Taxation, Bank Leverage, and Financial Crises. By Ruud de Mooij, Michael Keen, and Masanori Orihara

Taxation, Bank Leverage, and Financial Crises. By Ruud de Mooij, Michael Keen, and Masanori Orihara
IMF Working Paper No. 13/48
Feb 25, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40341.0

Summary: That most corporate tax systems favor debt over equity finance is now widely recognized as, potentially, amplifying risks to financial stability. This paper makes a first attempt to explore, empirically, the link between this tax bias and the probability of financial crisis. It finds that greater tax bias is associated with significantly higher aggregate bank leverage, and that this in turn is associated with a significantly greater chance of crisis. The implication is that tax bias makes crises much more likely, and, conversely, that the welfare gains from policies to alleviate it can be substantial—far greater than previous studies, which have ignored financial stability considerations, suggest.


Introduction excerpts:

The onset of the financial crisis of 2008 quickly prompted many assessments of the role that taxation might have played.1 Their consensus was clear, but vague: tax distortions did not trigger the crisis, but may have increased vulnerability to financial crises. Prominent among the reasons given for this was ‘debt bias’: the tendency toward excess leverage induced, in almost all countries, by the deductibility against corporate taxation of interest payments but not of the return to equity.2 By encouraging firms to finance themselves by debt rather than equity, this might have made them more vulnerable to shocks and so increased both the likelihood and intensity of financial crises. The point applies in principle to all firms, but is a particular concern in relation to financial institutions; and these are the focus here.

This potential link from tax design to financial crises is now widely recognized. But analysis has not progressed beyond metaphor and speculation. Shackelford, Shaviro, and Slemrod (2010, p. 784), for instance, stress “the possibility that the tax biases served…as extra gasoline intensifying the explosion once other causes lit the match”, and the European Commission that “The welfare costs related to debt bias might not be negligible [because] excessive debt levels increase the probability of default” (European Commission, 2011; p. 7), with both the ‘might’ and the ‘not negligible’ leaving much doubt and imprecision.  This paper aims to provide a first attempt to establish and quantify an empirical link between the tax incentives that encourage financial institutions (more precisely, banks, the group for which we have data) to finance themselves by debt rather than equity and the likelihood of financial crises erupting; and then to try to quantify the welfare gains that policies to address this bias might consequently yield.

The approach is to combine two elements in a causal chain. The first is that between the statutory corporate tax rate and banks’ leverage. This has received substantial attention in relation to nonfinancial firms,3 but very little in relation to the financial sector. Keen and De Mooij (2011), however, show that for banks too a higher corporate tax rate, amplifying the tax advantage of debt over equity finance, should in principle lead to higher levels of leverage; the presence of capital regulations does not affect the usual tax bias applying, so long as it is privately optimal for banks to hold some buffer over regulatory requirements (as they generally do). Empirically too, Keen and de Mooij (2012) find that, for a large crosscountry panel of banks, tax effects on leverage are significant—and, on average, about aslarge as for nonfinancial institutions. These effects are very much smaller, they also find, for the largest banks, which generally account for the vast bulk of all bank assets. One task in this paper is to explore these findings further, using data now available to extend coverage into the crisis period that began in 2008—enabling a comparison of tax impacts pre- and post-onset—and applying the same estimation strategy to country-level data for the OECD.

Importantly, the finding that tax distortions to leverage are small for the larger banks, which are massively larger than the rest, does not mean that the welfare impact of tax distortions is in aggregate negligible: even small changes in the leverage of very large banks could have a large impact on the likelihood of their distress or failure, and hence on the likelihood of financial crisis.

This is where the second link in the causal chain explored here comes in: that between the aggregate leverage of the financial sector and the probability of financial crisis.4 We estimate such a relationship for OECD countries, applying the estimation strategy of Barrell et al.  (2010) and Kato, Kobayashi, and Saita (2010) but, in contrast to these earlier studies, capturing data on the recent financial crisis from Laeven and Valencia (2010). The results suggest sizeable and highly nonlinear effects of aggregate bank leverage on the probability of financial crisis.

Combining the results from these two estimating equations enables simple calculations of the impact of a variety of tax reforms on the likelihood of financial crisis. Linking this, in turn, with estimates of the output loss that is historically associated with such crises gives some rough sense of the potential welfare gains from policies that mitigate debt bias in the financial sector. Putting aside the overarching debate as to the proper roles of taxation and regulation in addressing the potential for excess leverage in the financial sector,5 we consider three tax reforms that would reduce the tax incentive to debt finance: a cut in the corporate tax rate; adoption of an Allowance for Corporate Equity form of corporate tax (which would in principle eliminate debt bias); and a ‘bank levy’ of broadly the kind that a dozen or so countries have introduced since the crisis.6

All this gives a very different perspective on the nature and possible magnitude of the welfare costs associated with debt bias. Previous work, which has not reflected considerations of financial stability, has concluded that these are small: Gordon (2010) estimates the total efficiency loss from debt bias in the U.S. to be less than 1 percent of corporate income tax (CIT) revenue and concludes that: “tax distortions from corporate financial policy are not an important consideration when setting tax policy”; Weichenrieder and Klautke (2008) put the marginal welfare loss from debt bias somewhat higher, but still only at 0.06–0.16 percent of the capital stock. The question here is whether considerations of financial stability imply much higher welfare losses—and the conclusion will be that it seems they do.


Conclusion

The analysis here is in several respects simplistic and limited. In particular, we have not uncovered a direct link between tax incentives favoring debt finance and the probability of financial crisis. But the evidence presented here does suggest the real possibility of such a connection. If debt bias leads to higher aggregate bank leverage than would otherwise be the case—and it seems that it does—and if higher aggregate bank leverage makes financial crisis more likely—and it seems that it does—then debt bias increases the chances of financial crisis. This, in turn, can imply welfare gains from mitigating debt bias far higher than the small amounts found in previous work: noticeably more, in some of the calculations reported here, than 1 percent of GDP. Regulation, of course, has historically had the dominant role in addressing such problems of excess leverage in the financial sector, and the higher and tighter capital requirements of Basel III should to some degree reduce the welfare costs of debt bias. How much comfort is taken from this will depend on one’s evaluation of these reforms. What the evidence assembled here suggests, however, is that the tax incentive encouraging banks to use debt finance is not just an inelegant inconsistency with regulations intended to do the exact opposite, but a potential risk to be recognized, and, as need be, addressed, in the pursuit of financial stability.

Asset Price Bubbles: A Selective Survey. By Anna Scherbina

Asset Price Bubbles: A Selective Survey. By Anna Scherbina
IMF Working Paper No. 13/45
Feb 21, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40327.0

Summary: Why do asset price bubbles continue to appear in various markets? This paper provides an overview of recent literature on bubbles, with significant attention given to behavioral models and rational models with frictions. Unlike the standard rational models, the new literature is able to model the common characteristics of historical bubble episodes and offer insights for how bubbles are initiated and sustained, the reasons they burst, and why arbitrage forces do not routinely step in to squash them. The latest U.S. real estate bubble is described in the context of this literature.


Introduction excerpts:

The persistent failure of present-value models to explain asset price levels led academic research to introduce the concept of bubbles as a tool to model price deviations from presentvalue relations. The early literature was dominated by models in which all agents were assumed to be rational and yet a bubble could exist. In many of the more recent papers, the perfect rationality assumption was relaxed, allowing the models to shift the focus to explaining how a bubble may be initiated, under which conditions it would burst, and why arbitrage forces may fail to ensure that prices reflect fundamentals at all times. In light of the recent U.S. real estate bubble, the question of why bubbles are so prevalent is once again a matter of concern of academics and policy makers. This paper surveys the recent literature on asset price bubbles, with significant attention given to behavioral models as well as rational models with incentive problems, market frictions, and non-traditional preferences. For surveys of the earlier literature, see, e.g., Camerer (1989) and Stiglitz (1990).

There are a number of ways to define a bubble. A very straightforward definition is that a bubble is a deviation of the market price from the asset’s fundamental value. Value investors specialize in finding and investing in undervalued assets. In contrast, short sellers, who search the market for overvalued assets in order to sell them short, are routinely vilified by governments, the popular press, and, not surprisingly, by the overvalued firms themselves.1 Trading against an overvaluation involves the additional costs and risks of maintaining a short position, such as the potentially unlimited loss, the risk that the borrowed asset will be called back prematurely, and a commonly charged fee that manifests itself as a low interest rate paid on the margin account; for this reason, a persistent overvaluation is more common than a persistent undervaluation.

A positive or negative mispricing may arise when initial news about a firm’s fundamentals moves the stock price up or down and feedback traders buy or sell additional shares in response to past price movement without regard for current valuation, thus continuing the price trend beyond the value justified by fundamentals.2 However, because of the potentially nontrivial costs of short selling an overvaluation will be less readily eliminated, making positive bubbles more common. The paper will, therefore, focus predominately on positive price bubbles. We can define a positive bubble occurring when an asset’s trading price exceeds the discounted value of expected future cash flows (CF):

[traditional formula],

where r is the appropriate discount rate.3 Since it may be difficult to estimate the required compensation for risk, an alternative definition may be used that replaces the discount rate with the risk-free rate, r sub f:

[same formula with r sub f instead of r].

When the asset’s cash flows are positively correlated with market risk, as is the case for most firms, the required rate of return is strictly greater than the risk-free rate and the discountedcash- flow formula represents an upper limit of the justifiable range of fair values. Likewise, when it is difficult to forecast future cash flows for a particular asset or firm, an upper bound of forecasted cash flows for other firms in the same industry or asset class may be used.

Over the years, the academic study of bubbles has expanded to explore the effects of perverse incentives and of bounded rationality. The new generation of rational models identifies the incentive to herd and the limited liability compensation structure as pervasive problems that encourage professional money managers to invest in bubbles. Another problem contributing to bubbles is that information intermediaries are not paid directly by investors, and their incentives are not always compatible with reporting negative information. And rather than merely trying to answer under what conditions bubbles may exist in asset prices, behavioral models offer new insights for how a bubble may be initiated, under which conditions it would burst, and why arbitrage forces may fail to ensure that prices reflect fundamentals at all times.  Moreover, some models offer the explanation for why many bubble episodes are accompanied by high trading volume. The behavioral view of bubbles finds support in experimental studies.

Dealing with Private Debt Distress in the Wake of the European Financial Crisis - A Review of the Economics and Legal Toolbox

Dealing with Private Debt Distress in the Wake of the European Financial Crisis - A Review of the Economics and Legal Toolbox. By Yan Liu and Christoph Rosenberg
IMF Working Paper No. 13/44
February 20, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40326.0

Summary: The private non-financial sector in Europe is facing increased challenges in meeting its debt servicing obligation. In response, governments are revisiting legal tools and—in some cases—institutional arrangements to deal with over-indebtedness. For households, where the problem in some countries is large but no established best practice exists, reforms have generally sought to allow debtors a fresh start while minimizing moral hazard and preserving bank solvency and credit discipline. For the corporate sector, efforts have focused on facilitating debt restruturing (including through out of court mechanisms). Direct government intervention has been rare.


ISBN/ISSN: 9781475544305 / 2227-8885
Stock No: WPIEA2013044

Stapleton Roy: U.S. and China Must Halt Drift Toward Strategic Rivalry

Stapleton Roy: U.S. and China Must Halt Drift Toward Strategic Rivalry

HONOLULU (Feb. 20, 2013) -- With China’s leadership in transition and incoming Secretary of State John Kerry heading a new foreign policy team in the second Obama administration, leaders in both countries must face a “frightening array of domestic and foreign policy problems” in managing their vital relationship, longtime senior U.S. diplomat J. Stapleton Roy said in a Feb. 13 address at the East-West Center in Hawai‘i.

(View a video of Roy’s speech.)

“No task is going to be more important than trying to arrest the current drift in U.S.-China relations toward strategic rivalry,” he said. “If leaders in both countries fail to deal with this issue, there is a strong possibility that tensions will rise and undermine the benign climate that has been so important in producing the Asian economic miracle ­– and to a significant degree, political miracle ­– over the past 30 years.”

Roy, who served as U.S. ambassador to China from 1991 to 1995, said the two nations are “locked in the traditional problem of an established power facing a rising power, and we know from historical precedent that competitive factors that emerge in such situations often result in bloody wars.” The good news, he said, is that “leaders in both countries are aware of the historical precedents and are determined to not let history repeat itself.”

While top leaders on both sides have recognized the need to work together toward a stable balance between cooperation and competition, Roy said, neither country has been able to implement this, and “it remains to be seen if it is even possible to establish this new type of relationship.”

Roy said opinion polls over the last couple of years have shown a dramatic increase in the percentage of Chinese citizens and officials who view relations with the U.S. as characterized by hostility rather than cooperation. During the same period, he said, U.S. polls indicate that “we don’t think of China in same way.”

“This is something we need to be concerned about,” he said, “because the tensions and passions on the other side are stronger than they are on our side, and this requires careful management.”

While incoming Chinese President Xi Jinping and Premier Li Keqian have already declared their interest in implementing further market reforms and reining in pervasive corruption, Roy said, “the Communist Party may lack the legitimacy and will to force through the far-reaching reforms that are needed against the influence of special interests, especially large state-owned businesses. One can reasonably doubt if a party corrupted by wealth at the highest level can carry out the kind of fundamental systemic reforms that are necessary.”

In addition, he said, China’s new leaders will be faced with a litany of internal difficulties that “illustrate why it would still be foolish to postulate that the 21^st century will belong to China.” These include what even outgoing premier Wen Jiabao has characterized as an “unstable, unbalanced, uncoordinated and unsustainable” economy, Roy said, along with a rapidly aging population, slowing economic growth, and what is known as the “middle income trap,” when a rising economy loses the competitive advantage of low-cost labor as it climbs the income scale.

“Wages in China have been rising rapidly, especially for skilled labor,” Roy said. “So they have to substitute something else, such as innovation or efficiency.” Historically, he said, “over 100 countries have reached the middle income trap, and 86 percent failed to get out of it. They grow, then reach a certain level and stall out. China has to find way to avoid this, and that’s a big challenge.”

Another huge issue, Roy said, is that “rising nationalism is pushing China toward a more assertive international style and enmeshing it in difficulties with a lot of its neighbors. This has the potential to undermine the benign international environment that has underpinned the dramatic accomplishments China has made.”

China’s more assertive recent behavior is “both typical and predictable for a rising power,” he said. “But China is finding that when it expresses this nationalism through more assertive behavior, its neighbors all show solidarity with the U.S., which is not what China is trying to accomplish. And this is causing resentment in China, because they find that they can’t use their growing power effectively as a result of the negative consequences.”

This could actually prove to be a positive phenomenon for the U.S., he said, “because if we’re skillful enough to understand this dynamic, we are in a position to constrain China when it’s behaving irresponsibly and cooperate with it when it behaves responsibly.”

“China is not the Soviet Union,” he said. “China’s rise has benefitted all of the countries around it, and as a result they don’t want a containment policy; they want responsible behavior by China so they can expand economic and trade relations, which already dwarf their relations with other countries. But when China behaves badly, then they want the United States to be present because they can’t deal with China on their own. It’s a dynamic that skillful diplomacy should be able to take advantage from.”

With China now “locked in a web of disputes” with its neighbors over small but potentially resource-rich islands in the region, Roy said, “the United States finds itself in the awkward situation of trying to reassure our allies at the same time we try to restrain their behavior, because we don’t want tiny little islands in the western Pacific to end up bringing us into a great-power confrontation with China.”

The threat of such hostility is real, he said, and “these disputes are having direct impact on U.S.-China relations – but it’s an asymmetrical impact, because Americans basically don’t care about these islands. But in China it is an issue of great nationalist importance, as it is for Japan, the Philippines and other claimants.”

Such issues, he said, illustrate the complexity of trying to manage this vitally important relationship: “A stronger China will undoubtedly see itself as again becoming a central regional player, but the United States intends to remain actively engaged in East Asia, where we have formal alliances and strategic ties throughout the region.”

The question for leaders of both countries, Roy said, is whether they can find a solution to this conundrum. As of now, he said, “there is a disconnect between the high-level desire on both sides not to have our relationship drift toward rivalry and confrontation, and the way we’re actually behaving, which is driving us in that direction.”

Open military conflict is unlikely and preventable, he said, but just the threat of it could cause a costly “military capabilities competition” for decades to come, at a time when the U.S. is already facing budget cuts.

“Chinese and U.S. declared strategic goals and their actions are not yet in conformity with each other,” Roy said. “In my mind, this is the central strategic challenge in the U.S.-China relationship, and if we don’t address it forthrightly, it will be more difficult to manage in the future.”

 

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BCBS: Supervisory guidance for managing risks associated with the settlement of foreign exchange transactions

BCBS: Supervisory guidance for managing risks associated with the settlement of foreign exchange transactions
February 15 2013
http://www.bis.org/publ/bcbs241.htm

The purpose of this guidance is to provide updated guidance to supervisors and the banks they supervise on approaches to managing the risks associated with the settlement of FX transactions. This guidance expands on, and replaces, the BCBS's Supervisory guidance for managing settlement risk in foreign exchange transactions published in September 2000.

Since the BCBS's Supervisory guidance for managing settlement risk in foreign exchange transactions (2000) was published, the foreign exchange market has made significant strides in reducing the risks associated with the settlement of FX transactions. Substantial FX settlement-related risks remain, however, not least because of the rapid growth in FX trading activities.

The document provides a more comprehensive and detailed view on governance arrangements and the management of principal risk, replacement cost risk and all other FX settlement-related risks. In addition, it promotes the use of payment-versus-payment arrangements, where practicable, to reduce principal risk.

The guidance is organized into seven "guidelines" that address governance, principal risk, replacement cost risk, liquidity risk, operational risk, legal risk, and capital for FX transactions. The key recommendations emphasize the following:

• A bank should ensure that all FX settlement-related risks are effectively managed and that its practices are consistent with those used for managing other counterparty exposures of similar size and duration.
• A bank should reduce its principal risk as much as practicable by settling FX transactions through the use of FMIs that provide PVP arrangements. Where PVP settlement is not practicable, a bank should properly identify, measure, control and reduce the size and duration of its remaining principal risk.
• A bank should ensure that when analysing capital needs, all FX settlement-related risks should be considered, including principal risk and replacement cost risk and that sufficient capital is held against these potential exposures, as appropriate.
• A bank should use netting arrangements and collateral arrangements to reduce its replacement cost risk and should fully collateralise its mark-to-market exposure on physically settling FX swaps and forwards with counterparties that are financial institutions and systemically important non-financial entities.

An annex to the final guidance provides detailed explanation of FX settlement-related risks and how they arise.

A Banking Union for the Euro Area. IMF Staff Discussion Note

A Banking Union for the Euro Area. By Rishi Goyal, Petya Koeva Brooks, Mahmood Pradhan, Thierry Tressel, Giovanni Dell'Ariccia, Ross Leckow, Ceyla Pazarbasioglu, and an IMF Staff Team
IMF Staff Discussion Note 13/01
February 13, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40317.0

Summary: The SDN elaborates the case for, and the design of, a banking union for the euro area. It discusses the benefits and costs of a banking union, presents a steady state view of the banking union, elaborates difficult transition issues, and briefly discusses broader EU issues. As such, it assesses current plans and provides advice. It is accompanied by three background technical notes that analyze in depth the various elements of the banking union: a single supervisory framework; a single resolution and common safety net; and urgent issues related to repair of weak banks in Europe.

ISBN/ISSN: 9781475521160 / 2221-030X
Stock No: SDNEA2013001


Executive summary:

• A banking union—a single supervisory-regulatory framework, resolution mechanism, and safety net—for the euro area is the logical conclusion of the idea that integrated banking systems require integrated prudential oversight.

• The case for a banking union for the euro area is both immediate and longer term. Moving responsibility for potential financial support and bank supervision to a shared level can reduce fragmentation of financial markets, stem deposit flight, and weaken the vicious loop of rising sovereign and bank borrowing costs. In steady state, a single framework should bring a uniformly high standard of confidence and oversight, reduce national distortions, and mitigate the buildup of concentrated risk that compromises systemic stability. Time is of the essence.

• Progress is required on all elements. A single supervisory mechanism (SSM) must ultimately supervise all banks, with clarity on duties, powers and accountability, and adequate resources. But without common resolution and safety nets and credible backstops, an SSM alone will do little to weaken vicious sovereign-bank links; they are necessary also to limit conflicts of interest between national authorities and the SSM. A single resolution authority, with clear ex ante burden-sharing mechanisms, must have strong powers to close or restructure banks and be required to intervene well ahead of insolvency. A common resolution/insurance fund, sized to resolve some small to medium bank failures, with access to common backstops for systemic situations, would add credibility and facilitate limited industry funding.

• The challenge for policymakers is to stem the crisis while ensuring that actions dovetail seamlessly into the future steady state. Hence, agreeing at the outset on the elements, modalities, and resources for a banking union can help avoid the pitfalls of a piecemeal approach and an outcome that is worse than at the start. The December 2012 European Council agreement on an SSM centered at the European Central Bank (ECB) is an important step, but raises challenges that should not be underestimated. Meanwhile, to delink weak sovereigns from future residual banking sector risks, it will be important to undertake as soon as possible direct recapitalization of frail domestically systemic banks by the European Stability Mechanism (ESM). Failing, non-systemic banks should be wound down at least cost, and frail, domestically systemic banks should be resuscitated by shareholders, creditors, the sovereign, and the ESM.

• A banking union is necessary for the euro area, but accommodating the concerns of non-euro area European Union (EU) countries will augur well for consistency with the EU single market.

Views from Japan: Comments on the incidents with China's naval forces

Q&A session with "aki", a Japanese citizen, on contemporary politics

Q: Maybe you'd like to publish some short comments on the incidents with China's naval forces

A: yes, i've been interested in it indeed.

Chinese government seems pushing themselves to the edge of cliff. they are scared of that their citizens make disorder against the them, so they need to make "scapegoats" outside of the country to distract the people's view to protect themselves.

recently Chinese citizens' been tending to show their frustration to the government, because of the corruptions of politics and unfair distribution of wealth.

they are trying to make Japan the "scapegoat" now. but the government of Japan never reacted their provocations, just do what we should do in internationally "right" way. that makes China nervous - if they stimulate japan more, they will be censured in the world, but never can show their citizens compromising attitude... these days, their behavior looks like north Korea's. never look they are the economically 2nd biggest country.

need to watch it carefully. (personally, a sort of fun to see how they do)

aki

Mortgage insurance: market structure, underwriting cycle and policy implications - Consultative paper released by the Joint Forum

February 2013

This consultative report on Mortgage insurance: market structure, underwriting cycle and policy implications examines the interaction of mortgage insurers with mortgage originators and underwriters. The report sets out the following recommendations directed at policymakers and supervisors with the aim of reducing the likelihood of mortgage insurance stress and failure in such tail events.

1. Policymakers should consider requiring that mortgage originators and mortgage insurers align their interests;
2. Supervisors should ensure that mortgage insurers and mortgage originators maintain strong underwriting standards;
3. Supervisors should be alert to - and correct for - deterioration in underwriting standards stemming from behavioural incentives influencing mortgage originators and mortgage insurers;
4. Supervisors should require mortgage insurers to build long-term capital buffers and reserves during the valleys of the underwriting cycle to cover claims during its peaks;
5. Supervisors should be aware of and mitigate cross-sectoral arbitrage which could arise from differences in the accounting between insurers' technical reserves and banks' loan loss provisions, and from differences in the capital requirements for credit risk between banks and insurers; and
6. Supervisors should apply the FSB Principles for Sound Residential Mortgage Underwriting Practices ("FSB Principles") to mortgage insurers noting that proper supervisory implementation necessitates both insurance and banking expertise.

Comments on this consultative report should be submitted by Tuesday 30 April 2013 either by email to baselcommittee@bis.org or by post to the Secretariat of the Joint Forum (BCBS Secretariat), Bank for International Settlements, CH-4002 Basel, Switzerland. All comments may be published on the websites of the Bank for International Settlements (www.bis.org), IOSCO (www.iosco.org) and the IAIS (www.iaisweb.org) unless a commenter specifically requests confidential treatment.

A Jersey Lesson in Voter Fraud. By Thomas Fleming

A Jersey Lesson in Voter Fraud. By Thomas Fleming
My grandmother died there in 1940. She voted Democratic for the next 10 years.The Wall Street Journal, February 6, 2013, on page A11
http://online.wsj.com/article/SB10001424127887323829504578272250730580018.html

Some youthful memories were stirred by the news this week that the president plans to use his State of the Union speech next Tuesday to urge Congress to make voter registration and ballot-casting easier. Like Mr. Obama, I come from a city with a colorful history of political corruption and vote fraud.

The president's town is Chicago, mine is Jersey City. Both were solidly Democratic in the 1930s and '40s, and their mayors were close friends. At one point in the early '30s, Jersey City's Frank Hague called Chicago's Ed Kelly to say he needed $2 million as soon as possible to survive a coming election. According to my father—one of Boss Hague's right-hand men—a dapper fellow who had taken an overnight train arrived at Jersey City's City Hall the next morning, suitcase in hand, cash inside.

Those were the days when it was glorious to be a Democrat. As a historian, I give talks from time to time. In a recent one, called "Us Against Them," I said it was we Irish and our Italian, Polish and other ethnic allies against "the dirty rotten stinking WASP Protestant Republicans of New Jersey." By thus demeaning the opposition, we had clear consciences as we rolled up killer majorities using tactics that had little to do with the election laws.

My grandmother Mary Dolan died in 1940. But she voted Democratic for the next 10 years. An election bureau official came to our door one time and asked if Mrs. Dolan was still living in our house. "She's upstairs taking a nap," I replied. Satisfied, he left.

Thousands of other ghosts cast similar ballots every Election Day in Jersey City. Another technique was the use of "floaters," tough Irishmen imported from New York who voted five, six and even 10 times at various polling places.

Equally effective was cash-per-vote. On more than one Election Day, my father called the ward's chief bookmaker to tell him: "I need 10 grand by one o'clock." He always got it, and his ward had a formidable Democratic majority when the polls closed.

Other times, as the clock ticked into the wee hours, word would often arrive in the polling places that the dirty rotten stinking WASP Protestant Republicans had built up a commanding lead in South Jersey, where "Nucky" Johnson (currently being immortalized on TV in HBO's "Boardwalk Empire") had a small Republican machine in Atlantic City.

By dawn, tens of thousands of hitherto unknown Jersey City ballots would be counted and another Democratic governor or senator would be in office, and the Democratic presidential candidate would benefit as well. Things in Chicago were no different, Boss Hague would remark after returning from one of his frequent visits.

I have to laugh when I hear current-day Democrats not only lobbying against voter-identification laws but campaigning to make voting even easier than it already is. More laughable is the idea of dressing up the matter as a civil-rights issue.

My youthful outlook on life—that anything goes against the rotten stinking WASP Protestant Republicans—evaporated while I served in the U.S. Navy in World War II. In that conflict, millions of people like me acquired a new understanding of what it meant to be an American.

Later I became a historian of this nation's early years—and I can assure President Obama that no founding father would tolerate the idea of unidentified voters. These men understood the possibility and the reality of political corruption. They knew it might erupt at any time within a city or state.

The president's party—which is still my party—has inspired countless Americans by looking out for the less fortunate. No doubt that instinct motivated Mr. Obama in his years as a community organizer in Chicago. Such caring can still be a force, but that force, and the Democratic Party, will be constantly soiled and corrupted if the right and the privilege to vote becomes an easily manipulated joke.

Mr. Fleming is a former president of the Society of American Historians.

Liquidity and Transparency in Bank Risk Management. By Lev Ratnovski

Liquidity and Transparency in Bank Risk Management. By Lev Ratnovski
IMF Working Paper No. 13/16
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40258.0

Summary: Banks may be unable to refinance short-term liabilities in case of solvency concerns. To manage this risk, banks can accumulate a buffer of liquid assets, or strengthen transparency to communicate solvency. While a liquidity buffer provides complete insurance against small shocks, transparency covers also large shocks but imperfectly. Due to leverage, an unregulated bank may choose insufficient liquidity buffers and transparency. The regulatory response is constained: while liquidity buffers can be imposed, transparency is not verifiable. Moreover, liquidity requirements can compromise banks' transparency choices, and increase refinancing risk. To be effective, liquidity requirements should be complemented by measures that increase bank incentives to adopt transparency.

Conclusion

The paper emphasized that both liquidity buffers and — in a novel perspective — bank transparency (better communication that enhances access to external refinancing) are important in bank liquidity risk management. In a liquidity event, a liquidity buffer can cover small withdrawals with certainty. Transparency allows the bank to refinance large withdrawals too, but it is not always effective. Banks may choose insufficient liquidity and transparency; the optimal policy response is constrained by the fact that bank transparency is not verifiable.

The paper offers important policy implications, particularly for the ongoing liquidity regulation debate. The results caution that the focus on liquidity requirements needs to be complemented by measures to improve bank transparency and access to market refinancing. Without such measures, liquidity requirements may not achieve the full potential of improvements in social welfare, and under some conditions may have unintended effects. We also highlight the need for better corporate governance as a way to improve bank transparency, and the scope to use net stable funding ratios to increase the effectiveness of liquidity requirements.

Q&A session with a Japanese citizen on contemporary politics

The comments of a Japanese citizens on politics and our questions:

[...]

- what do supporters of Tokyo's governor say about him? I always read comments against him, but he wins the elections, so there are lots of (silent) supporters.

our present PM Shinzo Abe is supported by citizens pretty well so far. he showed a policy for economics called "Abenomics" lately. then even though nothing's done yet just show it to us, stock prises' been rising and rising, curency rate's been much better (Yen got too much strong and international exporting companies as even Sony, Panasonic or Toyota were getting big loss for these 3 years).

also, his strategy of international is evaluated. former government always compromised to Chinese or Korean's unreasonable accusations just for economical reasons. but he is trying to build a strong relationships between South-east Asian countries, Australia, India and Russia. especially SE Asian countries welcome this because they've been threatened by Chinese forces, they've actually wanted Japan to have leadership against China.

he seems doing very fine now.

i have to say many of japanese medias have big problems... many people in medias are kind of "traitor". they pick up "noisy minority" and show it just like the majority to give Japan bad names to the world... it's fine if their opinions are to make things better, but just critisise. it will be too long if i explain this.

Question: what do supporters of nuclear arms say? I always read assurances about the Japanese not wanting the A-bomb, but from time to time some politician says that Japan is considering protecting herself (against North Korea and China)

i think there are not many supporters of nuclear arms. some polititians and scholars are saying to discuss it. because almost all of Japanese has a sort of allergy for nuclear weapons (it comes from trauma of WW2) and even discussions are taboo. indeed, even though we have been aimed by Chinese and maybe Korean A-missiles. so they are claiming to get out of trauma now. also they say even only discussion will be a detterent to the countries. (personally i agree with them, we don't need to have it, but it's nonsense not to even talk). recently it seems peoples who agree with it has been increasing.

PM Abe is trying to have a good relationship between US, but on the other hand, trying to protect ourself with proper forces. and it's generally supported by majority (at least it seems so to me). almost all of people likes US better than China in politics, but lately people started to think stand by ourselvs.

actually now is the turning point of Japan after WW2 i think...

if you want to understand how Japanese are, it might be important to understand "Shinto". it's a domestic thoughts/philosophy of Japan, quite religious but not religion. it says we have 8 million gods in our land - god of fire, god of wood, god of sea, god of marrige, god of traffic, god of study... so we should thank to everything, be good and respect others. it is the base of moral of Japanese, we are brought up with it by our parents. it's easy to accept other religion for Shinto, because any god or buddha of other religions can be one of the god. (Japanese buddism are a lot influenced and mixed with Shinto). our Tenno (emperor) is regarded as offspring of the god. http://en.wikipedia.org/wiki/Shinto

last year, South Korean president insulted Tenno, then all of Japanese citizens got angry, (i have never seen such angry Japanese ever!), i understood Tenno is the symbol of this country and Shinto at the moment.

sorry it's getting out of focus.

[...]

take care,

[...]

---
Remember Ozawa: "If Japan desires, it can possess thousands of nuclear warheads." 2009. https://www.bipartisanalliance.com/2009/06/remember-ozawa-if-japan-desires-it-can.html

Are there clear affinities of Communism with Fascism?

Political philosopher John N. Gray on liberals' totalitarian temptation
Times Literary Supplement, Jan 02, 2013:

One of the features that distinguished Bolshevism from Tsarism was the insistence of Lenin and his followers on the need for a complete overhaul of society. Old-fashioned despots may modernize in piecemeal fashion if doing so seems necessary to maintain their power, but they do not aim at remaking society on a new model, still less at fashioning a new type of humanity. Communist regimes engaged in mass killing in order to achieve these transformations, and paradoxically it is this essentially totalitarian ambition that has appealed to liberals. Here as elsewhere, the commonplace distinction between utopianism and meliorism is less than fundamental. In its predominant forms, liberalism has been in recent times a version of the religion of humanity, and with rare exceptions— [Bertrand] Russell is one of the few that come to mind—liberals have seen the Communist experiment as a hyperbolic expression of their own project of improvement; if the experiment failed, its casualties were incurred for the sake of a progressive cause. To think otherwise—to admit the possibility that the millions who were judged to be less than fully human suffered and died for nothing—would be to question the idea that history is a story of continuing human advance, which for liberals today is an article of faith. That is why, despite all evidence to the contrary, so many of them continue to deny Communism's clear affinities with Fascism. Blindness to the true nature of Communism is an inability to accept that radical evil can come from the pursuit of progress.

John Gray is professor emeritus at the London School of Economics

Relying on financial models to set loan-loss reserves could hurt small banks and their customers

Bank Reform Takes One Flawed Step Forward. By Eugene A Ludwig and Paul A Volcker
Relying on financial models to set loan-loss reserves could hurt small banks and their customers.The Wall Street Journal
January 18, 2013, on page A15
http://online.wsj.com/article/SB10001424127887323468604578245421482083936.html

The Financial Accounting Standards Board finished 2012 on a high note, issuing a draft new rule to change the way banks build reserves against losses on loans. It is a major step forward from our current system. Still, FASB's proposed rule is flawed conceptually and in its application, and in itself it cannot achieve the international consistency that is desirable.

The good news: The board recognizes that its existing rules on the Allocation for Loan and Lease Losses may have worsened the 2008 financial crisis. These rules limited bank reserves to those that are already "incurred." This all but ensures that banks' rainy day funds will be too skinny, particularly in periods when credit markets are under stress. Worse yet, limiting loss estimates to events that have already occurred makes the allowance for loan and lease losses procyclical—reported earnings are too high in good times and losses hit hardest in bad times.

The FASB's draft proposal to reform these rules incorporates what is known as the "Current Expected Credit Loss Model." It is meant to expand reserves to reflect losses that are expected over the life of the loan, and it is a big improvement over the existing regime. But as it stands, the proposal could create risks for the financial system.

In an effort to ensure that everything is "auditable," the proposal ties the loan-loss reserve to what the accounting profession will decide is an acceptable "model." While the proposal is well-intentioned and makes clear that various models can be used, this model-driven approach is dangerous.

Modeling by its very nature is backward looking. It would push bankers to address only risks that are readily and historically quantifiable. It would discourage them from acting on forward-looking but less well-defined risks, like broader economic trends, that can be just as damaging.

A focus on modeling also unnecessarily favors large institutions. Banks with smaller loan books and more hands-on experience have some advantages when setting their reserves. But what community bank has a sufficient data set, a team of "modelers," or complex statistical analysis software on hand? The FASB proposal could hurt small banks and their customers.

That is not to say that some quantitative models have no place in establishing reserves. Some institutions may choose to use models, even slavishly. But this should not be a requirement, unless experience and judgment lead the bank's prudential regulator to think otherwise.

There are other ways to go about setting reserves. A bank can follow a rigorous, board-approved process, for example by drawing on well-documented reviews from its CEO, chief credit officer, and the credit committee of the board of directors. The assumptions used in these judgmental reviews can be audited by regulators and outside accountants, and implementation of the process itself can be audited. This approach can be honest and effective without relying entirely on mathematical models.

The FASB proposal may have at least one smaller-scale but serious flaw. Although the text is unclear, the proposal appears to base reserves on cash flows above all other credit factors, such as collateral. We understand that this is not what was intended, and that "cash flows" is meant to include monies derived from collateral liquidation too. If this is the case, the language should be clarified.

While we do believe it is critical to allow bankers to use their expertise in estimating losses for reserve purposes, we also believe it is critical that they disclose to regulators and the public both the methodology they employ to set reserves and the quarter-by-quarter decisions on reserves they actually make. That way investors can follow a bank's net revenue picture before and after loan reserves are set aside, and the methods they use to establish these reserves.

It would be highly desirable to have one international rule in this area, as with accounting standards in the financial services area generally. The International Accounting Standards Board is preparing a new standard for bank reserves. Both the FASB and the IASB approaches will be open to comment. The goal should be to achieve consistency along the broad lines opened by the FASB proposal.

In sum, the FASB's draft proposal is a positive step. But it will require revision so that small banks are not put at a disadvantage, and so that all banks can employ rational and effective methods to set aside their rainy day funds.

Mr. Ludwig, CEO of Promontory Financial Group, was comptroller of the currency from 1993 to 1998. Mr. Volcker was chairman of the Federal Reserve System from 1979-1987.

Incentive Audits: A New Approach to Financial Regulation

Incentive Audits: A New Approach to Financial Regulation. By Martin Cihak
World Bank Blogs, Jan 14, 2012
http://blogs.worldbank.org/allaboutfinance/incentive-audits-a-new-approach-to-financial-regulation

Economists often disagree on policy advice. If you ask 10 of them, you may get 10 different answers, or more. But from time to time, economists actually do agree. One such area of agreement relates to the role of incentives in the financial sector. A large and growing literature points to misaligned incentives playing a key role in the run-up to the global financial crisis. In a recent paper, co-authored with Barry Johnston, we propose to address the incentive breakdowns head-on by performing “incentive audits”.

The global financial crisis has highlighted the destructive impact of misaligned incentives in the financial sector. This includes bank managers’ incentives to boost short-term profits and create banks that are “too big to fail”, regulators’ incentives to forebear and withhold information from other regulators in stressful times, credit rating agencies’ incentives to keep issuing high ratings for subprime assets, and so on. Of course, incentives play an important role in many economic activities, not just the financial ones. But nowhere are they as prominent, and nowhere can their impact get as damaging as in the financial sector, due to its leverage, interconnectedness, and systemic importance. A large body of recent literature examines these issues in depth. For example, Caprio, Demirgüç-Kunt and Kane (2008) show that incentive conflicts explain how securitization went wrong and why credit ratings proved so inaccurate; Barth, Caprio and Levine (2012) highlight incentive failures in regulatory authorities. Incentives were not the only factor – they were accentuated by problems of insufficient information, herd behavior, and so on – but breakdowns in incentives had clearly a central role in the run-up to the crisis.

Despite the broad agreement among economists, the focus of financial sector regulation and supervision has often been on other things, leaving incentives to be addressed indirectly at best. At the global level, substantial efforts have been devoted to issues such as calibrating risk weights to calculate banks’ minimum capital requirements. Numerous outside observers have called for more concerted efforts to address the incentive breakdowns that led to the crisis (e.g., LSE 2010; Squam Lake Working Group 2010; and Beck 2010). At the individual country level, regulatory changes have taken place in recent years, but in-depth analyses show a major scope to better address incentive problems (see Čihák, Demirgüç-Kunt, Martínez Pería, and Mohseni 2012, based on data from the World Bank’s 2011–12 Bank Regulation and Supervision Survey). The World Bank’s 2013 Global Financial Development Report also called for more vigorous steps to address incentive issues, rather than leaving them as an afterthought.

In a recent paper, joint with Barry Johnston, we propose a pragmatic approach to re-orienting financial regulation to have at its core addressing incentives on an ongoing basis. The paper, which of course represents our views and not necessarily those of the World Bank, proposes “incentive audits” as a tool to help in identifying incentive misalignments in the financial sector. The paper is an extended version of an earlier piece recognized by the International Centre for Financial Regulation and the Financial Times among top essays on “what good regulation should look like“.
The incentive audit approach aims to address systemic risk buildup directly at its source. While traditional, regulation-based approaches focus on building up capital and liquidity buffers in financial institutions, the incentive-based approach seeks to identify and correct distortions and frictions that contribute to the buildup of excessive risk. It goes beyond the symptoms to their source. For example, the buildup of massive risk concentrations before the crisis could be attributed to information gaps that prevented the assessment of exposures and network risks, to incentive failures in the monitoring of the risks due to conflicts of interest and moral hazard, and to regulatory incentives that encouraged risk transfers. Building up buffers can help, but to address systemic risk effectively, it is crucial to tackle the underlying incentives that give rise to it. Focusing on increasingly complex capital and liquidity charges has the danger of creating incentives for circumvention, and can run into limited capacity for implementation and enforcement. In the incentive-based approach, more emphasis is given on methods for identifying incentive failures resulting in systemic risk. The remedies go beyond narrowly defined prudential tools and include also other measures, such as elimination of tax incentives that encourage excessive borrowing.

What would an incentive audit involve? It would entail an analysis of structural and organizational features that affect incentives to conduct and monitor financial transactions. It would comprise a sequenced set of analyses proceeding from higher level questions on market structure, government safety nets and legal and regulatory framework, to progressively more detailed questions aimed at identifying the incentives that motivate and guide financial decisions (Figure 1). This sequenced approach enables drilling down and identifying factors leading to market failures and excessive risk taking.

The incentive audit is a novel concept, but analysis of incentives has been done. One example is the report of a parliamentary commission examining the roots of the Icelandic financial crisis. The report (Special Investigation Commission 2010) notes the rapid growth of Icelandic banks as a major contributor of the crisis. It documents the underlying “strong incentives for growth”, which included the banks’ incentive schemes and the high leverage of their owners. It maps out the network of conflicting interests of the key owners, who were also the largest debtors of these banks. Another example of work that is close to an incentive audit is the analysis by Calomiris (2011). He examines incentive failures in the U.S. financial market, and identifies a subset of reforms that are “incentive-robust,” that is, they improve market incentives, market discipline, and incentives of regulators and supervisors by making rules and their enforcement more transparent, increasing credibility and accountability. These examples illustrate that an incentive audit is doable and useful.

Who would perform incentive audits? Our paper offers some suggestions. The governance of the institution performing the audits is important--its own incentives to act need to be appropriately aligned. Also, to be effective, incentive audits would have to be performed regularly, and their outcomes would have to be used to address incentive issues by adapting regulation, supervision, and other measures. In Iceland, the analysis of incentives was a part of a “post mortem” on the crisis, but it is feasible to do such analysis ex-ante. Indeed, much of the information used in the above mentioned report was available even before the crisis. The Commission had modest resources, illustrating that incentive audits need not be very costly or overly complicated to perform. As the Commission’s report points out, “it should have been clear to the supervisory authorities that such incentives existed and that there was reason for concern,” but supervisors “did not keep up with the rapid changes in the banks’ practices”. Instead of examining the reasons for the changes, the supervisors took comfort in banks’ capital ratios exceeding a statutory minimum and appearing robust in narrowly-defined stress tests (Čihák and Ong 2010).

An incentive audit needs to be complemented by other tools. It needs to be combined with quantitative risk assessment and with assessments of the regulatory, supervisory, and crisis preparedness frameworks. The audit provides an organizing framework, putting the identification and correction of incentive misalignments front and center.

Incentive audits are not a panacea, of course. Financial markets suffer from issues that go beyond misaligned incentives, such as limited rationality, herd behavior and so on. But better identifying and addressing incentive misalignments is a key practical step, and the incentive audits can help.

References
Barth, James, Gerard Caprio, and Ross Levine. 2012. Guardians of Finance: Making Regulators Work for Us, MIT Press.
Beck, Thorsten (ed). 2010. Future of Banking. Centre for Economic Policy Research (CEPR). Published by vox.eu.
Caprio, Gerard, Asli Demirgüç-Kunt, and Edward J. Kane. 2010. “The 2007 Meltdown in Structured Securitization: Searching for Lessons, not Scapegoats.” World Bank Research Observer 25 (1): 125-55.
Calomiris, Charles. 2011. Incentive‐Robust Financial Reform, Cato Journal  31 (3): 561–589.
Čihák, Martin, Asli Demirgüç-Kunt, Maria Soledad Martínez Pería, and Amin Mohseni. 2012. “Banking Regulation and Supervision around the World: Crisis Update.” Policy Research Working Paper 6286, World Bank, Washington, DC.
Čihák, Martin, Asli Demirgüç-Kunt, and R. Barry Johnston. 2013. “Incentive Audits: A New Approach to Financial Regulation.” Policy Research Working Paper 6308, World Bank, Washington, DC.
Čihák, Martin, and Li Lian Ong. 2010. “Of Runes and Sagas: Perspectives on Liquidity Stress Testing Using an Iceland Example.” Working Paper 10/156, IMF, Washington, DC.
London School of Economics. 2010. The Future of Finance: The LSE Report. London: London School of Economics.
Special Investigation Commission. 2010. Report on the collapse of the three main banks in Iceland. Icelandic Parliament, April 12.
Squam Lake Working Group. 2010. Regulation of Executive Compensation in Financial Services. Squam Lake Working Group on Financial Regulation
World Bank. 2012. Global Financial Development Report 2013: Rethinking the Role of the State in Finance, World Bank, Washington DC.

BCBS Principles for effective risk data aggregation and risk reporting

BCBS Principles for effective risk data aggregation and risk reporting
January 2013
http://www.bis.org/publ/bcbs239.htm

The financial crisis that began in 2007 revealed that many banks, including global systemically important banks (G-SIBs), were unable to aggregate risk exposures and identify concentrations fully, quickly and accurately. This meant that banks' ability to take risk decisions in a timely fashion was seriously impaired with wide-ranging consequences for the banks themselves and for the stability of the financial system as a whole.

The Basel Committee's Principles for effective risk data aggregation will strengthen banks' risk data aggregation capabilities and internal risk reporting practices. Implementation of the principles will strengthen risk management at banks - in particular, G-SIBs - thereby enhancing their ability to cope with stress and crisis situations.

An earlier version of the principles published today was issued for consultation in June 2012. The Committee wishes to thank those who provided feedback and comments as these were instrumental in revising and finalising the principles.

Objectives (excerpted):

The adoption of these Principles will enable fundamental improvements to the management of banks. The Principles are expected to support a bank’s efforts to:

• Enhance the infrastructure for reporting key information, particularly that used by the board and senior management to identify, monitor and manage risks;
• Improve the decision-making process throughout the banking organisation;
• Enhance the management of information across legal entities, while facilitating a comprehensive assessment of risk exposures at the global consolidated level;
• Reduce the probability and severity of losses resulting from risk management weaknesses;
• Improve the speed at which information is available and hence decisions can be made; and
• Improve the organisation’s quality of strategic planning and the ability to manage the risk of new products and services.

Capital Requirements for Over-the-Counter Derivatives Central Counterparties

Capital Requirements for Over-the-Counter Derivatives Central Counterparties. By Li Lin and Jay Surti
IMF Working Paper No. 13/3, January 08, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40220.0

Summary: The central counterparties dominating the market for the clearing of over-the-counter interest rate and credit derivatives are globally systemic. Employing methodologies similar to the calculation of banks’ capital requirements against trading book exposures, this paper assesses the sensitivity of central counterparties’ required risk buffers, or capital requirements, to a range of model inputs. We find them to be highly sensitive to whether key model parameters are calibrated on a point-in-time versus stress-period basis, whether the risk tolerance metric adequately captures tail events, and the ability—or lack thereof—to define exposures on the basis of netting sets spanning multiple risk factors. Our results suggest that there are considerable benefits from having prudential authorities adopt a more prescriptive approach to for central counterparties’ risk buffers, in line with recent enhancements to the capital regime for banks.

ISBN: 9781475535501
ISSN: 2227-8885
Stock No: WPIEA2013003

Group of Governors and Heads of Supervision endorses revised liquidity standard for banks

Group of Governors and Heads of Supervision endorses revised liquidity standard for banks
January 6, 2013
http://www.bis.org/press/p130106.htm

The Group of Governors and Heads of Supervision (GHOS), the oversight body of the Basel Committee on Banking Supervision, met today to consider the Basel Committee's amendments to the Liquidity Coverage Ratio (LCR) as a minimum standard. It unanimously endorsed them. Today's agreement is a clear commitment to ensure that banks hold sufficient liquid assets to prevent central banks becoming the "lender of first resort".

The GHOS also endorsed a new Charter for the Committee, and discussed the Committee's medium-term work agenda.

The GHOS reaffirmed the LCR as an essential component of the Basel III reforms. It endorsed a package of amendments to the formulation of the LCR announced in 2010. The package has four elements: revisions to the definition of high quality liquid assets (HQLA) and net cash outflows; a timetable for phase-in of the standard; a reaffirmation of the usability of the stock of liquid assets in periods of stress, including during the transition period; and an agreement for the Basel Committee to conduct further work on the interaction between the LCR and the provision of central bank facilities.

A summary description of the agreed LCR is in Annex 1. The changes to the definition of the LCR, developed and agreed by the Basel Committee over the past two years, include an expansion in the range of assets eligible as HQLA and some refinements to the assumed inflow and outflow rates to better reflect actual experience in times of stress. These changes are set out in Annex 2. The full text incorporating these changes will be published on Monday 7 January.

The GHOS agreed that the LCR should be subject to phase-in arrangements which align with those that apply to the Basel III capital adequacy requirements. Specifically, the LCR will be introduced as planned on 1 January 2015, but the minimum requirement will begin at 60%, rising in equal annual steps of 10 percentage points to reach 100% on 1 January 2019. This graduated approach is designed to ensure that the LCR can be introduced without disruption to the orderly strengthening of banking systems or the ongoing financing of economic activity.

The GHOS agreed that, during periods of stress it would be entirely appropriate for banks to use their stock of HQLA, thereby falling below the minimum. Moreover, it is the responsibility of bank supervisors to give guidance on usability according to circumstances.

The GHOS also agreed today that, since deposits with central banks are the most - indeed, in some cases, the only - reliable form of liquidity, the interaction between the LCR and the provision of central bank facilities is critically important. The Committee will therefore continue to work on this issue over the next year.

GHOS members endorsed two other areas of further analysis. First, the Committee will continue to develop disclosure requirements for bank liquidity and funding profiles. Second, the Committee will continue to explore the use of market-based indicators of liquidity to supplement the existing measures based on asset classes and credit ratings.

The GHOS discussed and endorsed the Basel Committee's medium-term work agenda. Following the successful agreement of the LCR, the Committee will now press ahead with the review of the Net Stable Funding Ratio. This is a crucial component in the new framework, extending the scope of international agreement to the structure of banks' debt liabilities. This will be a priority for the Basel Committee over the next two years.

Over the next few years, the Basel Committee will also: complete the overhaul of the policy framework currently under way; continue to strengthen the peer review programme established in 2012 to monitor the implementation of reforms in individual jurisdictions; and monitor the impact of, and industry response to, recent and proposed regulatory reforms. During 2012 the Committee has been examining the comparability of model-based internal risk weightings and considering the appropriate balance between the simplicity, comparability and risk sensitivity of the regulatory framework. The GHOS encouraged continuation of this work in 2013 as a matter of priority. Furthermore, the GHOS supported the Committee's intention to promote effective macro- and microprudential supervision.

The GHOS also endorsed a new Charter for the Basel Committee. The new Charter sets out the Committee's objectives and key operating modalities, and is designed to improve understanding of the Committee's activities and decision-making processes.

Finally, the GHOS reiterated the importance of full, timely and consistent implementation of Basel III standards.

Mervyn King, Chairman of the GHOS and Governor of the Bank of England, said, "The Liquidity Coverage Ratio is a key component of the Basel III framework. The agreement reached today is a very significant achievement. For the first time in regulatory history, we have a truly global minimum standard for bank liquidity. Importantly, introducing a phased timetable for the introduction of the LCR, and reaffirming that a bank's stock of liquid assets are usable in times of stress, will ensure that the new liquidity standard will in no way hinder the ability of the global banking system to finance a recovery."

Stefan Ingves, Chairman of the Basel Committee and Governor of the Sveriges Riksbank, noted that "the amendments to the LCR are designed to ensure that it provides a sound minimum standard for bank liquidity - a standard that reflects actual experience during times of stress. The completion of this work will allow the Basel Committee to turn its attention to refining the other component of the new global liquidity standards, the Net Stable Funding Ratio, which remains subject to an observation period ahead of its implementation in 2018."

• Annex 1: Summary description of the LCR (PDF, 2 pages, 42 kb)
• Annex 2: Complete set of agreed changes to the Liquidity Coverage Ratio (PDF, 2 pages, 36 kb)
• Full press release (PDF, 2 pages, 35 kb)
• Charter for the Basel Committee

Listen to the press conference

To listen to introductory remarks from GHOS Chairman Mervyn King and the Basel Committee on Banking Supervision's Chairman Stefan Ingves as well as the question and answer session which followed, please dial +41 58 262 07 00 and enter the following access code: 2641523333.

 
Translations in German, Spanish, French and Italian will be published soon.

We, Too, Are Violent Animals. By Jane Goodall, Richard Wrangham, and Dale Peterson

We, Too, Are Violent Animals. By Jane Goodall, Richard Wrangham, and Dale Peterson
Those who doubt that human aggression is an evolved trait should spend more time with chimpanzees and wolvesThe Wall Street Journal,January 5, 2013, on page C3
http://online.wsj.com/article/SB10001424127887323874204578220002834225378.html

Where does human savagery come from? The animal behaviorist Marc Bekoff, writing in Psychology Today after last month's awful events in Newtown, Conn., echoed a common view: It can't possibly come from nature or evolution. Harsh aggression, he wrote, is "extremely rare" in nonhuman animals, while violence is merely an odd feature of our own species, produced by a few wicked people. If only we could "rewild our hearts," he concluded, we might harness our "inborn goodness and optimism" and thereby return to our "nice, kind, compassionate, empathic" original selves.

If only if it were that simple. Calm and cooperative behavior indeed predominates in most species, but the idea that human aggression is qualitatively different from that of every other species is wrong.

The latest report from the research site that one of us (Jane Goodall) directs in Tanzania gives a quick sense of what a scientist who studies chimpanzees actually sees: "Ferdinand [the alpha male] is rather a brutal ruler, in that he tends to use his teeth rather a lot…a number of the males now have scars on their backs from being nicked or gashed by his canines…The politics in Mitumba [a second chimpanzee community] have also been bad. If we recall that: they all killed alpha-male Vincent when he reappeared injured; then Rudi as his successor probably killed up-and-coming young Ebony to stop him helping his older brother Edgar in challenging him…but to no avail, as Edgar eventually toppled him anyway."

A 2006 paper reviewed evidence from five separate chimpanzee populations in Africa, groups that have all been scientifically monitored for many years. The average "conservatively estimated risk of violent death" was 271 per 100,000 individuals per year. If that seems like a low rate, consider that a chimpanzee's social circle is limited to about 50 friends and close acquaintances. This means that chimpanzees can expect a member of their circle to be murdered once every seven years. Such a rate of violence would be intolerable in human society.

The violence among chimpanzees is impressively humanlike in several ways. Consider primitive human warfare, which has been well documented around the world. Groups of hunter-gatherers who come into contact with militarily superior groups of farmers rapidly abandon war, but where power is more equal, the hostility between societies that speak different languages is almost endless. Under those conditions, hunter-gatherers are remarkably similar to chimpanzees: Killings are mostly carried out by males, the killers tend to act in small gangs attacking vulnerable individuals, and every adult male in the society readily participates. Moreover, with hunter-gatherers as with chimpanzees, the ordinary response to encountering strangers who are vulnerable is to attack them.

Most animals do not exhibit this striking constellation of behaviors, but chimpanzees and humans are not the only species that form coalitions for killing. Other animals that use this strategy to kill their own species include group-living carnivores such as lions, spotted hyenas and wolves. The resulting mortality rate can be high: Among wolves, up to 40% of adults die from attacks by other packs.

Killing among these carnivores shows that ape-sized brains and grasping hands do not account for this unusual violent behavior. Two other features appear to be critical: variable group size and group-held territory. Variable group size means that lone individuals sometimes encounter small, vulnerable parties of neighbors. Having group territory means that by killing neighbors, the group can expand its territory to find extra resources that promote better breeding. In these circumstances, killing makes evolutionary sense—in humans as in chimpanzees and some carnivores.

What makes humans special is not our occasional propensity to kill strangers when we think we can do so safely. Our unique capacity is our skill at engineering peace. Within societies of hunter-gatherers (though only rarely between them), neighboring groups use peacemaking ceremonies to ensure that most of their interactions are friendly. In state-level societies, the state works to maintain a monopoly on violence. Though easily misused in the service of those who govern, the effect is benign when used to quell violence among the governed.

Under everyday conditions, humans are a delightfully peaceful and friendly species. But when tensions mount between groups of ordinary people or in the mind of an unstable individual, emotion can lead to deadly events. There but for the grace of fortune, circumstance and effective social institutions go you and I. Instead of constructing a feel-good fantasy about the innate goodness of most people and all animals, we should strive to better understand ourselves, the good parts along with the bad.

—Ms. Goodall has directed the scientific study of chimpanzee behavior at Gombe Stream National Park in Tanzania since 1960. Mr. Wrangham is the Ruth Moore Professor of Biological Anthropology at Harvard University. Mr. Peterson is the author of "Jane Goodall: The Woman Who Redefined Man."

Gross inflows, financial booms and crises. By Cesar Calderon and Megumi Kubota

Gross inflows, financial booms and crises. By Cesar Calderon and Megumi Kubota
World Bank Blogs, Wed, Jan 2nd, 2013
http://blogs.worldbank.org/allaboutfinance/gross-inflows-financial-booms-and-crises

Favorable growth prospects and higher asset returns in emerging market economies have been led to a sharp increase in flows of foreign finance in recent years. Massive inflows to the domestic economy may fuel activity in financial markets and — if not properly managed — booms in credit and asset prices may arise (Reinhart and Reinhart, 2009; Mendoza and Terrones, 2008, 2012). In turn, the expansion of credit and overvalued asset prices have been good predictors not only of the current financial crises but also past ones (Schularick and Taylor, 2012; Gourinchas and Obstfeld, 2012).

In a recent paper, Megumi Kubota and I synthesized both strands of the empirical literature and examine whether gross private inflows can predict the incidence of credit booms — and, especially, those financial booms that end up in a systemic banking crises.¹  More specifically, our paper finds that surges gross private capital inflows can help explain the incidence of subsequent credit booms — and, especially those financial booms that are followed by systemic banking crises. When looking at the predictive power of capital flows, we argue that not all types of flows behave alike. We find that gross private other investment (OI) inflows robustly predict the incidence of credit booms — while portfolio investment (PI) has no systematic link and FDI  surges will at best mitigate the probability of credit booms. Consequently, gross private OI inflows are a good predictor of credit booms.

Our paper evaluates the linkages between surges in gross private capital inflows and the incidence of booms in credit markets. In contrast to previous research papers in this literature: (i) we use data on gross inflows rather than net inflows; and, (ii) we use quarterly data for 71 countries from 1975q1 and 2010q4 instead of annual frequency. In this context, we argue that the dynamic behavior of capital flows and credit markets along the business cycle is better captured using quarterly data.² As a result, we can evaluate more precisely the impact on credit booms of (the overall amount and the different types of) financing flows coming from abroad. On the other hand, we are more interested the impact on credit markets of investment inflows coming from foreign investors. Using information on net inflows — especially since the mid-1990s for emerging markets — would not allow us to appropriately differentiate the behavior of foreign investors from that of domestic ones and it may provide misleading inference on the amount of capital supplied from abroad (Forbes and Warnock, 2012).³

Credit booms are identified using two different methodologies: (a) Mendoza and Terrones (2008), and (b) Gourinchas, Valdés and Landarretche (2001) — also applied in Barajas, Dell’Ariccia, and Levchenko (2009). Moreover, we look deeper into credit boom episodes and differentiate bad booms from those that booms that may come along with a soft landing of the economy. In general, the literature finds that credit booms are not always followed by a systemic banking crisis — see Tornell and Westermann (2002) and Barajas et al. (2009). For instance, Calderón and Servén (2011) find that only 4.6 percent of lending booms may end up in a full-blown banking crisis for advanced countries whereas its probability is 8.3 and 4.6 percent for Latin America and the Caribbean (LAC) and non-LAC emerging markets. Those credit booms that end up in an episodes of systemic banking crisis are denoted as “bad” credit booms — see Barajas et al. (2009).

Our panel Probit regression shows that gross private capital inflows are a good predictor of the incidence of credit booms. This result is robust with respect to any sample of countries, any criteria of credit booms and any set of control variables. Next, the probability of credit booms is higher when the surges in capital flows are driven by gross OI inflows and, to a lesser extent, by increases in gross portfolio investment (FPI) inflows. Surges of gross foreign direct investment (FDI) inflows would, at best, reduce the likelihood of credit booms. The main conduit is gross OI bank inflows10 when we unbundle the effect of gross private OI inflows on credit booms. Third, we find that capital flows do explain the incidence of bad credit booms and that the overall impact is significantly positive and greater than the impact on overall credit booms.

Finally, the likelihood of bad credit booms is greater when surges in capital inflows are driven by increases in OI inflows. As a result, the overall positive impact of gross OI inflows significantly predicts an increase in credit booms although the evidence on the impact of gross FDI and FPI inflows is somewhat mixed. So far, the literature has shown that increasing leverage in the financial system and overvalued currencies are the best predictors of financial crisis (Schularick and Taylor, 2012; Gourinchas and Obstfeld, 2012). Moreover, our findings suggest that surges in capital flows (especially, rising cross-border banking flows) are also a good indicator of future financial turmoil.

References
Barajas, A., G. Dell’Ariccia, and A. Levchenko, 2009.  “Credit Booms: the Good, the Bad, and the Ugly.” Washington, DC: IMF, manuscript
Calderón, C., and M. Kubota, 2012. “Gross Inflows Gone Wild: Gross Capital inflows, Credit Booms and Crises.” The World Bank Policy Research Working Paper 6270, December.
Calderón, C., and M. Kubota, 2012. “Sudden stops: Are global and local investors alike?” Journal of International Economics 89(1), 122-142
Calderón, C., and L. Servén, 2011. “Macro-Prudential Policies over the Cycle in Latin America.” Washington, DC: The World Bank, manuscript
Forbes, K.J., and F.E. Warnock, 2012. “Capital Flow Waves: Surges, Stops, Flight, and Retrenchment.” Journal of International Economics 88(2), 235-251
Gourinchas, P.O., and M. Obstfeld, 2012. “Stories of the Twentieth Century for the Twenty-First.” American Economic Journal: Macroeconomics 4(1), 226-265
Gourinchas, P.O., R. Valdes, and O. Landerretche, 2001. “Lending Booms: Latin America and the World.” Economia, Spring Issue, 47-99.
Mendoza, E.G., and M.E. Terrones, 2008. “An anatomy of credit booms: Evidence from macro aggregates and micro data.” NBER Working Paper 14049, May
Mendoza, E.G. and M.E. Terrones, 2012. “An Anatomy of Credit Booms and their Demise,” NBER Working Paper 18379, September.
Reinhart, C.M., and V. Reinhart, 2009. “Capital Flow Bonanzas: An Encompassing View of the Past and Present.” In: Frankel, J.A., and C. Pissarides, Eds., NBER International Seminar on Macroeconomics 2008. Chicago, IL: University of Chicago Press for NBER, pp. 9-62
Rothenberg, A., Warnock, F., 2011. “Sudden flight and true sudden stops.” Review of International Economics 19(3), 509-524.
Schularick, M., and A.M. Taylor, 2012. “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870–2008.” American Economic Review 102(2), 1029–1061

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¹ Read Working Paper.
² Rothenberg and Warnock (2011), Forbes and Warnock (2012) and Calderón and Kubota (2012) already provide a more accurate analysis of extreme movement in (net and gross) capital flows using quarterly data.
³ The “two-way capital flows” phenomena cannot be identified using net inflows.

From "Weiwei-isms." By Ai Weiwei

Selection from "Weiwei-isms," by Ai Weiwei. Edited by Larry Warsh. Princeton University Press, 152 pp, ISBN-13: 978-0691157665

Living in a system under the communist ideology, an artist cannot avoid fighting for freedom of expression. You always have to be aware that art is not only a self-expression but a demonstration of human rights and dignity. To express yourself freely, a right as personal as it is, has always been difficult, given the political situation.—NY Arts, March-April 2008

Tips on surviving the regime: Respect yourself and speak for others. Do one small thing every day to prove the existence of justice.—Twitter, Aug. 6, 2009

Choices after waking up: To be true or to lie? To take action or be brainwashed? To be free or be jailed? —Twitter, Sept. 4, 2009

No outdoor sports can be more elegant than throwing stones at autocracy; no melees can be more exciting than those in cyberspace. —Twitter, March 10, 2010

Nothing can silence me as long as I am alive. I don't give any kind of excuse. If I cannot come out [of China] or I cannot go in [to China] this is not going to change my belief. But when I am there, I am in this condition: I see it, I see people who need help. Then you know, I just want to offer my possibility to help them.—The Paley Center for Media, March 15, 2010

The officials want China to be seen as a cultured, creative nation, but in this anti-liberal political society everything outside the direct control of the state is seen as a potential threat.—CNBC.com, May 12, 2010

During my detention, they kept asking me: Ai Weiwei, what is the reason you have become like this today? My answer is: First, I refuse to forget. My parents, my family, their whole generation and my generation all paid a great deal in the struggle for freedom of speech. Many people died just because of one sentence or even one word. Somebody has to take responsibility for that. —Der Spiegel, Nov. 21, 2011

In a society like this there is no negotiation, no discussion, except to tell you that power can crush you any time they want—not only you, your whole family and all people like you.—Financial Times, Feb. 24, 2012

China might seem quite successful in its controls, but it has only raised the water level. It's like building a dam: It thinks there is more water so it will build higher. But every drop of water is still in there. It doesn't understand how to let the pressure out. It builds up a way to maintain control and push the problem to the next generation. —Guardian, April 15, 2012

I will never leave China, unless I am forced to. Because China is mine. I will not leave something that belongs to me in the hands of people I do not trust.—Reuters, May 29, 2012

Brookings: The Exaggerated Death of the Middle Class

The Exaggerated Death of the Middle Class. By Ron Haskins and Scott Winship
Brookings, December 11, 2012
http://www.brookings.edu/research/opinions/2012/12/11-middle-class-haskins-winship?cid=em_es122712

Excerpts:

The most easily obtained income figures are not the most appropriate ones for assessing changes in living standards; those are also the figures that are often used to reach unwarranted conclusions about “middle class decline.” For example, analysts and pundits often rely on data that do not include all sources of income. Consider data on comprehensive income assembled by Cornell University economist Richard Burkhauser and his colleagues for the period between 1979—the year it supposedly all went wrong for working Americans—and 2007, before the Great Recession.

When Burkhauser looked at market income as reported to the Internal Revenue Service (IRS), the basis for the top 1 percent inequality figures that inspired Occupy Wall Street, he found that incomes for the bottom 60 percent of tax filers stagnated or declined over the nearly three-decade period. Incomes in the middle fifth of tax returns grew by only 2 percent on average, and those in the bottom fifth declined by 33 percent.

Things appeared somewhat better when Burkhauser looked at the definition of income favored by the Census Bureau which, unlike IRS figures, includes government cash payments from programs like Social Security and welfare, and looks at households rather than tax returns.

Still, the income of the middle fifth only rose by 15 percent over the entire three decades, much less than 1 percent per year. The Census Bureau reports that from 2000 to 2010, the income of the middle fifth actually fell by 8 percent. With numbers like these, it’s understandable why so many people think the American middle class is under threat and in decline.

But there are three reasons why even the Census Bureau figures are deceiving. The size of U.S. households, which has been declining, is not taken into account. The figures ignore the net impact on income of government taxes and non-cash transfers like food stamps and health insurance, which benefit the poor and middle class much more than richer households, and the value of health insurance provided by employers is also left out.

Burkhauser and his colleagues show that if these factors are taken into account, the incomes of the bottom fifth of households actually increased by 26 percent, rather than declining by 33 percent. Those of the middle fifth increased by 37 percent, rather than by only 2 percent. There is no disappearing middle class in these data; nor can household income, even at the bottom, be characterized as stagnant, let alone declining. Even after 2000, estimates from the Congressional Budget Office (CBO) show the bottom 60 percent of households got 10 percent richer by 2009, the most recent year available.


Making sense of income trends
Aside from the brighter picture presented by the Burkhauser and CBO analyses, there is a more complicated trend emerging in the United States. Four factors, both inside and outside the market, explain those trends.

The first market factor affecting middle-class income is a longtime trend of low literacy and math achievement in U.S. schools, which partially explains why conventional analyses of income show stagnation and decline. Young Americans entering the job market need skills valuable in a modern economy if they expect to earn a decent wage. Education and technical training are key to acquiring these skills. Yet the achievement test scores of children in literacy and math have been stagnant for more than two decades and are consistently far down the list in international comparisons.

It is true that African American and Hispanic students have closed part of the gap between themselves and Caucasian and Asian students; but the gap between students from economically advantaged families and students from disadvantaged ones has widened substantially—by 30 to 40 percent over the past 25 years.1

In a nation committed to educational equality and economic mobility, the income gap in achievement test scores is deeply problematic. Far from increasing educational equality as an important route to boosting economic opportunity, the American educational system reinforces the advantages that students from middle-class families bring with them to the classroom. Thus, the nation has two education problems that are limiting the income of workers at both the bottom and middle of the distribution: the average student is not learning enough, compared with students from other nations, and students from poor families are falling further and further behind.

It is difficult to see how students with a poor quality of education will be able to support a family comfortably in our technologically advanced economy if they rely exclusively on their earnings.

The second market factor is the increasing share of our economy devoted to health care. According to the Kaiser Foundation, employer-sponsored health insurance premiums for families increased 113 percent between 2001 and 2011. Most economists would say that this money comes directly out of worker wages. In other words, if it weren’t for the remarkable increase in the cost of health care, workers’ wages would be higher. When the portion of market compensation received in the form of health insurance is ignored in conventional analyses, income gains over time are understated.

Turning to non-market factors, marriage and childbearing increasingly distinguish the haves and have-nots.

Families have fewer children, and more U.S. adults are living alone today than in the past. As a result, households on average are better off since there are fewer mouths to feed, regardless of income. At the same time, single parenthood has grown more common, thereby increasing inequality between the poor and the middle class. Female-headed families are more than four times as likely to be in poverty, and children from these families are more likely to have trouble in school as compared with children in married-couple families. The increasing tendency of similarly educated men and women to marry each other also contributes to rising inequality.

The most important non-market factor is the net impact of government taxes and transfer payments on household income. The budget of the U.S. government for 2012 is $3.6 trillion. About 65 percent of that amount is spent on transfer payments to individuals. The biggest transfer payments are: $770 billion for Social Security, $560 billion for Medicare, $262 billion for Medicaid, and nearly $100 billion for nutrition programs. In addition to these federal expenditures, state governments also spend tens of billions of dollars on programs for low-income households. Almost all of the over $1 trillion in state and federal spending on means-tested programs (those that provide benefits only to people below some income cutoff) goes to low-income households.

Thus, taking into account the progressive nature of Social Security and Medicare benefits, the effect of government expenditures is to greatly increase household income at the bottom and reduce economic inequality.

Similarly, federal taxation—and to a lesser extent state taxation—is progressive. Americans in the bottom 40 percent of the income distribution pay negative federal income taxes because the Earned Income Tax Credit and the Child Tax Credit actually pay cash to millions of low-income families with children.

IRS data on incomes incorporate only the small fraction of transfer income that is taxable. Census data includes all cash transfer payments but leaves out non-cash transfers—among which Medicaid and Medicare benefits are the most important—and taxes.

The bottom line is that market income has grown, and government programs have greatly increased the well-being of low-income and middle-class households. The middle class is not shrinking or becoming impoverished. Rather, changes in workers’ skills and employers’ demand for them, along with changes in families’ size and makeup, have caused the incomes of the well-off to climb much faster than the incomes of most Americans.

Rising inequality can occur even as everyone experiences improvement in living standards.

Even so, unless the nation’s education system improves, especially for children from poor families, millions of working Americans will continue to rely on government transfer payments. This signals a real problem. Millions of individuals and families at the bottom and in the middle of the income distribution are dependent on government to enjoy a decent or rising standard of living. While the U.S. middle class may not be shrinking, the trends outlined above make clear why this is no reason for complacency. Today’s form of widespread dependency on government benefits has helped stem a decline in income, but far better would be to have more people earning all or nearly all their income through work. Getting there, though, will require deeper reforms in the structure of the U.S. education system.

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1 Sean F. Reardon, Wither Opportunity? Rising Inequality and the Uncertain Life Chances of Low-Income Children (New York: Russel Sage Foundation Press, 2001).