that the threat of conversion from debt to equity is now affecting bond prices and is evidence that bank regulators are alert to possible stress in the banking system. That they will allow the stressed financial institutions to be automatically recapitalized. I.e., CoCos will work as advertised as canaries in the coal mine, and avert a repeat of the disaster of 2008-09.

Of course, European bank managers aren't happy that they're being disciplined by markets (and regulators):

...investors have indeed flipped out with concern about Cocos after the German lender Deutsche Bank was forced to reassure investors it could meet interest, or coupon, payments on its Coco bonds. 

The move has stoked fears that something is rotten at the heart of the European banking sector and led many to question why Cocos – considered a silver bullet solution – have melted like their chocolate breakfast cereal namesake in the face of market turmoil.

Which is what Charles Calomiris reported was their reaction when CoCos were authorized by the  1999 legislation known as Gramm, Leach Bliley:

I would establish a minimum uninsured debt requirement for large banks in the form of subordinated debt, known as contingent capital certificates, or "CoCos." The CoCos would automatically convert to equity based on predetermined market triggers, which would be very dilutive to pre-existing shareholders. One banker who understood my proposal for CoCo's said, "You are putting an electric fence behind me."

It's a feature...not a bug, guys.

Well, back to hiatusing.

The Sumner Also Rises (to the task)

We again interrupt our blogging hiatus, to acknowledge some fine work by Bentley University economist Scott Sumner (who is also the Ralph G. Hawtrey Chair of Monetary Policy at the Mercatus Center of George Mason University). This EconLog blog post by Scott is the only recognition of which we are aware (other than our own), of the potentially momentous change in banking regulation under consideration by the Fed. And we thank Scott for graciously crediting us for alerting him to it.

In the longer scholarly article from 2011, Herring and Calomiris report [to be read here] this stunning piece of information:

In response to the mandate within the Gramm-Leach-Bliley Act of 1999 that required the Federal Reserve and the Treasury to study the efficacy of a sub debt requirement, a Federal Reserve Board study reviewing and extending the empirical literature broadly concluded that sub debt could play a useful role as a signal of risk. Despite that conclusion, no action was taken to require a sub debt component in capital requirements; instead the Fed concluded that more research was needed.

So the law that provided the flexibility Bernanke needed to deal with the 2008 banking crisis, also suggested a policy reform that might have prevented the crisis entirely. Maybe Phil Gramm deserves a Nobel Prize in economics.

Apparently that "more research" that was needed has now been concluded, as the Fed is finally adopting the idea:

For immediate release

The Federal Reserve Board on Friday proposed a new rule that would strengthen the ability of the largest domestic and foreign banks operating in the United States to be resolved without extraordinary government support or taxpayer assistance.

The proposed rule would apply to domestic firms identified by the Board as global systemically important banks (GSIBs) and to the U.S. operations of foreign GSIBs. These institutions would be required to meet a new long-term debt requirement and a new "total loss-absorbing capacity," or TLAC, requirement. The requirements will bolster financial stability by improving the ability of banks covered by the rule to withstand financial stress and failure without imposing losses on taxpayers.

To reduce the systemic impact of the failure of a GSIB, an orderly resolution process should allow a GSIB to fail, and its investors to suffer losses, while the critical operations of the firm continue to function. Requiring GSIBs to hold sufficient amounts of long-term debt, which can be converted to equity during resolution, would facilitate this by providing a source of private capital to support the firms' critical operations during resolution.

Yes, this is a bit like closing the barn door after the horses have left, but it's still gratifying to see that after all the time wasted on 1000 page monstrosities like Dodd-Frank, we are finally getting somewhere.

With which, we are well pleased.Especially that line about Phil Gramm that we bolded in the above.

Team CoCo wins one

We interrupt our blogging hiatus for this news;

The Federal Reserve Board on Friday proposed a new rule that would strengthen the ability of the largest domestic and foreign banks operating in the United States to be resolved without extraordinary government support or taxpayer assistance.

The proposed rule would apply to domestic firms identified by the Board as global systemically important banks (GSIBs) and to the U.S. operations of foreign GSIBs. These institutions would be required to meet a new long-term debt requirement and a new "total loss-absorbing capacity," or TLAC, requirement. The requirements will bolster financial stability by improving the ability of banks covered by the rule to withstand financial stress and failure without imposing losses on taxpayers.

To reduce the systemic impact of the failure of a GSIB, an orderly resolution process should allow a GSIB to fail, and its investors to suffer losses, while the critical operations of the firm continue to function. Requiring GSIBs to hold sufficient amounts of long-term debt, which can be converted to equity during resolution, would facilitate this by providing a source of private capital to support the firms' critical operations during resolution.

Our bold in the above. Long time readers of this blog will immediately recognize our enthusiasm for the idea of using contingent convertible debentures to provide managers of banks with a powerful market incentive to not take too much risk in the first place. We could point to numerous posts, such as this one from almost a year ago;

HSIB has noted the enthusiasm for this form of bank self-regulation on the part of Columbia economist Charles Calomiris;

...the Columbia economist offers a suggestion to improve the banking system;

 I would establish a minimum uninsured debt requirement for large banks in the form of subordinated debt, known as contingent capital certificates, or "CoCos." The CoCos would automatically convert to equity based on predetermined market triggers, which would be very dilutive to pre-existing shareholders. One banker who understood my proposal for CoCo's said, "You are putting an electric fence behind me."

The potential for dilution of stockholder equity being the key incentive for management to work to prevent that from happening.

Calomiris has said, in speeches, that the Federal Reserve has had the legal authority to do this since the 1999 Gramm, Leach, Bliley Act, but chose not to implement that reform. Now would be a good time to listen to Charlie.

That's right, the 1999 legislative handiwork--which, btw, did not 'repeal Glass-Steagall'--of former Texas A&M economist Phil Gramm is finally being implemented 16 years after it was authorized. Unfortunately, seven years too late to have prevented the financial crisis of 2008.

Pardon the interruption

Blogging at this site will be suspended, at least temporarily, for non-econospheric reasons. Lo siento.

Ridin' the rails to Malmo

First, Mark Steyn risks his life speaking in Copenhagen;

where he details his own, very real, ordeals with the anti-free speech policemen of Canada. Speaking truth to power, if he weren't a conservative.

Then he takes a trip on a train, and thinks some more about Abdul;

...unlike the bad old days of Nazi-occupied Denmark and neutral Sweden that "some" are comparing it to, there are no border controls whatsoever between Copenhagen and Malmö. You just hop on a train at the aforementioned Central Station in Copenhagen and hop off a half-hour or so later on the other end of the impressive Øresund Bridge at the Central Station in Malmö. I did it myself the other day, and was looking forward to sitting back and enjoying the peace and quiet of Scandinavian First Class. But, just as I took my seat and settled in, a gaggle of Abdul's fellow "refugees" swarmed in, young bearded men and a smaller number of covered women, the lads shooing away those first-class ticket-holders not as nimble in securing their seats as I. The conductor gave a shrug, the great universal shorthand for there's-nothing-I-can-do.

What Abdul made of being shanghaied by some high-class Nordic totty to serve as her cabin mate on a stomach-churching voyage of moral exhibitionism, I cannot say. But, from personal observation, the "refugees" around me seemed to take it for granted that asylum in Europe should come with complimentary first-class travel (see picture at top right, from a German train).

There were more shrugs at Malmö, when I asked a station official about it. He told me that, on the train from Stockholm the other day, a group of "refugees" had looted the café car. The staff were too frightened to resist. "Everyone wants a quiet life," he offered by way of explanation.

That's looking unlikely.

Separat aber gleich?

Deutschland nicht über alles;

Separating refugees according to religion is now being mentioned as an interim solution to help alleviate the problems.
.... Tempers flare easily at close quarters. In Leipzig last week, about 200 refugees wielding table legs and bed frames started a fight after they couldn't agree who got to use one of the few toilets first. It took a large police contingent to calm the situation.

Elsewhere;

Other recent incidents include a riot at a refugee shelter in central Germany over a torn Koran and Muslim Chechens beating up Syrian Christians in a Berlin shelter.

Islam is a part of Germany, but Islamism clearly isn't, said opposition Greens party leader Cem Özdemir, adding that tolerance must not be misinterpreted and exploited as weakness.

Maybe it must not, but it is.

But insults, threats, discrimination and blackmail against Christian asylum-seekers in particular are a regular occurrence, according to the Munich-based Central Council for Oriental Christians (ZOCD).

"I've heard so many reports from Christian refugees who were attacked by conservative Muslims," said Simon Jacob, of the Central Council for Oriental Christians (ZOCD).

But that's only the tip of the iceberg, the ZOCD board member told DW: "The number of unreported cases is much higher."

 Our bold. Herr Jacob also summed it up thus;

"People bring with them the conflicts that exist in their native countries, Christians and Muslims, Kurds and extremists, Shiites and Sunnis - they don't leave them behind at the border."

And there will be more refugees to come.