Wednesday, February 25, 2015

Run Free Video

This is a talk I gave at the joint Mercatus/Cato "After Dodd-Frank" conference last spring.  It's based on Toward a Run-Free Financial System.


  1. I remember seeing this awhile back. Very interesting paper/video. Of course if certain bloggers see this, the headline will probably be "John Cochrane thinks people should kick their dogs!"

  2. For the folks who are not aware of Cochrane's conflict of interests, Mercatus is a think-tank which is financed by the Koch brothers.

    1. Personal attacks are not arguments. You should explain why you think he is wrong instead of calling names.

    2. Lies are not arguments. I did not attack Professor Cochrane personally but pointed out a conflict of interest issue.

    3. What is this conflict of interest you keep referring to? Is there some way the Kochs would directly benefit financially if these policies were enacted?

      (On a side note, I always think it's funny when different anonymous commenters argue back and forth with each other.)

    4. "I did not attack Professor Cochrane personally but pointed out a conflict of interest issue"

      The last part of the sentence contradicts the first part.

      Unlike a judge, a speaker at a conference is totally free to have conflicts of interests. Even if he had been paid by a company called "repeal Dodd Frank" that would be perfectly fine. He is making a point.

    5. I question where this Koch-brothers issue is coming from. If wealthy donors are excluded from university funding, that leaves taxpayers, unless the anonymous critic will step into the breach. Besides, Cochrane is a giant. I really think the poster should retract and apologize.

    6. For shame. Cochrane is a giant - you would know this if you had the least clue about economics - and suggesting that donors should refrain from financing research institutions leaves exactly one other alternative, the state. Russian biology tried that with Lysenko, didn't work too well.

    7. For the record, this is simply my internet name, means "illegal wiretap" in French.

    8. Gotta love libertarians who equate publicly funded tertiary education with communism.

  3. Commenting positively about the Fed and suggesting banks should delever is not exactly on the top of the Koch agenda.

    What about banks incentive to keep leverage, or at least their control of their leverage, high? I don't think they mind control of their assets because, as you highlighted, they will figure out a way around it. It's harder for them to skirt if regulators just say 'you need more capital'. Also, more regulation makes them more entrenched. It's almost a good thing because creates a huge fixed cost for potential new competitors that established players can pay easily.

    One potential criticism, at a high level, if banks delever, wouldn't that decrease lending in the economy? Not saying its necessarily a bad thing but if financial institutions have a fixed amount of equity, to delever they will have to decrease liabilities which will in turn decrease their assets. Decreasing their assets is effectively shrinking amount of loans or lending in the economy. Could decreased lending have a negative influence on growth?

    1. Anonymous,

      "Not saying its necessarily a bad thing but if financial institutions have a fixed amount of equity, to delever they will have to decrease liabilities which will in turn decrease their assets."

      The value of a bank's equity is directly proportional to it's profitability. And so I don't know what you mean by a bank have a fixed amount of equity.

      If bank share holders are happy with a 5% return, if the bank can maintain personnel and maintenance on 2% of total lending, and the bank can lend money at 7%, then it's equity rises proportionately with the amount of loans that it makes as long as those loans are repaid in a timely fashion.

      The problem isn't deleveraging per se, it is that share holders will likely demand a higher rate of return than what short term lenders (like the central bank) will demand. And so a move to equity financed lending could EITHER lift long term interest rates or constrict credit.

    2. Thanks for the reply!

      I didn't mean the value of its equity, but the equity capital that it holds. So if a bank has 8 dollars of equity capital, and 92 dollars of debt, it will have 100 dollars worth of assets (aka loans).

      To de-risk banks, you could make them hold more equity vs debt. So say 8 dollars of equity (fixed) vs 80 dollars of debt, hence new loans outstanding = assets = 88 dollars. Credit has been constricted by ~12%.

      Generally I agree that a main lesson of the financial crisis is that banks need to be de-risked but this has to reduce the amount of credit in the economy. An example would be the corporate bond market where increased capital charges have impaired liquidity (seen in TRACE volumes) which could have a negative impact on that market's size. This is an important source of credit for corporations.

      Again, not suggesting it means we shouldn't de-risk banks but highlighting downside to doing it.

    3. Anonymous,

      "To de-risk banks, you could make them hold more equity vs debt."

      That can become problematic from a fiscal position. Most of those large banks are also bidders on federal debt auctions.

      So the federal government tells banks they must hold more equity assets and at the same time tells them to keep submitting bids on federal debt?

      If federal government wants banks to hold more equity assets and fewer debt assets, then federal government must sell more equity assets and fewer debt assets.

  4. I think the quid pro quo for being 'too big to fail' (protecting short term debt) should be something where equity is zeroed out and long term debt gets a haircut, if certain thresholds are passed (eg, leverage ratios below some critical threshold, the bank asks for extreme lender of last resort intervention), and the CEO, CFO, Chairman of the Board, all lose their jobs.

    Another solution: apply some sort of progressive asset tax to discourage banks becoming too large to politically let fail.

    Alas, all this regulation is making megabanks more efficient at dealing with these large fixed costs.


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