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Paul Volcker, former Fed chairman who inspired bank risk rule, dies at 92

Paul Volcker, former Fed chairman who inspired bank risk rule, dies at 92

December 26, 2019

[Paul Volcker devoted most of his adult life to public service, spending years at the U.S. Treasury, the Federal Reserve Bank of New York, and as Chairman of the Federal Reserve during my tenure at the FDIC. Paul was given marching orders to bring inflation under control by President Carter who appointed him Chairman of the Fed in 1979. Despite intense criticisms and even death threats, Paul resolutely raised interest rates until the prime lending rate reached an astounding 21 1/2%. The bitter medicine caused a lot of pain: two recessions, widespread farm failures, voluminous bankruptcies, plummeting energy and housing prices, and thousand of bank and thrift failures. I dealt with Paul regularly and never saw anything but firm resolve to finish the necessary task at hand — breaking inflation’s back. His success is literally history, and due to it, he was reappointed Chairman of the Fed by President Reagan. Personally, he was intriguing. At 6’7″, with a booming voice, he was an imposing figure with deep knowledge of the financial world. The FDIC had been a sleepy agency from the 1940s to the late 1970s, staying in the background while the Chairman of the Fed and Secretary of the Treasury took the lead. It was clear that the Chairman of the Fed expected me to maintain that status quo, but he accepted that I couldn’t with the very viability of the FDIC in doubt. Paul and I had policy disagreements to be sure. But I never doubted that Paul always acted in good faith based on what he considered to be in America’s and the world’s best interests. I will always be grateful for the generous forward Paul wrote for my book, Senseless Panic: How Washington Failed America. Referring to our initially bumpy relationship he said: “My first impression of Bill was of a rather brash young man, certainly vigorous and self-assured, but perhaps lacking the seasoning that one might expect of an agency head. He was certainly not deferential. But as we got into the trenches together, I came to realize the importance of his character, of the personal strength desperately needed in perilous times.” Paul was clearly a man who was larger than partisanship and ego. He and I became friends and visited regularly over the years after we’d both left government. We each remained active in the financial and government worlds and tried our best to make the financial system stronger and more responsive. Paul was always on call to governments throughout the world whenever they needed a person of his stature, integrity and experience. Paul and I visited regularly throughout his last days, and I was deeply honored to attend his memorial service in New York City. It was a fitting tribute to one of the best public servants — and his family — it has been my privilege to know. I will miss him greatly.]

Paul Volcker, the former Federal Reserve chairman who broke the back of U.S. inflation in the 1980s and three decades later led President Barack Obama’s bid to rein in the investment risk-taking of commercial banks, has died. He was 92.

He died Sunday in New York, according to The New York Times, which cited his daughter, Janice Zima.

In a career that spanned more than half a century, Volcker became a one-man economic cleanup crew, called on to devise a successor to the gold standard, a cure for runaway inflation and, in 2008, a response to the housing-market collapse that exposed Americans as perilously leveraged and their banks as highly prone to risk. That last effort led to the Volcker Rule, widely loathed by bankers and subsequently a top priority for overhaul by the Trump administration.

The grandson of German immigrants, Volcker held strong beliefs about the dangers of inflation and the virtues of frugality. He flew coach, grumbled about restaurant prices and took his first wife on a honeymoon to a fishing cabin in Maine rather than to Bermuda, as she’d hoped. He scorned financial industry innovations such as credit-default swaps and quipped that the best new financial product in recent decades was the automated teller machine.

Obama’s Call
Volcker worked at the Treasury Department, the Fed, or as an economic adviser under six presidents. At 81, two decades removed from his Fed days, he was recalled to government duty in November 2008 by Obama, the president-elect, who named him to head a new Economic Recovery Advisory Board as the nation was struggling to pull out of a recession and recover from the worst financial crisis since the Great Depression.

Within months, the 6-foot-7-inch (2 meters) Volcker was standing out as the White House insider pushing for the most radical regulatory reforms. He wanted to bar traditional deposit-taking banks from making speculative investments on their own account, the practice known as proprietary trading, and from investing in hedge funds and private-equity funds. Obama formally proposed the idea in January 2010, calling it “a simple and common-sense reform, which we’re calling the Volcker Rule — after this tall guy behind me.”

Volcker’s rule was incorporated in the 2010 Dodd-Frank law — though not before being weakened, which led Volcker to express doubt about the Obama economic team’s commitment to it. “They say they’re for it, but their hearts are not in it,” he told Ron Suskind, author of the 2011 book “The Confidence Men.”

When Volcker left his White House post, in February 2011, regulators were sifting through a flood of public comments on the implementation of Dodd-Frank. Banks continued to argue that Volcker’s proposal would excessively restrict their business.

Wall Street critics
“Paul Volcker, by his own admission, has said he doesn’t understand capital markets,” Jamie Dimon, the chief executive of JPMorgan Chase & Co., said on Fox Business News in February 2012. “Honestly, he has proven that to me.”

The Federal Reserve, Federal Deposit Insurance Corp. and three other agencies completed the final rule in December 2013. It ran close to 100 pages, with hundreds more in supporting material, and sought to distinguish proprietary trading from still-permitted market making and hedging to mitigate risks. Volcker quipped that in the end, “I was gratified to see that the rule itself is shorter than my own home insurance policy.”

The rule took effect in July 2015. President Donald Trump, in 2017, ordered regulators to rewrite the rule and soften its effect. In an Aug. 20, 2019, letter to Fed Chairman Jerome Powell, Volcker complained that regulators had used “simplification” as an excuse to weaken the rule in a way that would amplify risks to the financial system.

Paul Adolph Volcker Jr. was born on Sept. 5, 1927, in Cape May, New Jersey, to Paul Sr., the coastal town’s manager, and his wife, the former Alma Klippel. The family moved to Teaneck, in northern New Jersey across the Hudson River from New York City, in 1930 when the elder Volcker, a civil engineer, became that town’s manager.

Known as Buddy to distinguish him from his father, Volcker had to repeat kindergarten because teachers interpreted his silent manner as a sign of immaturity, his mother told Newsweek for its 1986 profile.

Princeton, Harvard
He received a bachelor’s degree in 1949 from Princeton University and a master’s degree in political economy and government from Harvard University in 1951. In 1951-52, as a student at the London School of Economics, he toured Europe at the expense of his planned Ph.D. thesis, which never got done, Joseph B. Treaster wrote in “Paul Volcker: The Making of a Financial Legend,” his 2011 book.

Volcker’s career as an economist began in 1952, when he took a job at the Federal Reserve Bank of New York. He left five years later for Chase Manhattan Bank, where he worked closely with David Rockefeller, then the vice chairman. In 1962, Volcker took his first job in Washington, as director of the Treasury Department’s Office of Financial Analysis during the administration of President John F. Kennedy. He served as deputy undersecretary of monetary affairs under Lyndon Johnson, where he witnessed the president’s attempt to prevent then-Fed Chairman William McChesney Martin from raising interest rates. In 1965 Volcker returned to Chase.

He left Chase for Washington for a second time in 1969, this time to be Treasury’s undersecretary for monetary affairs in the Nixon administration. In that role, he helped craft a new international monetary framework to replace the fixed exchange rates and gold standard of the Bretton Woods system, which had been in place from 1944 until Nixon ended it in 1971.

Inflation warrior
As president of the New York Fed from 1975 to 1979, Volcker became the loudest voice on the Federal Open Market Committee advocating monetary restraint and high interest rates — a full-fledged inflation warrior. “Sometimes we still hear the argument that in time we can learn to live with inflation,” he said in a 1978 speech. “But experience suggests the contrary — that this powerful economy of ours will simply not work smoothly or at anything like maximum efficiency or output when there is pervasive uncertainty about the price level.”

President Jimmy Carter appointed Volcker as Fed chief in 1979, succeeding G. William Miller, who became Treasury secretary. Miller had been criticized for being insufficiently focused on fighting inflation. During his 17 months as Fed chairman, inflation had risen to 11.8% from 6.6%.

“The challenge was very clear when I was there: you’ve got an inflation problem and it was getting out of hand,” Volcker said in a 2006 interview. “And the country knew that something was the matter. There was unhappiness with the economy. That is a situation in which you can act.”

Volcker announced what became known as his “Saturday Night Special” on Oct. 6, 1979: a series of measures intended to squeeze inflation. The moves began with a 1 percentage point increase in the rate Fed banks charge financial institutions, to 12%. But the most dramatic was the Fed’s shift to focusing on limiting money supply growth — even if it meant large jumps in interest rates. Which in the end it did, as interest rates climbed as high as 20%.

‘Internal discipline’
In his 2018 memoir, “Keeping At It,” Volcker said that targeting the money supply provided the Fed with two advantages: A simple message to convey to the American public, and “an internal discipline that had been lacking.”

“We were ‘lashed to the mast’ in pursuit of price stability,” he wrote. “Did I realize at the time how high interest rates might go before we could claim success? No.”

Volcker’s policies came at a high price and the fallout contributed to Ronald Reagan’s landslide victory over Carter in the 1980 presidential election. The U.S. economy went into recession twice during his tenure, the jobless rate climbed to 10.8% in November 1982, and bad loans and bankruptcies soared. Homebuilders and farmers protested. Congressional leaders including Democratic Sen. Robert Byrd of West Virginia and Republican Rep. Jack Kemp of New York introduced legislation aimed at requiring the Fed to lower interest rates. The bills were not adopted.

A bodyguard was assigned to Volcker after a man entered the Fed building in Washington with a sawed-off shotgun, revolver and knife, according to William Greider’s 1987 book “Secrets of the Temple.”

Congressional hearings
Volcker struck some as aloof during televised congressional hearings, puffing on a cigar and shaking his head while being questioned by angry lawmakers. Toward the end of his tenure at the central bank, he was challenged by Reagan appointees to the Fed who favored lower rates.

Though he was vilified in some quarters for the impact on business, his determined — and successful — assault on inflation won him admirers in both U.S. political parties and among a generation of central bankers from New Zealand to South Africa.

Volcker “deserves primary credit for the signal macroeconomic achievement of the past 30 years — slaying the inflation monster that was engulfing the American economy at the end of the 1970s,” Charles R. Morris wrote in “The Sages,” his 2009 book about Volcker, Warren Buffett and George Soros. “The stable global economic growth of the 1980s and 1990s was grounded on Volcker’s conquest of inflation.”

Volcker stepped down in 1987, saying he didn’t want a third term. His departure and Reagan’s nomination of Alan Greenspan prompted stocks, bonds and the dollar to slide. By that time, the Fed’s benchmark rate was at 6.75%, inflation had slowed to about 4%, and the economy was in the fifth year of an economic expansion.

Volcker became chairman of James D. Wolfensohn & Co., a mergers-and-acquisitions firm that became Wolfensohn & Co. He left after the firm was sold to Bankers Trust in 1996.

Global assignments
His reputation for rigor and fairness led to his appointment in 1996 to supervise the payment of claims by Swiss banks to Holocaust victims, and in 2004-2005 to lead an independent investigation of the United Nation’s oil-for-food program in Iraq. In 2002 he led an unsuccessful effort to salvage part of Arthur Andersen LLP, the accounting firm that collapsed following its conviction of obstructing justice in the investigation of Enron Corp., its client — a ruling that would be overturned by the U.S. Supreme Court in 2005.

Volcker became a critic of the Fed’s response to the financial crisis after the central bank orchestrated the sale of Bear Stearns Cos. to JPMorgan Chase in March 2008 by taking some of Bear Stearns’s riskiest assets on to the Fed’s own balance sheet. The central bank was operating at “the very edge” of its legal authority, he said in an April 2008 speech to the Economic Club of New York.

He also challenged the easy-money policies under Greenspan, without attacking his successor by name. In an October 2008 interview with Charlie Rose, he said, “We bent over backwards to ease money for reasons I didn’t understand.”

In 2013 he formed the New York-based Volcker Alliance, an organization aimed at rebuilding public trust in government and enhancing the effectiveness of public administration.

Volcker had two children, Janice and James, with the former Barbara Bahnson, whom he married in 1954. Her severe arthritis and diabetes kept her in New York during her husband’s tenure as Fed chairman, and he would commute home from Washington on weekends. She died in 1998. In 2010, Volcker married his longtime assistant, Anke Dening.

A Rescue by the Unelected by Daniel Burgee

A Rescue by the Unelected by Daniel Burgee

November 29, 2019

[The following article, published by the Washington Post and also carried in the Sarasota Herald Tribune on November 29, 2019 is reprinted with permission from its author, Daniel Burge. The article responds to recent calls for the Federal Reserve to lower already historically low interest rates. Burgee provides a succinct and accurate description of efforts during the 1980s by both Congress and the Reagan Administration to pressure the former Federal Home Loan Bank Board and the former FSLIC to prop up badly insolvent S&Ls rather than providing meaningful financial assistance to merge them into stronger banks and thrifts as the FDIC did with the FDIC-insured mutual savings banks. Burge observes that the FDIC spent $7 billion from its own funds (maintained by bank assessments) to resolve the savings bank issues, while the much-delayed failure resolution costs for the S&L industry ultimately rendered the FSLIC insolvent and cost taxpayers over $125 billion.]

President Donald Trump has called Federal Reserve officials “boneheads,” and even speculated whether Fed Chair Jerome H. Powell was a “bigger enemy” than China’s Xi Jinping. Most recently, Trump claimed that the experts at the Fed “are their own worst enemies, they don’t have a clue.” “People,” the president later added, “are VERY disappointed. …”

The president’s mistrust of technocrats taps into a more widely shared sentiment. In the view of many Americans with populist impulses, both left and right, appointed technocrats or experts wield too much power. Regular voters have no direct way of holding these officials accountable when they make serious mistakes.

These concerns are understandable. But the savings and loan crisis of the 1980s — at the time, the worst rash of banking failures since the Great Depression — demonstrates that populist-oriented prescriptions might be worse and more dangerous. Sometimes effective regulatory decisions are politically unpopular. They can only be enacted by technocrats insulated from pressure by elected officials who are focused on short-term political objectives.

The S&L debacle had its roots in the rising inflation of the late 1960s and 1970s. In October 1979, with inflation around 11 percent, Federal Reserve Chairman Paul Volcker tightened the money supply, and allowed short-term interest rates to reach double digits in an effort to stop the inflationary spiral. As a result, savings and loans and mutual savings banks — which were community-oriented local banks — confronted disaster.

Before the high inflation of the late 1970s, these institutions had concentrated on making home loans. According to the standard joke, during the mid-20th century, bankers from these local institutions paid 3% interest on deposits, charged 6% on home loans, and headed to the golf course at 3 p.m.

But Volker’s disinflation turned this model into a disaster. On the one hand, S&Ls and MSBs had to pay higher interest rates to satisfy their customers. On the other hand, S&Ls and MSBs still had fixed-rate home mortgages that they had extended in years when interest rates were lower on the books. These older loans earned less than the new going rate for deposits. That meant that local banks paid more interest to their depositors than they made on their loans.

As a result, S&Ls and MSBs lost money. Lots of money. Savings and loans struggled to stay afloat in a pool of red ink deeper than $100 billion. Meanwhile, $3.3 billion of losses over three years threatened to debilitate MSBs. Both sets of institutions tottered on the brink.

The two crises unfolded in dramatically different ways. The MSB troubles cost the Federal Deposit Insurance Corporation (FDIC), which insured their deposits, roughly $7 billion. By contrast, the S&L problems ultimately cost American taxpayers $123.8 billion.

According to economists Paul M. Romer and George A. Akerlof, if the management program for mutual savings banks had been applied to S&Ls, the cost of the savings and loan crisis would have been substantially reduced.

Different regulatory agencies oversaw the two sets of local institutions. The FDIC insured the deposits of mutual savings banks. A separate entity with a different structure, the Federal Savings and Loan Insurance Corporation (FSLIC, pronounced “fizz-lick,”) backed the funds of S&L customers. Importantly, technocrats with financial and political independence managed the FDIC, while the Federal Home Loan Bank Board oversaw the FSLIC’s operations. The FSLIC remained vulnerable to political considerations because Congress controlled its purse strings through the appropriations process.

With such a financial structure, officials at the Bank Board could not easily ignore political pressure. The Reagan administration demanded that its appointed technocrats be faithful to its political agenda.

L. William Seidman, who served as FDIC chairman between 1985 and 1991, later recalled that “anyone calling for more banking supervision was branded a ‘re-regulator’ and by extension a disloyal Reaganite, the worst condemnation possible inside the Reagan administration.”

In January 1982, Bank Board Chairman Richard Pratt took actions that comported with the Reagan administration’s approach. He permitted S&Ls to make loans with even less of their own funds at stake. This action contributed to a deeply perverse incentive structure: S&Ls could grow and profit from high-risk, high-reward loans, without worrying about losses, which would first accrue to the FSLIC, and then to American taxpayers.

Later in 1982, Congress — cheered on by Pratt and the Reagan administration — made things worse by opening up previously closed off risky lending areas for S&Ls, including that of commercial real estate. Soon thereafter, the insolvent S&Ls that were still operating began making reckless, “Hail-Mary” loans with government-insured deposits. Other bankrupt S&Ls engaged in outright criminal activity, such as looting. Over time, losses piled up, bankrupted the FLSIC and left American taxpayers with a mess.

In contrast, the FDIC averted disaster by pursuing more measured policies than the FSLIC. In 1982, chairman William M. Isaac explained that “the FDIC … does not intend to litter the financial landscape for decades to come with crippled banks.”

Rather than allowing its banks to “gamble for resurrection” as Pratt permitted some S&Ls to do, Isaac pursued policies that bought time until the high interest rates declined. With many favoring the FSLIC’s approach, the FDIC received its fair share of criticism. But given that the FDIC’s funding was not subject to lawmakers’ political considerations, Isaac and his colleagues successfully resisted politically motivated but misguided fixes.

The case of the S&L crisis reveals that while technocrats may appear aloof and unaccountable, their insulation from politics is important for sound crisis management. Banking troubles tend to present policymakers with difficult choices that require careful analysis. Sometimes, the right responses to a crisis are politically unattractive to the administration in power and Congress.

For this reason, today’s lawmakers would be well-advised to protect the relative independence of appointed technocrats.

Daniel Burge is an associate lecturer in American Studies at the University of Massachusetts, Boston.

BankThink Regulators’ push for innovation shouldn’t come at expense of prudence by Thomas P. Vartanian published by American Banker

BankThink Regulators’ push for innovation shouldn’t come at expense of prudence by Thomas P. Vartanian published by American Banker

October 28, 2019

[My longtime friend, Tom Vartanian, wrote the following article for the American Banker on the rapidly evolving technological innovations affecting financial institutions throughout the world. All of us have been and will continue to be impacted by these developments – for the most part in positive ways but also in ways that threaten our right to privacy and even our national security. Tom’s article is a clarion call.]

As federal regulators rightly begin encouraging technological innovation rather than lagging behind it, one must also consider the darker side of technology.

There is a growing race for control of money, information and payments systems. The Washington Post recently reported that the government is seeing increasing warning signs of cyberattacks on industrial control systems that could cause “massive financial damage.”

Ultimately, technology will either empower or overpower financial services companies and their regulators. The difference will depend on how proactive firms and regulators are to control that evolution.

The head of the Federal Deposit Insurance Corp. is running the innovation baton down the field, encouraging the government to lead fintech rather than follow it. FDIC Chairman Jelena McWilliams offered an important insight in a recent op-ed: “If our regulatory framework is unable to evolve with technological advances, the United States may cease to be a place where ideas and concepts become the products and services that improve people’s lives.”

She could not be more correct.

Read the full American Banker Article

Public option for banking: solution in search of a problem by Rob Nichols published by San Francisco Chronicle

Public option for banking: solution in search of a problem by Rob Nichols published by San Francisco Chronicle

October 28, 2019

[The governor of California has signed into law legislation to authorize local governments to own banks.  The President & CEO of the American Bankers Association makes a strong case against publicly owned banks, a view I very much share for a lot of good reasons.  Nationalized banks in other countries – Israel and Mexico come immediately to mind – have never worked.  Politicians use them as their playthings to finance whatever the cause du jour may be, leaving it to taxpayers to clean up the resulting mess.  The FDIC and various state governments spent a lot of time and money cleaning up the substantial losses and hardships during the 1980s created by the failure of state-backed deposit insurance funds in Ohio, Maryland and Massachusetts.  The California idea will likely go nowhere unless the FDIC grants deposit insurance to the publicly owned banks, which we all should pray never happens.]

To its credit, California has always been a place of big dreams and experimentation. The Golden State has given us Hollywood, Silicon Valley, McDonald’s hamburgers and even blue jeans. Now some in California think they have discovered the next great innovation when it comes to financial services.

Taxpayers should be wary.

Gov. Gavin Newsom recently signed AB857, which will allow California’s local governments to charter their own banks, and there are already efforts under way. Supporters say the legislation will enable cities and counties to stop relying on regular commercial banks to help manage their own finances, while competing with those banks to provide financial services to the public. They point to other public banks in the U.S. as proof that this big idea can succeed. They should brush up on their history.

The reality is America’s experience with dozens of public banks over the years is littered with painful and costly failure. Nearly all have been closed down — many failing because of political interference that resulted in making risky loans and operating with too little capital (or both), then collapsing when the boom times ended. In fact, Abraham Lincoln’s earliest recorded speech as an Illinois legislator in 1837 criticized just this kind of political interference.

Read the full San Francisco Chronicle Article

FASB’s Latest Action the Last Straw – Your Help is Urgently Needed

FASB’s Latest Action the Last Straw – Your Help is Urgently Needed

July 18, 2019

Informed experts know that the mark-to-market accounting rules issued by the Financial Accounting Standards Board (FASB) in the last decade led directly to the unnecessary charge off of $500 billion of bank capital in the US.  This, in turn, led to an economic collapse, massive taxpayer infusions of capital into banks and other financial institutions, and a very serious recession that we are just finally shaking off. 

FASB is at it again, requiring substantial changes to loan loss reserving by banks that will likely result in a repeat of FASB’s last fiasco, hitting particularly hard community banks and the small cities and towns they serve.  Those of you who know me and my lifetime commitment to a strong and resilient banking industry serving our nation’s economic needs, know that I have never and would never advocate any policies that would diminish the industry’s strength and resiliency. 

FASB is a private organization set up by the accounting industry to impose accounting standards on companies throughout the nation, including financial organizations.  FASB’s rules have the force of law despite the fact that FASB is not subject to any public or government oversight.

Community bankers – already suffering more than enough – will be hit particularly hard by FASB’s latest proposed rules.  FASB’s latest proposal must be stopped in its tracks.  Bills are pending in Congress force FASB to withdraw its proposal to allow an economic impact study to be done.  I hope you will write to your members of Congress and urge them to pass legislation to bring FASB under reasonable public oversight.

The statement below from Rob Nichols, the President of the American Bankers Association, says it very well.  I urge you to read the statement and lend your support.

Best regards, Bill Isaac


ABA Statement on FASB Vote to Delay CECL
By Rob Nichols, ABA president and CEO

“FASB’s vote to delay CECL for certain smaller banks offers further proof that the required efforts to implement this costly standard are far greater than the board has previously led bankers to believe. A partial delay without a requirement for study or reconsideration simply kicks the can down the road – it does not reduce the ongoing data, modeling and auditing requirements facing smaller banks or address the increased pro-cyclicality it will cause. The delay should apply to banks of all sizes, and should be used to conduct a rigorous quantitative impact study to properly assess the effect this new standard will have on their ability to serve their customers and the broader economy, particularly during an economic downturn. We encourage Congress to act quickly to ensure this flawed standard is delayed for all institutions until such a comprehensive analysis can be completed.”

Easy Monetary Policy: A Threat to the Future by William C. Dunkelberg, Chief Economist, National Federation of Independent Business

Easy Monetary Policy: A Threat to the Future by William C. Dunkelberg, Chief Economist, National Federation of Independent Business

April 29, 2019

As the current economic expansion nears record length, observes more frequently publish lists pf “risks” that could precipitate a recession and an end to the expansion: weak global growth, China, the “black swan event” du jour, a Federal Reserve policy error, fiscal insanity, and the old inverted yield curve.  Pick your favorite interest rates (or ones that fit your story) and within 20 months or so (almost 2 years) of an inversion, a recession will allegedly start.  Inverted yield curves don’t “cause” recessions, they simply signal imbalances, however created, in financial markets and consequently in real markets.  Expectations matter: if we expect a recession and adjust our behavior accordingly, we’ll get a recession or slowdown.

Apparently, liquidity is like toothpaste: once you squeeze it out, you can’t put it back.  So out global central banks squeezed the tube and bought every risk-free asset they could find.  The Fed bought $4 trillion of them to provide liquidity, and in the process, interest rates headed toward 0. It was assumed that once the economy started growing, those assets would be returned (sold) to the private sector and the liquidity extinguished.

As the Fed started rising rates and reducing its bond holdings, a funny thing happened on the way to “normal.”  Financial markets ground and politicians, wanting a strong economy (i.e. a strong stock market) in 2020 for the elections, began to complain.  The Fed took cues from the stock market and shifted in neutral.  It abandoned its “plan” to continue to raise rates and move further away from 0, reverting back to “data dependency,” e.g. monthly monetary policy.  The Fed’s “plan” seems to be watch the data, them, are a policy change.  This rate change has no immediate effect on the real economy because according to past research, there are long lags between interest rate changes and changes in real economic activity (e.g. business investment, etc.). Financial markets however respond immediately, looking at the data that it expects the Fed will respond to. This will continue to drive monetary policy choices because there is no other road map for policy that looks to the future, just pressure to maintain asset prices.  Stock markets are at a record high levels, and the Fed appears afraid to do anything that might change that.

This is the position that all central banks in market economics now find themselves in.  They can’t reduce bond holdings because that raises rates becuase, well, that raises rates too, and financial markets don’t like it.  After all, raising short rates invites the much feared “inversion.” The economy is at full employment, and labor is in short supply.  Yet, the real wish-free of interest, a proxy for the return on capital, is well under 1% and saving for retirement is difficult with a 2.5% yield on the 10-year Treasury bond (which is held down by central bank hoarding of risk-free assets).

The Fed has squeezed itself into a corner.  When the economy slows, the Fed will have little room to cut rates (historically cutting 4 to 5 percentage points), but it will start buying bonds (QE again) hoping liquidity and lower rates will help even though they didn’t do much last time (round one excepted).  The Fed will add a few trillion to its balance sheet and, when the recession/slow period ends, it will have $8 trillion in riskless assets instead of $4 trillion.  The private sect demand for these rich free assets will keep rates low as central banks hoard them.  Maintaining that level as bonds mature will require major Fed excursions into bond markets.

Traders win, savers lose.  Interest rates, one of the most important prices in a market economy, allocating capital to highlight values uses, will be crippled as they were starting in 2009, and economic growth will pay a heavy price for this intrusion into private markets.

Why the Universal Use of the 30-Year Mortgage Is Dangerous by Edward Pinto published by the RealClear Markets on April 22, 2019

Why the Universal Use of the 30-Year Mortgage Is Dangerous by Edward Pinto published by the RealClear Markets on April 22, 2019

April 25, 2019

The short answer is that the 30-year mortgage amortizes extremely slowly, making it nearly twice as risky as a similar loan with a 20-year term. And the 30-year loan compounds risk-layering by promoting the use of higher combined loan-to-value and debt-to-income ratios (DTI).

The Housing Lobby unabashedly supports the broad availability of the 30-year mortgage, and even wants it extended to manufactured housing. This is because Housing Lobby sees the slow amortization as a feature that reduces monthly payments, making home “more affordable”. They choose to ignore the bug–the 30-year loan, when combined with other risk factors, drives up home prices when the supply of homes is tight, especially for buyers of entry-level homes. Since 2012, lower priced entry-level homes have risen by about 55%, while move-up homes have risen by about 31%. This means lower priced entry-level homes that cost an average of $103,315 in 2012, cost a whopping $160,138 in late-2018. Thus, rather than making housing more affordable as its supporters claim, 30-year loans make housing less affordable. But more on this entry-level home pricing penalty later.

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BankThink With stress tests, less is more by Thomas P. Vartanian published by the American Banker on April 18, 2019

BankThink With stress tests, less is more by Thomas P. Vartanian published by the American Banker on April 18, 2019

April 19, 2019

Dynamic stress testing — or using econometric models to forecast a financial institution’s income and regulatory capital through hypothetical economic shocks — is a good idea. But the Federal Reserve’s rules need to keep improving to make them less onerous and more reliable.

Fortunately, the Fed seems to agree, having taken several recent steps in that direction, among them the March 28 publication of 80 pages of new data explaining model assumptions and analytics. Vice Chairman Randal Quarles speaks openly about the issues that stress tests raise, which in itself is a breath of fresh air. Still, while the Fed has now disclosed more than it ever has about its stress tests since he was appointed, the information is not as granular as institutions would like, and timing of important assumptions still seems to be an issue. The delivery of this latest data came just one week before banks were scheduled to make their annual Comprehensive Capital Analysis and Review, or CCAR, submissions.

That said, it’s worth giving the Fed credit for signaling that it appreciates the relationship between risk management and profitability, and for taking the first steps to make its stress testing process more transparent and efficient. While some may feel that it is of no consequence if large banks are inconvenienced by cumbersome capital and stress testing requirements, they couldn’t be more misinformed. Stress test requirements directly impact the economy and the wallets of every American.

Capital requirements and stress tests assign risk to each asset on the books of a bank. Those risk weightings determine how much capital an institution must hold, which in turn influences how credit is allocated throughout the country.

In addition, economic and timing uncertainties in the process cause banks to hold capital buffers beyond what the law requires just to avoid being out of compliance when the assumptions of the model shift, as they can each year. Every extra dollar of capital that is locked away in a bank’s vault to pad this surplus directly reduces multiples of that dollar that could otherwise be lent to American consumers and businesses.

Link to the full story Click here