Wednesday, June 26, 2013

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

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

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

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

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

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

Monday, June 24, 2013

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Friday, June 21, 2013

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

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

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

ISBN: 9781484369999
ISSN: 2221-030X

Executive Summary

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

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

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

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

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

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

Monday, June 17, 2013

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

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

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

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

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

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

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

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

Figure 2: Bank Credit and English newspaper circulation

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

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

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


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


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

Thursday, June 13, 2013

Interact with people. Advise from Jean Adams, statistician

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



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

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

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

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

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


Pay It Forward

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

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

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


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

Saturday, June 8, 2013

How America Lost Its Way. By Niall Ferguson

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

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

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

By the Numbers

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Thursday, June 6, 2013

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Friday, May 31, 2013

241 Medicines in Development for Leukemia, Lymphoma and Other Blood Cancers

241 Medicines in Development for Leukemia, Lymphoma and Other Blood Cancers
PhRMA, May 2013

Biopharmaceutical research companies are developing 241 medicines for blood cancers—leukemia, lymphoma and myeloma. This report lists medicines in human clinical trials or under review by the U.S. Food and Drug Administration (FDA).

The medicines in development include:

• 98 for lymphoma, including Hodgkin and non-Hodgkin lymphoma, which affect nearly 80,000 Americans each year.
• 97 for leukemia, including the four major types, which affect nearly 50,000 people in the United States each year.
• 52 for myeloma, a cancer of the plasma cells, which impacts more than 22,000 people each year in the United States.
• 24 medicines are targeting hematological malignancies, which affect bone marrow, blood and lymph nodes.
• 15 each for myeloproliferative neoplasms, such as myelofibrosis, polycythemia vera and essential thrombocythemia; and for myelodysplastic syndromes, which are diseases affecting the blood and bone marrow.

These medicines in development offer hope for greater survival for the thousands of Americans who are affected by these cancers of the blood.

Definitions for the cancers listed in this report and other terms can be found on page 27. Links to sponsor company web sites provide more information on the potential products. See full report:

Thursday, May 30, 2013

CGFS: Asset encumbrance, financial reform and the demand for collateral assets

Asset encumbrance, financial reform and the demand for collateral assets
CGFS Publications No 49
May 2013

Executive Summary

The use of collateral in financial transactions has risen in many jurisdictions in the aftermath of the financial crisis, and is likely to increase further. This is driven by both market forces and regulatory changes, and has triggered concerns about real or perceived collateral scarcity and excessive asset encumbrance. Taking a system-wide perspective, this report examines how greater collateral use and asset encumbrance may impact the functioning of the financial system and draws lessons for policymakers. The key findings are summarised below.

Increasing collateralised funding and asset encumbrance

There is evidence of increasing bank reliance on collateralised market funding, particularly in Europe. A key driver of this development is perceptions of higher counterparty credit risk amongst investors, who demand more collateral or charge higher risk premia on unsecured debt.

However, the share of collateralised funding differs significantly among banks and between jurisdictions. Indeed, different business models, market structures and regulatory frameworks will tend to generate – and support – structurally different levels of collateralised funding in bank balance sheets.
Greater reliance on collateralised funding raises the share of bank assets that are encumbered. Asset encumbrance is also rising on account of initial margin requirements of central and bilateral counterparties to cover derivatives exposures and other aspects of regulatory reform.

No aggregate collateral shortages, but differences amongst jurisdictions
The demand for high-quality assets (HQA) that can be used as collateral will increase due to a number of key regulatory reforms. Examples are stricter standards for initial margin requirements on over-the-counter (OTC) derivatives transactions, both for central and for bilateral clearing arrangements, and the introduction of the liquidity coverage ratio under Basel III. This comes on top of greater demand for collateral assets in secured bank funding.
Current estimates suggest that the combined impact of liquidity regulation and OTC derivatives reforms could generate additional collateral demand to the tune of $4 trillion. At the same time, the supply of collateral assets is known to have risen significantly since end-2007. Outstanding amounts of AAA- and AArated government securities alone – based on the market capitalisation of widely used benchmark indices – increased by $10.8 trillion between 2007 and 2012. Other measures suggest even greater increases in supply.

Hence, concerns about an absolute shortage of HQA appear unjustified. Yet as the situation varies markedly across jurisdictions, temporary HQA shortages may arise in some countries, for example when the level of government bonds outstanding is low or when government bonds are perceived risky by market participants.

Implications for markets and financial stability
Private sector adjustments can mitigate shortages of HQA. Such adjustments include broader eligibility criteria for collateral assets in private transactions, more efficient entity-level collateral management and increased collateral reuse and collateral transformation.

Yet while lessening any collateral shortage, such endogenous responses will come at the cost of greater interconnectedness in the financial system, for example in the form of more securities lending or collateral transformation services. They may also increase concentration, if these responses rely on the services of only a small number of intermediaries, and will add to financial system opacity, including via shadow banking activities, and increase operational, funding and rollover risks.

Increased collateralisation of bank balance sheets mitigates counterparty credit risk, but adds to the procyclicality of the financial system. The channels through which this occurs, in times of financial stress, are the exclusion of certain assets from the pool of eligible collateral, higher haircuts on collateral assets, increased margin requirements on centrally cleared and non-centrally cleared derivatives trades and marking-to-market of bank assets in collateral pools.
Greater encumbrance of bank balance sheets can adversely affect the residual claims of unsecured creditors during bank resolution, increase risks to deposit insurance schemes and reduce the effectiveness of policies aimed at bail-in.  Given limited disclosures on encumbered assets, the ability of markets to accurately price unsecured debt can also be impaired.

Implications for policy
Market discipline can be enhanced by requiring banks to provide regular, standardised public disclosures on asset encumbrance. Transparency about the extent to which bank assets are encumbered or are available for encumbrance will allow unsecured creditors to better assess the risks they face. Such disclosures would include information on unencumbered assets relative to unsecured liabilities, on overcollateralisation levels, and on received collateral that can be rehypothecated. Development of such standards would benefit from outreach to market participants and could involve the reporting of lagged, average values to limit adverse dynamics in crisis periods. Supervisors, in turn, should receive more detailed and granular data, as required, including the amounts and types of unencumbered assets.

Including asset encumbrance in the pricing of deposit guarantee schemes deserves consideration in jurisdictions where encumbrance is of concern. Since depositors will not themselves factor in the risks posed by increased asset encumbrance – as their deposits are guaranteed – risk-sensitive deposit guarantee premia could serve to discipline banks. This would internalise the effect of asset encumbrance on residual risks for such schemes, as well as for the government as the ultimate safety net. Further analysis is needed to make this operational, taking into account differences in business models.

To internalise the risks of rising asset encumbrance, prudential limits can serve as a backstop to other policy measures, as practised in some jurisdictions. In cases where encumbrance could become a material concern, banks should be asked to perform regular stress tests that evaluate encumbrance levels under adverse market conditions.

Central banks and prudential authorities need to closely monitor and oversee market responses to increased collateral demand and their effects on interconnectedness. This provides support for work on best practice standards in securities financing markets and for shadow banking activities more generally, as well as for supervisory reviews of financial institutions’ risk and collateral management arrangements.
Concerns over procyclical demand for collateral assets lend support to efforts targeting strict standards for collateral valuation practices and through-the-cycle haircuts.

Tuesday, May 28, 2013

Competition Policy for Modern Banks. By Lev Ratnovski

Competition Policy for Modern Banks. By Lev Ratnovski
IMF Working Paper No. 13/126
May 23, 2013

Summary: Traditional bank competition policy seeks to balance efficiency with incentives to take risk. The main tools are rules guiding entry/exit and consolidation of banks. This paper seeks to refine this view in light of recent changes to financial services provision. Modern banking is largely market-based and contestable. Consequently, banks in advanced economies today have structurally low charter values and high incentives to take risk. In such an environment, traditional policies that seek to affect the degree of competition by focusing on market structure (i.e. concentration) may have limited effect. We argue that bank competition policy should be reoriented to deal with the too-big-to-fail (TBTF) problem. It should also focus on the permissible scope of activities rather than on market structure of banks. And following a crisis, competition policy should facilitate resolution by temporarily allowing higher concentration and government control of banks.

Saturday, May 25, 2013

Reading Hayek in Beijing. Bret Stephens on Yang Jisheng

Reading Hayek in Beijing. By Bret Stephens
A chronicler of Mao's depredations finds much to worry about in modern China.The Wall Street Journal, May 25, 2013, on page A11

On Yang Jisheng

In the spring of 1959, Yang Jisheng, then an 18-year-old scholarship student at a boarding school in China's Hubei Province, got an unexpected visit from a childhood friend. "Your father is starving to death!" the friend told him. "Hurry back, and take some rice if you can."

Granted leave from his school, Mr. Yang rushed to his family farm. "The elm tree in front of our house had been reduced to a barkless trunk," he recalled, "and even its roots had been dug up." Entering his home, he found his father "half-reclined on his bed, his eyes sunken and lifeless, his face gaunt, the skin creased and flaccid . . . I was shocked with the realization that the term skin and bones referred to something so horrible and cruel."

Mr. Yang's father would die within three days. Yet it would take years before Mr. Yang learned that what happened to his father was not an isolated incident. He was one of the 36 million Chinese who succumbed to famine between 1958 and 1962.

It would take years more for him to realize that the source of all the suffering was not nature: There were no major droughts or floods in China in the famine years. Rather, the cause was man, and one man in particular: Mao Zedong, the Great Helmsman, whose visage still stares down on Beijing's Tiananmen Square from atop the gates of the Forbidden City.

Mr. Yang went on to make his career, first as a journalist and senior editor with the Xinhua News Agency, then as a historian whose unflinching scholarship has brought him into increasing conflict with the Communist Party—of which he nonetheless remains a member. Now 72 and a resident of Beijing, he's in New York this month to receive the Manhattan Institute's Hayek Prize for "Tombstone," his painstakingly researched, definitive history of the famine. On a visit to the Journal's headquarters, his affinity for the prize's namesake becomes clear.

"This book had a huge impact on me," he says, holding up his dog-eared Chinese translation of Friedrich Hayek's "The Road to Serfdom." Hayek's book, he explains, was originally translated into Chinese in 1962 as "an 'internal reference' for top leaders," meaning it was forbidden fruit to everyone else. Only in 1997 was a redacted translation made publicly available, complete with an editor's preface denouncing Hayek as "not in line with the facts," and "conceptually mixed up."

Mr. Yang quickly saw that in Hayek's warnings about the dangers of economic centralization lay both the ultimate explanation for the tragedies of his youth—and the predicaments of China's present. "In a country where the sole employer is the state," Hayek had observed, "opposition means death by slow starvation."

So it was in 1958 as Mao initiated his Great Leap Forward, demanding huge increases in grain and steel production. Peasants were forced to work intolerable hours to meet impossible grain quotas, often employing disastrous agricultural methods inspired by the quack Soviet agronomist Trofim Lysenko. The grain that was produced was shipped to the cities, and even exported abroad, with no allowances made to feed the peasants adequately. Starving peasants were prevented from fleeing their districts to find food. Cannibalism, including parents eating their own children, became commonplace.

"Mao's powers expanded from the people's minds to their stomachs," Mr. Yang says. "Whatever the Chinese people's brains were thinking and what their stomachs were receiving were all under the control of Mao. . . . His powers extended to every inch of the field, and every factory, every workroom of a factory, every family in China."

All the while, sympathetic Western journalists—America's Edgar Snow and Britain's Felix Greene in particular—were invited on carefully orchestrated tours so they could "refute" rumors of mass starvation. To this day, few people realize that Mao's forced famine was the single greatest atrocity of the 20th century, exceeding by orders of magnitude the Rwandan genocide, the Cambodian Killing Fields and the Holocaust.

The power of Mr. Yang's book lies in its hauntingly precise descriptions of the cruelty of party officials, the suffering of the peasants, the pervasive dread of being called "a right deviationist" for telling the truth that quotas weren't being met and that millions were being starved to death, and the toadyism of Mao lieutenants.

Yet the book is more than a history of a uniquely cruel regime at a receding moment in time. It is also a warning of what lies at the end of the road for nations that substitute individualism with any form of collectivism, no matter what the motives. Which brings Mr. Yang to the present day.

"China's economy is not what [Party leaders] claim as the 'socialist-market economy,' " he says. "It's a 'power-market' economy."

What does that mean?

"It means the market is controlled by the power. . . . For example, the land: Any permit to enter any sector, to do any business has to be approved by the government. Even local government, down to the county level. So every county operates like an enterprise, a company. The party secretary of the county is the CEO, the president."

Put another way, the conventional notion that the modern Chinese system combines political authoritarianism with economic liberalism is mistaken: A more accurate description of the recipe is dictatorship and cronyism, with the results showing up in rampant corruption, environmental degradation and wide inequalities between the politically well-connected and everyone else. "There are two major forms of hatred" in China today, Mr. Yang explains. "Hatred toward the rich; hatred toward the powerful, the officials." As often as not they are one and the same.

Yet isn't China a vastly freer place than it was in the days of Mr. Yang's youth? He allows that the party's top priority in the post-Mao era has been to improve the lot of the peasantry, "to deal with how to fill the stomach."

He also acknowledges that there's more intellectual freedom. "I would have been executed if I had this book published 40 years ago," he notes. "I would have been imprisoned if this book was out 30 years ago. Now the result is that I'm not allowed to get any articles published in the mainstream media." The Chinese-language version of "Tombstone" was published in Hong Kong but is banned on the mainland.

There is, of course, a rational reason why the regime tolerates Mr. Yang. To survive, the regime needs to censor vast amounts of information—what Mr. Yang calls "the ruling technique" of Chinese leaders across the centuries. Yet censorship isn't enough: It also needs a certain number of people who understand the full truth about the Maoist system so that the party will never repeat its mistakes, even as it keeps the cult of Mao alive in order to preserve its political legitimacy. That's especially true today as China is being swept by a wave of Maoist nostalgia among people who, Mr. Yang says, "abstract Mao as this symbol of social justice," and then use that abstraction to criticize the current regime.

"Ten million workers get laid off in the state-owned enterprise reforms," he explains. "So many people are dissatisfied with the reforms. Then they become nostalgic and think the Mao era was much better. Because they never experienced the Mao era!" One of the leaders of that revival, incidentally, was Bo Xilai, the powerful former Chongqing party chief, brought down in a murder scandal last year.

But there's a more sinister reason why Mr. Yang is tolerated. Put simply, the regime needs some people to have a degree of intellectual freedom, in order to more perfectly maintain its dictatorship over everyone else.

"Once I gave a lecture to leaders at a government bureau," Mr. Yang recalls. "I told them it's a dangerous job, you guys, being officials, because you have too much power. I said you guys have to be careful because those who want approval from you to get certain land and projects, who bribe you, these are like bullets, ammunition, coated in sugar, to fire at you. So today you may be a top official, tomorrow you may be a prisoner."

How did the officials react to that one?

"They said, 'Professor Yang, what you said, we should pay attention.' "

So they should. As Hayek wrote in his famous essay on "The Use of Knowledge in a Society," the fundamental problem of any planned system is that "knowledge of circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess."

The Great Leap Forward was an extreme example of what happens when a coercive state, operating on the conceit of perfect knowledge, attempts to achieve some end. Even today the regime seems to think it's possible to know everything—one reason they devote so many resources to monitoring domestic websites and hacking into the servers of Western companies. But the problem of incomplete knowledge can't be solved in an authoritarian system that refuses to cede power to the separate people who possess that knowledge.

"For the last 20 years, the Chinese government has been saying they have to change the growth mode of the economy," Mr. Yang notes. "So they've been saying, rather than just merely expanding the economy they should do internal changes, meaning more value-added services and high tech. They've been shouting such slogans for 20 years, and not many results. Why haven't we seen many changes? Because it's the problem that lies in the very system, because it's a power-market economy. . . . If the politics isn't changed, the growth mode cannot be changed."

That suggests China will never become a mature power until it becomes a democratic one. As to whether that will happen anytime soon, Mr. Yang seems doubtful: The one opinion widely shared by rulers and ruled alike in China is that without the Communist Party's leadership, "China will be thrown into chaos."

Still, Mr. Yang hardly seems to have given up hope that he can play a role in raising his country's prospects. In particular, he's keen to reclaim two ideas at risk of being lost in today's China.

The first is the meaning of rights. A saying attributed to the philosopher Lao Tzu, he says, has it that a ruler should fill the people's stomachs and empty their heads. The gambit of China's current rulers is that they can stay in power forever by applying that maxim. Mr. Yang hopes they're wrong.

"People have more needs than just eating!" he insists. "In China, human rights means the right to survive, and I argue with these people. This is not human rights, it's animal rights. People have all sorts of needs. Spiritual needs, the need to be free, the freedoms."

The second is the obligation of memory. China today is a country galloping into a century many people believe it will define, one way or the other. Yet the past, Mr. Yang insists, also has its claims.

"If a people cannot face their history, these people won't have a future. That was one of the purposes for me to write this book. I wrote a lot of hard facts, tragedies. I wanted people to learn a lesson, so we can be far away from the darkness, far away from tragedies, and won't repeat them."

Hayek would have understood both points well.

Mr. Stephens writes "Global View," the Journal's foreign-affairs column.

Friday, May 17, 2013

"Near-Coincident" Indicators of Systemic Stress. By Ivailo Arsov, Elie Canetti, Laura Kodres, and Srobona Mitra

"Near-Coincident" Indicators of Systemic Stress. By Ivailo Arsov, Elie Canetti, Laura Kodres, and Srobona Mitra
IMF Working Paper No. 13/115
May 17, 2013

Summary: The G-20 Data Gaps Initiative has called for the IMF to develop standard measures of tail risk, which we identify in this paper with systemic risk. To understand the conditions under which tail risk is present, it is first necessary to develop a measure of what constitutes a systemic stress, or tail, event. We develop such a measure and uses it to assess the performance of eleven near-term systemic risk indicators as ‘early’ warning of distress among top financial institutions in the United States and the euro area. Two indicators perform particularly well in both regions, and a couple of other simple indicators do well across a number of criteria. We also find that the sizes of institutions do not necessarily correspond with their contribution to spillover risk. Some practical guidance for policies is provided.

Thursday, May 16, 2013

Unconventional Monetary Policies - Recent Experiences and Prospects (+ Background Paper)

Unconventional Monetary Policies - Recent Experiences and Prospects
IMF Policy Paper

Summary:This paper addresses three questions about unconventional monetary policies. First, what policies were tried, and with what objectives? Second, were policies effective? And third, what role might these policies continue to play in the future?

Unconventional Monetary Policies - Recent Experiences and Prospects - Background Paper
IMF Policy Paper

Summary:This paper provides background information to the main Board paper, “The Role and Limits of Unconventional Monetary Policy.” This paper is divided in five distinct sections, each focused on a different topic covered in the main paper, though most relate to bond purchase programs. As a result, this paper centers on the experience of the United States Federal Reserve (Fed), the Bank of England (BOE) and the Bank of Japan (BOJ), mostly leaving the European Central Bank (ECB) aside given its focus on restoring the functioning of financial markets and intermediation. Section A explores whether bond purchase programs were effective at decreasing bond yields and, if so, through which channels. Section B goes one step further in evaluating whether bond purchase programs had—or can be expected to have—significant effects on real growth and inflation. Section C studies the spillover effects of bond purchases on both advanced and emerging market economies, using very similar methods as introduced in the first section. Section D breaks from the immediate focus on bond purchases to discuss how inflation might decrease the debt burden in advanced economies, in light of possible pressures that could fall (or be perceived to fall) on central banks. Finally, Section E discusses the possible risks of exiting given the very large central bank balance sheets.

Tuesday, May 14, 2013

Creating a Safer Financial System: Will the Volcker, Vickers, and Liikanen Structural Measures Help?

Creating a Safer Financial System: Will the Volcker, Vickers, and Liikanen Structural Measures Help? By Jose Vinals, Ceyla Pazarbasioglu, Jay Surti, Aditya Narain, Michaela Erbenova, and Julian Chow
IMF Staff Discussion Notes No. 13/4
May 14, 2013

Summary: The U.S., the U.K., and more recently, the E.U., have proposed policy measures directly targeting complexity and business structures of banks. Unlike other, price-based reforms (e.g., Basel 3 and G-SIFI surcharges), these proposals have been developed unilaterally with material differences in scope, design and implementation schedules. This may exacerbate cross-border regulatory arbitrage and put a further burden on consolidated supervision and cross-border resolution. This paper provides an analysis of the potential implications of implementing different structural policy measures. It proposes a pragmatic and coordinated approach to development of these policies to reduce risk of regulatory arbitrage and minimize unintended consequences. In doing so, it also aims to identify a set of common policy measures that countries could adopt to re-scope bank business models and corporate structures.

Executive Summary
Structural constraints on banks proposed by a number of countries aim to address the too-important-to- fail problem by reducing the risk that these institutions will fail and by simplifying their resolution if they do fail.

Structural measures can contribute to financial stability in combination with enhanced, post-crisis price-based regulations, supervision, and cross-border bank resolution frameworks. Activity restrictions, when appropriately designed and judiciously implemented, can work in tandem with strengthened capital requirements to limit bank management’s capacity for excessive risk taking. Corporate structures aligned to business activities and limits on intra-group exposures and on their pricing can shield systemically important financial services from idiosyncratic shocks impacting other activities.  The nations proposing structural banking reform are global financial centers and systemically important economies. By enhancing financial stability in these countries, such policies can have positive spillovers on the global economy and financial system.

Nevertheless, our analysis suggests that these policies will also have potentially significant global costs given that they will be imposed on internationally active and systemic financial institutions. Our assessment points to the need for a global cost-benefit exercise encompassing extra-territorial implications of structural measures. This is necessary to determine whether the benefits of structural measures match or exceed costs at the global level; it would be difficult to justify them otherwise.

Subjecting a global institution to different structural measures in different jurisdictions could exert further pressure on consolidated supervision and cross-border resolution. Our view is that, with firm political support, a “targeted” approach—with structural measures tailored to the specific risk profiles of individual banks at a global group level—would promote global financial stability more effectively than an across-the-board approach. However, absent sufficient confidence in the supervisory capacity to design and forcefully implement the targeted approach, across-the-board measures would be appropriate provided their global benefits exceed their costs.

Wednesday, May 8, 2013

Can a Growing Services Sector Renew Asia's Economic Growth?

Can a Growing Services Sector Renew Asia's Economic Growth? By Marcus Noland, Donghyun Park, and Gemma B. Estrada
AsiaPacific Issues, No. 109
Honolulu: East-West Center, April 2013
Pages: 8

To continue Asia's economic growth the focus for expansion and improvement must move from export manufacturing to the services sector--primarily to cross-border trade in such modern services as finance, information and communication, and professional business services. As the Asian services-sector economies have historically been dominated by personal services rather than by more information-intensive services, serious concerns exist about their ability to rapidly and successfully grow these modern services. While Asia does have some well-known services-sector success stories--such as in India and the Philippines--most Asian services economies have a history of relatively slow developmental change. Removing internal and external policy and structural constraints will be key to productivity growth in modern cross-border services trade. Improving educational opportunities and strengthening infrastructure and capital and labor markets will all be needed complements to regulatory reform if Asia is to grow new and innovative service providers.

Thursday, May 2, 2013

U.S. SEC Proposes Rules For Cross-Border Swap Trades

U.S. SEC Proposes Rules For Cross-Border Swap Trades. By Sarah N. Lynch
Daily News (White Plains, NY)
May 02, 2013


The top U.S. securities regulator unveiled a proposal on Wednesday [May 1] that spells out how its rules for swaps will apply to foreign banks, saying it hoped its proposal can resolve a brewing global conflict over how to regulate the $640 trillion market.


 "This is particularly important because the global nature of this market means that participants may be subject to requirements in multiple countries," SEC Chair Mary Jo White said.

The SEC and another regulator, the Commodity Futures Trading Commission, won broad new powers in the 2010 Dodd-Frank Wall Street reform law to police the $640 trillion derivatives market, which was then largely unregulated. But Europeans and the CFTC have butted heads over the issue of how the U.S. rules should apply abroad for the past year, with CFTC Chairman Gary Gensler blamed for his aggressive stance in how he wants to apply the rules abroad.

European regulators have countered that the CFTC's approach, which was first proposed last summer, could create duplicative regimes, and have urged the United States to let them regulate the banks on their own turf.

"This type of overlapping regulatory oversight could lead to conflicting or costly duplicative regulatory requirements. Market participants need to know which rules to follow - and I believe that this proposal will serve as the road map," said Ms. White, who was just sworn in as SEC chair last month.


The CFTC late last year granted broad exemptions that vastly scaled back the cross-border reach of its proposal, but these expire in the middle of July, and it has given no clues as to whether its final draft will be equally loose. The SEC's proposal on Wednesday reflects a less aggressive approach than what the CFTC had initially proposed, and are more aligned with the CFTC's less stringent, time- limited exemptions that are currently in place.

"The proposed rules approved today by the SEC provide yet another example of the significant difference in approach taken by each of the SEC and the CFTC," said Michael O'Brien, a partner at Winston & Strawn.

Others said that the two sets of rules ultimately might not come out all that differently, and that the SEC's more accommodating stance towards foreign regulators by no means meant it would be easier on the industry.

"The detail of the rules implies that it is by no means going to be a free pass," said Gareth Old, a lawyer at Clifford Chance in New York. "The (SEC) is going to scrutinize both non-U.S. regulations and also conduct by market participants in terms of how they use those regulations probably just as carefully as the CFTC."


Still, a few SEC commissioners on Wednesday flagged a variety of reservations with the plan. Commissioner Luis Aguilar, a Democrat, said he had concerns that the SEC's plan exempts foreign subsidiaries of U.S. firms from being dubbed "U.S. persons" - a category that subjects firms to certain SEC regulations.

"The proposed rules seem to assume that any failure by these foreign subsidiaries would not financially affect the U.S. parents," he said. "However, even without a legal obligation, a U.S parent company will likely step in to save its financially troubled subsidiaries ... The proposed rules do not appear to address fully these contagion and spillover risks."

Commissioner Troy Paredes, a Republican, raised completely opposite concerns, saying he has fears that trades cutting across international boundaries could still too often be captured by the SEC's rules.

Tuesday, April 30, 2013

Central bank finances, by David Archer and Paul Moser-Boehm

By David Archer and Paul Moser-Boehm

BIS Papers No 71
April 2013
This paper looks at the relevance of a central bank's own finances for its policy work. Some central banks are exposed to significant financial risks, partly due to the environment in which they operate, and partly due to the nature of policy actions. While financial exposures and losses do not hamper central banks' operational capabilities, they may weaken the effectiveness of central bank policy transmission. Against this backdrop, the paper analyses the determinants of a central bank's financial position and the possible implications of insufficient financial resources for policymaking. It also provides a conceptual framework for considering the question of whether central banks have sufficient financial resources.

JEL classification: E58, E61, G01, M41

Title Languages
  Foreword EN
  Overview and conclusions EN
  Introduction EN
  Part A: Preliminaries: understanding central bank finances EN
  Part B: What financial resources do central banks have? EN
  Part C: What level of financial resources do central banks need? EN
  Part D: Assessing the appropriate amount of financial resources - a framework EN
  Annex 1: Central bank accounting policies EN
  Annex 2: Components of selected distribution schemes EN

Sunday, April 28, 2013

"What a civilised society, I thought to myself"

From the speech by Lee Kuan Yew at the Imperial College Commemoration Eve Dinner, Oct 22, 2002 (

Looking back at those early years, I am amazed at my youthful innocence. I watched Britain at the beginning of its experiment with the welfare state; the Atlee government started to build a society that attempted to look after its citizens from cradle to grave. I was so impressed after the introduction of the National Health Service when I went to collect my pair of new glasses from my opticians in Cambridge to be told that no payment was due. All I had to do was to sign a form. What a civilised society, I thought to myself. The same thing happened at the dentist and the doctor.

I did not understand what a cosseted life would do to the spirit of enterprise of a pe ople, diminishing their desire to achieve and succeed. I believed that wealth came naturally from wheat growing in the fields, orchards bearing fruit every summer, and factories turning out all that was needed to maintain a comfortable life.

Only two decades later when I had to make an outdated entrepot economy feed a people did I realise we needed to create the wealth before we can share it. And to create wealth, high motivation and incentives are crucial to drive a people to achieve, to take risks for profit or there will be nothing to share.

It is remarkable that powerful minds like Sir William Beveridge's, who thought out this egalitarian welfare system, did not foresee its unintended consequences. It took more than three decades of gradual decline in performance before Margaret Thatcher set out to reverse it, to restore individual incentives and the motivation to succeed, to encourage risk-taking, necessary for a successful entrepreneurial economy.

h/t: Haseltine, William A. Affordable Excellence: The Singapore Health System. Brookings Institution Press with the National University of Singapore Press, Apr 2013

The most interesting this, to me is that this once was the norm:
Perhaps the most impressive sight I came upon was when I emerged from the tube station at Piccadilly Circus. I found a little table with a pile of newspapers and a box of coins and notes with nobody in attendance. You take your newspaper, toss in your coin or put in your 10-shilling note and take your change. I took a deep breath - this was a truly civilised people.

But, as he added:
Five decades ago, London was a grimy, sooty, bomb-scarred city, with less food, fewer cars, and deprived of the conveniences of the consumer society. But the people, then homogeneous, white, and Christians, were admirable, self-confident and courteous.

From that well-mannered Britain to the yobs and football hooligans of the 1990s took only 40 years. I learned that civilised living does not come about naturally.

Saturday, April 27, 2013

Two Muslim Brothers Who Took the Assimilation Path. By Kenan Trebincevic

Two Muslim Brothers Who Took the Assimilation Path. By Kenan Trebincevic
The Wall Street Journal, April 27, 2013, on page A11

'I hope they're not Muslim," I told my brother, Eldin, when we first saw the pictures of the Boston bombers. We soon found out that Dzhokhar and Tamerlan Tsarnaev shared our religion, as we'd dreaded, when my Jewish college roommate jokingly texted: "Hey, would you please tell your people to stop blowing things up?"

I laughed, in sadness, but soon felt completely unnerved by how much the Tsarnaevs' story mirrored our own. My brother and I were born six years apart, and we're two foreign-born-and-named, athletic, Islamic brothers from difficult backgrounds in Eastern Europe, where we had experienced persecution and then been generously taken in by Americans. The 26-year-old Tamerlan Tsarnaev, killed in the police shootout, was the eldest, strong-minded child, like Eldin. Dzhokhar Tsarnaev, now in a federal medical detention center in Massachusetts, looked up to his sibling, as I always looked up to my strong-minded brother.

Boxing is big in Chechnya and nearby regions where the Tsarnaev family has its roots, and the brothers excelled in the sport, like their father. Martial arts are big in the Balkans, where we're from. Our dad owned a gym in our hometown of Brčko, Bosnia, where he trained athletes and where Eldin and I won brown belts and awards for karate.

The Tsarneavs were caught in the confusing war between Chechnya and Russia that erupted in 1999, and they wound up emigrating in 2003 to Cambridge, Mass. Caught in the bloody war between Bosnia and Serbia, factions of the former Yugoslavia, my family moved to Westport, Conn., in 1993.

Like the Tsarnaevs' father, our father suffered setbacks to his career in America, and to his health. While Anzor Tsarnaev reportedly toiled as a mechanic for $10 an hour, our dad, Senahid, slung poultry at a fast-food chicken place and took other low-paying jobs. While the Tsarnaevs' mother, Zubeidat, did facials at a Boston spa and later at their home to make ends meet, my mother, Adisa, baby-sat and found work at a data-processing firm. We too had little money, and it was hard to get jobs without connections or language skills.

Yet the Tsarnaev boys became angry, alienated young men who never quite assimilated into their new country (Tamerlan said on Twitter: "I don't have a single American friend, I don't understand them"), while my brother and I made many friends in the U.S. and wound up on the more successful side of the American dream.

There is a well-documented connection between unhappy, disenfranchised immigrants who can't connect and crime and terrorism. When I first moved here at age 13 I felt as lost, estranged and resentful as Tamerlan Tsarnaev appeared to be. In the days since the Boston bombing, I kept comparing Eldin's and my circumstances with the Tsarnaevs' to see where our paths diverged and what saved us from becoming embittered.

I was struck by news accounts that the Tsarnaev parents moved back to Russia, where they separated two years ago. One of their daughters lived in New Jersey, and she admitted that she hadn't spoken to her brothers in years. I was fortunate that my immediate family of four stayed together, first in Connecticut until my mother died of cancer in 2007, then in Queens, N.Y., where my father, brother and I now live blocks away from each other.

Even when I moved into my college dorm room at the University of Hartford and Eldin moved to the Stony Brook campus in Long Island, we spoke to our mother, father and each other daily—either by cellphone or email. I'm convinced that remaining a close-knit family kept my brother and me saner and safer. The Tsarnaev family, by contrast, seemed constantly roiled—by war, immigration, work and financial difficulties, serious illness and a marriage breakup. Throw in radical religion and, in retrospect, it seems a recipe for disaster.

Perhaps because my family survived the ethnic cleansing in the Balkans to wipe out Muslims, my family members—unlike Tamerlan Tsarnaev and his mother—did not seek solace with any specific religious figure or house of worship. While we remained proud of our heritage, we were sponsored by the Interfaith Council in Connecticut, a group of liberal churches and synagogues.

When we arrived in 1993 at JFK airport, we were met by the Rev. Don Hodges, a Methodist minister. He drove us to his Westport home, where we stayed for four months. It's not surprising or wrong for immigrants to deepen their focus on religion in a strange land. But I would speculate that in our case we felt such gratitude to the people of differing faiths who helped us that our chances of assimilating, and succeeding, in America were enhanced.

When my mother found a lump in her breast, the late surgeon Dr. Malcolm Beinfeld at Norwalk Hospital operated on her. Dr. Beinfeld, who was Jewish, told us that the Bosnian genocide against Muslims reminded him of the Holocaust. We never received a bill for the surgery or for my mother's subsequent radiation and chemotherapy.

A Protestant dentist, Richard Sands, asked my mother: "What does your son need?" At 13, I was taken to an orthodontist who gave me braces and took care of me for two years. I was embarrassed but deeply grateful that he never asked for a dime.

On my first day of school in Westport, Dr. Glenn Hightower, the principal, and a member of Mr. Hodges's church, introduced me to the seventh-grade English class with his arm draped around my shoulders. He explained that my family had been exiled in the Bosnian war, and he asked the other students to help me out. I had a foreign name, strange accent and could barely speak the language. I felt scared and pathetic, like a mutt waiting to be adopted. I was immediately befriended by Miguel Peman, a Catholic Spanish-American student, who offered me a seat.

When the school-bus driver who drove me home noticed that I had a long walk to Mr. Hodges's house, he introduced himself as Offir, from Israel, and dropped me off right at the driveway, making me promise not to tell anyone. Later, my Greek Orthodox soccer coach, Ted Popadoupolis, gave me rides to practices and games when my parents couldn't.

My brother and I didn't pursue sports with the dreams of Olympic glory that Tamerlan Tsarnaev apparently did. At schools in Westport, Norwalk and Hartford, a series of teachers and mentors helped us formulate a realistic career plan. They geared us toward a more feasible field than sports stardom: physical therapy.

We didn't experience the sort of disappointment and resentment that Tamerlan seems to have endured when his boxing dream went sour. Instead, sports teams gave us a sense of belonging.

Since my athletic father was a health nut, under his strong influence, my brother and I steered clear of the alcohol and drugs that seem to have plagued the Tsarnaevs—and might have fueled depression and hopelessness that, I would guess, twisted their judgment.

It is impossible to know what went on in someone else's childhood or what is happening in another's mind or heart. The Tsarnaevs took one path. My brother and I, despite our family's war displacement, persecution and years of poverty, thrived—but only with stable parents by our side, good jobs and help from many and diverse guardian angels. During a dark week, it was easy to forget that countless immigrants to America have similar stories to tell.

Mr. Trebincevic, a physical therapist who lives in Queens, is the coauthor, with Susan Shapiro, of "The Bosnia List," to be published by Viking next year.