regulation

07 Dec 09

any explanation of the financial crisis has to tell us why so many mortgage-backed bonds wound up in the hands of the world’s commercial banks.
For American banks, the answer seems to be an obscure regulation called the Recourse Rule. The Rule was enacted by the Fed, the FDIC, the Comptroller of the Currency, and the Office of Thrift Supervision in 2001. It was an amendment to the international Basel Accords governing banks’ capital reserves—and all over the world, these regulations appear to have caused the crisis.
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- By reducing their reserves—and thus increasing their leverage—banks can, at least in principle, increase their profitability. But under the Recourse Rule, American commercial banks were required to hold 80 percent more capital against commercial loans, 80 percent more capital against corporate bonds, and 60 percent more capital against individual mortgages than they had to hold against asset-backed securities, including mortgage-backed securities rated AA or AAA. The Rule thus created a 60-80 percent incentive to buy highly rated MBS for any bank that wanted to reduce its capital reserves.
- And without the Recourse Rule, there is no reason that American banks that were trying to leverage up would have converged on mortgage-backed bonds. No other group of investors—not hedge funds, not pension funds, not mutual funds—were, as a whole, so overinvested in mortgage-backed bonds. But then, only banks were subject to the Recourse Rule.
- Moreover, in 2006, a second set of accords began to be implemented outside the United States. Basel II took essentially the same approach as the Recourse Rule, encouraging foreign banks to take on-balance-sheet leverage in the form of mortgage-backed securities, just as in the United States.
- In a complex world where nobody really knows what will succeed until it is tried, competition that pits people’s ideas against each other is the only way to test these ideas.
- For this reason, herd behavior among capitalists may cause systemic risk. But regulations, by their very nature, homogenize the behavior of those being regulated, automatically increasing systemic risk.
- The bank-capital regulations inadvertently made the banking system more vulnerable to the regulators’ own errors. But this is what all regulations do. Whether by forbidding one activity or by encouraging a different one, the whole point of regulation is, after all, to change the behavior of those being regulated. And the direction of change is inevitably the one that the regulators think is wise.
- Liberals are right to notice that good luck explains many capitalists’ success, and that bad luck—accidents of birth—condemn millions to lives of misery.
- The baker intends to make money, but he can do so only by providing his customers with bread. In his case, greed is indeed good. But that doesn’t mean that greed is always good, or benevolence bad. Nor does it mean that greed accounts for the success of capitalism.
- Liberals are correct to see through the usual defenses of capitalism. But they are wrong on the big picture. They fail to notice that there’s more to capitalism than luck and greed: there is competition—the saving grace of the whole system and, when undisturbed, the source of its strength.
- Nobody can plausibly deny any more that modern societies are bafflingly complex and the solutions to modern problems difficult to discover. So the policies that seem to voters or regulators to be so obviously needed may turn out to be disastrous nostrums—unless regulators or citizens are infallible.

03 Dec 09

A Brief History of Media Merger Hysteria: From AOL-Time Warner to Comcast-NBC

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media business merger regulation history politics Adam Thierer

How to Fix Health Care—Lasik surgery for the medical debate

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health care insurance government regulation politics

The alternative is to base reforms on what works in the other
five-sixths of the U.S. economy, where choice and competition
increase quality and drive down prices over time.
"How to Fix Health Care" proposes three simple reforms that will
put us on a path to a health-care system that's better, more
affordable, and more accessible. And get this—these market-based
reforms can be implemented without creating new government
programs or raising taxes.

02 Dec 09

How Robber Barons hijacked the "Victorian Internet"

Matthew Lasar points to the history of the telegraph business to argue in favor of government regulation.

Questions:

Was Western Union ever a monopoly? The article quotes some people who described it as a monopoly, but it also refers to competitors.

If Western Union became a monopoly, why? What prevented competitors from entering the market? The article says the U.S. government subsidized particular telegraph companies, which would have hampered competition. Did the U.S. government or other governments do other things to pick winners?

Did Western Union become a monopoly on telegraph service when the market for telegraphy was in decline? Telephone companies were in business by the time the article says Western Union's stock price dropped.

If Western Union was not ever a telegraph monopoly, did consumers respond to their abuses by switching to competitors? Over time, consumers clearly did choose competitors offering substitute services, since most of us don't communicate through telegraphy today.

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telegraph network Internet net neutrality regulation politics

one wonders if there ever was an age when the hands-off school of regulation got exactly what it seems to want—a network environment largely untarnished by public oversight.

In fact, there was such a time.
It was no secret why Western Union sided with Republicans. By the 1870s, the Party of Lincoln (Abe himself being a former railroad lawyer) had given away massive quantities of land for the construction of railroads and telegraphs: almost 130 million acres (about seven percent of the continental United States) was granted to eighty enterprises.

28 Nov 09

After the Fall: What really caused the financial crisis?

Jeffrey Friedman reviews <em>A Failure of Capitalism</em>, by Richard Posner.

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Richard Posner financial crisis book review Basel Accords Recourse Rule capitalism regulation Jeffrey Friedman

The heart of Posner's case against "capitalism" is the following theory, which has been embraced by no less than the president of the United States: Perverse incentives, created by banks' executive-compensation systems, caused the crisis.
This leaves Posner to solve the puzzle of why rationally self-interested bankers seemed to ignore risk. But in the real world of contemporary capitalism, rational self-interest does not conform to the patterns it would follow under "a laissez-faire economic regime." Instead, rational self-interest follows the tens of thousands of pages of the tax code; it follows the millions of pages of the regulatory code. And these tortuous legal pathways are largely overlooked by Posner.
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- Thus, he argues that the most important risky behavior prompted by the banks' compensation structures was that bankers increased their leverage ratios. But banks' leverage ratios are regulated by law, and this law, unmentioned by Posner, was probably the main cause of the crisis.
- Ten years after the Basel accords were implemented in the United States, the American regulators amended them. Under the "Recourse Rule," adopted in 2001, mortgage-backed securities were risk-weighted at 20 percent, requiring 60 percent less capital than actual mortgages required.
- If the reason that "banks" were leveraging up in the first place is, as Posner maintains, that they cared only about profits and ignored possible losses (because their executives and employees were compensated for short-term profits, regardless of the long-term risks), then banks should have bought AA securities every time: The AAs paid more than the AAAs--precisely because they were riskier.
  
  But in fact, only 19 percent of the mortgage-backed securities held by the banks were rated AA or lower. Eighty-one percent were rated AAA, yielding less short-term profit because they carried less risk. This one fact may refute the executive-compensation theory all by itself.
- Another inconvenient fact: If banks were seeking to maximize their leverage because they were heedless of the risk, then they should have driven their capital holdings down to the minimum allowed by law: 8 percent for "adequately capitalized" banks; 10 percent for "well-capitalized" banks, to which American regulators give privileges that most banks need. But in December 2007, as the crisis was getting underway, the average capital level of all American banks combined was roughly 13 percent--30 percent higher than the legal minimum.
- If anybody really knew in advance which ideas were good and which were bad, there'd be no point testing the ideas against each other through competition. But the hidden premise of banking regulations such as the Basel rules is that regulators can, indeed, know such things in advance.
- In 2001, the American regulators had decided that it would be more prudent for banks to hold AA or AAA rated mortgage-backed securities than to hold actual mortgages, so banks that made this switch were rewarded with 60 percent more potential profits.
- If one seeks the cause of a systemic problem, a logical place to look is among the laws that govern the system as a whole. Individual capitalists, of course, make mistakes all the time; we discover this when they go broke. And being human, they are as susceptible as anyone to herding around the conventional wisdom of their time and place, which is so often wrong. Thus, a systemic "failure of capitalism" is possible: In a "laissez-faire economic regime" capitalists could all make the same mistake.

24 Nov 09

How Little We Know

Russell Roberts argues against giving more power to regulators for the purpose of reforming capitalism. Regulators were part of the problem, and there is no reason to believe they will be wiser in the future.

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regulation moral hazard financial crisis bailout mortgage housing government politics economics Russell Roberts pdf

Why did regulators bother with Utz-Snyder's deal? Companies called off merger that could have benefited consumers

As is all too common, the author maintains his faith in an enthusiasm for antitrust laws.

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antitrust merger business government regulation Federal Trade Commission FTC

This month Snyder's of Hanover and Utz Quality Foods, both in Hanover, just over the state line from Carroll County, halted a planned merger after regulators intervened.

In deciding to extend its review of the deal, the Federal Trade Commission sought documents that would have cost the companies millions of dollars and months of uncertainty.

"They were asking for a lot of data - obviously a very expensive process" says Utz President Tom Dempsey. "We looked at it and said, 'We've got to make a business decision here.' We just decided this isn't something we're prepared to go forward on."

Too bad. The merger, which the companies said would have been layoff-free, could have given them fighting weight to compete against monsters Frito-Lay and Kraft. It would have been good for Hanover, where they employ a couple of thousand people.

Not in anybody's imagination (except maybe an antitrust regulator's) could it have hurt consumers.

Between them Frito-Lay and Kraft control well over half of the U.S. snack market. Frito-Lay makes the eponymous chips and other junk food. Kraft makes Ritz and Triscuit crackers and Mister Salty pretzels.

Snyder's market share, by contrast, is about 2 percent. Utz's is even less. Combined, they would control a smaller portion of the snack business than Microsoft's share of Web-search activity.

06 Nov 09

Capitalism After the Crisis

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capitalism finance crisis regulation United States Luigi Zingales

05 Nov 09

The Tragedy of Health Insurance: How the insurance industry has haplessly abetted the rise of a government-run health care system

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health insurance regulation public option government politcs history Ronald Bailey

By conferring a regulatory monopoly on each state, the
McCarran-Ferguson Act ends up protecting insurance companies from
interstate competition—residents may not buy policies from
insurers located outside their state. Because health insurers are
insulated against out-of-state competition, state insurance
commissions and legislatures feel free to impose coverage
mandates that
significantly drive up policy premiums.
The truth is that companies don’t want competition; they want
government guaranteed profits. Mesmerized by the prospect that an
individual insurance mandate would provide them with tens of
millions of new government-subsidized customers, private health
insurers have allowed themselves to be maneuvered into an
inexorable process that will lead to their destruction.

Financial Market Reform: Why new regulations must avoid moral hazards

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finance crisis regulation moral hazard government politics Jeffrey Miron

According to perceived wisdom, the root cause
of the 2008 financial crisis was excessive risk-taking, and
proper regulation can detect and prevent such excess in the
future.
The Financial Crisis of 2008 did not occur because of
insufficient or ill-designed regulation. Rather, it resulted from
two misguided government policies.

The first was the attempt to promote homeownership.
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- The pressure to expand risky credit was especially problematic
  because of the second misguided policy, the long-standing
  practice of bailing out failures from private risk-taking. This
  practice meant that financial markets expected the government to
  cushion any losses from a crash in mortgage debt. Thus, the
  historical tendency to bail out creditors created an enormous
  moral hazard.
- any mistakes made by a powerful,
  centralized authority have a magnified impact because they
  distort the behavior of the entire market.
- under the proposed system, bank holding
  companies would forever more regard themselves as explicitly, not
  just implicitly, backstopped by the full faith and credit of the
  U.S. Treasury. That is moral hazard in the extreme, and it will
  create an unprecedented incentive for excessive risk-taking by
  these institutions.
- The only way to limit financial panics is to eliminate
  government-induced moral hazard, and that means letting failed
  institutions fail.
- Rather than being a cause, Lehman’s failure was merely the signal
  that time had come for the U.S. economy to pay the price for all
  the distortions caused by the misguided policies toward housing
  and risk. Given those distortions, a massive unwinding and
  restructuring was necessary to make the economy healthy again.
- The announcement that the Treasury was considering a
  bailout scared markets and froze credit because bankers did not
  want to realize their losses if government was going to bail them
  out. The bailout introduced uncertainty because no one knew what
  the bailout meant.
- The third and perhaps most important way to reduce moral hazard
  is to eliminate the Federal Reserve. As long as the Fed exists,
  it will regard itself as, and be regarded as, the economic
  insurer of last resort.

26 Oct 09

Learning to Love Insider Trading

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insider trading securities crime regulation law government Donald Boudreaux

Far from being so injurious to the economy that its practice must be criminalized, insiders buying and selling stocks based on their knowledge play a critical role in keeping asset prices honest—in keeping prices from lying to the public about corporate realities.

Prohibitions on insider trading prevent the market from adjusting as quickly as possible to changes in the demand for, and supply of, corporate assets. The result is prices that lie.

And when prices lie, market participants are misled into behaving in ways that harm not only themselves but also the economy writ large.
These prohibitions are meant to prevent all insiders with non-public information from profiting from the use of such information before it becomes public. It follows that unbiased application of these prohibitions should target not only traders whose inside information prompts them to actively buy or sell assets, but also traders whose inside information prompts them not to make asset purchases or sales that they would have made were it not for their inside information.
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- There are, of course, situations in which it is in the interest of both a company and the public for that company to delay the release of information. Such information should be protected as company property.
- the challenge is to distinguish information that should be treated as proprietary from information that does not warrant such treatment. While this challenge is theoretically easy—protect only that information whose revelation to the public through insider trading would likely reduce overall economic efficiency—practically it is devilishly difficult.
- Discovering what types of inside information are proprietary and which are not proprietary—and, hence, which types of information are appropriate to protect and which not to protect from insider trading—can be left to corporations themselves.
- Competition is a beautiful thing: It will punish firms that are either overly inclusive or under-inclusive in the sorts of information that they shield from inside trading.

21 Oct 09

In Health Care, Nobody Knows Anything: Two new industry studies reignite the debate about what makes health care so expensive.

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health insurance regulation economics politics

The president is right that we should always be skeptical of
studies that find in favor of the groups that sponsor them. And
these two insurance industry-sponsored studies do have their
flaws. But the finding that guaranteed issue and community rating
mandates increase insurance premium prices has been corroborated
by other academic researchers.
Massachusetts, the one state that combines an
individual mandate, community rating, and guaranteed issue, now
has the highest premiums for family insurance plans in the
country.
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- Why
  would health insurers spend so much money on administration?
  According to the New England Journal of
  Medicine, the director of the Office of Management and
  Budget, Peter Orszag, cites evidence that $830
  billion is being spent this year on unnecessary care.
- Averaging profits of 3.3 percent, health insurers are the
  86th most profitable industry in the U.S., well behind chain
  restaurants (7.7 percent), electric utilities (6.2 percent), and
  brewers (18 percent), but ahead of major auto manufacturers (-3.3
  percent), resorts and casinos (-8.9 percent), and major airlines
  (-11 percent).
- So why have health costs, and especially health insurance
  premiums, skyrocketed since 2000? Let’s look at one plausible
  theory: market consolidation.
- An essential player is absent from the competitive field: the
  actual consumer of health care services. So long as insurers can
  extract their premiums from employers and providers can extract
  payments from insurers, the health care industrial complex has
  very little incentive to rein in costs.
- One of the chief problems is that consumers haven’t a clue about
  what their insurance and medical services cost.
- So what kind of real reforms could increase health care
  competition? Congress should aim to break up the system of local
  monopolies into which our health care sector has devolved. In his
  Saturday attack on health insurers, President Obama noted that
  the industry enjoys “a privileged exception from our anti-trust
  laws, a matter that Congress is rightfully reviewing.” What he is
  talking about is the
  McCarran-Ferguson Act of 1945 that allows state governments
  to regulate the business of insurance without federal government
  interference. The Act is, in part, responsible for the evolution
  toward state insurance markets dominated by just a few large
  insurers.
- Barriers to increased competition among health care providers
  must be removed too. For example, many states have certificate of
  need programs that forbid the construction of new health care
  facilities without prior regulatory approval.

07 Oct 09

The Lesson of State Health-Care Reforms

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health care health insurance socialism regulation politics Peter Suderman

Like participants in a national science fair, state governments have tested variants on most of the major components of the health-care reform plans currently being considered in Congress. The results have been dramatically increased premiums in the individual market, spiraling public health-care costs, and reduced access to care. In other words: The reforms have failed.

24 Sep 09

Unintended Consequences of Regulation

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regulation unintended consequences deadweight loss Ford Google FCC economics David Henderson

21 Sep 09

Did Deregulation Cause the FInancial Crisis?

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financial crisis regulation Gramm-Leach-Bliley credit default swaps credit rating agencies mortgages politics pdf

ObamaCare: Status Quo on Steroids

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health insurance regulation government politics Sheldon Richman

World War II was a bonanza for the industry, especially Blue Cross Blue Shield. Government economic controls prohibited firms from attracting or keeping workers with higher wages. So someone hit on the idea of supplementing wages with noncash compensation, specifically, health insurance. The government said okay and the rest is history. Employee insurance was untaxed, creating a bias toward employer-provided health plans.
Under the old-style indemnity plans (which individuals shopped and bought for themselves), contracting a catastrophic disease triggered a fixed insurance payment — to the policyholder – according to an agreed-on predetermined schedule. The money was hers. If she could find services that cost less than the insurance payment, she pocketed the difference. Of course, this provided an incentive to be cost-conscious in buying medical care. Homeowners’ and other types of insurance still works like this.

In contrast, under the Blue Cross Blue Shield model pushed by government — which began not as insurance but as a prepayment plan for doctors and hospitals — the policyholder never sees a dime. Treatment simply sets in motion a process in which the insurance company sends a check to a hospital, lab, or doctor. No treatment, no payment. The individual has no reason to shop around (there can be great variation in prices), or to question whether a test or procedure is necessary, or to even ask what anything costs.
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- In most cases employers pay for their workers’ coverage with money that otherwise would have largely gone into cash wages. To the workers, it looks like free (or pretty cheap) coverage. Because of competition among employers and the rigged tax laws, coverage has become more luxurious, including services for situations that are not even insurable.
- To make matters worse, state governments have mandated that all “basic” policies include coverage for situations that are either uninsurable or unlikely to affect most people.
- You and I could evade the mandate plague somewhat if we were free to buy policies offered in low-mandate states. But — under the federal McCarran-Ferguson Act — we aren’t free. That 1945 decree shelters the states — and the insurance companies — from the interstate competition that might have reined in their regulatory regimes.
- We have mandates because the providers of those products and services wined and dined enough state legislators to get these special-interest bills enacted.
- State regulation also sets up barriers to entry in the insurance industry.
- None of this justifies what President Obama and his ilk call healthcare “reform.” They merely propose more of what we already have: more “free” insurance for more people, more coverage for more uninsurable situations, lower out-of-pocket costs — all of which means less cost-consciousness and higher prices, which seeds the ground for price controls and rationing. In the name of creating competition, Obama would further suppress it, rather than dismantling the current anticompetitive regime.

15 Sep 09

What I'm Saying

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finance crisis regulation history Arnold Kling

today's proposals for financial reform are just a continuation of the self-defeating policy approaches that got is in trouble. We need to think differently if we want to create effective reforms.
Putting people in debt up to their eyeballs ultimately does not promote home ownership. What happened was that subsidized mortgage credit and lenient mortgage credit promoted speculation. In 1995, five percent of mortgage loans were backed by non-owner-occupied houses. By 2005, fifteen percent of mortgage loans were backed by non-owner-occupied houses. Speculation had tripled. Speculation drove up home prices, which made houses less affordable, which made the Hill call for more mortgage subsidies and more leniency, which fueled more speculation, and so on. It seemed like an endless cycle, except that it did end--with a crash.
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- regulators outsourced bank capital regulation to the credit rating agencies. This set off a frenzy of innovations designed to manufacture AA and AAA rated securities out of junk mortgage loans.
  
  The net result was that bank capital regulations, which were supposed to promote safety and soundness, did the opposite. There was excessive leverage, because the banks were able to hold the same risk with less and less capital needed to comply with regulations.
- If we had a business continuity strategy, then allowing a bank to fail would be a credible and viable option for regulators. That in turn would change everyone's incentive to make them watch out for their own risks and watch out for their own exposures to counterparties. Instead, the more you try to make the system too regulated to fail, the more careless everyone becomes in their risk exposures. It is a self-defeating approach.

Rebuilding Wall Street: Suggestions for Reforming Financial Services Regulation

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finance regulation pdf

Not What They Had in Mind: A History of Policies that Produced the Financial Crisis of 2008

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financial crisis finance regulation Arnold Kling pdf

10 Sep 09

Political Malpractice

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health care health insurance regulation politics

Most Americans agree that our health care system is broken and must be fixed. But it is increasingly clear that what ails health care is not too little, but too much government intervention. Federal and state tax preferences for employer-sponsored health insurance distort the market in a way that limits choices for individuals, reduces competition among insurers, and artificially inflates costs for health care services. For most working Americans, switching jobs often entails switching health plans and doctors or losing coverage altogether, while many others find non-employer-sponsored insurance unaffordable or difficult to obtain.

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