Saturday, April 30, 2016

Equity-financed banking

My dream of equity-financed banking may be coming true under our noses. In "the Uberization of banking" Andy Kessler at the WSJ reports on SoFi, a "fintech" company. The article is mostly about the human-interest story of its co-founder Mike Cagney. But the interspersed economics are interesting.

SoFi started by making student loans to Stanford MBAs, after figuring out that the default rate on such loans is basically zero. It
has since expanded to student loans more generally and added mortgages, personal loans and wealth management. Mr. Cagney says SoFi has done 150,000 loans totaling $10 billion and is currently at a $1 billion monthly loan-origination rate. 
Where does the money come from?
SoFi doesn’t take deposits, so it’s FDIC-free. ... Instead, SoFi raises money for its loans, most recently $1 billion from SoftBank and the hedge fund Third Point, in exchange for about a quarter of the company. SoFi uses this expanded balance sheet to make loans and then securitize many of them to sell them off to investors so it can make more loans
Just to bash the point home, consider what this means:
  • A "bank" (in the economic, not legal sense) can finance loans, raising money essentially all from equity and no conventional debt. And it can offer competitive borrowing rates -- the supposedly too-high "cost of equity" is illusory.
  • There is no necessary link between the business of taking and servicing deposits and that of making loans. Banks need not (try to) "transform" maturity or risk.
  • To the extent that the bank wants to boost up the risk and return of its equity, it can do so by securitizing loans rather than by borrowing. (Securitized loans are not leverage -- there is no promise of your money back when you want it. Investors bear any losses immediately and without recourse.)
  • Equity-financed banking can emerge without new regulations, or a big new Policy Initiative.  It's enough to have relief from old regulations ("FDIC-free").
  • Since it makes no fixed-value promises, this structure is essentially run free and can't cause or contribute to a financial crisis. 

Tuesday, April 26, 2016

Macro Musing Podcast

I did a podcast with David Beckworth, in his "macro musings" series, on the Fiscal Theory of the Price Level, blogging, and a few other things.

(you should see the link above, if not click here to return to the original).

You can also get the podcast at Sound Cloud, along with all the other ones he has done so far, or on itunes here.  For more information, see David's post on the podcast.

Monday, April 25, 2016

Blinder on Trade

Alan Blinder has an excellent op-ed in the WSJ on trade. It's hard to excerpt as every bit is good.
1. Most job losses are not due to international trade. Every month roughly five million new jobs are created in the U.S. and almost that many are destroyed, leaving a small net increment. International trade accounts for only a minor share of that staggering job churn. ...

2. Trade is more about efficiency—and hence wages—than about the number of jobs. You probably don’t sew your own clothes or grow your own food. Instead, you buy these things from others, using the wages you earn doing something you do better.  ...
3. Bilateral trade imbalances are inevitable and mostly uninteresting. Each month I run a trade deficit with Public Service Electric & Gas. They sell me gas and electricity; I sell them nothing....

4. Running an overall trade deficit does not make us “losers.”...

5. Trade agreements barely affect a nation’s trade balance. ..a nation’s overall trade balance is determined by its domestic decisions, not by trade deals... America’s chronic trade deficits stem from the dollar’s international role and from Americans’ decisions not to save much, not from trade deals. Trade deficits are not a major cause of either job losses or job gains. makes American workers more productive and, presumably, better paid.
One could say much more. Trade is not a "competition," for example. But,  having done this sort of thing, I'm sure lots of other good bits are on the cutting room floor.

Alan is more sympathetic to government "help" to trade losers, which I agree sounds nice if it were run by the benevolent and omniscient transfer payment planner, but I think works out poorly in practice when we look at the success or failure of actual trade adjustment programs. But that is a small nitpick.

Alan closes by wishing that Bernie Sanders and Donald Trump understood these simple facts a bit better. I think his list of politicians needing enlightenment could be a little longer. But he's courageous enough for speaking the kind of heretical truth that will come back to haunt him should he ever want a government job.

Saturday, April 23, 2016

Lessons Learned I

I spent last week traveling and giving talks. I always learn a lot from this. One insight I got:  Real interest rates are really important in making sense of fiscal policy and inflation.

Harald Uhlig got me thinking again about fiscal policy and inflation, in his skeptical comments on the fiscal theory discussion, available here. At left, two of his graphs, asking pointedly one of the standard questions about the fiscal theory: Ok, then, what about Japan? (And Europe and the US, too, in similar situations. If you don't see the graphs or equations, come to the original.) This question came up several times and I had the benefit of several creative seminar participants views.

The fiscal theory says
 \[ \frac{B_{t-1}}{P_t} = E_t \sum_{j=0}^{\infty} \frac{1}{R_{t,t+j}} s_{t+j} \]
 where \(B\) is nominal debt, \(P\) is the price level, \(R_{t,t+j}\) is the discount rate or real return on government bonds between \( t\) and \(t+j\) and \(s\) are real primary (excluding interest payments) government surpluses. Nominal debt \(B_{t-1}\) is exploding. Surpluses \(s_{t+j}\) are nonexistent -- all our governments are running eternal deficits, and forecasts for long-term fiscal policy are equally dire, with aging populations, slow growth, and exploding social welfare promises. So, asks Harald, where is the huge inflation?

I've sputtered on this one before. Of course the equation holds in any model; it's an identity with \(R\) equal to the real return on government debt; fiscal theory is about the mechanism rather than the equation itself. Sure, markets seem to have faith that rather than a grand global sovereign default via inflation, bondholders seem to have faith that eventually governments will wake up and do the right thing about primary surpluses \(s\). And so forth. But that's not very convincing.

This all leaves out the remaining letter: \(R\). We live in a time of extraordinarily low real interest rates. Lower real rates raise the real value surpluses s. So in the fiscal theory, other things the same, lower real rates are a deflationary force.

Tuesday, April 19, 2016

Chari and Kehoe on Bailouts

V. V. Chari and Pat Kehoe have a very nice article on bank reform, "A Proposal to Eliminate the Distortions Caused by Bailouts," backed up by a serious academic paper.

Their bottom line proposal is a limit on debt to equity ratios, rising with size. This is, I think, a close cousin to my view that a Pigouvian tax on debt could substitute for much of our regulation.

Banks pose a classic moral hazard problem. In a financial crisis, governments are tempted to bail out bank creditors. Knowing they will do so, bankers take too much risk and people lend to too risky banks. The riskier the bank, the stronger the governments' temptation to bail it out ex-post.

Chari and Pat write with a beautifully disciplined economic perspective: Don't argue about transfers, as rhetorically and politically effective as that might be, but identify the distortion and the resulting inefficiency. Who cares about bailouts? Well, taxpayers obviously. But economists shouldn't worry primarily about this as a transfer. The economic problem is the distortion that higher tax rates impose on the economy. Second, there is a subsidy distortion that bailed out firms and creditors expand at the expense of other, more profitable activities. Third there is a debt and size distortion. Since debt is bailed out but not equity, we get more debt, and the banks who can get bailouts become inefficiently large.

Saturday, April 16, 2016

A better living will

"US rejects 'living wills' of 5 banks," from FTWSJ puts this event in the larger story of Dodd Frank unraveling. Juicy quotes:
WSJ: “living wills,” ... are supposed to show in detail how these banking titans, in the event of failure, could be placed into bankruptcy without wrecking the financial system.

FT:...the shortcomings varied by bank but included flawed computer models; inadequate estimates of liquidity needs; questionable assumptions about the capital required to be wound up; and unacceptable judgments on when to enter banktruptcy.

FT: David Hirschmann of the US Chamber of Commerce, the biggest business lobby, said the living wills process was “broken”. “When you can’t comply no matter how much money you put into legitimately trying to comply, maybe it’s time to ask: did we get the test wrong?” he said.

WSJ: Six years after the law was passed, and eight years since the financial crisis, regulators given broad authority to remake American finance, with thousands of regulatory officials on their payroll, cannot figure out a system to allow financial giants to fail, even in theory. What are we paying these people for?
It seems like a good moment to revisit an idea buried deep in "Toward a run-free financial system."  How could we structure banks to fail transparently?

Wednesday, April 13, 2016


What does "systemically important" mean? How can an institution, per se, be "systemically important?"  The WSJ coverage of Judge Rosemary Collyer’s decision rescinding MetLife’s designation as a "systemically important financial institution:" gives an interesting clue to how our regulators' thinking is evolving on this issue:
The [Financial Stability Oversight] council argued — bromide alert — that “contagion can result when relatively modest direct, individual losses cause financial institutions with widely dispersed exposures to actively manage their balance sheets in a way that destabilizes markets.”
It's not a bromide. It is a revealing capsule of how the FSOC headed by Treasury thinks about this issue.

Sunday, April 10, 2016


On Friday I attended the NBER Asset Pricing meeting (program here) in Chicago, organized by Adrien Verdelhan and Debby Lucas. The papers were unusually interesting, even by the high standards of this meeting. Alas the NBER doesn't post slides so I don't have great visuals to show you.

Tuesday, April 5, 2016

Next Steps for FTPL

Last Friday April 1, Eric Leeper Tom Coleman and I organized a conference at the Becker-Friedman Institute,  "Next Steps for the Fiscal Theory of the Price Level." Follow the link for the whole agenda, slides, and papers.

The theoretical controversies are behind us. But how do we use the fiscal theory, to understand historical episodes, data, policy, and policy regimes? The idea of the conference was to get together and help each other to map out this the agenda. The day started with history, moved on to monetary policy, and then to international issues.

A common theme was various forms of price-related fiscal rules, fiscal analogues to the Taylor rule of monetary policy. In a simple form, suppose primary surpluses rise with the price level, as
\[ b_t = \sum_{j=0}^{\infty} \beta^j \left( s_{0,t+j} + s_1 (P_{t+j} - P^\ast) \right) \]
where \(b_t\) is the real value of debt, \(s_{0,t}\) is a sequence of primary surpluses budgeted to pay off that debt, \(P^\ast\) is a price-level target and \(P_t\) is the price level. \(b_t\) can be real or nominal debt \( b_{t}= B_{t-1}/P_t\), but I write it as real debt to emphasize the point: This equation too can determine price levels \(P_t\). If inflation rises, the government raises taxes or cuts spending to soak up extra money. If inflation declines, the government does the opposite, putting extra money and debt in the economy but in a way that does not trigger higher future surpluses, so it does push up prices.

(Note: this post has embedded figures and mathjax equations. If the last paragraph is garbled or you don't see graphs below, go here.)

That idea surfaced in many of the papers.