Perhaps we need peer regulation in finance

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Guy Rolnik writes,

After acknowledging that the OCC knew of the issues within Wells Fargo as far back as 2010, it stated that “The OCC did not take timely and effective supervisory actions after the bank and the OCC identified significant issues with complaint management and sales practices.” The report also said that the team in charge of Wells Fargo “focused too heavily on bank processes versus what those processes were actually reporting” and “reached conclusions without testing or determining the root causes of complaints despite the existence of red flags.”

Pointer from Mark Thoma. Read the whole essay, which concludes,

Executives knew, board members knew (or should have known), and regulators knew almost all along, yet failed to do anything about it.

To me, this hints at the problems with the way that we currently try to deal with misbehavior on the part of financial firms. Top executives can be unreliable. Boards of directors are often unwilling or unable to delve deeply into operational issues. Regulators are just going through the motions.

There is one constituency that often really cares about financial firms that misbehave: their peers. When you lose customers to a firm that is using shady products and sales practices, you get angry. Unfortunately, the most profitable response is often to copy what the bad guys are doing.

I suggest creating a Financial Ethical Standards Board (FESB), which is analogous to FASB. FESB would provide a forum for discussing and offering guidance on ethics in the financial industry. If you see a competitor doing something unethical, you can take your complaint to FESB. FESB would have the ability to name and shame the wrongdoers, and it would have the ability to focus the attention of regulators.

I believe that a down side of FESB, or peer regulation in general, is that firms would try to use it to resist innovation that they find threatening but which in fact is not unethical. But I think that we can live with this potential down side in exchange for better regulation of the financial industry.

The way I see it, ordinary regulation simply gives clarity to banks about what they can get away with. As the banks adapt, ordinary regulation becomes ineffective, or even counterproductive. Peer regulation would be more adaptive. I believe it would be better, although nothing is perfect.

Affordable Housing is a Supply Problem

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Ed Glaeser writes,

If demand alone drove prices, then we should expect to see places that have high costs also have high levels of construction.

The reverse is true. Places that are expensive don’t build a lot and places that build a lot aren’t expensive. San Francisco and urban Honolulu have the highest ratios of prices to construction costs in our data, and these areas permitted little housing between 2000 and 2013. In our sample, Las Vegas was the biggest builder and it emerged from the crisis with home values far below construction costs.

Pointer from Tyler Cowen.

Glaeser also writes,

No locality considers the impact that their local rules may induce more building elsewhere.

This suggests a new maxim: Environmentalists impose negative externalities. If construction harms the environment, then diverting construction elsewhere harms someone else’s environment. Along the same lines, when we regulate fossil fuels in the U.S., we probably shift production to other countries which have a higher intensity of fossil fuel use than we do.

The Case Against Education

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Bryan Caplan may be coming out with the book, but Peter Gray makes it in this video, interviewed by Nick Gillespie. By the end, he is talking about school as comparable to child labor.

Those of us who grew up many decades ago probably would not want to trade our childhood for today’s childhood. My memories are of spending all day playing “hit the bat” out in the street, or practicing handstands in the yard, or playing board games. With no adult supervision.

Gray thinks that the school system is not capable of changing. If you are worried about what schools might do to your children, then probably home schooling is the most attractive alternative.

I recommend the whole 30-minute interview.

If I were trying to home school now–and I would give the idea much more consideration than I did 25-30 years ago, when we first sent our daughters to school–then I think that the challenge would be to connect with other home schoolers who are not motivated primarily to provide a religious environment. A Google search for “secular homeschool groups” turns up some resources. I do not know if these are extensive enough to make it a workable option for parents these days. One of the links I clicked on had malware, so I am not going to try to click on any more.

What Drives the Result?

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Douglas L. Campbell writes,

the Glick and Rose estimation strategy implicitly assumes that the end of the cold war had no impact on trade between the East and the West. Several of the Euro countries today, such as the former East Germany, were previously part of the Warsaw Pact. Any increase in trade between Eastern and Western European countries following the end of the cold war would clearly bias the Glick and Rose (2017) results, which naively compare the entire pre-1999 trade history with trade after the introduction of the Euro.

Pointer from Mark Thoma.

Campbell is criticizing a paper that found that the creation of the Euro increased trade by 50 percent. He is suggesting that the result could have been driven by the fall in the Berlin wall, which was not caused by the advent of the Euro. The question “what drives the result?” is one that you should ask about any empirical paper. Sadly, it is rarely disclosed honestly by authors, who may not even be aware of the answer.

Should Wal-Mart be allowed into banking?

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Ronald J. Mann wrote,

Wal-Mart’s application to form a bank ignited controversy among disparate groups, ranging from union backers to realtor’s groups to charitable organizations. The dominant voice, though, was that of independent bankers complaining that the big-box retailer would drive them out of business. Wal-Mart denied any interest in competing with local banks by opening branches, claiming that it was interested only in payments processing. Distrusting Wal-Mart, the independent bankers urged the FDIC to deny Wal-Mart’s request and lobbied state and federal lawmakers to block Wal-Mart’s plans through legislation. Ultimately, WalMart withdrew its application, concluding that it stood little chance of overcoming the opposition.

I was reminded of this by Lawrence J. White, who had written a piece in favor of allowing Wal-Mart into banking.

We are always told that we need regulation to protect consumers and make the financial system safer. That is the theory. The practice is that regulation very often gets used to limit competition.

This is an example of what I mean when I say that in any dispute between libertarians and statists, the libertarians are usually right.

Adam Ozimek’s Doubts about Libertarianism

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He writes,

you can argue that places with big government are great for other reasons, and this draws people there despite the big government and not because of it. And I think there’s a lot of truth to this. But what it tells you is that revealed preferences show that having a small government is less important to people than the other things that make a place great, like culture, quality of life, agglomeration, and economic dynamism.

Pointer from Tyler Cowen. In response, David Henderson points out that what is unrealistic today can change if you can change people’s opinions. My thoughts:

Find the locality with the most freedom of all of the localities in the U.S. Call it Libertymax. If economic liberty is what is most conducive to wealth creation, then why is Libertymax not the richest town in the country? If personal liberty is your highest priority, then why are you living where you are instead of moving to Libertymax?

Here is the way that I think about it. Statism comes from the Fear Of Others’ Liberty. The statists are more than 90 percent wrong. As people, they represent a positive externality–they make me wealthier, and I enjoy being around them. But as FOOLs, they represent a negative externality–their wrong views lead to statist policies that are clumsy, ineffective, and based on delusional notions of the benevolence and wisdom that political leaders can possess.

You cannnot escape from the statists. But it is still worth trying to convince them not to be FOOLs.

House price-to-income ratios across cities

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I find this sort of data fascinating. In Detroit, median house price is $38K and median household income is $26K, for a ratio of roughly 1.5 In San Francisco, with a median house price of $1.1 million and median household income of $81K, the ratio roughly 14.7

What should the ratio be? price/income = (price/rent) times (rent/income). Figure that in a city where there is plenty of housing supply, you might spend get by with spending only 1/5 of your income on rent. In an city where housing is scarce, you might need to spend 1/2 your income on rent.

A price/rent ratio is sort of comparable to price/earnings ratio on stocks. It should tend to be lower than stock P/E’s, because of high transactions costs, property taxes, HOA fees, and depreciation.

Historically, according to Robert Shiller, the housing price-rent ratio is around 10 or 12. So, if I take numbers on the low side, namely 1/5 for rent/income and 10 for price/rent, I get a price/income ratio of 2.0. Only Detroit is below that.

If I use high values, of 0.5 for rent/income and 12 for price-rent, I get a price/income ratio of 6.0 Of the 27 cities, 15 fall within a range of 2.0 and 6.0, which means that they are in line with historical values.

Another 6 cities have values ranging from 7 to 9. There are another 5 cities with ratios over 9, topped off by San Francisco.

Of course, the marginal buyer of the median home is not necessarily the person with median income. I think that is safe to say that in the cities with ratios over 9, median-income residents are not the marginal homebuyers. In Miami, for example, my guess is that a fair number of home buyers reside in other cities, and that could raise the price/income ratio within the city. But otherwise, those high ratios could be a sign that speculation is getting out of hand.

Remarks on the Canadian banking system

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A commenter writes,

Before the depression, the US heavily regulated banks and restricted the founding of branches; there lots of small banks tethered to local markets. In contrast, Canadian banks didn’t face such stringent regulations and were larger and more diversified. For this reason, in the US we had an epidemic of bank failures, and Canada did not.

My thoughts:

1. The best part of Canadian banking is their mortgage design: a five-year rollover, with recourse. Recourse means that if your house goes down in value, you cannot just turn the keys in to the lender and walk away. They can come back to you to make up their loss. Our 30-year, fixed-rate, no-recourse mortgage has lots of credit risk and interest-rate risk that sits with the lender, until stuff happens, and then it goes to the taxpayer. We got stuck with losses from interest-rate risk during the S&L crisis, and we got stuck with losses from credit risk during the 2008 crisis.

2. The worst part of Canadian banking is the high concentration in large banks. As in Europe, this goes along with a very stunted equity market. Firms raise capital using debt, and they owe that debt to big banks. The U.S. system, with its much more prominent stock markets, is better.

3. The worst part of the U.S. financial system is the political power of trade associations and large banks. The trade associations have leverage over Congress, and the large banks have leverage over everybody in Washington. In Canada, the big banks have to respect the regulators. Here, the bank executives can go over the heads of the regulators any time they need to.

4. Over the last thirty years, we have seen a decline in the relative importance of the stock market in the U.S.:fewer public firms, many fewer IPOs, and firms raising less of their capital in the stock market. At the same time, we have gone from a fragmented banking system to one that is very highly concentrated. Household wealth also has become more highly concentrated.

I think that if you don’t do something to limit the growth of big banks, you end up with big-bank-dominated corporate finance, meaning less active equity markets and a less democratized financial system. Also, given our political culture, you end up with the political system subservient to the CEOs of the biggest banks. In short, you combine the worst of Canada and the worst of the U.S.

Needed: A March for Fiscal Responsibility

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John Cochrane writes,

We live on the edge of a run on sovereign debt. The US has a shorter maturity structure than most other countries, and a greater problem of unresolved entitlements. Despite our “reserve currency” status, we may actually be more vulnerable than the rest of the high-debt, large entitlement western world.

That is at the end of a long post that makes points that I have made over the years.

Where Conservatives and Libertarians Part Ways

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A commenter writes,

I am confused by the conservative libertarian laments of the French and US realities. . .why are conservatives lamenting the towns so much? I think there is a degree of nostalgia for a better time and these towns better represent small c conservatism, but according to creative destruction doctrines we should let them fail.

I think that libertarians take exactly the “let them fail” position. And I think that most libertarians fall on the Bobo side of the Bobo vs. anti-Bobo axis. Don Boudreaux offers an almost daily dose of anti-Trump posts, strictly on the trade and immigration issues.

On the other hand, many conservatives are focused on lowering the status of progressives. You will notice that I am often in that camp. I hate the smugness of progressives so much that I do not wish to partake in the Trump-bashing that Don and my other libertarian friends dish out.

One of my progressive friends posted a picture of herself on Facebook carrying a sign at a demonstration that read, “Climate change is not an alternative fact.” I have adopted a rule of not commenting on politics on Facebook, but I was so-o-o tempted to write, “Indeed, it is an alternative religion.”