BoE's Haldane: "Too Big To Fail Is Far From Gone"

Authored by Andrew Haldane (Executive Director, Bank of England); originally posted at VoxEU,

Have We Solved ‘Too Big To Fail’?

No.

That is not my pessimistic verdict; it is the market’s. Prior to the crisis, the 29 largest global banks benefitted from just over one notch of uplift from the ratings agencies due to expectations of state support. Today, those same global leviathans benefit from around three notches of implied support. Expectations of state support have risen threefold since the crisis began.

This translates into a large implicit subsidy to the world’s biggest banks in the form of lower funding costs and higher profits. Prior to the crisis, this amounted to tens of billions of dollars each year. Today, it is hundreds of billions (Haldane 2012). In other words, if the market’s expectations are to be believed, the regulatory response to the crisis has not plugged the ‘too-big-to-fail’ sink.

On the face of it, that sounds perplexing. Rarely a day passes without a warning from the financial industry about overbearing regulation of, in particular, the world’s biggest banks. What is certainly true is that, in the light of the crisis, regulation to quell the too-big-to-fail problem has come thick and (at least in regulatory terms) fast. This reform effort falls into roughly three categories:

(a) Systemic surcharges: of additional capital levied on the world’s largest banks according to their size and connectivity. This Pigouvian tax on systemic risk externalities is built on conceptually sound foundations (for example, Brunnermeier 2009). And, encouragingly, good economics has found its way into good public policy. Last year, the Financial Stability Board (FSB) agreed a sliding scale of systemic surcharges for the world’s largest banks. The highest surcharge was set at 2.5% of capital.

 

Yet therein lies the problem. Based on my estimates (Haldane 2012), a charge levied at this rate would leave the majority of the systemic externalities associated with the world’s biggest banks untouched. The reduction in default probabilities associated with lowering leverage by a percentage point or two would not offset the higher system-wide loss-given-default associated with the world’s largest banks. The systemic tax is being levied at rates which are too low to meet Pigouvian ends.

 

(b) Resolution regimes: In principle, orderly resolution regimes for banks could lower the collateral costs of a big bank defaulting, thereby tackling at source these systemic externalities. And significant public policy progress has been made on this front, with the FSB publishing (and the G20 approving) some Key Attributes for Effective Resolution Regimes during the course of the past 18 months. A key component of these plans is the ability to impose losses on private creditors – so-called ‘bail-in’ – rather than have those losses borne by taxpayers.

 

As with systemic surcharges, the issue here is not to so much the bail-in principle, but its application in practice. Bail-in, whether of big banks, sovereigns or companies, faces an acute time-consistency problem. Policymakers face a trade-off between placing losses on a narrow set of tax-payers today (bail-in) or spreading that risk across a wider set of tax-payers today and tomorrow (bail-out).

 

A risk-averse, tax-smoothing government may tend towards the latter path – and historically has almost always done so, most notably in response to the present financial crisis. Next time may of course be different. But the market is sceptical. For example, in the US the Dodd-Frank Act on paper rules in future bail-in and rules out future bail-out. Yet market expectations of state support for US banks are higher today than before the crisis struck and are unchanged since Dodd-Frank became law. The time-consistency dilemma, at least in the eyes of markets, is as acute as ever.

 

(c) Structural reform: One way of lessening that dilemma may be to act on the scale and structure of banking directly. Several recent regulatory reform initiatives have sought to do just that, notably the “Volcker rule” in the US, the ‘Vickers proposals’ in the UK and, most recently, the ‘Liikanen plans’ in Europe. While different in detail, each of these proposals shares a common objective: a degree of separation or segregation between investment and commercial banking activities.

 

In principle, these ringfencing initiatives confer both ex-post (improved resolution) and ex-ante (improved risk management) benefits. Because they act on banking structure, they have a greater chance of proving time-consistent. While this is a clear step forward, those benefits are only as credible as the ringfence itself. The issue raised by some is whether, in practice, the ring-fence could prove permeable. Without care, today’s ring-fence could become tomorrow’s string vest.

If each of these initiatives is necessary but none is individually or collectively sufficient to tackle too-big-to-fail, what is to be done? One solution might lie in strengthening these proposals. For example, re-sizing the capital surcharge, perhaps in line with quantitative estimates of the ‘optimal’ capital ratio (Miles et al (2012), Admati et al (2011)), would be one option for bearing down further on systemic externalities.

Another more radical option, mooted recently by a number of commentators and policymakers, would be to place size limits on banks, either in relation to the financial system as a whole or, more coherently, relative to GDP (Hoenig (2012), Tarullo (2012)). Proposals of this type typically face two sets of criticism.

The first, practical issue is how to calibrate an appropriate limit. Recent research on the link between and financial depth and growth provides a way into this question. This research has suggested that there is a threshold at which the private-credit-to-GDP ratio may begin to have a negative impact on GDP and, in particular, productivity growth (Arcand et al (2012), Cechetti and Kharroubi (2012)). By taking a view on this aggregate threshold, and on an appropriate degree of concentration within the financial system, an institution-specific threshold could be derived.

The second, empirical issue is whether size limits would erode the economies of scale and scope which might otherwise be associated with big banks. The empirical literature on these economies has, until recently, suggested they may be exhausted at relatively low balance sheet thresholds. But a number of recent papers have painted a more optimistic picture, with economies of scale found for banks with balance sheets in excess of $1 trillion (Wheelock and Wilson (2012), Feng and Serilitis (2009), Hughes and Mester (2011)).

Yet this evidence needs to be interpreted cautiously, not least because it fails to recognise the implicit subsidies associated with too-big-to-fail. These would tend to lower funding costs and boost measured valued-added for the big banks. In other words, the implicit subsidy would show up as economies of scale. Bank of England research has recently shown that, once those subsidies are accounted for, evidence of scale economies for banks with assets in excess of $100 billion tends to disappear (Davies and Tracey (2012)). Indeed, if anything, there may even be evidence of scale diseconomies, perhaps consistent with big banks being ‘too big to manage’.

Too-big-to-fail is far from gone. It is even more important it is not forgotten. Further analytical work, weighing the costs and benefits of different structural reform proposals, would help keep memories fresh and policies on the right track.

Here Come The Drones, Or The True Reason For The Mali Incursion

Given our recent discussion (here and here) of the rising importance of Africa in the world’s power and money echelons, it is not entirely surprising that the NY Times reports that US military command in Africa is actively preparing to establish a drone base in northwest Africa to increase “unarmed surveillance missions on the local affiliate of Al Qaeda and other Islamist extremist groups” that American and other Western officials say pose a growing menace to the region. It would appear Niger will be the most likely place for the base – from which officials envision flying only unarmed surveillance drones though, of course, they have not ruled out conducting missile strikes at some point if the threat worsens. “This is directly related to the Mali mission, but it could also give Africom a more enduring presence for I.S.R.,” one American military official said Sunday, referring to intelligence, surveillance and reconnaissance. Perhaps, actually scratch the “perhaps”, what is really happening is the US now has a drone base with which to supervise Chinese expansion in Northweast Africa, anda drone fleet to use defensively and offensively as it sees fit.

From – “The Beijing Conference”: See How China Quietly Took Over Africa

 

And so it would appear we can draw a big red circle over northwest Africa in the map above which is where the US will literally have a bird’s eye view of all the resources that China is sequestering, and all the infrastructure that the world’s most populous nation is setting up.

Next we need a little dose of the perpetual “Al-Qaeda” bogeyman in Central, Eastern, and finally South Africa and the US will have military control over a continent that China is rapidly doing all it cen to colonize from the ground up.

Via NY Times,

The United States military command in Africa is preparing plans to establish a drone base in northwest Africa to increase unarmed surveillance missions on the local affiliate of Al Qaeda and other Islamist extremist groups that American and other Western officials say pose a growing menace to the region.

 

For now, officials say they envision flying only unarmed surveillance drones from the base, though they have not ruled out conducting missile strikes at some point if the threat worsens.

 

If the base is approved, the most likely location for it would be in Niger, a largely desert nation on the eastern border of Mali, where French and Malian troops are now battling Qaeda-backed fighters who control the northern part of that country…

 

The immediate impetus for a drone base in the region is to provide surveillance assistance to the French-led operation in Mali. “This is directly related to the Mali mission, but it could also give Africom a more enduring presence for I.S.R.,” one American military official said Sunday, referring to intelligence, surveillance and reconnaissance.

 

A handful of unarmed Predator drones would carry out surveillance missions in the region and fill a desperate need for more detailed information on a range of regional threats, including militants in Mali and the unabated flow of fighters and weapons from Libya. American military commanders and intelligence analysts complain that such information has been sorely lacking.

 

The United States military has a very limited presence in Africa, with only one permanent base, in Djibouti, more than 3,000 miles from Mali. …

 

If approved, the base could ultimately have as many as 300 United States military and contractor personnel, but it would probably begin with far fewer people than that, military officials said.

 

Some Africa specialists expressed concern that setting up a drone base in Niger or in a neighboring country, even if only to fly surveillance missions, could alienate local people who may associate the distinctive aircraft with deadly attacks in Pakistan, Yemen and Somalia.

 

Officials from Niger did not respond to e-mails over the weekend about the plan, but its president, Mahamadou Issoufou, has expressed a willingness to establish what he called in a recent interview “a long-term strategic relationship with the U.S.”

 

 

Senator Dianne Feinstein, a California Democrat who heads the Intelligence Committee, said on the CBS program “Face the Nation” on Sunday that in the wake of Osama bin Laden’s death and the turmoil of the Arab Spring, there was “an effort to establish a beachhead for terrorism, a joining together of terrorist organizations.”

 

 

General Ham said during an interview on his visit to Niger that it had been very difficult for American intelligence agencies to collect consistent, reliable intelligence about what was going on in northern Mali, as well as in other largely ungoverned parts of the sub-Saharan region.

 

“It’s tough to penetrate,” he said. “It’s tough to get access for platforms that can collect. It’s an extraordinarily tough environment for human intelligence, not just ours but the neighboring countries as well.”

 

The State Department has been extraordinarily wary of allowing drones to operate in the region, fearful of criticism that the United States is trying to militarize parts of Africa…

 

American drones regularly conduct surveillance flights over Somalia and occasionally launch airstrikes against people suspected of being members of the Shabab, a militant group linked to Al Qaeda.

 

 

“Without operating locations on the continent, I.S.R. capabilities would be curtailed, potentially endangering U.S. security,” General Ham said in a statement submitted to the House Armed Services Committee last March. “Given the vast geographic space and diversity in threats, the command requires increased ISR assets to adequately address the security challenges on the continent.”

Government to Dispose of Radioactive Waste By Putting It In Our SILVERWARE

114982596706602958 cAlWuJMP b Government to Dispose of Radioactive Waste By Putting It In Our SILVERWARE

 

The overwhelming scientific consensus is that any amount of radiation – no matter how small – can cause cancer and other serious health effects.

(Current safety standards are based on the ridiculous assumption that everyone exposed is a healthy man in his 20s – and that radioactive particles ingested into the body cause no more damage than radiation hitting the outside of the body.  In the real world, however, even low doses of radiation can cause cancer. Moreover, small particles of radiation – called “internal emitters” – which get inside the body are much more dangerous than general exposures to radiation. See this and this.  And radiation affects small children much more than full-grown adults.)

But the Department of Energy – the agency which is responsible for the design, testing and production of all U.S. nuclear weapons, promotes nuclear energy as one of its core functions, which has been covering up nuclear accidents for decades, and has used mutant lines of human cells to promote voodoo, anti-scientific arguments – proposes letting radiation into our silverware.

Counterpunch notes:

Even the deregulation-happy Wall St. Journal sounded shocked: “The Department of Energy is proposing to allow the sale of tons of scrap metal from government nuclear sites — an attempt to reduce waste that critics say could lead to radiation-tainted belt buckles, surgical implants and other consumer products.”

 

Having failed in the ‘80s and ‘90s to free the nuclear bomb factories and national laboratories of millions of tons of their radioactively contaminated scrap and nickel, the DOE is trying again. Its latest proposal is moving ahead without even an Environmental Impact Statement. Those messy EISs involve public hearings, so you can imagine the DOE’s reluctance to face the public over adding yet more radiation to the doses we’re already accumulating.

Congressman Markey writes:

A Department of Energy proposal to allow up to 14,000 metric tons of its radioactive scrap metal to be recycled into consumer products was called into question today by Rep. Ed Markey (D-Mass.) due to concerns over public health. In a letter sent to DOE head Steven Chu, Rep. Markey expressed “grave concerns” over the potential of these metals becoming jewelry, cutlery, or other consumer products that could exceed healthy doses of radiation without any knowledge by the consumer. DOE made the proposal to rescind its earlier moratorium on radioactive scrap metal recycling in December, 2012.

 

The proposal follows an incident from 2012 involving Bed, Bath & Beyond stores in America recalling tissue holders made in India that were contaminated with the radio-isotope cobalt-60. Those products were shipped to 200 stores in 20 states. In response to that incident, a Nuclear Regulatory Commission spokesperson advised members of the public to return the products even though the amount of contamination was not considered to be a health risk.

This is not the first time this has happened.

As the Progressive reported in 1998, radioactive scrap metal was ending up in everything from silverware to frying pans and belt buckles:

The Department of Energy has a problem: what to do with millions of tons of radioactive material.  So the DOE has come up with an ingenious plan to dispose of its troublesome tons of nickel, copper, steel and aluminum.  It wants to let scrap companies collect the metal, try to take the radioactivity out, and sell the metal to foundries, which would in turn sell it to manufacturers who could use it for everyday household products: pots, pans, forks, spoons, even your eyeglasses.

 

You may not know this, but the government already permits some companies under special licenses, to buy, reprocess and sell radioactive metal: 7,500 tons in 1996, by one industry estimate. But the amount of this reprocessing could increase drastically if the DOE, the Nuclear Regulatory Commission … and the burgeoning radioactive metal processing industry get their way.

 

They are pressing for a new, lax standard that would do away with special permits and allow companies to buy and resell millions of tons of low-level radioactive metal.

 

***

 

The standard the companies seek could cause nearly 100,000 cancer fatalities in the United States, by the NRC’s own estimate.

(A couple of years later, Congressman Markey successfully banned most radioactive scrap … but now DOE is trying to bring it back.)

Radioactive scrap is a global problem.  As Bloomberg reported last year:

“The major risk we face in our industry is radiation,” said Paul de Bruin, radiation-safety chief for Jewometaal Stainless Processing, one of the world’s biggest stainless-steel scrap yards. “You can talk about security all you want, but I’ve found weapons-grade uranium in scrap. Where was the security?

 

More than 120 shipments of contaminated goods, including cutlery, buckles and work tools such as hammers and screwdrivers, were denied U.S. entry between 2003 and 2008 after customs and the Department of Homeland Security boosted radiation monitoring at borders.

 

The department declined to provide updated figures or comment on how the metal tissue boxes at Bed, Bath & Beyond, tainted with cobalt-60 used in medical instruments to diagnose and treat cancer, evaded detection.

 

***

 

The general public basically isn’t aware that they’re living in a radioactive world,” according to Ross Bartley, technical director for the recycling bureau, who said the contamination has led to lost sales. “Those tissue boxes are problematic because they’re radioactive and they had to be put in radioactive disposal.”

 

Abandoned medical scanners, food-processing devices and mining equipment containing radioactive metals such as cesium-137 and cobalt-60 are picked up by scrap collectors, sold to recyclers and melted down by foundries, the IAEA says.

Dangerous scrap comes from derelict hospitals and military bases, as well as defunct government agencies that have lost tools with radioactive elements.

 

Chronic exposure to low doses of radiation can lead to cataracts, cancer and birth defects, according to the U.S. Environmental Protection Agency. A 2005 study of more than 6,000 Taiwanese who lived in apartments built with radioactive reinforcing steel from 1983 to 2005 showed a statistically significant increase in leukemia and breast cancer.

 

***

 

India and China were the top sources of radioactive goods shipped to the U.S. through 2008, according to the Department of Homeland Security. Bartley, a metallurgist who has tracked radioactive contamination since the early 1990s, said there’s no evidence the situation has improved.

 

***

 

Two years after an Indian scrap-metal worker died from radiation exposure, the world’s second-most populous country hasn’t installed alarms, the Ministry of Shipping said in December.

 

***

 

The same thing could easily happen again tomorrow,” said Deepak Jain, 65, who owns the yard where the worker died. “We have no protection. The government promised a lot, but has delivered absolutely nothing.”

Indeed, we are being bombarded with low-level radiation from all sides:

  • In Japan, radioactive crops are being mixed into non-irradiated foods

(The government would never treat us as guinea pigs … would it?)

What can we do?  Counterpunch notes:

You can tell the DOE to continue to keep its radioactive metal out of the commercial metal supply, commerce, and our personal items. You can demand a full environmental impact statement. Comment deadline is Feb. 9, 2013. Email to: scrap_PEAcomments@hq.doe.gov (with an underscore after “scrap_”). Snail mail to: Jane Summerson / DOE NNSA / PO Box 5400, Bldg. 401K. AFB East / Albuquerque, New Mexico 87185

 

Mark Spitznagel On Confusing Means With Ends

Authored by Mark Spitznagel, Founder of Universa Investments, originally appearing in Forbes

The Role Of Capital Has Politicians Confused

The nonchalance with which politicians on both sides of the aisle discuss ever higher taxes as the solution to our endless budgetary ills is emblematic of a widespread and consequential misunderstanding of capital. Indeed, those who claim that higher taxes bring prosperity miss the point entirely. That is, they mistake means for ends.

You see, capital is not ends; capital is means. Capital is not what humans strive for, the triumphant reward of our material aims. Rather, it is what we strive with, the intermediate tool by which we attain those aims. It is the means of higher output per unit of input (bringing our species from its hand-to-mouth past to the present), whereby, when paired with more inputs – among which is labor – we get greater economic profit and real GDP growth.

But these means are typically far removed from their ends, both temporally (production takes time) and economically (production is costly); they are exceedingly indirect (or, as the Austrian economist Eugen von Behm-Bawerk said, they are “round-about”). The entrepreneur must navigate a circuitous path, and those who think it benign to hand their capital over to bureaucrats miss this path altogether; they see only the lucky pot of gold at the end. They fixate on the inanimate stuff of capital and overlook the human imagination, patience and effort to anticipate consumer desires and bring together the many factors of production to eventually satisfy them.

It is a tautology of corporate finance that growth in profits comes from the recursive reinvestment and compounding of past profits. For instance, GDP growth is a result of (in addition to population growth) the income reinvestment rate in the economy multiplied by the rate of return on that reinvestment (or the aggregate ROIC in the economy). So when taxes skim from the reinvestable-capital stock each year, they thus skim a proportional share from subsequent economic growth. (And, no, governments do not replace private ROIC with their own public ROIC.)

Politicians are certainly not alone in their profound misunderstanding of the process of capital and production (while the high-tax impresario himself, Warren Buffett, understands the compounding tax impact so well that he dis-ingenuously structures his investments to evade them). This misconception is often at the core of much bad thinking among economists and investors alike (two groups that should know better).

Consider most economists’ treatment of capital as a homogeneous blob fabricated by central bankers out of credit. They ignore that means, by necessity, are scarce (they are foregone consumption) and must be economized to attain the most desired ends. Circumventing that fact, as history has repeatedly shown (for instance, in past periods of economic growth despite high taxes), leads only to artificial booms canceled out by subsequent credit collapses.

In investing, ours is the age of immediate and direct ends. We have become a capitalism of momentum-based hedge Fund punters, quarterly earnings growth and the cash-out IPO dream: and it is the age of pundits pushing an incomprehensible world, such that meandering aims seem to trump the commitment of entrepreneurial long-range designs.

Amid all of this messy thinking we miss the simple truth behind our material wealth: It has been achieved through the accumulation, by us and inherited from our forefathers, of a stock of highly configured and embedded tools that make human effort more effective and things possible that never were before. And we turn our backs on this truth when we turn more and more of these tools over to government bureaucrats.

Profits are but an intermediate end of capital investment. Its ultimate end, in fact, is the material progression of our civilization. How easily we lose sight of this, at our and our progeny’s peril. We all want more economic growth, but we ignore the means to get there: the onerous choices and commitments made along the round-about path to those ends. We even confuse the means with the ends.

 

[ZH: As we have described before, Mark succinctly describes not just the misunderstanding of capital but its unintended flows as it is misallocated due to forced capital injection by central banks into an environment that is far from normal or stable…]

Since it is now quite clear that despite calling for even endless-er QE, the uberdovish Chicago Fed, and by implication the entire FOMC, is still clueless about the two most critical processes of modern fiat-based economics, namely bubble formation, and its counterpart, bubble bursting, we decided to give them a helping hand, and to explain just how these two fundamental events occur, with flow charts so simple, even an Economics PhD can get it.

Bubble Formation: start at the bottom left…

Bubble Bursting: …and end with a ‘debt crisis’ and a ‘rush for the exits’

Rinse and Repeat – Simple. QED

Labor Minister Says France Is "Totally Bankrupt"

Things in France must not be very serious, because the French labor minister accidentally let the truth come out a little earlier today. As the Telegraph reports, France’s labour minister sent the country into a state of shock on Monday after he described the nation as “totally bankrupt.

Remember: France is one of the supposedly stable countries in Europe.

“Michel Sapin made the gaffe in a radio interview, which left French President Francois Hollande battling to undo the potential reputational damage. “There is a state but it is a totally bankrupt state,” Mr Sapin said. “That is why we had to put a deficit reduction plan in place, and nothing should make us turn away from that objective.” It appears that once one wipes out the propaganda and the smooth politico talk, things are bad and getting worse at Europe’s core. “Data from Banque de France showed earlier this month that a flight of capital has already left the country amid concerns that France’s Socialist leader intends to soak the rich and businesses. The actor Gérard Depardieu has renounced his French citizenship and decamped to Russia in protest, while David Cameron said Britain will “roll out the red carpet” to attract wealthy individuals. Pierre Moscovici, the finance minister, said the comments by Mr Sapin were “inappropriate”.”

At least France can hike the tax on the millionaires to 75% to generate more money. Oh wait, no it can’t.

But if capital is leaving France, where is it going? The FT has the answer:

Almost €100bn of private funds flowed back into the eurozone’s periphery late last year after action by the European Central Bank encouraged reinvestment in the crisis-hit countries.

 

The scale of the net inflows, equivalent to about 9 per cent of the economic output of Spain, Italy, Portugal, Ireland and Greece according to calculations by ING, the Dutch bank, highlight the revival in investor confidence in Europe’s monetary union after Mario Draghi, ECB president, pledged to preserve its integrity.

 

The return of capital has encouraged policy makers to believe the eurozone crisis is over, with Mr Draghi this month pointing to “positive contagion” in the region. The euro has also moved sharply higher.

Turns out it isn’t, and the capital was merely rotating from the frying pan and into the 9th circle of insolvency hell. But at least the SNB is still buying up every French bond it can get its hands on to indicate that all is well with the “totally bankrupt state.”

And speaking of private capital rotation, well Europe needed it. Recall the chart of European M3 loans to non-financial corporations we showed earlier based on central bank data:

Yup – a record outflow.

So if it wasn’t for the private capital scrambling to fill the hole, Q4 in Europe would have been an absolutely epic disaster. One can only hope that private funds are as bottomless as the public central banks backstopping them, because should there be a reflaring of risk, all bets for Europe are off, precisely at a time when everyone is hoping that the worst is behind and that Europe, as every European politician was quoted as saying in past weeks, is now “fixed.

Of course, if France is totally bankrupt, there’s nothing that a little diversionary war can’t fix. Perhaps it is time to expand the Mali offensive a bit: there’s a tempting little country in Asia called Vietnam…

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