Of Inflation and Borrowing

Photo by Mar Cerdeira on Unsplash

Inflation is good for borrowers?  Really?  So some say.  The case goes like this:  when the borrower receives his loan for so much, he promises to pay it back with money that would buy so much, but after inflation the money he uses to repay the loan will buy less.  He repays with cheaper money.  The lender gets his money back, but it is worth less than it was when he lent it.  Hold that thought, because that is the weakness in the case.

This inflation “benefit” may work for borrowers who already have loans, with a fixed rate that they can handle.  For all others, however, inflation raises the costs of everything, including borrowing.  How long will lenders be willing to lose value in the loans they make?

Think of it this way.  Does inflation work for people who sell things?  Maybe for their current supply, but their new supply will cost them more, eating into what they earn and raising the cost of what they try to sell to the next potential buyer.  The same reality is true for people who “sell” money, which is what lenders do. 

As we buyers know, inflation does not work well for buyers.  We face ever higher prices for the same things.  The same is true for people who “buy” money, which is what borrowing is.

New borrowers will find interest rates, the price of borrowing, rising with inflation, too.  That could put borrowing out of reach for some, just as it does for buying a house, a car, or work tools.  Businesses that need to roll over their existing loans could find the new loan more expensive, maybe even too expensive.  People who want to refinance their mortgage may find the new rate makes that much less attractive.  Floating rates, like credit card rates, will rise, so the cost of the products charged to the card will not be the only higher costs that card users face.  In short, only some borrowers, a declining some, may benefit from inflation, and only for a time.

Today’s money rests on trust, whether we talk of paper money, coins, or financial accounts.  We sell our time, our goods, our services in exchange for money.  That money is a promise that we can use it in trade with someone else for something of comparable worth.  When we accept money in payment, we in turn are making a loan to someone who has already received our goods, or services, or time.  All we got was a promise, which we trust we can exchange with someone else.  Inflation undermines that trust.  We receive a $100 payment of money which because of inflation may soon buy only what $95 used to buy.

Even governments will face the challenge of higher costs.  Sure, they will be paying back existing government debt with devalued money, but their new borrowings will carry a higher price tag, as will the things that governments buy.  I was going to say, look in the mirror if you want to know who will pay that higher cost of government debt, but if you do, have your children looking with you.

Of More Money and Higher Prices

Photo by Shane on Unsplash

We have a new occupant of the Oval Office.  I did not hear his inaugural address, uncertain who would forget it more quickly, myself or its deliverer.  Inaugural addresses are highly forgettable literature, Lincoln’s first and second addresses (the second especially) the only ones that anyone can seem to remember, and worthy they are as exceptions to the genre.

I have been remembering the mountains of money that the government has been spending that it does not have, wondering where it is coming from even more than where it is going.  It is hard to find anyone who can tell you much with certainty about either.  The current attention is more focused on plans to spend yet another two trillion dollars that the government does not have on things that are not very clearly explained.  This would be on top of the most recent trillion dollars approved by Congress drawn from an empty well to be spent watering many a hidden garden.

I can understand the first round or two of multi-trillion dollar government expenditures.  Since government caused the collapse of a strongly growing economy by shutting down commerce and locking up the population, a strong argument can be made that paying these victims is not exactly a bailout as it is compensation.  To quote Will Rogers, if Stupidity got us into this mess, then why can’t it get us out? 

A serious problem seems to be that once you get into the game of paying people more to stay at home than they can earn on the job, how do you bring the game to an end.  The plan of the new Oval Office occupant seems to be to go into extra innings but continue serving spiritous refreshments well past the seventh inning.  How will the people get home safely once the game is over?

The classic formula for inflation is to have too much money chasing too few goods and services.  The kindling for a roaring inflation would appear to be carefully set. The Treasury and the Federal Reserve have been dramatically expanding the money supply, with the Federal Reserve supporting the market for the government’s electronic debt (not much money is printed on paper anymore) by purchasing gobs of Treasury securities from banks, paying the banks with electronic credits on their accounts held at the Federal Reserve, which the banks cannot find much to do with.  At the same time, many governors continue to issue orders to suppress the supply of goods and services.  As Elon Musk reportedly said last year, if you don’t make stuff, there is no stuff.

If this worry is well-founded, then why have we not yet seen any inflation, government spending surges and the Great Cessation having been Federal and State policies for nearly a year?  A very good question, the answer to which may be found in the savings rate.  While a lot of electronic money has been going into people’s bank accounts, people have been shy about spending it.  The personal savings rate jumped in 2020 from about 7% to nearly 35%.  Worried people hoard more than toilet paper.  And a lot of things that people might spend money on, such as travel, suddenly were not available.  I was surprised last year when our car insurance company sent us a rebate:  insurance losses were down because people were traveling less.

The roads are a bit more congested these days, and the economy is showing strong signs of trying to recover.  Even the savings rate is coming down, dropping to about 13% as 2020 approached its close.  More activity is good, but what is the Federal Reserve going to do if more people spend more savings faster than more goods and services are provided?  How will the Federal Reserve respond to another couple trillion dollars of deficit spending to stimulate an economy that is already on a recovery trajectory and families continue draining their savings?  They could allow interest rates to rise, to encourage people to keep some of their money in savings accounts that have paid less than a penny a year per dollar saved.  Recent Federal Reserve comments, though, declare that is not on the table.

In the late 1970s, when Jimmy Carter was president, economists invented the term “stagflation,” as inflation was high and the economy was in the doldrums.  Joe Biden was a relatively new Senator back then.  Maybe he will remember those days.  That economic pattern served no one well.

Of Good Banking and the New Year

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A year in retirement can give you perspective, particularly a year fraught with ample opportunity to do some good amidst challenge, risk, and danger of various flavors.  Such was the year behind us.  Does the year ahead offer any less?

Many such thoughts were brought to mind in a recent conversation with the chief financial officer of a community bank.  As you would guess, we discussed the outlook for banking.  I observed that the condition of the industry reminded me of the dot-com bust of 2000.  While the economy was in decline, hit a second time by the terrorist attacks of September 2001, the banking industry was thankfully in strong financial condition.  The dot-com bust had a securities market and Silicon Valley locus.

As in 2001, so also today, the banking industry is strongly capitalized, liquid with financial resources, well positioned to fund economic recovery.  Fortuitously, that position is matched by a host of potential customers, especially entrepreneurs eager to start up new businesses or expand ones that survived the government-led shutdowns.  Among those entrepreneurs are many people whose businesses closed not from bad business plans, but due to the Great Cessation of 2020.  That is to say, there are people who want to start new businesses who know how to run businesses, if government strictures will let them.

Their problem is one of resources exhausted by trying to keep their businesses floating as the tide went out.  As the tide is coming back in, there is a ready supply of people who would like to have a go with a new boat.  Good bankers have always been in the business of finding and funding good risks. 

Banks grow as their customers and communities grow.  Good banking fosters and facilitates the generation, management, preservation, and application of wealth. 

Bad banking bleeds wealth, which is why failed banks should be allowed to fail, to end the drain on the economy and to make room for the productive work of good banks, new and old.  Good bankers do their work by insightful weighing of opportunities and risks, tailoring terms and conditions to such opportunities and risks.  Bad banking either mistakes opportunities, or it miscalculates or ignores risk, or both.  Which, by the way, is why governments should stay out of the business of banking (other than as prudential supervisors), as the history of government shows an atrocious record of missing opportunities and miscalculating risk, sometimes for the short-term benefit of government’s associates.

The other day I saw a happy video from the chief executive officer of a southwestern bank.  Her timely message was of gratitude to the bank’s customers for constant communication and support.  In return, she offered a reaffirmed invitation apropos to serving in a way tailored to customers’ financial needs.  Reach out to the bank, including its CEO, 24-7 for financial service.  In conclusion, she pledged the bank to “connect you with others in our community who can serve you best.”  Now, that is good banking.

Of Overreaching Concerns and Asset Allegation

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What’s in a word?  That is an old question.  Often what is in the word may not be what the author intended.  The result can be humorous, and sometimes insightful.

Before retiring from the American Bankers Association, I became acquainted with a couple of examples where perhaps the wrong word presented an insightful meaning.  Listening to a seminar broadcast I heard the speaker explain the “overreaching concern” of his particular program.  Since the beginning of the Great Cessation and related lockdowns, I have heard many overreaching concerns expressed.  Perhaps we may learn from them.

On another occasion, in reference to money management, I became acquainted similarly by insightful accident with the term “asset allegation.”  I think that many a loan officer or bank examiner has had to come to terms with cases of asset allegation.

In 1775 the English playwright Richard Brinsley Sheridan introduced us to Mrs. Malaprop, who delightfully uses words in unintended ways, at least unintended by whoever created the words.  His play, “The Rivals,” is a classic of English comedy.  In one example, Mrs. Malaprop, trying to convince her niece to give up on a young man of interest, expresses the wish that Lydia, the niece, would “illiterate him” from her memory.  In recent days, I think that we have all come across efforts by some to “illiterate” events from our historical memory.  Much to her happiness, Lydia ignored the advice.

Mrs. Malaprop, quite displeased with Lydia’s response, cautions her niece not to “extirpate” herself from the matter, explaining to the young girl that Malaprop has “proof controvertible” for her case.  Again, in recent days many have indeed been called upon to “extirpate” themselves or their ideas, prodded by noisy voices offering much “proof controvertible.”

In conversation, discussing what she considers proper education, Mrs. Malaprop recommends boarding school, where the student could obtain “a supercilious knowledge in accounts”.  I may admit that considering the CECL financial accounting rule, I have been tempted to wonder to what degree “a supercilious knowledge in accounts” might have had a role in its development.

I would also wonder, as I compare the variety of approaches across the globe to the current virus, whether some policymakers were subjected to Mrs. Malaprop’s advice that youth be “instructed in geometry” that they “might know something of the contagious countries”.

As a final reference, of many wonderful examples in the play, I would call upon Mrs. Malaprop’s advice that proper education of Lydia might lead the dear niece to “reprehend the true meaning of what she is saying.”  I have heard and read many things in recent days by many people and mused whether the time would arrive when these people would come to reprehend the true meaning of what they were saying.

In my days of Civil War reenacting I became familiar with the Union song, “Grafted Into the Army.”  Composed by Henry Clay Work, it pretends to be written in the words of a widow, immigrant to the United States, lamenting her son Jimmy being “grafted” into the army.  Military jargon can be difficult enough for those not in the army, even more so for someone arrived in a new society.  Jimmy’s mother does express pride in her son “Dressed up in his unicorn.”  Intended to provide lighthearted moments in a dark time, the song also tells of the widow mother complaining at “the captain’s fore-quarters” about her son being too young.  Many sons were too young, and too many did not return.  Mixed in the mirth is the sad message that Jimmy’s “brothers fell / Way down in Alabarmy.”

An anecdote from dining at a restaurant:  I had occasion to visit the restroom.  The following instruction, printed in large letters, was displayed prominently over the sink:  Employees must wash hands.  I waited there some minutes, pondering the appearance lately of many strange requirements, but at last I gained the courage to break the rule and washed my hands myself.

Of the Federal Reserve and Taking from Savers

Ben Bernanke has a blog. You can find it here, courtesy of the Brookings Institution. Of course, what would the former Chairman of the Federal Reserve Board write about, other than decisions he made as Chairman, and why people who take issue with them are wrong? One would expect no less, and reading the light he sheds on previous decisions—offered in Fedspspeak at the time that they were made—is surely the chief lure of Ben Bernanke’s blog. Allowed to communicate in regular English, not worried about how Fed Watchers might construe or misconstrue everything he says and does not say, Ben is more able to speak his mind clearly.

The former Fed Head chose for his first blog post a vigorous defense of price controls on interest rates. In the process Bernanke demonstrates the assumption that we are safe letting government economists control the economy—an assumption continually disproven by real-world experience.

In fact, as a result of entrusting much of our economic freedom in the United States to government economists, we do not have a free market for interest rates, at least not short term rates, and we pay for that every day. The Federal Reserve sets short term rates in this country, and so far the market has had zero success in moving rates from the near zero interest rate range that the Federal Reserve has decreed and maintained for some years. Keep that in mind the next time you wonder why you earned $1.73 in interest on your savings account last year.

If you borrow money—when you can get a loan—then you might consider yourself lucky. The biggest borrower of all, in the whole world, is the United States Government. Uncle Sam must be feeling very lucky, because he is paying comparatively little on the $18 trillion of U.S. Government debt, increased by another half trillion dollars last year.

If you save money, though, especially for your retirement—and if you have to live off of those savings in retirement—you might not feel so fortunate. By keeping interest rates lower than the market would set them, the Federal Reserve is daily transferring many billions of dollars from savers to the Federal Government. And you thought that only the IRS takes your money.

Let me illustrate with an example. For the last three months of 2014, all of the banks in the United States, all of them together, paid no more than $11 billion to people who had their money in banks. Is that a lot of money? It depends. When that is the interest paid on nearly $12 trillion in deposits, the answer is, no, that is not very much money at all.

Do not blame the banks, though. They are in the saving and lending business, too. Try as they might, with the Federal Reserve controlling interest rates, banks could not pay any more interest to depositors. If a bank did, it would have more money than it could lend as people shifted their deposits where they could get a better return. To pay interest on deposits, banks cannot get much more interest from the loans they make than the Federal Reserve price controls allow, and many relatively good loans present more repayment risk (banks do need to be paid back) than those low interest rates would cover. Low interest earned means low interest paid.

All the banks in the nation have a little over $15 trillion in loans and other assets, on which they earned last year about the same amount as they did five years ago, when they had $2 trillion less in loans and other assets. In an environment of low interest rates, banks have to concentrate their lending on the safest borrowers.

That is how the low interest rates controlled by the Federal Reserve are oppressing the economy. When savers and lenders can only get a few cents on a hundred dollars lent, they place their money with the very safest of borrowers, since they cannot afford to take any losses. Someone who has a really good idea—which like all good ideas may or may not succeed the first time—has trouble getting the money to give his idea a go and hire people to help him try.

Ben Bernanke claims that the Federal Reserve’s near zero interest rate policy—called ZIRP—has been stimulating the economy. If so, where is the stimulation? Why has the recovery been so weak? There has been stimulus, but it has gone primarily to support Federal Government spending and to pay down the debt of the largest and healthiest businesses that can trade in their higher cost loans for the Federal Reserve’s lending bargains. The biggest increases in bank loans have been in Treasury debt and deposits at the Federal Reserve.

Ben Bernanke, in his blog, reminds me of the story of the lawyer representing a client charged with stealing a car and returning it damaged. The lawyer says, first, that his client never had the car; second, that he returned it in perfect condition; and, third, that it was already irreparably damaged when his client took it.

Bernanke begins by explaining that the Federal Reserve does not set interest rates, or that at most its ability to do so is only “transitory and limited.” He pleads that the Fed can only affect short term rates “in the short run.” He does not explain how seven years of ZIRP can be considered the short run. Then he progresses in his blog to describe how the Federal Reserve “influences” interest rates and then how the “Fed’s actions determine” interest rates. His argument, after denying that the Fed can set rates, is that the economy has been so weak that the Fed has had to lower interest rates for the nation’s own good. Bernanke next argues that the economy has remained so troubled (he does not say, despite ZIRP) that the Federal Reserve has had no choice but to continue with ZIRP, concluding that it is the economy after all the forces the Fed to do what it does. Do not blame the Fed Governors, they had no choice but to continue doing what they cannot do because it has not done any good so far. I think you need to have a Ph.D. in economics to make such an argument.

We cannot do it, we did what we had to do, and since it has not helped we cannot stop. I wonder how he reacted to those kind of explanations from his teenagers. Any responsible parent would reply, no, you cannot have the car, give me back the keys.

Of Presidents and Training for the Job, 2015

More and more I have been struggling for the words to express my concern over the frightening incompetence of the current President of the United States. Barack Obama’s economic blunders deepened and prolonged the recession and bequeathed to us the most anemic recovery of modern times. Most of us have been seriously harmed by those policies, some more than others. Unfortunately, the extent of his economic errors are obscured by the benighted economic management in Europe, which amazingly is managing even to underperform ours.

President Obama’s politics have yielded the opposite of what he publicly promised: division in place of unity, secrecy and deception in place of open government, exclusion of those who disagree with him in place of inclusive embrace of open debate, privilege for the few in place of opportunity for the many, racial bigotry for political gain in place of a “post racial” society, rule by breaking laws and ignoring the Constitution in place of rule of law. I am sure that you could easily lengthen the list. Again, these perfidies have been to some degree obscured by congressional Democrat leaders far too willing to compromise their duties of office and the rights of the legislative branch of government, all to cover up and support the Obama Administration’s outrages on the nation and the political institutions of the Republic.

Most frightful of all, however, is President Obama’s dangerously bungling foreign policy. No friend of the United States is safe from this Administration’s blunders. Vladimir Putin, the boss of a second rate economic and military power—albeit one with a formidable nuclear arsenal—has been able to engage in 19th Century military adventures of invasion, conquest, and territorial acquisition against little more than vacuous bully talk from Obama, the emptiness of which has produced similarly pitiful responses from the leading Powers of Western Europe, derision from Moscow, and fear among America’s friends only recently escaped from the Soviet Union. China commits aggression against India and the Philippines, threatens Japan, and toys with close relations with Russia to isolate the United States, while openly engaging in cyber attacks on the U.S. government and American industry. Islamist barbarians increasingly brutalize Muslims, Jews, Christians, and humanists alike, undeterred by inchoate responses from Obama, who asserts leadership while failing to lead, other than with his transparent policies of pusillanimity and indecision. American allies in the Middle East feel abandoned or betrayed, while enemies are emboldened; the best counter strategy that Barack Obama is able to envision is a plan that might delay but will not prevent the nuclear arming of the mullahs of Iran—committed to the incineration of Israel, the more Jews killed the better. Each day seems to extend the list of foreign policy failures.

While considering the consequences of an amateur in the Oval Office, I came across a brief note I wrote during the 2008 presidential campaign. It might be immodest for me to point out how correct my warnings proved. I can make no claims to perspicacity, as all of this was rather obvious. No self congratulations are in order. It is too dangerous a world to trust the Presidency of the United States to one whose inexperience is only matched by his hubris. This is what I penned August 25, 2008, just before Barack Obama received the nomination of the Democrats:

There are some jobs you just cannot safely do without proper training and experience. Flying an airplane is one that comes to mind. Driving a bus is another. I would put being President of the United States in the Twenty-First Century on the list, too.

President of the United States was a tough job in the days of George Washington. It was even a challenge in the days of Millard Fillmore. It has not become any easier in recent years, and next year it will be a very big job. Considering the global responsibilities of the United States, with several irresponsible oil-drunk regimes threatening peace and freedom (ours and other’s) around the world, can we afford to enroll our new President in a foreign policy on-the-job-training program?

Economically as well, there is little room for error. So far we have gone through a year and a half of the housing market bust without falling into a recession. But our economic growth is anemic. A small false step or two can put us into a full-blown economic decline, exploding banking and financial markets that will then take years to recover. It is important that economic policy next year be led by someone who understands economic growth and how to promote it. The formula for growth—low taxes and steady prices—is well known to those who have learned the lesson; we do not need a novice who does not have enough experience to know that you cannot tax and spend your way to prosperity. We cannot afford his experiments with our jobs and livelihood.

That is why it is breathtaking that a major political party is on the verge of nominating for President someone so inexperienced as Barack Obama. I am unable to recall a single nominee for President, by any major party, less prepared for the office than Barack Obama. Really, there is the challenge for you. Name a nominee—Republican, Democrat, Whig, Federalist—less prepared than Obama.

Barack Obama likes to liken himself to Abraham Lincoln. I cannot claim to have known Abraham Lincoln or assert that he was a friend of mine, but I do say, Barack Obama is no Abraham Lincoln. Even liberal exaggerations of Obama’s undistinguished career cannot make it compare favorably with the long and grueling life experiences that schooled Lincoln for the White House.

In short, Obama does not have the training for the job. It may be that the Democrats’ talent pool is so thin that he will be nominated. But the job of President is too important—to all of us—to be extended to someone so unready.

Of Unbanked and “Underbanked”

Speaking of banks, as I did on this page a short time ago, there are those who are concerned that too many people in the United States are “unbanked” or “underbanked.” By the former they seem to mean those who do not use any banking services, particularly who do not have any bank accounts. By the former, they mean those who obtain some banking services from businesses that are not banks. The very existence of the terms, and the way that they are used by those who use them, implies that being “unbanked” or “underbanked” is a bad thing.

I will here disclose that I have worked for banks for nearly 10 years and for all I know may continue to do so for some time into the future. Whatever bias or color to my views that this condition provides I will nevertheless try to comment from a fair and factual point of view.

My first point, therefore, is that I am not prepared to assert that absolutely everyone should have a bank account. I can easily envision the value of a bank account for most if not all people, but I concede that they should be allowed to choose for themselves and that it would be terribly wrong to force people into banks. I acknowledge that there are some alternative providers of financial services who seem to please their customers, and I do not deny that banks can benefit from good competition. Banks have a long history of drawing upon the ideas and innovations of non-banks, just as non-banks have been eager to try their hand at successful new products and services that banks have pioneered. Bank customers have benefited the most from that process, as the variety and value of financial products have expanded, and the United States has led the world in the discovery of new and useful financial services.

Having said that, the nation cannot do well without a strong, vibrant, and prosperous banking industry. Our nation and people grow as we save financial resources and invest them in improvements for the future, whether new homes, new factories, or new ideas of how to do and make things better, faster, and cheaper. That is a major part of what banks do and are all about.

Moreover, there are a lot of things we do and a lot of places we go because we know that our ability to pay and get paid—to exchange things we value less for things that we value more (the reason we buy and sell things and use money to do it)—is secure, reliable, accurate, and relatively quick. That is our payments system, and banks created it and are at the center of it.

Americans also like the idea of becoming wealthier and expect to do so. If that seems a commonplace to you, recognize that it is not so in all parts of the world, where getting by from day to day is about the most to which people can aspire, for whom poverty is a way of life that they expect to bequeath to their children. To the extent that this miserable condition is becoming less the case in much of the world, that more people are beginning to believe that they can build and improve their wellbeing for themselves and their posterity, this new-found hope for accumulating wealth is attributable to the dispersion of principles of freedom and prosperity that Americans take for granted but which are new to much of the world. The global adoption of many American principles of prosperity has been a major contribution of the New World to the Old World and to all mankind.

Now get ready for the bold but true statement: you cannot get there and stay there without banks and the services that banks provide. Banks gather wealth, safeguard wealth, allow it to be used efficiently, and apply it to building the future. That is why governments pay so much attention to banks, and also why it is so harmful when governments try to capture banks and channel their services to the personal gain of themselves and their cronies. That is also why misguided bank regulations are harmful—even if in subtle but powerful ways—to the nation and its people.

Which brings us back to the agenda of the “unbanked” and the “underbanked.” In the United States, chief causes for people remaining “unbanked” are regulations that make banking more difficult and services more expensive; cultural barriers for people who come from societies where personal banking is either unknown or where the experience has been one of banks used by local governments to harvest wealth from people to enrich the governing elites and their cronies (much of Latin America, for example); and people who for whatever reason just do not prefer to use banks. The first cause regulators can solve but have largely been resistant to solving; the second can be overcome by time and experience and is showing signs of that; and the third cause is no more of a problem than people who prefer to rent rather than own their home, to eat eggs without grits, or who do not like the New York Yankees. I do not have to understand the personal preference to acknowledge it.

The concept of “underbanked” (that government needs to help banks figure out how to serve people who may get some banking services outside of banks) I fear may be a political device to harness American banks to serve the cronies of the “underbanked” advocates. We have already seen this game with the Community Reinvestment Act (CRA) regulations, adopted ostensibly to ensure that banks lend to their local communities (as if bankers, unlike other businessmen, need government regulation to notice business opportunities right under their own nose). In practice, CRA has been used to coerce banks into providing loans and even grants to and through poverty advocacy agencies that tend to prosper more than the people whom they claim to be helping. The folks who fret about the “underbanked” have marvelous formulas and plans for other people’s money to solve problems about which the people to be helped seem little concerned. I have never heard of any truly “underbanked” people themselves calling for the firm hand of government to get them into the banking system; if they want banking services, they just go and get them.

I have the haunting suspicion that the “underbanked” advocates would if they could use banks the same way found in the abandoned societies of the “unbanked,” where banking services came through the hands of people who knew better than others and always made sure to get their cut for their benevolence. That is not really banking, and that is symptomatic of why people flee those lands. The wealth creation of such captive banks seems to be for someone else. If it happens in America, where will the people go?

Of Banks and Over Taxed Regulators

Banks, who needs them? A quick question and a quick answer: a thriving, prospering banking system is essential for a thriving, prospering modern economy. Banks bring together the resources of savers and the needs of borrowers, particularly borrowers who seek funds to establish or expand businesses or families and individuals who use occasional borrowing to smooth out their income (good banking principles penalize people who would borrow in order to live beyond their means, but more on that at another time).

Banks also created and maintain the payments system, the means by which money is transferred quickly and accurately throughout the nation and even internationally. Bank services include as well a variety of wealth management tools by which individuals, families, businesses, and governments can store, grow, and make best use of their financial wealth.

Without banks, almost none of these services would be available. Many non-banks provide bank-like services, but they all come to find the need to rest their own services at some point on a bank.

Banking in the United States has grown with the nation, from very simple institutions in the eighteenth and early nineteenth centuries, to a wide variety of bank types, charters, and business models, as diverse as the financial demands of the customers of the largest and most diverse economy in the world. I once presented at a meeting in Chicago a list of about two-dozen different types of banks in the United States. We have national banks, state chartered banks, small community banks, larger regional banks, and very large banks with extensive national and international business products and services. All of these operate and compete together, with a body of customers behind each one who think that their bank offers the best available choice of services that they want. No other nation in the world has a banking industry like ours.

The recent recession and financial panic—and the inevitable politicizing of finance that came in its wake—have thrown much into confusion and imposed upon sound and prudent bank supervision harmful ideas born of reckless sloganeering and hubristic financial engineering. The complexity of banking—no more complex than information technology, communications systems, or modern manufacturing—has been superseded by even more complex bank regulation.

The rules governing banking are too much and too many to function reasonably. They have become more than the very human people in the multitude of bank regulatory agencies can manage. The disciplining role of markets and the valuable service of banker judgment have in large measure been replaced by bureaucratic procedures and the judgments of government officials. These officials have had little if any practical experience making loans, taking deposits and putting them to work, building financial wealth, or otherwise providing products to customers. Government officials cannot run businesses. Now, their government jobs have become so demanding and complex, that they will not be able to do their own jobs, either. Too much has been placed upon them.

Those most harmed by all of this are bank customers. For the moment, bank profits are up, but that is because their losses are down as they recover from the recession, not because services to customers are expanding. As a result of government interest rate policies, depositors earn almost nothing on the money that they place in banks. The expanding oversight involvement of bank regulators makes it dangerous for banks to offer new services to customers; the risk of breaking any of thousands of pages of regulations has become too great. It takes almost half an hour to open a new bank account, something that used to take minutes. Fewer credit-worthy borrowers today qualify for mortgages than just a year ago, before new regulations went into effect. The number of banks has been declining in recent years, dropping at the rate of nearly one for every business day, week in and week out. Only one new bank has been opened since 2010. We have fewer banks today than the nation had in 1893. A stagnant industry is less able to evolve to meet changing customer needs and preferences.

For the good of all of us who rely upon banking services, and for the sanity of financial regulators, we need to return to the principles of good banking. We need to restore a system of supervision that is measured, not by how much banker judgment it takes over, but by how it adds value to the ability of banks to serve customers. Government agencies—and the laws that they administer—that are derived from a founding document that begins with the words, “We the People,” should do nothing less, and nothing more.

On another day I would like to share some thoughts about how banks are being goaded to become their own enemies.

Of the Rule of Law and the Separation of Powers

In the 1990s I was part of a congressional delegation to Argentina. At that time the Argentine economy was growing strongly and steadily, inflation was low, the currency was pegged to the dollar, convertible 1-for-1. Trade barriers were being lowered, commerce was booming. I recall asking Argentines what could possibly darken what seemed to be a very bright future. They were quick to reply: “Here in Argentina we have no rule of law. You can have no confidence in getting justice from the courts.”

That reminded me of Washington Irving’s observation on a European judge, from his famous work, The Alhambra:

It could not be denied, however, that he set a high value upon justice, for he sold it at its weight in gold.

Not long after that visit, the politics of income redistribution and confiscation threw the Argentine economy into turmoil, where it has remained.

I recently spoke with an economist friend of mine, who was waxing eloquent about the attractive monetary and tax policies in Bulgaria. I remarked that this would probably invite foreign investment. He replied, “No, there is no rule of law there.”

The point is that good economic policy cannot long survive inadequate legal safeguards. Many businesses that made major investments in China, attracted by a market of a billion people, have learned that the lack of a reliable legal and justice system in China has undermined much of the business value they thought to find. A similar story has been holding back investment and economic development in Russia.

Bringing that home, I would venture that concern for changing rules (or even lack of rules)—the substitution of arbitrary bureaucratic powers in Washington over objective rule of law—has been inhibiting more robust investment in the United States, a major cause for our current anemic economic recovery.

An ancient king in the Western Hemisphere, named Mosiah, warned, “because all men are not just it is not expedient that ye should have a king or kings to rule over you.” (Mosiah 29:16) Because men are not consistently just, freedom has historically rested upon rule by law rather than rule by men.

Fundamentally, that was the very reason for the American Revolution. Our revolution was based on the rule of law, an assertion of the rule of law, a response to violations of the rule of law by the English king and parliament. Most of the Declaration of Independence is a lengthy litany of violations of law by the English rulers. The Revolution was designed to take power away from man and men and rest it upon laws and rights, soon to be secured by a written supreme law embodied in the Constitution. Any erosion in the force and effect of the Constitution is an erosion of the rule of law and of the freedoms that rely upon law for their defense.

The Progressive Movement that thrived about a century ago, and found a major advocate in the federal government in President Woodrow Wilson, aggressively proposed an alternative to the rule of law. This program was the Rule of Experts. Their new view—and it really was a very old view though they dressed it up in modern-sounding rhetoric—was that there are Benign People, Experts, who know the process of modern government better than most people do, to whom we can safely yield governing authorities.

It sounds akin to the ancient theory of Divine Right of Kings, that the monarchs of the world are chosen by God and endowed with greater wisdom and perspective than the average man and woman. To their benign expertise and fatherly care was to be entrusted the governance of the rest of us.

The modern Rule of Experts people have much the same view, that these experts were endowed by their universities and other sources of expertise with ability far above that of most, and it would be wise to trust ourselves to their benign care. Not very democratic, and in fact these Benign Experts make no secret of their impatience with the Congress and other constitutional brakes on arbitrary authority.

As King Mosiah wisely pointed out that men are not always just, it is also appropriate to recognize that putting men in government does not make them any more reliably wise than the rest of us. The American Founders thought to address this problem by dividing political power among not only three branches in the Federal Government but also by embracing the federal system of dividing government with the States.

The current regulatory structure and program of the United States rest heavily on the idea that Benign Experts should be entrusted with authority for many of the big questions facing Americans and for many of the much smaller questions, too. That is certainly the structure of the Dodd-Frank Act, to offer one recent, prominent example among many.

Charles Calomiris, of the Columbia University business school, described the theory of the Dodd-Frank Act and related regulations this way:

The implicit theory behind these sorts of initiatives, to the extent that there is a theory, is that the recent crisis happened because regulatory standards were not quite complex enough, because the extensive discretionary authority of bank supervisors was not great enough, and because rules and regulations prohibiting or discouraging specific practices were not sufficiently extensive.
(Charles W. Calomiris, “Meaningful Banking Reform and Why it Is so Unlikely,” VoxEU, January 8, 2013)

This program of federal regulation has been imposed increasingly in contravention of the basic constitutional principle of separation of powers, by merging legislative, executive, and judicial authority in “independent” regulatory agencies. The unelected federal regulator today decides the details and specifics of binding mandates, identifies violators of those regulations, assesses guilt, and applies penalties.

Taken together our current regulatory system, by merging rather than maintaining the separation of powers of the Constitution, is eroding the rule of law. It is returning us to the age old practice of rule by men, with all of the potential for abuse of rights and freedoms, abuses that fill up most of the sadder pages of human history.

During the debate over the creation of the new financial consumer Bureau, Senate Banking Committee Chairman Dodd boasted that with this new agency people would no longer have to come to Congress for the enactment of new consumer laws. The Bureau would take care of all that.

There are serious operational flaws—too often overlooked—in the program of governance by Benign Experts. First, the regulators are not dispassionate umpires, limited to calling the balls and strikes. These umpires are also players in the game, the federal agencies each having their own set of particular interests and incentives that they take care of first.

Second, reliance on Benign Experts assumes an unproven, undemonstrated level of knowledge, insight, and forecasting skills. AEI President Arthur Brooks, in his book, The Battle, provides one of many examples of this flaw:

Federal Reserve economists were still forecasting significant positive growth and moderate unemployment in May and June 2008. They believed that economic growth in 2009 would be 2.4 percent, and unemployment would be 5.5 percent. What we experienced instead was negative growth, double-digit unemployment, and the destruction of at least $50 trillion in worldwide wealth. No one can get the numbers exactly right, to be sure. But getting them this much wrong certainly lends a whole new meaning to the expression ‘margin of error.’
(Arthur C. Brooks, The Battle, p.46)

It is not that regulators are dumber than the rest of the population, but they are no smarter either. The regulatory problems are increasingly too great for any designated group of humans to solve.

Third flaw, mission creep: power attracts power. Even if the tasks are too great, require too much knowledge, insight, foresight, and other skills in unachievable degree, the regulators still take them on, especially if the task increases the reach and influence of the agency.

I offer two examples from an example-rich environment.

Basel III capital rules started from a simple idea, that banks all around the world should be subject to the same capital standards. Capital (the financial cushion a bank carries against losses) is one of the three key elements of sound banking, the other two being liquidity and earnings. These international rules did not remain simple. Developed by an international team of experts from around the world, who labored on them for years, the rules number hundreds of pages, affecting the entire financial structure and business model of a bank, any bank. Congress was not involved and has no particular role in approving the rules. When exposed to public review they attracted thousands of comment letters expressing dismay that they are a bad fit for the U.S. economy. In the end, though, the regulators can go ahead with what they alone think is best.

A second example would be the Federal Reserve. One hundred years ago this year the Fed was created with a specific, identifiable, and rather narrow purpose, to provide liquidity for the banking system in times of financial stress. Before long, the Federal Reserve gained control of monetary policy and built up the practice of controlling interest rates. Later, it was given the task of promoting maximum employment. Under Dodd-Frank the Federal Reserve’s role in supervising banks and bank holding companies was expanded to supervising any financial business considered to be significant for financial stability. Each of these powers has drawn the Federal Reserve away from its narrow, objective task, to broad fields of subjective authority.

Perversely, this expansion of authority into more judgmental areas is eroding the independence of the Federal Reserve, making it yet one more political player in Washington, with responsibilities that far exceed human ability to fulfill, but which reach to every business and every home. The Fed’s prolonged policy of keeping short-term interest rates at or about zero has penalized all who save and live off of their savings, transferring trillions of dollars from savers to borrowers, the biggest borrower being the Federal Government, a policy decided by a small group of Washington experts.

I offer a partial but simple solution to point us back toward strengthening the rule of law and reducing our exposure to the rule of man and men, however expert they might be. Return the lawmaking and the policy decisions to the elected representatives. It is a messy process, but exactly the messy process that the Founders intended to preserve freedom from the encroachment of arbitrary and oppressive government. The regulators, which are theoretically part of the executive branch, should be left with the duty of implementing the laws and policy decisions that the elected and accountable representatives make.

If Congress were required to write the rules and mandates and delegate to the executive agencies only the execution, the mandates of government would be circumscribed by the limitations of a legislative body forced to be directly accountable for what it has wrought. It is easy for legislators to complain about bad regulatory decisions, when all too often these are decisions that Congress never should have delegated to regulators in the first place.

We would still have laws and regulations, but the laws might be more direct and specific, and perhaps fewer and surely smaller. We would probably not have Dodd-Frank Acts that number thousands of pages read by no congressman or Senator, containing a cacophony of half-baked ideas and multiple solutions to the same problem, all left for the regulators to sort out.

And legislators might recall this caution, from Thomas Paine:

Laws difficult to be executed cannot be generally good.
(Thomas Paine, The Rights of Man)

(First published February 17, 2013)

Of Obama and Ethelred the Unready

As the troubled year of 2009 was approaching its final weeks I wrote a commentary, reprinted below, reflecting on how President Obama’s unreadiness for the job of President was endangering our soldiers abroad and weakening the economy at home. As we have witnessed a recovery that month after month remains so anemic that many Americans are not experiencing much of a recovery at all, as our retreat from world affairs encourages aggression by adventurers in Russia and elsewhere, and as the Obama Administration plans to return our Army to levels not seen since before World War II, it seemed to me appropriate to reprise my musings of November 2009. I also have to wonder whether the Nobel committee, which was so excited to award the peace prize to Barack Obama for promises to reduce American influence in world affairs, still considers its decision and the policy that it celebrated to have been wise and fortunate for the world.

Arguably the worst king of England was Ethelred the Unready. He was unready to rule his kingdom, he was unready to promote its prosperity, he was unready to repel the invader. The chief manifestation of his unreadiness was his inability or unwillingness to recognize reality. Reality eventually caught up with him—as it always does—and with his kingdom—as it always does for those subject to unready rulers.

The current President of the United States, Barack Obama, may be working hard to earn himself the title of Obama the Unready. The evidence is accumulating.

For months, the novice commander-in-chief has been at a loss to know how to respond to the urgent recommendations of the field commanders in Afghanistan. They have been pleading to increase the troop levels. The added troops are needed to respond to increased enemy activity. Unwilling to say yes or no, the President vacillates while American soldiers die because they are stretched too thin. He seems to have forgotten that American soldiers under President Clinton were similarly sacrificed in another poor corner of the world—Somalia—only because Clinton did not provide enough troops to do the job. Rather than decrease casualties, insufficient troop strength increases casualties, soldiers who would not die if given enough support to overwhelm the enemy. This week the White House announced that President Obama is still unready to decide on troop strengths for the mission in Afghanistan. Unfortunately, the Taliban is not waiting for him to make up his mind.

Also this week, President Obama gave a little speech about the economy. It was hard to miss the sense of frustration and perplexity in his remarks, made quickly as the Nobel laureate left town to seek more praise from his adoring foreign fans. He admitted that unemployment remains high, despite his economic program. He admitted that employers are reluctant to hire new people. He just does not seem to know why. His solution is to call a conference of economic talkers in December to talk about it. He remains unready to do something about his economic plans and government policies that are making it riskier for employers to take on more employees. Faced with half a trillion dollars in new taxes (many focused on small businesses), higher health care expenses from the trillion dollar “reform” program, new environmental plans to cool off the globe by cooling off economic growth, and dozens of other new plans to make it harder for businessmen to succeed, businessmen are reluctant to hire new people that they will later have to let go. All the while, the natural tendency for the economy to recover is weakened.

Consumer spending remains suppressed, while the Obama Administration and its friends in Congress pursue policies that make consumer credit more expensive and harder to get. Congress this year, with the Obama Administration cheering on, passed new credit card laws that make it difficult for lenders to have riskier borrowers pay higher rates. The result is that everyone gets to pay higher rates. Predictably, consumer credit declined by 15% in September and shows little sign of getting better. As we approach the holiday season, so important for the success of retailers, the Obama Administration and its Congressional allies are busily making it tougher for banks to run their debit card programs. Expect more debit cards denied at the checkout lines. Also expect the pace of store closures, already growing faster than swine flu, to continue to grow. Seen any empty storefronts at shopping centers lately? Be ready to see more, even as President Obama convenes his economic talk show in December.

Not to forget swine flu, the Obama Administration was eager all year to pump up the worry about a swine flu epidemic, in hopes that it might frighten people into supporting healthcare legislation. In the meantime, the Obama Administration’s health officials, who are heavily involved in development and distribution of vaccines (lawsuits that plague the medical industry have driven most vaccine manufacturers out of the business), were ready to promise but unready to deliver swine flu vaccine. Expect more of the same, of promises that do not meet actual needs as government becomes even more involved in regulating healthcare. Service and speed are what most people look for when they are sick, but service and speed are not what government programs are known to provide—any government program.

It should be no surprise that President Obama is not ready for the growing challenges of being President. Like Ethelred, Barack Obama had little training for the job. Governing has not gotten easier in the thousand years since Ethelred disgraced the throne of England. It is not getting any easier for Barack Obama. Fortunately for America, we do not invest all power in a king.

(First published on November 13, 2009)

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