## Saturday, May 21, 2016

### Ideas had sex

 Adam Smith. Source: WSJ
Why are we so much better off than our ancestors? Why did this process only start where and when it did, in Western Europe, not in Rome or China?

Deirdre McCloskely has an excellent essay in the Saturday Wall Street Journal Review.

Her answer: "Ideas started having sex," a glorious sentence she attributes to Matt Ridley.
"The idea of a railroad was a coupling of high-pressure steam engines with cars running on coal-mining rails. The idea for a lawn mower coupled a miniature gasoline engine with a miniature mechanical reaper. "
And so on. She is exactly right. We tend to focus on the original idea, the basic science. That's necessary, but 99% of growth comes from elaboration, implementation, and the marriage of ideas -- sex in the sense of genes combining and making new things.

What's the bar for these hookups?
The answer, in a word, is “liberty.” Liberated people, it turns out, are ingenious.
Also,
...equality. ...not an equality of outcome... equality before the law and equality of social dignity.
Though, as she points out at length, the social dignity, property rights, and equality of entrepreneurs has always been a dicey matter.

## Friday, May 20, 2016

### Overtime

Like most economists, I was a bit baffled by the Administration's announcement of stricter overtime rules. The WSJ, and Jonathan Hartley and many others cover the obvious consequences on jobs, business formation and destruction, and so forth. A bit less mentioned, it reduces employee flexibility. If you like working more hours one week and less the next -- perhaps you have child or parent care responsibilities -- you're going to be stuck working an 8 hour day.  It's part of the general regulated ossification of American employment. Or, it could be one more inducement to substitute machines for people or make people independent contractors.

Why are they doing it? The government says it wants more jobs, yet there is no area in American life with larger impediments between a willing employer and employee than labor.

I'm trying to bend over backwards to understand a worldview under which this is a sensible idea.

One possibility. Suppose this is your image of work: Take as given that a person has a job, and the employer will keep that job going, and won't change the terms of the job -- lower the base wage, allow people to take overtime, etc. Take as given that the terms of the job are a pure bilateral negotiation, and there is money somewhere to absorb extra costs without raising prices.  Take as given also that the worker is in a bad negotiating position, and you, the benevolent central department of labor, care about moving this negotiation in the worker's way. Then, a rule like this is a way of strengthening the worker's bargaining position and driving some resources the worker's way out of the employer's pocket.

The counterargument is really just that all this "take as given" is false.

Here is an effort to put that debate in econ 101 supply and demand diagrams. Let's think of the rule as a mandated higher wage, like a minimum wage. The classic analysis says you get fewer jobs.

Now, how might you not lose jobs? The implicit assumption in my paragraph above is that the labor demand curve is vertical. Employers will hire the same number of people for the same hours no matter how much they have to pay. And they'll all stay in business too.

If that were the case, as you see, we wouldn't lose any jobs. There would be some unemployment, as more people want to work or employees want more hours than they can get. But I think advocates of these policies don't mind. Getting people to go out and look for jobs might not be so terrible.

Another way to apply econ 101 is to think of the new rules as new costs imposed on the employer. If employers have to bear more costs, their demand for workers drops down by the amount of the extra costs. Again, adding costs reduces employment. Once again, what are they thinking?

Well, again, suppose that the demand curve is vertical. Now employers simply bear the cost, grumble, but there is no reduction in the number of employees and hours.

Of course, with the assumptions made bare, we can think of lots of reasons that demand curves do slope, employers cut down on workers if they have to pay more direct or indirect costs, and companies don't have infinite funds coming from nowhere. But perhaps by showing implicit assumptions, there is some room for discussion that gets somewhere. I would be interested in hearing serious defenses of the vertical demand curve assumption.

## Tuesday, May 17, 2016

### Equity-financed banking

I gave a talk at the Minneapolis Fed's "Ending Too Big to Fail" symposium, May 16. Agenda and video of the event here.

My  talk is based on "towards a run-free financial system," and a bit on a new structure for federal debt, and blog readers will notice many recycled ideas. But it incorporates some current thinking both on substance and on marketing -- the proposal is so simple, most of the work is on meeting objections.

Here's my talk. This is also available as a pdf here.

Equity-financed banking and a run-free financial system

Premises

We have to define what “sytstemic” and “crisis” mean before we can try to fix them.

My premise is that, at its core, our financial crisis was a systemic run. The mechanism is familiar from Diamond and Dybvig, and especially Gary Gorton’s description of how “information-insensitive” assets suddenly lose that property and become illiquid.

You see a problem at a bank – a word I will use loosely to include shadow-banks, overnight debt, and other intermediaries. You wonder, what about my bank? You don’t really know. The point of short-term debt is that you don’t generally pay attention to the bank’s assets. But you also have the right to take your money out at any time, and the last one out gets the rotten egg. When uncertain, you might as well forego a few basis points of interest and get out now. Everyone does this, and the bank fails.

Runs at specific institutions, caused by identifiable problems, are not really a danger. My story includes a specific “contagion,” that troubles at one institution spread to another, because they cause people to wonder about the other bank’s assets. That “systemic run” element means that banks cant’ easily sell assets to raise cash, or issue new equity.

This description is important for what it denies, and thus for “problems” we don’t have to “solve.”

It’s not a chain of dominoes: A fails, B loses money, B falls, and so forth, so by saving A the whole system is saved.

Contrariwise, even saving A is not enough to assure investors that B’s assets are ok. In fact, saving A might verify investor’s worries about B’s assets, and set off a run!

It’s not huge losses on particularly unsafe assets. Bank assets are not that risky. Bank liabilities are fragile. Small losses spark large runs.

Our crisis and recession were not the result of specific business operations failing. Failure is failure to pay creditors, not a black hole where there once was a business. Operations keep going in bankruptcy. The ATMs did not go dark.

In my premises, the 2000 stock market bust was not a crisis, because it was not a run. Yes, there were huge losses. But when stocks plunge, all you can do is go home, pour a drink, yell at the dog, and bemoan your dumb decisions. You can’t demand your money back from the issuing company, and you can’t drive the company to bankruptcy if it does not pay. Panic selling, even if “irrational,” even if it causes “herding” by others, even if it drives prices down, is not a crisis, and it’s not a run, because the issuing company doesn’t have to do anything about it.

If we want to stop crises, we have to describe when we will say “good enough” and stop trying to fix things in the name of crisis prevention. My premise: an economy with booms and busts, risks taken, and losses transparently absorbed by falling prices, is good enough for now.

If we try to create a financial system in which nobody ever loses money, we will just create a system in which nobody ever takes any risk, and does not fund any remotely risky investment opportunity. That is the direction we are going. And steps that actually matter to fixing crises are getting lost in the effort rush to “fix” every perceived financial “problem.”

(A small random sample of current causes being commingled with crisis prevention, some worthy but separate, some silly: Fannie and Freddie, the community reinvestment act, “predatory lending,” insufficient down payments, FICO scores, Wall Street "greed," executive compensation, credit card fees, disparate-impact analysis, the last names of auto-loan customers, the terms of student loans, hedge fund fees, active management and its fees, “herding” and “crowding” by equity portfolio managers (OFR), over-the-counter versus exchange-traded derivatives, swap margins, position limits, risk-weights, credit ratings, the Volker rule, insider trading, global imbalances, savings gluts, bubbles in houses and stocks, and the ridiculous tiny type on my credit-card agreement.)

I do not mean that other financial regulation is not necessarily bad, or even that one shouldn’t contemplate policies to reduce stock market volatility. But if we actually want to fix crises, or end TBTF, we have to separate those other measures into everyday regulation.

A better world

Given these premises, the central weakness in financial system is clear: fragile, run-prone liabilities.

The answer then is simple too: we should have no more large-scale funding of risky or potentially illiquid assets by run-prone securities – short term debt in particular, but any promise that is fixed-value, first-come first-served, if unpaid instantly bankrupts the company, and in volumes that could even remotely trigger such bankruptcy.

(The caveats here exempt bills, receivables, trade credit, and so on, which are fixed value but not run-prone. “Funding” is the important qualifier. You can trade in short term debt without funding the bulk of investments with it.)

Banks and shadow banks must get the money they use to hold risky and potentially illiquid loans and securities overwhelmingly from run-proof, floating-value assets – common equity mostly, some long term debt. (I say “hold” specifically to distinguish it from “originate” or “make” loans, which are then securitized and sold. )

Once we have done this, financial crises are over. A 100% equity-financed institution cannot fail, and cannot suffer a run. Fail means fail to pay your debts, and if you have no debts you cannot fail.

(OK, technically you can take on such a huge derivatives position that you can lose more than 100% of equity, but it takes very little attention from regulators and analysts to make sure that doesn’t happen.)

Such an institution needs next to no risk regulation, beyond the regular transparency we demand of any public corporation.

Any remaining fixed-value demandable assets must be backed entirely by short-term government debt, or reserves. These are run-proof because there is no doubt on the value and liquidity of the assets (at least for the US, and away from sovereign debt worries, which I also put off the table for now.)

Objections

The major objection is the flow of credit. If banks can’t issue conventional deposits and unconventional short-term debt, they won’t have money to lend and the economy will dry up, the objection goes. Others object similarly that without bank “transformation” of maturity and risk, economic growth would be slower.

This perception is false. Not one cent more or less money needs to be provided, not one iota more risk needs to be shouldered, not one cent less credit need be extended. And I think the case is strong that growth will be substantially higher than the current run-prone but highly regulated system. Let’s look.

Structure (1) is a simplified version of today’s “bank.” There are a lot of complex or illiquid assets. The bank is too complicated to go through bankruptcy. It is funded by very little equity and a huge amount of debt. The debt is prone to runs. (“People” here includes non financial business and institutions such as pension funds and endowments.)

Structure (2) is the simplest equity-financed bank. Banks issue only equity. Households hold that equity, in a diversified form, potentially through a mutual fund or ETF.

In this structure, households provide the same amount of money, and shoulder the same amount of risk, and the bank makes the same amount of loans. But runs and crises are now eliminated.

You will laugh, but I’d like to take this structure seriously. With today’s technology, people can have floating-value accounts.

This was not technically possible in the 1930s, when our country chose instead the path of deposit insurance and risk regulation. But now, you could easily go to an ATM, ask for $20, and it sells$20 of bank shares at the current market value, within milliseconds. “Liquidity” now is divorced from “fixed-value” and “runnable.” Even better, you could go to the ATM, or swipe your card or smartphone, and instantly sell shares in an ETF that holds mortgage-backed securities. This is a “bank,” providing transactions services based on a pool of mortgages and shows that money still flows from people to mortgages. But with floating value, it is run proof.

Unlevered bank equity would have 1/10 or less the volatility it has today. So, we’re talking about something like 2% volatility on an annual basis. Shouldering 2% price volatility is not hard for the majority of depositors (especially dollar-weighted). To argue otherwise, you need some fundamentally non-economic, psychological theory; you need to assert that the same households who are up to their ears in debt, handle 401(k) stock investments, health care copayments, cable and phone bills, and vacation in Las Vegas, can’t somehow stomach 2% volatility in their bank accounts.

(Wait, you ask, the Modigliani-Miller theorem fails for banks, no? The MM theorem for risk is an identity, not a theorem. Risk is not created, destroyed or transformed, it is simply parceled up differently and people end up holding all of it one way or another (even as taxpayers). The contentious part of the MM theorem is whether the price of risk or cost of capital depends on how you slice it. A pizza sliced 10 ways has the same calories, but might sell for more or less than whole.)

But if you want, we can even keep exactly the household assets we have today. Consider structure 3. Banks still issue 100% equity, but that equity is held in a mutual fund, ETF, or similar holding company, which in turn issues debt and equity.

The bank – complex, full of illiquid assets, Ben Bernanke’s specialized human capital, hard to resolve – still can’t fail. The fund can fail. But this failure can be resolved in a morning, and still make it to a 3-martini lunch and golf. The fund’s assets are publicly traded bank equity and nothing else. The bank’s liabilities are common equity and debt. The equity holders get zero, the debt holders get the bank equity. It can be done by computer.

The funds do have debt. But there is little risk of a systemic run on the funds, because their assets are supremely liquid, and visible on a millisecond basis. The failure of one fund need not inspire a run on the next one.

One might object to structure (2) that the Modigliani Miller theorem fails for banks, so it would imply a higher cost of equity. If so, structure (3), by giving households exactly the same assets as they have not, must give exactly the same cost of capital as now — minus the value of taxpayer guarantees.

Structure (3) emphasizes that the issue is not whether “transformation” must occur, whether people really need to hold a lot of fixed-value debt. The issue is whether “transformation,” if it is needed, must be tied to bankruptcy and liquidation of the institution handling the complex assets. One can cook up stories why this must be the case — corporate finance and banking theorists are a clever lot — but are such stories remotely understood and well-tested enough to justify either our occasional crises, or our massive regulatory response? I think not, but I’ll leave that case to be made by our panelists, if they are so inclined.

Structure (3) is a rhetorical point, not a proposal. I do not think it is necessary or desirable to exactly replicate the securities on both ends of the financial system. The point is just that eliminating financial crises by moving to equity-financed banking does not require any new money, any less credit, any less economic growth or any different risk taking. People will likely choose different assets in my world, and thereby improve on it.

Structure (4) elaborates. Not all bank assets are complex and illiquid. Once we remove short-term financing, I suspect that securitized debt and other liquid securities will move off bank balance sheets. They will migrate to long-only floating-value mutual funds and ETFs, and people will move money out of savings accounts and bank CDs into those very safe investment vehicles. The banks will be smaller, holding only those complex and illiquid risks that can’t easily be securitized.

On the other side, banks now have about $2.3 trillion of reserves, (May 5 H.4.1) and$1.2 trillion of demand deposits. Narrow deposit taking is here! We just need to move the deposits and their backing reserves to bankruptcy-remote vehicles (which banks can still operate for a fee, if that makes sense).

### Art

Sally Fama Cochrane on Painting Allegories of the Body By Milene Fernandez, Epoch Times | May 5, 2016
 Sally Fama Cochrane paints at Grand Central Atelier in New York on April 8, 2016. (Benjamin Chasteen/Epoch Times)
NEW YORK—When she paints, Sally Fama Cochrane dives into the chasm between invisible and visible worlds—between the inside and the outside of the body, between numbers and emotions, between cold analysis and comforting storytelling. While some old masters painted allegories of time, wisdom, faith, and themes imbued with Greek mythology or religious morals, Cochrane creates her own allegories inspired by a predominant paradigm of this century—science and medicine....

 Painting by Sally Fama Cochrane, “The Organic Body,” oil on panel, 12 by 36 inches, 2015. (Courtesy of Sally Fama Cochrane)

The rest of the story (with pictures and paintings.)  Sally's web page with lots of her art. The exhibition (Grand Central Atelier, Long Island City). Sally and Devin's still life painting workshop.

Ok, this has nothing to do with economics, and it's blatant nepotism from a proud dad. But it's fun, you need something to avoid getting to work on a Monday morning,  and the art is really cool.

## Friday, May 6, 2016

### Global Imbalances

I gave some comments on “Global Imbalances and Currency Wars at the ZLB,” by Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas at the conference, “International Monetary Stability: Past, Present and Future”, Hoover Institution, May 5 2016. My comments are here, the paper is here

The paper is a very clever and detailed model of "Global Imbalances," "Safe asset shortages" and the zero bound. A country's inability to "produce safe assets" spills, at the zero bound, across to output fluctuations around the world. I disagree with just about everything, and outline an alternative world view.

A quick overview:

Why are interest rates so low? Pierre-Olivier & Co.: countries can't  “produce safe stores of value”
This is entirely a financial friction. Real investment opportunities are unchanged. Economies can’t “produce” enough pieces of paper. Me: Productivity is low, so marginal product of capital is low.

Why is growth so low? Pierre-Olivier: The Zero Lower Bound is a "tipping point." Above the ZLB, things are fine. Below ZLB, the extra saving from above drives output gaps. It's all gaps, demand. Me: Productivity is low, interest rates are low, so output and output growth are low.

Data: I Don't see a big change in dynamics at and before the ZLB. If anything, things are more stable now that central banks are stuck at zero. Too slow, but stable.  Gaps and unemployment are down. It's not "demand" anymore.

### Delong and Logarithms

Brad Delong posted a response to my oped on growth  in the Wall Street Journal. He took issue with my graph, reproduced here,

by making his own graph, here

He characterizes the difference between our graphs with his usual gentlemanly restraint,

### "Extraordinarily Unprofessional!!:" "total idiocy" The University of Chicago and the Wall Street Journal Have Very Serious Intellectual Quality Control Problems

and so forth.

If you read Brad, you may wonder what skulduggery I used to make the plot. I will now reveal the dark secret. It's a clever Chicago-school mathematical trick:

Logarithms.

## Wednesday, May 4, 2016

### Central Bank Governance and Oversight Reform

The Hoover Institution Press just published "Central Bank Governance and Oversight Reform," the collected volume of papers, comments, and discussion from last May's conference here by the same name. You can get the  book or e-book here at the Hoover press or here at amazon.com. The individual chapter pdfs are available here.  Press release here.

(My modest contributions are in the preface and a discussion of Paul Tucker's Chapter 1. I agree it would be nice to have a more rule-based approach to lender of last resort and bailout functions, but wouldn't lots of equity so you don't have to mop up so often be even better?)

This is part of an emerging series of monetary policy conferences at Hoover. Tomorrow we will have a conference on international monetary policy. Stay tuned...

## Tuesday, May 3, 2016

### Growth Interview

I did a short interview with the WSJ's Mary Kissel about my growth oped. If you can't see the embed above, try this direct link or this one

### WSJ Growth Oped

I did an oped on growth in the Wall Street Journal, titled "Ending America’s Slow-Growth Tailspin." I'll post the full thing here in 30 days.

Blog readers will recognize a distilled version of my longer essay on growth (blog post herehtml here,   pdf here), and the graph from Smith v. Jones blog post. I think out loud. The growth essay is much more detailed on diagnosis and especially on policy.

There are three basic ideas (two too many for a good oped).

1) Growth is everything. Increasing growth will do way more for every problem you can name than anything else on the economic agenda. Even if workers in 1910 could have taken all of Rockefeller's wealth, they would have been disastrously poor compared to today.

2) Can policies actually improve growth? The tut-tutters mocked Jeb Bush's 4% aspiration. I outline the "we've run out of ideas" school of thought, most recently in Bob Gordon's thoughtful book; the "everything is right but the zero bound" secular-staglation school, and the view that the growth giant is being held back by a liliputian army of politicized regulators.

As evidence,  I improved on the graph from an earlier post of the World Bank's ease of doing business score vs. GDP per capita,

## Saturday, April 30, 2016

### Equity-financed banking

My dream of equity-financed banking may be coming true under our noses. In "the Uberization of banking" Andy Kessler at the WSJ reports on SoFi, a "fintech" company. The article is mostly about the human-interest story of its co-founder Mike Cagney. But the interspersed economics are interesting.

SoFi started by making student loans to Stanford MBAs, after figuring out that the default rate on such loans is basically zero. It
has since expanded to student loans more generally and added mortgages, personal loans and wealth management. Mr. Cagney says SoFi has done 150,000 loans totaling $10 billion and is currently at a$1 billion monthly loan-origination rate.
Where does the money come from?
SoFi doesn’t take deposits, so it’s FDIC-free. ... Instead, SoFi raises money for its loans, most recently \$1 billion from SoftBank and the hedge fund Third Point, in exchange for about a quarter of the company. SoFi uses this expanded balance sheet to make loans and then securitize many of them to sell them off to investors so it can make more loans
Just to bash the point home, consider what this means:
• A "bank" (in the economic, not legal sense) can finance loans, raising money essentially all from equity and no conventional debt. And it can offer competitive borrowing rates -- the supposedly too-high "cost of equity" is illusory.

• There is no necessary link between the business of taking and servicing deposits and that of making loans. Banks need not (try to) "transform" maturity or risk.

• To the extent that the bank wants to boost up the risk and return of its equity, it can do so by securitizing loans rather than by borrowing. (Securitized loans are not leverage -- there is no promise of your money back when you want it. Investors bear any losses immediately and without recourse.)

• Equity-financed banking can emerge without new regulations, or a big new Policy Initiative.  It's enough to have relief from old regulations ("FDIC-free").

• Since it makes no fixed-value promises, this structure is essentially run free and can't cause or contribute to a financial crisis.

## Tuesday, April 26, 2016

### Macro Musing Podcast

I did a podcast with David Beckworth, in his "macro musings" series, on the Fiscal Theory of the Price Level, blogging, and a few other things.

You can also get the podcast at Sound Cloud, along with all the other ones he has done so far, or on itunes here.  For more information, see David's post on the podcast.

## Monday, April 25, 2016

### Blinder on Trade

Alan Blinder has an excellent op-ed in the WSJ on trade. It's hard to excerpt as every bit is good.
1. Most job losses are not due to international trade. Every month roughly five million new jobs are created in the U.S. and almost that many are destroyed, leaving a small net increment. International trade accounts for only a minor share of that staggering job churn. ...

2. Trade is more about efficiency—and hence wages—than about the number of jobs. You probably don’t sew your own clothes or grow your own food. Instead, you buy these things from others, using the wages you earn doing something you do better.  ...
3. Bilateral trade imbalances are inevitable and mostly uninteresting. Each month I run a trade deficit with Public Service Electric & Gas. They sell me gas and electricity; I sell them nothing....

4. Running an overall trade deficit does not make us “losers.”...

5. Trade agreements barely affect a nation’s trade balance. ..a nation’s overall trade balance is determined by its domestic decisions, not by trade deals... America’s chronic trade deficits stem from the dollar’s international role and from Americans’ decisions not to save much, not from trade deals. Trade deficits are not a major cause of either job losses or job gains. ...trade makes American workers more productive and, presumably, better paid.
One could say much more. Trade is not a "competition," for example. But,  having done this sort of thing, I'm sure lots of other good bits are on the cutting room floor.

Alan is more sympathetic to government "help" to trade losers, which I agree sounds nice if it were run by the benevolent and omniscient transfer payment planner, but I think works out poorly in practice when we look at the success or failure of actual trade adjustment programs. But that is a small nitpick.

Alan closes by wishing that Bernie Sanders and Donald Trump understood these simple facts a bit better. I think his list of politicians needing enlightenment could be a little longer. But he's courageous enough for speaking the kind of heretical truth that will come back to haunt him should he ever want a government job.

## Saturday, April 23, 2016

### Lessons Learned I

I spent last week traveling and giving talks. I always learn a lot from this. One insight I got:  Real interest rates are really important in making sense of fiscal policy and inflation.

Harald Uhlig got me thinking again about fiscal policy and inflation, in his skeptical comments on the fiscal theory discussion, available here. At left, two of his graphs, asking pointedly one of the standard questions about the fiscal theory: Ok, then, what about Japan? (And Europe and the US, too, in similar situations. If you don't see the graphs or equations, come to the original.) This question came up several times and I had the benefit of several creative seminar participants views.

The fiscal theory says
$\frac{B_{t-1}}{P_t} = E_t \sum_{j=0}^{\infty} \frac{1}{R_{t,t+j}} s_{t+j}$
where $$B$$ is nominal debt, $$P$$ is the price level, $$R_{t,t+j}$$ is the discount rate or real return on government bonds between $$t$$ and $$t+j$$ and $$s$$ are real primary (excluding interest payments) government surpluses. Nominal debt $$B_{t-1}$$ is exploding. Surpluses $$s_{t+j}$$ are nonexistent -- all our governments are running eternal deficits, and forecasts for long-term fiscal policy are equally dire, with aging populations, slow growth, and exploding social welfare promises. So, asks Harald, where is the huge inflation?

I've sputtered on this one before. Of course the equation holds in any model; it's an identity with $$R$$ equal to the real return on government debt; fiscal theory is about the mechanism rather than the equation itself. Sure, markets seem to have faith that rather than a grand global sovereign default via inflation, bondholders seem to have faith that eventually governments will wake up and do the right thing about primary surpluses $$s$$. And so forth. But that's not very convincing.

This all leaves out the remaining letter: $$R$$. We live in a time of extraordinarily low real interest rates. Lower real rates raise the real value surpluses s. So in the fiscal theory, other things the same, lower real rates are a deflationary force.

## Tuesday, April 19, 2016

### Chari and Kehoe on Bailouts

V. V. Chari and Pat Kehoe have a very nice article on bank reform, "A Proposal to Eliminate the Distortions Caused by Bailouts," backed up by a serious academic paper.

Their bottom line proposal is a limit on debt to equity ratios, rising with size. This is, I think, a close cousin to my view that a Pigouvian tax on debt could substitute for much of our regulation.

Banks pose a classic moral hazard problem. In a financial crisis, governments are tempted to bail out bank creditors. Knowing they will do so, bankers take too much risk and people lend to too risky banks. The riskier the bank, the stronger the governments' temptation to bail it out ex-post.

Chari and Pat write with a beautifully disciplined economic perspective: Don't argue about transfers, as rhetorically and politically effective as that might be, but identify the distortion and the resulting inefficiency. Who cares about bailouts? Well, taxpayers obviously. But economists shouldn't worry primarily about this as a transfer. The economic problem is the distortion that higher tax rates impose on the economy. Second, there is a subsidy distortion that bailed out firms and creditors expand at the expense of other, more profitable activities. Third there is a debt and size distortion. Since debt is bailed out but not equity, we get more debt, and the banks who can get bailouts become inefficiently large.

## Saturday, April 16, 2016

### A better living will

"US rejects 'living wills' of 5 banks," from FTWSJ puts this event in the larger story of Dodd Frank unraveling. Juicy quotes:
WSJ: “living wills,” ... are supposed to show in detail how these banking titans, in the event of failure, could be placed into bankruptcy without wrecking the financial system.

FT:...the shortcomings varied by bank but included flawed computer models; inadequate estimates of liquidity needs; questionable assumptions about the capital required to be wound up; and unacceptable judgments on when to enter banktruptcy.

FT: David Hirschmann of the US Chamber of Commerce, the biggest business lobby, said the living wills process was “broken”. “When you can’t comply no matter how much money you put into legitimately trying to comply, maybe it’s time to ask: did we get the test wrong?” he said.

WSJ: Six years after the law was passed, and eight years since the financial crisis, regulators given broad authority to remake American finance, with thousands of regulatory officials on their payroll, cannot figure out a system to allow financial giants to fail, even in theory. What are we paying these people for?
It seems like a good moment to revisit an idea buried deep in "Toward a run-free financial system."  How could we structure banks to fail transparently?