Trump Gets Yellow Light From Yellen on Bank Deregulation

Fed chairwoman defends bank regulation at Jackson Hole, but opens the door to changes

By Aaron Back

Federal Reserve Chairwoman Janet Yellen, above from July, opened the door on simplifying the Volcker rule in a speech Friday, but she also highlighted the positive side of higher capital cushions. Photo: carlos barria/Reuters

Federal Reserve Chairwoman Janet Yellen delivered a wide-ranging defense of postcrisis financial regulation on Friday that nonetheless could have mildly positive implications for investors in bank stocks.

Speaking at the Jackson Hole summit, Ms. Yellen opened the door to at least one step that would provide substantial relief for Wall Street banks: simplifying the Volcker rule.

The rule, which bars institutions taking insured deposits from making speculative bets with their own money, has resulted in a massive downsizing of trading operations at major banks. Many on Wall Street say they agree with the rule in principle, but they argue that its enforcement is too complex, involving up to five different federal agencies.

A study last year by the Federal Reserve found that the rule has hurt the functioning of bond markets, so it isn’t entirely surprising that Ms. Yellen would be open to some changes. Still, her formal acknowledgment that the Volcker rule could be simplified is a clear positive for banks with large trading operations such as Goldman Sachs and J.P. Morgan Chase .

On the sensitive issue of capital requirements, though, Ms. Yellen was more circumspect. The White House’s financial deregulation plan, unveiled in June, pointed out that the biggest U.S. banks are required to hold more capital than their international peers, potentially making them less competitive. Gary Cohn, director of the White House Economic Council and former president of Goldman Sachs, publicly complained in February that U.S. banks are “way out front of where the European banks are in capital.”

On the sensitive issue of capital requirements, though, Ms. Yellen was more circumspect. The White House’s financial deregulation plan, unveiled in June, pointed out that the biggest U.S. banks are required to hold more capital than their international peers, potentially making them less competitive. Gary Cohn, director of the White House Economic Council and former president of Goldman Sachs, publicly complained in February that U.S. banks are “way out front of where the European banks are in capital.”

U.S. Banks hold more capital relative to total assets. End-2016 leverage ratios:

Ms. Yellen, however, highlighted the positive side of higher capital cushions, saying fast action in the U.S. to raise capital levels has “resulted in a return of lending growth and profitability among U.S. banks more quickly than among their global peers.”

While not conclusive, these comments suggest the Fed would look less favorably than the Trump administration on efforts to weaken capital rules. That matters because it is the Fed, through its annual stress-testing process, that effectively sets capital requirements for the biggest banks.

It remains unclear if Ms. Yellen will remain Fed chairwoman after her term ends in February. A more deregulation-minded individual like Mr. Cohn could be the person to take her place. But, for as long as she is in the seat, the Trump administration will get only a yellow light from the Fed to loosen constraints on Banks.

Will the US Strike North Korea?

Minghao Zhao
. North Korea missile


BEIJING – Donald Trump is running out of patience with North Korea. Using heated language unusual for a US president, Trump recently warned that if Pyongyang threatens to attack the United States again, the US will respond with “fire and fury like the world has never seen.”
Whatever action Trump decides to take, he must recognize that the stakes – not just for the Korean Peninsula, but also for America’s relationship with China – could not be higher.
North Korea’s two latest intercontinental ballistic missile tests, carried out last month, suggest that the country now has the capability to hit the continental US. The US Defense Intelligence Agency has concluded that North Korea may well have already developed a miniaturized nuclear warhead that could be delivered on such a missile. Experts from Johns Hopkins University anticipate a sixth nuclear test at any moment.
The United Nations Security Council has now unanimously passed the harshest sanctions yet against North Korea, in the hope of pressuring the small country to renounce its nuclear-weapons program.
The resolution bans North Korean exports of coal, iron, iron ore, lead, lead ore, and seafood products, which together account for one third of the country’s already meager annual export revenue of $3 billion. It also prohibits countries from issuing new permits to North Korean workers abroad, whose wages, it is suspected, help fund nuclear and missile programs.
So far, however, the sanctions do not seem to be having the intended effect. North Korea has threatened to retaliate against the US “thousands of times” over – including by striking the US territory of Guam in the western Pacific – and reiterated its vow to never give up its nuclear arsenal.
Similarly, at the just-concluded ASEAN Regional Forum in Manila, North Korean Foreign Minister Ri Yong-ho asserted that the North would not participate in negotiations on its nuclear and missile programs unless the US abandons its “hostile” policy.
The US has taken a similarly stubborn line. In a recent Senate Foreign Relations Committee hearing, Acting Assistant Secretary of State for East Asia Susan Thornton articulated the administration’s belief that talks would not get North Korea to abandon its nuclear-weapons program, even if they brought much-needed economic concessions. “We will not,” she added, “negotiate our way to talks.”
Instead, the US has been working hard to tighten the screws on Pyongyang, by reinforcing its international isolation. The Trump administration attempted to convince the Philippines to exclude North Korea from the ASEAN forum, and is pushing Myanmar to suspend its military ties with the country.
The US has been more successful in pressuring Australia, the European Union, Japan, and other US allies to strengthen unilateral sanctions on the North. According to Federica Mogherini, the EU’s High Representative for Foreign Affairs and Security Policy, the EU is considering additional measures, including further reductions in trade and financial exchanges. Japan’s government has decided to expand a re-entry ban for North Korean officials, and widen the scope of its asset-freeze program for entities and individuals connected to the country’s nuclear and missile development.
But the US is unlikely to put all of its eggs in the sanctions basket. Already, the Department of Defense announced that US Joint Chiefs of Staff Chairman Joseph Dunford and US Pacific Command Chief Harry Harris had spoken by phone with South Korea’s top military official, General Lee Sun-jin, to discuss military-response options to the launch. Moreover, US, Japanese, and South Korean forces have conducted several joint drills involving B-1B bombers and other strategic assets. The message is clear: the US is ready to fight, should it come to that.
Of course, avoiding such a fight is still the world’s best bet – a fact that even the turbulent Trump administration seems to recognize. But that will require cooperation from China, which the Trump administration has gone to great lengths to alienate.
As North Korea’s main trading partner, China has substantial leverage over the country. China’s suspension of North Korean coal imports alone – part of its obligations under the Security Council resolution – will reduce the North’s export earnings by an estimated $400 million this year (while also costing China a pretty penny).
But China has serious reservations about America’s North Korea policy. For example, China adamantly opposes the deployment of the Terminal High Altitude Area Defense (THAAD) anti-missile system in South Korea, claiming that it undermines China’s own security.
Moreover, China condemns “secondary sanctions” placed by the US on Chinese companies and individuals found to have illicit dealings with North Korea as assaults on its sovereignty. Yet the Senate’s leading Democrat, Minority Leader Chuck Schumer, is ready to double down on this approach, calling for the suspension of direct investment from China.
And that is not the only way the US Congress is antagonizing China. The 2018 National Defense Authorization Act, passed by the US House of Representatives last month, includes demands for the US government to strengthen military ties with Taiwan, with US Navy ships calling in at Taiwan’s ports.
Last April, Senator John McCain said that North Korea is presenting the US with a “Cuban Missile Crisis in slow motion.” It is an apt analogy, but it gets one thing wrong: there is no longer anything slow about the situation. Trump’s administration had better catch up.

Throwing China’s Economy Off Balance

By Xander Snyder

For all that isn’t known about Chinese economics and finance, it’s no secret that China has a debt problem. But debt may be even more problematic in light of new figures recently disclosed by the China Banking Association. Its 2017 annual report showed that off-balance sheet assets in the Chinese financial system are 109 percent of on-balance sheet assets (approximately $38 trillion). In other words, there is more debt in off-balance sheet assets than is currently held by banks. This is systemically risky for a country such as China, which relies heavily on its real estate industry to spur economic growth and whose economic problems are uniquely political.
What are off-balance sheet assets, and what is the shadow banking system? When a bank lends money, the loan is recorded on its balance sheet, a ledger that records the quantity of loans outstanding (its assets) versus its deposits (its liabilities). Credit extended by banks, then, are “on-balance sheet” assets. An off-balance sheet asset is a loan or investment that’s made that, for whatever reason, is not included or accounted for on the bank’s balance sheet. A bank might be incentivized to move assets off its balance sheet because if it does not need to record the loan on its books then it doesn’t need to carry reserve provisions for them, which lets a greater portion of its capital be lent out to generate profits. Of course, this increases the risk of bank failure if enough loans become nonperforming.

In China, many banks have subsidiaries that manage what are called wealth management products. WMPs seek returns on invested capital that are higher than can be provided for by bank deposits. Since they are technically not deposits at the bank – instead, they are managed by a separate corporate entity – they are not subject to banking regulations. (Banks, for example, are required to hold a certain amount of capital reserves.) Assets managed in WMPs and other similar bank subsidiary products are often not recorded on the parent bank’s balance sheet. The aggregation of these entities that manage off-balance sheet assets is what’s known as the “shadow banking system.”

Initially, WMPs were seen by retail investors as a substitute for deposits. Many believed they, like bank deposits, came with explicit guarantees by the government. Since WMPs provided higher yields, they became an attractive alternative for Chinese investors and savers. WMPs, however, are not explicitly guaranteed by the government since they are not deposits. And though this misconception has largely been corrected over the past few years, there is still a tacit understanding that the government will sometimes guarantee them. And why wouldn’t there be? Beijing has, in fact, bailed out large, failing WMPs even when it was not legally obligated to do so.

WMPs provide higher yields to investors than deposits do because they invest in riskier assets and projects. And since China doesn’t have too many opportunities for investment other than real estate, WMPs tend to invest heavily, though not exclusively, in this sector. Moreover, since the WMP investments are not considered banking deposits, reserve requirements that compel banks to withhold capital against the loans they make as protection against losses do not apply equally to WMPs. So these subsidiaries can invest far more capital – often in real estate projects that would be too risky for the bank itself to underwrite – with even fewer protections than banking reserve requirements would normally provide for.

It is not just the higher returns that appeal to investors. WMPs provide investors with exposure to real estate without the same upfront capital requirements to own real estate outright. Further, WMPs often have short investment periods – three, six or 12 months – which reduces the risk to investors that they will lose or not fully recover their money. But WMPs often fund projects with timelines exceeding the maturation periods of the underlying securities providing those funds. For example, a new building may take two years to be built but be funded with WMP capital with a 6-month maturity period. This creates the possibility that the capital required to complete the project will dry up midconstruction.
The Bill
Investing too much in real estate, sometimes with insufficient funds, is a blight on the Chinese economy. If developers go out of business, WMPs will be unable to repay their investors in full, essentially footing the central government with the bill. Whether it decides to pick up the bill is another question. Though the central government allowed smaller WMPs to go under, it has intervened to prevent larger ones – ones whose failure could imperil the economy – from going under.

The central government understands these risks, and it knows it must try to lower the amount of credit extended through the shadow banking sector to the real estate industry. But the government can’t move too quickly. Reducing the amount of available credit drives down real estate prices, and when prices fall too quickly, developers are unable to sell new projects at the prices they used to underwrite the loan – or even above the value of the debt they took out to complete it.

Since other areas of the economy are dependent on real estate – for example, state-owned enterprises that provide construction material for real estate – a rapid correction in real estate prices could impact more than just real estate. Many of these SOEs are politically important because they provide jobs to urban populations. Some SOEs also pay out pensions, which are important for retired city residents. The more inflated the real estate sector becomes, the more painful the eventual contraction would be. A real estate-driven recession would not be confined to real estate – it would affect the entire economy and financial system.
Thus is China’s balancing act. It must decrease credit and prevent housing prices from rising too far – which heightens the risk of a rapid contraction – without driving down prices by restricting credit. The government has pursued this policy incrementally. The People’s Bank of China gradually decreased liquidity in the banking sector through monetary facilities like the medium-term lending facility and its shorter-term standard lending facility. Restrictions on real estate transactions have been imposed in major cities such as Beijing, including requiring greater down payments, preventing homeowners from purchasing multiple houses for speculation instead of owner-occupation, and re-zoning multi-use property to commercial only.

The government has also attempted to address risks created by the shadow banking sector directly, increasing reporting requirements for WMPs and other banking subsidiaries so that regulators can better monitor the extent of the risk caused by the amount of credit they have extended to the market. In April, by implementing new regulatory requirements, the government restricted $1.7 trillion in liquidity that WMPs and other shadow banking entities previously had access to. This contributed to an unusual inversion in the yield curve of Chinese government securities that we observed in which both the seven-year bond and five-year bond interest rate traded above the 10-year bond. As capital was pulled from the WMPs, demand for these bonds decreased, driving their interest rates up. The inversion was caused in part by the lower trading volumes of the five- and seven-year bonds than the 10-year. This means the decrease in demand caused by the government’s restriction of liquidity had a greater impact on total demand for five- and seven-year bonds. Yield curve inversions are often signs of a coming economic recession, and have fairly accurately predicted recessions in the U.S.

Despite China’s initiatives to make the shadow banking system more transparent and to gradually reduce credit, the China Banking Association’s annual report shows the risks are still there. How successfully the government handles shrinking shadow banking loans will help determine the extent of systemic risk and the government’s ability to mitigate it.

Economics and politics are useful prisms for certain issues, but geopolitics dictates that they are inextricably linked. Perhaps in no country is this more apparent than in China, where the government has a much higher degree of control over its economy than most others. Separating these two issues is impossible for the Communist Party, and it must continue to consider the political ramifications its economic solutions would create.

Neymar transfer exposes football’s modern-day trafficking scheme

Governments and clubs have done a deal to erase players’ rights

by: Stefan Szymanski

The money PSG pays to Barcelona could have been part of Neymar's wage had he been allowed to bargain on his own behalf © AP

The agreement by Barcelona to transfer the football player Neymar to Paris St Germain for €222m has provoked media outrage — but of the wrong kind. We should not be incensed by the pricetag, but by the fact that it remains legal for a business to sell an employee to another business.

Barcelona sold Neymar to PSG. That is the only reason he is allowed to move. He could not have sold himself, and had he sought to transfer to another club of his own volition, and without Barcelona’s agreement, he could have been banished from professional football.

Most readers of this column will have a job — how would you feel if your current employer said you could not take up an opportunity at another company unless they received compensation equal to four or five times your annual salary? How would you feel if your employer said you could not even talk to another company interested in hiring you without their prior consent? You would almost certainly go to court to defend your rights — in the EU, you would almost certainly win. The free movement of labour clauses of EU law protect your autonomy in this regard. We accept this as right and good. Why, then, are we comfortable with the bartering of professional football players?

Consider further that this business transaction actually hurts Neymar financially — the money PSG pays to Barcelona could have been part of his individual compensation had he been allowed to bargain on his own behalf. Of course, he is already a multi-millionaire; few will have sympathy for his financial plight here. But FIFPro, the player’s union which by its own account represents more than 60,000 professional players, does not speak just for the superstars and the mega-rich. I estimate, in fact, that the median salary of its members is less than $50,000.

For the vast majority of players, the restrictions imposed by the transfer system can create genuine hardship. For example, in many countries, players in the lesser leagues routinely do not get paid their wages. Yet the transfer regulations stipulate that they cannot even begin the process of finding another employer until they have gone without pay for a full six months. Imagine you are a middle-class employee, perhaps with a family. You have not seen a paycheck in four months, but you cannot leave or even try to find another job.

The transfer system as it currently stands was created in 2001, following the 1995 Bosman judgment of the European Court of Justice, which declared the old transfer system illegal — precisely because it did not respect the right of free movement. Astonishing as it may sound, the new system was agreed between Fifa (then headed by Sepp Blatter) and the European Commission, without the consent of the players’ representatives. Unsurprisingly, it favours the employers.

Research by FIFPro has identified other forms of abuse in the transfer system. Players who ask to leave their club against owners’ wishes are bullied, harassed, and at times even physically abused. No one would tolerate this state of affairs in any other business (with the possible exception of organised prostitution), but naive young professional players can be easily exploited.

To be sure, many clubs are exemplary employers and treat players well — but basic rights should not be a matter of your employer’s goodwill. Consequently, FIFPro has now brought a complaint to the commission seeking to have the current system ruled illegal. In an economic analysis for the union, I found that the transfer system helps cement the dominance of the largest clubs: exorbitant transfer fees act as a barrier to smaller clubs. As a result, a large fraction of transfer fee revenue just circulates among the dominant clubs in Europe.

The idea of abolishing the transfer system makes many football fans weak at the knees; they fear that small clubs that rely on transfer fee income would collapse. There are two responses: first, small clubs depend on transfer revenue far less than fans believe, and the transfer market is of little help when it comes to financial crises because prices fall in a fire sale. Even if a small club occasionally does well out of the system, the second point is far more important: equality before the law is a bedrock principle of liberal democracies. We simply must not deprive one class of people of the rights that the rest of us enjoy just because the victims supply us with entertainment.

The transfer system is nothing less than a global trafficking scheme in human labour — shockingly, it represents an agreement between the representatives of national governments and employers to erase employees’ rights

The writer is professor of sport management at the University of Michigan

This $5 Trillion Time Bomb Will Devastate Americans

by Nick Giambruno

Over 3,000 millionaires have fled Chicago in recent months.

This is the largest outflow of wealthy people from any US city right now. It’s also one of the largest outflows of wealthy people in the world.

But it’s not just millionaires… Every five minutes someone leaves Illinois.

In a recent poll, 47% of people in Illinois said they want to leave the state. Over the last decade, more than half a million people have done just that.

This is the largest outflow of people from any state in the country.

The people who leave are generally better educated, more skilled, and earn more money than those who stay. Entire towns of affluent Illinois refugees have sprouted up in Florida, Arizona, and other states.

Illinois is bleeding productive people.

This is a major warning sign.

Wealthy people are often the first to leave a bad situation. They have the means to simply get up and go. And when they do, they take their money and their businesses with them.

This hurts the local property market and the rest of the local economy.

Many of Illinois’ millionaires own businesses that employ large numbers of people. As they leave, there are fewer people and businesses left to shoulder the state’s enormous and growing financial burdens.

Many of these people are leaving for one simple reason: rising taxes.

Illinois’ leftist tax-and-spend politicians are continuing to increase all sorts of taxes, which were already high in the first place.

The state just passed a 32% income tax hike.

Rising taxes are pushing more and more productive people to make the chicken run… and at the worst possible moment for the state’s coffers.

Illinois is the most financially distressed state in the US. Every month, it spends $600 million more than it takes in. It’s now $15 billion behind on its bills and counting.

Illinois is about to become America’s first failed state.

Even its governor has described it as a “banana republic.”

Today, Illinois can’t pay contractors to fix the roads. It doesn’t have enough cash to pay lottery winners. (What happened to the money it collected selling lottery tickets?)

The state can’t even afford food for its prisoners.

Here are the sad facts. Illinois has:

• Nearly $15 billion in overdue bills (including $800 million in interest).

• A $7 billion budget deficit.

• And an eye-watering $250 billion bottomless pit of unfunded pension obligations.

For perspective, $250 billion is more than the combined market value of Allstate, Boeing, United Continental, and Caterpillar, four large Illinois companies.

This $250 billion tab is one of the worst public pension crises in the US.

It’s also Illinois’ biggest financial problem.

Illinois’ latest income tax hike will bring in an additional $5 billion in revenue. But that won’t do much for its $250 billion pension shortfall.

No tax hike will ever be enough to put Illinois’ fiscal house in order. But higher taxes will push more productive people out of the state. This will only exacerbate the problem.

Illinois already has the worst credit rating of any US state. It’s just a matter of time before it becomes the first state in US history to receive a “junk” credit rating, which signals a higher risk of default.

In the months ahead, it’s a mathematical certainty that Illinois will default on some of its obligations.

That’s bad news for pensioners, state contractors, and pretty much everyone living in the state.

According to a former budget adviser to the governor, soon more than 25 cents of every tax dollar collected will go to retired state employees.

Politicians in Illinois—like a number of other distressed states—have amended their state constitutions to prohibit reducing these pension payments. That means taxpayers are on the hook.

No wonder wealthy people are fleeing this sinking ship.

The problem is Illinois’ leftist politicians don’t understand that taxpayers aren’t their personal milk cows.

The state is not a captive market. Taxpayers can vote with their feet. And they already have… in record numbers. Higher taxes will only accelerate this trend and further bankrupt the state.

While Illinois has the worst pension situation, it’s not the only state or city in crisis.

California’s public pension system is also broken beyond repair. It’s $750 billion underfunded.

State pension plans in Connecticut, Pennsylvania, New Jersey, and many other states are taking on water, too.

Unfunded public pension liabilities in the US have surpassed $5 trillion. And that’s during an epic stock and bond market bubble.

Public pensions have long been a financial time bomb… and the fuse is getting shorter by the day.

The inevitable explosion has now become imminent. And it’s going to devastate many Americans.