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

Office of Financial Research Reports on Potential Threats to Financial Stability

The U.S. Office of Financial Research (“OFR”) reported that the U.S. financial system showed improved resilience over the past year but that it faces several threats stemming from global disruptions and “financial system evolution.” The findings were published in the 2016 Annual Report to Congress and in the 2016 Financial Stability Report.

OFR Director Richard Berner highlighted the key vulnerabilities uncovered by the reports:

“. . . Those created by global economic and financial disruptions, by continued risk-taking amid still-low long-term interest rates, by risks facing U.S. financial institutions, and by challenges in improving financial data.”

Both reports cited the following factors and developments as specific threats:

  • potential spillovers from Europe stemming from the long-term uncertainty posed by the Brexit vote;
  • credit risks in U.S. nonfinancial corporations posed by the rapid growth of high debt levels;
  • cybersecurity incidents stemming from electronic transactions;
  • the concentration of risk in central counterparties (“CCPs”) caused by clearing from CCPs;
  • pressure on U.S. life insurance companies;
  • systemic footprints of the largest U.S. banks and the substantial risks inherent in large bank failures; and
  • deficiencies in data and data management.

In the reports, the OFR also discussed the role of shadow banking in the financial system.

Lofchie Comment: A number of the systemic threats in the reports are due in large part to government intervention in the markets; e.g., the high debt levels that result from extremely low interest rates, and the increase in size of very large banks, which arguably is exacerbated by the costs of regulation that weigh most heavily on smaller firms.

The most notable threat acknowledged by the OFR is that which is created by central counterparties: “We are concerned that, although clearing swaps transactions through central counterparties reduces the risk from the other party defaulting in two-way swap transactions, it also concentrates risk in the CCP itself.”

“No kidding,” one is tempted to say. The government’s acknowledgment of this risk, which resulted from Dodd-Frank’s supposed magic bullet, is beneficial if remarkably belated. (Kudos to University of Houston Finance Professor Craig Pirrong, who predicted the threat many years earlier in posts on the Streetwise Professor blog.)

IOSCO Reports on Implementation of Post-Crisis Recommendations for Securities Markets

The IOSCO Board reported on the implementation of the G20/Financial Stability Board’s (“FSB”) post-crisis recommendations to strengthen securities markets. The Board report includes insight and analysis on the implementation of recent reforms and is based on self-reporting by national authorities in FSB jurisdictions. The report focused on (i) hedge funds; (ii) structured products and securitization; (iii) oversight of credit rating agencies; (iv) measures to safeguard the efficiency and integrity of markets; and (v) supervision and regulation of commodity derivative markets.

Highlights of the report:

  • hedge funds – all responding jurisdictions which permit or have hedge funds reported implementation of the G20 and IOSCO recommendations relating to registration, disclosure and oversight of hedge funds. Almost all reported implementation of recommendations in relation to international information and enhancing counterparty risk management;
  • structured products and securitization – most responding jurisdictions reported the introduction of measures to strengthen supervisory requirements or best practices for investment in structured products, and to enhance disclosure of securitized products as recommended by the Financial Stability Forum (now the FSB) in 2008 and IOSCO in a number of reports from 2009 onwards; and
  • oversight of credit rating agencies – all responding jurisdictions implemented G20/FSB recommendations to require registration and provide appropriate oversight of FSB jurisdictions in line with IOSCO’s Code of Conduct Fundamentals for Credit Ratings Agencies.

In addition, the report stated that the implementation of G20/FSB recommendations “is still progressing” in the areas of (i) measures to safeguard the integrity and efficiency of financial markets, and (ii) the supervision and regulation of commodity derivatives markets.

International Money: Interview with Professor Richard N. Cooper

Professor Richard N. Cooper – advisor to many U.S. Presidents on international monetary affairs – was recently interviewed by the Center for Financial Stability on his decades of experience at the center of international monetary policy.

Highlights include:

  • Evolution of the international monetary system,
  • Insights into Nixon Shock (cessation of the gold standard),
  • System of floating exchange rates,
  • Recent revelations regarding the 1944 Bretton Woods Conference,
  • China and measures to move forward,
  • Proposals for the future.

We thank Kurt Schuler and Robert Yee for such a wonderfully insightful exchange and Richard Cooper – Maurits C. Boas Professor of International Economics at Harvard and formerly Under-Secretary of State for Economic Affairs, and Chairman of the Federal Reserve Bank of Boston.

To view the full interview:

OFR Says “Brexit” Could Pose Risk to U.S. Financial Stability

The Office of Financial Research (“OFR”) asserted that “severe adverse outcomes in the U.K. from ‘Brexit’ could pose a risk to U.S. financial stability.”

In its biannual report, titled the Financial Stability Monitor, OFR provided the results of an assessment that focused on “vulnerabilities – weaknesses in the financial system that can originate, amplify or transmit shocks, potentially destabilizing the system.” The report was organized into five risk categories: macroeconomic, market, credit, funding and liquidity, and contagion.

The report found that risks to financial stability have stayed within the medium range, but also have risen as a result of the U.K. withdrawal referendum. The report specified that “Brexit” could pose moderate risks to the financial stability of the United States:

  • Trade: Although a recession in the United Kingdom or countries in the European Union would reduce the demand for U.S. exports, it is unlikely that the reduction would threaten U.S. financial stability due to the low percentage of U.S. exports to the European Union and vice versa. However, a reduction in exports could slow U.S. growth moderately.
  • Financial Exposures: The financial claims of the United States on the United Kingdom and, more broadly, the European Union could be vulnerable to losses due to (i) currency depreciations and volatility, (ii) declines in asset market prices, and (iii) increased defaults on debt claims.
  • Confidence and Indirect Effects: Financial instability in the United Kingdom or, more broadly, the European Union could do lasting damage to the confidence of global investors, and that damage could become “self-perpetuating.” Additionally, “U.S. long-term interest rates reached historic lows in the week after the [“Brexit”] referendum,” which in turn “underpin[ned] excesses in investor risk-taking.”
  • Funding and Liquidity Risks: Although “[k]ey funding risks are much lower than before the financial crisis due to major changes in short-term funding markets,” several vulnerabilities still persist. These include risks in certain money market funds and short-term investment vehicles, and sharp falls in market liquidity during certain moderate stress events.
  • Contagion Risks: “[C]ontagion risk is greater than available metrics indicate. . . . It is unlikely that the contagion risks disappeared as stress receded. It is more plausible that underlying factors – such as risky assets’ tendency to become more correlated during market stress – pose enduring contagion risks.”

The report stated:

Because the U.K. economy and especially the U.K. financial system are highly connected with the rest of Europe and the United States, severe adverse outcomes in the U.K. could pose a risk to U.S. financial stability.


Lofchie Comment: The value of these government reports is questionable. Statements in the OFR report like: “severe adverse outcomes in the U.K. could pose a risk to U.S. financial stability,” are trivial given the current economic environment, and they offer no useful insight for market participants. More remarkable, however, was the failure of the Financial Stability Oversight Council (“FSOC”) to identify “Brexit” as a risk in its own annual report, produced just before the “Brexit” vote. The OFR’s biannual report and FSOC’s annual report raise necessary but basic questions: (1) are these agencies particularly skilled at identifying risks before the fact, and (2) do they have anything useful to say about risks after the fact?

Improbable Success

I am delighted to share the launch of Dr. Richard Rahn’s television documentary series “Improbable Success: Free Markets at Work” (www.improbablesuccessproductions.com). Richard is Chairman of the Institute for Global Economic Growth, and serves on the editorial board of the Cayman Financial Review.

At a time, when policies are increasingly encountering limits, Richard’s reflection on prior success stories is refreshing. At a minimum, contemplation of these ideas is vital, if we want to emerge from the present low growth trap.

Richard let us know that “For the past 17 years I have been writing a weekly column which appears in the Washington Times and many other places – and the world has only become worse. So, I decided that it might be useful to produce films of successful countries and the results of following good economic policies.”

The TV broadcast begins this Sunday, June 12 in 42 U.S. markets. Watch as Richard and journalist Emerald Robinson travel around the globe looking at unlikely success stories in countries that have beat the odds to become an improbable success. Chile, Switzerland and Estonia are the first three to be filmed.

I especially look forward to the show on Chile. I had the privilege of a front row seat watching the Chilean miracle unfold – from working on the nation’s last debt restructuring agreement to advising investors and corporates on trading and long-term investment strategies. In fact, CFS Advisory Board Member Eduardo Aninat deserves much credit for steering and guiding Chile to growth during his tenure as Finance Minister.

Singapore is another wonderful story. Nearly ten years ago, I heard Lee Kuan Yew engagingly discuss the varying struggles and ultimate drivers of his nation’s success at the Singapore Economic Club. These ideas and many others are chronicled in his book “From Third World to First: The Singapore Store: 1965-2000.”

Needless to say, I look forward to watching the “Improbable Success” and thank Richard and Emerald in advance, for their work. Specific viewing times and further information, visit Improbable Success Productions website (www.improbablesuccessproductions.com).

NY Federal Reserve Bank President Cites Progress in Cross-Border Regulation

Federal Reserve Bank of New York President and CEO William C. Dudley voiced optimism about the “substantial progress” made in “strengthening the global banking system.” He cited the establishment of capital and liquidity standards for internationally active banks as an example. In addition, he noted that “steps have been taken” to respond to the failure of systemically important financial firms on a cross-border basis.

Even so, Mr. Dudley asserted, “more needs to be done.” His recommendations include: (i) identifying and dismantling the impediments to orderly cross-border resolutions, and (ii) enhancing cross-border regulatory cooperation through the “greater exchange of confidential supervisory information so that national regulators can be fully informed about the conditions of the banks that operate within their borders.”

Mr. Dudley asked the following questions, which he said were raised by the idea of a convergent transcontinental economy:

  • Can policy strategies ensure that the global economy will escape from this long period of low inflation and real interest rates? If so, what are those strategies?
  • Does fiscal policy have sufficient scope to assume part of the burden of ending this period of persistently low inflation and interest rates?
  • Is the economy going through a period of secular stagnation or is it simply at the midpoint of a deleveraging process that will dissipate gradually?
  • Why hasn’t investment spending reflected the low level of interest rates?
  • What underlying factors have contributed to the recent slowdown in the growth of global productivity?
  • Is it possible for Europe to realize a banking union with a common deposit guarantee scheme?
  • Are there practical opportunities for furthering additional regulatory and supervisory convergence between the United States and Europe?

Mr. Dudley delivered his remarks at a conference hosted by the European Commission, the Federal Reserve Bank of New York and the Centre for Economic Policy Research: “Transatlantic Economy: Convergence or Divergence?”

Lofchie Comment: Since Mr. Dudley is pondering the lack of growth in investment spending and whether the economy is going through a period of secular stagnation, the ideal question for him to ask might be this: are there regulations that are materially damaging to economic growth? New rules have imposed billions of dollars’ worth of compliance and transactional costs. Many of those rules are not particularly sensible and a fair number are actually destructive. The time for regulators to exercise self-criticism is long past due. Unfortunately, too many seem to believe that economic growth can be achieved only by adding more regulations, without first conducting a meaningful analysis of which rules might work, which rules might fail, and which are not worth the costs their implementation would demand.

Economic Policy Uncertainty and the Credit Channel…

I am grateful to John Duca at the Federal Reserve Bank of Dallas for highlighting a recent NBER paper that he co-authored with Michael Bordo and Christoffer Koch.

The authors find that “policy uncertainty significantly slows U.S. bank credit growth, consistent with it having an effect on broad loan supply and demand.”

These results corroborate our findings in recent years evaluating the performance of CFS Divisia monetary aggregates.

Bordo, Duca, and Koch also did fine work quantifying the regulatory and reporting burden on banks since Dodd-Frank (see Figure 2 on page 26). In fact, their data stretch back to 1960. For instance, the number of pages per regulatory filing for banks was less than 10 from 1960 into the early 1980s, gradually advancing to roughly 50 prior to the financial crisis. Since the crisis, the pages per filing are near 90 and advancing at a seemingly geometric rate.

The paper is available at http://www.nber.org/papers/w22021.

Crisis Detection: Implications for Investors and Officials…

At the Boston Economic Club, I discussed crisis detection and prevention based on experiences chairing an inter-agency crisis prevention group — while at the U.S. Treasury — and working as a strategist on Wall Street.

I concluded with eight actionable ideas to improve crises detection for investors and officials.

For full remarks: