For decades, William Isaac’s insights on the U.S. financial system have been featured in leading news publications. Now, you can browse them all in one location.

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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.

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BankThink Fed ‘independence’ is a slippery slope by Alex J. Pollock published by American Banker on March 21, 2019

BankThink Fed ‘independence’ is a slippery slope by Alex J. Pollock published by American Banker on March 21, 2019

March 21, 2019

Many observers, like Captain Renault in “Casablanca,” were “shocked, shocked!” at President Trump’s sharp criticism of the Federal Reserve and his attempt to influence it against raising interest rates, inquiring whether the president can fire the Fed chairman.

Yet many presidents and their administrations have pressured the Fed, going back to its earliest days, when the Woodrow Wilson administration urged it to finance bonds for the American participation in the First World War. The Fed compliantly did so, proving itself very useful to the U.S. Treasury.

That was not surprising, since the original Federal Reserve Act made the secretary of the Treasury automatically the chairman of the Federal Reserve Board, and the board met in the Treasury Department.

In the decades since then, lots of presidents have worked to influence the Fed’s actions. Their purpose was usually to prevent the Fed from raising interest rates, exactly like Trump. It was also often to cause the Fed to finance the U.S. Treasury and to keep down the cost of government debt, just as “quantitative easing” does now.

But has a president ever fired a Federal Reserve Board chairman?

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BankThink A simple fix to brokered-deposit battle by William Isaac published by American Banker on March 12, 2019

BankThink A simple fix to brokered-deposit battle by William Isaac published by American Banker on March 12, 2019

March 12, 2019

The American Bankers Association recently released a report from a major law firm detailing the legislative history of the Federal Deposit Insurance Corp.’s battle against bank purchases of deposits from money brokers, continuing a policy debate that began over 30 years ago when I was chairman of the FDIC. The ABA report suggests that over time the FDIC may well have gone further than necessary in addressing the underlying problems with the practice.

I believe the ABA report is responsible and helps illuminate a possible solution to the issues that have arisen with the FDIC’s rules. That said, I’m concerned that the rhetoric of some bankers paints the FDIC’s restrictions on brokered deposits as antiquated vestiges of a bygone era of no value in today’s rapidly evolving internet era.

Let’s take a quick look at the origins of the restrictions in order to better understand the problem and a possible solution. Deregulation of interest rates in the 1980s gave rise to the practice of money brokers raising vast sums of money and bundling the funds for sale to the banks and thrifts that bid the highest prices, generally those that had the highest risk profile. The then-$100,000 limit on deposit insurance flowed through to each of the thousands of investors in the money broker, allowing hundreds of millions of dollars to be placed by the deposit broker fully insured in each bank.

As the bank and thrift failure rate began its dramatic rise, we found an increasing number of failed banks and thrifts had large amounts of fully insured brokered funds. We concluded we had to take strong actions to stop this massive abuse of the deposit insurance system which was under siege.

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High taxes are driving away the tri-state golden geese, by Stephen Moore and Arthur Laffer published by NY Post on February 13, 2019

High taxes are driving away the tri-state golden geese, by Stephen Moore and Arthur Laffer published by NY Post on February 13, 2019

February 13, 2019

“This is the flip side [of] tax the rich, tax the rich, tax the rich. The rich leave, and now what do you do?” Gov. Andrew Cuomo asked this month, and it’s a vexing question.

When Congress enacted President Trump’s tax reform a little over a year ago, many economists, ourselves included, predicted that the lower tax rates would supercharge the national economy but could cause big financial problems for the tri-state region of New York, New Jersey and Connecticut.

The cap on the state and local tax deductions at $10,000 raised the highest effective state tax rates to 12.7 percent from 7.7 percent in New York City, to more than 10 percent from 6.5 percent in New Jersey, and to 7 percent from 4.2 percent in Connecticut.

The danger was clear: Unless these states cut their taxes sharply, they would witness an exodus of wealthy residents, who would migrate to low-tax states like Florida, Tennessee and Texas, taking their money with them and dramatically diminishing the tax base in their home states.

Cuomo is now calling the SALT change “diabolical.” But Albany sat back and did nothing. Ditto for legislators in Hartford. And in Trenton, they raised taxes.

The exodus may already be underway.

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IT’S ALL ABOUT STOCKS – AND IT SHOULDN’T BE! by William Dunkelberg Chief Economist of the National Federation of Independent Business

IT’S ALL ABOUT STOCKS – AND IT SHOULDN’T BE! by William Dunkelberg Chief Economist of the National Federation of Independent Business

January 4, 2019

Critics of the Federal Reserve are popping up everywhere. They say that the Federal Reserve is not paying attention to “what markets are telling” about the economy. Critics have forgotten what impact zero interest rates had and are still having. If investors can’t earn anything in bonds, they put their money into stocks and real estate, bidding up those prices. When interest rates start to normalize (e.g. rise), bonds become more attractive, and money flows into bonds rather than stocks.

Another perspective – shares of stock in a company reflect the earnings the company makes and is expected to make. The price of the share multiplied by the number of shares outstanding is the value of the company. Similarly, the value of our stock markets must collectively reflect the value of USA Inc., the value of the production of all of our companies taken together.

Share prices have not been connected to reality for some time, thanks to the Federal Reserve artificially holding rates down for so many years. This created distortions that will still take years to resolve. Since 2008, the S&P 500 stock index has risen 110 percent. But our output, measured by GDP, has increased only 25 percent over the same period. This indicates that the growth in output owned by each share has lagged far behind the share price, or, viewed another way, there is less real output per dollar of share price, a lower real return. So, as interest rates rise, bonds provide an attractive alternative to owning stocks and stock prices will weaken as investment money shifts to Tbonds.

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Anderson: Southwest Florida residents remember George H.W. Bush published by Herald Tribune on December 9, 2018

Anderson: Southwest Florida residents remember George H.W. Bush published by Herald Tribune on December 9, 2018

December 9, 2018

William Isaac was just 34 when he joined the board of the Federal Deposit Insurance Corporation in 1978.

The country was on the precipice of a banking crisis that would stretch throughout the next decade.

Isaac — a Lido Key resident who remains the youngest FDIC board member in U.S. history — would end up serving five years as chairman of the agency, a job that put him in contact with George H.W. Bush back when Bush was vice president.

A wave of bank failures in the 1980s kept Isaac extremely busy. The financial turmoil led to calls for reform.

In the early 1980s Isaac participated in a federal task force on reforming the nation’s financial regulators. It was led by Bush.

Isaac met with Bush privately and in group settings as the task force worked on a plan. The problem, Isaac said, is that the financial regulatory system had evolved piecemeal over 100 years and lacked proper coordination, which resulted in failures to identify problems.

Here is the link to the full article

BankThink We can do better on de novos By Jelena McWilliams published by American Banker on December 6, 2018

BankThink We can do better on de novos By Jelena McWilliams published by American Banker on December 6, 2018

December 6, 2018

[The 12th Chairman of the FDIC wholeheartedly supports the 21st Chairman in her efforts to streamline the FDIC’s applications processes and to encourage the formation of new banks throughout the country. Community banks are essential to economic growth and we need more of them, not fewer. Bill Isaac]

Recently, I went to a small community bank to open a checking account. I drove away from Washington and entered a branch of a small bank. It’s a transaction I easily could have made from home — over the phone or online — but I wanted to experience firsthand what consumers across the country experience when they visit a community bank. Community banks are characterized by their relationship-based practices. And my visit was no exception.

I was greeted with a smile and an offer of candy. While the patient branch manager went through the requisite paperwork to open my account, a customer walked in with his 3-year-old daughter. Mary ran up to the teller to give her a hug. The father said that, as they drove by, Mary insisted on stopping by the bank to say “hi.” The bank manager smiled and told me, “She has been coming here since she was born.” It felt like I just entered a Norman Rockwell painting.

Small banks like these are slowly disappearing from America’s landscape. Today, 627 counties are only served by community banking offices, 122 counties have only one banking office, and 33 counties have no banking offices at all.

The banking landscape in the United States has changed dramatically in the last few decades. After remaining fairly steady for more than three decades, the total number of banking and thrift charters declined from around 15,160 in 1990 to 5,670 at the end of 2017. The share of industry assets held by the top 10 banking organizations rose from 19% in 1990 to 51% at the end of 2017.

I do not profess to know what the right number of banks in the U.S. is, but I recognize that, like many competitive industries, a dynamic banking sector needs new startups entering the marketplace. De novo banks are a key source of new capital, talent, ideas, and ways to serve customers. Most de novos are traditional banks that offer services and products to underserved communities and fill gaps in overlooked markets.

Over the past decade, de novo activity has screeched to a historic halt. As FDIC chairman, one of my key priorities is to encourage new bank formation. The FDIC needs to do its part to make that happen.

Link to full article here