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Monday, November 18

Reign of terror

I want to return to Bloomberg/Business Week Economics Editor Peter Coy's observation, "Good-bye globalization, hello balkanization," which he made in his report on the Federal Reserve's proposed regulation to force U.S. branches of major European banks to concede to the same high capitalization rates that are being imposed on U.S. banks. (The Fed Wants Bigger Cushions For Units of Deutsche Bank and Others, September 19, 2013.) I quoted without comment from the report around the time it was published (and discussed with Peter Coy on John Batchelor's radio show). Here I want to discuss a part of the report I didn't quote earlier:

Coy details the rationale for the proposed regulation, which was largely crafted by attorney and Federal Reserve Governor Daniel Tarullo:
Economists on the staff of the Federal Reserve have documented what looks like genuine harm to the U.S. economy from a 2011 episode in which foreign banks operating in the U.S. were temporarily starved of cash. The Fed economists found that in the spring of 2011, investors began to fret that a Greek default would damage European banks that had lent to Greece. Money-market mutual funds that had lent to the European banks by buying certificates of deposit were forced to cut back their loans because their own customers were withdrawing deposits.

What happened next never made the newspapers. According to the latest version of a working paper by three Fed staff economists, published in July, the European bank branches in the U.S. appealed to their home offices for funds to replace what they’d lost, but they didn’t get all they needed. They were forced to cut back lending in the U.S. by about $20 billion, the working paper said. That’s not a lot in an almost $16 trillion U.S. economy, but to the Fed it was a taste of what might happen in a more serious funding squeeze.
I suspect that every economist at the Federal Reserve lives in fear of Daniel Tarullo, so I question the working paper's calculations and conclusions. But taking the paper at face value, how is that foreign banks cutting back lending to Americans harmed the U.S. economy? In other words, how is that Americans who tried to borrow $20 billion from foreign banks couldn't turn to American banks for the loans?

Peter Coy did not put the question to Daniel Tarullo during their discussion, which he details in the report -- or if he did, the question was off the record. But there really is no answer, except the truth.

The truth is that first the American banks were tied up with regulatory red tape, then the regulations were used by government to force them to write mortgage loans that had "default" written all over them. Then the banks speculated in junk investment vehicles in the attempt to offset the floods of defaults.

When it call came crashing down, then the Fed and White House wanted the banks to write loans to American big business to stimulate hiring -- at a time when the businesses were slashing costs and payrolls in an attempt to stay afloat. When the banks wouldn't strap on suicide vests, the Fed and White House backed the writing of even more regulations in the form of the Dodd-Frank Act, which isn't even half written yet! So the banks still don't know what they're facing in terms of more regulations.

In the midst of all this madness there were European and other foreign banks willing to take risks to loan to Americans -- risks that American banks would not take, could not take. But after hearing about the proposal to force them under the rule of the Federal Reserve, they're having second thoughts.

Peter Coy reported:
Deutsche Bank Chief Financial Officer Stefan Krause told analysts in July that rather than raise more capital to comply -- say, by selling shares to the public -- the German bank would book some operations in other countries.
I would think, I would hope, that such statements caused the Fed to reconsider its proposed regulation, but I'm not seeing evidence that rational actions are informing American monetary or fiscal policy. What I'm seeing is a reign of terror.

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