Sunday, October 10, 2010

Today's Best Reads

1--Moral Hazard in the Shadow Banking System, Economist's view

Excerpt: In the traditional banking system, firms are required to hold capital that is "impaired" should the resolution process be triggered, and they pay risk based fees to the FDIC. Thus, the traditional banking system mimics the standard response to moral hazard in insurance markets generally (and the deposit insurance, fees, capital impairment, activity restrictions, and regulation have all but eliminated runs in the traditional system while minimizing moral hazard).

But in the shadow banking system, when the crisis hit there was no legal way to impair capital. That is, there was no legal authority to force firms into the resolution process, and then force capital holders to take the first loss. Thus, if regulators wanted capital holders to face market discipline, their only choice was to let firms fail. They tried that with Lehman and it didn't works so well -- the outcome was a run on the shadow banking system (stopping these runs with an insurance regime along the lines of the FDIC is the point of the Morgan Ricks paper). The other choice was to bail the too big to fail firms out with all the negatives that come with that decision (both political and economic). Given those two choices, I think regulators made the right decision.

But they should not have been forced into just these two options, and Dodd-Frank tries to fix that. With the passage of Dodd-Frank, regulators now have the authority to impair capital in the resolution process, and that should help with the moral hazard problem. However, the current regulations do not eliminate the chance of a run on the shadow banking system, that danger is still present.

2--Is ForeclosureGate About To Become The Banking Industry's Stalingrad?, zero hedge

Humorous take on foreclosure crisis.

3--Shadow Banking: What It Is, How it Broke, and How to Fix It, Mike Konczal, The Atlantic

Excerpt: Mike Rorty: Let's start by talking about what a traditional bank does, how it takes money and the special kinds of risks it faces.

Perry Mehrling: You are talking about the Jimmy Stewart bank. There are two sides to it, the liability side which looks to the depositor. The other side is lending, for consumer loans and other loans. The regulatory support and backstop for that system was devised over many years to deal with two fundamental problems facing that kind of structure.

One risk is liquidity risk, which is the risk that people on the deposit side might want to take their money out and, since the money is locked up in houses and long term loans, it can't happen. So there has to be a lender of last resort. There's a second problem, a solvency problem, which is maybe all those loans go bad, and we want to make sure that the depositors aren't all wiped out. That's where the Federal Desposit Insurance Corporation (FDIC) comes into the picture, making sure that if the bank is insolvent that the depositors are covered to a certain limit.

I referred to the lender of last resort, and that's the role of the Federal Reserve in this story. If a bank does not have liquid funds to pay depositors who want to withdraw their money, the Fed can lend a bank the funds it needs in order to make the payment system work. It isn't then a problem for the depositor, but instead a problem between the bank and the Fed.

That's traditional banking. One thing to understand is that the regulatory support structure of the government is designed for that kind of banking. (Great article)

4--Gary Gorton On The Shadow Banking System Run, And The Interplay Of Shadow And Traditional Banking, zero hedge

Excerpt: There are few people as qualified to discuss the stresses of (and on) the financial system over the past several years as Yale and Wharton Professor Gary Gorton, who just incidentally has held positions at the Bank Of England, the Federal Reserve and the FDIC. In a submission to Zero Hedge, Professor Gorton provides some unique perspectives into what we have long claimed was the immediate catalyst for the near collapse of the banking system: the bank run, not so much on depository institutions, but on the much more critical shadow banking system.

5--The 'Limited Inflationists' , Wall Street Journal

Excerpt: The theory of QE2 is that by buying Treasurys and other assets, the Fed help drive long-term interest rates down even lower than they are already. This in turn will spur more private lending and borrowing and kick-start faster growth. But we're told the Fed's own internal models suggest that a purchase of $500 billion in Treasurys would only reduce the 10-year bond by something like 15 basis points. (The 10-year yield is now 2.38%.) This in turn would increase GDP by 0.2% a year and cut the jobless rate by 0.2%. That's not much bang for a lot of bucks.

The case for QE2 assumes that the problem with the economy is merely a lack of money. But trillions of dollars are already sitting unused on bank and corporate balance sheets. The real problem isn't lack of capital but a capital strike, as businesses refuse to take risks or hire new workers thanks to uncertainty over government policy, including higher taxes and regulatory burdens. More Fed easing in this environment risks "pushing on a string," adding money to little economic effect.

Meanwhile, the costs of QE2 would be real and significant. With Congress spending as much as ever, the Fed would appear to be financing a spendthrift government almost on a dollar-for-dollar basis. This would make it even harder, and take even longer, for the Fed to extricate itself from the market for Treasurys and mortgage securities once it decided to do so. And by firing all of its ammo now amid a recovery, what would the Fed have left if we get another financial panic?

6--U.S. Banks Get Boxed In on Foreclosures, Wall Street Journal

Excerpt: In recent weeks, J.P. Morgan Chase, Bank of America and Ally Financial have temporarily halted foreclosures in 23 states due to flawed affidavits used in legal proceedings. Friday, Bank of America expanded this halt to all 50 states, while PNC Financial Services said it was stopping foreclosures in 23 states for a month.

Banks insist the problems are administrative and can be cleared up in a few weeks or months. But investors, who have largely shrugged off the issue, should dig a little deeper.

The affidavit problems may yet point to more serious issues with the documentation and the legal basis for mortgages that were securitized, or sold to investors.

"Is there a question about who owns things?" said Christopher Peterson, a law professor at the University of Utah who has studied securitization and mortgage-title issues. "If you don't think so, you're kidding yourself." (uh, oh)

7--Manning the Barricades, The Economist Intelligence Unit (Still a great read more than 1 year later)

8--America's disastrous policy of assassination, Jason Ditz, antiwar.com

Excerpt: ...Executive Order 12333, signed in December of 1981 by President Ronald Reagan, which read, "No person employed by or acting on behalf of the United States Government shall engage in, or conspire to engage in, assassination."

Yet extralegal assassinations, whether by means of federally employed assassins or the aerial bombardment of nations with which the United States is not at war, remains a terrifying fact of life. The WikiLeaks documents revealed, among other things, that the U.S. Army had an active assassination team operating in southern Afghanistan, and that the team has killed a number of innocent civilians in its heedless operations.

But the Army's assassins are small potatoes compared to the CIA, which was revealed in Bob Woodward's new book Obama's Wars to have an active team of 3,000 trained assassins operating in both Afghanistan and Pakistan. Combined with the CIA's constant drone strikes, the number of civilians killed by these plans since President Obama took office is well into the thousands.

9--Gallup Finds U.S. Unemployment at 10.1% in September, Gallup

Excerpt: Unemployment, as measured by Gallup without seasonal adjustment, increased to 10.1% in September -- up sharply from 9.3% in August and 8.9% in July. Much of this increase came during the second half of the month -- the unemployment rate was 9.4% in mid-September -- and therefore is unlikely to be picked up in the government's unemployment report on Friday.

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