WSJ: Is Silicon Valley Funding the Wrong Stuff?

Few would argue that our transportation and energy infrastructure isn’t dilapidated, but is it really Silicon Valley’s responsibility to worry about these sorts of things?

See here for full article. 

Silicon Valley and a lot of the modern tech scene are tackling problems that that the actual creators find important to solve. Tired of unreliable transportation? Start a car service like Uber where you can rely on both quality, smooth transactions and timeliness. Tired of expensive hotels that don’t cater to your needs? Start an accommodations service like Airbnb where niche markets can be serviced. The list continues, even for things the 0.1% don’t need, like basic education and low-cost entertainment. 

I’m just throwing this out there, but what if the problems that a majority of the U.S. has created for itself (dilapidated infrastructure, inefficient energy, etc.) don’t need to be solved? What if…people were to live differently?

Urban dwellers are different animals, and in many ways, they don’t need the necessary expansionary infrastructure and loads of energy that people use when they live far from work or other social activities. When they do, their tax revenue should cover it. If not, they shouldn’t get it. Living in urban areas also allows people to easily share, so there’s greater marginal value per unit. 

If you prefer the rural life, just know there are consequences to that decision. Prices should adjust accordingly. 

The problem may not be that we need technological gains in these areas so we can consume more resources, but perhaps not use as many resources to begin with.

This is what I think Silicon Valley/the Bay Area is actually doing to the U.S. economy, and I’m alright with it. 

Rogoff Says Globalization Reduces Global Inequality

From Kenneth Rogoff, reviewing Piketty on Project Syndicate

My emphasis in bold

Alternative steps (to Piketty) to reduce inequality within the U.S. - 

There are many practical policies that can be adopted to reduce inequality, in addition to a progressive consumption tax. Focusing on the US, Jeffrey Frankel of Harvard University has suggested the elimination of payroll taxes for low-income workers, a cut in deductions for high-income workers, and higher inheritance taxes. Universal pre-school education would enhance long-term growth, as would a much greater emphasis on lifetime adult education (my addition), possibly via online courses. Carbon taxes would help mitigate global warming while raising considerable revenues.

Where Rogoff disagrees with Piketty - 

"In accepting Piketty’s premise that inequality matters more than growth, one needs to remember that many developing-country citizens rely on rich-country growth to help them escape poverty. The first problem of the twenty-first century remains to help the dire poor in Africa and elsewhere. By all means, the elite 0.1% should pay much more in taxes, but let us not forget that when it comes to reducing global inequality, the capitalist system has had an impressive three decades.”

Sharing Economy — More sharing, fewer jobs? No.

My trip to SF this past weekend included a visit to the offices of the disruptive travel/accommodation tech start-up Airbnb

I enjoyed the experience, mainly because the company has great office culture, smart people, and I admire their mission to expand the “sharing economy.” 

But this recent op-ed in the LA Times about the financial crisis and the rise of sharing economy got me thinking about it all a bit more:

"…The boom time left us with too much of everything, from cars to second homes to power drills. Now that it’s over, we’ve never had a greater financial need to make use of these assets. An alternative economic and social model has risen from the wreckage of the credit crunch.

If we buy fewer houses and cars  our largest, most highly financed investments  it will help in the deleveraging of the economy. Fewer mortgages mean less debt for bankers to collateralize; and, according to Zipcar, every shared car takes several others off the road.”

Think about that for a moment. It sounds like “more sharing, fewer jobs.” 

And at first, that’s what is seems like. The problem that America faces today (post crisis) is lack of employment opportunities for lower-income households. While over-consumption funded by mortgage debt is without a doubt a bad thing, I do wonder where jobs will come from in the future — surely not the traditionally blue-color jobs of construction or auto-manufacturing, right?  

I think there’s truth to that — reduced consumption could lead to fewer lower-income jobs — but I disagree that it would stay that way over the long-term. 

The sharing economy is not about “more sharing, fewer jobs,” but sharing assets in general, which can eventually change what kind of jobs become available. With these jobs, it’s about sharing a bigger slice of everything, including the profit pie. When you do that, the “sharing economy” leads to job creation because lower-income households can now afford goods and services they reached for (with leverage) leading up to the financial crisis. Combined with greater education and a culture of sharing, it could lead to better decisions about consumption (travel and leisure?), not less consumption, per se. 

The “sharing economy” is radical. It doesn’t play by the same rules of the past, where jobs were funded by leveraged bubbles. It’s an equity based system, and our policymakers should take note. Encouraging greater asset/equity sharing is a noble policy platform that both the political left and the right could support. That’s disruption on another level. 

Bernanke: Transparency x10

Bernanke’s most recent speech is pretty straightforward — he wants the market to understand what the Fed is doing. If forward guidance is based on “economic objectives,” then that’s what it means. 

I wonder if he’s saving “it is what it is” for the finale? Transparency x10:

1. “…one of my priorities was to make the Federal Reserve more transparent…”

2. “…to make monetary policy as transparent and open as reasonably possible.”

3. “…transparency in monetary policy enhances public understanding and confidence, promotes informed discussion of policy options.” 

4. “…the deepest recession since the Great Depression has required a more prominent role for communication and transparency in monetary policy than ever before.”

5. “…I will discuss how the Federal Reserve’s communications have evolved in recent years and how enhanced transparency is increasing the effectiveness of monetary policy.”

6. “… I believe that policy transparency remains an essential element of the Federal Reserve’s strategy for meeting its economic objectives.”

7. “Experience demonstrates that a useful approach to managing expectations—one that dovetails well with basic principles of transparency—involves policymakers stating clear objectives as well as their plans for attaining those objectives.”

8. “…numerical inflation goals have helped increase the transparency and predictability of policy in a number of economies.”

9. “This increased transparency about the framework of policy has aided the public in forming policy expectations, reduced uncertainty, and made policy more effective.”

10. “I began my time as Chairman with the goal of increasing the transparency of the Federal Reserve, and of monetary policy in particular.”

Geithner goes in through the out door

He took the a-typical path for someone fascinated with finance. It wasn’t the most lucrative, but it was an intellectual roller-coaster. He devoted himself to public institutions and the functioning of global markets, ran the world’s largest portfolio, and after 25 years he’s going to work in global private equity where he can apply what he learned in a different way. 

Is that a bad thing? Evidently, some people think so. And evidently, whether we want to crap another man’s private decision to make a living boils down to our view of such things:

Is Scheiber right? That whether you think Geithner’s decision is respectable or not is based on your world-view? Yes, I think so.

However, this tweet gets more to the point than Scheiber’s article does, which is that his beef with Geithner is nothing more than him expressing his feelings about the financial industry, not Geithner himself. 

Call me crazy, but perhaps Scheiber should write about whether he thinks America is over-financed (fellow TNR’er Robert Solow does). Or better, what careers he thinks Geithner should be doing to better serve the public good; if that’s his world-view.

One more thought — What if Geithner went to run a health-care company or a university? Noah Smith says these positions might be equally ”bullshit jobs”. Even more reason to write about what Geithner should be doing! 

Remember that $83 billion dollar subsidy?

In August, Moody’s Investor Services stated that they were reviewing the credit ratings of large banks in order “to reflect the impact of US bank resolution policies.” Moody’s competitor S&P has already made these changes.

This past week, Moody’s finished their review by downgrading the likelihood of government support, stating, “Today’s rating actions reflect strengthened US bank resolution tools, prompted by the Dodd-Frank Act, which affect Moody’s assumptions about US government support.” 

While financial markets already priced in regulatory changes associated with Dodd-Frank – changes that make bank failure less likely and failure less messy – critics often pointed to credit ratings to state that big banks were receiving an implicit subsidy (valued at $83 billion), in a large part because this was the only methodology that stated there was one.

With these changes, no matter what methodology one uses, no “implicit TBTF subsidy” exists. 

Lend Freely At A Penalty Rate, Or Something

Walter Badgehot summarized the lender of last resort function by saying: “Lend freely at a high rate, on good collateral.” This is often translated: “Lend freely, but at a penalty rate.”

Based on analyses of the programs, the Fed did lend at a penalty rate, although, similar to “high rates,” the definition of a penalty changes as market conditions change. The fact that the market wound down the programs before the Fed actually closed them is a perfect example of why they did lend at a penalty. As the financial system stabilized, why did the market stop relying on the Fed if it wasn’t at a penalty rate? 

Here’s the New York Fed in a 2010 study on the pricing structure of the CPFF:

"The CPFF’s pricing structure and other program requirements helped ensure that the facility played a constructive role in restoring stability to the market. At the same time, they also served to: 1) prevent artificial inflation of issuance beyond what may be absorbed by investor demand under normal conditions, 2) ensure that the facility was used as a backstop in times of stress while also providing a disincentive to issue to the facility under more liquid market conditions, and 3) mitigate the credit risk associated with adverse selection to minimize the Federal Reserve’s exposure to loss relative to its accumulated capital from program fees.”

At its peak in January 2009, the CPFF held more than 20 percent of all outstanding commercial paper. By the time it expired on February 1, 2010, the facility represented only 1 percent of market issuance. The self-liquidating feature of the CPFF is illustrated by the steady decline in the amount of outstanding commercial paper throughout 2009.” 

Their Liberty Street Blog says something similar about the PDCF program:

The terms of the PDCF were designed to make the facility’s usage unattractive in normally functioning markets, so that it would be used only as last-resort funding…In particular, the Fed extended loans at the discount rate, which was set above the fed funds rate (at the same level as the primary discount rate). Because rates in the repo market generally fall below the fed funds rate, borrowing through the PDCF would ordinarily be more expensive than borrowing in the private market. Moreover, the Fed implemented an escalating usage fee, which was imposed on borrowers that used the facility for more than forty-five days. In addition, the haircuts imposed on pledged collateral were monitored and updated to achieve a balance between preventing losses, which required higher haircuts, and helping restore greater liquidity, which required lower haircuts.” 

Douglas Elliot of Brookings also offers good insight on this issue in his response to the latest GAO study on Fed lending programs: 

“Completely unsurprisingly, the government support was more favorable than market terms. There is no point in intervening by offering the same terms as the market under crisis conditions. Financial crises cause prices to be distorted. Credit spreads shoot up to unreasonable levels and stock prices collapse temporarily. Offering the same terms as the market provides no help in fighting these distortions and stabilizing the system.

Central banks like our Federal Reserve have dealt with this issue for years, in the context of their role as “lender of last resort”. It is well accepted that lending by central banks under crisis conditions should be on more favorable terms than the market, even though the costs generally still represent a penalty rate compared to more normal conditions.

The GAO figures are interesting and of historical significance, but do not contradict the fact that government support during the financial crisis was essential and that taxpayers escaped with remarkably little direct cost from that support, actually making money on most of the programs. The indirect costs of the crisis, which triggered the Great Recession, were much larger. However, these societal costs were reduced, not increased, by the government’s bold actions in stepping up to provide the necessary support to the financial sector.”

Break up the banks “…so I can replace them.”

Yesterday on CNBC, Citadel’s Ken Griffin opined on whether we should break-up the banks: “…We don’t have a good legal justification for breaking up the banking system, but if I could wave a magic wand, I’d break up the banking system.”

Aside from not having good legal justification (anti-competitive), there are many reasons why a bank break-up is a bad idea; however, in order to understand why people like Griffin would say this, one needs to understand his bias. The best response to this comes from Noah Smith, well-known financial blogger and economics professor, in his tweet to Jim Pethokoukis (Jimmy P happens to agree with Griffin):

Simply, in event of a break-up, the services that large banks provide can only be provided by other large foreign or non-bank financial institutions (call them the shadow banking sector). They will be the ones to replace them.