Saturday, June 29, 2013

Basel Committee consults on derivatives-related reforms to capital adequacy framework

Basel Committee consults on derivatives-related reforms to capital adequacy framework
BCBS, June 28, 2013

The Basel Committee today released two consultative papers on the treatment of derivatives-related transactions under the capital adequacy framework.

1  Capital treatment of bank exposures to central counterparties - consultative document
PDF of full document:

The Basel Committee on Banking Supervision, in cooperation with the Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO), is seeking views on potential changes to the capital treatment of banks' exposure to central counterparties (CCPs). The Basel Committee published an interim standard in July 2012 and noted at that time that additional work was needed to improve the capital framework. Introduction of the interim standard represented an important step towards ensuring appropriate measurement, monitoring and management of banks' exposures to CCPs, exposures which had previously attracted no regulatory capital charge.

The proposed changes to the interim standard seek to establish a capital treatment that ensures banks' exposures to central counterparties are adequately capitalised, while also preserving incentives for central clearing. They promote robust risk management by banks and CCPs, including by encouraging CCPs to satisfy the CPSS-IOSCO Principles for financial market infrastructures (PFMIs). The proposed changes respond to evidence that application of the interim rules could lead both to instances of very little capital being held against exposures to some CCPs, and potentially in certain cases, to capital charges that are higher than for bilateral (non-centrally-cleared) transactions. There was also concern that, in some cases, the interim capital treatment might not create the appropriate incentives for maintaining generous default funds. [my emphasis] These outcomes are potentially inconsistent with the Committee's objectives and the changes set out in the consultative paper seek to address those concerns. 

In parallel to this consultation, the Committee will also conduct a quantitative impact study. Any amendments to the proposed standard will be based on feedback on this consultative document, evidence from the quantitative impact study that will be conducted alongside this consultation, and further consultation with CPSS and IOSCO. The Committee is not proposing any change to the capital treatment of exposures to non-qualifying CCPs. Nor does this consultative paper consider any changes to the rules on capital treatment of clearing member exposures to clients. 

2  The non-internal model method for capitalising counterparty credit risk exposures - consultative document
PDF of full document:

The Basel Committee's consultative paper The non-internal model method for capitalising counterparty credit risk exposures outlines a proposal to improve the methodology for assessing the counterparty credit risk associated with derivative transactions. The proposal would, when finalised, replace the capital framework's existing methods - the Current Exposure Method and the Standardised Method. It improves on the risk sensitivity of the Current Exposure Method by differentiating between margined and unmargined trades. The proposed non-internal model method updates supervisory factors to reflect the level of volatilities observed over the recent stress period and provides a more meaningful recognition of netting benefits. At the same time, the proposed method is suitable for a wide variety of derivatives transactions, reduces the scope for discretion by banks and avoids undue complexity.

The Basel Committee will conduct a quantitative impact study in order to inform the final formulation of the non-internal model method and to assess the difference in exposure and overall capital requirements under this proposal as compared to other measures of counterparty credit risk under the Basel framework. In addition to replacing the Current Exposure Method and the Standardised Method, the  non-internal model method may also be used with respect to the leverage ratio, large exposures, and exposures to central counterparties (CCPs).

Friday, June 28, 2013

Contradictory rules are putting bankers in a bind and threatening the housing recovery. By Frank Keating

Regulators Have Created a Mortgage Minefield. By Frank Keating
Contradictory rules are putting bankers in a bind and threatening the housing recovery.
The Wall Street Journal, June 27, 2013, on page A19

Bankers will soon step into a mortgage minefield—a no-win landscape in which every move will be fraught with peril, and in which the ultimate casualties will be the nascent housing recovery and the American home buyer.

This minefield—a set of incompatible, contradictory regulations—is a creation of the federal government. The first regulation came from the Department of Housing and Urban Development in March, and it said that mortgage lenders can be liable for violations of the 1968 Fair Housing Act if their lending decisions have a so-called "disparate impact" on minorities. No evidence of discriminatory intent or action is required, merely statistical variance in a bank's lending outcomes.

Bankers support equal housing opportunity, but this represents a radical shift in how the government enforces fair housing law. The text of the law prohibits discrimination "because of" race, religion, sex and other protected classes, which means that the lender must have intended to discriminate. This is how we understood the law during the first Bush administration, when I enforced fair housing laws as general counsel and acting deputy secretary atHUD.

The Supreme Court recently agreed to hear the Mount Holly v. Mt. Holly Gardens Citizens in Action case to review whether disparate impact creates liability under the Fair Housing Act. But in the meantime, lenders are facing lawsuits and prosecutions even if they have done nothing wrong.

That's bad enough, but on Jan. 10, the Consumer Financial Protection Bureau's "ability to repay" rule will take effect. This Dodd-Frank mandated rule exposes lenders to risk of litigation if borrowers default on a mortgage—unless the loan falls into a legal "safe harbor" under the CFPB's qualified-mortgage, or QM, guidelines. For example, a loan in which the borrower's total monthly debt payments exceed 43% of his income would presumably fall outside the QM safe harbor.

Even when lenders can prove they have done their best to serve consumers outside the safe harbor, the expected costs of defenses—and delays in resolving defaults—will be passed on to all consumers. This will make lending, even to many creditworthy borrowers, too costly.

Many banks have said that they plan to loan only within the QM guidelines, and Fannie Mae and Freddie Mac —the taxpayer-backed companies that undergird the secondary mortgage market—will buy only qualified mortgages. Thus, the QM will be the primary mortgage product available to home buyers.

The QM requirements will result in an immediate tightening of credit, with banks substituting a one-size-fits-all federal mandate for their own good judgment and sound underwriting. Many creditworthy borrowers who are on the cusp of meeting the requirements—and who may qualify before Jan. 10—will be cut off from the dream of home ownership.

Many of these aspirational home buyers—those who have solid financial futures but who don't fit the QM box—are members of minorities. Moreover, the poverty gap that exists along many racial lines virtually guarantees that tightened mortgage standards will mean that members of some races will be denied credit at a higher rate than others—and voila, disparate impact.

Bankers will be damned if they do and damned if they don't. If they follow the QM guidelines and thus tighten credit, they will run afoul of the novel disparate-impact interpretation of housing laws. If they loosen lending standards to ensure that lending outcomes are identical for every protected group, then they expose themselves to risk of litigation if some of those loans end up in default.

The end result will be confusion and uncertainty. Some banks will stop making mortgage loans altogether, which will further cut access to credit, reduce competition and drive up costs for all home buyers.

Raj Date, the former deputy director of the Consumer Financial Protection Bureau who wrote a large portion of the qualified-mortgage guidelines, now runs a startup venture and mortgage lender that he says will offer loans outside the QM guidelines. As he recently told this newspaper: "It is just way too hard for good, responsible people to get good mortgages today."

We agree. To get people into "good mortgages," the government needs to clear the minefield it created.

Mr. Keating, a former governor of Oklahoma and HUD general counsel, is president and CEO of the American Bankers Association.

Wednesday, June 26, 2013

Revised Basel III leverage ratio framework and disclosure requirements - consultative document

Revised Basel III leverage ratio framework and disclosure requirements - consultative document
BIS, June 2013

An underlying feature of the financial crisis was the build-up of excessive on- and off-balance sheet leverage in the banking system. The Basel III reforms introduced a simple, transparent, non-risk based leverage ratio to act as a credible supplementary measure to the risk-based capital requirements. The leverage ratio is intended to:
  • restrict the build-up of leverage in the banking sector to avoid destabilising deleveraging processes that can damage the broader financial system and the economy; and
  • reinforce the risk-based requirements with a simple, non-risk-based "backstop" measure.
The Basel Committee is of the view that a simple leverage ratio framework is critical and complementary to the risk-based capital framework and that a credible leverage ratio is one that ensures broad and adequate capture of both the on- and off-balance sheet leverage of banks.

Implementation of the leverage ratio requirement has begun with bank-level reporting to supervisors of the leverage ratio and its components from 1 January 2013, and will proceed with public disclosure starting 1 January 2015. Any final adjustments to the definition and calibration of the leverage ratio will be made by 2017, with a view to migrating to a Pillar 1 treatment on 1 January 2018 based on appropriate review and calibration.

The Basel Committee's consultative paper The revised Basel III leverage ratio framework is set out in the remainder of this document, along with the public disclosure requirements starting 1 January 2015. In summary, revisions to the framework relate primarily to the denominator of the leverage ratio, the Exposure Measure. The major changes to the Exposure Measure include:
  • specification of a broad scope of consolidation for the inclusion of exposures;
  • clarification of the general treatment of derivatives and related collateral;
  • enhanced treatment of written credit derivatives; and
  • enhanced treatment of Securities Financing Transactions (SFTs) (eg repos).
In parallel with the consultation on the proposals, the Committee will also undertake a Quantitative Impact Study to ensure that the calibration of the leverage ratio, and its relationship with the risk-based framework, remains appropriate.

Comments on this consultative report should be submitted by 20 September 2013 by email to Alternatively, comments may be sent by post to: Secretariat of the Basel Committee on Banking Supervision, Bank for International Settlements, CH-4002 Basel, Switzerland. All comments may be published on the website of the Bank for International Settlements unless a contributor specifically requests confidential treatment.

Monday, June 24, 2013

Cochrane: Regulating the riskiness of bank assets is a dead end. Instead, fix the run-prone nature of bank liabilities

Stopping Bank Crises Before They Start. By John Cochrane
Regulating the riskiness of bank assets is a dead end. Instead, fix the run-prone nature of bank liabilitiesThe Wall Street Journal, June 24, 2013, on page A19

In recent months the realization has sunk in across the country that the 2010 Dodd-Frank financial-reform legislation is a colossal mess. Yet we obviously can't go back to the status quo that produced a financial catastrophe in 2007-08. Fortunately, there is an alternative.

At its core, the recent financial crisis was a run. The run was concentrated in the "shadow banking system" of overnight repurchase agreements, asset-backed securities, broker-dealers and investment banks, but it was a classic run nonetheless.

The run made the crisis. In the 2000 tech bust, people lost a lot of money, but there was no crisis. Why not? Because tech firms were funded by stock. When stock values fall you can't run to get your money out first, and you can't take a company to bankruptcy court.

This is a vital and liberating insight: To stop future crises, the financial system needs to be reformed so that it is not prone to runs. Americans do not have to trust newly wise regulators to fix Fannie Mae and Freddie Mac, end rating-agency shenanigans, clairvoyantly spot and prick "bubbles," and address every other real or perceived shortcoming of our financial system.

Runs are a pathology of financial contracts, such as bank deposits, that promise investors a fixed amount of money and the right to withdraw that amount at any time. A run also requires that the issuing institution can't raise cash by selling assets, borrowing or issuing equity. If I see you taking your money out, then I have an incentive to take my money out too. When a run at one institution causes people to question the finances of others, the run becomes "systemic," which is practically the definition of a crisis.

By the time they failed in 2008, Lehman Brothers and Bear Stearns were funding portfolios of mortgage-backed securities with overnight debt leveraged 30 to 1. For each $1 of equity capital, the banks borrowed $30. Then, every single day, they had to borrow 30 new dollars to pay off the previous day's loans.

When investors sniffed trouble, they refused to roll over the loans. The bank's broker-dealer customers and derivatives counterparties also pulled their money out, each also having the right to money immediately, but each contract also serving as a source of short-term funding for the banks. When this short-term funding evaporated, the banks instantly failed.

Clearly, overnight debt is the problem. The solution is just as clear: Don't let financial institutions issue run-prone liabilities. Run-prone contracts generate an externality, like pollution, and merit severe regulation on that basis.

Institutions that want to take deposits, borrow overnight, issue fixed-value money-market shares or any similar runnable contract must back those liabilities 100% by short-term Treasurys or reserves at the Fed. Institutions that want to invest in risky or illiquid assets, like loans or mortgage-backed securities, have to fund those investments with equity and long-term debt. Then they can invest as they please, as their problems cannot start a crisis.

Money-market funds that want to offer better returns by investing in riskier securities must let their values float, rather than promise a fixed value of $1 per share. Mortgage-backed securities also belong in floating-value funds, like equity mutual funds or exchange-traded funds. The run-prone nature of broker-dealer and derivatives contracts can also be reformed at small cost by fixing the terms of those contracts and their treatment in bankruptcy.

The bottom line: People who want better returns must transparently shoulder additional risk.

Some people will argue: Don't we need banks to "transform maturity" and provide abundant "safe and liquid" assets for people to invest in? Not anymore.

First, $16 trillion of government debt is enough to back any conceivable demand for fixed-value liquid assets. Money-market funds that hold Treasurys can expand to enormous size. The Federal Reserve should continue to provide abundant reserves to banks, paying market interest. The Treasury could offer reserves to the rest of us—floating-rate, fixed-value, electronically-transferable debt. There is no reason that the Fed and Treasury should artificially starve the economy of completely safe, interest-paying cash.

Second, financial and technical innovations can deliver the liquidity that once only banks could provide. Today, you can pay your monthly credit-card bill from your exchange-traded stock fund. Tomorrow, your ATM could sell $100 of that fund if you want cash, or you could bump your smartphone on a cash register to buy coffee with that fund. Liquidity no longer requires that anyone hold risk-free or fixed-value assets.

Others will object: Won't eliminating short-term funding for long-term investments drive up rates for borrowers? Not much. Floating-value investments such as equity and long-term debt that go unlevered into loans are very safe and need to pay correspondingly low returns. If borrowers pay a bit more than now, it is only because banks lose their government guarantees and subsidies.

In the 19th century, private banks issued currency. A few crises later, we stopped that and gave the federal government a monopoly on currency issue. Now that short-term debt is our money, we should treat it the same way, and for exactly the same reasons.

In the wake of Great Depression bank runs, the U.S. government chose to guarantee bank deposits, so that people no longer had the incentive to get out first. But guaranteeing a bank's deposits gives bank managers a huge incentive to take risks.

So we tried to regulate the banks from taking risks. The banks got around the regulations, and "shadow banks" grew around the regulated system. Since then we have been on a treadmill of ever-larger bailouts, ever-expanding government guarantees, ever-expanding attempts to regulate risks, ever-more powerful regulators and ever-larger crises.

This approach will never work. Rather than try to regulate the riskiness of bank assets, we should fix the run-prone nature of their liabilities. Fortunately, modern financial technology surmounts the economic obstacles that impeded this approach in the 1930s. Now we only have to surmount the obstacle of entrenched interests that profit from the current dysfunctional system.

Mr. Cochrane is a professor of finance at the University of Chicago Booth School of Business, a senior fellow at the Hoover Institution, and an adjunct scholar at the Cato Institute.

Friday, June 21, 2013

Macroprudential and Microprudential Policies: Towards Cohabitation. By J Osinski, K Seal, and L Hoogduin

Macroprudential and Microprudential Policies: Towards Cohabitation. By Jacek Osinski, Katharine Seal, and Lex Hoogduin
IMF Staff Discussion Note SDN13/05
June 21, 2013

Summary: Effective arrangements for micro and macroprudential policies to further overall financial stability are strongly desirable for all countries, emerging or advanced. Both policies complement each other, but there can also be potential areas of overlap and conflict, which can complicate this cooperation. Organizing their very close interactions can help contain these potential tensions. This note clarifies the essential features of macroprudential and microprudential policies and their interactions, and delineates their borderline. It proposes mechanisms for aligning both policies in the pursuit of financial stability by identifying those elements that are desirable for effective cooperation between them. The note provides general guidance. Actual arrangements will need take into account country-specific circumstances, reflecting the fact that that there is no “one size fits all.”

ISBN: 9781484369999
ISSN: 2221-030X

Executive Summary

How can policymakers promote effective cooperation between two closely related financial sector policies? This Staff Discussion Note identifies complementarities and potential conflicts between microprudential policy, which focuses on the health of individual financial institutions, and macroprudential policy, which addresses risks to the financial system as a whole.

These policies usually complement and reinforce each other in pursuit of their respective goals. For example, the health of individual institutions is a necessary, though not sufficient, condition for system-wide stability, while a stable system contributes to the health of individual institutions. In certain situations, however, conflicts may occur because of overlapping policy mandates and the way in which policies are applied.

This paper shows that the clarification of respective mandates, functions, and toolkits can help maximize synergies and limit the potentially negative consequences of policy interaction. Specifically, it is helpful to set primary and secondary policy objectives to clarify the respective responsibilities. It is also important to establish separate, but complementary, policy functions. These include supervision and enforcement (microprudential authority) as well as the identification of systemic risks and the vetting of financial regulations from a systemic risk perspective (macroprudential authority). The potential for tensions between the two policies can be further reduced by clearly assigning powers.

Tensions are more likely to occur at certain stages of the credit cycle, notably during the downturn phase and at crucial turning points. Information sharing, joint analysis of risks, and general dialogue between the microprudential and macroprudential authorities can reduce the likelihood of differences of opinion between the two. Tensions during the downturn are also less likely to occur if policymakers encourage the buildup of shock-absorbing buffers in good times, and if effective resolution mechanisms are in place that allow unviable institutions to die safely. Finally, in order to minimize the risk of misperceptions among market participants, microprudential and macroprudential authorities should establish a credible joint communication strategy that can bolster investor confidence during turbulent periods.

Certain institutional mechanisms can enhance policy cooperation and coordination. The specific features of these mechanisms often reflect country-specific circumstances. For example, if the two policy mandates are held by different entities, it will be important to establish a coordination committee. Other jurisdictions may want to award both policy mandates to a single authority. And in those cases where conflicts between the two policy objectives remain, mechanisms need to be in place to decide which policy should prevail.

This paper provides general and preliminary guidance on measures and arrangements to promote effective cooperation between both policies in their joint pursuit of financial stability. Solutions will be shaped, to a large extent, by country-specific circumstances. Moreover, some flexibility in policy design and arrangements is needed because of the stillconsiderable uncertainty about the impact of these policies and our evolving understanding of systemic risk.

Monday, June 17, 2013

Finance and Poverty: Evidence from India. By Meghana Ayyagari & Thorsten Beck

Finance and Poverty: Evidence from India. By Meghana Ayyagari & Thorsten Beck
World Bank Blogs
Mon, Jul 17, 2013

The relationship between finance, inequality and poverty is a controversial one. While some observers attribute not only the crisis but also rising inequality in many Western countries to the rise of the financial system (e.g. Krugman, 2009), others see an important role of the financial sector on the poverty alleviation agenda (World Bank, 2008). But financial sector policies are not only controversial on the macro, but also micro-level. While increasing access to credit services through microfinance had for a long time a positive connotation, this has also been questioned after recent events in Andhra Pradesh, with critics charging that excessive interest rates hold the poor back in poverty. In recent work with Meghana Ayyagari and Mohammad Hoseini, we find strong evidence for financial sector deepening having contributed to the reduction of rural poverty rates across India by enabling more entrepreneurship in the rural areas and by enticing inter-state migration into the tertiary sector.

Cross-country evidence has linked financial development both to lower levels and faster reductions in income inequality and poverty rates (Beck, Demirguc-Kunt and Levine, 2007; Clarke, Xu and Zhou, 2006). As is often the case with cross-country work, endogeneity concerns are manifold, exacerbated by measurement problems inherent to survey-based inequality and poverty measures.  In addition, cross-country comparisons face limitations in identifying the channel through which financial deepening helps reduce poverty rates. Researchers have therefore turned to country-level studies, which allow better to control for omitted variable and measurement biases.  Richer data on the country level also allow for a better exploration of channels through which finance affects inequality and poverty.

India is close to an ideal testing ground to ask these questions given not only its large sub-national variation in socio-economic and institutional development, but also significant policy changes it has experienced over the sample period (Besley, Boswell and Esteve-Vollart, 2007). We use two of these policy changes as identification strategies in our work. Specifically, we follow Burgess and Pande (2005) and exploit the policy driven nature of rural bank branch expansion across Indian states as an instrument for branch penetration and thus financial breadth. According to the Indian Central Bank’s 1:4 licensing policy instituted between 1977 and 1990, commercial banks in India had to open four branches in rural unbanked locations for every branch opening in an already banked location. Thus between 1977 and 1990, rural bank branch expansion was higher in financially less developed states while after 1990, the reverse was true (financially developed states offered more profitable locations and so attracted more branches outside of the program), as illustrated by Figure 1.

Figure 1: Bank branch penetration as function
of initial financial development

Figure 1: Bank branch penetration as function of initial financial development

As an instrument for financial depth, we use the cross-state variation of per-capita circulation of English-language newspapers in 1991 multiplied by a time trend to capture the differential impact of the media across time after liberalization in 1991. With the relatively free and independent press in India (Besley and Burgess, 2002), a more informed public is better able to compare different financial services, resulting in more transparency and a higher degree of competition leading to greater financial sector development. Figure 2 shows the differential development of Credit to SDP in states with English language newspaper penetration above and below the median.

Figure 2: Bank Credit and English newspaper circulation

Figure 2: Bank Credit and English newspaper circulation
Our main findings

Relating annual state-level variation in poverty to variation in financial development, we find strong evidence that financial depth, as measured by Credit to SDP, has a negative and significant impact on rural poverty in India over the period 1983-2005. On the other hand, we find no effect of financial depth on urban poverty rates.  The effect of financial depth on rural poverty reduction is also economically meaningful. One within-state, within-year standard deviation in Credit to SDP explains 18 percent of demeaned variation in the Headcount and 30 percent of demeaned variation in the Poverty Gap over our sample period.  We also find that over the time period 1983-2005, financial depth has a more significant impact on poverty reduction than financial outreach. Our measure of financial breadth, rural branches per capita, has a negative but insignificant effect on rural poverty over this period, though a strong and negative effect over the longer period of 1965 to 2005, which includes the complete period of the social banking policy.
The channels

The household data also allow us to dig deeper into the channels through which financial deepening affected poverty rates across rural India. First, we find evidence for the entrepreneurship channel, as the poverty-reducing impact of financial deepening falls primarily on self-employed in rural areas. Second, we find that financial sector development is associated with inter-state migration of workers towards financially more developed states. The migration induced by financial deepening is motivated by search for employment, suggesting that poorer population segments in rural areas migrated to urban areas. The rural primary and tertiary urban sectors benefitted most from this migration, consistent with evidence showing that the Indian growth experience has been led by the services sector rather than labor intensive manufacturing (Bosworth, Collins and Virmani, 2007)
This last finding is also consistent with the finding that it is specifically the increase in bank credit to the tertiary sector that accounts for financial deepening post-1991 and its poverty-reducing effect.


Our findings suggest that financial deepening can have important structural effects, including through structural reallocation and migration, with consequences for poverty reduction. Our findings also have important policy repercussions. The pro-poor effects of financial deepening do not necessarily come just through more inclusive financial systems, but can also come through more efficient and deeper financial systems. Critical, the poorest of the poor not only benefit from financial deepening by directly accessing financial services, but also through indirect structural effects of financial deepening. This is consistent with evidence from Thailand (Gine and Townsend, 2004) and for the U.S. (Beck, Levine and Levkov, 2010) who document important labor market and migration effects of financial liberalization and deepening.


  • Ayyagari, M., T. Beck and M. Hoseini (2013) “Finance and Poverty: Evidence from India”, CEPR Discussion Paper 9497.
  • Beck, T., A. Demirgüç-Kunt and R. Levine, (2007) “Finance, Inequality and the Poor”, Journal of Economic Growth, 12(1), 27-49.
  • Beck, T., R. Levine and A. Levkov (2010), “Big Bad Banks? The Winners and Losers from Bank Deregulation in the United States”, Journal of Finance, vol. 65(5), pages 1637-1667.
  • Besley, T., and R. Burgess, (2002) “The Political Economy Of Government Responsiveness: Theory And Evidence From India”, Quarterly Journal of Economics 117(4), pages 1415-1451.
  • Besley, T., R. Burgess, and B. Esteve-Volart (2007) “The Policy Origins of Poverty and Growth in India,”  Chapter 3 in Delivering on the Promise of Pro-Poor Growth: Insights and Lessons from Country Experiences, edited with Timothy Besley and Louise J. Cord, Palgrave MacMillan for the World Bank.
  • Bosworth, B., Collins, S. and Virmani, A. (2007), “Sources of Growth in the Indian Economy”, in Bery, S., Bosworth, B. and Panagariya, A. (eds.), India Policy Forum, 2006-07, Washington, DC: Brookings Institution Press.
  • Burgess, R., and R. Pande (2005), “Do Rural Banks Matter? Evidence from the Indian Social Banking Experiment”, American Economic Review, vol. 95(3), pages 780-795.
  • Clarke, G., L. C. Xu and H. Zhou, (2006) “Finance and Income Inequality: What Do the Data Tell Us?”, Southern Economic Journal vol. 72(3), pages 578-596.
  • Gine, X. and R. Townsend (2004) “Evaluation of financial liberalization: a general equilibrium model with constrained occupation choice”, Journal of Development Economics 74, 269-307.
  • Krugman, Paul, (2009), The financial factor.
  • World Bank (2008): Finance for All?  Policies and Pitfalls in Expanding Access. Washington DC.

Thursday, June 13, 2013

Interact with people. Advise from Jean Adams, statistician

1  Master's Notebook: Not Everything That Counts Can Be Counted. By Jean Adams
AmStat News, Mar 1, 2013



Humans. They’re a strange bunch. Incredibly varied and unbelievably complicated. Like it or not, these creatures will play a huge role in your life and in your career. Anything you can do to understand them better, do it. In school? Take a psychology course. On the job? Take a management course on personality types or communication skills. Been there done that? Please. Don’t make me laugh. When it comes to human nature, there’s always room to learn more.

Connect with the people around you. Consciously put yourself in situations in which you will interact with the members of your community, be it at school or work. Is someone approaching you in the hallway? Look him in the eye and say hello. Is your room or office located at the far end of the building, near a remote entrance? Make a habit of entering the building at the main entrance. Is there a group that goes bowling every Friday? Go with them. Have a question for a colleague down the hall? Ask her in person. Is there a brown bag group that eats in the break room? Eat with them. Think of it as an optimization problem. You want to maximize your daily face time.

Unless you are gregarious by nature, these suggestions may take you a bit out of your comfort zone. That makes it all the more important. And it’s okay to experience some discomfort. You will get better with practice. And let me tell you a secret. Connecting with the people around you will do wonders for your career. It will open doors; it will bring you joy. It will reward you with an intangible quality that no one verbalizes, but everyone perceives.

Find your passion. Connect with people. That’s my recipe for a long and happy career.

2  Master's Notebook: Seeing Is Believing. By Jean Adams
AmStat News, Jun 1, 2013


Pay It Forward

Have you ever had your work improved by the comments of a good reviewer? Have you ever benefited from the sage advice of a mentor? Have you ever gotten stuck trying a new analysis or software and turned to Internet forums to get unstuck? Of course you have. We all have. We are surrounded by people willing to help, including some we have never met. Don’t hesitate to ask for assistance. If you choose your target wisely and clearly state your question, you will be rewarded for your efforts. I find that just the process of framing the question for someone else brings some answers to light.

Have you ever been on the other side? Reviewed someone else’s work? Advised a protégé? Answered questions on an Internet forum? If not, give it a try. You may be surprised to discover that you get as much out of the interaction as the person you’re helping. It can be quite gratifying, and there’s always something to learn. As every teacher knows, the best way to really understand a subject is to try to explain it to someone else.

No matter how much experience you have, there’s always someone with more experience from whom you can learn, and there’s always someone with less experience who could benefit from your help.


Jean Adams is a statistician with the U.S. Geological Survey – Great Lakes Science Center and the Great Lakes Fishery Commission, both headquartered in Ann Arbor, Michigan

Saturday, June 8, 2013

How America Lost Its Way. By Niall Ferguson

How America Lost Its Way. By Niall Ferguson Wall Street Journal, June 8, 2013, on page C1
It is getting ever harder to do business in the United States, argues Niall Ferguson, and more stimulus won't help: Our institutions need fixing.

Not everyone is an entrepreneur. Still, everyone should try—if only once—to start a business. After all, it is small and medium enterprises that are the key to job creation. There is also something uniquely educational about sitting at the desk where the buck stops, in a dreary office you've just rented, working day and night with a handful of employees just to break even.

As an academic, I'm just an amateur capitalist. Still, over the past 15 years I've started small ventures in both the U.S. and the U.K. In the process I've learned something surprising: It's much easier to do in the U.K. There seemed to be much more regulation in the U.S., not least the headache of sorting out health insurance for my few employees. And there were certainly more billable hours from lawyers.

By the Numbers

    433: Total number of days it takes in the U.S. to start a business, register a property, pay taxes, get an import and export license and enforce a contract
    368: Total number of days it took to do the same in 2006
    7: U.S. ranking, out of 144 countries, on the World Economic Forum's 2012-2013 Global Competitiveness Index
    1: U.S. ranking on the 2008-2009 Global Competitiveness Index
    33: U.S. ranking for its legal system and property rights in 2010 on the Fraser Institute's Economic Freedom index, out of 144 countries
    9: U.S. ranking for its legal system and property rights in 2000

Sources: 'Doing Business'; World Economic Forum; Fraser Institute

This set me thinking. We are assured by vociferous economists that economic growth would be higher in the U.S. and unemployment lower if only the government would run even bigger deficits and/or the Fed would print even more money. But what if the difficulty lies elsewhere, in problems that no amount of fiscal or monetary stimulus can overcome?

Nearly all development economists agree that good institutions—legislatures, courts, administrative agencies—are crucial. When poor countries improve their institutions, economic growth soon accelerates. But what about rich countries? If poor countries can get rich by improving their institutions, is it not possible that rich countries can get poor by allowing their institutions to degenerate? I want to suggest that it is.

Consider the evidence from the annual "Doing Business" reports from the World Bank and International Finance Corporation. Since 2006 the report has published data for most of the world's countries on the total number of days it takes to start a business, get a construction permit, register a property, pay taxes, get an export or import license and enforce a contract. If one simply adds together the total number of days it would take to carry out all seven of these procedures sequentially, it is possible to construct a simple measure of how slowly—or fast—a country's bureaucracy moves.

Seven years of data suggest that most of the world's countries are successfully making it easier to do business: The total number of days it takes to carry out the seven procedures has come down, in some cases very substantially. In only around 20 countries has the total duration of dealing with "red tape" gone up. The sixth-worst case is none other than the U.S., where the total number of days has increased by 18% to 433. Other members of the bottom 10, using this metric, are Zimbabwe, Burundi and Yemen (though their absolute numbers are of course much higher).

Why is it getting harder to do business in America? Part of the answer is excessively complex legislation. A prime example is the 848-page Wall Street Reform and Consumer Protection Act of July 2010 (otherwise known as the Dodd-Frank Act), which, among other things, required that regulators create 243 rules, conduct 67 studies and issue 22 periodic reports. Comparable in its complexity is the Patient Protection and Affordable Care Act (906 pages), which is also in the process of spawning thousands of pages of regulation. You don't have to be opposed to tighter financial regulation or universal health care to recognize that something is wrong with laws so elaborate that almost no one affected has the time or the will to read them.

Who benefits from the growth of complex and cumbersome regulation? The answer is: lawyers, not forgetting lobbyists and compliance departments. For complexity is not the friend of the little man. It is the friend of the deep pocket. It is the friend of cronyism.

We used to have the rule of law. Now it is tempting to say we have the rule of lawyers, which is something different. For the lawyers can also make money even in the absence of complex legislation.

It has long been recognized that the U.S. tort system is exceptionally expensive. Indeed, tort reform is something few people will openly argue against. Yet the plague of class-action lawsuits continues unabated. Regular customers of Southwest Airlines recently received this email: "Did you receive a Southwest Airlines drink coupon through the purchase of a Business Select ticket prior to August 1, 2010, and never redeem it? If yes, a legal Settlement provides a Replacement Drink Voucher, entitling you to a free drink aboard a Southwest flight, for every such drink coupon you did not redeem."

This is not the product of the imagination of some modern-day Charles Dickens. It is a document arising from the class-action case, In re Southwest Airlines Voucher Litigation, No. 11-cv-8176, which came before Judge Matthew F. Kennelly of the District Court for the Northern District of Illinois. As the circular explains: "This Action arose out of Southwest's decision, effective August 1, 2010, to only accept drink coupons received by Business Select customers with the purchase of a Business Select ticket on the date of the ticketed travel. The Plaintiffs in this case allege Southwest, in making that decision, breached its contract with Class Members who previously received drink coupons," etc.

As often happens in such cases, Southwest decided to settle out of court. Recipients of the email will have been nonplused to learn that the settlement "will provide Replacement Drink Vouchers to Class Members who submit timely and valid Claim Forms." One wonders how many have bothered.

Cui bono? The answer is, of course, the lawyers representing the plaintiffs. Having initially pitched for "up to $7 million in fees, costs and expenses," these ingenious jurists settled for fees of $3 million "plus costs not to exceed $30,000" from Southwest.

Canada's Fraser Institute has been compiling an "Economic Freedom" index since 1980, one component of which is a measure of the quality of a country's legal system and property rights. In the light of a case like the one described above, there is nothing surprising about the recent decline in U.S. performance. In 2000 U.S. law scored 9.23 out of 10. The most recent score (for 2010) was 7.12.

Such indexes must be used with caution, but the Fraser index is not the only piece of evidence suggesting that the rule of law in the U.S. is not what it was. The World Justice Project uses a completely separate methodology to assess countries' legal systems. The latest WJP report ranks the U.S. 17th out of 97 countries for the extent to which the law limits the power of government, 18th for the absence of corruption, 19th for regulatory enforcement, 22nd for access to civil justice and the maintenance of order and security, 25th for fundamental rights, and 26th for the effectiveness of criminal justice. Of all the former British colonies in the report, the U.S. ranks behind New Zealand, Australia, Singapore, Canada, Hong Kong and the United Kingdom—though it does beat Botswana.

The decline of American institutions is no secret. Yet it is one of those strange "unknown knowns" that is well documented but largely ignored. Each year, the World Economic Forum publishes its Global Competitiveness Index. Since it introduced its current methodology in 2004, the U.S. score has declined by 6%. (In the same period China's score has improved by 12%.) An important component of the index is provided by 22 different measures of institutional quality, based on the WEF's Executive Opinion Survey. Typical questions are "How would you characterize corporate governance by investors and boards of directors in your country?" and "In your country, how common is diversion of public funds to companies, individuals, or groups due to corruption?" The startling thing about this exercise is how poorly the U.S. fares.

In only one category out of 22 is the U.S. ranked in the global top 20 (the strength of investor protection). In seven categories it does not even make the top 50. For example, the WEF ranks the U.S. 87th in terms of the costs imposed on business by "organized crime (mafia-oriented racketeering, extortion)." In every single category, Hong Kong does better.

At the same time, the U.S. has seen a marked deterioration in its World Governance Indicators. In terms of "voice and accountability," "government effectiveness," "regulatory quality" and especially "control of corruption," the U.S. scores have all gone down since the WGI project began in the mid-1990s. It would be tempting to say that America is turning Latin, were it not for the fact that a number of Latin American countries have been improving their governance scores over the same period.

What is the process at work here? Perhaps this is a victory from beyond the grave for classical Western political theory. Republics, after all, were regarded by most ancient political philosophers as condemned to decadence, or to imperial corruption. This was the lesson of Rome. Democracy was always likely to give way to oligarchy or tyranny. This was the lesson of the French Revolution. The late Mancur Olson had a modern version of such cyclical models, arguing that all political systems were bound to become the captives, over time, of special interests. The advantage enjoyed by West Germany and Japan after World War II, he suggested, was that all the rent-seeking elites of the pre-1945 period had been swept away by defeat. This was why Britain won the war but lost the peace.

Whatever the root causes of the deterioration of American institutions, smart people are starting to notice it. Last year Michael Porter of Harvard Business School published a report based on a large-scale survey of HBS alumni. Among the questions he asked was where the U.S. was "falling behind" relative to other countries. The top three lagging indicators named were: the effectiveness of the political system, the K-12 education system and the complexity of the tax code. Regulation came sixth, efficiency of the legal framework eighth.

Asked to name "the most problematic factors for doing business" in the U.S., respondents to the WEF's most recent Executive Opinion Survey put "inefficient government bureaucracy" at the top, followed by tax rates and tax regulations.

All this should not be interpreted as yet another prophecy of the imminent decline and fall of the U.S., however. There is some light in the gloom. According to the most recent United Nations projections, the share of the U.S. population that is over 65 will reach 25% only at the very end of this century. Japan has already passed that milestone; Germany will be next. By midcentury, both countries will have around a third of their population age 65 or older.

More imminently, a revolution in the extraction of shale gas and tight oil, via hydraulic fracking, is transforming the U.S. from energy dependence to independence. Not only could the U.S., at least for a time, re-emerge as the world's biggest oil producer; the lower electricity costs resulting from the fossil-fuel boom are already triggering a revival of U.S. manufacturing in the Southeast and elsewhere.

In a functioning federal system, the pace of institutional degeneration is not uniform. America's four "growth corridors"—the Great Plains, the Gulf Coast, the Intermountain West and the Southeast—are growing not just because they have natural resources but also because state governments in those regions are significantly more friendly to business. There are already heartening signs of a great regeneration in states like Texas and North Dakota.

"In America you have a right to be stupid—if you want to be." Secretary of State John Kerry made that remark off the cuff in February, speaking to a group of students in Berlin. It is not a right the founding fathers felt they needed explicitly to enshrine. But it has always been there, and America's leaders have frequently been willing to exercise it.

Yes, we Americans have the right to be stupid if we want to be. We can carry on pretending that our economic problems can be solved with the help of yet more fiscal stimulus or quantitative easing. Or we can face up to the institutional impediments to growth I have described here.

Not many economists talk about them, it's true. But that's because not many economists run businesses.

Adapted from Mr. Ferguson's new book, "The Great Degeneration: How Institutions Decay and Economies Die," to be published by Penguin Press on Thursday.

Thursday, June 6, 2013

Why China Frets Over America's Retreat. By Daniel Blumenthal

Why China Frets Over America's Retreat. By Daniel Blumenthal
The Wall Street Journal, June 6, 2013, on page A17
Usually Chinese leaders decry Washington's foreign-policy aggression. That won't be an issue at this week's summit.

When Chinese President Xi Jinping meets with President Obama in California at week's end, Mr. Xi will confront a new strategic reality: America in retreat. Chinese leaders normally complain that Washington is too aggressive. But what should really worry Beijing is the opposite—a bipartisan U.S. consensus for a foreign policy of retrenchment. As much as China aspires to global leadership, Beijing has neither the wherewithal nor the desire to take on the responsibilities that come with that role.

Since the Cold War ended in the early 1990s, Sino-American summitry has followed a pattern to which both countries have grown accustomed. Beijing complains of U.S. heavy-handedness. Washington complains that it shoulders all the burdens of global leadership and asks China to play a more responsible and prominent role in world affairs.

Neither country is serious while doing this minuet. At best Washington is conflicted about a greater leadership role for an authoritarian China. For its part, China has become accustomed to the benefits of a post-World War II American-led (and paid-for) global compact that includes freer markets, more peaceful international relations and more liberal governments.

The temptation to repeat this dance will be great this week. Presidents Xi and Obama will be meeting during a period of deep mutual suspicion. The downward spiral of distrust began in 2009 over escalating tensions about territory between China and its Southeast Asian neighbors, and it reached a new low when then-Secretary of State Hillary Clinton announced a "pivot" toward Asia in 2011.

The pivot strategy has two pillars. The first is a positive desire to deeply embed the U.S. in all of Asia's increasingly vibrant political and economic life. The second is a reaction to growing Chinese dominance in the region, and the resulting clamor—from America's regional allies and in the U.S.—for Washington to counterbalance predatory Chinese military power.

China chose to hear only the second part of the pivot strategy, reacting to it as Cold War-style containment with Asian characteristics. Relations between the two powers have been frosty since then.

Yet if Mr. Xi examines U.S. foreign policy more closely, he will see that Beijing is worried about the wrong things. The problem is not too much American power. It is too little.

Consider recent events in Washington: Mr. Obama announced the end of the war on terror without evidence that the conflict had ended and denied leaks suggesting the imposition of a no-fly zone in Syria. He ignored a new International Atomic Energy Agency report suggesting that Iran is making huge progress in developing nuclear weapons, and refused efforts to restore draconian cuts to the U.S. military budget.

In response—a few outliers notwithstanding—Congress, including Republicans, remained silent. This marked a significant shift. Once the tribune of American global leadership, much of the right now marches in foreign-policy lock step with a left that has little interest in the exercise of U.S. power. This left-right neo-isolationist alliance is a recipe for global chaos—an outcome more harmful to China than the big-footed America that China is used to complaining about.

Why? Because despite China's politically correct paeans to international institutions and multilateralism, Chinese leaders well know that international politics needs a prime actor willing to provide global public goods such as secure maritime trade, peace between great powers, nonproliferation, counterterrorism and leadership on international trade and investment.

If the U.S. abdicates its role, China is the only other nation in line for the post of prime power. Is China ready to assume primacy in the international community? The answer is no.

Granted, China is active on the world stage. Recently President Xi announced proposals for Arab-Israeli peace and a Syrian cease-fire. Once again, Beijing prodded North Korea to open up and reform its economy. But peace proposals, state visits and commercial diplomacy cannot maintain world order.

Taking the global leadership reins from the U.S. would require incurring real costs, taking big risks, using political capital and, if necessary, expending blood and treasure. If China wanted to lead the world, it would build a navy capable of protecting—rather than disrupting—sea lanes. It would contribute to the fight against terror and help to keep cyberspace an open commons for commercial transactions and the sharing of ideas. It is doing none of these things.

Think of it this way: Does China wish to anger anyone in the Middle East by taking sides in Syria or pressuring Iran? Manage the collapse of North Korea? Steward a new era of free trade? Push back al Qaeda?

Chinese leaders appear not to give much consideration to taking on these tasks, nor has Washington thought through what a world with no leader would look like. Does a global system of anti-democratic regional hegemons, spheres of influence, and exclusive trading blocs really appeal?

For all of these reasons, this could be a truly pivotal summit. As counterintuitive as it may seem, for the first time since the Soviet collapse China has an interest in America acting more, not less, assertively in foreign affairs.

Mr. Blumenthal is the director of Asian Studies at the American Enterprise Institute.

South Korea: National Security or National Pride Regarding Japan?, by Krista E. Wiegand

South Korea: National Security or National Pride Regarding Japan?, by Krista E. Wiegand
Asia Pacific Bulletin, No. 214
Washington, D.C.: East-West Center
May 22, 2013

Krista E. Wiegand is Associate Professor of Political Science at Georgia Southern University and a recent POSCO Visiting Fellow at the East-West Center. She explains in this bulletin that "The South Korean government will not be able to deal with the larger issue of security relations with Japan until disputed issues symbolized by Dokdo/Takeshima are sufficiently resolved—and the likelihood of this happening anytime soon is fairly low."

The first official state function of newly inaugurated President Park Geun-hye was a ceremony on March 1 commemorating Independence Movement Day—celebrating Korean resistance in 1919 to Japanese occupation—where she appealed: “It is incumbent on Japan to have a correct understanding of history and take on an attitude of responsibility in order to partner with us in playing a leading role in East Asia in the 21st century.” Her speech outlined a hard line stance regarding ROK-Japan relations. It also did not help that at the end of March, the Korean Foreign Ministry summoned a high ranking Japanese official in Seoul to strongly protest the inclusion of the islets as being called Takeshima in newly released Japanese school books. Japanese cabinet members then went to Yasakuni Shrine in April which further exasperated matters, resulting in South Korean Foreign Minister Yun Byung-se cancelling a proposed visit to Japan.

If Park wants to maintain high approval ratings and not lose credibility regarding her tough position towards Japan, she will have to take into account domestic public opinion on any future security plans with Japan, even under US pressure. Yet, taking this tough approach causes unconstructive tensions in the ROK-Japan-US security relationship, and at a time of recent unprecedented heightened tensions on the Korean Peninsula. Moreover, Korea’s role as an increasingly important actor in regional security indicates that Japan and South Korea will have to cooperate more in the future.  They are both democracies, have shared values and interests, and each looks to the United States as the preferred security partner. Park will have to balance Korea’s security interests with domestic opposition to closer ties with Japan, an extremely difficult challenge under current circumstances.

Even if Korean officials are not as supportive of the GSOMIA as their counterparts in Japan and the United States, moving forward on security relations with Japan is critical. Yet, domestic opposition to issues related to Japan has effectively prevented such cooperation. The South Korean government will not be able to deal with the larger issue of security relations with Japan until disputed issues symbolized by Dokdo/ Takeshima are sufficiently resolved—and the likelihood of this happening anytime soon is fairly low. The United States has encouraged better bilateral relations between its two closest allies in East Asia, yet at the same time, the US government has been hesitant to take sides in a dispute that the United States itself inadvertently created as a result of its ambiguity in its role as mediator of the 1951 San Francisco Treaty. President Park and future Korean presidents will have a tough time successfully pursuing any plans of security engagement with Japan as long as the Dokdo/Takeshima dispute and related issues flare up. The United States is in a unique position to influence both Korea and Japan and it should continue to pressure both states to work toward reconciliation.