March 22, 2016
Book Club: Peter Conti-Brown’s Response - Is Democracy Good For The Fed?
Posted by David Zaring

My thanks to my inimitable friend and colleague David Zaring for hosting this book club and for inviting me to respond. It’s a real pleasure to be back among the Glomerati—my first venture into academic blogging was on these digital pages back in 2011, including a real-time record of my finding the primary source for the “punch bowl” metaphor that figures so prominently in my book. I still love those stories about Stanford’s Erika Wayne, equal parts document sleuth and librarian.

I wanted to write a few responses to the excellent posts from David, Matt, and Usha and in the process write a bit more about what I see as the central intellectual puzzle of Federal Reserve independence, governance, and accountability, which is this: how can such a technical field benefit from democratic processes without corrupting the entire enterprise? As I wrote, I realized I was going to end up droning on and on, so I’ll keep this a bit more limited than the quality of these responses warrant.

This framing gets at the pith of Matt’s first post. He asks, “is it okay to ‘Bork’ a Federal Reserve appointee?” This question can be broken into two—should there be a more searching assessment of Fed appointees subject to the Appointments Clause, and what is the standard at which the senatorial consent should be withheld?

On the first, I think the answer is a resounding yes, with one clarification. The more searching assessment I would hope to see would not necessarily be at the Senate level alone—we’ve had plenty of closed-door politicking on Fed appointments that have led to some extraordinary appointments and also some very regrettable decisions. On the unfortunate side, I’m thinking of Senator Shelby’s decision to block Peter Diamond from a Fed governorship because Diamond was “unqualified,” just as he received the Nobel prize in economics. I’m thinking, too, of the regrettable—and hopefully temporary—decision to “pair” Fed appointments on a partisan basis, such that Jeremy Stein (a Democrat) could only get through the Senate with Jerome Powell (a Republican), despite no partisan balancing requirement in the Federal Reserve Act. We don’t need more Senators trying to play fast and loose with Fed appointments; we need more public attention on these appointments.

An example of this that I find exactly in line with my vision of a successful public engagement on the Fed was in the summer of 2013 when the Obama Administration leaked that the president was considering Janet Yellen and Larry Summers for the Fed Chairmanship, and leaned Summers. The reaction was swift and very public: from every corner of the democracy came searching assessments of these two proto-candidates’ personalities, histories, ideologies, expertise, and more.

At the time, some lamented this attention to the Fed from outside the temple of full-time Fed watchers as corrosive and lamentable. I think they are exactly wrong. There was plenty of frivolity, gossip, and consideration of extraneous factors in the public vetting we saw in Yellen vs. Summers. But the level of public attention was also impressively substantive. My favorite example in this phenomenon was the non-ironically titled “Seventeen academic papers of Janet Yellen’s that you need to read.” (Full disclosure: I used to work indirectly for Summers at Harvard and continue to have enormous respect for him.)

To Matt’s first question, then, I would like to see more of this kind of public attention to these appointments. The authority of the Fed governors is extraordinary. It’s important that the public have a role in selecting them so that their values are as known as they can be.

To the second question—when should Senators reject a candidate?—I’ll confess something that may make my liberal friends cringe. I’m not convinced that Robert Bork himself should have been Borked. I would prefer a model of Senatorial advice and consent that looked much more like a brake on cronyism than on a sustained attack on a candidate’s (or the sponsoring Administration’s) politics. The Senators’ role, then, is to prevent presidents from rewarding their talentless but politically or financially connected friends with jobs that require policy expertise. It’s not to attempt a redo of our most essential of institutions, the quadrennial presidential election.

To take Supreme Court history (not to say the Supreme Court present) as an example, there was simply no question that Bork was qualified to sit on the court, even if his values and judicial philosophy (and beard?) were out of sync with the Democratic and perhaps American majority. But minus the beard, what about Bork was different from Antonin Scalia, who sailed through the nomination process? Not much that could be known at the time. And it’s not clear to me that the kind of judging we see in the jurist who took Bork’s place—Anthony Kennedy—is better for our democratic institutions, even as I have endorsed and celebrated some of the outcomes in cases that make Kennedy so famous.  

If I were a Senator in 1987, then, I would’ve voted for Bork and then sought to campaign hard in 1988 to say that while qualified, we needed justices of a different philosophy much more likely to be sponsored by a Democratic president than a Republican one. At the same time, I would’ve felt more comfortable voting against Abe Fortas (given the air of scandal and undue proximity to President Johnson) and felt very comfortable voting against Nixon’s nomination of Harrold Carswell (about whom—in his defenseSenator Roman Hruska said “Even if he is mediocre, there are a lot of mediocre judges and people and lawyers, and they are entitled to a little representation, aren't they?”). Qualifications, not politics.

It’s the same analysis for the Fed. There are a few Governors who I think should not have been nominated given their abundant lack of anything except a connection to the President. And as mentioned, there are others who were dinged because of their perceived politics despite sterling credentials. I would want to see more public attention on the expertise and less of the politics, recognizing with Churchillian sobriety that the democratic process will lead to all kinds of regrettable excesses. It’s just better than anything else we might design to take its place.

On Matt’s other post, his hypothesis that “Fed appointees cannot have the expertise necessary to do their job without also being wed to some of the economic and banking orthodoxies that led to the 2008 financial crisis,” I say that we should have that debate. Not just in the Senate Banking Committee hearing room, but in the blogosphere, editorial pages, academic conferences, and around the water cooler. Let’s inquire about what a potential Fed Governor believes about the world and the Fed’s place in it before we hand over a vote that can influence the development of the global economy. The stakes are just too high to leave it to backroom deals. And this is the overarching point: politics is already happening in and around the Fed. To pretend otherwise is fantasy. The question is whether those politics will be little-d democratic or whether they will be something else.  

David highlights the essential importance of looking beyond traditional methodological or institutional paths in trying to get a sense of how agencies work in practice. Like anyone, I’m likely to overemphasize my own methodological approach over others. For example, I am decidedly skeptical that indices of central bank independence coded on the basis of central bank charters tell us much of anything. I think the question of “independence”—to the extent it’s a coherent question at all—is better explored through the methods of narrative history rather than quantitative econometrics. But that’s the point: we need to have multiple approaches in case my view is filled with blind spots and otherwise limited—narrative history isn’t great for doing a 100-nation study, for example.

Finally, I’m delighted Usha brought in her excellent perspective on “fetishization” of independence, an article that has shaped my thinking over the years. I think she’s exactly correct. I’d even go a step further and say that the term itself is devoid of much or any analytical content. Part of my aim in this book is to prompt readerly skepticism anytime anyone—whether in defense of the Fed or in attack—invokes “independence” as the support for their proposition. As I argue at length, and as Usha makes clear in the corporate governance context, Fed independence on the ground is not what those who rely on it have supposed it to be. 

Again, my thanks for taking the book seriously and providing a wonderful forum for discussing it.

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March 19, 2016
Book Club: The Independence Fetish
Posted by Usha Rodrigues

In The Power and Independence of the Federal Reserve, Peter Conti-Brown has written an accessible book about the Fed.  Did you catch that?  I'll say it again: Peter Conti-Brown has written an accessible book about the Fed.  More than that, the WSJ calls it "riveting."  And it is--especially for those of us corporate types who have always had the feeling that we should understand the workings of the Fed a lot better than we actually do.  So, go read the whole thing.  For now, I'm going to focus on that resonant word in the title, independence.

We Americans are used to thinking about independence as an unalloyed good.  Heck, we even have an independence day.  But independence one of those concepts defined by what it is not--like good faith, it's an excluder (see Robert Summers' work).  The key question is, independence from what?  In corporate law, we're concerned about independence from conflict of interest.  In the Fetishization of Independence I contrasted the static view of director independence taken at the federal level (in statute and the exchange rules) with the more dynamic, situational definition of Delaware.  While I stressed the difference between these two notions of independence, both jurisdictions are ultimately concerned about a lack of conflict.  

Not so the Fed.  Conti-Brown begins his book by articulating what he calls the Ulysses/punchbowl view of Fed independence: that the Fed must be independent, like Ulysses, tied to the mast to resist the siren song of public demand for easy credit.  Or like "the chaperone who has ordered the punch bowl removed just when the party was really warming up."  The Fed needs to independent of political pressures so that tipsy citizens don't pressure it to introduce easy money policies that lead to high inflation. Thus, independence in Fed terms means "independence from political control"--not from a conflict of interest.  Still, we have definition by absence rather than positive attribute in both cases.

As with corporate law, the inherent irreducibility of independence leads to problems.  The basic problem is the same: how can one reliably verify the absence of something?  There are two problems with this notion of Fed independence that Conti-Brown identifies in his book that I'll highlight here.  The Ulysses/punchbowl conception of independence assumes that sirens and partygoers always act a certain way.  The problem was, the sirens weren't singing on cue in the wake of the 2008 financial crisis, and not all the partygoers were lurching towards the punchbowl of easy money.  Indeed, as Conti-Brown colorfully puts it, "After the crisis, the Fed was in the position of trying to get a bunch of wallflowers to take tequila shots."  The Fed faced political backlash for its quantitative easing policy from Rick Perry among other politicians.  And during the crisis the Fed, far from standing aloof from politics, coordinated closely with Treasury on a response. This coordination, Conti-Brown argues, is perfectly appropriate.  But it illustrates the paucity of the Ulysses/punch bowl metaphor and justification for the Fed's independence. 

The second problem is that independence from political pressure isn't an unmitigated good--it also means insulation from accountability, as Dave and Matt have already mentioned.  I've been thinking a lot about when and why Congress delegates authority (on which more later).  Conti-Brown makes a strong case that the process by which the presidents of the regional Feds are selected is unconstitutional, because of the executive's lack of power to appoint or remove them.  The incredible discretion that the Fed wielded in applying Section 13(3) of the Federal Reserve Act during the 2008 crisis is another example of the Fed's freedom to operate--it could use vague statutory language and lawyerly justifications to lend to Bear Stearns and AIG but not to Lehman Brothers.  A mere 2 years later, with Dodd-Frank, Congress  delegated still more discretion to the Fed--ultimately, to its economists and lawyers, who make "judgements about the permissible scope of banking cities and the requirements of law that are not exclusively, perhaps not even mainly, technocratic.  They reflect the values of the people making them." (By the way, Conti-Brown is very, very good at bringing to life the people of the Fed--Greenspan, Volcker and Bernanke, yes, but whistleblowing examiner Carmen Segarra as well. And who knew O. Henry worked as a bank examiner?).  But I digress.  The main point is, independence from political control and may be wise policy (but see the problem one above).  And it might be expedient to delegate tough questions to the discretion of the central bankers and their lawyers and economists.  But it's not a democratic form of government. 

Ultimately I'm left with independence in the Fed context as being as empty a concept as it is in the corporate world.  Maybe we agree that we want independent corporate directors and independent bankers because it's easy.  Certainly it lets us ignore the meatier question of what we should affirmatively expect of the individuals in these roles.   

 

 

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Book Club: Staff Against Governors At The Fed
Posted by David Zaring

How much of what the Fed does is controlled by its political leaders?  Peter's book makes a case for "less than you would think," and I am generally persuaded by such stories.  He's got some great color here.  The general counsel of the Fed, for example, has held that job for about two decades, and you'd never see that anywhere else in Washington.  Ted Truman, the head of the Division of International Finance, was the person who did the Fed's international relations, occasionally in consultation with the Chair.  Truman "thought he was the guardian of the gate," observed on Fed governor, with a tone of what sounds like frustration.  Peter documents how influential these "barons" of the agency are in setting policy.  And that doesn't even get into the ways that economists can moderate the range of acceptable choices to be made in places where it does look like the political leaders of the Fed play an important role - monetary policy.

It all rather reminded me of this.

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March 18, 2016
Book Club: Balancing Technocracy with Democracy
Posted by Matt Bodie

A thesis: Fed appointees cannot have the expertise necessary to do their job without also being wed to some of the economic and banking orthodoxies that led to the 2008 financial crisis.  This is just a thesis, and perhaps a demoralizing one at that.  But I wonder if the "sweet spot" of wise and industry-independent Fed folks that Conti-Brown seems to be aiming at actually exists.

Just to elaborate: one of the great strengths of The Power and Independence of the Federal Reserve is its portrait of the culture within which the Federal Reserve operates.  It is a culture dominated by bankers and economics Ph.Ds.  To a significant extent, this makes sense -- much of what the Fed does is incredible sophisticated and requires a great depth of expertise.  Indeed, as Conti-Brown persuasively argues, the Fed needs a lot of discretion because it needs to be nimble and creative in applying its various powers.  And this discretion requires an understanding of how to use it.  At the same time, Conti-Brown persuasively describes the influence of private bankers, international central bankers, and economists in shaping the Fed's use of its power.  And these communities have strong ideologies as to many of the critical policy issues that face the Fed.  So a reformer may not have anyone with the know-how to run the Fed that actually has the background and understanding of the Fed to keep the economy humming.  In other words, technical expertise may be inexorably intertwined with certain ideological commitments.

My thesis here may be seen by reformers as an undue elevation of technical "expertise" that ends up with a unending cycle of insiders shuffling through the system to maintain the status quo.  Bankers and economists want to convince everyone that only they can run the economy so that they can keep things the way they are.  But it is undoubtedly true that the Fed could really fly off the rails if it was run by an amateur or an ideologue who doesn't respect what it does well.  I'm a believer in the idea that the 2008 Crisis would have been a lot worse if the Fed and Treasury folks did not reach out to save our financial institutions, in ways that the average voter finds offensive or ludicrous on their face.

So ultimately, my thesis is more of a question: how do we avoid ideological capture at the Fed without sacrificing the knowledge and experience that are required to run it?  And to provide another angle on this question: who would Bernie Sanders appoint to chair the Fed?  Or who would Rand Paul appoint?  Both have shown deep suspicions for the Reserve.  On the Sanders side, Joseph Stiglitz comes to mind as a potential appointee.  But is he enough of a reformist for the reformers?  And how deep is the bench behind him?

Conti-Brown does seem to believe that there is potential middle ground between industry capture and populist naivete.  I'd be interested to hear more about this in specific terms -- where is that ground to be found?

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March 17, 2016
Book Club: How Does The Fed Actually Work, And How Can We Tell?
Posted by David Zaring

Peter's book on the Fed represents, among other things, a take on how you figure out what a particular government institution is up to.  You could try to do this quantitatively, especially if the part of the Fed you care about sets interest rates.  What market conditions predict what the Fed is going to do?  You can also do this by going big history, and critical as a matter of policy.  That's what Alan Meltzer has done in his two volume history of the Fed, which processes an enormous amount of archival information - minutes, policy papers, etc - to describe what the Fed has done.  These days, Meltzer often finds something to criticize.  You could also try to understand it purely as a weird culture, which it very much is.  Central bankers all talk to one another, only really do central banking throughout the course of their careers, have Ph.D.s in economics, and stay close to the discipline (but not too close! you write a couple of good articles, and then stick to policy with modest empirics.).  It's a super insular, almost quintessentially technocratic community.  Or you could simply look at its legal authority and examine its rules and orders.

I take Peter to be suggesting that none of these approaches could, if taken alone, provide you with a full picture of how the Fed works.  One of the themes that runs through the book is that consideration of the law alone would lead observers to think that members of the Board of Governors are insulated and empowered, when in practice, they cycle through the Fed quickly, and presidents get to appoint many of them.  The culture of the Fed, or at least Fed-watching, on the other hand, reifies the Fed chair, and the FOMC, without paying attention to the truly powerful Fed staff, who never leave, even as their leaders revolve away.  Finally, Peter rejects the idea that the Fed is a technocratic exercise in the abstruse, but a place where powerful value judgments are made, and so therefore worth some measure of accountability - Matt talks about that.  The Fed is much more than a vehicle for monetary policy, as we found out during the financial crisis, and encapsulates a disturbingly large number of bureaucratic actors - Peter is particularly critical of the continued existence of the regional federal reserve banks, and with good reason.

I admit that I prefer these sorts of mixed method accounts, on the assumption that more inputs probably creates a more accurate output.  It does complexify things, to be sure.  But the Fed is a complex beast, and pretending it is anything but is disengenously reductionist. 

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March 16, 2016
Book Club: Is it okay to "Bork" a Federal Reserve appointee?
Posted by Matt Bodie

I wanted to start off our book club on Peter Conti-Brown's engaging and thoughtful book, "The Power and Independence of the Federal Reserve," with a quick reference to the big news of the day.  One of Conti-Brown's key points is that we should care more about the people who run the Fed -- their backgrounds, educations, ideology, and policy goals.  In making his point, Conti-Brown draws a comparison between the appointment of the Fed chair and the process underway (or maybe not so much underway) with Judge Garland:

Just as senators spar with judicial appointees over the latter's views on, say, abortion or the death penalty, they should expect (and, hopefully, receive) insight into what the central bankers' views are on such ideas as the monetary policy rules, forward guidance, and the other theoretical and empirical components of influential topics in macroeconomics.  (p. 235)

Conti-Brown also argues that Fed appointments should be more politicized, as such attention provides "a tremendous amount of insight and accountability to how much personalities matter in shaping the power and policies of the Federal Reserve System."  (p. 240)  Personalities matter because the Fed's power is by design flexible and difficult to cabin with specific rules or regulations.  At the same time, some level of democratic oversight is necessary to prevent industry capture (or, at least, industry culture capture) or unexpected policy shifts from occurring.  Along these lines, Conti-Brown also argues that the President should have a broader power of appointment over a larger number of Fed staff members, particularly the general counsel.

I just wanted to press a little bit on Conti-Brown's point and ask: to what extent should the Senate exercise its own discretion in reviewing appointments to the Fed?  As Conti-Brown skillfully illustrates in his historical discussion, the Fed must walk a tightrope between a lack of accountability to the people, on the one side, and too much accountability on the other.  Many commentators have bemoaned the rising visibility of the Fed's role in the economy, in fear that populism and politics may lead the Fed astray.  Similar arguments have been raised about the Supreme Court appointment process: namely, that nominations have become too political, too ideological, and too heated.  Those Senate Democrats who rejected the nomination of Robert Bork are often blamed for this development.  "Borking" has become a verb that means to pillory a judicial nominee for her or his ideology in an over-hyped and inflammatory manner.

So my question is: to what extent should the Senate be allowed to "Bork" a nominee to the Fed?  What discretion should Senators have in voting down a president's nominee for Fed chair?  Conti-Brown wants more accountability, participation, and politicization.  But I'd be interested in hearing how big a scoop he is looking for.

I was amused when Kai Ryssdal opened "Marketplace" with "Garland, Yellen -- Yellen, Garland . . . We're going with Janet Yellen every single time!"  At least when it comes to Ryssdal and his program, the Fed gets more attention than a new Supreme Court nominee.  My guess is that Conti-Brown approves!

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Book Club For Peter Conti-Brown: The Power and Independence of the Federal Reserve
Posted by David Zaring

We're going to put together a few takes on Peter's excellent book on the Fed.  He's an invaluable colleague of mine and an already prolific scholar on financial regulation.  Stay tuned for some views from us on his book, here's the Wall Street Journal's take, to whet your appetite.

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December 03, 2015
How the Other Half Banks: Accept the World or Change It?
Posted by Usha Rodrigues

First, it’s impossible for me to be objective about HTOHB. I remember 2 years ago at Ted’s Most Best (yes, it's good local pizza with a kid-friendly sandpit, yes that's its name) telling Mehrsa to submit an editorial to the NYT about postal banking. I remember sharing her elation at the editorial’s publication, and of her book contract. I’ve been on the sideline cheering this book for a long time, and I’ve watched its reception with pride and pleasure. Funnily enough, however, I never actually read it in draft form, although we’ve spoken about aspects of it over the past two years, so I've been eager for an excuse to take it up.

My overall first impression was: This isn’t your typical academic book. This is an unabashed cri de coeur, with a tone of barely concealed anger and urgency. It’s a book with a message much broader than advocating for postal banking although, that being the culminating chapter, that is where the reviews have focused. HTOHB is describes and diagnoses the current banking problem facing poor and middle-income Americans, contextualizes that problem historically, and proposes a solution.  The funny thing--and it may well be a calculated move--is that the solution addresses so little of the problem.

First, on the descriptive: Even though I consider myself a fairly educated banking reader, I learned a lot. Like that there are more payday lender storefronts than Starbucks and McDonald’s combined. Wow.  Like my co-bloggers I found her description of the role of regulation in banking compelling. She skillfully rebuts the arguments of those who would blame the financial crisis on the CRA or on greedy and improvident subprime borrowers. 

Second, the book leaves me feeling sorry for the big banks. Given the world that they live in—and yes, they created via lobbying and campaign contributions—they’re stuck. They just can’t afford to let the poor bank with them. Let’s take overdraft fees. They’re close to my heart, because once upon a time, in a moment of youth, inattention and temporary low bank balance, I swiped my bank card instead of my credit card and wound up overdrawing my account. I fumed at the overdraft fee, but knew it was my mistake.

Overdraft fees look a lot worse these days. Mehrsa describes one customer who received a notice of 5 transactions ranging from $4.35-$39.46 for which there was not enough money in the account. Bank of America reordered the withdrawals so that the highest withdrawal was taken out first—without that manipulation, there would have been 2 overdraft fees, instead of 5. At $35 a pop, these added up to $175, or an interest rate of 3,335%. And fresh fees are assessed each day you’re overdrawn. And now apparently banks pool their data in a ChexSystems database and banks will decline account applications because of them—97.5% of the denials are from this kind of “account mishandling,” and just one overdraft can cut you off from conventional banking for years.

What this story makes clear is that, although the banks are imposing punitive fees on these borrowers, they're not trying to make a business of it--they're trying to drive them away.  Although the percentage profits are high, these absolute dollar numbers are just too small to be worth it for the big banks. 

Do you remember back in 2010 when Bank of America tried to institute a $5 debit card swipe fee? It sparked a social uprising, including a “Bank Transfer Day” where people were urged to take their money out of big banks and put them in small banks and credit unions. President Obama weighed in against the outrageous fee.  But I remember feeling sorry for BoA at the time—it was responding to regulation in Dodd-Frank and imposing an upfront fee, just like it was supposed to. Political firestorm followed.  What was the lesson big banks learned?  Keep the fees on the downlow, and no one gets hurt.  And if the fees aren't enough to make the business profitable, the only alternative is to get out of the business.

So ultimately I guess I'm with Matt, who said this much better: that there's "an ambivalence that underlies a lot of the book.  Yes, banks are making beaucoup bucks while safely within the arms of their government protectors. At the same time, however, they are just being what they were designed to be: profit-making businesses operating within a market." Mehrsa tacitly accepts the status quo and works within it to argue for postal banking.  But her larger argument, particularly the larger historical narrative, seems to support a much more radical rethinking of government's support for banking.  Mehrsa starts off with a shrewd move, nodding to history by pointing out that debate about banking’s identity and core function dates back to the founders, with the Hamilton central banking model at odds with Jefferson’s localism and suspicion of concentrated banking power. She makes clear in that chapter that the tension between consolidated and local banking is an age old one in our republic. She asserts in the first line of Chapter 1 that "One of the most important sand oft-forgotten truths about any banking system is that it simply cannot exist without the government."  Her overall narrative sets the stage for a larger rethinking of what we as a society expect of the banks our government enables to exist.  Well-written and engaging, this is a big and important book, with big implications--for postal banking, and for banking as an industry.

 

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December 02, 2015
How the Other Half Banks: Banking and Blame
Posted by Matt Bodie

I will echo the praise of the prior contributors: this is a really well-written book, packed full with insightful and accessible anecdotes, thoughtful analysis, and a strong message.  Like Christine, I was particularly interested in the middle chapters, as I worked on bank lending and Community Reinvestment Act issues with the Woodstock Institute prior to law school.  My former boss at Woodstock went on to work with South Shore Bank/ShoreBank, and I remember the real enthusiasm and optimism surrounding that bank and its mission.  But as the book points out, ShoreBank became insolvent in 2010 after being refused TARP funding.  The story of that bank's failure could be one of liberal cronyism and ideology run amok, or simply the collapse of an undiversified regional bank in the midst of an international financial breakdown.

The narrative is important and therefore contested because blame is important in this space.  The facts, marshaled clearly and thoroughly by the book, are undeniable: approximately 70 million Americans do not have a bank account or access to traditional financial services.  The services provided to the unbanked or underbanked are generally much more expensive and filled with costly penalties and fees.  At the other end of the spectrum, banks provide services to the well-off for reasonable prices and in turn are backed by a myriad of federal and quasi-federal protections.  The book makes a convincing case that our banking system is not a free market, but rather a highly-regulated market that is supported by the government.  And, due to a series of changes in the law over the last century -- ones that accelerated after the 1980s -- average Americans are much more likely to be left out of traditional banking services.

So who is to blame for all this?  The book essentially paints a picture of greedy banks shunning the poorer and less profitable consumers in flagrant disregard for their original, public purpose.  It is Jeffersonian in its approach: smaller is better, more local is better, community is better.  It is not wholeheartedly in this camp -- it acknowledges that large banks are more efficient, less vulnerable to regional conditions, perhaps better (and even cheaper) at providing certain services to certain clients.  And it also recognizes that banking services for the poor may not be that profitable (not profitable?) when conducted along the same terms as applied to richer folks.  But the central theme of the book, at least on my reading, is that banks have become unmoored from their public trust and are exploiting their special relationship with the government to capture the upsides of capitalism without the downsides.

So it is somewhat surprising that the book lets banks off the hook at the end by promoting a public option for banking, specifically postal banking.  The idea has a lot to recommend it, beyond even the problem of underbanking.  But it also raises a lot of questions.  Can the post office do what community banks couldn't?  Do we think post offices will do a better job of moving beyond the credit score to asses the "real" credit risks presented by each loan applicant?  Does the public really trust the post office?

But my more theoretical question is this: why should we let the big banks off the hook?  If the book had presented the problem of underbanking as a natural and understandable market failure, based on the inability of the poor to make traditional banking profitable for banks, then a public option would make a lot of sense.  But if banks are pulling a fast one here by shirking their public responsibilities , shouldn't we make them accountable?  The book's discussion of the CRA does a nice job of briefly outlining the history of the act, as well as the views of its supporters and critics.  But it left me wondering whether the CRA was doomed to failure, or whether it just hadn't been implemented with the appropriate teeth.  And I think this strikes at an ambivalence that underlies a lot of the book.  Yes, banks are making beaucoup bucks while safely within the arms of their government protectors. At the same time, however, they are just being what they were designed to be: profit-making businesses operating within a market.  

Perhaps, in the end, we'd rather solve the problem of underbanking than exact a just recompense from powerful economic and political actors.  Or perhaps we can square the circle by requiring banks to fund the public option with a special bank tax or fee -- something similar to the FDIC.  But I think a whole lot more people will be asking these questions thanks to Mehrsa's thoughtful, engaging, and provocative book.  Congrats to her on this terrific accomplishment.

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December 01, 2015
How the Other Half Banks: More of the Regulatory Story
Posted by Christine Hurt

Rarely does a fellow law prof's well-researched, well-written nonfiction book deserve as much attention as Mehrsa's book does.  In a very readable manner, the book gives all readers a window into the underbelly of banking.  HTOHB provides several contributions:  a brief history of banking, a broad overview of fringe banking and the high cost of being poor, a survey of governmental, market and philanthropic responses to the problem, and a proposal to implement postal banking.  The title is a nod to the middle chapters; an alternate title might be "How the Post Office Could Save Retail Banking." 

As someone who teaches The Law of Microfinance and has spent a lot of time in the economic development literature on microfinance, I was fixated on the middle chapters.  Microcredit and microfinance are proposed fixes to the ills of the unbanked in developing countries, and not enough time is spent discussing the challenges of the unbanked in the U.S.  Though being unbanked is difficult in a developing economy, being unbanked is becoming nearly impossible in our own cashless, electronic economy.  As Mehrsa notes, turning a paycheck into cash and then back into money orders and transfers for everyday expenditures is extremely inefficient and expensive.  If the book was Chapter 5 alone, it is worth the price just to see the daily toll being unbanked extracts.  The problems of the unbanked can be divided at least into two categories:  access to payment systems (the ability to write checks, make ACH transfers, use debit cards/ATMs) and access to credit (for either income smoothing or longer-term finance).  I say this because the solutions to each category may be different.  A payday lender may also cash checks and sell money orders; a microlender may only make small loans; a community bank may take deposits, make loans and sell financial products.  I believe that Mehrsa envisions the postal banking solution to address at least the most basic needs in each category:  payment systems, deposit accounts, and small loans.

One might envision unmet banking needs to be addressed by the market, government regulation or philanthropy.  Chapter 6 runs down the pitfalls in each.  Though I understand that postal banking may be the best of these solutions, I would push back a little on the reasons why neither the market nor philanthropy have fixed these concerns.  The one tension that will always be present in any solution is the tension between profit and protection.  As Mehrsa points out, commercial banks don't chase small depositors or borrowers because the profit margin isn't there.  But when the fringe market steps in, those players have the same math that big banks do.  So, interest rates have to be higher and so do transaction fees.  That may be enough to dismiss a market solution.  However, P2P businesses have tried to fill this niche with a different, cheaper model than brick-and-mortar businesses.  They seem to be meeting a need, but of course that is the need of people with access to computers and the internet and a bank account for funds to be wired into -- Lending Club cannot reach out and put cash into your hand.  However, one reason that the profit margins aren't there is regulation.  In talking to founders of P2P banking ventures, state lending laws come up quite a bit (not depositary safety and soundness laws, just lending laws), and of course Prosper and Lending Club had to eventually deal with SEC regulation.  It is very hard to simultaneously democratize credit and pursue consumer protection.   Perhaps this is where postal banking has an advantage with preexisting infrastructure and perhaps relaxed regulation.  In addition, philanthropy suffers from the same regulatory costs.  Chapter 7 talks about the now-defunct Chicago Shorebank.  Chicago is also the headquarters of Opportunity International, a global microfinance organization.  In talking with managers about why microfinance does not work well in the U.S., regulation will also be mentioned.  The magic question is how to simultaneously provide credit and banking services to the poor at affordable rates, with a low default rate, at a profit, in a highly regulated environment.  I think Mehrsa is saying that the answer is postal banking, and I think a lot of people are intrigued enough to hear more details!

I'm looking forward to hearing that answer in "How the Post Office Could Save Retail Banking"!

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How The Other Half Banks As A Regulation Story
Posted by David Zaring

Mehrsa's fine book is an appealing combination of history and policy. On the one hand, the book reviews the way that the poor and middle-class have accessed the finance system in the United States over decades, and how that access has been a story of changing institutions. On the other, policy, hand, the book features an appealing recommendation, not for a return to the community banking days of yore, but rather for a supplementation of our current national banking system with a reanimated postal bank.  While community banks, for a variety of reasons, handled the banking needs of the poor and middle class (or so she argues; I'm not entirely convinced about that), national banks are unwilling to chase small depositors, for profit lies only in servicing big ones.  A postal bank might at the very least be able to provide the unbanked with debit cards, and at best might be able to give them the sorts of financial services that are now being provided by shadow banks such as payday lenders, title loan companies, and the like.

I could see assigning this book to the class of business school or law school students interested in how the banking system has changed and what it does today.

One of the things it does, and has always done, according to Mehrsa, is dependent on the government. On page 16, she posits that "government support is the only reason depositors trust banks, and without trust from depositors, banks don't exist."  One of the interesting memes that I have noticed in law and finance scholarship is that, in marked contrast to corporate law scholarship, many of the authors agree with Mehrsa that finance, by some measures the largest component of the economy, is almost entirely a creature of regulation. For other examples of this sort of work see here and here. As someone interested in regulation generally, I see why I've grown particularly interested in financial regulation, though I suspect that an important component of financial intermediation is not purely an example of regulatory beneficence.  Indeed, the whole regulatory arbitrage story that plagues financial oversight suggests that regulatory fixes to fundamental finance problems, like banking the unbanked, will always be challenging.

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Book Club: How the Other Half Banks
Posted by Usha Rodrigues

We are launching our Conglomerate Book Club on my friend Mehrsa Baradaran's How the Other Half Banks: Exclusion, Exploitation, and the Threat to Democracy.  Mehrsa has been tearing it up with this book, and it is well worth the read.  Here's a sample of some reviews:

Ben McLannahan, Financial Times

Ralph Nader, Huffington Post

Nancy Folbre, New York Times

Daria Roithmayr, Jotwell

Brian Bethune, Maclean's

We look forward to a lively discussion of How the Other Half Banks!

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November 24, 2015
Upcoming Conglomerate Book Club: How the Other Half Banks
Posted by Usha Rodrigues

Thanksgiving is my favorite holiday.  We have been making the same recipe for about 15 years, and it's simply dreamy (Cooks Illustrated: high-roasted, brined and butterflied bird, set atop a broiler pan set atop a pan of dressing that is basted in drippings as the turkey roasts.  Yum). 

For many of us this week will be filled with food, family, and friends....What could be better?  Well, if you're an introvert or your family has less-than-functional moments, if all of that togetherness starts to feel a little claustrophobic, why not retire to a quiet room with a book?  We Glommers will be reading my friend and colleague Mehrsa Baradaran's How the Other Half Banks , which has been favorably reviewed by the NYT, FT, and many others. Starting on 12/1 we'll host a book club on How the Other Half Banks. We hope you can join us next week!

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October 06, 2014
Book Review: Berkshire Beyond Buffett
Posted by David Zaring

Larry Cunningham's Berkshire Beyond Buffett is the kind of book I might expect to see produced by a business school academic; it is unsurprising to see that it has been published by an excellent business school press.  The book is oriented around an extremely interesting question: does Berkshire offers some sort of competitive advantage beyond that provided by its once-in-a-generation-brilliant chairman Warren Buffett? 

Berkshire has invested in a vast array of businesses; in each of those businesses Buffett looks for a "moat."  That is, he looks for a market position that will deter competitors from appearing, prevent customers from disappearing, and retain contracting advantages over suppliers, workers, and other inputs.

But what is Berkshire’s moat?  Is it the fact that it is good at finding moats?  Or is it something else?  Larry answers this question in a way that gets at a division in business schools between management-oriented approaches to scholarship and finance-oriented ones.  Financial analysis would focus on the existence of barriers to entry (moats); it might also focus on the low cost of capital that Berkshire Hathaway enjoys, given, among other things, its stellar track record.  Management departments might look to something else: a strong corporate culture.  In this case, Larry reads more as a management scholar than a finance scholar.  Larry's describes, through case studies on a number of Berkshire’s subsidiaries, an ethos that focuses on:

  • long time horizons
  • an approach to management that is hands off but investor-oriented
  • an eschewal of complicated financial engineering
  • a preference for straightforward products and quiet but respected branding. 

In his view, it is this ethos that makes Berkshire a better manager of firms than most.

Can corporate culture explain business success?  It is difficult to measure, but obviously it must play some role.  If culture was meaningless we could evaluate the quality of a workplace without setting foot inside it, and nobody does that.  In my mind, the more difficult question is this: is Berkshire’s culture replicable?  Although Larry has developed a translatable story about what works for Berkshire, implementing it may require a certain set of special skills that most managers simply do not enjoy or possess – to describe, in this view, would not result in the ability to do.

Along the way I learned some interesting things about Berkshire.  For example, and for what's it worth:

  • The firm is not secretly an insurance company with a hobby in acquiring other firms.  Insurance revenues form a minority of the revenues of the conglomerate.
  • Nor is it a hedge fund, although it does take positions in numerous companies that it does not own.  Those revenues, however, are dwarfed by the revenues provided by the firms it does own.
  • Nor is Berkshire a story about a few winning companies saddled to a bunch of modest losers, or, at least, it does not seem to be.  In its extremely diversified way, the company has enjoyed productivity from almost unit.

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January 13, 2012
Amy Chua On Being a Law Student
Posted by Christine Hurt

At the Glom, we haven't hid our fascination with the Battle Hymn of the Tiger Mother, and we have even held a discussion among other law prof supermoms on the book.  One of my disappointments with the book was that Prof. Chua didn't discuss her dreams, aspirations, successes and failures in her on career path.  Today, I saw this interview with Chua that talks a little bit about her dissatisfaction with law school and practicing law.

Law school tore down my confidence. I hated being called on. It's not a discipline that comes naturally to me. I did not click with law. I'm the hardest worker, but I could not retain the information

Chua then explains that her hard work led her to a clerkship, which she did not enjoy, and a career at Cravath, which she also didn't enjoy, though she worked extremely hard at both.  After a 14-year odyssey to break into tenure-track teaching, she found a niche for herself in law and ethnicity in developing countries, a few leaps away from traditional law classes and law practice.  One can jump to the conclusion that she might have been happier in a different graduate program in that field without the wandering in the wilderness.

As a professor, this makes me wonder how many really smart folks stumble into law school and just don't enjoy it because they would "click" with a different discipline.  As a law professor, we have the amazing flexibility of dabbling in other disciplines, but most folks in law school are destined for the less flexible world of practicing law.  I know that I have seen my share of students who are used to succeeding in school by working very, very hard and are flummoxed by the first year of law school.  Some double down and work even harder, like Chua, but others sort of stall.  (Of course, this is one reason why there are a growing number of people arguing to make it cheaper for law students to leave after one year:  Me, Ian Ayres & Ahkil Amar, and Ari Kaplan.

Of course the tabloid-y bit of information in the interview was that Chua and her older daughter, Sophia, were asked to be on The Amazing Race, though they declined.  From reading her book, I think Chua and younger daughter, Lola, would make a more ratings-ready pairing!

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