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Posts from the ‘Banking’ Category

Credit Cards—The Decline of a Status Symbol

In a previous post, we discussed the fact that the relationship between consumer debt and economic growth hasn’t changed much over the last several decades, despite the proliferation of consumer debt products—credit cards in particular. But attitudes toward debt have changed quite a bit, especially since the rise of credit cards in the 1970s.

Like any new technology or product, credit cards carried a certain cachet when they first arrived on the scene. Even into the early 1990s, they were treated as something of a novelty in pop culture. Consider, for example, an episode of the long-running series Murder, She Wrote from May 1992, in which a local sheriff asks the employee of a murder victim whether his boss carried credit cards in his wallet. “Oh, sure—a lot of those,” responds the employee. “Made him look important.”

As historian Louis Hyman points out in Debtor Nation, in the 1980s and early 1990s credit cards symbolized the “care-free consumption of the affluent.” But in the post-recession 2010s, there is little in the realm of credit card debt that can be considered care-free. According to cultural critic Andrew Ross, in a recent screed against consumer debt, “The revolving credit card has become the operational lifeline for individuals or families struggling to keep their heads above water.” Once a status symbol of the affluent and “important,” credit cards now range from a commonplace means for effecting transactions to an expensive tool to help cash-strapped households make ends meet.

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Marketplace of Ideas

Before you head out for the holiday weekend, catch up on some of the week’s economic news:


  • Congratulations, America—most of you survived tax day! If you’re getting a refund, you essentially made an interest-free loan to the government last year. According to the Brookings Institution, tax overpayments in 2013 totaled $192 billion. Washington Post’s Wonkblog has some maps illustrating how over- and underpayments are distributed across the country. Overpayments are centered in Appalachia and the deep South, while underpayments are concentrated in the Plains states. Wonkblog also looks at H&R Block’s claim that taxpayers are leaving $1 billion in potential refunds on the table by doing their own taxes. While Americans’ tax returns are rife with errors, those errors can lead to both under- and overpayments—even when a tax professional does the return. Worried about getting audited? Wonkblog says the likelihood is decreasing, in part because the IRS has fewer auditors now than in the 1980s. Last year fewer than 1 percent of returns were audited. Meanwhile, the New York TimesEconomix blog looks at debates over whether the tax code is “fair”—a tough task, since there are many, often conflicting, ways to evaluate fairness. Wherever you stand on the issue, you can likely agree that the chances Congress will get its act together and reform the tax code are pretty low.

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What’s on Janet Yellen’s Dashboard?

The Federal Reserve’s Federal Open Market Committee (FOMC) this week changed its “forward guidance” on monetary policy, dropping its 6.5 percent unemployment rate “threshold” for considering an increase in the federal funds target rate. Previously, the Fed had said that it would keep its key interest rate target near zero “at least as long as” the unemployment rate remained above 6.5 percent, then “well past the time” it declined below 6.5 percent. The unemployment rate is currently 6.7 percent.

Explaining the move, Chair Janet Yellen said that as the economy comes closer to achieving full employment, the FOMC will have a more finely balanced decision about when and by how much to raise the target for short-term interest rates. So what will the Fed, and Ms. Yellen, be looking at to assess labor market conditions? In her press conference, Ms. Yellen listed a “dashboard” of indicators that she watches to gauge the progress the labor market has made in its recovery from the Great Recession. We have represented those indicators in a series of six charts, so you can get a sense of the trends and lingering troubles Ms. Yellen has her eye on.

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The New Normal in Our Economy

Federal ReserveIn the aftermath of the financial crisis of 2007-08, the Federal Reserve has implemented so-called “quantitative easing programs” to inject liquidity into the financial system to support economic growth. However, weak economic conditions and tight financial restrictions have discouraged lending and borrowing. As a result, unprecedented amounts of potential liquidity created through the QE programs have been sitting in the banking system as excess reserves. As the Fed started tapering its large asset purchases in January 2014, the critical question has become how to further normalize unconventional monetary policy. Before we try to find an answer to “where from here,” we should first answer “where are we now?” Given the untraditional monetary policy implemented since 2008 and the special nature of the recent recession, there are now several important new elements in our economy. There are reasons to believe that a new operating framework is needed for the Fed to conduct policy if such new elements are going to be workable for the long term. The new elements are listed as follows.

  • The Federal Reserve created various emergency liquidity facilities to ease the liquidity problem during the crisis by lending to banks as well as non-banks.

These facilities, such as Term Auction Facility (TAF), the Term Asset-Backed Securities Loan Facility (TALF), and central bank liquidity swap lines etc., have helped bank and non-bank lending. The enormous demand for loans from the emergency facilities shows the importance of those facilities to improving financial conditions.  Going forward, the Fed should consider retaining this new framework to be able to respond to any future financial stresses without having to change its target for the overnight interest rate.

  • Unprecedented levels of free reserves were created and likely to persist for an extended period of time.

The Fed has increased its assets holdings to over $4 trillion. If the Fed continues tapering at the current pace, the asset purchase will end in the fourth quarter of this year. Therefore, the total amount of assets held by the Fed is expected to reach a peak of $4.5 trillion. How to shrink the Fed’s balance sheet is an important question to be answered. Based on the previous Federal Open Market Committee (FOMC) meetings, the Fed is more likely to hold the assets as they are redeemed than sell them off quickly. Since most of the assets held by the Fed have maturities of more than 10 years, it will take a long period of time to shrink its balance sheet to a size similar to that prior to the crisis. The normalizing monetary policy will have to take place in the presence of high potential liquidity.

  • The Fed has paid interest on excess reserves since 2008 in an effort to keep liquidity from flooding to the financial system and causing price level to rise.

Another important contributor to the unprecedented amount of excess reserves is the fact that the Fed started paying interest at the rate of 25 basis points on excess reserves since 2008. This undoubtedly helped prevent liquidity from flooding into the financial system and causing a big rise in price level. Paying interest on reserves has other effects, like limiting the Fed’s ability to control the federal funds rate and causing arbitrage opportunities. Still, it is widely expected that the Fed will continue it in an effort to avoid pouring too much liquidity into financial markets and maintain price stability.

  • Short-term interest rates have been kept at a record-low level for years. How to regain the Fed’s control over short-term interest rates is still puzzling.

Near-zero short-term interest rates have been a key element of the financial system for several years now. There has been a lot of debate about when the Fed should raise short-term interest rates. In order to make its policy transparent, the Fed has reaffirmed its anticipation that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal. As the unemployment rate recently fell to near 6.5 percent, the Fed might soon need to revise this guidance and implement more measures. There are reasons to expect short-term interest rates to be raised in 2015 after the QE ends.

  • Closer scrutiny by regulators since the financial panic in 2008 has been viewed as a new element of the financial system. How increased stringency in regulation will affect the ongoing economic recovery has important implications for monetary policy normalization objectives.

Well-functioning bank lending is a major driver of economic growth. Even though making or adjusting financial regulation is not the central bank’s policy objective, it is important for the Fed to take into account the lending environment when conducting monetary policy. Going forward, tougher financial regulations will affect other objectives around normalizing monetary policy.

[Photo: Wikipedia/Dan Smith]

Fed to the Rescue?

Ben Bernanke at FOMCBen Bernanke was center-stage at his last FOMC meeting as chairman this week. The Fed was widely expected to continue to taper its large-scale asset purchase program, and it did—reducing its monthly purchases by another $10 billion to $65 billion, following a $10 billion reduction at its previous meeting. However, there was some speculation among analysts that in the wake of the emerging markets sell-off that has plagued global financial markets since last week, the Fed might postpone any further tapering in an effort to alleviate some of the panic. Why might the Fed be considered responsible for this market correction? In a recent report, the World Bank warned that changes in Fed policy could have negative implications for emerging market economies this year—if the adjustment to the policy changes is disorderly.

In the end, the Fed continued with its tapering, heedless of the plight of emerging markets. It received some flack for this in the press, but it also faced a “credibility crisis” if it deviated from its presumed intention to continue a steady $10-billion-per-month tapering program. The Fed was in a lose-lose situation: To postpone tapering would be to neglect the U.S. economy. To taper would be to neglect global markets.

Here are some other issues the Fed failed to address this week: It did not propose a solution to the stubbornly high long-term unemployment rate in the United States. It also did not take a stand on various proposals to raise the minimum wage, or to address income inequality. It made no effort to help resolve the impasse on immigration reform in Congress. The Fed did not draft a contingency plan for the bailout of European banks at risk of failing because of new regulatory standards about to be imposed by the European Central Bank. Furthermore, Ben Bernanke did not give Canadian Mark Carney advice on how to be a more effective Governor of the Bank of England.

The Fed did not draft a treaty to achieve peace in the Middle East. It did not fix the polar vortex, nor did it predict a winner for the Super Bowl. It did not even disclose which team the majority of FOMC members are rooting for. What is the Fed hiding? Does it not even care about football? How could the Fed be so un-American? Worst of all, Ben Bernanke did not personally call my mother to wish her a happy birthday.

In responding to the 2007-08 financial crisis, the Fed may have overstepped the bounds of its mandate. Bernanke himself has seemingly justified this as a valid response to the tight fiscal policy imposed by Congress. Unfortunately, the Fed’s attempt to single-handedly resolve the financial crisis and foster an economic recovery from the Great Recession has encouraged the markets, media, and punditry to expect the Fed to solve all the problems plaguing the U.S. economy—and the world. But that is not its job.

[Photo: REUTERS/Business Insider]

Marketplace of Ideas

The Wolf of Wall StreetYour correspondent is abroad this week, so today’s roundup takes a look at key developments in the U.S. economy with a global perspective.

  • Congress has rejected a plan that would “democratize” the IMF and give more decision-making authority to countries like China and India. All involved countries except the U.S. have ratified the plan, drafted in 2010, which seeks to recognize the growing roll of China and other emerging markets in the global economy. This is sure to be a key topic for debate at the World Economic Forum—a ski holiday for the world’s financial glitterati—which takes place in Davos, Switzerland, next week. The concern is that China could leave the IMF and set up its own, competing institution, destabilizing the international monetary system and reducing the influence of the United States in the global economy. According to the latest data, China holds $3.82 trillion in foreign currency reserves.
  • The news keeps getting worse for Target customers: The latest figures now suggest that 70 million to 110 million people were affected by the discount retailer’s credit card security breach. Now luxury department store Neiman Marcus admits that it was hacked, unawares, from July through December last year. Bloomberg warns that this is just the beginning, unless retailers move quickly to enhance their credit card security. The “chip and pin” system, which has been commonplace elsewhere in the world for over a decade, may be one solution. While retailers say they are anxious to adopt the technology, the implementation costs to both merchants and card companies are likely keeping U.S. consumers in the credit card dark ages. Perhaps the cost to retailers, card companies and defrauded consumers of the recent security breaches will make the investment finally seem worth it.
  • It may be a sign of the times when two best picture Oscar nominees are based on true stories of financial hucksterism. American Hustle, a fictionalized account of the Abscam scandal, and The Wolf of Wall Street, the story of how Jordan Belfort fleeced millions from guileless investors, both picked up Golden Globe and Oscar nominations this year. Strange but true, even after Wall Street, Wall Street 2, Boiler Room, Margin Call and Arbitrage, Americans still have an appetite for glamorized accounts of financial corruption. James Surowiecki argues on the Financial Page of the New Yorker that con artistry and the American dream go hand-in-hand: “Risk, hope, and hype [provide] both the capitalist’s formula for transforming the world and the con artist’s stratagem for turning your money into his money.” But it’s not just Americans who are enthralled. Over in Europe, banks are renting theaters to hold exclusive screenings of The Wolf of Wall Street for employees and clients. Contrition was never the financial industry’s strong suit.
  • While European bankers might be savoring The Wolf of Wall Street, few can say they “partied like a rock star, lived like a king”—at least not recently. The European banking industry is still a disaster, riddled by zombie banks that won’t fail and can’t lend. Policies in the U.S. to recapitalize banks after 2008 have seemingly slayed our zombies. However, U.S. banks still aren’t lending as much as you might expect given the mountains of reserves they’re sitting on as a result of the Fed’s quantitative easing. There’s some evidence that banks won’t lend, even to creditworthy borrowers, because they don’t stand to make a profit with interest rates so low. There’s also evidence that certain banks’ balance sheets are still too impaired to lend. But if the credit worthiness of borrowers is the issue, some startups are hoping to step into the breach.

[Photo: Paramount]

On the Fed’s 100th Birthday—Many Happy Returns?

Andrew Jackson slays Monster Bank

Amidst all the fuss over the Fed’s decision to slow the pace of its long-term asset purchases—the much-anticipated but largely symbolic “taper”—a more significant milestone passed relatively unnoticed: December 23 marked the 100th anniversary of the Federal Reserve Act, the legislation that paved the way for the creation of the Federal Reserve System and its current policymaking body, the Federal Open Market Committee.

That’s right—the United States lacked a central bank for much of the first 125 years of its existence. The nation’s first two attempts at central banking fell victim to partisan rancor, regional animosity, and fears that the centralization of monetary authority would lead to an unruly “Monster Bank,” all too susceptible to the whims of corrupt politicians and financial elites. While these matters were still hotly contested in the early years of the twentieth century, the Panic of 1907—which was widely seen as the result of a preventable liquidity crunch—fomented consensus over the need for a central bank to mitigate such crises in the future.

Most of the Fed’s century-long history of monetary policymaking has been marked by trial and error rather than scientific precision—but by necessity, not caprice: Congress did not bestow the Fed with a monetary policy playbook. The Federal Reserve Act of 1913 lacked a clear policy mandate for the new central bank, beyond fostering financial stability. In fact, a specific set of monetary policy objectives was not legislated until 1977, when Congress gave the Fed its “dual mandate”—to foster maximum employment and stable prices “commensurate with the economy’s long run potential.”

Just as the financial system has evolved over time, the Fed’s policy scope and authority have shifted and expanded. In fact, its ability to “innovate” in this regard might be considered one of the institution’s merits. But in the context of the Fed’s 100-year history, the monetary policy innovations implemented in the wake of the 2007-08 financial crisis are unprecedented and contentious. After driving its key interest rate down to zero in 2008, the Fed effectively exhausted its conventional, time-tested policy tools. In an effort to mitigate the effects of the still-raging financial crisis, the Fed undertook the extraordinary measure of making large-scale asset purchases, also known as quantitative easing, or QE. Successive waves of QE, aimed at restoring the economy to its long-run potential growth rate, have expanded the Fed’s balance sheet from roughly $800 billion to over $4 trillion. The “tapering” approved by the Fed last month will only slow the rate at which its balance sheet continues to grow, to $75 billion per month instead of $85 billion. This is by no means a policy reversal.

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Was the Fed a Good Idea?

31st Cato Monetary Conference
By Steven R. Cunningham, PhD, Chief Economist and Jia Liu, PhD, Research Fellow

112213 Was the Fed a Good IdeaThis year marks the 100th anniversary of the founding of the Fed with the Federal Reserve Act of 1913. With a hundred years of experience behind us, it seems like a good time to evaluate the performance of the nation’s system of central banks. To this end, on November 14, the Cato Institute held its 31st annual Monetary Conference, entitled “Was the Fed a Good Idea?

A pretty heady group of economists, policymakers, business/economics writers, and bloggers converged on Washington to participate. The attendees were too many to list, but a few examples may serve to give the reader a sense of the proceedings.

As former chairman and CEO of BB&T, John Allison was certainly well-qualified to talk about the Fed’s performance through the recent financial crisis. Current and past Federal Reserve Bank Presidents Charles Plosser (Philadelphia) and Jerry Jordan (Cleveland) offered perspective from the lectern, while former Fed Governor Wayne Angell commented from the floor. (I remember Wayne well from my time at the Board of Governors, and he doesn’t seem to have slowed down a bit.)

We got a European perspective from Leszek Balcerowicz, chairman of the National Bank of Poland, and Athanasios Orphanides, formerly a governor of the Central Bank of Cyprus and an advisor to the Federal Reserve Board. Orphanides also served on the Governing Council of the European Central Bank.

Rep. Kevin P. Brady, chairman of the Joint Economic Committee, and Rep. Jeb Hensarling, chairman of the House Financial Services Committee, offered Congressional representation. Lawrence H. White (George Mason University) and George Selgin (University of Georgia), known in particular for their writings on free banking, are past participants in AIER programs. Lewis E. Lehrman, of the Lehrman Institute, gave the closing address.

The issues addressed at the conference include lessons from a century of U.S. central banking, alternatives to discretionary government fiat money, comparisons between the Fed and the market as bank regulators, and the case for a National Monetary Commission and fundamental reform.

Charles Plosser gave the keynote address to discuss the Fed’s essential role and to propose how this institution might be improved. Plosser offered four suggestions for the central bank to limit discretion and improve outcomes and accountability.

First, the Fed should abandon its mandate of maximum employment and solely focus on price stability. Second, the Fed should only hold Treasury securities on its balance sheet. Third, the Fed should use a systematic and rule-like approach to conduct its monetary policy. Fourth, the Fed should limit the boundaries of its lender-of-last-resort credit extension.

Plosser also argued that the Fed’s mandate should have its emphasis on the longer run. He said “…focusing on short-run control of employment weakens the credibility and effectiveness of the Fed in achieving its price stability objective.” In order for the public to hold the Fed accountable for its monetary policy, he offered three solutions: “Simplify the goals, constrain the tools and make decisions more systematically.”

When asked about the Fed’s current 2 percent inflation target in the Q&A session, Plosser argued that 2 percent is just a number the Fed used to show the public its commitment and ability to achieve policy goals.

But if 2 percent is just a random number picked by the Fed to only serve that purpose, why didn’t the Fed pick 3 percent or 4 percent? Higher numbers would make it easier for the Fed to claim inflation is under control.

It is true that the central bank cannot control real economic variables, at least not in the long run, and the public has come to expect too much from its central bank. But since price stability is the Fed’s primary objective, isn’t it reasonable for the public to expect central bankers to rigorously and analytically determine its inflation target? If “simplifying the goals” means randomly selecting a number for inflation target without considering its impact on the economy, maybe this is not the right approach.

Scott B. Sumner, a professor of economics at the Bentley University, gave a controversial presentation on nominal GDP (NGDP) targeting that brought on a wide-ranging audience discussion. Sumner argued that the optimal monetary rule is for the Fed to target NGDP instead of targeting a certain level of inflation or attempting to achieve maximum employment. He started out by showing the co-movement between NGDP and total losses to the U.S. banking system during 2008-2009 to argue that the decline in NGDP, not failure of the financial markets, caused the Great Recession.

We would argue that NGDP is the market value in current dollars of final production, namely a measure of the economy unadjusted for inflation. Hence, changes in NGDP capture upward and downward growth of the economy.

When the housing bubble burst in 2007-2008, sharply declining housing prices caused quickly spreading financial distress, which resulted in a financial crisis. Disposable personal income started to drop, and consumption and investment went down sharply until 2009, when, as Sumner pointed out, NGDP reached the largest decline since the 1930s. The decline in NGDP only measured the downturn of the economy that was caused by the financial crisis; not the other way around.

There are problems with Sumner’s advocacy of the Fed targeting NGDP rather than inflation. A central bank with authority to control the money supply can only achieve its goal for price stability in the long run and cannot control real economic activity, at least not over time. The only long-term role for the central bank and monetary policy in ensuring economic growth or NGDP growth is in providing price and financial stability to provide a healthy environment for growth to occur.

Lawrence H. White, a professor of economics at George Mason University, made the case for two alternative monies, the Liberty Dollar and E-gold.

White believes that there is a single monetary standard in the economy that requires alternative monies to be transformed from the existing money. But he told stories about the Liberty Dollar and E-gold to discuss alternative monetary standards that might arise in parallel with the fiat dollar. He concluded that the legal barriers to open currency competition in the U.S. include anti-money-laundering laws, money transmitting licensing requirements, capital gains taxes, state sales taxes on precious metals, and banning private coinage.

Larry Summers’s Turkey Hangover

Thanksgiving Turkey Dinner HangoverA colleague lamented at the lunch table yesterday that he hates Thanksgiving because he tends to overeat. Who doesn’t? The overindulgence of Thanksgiving dinner is followed by the turkey hangover—listlessness, bloating and a sizable portion of guilt.

In addition to our turkey and pumpkin pie this Thanksgiving, we have this morsel from Larry Summers—President Obama’s first choice for the Federal Reserve chair—to digest: in a speech at the International Monetary Fund last week, he suggested, “Suppose that the short-term real interest rate that was consistent with full employment had fallen to -2 percent or -3 percent sometime in the middle of the last decade.” This somewhat opaque notion has won a lot of attention from economists and pundits, much of it positive. But what does it mean?

Let’s indulge in a little Thanksgiving metaphor: in the years leading up to the 2008 crisis, every day was Thanksgiving. Americans were eating a lot of turkey—in fact, more turkey than was good for us. Why did we do this? Because turkey was relatively cheap, because we were told that turkey was good for us, and because with the price of turkey so low, turkey producers and vendors had to sell more and more of the stuff to make a profit.

In other words, leading up to the 2008 crisis, Americans consumed a lot of credit. Why? Because credit was relatively cheap (interest rates were low), because we were told that credit was good for us (owning a home is the American dream! Get a mortgage!), and because with the price of credit (interest rates) so low, lenders had to push more and more of it to make a profit. We all know that recovering from an extended bout of overeating requires a diet of discipline and moderation—and much, much less turkey. Diets are never fun, they are never easy, and it usually takes longer to work off the pounds than it did to put them on in the first place.

In his IMF speech, Larry Summers essentially argued that the recovery of the U.S. economy from the Great Recession is sluggish not because the nation collectively overate in the years leading up to the crisis, and the diet necessary to correct that overeating will be long and difficult, but rather that turkey prices (interest rates) are still too high. What Summers thinks we need is even cheaper turkey, incentivizing us to give up our diets and go back to overeating.

This might make sense if you tend to see the world from the perspective of people who benefit from selling a lot of turkey, but is it the right answer for the longer-term health of the economy?

photo courtesy Mom Prepares/Flickr

The Regulation Argument: Auto Loans Up, Credit Cards Down

Two recent articles from Quartz look at how lending and credit have changed since the 2007 recession and show how government regulation can impact (or not impact) American consumer economics.

The first article, which looks at sub-prime auto lending trends in the last few years, found that independent lenders are giving more car loans to U.S. customers with bad credit. Nearly 27 percent of all auto loans in the past five years were to consumers with credit scores of 500 or less. A loophole in the Dodd-Frank financial reform act of 2010 is seen as a cause of this trend.

From Quartz:

“That law had created the Consumer Financial Protection Bureau (CFPB) to act as a watchdog for retail lending, but had explicitly carved out auto dealerships from supervision. This made consumer advocates nervous but had investors seeing an opportunity to charge high costs for loans at a time of low yields.”

While regulation (or lack there of) has made it easier (if not safer) to get a car loan in 2013, it has had the opposite impact on credit cards. The second story looks at the way credit card debt has decreased in America since implementation of the US Credit Card Accountability, Responsibility and Disclosure Act (CARD) in 2010.

From Quartz:

“The CARD ACT … blocked credit card companies from extending credit without assessing the customer’s ability to pay … implemented rules on marketing to people under the age of 21 to crack down on abuse at college campuses … limited a credit card company’s ability to levy penalty fees … and restricted the circumstances in which the company could jack up interest rates.”

The results of CARD, according to the story, include a 2 million decrease in the the number credit cards issued to Americans under the age of 21 since 2007, and that credit card companies have “just stopped giving cards to people on the bubble.”

You can read both stories on Quartz by clicking the links below.

More Bad Borrowers are Getting Car Loans

The U.S. Has Kicked its Credit Card Addiction