Oil Bubble

Note: This first ran 08/06/2008, links no longer work. For fun, look at the date oil peaked and the date my first Energy Article ran.

New York— (People Port) A financial commentator, CNBC's Melissa [Francis]floated the Oil Bubble Bursting idea today. Her ever changing panels did not go along with that idea. Somehow a 20% decline in the price of oil and the absence of market liquidity at any price did not meet the panel members's idea of a bubble.

Asked the Treasury Department on Monday for a comment on what some were calling a melt-down in the commodity markets. The stock market held its own. When the rules covering the oil market were changed eight years ago to allow you and I to hedge our future oil needs. We may have went too far. Senator Reid has said as much.

From 2003 to 2004, Oil prices increased 37 percent. Spot price for Brent Crude closed at $40.38 on Friday 12/31/2004. Gasoline was $1.91. For most of the world, it was a huge increase. It sparked China and India going head to head to close energy deals. See for most of the world, what Floridians call rolling blackouts (cold spell), are part of everyday life. As oil zoomed up, those blackouts grew longer. In India today, there are areas that experience 14 to 22 hours, even for utility paying customers. In India blackouts are called load shedding.

China has the same problem. The higher the price of oil, the less that is used. India now embraces that nuclear deal we struck with them. If we gave them a dozen, that may take care of their current needs. China, like the US, saw those high prices and took action. They implemented a ten year plan in 2006. A good portion is dedicated to wind. They achieved their goals in three years. Today, instead of fighting India, they are cooperating. Most of those windmills were made in India. In China, it is a little easier than in India to build wind farms. China can push through the needed local acceptance. Harder to do in India. Wind farms are noisy.

Here, our own people are pushing through wind projects. Right now we produce twice as much electricity from wind than China. India thinks, She will surpass China. If she had enough electrical power plants, she could. Much of the world, is switching to natural gas to power their electric generation. That Iran to Pakistan, to India, to China, natural gas pipeline would help. Right now, the gas will not be coming from Iran.

In 2005 we felt Hurricane Katrina. We also saw $4 gas. The self perpetuating, in this case oil market, increase in price. More investors want a piece of the action. Which keeps the price up, Someone was willing to buy it at that price. This attracts more investors. Oddly enough, this behavior tends to lock out true innovators because their new firms, story, does not sound like most of the others. The first one I know of, the Tulip Craze in Holland. Had a small service firm when the markets crashed in the 1980s. One of my accounts, fancy restaurant downtown, explained his business slowed. I made a suggestion first then asked, what had changed. Within a three month period of time the occupancy rate in those office buildings had dropped to 25%. I thought he meant vacancy. No, occupancy. Everyone moved their offices to their homes.

It did come back, Miami, only took a year. The wind farms springing up all over the US are driven by the tax break. Solar heating has tax breaks. That industry, like most, depend on the suppliers to get the word out to their customers. We do not have, billion dollar solar power projects, yet. Our solar R&D industry is clicking away. They are moving solar forward at light-speed. Many are leaving, going into business for themselves. Let's pray they all receive financing.

Speculators have run up the price of oil in a very big way. Two dollar gasoline is expensive.

Copyrighted, 2008, J John Swanko, All rights reserved. This work is licensed under a Creative Commons Attribution 3.0 United States License Permission is granted for web based usages; the internal links must link back to store. For more information Click

Congress Needs To Sober Up

"The Fed, as I see it, has taken a leap of faith that our political leaders will forge a sensible budgetary and regulatory path that incentivizes businesses to put to work the money the Fed is printing to invest in creating jobs for American workers..," Richard W. Fisher, CEO of the Federal Reserve Bank of Dallas, 11/08/10.

by J John Swanko

11/16/10 (People Port) "We need for the Congress to move quickly, beginning in its lame-duck session," The Dallas Fed's Chief speaking to the Association For Financial Professionals. Those listening to both sides are not in a pro-active mood. Unemployment is the underlying problem, the banks, capital markets, large firms, majority of midsize and small, firms have credit available.

He points out the manufacturing world (low end) is working to increase employees wages. The Chinese government is -encouraging- their manufacturers to put in place wage increases. China knows that will encourage consumer spending in China. They took steps to knock down their inflation this week.

Some could see this as a shift to lower cost governments (e.g, Mexico), from China, Vietnam, India and the like, however, firms using the traditional manufacturers margins will be squeezed from the higher rates, dollar, US Tax Code.

Without this pricing power, large, small, publicly traded, private, will continue working to protect margins. This means fewer US based, foreign based workers because of productivity enhancements made possible by today's cheap money.
Congress, The Media, has throughout this election cycle ignored unemployment, underemployment. Some have written editorials lamenting this.

Most firms with cash reservoirs overseas, however, point to the same Tax Code that originally encouraged their move overseas from preventing them from returning capital here. Firms supporting this candidate or that bill are reminded, This is market allowed them to grow into that large firm.

Congress, this Administration, rarely mentions unemployment, underemployment, in the debate about this upcoming session. Unless you believe the current tax policy in place now, will somehow prove all these business leaders, governments -wrong.

You may want to read his speech here. Plenty of ammunition for all three partys's talkers. You will come to understand why the Fed must remain independent, non-partisan.

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China, US tensions Could Result In Gold Bubble Burst

Note: This article ran back in February.
This was rebuilt from notes and is essentially similar.

by J John Swanko

2/09/10 (People Port) As US China relations enter a new rub, Arm Sales to Taiwan, The two giants search for a brighter path together. All types of calamities are predicted. Our Fed, for its part, announced it will start the unwinding of this Great Recession fix.

The gold bugs are happy, war always drives up the price of gold. EU arms manufacturers see this as a chance to sell all types of -Wow- military stuff to China. America sees the sale, good for exports. Answering, China's missiles aimed at Taiwan. China has interfered with our Navy on maneuver's.

That grew into joint US China military exchanges. China has asked to cancel those. We need to stay engaged. China, for its part, asked it be given the same deal as Taiwan -even more exports. The problem has been its small arms sales in Africa. This all started after Tienanmen Square.

China, when pushed very hard, will use force. The EU argues that was a very long time ago and we should sell her anything she wants to buy. The real friction will come as monetary measures are considered by China. Not buying our debt is not the problem it once was. As some see the maneuver, the debt card, can only be played for a short time. We have Secretary Geithner, a tiger in finance. He may simply offer China 200 million ounces of gold.

The Trojan horse would be seen by gold bugs as joyful. China has been buying gold for her own reserves, the US only produced 1.5 million ounces last year. China's gold mining is just getting underway. Cannot get any better for gold bugs. China needs our treasuries to keep her economy going. What would happen is President Obama would see those high paying gold miners as new jobs, opening up vast untapped deposits of gold on federal lands.

While this is going on, the EU depends on Greece for a large part of its needed gold reserves. Greece's economy is in turmoil right now. Selling gold to help would be on the top of its list. The 500 ton per year limit on gold sales would hit the waste basket. This all would be good for Russia, US, and Canada. That new gold rush would create many well paying jobs. The world's economy will take a hit. Some feel the unemployment is a deserved consequence of bad fiscal policy.

No person expects China exports, lack of internal consumption, rising home prices, would [yield] benefit[s]. Nations coined silver, gold, as a use for those precious metals. At one point UK coin makers complained at all the[ir] work shipped to France. Soon, the nations came to understand the true cost of trade. Well, here we are again. How many times will nations repeat these same misteaks. Will Beijing and Washington see the arms sales as what more than one American saw it as a sneaky way to sell our fancy arms to China (Rumor that reunification of Taiwan and China would happen sooner rather than later).

As China has repeatedly called for in recent history, Export to us. May be the very best way to work through these issues. China must let US know when we hurt her. Most likely, we do that more than we know. China has become very good at exporting to US. We must learn how to export to her.

The old adage, Look at the price of gold and you see inflation. Seemed to hold for many years. Some use the price of gold as a measure of war, war threats. Well it has moved with tension in the past.

Are Companies Buying Back Stock Too Soon

by J John Swanko

06/15/2010 (People Port) Stock buy backs used to be a great way to boost your share price. Today, firms are considering buying back their shares anew. Could have been a good idea in 2009, today it shows very productive firms may have unskilled management.

In 2007 there were more than one tale of a retiree selling their stock because the firm did not or in some instances, refused to raise the dividend. The stock price was just to high to keep it. Many of those were lucky. Sold the stock, their house, and moved to a sunbelt retirement home they vacationed in for years.

Searched the web for some examples, none. I too, heard the tale. I remembered July... The point, stock buybacks now seem to indicate a firm cannot manage these tough waters, headwinds. Many firms are building up cash now, some were lucky or smart and had enough cash to make this far.

These are tough times. If you pay a dividend, people expect it. There are all types of ways to get shareholders assets of a firm, however, those firms with large cash on their books could do better moving on some of their projects that seemed to be a good idea before this Great Recession started.

A good buyback reason, way under-priced shares, lots of shorts, dividends were increased, most of your competitors cannot compete, gaining market share, and your firm's future could not look brighter. The commonly reported assumption in 2001, 2007 firms were playing with the ratios.

I am testing alternate platforms.

For now, Editorials may be found at People Port's Editorials

My People-Port.com turned up as an expired URL, Not wanting to fight right now, People Port Working on fixes. The link will take you to the Main Page, Editorials and FamilyPeople Port Ethical Conduct Statement

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I took the links out and moved it here for publication on 11/23/10. It, my notes, were lost for a time, that note, article will not run.

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Governor Daniel K. Tarullo Conference On Dodd-Frank Act

Governor Daniel K. Tarullo

At the George Washington University Center for Law, Economics, and Finance Conference on the Dodd-Frank Act, Washington, D.C.

November 12, 2010


Next Steps in Financial Regulatory Reform


Thank you very much for your invitation to speak at this second annual symposium on financial regulatory reform. Before addressing that topic, I want to say a word about the mortgage foreclosure documentation imbroglio, the latest chapter in the recent sad history of mortgage finance in this country.



The Need to Increase Mortgage Modifications


As you know, inquiries into the extent of, and culpability for, these problems are currently being conducted by banking regulators, other federal agencies, and state attorneys general. Regardless of the findings that emerge, and the steps that servicers and others may take to correct their mistakes, this episode has again drawn attention to what can only be described as a perverse set of incentives for homeowners with underwater mortgages. Homeowners who try to get a modification of the terms of their mortgages are all too frequently subject to delay and disappointment. On the other hand, those who simply stop paying their mortgages have found that they can often stay in their homes for a year or more, rent free, before the foreclosure process moves ahead.



This simply is not a good outcome from any broad perspective--not for the revival of housing markets, not for the banks and investors that hold the delinquent mortgages, and in the longer run, not even for the homeowners themselves, who will ultimately have to move out, taking with them a dark cloud over their creditworthiness.



Several possible explanations have been suggested for this untoward state of affairs--the lack of servicer capacity to execute modifications, purported financial incentives for servicers to foreclose rather than modify, what until recently appeared to be easier execution of foreclosures relative to modifications, limits on the authority of securitization trustees, and conflicts between primary and secondary lien holders. Whatever the merits and relative weights of these various explanations, the social costs of this situation are huge. It just cannot be the case that foreclosure is preferable to modification--including reductions of principal--for a significant proportion of mortgages where the deadweight costs of foreclosure, including a distressed sale discount, are so high. While some banks and other industry participants have stepped forward to increase the rate of modifications relative to foreclosures, many have not done enough. I would hope that both servicers and ultimate holders of the mortgages will take this occasion not just to correct documentation flaws and to contest who should bear the losses of mortgages gone bad, but to invigorate the modification process.



Next Steps Down the Reform Road

I note that while last year's conference was called Regulatory Reform at the Crossroads, this year's event is entitled "The Dodd-Frank Act and the Road Ahead for Financial Regulatory Reform." The metaphor of a long road ahead following key decisions in Dodd-Frank is an apt one for the Federal Reserve and other regulatory agencies that will, over the next 15 to 20 months, complete implementation of that bill through scores of regulations. The metaphor also applies to elaboration and domestic implementation of the framework for Basel III that was agreed to internationally in September.



Though we may no longer face a major crossroads, the federal banking agencies will certainly encounter numerous forks in the road we are travelling. Choices will be presented during implementation of certain Dodd-Frank provisions that set a general direction for change, but do not mandate a precise route. Others will be encountered as we continue the Basel III exercise, to which I will return in a moment. Still other choices will doubtless be required as all the member agencies of the new Financial Stability Oversight Council evaluate and, potentially, respond to developments in financial markets. Finally, at least one big crossroad still lies ahead--a decision on the future of the government-sponsored housing finance agencies.


We are, of course, in the middle of the Dodd-Frank implementation process. Thus, while I recognize there is enormous interest in where the Federal Reserve and other rule-writing agencies may be headed, I cannot say much about the substance of the regulations that will eventually be proposed and adopted. Indeed, I think it would be inconsistent with the very purpose of administrative law requirements for me to come to my own conclusions, much less opine publicly on them, before we have made our proposals and evaluated all the comments.



What I can say is that, in implementing Dodd-Frank, the Board of Governors will be guided by the same norms of statutory construction that a court would apply. Most importantly, where Congressional intentions are clear from the language of the statute, we must faithfully execute those intentions. Of course, there are a good many provisions that do not admit of a single interpretation, and the implementation of those provisions will require the exercise of discretion by the Federal Reserve or other regulatory agencies.



I can also say that we are following a transparent and inclusive process that goes well beyond the classic notice and comment requirements for agencies adopting regulations. As to transparency: At the Federal Reserve, we are entering into the public record a summary of all communications with non-government groups or individuals regarding matters subject to a potential or proposed rulemaking under Dodd-Frank. As to inclusiveness: We have joined with the other banking agencies in sponsoring a series of joint forums to solicit views from industry, academics, and others on some key issues relevant to Dodd-Frank implementation. We are also hearing views on regulatory implementation at meetings that cover a broad range of topics, such as at our last Consumer Advisory Council session.



Reforming Minimum Capital Requirements


Although they had long used bank capital ratios as a supervisory tool, U.S. bank regulators did not impose explicit minimum capital requirements until the 1980s. The proximate reason for this change was regulatory concern over the decline in capital ratios of the largest banks--a concern reinforced by Congress, as it saw some of those large banks facing enormous losses on their loans to foreign sovereigns. This U.S. regulatory innovation was effectively internationalized a few years later in the original Basel Accord.



At the same time, regulators came to regard capital requirements as a supple prudential tool. As activity and affiliation restrictions were loosened in the United States, capital requirements seemed a promising way to protect the public's interest in the stability of financial institutions that had access to the Federal Reserve's discount window and Federal Deposit Insurance Corporation insurance. Capital requirements promised to provide a buffer against bank losses from any activities in which the bank or its affiliates might engage, a consideration of equal or greater relevance in countries with universal banking models. Some support also developed for the proposition that minimum capital levels could, by maintaining a material equity value for the bank, serve as a disincentive for excessive risk-taking by management and shareholders.



In the ensuing quarter century, the attention of banking regulators around the world had been heavily oriented toward elaborating capital requirements to reflect more precisely the particular risks faced by a financial institution. Capital requirements had, to a considerable extent, become the dominant prudential regulatory tool.



The financial crisis showed that the concentrated, almost all-consuming regulatory focus on refining bank capital requirements in Basel II had come at the expense of attention to other risks in the financial system. In particular, there was insufficient appreciation of the implications of the growth in size, leverage, and maturity transformation levels of the shadow banking system for the balance sheets of commercial banks and for overall financial stability. The limitations of capital requirements as a regulatory tool, such as the frequent lag between declines in asset values and reductions in bank capital, were also confirmed by experience during the crisis.



But it was also evident that capital requirements had simply been set too low in general, and with respect to particular assets. One of the most obvious examples was the capital requirement for asset-backed securities in the trading books of banks. The requirement was based on returns over a 10-day holding period, used a one-year observation period that had been characterized by unusually low price volatility, and neglected the credit risks inherent in these traded instruments. It was also apparent that at least some of the instruments that qualified as Tier 1 capital for regulatory purposes were not reliable buffers against losses, at least not on a going concern basis.



It is instructive that during the height of the crisis, counterparties and other market actors looked almost exclusively to the amount of tangible common equity held by financial institutions in evaluating the creditworthiness and overall stability of those institutions--they essentially ignored the Tier 1 and total risk-based capital ratios in regulatory requirements. In the fall of 2008, there was widespread doubt in markets that the common equity of some of our largest institutions was sufficient to withstand the losses that those firms appeared to be facing. This doubt made investors and counterparties increasingly reluctant to deal with these firms, contributing to the severe liquidity strains that characterized financial markets at the time.



It is obvious that the post-crisis regulatory system will not be as dependent on capital requirements as the pre-crisis regime. Dodd-Frank itself is testimony to this fact, as are a number of changes already made by banking agencies. There will be increased emphasis on market discipline, liquidity regulation, activities restrictions, and more effective supervision. But the crisis reinforces the point that robust capital requirements should continue to be a central component of the financial regulatory system. The U.S. banking agencies, and most of our counterparts from countries represented in the Basel Committee on Banking Supervision, made strengthening the capital regime a high priority in the latest financial reform agenda.



Basel III makes a number of important changes to address deficiencies in the pre-crisis capital rules:



First, reflecting both intuitive good sense and market realities during the crisis, Basel III creates a new minimum common equity capital requirement. Moreover, the agreement provides a definition of common equity that will prevent firms or national regulators from including in the calculation of common equity certain assets that could dilute its loss-absorbing character.



Second, the minimum common equity ratio will be set at 4.5% of risk-weighted assets, with an additional requirement for a 2.5% "conservation buffer." The minimum ratio should be understood as defining the amount of common equity needed for a firm to be regarded as a viable financial intermediary. The conservation buffer is a new feature of capital regulation, intended specifically to reflect the losses that a firm may suffer during periods of financial stress.



Thus the concept behind the two-level requirement is that a banking organization should be able to withstand losses associated with systemic stress and still be a viable financial intermediary. This concept is comparable to the approach we adopted during the Supervisory Capital Assessment Program (SCAP) in early 2009. There, you may recall, we used a special stress test to provide a rough estimate of losses that the large banking organizations could face in an adverse scenario and asked that they hold capital sufficient to absorb those losses and still be above common equity levels that would maintain the firms as viable intermediaries.



There is no direct way to calculate how much equity is needed to assure markets that a banking organization is viable. In our internal analysis at the Federal Reserve in preparation for the Basel Committee deliberations, we analyzed distributions of actual losses suffered by larger institutions over the last several decades, on the assumption that an institution that could withstand such losses at a high confidence level would be regarded as a viable going concern.

For the conservation buffer, we looked at actual pre-SCAP losses incurred by large banking firms during the recent stress period and SCAP estimates of additional losses associated with the recent stress period. Both these determinations required considerable judgment, and thus we developed ranges, rather than point estimates, for the levels we thought reasonable. In particular, government capital injections and debt guarantees in the fall of 2008 complicated the estimation of losses that might have been incurred in the absence of too-big-to-fail support. The ratios agreed to in Basel were at the lower end of, though still within, the ranges we had calculated.



The practical effect of the two-level approach is that banks under stress may let their common equity ratio drop below the 7% level that is the sum of the minimum and buffer requirements. However, restrictions on capital distributions will result, which will become progressively more stringent as the common equity ratio drops closer to the 4.5% minimum. The buffer is thus designed to forestall banks from continuing to pay dividends even as they come under stress, a practice observed in some institutions during the financial crisis. Realistically, both regulators and markets will expect firms generally to maintain their common equity ratios above 7%.



Third, Basel III makes extensive changes to the risk weights assigned to a financial institution's traded assets and counterparty exposures. As I mentioned earlier, the market-risk requirements of the pre-crisis capital regime were woefully inadequate. In many instances, they simply did not reflect the actual risk assumed by an institution. They also created an invitation to arbitrage credit risks by turning them into traded assets with lower risk weights. It is also noteworthy that the changes in risk weights incorporate some elements of a macroprudential perspective as, for example, in higher capital requirements on equity investments in other financial firms and credit exposures to large financial firms



Fourth, Basel III provides for a minimum leverage ratio, roughly similar to requirements already applicable under national law in the United States and Canada. While the terms of this leverage requirement have been agreed to, there will be a supervisory monitoring period and then a parallel run to assess its impact, particularly in countries with no history of such a requirement, and to provide for adjustments if warranted.



Finally, Basel III has a rather lengthy and complicated transition period, with the new requirements to be phased in between January 1, 2013, and January 1, 2019. We favored a significant transition period, so as to allow firms flexibility in adjusting to the new regime through such means as running off higher risk-weighted assets, adjusting their business models gradually, or using retained earnings to add any new capital that might be required under the new rules. To be honest, however, we did not think the transition period needed to stretch over eight years. In fact, it appears that most U.S. banking entities expect to meet the new requirements considerably sooner. However, the lengthy transition period was an important inducement for some countries to agree to the new, much stronger standards.



With the agreements reached in July and September at meetings of the Governors and Heads of Supervision (GHOS) in Basel, the structure and basic elements of Basel III are clear. Details are still being worked out by the Basel Committee. Then, of course, the U.S. banking agencies will need to implement Basel III through domestic capital regulations.



Basel III is not a perfect agreement, of course. There are things we would have done differently if we were writing a capital regulation on our own. There will surely be some technical challenges in implementing it. It does not really address some pre-crisis problems in capital regulation such as pro-cyclicality. But it is a major step forward for capital regulation. It will raise minimum requirements substantially, ensure that regulatory capital is truly loss absorbing, and discourage some of the risky activities for which the pre-crisis regime required far too little capital.



Basel III was also a major step forward in international cooperation. In all candor, as recently as this past spring I was concerned that we might be unable to agree in Basel on such key issues as a distinct common equity requirement. However, under the strong leadership of Nout Wellink in the Basel Committee and Jean-Claude Trichet in the GHOS, we concluded a good agreement in timely fashion. I believe that another factor in turning things around was that, unlike at some times in the past, the U.S. banking agencies spoke with a single, unified voice in Basel.



Obviously, the benefits of Basel III for financial stability will be realized only if they are implemented rigorously. In this regard, it is important to draw a distinction between, on the one hand, implementation in the sense of enacting national regulations that incorporate the Basel standards and, on the other, implementation in the sense that firms are actually holding the amounts of capital called for by the internationally agreed rules.



The Basel Committee must be able to monitor effectively implementation of, and compliance with, these new capital standards. A number of market analysts have noted that, even under current market risk capital rules, there is considerable apparent variation in the risk-weightings apparently applied by different banks. We are urging the Committee to explore mechanisms for ensuring that these strengthened capital standards lead to a consistency in application, as well as in the provisions of relevant domestic regulations.



Along these lines, we have heard complaints from a few other countries that Basel II is not yet operative for our large, internationally active banking organizations in the United States. As we have explained, despite the substantial resources devoted by both banking organizations and supervisors to the tasks of developing and validating the Advanced Internal Ratings-Based Approach in those institutions, we continue to encounter significant difficulties. The suggestion that U.S. banking organizations have thereby gained a competitive advantage is misplaced, however. For one thing, we required significant capital increases as part of the SCAP and the Troubled Asset Relief Program repayment processes last year. Also, we note that the required capital levels for some foreign banks adopting Basel II apparently declined from Basel I levels.



In-depth oversight by the Basel Committee of implementation and compliance would allow supervisors from all member countries better to understand issues such as these. I suspect it would also result in supervisors learning from one another and thus improving the quality of large institution capital regulation globally. Although, fortunately, Basel III does not present nearly the degree of technical challenge posed by the advanced approach of Basel II, there will still be a good bit of opaqueness in how some of its components are implemented and thus a continuing need for significant monitoring by the Basel Committee.



One piece of unfinished business on the international capital regulatory agenda arises from the agreement by the GHOS in September that systemically important financial institutions should have loss absorbing capacity beyond the Basel III requirements. This international position parallels the Dodd-Frank requirement that the Federal Reserve apply capital requirements to large, interconnected financial institutions that are more stringent than those applied to other banks. We think it serves U.S. interests to develop our plans for implementing our domestic statutory obligation in tandem with our participation in this international process, so as to maximize the chances of convergence of international standards and our own practice. Work on this issue in the Basel Committee and the Financial Stability Board will continue well into next year.



Dividend Policy
Before closing, I want to address requests for renewed or increased dividends by our large bank holding companies, an issue in which there has been substantial recent interest. During the crisis, dividends were eventually suspended or reduced to minimal levels by all the banking organizations covered by the SCAP. As the financial system has stabilized, some firms have indicated an interest in resuming or increasing dividends, or repurchasing shares. We have been concerned with the safety and soundness implications of resuming or increasing capital distributions in the absence of a strong, forward-looking demonstration that the capital position of a firm would be protected even under stressed conditions. Until Basel III was completed and Dodd-Frank enacted, it was obviously difficult for any firm to make that kind of demonstration, since its future capital needs and potential business model changes were obviously unknown.



While there continues to be a relatively high degree of uncertainty about near- to medium-term economic prospects, the basic questions surrounding capital and regulatory reform have now been answered. We anticipate that some firms with high capital levels that have been retaining solid earnings for several quarters will be interested in increasing or resuming dividends. In response to these anticipated requests, we will soon be issuing supervisory guidelines applicable to such requests from the largest holding companies for the first quarter of next year.



Although the details of these guidelines are still being finalized, I can say that our approach to considering such requests will be a conservative one. We will expect firms to submit convincing capital plans that demonstrate their ability to absorb losses over the next two years under an adverse economic scenario that we will specify, and still remain amply capitalized. We also expect that firms will have a sound estimate of any significant risks that may not be captured by the stress testing, such as potential mortgage putback exposures, and the capacity to absorb any consequent losses. The firms will also be asked to show how, even with their proposed capital distributions, they will readily and comfortably meet the Basel III requirements as they come into effect, as well as to accommodate any business model changes that might be necessitated by Dodd-Frank.



Conclusion


The final set of major Dodd-Frank regulations will not be completed until early 2012. A year from now we will be in the midst of a regulatory process implementing Basel III, and there will likely be an active debate over the future of the government-sponsored enterprises. So I see little risk that the third annual conference on financial regulatory reform at George Washington Law School will be entitled "The End of the Road." Maybe, just maybe, I have given you a title for the fourth. Then again, maybe not.

Governor Sarah Bloom Raskin: Problems, Mortgage Servicing Industry

Governor Sarah Bloom Raskin

At the National Consumer Law Center's Consumer Rights Litigation Conference, Boston, Massachusetts

November 12, 2010
Problems in the Mortgage Servicing Industry


Good afternoon. I would like to thank the National Consumer Law Center (NCLC) for inviting me to speak here at the Consumer Rights Litigation Conference. I'm particularly pleased to share my thoughts with you in my first public speech since joining the Federal Reserve Board of Governors last month.


These are challenging times for policymakers because they are profoundly challenging times for millions of Americans. Many families have suffered significant declines in their net worth over the past several years, especially as the value of their homes and other assets has plummeted. Many households have faced job losses or large reductions in the number of hours worked, events that have reduced family income and well-being. Retirees are feeling heightened anxiety as companies and local and state governments debate measures to restrict retiree pensions. The ability of households to borrow has also shrunk as underwriting standards have tightened, placing more weight on existing debt obligations of consumers. For households trying to navigate these difficulties, the work that many of you do to directly help consumers deal with the legal dimensions of their financial lives is of great importance. I commend you for your ongoing and persistent contributions to stabilizing family and community life in our country.


One aspect of the financial crisis that touches directly on your work is foreclosure. As you well know--and in fact you were among the first to predict the problem--millions of homeowners have gone through foreclosure in recent years; many more will go through it in the near future; and countless others are struggling to keep their payments current even as the housing market and the overall economy make it hard to do so.


The number of foreclosures initiated on residential properties has soared from about one million in 2006, the year that house prices peaked, to 2.8 million last year. There were 1.2 million foreclosure filings in just the first half of this year. In addition, right now nearly five million loans are somewhere in the foreclosure process, or are 90 days or more past due and hence at serious risk for a foreclosure filing.


Our projections remain very grim for the foreseeable future: All told, we expect about two and one-quarter million foreclosure filings this year and again next year, and about two million more in 2012. While these numbers are down from their peak in 2009, they remain extremely high by historical standards and represent a trauma in the lives of millions of people affected.


The most recent alarming development in the foreclosure process that has caught public attention involves improper activities by mortgage servicers. But let's remember that, for years, housing counselors and advocates nationwide have documented patterns of fraudulent and abusive mortgage servicing practices. Current attention is focused on so-called "robo-signers," individuals who appear to have attested to the validity of documents in a number of foreclosure filings so large as to suggest that something may be amiss in the recording process. This development is troubling on its own, but it also shines a harsh spotlight on other longstanding procedural flaws in mortgage servicing.


Many may view these procedural flaws as trivial, technical, or inconsequential, but I consider them to be part of a deeper, systemic problem and am gravely concerned. During my time as Commissioner of Financial Regulation for the State of Maryland, I encountered a Pandora's Box of predatory tactics that included:

• The padding of fees, such as late fees, broker-price opinions, inspection fees, attorney's fees, and other fees;


• The strategic misapplication of payments so that the homeowner's payments for principal and interest due on the loan were improperly applied to the servicer's fees, sometimes improperly causing the loan to be considered to be in default; and


• The inappropriate assessment of force-placed insurance, with premiums of two to four times the cost of standard homeowners' insurance, which in turn caused servicers to collect these premiums before applying the payments to principal and interest, precipitating foreclosure.

Theoretically, it is possible that the robo-signer controversy may turn out to be a short-term technical problem that can be addressed through additional verifications and, when necessary, re-processing of critical documents. Nevertheless, I believe that serious and sustained reform is needed to address the larger problems in mortgage servicing.


The mortgage servicing industry as we know it is a relatively recent invention, and, undoubtedly, it has never before been tested in a national housing crisis of this magnitude. As the continuing surge in foreclosures suggests, mortgage servicers simply are not doing enough to provide sustainable alternatives to foreclosure. This may be due to the fact that the vast bulk of loan servicing today is done by large servicers, which are either subsidiaries of depository institutions, affiliates of depository institutions, or independent companies focused primarily or exclusively on loan servicing.


Before securitization became commonplace, it was much more likely for a mortgage to be serviced by the same entity that had originated the loan. This simple approach ensured that lenders knew immediately if a homeowner was having payment problems, and could take action to mitigate possible losses. A fair bit of this kind of "portfolio servicing" still takes place, but as the residential real estate market shifted from an originate-to-hold model to an originate-to-distribute model, an industry of independent third-party entities emerged to service the loans on behalf of the securitization trusts. These trusts, as a requirement for their tax-preferred status, were supposed to be passive, with the management of individual loans left to the servicer. These servicing arrangements are now commonplace in the industry: In fact, the system has matured rapidly and experienced considerable consolidation over the past twenty years.


The benefits to consolidation include significant economies of scale in the collection and disbursal of routine payments. But the kind of time-consuming, involved work that is now needed in the loss mitigation area was not contemplated at anything like this kind of scale, and the payment structures between the servicers and investors may not always be sufficient to support large-scale loan workout activity. Unfortunately, as we are seeing now, there are also dramatically significant drawbacks to this model. Third-party servicers earn money through annual servicing fees, a myriad of other fees, and on float interest, and they maximize profits by keeping their costs down, streamlining processes wherever possible, and by buying servicing rights on pools of loans that they hope will require little hands-on work. Again, for routine payment processing this all leads to economies of scale, and the industry has consolidated significantly in recent years as a result.


But the services needed in the current housing crisis are not one-size-fits-all. Loan servicers likely never anticipated the drastic need for the kind of time-consuming, detailed work that is now required in the loss mitigation area, and the payment structures between the servicers and investors are not sufficient to support large-scale loan workout activity. As it turns out, the structural incentives that influence servicer actions, especially when they are servicing loans for a third party, now run counter to the interests of homeowners and investors.


While an investor's financial interests are tied more or less directly to the performance of a loan, the interests of a third-party servicer are tied to it only indirectly, at best. The servicer makes money, to oversimplify a bit, by maximizing fees earned and minimizing expenses while performing the actions spelled out in its contract with the investor.


In the case, for instance, of a homeowner struggling to make payments, a foreclosure almost always costs the investor money, but may actually earn money for the servicer in the form of fees. Proactive measures to avoid foreclosure and minimize cost to the investor, on the other hand, may be good for the homeowner, but involve costs that could very well lead to a net loss to the servicer. In the case of a temporary forbearance for a homeowner, for example, the investor and homeowner both could win--if the forbearance allows the homeowner to get back on their feet and avoid foreclosure--but the servicer could well lose money. In the case of a permanent modification, the investor and homeowner could both be considerably better off relative to foreclosure, but the servicer could again lose money.


Why might a servicer lose money in an instance that could be win-win for the borrower and investor? It's because of the amount of work needed, the structure for reimbursing costs to the servicer, and other costs incurred by the servicer on delinquent, but not yet foreclosed upon, borrowers. Loss mitigation options, such as forbearance and loan modification, require individualized case work. Thus, the servicer needs to invest in additional resources, including trained personnel who can deal with often complex one-off transactions. In the case of a private-label security, many of the costs of this work may not be reimbursed by the trust. Other costs result from even temporary forbearance, such as the servicer's requirement, in most cases, to advance principal and interest to the investor every month, even though it has not received payment from the borrower. Even in the case of a servicer who has every best intention of doing "the right thing," the bottom-line incentives are largely misaligned with everyone else involved in the transaction, and most certainly the homeowners themselves.


We don't know yet what the end results will be for homeowners. But the best third-party servicers would have to be diligent and willing to absorb relative losses when the standard business model for the industry would seem to put a thumb on the scale in favor of foreclosure. The most urgent needs of the servicing world today require a sufficient number of personnel with the adequate mix of training, tools, and judgment to deal with problem loans on a large scale--in other words, activities with few economies of scale. The skill set of personnel hired and trained for routine work--efficiency and accuracy in following rules, and little discretion in decisionmaking--is likely a poor match for loss mitigation activities that require constant creativity and case-by-case judgment. Therefore, simply transferring work from one part of a company to another does not achieve much without significant investments in training and retraining. Servicers have been publicly pledging for several years to increase their servicing capacity, and many have. Unfortunately, there is plenty of evidence to suggest that many servicers' workforces lack the knowledge and capacity to deal with the immensity of the mortgage crisis.


In order to do their jobs well servicers need strong internal procedures and controls. Recent events suggest that servicers may be lacking in this regard, to the detriment of consumers, and, quite possibly, to the detriment of the investors to whom they are contractually obligated to maximize revenue. I recognize that many servicers have stepped up and diligently tried to improve their work; I applaud and encourage them. However, lingering problems remain and I suspect that these may be due to deferred maintenance and investment on a significant scale. In boom times, servicers had the luxury of building out relatively lean systems that efficiently processed the more routine aspects of the business, but they do not appear to have planned for the infrastructure that would be needed during a serious down cycle. As you know, consumers hold the losing end of this stick.


More seriously, recurring issues that have dogged some elements of the servicing industry go beyond misaligned incentives to simple bad business practices. One recurring problem that has triggered litigation involves the servicer's handling of fees. When a servicer does not properly carry out its primary duty of collecting and appropriately allocating mortgage payments, it can cost homeowners money and, in the most extreme cases, cause a homeowner to be pushed into premature default. Some servicers obtain unwarranted or unauthorized fees from borrowers after engaging in unfair collection practices, or through other conduct that causes borrower default, such as misapplied payments, padded costs, erroneous charges, late fees, and so on.


Too many accounts of shoddy operating procedures--lost paperwork, slow response times, and sloppy recordkeeping--cast a dark shadow on this part of the industry that links mortgage borrowers and lenders. The broad grant of delegated authority that servicers enjoy under pooling and servicing agreements (PSAs), combined with an effective lack of choice on the part of consumers, creates an environment ripe for abuse. Moreover, the inability of some servicers to maintain complete and accurate records, and to transfer servicing rights cleanly, causes additional uncertainties and vulnerabilities.


The impact of poor business practices can linger on even after the foreclosure sale. In managing foreclosed properties in lenders' inventories, servicers may be motivated by timeliness measures in PSAs to induce the former homeowner or bona fide tenant to vacate before they are legally required to do so, sometimes under the threat of eviction. Once the properties are vacant, servicers exercise great discretion in deciding whether or not to repair foreclosed property based on the likelihood that the servicer's advances are recoverable from the sale proceeds. With real estate owned (REO) inventories projected to reach one million by the end of 2010, servicer actions will heavily influence the effectiveness of neighborhood, stabilization efforts at a time of persistent decline in home values and in fragile markets already weakened by a glut of vacant and abandoned properties, particularly in low-wealth communities.


Finally, we face a cluster of problems surrounding loan modification. Servicers' significant concerns about the U.S. Treasury's Home Affordable Modification Program (HAMP) are well-known. That said, we do not know enough about how well servicers are complying with the requirements of that program, or whether all of the HAMP modifications that should be made are indeed being made. Many servicers, in fact, currently report that the bulk of their loan modifications are being done outside of HAMP. Again, we do not know enough about what those modifications look like or how they are being structured.


Prior to HAMP, many servicers were creating modifications that themselves were problematic. For example, high percentages of the pre-HAMP modifications provided no payment relief to borrowers and, not surprisingly, then exhibited high re-default rates. Servicers may not be doing everything they can do to ensure that loss mitigation activities, including HAMP and non-HAMP modifications, are responsible and sustainable and subject to strong internal controls.


So the problems that have been grabbing headlines in recent weeks are neither new nor amenable to quick fixes. While there may be some specific practices--"robo-signing" among them--that are possible to isolate and eliminate, chronic, uncured problems continue to plague this industry. There is a long track record of actions and cases brought by attorneys general, which some of you in this room have no doubt litigated, demonstrating the harm done to consumers by sloppy or unscrupulous practices. Because consumers cannot choose to hire or fire their servicers (other than by paying off the loan), the industry lacks the level of market discipline imposed in other industries by the working of consumer choice. For this reason, if servicers do not actively maintain adequate and trained staff and do not establish and heed internal controls, if investors do not monitor their servicers' behavior, if regulators do not conduct meaningful examinations, if courts do not stand guard against unfair practices, both substantive and procedural, then it will be much less likely that a well-functioning housing market will reemerge from this crisis.
Because the very structure of the loan servicing industry as it currently operates inevitably leads to misaligned incentives and a propensity to defer costly investments, a more significant re-thinking of the basic business model must also be undertaken if we are to avoid repeating prior mistakes.


I realize that I'm painting a rather gloomy picture. But be assured that I do believe that we can make real progress on the ground through coordinated public and private action. Let me conclude by talking a little bit about what the Federal Reserve and others are doing to address these issues.


Although foreclosure practices have traditionally been--and rightfully should remain--a domain of the states, the Federal Reserve has been expanding its expertise in working with the industry--first, in a review of non-bank subsidiaries in conjunction with other state and federal regulators, and, currently, with a review of loan modification practices by certain servicers. As the current servicing issues began to emerge more clearly, the Federal Reserve and other federal banking agencies initiated an in-depth review of practices at the largest mortgage servicing operations. The review focuses on foreclosure practices generally, but with a concentration on the breakdowns that seem to have led to inaccurate affidavits and other questionable legal documents being used in the foreclosure process. When the interagency review is completed, we will have more information about the extent and significance of these very troubling practices, as well as an understanding of what must be done to prevent them in the future. We have also solicited information and input from other knowledgeable sources, including NCLC, to help us better direct our actions to detect possible systematic problems at specific servicers or within the industry at large.


Preliminarily, we have directed certain firms to complete thorough self-assessments of the policies and procedures they use for determining whether to foreclose on a residential mortgage loan, and, in those cases where foreclosure is authorized, an examination of the processes they used to comply with relevant federal and state laws. We have directed these firms not just to address their stated policies and procedures, but to assess how they actually work in practice. At the same time, examiners from the banking agencies will be on-site to review individual loan files, evaluate controls over the selection and management of third-party service providers, and carefully test the assertions that the institutions make in their self-assessments. Institutions will be directed to correct any deficiencies that they discover in their self-assessments or that come to light in the on-site examination process.


As a general matter, the Federal Reserve reviews the compliance procedures of the banking organizations that we supervise as part of the examination process. However, federal examiners typically are not experts in the application of each state's laws, especially in an area as complex as mortgage foreclosure procedures. So, federal examiners need to coordinate with their state examiner counterparts who should have a stronger understanding of their state foreclosure laws. For federally chartered institutions, the Federal Reserve requires that the banks we supervise have adequate compliance risk management programs that are being followed.


Given the potential ramifications for consumers, the housing market, and the economy as a whole, I believe it's fair to say that every relevant arm of the federal government is taking the underlying dynamics of the mortgage foreclosure crisis very seriously. I also hold out hope that the multi-state work engaged in by the 50 state attorneys general will prove to be a vehicle for resolving the underlying problems. The coordination and expertise at the state level in these matters is an essential corrective. To the extent that legal settlements are structured in such a way as to generate a broader underlying reform of servicing processes, it will be more likely that we can assure consumers that they will not encounter other mortgage harms moving forward.


The complex challenges faced by the loan servicing industry right now are emblematic of the problems that emerge in any industry when incentives are fundamentally misaligned, and when the race for short-term profit overwhelms sustainable, long-term goals and practices. Responsible parties within the industry are no doubt already scrambling to fix some of the problems that have surfaced. However, because so much is riding on getting these systems right, and because consumers have such little measure of individual choice or recourse, reliance on pledges from market participants will not be enough. Many of you have been doing your part for years to point out problems in the industry and to give consumers some protection and redress when wronged. The public sector too is stepping up its efforts to monitor firms' actions and systems. Until a better business model is developed that eliminates the business incentives that can potentially harm consumers, there will be a need for close regulatory scrutiny of these issues and for appropriate enforcement action that addresses them.


Thank you.

Richard W. Fisher: A Bridge to Fiscal Sanity?

Recent Decisions of the Federal Open Market Committee: A Bridge to Fiscal Sanity? (Acknowledging Henry B. Gonzalez and Winston Churchill)

Remarks before the Association for Financial Professionals
San Antonio, Texas

November 8, 2010


It hasn’t escaped me that you asked me to speak today in the Henry B. Gonzalez Convention Center. Politely stated, Congressman Gonzalez was “wary” of the Federal Reserve. Today, in his memory, I will operate under the presumption that the good congressman, bless his soul, is holding a congressional hearing somewhere in the hereafter and has, as he did here on earth, called upon members of the Federal Open Market Committee (the FOMC) to account for themselves after the Fed’s recent actions.


As is our tradition, I can only account for and speak for myself and the Dallas Fed, not for anybody else or any other Bank or for the Federal Reserve’s Board of Governors. Today, I will provide a précis of the analysis of the nation’s economic predicament I presented to the FOMC last week on behalf of the Dallas Fed, summarize the arguments I made with regard to the course of monetary policy, and then provide a personal perspective on the decision made by the committee as a whole. Afterward, I will do my best to answer any questions you may have.


At all FOMC meetings, after the staff has briefed the committee on projections of the models and provided their own insights, Chairman [Ben] Bernanke calls upon all of the participants in the FOMC discussion to present to the others at the table their individual sense of the economy. When I am called upon, I endeavor to give a perspective derived from the work of the Dallas Fed staff, complemented by the responses to a survey I do personally of a wide swath of CEOs and CFOs of businesses, large and small, across the country as well as financial market operators I know from my former days as a fund manager. There are plenty of sophisticated forecasting models available to all of us at the Fed. To me, the key to crafting monetary policy is placing the theoretical analysis―done by our able staffs of economists using quantitative modeling―within the qualitative context of economic behavior as practiced by businesses, consumers, investors and other players actually operating in the field.


The essence of what I reported to my colleagues when we met last week is that more things are moving in the right direction than in the wrong direction. There are some green shoots beginning to emerge in a landscape still pocked-marked by brown spots. General economic conditions are improving slightly and are expected to continue doing so. The risk of a double dip in economic activity has lessened, as has the risk of deflation. Financial speculation and excess, however, is beginning to raise its hoary head.


On the real economy front, data from the manufacturers, railroads, shippers, express shippers, retailers, service-sector operators and others I survey indicate that activity picked up on a year-over-year basis in October and was slightly better than the year-over-year pace of September.


As might be expected, my contacts report price pressures for a range of commodities, including corn, higher-grade food oils, cotton, pulp and, of course, metals and gold used in manufacturing, including specialized products such as semiconductors. This is nothing you wouldn’t already know from a daily reading of the financial press. I do find it of interest that one of my CEO contacts just came back from meeting with all 450 of his Chinese suppliers and reports that the Chinese government was “encouraging” those manufacturers to grant wage increases to their workers on the order of 15 to 20 percent, in large part to goose up domestic spending. Combining wage imperatives with recent commodity price increases, the manufacturers of low-tech Chinese products, from wicker to clothing to the lower end of entertainment devices, have started their bids for supplying the fall of 2011 needs of this particular large importer at dollar price levels 30 percent higher than current levels. Alternative production sites like Vietnam and India, according to this source, are only slightly underbidding these Chinese suppliers.


To be sure, these are opening positions for negotiation. But they are alarming. They might portend a shift back to sourcing low-value-added goods in lower-cost venues like Mexico over time, but in the immediate future, this hints at a squeeze on margins for those sourcing from China, Vietnam and India. Other CEOs who source inputs in the Far East report the same phenomenon, which is vexing because none of them feel they have the pricing wherewithal to pass on cost increases of more than 2 percent or so in light of the weakness of consumption. The one thing they are certain of, however, is that retail goods inflation is highly unlikely to drift downward.


This is in keeping with what we see by examining the entrails of the Trimmed Mean PCE calculation of inflation that is done uniquely by the Dallas Fed of the broad basket of items that make up the nation’s personal consumption expenditures, or PCE.[1] The Trimmed Mean PCE inflation rate tells a slightly different story from that told by the core PCE analysis, which gets so much attention from most analysts and the FOMC. To be sure, the trimmed mean came in at a 1 percent annualized rate in September, compared with an annualized 1.3 percent rate in August. The numbers for those two months, however, are both above the rates we saw earlier in 2010, and the 12-month trimmed mean rate has been steady over the past six months, within 0.1 percentage points of 1 percent (and clocking in at precisely 1 percent for the past three months).


If the trimmed mean is a better gauge of the underlying trend in PCE inflation (and we at the Dallas Fed think it is), then it’s not too surprising that the core PCE rate should be moving down toward the lower and steadier trimmed mean rate. That does not mean we are drifting toward deflation. The message the trimmed mean is sending is consistent with the price picture I have drawn for my colleagues in the past couple of meetings: The underlying trend in inflation appears, for the time being, to be holding steady, albeit at the rate we were accustomed to in the 1950s rather than the rate we have become accustomed to since then.


Without pricing power, and in the face of anemic demand, all of my nonfinancial business contacts—large or small, public or private—continue working to protect their margins through productivity enhancement. And to take advantage of ready access to cheap money to finance productivity enhancement, as well as to refinance their balance sheets, pay dividends or buy in their stock (if they are public). Some of the larger ones report borrowing domestically in size and warehousing those funds so as to avoid having to repatriate the funds building up abroad at onerous tax rates. A few—and this is good news—are using cheap money to refinance their remaining pension obligations in light of unsustainable discount factors used for accounting purposes.


To dwell on a point: Most all the businesses I talk to are expanding investment in productivity enhancement. Far too few of the large companies I talk to report interest in hiring American workers or committing to large-scale CAPEX (capital expenditures) in the United States; they believe their potential for return on investment (ROI) is greater elsewhere. The smaller companies that do not have global options are putting off hiring until the coast is clear on the tax and regulatory fronts. This reticence intensified during the final innings of the election season, which begs the question of whether this will now change with the new Congress. I’ll circle back to this issue in my concluding remarks.


Nonfinancial and financial companies alike report that they are flush with liquidity. Bankers are aggressively courting the larger corporate credits; several of my CEO and CFO interlocutors report that in the last few weeks, the biggest banks have approached them “literally begging to lend us 10-year money at less than 3 percent.” As you well know, corporate debt markets, including junk markets, are robust. And smaller companies are not complaining about the lack of access to capital. As a special part of our last monthly Texas Manufacturing Outlook Survey, conducted during October, I had our staff ask questions of the 240 companies surveyed about credit availability. Only 60 percent responded that they were seeking credit for financing long-term expenditures, and of that 60 percent, only 18 percent responded that they were having “substantial” or “extreme” difficulty obtaining that financing. Only 54 percent of those 240 Texas companies reported that they were seeking short-term credit, and of that 54 percent, only 12 percent responded that they were having “substantial” or “extreme” difficulty getting credit. To be sure, this survey was specific to my district, the Eleventh Federal Reserve District. But given that the Dallas Fed’s Business Activity Index has the highest correlation of all Federal Reserve Bank surveys to sentiment reflected in the national Purchasing Managers Index, or PMI, our survey might have some credence.


It concerns me that liquidity is omnipresent on bank and corporate balance sheets, and yet it is not being used to hire American workers.

It also concerns me that the most recent Lipper/AMG financial market data show year-to-date flows into virtually all asset classes except money market funds. The flows are strong into every category: high-risk to low-risk bond vehicles, taxable and nontaxable, domestic and external, fixed and floating rate, and, of course, commodities. Margin debt remains shy of 2007 highs but is fast approaching levels that prevailed before the NASDAQ implosion in 2001; in fact, margin-account debit balances as a percentage of the market capitalization of the S&P 500 now exceed the precrash level of 1987 and 2001.

Junk yields are at their lowest levels since October 2007. And the leveraged buyout market is back to paying 2006 levels of EBITDA (earnings before interest, taxes, depreciation and amortization) of 6 to 8.5 times, with the recent announcement of Carlyle Group’s reported 11 times EBITDA purchase of Syniverse Holdings echoing the peak of the precrash craze. As you know, buyout people do not typically acquire companies with a plan to expand the workforce, but instead with an eye to tighten operations, drive productivity, rejigger balance sheets and provide an attractive payback, usually in shorter time than under normal corporate horizons. And the corporations I talk to that are eyeing possible acquisitions with their surplus cash and ready access to the credit markets are not given to thinking of strategic acquisitions as a way to expand payrolls.


In sum, scanning the business landscape and the conditions of the financial markets, I concluded as a golfer that the greens are playing very fast and must be approached with great caution. At a minimum, I concluded, the committee would need to be very careful in how we calibrated our next strokes, lest we overplay it.


I fully understand the theoretical impulse to drive long-term interest rates to lower levels in hopes of stimulating loan demand and challenging the propensity for economic actors to hoard rather than invest. Given that foreign exchange markets react to interest rate differentials between countries, one effect of engineering lower rates would be to devalue the dollar, presumably to create demand for exports. The ultimate objective would be to advance final demand, generate employment for American workers and revive output.


I agree that we are indeed in what is referred to in economic parlance as a liquidity trap. Yet, I think it worth noting that we already have low interest rates, and spreads against risk-free instruments are historically narrow. Despite their theoretical promise, reductions in interest rates to Lilliputian levels have not done much thus far to spark loan demand. Loans are desirable when business see an opportunity for tapping credit markets to earn a return on investment that significantly outpaces the cost of credit and other risk factors. Even with the low rates that already prevail, businesses lack confidence that they will earn a superior ROI by investing so as to expand their domestic workforce, in comparison to what they might earn from alternative investments abroad or by buying in their stock or cleaning up their balance sheets. For their part, consumers will borrow when they believe it makes sense to shift consumption forward. But after the sobering experience of the past three years, they are restrained by a lack of confidence that their future income streams will be sufficient to cover their payment obligations.


On the supply side, we know that businesses are floating on a sea of liquidity. Banks already hold over $1 trillion in excess reserves; holdings of government securities as a percentage of total assets on bank balance sheets are growing; loans as a percentage of assets are declining.


If we had a level of bank reserves or liquidity in the marketplace that was binding or inhibiting loan growth, I could understand the impulse to relieve that stricture. Further quantitative easing through additional asset purchases will surely increase the level of bank reserves, lower rates marginally and add more liquidity to markets while weakening the dollar. The more germane question is whether this works to the benefit of job creation and wards off financial excess.


In his speech in Jackson Hole, Wyo., in August, Chairman Bernanke had asked all of us to consider the costs and the benefits of further accommodation. My response was that I was skeptical about many of the presumed benefits of further asset purchases. I was more certain of some of the potential costs.


One cost is the risk of being perceived as embarking on the slippery slope of debt monetization. We know that once a central bank is perceived as targeting government debt yields at a time of persistent budget deficits, concern about debt monetization quickly arises.


I realized that two other central banks were engaging in quantitative easing—the Bank of Japan and, most notably, our friends at the Bank of England. But the Bank of England is offsetting an announced fiscal policy tightening that out-Thatchers Thatcher. This is not the case here. Here we suffer from fiscal incontinence and regulatory misfeasance. If this were to change, I might advocate for accommodation. But that is not yet happening. And I worry that by providing monetary accommodation, we are reducing the odds that fiscal discipline will be brought to bear. More on that in a moment.


I also worry about the risk of our being perceived as using quantitative easing and buying copious amounts of financial assets above and beyond the ordinary bounds of the Federal Reserve’s System Open Market Account as “the new normal” for implementing monetary policy. Everything we know from monetary history tells us that in times of crisis, we should open the floodgates—this has been the practice of central bankers since the 19th century. This is what monetary theorists might call Bagehot 101, after the British patron saint of central banking, Walter Bagehot. We did it in 2008 and it worked to pull us from the maw of financial panic and economic ruin. But it did not seem to me last week to be a time of panic or crisis. I suggested that were we to act by throwing more money at the economy under these more benign circumstances, the markets might come to expect more, that quantitative easing could become like kudzu for market operators—expectations of continued Federal Reserve purchases of Treasury securities as normal operating procedure might grow and grow and be terribly difficult to trim once they take root in the minds of market operators.


I might understand the case for accommodation if serious deflation were a clear and present danger. As I pointed out by citing the trimmed mean and through my anecdotal reports, it is not. I would add for this audience here today that this is thanks to Ben Bernanke’s adroit leadership in engineering the liquidity measures implemented during the Panic of 2008-09 and by avoiding the policy errors of the 1930s. Because of what we did in staring down panic and its aftermath, neither M2 money growth nor inflation has fallen off the cliff.[2] And while nominal growth is less than desired and is very painful, nominal income is growing, however incrementally, not shrinking.


I expressed concern about the purported benefits of a weaker dollar in the exchange markets. Much of what we export is in the form of high-value-added goods and services and in commodities like cotton and soybeans that we produce with enormous efficiency. A not insignificant portion of what we import, in addition to oil that feeds into gasoline prices, is used to clothe and support lower-income earners, the very people suffering from unemployment or job insecurity whom we are endeavoring to help. When faced with a further squeeze on their margins that comes with higher import prices, the Wal-Marts, Dollar Generals, Costcos and other stores where the most impacted people buy necessities will likely react by driving productivity even harder, which, translated, means selling more while employing fewer workers.


I also suggested that if the consequence of further easing was to weaken the dollar, this might undermine our standing in international fora, and drawing on my experience as a former Deputy U.S. Trade Representative, might undermine efforts to ward off protectionism.


As to the proposition that higher prices of financial assets will liberate those most in need, I wondered aloud if that were indeed true. We are already seeing the beginnings of speculative activity in stocks, bonds, buyouts and commodity markets. The rich and the quick are certainly able to exploit these circumstances to get richer. I have no problem with market operators making money; I did so myself in my previous life as a funds manager (before I took the vow of financial chastity and joined the Fed!). But I take no comfort, and see considerable risk, in conducting monetary policy that has the consequence of transferring income from the poor and the worker and the saver to the rich. Senior citizens and others who saved and played by the rules are earning nothing on their savings, while big debtors and too-big-to-fail oligopoly banks benefit from their subsidy. I know of no presidential administration or Congress, Republican or Democrat, that will tolerate, let alone advocate for, that dynamic for long, and I expressed my worry that this could come back to bite us and possibly threaten our independence.


Then there is the issue of exit policy. The more we engage in a policy of asset purchases that moves us further out the yield curve—and the more we laden our balance sheet with price-sensitive assets—the greater the likelihood of realizing a loss on our holdings. One can model out some of this risk and conclude that the coupon stream of the securities we will be holding will protect us against capital loss under reasonable price-reversal scenarios. But if unreasonable scenarios prevail, I shudder at the prospect of the Chairman or any other members of the FOMC appearing before the House Banking Committee in 2012 to report that the central bank of the United States has generated a loss of X billion dollars.


In sum, I asked that the FOMC consider that we might be prescribing the wrong medicine for the ailment from which our economy is suffering. Liquidity and abundant money are not the binding constraints on the economic activity we wish to see. The binding constraints are uncertainty about income and future aggregate demand, the disincentives fiscal and regulatory policy impose on ridding decisionmakers of that uncertainty, and the reluctance, given those disincentives, of those who have the power to create jobs for our people to invest in undertakings that would create them.


The remedy for what ails the economy is, in my view, in the hands of the fiscal and regulatory authorities, not the Fed. I could not state with conviction that purchasing another several hundred billion dollars of Treasuries—on top of the amount we were already committed to buy in order to compensate for the run-off in our $1.25 trillion portfolio of mortgage-backed securities—would lead to job creation and final-demand-spurring behavior. But I could envision such action would lead to a declining dollar, encourage further speculation, provoke commodity hoarding, accelerate the transfer of wealth from the deliberate saver and the unfortunate, and possibly place at risk the stature and independence of the Fed.


My perspective, as with those of all other members of the FOMC, was given a thoughtful and fair hearing at the table. After deliberation, the majority of the committee concluded that under current and foreseeable conditions, the better approach was to purchase $600 billion in Treasuries between now and the end of the second quarter of next year, on top of the amount projected to replace the paydown in mortgage backed-securities. The math of this new exercise is readily transparent: The Federal Reserve will buy $110 billion a month in Treasuries, an amount that, annualized, represents the projected deficit of the federal government for next year. For the next eight months, the nation’s central bank will be monetizing the federal debt.


This is risky business. We know that history is littered with the economic carcasses of nations that incorporated this as a regular central bank practice. So how can the decision made last Wednesday be justified?


Chairman Bernanke provided a public answer in an editorial in the Washington Post the day after the meeting. In that editorial, he summarized the analysis of the majority of the committee:


“This approach eased financial conditions in the past and, so far, looks to be effective again. … Easier financial conditions will promote economic growth … lower mortgage rates will make housing more affordable and allow home owners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”


For good measure, he added, “We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time.” And over this weekend, he added in a public speech that he did not think the new levels of asset purchases would unleash “super ordinary” inflation.


Having made my arguments to the contrary, I am a member of the committee that Chairman Bernanke leads. I respect the will of the committee and defer to the Chairman as its spokesperson.


I would suggest that even if you share my cautious perspective on this matter, you might be assuaged by looking at this new initiative as a bridge loan to fiscal sanity. We have a new Congress. From my perspective, there are two ways your central bank can approach them: the way it is being done by the Bank of England, which appears to me to be seeking to cushion the adjustment to a policy of fiscal abstinence by a new government after a prolonged period of fiscal debauchery; or to provide the space necessary for our newly elected Congress to work with the president to find a way to restore fiscal sobriety without choking off economic recovery.


The new leadership of the House of Representatives, and the reelected leadership of the reshaped Senate, together with President Obama, surely must understand that we are at the end of the line and that time is of the essence. The Fed is doing its level best to deliver on the dual mandate it was given by the Congress. But monetary accommodation, by itself, is not the answer to our current woes. The Fed, as I see it, has taken a leap of faith that our political leaders will forge a sensible budgetary and regulatory path that incentivizes businesses to put to work the money the Fed is printing to invest in creating jobs for American workers while averting what the Stanford historian David Kennedy described in yesterday’s New York Times as “a looming fiscal apocalypse.” We need for the Congress to move quickly, beginning in its lame-duck session. As Winston Churchill said, “We need action this day!”


Otherwise, the effect of quantitative easing will, in my view, simply result in financial speculation, further investment in more welcoming quarters abroad and, ultimately, in “super ordinary” inflation. The FOMC is taking a calculated risk. If the Congress and the Executive fail to deliver, I believe the FOMC will have to consider changing course.


Here is the message: The Fed is going out of its way to be a good citizen. It is time for the Congress to do the same.


Thank you.

New Tools To Monitor Systemic Risk

Governor Daniel K. Tarullo's speech, delivered Febuary 12, 2010 to the US Senate, Subcommittee on Security and International Trade and Finance titled, Equipping financial regulators with the tools necessary to monitor systemic risk

"Chairman Bayh, Ranking Member Corker, and other members of the Committee, thank you for inviting me to testify today. I also want to thank all of you for taking the time to explore a subject that is easily overlooked in the public debate around financial reform, but that will be central to ensuring a more stable financial system in the future.

"The recent financial crisis revealed important gaps in data collection and systematic analysis of institutions and markets. Remedies to fill those gaps are critical for monitoring systemic risk and for enhanced supervision of systemically important financial institutions, which are in turn necessary to decrease the chances of such a serious crisis occurring in the future. The Federal Reserve believes that the goals of agency action and legislative change should be (1) to ensure that supervisory agencies have access to high-quality and timely data that are organized and standardized so as to enhance their regulatory missions, and (2) to make such data available in appropriately usable form to other government agencies and private analysts so that they can conduct their own analyses and raise their own concerns about financial trends and developments.

"In my testimony this morning I will first review the data collection and analysis activities of the Federal Reserve that are relevant to systemic risk monitoring and explain why we believe additional data should be collected by regulatory authorities with responsibility for financial stability. Next I will set forth some principles that we believe should guide efforts to achieve the two goals I have just noted. Finally, I will describe current impediments to these goals and suggest some factors for the Congress to consider as it evaluates potential legislation to improve the monitoring and containment of systemic risk.

The Federal Reserve and Macro-Prudential Supervision
"The Federal Reserve has considerable experience in data collection and reporting in connection with its regulation and supervision of financial institutions, monetary policy deliberations, and lender-of-last-resort responsibilities. The Federal Reserve has made large investments in quantitative and qualitative analysis of the U.S. economy, financial markets, and financial institutions. The Federal Reserve also has recently initiated some new data collection and analytical efforts as it has responded to the crisis and in anticipation of new financial and economic developments.

"For supervision of the largest institutions, new quantitative efforts have been started to better measure counterparty credit risk and interconnectedness, market risk sensitivities, and funding and liquidity. The focus of these efforts is not only on risks to individual firms, but also on concentrations of risk that may arise through common exposures or sensitivity to common shocks. For example, additional loan-level data on bank exposures to syndicated corporate loans are now being collected in a systematic manner that will allow for more timely and consistent measurement of individual bank and systemic exposures to these sectors. In addition, detailed data obtained from firms' risk-management systems allow supervisors to examine concentration risk and interconnectedness.

"Specifically, supervisors are aggregating, where possible, the banks' largest exposures to other banks, nonbank financial institutions, and corporate borrowers, which could be used to reveal large exposures to individual borrowers that the banks have in common or to assess the credit impact of a failure of a large bank on other large banks. Additional time and experience with these data will allow us to assess the approach's ability to signal adverse events, and together they will be a critical input to designing a more robust and consistent reporting system.

"Furthermore, we are collecting data on banks' trading and securitization risk exposures as part of an ongoing, internationally coordinated effort to improve regulatory capital standards in these areas. Moreover, analysis of liquidity risk now incorporates more explicitly the possibility of marketwide shocks to liquidity. This effort also is an example of the importance of context and the need to understand the firms' internal risk models and risk-management systems in designing data collection requirements. Data that only capture a set of positions would not be sufficient since positions would not incorporate behavioral assumptions about firms, based on information about firms' business models and practices.

"The Federal Reserve's responsibilities for monetary policy are also relevant for systemic risk monitoring. Systemic risk involves the potential for financial crises to result in substantial adverse effects on economic activity.

"As the nation's central bank, the Federal Reserve assesses and forecasts the U.S. and global economies using a wide variety of data and analytical tools, some based on specific sectors and others on large-scale models. In the wake of the crisis, research has been expanded to better understand the channels from the financial sector to the real economy.

"For example, building on lessons from the recent crisis, the Federal Reserve added questions to the Survey of Professional Forecasters to elicit from private-sector forecasters their subjective probabilities of forecasts of key macroeconomic variables, which provides to us, and to the public, better assessments of the likelihood of severe macroeconomic outcomes.

"The Federal Reserve has made substantial investments in data and analytical staff for financial market monitoring. Each day, the Trading Desk at the Federal Reserve Bank of New York analyzes and internally distributes reports on market developments, focusing on those markets where prices and volumes are changing rapidly, where news or policy is having a major effect, or where there are special policy concerns.

"Those analyses begin with quantitative data, supplemented with information obtained through conversations with market participants and reviews of other analyses available in the market. Over the past few years, the Desk has worked closely with our research staff in developing new quantitative tools and new data sources.

"This ongoing monitoring requires continual evaluation of new data sources and analytical tools to develop new data as new markets and practices develop. For example, information on market volumes and prices can be collected from new trading platforms and brokers, data on instruments such as credit default swaps, or CDS, are provided by vendors or market participants, and fresh insights are gained from new methods of extracting information from options data.

"In some cases, publication of data by the private sector may be mandated by legislation (such as, potentially, trade data from over-the-counter derivatives trade repositories); in other cases, the Federal Reserve or other government agencies or regulators require or encourage the gathering and publication of data.

"Our experiences with supervision, monetary policy, and financial market monitoring suggest that market data gathering and market oversight responsibilities must continuously inform one another. In addition, efforts to identify stresses in the system are not a matter of running a single model or focusing on a single risk. Rather, it is the assembly of many types of analysis in a systematic fashion.

"The Supervisory Capital Assessment Program (SCAP) for large financial institutions--popularly known as the "stress test" when it was conducted early last year--illustrates the importance of combining analysis by credit experts, forecasts and scenario design by macroeconomists, and hands-on judgments by supervisors in assessing the financial condition and potential vulnerabilities of large financial institutions.

"While considerable steps have been made in the wake of the financial crisis, the Federal Reserve intends to do a good deal more. The Federal Reserve also will continue to strengthen and expand its supervisory capabilities with a macro-prudential approach by drawing on its considerable data reporting, gathering, and analytical capabilities across many disciplines. In the areas in which we are collecting data through the supervisory process on measures of interlinkages and common exposures among the largest financial firms we supervise, we are developing new analytical tools that may lead us to change our information requests from supervised firms.

"The Federal Reserve is exploring how to develop analytically sophisticated measures of leverage and better measures of maturity transformation from information that we can collect from the supervised firms in the supervisory process and from other available data and analysis. We envision developing a robust set of key indicators of emerging risk concentrations and market stresses that would both supplement existing supervisory techniques and assist in the early identification of early trends that may have systemic significance and bear further inquiry. This kind of approach will require data that are produced more frequently than the often quarterly data gathered in regulatory reports, although not necessarily real-time or intraday, and reported soon after the fact, without the current, often long, reporting lags. These efforts will need to actively seek international cooperation as financial firms increasingly operate globally.

The Potential Benefits of Additional Data
"Improved data are essential for monitoring systemic risk and for implementing a macro-prudential approach to supervision. The financial crisis highlighted the existence of interlinkages across financial institutions and between financial institutions and markets. Credit risks were amplified by leverage and the high degree of maturity transformation, especially outside of traditional commercial banking institutions. Moreover, supervision traditionally has tended to focus on the validity of regulated firms' private risk-management systems, which did not easily allow comparisons and aggregation across firms.

"One key feature of the recent crisis was the heavy reliance on short-term sources of funds to purchase long-term assets, which led to a poor match between the maturity structure of the firms' assets and liabilities. Such maturity transformation is inherently fragile and leaves institutions and entire markets susceptible to runs. Indeed, a regulatory, supervisory, and insurance framework was created during the Great Depression to counter this problem at depository institutions.

"However, in recent years a significant amount of maturity transformation took place outside the traditional banking system--in the so-called shadow banking system--through the use of commercial paper, repurchase agreements, and other instruments. Our ability to monitor the size and extent of maturity transformation has been hampered by the lack of high-quality and consistent data on these activities. Better data on the sources and uses of maturity transformation outside of supervised banking organizations would greatly aid macro-prudential supervision and systemic risk regulation.

"Another feature of the recent crisis was the extensive use of leverage, often in conjunction with maturity transformation. The consequences of this combination were dramatic. When doubts arose about the quality of the assets on shadow banking system balance sheets, a classic adverse feedback loop ensued in which lenders were increasingly unwilling to roll over the short-term debt that was used as funding.

"Liquidity-constrained institutions were forced to sell assets at increasingly distressed prices, which accelerated margin calls for leveraged actors and amplified mark-to-market losses for all holders of the assets, including regulated firms. Here, too, government regulators and supervisors had insufficient data to determine the degree and location of leverage in the financial system.

"More generally, the crisis revealed that regulators, supervisors, and market participants could not fully measure the extent to which financial institutions and markets were linked. A critical lesson from this crisis is that supervisors and investors need to be able to more quickly evaluate the potential effects, for example, of the possible failure of a specific institution on other large firms through counterparty credit channels; financial markets; payment, clearing, and settlement arrangements; and reliance on common sources of short-term funding.

"A better system of data collection and aggregation would have manifold benefits, particularly if the data are shared appropriately among financial regulators and with a systemic risk council if one is created. It would enable regulators and a council to assess and compare risks across firms, markets, and products. It would improve risk management by firms themselves by requiring standardized and efficient collection of relevant financial information. It also would enhance the ability of the government to wind down systemically important firms in a prompt and orderly fashion by providing policymakers a clearer view of the potential impacts of different resolution options on the broader financial system.

"Additional benefits would result from making data public to the degree consistent with protecting firm-specific proprietary and supervisory information. Investors and analysts would have a more complete picture of individual firms' strengths and vulnerabilities, thereby contributing to better market discipline. Other government agencies, academics, and additional interested parties would be able to conduct their own analyses of financial system developments and identify possible emerging stresses and risks in financial markets.

"One area in which better information is particularly important is the web of connections among financial institutions though channels such as interbank lending, securities lending, repurchase agreements, and derivatives contracts. Regulators also need more and better data on the links among institutions through third-party sponsors, liquidity providers, credit-support providers, and market makers. Knowledge of such network linkages is a necessary first step to improve analysis of how shocks to institutions and markets can propagate through the financial system.

"Principles for Developing a System of Effective Data and Analytical Tools
Moving from the recognition of the need for more data to an efficient data system is not an easy task. Data collection entails costs in collection, organization, and utilization for government agencies, reporting market participants, and other interested parties.

"Tradeoffs may need to be faced where, for example, a particular type of information would be very costly to collect and would have only limited benefits. The Internet and other applications of information technologies have made us all too aware of the potential for information overload, a circumstance in which relevant information is theoretically available, but the time and expense of retrieving it or transforming it into a usable form make it unhelpful in practical terms.

"Collection of more data just for its own sake also can raise systemic costs associated with moral hazard if investors view data collection from certain firms, products, and markets as suggesting implicit support. It is thus particularly worth emphasizing the importance of having data available readily and in a form that is appropriate for the uses to which it will be put. With these considerations in mind, we have derived a number of guiding principles for a system of new data and analytical tools for effectively supervising large institutions and monitoring systemic risk.

"First, the priorities for new data efforts should be determined by the nature of regulatory and supervisory missions. In particular, the data need to be sufficiently timely and to cover a sufficient range of financial institutions, markets, instruments, and transactions to support effective systemic risk monitoring and macro-prudential supervision, as well as traditional safety-and-soundness regulation. The events of the past few years have painfully demonstrated that regulators, financial institutions, and investors lacked ready access to data that would have allowed them to fully assess the value of complex securities, understand counterparty risks, or identify concentrations of exposures.

"The data needed for systemic risk monitoring and supervision are not necessarily real-time market data--information about trades and transactions that can be reported at high frequency when the events occur--but certainly data would need to be timely. What is considered to be timely will depend on its purpose, and decisions about how timely the data should be should not ignore the costs of collecting and making the data usable. For many supervisory needs, real-time data would be impractical to collect and analyze in a meaningful way and unnecessary.

"For example, while supervisors may indeed need to be able to quickly value the balance sheets of systemically important financial institutions, very frequent updates as transactions occur and market prices change could lead to more volatility in values than fundamental conditions would indicate and would be extraordinarily expensive to provide and maintain.

"Certainly, real-time data could be needed for regulators responsible for monitoring market functioning, and daily data would be helpful to measure end-of-day payment settlements and risk positions among the largest firms. But for supervising market participants, real-time market data could require enormous investments by regulators, institutions, and investors in order to be usable while yielding little net benefit. As policymakers consider redesign of a system of data collection, the goal should be data that are timely and best suited to the mission at hand.

"A second principle is that data collection be user-driven. That is, data on particular markets and institutions should be collected whenever possible by the regulators who ultimately are responsible for the safety and soundness of the institutions or for the functioning of those markets. Regulators with supervisory responsibilities for particular financial firms and markets are more likely to understand the relevance of particular forms of standardized data for risk management and supervisory oversight.

"For example, supervisors regularly evaluate the ability of individual firms' own risk measures, such as internal ratings for loans, and of liquidity and counterparty credit risks, to signal potential problems. As a result, these supervisors have the expertise needed to develop new reporting requirements that would be standardized across firms and could be aggregated.

"Third, greater standardization of data than exists today is required. Standardized reporting to regulators in a way that allows aggregation for effective monitoring and analysis is imperative. In addition, the data collection effort itself should encourage the use of common reporting systems across institutions, markets, and investors, which would generally enhance efficiency and transparency. Even seemingly simple changes, such as requiring the use of a standardized unique identifier for institutions (or instruments), would make surveillance and reporting substantially more efficient.

"Fourth, the data collected and the associated reporting standards and protocols should enable better risk management by the institutions themselves and foster greater market discipline by investors.

"Currently, because the underlying data in firms' risk-management systems are incomplete or are maintained in nonstandardized proprietary formats, compiling industry-wide data on counterparty credit risk or common exposures is a challenge for both firms and supervisors.

"Further, institutions and investors cannot easily construct fairly basic measures of common risks across firms because they may not disclose sufficient information. In some cases, such as disclosure of characteristics of underlying mortgages in a securitized pool, more complete and interoperable data collection systems could enhance market discipline by allowing investors to better assess the risks of the securities without compromising proprietary information of the lending institution.

"Fifth, data collection must be nimble, flexible, and statistically coherent. With the rapid pace of financial innovation, a risky new asset class can grow from a minor issue to a significant threat faster than government agencies have traditionally been able to revise reporting requirements.

"For example, collateralized debt obligations based on asset-backed securities grew from a specialized niche product to the largest source of funding for asset-backed securities in just a few years. Regulators, then, should have the authority to collect information promptly when needed, even when such collections would require responses from a broad range of institutions or markets, some of which may not be regulated or supervised. In addition, processes for information collection must meet high standards for reliability, coherence, and representativeness.

"Sixth, data collection and aggregation by regulatory agencies must be accompanied by a process for making the data available to as great a degree as possible to fellow regulators, other government entities, and the public. There will, of course, be a need to protect proprietary and supervisory information, particularly where specific firm-based data are at issue. But the presumption should be in favor of making information widely available.

"Finally, any data collection and analysis effort must be attentive to its international dimensions and must seek appropriate participation from regulators in other nations, especially those with major financial centers. Financial activities and risk exposures are increasingly globalized.

"A system without a common detailed taxonomy for securities and counterparties and comparable requirements for reporting across countries would make assembling a meaningful picture of the exposures of global institutions very difficult. Efforts to improve data collection are already under way in the European Union, by the Bank of England and the Financial Services Authority, and the European Central Bank, which has expressed support for developing a unified international system of taxonomy and reporting.

"The Financial Stability Board, at the request of the G-20, is initiating an international effort to develop a common reporting template and a process to share information on common exposures and linkages between systemically important global financial institutions.

Barriers to Effective Data Collection for Analysis
"Legislation will be needed to improve the ability of regulatory agencies to collect the necessary data to support effective supervision and systemic risk monitoring. Restrictions designed to balance the costs and benefits of data collection and analysis have not kept pace with rapid changes in the financial system. The financial system is likely to continue to change rapidly, and both regulators and market participants need the capacity to keep pace.

"Regulators have been hampered by a lack of authority to collect and analyze information from unregulated entities. But the recent financial crisis illustrated that substantial risks from leverage and maturity transformation were outside of regulated financial firms. In addition, much of the Federal Reserve's collection of data is based on voluntary participation.

"For example, survey data on lending terms and standards at commercial banks, lending by finance companies, and transactions in the commercial paper market rely on the cooperation of the surveyed entities. Moreover, as we have suggested, the data collection authority of financial regulators over the firms they supervise should be expanded to encompass macro-prudential considerations. The ability of regulators to collect information should similarly be expanded to include the ability to gather market data necessary for monitoring systemic risks. Doing so would better enable regulators to monitor and assess potential systemic risks arising directly from the firms or markets under their supervision or from the interaction of these firms or markets with other components of the financial system.

"The Paperwork Reduction Act also can at times impede timely and robust data collection. The act generally requires that public notice be provided, and approval of the Office of Management and Budget (OMB) be obtained, before any information requirement is applied to more than nine entities. Over the years, the act's requirement for OMB approval for information collection activity involving more than nine entities has discouraged agencies from undertaking many initiatives and can delay the collection of important information in a financial crisis.

"For example, even a series of informal meetings with more than nine entities designed to learn about emerging developments in markets may be subject to the requirements of the act. While the principle of minimizing the burdens imposed on private parties is an important one, the Congress should consider amending the act to allow the financial supervisory agencies to obtain the data necessary for financial stability in a timely manner when needed.

"One proposed action would be to increase the number of entities from which information can be collected without triggering the act; another would be to permit special data requests of the systemically important institutions could be conducted more quickly and flexibly.

"The global nature of capital markets seriously limits the extent to which one country acting alone can organize information on financial markets. Many large institutions have foreign subsidiaries that take financial positions in coordination with the parent. Accordingly, strong cooperative arrangements among domestic and foreign authorities, supported by an appropriate statutory framework, are needed to enable appropriate sharing of information among relevant authorities. Strong cooperation will not be a panacea, however, as legal and other restrictions on data sharing differ from one jurisdiction to the next, and it is unlikely that all such restrictions can be overcome. But cooperation and legislation to facilitate sharing with foreign authorities appears to be the best available strategy.

"Significant practical barriers also exist that can, at times, limit the quality of data collection and analysis available to support effective supervision and regulation, which include barriers to sharing data that arise from policies designed to protect privacy.

"For example, some private-sector databases and bank's loan books include firms' tax identification (ID) numbers as identifiers. Mapping those ID numbers into various characteristics, such as broad geographic location or taxable income measures, can be important for effective analysis and can be done in a way that does not threaten privacy. However, as a practical matter, a firm may have multiple ID numbers or they may have changed, but the Internal Revenue Service usually cannot share the information needed to validate a match between the firm and the ID number, even under arrangements designed to protect the confidentiality of the taxpayer information obtained.

"In addition, a significant amount of financial information is collected by private-sector vendors seeking to profit from the sale of data. These vendors have invested in expertise and in the quality of data in order to meet the needs of their customers, and the Federal Reserve is a purchaser of some of these data.

"However, vendors often place strong limitations on the sharing of such data with anyone, including among federal agencies, and on the manner in which such data may be used. They also create systems with private identifiers for securities and firms or proprietary formats that do not make it easy to link with other systems. Surely it is important that voluntary contributors of data be able to protect their interests, and that the investments and intellectual property of firms be protected. But the net effect has been a noncompatible web of data that is much less useful, and much more expensive, to both the private and the public sector, than it might otherwise be.

"Protecting privacy and private-sector property rights clearly are important policy objectives; they are important considerations in the Federal Reserve's current data collection and safeguarding. Protecting the economy from systemic risk and promoting the safety and soundness of financial institutions also are important public objectives. The key issue is whether the current set of rules appropriately balances these interests. In light of the importance of the various interests involved, the Congress should consider initiating a process through which the parties of interest may exchange views and develop potential policy options for the Congress's consideration.

"Organization Structure for Data Collection and Developing Analytical Tools
In addition to balancing the costs and benefits of enhanced data and analytical tools, the Congress must determine the appropriate organizational form for data collection and development of analytical tools. Budget costs, production efficiencies, and the costs of separating data collection and analysis from decision-making are important considerations. Any proposed form of organization should facilitate effective data sharing. It also should increase the availability of data, including aggregated supervisory data as appropriate, to market participants and experts so that they can serve the useful role of providing independent perspectives on risks in the financial system.

"The current arrangement, in which different agencies collect and analyze data, cooperating in cases where a consensus exists among them, can certainly be improved. The most desirable feature of collection and analysis under the existing setup is that it satisfies the principle that data collection and analysis should serve the end users, the regulatory agencies.

"Each of the existing agencies collects some data from entities it regulates or supervises, using its expertise to decide what to collect under its existing authorities and how to analyze it. Moreover, the agencies seek to achieve cost efficiencies and to reduce burdens on the private sector by cooperating in some data collection.

"An example is the Consolidated Reports of Condition and Income, or Call Reports, collected by the bank regulatory agencies from both national and state-chartered commercial banks. The content of the reporting forms is coordinated by the Federal Financial Institutions Examination Council, which includes representatives of both state and federal bank regulatory agencies.

"A standalone independent data collection and analysis agency might be more nimble than the current setup because it would not have to reach consensus with other agencies. It might also have the advantage of fostering an overall assessment of financial data needs for all governmental purposes.

"However, there would also be some substantial disadvantages to running comprehensive financial data collection through a separate independent agency established for this purpose. A new agency would entail additional budget costs because the agency would likely need to replicate many of the activities of the regulatory agencies in order to determine what data are needed. More importantly, because it would not be involved directly in supervision or market monitoring, such an agency would be hampered in its ability to understand the types of information needed to effectively monitor systemic risks and conduct macro-prudential supervision. Data collection and analysis are not done in a vacuum; an agency's duties will inevitably reflect the priorities, experience, and interests of the collecting entity.

"Even regular arms-length consultations among agencies might not be effective, because detailed appreciation of the regulatory context within which financial activities that generate data and risks is needed. The separation of data collection and regulation could also dilute accountability if supervisors did not have authority to shape the form and scope of reporting requirements by regulated entities in accordance with supervisory needs.

"An alternative organizational approach would be available if the Congress creates a council of financial regulators to monitor systemic risks and help coordinate responses to emerging threats, such as that contemplated in a number of legislative proposals. Under this approach, the supervisory and regulatory agencies would maintain most data collection and analysis, with some enhanced authority along the lines I have suggested. Coordination would be committed to the council, which could also have authority to establish information collection requirements beyond those conducted by its member agencies when necessary to monitor systemic risk.

"This approach might achieve the benefits of the current arrangement and the proposed independent agency, while avoiding their drawbacks. The council would be directed to seek to resolve conflicts among the agencies in a way that would preserve nimbleness, and it could recommend that an agency develop new types of data, but it would leave the details of data collection and analysis to the agencies that are closest to the relevant firms and markets. And while this council of financial supervisors could act independently if needed to collect information necessary to monitor the potential buildup of systemic risk, it would benefit directly from the knowledge and experience of the financial supervisors and regulators represented on the council. The council could also have access to the data collected by all its agencies and, depending on the staffing decisions, could either coordinate or conduct systemic risk analyses.

Conclusion
"Let me close by thanking you once again for your attention to the important topic of ensuring the availability of the information necessary to monitor emergent systemic risks and establish effective macro-prudential supervisory oversight. As you know, these tasks will not be easy. However, without a well-designed infrastructure of useful and timely data and improved analytical tools--which would be expected to continue to evolve over time--these tasks will only be more difficult. We look forward to continued discussion of these issues and to a development of a shared agenda for improving our information sources. I would be happy to answer any questions you might have."