- "That one million hours a year devoted to resolution planning is 500 full-time employees"
- "There are 8,000 employees 'dedicated solely to building and maintaining an industry-leading Anti-Money Laundering (AML) program.' JPMorgan employs more AML compliance officers than the Treasury and the Fed combined."
- Stress testing required 500+ FTEs
- Compliance with Basel's new securitization rules has required 35,000 hours of work (at 2000 hours per year, that's only 17.5 FTEs, so you can see why they moved to hours there).
That's a lot of compliance, and indeed, at these rates, way more people do compliance for JPMorgan than, probably, do actual investment banking. Of course, maybe we want all of this given that the firm is far too big to fail, and maybe we want to make banking burdensome and unprofitable. If so, we are on our way!
The leverage rule agreed to internationally is 3%, and you should think of a it as an alternative minimum tax. Worried that banks might be able to game capital requirements, which require them to hold funds in reserve to deal with shocks, the world's regulators also decided to forbid, on pain of cutting dividends and executive compensation, large banks froms from taking positions that would mean that more than 3% of their assets are capital. American banking regulators are going further - they are disincentivizing bigness by requiring the 8 largest banks to comply with a 5% leverage ratio. Some thoughts:
- The giveback to industry is that this rule isn't effective until 2018. Only in financial regulation do you ever see such long-dated rules.
- American banks might have to add $68 billion in capital to comply with this requirement. Would you sue to avoid that kind of a charge? Of course you would! But the banks probably won't. The Fed just doesn't face the sort of Total Litigation regulatory contest that the SEC faces.
- Ditto, you'd think that such a big deal rule would require review by OIRA. Nope!
The answer is no, it won't kill monetary policy, but here's the way it might constrain the Fed, which relies on primary dealers (that is, big banks, who would now be subject to leverage requirements) to help it set the federal funds rate. This reliance has been cited as a reason to delay the leverage rule. Felix Salmon also thinks that's no reason to delay the imposition of the rule, but here's how the argument works, in his nicely straightforward words:
The way that the Fed conducts monetary policy is by instructing the traders at the New York Fed to buy and sell certain financial instruments so that a particular interest rate — the Fed funds rate — is very close to a certain target. Through a complex series of financial interlinkages, setting the Fed funds rate at a certain level then has a knock-on effect, and ultimately helps determine every interest rate in America, from the Treasury yield curve to the amount you pay for your credit card or your mortgage.
Those interlinkages are so complex that they’re impossible to model with any particular accuracy: all the Fed can do, really, is set the Fed funds rate and then see what happens to everything else. And directionally the causality is clear: if the Fed wants rates to rise, then it pushes the Fed funds rate upwards, and if it wants rates to fall, then it brings the Fed funds rate down. That doesn’t always work at the distant end of the yield curve, but it’s still most of what monetary policy can do.
Especially early on in the chain, a lot of the interlinkages take place at the level of big banks. And so it stands to reason that if you change the leverage requirements of big banks, that might change what happens to interest rates when you move the Fed funds rate.
In my last post—also a shameless plug for my recent article, “Boilerplate Shock”—I argued that boilerplate terms governing securities could serve as a trigger that transforms an isolated credit event into the risk of a broader systemic failure. I’ll now briefly explain why I see this danger—which I call “boilerplate shock”—as a general problem in securities regulation, not just some quirky feature of Eurozone sovereign debt (the focus of the paper and post). Any market where securities are governed by uniform boilerplate terms is vulnerable to boilerplate shock.
The nature of this phenomenon—systemic risk—is of course familiar, but its source in contract language is a little unintuitive. How could private contracts unravel an entire securities market or the world economy?
Coordination around uniform standards.
In the back of our mind most of us probably still conceive of contracting as an activity that occurs among two, or perhaps a few, individuals or firms. But when standard terms are used by virtually all actors within a given market, it’s worth considering the collective impact of those terms as a distinct phenomenon.
Coordination’s benefits are well known. Consider uniform traffic signals. But coordination can also compound the effects of bad individual decisions.
As Charles Whitehead has argued, widespread “destructive coordination” among banks during the precrisis days helped generate systemic risks. When the credit markets froze, for example, firms using the same risk management formulas reacted in the same way at the same time. This helped transform isolated events into systemic ones—e.g., Lehman, the canonical example of a failure that triggered a de facto coordinated panic.
A similar risk, I argue, is present where participants in a securities market rely on the same standardized contract terms. Whether they were intended to or not, these terms will often control what happens in the event of certain legal emergencies, like a country departing the euro or Lehman declaring bankruptcy.
For example, if an effort by Greece to pay its bonds in “new drachmas” is rejected because of Boilerplate Contract Terms A and B, the market will surely be concerned that Terms A and B also govern the bonds of similarly situated borrowers, like Spain, Italy, etc. You’ll see that the borrowing premium the “peripheral” euro countries (the uppermost five lines: Ireland, Italy, Greece (biggest spike), Portugal, Spain) paid versus richer euro countries (Germany, France, the Netherlands, the three lowest lines) zoomed higher as worry over a Greece exit gripped markets in late 2011/early 2012, and again (to a lesser extent) because of Cyprus exit talk in early 2013:
Bloomberg. Click to enlarge.
Moreover, this panic occurred against a backdrop of unduly rosy assumptions (namely, that a departing euro country could convert its bonds into a new currency and thereby avoid default, a likely contagion trigger). I argue that the uniformity of boilerplate across these bonds would intensify these problems significantly since it’s likely to result in a declaration of default.
To my mind, this demonstrates that boilerplate securities contracts, in the aggregate, can be systemically significant. “Boilerplate Shock” introduces this concept and offers a modest proposal to mitigate its dangers in the Eurozone.
Beyond the euro, what about the risks of boilerplate shock in general?
Boilerplate shock is probably an inherent and permanent risk in any securities market.
Securities contracts are quintessential candidates for boilerplate. They are used by sophisticated parties for repeat or similar transactions and are drafted quickly—sometimes in three and a half minutes. The (correct) assumption is that they are more efficient for the parties that use them.
I’d like to begin thinking about how contracts can be drafted with a view to systemic risk mitigation, or at least to avoid exacerbating existing risks. But I think this is a hard problem that lacks an off-the-shelf solution:
- The nature of the risk is that it is a byproduct, not the result of intentional choices about risk allocation. This is the reason for the information-forcing default rule I propose in the Eurozone.
- The risk is also an externality: it is severe because of its collective impact. The parties do not bear the primary risk that uniform contracts will result in a meltdown, and in the unlikely event a crash happens (1) no individual party will be to blame and (2) at least one party to the initial transaction (the initial purchaser of a bond, for example) will probably no longer hold the asset, because most systemically significant securities are actively traded on the secondary market.
But banning or discouraging boilerplate is not the answer:
- The risk that a bunch of assets governed by the same terms will plummet in value is not only an externality. Risk allocation among parties might improve if scrutiny of existing securities boilerplate improves. The terms can evolve.
- A requirement to craft unique, artisanal terms—disclosures, subordination provisions ("flip clauses"), choice of governing law—for each individual securities transaction would be criminally inefficient.
- A requirement to craft unique contract terms might even be unjustified on risk-management terms alone, because it would increase drafting errors.
It's tricky to mitigate the risks of securities boilerplate.
Some options for places to start:
- Validation by third parties: perhaps issuers could use risk-rated contract templates. For example, see credit ratings…but see credit ratings.
- Culture: inculcate systemic risk mitigation as a professional norm among private sector lawyers? In principle, this could work. The number of lawyers who draft these contracts is pretty small. In practice, one could envision many complications.
- Insurance: encourage the development of derivatives to account for the possibility of boilerplate shock? Like some of the other solutions, this one presumes some agreement on what terms create the risk of boilerplate shock. It could also encourage new forms of moral hazard.
- Mandatory regulation: some public entity could be tasked with the mission of proactively identifying and combating the risk of boilerplate shock in contract practices. Arguably a natural choice given that the risk is an externality. Nevertheless, I’m a little skeptical. First of all, who would do it? A domestic regulator, like the SEC or CFTC, that might be dodged on jurisdictional grounds? An international institution, which is arguably more subject to capture? More generally, regulation seems like a heavy-handed first choice.
In sum, when standardized and aggregated, choices that determine legal risks—e.g., contract terms designating governing law, payment priority—can create the same hazards as choices about business risks. This suggests that contract terms should be taken seriously as possible sources of systemic risk alongside more familiar sources, like leverage and credit quality.
Securities contracts as a source of systemic risk—what do you think?
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By now, the risk that a distressed European nation such as Greece might leave the Eurozone and thereby spark global economic calamity is well known. Regular readers of this blog may even privately relish the prominence of the issue. Not since the days of the gold standard has international monetary policy come so close to being a socially acceptable topic of dinner conversation.
As I noted in my first post, observers rightly perceive the Eurozone sovereign debt crisis to be driven by political and economic forces. But many consequences of a euro breakup would be determined by law, including sources of American (specifically New York) private law.
This is a complex issue. I try to address it more fully in a new article, "Boilerplate Shock," which I've just posted on SSRN.
In brief, and to continue picking on Greece, one key question in the event of a euro breakup would be: would a court recognize an attempt by Greece to convert its euro-denominated debt into its new currency, or would it instead insist that Greece pay in euros, the currency of contract? The answer is important because, as a practical matter, requiring payment in euro would be tantamount to forcing a default.
That's the familiar narrative, anyway. And I agree. But I believe that the ubiquity of boilerplate terms in these bonds—specifically, clauses selecting governing law (usually foreign) and currency of payment (euro)—is likely to make any dispute over redenomination even more damaging than this suggests.
In the article, I argue that the sparse literature on the question of redenominating sovereign bonds overlooks some sources—especially cases interpreting New York contract law and private international law—that, if extended to Eurozone sovereign bonds, could surprise the market and cause serious global repercussions. I argue that the reason for this is not only that the dominant view overlooks what are likely controlling sources of law. It is that standardization of contract terms across the Eurozone sovereign lending market makes the stakes of surprise that much higher.
If Greece's attempt to redenominate its bonds is declared a default, then the fact that the operative terms in Italian, Spanish, Irish, etc. sovereign bonds are the same or similar makes markets likely to demand unsustainable premiums from those countries. Capital and investor flight could be very rapid. We have seen several previews of this movie over the past few years in the Eurozone, and each time official-sector bailout institutions have saved the day. But the European Union/European Central Bank and IMF probably do not have the resources to stop a broad-based bank run of this nature, to say nothing of the political support necessary to attempt it.
Maybe none of that will happen. Nevertheless, the potential for uniform contract terms to create risk not just to individual third parties but to securities markets seems likely to grow at least as fast as those markets. Using Eurozone sovereign bonds as a case study, I introduce the term "boilerplate shock" to describe the potential for standardized contract terms—when they come to govern the entire market for a given security—to transform an isolated default on a single contract into a threat to the market of which it is a part, and, possibly, to the economy in general. My larger objective here is to foster a discussion of the potential for securities law and private-sector securities lawyers to manage (or alternatively, to contribute to) systemic risk.
I've posted an abstract below and will be returning to the subject. I look forward your comments.
Boilerplate Shock abstract:
No nation was spared in the recent global downturn, but several Eurozone countries arguably took the hardest punch, and they are still down. Doubts about the solvency of Greece, Spain, and some of their neighbors are making it more likely that the euro will break up. Observers fear a single departure and sovereign debt default might set off a “bank run” on the common European currency, with devastating regional and global consequences.
What mechanisms are available to address—or ideally, to prevent—such a disaster?
One unlikely candidate is boilerplate language in the contracts that govern sovereign bonds. As suggested by the term “boilerplate,” these are provisions that have not been given a great deal of thought. And yet they have the potential to be a powerful tool in confronting the threat of a global economic conflagration—or in fanning the flames.
Scholars currently believe that a country departing the Eurozone could convert its debt obligations to a new currency, thereby rendering its debt burden manageable and staving off default. However, this Article argues that these boilerplate terms—specifically, clauses specifying the law that governs the bond and the currency in which it will be paid—would likely prevent such a result. Instead, the courts most likely to interpret these terms would probably declare a departing country’s effort to repay a sovereign bond in its new currency a default.
A default would inflict damage far beyond the immediate parties. Not only would it surprise the market, it would be taken to predict the future of other struggling European countries’ debt obligations, because they are largely governed by the same boilerplate terms. The possibility of such a result therefore increases the risk that a single nation’s departure from the euro will bring down the currency and trigger a global meltdown.
To mitigate this risk, this Article proposes a new rule of contract interpretation that would allow a sovereign bond to be paid in the borrower’s new currency under certain circumstances. It also introduces the phrase “boilerplate shock” to describe the potential for standardized contract terms drafted by lawyers—when they come to dominate the entire market for a given security—to transform an isolated default on a single contract into a threat to the broader economy. Beyond the immediate crisis in the Eurozone, the Article urges scholars, policymakers, and practitioners to address the potential for boilerplate shock in securities markets to damage the global economy.
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Over at DealBook, I’ve got a piece on the analysis of FOMC transcripts – a cottage industry, now that the Bernanke era version of the committee has released its 2008 (that is, depth of the crisis) records. There’s lots of counting that can be done, including some, in honor of Jay Wexler’s Supreme Court study, on the number of times the FOMC broke into laughter. Easy enough to actually do for the Greenspan FOMC, and so I do it:
For what it is worth, the mood lightened as the chairman aged, although the F.O.M.C. certainly went through turbulent times during both the beginning and the end of Mr. Greenspan’s tenure. Meeting transcribers recorded laughter on a per-transcript-page basis increasing from an average of less than 20 percent from 1988 to 1992 to more than 20 percent from 2001 to 2006. In a few years, we will be able to make comparable statements about the F.O.M.C. when Ben S. Bernanke was the Fed chairman. Mr. Greenspan used wit far more than any other single Fed official (although he spoke far more at F.O.M.C. meetings than the others did) – laughter ensued after something he said 556 times over the course of his tenure.
Do give it a look.
Late last month I posted my colleague Mehrsa Baradaran's thoughts on the US Postal Service moving into banking. She'd written an article on the subject 2 years ago, and the US Postal Service seemed to be warming up to the idea. Since then, Mehrsa has written a NYT op-ed on the subject and, most recently, has a short piece up in the Harvard Law Review Online Forum: It's Time for Postal Banking.
From the introduction:
... government support and even subsidies to enable postal banking in the United States are appropriate and justifiable. First, banking-related subsidies are grounded in historical practice, as demonstrated by government support for credit unions, savings and loans, and student loan associations. Postal banking derives from these longstanding practices, but broadens the scope to include the poor, not just the middle class. Further, state support of banking throughout U.S. history has operated much like a social contract: the state supports the banking system in a variety of ways and, in return, banks serve as credit intermediaries, providing the populace with access to loans and financial services. Thus, subsidies for banking have been justified because they provide a benefit to all citizens. Mainstream banks have met part of their obligation, but a large portion of the population, namely the poor, has been left out. It is time, then, for the government itself to meet the demand for credit.
Go read the whole thing!
The Bitcoin exchange Mt. Gox appeared to be undergoing more convulsions Tuesday [February 25], as its website became unavailable and trading there appeared to have stopped, signaling a new stage in troubles that have dented the image of the virtual currency. . . .
Investors have been unable to withdraw funds from Mt. Gox since the beginning of this month. The exchange has said that a flaw in the bitcoin software allowed transaction records to be altered, potentially making possible fraudulent withdrawals. No allegations have been made of wrongdoing by the exchange, but the potential for theft has raised concern that the exchange wouldn't be able to meet its obligations.
The apparent collapse of Mt. Gox is just the latest shock to hit Bitcoin, the price of which is now off more than 50% from its December 2013 peak:
For those better acquainted with the dead-tree/dead-president variety of money, Bitcoin is a virtual currency not backed by any government. Rather than being printed or minted by a central bank, Bitcoins are created by a computer algorithm in a process known as "mining" and are stored online or on your computer. They are bought and sold on various exchanges, including until recently Mt. Gox (whose troubles have been reported for a few weeks now).
There are many reasons, some of them even lawful. Bitcoins can be regarded as a medium of exchange, an investment, a political statement...or a way of avoiding capital controls and other pesky laws like bans on drug trafficking and human smuggling.
But the criminal potential of Bitcoin is probably overstated. The Chinese have gotten wise to its use for avoiding capital controls. Using Bitcoin for criminal or fraudulent activity would be difficult at scale (PDF). The Walter White method is still far and away the best way to ensure your criminal proceeds retain their value and anonymity.
I don't share the utopian fervor for Bitcoin expressed in tech and libertarian circles (see, e.g., this supposedly non-utopian cri de coeur), but it may have some positive potential as a decentralized and lower-cost electronic payments system. We'll see if that ever gets off the ground.
In the meantime, the Mt. Gox collapse is pretty huge news for Bitcoinland. Unlike the NYSE (the failure of which would be hard even to imagine), Mt. Gox does not benefit from any systemic significance and thus is unlikely to receive a lot of official-sector help. The situation has some early adopters running for the Bitcoin exits, like this leading Bitcoin evangelist.
Despite (because of?) my agnosticism on the currency, I'll be writing more about Bitcoin soon. (Mainly, I wanted to stake a claim to being the first to write about Bitcoin on The Conglomerate.) If your Palo Alto cocktail party can't wait, however, this explainer (PDF) from the ever-impressive Chicago Fed should tide you over.
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Below you'll see the first of what I suspect will be many interesting posts from guest blogger Greg Shill. Do welcome him.
And here you'll see a neat graphic of the money that the big American banks are agreeing to pay to settle their financial crisis suits; the tl;dr is poor Bank of America! Here's USC's worthy effort to track all the settlements.
Greetings, Glommers! (and hello, Janet and Mario*!)
It’s an honor to join this extremely sharp and thoughtful community of corporate and commercial law scholars for the next two weeks. The Conglomerate has long been one of my favorite law blogs and it’s truly a privilege to walk among these folks for a time (if a bit daunting to follow not just them but Urska Velikonja and her excellent guest posts). Thanks to Gordon, David, and their Glom partners for inviting me to contribute.
By way of biographical introduction, I’m currently a Visiting Assistant Professor at the University of Denver Sturm College of Law, where I teach International Business Transactions and International Commercial Arbitration. Last year, I did a VAP at Hofstra Law School (and taught Bus Orgs and Contracts).
In the next few weeks, I’ll be exploring a number of issues related to law and global finance. I have a particular interest in currencies and monetary law, or the law governing monetary policy. Two of my current projects (on which more soon) address legal aspects of critical macroeconomic policy questions that have emerged since 2008: U.S. monetary policy and the Eurozone sovereign debt crisis.
Without further ado, I will take a page from Urska and kick off my residency here with a somewhat meta question: should scholars refrain from writing about legal issues in macroeconomics, specifically monetary policy?
One thinks of monetary policy decisions—whether or not to raise interest rates, purchase billions of dollars of securities on the secondary market ("quantitative easing"), devalue or change a currency—as fundamentally driven by political and economic factors, not law. And of course they are. But the law has a lot to say about them and their consequences, and legal scholarship has been pretty quiet on this.
Some concrete examples of the types of questions I’m talking about would be:
- Pursuant to its dual mandate (to maintain price stability and full employment), what kinds of measures can the Federal Reserve legally undertake for the purpose of promoting full employment? More generally, what are the Fed’s legal constraints?
- What recognition should American courts extend to an attempt by a departing Eurozone member state to redenominate its sovereign debt into a new currency?
When it comes to issues like these, it is probably even more true than usual that law defines the boundaries of policy. Legal constraints in the context of U.S. monetary policy appear fairly robust even in times of crisis. For example, policymakers themselves often cite law as a major constraint when speaking of the tools available to the Federal Reserve in combating unemployment and deflation post-2008. Leading economics commentators do too. Yet commentary on “Fed law” is grossly underdeveloped. With the exception of a handful of impressive works (e.g., by Colleen Baker and Peter Conti-Brown), legal academics have largely left commentary on the Fed and macroeconomics to the econ crowd.
A different sort of abstention characterizes legal scholarship on the euro crisis. Unlike the question of Fed power, there is a burgeoning literature on various “what-if” euro break-up scenarios. But this writing tends to focus on the impact on individual debtors and creditors, not on the cumulative impact on the global financial system. Again, the macro element is missing.
It is curious that so many legal scholars would voluntarily absent themselves from monetary policy debates. The subtext is that monetary policy questions are either normatively or descriptively beyond the realm of law. If that is scholars’ actual view, I think it is misguided. But maybe the silence is not as revealing as all that.
- One issue is sources. You will not find a lot of useful caselaw on the Fed’s mandate or the Federal Reserve Act of 1913, and the relevant statutes and regulations are not very illuminating. Further, it’s a secretive institution and that makes any research (legal or otherwise) on its inner workings challenging.
- Another issue is focus. Arguably the natural home of legal scholarship on domestic monetary issues, for example, should be administrative law. But the admin scholarly gestalt is not generally as econ-centric as, say, securities law. Meanwhile, securities scholars tend to focus on microeconomic issues like management-shareholder dynamics.
- A final possibility, at least in the international realm, is historical. After World War II, Bretton Woods established a legal framework intended to minimize the chance that monetary policy would again be used as a weapon of war. The Bretton Woods system collapsed over forty years ago, the giants of international monetary law (Frederick Mann, Arthur Nussbaum) wrote (and died) during the twentieth century, and now even some of the leading scholars who followed in their footsteps have passed away. At the same time, capital now flows freely across borders and global financial regulation has become less legalized in general. These factors plus the decline of exchange-rate regulations (most countries let their currencies float) may have undermined scholars’ interest in monetary law. But as the ongoing euro saga demonstrates, international monetary law and institutions remain as critical as ever.
These are some possible explanations for why legal scholars have largely neglected questions of monetary law, but I’m sure I’ve overlooked others. What do you think?
*Pictured are Janet Yellen and Mario Draghi, chiefs, respectively, of the Federal Reserve and the European Central Bank.
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Better Markets is an advocacy group worried about the failure of the government to hold banks accountable for misdeeds that lead to the financial crisis. No problem there, I'm mystified by it myself, though there might be a normative case to be made for the policy, depending on how you feel about how the government treated Arthur Andersen and varous Enron executives during the last crisis.
But the group's suit against the government for violating separation of powers principles and FIRREA for settling with JPMorgan without filing the settlement with a court must have made the lawyers who filed the complaint a little nervous, in the "is this frivolous and will I get sanctioned?" kind of way.
Are you depriving courts of their Article III jurisdiction if you settle a case, instead of trying it to completion (and presumably then filing an appeal)? Owen Fiss thought so, in an article that I really love, but perhaps we should put the piece under the "seminal Yale thought experiment" rubric.
Settlement isn't exactly unprecedented in our federal system. Sometimes the government announces that it won't be defending a statute like DOMA in court, thereby depriving the judges of their Article III powers to assess the constitutionality of the law. Sometimes it changes policies when a powerful senator complains, thereby depriving Congress of its Article I right to reverse the executive branch's overreaching through legislation. And sometimes it enforces statutes - Title VII is an example - that deprive millions of potential plaintiffs of their right to file constitutional suits, in that case invoking the Equal Protection Clause. Sometimes, it also just settles cases before they go to trial, just like every other institution in America.
And yet somehow these dramatic examples of executive branch overreaching have never resulted in a colorable separation of powers claim. Indeed, separation of powers claims are almost never colorable; as a rule of thumb, they are step one towards losing a lawsuit, because they can be made about all cases, which is basically the same thing as saying they can be made about no cases. I'm generally not a fan of holding the government to particularly different standards than, say, Amnesty International, but even if you feel differently, you might do so because of the government's criminal powers, which the JPMorgan settlement doesn't involve.
The FIRREA count isn't a whit better, by the way. FIRREA authorizes the Attorney General to file suits against banks who violate the substantive principles of that banking statute. But just because a statute permits such litigation hardly means that it means that courts will be reviewing the AG's decisions as to whether to bring a case under it or not. THAT would be a separation of powers problem; courts would get to micromanage every decision whether to prosecute a case, supposedly one of the most core executive branch functions there is. Just ask Justice Scalia.
And don't even get me started on whether Better Markets has standing to sue over a settlement between the government and some other party that has nothing to do with Better Markets.
I asked my colleague, Mehrsa Baradaran, to comment on some recent news out of the USPS. Here are her excellent insights:
Two years ago, I wrote an article about how the poor are not being properly served by the banking sector, suggesting the outlandish idea that the U.S. Postal Service could help by offering loans and other financial services. Imagine my delight this week when the Office of the Inspector General of the USPS came out with a white paper suggesting more or less the same thing! Immediately, American Banker called it the“worst idea since Edsel.” (the infamous Ford marketing disaster). The main criticism is that the USPS should focus on what it does best (er, or more accurately, what it does) and that it’s dangerous to let non-banks provide bank-like services. (Sound familiar?)There are good reasons to be concerned about the USPS entering financial services. We certainly would not want to create another federally subsidized GSE. And we may need to be convinced that a bloated government agency that’s been hemorrhaging tax dollars for years can run anything well. However, there are several hurdles to banking the poor that the post office can uniquely overcome.
So in the spirit of buzzfeed lists and magazine covers, here are the top 5 reasons that postal (non-)banking is a great idea whose time has come:
1. Location, Location, Location: When mainstream commercial banks and thrifts started facing intense market competition in the 1970s and 1980s, they deserted low-income neighborhoods en-masse and basically stopped lending there. This is what the Community Reinvestment Act (CRA) is meant to address. When the banking establishment left, the fringe banks moved in. In many low-income neighborhoods, payday lenders are the only establishments offering credit. But you know who is still there? That’s right, your local post office.
2. Your local post office is more inviting than your local bank: Another documented reasons the poor avoid banks is that they feel certain race/class/language barriers--they just don’t feel comfortable there. Payday lenders are different—they have a façade of informality (which masks their large corporate structures). They speak your language and are located in the strip mall you frequent. The post office doesn’t have a stiff formality like most mainstream banks and can overcome some of these cultural barriers because it serves a diverse array of customers.
3. Postal banking used to happen in the US and still happens abroad: President Grant suggested and President Taft initiated post office savings accounts in the early 1900s. The Postal Savings accounts were created and geared to recent immigrants and the unbanked poor, and were widely successful—at the end of the first year, there was a total of $20 million in deposits, most of which had been coaxed out of hiding. Many other countries use their postal service to provide credit and savings to their citizens (though not necessarily the poor), including: Japan, Germany, China, Brazil, Israel, France, Korea, India, South Africa, Kenya, and Sri Lanka.
4. They would fill a market gap: A recent FDIC study found that over half the population could not access $2000 in the event of an emergency and that about 30% is either unbanked or underbanked. In fact, this problem is at the top of the FDIC’s agenda this year. Banks do not offer the types of small loans the poor need--it’s just not profitable. For a bank, the cost of making a $1000 loan or a $100,000 loan is the same, but the returns on the latter are much greater. On the flip side, loans from payday lenders, with an average interest of 500%, are very costly to those who need them. Even check-cashing can cost the unbanked up to 5% of their paycheck (even if your paycheck is issued from the US military and is risk-free). A few corporations, like Wal-Mart, are beginning to offer basic financial services, but they are nowhere near market saturation. If the USPS can offer small loans and other simple transactional services at lower costs, they don’t put anyone out of business and they fill a real market need. How can they do this? (1) I don’t buy the argument that the poor are too high of a credit risk to serve--you just need to price for the risk. But the premiums charged by the fringe banks are just too high--as demonstrated by the fact that they are so profitable that many large banks have invested in these charters to boost their own revenue). (2) The post office can offer these services at a much lower cost because it would be using the infrastructure it already has with little marketing expenses and a large customer base. Yes, all these things are federal subsidies….and I’m perfectly comfortable with that.
5. The government should facilitate and subsidize access to credit for all people. Let’s face it, our banking system has always been and will always be a heavily-subsidized sector. And a big justification for these subsidies is that the populace gets something in return--I’ve called it a social contract. The state supports banks because we need them to provide credit, which allows companies and individuals to improve their economic position. But unfortunately, most of these subsidies (especially in the form of bailouts) flow to the largest banks who are not serving most of the public. Nor should we force them to; their job is to maximize profits for their shareholders and past attempts at enlisting large banks to service the poor have failed. So we have two banking systems: a subsidized one for the rich and middle class and the “wild west” for the poor. It wasn’t always this way. Credit Unions and S&Ls used to be subsidized by the US government to provide credit to the poor, but they stopped doing that a few decades ago. Since then, our government continues to subsidize banks, but those subsidies are not making their way to those who most need banking and credit services. This gap of services to the poor is a relatively new phenomenon and one that I believe the USPS should help to fill.
This proposal will likely garner significant opposition from the banking industry and from the payday lenders (see e.g. the media and lobbying firestorm surrounding Wal-Mart’s proposal to enter banking). But I, for one, am hoping that someday I can go cash a check at the post office on my way to UPS to drop off a package (the lines are much shorter).
Chris Brummer has a column over at Project Syndicate with some proposals for improving an increasingly frayed relationship. You'll have to head over there for the prescriptions, but here's his encapsulation of the problem:
Radical disparities between the rule-making cultures of the US and the EU are exacerbating the problem. Unlike the US, where independent agencies lead the rule-making process according to Congressional dictates, legislative actors in Brussels and Strasbourg – the European Commission, the European Council, and the European Parliament – set regulatory agendas and write the rules. And, though EU agencies like the European Central Bank are assuming an increasing share of regulatory responsibility, divergences in decision-making procedures continue to affect the rate and nature of transatlantic coordination.
Making matters worse, market and monetary reforms have occasionally merged, with rule-making becoming partly dependent on the decisions of disparate agencies and institutions. Meeting enhanced Basel III capital standards, for example, is about more than just rules; it requires the recapitalization of banks – a process that is taking longer in Europe than in the US, partly because the eurozone has had to negotiate funding mechanisms for banks and cash-strapped governments. Now these delays are raising doubts in the US about the EU’s commitment to reform.
Well worth your time, if you think that this sort of regulatory diplomacy is an increasing feature of financial supervision....
Nathaniel Popper’s story this week in the New York Times on the state of banking Iceland underscores how history makes a mess of neat divisions between financial crisis containment/resolution on the one hand and financial regulation for crisis prevention on the other. The Times article does not delve extensively into Icelandic regulation, but this report outlines some of the dramatic changes in that country’s financial regulatory architecture since 2008 (see pages 17-21). Iceland chose to let banks fail, and its financial services sector and its approach to regulation continues to reflect that choice.
The following insight may sound obvious to the uninitiated: the path that a country chooses to deal with a financial crisis shapes the course that regulation will take after the crisis ends. Even so, there remains a stark divide in scholarship between the study of regulation in normal times and the management of financial crises in not-so-normal times. Management of a financial crisis reflects not just ad hoc decision-making under fire, but also clear policy and value choices of what the legal landscape should look like when the earth stops shaking.
This story with respect to the United States can be told with much more nuance than simply equating the bail-out of big banks with the government green-lighting business as usual on Wall Street. Disaggregating the “bailout” into its constituent parts – not just TARP, but also a series of bespoke interventions and an array of Federal Reserve facilities – reveals the extraordinary lengths the government went to in order to preserve the shadow banking system (a topic I’ve been writing about for a while and that appears in my new book) as it was.
Christian Johnson’s chapter on the Federal Reserve and Section 13(3) (which appears in this excellent edited volume) provides a travel guide to these government interventions. Consider the least known aspects of the government intervention, the Federal Reserve facilities that provided guarantees and liquidity to various financial markets during the crisis. Chewing through the letters of this alphabet soup – from ABCPMMMFLF (asset-backed commercial paper money market mutual fund liquidity facility) to TALF (Term Asset- Backed Securities Loan Facility) – it becomes clear that the government attempted to save securitization, money-market mutual funds and other shadow banking markets. How did the Federal Reserve accomplish this? It created complex structures that essentially replicated the mechanics of shadow banking. In essence, the government became sponsor to one after another mammoth securitization vehicles.
And now the Economist tells us that securitization is back!
What’s the problem? To start with, with these interventions, the government essentially adapted the same tools governments have used to fight banking crises throughout history to fight the (the first (so far)) shadow banking crisis. What were the government interventions – both equity infusions, loans, and guarantees – if not deposit insurance for shadow banking investments, the government acting as liquidity-provider-of-last-resort to shadow markets, and the government resolving institutions that failed because of shadow banking investments. However, the government offered all these forms of relief without acting like a bank regulator – charging an appropriate premium for insurance or loans or wiping out shareholders of failed institutions.
So we had a shadow system that performed the same functions as banks, posed the same risks as banks, suffered runs and failed just like banks, was rescued just like banks, but was never regulated like banks. (For more on the role of regulation in fueling the shadow banking bubble, see Chapters 10 and 11 of my book).
And now that securitization has returned, the continuing failure of financial reform to address the risks of shadow banking has become even more worrisome. What me worry? We can’t have another crisis so soon after a bubble popped? The financial industry and its advocates hate the term shadow banking. Why? Because disaggregating the financial crisis into various technocratic failures, allows them to say the problem has been fixed by the bubble gum (pun half-intended) and shoe string patchwork of financial reforms, and even to argue that this patchwork goes too far.
To return to lesson of Iceland: the course of financial reform may have been set in the first responses to crisis management. We could see that the government wanted to preserve shadow banking. And a second lesson from Iceland: the government’s success in preventing a deeper crisis likely took the political wind out of the sails of deeper and more effective financial reform.
After over four years of work, my book Law, Bubbles, and Financial Regulation came out at the end of 2013. You can read a longer description of the book at the Harvard Corporate Governance blog. Blurbs from Liaquat Ahamed, Michael Barr, Margaret Blair, Frank Partnoy, and Nouriel Roubini are on the Routledge’s web site and the book's Amazon page. The introductory chapter is available for free on ssrn.
Look for a Conglomerate book club on the book on the first week of February!
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