tag:blogger.com,1999:blog-582368152716771238.post1214150423910477937..comments2024-03-28T14:41:03.793-05:00Comments on The Grumpy Economist: Dodd-Frank ReformJohn H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.comBlogger24125tag:blogger.com,1999:blog-582368152716771238.post-57314352737672327542017-02-09T00:47:45.390-06:002017-02-09T00:47:45.390-06:00I cannot find those words.
I find "while taxp...I cannot find those words.<br />I find "while taxpayers have more protection against the next bailout".<br />My reading has it saying that there will be less likelihood of a bailout being needed.<br />--E5 Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-63761901595837278532017-02-08T22:55:54.153-06:002017-02-08T22:55:54.153-06:00Frank I think the promoters of the Choice act beli...Frank I think the promoters of the Choice act believe that the low-regulation, high-capital choice will be naturally attractive and preferable, with the act providing a gentle nudge to this alternative business strategy. But as a bank CEO I need some way to know if the new strategy option is actually viable.<br /><br />If I simply issue equity, and use it to buy government debt, then I can definitely meet the higher capital requirement. But if I do nothing with that government debt other than hold it and pay the convenience yield, and no big business opportunity opens up from the relaxed regulatory requirements, then I'm worse off with the high-capital strategy. This makes the bank a takeover target, and the high-capital strategy will be reversed by the new owners.<br /><br />But if I test the waters by simply announcing my intention to pursue the lightly-regulated option, and there is a large jump in stock price, then I don't need to issue much more equity (perhaps none at all). I will have generated the capital I need to meet the requirement, by stock appreciation, because investors see that some really valuable new opportunities are available now that I am free from important regulatory impediments.<br /><br />If the Choice act is passed, probably all banks will get some bump in share prices due to the value of the real option that they have been given. But there will still be some uncertainty regarding the intentions of management. It will be really interesting to watch how this uncertainty resolves, and that will tell us new things about capital regulation.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-16261651651887817522017-02-08T22:19:16.900-06:002017-02-08T22:19:16.900-06:00On banks: Another KISS solution.
No regs, but one...On banks: Another KISS solution.<br /><br />No regs, but one. Banks must provide privately purchased, privately offered deposit insurance for depositors. <br /><br />Now, maybe there is another reg here. The banks must purchase deposit insurance from "licensed insurers." <br /><br />Perhaps the US could generate a small pool of national deposit insurers, five or so large outfits, that are licensed. <br /><br />We could hope the deposit insurers charge according to risk, and those costs are passed on to depositors, and the market works out the rest. <br /><br />One last note: Ultimately, I still think you have to have a central bank available to back-up the deposit insurers, print money when necessary to bail out the insurers. My sense is that private financial institution can be built to weather storms, and maybe really big storms---but not the 50-to-100 year storms of an unanticipated type. <br /><br />Sooner or later the insurers will bust. See AIG for clues. <br /><br />But a good approach nonetheless. Benjamin Colehttps://www.blogger.com/profile/14001038338873263877noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-141148795320932022017-02-08T19:00:17.870-06:002017-02-08T19:00:17.870-06:00Anwer,
"And regarding government vs. bank de...Anwer,<br /><br />"And regarding government vs. bank debt: I don't think we can have less of both, because we need someone to produce our information-insensitive transactions media."<br /><br />Regarding the choice between less bank debt and less government debt, my choice would be less government debt for a number of reasons.<br /><br />"If the bank's share price jumps enough on that announcement to meet the higher capital requirement, I've won the gamble."<br /><br />I am still not understanding here. What have you won? After the share price jumps and your bank meets the capital requirement do you follow through with leaving the Dodd Frank regulatory regime - share price stays elevated - or do you renege - share price goes back to where it was? Are you assuming that this "one trick" can be repeated as you move your bank back and forth between regimes?<br /><br />FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-6464579535494106712017-02-08T18:47:04.782-06:002017-02-08T18:47:04.782-06:00David,
"Still, TBTF is policy. Eliminate tha...David,<br /><br />"Still, TBTF is policy. Eliminate that, and the problem is greatly reduced."<br /><br />Agreed. Then leverage limits become a survival technique instead of a government mandate.FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-13838406355206483112017-02-08T09:13:55.324-06:002017-02-08T09:13:55.324-06:00Frank, fair points. Any tax gets passed on to depo...Frank, fair points. Any tax gets passed on to depositors in the form of higher fees. As for long term debt in cap structure, why not consols? as n approaches infinity, the bond will pay a fixed coupon with no effective maturity date. Runs are exacerbated by mismatched maturities. Do consols ameliorate this? Nice topic for PHD candidates. Still, TBTF is policy. Eliminate that, and the problem is greatly reduced. David Seltzernoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-51355376715620721502017-02-08T05:33:57.049-06:002017-02-08T05:33:57.049-06:00Frank I was trying to take people along with me on...Frank I was trying to take people along with me on a thought experiment on how the Choice act might affect strategy choice at an actual bank. And regarding government vs. bank debt: I don't think we can have less of both, because we need someone to produce our information-insensitive transactions media. In the dilemma between inside and outside liquidity, Prof. Cochrane leans heavily towards outside (government-produced) money, with his narrow-banking proposals. And we can think of this as "equity money" because it is based on fiat and not redeemable. Indeed Prof. Cochrane has posted pricing equations to determine its real value.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-4480227299461862582017-02-07T18:07:48.642-06:002017-02-07T18:07:48.642-06:00I'm interested in the choice of words "pr...I'm interested in the choice of words "provide taxpayers protect in the next bailout"<br /><br />Shouldn't the goal to be to eliminate tax payer bailout. This statement implies that a ballot will always be necessary.Anonymoushttps://www.blogger.com/profile/11081609879652411420noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-67728679848716090842017-02-07T17:38:39.024-06:002017-02-07T17:38:39.024-06:00Anwer,
I have always felt that the whole notion o...Anwer,<br /><br />I have always felt that the whole notion of an "off ramp" from Dodd Frank is a silly way to go.<br /><br />Sooner or later we will get banking regulation that has "on ramps", "off ramps", "HOV lanes", "underpasses", "cloverleafs", and every other roadway metaphor that you can think of.<br /><br />And this will be simpler than Dodd Frank? Or Graam-Leach-Bliley? Or Glass-Steagal?<br /><br />FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-929115739718102452017-02-07T17:31:56.593-06:002017-02-07T17:31:56.593-06:00Anwer,
"But if I were a CEO I would respect ...Anwer,<br /><br />"But if I were a CEO I would respect the market reaction to my announcement and back down from any decision that doesn't serve shareholders well."<br /><br />Not only would you as CEO be notifying your shareholders, you would be notifying federal regulators of your intentions.<br /><br />I don't think the off ramp from Dodd Frank to higher equity / lower regulation is a two lane highway that you jump back and forth across as you please. <br /><br />Is this what you had in mind?<br /><br />2018 - JP Morgan CEO Anwer announces they are going to submit to the Ryan / Trump plan of higher equity requirements in exchange for less regulation.<br /><br />2019 - JP Morgan CEO Anwer announces they are going back to the Dodd Frank regulation requirements and buying back shares.<br /><br />2020 - JP Morgan CEO Anwer announces they are once again jumping on the Ryan / Trump higher equity requirement bandwagon.<br /><br />FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-57011576286512331272017-02-07T17:14:49.699-06:002017-02-07T17:14:49.699-06:00Anwer,
"..we don't see banks in the regu...Anwer,<br /><br />"..we don't see banks in the regulated system issuing lots of equity simply to buy government debt..."<br /><br />Which is why approaching the debt question from the banking side (instead of the fiscal side) is a silly way to do things.<br /><br />Banks are not going to sell equity to buy federal debt - they will simply refuse to bid at auction.<br /><br />And so it's up to the fiscal authority (government) to reduce it's own borrowing requirements, which in turn would reduce the banking industry's need for short term borrowing. Banks are maturity transformers at their heart. They borrow short term (including overnight) to lend long term.<br /><br />If you want banks to borrow less short term money, then it's up to the federal government to borrow less long term money. See several pieces that I have written that talk about the federal government selling equity securities.FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-47612452215381973232017-02-07T17:08:13.420-06:002017-02-07T17:08:13.420-06:00David,
"As for D/E ratios, instead, why not ...David,<br /><br />"As for D/E ratios, instead, why not a Pigouvian tax on excessive run prone short term debt?"<br /><br />Because long term debt eventually becomes short term debt as it reaches maturity - unless you actually think a bank can successfully market and sell perpetual bonds.<br /><br />Because a bank can issue even more short term debt to pay the taxes on it.<br />I am not convinced that a Pigouvian tax would actually limit the issuance of short term debt. Government receives Pigouvian taxes on short term debt and does what with it - bails out failing banking institutions?<br /><br />Excessive debt relative to what - all other debt, equity, assets, other?<br /><br />How short term is too short - is 1 year considered short term, how about 2 years or 5 years?<br /><br />How liquid must the debt be to be considered run prone?<br /><br />- Marketable?<br /><br />- Transferrable by inheritance, will, or deed for the owner of the debt (It's yours till you die)?<br /><br />- Transferrable by legal action (bankruptcy / divorce settlement / etc.) for the owner of the debt.FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-45071894604421018082017-02-07T12:32:42.575-06:002017-02-07T12:32:42.575-06:00Because accepting deposits is part of the banks...Because accepting deposits is part of the banks' business model, and taxing deposits reduces banks' profits and thus their capital as well. If the goal is to reduce the need for bailouts, a Pigouvian tax is counterproductive. At best, it draws the funding for future bailouts from bank depositors, and I don't see how that is much better than simply drawing from tax revenues.<br /><br />Banks have such low capital because we live in a part of the world where the demand for deposits has grown more quickly than the demand for loans. We can solve this problem by expanding the banking union to include countries that need bank loans more badly than they need large deposit balances. This is a difficult problem of international cooperation, but I don't see how it can be avoided.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-66763670913775978592017-02-07T10:57:02.615-06:002017-02-07T10:57:02.615-06:00B-S does apply to American style options as well a...B-S does apply to American style options as well as European style. In fact, early expiration for in the money calls and puts is the ex-dividend date. Go to any B-S online option calculator and you can solve for implied vol. The same applies to Binomial option pricing. Finally, establish a risk neutral conversion and you will see the affect(s)/effect(s) of all six variables in the model. David Seltzernoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-29768709147439691472017-02-07T10:42:57.902-06:002017-02-07T10:42:57.902-06:00The 2000 Dot com crash hurt shareholders. No run p...The 2000 Dot com crash hurt shareholders. No run prone short term debt. Debt bias in the tax code, M and M Theorem, induces more debt in capital structure. Of course the value of an asset is its discounted expected future earnings. As for D/E ratios,instead, why not a Pigouvian tax on excessive run prone short term debt? David Seltzernoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-25232326567482849562017-02-07T10:32:28.650-06:002017-02-07T10:32:28.650-06:00In what other specific cases should the fiduciary ...In what other specific cases should the fiduciary rule be eliminated? Or kept? Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-85631665408425624672017-02-07T02:28:29.967-06:002017-02-07T02:28:29.967-06:00Dr. Cochrane,
These are some very interesting ide...Dr. Cochrane,<br /><br />These are some very interesting ideas for financial regulatory reform and I agree with many of them, though some will require more study on my part. I particularly like the idea of using liquid asset market-based metrics for risk. However, I do have some questions. For example, with regard to your essay linked to above where you suggest using implied market volatility of equity to help calculate the risk of a bank run, how are you calculating implied volatility, given that Black-Scholes doesn't apply to American-style options?Antihttps://www.blogger.com/profile/17677035271760844211noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-45918710646359750892017-02-06T22:19:52.281-06:002017-02-06T22:19:52.281-06:00Hmmm Frank I wonder a bit about the asset pricing ...Hmmm Frank I wonder a bit about the asset pricing framework you are using for those predictions. But if I were a CEO I would respect the market reaction to my announcement and back down from any decision that doesn't serve shareholders well. And I'm sure that most bank CEOs think like that today, which is why we don't see banks in the regulated system issuing lots of equity simply to buy government debt (which would easily improve capital ratios).Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-77300833231532388592017-02-06T21:05:12.639-06:002017-02-06T21:05:12.639-06:00I agree with the journal. It will not get better a...I agree with the journal. It will not get better advice to people, will lead to more compliance costs, more litigation, and more CYA behavior. John H. Cochranehttps://www.blogger.com/profile/04842601651429471525noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-44684618661470616942017-02-06T18:00:59.452-06:002017-02-06T18:00:59.452-06:00Anwer,
Any announcement of pursuing the high capi...Anwer,<br /><br />Any announcement of pursuing the high capital, low regulation option would likely push bank bond prices up (bondholders are about to be paid) and share prices down (new issuance is coming).<br /><br />I think John addresses this, but when doing a leverage ratio for liabilities you need to use the market value of equity and the par value of debt.<br /><br />Otherwise, any attempt to hit a fixed ratio of debt to equity can be undone by market forces. You sell new shares to buy back debt, but that only pushes down the market price of existing shares and pushes up the price of existing debt - you get nowhere.FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-32303134350653664852017-02-06T17:29:12.240-06:002017-02-06T17:29:12.240-06:00John,
I guess my only comment is that banks shoul...John,<br /><br />I guess my only comment is that banks should not have to be told or offered anything to maintain a lower debt to equity ratio - it's just a smart long term business decision.<br /><br />And saying that swapping less regulation (carrot) for less debt relative to equity (stick) is a bit of a misnomer. It's more like saying banks are getting their healthy to eat carrots (more equity) and getting their sweet ice cream desert (less regulation) too.FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-84680815879665693792017-02-06T16:34:57.917-06:002017-02-06T16:34:57.917-06:00Grumpy,
Minor issues (or perhaps major issues dep...Grumpy,<br /><br />Minor issues (or perhaps major issues depending on how you look at it):<br /><br />1. What form should the equity shares that are required of banks take - voting / non-voting, restricted / unrestricted, dividend paying / dividend free?<br /><br />2. How do equity (stock) options affect the debt / equity ratio of a bank?<br />FRestlyhttps://www.blogger.com/profile/09440916887619001941noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-61830748365667887762017-02-06T15:47:19.800-06:002017-02-06T15:47:19.800-06:00The Choice act presents an interesting gamble. If ...The Choice act presents an interesting gamble. If I was running a bank, I would announce my intentions to pursue the high capital, low regulation option. If the bank's share price jumps enough on that announcement to meet the higher capital requirement, I've won the gamble. If not, I wouldn't try to raise money to meet the requirement, because I don't have any new plans on how I would use that new funding to make profitable investments. Instead I would just back down and say that the announced plans were a lapse in judgment, and we will carry on with business as usual.<br /><br />The government's use of the Choice act in this way helps gather more information and sheds more light on the issue of capital regulation than if they simply imposed a higher capital requirement on everyone. And it would be great for us to learn more about an issue that is not understood very well right now.Anwerhttps://www.blogger.com/profile/08277173974258559733noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-67245847722182110952017-02-06T13:42:53.525-06:002017-02-06T13:42:53.525-06:00The Wall Street Journal editorial today also touch...The Wall Street Journal editorial today also touches on the fiduciary rule regarding investment advisers, which Trump included in his executive order. I was wondering if you had any comment on that.Manfred the mamoothhttps://www.blogger.com/profile/07516724901598949627noreply@blogger.com