Historical Balance Sheets of U.S. Central Banking

Balance sheet data on two episodes of U.S. central banking are now available in spreadsheet form for the first time. Adil Javat has written a paper that digitizes data on the First Bank of the United States. The bank, established in 1791, was federally chartered and partly owned by the federal government. It was the only bank to have a nationwide branch network because states did not allow banks they chartered to branch across state lines, or in many cases even within them. The bank’s unusual attributes made in in effect a quasi central bank. The Democratic Party objected to it for that reason, and denied the bank an extension when its federal charter expired in 1811. The following year the United States became embroiled in the War of 1812 and missed the services that the Bank of the United States had provided. The U.S. Congress chartered a second Bank of the United States that began operations in 1817. It in turn was denied an extension of its charter by the Democratic Party in 1836. A fire at the U.S. Department of the Treasury in 1833 destroyed many records of the First Bank of the United States, so what remains is fragmentary, and is the fruit of searches of various archives by the 20th century historian James Wettereau. Perhaps more records are still out there, gathering dust somewhere?

Justin Chen and Andrew Gibson have written a paper that digitizes the weekly balance sheet of the Federal Reserve System (now called the H.4.1 release) from the Fed’s opening in 1914 to 1941. Their data will be of interest to anyone interested in the Fed’s behavior during the tumultuous period that included World War I, the sharp but short postwar depression of 1920-21, and the Great Depression. Previously — and surprisingly, given how much has been written about the early years of the Fed — digitized data were only available at monthly frequency. Weekly data should offer finer insights into the Fed’s behavior during episodes in which events were moving fast.

Javat, Chen, and Gibson are all students of CFS Senior Counselor Steve Hanke, and wrote their papers in a research course Hanke teaches for undergraduates at Johns Hopkins University. I read and commented on drafts of the papers.

(For the spreadsheets, see this page. There is a link underneath each paper to its accompanying workbook.)

Federal Reserve Governor Tarullo Resigns

Board of Governors of the Federal Reserve System (“Board”) Governor Daniel K. Tarullo submitted his resignation letter to President Trump. The resignation is effective April 5, 2017. Governor Tarullo’s departure will leave the Board with three vacancies.

Governor Tarullo served as Chair of the Board’s Committee on Supervision and Regulation and Chair of the Financial Stability Board’s Standing Committee on Supervisory and Regulatory Cooperation. He also served as the informal “Vice Chairman of Supervision,” a Dodd-Frank created position that was never filled by President Obama. In that capacity, Governor Tarullo has been recognized as the architect of much of the Board’s post-crisis policy and regulatory decision-making.

The four current Governors are: Stanley Fischer (term expires January 31, 2020); Janet Yellen (term expires January 31, 2024); Lael Brainard (term expires January 31, 2026); and Jerome H. Powell (term expires January 31, 2028). The term of current Chair Janet Yellen expires February 3, 2018. President Trump will have the opportunity to influence the direction of the Board by filling the three vacant seats, naming a new Chair, and filling key leadership positions.

Lofchie Comment: Governor Tarullo pursued an expansionary regulatory philosophy. He believed that financial market participants fell into two categories: banks that were at least indirectly regulated by the Federal Reserve Board, and shadow banks that were improperly avoiding regulation by the Board. (See Fed Governor Examines Post-Crisis Financial RegulationGovernor Tarullo Delivers Speech Regarding Shadow Banking and Systemic Risk Regulation.) Throughout his tenure, Governor Tarullo seemed to be oddly hostile to the securities financing markets and largely indifferent to declines in liquidity in the financial markets. (See Federal Reserve Board Governor Tarullo Calls for Regulatory Approach to “Runnable Funding”.)

Governor Tarullo could have remained to complete his full term set to expire on January 31, 2022. It is clear, however that the Governor’s expansionary regulatory philosophy would have come into direct conflict with the views of the new administration. Governor Tarullo’s resignation is significant given the influence that he held over the regulatory direction at the Board.

Testimony on Monetary Policy

Mickey D. Levy (Chief Economist of Berenberg Capital Markets for the Americas and Asia) testified before the House Financial Services Committee on monetary policy.

He focused on how non-monetary factors including a growing web of government taxes, regulations and mandated expenses were harming the economy.

His line of thinking is of special note as these themes have been revealed over the years by CFS Divisia monetary aggregates and components.

His Testimony Resetting Monetary Policy is available online – http://financialservices.house.gov/uploadedfiles/hhrg-114-ba19-wstate-mlevy-20161207.pdf

Congress can help the Fed…

President-elect Donald Trump noted that “we have a very false economy,” due to the Fed “keeping the rates down.”  He is right.

Yet, the question remains how to exit from this policy while avoiding catastrophe in the bond market and building a safer monetary policy framework for the future.

The Fed needs to integrate state and bank money into the policy discourse, including its own reports to Congress and the public.

Here, Congress can help.

For full remarks:

NY Fed Issues New Policy on Counterparties for Market Operations

The Federal Reserve Bank of New York issued a comprehensive overview of its counterparty framework, which includes a new policy on counterparties for all domestic and foreign market operations. The new counterparty policy is the result of a multi-year review of the framework for counterparty relationships across the full range of the trading desk operations in domestic and foreign financial markets.

Highlights from the new policy include:

  • reducing the minimum net regulatory capital (“NRC”) threshold for broker-dealer counterparties from $150 million to $50 million, in order to broaden the pool of eligible firms;
  • raising the minimum Tier 1 capital threshold for the banks, branches, and agencies of foreign banking organizations from $150 million to $1 billion, to better align the Tier 1 threshold with the new NRC threshold (which is measured with respect to Tier 1 capital of the bank holding company); and
  • introducing a 0.25% minimum U.S. government market share threshold as a means to more directly quantify the business capabilities of firms that express interest in becoming a primary dealer.

Under the new policy, counterparties will be expected to:

  • operate in accordance with the Best Practices for Treasury, Agency Debt and Agency Mortgage-Backed Securities Markets (published by the New York Fed-sponsored Treasury Market Practices Group) and FX market best practices guidance (such as the Global Preamble, promulgated by the New York Fed-sponsored Foreign Exchange Committee);
  • provide insight to regulators on an ongoing basis into developments in the markets in which they transact;
  • meet any minimum capital thresholds or other standards that are set forth by their primary regulator;
  • provide information (as needed) for counterparty risk management and monitoring; and
  • establish a compliance program that is consistent with the sound practices observed in the industry, and support adherence to the terms of its counterparty relationship with the Federal Reserve Bank of New York.

The Federal Reserve Bank of New York also provided the following materials for firms interested in becoming a counterparty:

The new policy and eligibility criteria are immediately effective.

Lofchie Comment: It is notable that the New York Fed reduced the capital requirements for primary dealers, while at the same time increasing those requirements for counterparties to foreign exchange transactions. Further, one could question whether reduced capital requirements for primary dealers reflect diminished market interest in operating as a primary dealer.

Coats on “What is wrong with our monetary policy?”

Former Chief of the SDR Division at the IMF Warren Coats unpacks a statement by Senator Jeff Merkley that

“The Fed should be using its economic expertise to highlight the long-term devastating impacts of failing to provide the opportunity for the skills needed for the economy of the future.” [1]

Warren’s paper examines monetary management in the United States – since the Nixon shock of closing the gold window and launching wage and price controls – to research the statement above. He finds:

  • No tradeoff exists between employment and inflation in the long run.
  • Radical innovations in New Zealand sparked rules that ultimately fell short of expectations.
  • NGDP targeting ignores the benefits of stable money.
  • The return to a hard anchor for monetary policy – such as the SDR – is attractive.

Although CFS is not promoting the idea of a newfound use for the SDR, monetary policy is in need of a rethink. Warren’s ideas are thoughtful and informative.

To view the full paper:

As always, CFS welcomes opinion.

[1] Ylan Q. Mui, https://www.washingtonpost.com/news/wonk/wp/2016/08/26/liberals-fought-for-janet-yellen-to-lead-the-fed-now-they-hope-shes-more-more-ally-than-adversary/ The Washington Post Aug. 27, 2016

Lofchie on Financial Reform Platforms

When considering financial regulation (and regulation generally) and their expressed attitudes towards the financial system, the two platforms are positioned almost diametrically in opposition. It is necessary, therefore, to say something about the parties’ views of the role that government should play both in providing employment and in the role of private enterprise. The Republican platform is based on the standard position that private enterprise is to be strongly encouraged and is generally preferable to governmental enterprise. By contrast, the Democratic platform is largely about governmental spending and enterprise; including, for example, government spending on infrastructure: drinking water and waste systems, climate change initiatives, education, industrial energy efficiency, broadband networks, health care, child care, care for the aged, housing, supporting groundbreaking research and so on. The Democratic platform supports such spending not only at the federal level, but also at the state and municipal level. While the summary above does not fully include these spending initiatives, it would not be possible to assess the Democratic position on financial regulation and the direct conduct of financial activities by the government without that context.

The focus of this discussion is on financial regulation. The Republican platform, provides little in the way of ambitious new plans. It is, at its core, completely skeptical of regulation, describing all of it as a “tax.” This is obviously not true: good regulations are necessary for growth because they keep market participants honest. Advocating for the abolition of the Internal Revenue Service, as the platform does at one point, seems to be a wholly unserious proposition. That being said, it is all a matter of perspective. If one believes that our current system of financial regulation is more in need of pruning than of fertilization, then such unseriousness is a bit of welcome relief from the unseriousness of our current debates.

The Democratic platform, by contrast, is breathtaking in its ambition. It is not possible to ignore the extent to which the Democratic platform envisions a substantial replacement of the private financial system by government-owned financial enterprises. A notable example: the platform advocates the idea that the Postal Service should provide “basic” banking services. While the only such service that is expressly mentioned is check cashing, the platform strongly suggests that such services would also include deposits and lending. In addition, the platform would establish an “independent, national infrastructure bank” to, among other things, “provide loans and other financial assistance for . . . multi-modal infrastructure projects.” (What in the world does that mean?) Then there are also the half dozen or more other loan and investment services for which the platform makes provision. The platform seems to intend that the Postal Service would enter into direct competition with community banks. It would seem to be the strong, albeit implicit, belief of the drafters of the Democratic platform that the government would be successful in not only community banking but in a whole range of investment banking-type activities.

The Democratic platform spends a fair amount of time demonizing all those who work in financial services as part of a hostile and criminal operation. Perhaps those who are in government should be a bit more modest given that the number of senior government officials who have been convicted of financial crimes is fairly substantial. That said, the supposedly corrupt “revolving door” between financial regulators and the financial industry seems to be overstated if not completely fictional. Where is the evidence that anyone at the SEC has been negatively influenced by their previous job? Whether or not the authors of the draft platform have any genuine goal in that regard, the effect of the assumption will be the same: preventing knowledgeable individuals from working for financial regulators. If being ignorant of how markets work should be considered to be such an asset, then perhaps financial regulators should be selected randomly from the phone book (though a lottery drawn from a list of academics might yield even more candidates with this particular asset).

Much of the detail of the Democratic platform is either unserious or intellectually incoherent. What does it mean to protect the independence of the Federal Reserve Board, but to make it more representative? If the Board is to be more “representative”; i.e., reflecting the popular will, what is the purpose of its independence? Likewise, is it absolutely necessary that “every Republican effort to weaken” Dodd-Frank must be stopped – i.e., that it is wrong to reassess the 2,000-page statute after six years of operation in order to gauge its failures and successes? Does anyone really believe that Dodd-Frank is such a perfect work of art that any attempt to revisit its contents is a form of desecration? The politicization of every issue makes it impossible to have a rational discussion about financial regulation.

Interestingly, there are some areas of agreement between the Democrats and the Republicans in their political platforms. Both express skepticism of international trade (both single out China) and both are opposed to “too big to fail” (which seems to be the regulatory equivalent of supporting the baking of apple pie).

It is perhaps unfair to critique political platforms given the general understanding that they are for the most part meaningless monologues that will be ignored by the soon-to-be elected officials. Nonetheless, even if they are not directly actionable documents, they do influence the parameters of the debate that is to come, and thus it seems appropriate to treat the documents as significant.

Republican Financial Reform Platform Summary

The Republican platform position is highly critical of Dodd-Frank for “establish[ing] unprecedented government control over the nation’s financial markets,” forcing “central planning of the financial sector” and creating “unaccountable bureaucracies” that have “killed jobs.” In general, the Republican platform describes financial regulations as “just another tax” and states that Americans should “consider a regulatory budget that would cap the costs federal agencies could impose on the economy in any given year.” In particular, Republicans would:

  • abolish the Consumer Financial Protection Bureau or subject it to congressional appropriation;
  • “advance legislation that brings transparency and accountability to the Federal Reserve, the Federal Open Market Committee, and the Federal Reserve’s dealing with foreign banks”;
  • (regarding “too-big-to fail”) “ensure that the problems of any financial institution can be resolved through the Bankruptcy Code”; and
  • endorse prudent regulation of the banking system to ensure that FDIC-regulated banks are properly capitalized and taxpayers are protected against bailouts.

The Republican Platform criticized the Dodd-Frank Act:

Rather than address the cause of the crisis — the government’s own housing policies — the [Dodd-Frank Act] extended government control over the economy by creating new unaccountable bureaucracies. Predictably, central planning of our financial sector has not created jobs, it has killed them. It has not limited risks, it has created more. It has not encouraged economic growth, it has shackled it.

Democratic Financial Reform Platform Summary

The Democratic platform position on financial regulation begins with an endorsement of Dodd-Frank. The Democrats state that they will “vigorously implement, enforce and build on the landmark Dodd-Frank financial reform law” while “stop[ping] dead in its tracks every Republican effort to weaken it.” When addressing the financial industry, a term used interchangeably with “Wall Street,” the Democrats aver that it is marked by “greed and recklessness” and that it is “gambling trillions” for the benefit of a “handful of billionaires.” To combat this, the Democrats would “support stronger criminal laws and civil penalties for Wall Street criminals who prey on the public trust” and would support “extending the statute of limitations” to prosecute such people.

The Democrats propose to:

  • support the Department of Labor’s new fiduciary rules;
  • “oppose any efforts to change the CFPB’s structure from a single director to a partisan, gridlocked Commission” and “oppose any efforts to remove the [CFPB’s] independent funding and subject it to the appropriations process”;
  • “nominate and appoint regulators and officials who are not beholden to the industries they regulate”;
  • “crack down on the revolving door [sic] between the private sector . . . and the federal government,” and “ban golden parachutes” [payable to those leaving private industry to work in government];
  • “limit conflicts of interests by requiring bank and corporate regulators to recuse themselves from official work on particular matters that would directly benefit their former employers”;
  • “bar financial service regulators from lobbying their former colleagues for at least two years”;
  • adopt an “updated and modernized version of Glass-Steagall”
  • impose a “financial transactions tax on Wall Street to curb excessive speculation and high-frequency trading,” although the platform does “acknowledge that there is room within our party for a diversity of views on a broader financial transactions tax”; and
  • “defend the Federal Reserve’s independence,” but also “reform the Federal Reserve so that it is more representative of America as a whole, and . . . fight to make sure that executives at financial institutions are not allowed to serve on the boards of regional Federal Reserve banks or select its members.”

The Democratic Party emphasized its determination:

Democrats will not hesitate to use and expand existing authorities as well as empower regulators to downsize or break apart financial institutions when necessary to protect the public and safeguard financial stability, including new authorities to go after risky shadow-banking activities.

The Democratic platform envisions not only a continuing expansion of financial regulation, but also seems to promote the idea that government should play a very major role as a direct provider of financial services.

As a provider of financial services, the federal government would:

  • expand the powers of the Postal Service so that it may offer “basic financial services such as paycheck cashing”; and later, the platform again emphasizes that the Democrats “believe that we need to [provide additional banking services] by empowering the United States Postal Service to facilitate the delivery of basic banking services”;
  • create an “independent, national infrastructure bank that will support critical infrastructure improvements” and “provide loans and other financial assistance for . . . multi-modal infrastructure projects”;
  • continue to support the interest tax exemption on municipal bonds . . . to encourage infrastructure investment by state and local governments;
  • defend the “Export-Import Bank”;
  • “provide direct federal funding for a range of local programs that will put young people to work”;
  • “provide targeted funding and support for entrepreneurship and small business growth in underserved communities”;
  • “double loan guarantees that support the bio-based economy’s dynamic growth”; and
  • expand “federal funding for New Markets Tax Credit, community development financial institutions, and the State Small Business Credit Initiative.”

G20 Describes Path to Global Economic Recovery

The Group of 20 Finance Ministers and Central Bank Governors (“G20”) reviewed efforts to respond to “key economic challenges, as well as the progress . . . made since the beginning of this year.” The meeting was held over two days in Chengdu, China.

In a Communiqué issued at the end of the conference, the G20 members conveyed the following:

  • “The global recovery continues but remains weaker than desirable.” This is due in part to high financial market volatility and geopolitical conflicts, and to fluctuating commodity prices and low inflation, both of which could be prevented by sharing the benefits of growth within and among countries in order to promote inclusiveness.
  • The G20 will use “all policy tools – monetary, fiscal and structural – individually and collectively to achieve . . . strong, sustainable, balanced and inclusive growth.” Achieving that goal will involve making tax policy and public expenditure more “growth-friendly” by prioritizing high-quality investments.
  • Structural issues, such as excess capacity in certain industries, are “exacerbated by a weak global economic recovery and depressed market demand” and have affected trade and workers negatively.
  • Multilateral development banks (“MDBs”) have a “unique role in supporting infrastructure investment.” G20 has asked MDBs to undertake joint actions that support “quality infrastructure development, which aims to ensure economic efficiency in view of life-cycle cost, safety and resilience.”
  • The G20 supports the “continued effort to incorporate enhanced contractual clauses into sovereign bonds.”
  • The G20 prioritizes “building an open and resilient financial system,” by implementing the total-loss-absorbing-capacity standard and effective cross-border resolution regimes. Members will “continue to address systemic risk within the insurance sector,” along with “emerging risks and vulnerabilities in the financial system, including those associated with shadow banking, asset management and other market-based finance.”
  • The G20 recognizes “recent progress made on effective and widespread implementation of the internationally agreed standards on tax transparency.” The G20 recognizes the effectiveness of “tax policy tools in supply-side structural reform for promoting innovation-driven, inclusive growth, as well as the benefits of tax certainty to promote investment and trade.” The G20 will continue working on issues surrounding pro-growth tax policies and tax certainty.
  • G20 countries should participate in a “voluntary peer review of inefficient fossil fuel subsidies that encourage wasteful consumption.” Further, green financing must be increased if environmentally sustainable growth on a global scale is to be supported.

Lofchie Comment: Although the G20 Communiqué has no actual legal effect, the intellectual bent is clear: it supports globalism and government intervention while remaining either indifferent or hostile to private enterprise. The Communiqué begins with a recognition that the global economy is weak. It then pivots toward questions of infrastructure spending which inherently means either government spending or spending through international government agencies and “multilateral development banks.” The G20 seems to view private financing sources with suspicion and perhaps even hostility in its assessment of “vulnerabilities . . . associated with shadow banking, asset management and other market-based finance.”

The G20 stance on energy is that “green financing must be increased,” presumably, through additional government financing. At the same time, the G20 advocates for the reduction of “fossil fuel subsidies that encourage wasteful consumption.” It is difficult to understand the policy implications of these statements. Wouldn’t governmental subsidies of green financing also encourage wasteful energy consumption? If, for example, you wanted to reduce energy consumption, wouldn’t you have to raise the cost of energy, instead of subsidizing its production?

According to the G20, tax collection must be improved while “pro-growth tax policies” are implemented. Again, it is difficult to understand what is being advocated here. Is this an argument for reduced taxes? The G20 says that it favors the use of “tax policy tools in supply-side structural reform for promoting innovation-driven, inclusive growth, as well as the benefits of tax certainty to promote investment and trade.” What does this mean? Who possibly could be against “innovation-driven, inclusive growth”? Or better yet, how about this incomprehensible line: “We launch the Global Infrastructure Connectivity Alliance to enhance the synergy and cooperation among various infrastructure connectivity programs in a holistic way.”

In a passage from the Communiqué that seems particularly problematic, the G20 observes that “fluctuating commodity prices and low inflation . . . could be prevented by sharing benefits of growth within and among countries to promote inclusiveness.” Perhaps this is true, but since the Democratic and Republican parties both seem to oppose further trade agreements, and likely are in favor of reevaluating established ones, it is unclear what part or political faction of the U.S. government would endorse the G20’s position.