Tag Archives: financial reform

Visa and Mastercard Retail Debit Transaction Fees Restricted under New Reform Amendment

By Marc Seltzer; originally published on May 13, 2010, at care2.com

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A Senate amendment to the comprehensive financial reform legislation directs the Federal Reserve to cap retail debit card transaction fees at a level that is “reasonable and proportional” to the cost of processing the transactions.  Sixty-four Senators sided with retailers over banking industry objections.  33 opposed.

The restrictions are not contained in the House version of financial reform that passed in December.  Thus, if the current bill passes the full Senate vote, the provision will still have to make it into the final legislation during reconciliation of the House and Senate bills.  The banking lobbyists will push hard to stop the final legislation from containing the restrictions, which could cost banks billions of dollars.

Anger at banks has shifted the power in the Senate towards small businesses and away from large banks, for the time being.  The amendment was written by Senator Dick Durbin, Democratic whip, and brought for a vote by Senator Chris Dodd of Connecticut, who is managing the financial reform legislation as Chairman of the Senate Banking Committee.

Some of the savings would likely be passed from retailers to customers, especially in highly competitive markets like groceries and chain stores.

The law would only apply to large banks and would not apply to credit card transaction fees.  Still, it would give retailers a path to lower transaction costs.

The Columbia Journalism Review covered the change and noted that the press has been fairly mute on amendments to the financial reform bill and poor in explaining what’s at stake.  Spotty Coverage of the Financial Reform Amendments More information is available:  Reuters reportingProgressiveOhio

Marc Seltzer is also a contributor to SupremePodcast.com and Redefining America: Constitution and Leadership 2010.

Are Republicans Lying About Financial Reform?

By Marc Seltzer; originally posted on April 20, 2010, at care2.com

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As the Senate moves towards consideration of financial industry reform, politics again threatens to overwhelm substance in the debate.  Conservatives have attacked Democratic legislation with the moniker “bailouts forever.”  Political writer Mark Halperin charged Republicans with “intentionally misreading the law,” echoing claims of angry Senate Dems.  Unlike with health care reform, where budget complexity defied evaluation without experts and CBO forecasts, the core principles of financial reform are fairly straight forward.

The following is what you need to know to make your own decision:

A.  Protections against risky behavior by financial institutions

1. Capital Requirements

Companies will be forced to keep more money available — “capitalization” or “capital reserves” — to protect themselves against losses so that typical companies will not be at risk of collapse in a downturn.  Sufficient capital could have eliminated the need for bailouts of financial institutions in 2008-2009.

2.  Leverage Restrictions
Financial companies will be limited in how much money they borrow and put at risk. Many institutions make money by investing and taking risk with borrowed funds.  This extends their gains in boom times, but threatens overwhelming losses in a bust.  Private companies are still allowed to place their bets, even risky bets, but they cannot do so using such high percentages of borrowed funds, creating a risk of nonpayment when their investments go bad.

Capital and Leverage rules are the key to protecting the economy from a 2008-style crisis. No longer would the great extent of irresponsible risk be tolerated.  With each individual company taking less risk, a severe downturn in the economy could drive some financial entities out of business, but would not threaten the entire financial industry and thus require government assistance.

Watch out for “too big to fail” arguments from the Left (“break up the banks”) or Right (“endless bailouts”). Canada has five of the largest banks in the world and none faltered.  Canada’s financial institutions are regulated with the same type of serious oversight included in current US proposals.  Capital requirements for Canadian banks were held at 7 percent going into this crisis, while the global average was closer to 4 percent. Canada’s chief financial regulator, OSFI Superintendent Julie Dickson, remarked in November 2008, “We have seen how strong capital cushions in Canada have paid off to the benefit of our institutions and overall financial system.” (My comparison of the U.S. administration’s proposals with the Canadian regulatory system)

The point is, capital, leverage and risk management are more important than size.  In fact, no one financial institution in the US was too big to fail as far as the effect on jobs, small business loans or the stock market.  The problem was that many separate but co-dependent entities were unable to handle a downturn and would have failed within a period of months, if not for government intervention.  Early in the Great Depression 5000 banks failed.  Making each bank smaller is irrelevant, if they all fail.

B.  Specifically dealing with failing companies.

1.  Closing companies down — “FDIC Resolution Authority”
The administration’s proposal is to use the FDIC (Federal Depository Insurance Corporation), which currently closes banks that are failing, to close all financial institutions, when they fall below financial operating requirements.  The FDIC is highly regarded for efficient and effective “weekend” bank closures.  FDIC agents take over Friday at 5:00 p.m., and Monday the bank is open for customers, but under FDIC supervision.  The FDIC locates a new buyer quickly and gets out of the way once new management takes over.  Previously, there was no law permitting FDIC action on failing financial institutions that were not technically chartered banks.  Thus, Bear Sterns, Lehman Brothers, Citi, etc., could not have been closed by the FDIC.

The alternative approach, proposed by critics of the FDIC model, is to allow failing financial institutions that are not banks to file for bankruptcy.  Advocates say that bankruptcy courts have more expertise than the FDIC at large complicated business structures.  However, bankruptcy does allow the management to continue through the failure and to propose corrective plans, using the bankruptcy court to deal with creditors.

In the 2008-2009 crisis, insurer AIG would have had to file bankruptcy, if the federal government did not bail it out.  In bankruptcy, AIG and its management would still have aimed to protect their own interests, despite the anticipated international catastrophe of its own making. (Many financial institutions had used AIG to insure themselves against losses; AIG’s collapse would have led to additional major collapses worldwide)

According to the proposed “FDIC resolution authority” model, the financial institution will be taken over and immediately managed by experts with the public’s interest in mind.  Presumably, the bankruptcy model would also protect the larger financial system, since higher capital and leverage standards, discussed above, would serve to lower the amount of damage that any one institution could cause in failure. However, the FDIC, as a banking regulator, has expertise in the financial system, while bankruptcy courts handle competing public and private interests in all types of businesses, and may not always have a view to protecting financial stability.  Remember, the purpose of the new law is to stop poor decision-making of a few entities from impacting the entire industry and the wider economy.

2.  Industry-Financed Disaster Fund
The Senate legislation plans for the financial institutions to contribute to a fund to be used if needed in closing companies.  The 50 billion dollar fund would shield taxpayers from having to pay for any costs incurred by failing financial institutions.  While the new law intends to avoid bailouts altogether, by making financial institutions less risky, more self-sufficient, and by closing them before they create systemic damage, it provides that any bailouts that do occur will be paid from a fund created with private financial company fees.

Should industry-financed bailouts be allowed? Imagine, for example, that a financial institution failure would cause a functioning private hospital to be shut down for a week while it sought new financing from another bank.  In that case, not because of a threat to the wider economy, but because of other public purposes, short-term bailout financing, using the institution-financed fund, might be deemed appropriate, at no cost to the tax payer.

The reason that Congress is rejecting the idea of outlawing any possibility of bailouts, is that it is possible that public purposes will be served by having a bailout option.  What is different here is that the government will not be forced into bailout because the new capital and leverage requirements will protect the wider economy.  Thus, Republican claims that bailouts using public funds will continue, do not take into account the fact that new capital and leverage requirements are the primary defense against systemic risk.  It is not by pledging, even through legislation, to avoid bailouts that we will be protected.  It is by stopping companies from taking so much risk that the entire system is put in danger of collapse.

C.  Consumer Protection

Fundamental consumer protections already exist to keep financial institutions from stealing or mismanaging their customers assets.  However, as the Madoff scandal illustrates, the government is not always effective in policing.  In addition, in the real estate market, many homebuyers obtained mortgages without fully comprehending the terms and consequences.  The new law aims to provide additional protection for consumers.  Krugman: Looters in Loafers

The financial industry is strongly against the consumer protection provisions, partly because they do not know how aggressive the new body will be in regulating business practices.  (Auto-finance example)  The current proposal puts a new consumer-protection agency under the authority of the Federal Reserve.  As the Federal Reserve traditionally regulates banks and manages monetary policy, including the interest rates that banks are charged to borrow funds for their business operations, the issue for the new consumer protection regulator will be how independent it remains from Fed regulators with different goals, and determining what level of protection balances business objectives with consumer rights.

These are the core ideas behind the administration’s plan, as spearheaded by Treasury Secretary Timothy Geithner and now incorporated into Democratic legislation.  As Congressional leaders posture about whether to support or oppose the plan and why, decide for yourself what’s politics and what’s substance.

More by Marc Seltzer:  Hate that Obama’s Near the Middle, Think Again!
Questioning Conventional Wisdom

Will Republicans return to power in November?  Listen to Marc Seltzer and Jessica Pieklo discuss political prospects at Redefining America:  Constitution and Leadership 2010

April 22, 2010 UPDATE: NY Times updates Dems efforts to push forward in the Senate and Republican opposition.

Questioning Conventional Wisdom — “Jobless Recovery”

By Marc Seltzer; originally published January 6, 2010

Don’t be too sure

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“Jobless Recovery”

No adjective characterizes political and media discussions of the recovery from the 2008 recession more than the word “jobless.”

Is it true?  Have the stars aligned to deny us a bright future?  Should we be worried?


One way to evaluate what people are saying is to look at their motivation.  In this case, liberals and conservatives are both motivated to characterize the job prospects as worse than they likely are.  Many liberals, such as outspoken Nobel Laureate Economist Paul Krugman, want the government to take action in support of job creation so they focus on the high unemployment rate.  Ten percent is certainly higher than a more ideal 5 or 6 percent that would be a healthy level for the economy, if it were not in either an excessive boom or bust cycle.  But the current high unemployment reflects the depth of the recession, not a “jobless” recovery.

In 2009, the growth rate only turned positive in the third quarter.  Jobs are a lagging indicator and always follow the business turn-around and improvement in growth rate by many months.

Thus, the 2009 recovery is not “jobless” because unemployment has not yet come down.  Every recession involves the loss of jobs and every recovery involves the improvement in business conditions and higher growth rate long before jobs return.

Professor Krugman is worried about a weak recovery and thus wants to see additional stimulus aimed at creating jobs.  He is particularly concerned that the slow return of jobs creates great suffering and harms employment prospects for the long-term unemployed.  His proposals could help alleviate high unemployment and move the economy more quickly towards full employment, but they do not indicate that this is a jobless recovery whereas other recoveries were not.  Rather they reflect the fact that the severity of the recession led to millions of layoffs and that it will take time for millions of workers to be rehired into the labor market.


On the other side of the isle, the Republicans are constantly saying that the Obama administration actions such as stimulus spending and health care reform are bad for the economy and that we are headed for a jobless recovery.  However, it serves the Republican political goals if the Obama administration can be described as failing to lead an economy out of recession.  Millions of people are unemployed and many who are employed face job insecurity.  The Republicans exploit this to political advantage by claiming that current policies are wrong and pointing to a “jobless” recovery as evidence of failure.  The Republicans will continue to have every incentive to claim that Democratic policies are causing a jobless recovery until the 2010 elections.

But that doesn’t make it so.  Remember that it is far quicker to lay off employees than it is to rehire them.  Layoffs can be done by thousands on a single day, while rehiring takes substantial human resource department efforts, paperwork and staffing in itself.  Unless employees were simply furloughed, a thousand employees laid off in a single afternoon could take months to rehire in ordinary conditions.  For this reason, and because the recession of 2007-2008 involved a spectacular financial crisis with fast and deep layoffs, reaching a peak 750,000 a month in January of 2009, unemployment may only decrease by 750,000 to two million new jobs a year in coming years.  Remember, we lost more than seven million jobs.

Nonetheless, six to eighteen months after the growth rate becomes strong, we should expect to see substantial gains in employment.  It will be correct to say during the recovery that jobs are not created as fast as they were lost, but that is a hardly the standard for a “jobless” recovery.  The real key is the growth rate.  It reached more than 2% in the third quarter of 2008.  Six months from now it should be higher still.   The activity is reflected in increased hours and temp job hires for now, but inevitably job creation will follow.

The real question is whether innovative action in the public and private sector can increase the speed of job creation without distorting the marketplace and creating waste.  Nations such as Germany subsidized jobs during the crisis to limit layoffs.  Many nations, including ours, supported public and private sectors with stimulus spending, preventing layoffs from getting worse than they did.  Now, the question is whether means will be found to efficiently return to higher employment more quickly than in other deep recessions.

May 6, 2010 UPDATE:  Recent jobs data finally confirming predictions:  Denver Post

Federal Reserve Independence Under Threat

By Marc Seltzer; originally published on December 1, 2009, at care2.com

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Readers of this website (care2.com)  have a healthy skepticism of government. They see that well-heeled special interests assert too much power in Congress.  Our representatives in Washington should devote themselves to the public interest, but too often appear to serve lobbyists and work for campaign contributions, instead. This view is held by Democrats and Republicans alike, one of few shared beliefs.

Unfortunately, this bipartisan, anti-government nexus has led to legislation to audit the Federal Reserve, the powerful financial stewards of the economy.

This is likely a bad idea and one that suckers good activist public energy down the wrong path.  The reason that the Federal Reserve is unelected and insulated from political manipulation is that its powers would be very tempting to misuse for political gain.  If Congress or the President could, for example, force the Federal Reserve to lower interest rates and stimulate the economy when unemployment goes up, they would do so.  However, the Federal Reserve manages long-term monetary policy to obtain stability and growth in light of concerns over inflation, exchange rates, and productivity.  This may include inflicting a certain amount of household suffering on the American economy to fight inflation or deal with crises where sacrifice today insures wealth and stability tomorrow.  If politicians could interfere, this would never happen.

The audit legislation responds to anguish about the failure of the government to regulate financial activity and risk in the lead-up to the current crisis. It also channels anger over the solutions to the crisis that the Fed has created.

Those who are against corporate greed and excessive wealth could better use the tax code to force corporations to pay their fair share.  Moreover, the proper response to failures of deregulation is increased regulation forcing private institutions to have higher capital reserves, lower leverage ratios and more significant safeguards and oversight than existed since Clinton-era deregulation.  No one is claiming that government got it all right.  But remember, it was political and financial interests that led to the current crisis.  And note that politicians have proposed everything from doing nothing to nearly twice the stimulus that was passed in response to the crisis.

The Federal Reserve is made up of professional economists and financial experts fulfilling a public service.  It is not immune to mistakes, but the Federal Reserve has, with specific limited exceptions, maintained a healthy independence from political authority.

Sacrificing that independence when the Fed makes mistakes or when we don’t like its decisions — which is what this legislation is really about — is not the answer.  Once the Federal Reserve is damaged, political and financial interests will use the Fed to serve current political goals at the expense of the long term financial health of the nation.

We know what that scenario looks like in practice because we have the example of Congress.  Congress never cuts expenses because our representatives are beholden for their jobs to special interests served by that government spending. One of the great examples of cost-cutting in government was done by the Base-Closings Commission, an independent panel appointed for the purpose of solving a problem that congress could not otherwise solve.

What we need is more fiscal responsibility, not less.

May 6, 2010 UPDATE:  The Senate voted down an amendment to the financial reform legislation today that would have subject the Federal Reserve to more congressional authority.