Some quick thoughts- Prudential and consumer regulations as a preferential tool for controlling bank money creation?

This quote from the Levy Institute’s recent paper entitled “Federal Reserve Bank Governance and Independence During Financial Crisis” really got me thinking:

 “Excessive private credit creation was the key policy challenge facing the Fed after WW2. The Truman Administration ran budget surpluses for several years, but strong bank lending neutralized their effects. The banks, in other words, created an amount of money just about as fast as the Federal Government, through its fiscal policy, contracted the money supply. "

MMT talks a lot about how the creation of bank money affects aggregate demand, and how permanent zero rates might be a good idea going forward. I think we should also begin discussing how growth in bank money might be controlled in this permanent zero environment. It seems to me that if raising interest rates to slow down lending is off the table, then we would need to have other tools available. Since I have been working in financial regulations for a while now, I have come to see firsthand the truth of MMT’s claim that regulations, not interest rates, truly affect lending. And anecdotally, I frequently hear compliance people complaining about how all the new Dodd-Frank rules are curtailing lending. So here are some of my preliminary thoughts on this issue: 

• The last few decades have demonstrated the failure of traditional monetary policy tools to control growth in the money supply

• We know that the Fed controls only price of required reserves, and cannot directly control quantities of bank money, since this growth is mostly demand based

• Central banks are moving away from reserve requirements and monetary aggregate targeting anyway. Cant’ push on a string during times of low loan demand

• Inflation can be caused by excessive and imprudent lending. It’s not always due to too much horizontal money creation by federal deficit spending (although its remarkable that the explosion of bad lending and large deficits of the Bush admin were *still* not enough to create inflation)

• Using interest rates to manage an economy has mostly failed, and created enormous side effects:
• Market volatility
• Creates unnecessary interest rate risk burdens for depository institutions (cost of short term funding goes up, while long term assets are fixed)
• Creates risk of deposit flight from traditional banking system into higher yielding shadow banking/money markets which are not as closely regulated or monitored

My premise is that:

• Consumer and prudential regulations can be a much more effective and precise way of reducing lending-based creation of bank money (M2), than the tradition tool of raising interest rates

• Question is how do you develop a regulatory regime that is flexible enough to be ratcheted up or down for macroeconomic needs?

• Housing finance is a major source of bank money growth and therefore aggregate demand, so it is a good place to focus, using these tools:
• Raising/lowering agency (Fannie, Freddie, FHA, VA) conforming loan limits (very influential in housing esp. now that they control so much of the market)
• Weighing of risk-based bank capital 
• Risk retention/QRM rules from the prudential regulators
• Qualified Mortgage standards from CFPB

• From the firm perspective, these changes would:
• Increase compliance risk/burdens (bad for banks)
• But decrease volatility/interest rate risk, if rates are permanently kept at zero (good for banks)

Therefore-- 

With the end goal being full employment, the primary focus of federal financial/fiscal policymakers should be to strike the right balance between US dollar creation via federal deficits, and bank money creation via net bank lending. Both of these money creation forces contribute to aggregate demand, and if they outstrip the ability of the nation to produce a commensurate level of real goods and services, can cause an undesirable rise in the price level. Policymakers should approach full employment with as much of a utilitarian mindset as possible-- the only “moral” issues that should be taken into consideration here are the deleterious social effects of involuntary unemployment. 

Thoughts?

Department of Stupid: Congress to consider a bill comparing public and private lending

Via Center on Budget and Policy Priorities: 

The House will consider three bills in the coming weeks that would make the budget process more complicated, less transparent, and less credible. One of these is the Budget and Accounting Transparency Act (H.R. 1872), which would add an extra amount to the recorded budgetary cost of federal credit programs, beyond their actual cost to the government, to reflect what private lenders would charge if they issued the loans and loan guarantees.  By artificially inflating federal lending costs, this change would disadvantage direct loans and loan guarantees relative to other federal programs and expose them to a greater likelihood of cuts.

H.R. 1872 would change the accounting for credit programs such as Federal Housing Administration and veterans’ mortgage guarantees, student loans, small business loans, and rural electric loan guarantees by adding anextra amount to their recorded budgetary cost.  This extra amount would reflect what private lenders would charge if they, rather than the federal government, issued the loans or loan guarantees.  

The proposal is not based on a contention that current estimates of federal credit programs understate their cost to the government.  Therefore, the proposal would distort the budget by making federal credit programs appear more expensive than their actual cost to the government.  It would also undercut one of the key purposes of the budget, which is to provide a meaningful comparison of the cost to the federal Treasury of different programs.  

The bill also would make federal loan programs likelier targets for deficit reduction measures, since they would appear to cost more than unbiased projections show they actually would cost.  In the area of student loans, for example, this could result in higher costs for borrowers or less access to loans.  The size of the student loan program and how much of the cost students should bear are valid policy questions, but policymakers should not distort these issues by artificially inflating the program’s cost.

This idea is dumb enough even for those who don't understand monetary sovereignty...but for those of us that do, its just mind mindbogglingly stupid. CBPP does state that:

The concerns for the federal budget, however, are different from the concerns of private-sector investors.  The federal budget is a straight record of the cash flowing into and out of the Treasury; the deficit or surplus equals the difference between the money actually spent and the money actually collected.  That is what the existing credit rules ask the Congressional Budget Office (CBO) and the Office of Management and Budget (OMB) to estimate.  If the estimates are unbiased and take all possible factors into account, including expected defaults and their likelihood, then the overestimates and underestimates should net to zero over the long term.  Adding a penalty because private investors are loss averse should have nothing to do with government budgeting and accounting. 

However, they don't go far enough, and say that the government's risk of default as a currency issuer is zero, and thus should never be compared to any private entity with inherent, nonzero credit risk. If a borrower of a federal loan defaults, this does not affect the federal government's credit/spending ability by one penny. There is therefore no reason to price this risk in any federal budget-scoring mechanism.

Warren Mosler fisks Alan Blinders WSJ op ed

Warren fisks Alan Blinders WSJ op ed. Blinder, a former Fed vice chair, really is clueless about monetary operations. It's astounding.

The Center of the Universe

Blinder editorial in WSJ

Warren Mosler

Loan growth is losing momentum

Looks like lending is starting to lose momentum. This chart suggests momentum peaked back in June. Could be a sign that the economy is slowing and will continue to slow.

Bloomberg — Banks Use $1.77 Trillion To Double Treasury Purchases

Scott Fullwiler tweets, As I've always said, Treasuries are the opportunity cost of bank lending, NOT IOR.

Bloomberg
Banks Use $1.77 Trillion To Double Treasury Purchases
Cordell Eddings and Daniel Kruger

Comprehensive post on saving and borrowing/lending in the US.

Peter Stella — Level of bank reserves at a central bank not linked to loan growth

Scott Fullwiler tweets, "Peter Stella, former IMF; yet another of the few that understand the money multiplier is wrong h/t @edwardnh[arrison]

Read it at The Financial Times | Letters
Level of bank reserves at a central bank not linked to loan growth
From Dr Peter Stella | Former chief of the monetary and foreign exchange operations and central banking divisions at the IMF

Izabella Kaminska — The base money confusion

Peter Stella, former head of the IMF Central Banking and Monetary and Foreign Exchange Operations Divisions, clarifies his postion on bank reserves and lending, emphasizing that banks don't lend reserves, that the quantity of base money has nothing to do with bank lending, and that negative reserve rates would be contractionary rather than expansionary.

Right in line with MMT.

Read it at The Financial Times | FT Alphaville
The base money confusion
by Izabella Kaminska

(h/t Andy Blaltchford and Kevin Fathi via email)

Warren Mosler links to the post, too. Peter Stella on QE

Loan growth surging, but incomes are not keeping up

Total loans and leases have increased by over $200 bln since the end of March, so private credit expansion is replacing falling government spending. That’s good because it’s keeping the economy supported, but it can only go so far as incomes have to be able to support the expanding debt service. The problem is, incomes have been falling.

Take a look:

But personal income has started contracting...

So it doesn't look like this is sustainable for very long.

"Horizontal money" (private credit creation) needs income to sustain it.

"Verticle money" (the government's fiat) adds to income.

It's a lot better to have the latter than the former, at least during times like now.

Bank loans surge as government spending slows

Followers of MMT understand that government deficits add to non-government (private sector) income and savings. That means high and rising deficits tends to cool credit demand because private sector balance sheets are getting healthier.

On the other hand, a slowdown in deficit spending tends to do the opposite: it DRAINS income and savings thus causing credit demand to rise in order to compensate for that loss in income and savings.

The chart below is quite eye-opening. It shows a very strong correlation between government spending and private credit creation. Bank loans have begun to grow since the slowdown in net government spending that started back in March-April of this year. And when net government spending went negative year-over-year in July, bank lending absolutely took off.

The private sector is now tapping credit as the government begins to step out of the economy. Unfortunately, this will not be a repeat of 2004 - 2007, where we had a credit boom, because credit conditions are, generally, much tighter now. And with unemployment high, the ability to get credit and service that credit is poor, so this credit cycle can collapse very quickly.