September 15, 2008
The financial news is bad, and so is much of the analysis

On campus this afternoon I overheard the following remark by a non-economist, trying to explain to another non-economist the Lehman failure and today's stock market decline: “It’s a combination of deregulation and greed. Boy, if you deregulate enough, the greed will follow.”

If I had butted in, I would have made two points. (1) If an unusually large number of airplanes crash during a given week, do you blame gravity? No. Greed, like gravity, is a constant. It can’t explain why the number of crashes is higher than usual. (2) What deregulation have we had in the last decade? Please tell me. On the contrary, we’ve had a strengthening of the Community Reinvestment Act, which has encouraged banks to make mortgage loans to borrowers who previously would have been rejected as non-creditworthy. And we’ve had the imposition of Basel II capital requirements, which have encouraged banks to game the accounting system through quasi-off-balance-sheet vehicles, unhelpfully reducing balance sheet transparency.

No more edifying are the statements of Noriel Roubini of NYU in a video interview that had top billing on Yahoo’s entry page this afternoon. The accompanying text story is headlined “Top Economist: Americans Should Worry About Bank Deposits if Congress Doesn't Act”.

In the interview Roubini says that “right now there is actually [a] slow-motion run on retail banks around the country”. This is both conceptually and factually wrong. A slow-motion run, where people do not roll over their time deposits, is not a run at all. It allows the bank to shrink in a more orderly fashion, without losses from overly hasty asset sales. A run is where checking account depositors seek to empty out their accounts. Neither a run nor a slower exodus from retail banks is in fact underway. Total checkable deposits (seasonally adjusted), as tracked by the St. Louis Fed’s FRED data base, are not shrinking (comparing the latest weekly observation, 2008-09-01, to three weeks, six weeks, or three months earlier).

Here is how the text story reports a subsequent Roubini claim:

That "run" could accelerate as people realize the FDIC fund has about $50 billion to "insure" about $1 trillion in assets at the nation's financial institutions, says Roubini. "They're going to run out of money" unless Congress acts soon to recapitalize the FDIC.

What the heck would it mean for Congress to “recapitalize” an institution that has $50 billion in net worth? Roubini fails to note that the FDIC already has, as was made explicit when the FDIC came close running out of funds in 1991, an unlimited line of credit from the US Treasury. If the FDIC starts running out of money, the Treasury will lend it however much more is needed to keep insured bank depositors whole. In the worst case imaginable, the Fed will print however much money the Treasury needs. (At that point we’d need to distinguish depositors’ nominal wholeness from their purchasing-power wholeness.) Failing to note the FDIC's Fed-backed credit line, Roubini's contrast between the size of the FDIC's current fund to the size of worst-case draws on the fund misleadingly exaggerates the nominal risk to depositors.

Roubini’s interviewers do not provide any balance. Instead they add to the confusion by conflating the risky liabilities of investment banks and brokerage firms (which are not runable because they are not demand-deposit liabilities) with the (runable but insured) deposit liabilities of commercial (retail) banks.

Posted by Lawrence H. White at 07:07 PM in Economics

The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it. -Adam Smith

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