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Thursday, May 9, 2013

Big Banks Opposing Anti-TBTF Regulations: A Conflict-of-Interest

Being able to count on a person or company thereof having sufficient motivation to provide a self-defense is no feat, for self-interest is a staple—perhaps the staple—in human nature.  It should be no surprise, therefore, that after raking in $102 billion in subsidies, including lower lending costs due to the general perception that the government would bail them out, and repaying the TARP money, the biggest American banks were sufficiently re-energized (i.e., self-motivated) to go on the offensive to protect their places on the perches under fire. Specifically, they planned a lobbying campaign to fend off increasing Congressional calls to break up the banks to solve the too big to fail problem (which includes the subsidy problem that exacerbates the wider problem). There are problems with the lobbying itself—problems caught in America’s blind-spot even as they subtly undermine the body politic.
To begin with, the banks’ lobbyists suffer from a conflict of interest in providing credible “facts” that support the financial interests of the banks being represented. Sadly, regulatory agencies often get into the habit of relying on such information. Congressional committees even allow such lobbyists and even particular corporations to write the very law that will impact them. It is no accident that those lobbyists and corporations make huge campaign contributions. In addition to the influence that they purchase, bankers (and business practitioners in general) have an amazing ability to scare elected representatives and appointed government officials. I submit that greater awareness of the conflict of interest ought to reduce the fear factor.
As an example of how fear enervates governmental efforts to hold banks accountable, U.S. Attorney General Eric Holder claimed that some banks were too big to jail because prosecuting such large and interconnected banks could harm the economy. All a banker executive of such a bank need tell prosecutors is that a judgment against the bank would trigger a run on the bank and a resulting industry-wide credit-freeze  and the U.S. Department of Justice lays off the bank in spite of the probable criminality. Should such a dire warning from a banker of such a bank simply be accepted at face value by the department, given the bankers’ conflict of interest? It is in the bankers’ interest that the prosecutors back off out of fear of systemic risk, and the bankers know this. The prosecutors should not take the “fact” of probable catastrophe at face value, and yet they often do. Where a subterranean motive exists, the existence of a subterfuge should be suspected not relied on.
As banks such as Morgan Stanley, Bank of America, and Goldman Sachs were “shedding lucrative assets that would have required them to hold more capital to compensate for their risk” in 2013, bankers from the big banks were “telling members of Congress that every additional dollar in capital they are required to hold translates into $8 to $10 less to lend.” Because it is so much in the banks’ financial interests to make such a claim, it should be treated as a problem rather than a given. Back in the days of the TARP bailout, the big banks did not use the cheap money to lend more. Therefore, self-serving claims about future likely lending should not be swallowed whole.
The issue is the validity of self-serving claims in a debate. Ken Bentsen Jr, head of the Securities Industry and Financial Markets Association, said that the expected cumulative effects of the changes on the system are enough for the banking industry to have “legitimate concerns that it will be hard to make loans and raise capital for businesses.” Just because an official of a financial sector association claims that the concerns are legitimate does not mean that the public and its legislative represenatives should assume the legitimacy as an assumption in determining how to reduce the risk of banks that are too big to fail.

    The banking lobby snagged the ethos of "external authority" by hiring Tony Fratto, a former Bush aide. Besides getting his government contacts, the lobby's claims can have greater credibility societally and in Congress.    AP
That several banks and the Financial Services Forum hired Tony Fratto, a former Bush administration official, to provide “rapid response” to claims that the biggest banks are too big indicates that the bankers realize that the credibility of their claims has a certain currency. So too does making public the fact that Stephanie Cutter, a former advisor to President Obama, and Ed Gillespie, a former Bush official, have been giving the banks advice on Congressional efforts like the legislation co-sponsored by Sens. Vitter and Brown that would significantly increase capital cushions so large banks would be forced, in effect, to shrink.

The external ethos of former government officials is intended to add authority, and thus credibility, to the bankers’ self-serving retorts. An implicit assumption in making the hires is that the self-interested position of the banks could compromise the validity of their responses to the criticism of banks still instantiating too much systemic risk. External observers ought to be aware of this assumption themselves in order not to be manipulated. As Richard Davis, CEO of US Bancorp, said after his attempt at broadening the coalition to include regional and community banks, “If just the big banks oppose it, it will be a problem.” The other CEOs of the big banks rejected his proposal, preferring to have the Financial Services Forum, which represents only the 19 largest American financial institutions, handle the threat of additional legislation. This demonstrates that the bankers themselves do not adequately appreciate the compromising nature of their banks’ financial interest on their collective responses.

To be sure, the banking executives have been getting away with quite a bit of credibility on claims that are self-serving with respect to the banks. Members of Congress, and even the general public, typically take the bankers’ warnings at face value and relent in holding the bankers accountable. I suspect that the bankers exploit this naivety; otherwise, they would have felt the need for a broader coalition. The result of the manipulation is that bankers have been able to weaken or circumvent new regulations such that the risk to the public remains excessive. For this pattern to break, the conflict of interest would have to be made transparent societally and in the political discourse.


Deborah Solomon, Robin Sidel, and Aaron Lucchetti, “Big Banks Push Back Against Tighter Rules,"
The Wall Street Journal, May 8, 2013.

Mark Gongloff, “Too-Big-To-Fail Banks Have Raked In $102 Billion in Subsidies Since 2009: Report,” The Huffington Post, May 10, 2013.

Monday, May 6, 2013

Does Austerity Work?

Does raising taxes and cutting government spending reduce a government’s deficits and thus debt? Confine consideration to more tax revenue and less spent and the theoretical answer is yes; it being a simple matter of mathematics. Include the impacts of raising taxes and cutting spending and the answer become far less straightforward. More paid in tax means less disposable income, which means less consumption and thus less produced (i.e., GNP). A government spending less also means less consumption in the economy, and therefore even less to be produced to meet demand. In short, austerity is recessionary. Whether the ratios of deficit and debt to GDP increase depends on how much the numerators drop relative to the decrease in GDP. We can look at the E.U. for some empirical evidence.
For the states that have adopted the euro currency, government spending exceeded tax revenue by 3.7% in 2012, down from 4.2% in 2011. Add in the remaining E.U. states and those figures are 4 and 4.4 percent. In fact, 2012 was the fourth straight year of deficit reductions in the European Union. So far, everything looks to be in line with the theory: adding revenue and reducing what is spent reduces a deficit. Lower deficits in turn mean that the government debt does not increase as much from year to year than would be the case were the deficits larger.
Unfortunately, as the excess spending was reducing in percentage terms over the revenues collected, the debt burden, which is simply the government debt relative to GDP, was increasing. In the states that use the euro, government debt as a percentage of total economic output, or GDP, increased to 90.6% in 2012 from 87.3% in 2011. Include the remaining states and public debt rose to 85.3% from 82.5 percent. Interestingly, the difference between the “euro-zone” and the entire Union was around 5% in both years. Relative to the E.U. as a whole, the euro-zone debt burden had not improved or worsened. Both the euro-zone and all of the E.U. states together saw a roughly 3% debt-burden increase. Why is that?
For the states undergoing austerity, decreases in GDP exceeded the decreases in the deficits. Although exogenous factors such as a dip in global trade could have played a role, it is also possible that the recessionary impacts of the austerity exceeded the decrease in the deficits. Austerity reduces demand in the economy and increases unemployment, which in turn puts pressure of governments to increase social spending—either by raising taxes or increasing the deficit, and thus debt. It can be a rather vicious cycle, with the most vulnerable people put most at risk. Even if GDP contracts without any increase in the deficits, we would expect to see the total debt-burden in the euro-zone worsen relative to the combined debt-burden of all the E.U. states, unless a number of non-euro-zone states were also undergoing austerity.
                                           If austerity kills dignity, then pressure on governments to relax spending cuts can be expected.   source: rt.com
In any case, at least some experts have concluded that austerity in practice is less stellar than its advocates have admitted. Ben May, an economist at Capital Economics, argues that “the fact that most economies’ deficits have fallen by less than expected and that the consolidation has coincided with deeper than anticipated recessions confirms that the costs have been large.” He noted that the state of Germany, which posted a budget surplus in 2012, accounted for 60% of the improvement. Yet how is it then that the debt-burden of the euro-zone did not change in percentage terms relative to all of the states put together?


David Jolly, “E.U. Austerity Shrinks Deficits, If Not Debt,” International Herald Tribune, April 23, 2013, p. 15.