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Confusion About the Fed and Bank Debt at the NYT
Andrew Ross Sorkin seems badly confused about the Fed and bank obligations in his NYT column this morning. When it comes to the Fed, he warns against the idea of making the institution more transparent and accountable to Congress based on warnings from Senator Judd Gregg: "Congress has demonstrated time and again its inability to manage the nation’s fiscal policy, illustrated by our staggering national debt in excess of $12 trillion. So how can anyone think that its involvement in monetary policy would be good for the country?"
Senator Gregg, along with Andrew Ross Sorkin, apparently missed what happened in the last two years. The Fed either failed to notice an $8 trillion housing bubble or somehow didn't realize that it was dangerous to the economy. As a result, the Fed allowed the bubble to grow unchecked. The collapse of this bubble has given the economy the worst downturn since the Great Depression. The downturn caused by the collapse of the bubble, not Congress, is also directly responsible for the huge deficits the country now faces. It is remarkable that anyone involved in policy debates does not realize this fact.
Sorkin also complains that a bill before Congress would require that bondholders in systemically important institutions would be required to take a haircut (less than 100 percent payout) in the event of a taxpayer funded bailout. Sorkin complains that this would make it more expensive for these banks to borrow funds.
While Sorkin terms the higher cost of funds an unintended consequence, it is actually an intended consequence. At the moment, large "too big to fail" banks can borrow money at lower interest rates than smaller banks because creditors believe that the government will insure their debt. The point of the proposed change is to make a step toward leveling the playing field. It is supposed to raise the cost of borrowing at large banks. The greater risk associated with loans to large banks will make money available to smaller banks at lower interest rates.
Doesn't Sorkin understand this?
--Dean Baker
COMMENTS (7)
The question is not whether the Fed messed up, the question is whether more Congressional involvement would make things better.
Given that Congress has become totally dysfunctional, it's hard to believe giving politicians more power would make things better.
Have you been following Congress recently?
Posted by: foosion | November 24, 2009 6:27 AM
"While Sorkin terms the higher cost of funds an unintended consequence, it is actually an intended consequence."
I'm not sure it's actually intended, but it *should* be intended.
Posted by: a | November 24, 2009 8:38 AM
What Congress needs to do is not micromanage monetary policy, but take some control of appointments and overall policy. There is no reason that national monetary policy should be in the hands of bankers and financiers.
Maybe what is required is less monetary policy altogether. The country did just fine after WW II and before economists came to believe that Friedmanite monetary manipulations could control everything.
Posted by: skeptonomist | November 24, 2009 9:21 AM
I believe the average recovery rate for bank debt has historically been right around 80%, not a coincidence I would imagine. This necessarily means that a 20% haircut in case of default (on average) is already priced in to all bank debt at issuance. So this rule cannot and would not increase the price of debt. Rather, it seems to codify that the public sector be on an equal playing field with the private sector in the case of a government-run bankruptcy / resolution proceeding –- that is, it entirely eliminates the possibility that a government-run process would result in a more generous concession to holders of bank debt than the average concession that has been historically negotiated within the private sector, independent of any government involvement. Surely this falls in the category of "intended" rather than "unintended" consequences.
Posted by: ISOK | November 24, 2009 2:56 PM
Dean! Get with it. Why even critique Sorkin as an honest player? He's not. He's so obviously in the pocket of the investment bankers it's ridiculous. He makes elementary mistakes in his understanding of finance and how to read a balance sheet. Please not his 2008 valuation of GM and his claim in his book that investors flocked to treasuries because people had lost faith in the US Government. What? Why does he have a column? I dunno. His daddy was a bigtime financial lawyer, actually Madoff's. No joke.
Posted by: Stephen | November 25, 2009 4:20 AM
I do not agree with the below assertion (or similar ones, which I have seen Dean make before)
"The collapse of this bubble has given the economy the worst downturn since the Great Depression. The downturn caused by the collapse of the bubble, not Congress, is also directly responsible for the huge deficits the country now faces."
How can one not blame congressional accounting? If we say there was a bubble, that means congress used to be getting "excess revenue" from the imaginary profits. If congress had built up a surplus during that time, then we would not have a large national debt now. Indeed, if we had kept lower federal expenditures (rather than expanding them earlier), the -annual- deficits would also be smaller now.
I don't understand why Dean doesn't blame congress for not having a little foresight. One could argue that it is in our interests to have debt and make investments for our future, but that is different argument from saying there is an external -cause- of our debt rather than our own budgeting.
Posted by: Aditya Savara | November 26, 2009 7:40 AM
"If congress had built up a surplus during that time, then we would not have a large national debt now."
Bush Tax Cuts.
Posted by: zapster | November 29, 2009 1:29 PM