« Paul Krugman on why the liquidity trap really matters | Main | Ike Brannon, where is my talk? »
Arnold Kling's alternative: lower capital requirements
My alternative is to encourage new lending by lowering capital requirements at the margin. Tell banks that loans issued after September 1, 2009, require half the capital of similar loans issued before September 1. Some banks are in such bad shape that even with those lower capital standards they will not be able to make new loans. Fine. You don't want those banks to grow. But other banks have room to grow, and you want them to grow more than they would under the existing regulations.
As with changing accounting rules, lowering capital requirements ultimately exposes the government funds that insure banks to more risk. That is the flaw in the idea. However, there has to be some risk exposure to tax payers for any policy that encourages bank lending.
Here is more. One question I have is how to calculate the existing capital for the very worst, most insolvent, and most corrupt banks. You don't want them making loans to their uncles, so to speak. Would requiring 1/2 capital discriminate usefully against such banks or would it in fact select for their relative expansion? Or do we have this problem in any case?
Via Brad DeLong, here is a summary of the Dodd plan. It sounds like an improvement over the Paulson plan.
Posted by Tyler Cowen on September 22, 2008 at 03:49 PM in Economics | Permalink
Comments
Part of the Dodd plan may be unconstitutional. According to your linked article, it creates a "credit review committee" that consists of five members. Two of the members are appointed by Congress. This may mean that Congress is delegating executive power to a legislative agency, which is something that it is not allowed to do. See Bowsher v. Synar (summarized here: http://en.wikipedia.org/wiki/Bowsher_v._Synar). The remedy: Make those two officials appointed by the President.
Posted by: blabla at Sep 22, 2008 4:45:26 PM
The regulators are already doing everything they can to ease capital requirements. That was part of the original sin -- the SEC exempted the big 5 investment banks (now none of them are around anymore in the form of investment banks) so their leverage reached 30:1 or more and Fannie/Freddie were also encouraged to let leverage get out of hand. Letting "goodwill" count is just the newest of the regulatory forebearance steps.
The problem is not primarily due to a credit crunch from regulatory restrictions on booking new assets. It's that banks can't get access to funds they need in order to be able to make new loans. The flight to quality has even hit the asset-backed commercial paper market. The interbank market froze last week, and it's not running all that smoothly now. The market is now just as uneasy as regulators as to the value of the toxic waste on the FIs books. And contagion is likely to spread, via flight to quality, to the even more highly leveraged and even more opaque hedge funds.
Bookkeeping rules and regulatory requirements may have added juice to the downward spiral in asset values, but there's no magic wand left to produce market confidence in these suspect balance sheets now it's been lost.
I think we need a major intervention, but not Paulson's backdoor informal recapitalization plan that has no principles for which institutions are going to receive what level of assistance. At this stage it's hard to tell which institutions are truly in trouble. I'd like to see a large takeover that does a quick triage, returns the healthy firms to the market with some of the worst stuff removed from their balance sheets, reorganizations and sales for the next-worse candidates, and orderly liquidation for the balance. And a Mortgage Management Company(ies) to handle the hard-to-value assets, a la Asset Management Companies in other countries' rescue operations.
It's a standard approach we've seen work around the world. It's what we would recommend if the US financial system were Thailand or Korea in lieu of temporizing measures that benefit the rich and well-connected. We ought to be prepared to take our own advice.
Posted by: nadezhda at Sep 22, 2008 4:52:33 PM
While I agree with the principle Dodd's plan espouses that taxpayers should share in the upside banks get by offloading bad assets to the treasury (whether via warrants or simply grants of stock), setting the compensation at a dollar for dollar level seems too high. After all, in theory the treasury is paying "market prices" for these securities, so they're already getting something in return.
Say Citi wanted to sell $50bn of CDOs at whatever price they agree to with the treasury - does that mean that the treasury now owns something like 50% of Citi (based on today's closing price)? Or would they get 2.5bn new shares (based on a value of $20/share from today's close) and thus have 33% of the equity? Either way seems to be rather exorbitant.
Equity warrants or call options both seem like better options to me. But I don't know anything.
Posted by: Kyle S at Sep 22, 2008 5:03:09 PM
While I agree with the principle Dodd's plan espouses that taxpayers should share in the upside banks get by offloading bad assets to the treasury (whether via warrants or simply grants of stock), setting the compensation at a dollar for dollar level seems too high.
I think the idea is that it would be dollar for dollar on losses, if the government broke even or made money then they'd get nothing. I think there should be some encouragement for the banks to not just purchase toxic waste and sell it off to the government for a profit.
Posted by: JordanT at Sep 22, 2008 5:51:42 PM
Well, given that there isn't going to be an agreement, I'm closing out my money market fund. The commercial paper market will have to take care of itself. So will the VRDO market that funds all those higher education financings. I hope they take the money out of the professors' salaries.
Posted by: y81 at Sep 22, 2008 7:50:58 PM
$700 Billion Dollar Bailout Good For Economy
WASHINGTON (AP) -- It's the largest government bailout in U.S. history and two days after it was introduced to the Americans paying for it, the proposal is still largely a mystery.
Among the unanswered questions: How will the government mop up the bad mortgage debt on banks' books, who will run the process and how much will it cost?
ADVERTISEMENT
Key elements of the plan remain in flux as behind closed doors Democrats demand modifications that would provide more help for ordinary Americans in return for bailing out the country's financial giants.
Posted by: Bort at Sep 22, 2008 9:15:54 PM
At the risk of repetition:
Require that some stipulated proportion of paper (loans) brought to the discount window be "new" credits. Then increase that proportion each quarter until it reaches some level (25%?). Get the Fed credit out in the field.
Posted by: R Richard Schweitzer at Sep 22, 2008 9:50:53 PM
R. Richard Schweitzer: Require that some stipulated proportion of paper (loans) brought to the discount window be "new" credits. Then increase that proportion each quarter until it reaches some level (25%?). Get the Fed credit out in the field.
By all means, let's fill the world with even more mortgages that will end up being paid by the taxpayers rather than the house buyers.
Posted by: CommonNonsense at Sep 22, 2008 10:20:20 PM
Isn't the problem that banks won't even loan to themselves? Why would lower capital requirements help.
What about the liabilities on the other side of those institutions?
I don't think that the problem is being capital constrained via regulation
Posted by: ziggurat at Sep 22, 2008 11:02:38 PM
If we are going to accept all the socialist reaons given for this government intervention then why not just write a 5k check to every person in the country...that equates to about 1.5 trillion dollars...household of 4 get 20 k....this would help make mortgage payments for a year or two for lots of lower middle class folks. Sure we get a little inflationary stuff happening but it will be counterbalanced with Goldman and JP Morgan going bankrupt. This is the socialist website right? no...oh did I accidentally come to the corporate welfare website...ok see ya later I'm going back to a libertarian website.
Posted by: gabe at Sep 23, 2008 1:35:32 AM
I have an asinine question, but first, Hussman has a similar conclusion in his analysis
http://hussmanfunds.com/wmc/wmc080922.htm
Now, maybe I've earned my asinine question. What is the difference between lending someone money so they can make a profit, versus lending them money so they might not go bankrupt?
Obviously, banks don't want to make long-term loans to their competitors when they themselves have short-term liabilities. It would seem interest rates would have to go up, but can they go up in a slowing economy. What if the Treasury stopped selling "risk-free" notes? What if people had to start measuring risk? Okay, maybe that's more than one asinine question.
Posted by: Andrew at Sep 23, 2008 4:12:47 AM
Yes, more hair of the dog what bit you is just what we need.
Over leveraged and under capitalized financial institutions is one of the things that created the mess we have. So we solve that problem with more under capitalization of banks.
Posted by: spencer at Sep 23, 2008 11:22:06 AM
I'm going to post this request at a number of econ blogs I read, in case others have suggestions.
I'm feeling, rather desperately, that we need a faster tool for critiquing and comparing the different proposals out there. I want a mechanism by which the experts can point out flaws in different solutions and arrive at an optimal selection (if not consensus). If this all has to happen in a week, the blogosphere needs to be even faster than usual.
Is there a site out there doing that now?
Could wikipedia support this, or would the comment threading collapse under the weight?
Other suggestions?
Posted by: Andrea at Sep 23, 2008 3:37:57 PM
That does sound worth while Andrea. Such a website would be the center of much of the sane debate. For this reason I predict that control of such a website would quickly be influenced by some people with big pockets. It could be very lucrative.
Posted by: Gabe Harris at Sep 24, 2008 11:49:52 AM
If you have to buy cabal alz, please come to our company.
Posted by: buy cabal alz at Jan 1, 2009 11:54:46 PM
Bvlgari Jewelry
Replica Bvlgari Jewelry
Bvlgari Replica Jewelry
Gucci Jewelry
Replica Gucci Jewelry
Gucci Replica Jewelry
Posted by: aion kina at Mar 18, 2009 3:11:41 AM
Is it realistic?
Posted by: tom at May 15, 2009 2:03:35 AM
it is not bad
Posted by: anna at May 15, 2009 2:04:12 AM
It is enlightening!
Posted by: nick at May 15, 2009 2:04:48 AM
