February 13, 2012 6:25 pm

Foreign critics should not worry about ‘my’ rule .

By Paul Volcker

I confess total surprise about the complaints by some European and other foreign officials about the restrictions on proprietary trading by American banks embedded in the Dodd-Frank Act – now dubbed the “VolckerRule.

It made me thinkthink all the way back to my years in the US Treasury and Federal Reserve, when the Glass-Steagall Act was in full force. The practical effect was to ban all securities trading by US banksnot justproprietarytrading, but also “market making” and “underwriting” (except in US government and certain municipal securities). I do not recall – and I am morally certain it never happened – receiving a single complaint that US law was discriminatory, that it damaged other sovereign debt markets or that it limited the ability of foreign governments to access capital markets.

There is a certain irony in what I read. In Europe, there are plans to introduce a financial transaction tax, justified in part by officials because it putssand in the wheels” of overly liquid, speculation-prone securities markets. For reasons analogous to those behind the Volcker Rule, the UK is planning to “ring fencetrading and investment banking from retail banking, creating airtight subsidiaries of larger organisations. The commercial banks responsible for what are deemed essential services to the economy will be insulated from all trading and only then will they be protected by the official safety net of access to the central bank, deposit insurance and possible assistance in emergencies.

That approach, as a matter of regulatory philosophy and policy, resembles the seemingly less draconian US restrictions on proprietary trading.

The simple fact is that Dodd-Frank specifically permits both “market making” in response to customer needs and “underwriting”. No doubt US banks will, upon request, be happy to provide those services to the UK and other governments. They can continue to purchase foreign sovereign debt for their investment portfolios – should I say à la MF Global? What would be prohibited would be proprietary trading, usually labelled as “speculative”. How often have we heard complaints by European governments about speculative trading in their securities, particularly when markets are under pressure?

Is there really a case that proprietary trading is of benefit to the stability of commercial banks, to their risk profile and to their compensation practices and desirably fiduciary culture? I think not, and we need to look no further than Canada for a system in which its large banks have been much less committed to proprietary trading than a few US giants. In any event, there are and should be thousands of hedge funds and other non-bank institutions ready, willing and able to undertake proprietary trading in unrestricted securities in large volumes. The point is that those traders should not have access to the taxpayer support implicit in the safety net of commercial banks.

In addressing liquidity, can it really be of concern that some of the largest banks in Europe, in Japan, in China and indeed in Canada cannot maintain effective markets in their own sovereign debt? US chartered commercial banks could remain participants making markets” for their customers wherever they are.

Let’s get serious.

National regulatory (and at least as important, accounting and auditing) authorities should, to the extent that it is practical, seek common understanding and common approaches. In the past, I participated in that process, helping to initiate the effort to achieve common capital standards for banks. I am today encouraged by efforts under way by the US, British and other authorities to reach the needed degree of consensus with respect to resolution authority – in plain English how practically to end the “too big to failsyndrome. This is really complex. The major banks are international and managing their orderly merger or liquidation will necessarily involve co-operation among jurisdictions. That is a key challenge, arguably the most important one for banking reform. It needs to be dealt with.

Meanwhile, let us not be swayed by the smokescreen of lobbyists dedicated to protecting the interests of some highly compensated traders and their risk-prone banks.

US regulators are now considering what adjustments should be made in their preliminary rules with respect to market-making and proprietary trading, while hopefully reducing the inevitable complications imposed by the very complexity of modern finance. I regret that the effect, if not the intent, of much of the lobbying has been to add complications rather than to clarify the principles involved. As with any new regulation, there will be, with experience, opportunities to deal with unnecessary frictions or unintended consequences. But I certainly take comfort with the stated confidence of the authorities that the rule adopted will be both workable and effective.

The writer is former chairman of the US Federal Reserve

Copyright The Financial Times Limited 2012.


FEBRUARY 14, 2012

The Chaos of Greece

What happens to countries that choose economic decline.

Rioters torched shops and offices, with banks and foreign businesses the main targets. Pensioners wearing gas masks joined a blockade of Parliament and squared off against some 4,000 police officers. The city's best-known cinema was burned to the ground, along with nine other national-heritage sites.

This was Athens on Sunday night as the Greek Parliament voted for austerity measures that are their only ticket to a €130 billion bailout. Don't think these scenes can't—or won't—be repeated in other Western capitals.

When it comes to naming the bad guys in this Greek tragedy, the net can be cast very widely. Both leading political parties acquitted themselves dishonorably, one by lying about the country's fiscal position, the second by failing to do much about it. The country's government unions have resisted every serious reform and paralyzed the economy with strikes. An anarchist movement with an appetite for destruction rarely misses an opportunity to feast on mass discontent.

Greeks themselves seem unable to choose between taking another bailout and adopting austerity, or abandoning the euro and accepting the consequences of default. It's so much more convenient to blame foreign creditors ("thieves") for demanding repayment of loans that funded the lavish welfare benefits Greeks could never have afforded on their own. And when that fails, blame the Germans for being such demanding paymasters.

To top it off, the technocrats in Brussels and at the IMF have misdiagnosed the crisis from the beginning. First, they thought Athens had a liquidity problem that could be eased by large infusions of loans, rather than a fundamental solvency problem. Second, they believed that what Athens needed most was a balanced budget and a smaller debt load, to be solved arithmetically with less spending and higher taxes. But Greece's real problem is the lack of economic growth, itself a product of policies that discourage private enterprise. That's why Greece ranks 100th on the World Bank's most recent rankings of "ease of doing business"—right behind Yemen.

In other words, the fires in Athens are the result of the combustible mix of a desiccated welfare state and the burning embers of Keynes's cigarette. Don't expect those fires to be put out by this latest round of austerity. In theory, Athens has agreed to carve €3.3 billion out of this year's budget (including €300 million out of pensions), slash the minimum wage by 22%, and eliminate 150,000 government jobs by 2015.

These are necessary measures for a government sliding toward a debt-to-GDP ratio of 160%. But they do nothing to address the growth side of Greece's problem. They will also create an intolerable political problem for Greece's government as state workers are laid off into a shrinking economy. Expect a fresh exodus of Greek labor, along with increasingly powerless (and short-lived) Greek governments.

With Sunday's vote, Greece has dodged a disorderly default, at least for the time being, and Greece's private creditors can consider themselves lucky for taking only a 50% haircut under the latest proposed restructuring deal, when they might have had their heads shaved. But the crisis will not end until Greeks understand that they must live off what they produce, and adopt the policies that enable them to produce more. The larger question is whether the rest of Europe and America will learn from Greece's chaos before they experience the same fate.

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

Inside Business

February 13, 2012 5:34 pm

Leverage cap has the power to reshape banking

In the real world, leverage means power over someone or something. In banking, it stands for the ability to support a wide variety of lending and investment activities using only a relatively small amount of capital.

In good times, leverage allows a tiny base to spread upward and outward like a tree, fostering growth and generating profits. In bad times, when asset prices fall rapidly, high leverage can leave a bank or hedge fund without enough cash and equity to withstand losses. In high winds, the tree risks being blown over.


In the years leading up to the financial crisis, bank balance sheets grew from 15 or 20 times their equity to 80 times at places such as Lehman Brothers. Expressed as a ratio of capital over assets, the equity base fell from 5 or 6 per cent to 1 per cent. In other words, the tree grew taller, spread and was more likely to tip over.

After the 2008 fiasco, regulators, determined to prevent a repetition, became convinced that a mandatory cap on leverage would make the system more stable. A leverage ratio not only limits overall borrowing by banks - linking the size of the tree to its root structure - but also addresses a dangerous weakness in the main measure of bank safety, the core tier one capital ratio.

Like leverage, capital is expressed as equity over assets, but the assets are weighted using complex internal models. In theory, banks have to hold more capital against risky trading and complex products than they need for safe lending to top rated borrowers. In reality, risk-weighted assets (RWAs) are vulnerable to regulatory arbitrage, such as when collateralised debt obligations were constructed to turn pools of risky loans into supposedly safe securities before the crisis. RWAs can also be affected by collective blindness, such the fact that all sovereign bonds have historically been considered risk-free with a zero weighting.

Some Bank of England officials, for example, see a leverage ratio as the best way to keep bankers honest about their balance sheets. They have proposed forcing UK banks to make their ratios public by 2013 as a way of reassuring investors that banks have enough capital.

The Basel Committee on Banking Supervision, which sets global standards, agrees and has included a 3 per cent leverage ratio as part of its Basel III reform package. As envisioned, banks would have to reveal their leverage in 2015 and balance sheets would be capped at 33 times top quality capital by 2018.

But there is another side to this story. Capping total leverage has a disproportionate impact on banks that provide basic services to the wider economy, such as financing overseas trade. Because these are low-risk activities, they require very little capital under the RWA system, but under the leverage ratio they are treated exactly the same as high risk derivatives and speculative loans.

Bankers, industry groups, and some governments fear that imposing a leverage ratio could constrain such lending, halt global trade and damage the already fragile green shoots of recovery in the world economy. Cap leverage too low they say, and the tree won’t grow out of sapling stage.

French and German officials have led the charge against moving too far too fast on leverage, in part because their banks are expected to be hit particularly hard.

The issue has become live again this winter because the European parliament and council are debating the regulation that will apply the Basel package across the 27-nation bloc. Private French and German documents propose removing the requirement for banks to disclose their leverage levels by 2015 and further weakening may be in store. Trade finance providers, for example, are pushing for their activities to be exempted from the leverage ratio because they involve short-term loans with minuscule default rates.

Pushing against them are public interest groups such as Finance Watch, which recently suggested a moving leverage ratio 5 per cent in good times, and 3 per cent in downturns – to encourage banks to be more cautious in booms while maintaining lending after a bust. They also want total assets to include all derivatives, rather than allowing banks to net off bets in opposite directions, a step that could force investment banks to shrink dramatically.

Finding a solution that curbs banker excess without choking growth will not be easy. There is a real temptation to create all sorts of exceptions for “goodlending. But policymakers should resist calls to add too many bells and whistles to what is supposed to be a straightforwardback of the envelope calculation. In the end, it is the simplicity of the leverage ratio that gives it the power to shape banking into what society wants it to be.

Brooke Masters is the FT’s Chief Regulation Correspondent

Copyright The Financial Times Limited 2012

Is Gold Money?… Don't Ask Ben Bernanke, Examine the Federal Reserve

February 13, 2012

By Peter Krauth,
Global Resources Specialist, Money Morning

If you really care about your financial future, here's something you need to know.

It's about a story that received almost zero coverage from the mainstream press. I can't say that I am surprised
It involves gold

Thanks to requests by Bloomberg News under the Freedom of Information Act, the Federal Reserve has revealed unprecedented details concerning the personal holdings of its regional bank presidents.

What they found is nothing short of stunning ...

Ben Bernanke on Gold
But let me back up a little.

There's an exchange between Fed Chairman Ben Bernanke and Congressmen Ron Paul you need to hear first

During a monetary policy report delivered to Congress last summer, Congressman Ron Paul asked Bernanke if he thought gold is money

After a clearly uncomfortable pause Ben said, "No. It's a precious metal." [By the way, if you haven't seen Ron Paul questioning Bernanke about gold, click here. It's already had over half a million views.]

Paul went on to ask Bernanke why it is then that central banks hold so much gold. Bernanke answered that it was simply a tradition.

Well, congrats Ben, you did get that one right, just for the wrong reasons. (Deep down, you surely know the true reasons).

The fact is gold has been a monetary tradition for millennia.
Nearly 2,000 years ago Aristotle laid out what characteristics make for good money. According to Aristotle:

  1. It must be durable.
  2. It must be portable.
  3. It must be divisible.
  4. It must be consistent.
  5. It must have intrinsic value.

So it's no accident that the most common basis for money - in all of human history - has been gold
You might want to reread that: the most common basis for money - in all of human history - has been gold. It's no accident

After all, only gold meets all five of those requirements for sound money.

It is only in the past century that fiat money has supplanted gold or gold-backed currencies on a worldwide basis.

What makes today's central bankers and their system of printing fiat currencies and setting interest rates so special? It is hubris and nothing more.

Fiat currencies are just a relatively recent, and failing, experiment in economics. So much so, it's become exceedingly dangerous to hold them of late.

Here's why.

It has to do with characteristic No. 5, that bit about having intrinsic value. That's the real thorn in today's U.S. currency.

What intrinsic value does a piece of paper, with some ink saying "Federal Reserve Note," truly have?

Not much, aside from being able to buy things with them. 

Since 1913, the very year the Federal Reserve was created, the dollar has lost 95% of its value.

And it's getting worse...

Before the late 2008 financial fallout, the Fed's balance sheet had $800 billion in assets. Today, it has tripled to $3 trillion.

That's a lot more dollars sloshing around. How could things possibly not go up substantially in price when there is three times the number of dollars chasing nearly the same amount of goods and services
And here's another question.

Why does a group of Fed Governors think they know what interest rates (the price of money, really) should be? Why not let the market determine the price of money, as it does with most everything else?

The cure for all of this is gold because it is real money. Always has been. Always will be.


Gold is De Facto Money

If you don't believe gold is already reasserting its traditional role as money, consider this.

Dr. Stephen Leeb, Chairman and CIO of Leeb Capital Management, recently said, "Gold is now the de facto reserve currency."
Purchasing Power of the Dollar

Last week, Reuters reported that Iran is looking to skirt U.S.-led financial sanctions by paying for wheat using gold as payment. American grains giant Cargill said sales could still be made to Iran, particularly if they paid with non-dollar currencies.

There are also reports that India is buying Iranian oil, and paying for it with gold... 
All of this is happening at a time when as many as 13 U.S. states want to issue their own currencies in silver and gold.

In fact, North Carolina Republican Representative Glen Bradley introduced a currency bill last year. 

Bradley said, "In the event of hyperinflation, depression, or other economic calamity related to the breakdown of the Federal Reserve System ... the State's governmental finances and private economy will be thrown into chaos."

What's more, Utah has already signed a bill into law recognizing U.S. mint-issued gold and silver coins as an acceptable form of payment

The coins are treated like U.S. dollars for tax purposes and Utah State citizens can now contract to pay each other in gold if they so choose.

A Classic Case of "Do As I Do, Not As I Say"

But back to the breaking news about the Federal Reserve bank presidents.

Thanks to the recent disclosure by regional Fed bank chiefs, we now know how some have chosen to invest

To call it "revealing" would be an understatement.

Among others, New York Fed President Dudley owned shares of insurer American International Group (NYSE: AIG) and General Electric Co. (NYSE: GE) while the Fed negotiated massive emergency funding bailouts for the insurance and finance giants.

Even more stunning are the holdings of Dallas Fed President Fisher, one of the richest of the 12. He's an alumnus of the financial industry, having worked as a banker, broker, and hedge fund manager, accumulating at least $21 million in the process.

Fisher's inflation-hedging assets include over 7,000 acres of farmland, and $50,000 each in platinum and uranium

He also owns some of that stuff Bernanke doesn't think is real money. Fisher is practically a gold bug with $1 million invested in the SPDR's Gold Trust (NYSE: GLD).

Can you say conflict of interest? I rest my case.

Keep in mind that Fed decisions are made at secret meetings. The transcripts of those meetings are destroyed; a procedure that began in 1970, ironically the same year the Freedom-of-Information Act was passed.

What information about the economy, interest rates, employment, and so on, is so "sensitive" that the American people can't know?

Fisher's own "access to information" is not only privileged, it probably includes a little reading on Aristotle, too.

Look, these guys are not idiots. They just happen to think that we are.

So let's learn from Aristotle, and prove them wrong by investing in gold.

The Public and Its Problems

Raghuram Rajan


CHICAGO – On a recent visit to Europe, I found economists, journalists, and business people thoroughly frustrated with their politicians. Why, they ask, can’t politicians see the abyss that yawns before them, and come together to resolve the euro crisis once and for all?

Even if there is no consensus on what a solution might be, can’t they meet and thrash out a plan that goes beyond their repeated half-measures? It is only because of the European Central Bank’s bold decision to lend long term to banks that we have seen some respite recently, or so their argument goes. Politicians, in contrast, are failing Europe by being forever behind the curve. Why do they find it so hard to lead?

One answer that can be easily dismissed is that politicians simply don’t understand the gravity of the situation. Political leaders need not be economic geniuses to understand the advice that they hear, and many are both intelligent and well-read.

A second answer – that politicians have short time horizons, owing to electoral cycles – may contain a kernel of truth, but it is inadequate, because the adverse consequences of timid action often become apparent well before they are up for re-election.

The best answer that I have heard comes from Axel Weber, the former president of Germany’s Bundesbank and an astute political observer. In Weber’s view, policymakers simply do not have the public mandate to get ahead of problems, especially novel ones that seem small initially, but, if unresolved, imply potentially large costs.

If the problem has not been experienced before, the public is not convinced of the potential costs of inaction. And, if action prevents the problem, the public never experiences the averted calamity, and voters therefore penalize political leaders for the immediate costs that the action entails. Even if politicians have perfect foresight of the disaster that awaits if nothing is done, they may have little ability to persuade voters, or less insightful party members, that the short-term costs must be paid.

Talk is cheap, and, in the absence of evidence to the contrary, the status quo usually appears comfortable enough. So leaders’ ability to take corrective action increases only with time, as some of the costs of inaction are experienced.

Calamity can still be averted if the costs of inaction escalate steadily. The worst problems, however, are those with “inaction costs” that remain invisible for a long time, but increase suddenly and explosively. By the time the leader has the mandate to act, it may be too late.

A classic example was Winston Churchill’s warnings against Adolf Hitler’s ambitions. Hitler’s plans were outlined in Mein Kampf for all to read – and he did not disguise them in his speeches. Yet few in Britain wanted to give them credence, and many thought that communism was the greater threat, especially in the bleak years of the Great Depression.

The Nazis’ dismembering of Czechoslovakia in 1938 made the sincerity of Hitler’s ambitions all too clear. But it was only after the invasion of Poland the following year that Churchill was appointed First Lord of the Admiralty, and he became Prime Minister only after the invasion of France in 1940, when Britain stood alone.

Britain might well have been better off had Churchill held power earlier, but that would have meant costly rearmament, which was unacceptable so long as there was a chance that Hitler proved to be a paper tiger. And, of course, it would also have meant entrusting Britain’s fate to a politician who, though now regarded as an indomitable leader, was widely distrusted at the time.

Non-linear costs of inaction are most obvious in the financial sector. At the same time, financial-sector problems may be particularly difficult to address: if politicians emphasize the need for action too strongly in order to get a mandate, they might precipitate the very turmoil that they seek to contain.

Between the Bear Stearns crisis and the failure of Lehman Brothers, the United States government could do little to get ahead of the growing problem (though, of course, the government-backed mortgage underwriters Fannie Mae and Freddie Mac were placed under conservatorship in the interim). It took the post-Lehman panic for Congress to authorize the Troubled Asset Relief Program, which threw a financial lifeline to banks and the auto industry, among others.

And only frenetic action by the Federal Reserve and Treasury (with authorities around the world joining) prevented a systemic meltdown. A subprime-mortgage problem that was initially estimated to imply losses of a few hundred billion dollars imposed far higher costs on the entire world.

Similarly, eurozone politicians have obtained a mandate to take bolder action only as the markets have made the costs of inaction more salient. Even setting aside Germany’s understandable attempt to limit how much it would have to pay, it is difficult to see how politicians could have gotten ahead of the problem.

While the ECB has bought the eurozone some time, the calming effect on markets may be a mixed blessing. Have Europeans seen enough of the abyss to tolerate stronger action by their leaders? If not, markets might have to deteriorate further to make possible a comprehensive resolution to the eurozone crisis.

Similarly, with government bond yields as low as they are in the US, the public has little sense of urgency about its fiscal problems, though some doomsayers, like Peter Peterson of the Blackstone Group, have been trying their best to awaken it. One hopes that the coming US presidential election will lead to a more enlightened public debate about tax and entitlement reform. Otherwise, a rapid escalation of yields in the bond market might be necessary for the public to accept that there is a problem, and for politicians to have the room to resolve it.

Don’t blame the leaders for appearing short-sighted and indecisive; the fault may lie with us, the public, for not listening to the worrywarts.

Raghuram Rajan is Professor of Finance at the Booth School of Business, University of Chicago, and the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.

Copyright: Project Syndicate, 2012.