Author: Daniel Indiviglio

Reports today indicate that Blockbuster Video is on the brink of bankruptcy. 10 or 15 years ago, it was probably unthinkable that Blockbuster would run into the kind of trouble it has in recent years. It was dominant in its market: the most significant of the national video rental chains. And for most consumers, renting a movie is a much more sensible alternative to buying a video, DVD or now Blu-ray. Its business appeared to have a bright future.

Blockbuster’s story is one of a company with a business model that became obsolete. It tried to adapt to a changing world, but failed. I would cite three major reasons for its ultimate demise.

Netflix

I think Netflix deserves some credit for dethroning Blockbuster as the movie rental king. Its business model merged technology, convenience and good customer service. If you enjoyed using a website to choose movies, hated driving to the video store, and got annoyed with late fees, then Netflix was for you. And the more movies you watched, the more Netflix paid off. So that stole a big moneymaking segment of customers from Blockbuster. Of course, Netflix also didn’t have Blockbuster’s expensive retail location overhead costs.

Eventually, Blockbuster entered the online rent-by-mail market. It even offered the added bonus of being able to bring back your rentals to a store location to get a new movie faster. But Netflix remained more successful. I’m not entirely sure why, but it’s probably because it simply entered the market first. Personally, I didn’t bother switching to Blockbuster for two reasons. First, I already had a queue of 200+ movies that I didn’t feel like recreating on a new website. Second, there was no Blockbuster near where I lived in Manhattan at the time anyway.

Movies On-Demand

Perhaps the most fatal blow to Blockbuster came from the rise of on-demand viewing. What’s easier: pressing a few buttons on your remote control to watch a move or driving a few miles to pick one out, hoping the movie you want to watch is in stock? It’s a no-brainer. Although on-demand viewing began quite a few years ago, only recently has it really become an extremely convenient way for the average American to consume movies.

Indeed, these days consumers have even more ways to view movies on-demand. You can do it through most cable, broadband and satellite TV services. New televisions and Blu-ray players also often come with additional Internet-based on-demand services built in. Some even include free-streaming for Netflix subscribers — just so the company could twist the knife a little, hurting Blockbuster in both areas where it was most vulnerable.

Digital Piracy

Finally, I don’t begin to doubt that digital movie piracy played a role. Even though authorities have begun cracking down on some of this in recent years, there’s little doubt that Blockbuster and others lost millions of dollars in potential rentals when movies were illegally downloaded.

All of these causes of Blockbusters troubles have something in common: technology. Without the Internet, Netflix wouldn’t have been created and digital piracy wouldn’t have been an issue. Without advances in cable, satellite and broadband, on-demand services wouldn’t have emerged as a desirable source for movie viewing. Blockbuster could have sought to capitalize on these technologies earlier. If it had developed a mail-rental system before Netflix or been the first to create an Internet-based on-demand module available in new TVs and Blu-rays, things may have been different. Blockbuster’s fate was mostly sealed by its failure to embrace technology quickly enough.

(Nav Image Credit: Wikimedia Commons)

The House Financial Services Committee is holding a hearing today which seeks to find an answer to precisely that question. Testifying on its first panel were two men who should know quite well about the Federal Reserve’s role: current and former chairmen Ben Bernanke and Paul Volcker. As you might guess, they agree that the Federal Reserve should supervise banks. I didn’t find their arguments particularly compelling.

This question is especially important right now, since Senator Dodd’s proposed financial reform would reduce the Fed’s bank supervisory to only about the 40 largest banks. It’s also an important question because the financial crisis appeared to suggest that the Fed hadn’t done a very good job of supervising banks. After all, the banking industry came dangerously close to collapse. Many of the members of the committee brought up this particular criticism, to which Bernanke didn’t have a very convincing reply, other than conceding that the Fed should have done better.

Here’s part of his prepared testimony summing up why he believes the Fed should retain this duty:

The Federal Reserve’s involvement in regulation and supervision confers two broad sets of benefits to the country. First, because of its wide range of expertise, the Federal Reserve is uniquely suited to supervise large, complex financial organizations and to address both safety and soundness risks and risks to the stability of the financial system as a whole. Second, the Federal Reserve’s participation in the oversight of banks of all sizes significantly improves its ability to carry out its central banking functions, including making monetary policy, lending through the discount window, and fostering financial stability.

Large Banks

Let’s start with Bernanke’s first point. What about large financial firms? Shouldn’t the Fed be in charge of their supervision? Indeed, now both the House and Senate versions of financial reform call for that. Of course, this also implies that, at least at this time, no legislation being seriously considered by Washington would remove the Fed’s supervision of large banks. So I’d begin by noting that I don’t think this claim is particularly controversial right now.

But that doesn’t mean the consensus is necessarily right. I do agree that the Fed is “uniquely suited” to oversee these big firms. But I’m far less convinced that it’s the only potential regulator that could handle this duty. A new or existing regulator could be given the resources necessary to accomplish this task. The Fed could retain emergency lending programs without also being in charge of regulating large institutions. It could also conduct monetary policy without regulatory authority.

Banks of All Sizes

I think the argument that the Fed must regulate smaller banks is even weaker. While the Fed does need to understand how banking on a whole is functioning, that doesn’t necessarily mean it needs regulatory power over the entire industry. Surely, whatever regulator is in charge of these banks could supply the Fed with the industry data it needs to analyze the macroeconomic trends in the market.

And really the same goes for big banks, but for smaller banks this point seems even more obvious. Why does the Fed need to regulate a regional bank in, say the Pacific Northwest, if its regulator supplies the Fed with all of its trends in loan origination, delinquency, savings accounts, checking activity, etc.? Since it doesn’t pose a systemic risk, there’s no reason the Fed need be too worried about whether it fails either.

When it comes to function, I’m kind of a purist. I’d like to see the central bank focus on its monetary policy function and have a bank regulator focus on its supervisory function. Unless there’s some stronger argument out there that I’m missing, I just can’t see the need for the Fed to have a role as a bank regulator. I think this goes up for all banks, but this argument is even stronger for those that don’t pose any systemic risk to the financial system.

I think one last post should suffice about Senate Banking Committee Chairman Christopher Dodd’s (D-CT) new financial reform proposal (.pdf) — for now. When markup starts (and supposedly ends) next week, there may be more to say about amendments that pass and fail in committee. But for my seventh post on the topic (links to the others below), I thought it might be useful to comment on what I found most surprising about his version of financial regulation. Some of this will serve as a summary for points I’ve made before, but a few I have neglected to mention until now.

Consumer Financial Protection Bureau Director’s Power

Despite the fact that the most talked-about aspect of Dodd’s CFPB is his decision to place it in the Fed, I think it’s also probably the least interesting. As far as I can see, the CFPB would be essentially independent, even if its staff would share office space with other Federal Reserve personnel.

Instead, I found the most surprising aspect of Dodd’s CFPB the power he would provide to its director. The U.S. Chamber of Commerce did a good job in illuminating this criticism of Dodd’s version yesterday. The House version would have the agency’s power much less concentrated, with group of appointed commissioners in place to take on some of the responsibility for doing the regulating. With Dodd’s version, the director would do all the hiring, decide how to spend the budget and presumably have a huge impact on the regulation.

The Council’s Two-thirds Standard

Another difference between what the House and Dodd propose for systemic risk regulation is the difficulty that their respective councils would have in making decisions. In deciding to subject a firm to systemic risk regulation or breaking big ones up, the House bill would only require a simple majority of the council to vote in favor. Dodd’s would require a two-thirds majority for both tasks. As I said, I think the difficulty in achieving a majority would ideally be based on how controversial a decision is being made. So for systemic risk regulation I like a simple majority, but for break-up, two-thirds is probably prudent.

Fed “Strengthening”

Dodd’s bill manages to give the Fed a great deal more power than his original proposal in November would have. Now he’s conceded that the Fed should do most of the systemic risk regulation. He even hands it the CFPB, though it will be held at arm’s length. Yet at the same time he appears to want to rein in the Fed a bit. Those aspects of his plan, he amusingly titles “Strengthening The Federal Reserve” in his summary.

I didn’t see several of these proposals coming. For starters, it’s interesting that he hopes to add “financial stability” as a specific duty the Fed must aim for. Even though the Fed has sort of implicitly tried to smooth economic cycles over the past few decades, it has never explicitly been ordered to pop or prevent bubbles.

Dodd’s desire to prevent bank employees, past or present, from acting as directors of the Federal Reserve is also not an idea I had heard being loudly shouted in Washington before. While I think it’s sensible insofar as these individuals could favor their own banks’ interests with a role in the Federal Reserve, I also worry about losing their market expertise and experience entirely. These people are in the trenches, so you don’t want them to stay away from the central bank altogether. Perhaps this proposal could be changed to simply recommend that bank employees not have any voting power, but can sit on Fed boards as non-voting members.

Finally, the idea that the President should appoint the New York Fed president is kind of strange. Sure, that’s an important role, but I have to ask the counterfactual question here: would the banking industry have fared any better during the financial crisis if President Bush had appointed the NY Fed president? I sort of doubt it. Indeed, Geithner was considered by President Obama to have performed so admirably during the crisis that the President made him Treasury Secretary. As the appointments become more driven by politics, I worry that the Fed’s independence could also suffer.

Small Resolution Fund

This is another one I noted: Dodd only wants his bank resolution fund to be $50 billion, while the House version calls for $150 billion. Past experience suggests that $50 billion won’t get you very far in a deep financial crisis. It’s unclear why Dodd picked such a low number, but I think the House’s $150 billion is probably closer to what would be needed.

No Specific Leverage Limit

I did my best to fully absorb Dodd’s 1,336 bill, and as far as I can see, Dodd has no specific leverage limit proposed for banks. The House bill does — it calls for a maximum of 15 to 1 leverage for financial holding companies subject to systemic risk regulation. I’ve written before about the importance of leverage requirements. Hidden leverage in the banking system was one of the direct causes of the crisis. If leverage would have been more transparent and lower, the banking system would have been far more stable. I was surprised to see Dodd overlook this and be so vague on his proposal’s treatment of leverage.

Bank Supervision Changes

Another interesting feature of Dodd’s new draft is his hope to take smaller bank regulation away from the Fed. He would delegate the regulation of state banks, thrifts and bank holding companies of state banks with assets below $50 billion to the FDIC. The Office of the Comptroller of Currency would get the national banks, thrifts and holding companies that fall within that same size cap. The Fed would get what remains, which is about 40 large banks. As far as I can tell, the House version doesn’t seek to do anything like this.

A Seemingly Irrelevant Derivatives Section

Finally, in his summary of the proposal, Dodd says that a new derivatives section is still being worked on. It might not be completed by the time Dodd wants the bill out of committee and onto the Senate floor. I don’t believe it’s particularly common for a seemingly incomplete bill to be quickly swept out of committee onto the Senate floor, but that’s likely what would happen here if Dodd gets his way. The committee would vote for the bill with a derivatives section that Dodd himself admits will probably be replaced.

While these seven aspects were perhaps the most surprising, I could have named other eyebrow raising features of Dodd’s proposal as well. In general, however, it really did manage to trace over the House bill on most of the significant aspects. While some of the details of the two versions differ, I suspect that if the Senate does pass a version of Dodd’s proposal, they will be easily reconciled. I would predict that many of these surprises, consequentially, will drop out between now and when Congress votes on a final version.

To read my other posts related to Dodd’s proposal, please see:

Initial Thoughts on Dodd’s New Financial Reform Proposal
Dodd’s Bureau of Consumer Financial Protection
Comparing Financial Stability Oversight Councils
Chamber Stands Against Consumer Financial Protection Bureau
Non-Bank Resolution Process: House v. Dodd
Ron Paul on the Dodd Proposal’s Treatment of the Fed

The Producer Price Index for finished goods declined by 0.6% in February on a seasonally adjusted basis, according to the Bureau of Labor Statistics. That’s a pretty big drop from the 1.4% increase in January. In fact, it’s the first decline since September and the largest drop since July. It’s also a steeper fall than the 0.2% decline economists expected.

Within that drop, energy played a large part, with its price declining by 2.9%. Food prices, however increased by 0.4%. If you strip out food and energy, PPI for finished goods actually increased slightly by 0.1%.

For intermediate goods, the PPI saw a similar movement, but didn’t quite go negative. There, it increased slightly at a 0.1% rate. That’s still much less than January’s 1.7% increase, however. It’s also the smallest increase since September.

For crude goods, PPI’s drop was the steepest. There, it fell by 3.5% in February, a huge decline compared to January’s 9.6% increase. This was the largest decline for crude goods prices in a year.

Even though Consumer Price Index is generally the more interesting inflation metric, PPI can be important for understanding the price pressures producers might be under. For example, if PPI experiences an upward trend, then CPI will have to eventually increase before too long.

So my take away here would be that, again, we probably don’t have much to worry about on the inflation front in the near-term. Producer prices were flat to slightly deflationary across the board in February. Tomorrow CPI data is released for February, so we’ll be able to have a little more confidence about inflation’s overall direction then.

Perhaps the most surprising aspect of Senate Banking Committee Chairman Christopher Dodd’s (D-CT) proposed financial reform bill (.pdf) was the role of the Federal Reserve. In his original draft from November, Dodd mostly stayed away from increasing the power of the Fed, seeking to establish a new systemic risk regulator, rather than provide that duty to the Fed like the House version. This week’s new proposal, however, mostly fits in the House’s mold. But he ultimately provides the Fed with even more power, by putting the Consumer Financial Protection Bureau under its umbrella, though it remains mostly independent. Then, he sort of attempts to rein in the Fed in a little with some new restrictions that come out of no where — like not allowing any bank employees on the Fed’s Board of Directors and requiring the president of the New York Fed to be nominated by the President and confirmed by the Senate.

When I think of someone opinionated about the Federal Reserve, Congressman Ron Paul (R-TX) comes to mind. He also happens to be a rock star of the GOP, fresh off his 2012 Presidential straw poll win at the annual Conservative Political Action Conference last month. So I thought it might be interesting to get his thoughts on some of the more controversial aspects of Dodd’s bill that involve the Fed. Given that Paul wants the Fed abolished, you can probably guess the direction his opinions take: anything that strengthens the Fed he’s against, while anything that limits its independence he’s for. The transcript of our conversation is below.

Me: Are you disappointed that Dodd’s new proposal provides the Fed with more systemic risk authority than his original bill?

Paul: Well, I don’t know whether I’m disappointed or excited. It’s just sort of what I expected. What else do they do? When somebody gets very powerful, and they mess things up, Congress tries to clean it up, and they exacerbate it by giving the people who caused all the trouble more power. I just think it’s typical of the way government works. I don’t expect much good to come form this, and the Fed’s gonna be more powerful than any other, and there’s really not gonna be any real transparency of the Fed. They’re protected from that happening.

What do you make of Dodd putting the Consumer Financial Protection Bureau in the Fed?

Well, I think that’s the main thing where they’re getting a lot more power. It’s interesting that, of course, it’ll be funded by the Fed. So they’re going to do all this mischief and have all these bureaucrats. It won’t even be on the budget. And there will really be no oversight by the Congress. It’s government totally out of control. It’s just absolutely bizarre that you could create a Consumer Protection Bureau within the Fed, and they do all their own funding. And Congress probably won’t do anything about it.

Dodd does want a GAO audit of the Fed. What’s your sense of how that compares to your amendment that passed for the House version?

I haven’t looked in total detail, but it looked to me like the same language of the Watt bill, when Mel Watt and I had the debate in committee when his went down and mine prevailed. I think the Watt language got put in there, which was just sort of words, but no true audit. It’s been more or less been conceded by the Fed and others that these lending agencies that were created during the crisis, that we will eventually will get that material, and I think that’s what they say they can do. But it doesn’t do anything about overseas lending, central banks and other governments, and what happens at the discount window. None of that will be audited.

Dodd wants financial stability to now be an explicit function of the Fed. What do you think the outcome of that would be?

Financial stability? Well you need a stable dollar to have that. You can’t allow somebody to double the money supply in one year and have the financial community wondering: when is he gonna take that off the balance sheet? You don’t get stability that way. It’s impossible. They created the bubble — they’ve created all of the bubbles since 1913. And they create the depressions and recessions. The last thing they’re capable of doing is giving us financial stability, because they create the financial instability. And with more power, I just think it will get that much worse.

Dodd also wants to disallow any bank employee past or present to sit on the Federal Reserve’s Board of Directors. Do you think that’s a good idea? (For example, Jamie Dimon, JP Morgan’s CEO, currently sits on the NY Federal Reserve’s Board of Directors.)

Would that exclude people from Goldman Sachs and things like that?

It would.

I guess if I had an individual vote like that, I’d say, yes. I’d support that. But I wouldn’t expect much to come of it.

The proposal would also have the President appoint (with Senate confirmation) the New York Fed president. Would you support that?

Yeah, I think so. If we’re not gonna have my druthers and revamp the whole thing, and we have this system, yes. I think the President should appoint all of them — all of the regional presidents too and have them confirmed by the Senate. Because they have a lot of influence. It’s not really private. I think there should be more to say about the President appointing them as well. And there have been people that have made that argument from a constitutional viewpoint. But to me, that is not the most crucial thing, because I don’t think there’s authority in the constitution to have a central bank. But if the President appointed (the NY Fed President), I wouldn’t object to that.

The next stop as I continue to go through Senate Banking Committee Chairman Christopher Dodd’s (D-CT) new financial reform proposal (.pdf) is how he intends to resolve too big to fail firms. As with most other sub-proposals I’ve discussed thus far, this one largely resembles what’s found in the House bill. The big differences have to do with the creation of a “Orderly Liquidation Authority Panel” of bankruptcy judges to bless the resolution and the size of the fund to pay for it.

Both proposals call for firms to create resolution plans. In each proposal, the Treasury Secretary, Federal Reserve Chairman, relevant regulator or the firm itself requests resolution. The firm’s failure must pose a systemic risk to the U.S. economy in order to utilize this process instead of the bankruptcy code. The Federal Reserve Board and the relevant regulator’s board or commission vote on whether or not to proceed. A two-thirds vote is required. All of this is essentially identical for both Dodd’s and the House’s versions.

Orderly Liquidation Authority Panel

Next, the House version turns the process over to the FDIC, who completes the resolution process. Dodd’s proposal, however, takes a quick detour. He wishes to establish a panel of three bankruptcy judges who must first approve. If they agree that the firm in question is, indeed, in default or in danger of default, then the FDIC takes over.

This is an interesting deviation, and I suspect that Senate Republicans may have had a hand in this provision, based on reports during the compromise process. I’m a little mixed on whether it’s a good idea or not. I don’t know that it would hurt much — the judges must decide within 24-hours, so it would still be pretty quick. But then, a lot can happen in the world of finance in a day’s time.

So the question, I think, is whether the value of these bankruptcy judges’ opinion is worth the risk of what can happen in a day. If you’re worried that the government officials working for the Fed and other regulators could needlessly order firms to wind down, then you might think so. If you are less cynical, then you might think it’s a needless step. Frankly, I think if two-thirds of the Fed Board and firm’s regulator’s board/commission agree, then that’s a high enough standard to order resolution.

How Much Will Resolution Cost

Each proposal would create a resolution fund, maintained by the FDIC, to pay for the dirty work of resolution. Both versions of legislation call for this to be created from assessments on large firms. The sizes of those assessments would be based on risk-ratings. In other words, if a firm poses more systemic risk, then it has to pay more into the fund. So far so good.

The difference is in size. The House bill calls for a fund of $150 billion. Dodd calls for just $50 billion.

Which size is better? Who knows? Past precedent would tell us that the Dodd’s might come up short, but again, it’s hard to tell. Excluding government-sponsored entities Fannie and Freddie, the biggest bailout was AIG at about $180 billion. But that probably wouldn’t be the cost of its resolution. There’s already evidence that the cost of the bailout will be significantly less, as AIG has begun selling its profitable divisions to pay back the government. It’s likely that the cost will be below the $150 billion threshold. It’s less likely, however, that it will be below the $50 billion threshold. Add in a few other big resolutions, like those of GM, Chrysler, GMAC, etc. and that $50 billion is looking even less adequate.

So why is Dodd’s fund so small? I’m not sure. But I’d wager that the banking lobby would want as small an amount as possible — remember it’s mostly big banks who will end up paying for that fund. And banks would probably be a lot happier only having to pay $50 billion instead of $150 billion. Not that the banking lobby necessarily swayed Dodd, I’m just saying…

Both resolution authorities are a good start. I’d give a slight edge to the House plan, however, because I think its resolution fund is more sufficient. I also don’t really see the point of the bankruptcy judge panel.

The Federal Reserve’s Federal Open Market Committee (FOMC) met today to discuss monetary policy. The statement it issued was almost identical to what it said in January. It sees the economy continuing to improve, though slowly, with inflation likely subdued for some time. It also indicated that the winding down of its emergency facilities would continue, as scheduled. Finally, it reiterated that it intended to keep the federal funds rate very low for an “extended period of time.”

That final aspect of the statement has become the most controversial in recent months. One member of the FOMC, Kansas City Fed President Thomas Hoenig dissented in January that the language used should be a little more conservative in terms of setting the market’s fed funds rate expectation. The minutes of the January meeting explained that he have preferred if the committee stated that the rate would be low “for some time” instead of for an “extended period of time.” That way the FOMC would have more flexibility to act swiftly to raise rates, if necessary, without upsetting the market.

While the difference is subtle, whenever the Fed does make this change in language, you can be sure that the market will react. Even though the broader FOMC resisted making the change in language this time around, I wouldn’t be surprised if you see it in April or May. The committee can’t keep rates near zero forever, so they’re going to have to begin getting the market used to the idea that rates will increase eventually.

Other than that, the March statement was almost a copy-and-paste of January’s statement. The only even vaguely significant difference in language is that concerning the possibility that the FOMC would extend or increase its residential mortgage security purchase programs. In January, the committee made clear that it probably wouldn’t do so, but the March statement puts that hope pretty much to rest for good. In January, it said:

The Committee will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets.

This changed in March to:

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

That slight movement towards more general language probably means that it’s put the residential mortgage security purchase tools back in their box, locked it and put it back on the shelf. Naturally, it’s possible that they revisit such policies if the economy or residential mortgage market suddenly deteriorates further, but it’s pretty clear that the FOMC doesn’t see that happening at this time.

I just listened to a conference call conducted by the U.S. Chamber of Commerce regarding Senator Dodd’s new financial reform proposal (.pdf). While the group addressed the bill at large, the vast majority of its discussion focused on objections to the proposed Bureau of Consumer Financial Protection. Several of these criticisms stood out as quite compelling.

The two parties doing most of the speaking were David Hirschmann, the President and CEO of the Chamber’s Center for Capital Markets, and Andrew J. Pincus, a Partner at Mayer Brown LLP who works as the Chamber’s counsel. Since it’s difficult on these calls to hear who it is talking, I’ll just refer to the Chamber broadly when characterizing their comments.

The Director’s Power

One difference I noted between the House’s version and Dodd’s Bureau was how the power was focused. The House would establish a commission of five individuals within the new Agency, in addition to its director. Individuals on that commission would have staggered Presidential appointments. Dodd’s version would just have a director, who has pretty much complete autonomy to hire whoever he or she chooses.

The Chamber complains that Dodd’s Bureau provides an awful lot of power to that one director. I think this is a valid concern. The House version is much more careful to create a robust, more diverse commission within its Agency to regulate. Dodd’s director would also have sole discretion to spend the Bureau’s lofty budget, which the Chamber estimated to start at around $430 million — more than twice the Federal Trade Commission’s budget for consumer protection. Dodd’s director could also only be fired for cause.

It’s unclear to me why Dodd would want to assign so much power to the director. The Bureau would be a powerful regulator, and he would put all of its power in the hands of one individual.

Vague Standard of Abusive Practices

The Chamber also doesn’t like the vagueness that Dodd’s proposal uses in saying that the Bureau could enforce actions against firms who engage in “abusive” practices. The group wonders what “abusive” means. Vague laws are a bad practice, because without clear rules to follow firms can’t function effectively.

The following example was offered on the call to explain why vagueness is a problem here: Imagine if we had a law that it was illegal to speed when you’re driving, but we didn’t define exactly what speeding meant. Yet, the law also empowers federal and state speeding enforcers to make sure people don’t speed. All sorts of different standards of speeding could be established.

I think some expanded detail of what is meant by “abusive” is a reasonable request. At the same time, however, the Bureau could eventually determine that detail once it sets up shop. As long as that determination is made clear at that time — and state regulators hold the same standard — then I think this criticism would be answered. But Dodd’s current proposal doesn’t make clear that defining abusive practices will necessary take this path.

Duplication

The Chamber also complains that there remain too many groups with consumer protection enforcement power. In addition to the Bureau, the Federal Trade Commission and State Attorney Generals would still be empowered to bring action against firms that engage in abusive practices. I think this is also a pretty legitimate complaint. If you’re going to bother creating an agency that hopes to streamline consumer protection, shouldn’t you also consolidate enforcement authority and eliminate overlap? This, again, boils down to firms potentially having to worry about different sets of rules that different agents of enforcement might care about.

Another Note

One last note of interest. The Chamber didn’t seem at all impressed that Dodd’s Bureau would be contained in the Fed, rather than a stand-alone agency. As I mentioned in my earlier post, the independence of the Bureau intended by Dodd would result in it not really mattering where the Bureau is located. I, too, am a little unclear why Republicans fought for having the Bureau located in the Fed. I don’t see that as any kind of game-changing characteristic in the eyes of pro-business critics of a new consumer financial protection watchdog, so long as its independence is provided for.

On Dodd’s new bill, also see:

Initial Thoughts on Dodd’s New Financial Reform Proposal
Dodd’s Bureau of Consumer Financial Protection
Comparing Financial Stability Oversight Councils

(Nav Image Credit: Wikimedia Commons)

Another extremely prominent part of Senate Banking Committee Chairman Christopher Dodd’s (D-CT) new financial reform proposal (.pdf) is the Financial Stability Oversight Council he hopes to establish. In many ways, it resembles the House bill’s (.pdf) “Financial Services Oversight Council.” I thought it might be useful to see compare the two councils.

Both councils would serve essentially the same purpose. Each would be a group consisting of the heads of various regulators who seek to prevent systemic risks from destabilizing the financial system. A council would address the big picture issues and makes decisions regarding how to handle potential risks. But even though the two conceptions of what a council should do are mostly the same, there are some important differences in Dodd’s version.

Council Members

First, who sits on each version of the council? Mostly the same regulators. The overlap includes the Treasury Secretary (who sits at its head), Federal Reserve Chair, Comptroller of Currency, Consumer Financial Protection Agency/Bureau Director, Securities and Exchange Commission Chair, Federal Deposit Insurance Corporation Chair, Commodities Futures Trading Commission Chair and Federal Housing Finance Agency Director.

Then the differences begin. To round out voting members (after those eight just listed) Dodd would add an independent insurance industry expert appointed by the President. He would then have a nonvoting member — the Director of a newly established Office of Financial Research (explained below).

The House version would have neither of those parties on the council. It would add to its voting members (after the initial 8) the National Credit Union Administration Chair and the Office of Thrift Supervision Director (until abolished under the legislation). Its nonvoting members would include the Federal Insurance Office Director (an office which the House legislation would establish), a rotating state insurance commissioner, a rotating state banking supervisor and a rotating state securities commissioner.

The most notable difference is that Dodd’s version gives an insurance industry expert some voting power, while the House version does not. The House bill also provides some voice to state banking. But since Dodd’s version consolidates state banking regulation to the FDIC and OCC, it makes sense that he left other state banking officials out.

Voting

In both cases, the council votes on big decisions. But Dodd’s version requires a two-thirds majority, while the House version appears to just require a simple majority. This would particularly affect two important decisions of the council: which non-bank firms would be subject to systemic risk regulation and which firms should be broken up.

I’m a little bit mixed on my opinion of whether this council should have an easier or more difficult time getting a majority vote. I think it might depend on what they’re voting on. For the firms that need prudential regulation, a simple majority is probably sufficient. I think, in that case, it’s best to err on the side of more closely watching additional bigger firms, instead of fewer.

In terms of break-up, however, I think a simple majority might be a little too easy. Rep. Paul E. Kanjorski (D-PA) originally offered the amendment that led to this authority being included in the House’s bill. Dodd’s November proposal contained more explicit break-up authority, but his revised version hones how this would work. I think, here, a two-thirds vote is prudent. It’s an important and major decision to break up a firm. That shouldn’t be taken lightly, so I worry a simple majority is too weak a standard.

Office of Financial Research

One major difference between the two reform proposals is that Dodd seeks to create an Office of Financial Research which would be responsible for collecting data on behalf of the council. It would be located within the Treasury. The House bill provides that duty to the Federal Reserve.

I’m a little bit unclear why this is necessary, unless Dodd doesn’t believe the Fed should be trusted with this responsibility. I guess you could argue that having an office charged with this specific task could result in better data, but I’m not entirely convinced. I don’t know that the problem in systemic risk oversight is a lack of data as much as a failure to harmonize that among regulators. I think the council would already do that through its mere existence and discussions. I don’t think a specific office would harm this end, but I don’t know that it really does that much to better achieve it either.

Hotel California Provision 

Finally, there’s the so-called “Hotel California” provision. This would require any firm who declared bank holding company status to get bailout funds to retain that status and potentially be subject to systemic risk regulation. Dodd indicated that this was the brainchild of Senator Bob Corker (R-TN). It got its nick-name through the lyric from the Eagle’s song which says, “You can check out, but you can never leave.”

The fear here is that some firms, like investment banks Goldman Sachs and Morgan Stanley, that were quick to claim bank holding company status to obtain financial assistance during the crisis, may want to shed that status if they would be subjected to additional regulation from Congress’ bill. This would prevent that possibility. Goldman’s CFO, in particular, has said that the firm has no intention of dropping its bank holding company status, but it’s pretty easy to see where Corker is coming from on this one.

Overall, each version has some good ideas to offer. The hope, I think, would be that the best of both proposals ends up in the final version when the two Houses confer to decide what the final bill would look like. That is, of course, assuming that Dodd manages to get his proposal out of the Senate.

As I begin to trudge through Senate Banking Committee Chairman Christopher Dodd’s (D-CT) new financial reform proposal, I thought a good first stop for additional detail might be the much-debated consumer financial protection function. I mentioned earlier that they’re actually pretty similar, despite the fact that Dodd’s version is housed in the Federal Reserve. I still think that’s true, but there are a few differences worth noting.

One easy way to differentiate the House version from what Dodd proposes is to just use the terminology provided. The House wants a stand-alone “Consumer Financial Protection Agency” (the “Agency”), while Dodd wants a “Bureau of Consumer Financial Protection” (the “Bureau”).

I don’t intend to address all the differences and similarities between these two proposals, because they’re pretty complex and, well, long. My general sense is that the House version is a bit more robust than Dodd’s version. One aspect of the two plans that make this kind of obvious is the fact that the House’s proposal is 404 pages long, while the Senate’s is just 306 pages. Of course, this is also stressed by the fact that the Agency would be truly independent while the Bureau would be basically independent, but housed in the Fed.

Yet it looks like Dodd really wants his Bureau to be the final word when it comes to consumer protection. In many instances, he specifically says that the Bureau will have the “exclusive” authority for this and that, while on the same points, the Agency would just have “primary” authority. That could just be semantics, but there’s a sense that Dodd’s Bureau would have a touch more power than the House’s Agency.

The Agency would also create a Consumer Financial Protection Oversight Board made up by a council of important regulators (think Fed chair, FDIC chair, etc.) who would advise the director of the agency on what the market does or does not need in terms of consumer financial protection. The Bureau has no such provision, though the proposal does say that it would work broadly with regulators to ensure that its rules are sensible.

The House’s bill is also a little more specific about the most important employees of the Agency. It would have a commission of five individuals (all appointed by the President and confirmed by the Senate) in addition to the director who would prescribe the regulations. No such commission is laid out for the Bureau, and its employees would all be hired by its head (who is appointed by the President, like the Bureau’s director).

As far as how the two bodies would examine and enforce, they differ mostly in the details. For example, the House version would exempt auto dealers; Dodd’s proposal would not.

Also interesting is that Dodd’s version would create an “Office of Financial Literacy.” While the House version speaks to the importance of financial literacy, it doesn’t go as far as to actually create a new body to specialize in it.

As I mentioned in my earlier post, the broad strokes of these two proposed consumer financial watchdogs are essentially the same. Of course, the details matter with these things, so I’ll be curious to see how policy wonks pull the Senate’s version apart in the days to come. But at this point, it doesn’t look like the House or the Obama administration would have any major objections to what Dodd has proposed. Though a distinctive flavor, it still creates a new regulator dedicated to consumer financial protection with sufficient independence and autonomy, and that’s the goal.

Senator Christopher Dodd (D-CT) unleashed his new 1,336-page financial regulation proposal (.pdf). I listened to his press conference, read the summary (.pdf) and just begun going through the bill itself. My first reaction: it sure does look an awful lot like the House bill (.pdf), passed in December.

Dodd’s original draft, revealed in November was far more aggressive compared to what he proposes this week. And it was more ambitious than the House bill as well. The new bill, however, may be even weaker than the House’s version. Let’s go through a few highlights:

Consumer Financial Protection Agency (CFPA)

This is a good place to start because Dodd’s version a little different from what’s in the House bill — but even it isn’t that different. As the rumors indicated, the Federal Reserve will house the CFPA. But other than that technicality, it’s almost identical to what the House intended from what I’ve read so far (which, admittedly, is incomplete).

Dodd’s CFPA is approximately as independent as the House’s version. In both cases, the president would nominate the head of the CFPA, confirmed by the Senate. In both versions the Federal Reserve System would pony up the money to fund the CFPA, though the specific amounts of funding differ a little. In each proposal, the CFPA will only have authority over banks and credit unions with assets over $10 billion. I need to check to see what specific differences exist, but both appear to have various exclusions for certain types of finance companies.

Volcker Rule

Does the so called Volcker rule proprietary trading ban make it into Dodd’s proposal? Only insofar as it did into the House’s proposal. You may recall that was passed way back in December, before the president even sent the Volcker proposal to Congress. But the House version did include a provision which would ban prop trading if a study determines that doing so would be a prudent step towards stronger systemic risk protection. The new Senate proposal contains the same such provision.

Both versions also contain some credit concentration limit language, which is the second part of the Volcker rule. I’ll look at this more closely as I dig in.

Systemic Risk Council, Fed as Regulator

Dodd’s original proposal would have created a new systemic risk regulator. He gave that up. Instead, he would mostly mimic the House’s proposal here as well. Like the House he intends to establish a systemic risk council, led by the Treasury Secretary. He would also give the lion’s share of systemic risk enforcement power to the Federal Reserve.

Resolution Authority

There were some reports, during the negotiation process between Dodd and Republicans that the new resolution authority’s power could be in jeopardy. In fact, it looks like Dodd, again, went essentially with what the House passed. A council of regulators would decide whether to resolve a firm. That resolution process would be handled by the FDIC.

Securitization

Another area where Dodd was more aggressive in his November proposal was with securitization. He wanted issuers and securitizers to retain 10% of the risk. The House, however, thought 5% was enough. Now, Dodd agrees.

Say on Pay

Like the House proposal, the Senate version would give shareholders a non-binding vote on executive compensation.

Derivatives

One area where the two proposals may disagree a bit is derivatives. But that’s mostly because Dodd’s version hasn’t finalized the derivatives regulation language yet. In his summary Dodd actually states the following about his derivatives section:

Today’s bill largely reflects the November draft. Senators Jack Reed (D-RI) and Judd Gregg (R-NH) are working on a substitute amendment to this title that may be offered at full committee.

In other words, I wouldn’t even bother analyzing this portion of the bill yet, because it’s to-be-determined. Last week, I mentioned that Senator Corker (R-TN) said that Reed and Gregg were still several weeks away from finalizing their derivatives regulation proposal. I expect that means that the amendment will be offered on the Senate floor, since Dodd hopes to get this out of committee in just a week’s time.

Overall Thoughts

Frankly, I’m a little surprised how closely Dodd’s bill follows the House’s version. But if it passes, that should make conference a breeze! But that Senate vote won’t be easy. Even after it gets out of committee, Dodd needs to sway at least one Republican to vote for the bill, which might not be easy, given that Senate Republicans view his effort as rushed after he abruptly ended bipartisan compromise. Indeed, it could even be difficult to get all Democrats on board. The House version only passed by five votes, even though the House had a 40-seat majority. If the same probability holds in the Senate, then that would equate to eight Democratic Senators voting against. Clearly, that 51 won’t get the bill past the 60-vote hurdle Dodd needs for a floor vote. He has a difficult road ahead.

If you want to read my writings on the Dodd original bill from November, they can all be found here:

Dodd’s New Financial Regulation Bill
The Proposed Agency For Financial Stability
The Senate Plan’s Resolution Authority
A Few Notes On The Proposed Super Bank Regulator
Senate Slams Securitization
The Senate’s Disappointing Rating Agency Reform Proposal

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Ever since Wall Street pay became a hot topic of conversation for Americans everywhere, there has been a debate of how to make incentive pay work best. I’ve even offered my own thoughts on the subject. As it becomes increasingly difficult to devise a way to best motive employees based on their pay structure, the Wall Street Journal reports that a new strategy is gaining popularity: semiannual bonuses. I’m rather skeptical.

So what’s the point of semiannual bonuses anyway? To make employees happy by getting them their bonuses more quickly. According to the article:

In addition to boosting morale at a time of salary freezes and pay cuts, semiannual bonuses help companies retain key players by dangling the carrot of two targets a year, while giving boards a chance to raise those goals quickly if economic conditions improve.

Really? I wasn’t aware companies needed tactics to retain employees at a time when U.S. unemployment is at around 10% — or that firms were flush with cash used to lure new talent. I’m sure that getting bonuses more quickly will help morale, but it’s a rare breed of employee who a company really needs to worry about retaining at a time when there is already something like six unemployed Americans for every job opening. Besides, if an employee only has to wait for six months, instead of a year, to get her next bonus, then she could leave even sooner.

Incentive compensation is a good idea, in theory. There are few ways to better encourage your employees to work their hardest other than making their pay directly dependent on their product. But in doing so, it’s important to ensure that the profit they earn the firm is real, and not temporary or just short-term. Otherwise, the incentive pay scheme can become counterproductive.

And that’s the fear I would have with more frequent bonuses. To me, that would imply that the time frame being evaluated would be even shorter and the performance more closely aligned to short-term profits. Now you don’t even need to care about what happens a year out — just in the next six months.

Obama administration pay czar Kenneth Feinberg picks up on this criticism in the Journal article:

Rewarding managers for brief bursts of performance strikes certain compensation critics as a bad idea. “Earning a bonus every six months is an awful short-term vindication of worth,” says Kenneth Feinberg, the U.S. pay czar. People will “cut corners to get the quick fix,” he warns.

To be fair, the article doesn’t cite any financial firms championing semiannual bonuses — yet. It says that the trend is mainly being seen in retail and tech industries. It might be less likely that management’s actions could result in short-term profit and long term losses in those industries than in finance, but it certainly isn’t impossible.

And there’s also little doubt that banks could raise their eyebrows at this idea and begin to consider it. One nice benefit would be less headline risk for big bonuses. If a bank used to have 100 employees get a $1 million bonus, it sure sounds a lot better to say that 100 employees got bonuses of $500,000 — and then say the same thing six months later. Even though the result is the same, semiannual bonuses could obscure how much people are really getting paid to avoid the bad publicity associated with big numbers.

Let’s hope that’s not a motivating factor for any firms considering a semiannual bonus structure. I’m not sure I really see the point, other than it making personal budgetary planning a little bit easier for employees. Ultimately, semi-annual bonuses could be okay — so long as some additional rules are in place. If an employee’s performance could go bad in the future, then the pay should be deferred to guard against potential loss. For that reason, company stock that doesn’t vest until some later date is generally ideal.

At this point, it’s looking like Google’s pull out of China will is imminent. The Financial Times reports this outcome is “99.9 per cent” certain, according to a source close to the talks between the search company and Asian superpower. Combine that with other news that journalists are camping outside of Google’s China headquarters due to a company representative saying “something will happen soon,” and it’s pretty clear that we should hear google.cn’s fate very shortly. So the big question is: will Google’s decision to depart China inspire other companies to stop putting up with the nation’s censorship policies?

Some reports indicate that China has already begun putting pressure on other companies to distance themselves from Google. The New York Times reports that the nation has is warning some of the search provider’s major partners to sever ties:

The Chinese government information authorities warned some of Google’s biggest Web partners on Friday that they should prepare backup plans in case Google ceases censoring the results of searches on its local Chinese-language search engine, said the expert, who did not want to be identified for fear of retaliation by the government.

Separately, consultants are telling Chinese advertisers to start thinking about abandoning Google for other search sites. Bloomberg reports:

“When we talk to clients, we have been pushing them in the direction of Baidu more,” said Vincent Kobler, managing director at EmporioAsia Leo Burnett in Shanghai, which buys advertising on behalf of customers. “The Chinese government has taken a firm stance, and Google, they have their own principles, and are going to shut down.”

I’ll be curious to see if these partners and advertisers will be quick to abandon Google, or if they’ll stick by Google until the ugly end. It could reveal a little about whether other companies will respect Google’s decision so much that they also consider disputing China’s policies. But given the nation’s strong stance, I’m pretty unconvinced they will.

China has shown that it simply won’t tolerate even a company like Google trying to assert itself. So I’d be pretty surprised if other firms try to press their luck and risk losing out on the enormous revenue potential the nation could provide for their principles. And on that note, it’s impressive that Google wasn’t bluffing. Assuming that the company does pull out, Chinese users will have to go to the worldwide google.com destination to use its search, which will still filter out whatever Chinese officials deem appropriate.

Are you a film buff who can’t seem to find a way to put your excessive knowledge of movies to good use? Do you think: “Gosh, if I knew as much about stocks as I do about Hollywood, I’d be rich!”? Well, your time may have finally come. Investment firm Cantor Fitzgerald will be starting an online service in April that will allow users to bet on the success (or failure) of movies.

The New York Times reported on Thursday:

Cantor Futures Exchange, a subsidiary of Cantor Fitzgerald, expects to open an online futures market next month that will allow studios, institutions and moviegoers to place bets on the box-office revenue of Hollywood’s biggest releases. Last week, the company learned from regulators that customers could start putting money into their accounts on March 15.

Here’s how it would work:

In the real market, contracts on the Cantor exchange will trade at $1 for every $1 million a movie is expected to bring in — a figure determined by traders — at the domestic box office during its first few weeks in theaters. So if “Robin Hood” is expected to bring in $100 million in its opening weeks, a single contract could be bought for $100 by a trader who thinks Russell Crowe’s role in the movie will drive sales far above expectations. If that trader guesses right, and the movie sells $150 million in tickets, the trader makes $50.

Anyone could use the service — not only the film industry. Though, unlike NYU film school students, studios would have an actual legitimate business reason for using the exchange: they can hedge their investments in movies. So even though this idea might seem sort of silly to the serious stock investor, it’s no more ridiculous than Exxon using oil futures to hedge energy prices.

And you don’t only have to go long on a film: you can also short movies that you think will flop. For example, if they ever decide to put Dane Cook in a movie again, you can bet that it’ll be a stinker. I know I would.

This does raise an interesting question about insider trading. For example, if Brad Pitt just made a movie that he now realizes was a big mistake, because it’s absolutely horrendous, can he bet against it? He clearly has nonpublic information. What if he tells his friend George Clooney how bad it is, and Clooney shorts the film? Or what if I was lucky enough to see an advanced screening to come to the same conclusion? That’s a little bit like hearing a company’s earnings before release. I’d hope the SEC has given these considerations some thought before approving the new exchange.

Betting on films could happen before in just-for-fun exchanges and probably for real money in Vegas. But I’ll be curious to see how a real exchange does — and who uses it more. Even though it would only have legitimate appeal to studios, if my movie-loving friends’ passion for film is any indication, the exchange could be wildly popular.

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The Treasury released its monthly report (.pdf) today on its Home Affordable Modification Program (HAMP) through February. There’s not a lot of surprising or shocking news to report. It continues to see moderate improvement in servicers making modifications permanent, adding another 52,905 in February. That brings the total active permanent modifications to 116,297, still a ways off from their target of 3-4 million. Perhaps most notable is that the new trial modifications appear to be slowing.

Here’s a graph showing how many new trial modifications were started each month since the program has been going:

I added in permanent modifications just for fun. But if you look at the red line, you can clearly see that, since October, new trials have steadily declined. February marks the lowest number since last May.

Also interesting to note is that, of those trial modifications that have run their course, 116,297 are permanent and 61,481 have failed. That’s a roughly 65%/35% success/failure rate. Not bad, but if that ratio holds going forward, then the remaining 830,438 active trials would only yield about 543,247 additional permanent modifications. There would potentially be more than that with additional trials started in the months to come. But as the chart above shows, those trials are slowing, so the numbers there will likely be limited. At this point it looks like reaching the one million mark will be challenging.

These monthly reports get harder and harder to read, because the Treasury keeps changing how what data they include and how they present it. I noted this last month, and the changes continue. Again, check out the evolution of the most important chart (now charts) in the report over the past several months:

From the December report:  

From the January report:

From the February report:

That final new stat on the latest chart is also rather amusingly presented. I wasn’t aware that the Treasury’s goal was merely to “offer” 3-4 million modifications. I thought when they said they wanted to “reach up to 3 to 4 million at-risk homeowners,” they meant to permanently modify their mortgages. Silly me. Under their criteria, if they never achieved a single permanent modification then their goal could still be satisfied, so long as enough failed trials were offered. But then, if this line instead said “percentage to goal of 3-4 million permanent modifications”, the result would read an embarrassing “4-6%” instead.

Another example of data presentation changing comes from their state delinquency maps. Check them out in January versus February:

At first glance you might think: Wow! Delinquencies really improved in February — look at all that yellow! But, in fact, they didn’t. If you look closer, you’ll see that the map’s legend changed.

Now look: I’m not implying that the Treasury is purposely trying to mislead people. They might have quite legitimate reasons for changing this report so drastically month-to-month. But from an analytical standpoint, it sure is frustrating. A little consistency would be appreciated.

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As I mentioned yesterday, Senate Banking Committee Chairman Christopher Dodd (D-CT) will release his revised financial reform proposal on Monday. Yesterday, he announced that he had abandoned bipartisan talks and will go forward without Republican support. While the move came out of nowhere, there’s been some reporting today on what’s going on here.

Several reports indicate that Dodd simply became impatient with Republicans. Although progress was being made, it was just taking too long for Dodd’s liking. How much longer would a bipartisan measure have taken? The Wall Street Journal’s Real Time Economics reports that Senator Bob Corker (R-TN) says that the stickiest issue was derivatives reform. That section, being written up by Jack Reed (D-RI) and Judd Gregg (R-NH), was still several weeks off. He sees derivatives regulation being handled with an upcoming amendment, as a result.

I’m trying to figure out: why is Dodd in such a hurry all of a sudden? The Senate Banking Committee has had over a year to get their financial reform bill passed. Yet, Dodd waited until November to release his version — more than a year after the climax of the financial crisis. Suddenly, he wants to forego taking the time to ensure he can get a bill that will actually pass by trying to push his version though committee?

For starters, the measly one week Dodd intends to allow for markup is a very short time. I don’t remember exactly how long the House’s markup took, but I’m pretty sure it was at least a month (for some odd reason the bill’s markup page disappeared from the Financial Services Committee web site). How much can you change a 1,200-page bill in one week? Very little. And that’s what Dodd must expect. He doesn’t need it to change much to get it through the committee — it consists of 13 Democrats and 10 Republicans. Majority votes are easy for his party.

The Senate floor will be an entirely different story. There, he needs 60 votes. It doesn’t appear that he will have them. His decision to move forward prematurely has already spurred his sole Republican ally Corker. Without Corker, I think it will be very, very difficult to get even a single Republican on board. And there’s no telling if all 59 Democrats will even go along. Like with health care reform, some may want Republican cover — especially in an election year.

Of course, it will partially depend on what this bill actually looks like. I certainly haven’t seen it, but if any of Dodd’s staff would like to leak me a copy this weekend, my e-mail can be found above! If the bill does incorporate enough Republican ideas, then it’s not impossible that he gets a GOP vote.

I really don’t understand the hurry on a broader level. It’s only March. Sure, there’s an April recess, but then he’s got all summer and most of fall. Some Senators’ focus may shift to midterm elections at that time, but several months still seems like plenty of time to get a bill though. One theory is that Dodd worries that it may get harder for Senate Democrats to vote for something controversial as the election year wears on. I can kind of see that, but I also don’t see how telling your constituents, “I voted to crackdown on the Wall Street banksters!” hurts your chances of election much in November.

From the Republican side, however, I can’t see much political capital gained by casting a single vote in favor of the reform bill at this time. Their Democrat opponents can claim that they’re just cozying up to Wall Street, but Republicans can just retort that they tried to work on a bipartisan bill, but just like with health care reform, ultimately Democrats decided to move forward without them. They could continue: “Dodd left us behind, after a tremendous effort on our part. And we had our own proposal too — we just worried that Democrat’s version would damage the already fragile U.S. economy.”

Whether that’s true or not is somewhat irrelevant in terms of political strategy: financial regulation is some of the most complicated stuff out there. The subtleties of this proposal versus that one will be mostly lost on the average American. So most voters already feeling alienated from Democrats may find this plausible. It just matters what Republicans think voters will believe.

All-in-all, I remain unconvinced that this was a smart move by Dodd. It could result in the 111th Congress not passing a financial reform bill at all — which I never thought was a real possibility until this week. Unless he takes special care to include significant Republican amendments to the bill when it’s being considered on the Senate floor, it may have an even more hopeless fate than health care reform. At least some version of that passed in the Senate. Financial reform may not even get that far.

A few consumer-focused economic data points came out today. Retail sales were up in February, sort of. But consumer confidence, which was already dreadful in February, may be getting even worse in March.

The Census Bureau reports (.pdf) that seasonally adjusted retail sales were up 0.3% in February. That doesn’t sound like much, but it’s a movement in the right direction, right? Well, yes. But the report also revised January’s number down $1.4 billion and December’s down by $270 million. That changes the picture from the orange line to the green line below:

So Sales were slightly worse in February than what we believed they were in January. But they are, indeed, heading in the right direction since December. Just not as quickly as we thought.

The news is worse for consumer sentiment. The Thomson Reuters/University of Michigan’s Surveys of Consumers was even lower in March than in February. Reuters reports:

The preliminary March reading for the surveys’ overall index on consumer sentiment was 72.5, down from 73.6 where it ended in February, and below the 73.6 forecast by analysts polled by Reuters.

The survey also indicated that Americans are losing confidence that the government will manage to do much to help the economy. They don’t believe the unemployment rate will change much this year.

Whether U.S. consumers will do more to stimulate the economy is still unclear through this data. Sales are improving a bit. But Americans’ belief that the recovery will be a slow one and that unemployment will remain high could turn out to be a self-fulfilling prophecy if it affects their spending. At best, today’s data supports the thesis that the recovery will likely be a slow one.

The Obama administration’s pick for the new vice chairperson of the Federal Reserve is said to be current San Francisco Fed President Janet Yellen, according to New York Times sources. Current vice chair Donald Kohn will retire in June. While I’m no expert on Yellen, from what I have read it makes sense that she would be the President’s choice.

What type of economist would the administration want? A liberal one. Probably a dove, so to ensure that the economic recovery is put ahead of inflation. The economist should also have some concentration of expertise to deal with a big problem that the U.S. is dealing with right now.

This description fits Yellen perfectly. She teaches at UC Berkeley, is a Keynesian and sat on President Clinton’s Council of Economic Advisors. And Paul Krugman likes the idea (liberal: check!). She is widely understood to be a dove. Her specialty? The Times explains:

She has published widely on a variety of macroeconomic topics and is an authority on unemployment.

And what’s the chief problem the U.S. economy is currently grappling with? That’s right: unemployment. There’s little doubt that the Obama administration would absolutely love to have someone with her kind of expertise as the Fed’s #2. In fact, some have complained that the Fed currently doesn’t care enough about unemployment. This pick directly addresses that criticism.

An added bonus: nominating a woman would bring some gender diversity to the Fed’s leadership. There’s little doubt that the Obama administration would like that too. There’s only one woman currently on the Board of Governors (Elizabeth Duke). I believe she would be only the second woman to serve as vice chair of the Fed.  

If offered would Yellen accept? No word on that, but vice chair of the Fed is a pretty hard position to turn down. The Times notes, however, that her salary would be less than half what she gets as San Francisco Fed president. But the influence she’ll wield as vice chairwoman would make up for that.

The only deep experience the Obama administration might like in a pick that I can’t find on the various bios I’ve read about Yellen is with financial regulation. Regulation is clearly a priority for the President, and since the Fed will likely get some more regulatory power in the months to come that knowledge could come in handy. But the administration does have a few more seats to fill at the Fed after they pick a vice chair. So the President could want a dove with unemployment expertise in a higher position and leave the regulatory prowess to the underlings.

Late yesterday I finally finished going through the TARP Congressional Oversight Committee’s new report (.pdf) on GMAC. It’s totally fascinating. Reading the report was like witnessing one of those horrible car accidents where you don’t want to look, but you can’t look away. It’s pretty clear that the Congressional Oversight Committee deeply disapproves of how the GMAC bailout was handled. I do too, so I was eager to read what they had to say. The report is informative, thorough, sensible and revealing.

But it’s also long. I can’t possibly sum up its entire 170 pages here, but I’ll do my best to provide some highlights. If you want the whole story, you can find all the gory details here (.pdf).

A Taxpayer’s Nightmare

Who should be concerned with the GMAC bailout? The U.S. taxpayer. This diagram explains why. You’re the little building with columns on the left:

(TruPS are “Trust Preferred Securities”; MCP is Mandatory Convertible Preferred Stock)

$17 billion might not seem like much (ya know, in context), but it amounts to a 56% ownership stake in the lender. According to the Office of Management and Budget, the taxpayer loss will be at least $6.3 billion. And that doesn’t take into account the $7.4 billion of FDIC guaranteed debt GMAC issued. Or the $7.8 billion credit line ($5 billion utilized) from the Fed’s Term Auction Facility. Or the $3.1 billion obtained through the Fed’s Term Asset-Backed Securities Loan Facility.

Its financial performance makes pretty clear why a big loss is likely:

As you can see, GMAC is doing horribly in pretty much every aspect of its business. Its Global Automotive Finance (GAF) is near breaking even, but its mortgage portfolio is just awful.

Why Was It Rescued?

So if GMAC was so far gone, then why was it rescued? Not because it was systemically important to the U.S. economy — according to the Treasury. The report says:

Treasury has never argued that GMAC itself was systemically important, although in 2008 some Treasury staff members believed that GMAC’s failure at that time – independent of its effects on the domestic automotive industry – could have thrown an already precarious financial system into further disarray during the depths of the financial crisis.

GMAC, however, was no Bank of America or Citigroup. It wasn’t that interconnected like a Goldman Sachs either. It wasn’t too big to fail: it was too important to GM to fail.

Why was the lender so vital to the automaker? Not so much because of its auto loans — GM’s customers probably could have got those elsewhere. It had more to do with a different type of loan GMAC and other captive auto lenders provide: dealer floorplan loans. The report explains:

Floorplan financing is a vital cog in the U.S. automotive market, as it allows dealers to offer cars to consumers. Floorplan financing is crucial for dealers because of the significant cost associated with financing their entire inventories via wholesale automobile purchases from the manufacturers. The average floorplan loan is $4.9 million, and collectively U.S. automobile dealers hold about $100 billion worth of inventory. Floorplan loans provide dealers with a revolving line of credit that allows dealers to maintain their inventories for sale to customers. This also helps manufacturers manage their inventory, facilitating the transfer of automobiles from the plant to the dealer. For the lender, the generally low profit margins in floorplan financing are balanced by an attractive credit profile and gateway business opportunities to other, potentially more lucrative product lines (e.g., consumer auto and dealer real estate lending).

Without floorplan loans, dealerships would fail. Without dealerships, GM couldn’t sell cars. Without selling cars, GM would fail. And as we know all too well, GM’s failure was not an option the federal government was willing to consider. So, really, the big picture shows that GMAC’s rescue was just a backdoor bailout of GM. In order to keep GM going, GMAC had to be saved. (I should note that GMAC also provided lending to Chrysler, so the other troubled U.S. automaker was part of that equation too.)

Could Bankruptcy Have Accomplished The Same Task?

So GM needed floorplan loans, but did GMAC necessarily have to be the provider of those loans? The oversight panel isn’t so sure. In the executive summary, they write:

Moreover, the Panel remains unconvinced that bankruptcy was not a viable option in 2008. In connection with the Chrysler and GM bankruptcies, Treasury might have been able to orchestrate a strategic bankruptcy for GMAC. This bankruptcy could have preserved GMAC’s automotive lending functions while winding down its other, less significant operations, dealing with the ongoing liabilities of the mortgage lending operations, and putting the company on sounder economic footing. The Panel is also concerned that Treasury has not given due consideration to the possibility of merging GMAC back into GM, a step which would restore GM’s financing operations to the model generally shared by other automotive manufacturers, thus strengthening GM and eliminating other money-losing operations.

Indeed, other options could have been seriously considered. The Treasury also could have empowered other lenders to provide floorplan financing to GM through guarantees. That wouldn’t have been as costly as you think. As the report rightly notes, “Floorplan financing is a low-risk business, particularly in comparison to consumer automotive.” I find it a little difficult to believe that other lenders wouldn’t have eagerly stepped in to provide already low-risk loans to GM if government guarantees were also in place. That would have been better for moral hazard and would not have forced taxpayers to cover GMAC’s enormous mortgage losses.

No Strategy

Another big concern of the oversight panel is that all this money was provided to GMAC without the firm first providing a clear strategy for recovery:

Treasury’s previous and current support is not underpinned by a mature business plan. Although GMAC and Treasury are working to produce a business plan, Treasury has already been supporting GMAC for over a year despite the plan’s absence. Given industry skepticism about GMAC’s path to profitability and the newness of the non-captive financing company model, it is critical that Treasury be given an opportunity to review concrete plans from GMAC as soon as possible.

The report mentions such plans had generally been required when the Treasury involves itself in other seemingly unconditional rescues, like those of GM and Chrysler. Why not GMAC? Indeed, a year later, its losses are still incredibly deep.

Stress Test Debacle

GMAC was one of the 19 bailout recipients to be subjected to the government stress tests. It failed. Along with 9 other banks, it was required to acquire capital by November. It was the only bank that failed to do so from the private market. That’s why it needed three bailouts, instead of just one. The Treasury felt compelled to provide GMAC with capital due to its participation in the stress tests. I don’t understand this why; neither does the oversight panel:

There was no specific contractual obligation to GMAC either as a result of the stress tests or as a result of previous injections of capital. At the time of the May 2009 investment, Treasury and GMAC executed the May Stock Purchase Agreement (SPA), which described the terms under which Treasury would provide capital to GMAC should it be unable to obtain additional capital from private sources. The term sheet appended as a schedule to the May SPA, however, only stated that Treasury stood ready to commit “up to $5.6 billion” in additional capital. Treasury clearly retained the legal flexibility to provide less than that amount – even zero – if circumstances warranted.

My analysis here is that the Treasury a) didn’t want to lose its initial $5 billion investment (the 1st bailout) and b) had an essentially unlimited commitment to do whatever it took to keep GM afloat. That’s what drove it to use the stress test as an excuse to provide GMAC with more money. So it just kept throwing good money into the furnace to keep GMAC going.

Treasury’s Lenience

This point gets into the weeds a little, but when the Treasury established the stress tests, it created the “Capital Assistance Program” (CAP) to recapitalize banks that failed, if it chose to do so. And the requirements of firms obtaining money from the CAP were different from the general the TARP requirements — the CAP was stricter. The report explains:

An institution that received funding under the CAP would be subject to several restrictions, including restrictions on executive compensation, increased disclosure requirements, and a requirement that the institution provide information regarding how it would use the CAP funds to increase lending.

Treasury’s rationale for disregarding the CAP? Since GMAC would have been the only firm to utilize the CAP, officials didn’t feel that it made sense to bother with the program just for GMAC’s funding. After all, it could just give GMAC more all-purpose TARP money. But wasn’t there a reason they created these stricter rules for the CAP? Receiving additional bailout funds was an exceptional situation that deserved exceptional treatment.

Other Concerns

WTO Worries

Another interesting worry from the report: trade implications. It says:

As discussed above, although GMAC is no longer a subsidiary of GM, the TARP funds provided to GMAC have been cited by at least one trading partner as giving rise to subsidy concerns under applicable WTO rules. Thus, another consequence of the GMAC/GM model, in which GM and GMAC (whether captive or otherwise) are almost inextricably entwined, is that funds provided to GMAC have also been viewed as a subsidy to GM itself. The Panel takes no position on whether funds provided to either GM or GMAC could in fact constitute a subsidy under WTO rules. However, one trading partner has included the aid to GMAC in that analysis, raising the question as to whether any trading partner could be successful in arguing that support for GMAC could constitute an actionable subsidy under World Trade Organization (WTO) rules.

China, in particular, was not amused.

CEO Salary

I’ve already commented on the GMAC CEO’s salary. It was pretty sizeable:

That deferred stock vests immediately, but its payout is deferred.

Conclusion

I don’t know that I can conclude any better than the final paragraph of the report:

Viewed from the vantage point of March 2010, or even December 2009, the decision to rescue GMAC is one of the more baffling decisions made under the TARP. A company that apparently posed no systemic risk to the financial system, that did not seem to be too big to fail, too interconnected to fail, or indeed, of any systemic significance, was assisted to the extent of a total of $17.2 billion of taxpayers’ money and became one of the five largest wards of state. The decision to save GMAC was not, however, a December 2009 decision. It was made in the turbulent early months of 2009 as an intrinsic part both of the rescue of GM and Chrysler and of the stress tests, and can only be understood in that context. Within that context, Treasury’s objectives become clearer, and within that context, it is also clear that there are lessons to be learned.

And let’s hope those lessons are learned. But for now, it looks like GMAC will continue to enjoy unconditional government support as long as GM does.

(Nav Bar Image Credit: faris/flickr)

The Federal Reserve released its quarterly Flow of Funds data (.pdf) through the fourth quarter of 2009 today. The report includes thousands of data points, so it’s pretty impossible to summarize the entire thing, but I did note several interesting observations to share. The predominate theme: in 2009 households shrunk their debt and saved more, while government borrowed a lot.

Debt Growth

The report tracks debt growth by sector. Household debt shrunk by 1.7% in 2009. That might not sound like much, but it’s the largest decline since the Federal Reserve began keeping track in 1946. In fact, it’s the only annual decline in household debt over that period — even in 2008 household debt increased slightly by 0.1%. Within household debt, mortgage debt declined by 1.6% while consumer credit declined by 4.3%.

Business debt also declined — by 1.8%. Interestingly, “Corporate” debt increased by 1.4%, which means mostly smaller businesses (partnerships and sole proprietorships, according to the Fed) shrank their debt more than larger corporations.

Yet, for the year overall, debt grew by 3.3%. How could that be? When it came to debt growth in 2009, government picked up the slack. State and local governments’ debt grew by 4.8%. Federal government debt grew by a whopping 22.7%. That’s easily the second largest increase since at least 1952 — just shy of 2008’s 24.2% growth in federal debt.

Borrowing

Percentages are useful, but what about the actual numbers of dollars in borrowing during 2009? Household borrowing declined by $237 billion, $165 billion of which was thanks to mortgage debt shrinking. Business borrowing declined by $200 billion, even though corporate borrowing increased by $101 billion. That implies that non-corporate borrowing must have declined by $301 billion.

Meanwhile, the government story was quite different. State and local governments borrowed a fresh $109 billion during the year. The federal government borrowed $1.4 trillion. That’s more than the $1.2 trillion borrowed in 2008, and nearly seven times the borrowing of 2007. That’s also a full trillion-plus more dollars of borrowing than in any year other than 2008.

Personal Savings

Another trend you might have expected is that personal saving ramped up in 2009. Americans saved $472 billion during the year. That’s the most we’ve seen on record — more than 2007 and 2008 combined.

If we weren’t in a deep recession, then I’d say the household trends of decreasing debt and increasing saving were objectively healthy. Yet, some economists wish that consumers would spend more, so to help stimulate the economy and reduce unemployment. And while the government borrowing would be utterly alarming at any other time since the Great Depression ended, most of it was done to cope with the financial crisis and deep recession. But those levels will need to come down dramatically once the unemployment level gets closer to normal. Let’s hope Americans’ debt and savings habits don’t revert back to their pre-2008 behavior then as well, however.