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  • Treasury Secretary Lew on the "End" of Too Big to Fail

    Treasury Secretary Jacob Lew is feeling good about the economy. In an interview with Charlie Rose last night, Lew expressed optimism that growth will pick up in 2014, and though he tended to remain cautious about his predictions, he suggested that our elected officials in Washington are making progress in economic policy around debt and immigration. Rose and Lew covered a lot of ground--from domestic issues to emerging markets and China. In this excerpt, Lew argued that banking rules are significantly stronger now than they were six years ago: We will post the full video when it becomes available. See also: Damian Paletta 's "12 Takeaways" from the interview at the Wall Street Journal Washington Wire blog, here .
  • Breaking the Habit of Overworking

    Hopefully, if you work in the U.S., you are spending Martin Luther King Day someplace other than your office. Not only to honor Dr. King, but also because you realize that working more hours does not necessarily make you more productive, and some time away from your work can be healthy for you and your company. In his New Yorker column, James Surowiecki makes the point that working more and more is now driven more by a cult-like workplace culture than by the bottom line (unless, that is, you get paid by the hour): Thirty years ago, the best-paid workers in the U.S. were much less likely to work long days than low-paid workers were. By 2006, the best paid were twice as likely to work long hours as the poorly paid, and the trend seems to be accelerating. A 2008 Harvard Business School survey of a thousand professionals found that ninety-four per cent worked fifty hours or more a week, and almost half worked in excess of sixty-five hours a week. Overwork has become a credential of prosperity. The perplexing thing about the cult of overwork is that, as we’ve known for a while, long hours diminish both productivity and quality. Among industrial workers, overtime raises the rate of mistakes and safety mishaps; likewise, for knowledge workers fatigue and sleep-deprivation make it hard to perform at a high cognitive level. As Solomon put it, past a certain point overworked people become “less efficient and less effective.” And the effects are cumulative. The bankers Michel studied started to break down in their fourth year on the job. They suffered from depression, anxiety, and immune-system problems, and performance reviews showed that their creativity and judgment declined. If the benefits of working fewer hours are this clear, why has it been so hard for businesses to embrace the idea? Simple economics certainly plays a role: in some cases, such as law firms that bill by the hour, the system can reward you for working longer, not smarter. And even if a person pulling all-nighters is less productive than a well-rested substitute would be, it’s still cheaper to pay one person to work a hundred hours a week than two people to work fifty hours apiece. (In the case of medicine, residents work long hours not just because it’s good training but also because they’re a cheap source of labor.) On top of this, the productivity of most knowledge workers is much harder to quantify than that of, say, an assembly-line worker. So, as Bob Pozen, a former president of Fidelity Management and the author of “Extreme Productivity,” a book on slashing work hours, told me, “Time becomes an easy metric to measure how productive someone is, even though it doesn’t have any necessary connection to what they achieve.” Read The Cult of Overwork here .
  • Lessons From Wolf of Wall Street: Avoiding Psychopaths in Your Business

    The Wolf of Wall Street nearly reached the $70 million ticket mark with another strong weekend at the box office, and star Leonardo DiCaprio took home the Golden Globe for best actor last night. INSEAD professor Manfred F. R. Kets de Vries sees more than entertainment in the film. At the Harvard Business Review , he goes beyond all the morality lessons to give some practical advice about people like Jordan Belfort--the conman DiCaprio plays in the film. Kets de Vries calls such people "Seductive Operational Bullies." Estimates vary, but perhaps 3.9 percent of corporate professionals could be described as having psychopathic tendencies, a figure considerably higher than is found in the general population. From these observations we can deduce that many people working in organizations have a fair chance of having an experience with a pathological boss. Unfortunately, most people working for seductive operational bullies lack the knowledge and skills to effectively respond and deal with them. Either they don’t understand the cause of their problems, or they don’t know how to fight back. To make matters worse, these psychopathic executives usually have the dedication, focus, and business acumen to create at least the appearance of success. They are highly manipulative, discrediting others around them, deflecting the issue at hand when confronted. They will threaten and distort the facts, all the while presenting themselves as helpful and or working “for the good of the company.” They are very talented at hiding their true motives, while making others look incompetent, uncooperative, or self-serving. The only thing that counts for these people is to win. They prey on people’s emotional vulnerabilities. So what can be done to prevent such people can causing havoc? Ideally, organizations should fine-tune their recruitment procedures in order to avoid hiring them in the first place. Scrutinize resumes for any anomalies and put the candidate through multiple interviews. Seductive operational bullies have a tendency to tell interviewers what they think they want to hear, and different interviewers can elicit different, sometimes contradictory, responses. What if the psychopath is already on your staff? If you see talented people leaving a project or a company, that may be a sign. A red flag should also go up if there are glaring discrepancies between how direct reports and junior employees perceive an executive and how that executive’s peers or boss perceive him or her. Lower-level employees are often on the receiving end of a boss’s psychopathic behavior and usually spot a problem much sooner than senior management. It’s also important to encourage teamwork, as that’s something that psychopaths don’t feel comfortable with; they’ll look for the door. And take steps to develop a corporate culture in which junior employees are able to express concerns about their colleagues and superiors without fear of reprisal. Read Is Your Boss a Psychopath? here .
  • Barry Ritholtz Shares 10 Financial Resolutions He Thinks We Can Keep

    The time has come to start looking at other people's New Year resolutions. We can't advocate making resolutions (unless you are the sort to feel compelled to cross items off a list. Otherwise, we don't like watching people set themselves up for failure). But we learn a lot from smart people writing out what all of us should do--as long as the goals are realistic. When it comes to finance, Barry Ritholtz is one of those people who tends to share some thoughtful, no-nonsense guidance. In his Washington Post column this week, he puts forward 10 resolutions. Here are three: 3. Stop trading. The evidence is overwhelming: You are not a good trader. You individually, as well as the rest of your emotional, irrational species. You lack the temperament, the discipline, the ability to set aside ego and make cold, calculating decisions. No wonder algorithms are replacing people on so many trading desks. For those of you who just cannot quit, try this: Put 5 percent of your investable assets in a trading account. Track how well your trading does vs. what I described above. If after five years you have outperformed your real investments net of fees, taxes and all other expenses, you can pull an additional 15 to 20 percent into this account. Experience teaches that most of you will close this account long before five years elapse. 4. Max out tax-deferred accounts. The math on this is incontrovertible: Income you invest before taxes starts out with about a 40 percent advantage vs. post-tax cash. It’s that simple. If your job offers a 401(k) (or a 403(b) for nonprofits), max it out. And if your firm does not, ask why? Get it to take advantage of this huge tax savings. You should also max out your IRA — $5,500 per year for those under 50, and $6,500 for those over 50. 5. Refinance your debt. The Fed has announced the beginning of the end of quantitative easement, and the end of ZIRP (zero interest rate policy) is coming. In plain English, this means rates should “normalize” sooner rather than later. That means higher — and, in some cases, appreciably higher — credit costs. Start with your home. Lock in a low rate, refinancing in a fixed (not variable) mortgage. If you can afford to make the higher payments, go for the 15-year note vs. the standard 30-year note, and your rates will be even lower. You should also carry as little credit card debt as possible; you might negotiate a lower rate with your bank just by asking. Usually the threat of transferring the balance to a zero-rate “teaser” card gets the job done. Read all the resolutions here .
  • Eric Weinstein Argues Math and Physics Can 'Rescue Economics'

    Eric Weinstein earned a PhD in Mathematical Physics but decided to leave academia for the world of finance. Now managing director of Thiel Capital, he thinks the field of economics needs an adjustment. And he thinks people in finance need to apply better tools from physics and mathematics to their work. He makes his case to the Institute for New Economic Thinking 's Marshall Auerback :
  • The Relationship Between Finance and Growth In Highly Advanced Economies

    We have come to accept that there is a direct relationship between the strength of a financial system and economic growth. The "literature" mostly supports that thinking, according to Thorsten Beck . But, Beck notes, recent studies point to a curious deviation: there may be diminishing returns, or worse. The relationship between financial system and growth may even "[turn] negative at very high levels of financial development." From Vox : What are the reasons for this insignificant or even negative relationship between finance and growth across high-income countries? Recent papers have put forward several explanations. While these are not necessarily incompatible with each other, they have different policy implications. •First, the measures of financial depth and intermediation the literature has been using might be simply too crude to capture quality improvements at high levels of financial development. Some authors have argued that it is not so much the quantity of financial intermediation, but the quality that matters (Hasan, Koetter and Wedow 2009). The question is, however, whether there are limits to these efficiency gains, as there are to the volume of intermediation. In addition, the financial sector has gradually extended its scope beyond the traditional activity of intermediation towards so-called 'non-intermediation' financial activities (Demirgüc-Kunt and Huizinga 2010). As a result, the usual measures of intermediation services have become less and less congruent with the reality of modern financial systems. The literature has not developed yet good gauges of these non-intermediation services to properly assess their relationship with economic growth. •A second explanation focuses on the beneficiaries of the credit. While the theoretical and most of the empirical finance and growth literature has focused on enterprise credit, financial systems in high-income countries provide a large share of their services, including credit, to households rather than enterprises. In several countries, including Canada, Denmark, and the Netherlands, household credit constitutes more than 80% of overall bank credit – mostly mortgage credit. Theory makes ambiguous predictions about the effects on the relationship between household credit and growth, and initial empirical evidence shows an insignificant relationship between the two (Beck et al. 2012). The relationship between financial deepening and economic growth goes through enterprise credit, and the fact that much of the financial deepening in high-income countries over the past 20 years has been in household credit can partly explain the insignificant relationship between finance and growth in these countries. •A third explanation posits the financial system might actually grow too large relative to the real economy if it extracts excessively high informational rents, and in this way attracts too much young talent towards the financial industry (Bolton et al. 2011, Philippon 2010). Kneer (2013a,b) provides empirical evidence for this hypothesis, showing that industries relying more on human capital suffer more in their productivity as the financial system expands. This hypothesis thus clearly points to a trade-off between the intermediation function a financial sector provides to the real economy and a drain on talent needed by the same real economy. Read Finance and growth: Too much of a good thing? here .
  • Marketplace Whiteboard: Capital Requirements

    Now that Washington has re-opened for business , lawmakers can get back to their long to-do list. One of the items on that list remains to shore up the financial system. And that includes doing something about bank reserves, or capital adequacy requirements. Paddy Hirsch takes to the Marketplace Whiteboard to describe capital requirements, and the need for a fix:
  • Shiller's Econ 252: Financial Markets

    Care to take a course with an economist recently honored by the Swedish Royal Academy of Sciences for the Prize in Economic Science in Memory of Alfred Nobel ? This 2011 lecture from Robert Shiller may not be exactly the same thing, but it does give you a clear sense of what the Royal Academy is referencing when it praises Shiller for his work. (hat tip Barry Ritholtz)
  • Marketplace Whiteboard: Stock Exchanges as Supermarkets

    Paddy Hirsch is back at the Marketplace Whiteboard . This time it is to explain how stock exchanges work. He wants us to let go of the exciting scenes from films like Trading Places, and instead imagine a sort of supermarket.
  • Simon Johnson on Getting the Financial Sector on Safer Tracks

    Simon Johnson is required reading at The Watch, especially at the Baseline Scenario blog. For years now, Johnson has been speaking out against the failure of policy makers to adequately oversee the finance sector. His warnings did not steer us clear of the near meltdown five years ago, and he remains dissatisfied with the overall response to the global financial crisis. He recently sat down with Marshall Auerback of the Institute for New Economic Thinking to discuss what he believes needs to be done to protect citizens and economies (as opposed to the banks themselves) from future crises.
  • Confidence and the Continued Success of Hedge Funds

    Hedge funds seemed to recover rather quickly when compared to other parts of the finance industry. Writing at The Guardian , Timothy Spangler chalks that up to confidence. The confidence of the traders at hedge funds. And the confidence in those hedge funds by big investors. And by "big investors" Spangler doesn't so much mean personal estates of the super wealthy as much as he means big pension funds. As has been well reported, although many hedge funds perished on the rocks of the market volatility and the liquidity crisis that followed on from the Lehman bankruptcy, several funds profited from the ensuing chaos. Similarly, although much hand-wringing occurred when the credit crunch shut down the flow of leveraged finance that was a mainstay of private equity buyouts for two decades, many funds continued to engage in successful investments and divestments as buying opportunities presented themselves in the economic wreckage that ensued. Even America's beloved Twinkies and Ding Dongs were ultimately saved by private equity. The reason for the continued success of hedge funds and private equity funds is actually quite simple – investors love them! Of course, there were doubts and recriminations that surfaced again and again at the end of 2008 and the beginning of 2009. Of course, there were investors that suffered eye-watering losses on their fund investments who would require some coaxing (and a little TLC) before their would allocate money again. But when fund after fund continued to post high investment returns, and the rest of the financial markets seemed to oscillate between pessimism and indifference, investors began writing checks again. With replenished war chests, hedge funds and private equity funds were back in business. So long as these funds can credibly promise high returns, there will be a steady flow of investors willing to back them. Once accumulated, the money is deployed wherever the men and women running them feel there is an opportunity to profit. This industry is driven, first and foremost, by the confidence level of these investors. Read Hedge funds and private equity are thriving … thanks to pension funds here .
  • Glenn Hubbard: Avoiding Next Great Financial Crisis Requires Clear Policy Framework

    Writing at The Atlantic , Glenn Hubbard gives his assessment of efforts to fix the financial sector and avoid a crisis like the one that peaked five years ago. Hubbard, now dean of the Columbia Business School, was chairman of the Council of Economic Advisers for President George W. Bush. He points to monetary policy during the Bush presidency as the primary cause for the crisis. In fixing the crisis, he argues for a response that is not simply technical, but rather provides a "policy framework." Hubbard: Five years ago, a massive failure on the part of financiers and financial regulators precipitated the fall of Lehman Brothers and nearly crashed the global economy. Today, investors, taxpayers, and elected officials are entitled to ask: Are we safer now? At one level, yes. We are both healthier and smarter. We are healthier because both banks and households have repaired their balance sheets, improving the economy’s ability to withstand future shocks. We are smarter, because we have discarded the myth that the Federal Reserve can easily clean up the fallout from financial excesses and replaced it with an attitude of vigilance and caution about financial excesses. This raises another question: have we created public policies that make us safer? It is hard to say. We know more today about how Washington can inflate bubbles. Government-sponsored enterprises encouraged excessive risk-taking in housing finance. Easy monetary policy in the early 2000s not only kept mortgage interest rates low, but also encouraged investors to reach for yield and amplify that reach with leverage. If investors perceive low rates to be lasting, the incentive for leverage is particularly great. Fed officials focused on low rates as coming from a global savings glut, without emphasizing large flows in to the United States from global banks, particularly European banks. The Fed did not restrain the housing bubble, and it was not alone. The European Central Bank stood back as credit surged in peripheral European economies. And, of course, tax policy encouraged leverage. Since the crisis, the Dodd-Frank Act increased transparency in many derivatives – a good thing. But it also made a complex system of bank and nonbank regulators more complex and created a class of systemically important banks (and even non-banks), codifying “too big to fail.” It did not – nor did other legislation – seriously address reform of housing finance or direct the central bank to focus more on financial stability. Writing the Act’s web of rules will take years. Globally, an emphasis on higher capital requirements leaves open questions of how one measures the risks taken against that capital – recall the sovereign bonds were deemed “riskless” for that purpose before the crisis – or how to limit the incentive for “shadow banking” forms of intermediation to grow outside more heavily regulated sectors. Read How to Stop the Next Financial Crisis: The Fed Might Be Our Last Great Hope here .
  • In Defense of Economists

    With the five year anniversary of the Lehman collapse upon us, we've seen a fair number of articles focusing on the failures or limitations of economists, and the field of economics in general. Like this one . Such critiques have prompted budding University of Michigan economist Yichuan Wang to defend the field, and the work of economists. From the [Not Quite] Noahpinion Blog : Economists have also managed to change the way we talk about poverty policies in the United States. A common misconception is that impoverished people are just lazy, and that nothing can be done for them. And as a result, welfare just represents an unproductive transfer from the makers to the takers. However, survey data from the Survey Research Center at the University of Michigan has shown that poverty is most often a transitory phenomenon, and that no, welfare is not about Cadillac queens or subsidizing sloth, but rather about providing insurance for a wide range of people who live on the threshold of poverty. The fact that the national conversation sometimes forgets this point is a reminder that economists do have an important role to play in shaping the welfare policy debate, and that neglecting this can have serious human impact. And when we take a look at the the role of economists in analyzing aid and development, the impact is even larger. The foundations of international finance and the study of capital flows explains what kinds of aid are better than others, and why it's important not only to provide money but also personnel and expertise. On a micro level, pioneering experimental work, as popularized by Esther Duflo and Abhijit Banjeree in their book titled "Poor Economics", has added an additional subtlety to the design of development policy. By integrating insights from psychology and political science, development economists like them have gone on to revise how to better provide fertilizers to farmers or how to limit the extent of patronage politics. These are all critical issues in the task of economic development, and it has fallen to economists to address them. So far, I have focused on micro topics. But there are actually a surprisingly robust set of results about how emerging markets should handle capital flows. Steven Salant (who is teaching me applied micro modeling this fall!) laid the foundation for speculative attacks on stockpiles of resources, such as oil or food. His model later led to Krugman's pioneering work on how currency crises happen, and the lessons from the literature on currency crises showed why external debt could be so harmful for developing economies. Anton Korinek has also made great contributions outlining the welfare arguments for avoiding external debt and currency crises. Indeed, those economies who had large stocks of external debt relative to foreign reserves were precisely the ones who suffered the most during the financial crisis . While it may not be a direct result, it is now clear to all emerging markets that a combination of external debt and exchange rate pegs can be extremely dangerous. And the absence of those two fault lines has put the emerging markets on much more stable footing during the current sell-off. Even in the controversial field of monetary policy we're doing better. Back in the 1920's, it was thought that monetary policy should ease during the boom and tighten during the bust. This was called the Real Bills Doctrine , and ended up amplifying the business cycle. Doubt about the effect of Quantitative Easing is not equivalent to ignorance about money's effect on the macroeconomy. We might not be clear on magnitudes, but we at least know which way goes up and which goes down. Read No, Economics Is Good for Lots of Things here .
  • A Potential Model for Putting the International back in International Banks

    The international bank, as we knew it before 2008, seems to have gone away. Instead, it has been replaced by banks that Dirk Schoenmaker refers to as multinational banks, "under which the national subsidiaries are supervised separately." Schoenmaker--Dean of the Duisenberg School of Finance and Professor of Finance, Banking and Insurance at the VU University Amsterdam, and author of Governance of International Banking --thinks this may be temporary, and he believes that international banking will again be international. Writing at Vox , he outlines the model he expects: The solution is a supranational approach for supervision and resolution. The bottom line is to arrange an appropriate fiscal backstop through burden sharing (see also, Goodhart and Schoenmaker 2009). The Banking Union in Europe is moving into that direction with proposals for a European Resolution Board, backed up by the European Stability Mechanism. The Banking Union will save the international banking model for the Eurozone. Figure 2 shows the improvement in resolution. The starting point is that a recapitalisation is efficient when the benefits (in the form of financial stability) exceed the costs. The solid diagonal in Figure 2 represents the line where benefits (B) and costs (C) are equal. The left dashed line measures the home country benefits.1 Basically, the home country only considers their local share of the benefits, ignoring the cross-border impact of averting bank failure. In the diagram area A – where there is no bank recapitalisation since the costs outweigh the benefit – there is an efficient outcome. Area B – where there is a recapitalisation – is, similarly, efficient. Area C, however, involves inefficiency. This is where the recapitalisation would be socially efficient considering spillovers but the costs for one nation exceed the one-nation benefit. Put simply, the home country will not do the recapitalisation. In the supranational approach (all benefits in the home country and the rest of Europe are incorporated by the supranational body), area C, which indicates the area of inefficiency, is smaller under the supranational line than under the home country line. Read Is there a future for international banks here .
  • Paul Volcker on the Fed's Independence and Restoring Trust in the Financial World

    Paul Volcker believes the Fed is at a "crossroads," just as it was when he first worked there, 64 years ago. Writing in the August 13 issue of The New York Review of Books , the former Fed Chair shares a bit of historical analysis as he looks at threats to the Fed's most important mandate: independence. I know that it is fashionable to talk about a “dual mandate”—the claim that the Fed’s policy should be directed toward the two objectives of price stability and full employment. Fashionable or not, I find that mandate both operationally confusing and ultimately illusory. It is operationally confusing in breeding incessant debate in the Fed and the markets about which way policy should lean month-to-month or quarter-to-quarter with minute inspection of every passing statistic. It is illusory in the sense that it implies a trade-off between economic growth and price stability, a concept that I thought had long ago been refuted not just by Nobel Prize winners but by experience. The Federal Reserve, after all, has only one basic instrument so far as economic management is concerned—managing the supply of money and liquidity. Asked to do too much—for example, to accommodate misguided fiscal policies, to deal with structural imbalances, or to square continuously the hypothetical circles of stability, growth, and full employment—it will inevitably fall short. If in the process of trying it loses sight of its basic responsibility for price stability, a matter that is within its range of influence, then those other goals will be beyond reach. Back in the 1950s, after the Federal Reserve finally regained its operational independence, it also decided to confine its open market operations almost entirely to the short-term money markets—the so-called “Bills Only Doctrine.” A period of remarkable economic success ensued, with fiscal and monetary policies reasonably in sync, contributing to a combination of relatively low interest rates, strong growth, and price stability. That success faded as the Vietnam War intensified, and as monetary and fiscal restraints were imposed too late and too little. The absence of enough monetary discipline in the face of the overt inflationary pressures of the war left us with a distasteful combination of both price and economic instability right through the 1970s—a combination not inconsequentially complicated further by recurrent weakness in the dollar. We cannot “go home again,” not to the simpler days of the 1950s and 1960s. Markets and institutions are much larger, far more complex. They have also proved to be more fragile, potentially subject to large destabilizing swings in behavior. There is the rise of “shadow banking”—the nonbank intermediaries such as investment banks, hedge funds, and other institutions overlapping commercial banking activities. Partly as a result, there is the relative decline of regulated commercial banks, and the rapid innovation of new instruments such as derivatives. All these have challenged both central banks and other regulatory authorities around the developed world. But the simple logic remains; and it is, in fact, reinforced by these developments. The basic responsibility of a central bank is to maintain reasonable price stability—and by extension to concern itself with the stability of financial markets generally. In my judgment, those functions are complementary and should be doable. Read The Fed & Big Banking at a Crossroads here .
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