Friday, August 11, 2017

William Nelson — Setting the record straight on why leverage ratio must change

A recent op-ed on this blog by Paul Kupiec misstates the Clearing House’s criticism of the supplementary leverage ratio. Kupiec’s article indicates that the Clearing House’s position is contained in a recent article by Darrell Duffie, a professor at Stanford University. Although Professor Duffie’s article appeared in the Clearing House’s quarterly journal “Banking Perspectives”, his views were his own, and he received no compensation from the Clearing House.
We will let Mr. Kupiec debate Dr. Duffie’s views with Dr. Duffie. As for us, the Clearing House’s arguments against the leverage ratio are explained in a Clearing House Research note, “Shortcomings of Leverage Ratio Requirements,” which has been available on our website for over a year. The leverage ratio’s core intractable problem is that it treats all bank assets as having the same level of risk, from deposits at the central bank and Treasury securities to leveraged loans, loans to small businesses and credit card loans. If the leverage ratio were simply a backstop that didn’t influence bank behavior, its poor design would be irrelevant for banks’ capital planning decisions. But as I explain below, it clearly is influencing banks’ behavior, and its flaws therefore have dangerous implications....
American Banker
Setting the record straight on why leverage ratio must change
William Nelson | head of research and chief economist for The Clearing House, and formerly a deputy director of the Division of Monetary Affairs at the Federal Reserve Board

47 comments:

Andrew Anderson said...

The leverage ratio’s core intractable problem is that it treats all bank assets as having the same level of risk, from deposits at the central bank and Treasury securities to leveraged loans, loans to small businesses and credit card loans. William Nelson American Banker [bold added]

Deposits at the central bank are inherently risk-free and the natural question is why US citizens may not also have checking accounts there? But instead are forced to work through a government privileged* usury cartel? Or be limited to grubby, unsafe, inconvenient physical fiat, aka "cash"? Cui bono that they can't?

Treasury securities are inherently risk-free too and should yield no more than 0% to avoid welfare proportional to account balance rather than need. And that 0% is for the longest maturity sovereign debt (e.g. 30 yr US Treasury Bonds); shorter maturities should yield even less, i.e. have negative yields, with deposits at the central bank having the most negative yield.


*e.g. goverment insurance of their liabilities including liabilities the banks themselves create ("Bank loans create bank deposits")(!)

Matt Franko said...

"Treasury securities are inherently risk-free too and should yield no more than 0%"

Tell it to the Monetarists... they think they can (and do) modulate the risk free rate to regulate economic activity ...

Dan Lynch said...

How would Minsky regulate banks?

Minsky considered deposit creation the basic activity of banks. He defined it as the “acceptance function. Banking is not money lending; to lend, a money lender must have money. The fundamental banking activity is accepting, that is, guaranteeing that some party is creditworthy."

I don't agree 100% with some of Minsky's proposals but nonetheless he makes some good points, particularly about the necessity of protecting the payments system (which is currently linked to investment banks hence they need to be bailed out or else the payments system grinds to a halt) and the concept of "deposit creation." Minsky's main regulatory argument was that, in return for being backed up by the Fed, private banks should agree to allow their activities to be restricted.

Minsky seemed to oppose public banking because he felt the public should not get involved in choosing winners and losers, yet he acknowledged that the public was on the hook one way or the other.

My suggestion is that we should have postal banking (tied to the central bank) for payments, savings, checking, and debit cards, but leave investment banking and lending to private banks. That way the payments system and the accounts of the 99% would remain intact even if private banks go under. As Andrew asked, why can't U.S. citizens have checking accounts at the central bank? Well, postal banking would serve the same purpose.

Of course the reason we don't have more public banking functions is because the private banks don't want it.

MRW said...

”Of course the reason we don't have more public banking functions is because the private banks don't want it.”

More correctly, Dan, it’s because Congress doesn’t want it. That’s the bottleneck.

MRW said...

Dan, ”As Andrew asked, why can't U.S. citizens have checking accounts at the central bank? Well, postal banking would serve the same purpose.”

So do private banks that are federally chartered. Except that as you astutely note: ”protecting the payments system (which is currently linked to investment banks hence they need to be bailed out or else the payments system grinds to a halt).”

And they’ve only been linked to investment banks since the abolition of Glass-Steagall in 1999, altho’ the gradual erosion started entering their twinkling conniving minds under Reagan.

Andrew Anderson said...

Well, postal banking would serve the same purpose. Dan Lynch

Local post offices should serve as convenient branch locations for the central bank since the services a central bank may PROPERLY provide DO NOT include such labor intensive activities as determining who is so-called worthy of the PUBLIC'S CREDIT but for private gain.

But let's end the distinction between banks and the people, i.e. if local post offices, ATM's and the Internet are deemed sufficient for the public then they should be sufficient for the biggest commercial banks too. If not, then local post offices should be expanded/improved until they are adequate since banks should not have privileged access to the central bank via, for example, central bank branch locations reserved for them.

MRW said...

So a postal bank manager would get to determine whether I get a mortgage of not? Or determine whether I can buy a Suburu or an Escalade SUV?

They going to have public banks in 150-person towns? What is the public banking credit officer—the one who will determine whether I survive or not—lives 200 miles away and doesn’t know me or my business? But ‘ole Cranston who runs the Podunk S&L and who I grew up going to school with knows me. He knows whether I’m credit-worthy or not. He knows whether my farmland is any good, if I have good help, and whether I have a head for numbers or need my wife to do the two-plus-two.

Also, can you image the federal department that would have to be put in place to have public banking? It would put the DHS to shame.

Or does my local postman become my bank teller with access to my tax and banking records?

What about Congress and the Fed doing its goddam job? Regulating the fuckers they are supposed to be regulating now.

Dan Lynch said...

@MRW my particular proposal for postal banking is payments, savings, checking, and debit cards, but not credit cards or loans, for all the valid concerns that you point out, and more.

If a public bank issued loans and credit cards then it would have to foreclose and/or garnish paychecks when the loan went into default. That would be politically messy. I say leave credit to the private sector.

Andrew Anderson said...

I don't see anyone here arguing for public banking but for an additional, inherently risk-free payment system consisting of individual, business, State and local government, etc. accounts at the central bank itself in addition to those of the commercial banks, credit unions, etc.

Dan Lynch said...

Of course you can make the argument that the public is already heavily involved in deciding who gets credit since Uncle Sam is behind most mortgage loans and student loans.

MRW said...

Andrew,

Since you live in England and are woefully lacking in the US history of what actually happened in the months leading up to the Federal Reserve Act of 1913—most Americans have no idea because they don’t read or research and the info is buried in Library of Congress microfilm—you have zero knowledge that the idea of nationalized banks (aka public banking) was proposed with an invitation for national public participation and commentary on the idea before the newly formed Senate Banking Committee in September, 1913.

The hearings were held during the entire month of October, 1913.

They produced over 3600 pages of public testimony—volumes and volumes—from 500+ witnesses, available if you have a university library access card (or are an alumni) from hathitrust.org. Google scanned the docs about 7-8 years ago. I have the complete copy.

The witnesses included small and large farmers, small and regional bankers, concerned businessmen, and anyone who would make the trip to DC.

Almost to a one, they rejected the idea because they thought it was socialism to have the federal government be their banker. They were terrified of the idea—the Russian Revolution was brewing—and they wanted someone they already knew and who knew them and who was local to control their funds. The bank panics of 1893 and 1907 had them spooked; and farmers in particular were loathe to have a federal version of what the NY bankers did to them in the months leading up to harvest in the fall charging usury rates of interest for credit before the harvest came in.

We still have people wailing about “socialism.” Even though they don’t know what it is. But “social media” is OK.

And Americans are as hard-wired to react to the term as you Brits are about maintaining the monarchy.

MRW said...

Dan,

I say leave credit to the private sector.

Yeah, with the bastards anchored on a payment system in the middle of an alligator lake and they can’t go home at night on the only boat available if they misbehave.

MRW said...

I don't see anyone here arguing for public banking but for an additional, inherently risk-free payment system consisting of individual, business, State and local government, etc. accounts at the central bank itself in addition to those of the commercial banks, credit unions, etc.

Americans like division of power. We’re a Republic. Our Constitution reflects it. We specifically designed it to provide checks and balances. Messy? Yeah. Contentious at times? Sure. But we like it that way. Putting all the power in the hands of a Central Bank is anathema to them. We want their power chopped up so someone else is looking at them.

Ain’t no fucking way Americans will put up with a centralized system. Not in this century.

Right now we have 12 District Federal Reserve central banks nationally. You think I want my account at mine two states away? You’re whistling dixie, bub.

You live in a country the size of our state of Kansas; in fact, Kansas is larger. You can bicycle across it in a day.

Andrew Anderson said...

I don't see anyone here proposing nationalizing the banks but, once again, an additional, inherently risk-free payment system consisting of individual, business, State and local government, etc. accounts at the central bank itself in addition to those of the commercial banks, credit unions, etc.

People could still deposit at (i.e. lend to) and borrow from commercial banks, credit unions, etc. but their deposits would not be explicitly or implicitly guaranteed by the government nor would the banks, credit unions, etc. enjoy any other privileges from government such as a lender of last resort, interest on reserves and positive yields on other sovereign debt.

Andrew Anderson said...

As for high interest rates, let individual citizens have accounts at the central bank that are negative-interest-free up to, say, $250,000 but charge the banks (and all other private and foreign sector accounts) sufficiently high negative interest that their lending to individual citizens is encouraged.

Matt Franko said...

"deposit at (i.e. lend to) "

The words "deposit" and "lend" mean different things... they are not synonymous...

Matt Franko said...

Banks can issue bonds or preferred securities to establish liabilities as things stand right now...

MRW said...

”… enjoy any other privileges from government such as a lender of last resort, interest on reserves and positive yields on other sovereign debt.”

You still doing your nails and making shit up? if you read the actual history, you would know these are not “privileges.” They have historical precedent.

‘Lender of last resort’ was designed to protect the public from bank runs and panics. And Senator Robert Owen, the actual designer and writer of what became the Federal Reserve Act of Dec 1913 (not Rep. Glass, who represented the NYC bankers’ ideas in his June 1913 House Banking Committee proposal which sent Owen to the roof), specifically came up with the idea to protect what happened to local bankers who got crunched with bank runs and couldn’t guarantee their customers they would get their money back. Hence, panic. Hence, doom. And Owen (an Oklahoma banker before he became a Senator) first came up with the idea actually in 1900 AD after two years at his own expense visiting the German, British, French, and Canadian central banks to understand why their countries never experienced banks runs or panics. All this in the Congressional Record (1900 AD).

It was Warren Mosler who convinced the Fed to offer interest on reserves in 2008. I can’t remember his reason why.

Positive yields on sovereign debt (treasury securities) have been in place since the Liberty Bonds (1914). [Even though there were public bonds in the 1800s, but not for the people.] How else at the time to get people to desist changing their dollar bills for physical gold, which they could do because the back of the dollar bill guaranteed it? Sure, they invented ‘patriotism’ like Help Pay for the War to sell them, but it was bullshit sentimentality to protect the gold supply because all international payments for WWI expenses had to be made in gold. After the war the federal government kept it up because we were still on the gold standard. A holder of a treasury security could trade them all day long until maturity, but neither he nor his buyer could exchange the treasury security for gold which was guaranteed on the certificate until the date of maturity which was usually 10 years at the time.

Matt Franko said...

"It was Warren Mosler who convinced the Fed to offer interest on reserves in 2008. I can’t remember his reason why."

???????

MRW said...

Owen had become alarmed with Glass's coziness with the NYC bankers on the Congressional Banking Committee, so he split the Committee into the House Banking Committee and Senate Banking Committee as he got the newly-elected Woodrow Wilson (inaugurated March 1913) to go along with his idea at an April 1913 Oval Office with Glass and the SecTreas in attendance.

Owen argued that the federal government should be in control of a newly constructed federal central bank not the NYC bankers, which the Wilson and his SecTreas (future son-in-law) agreed to…all Owen had to hear because Wilson was veering Glass’s way and, I believe, had campaigned against the idea of a federal central bank ( forget).

So, he proposed that Glass run the House Banking Committee, which Glass liked. He and Glass grew up a few blocks from each other, and Owen had to be “collegial.” Rep. Glass had nowhere near Owen’s experience or knowledge. None. The NYC bankers could wrap him around their little fingers. But Owen had his ‘revenge’ such as revenge was in those days of collegiality. He wrote a little book in 1918 or 1919 describing in detail what happened and what he deposited in the Congressional Record in 1900 AD as an official record. I had to inform the St Lousi Fed where these docs are. THEY have no clue.

MRW said...

Yeah, Matt, he said it one of the Columbia Law School seminars, IIRC. It was at one of his presentations. Maybe "convinced" is too strong a word. He certainly "suggested." I have a video copy somewhere of his explaining it, but it's too fucking hot here to find it. (I think he and Scott Fullwiler were explaining how the interest rate floor worked. Brain too frazzled at the moment. But I know he said it.)

MRW said...

After all, he spent 40 years working with the fed and treas accountants in the bowels, as he has stated many many times. Not the political appointees, the worker bees.

MRW said...

When I find it, I'll let you know.

Matt Franko said...

I have it as Milton Friedman's idea originally ...

Matt Franko said...

Which is not good...

Matt Franko said...

MRW you have to remember the context of all of that was we were still using the metals...

Matt Franko said...

Btw as far as the post I think the guy more or less is onto things correctly but his use of "must" here is self serving ...

MRW said...

He never uses "must" anywhere in his article. Probably an American Banker editor. Editors determine headlines, not the authors. Authors propose. But editors usually recast to either reflect the lede or the gist of the article.

Matt Franko said...

Well it "must" because they will end up with 100s of $b of excess munnie LOL!

Andrew Anderson said...

‘Lender of last resort’ was designed to protect the public from bank runs and panics. MRW

Once individual citizens, their businesses, organizations, state and local governments, etc. may have inherently risk-free checking accounts at the central bank itself or equivalent (e.g. at the US Treasury) and all other privileges for the banks, credit unions, etc. have been abolished, then we shall have two payment systems:

1) a risk-free, 100% liquid payment system consisting of individual citizen, business, organization, state and local governments, etc. checking accounts at the central bank itself or equivalent
AND
2) an at-risk, not-necessarily-liquid payment system consisting of checking accounts at the banks, credit unions, etc.

1) is immune to bank runs since the liabilities of the central bank are not redeemable.

2) would and SHOULD be susceptible to bank runs since its liabilities would be genuine liabilities wrt the non-bank private sector and not largely the sham they are today.

Ralph Musgrave said...

I quite agree with this sentence of Dan Lynch's:

"My suggestion is that we should have postal banking (tied to the central bank) for payments, savings, checking, and debit cards, but leave investment banking and lending to private banks."

That actually comes to the same thing as "full reserve" or "100% reserve" banking long proposed by a long list of luminaries (half of them Nobel laureate economists)including: Milton Friedman, Lawrence Kotlikoff, Merton Miller, Maurice Allais, James Tobin, John Cochrane, and (in the 1930s) Irving Fisher.

Ralph Musgrave said...

The link at the start of Dan Lynch’s first comment above (“How would Minsky regulate banks?”) links to an article by Jan Kregel in which Kregel explains why Minsky eventually rejected what Kregel calls narrow banking and what most people call “full reserve” banking.

Kregel’s article is largely nonsense. I dealt with some of the nonsense in my book a year or two ago. The book is available for free here (word-search for “Kregel”).

https://www.yumpu.com/en/document/view/57025889/fulresbk179senttocrspto

According to Kregel, Minsky rejected narrow banking because “nar-
row bank on this definition is not a bank…”. See Kregel’s last para. Well the simple answer to that is that advocates of “narrow/full reserve” banking are well aware that banks in their current form cease to exist under narrow banking and are replaced with very different entities. A Bloomberg article by Matthew Klein (link just below) is very explicit about that. In fact the title of the article is, “The best way to save banking is to kill it”. Can’t get clearer than that, can you?

http://www.bloomberg.com/news/2013-03-27/the-best-way-to-save-banking-is-to-kill-it.html

Seems that Kregel’s and Minsky’s reasons for rejecting narrow/full reserve are not too clever.

Dan Lynch said...

@Ralph, I disagree with much of Minsky but did appreciate his comments on the importance of preserving the payments system during a crisis, and the notion of banks as deposit creators.

I have not read your book so I can't comment on it. Banking is not my area of knowledge. Minsky seemed to dance around the banking issue and never actually endorsed a banking plan as far as I know.

The problem with bailing out banks is not money, which the government can create with keystrokes, but that it rewards bad behavior and misallocation of resources. The whole point of capitalism is that it supposedly does a better job of allocating resources -- but that only works if we allow bad businesses to fail.

MRW said...

The article on Bloomberg you link to is unavailable. Is Matthew Klein the person recommending killing banks? If so, who is he? What are his credentials? Or is he a Bloomberg journalist? If so, who is he quoting?

MRW said...

The problem with bailing out banks is not money, which the government can create with keystrokes, but that it rewards bad behavior and misallocation of resources. The whole point of capitalism is that it supposedly does a better job of allocating resources -- but that only works if we allow bad businesses to fail.

Allowing bad businesses to fail is no panacea. They allowed Lehman Brothers to fail in September 2008 and it precipitated the Global Financial Crisis. And 8 million people lost their jobs almost overnight.

The ‘recovery’ didn’t allocate resources, and still hasn’t. People still don’t have sufficient jobs. I know I know I know, the rosy figures touted about the unemployment figures improving, but they are neither accurate nor complete. You only have to look around your own neighborhoods: have the businesses returned?

And pouring through the numbers on the Bureau of Labor Statistics site carefully doesn’t show improvements. Maybe for some sectors, but not for the general population in total. In fact, the Civilian labor force participation rate is still the lowest it’s been since Feb 1987. https://data.bls.gov/timeseries/LNS11300000

Trump better get people jobs, but he doesn’t know how.

Dan Lynch said...

Allowing bad businesses to fail is no panacea. They allowed Lehman Brothers to fail in September 2008 and it precipitated the Global Financial Crisis.

Right, because the powers that be had no plan to deal with it -- and they still don't. In their worldview, the system wasn't supposed to fail in the first place so they never had a plan to deal with failure.

There are alternatives. As Bill Black suggested, the Feds could have taken over the banks and pumped liquidity into them to restore solvency -- but retained ownership while the bank managers went to jail. Later the banks could have been sold back to the private sector.

Or Steve Keen's $75,000 debt jubilee could have bailed out homeowners rather than banks, and that would have indirectly restored bank solvency.

Either way, there is no excuse for not having a 100% reliable payments system.

Remember when Greece debated leaving the Euro, and one of the reasons they chickened out was because they didn't have their own payments system and it might have taken them 2 - 3 years to create a payments system from scratch?

That's crazy. The payments system should be considered a public utility similar in importance to the electric grid or the internet. It may take WWIII to force us to do national planning for those sorts of things.

Matt Franko said...

"because the powers that be had no plan to deal with it "

Deal with WHAT? They caused it...

Go back and look at Reserve assets from back in 2006 thru summer of 2008 steady at $300b... then by Dec 2008 they ran them up to $1T which is 700B increase in like 90 days ... where the hell are banks going to get another $70b of capital that fast?????

N-O-W-H-E-R-E....

Andrew Anderson said...
This comment has been removed by the author.
Andrew Anderson said...

... there is no excuse for not having a 100% reliable payments system. Dan Lynch

Absolutely. But in addition to 100% reliability, we should make also make sure the system is 100% ethical. That way, for example, we won't have the injustice of workers being replaced with automation financed with what is, in essence, because of government privileges for the banks, the PUBLIC'S CREDIT, but for private gain.

MRW said...

As Bill Black suggested, the Feds could have taken over the banks and pumped liquidity into them to restore solvency -- but retained ownership while the bank managers went to jail.

An idea I liked. And I’m sure the general public too. Remember the hordes that hit bank CEO’s private houses in CT and parts of NY threatening to kill them for what they did to them?

Or Steve Keen's $75,000 debt jubilee could have bailed out homeowners rather than banks, and that would have indirectly restored bank solvency.

Instead the Fed gave $29T to the banks. Main Street? Go fuck yourself.

Deal with WHAT? They caused it...

And that goes back to the S&L crisis that identified the culprits and put in place rules and regs that Timothy Geithner was legally bound to regulate. The FBI had warned in open testimony before Congress in Sept 2004 that there was “an epidemic of mortgage fraud” in the US and that 90% of mortgages were fraudulent. As NY Fed head, it was his responsibility to regulate the mortgage banks, because mortgage banks do not come under the federal bank charter.

It may take WWIII to force us to do national planning for those sorts of things.

Why could FDR do it in a year and a half?

Matt Franko said...

Well if they commit fraud all the time why are they coming in here and asking for a change in the regulations?

Total bank assets back then were like 8 or 9 $T why would they need $29T that is a BS #

Your whole view is BS....

MRW said...

Matt,

”Economist: True Fed Exposure $29 Trillion”
http://www.newsmax.com/StreetTalk/Economist-Fed-Exposure-Trillion/2011/12/13/id/420763/

”$29,000,000,000,000: A Detailed Look at the Fed’s Bailout by Funding Facility and Recipient”
http://www.levyinstitute.org/publications/29000000000000-a-detailed-look-at-the-feds-bailout-by-funding-facility-and-recipient

Here’s Bill Black to explain how the fraud happened, and how it was engineered. Interview with Harry Shearer, May 1, 2011. Not boring.
http://harryshearer.com/le-shows/may-1/?tag=bill%20black#

MRW said...

”FBI warns of mortgage fraud 'epidemic’”
http://www.cnn.com/2004/LAW/09/17/mortgage.fraud/

Matt Franko said...

That's why they get nowhere they are FOS....

Matt Franko said...

It's funny they make shit up all the time like "$29T!" and all their "neoliberal conspiracy!" theories but then here we have an actual event where the industry is asking for a regulatory modification and they don't exhibit any understanding of it...

Matt Franko said...

And it's a simple algebraic relationship...

Matt Franko said...

MRW explain to me the functional relationship where some people were committing mortgage fraud and then 2 years later oil price collapses to $33...