Banks Face Wipeout in some Financial Services

In the FT, Martin Arnold summarizes a McKinsey study on banking. Arnold entitles his article “McKinsey warns banks face wipeout in some financial services.”

According to the report, competition arises from technology companies that deliver specific financial services at much lower cost.

McKinsey said technological competition would reduce profits from non-mortgage retail lending, such as credit cards and car loans, by 60 per cent and revenues by 40 per cent over the next decade. … It predicted a smaller, but still significant, chunk of profits and revenues would be lost from payments processing, small and medium-sized enterprise lending, wealth management and mortgages. These would decline between 35 and 10 per cent, McKinsey said.

See my previous posts on structural change in banking and fintech competition for banks.

Sterilized Exchange Rate Intervention

In a Baker Institute working paper, Jeffrey Frankel reviews the Plaza Accord 30 years ago. Regarding the effectiveness of sterilized intervention, he argues that

… purchases and sales on the scale that governments are generally prepared to make will not have much effect if the market is already firmly convinced of the proper value of the currency. … The successful effect of intervention comes when the market holds weak views as to the true worth of the currency, particularly in the case of a speculative bubble, and is willing to be led by the authorities. A good example of this was the dollar in 1985.

The effort generally has an effect within the first few days or weeks if it is going to have an effect at all.

… operations are more likely to be effective if they are “concerted,” i.e., coordinated among a number of major central banks as they were in 1985 and subsequent years. It is particularly important that the U.S. be one of the countries participating.

… the major effect comes via expectations.

… authorities are not necessarily able to affect the exchange rate for a long period, absent a corresponding change in fundamentals.

In recent years, interventions in foreign exchange markets have mostly been confined to emerging markets.

European Monetary Union: A Status Report

In the NZZ (August 7, 2015), René Höltschi provides an excellent overview over the status of European Monetary Union (EMU).

Issues:

  • EMU combines centralized monetary policy authority with decentralized fiscal powers. This creates the risk that national governments try to free ride.
  • Heterogeneity across Euro Zone member states renders centralized monetary policy difficult. Without national monetary policy instruments, prices and wages need to adjust more in the face of asynchronous business cycles.

Previous solutions:

  • The stability and growth pact was meant to address the first issue. It failed, for political reasons. Markets didn’t impose sufficient discipline either; they anticipated bailouts.
  • Hopes for reduced heterogeneity—as a consequence of EMU—have been shattered.

Reforms so far:

  • During the crisis, member states established rescue funds and agreed on various crisis measures.
  • They pursued a two-pronged strategy. On the one hand, they tried to build on the decentralized approach of the Maastricht treaty. On the other, they aimed at closer integration in the form of banking, fiscal and eventually, political union.
  • Major responsibilities in the area of banking supervision and resolution have been transferred to the European Central Bank. Bail-in procedures have been agreed upon.
  • No major changes occurred in the fiscal policy domain. The “Six-pack” and “Two-pack” measures to strengthen fiscal discipline, coordination and supervision have proved ineffective (e.g., no action against France).

Proposals and discussion:

  • The recent “Five-presidents’ report” distinguishes between short-term (until 2017) and longer-term (until 2025) measures (see below). The report proposes to strengthen the existing framework before moving towards closer integration (Euro treasury, macroeconomic stabilization, fiscal and political union). France and Italy have voiced support.
  • Fiscal union entails a common budget and potentially, a common unemployment insurance. Unity of liability and control would require that fiscal competences are centralized as well. In turn, this would require changes of the European treaties.
  • A further strengthening of banking union, e.g. delegation of banking supervision to a newly created European authority (rather than the European Central Bank), also would require treaty changes.
  • But throughout Europe, there is no desire to delegate powers to “Brussels.”
  • Instead, skeptics like the Bundesbank or the German Council of Economic Experts advocate a bankruptcy procedure for Euro-zone governments: to strengthen discipline and encourage monitoring by financial markets any assistance by the European Stability Mechanism should be preceded by private creditor bail-ins (extensions of maturity, haircuts).
  • Some observers also advocate exit from the Euro zone as an ultima ratio measure. But others argue that this very possibility would undermine the stability of the Euro area.

Five-president’s report:

  • Commissioned in October 2014 by the heads of state and government, the report has been published in June 2015 by presidents Jean-Claude Juncker (European commission), Donald Tusk (European council), Jeroen Dijsselbloem (Euro group), Mario Draghi (European Central Bank) and Martin Schulz (European parliament).
  • In the short term, the report proposes: to improve elements of the previous “six-pack” and “two-pack” reforms, including streamlined coordination and supervision of national fiscal policies;
  • a common backstop for national deposit insurance systems;
  • a European fiscal council serving as watchdog; and
  • independent national agencies to monitor competitiveness.
  • For the longer term, the report proposes: completion of monetary union and fiscal union;
  • macroeconomic stabilization, stopping short of permanent transfers or income equalization schemes; and
  • a Euro zone treasury.
  • Accountability as well as the role of national parliaments and the European parliament in coordinating fiscal policy is to be strengthened. The Euro zone is to be better represented vis-a-vis third parties. Intergovernmental arrangements (for example the European Stability Mechanism) that were created during the crisis are to become integral parts of the EU treaties.

Previous Cohorts’ Household Debt Was Much Lower

In a blog post, May Rostom documents that “secured debt is rising super-fast for the young.”

Over the life cycle, each generation accumulates household debt until reaching age forty or fifty, and repays afterwards. But the level of indebtedness (in real terms) has increased from cohort to cohort, and peak indebtedness has shifted to older age. The amplitude of the income paths has not changed to the same extent—“income growth has been unable to keep up with the pace of house price inflation.” Moreover, while “the younger groups have taken the lion’s share of the increase in debt from 1995-2012, … the biggest winners [when it comes to wealth accumulation] have been the older generations.”

Crime and Punishment

In a blog post, Alex Tabarrok argues that Gary Becker was wrong to argue that an optimal punishment system combines a low detection and punishment risk with a very severe punishment conditional on detection. Tabarrok argues:

We have now tried that experiment and it didn’t work. Beginning in the 1980s we dramatically increased the punishment for crime in the United States but we did so more by increasing sentence length than by increasing the probability of being punished. …

Why did the experiment fail? Longer sentences didn’t reduce crime as much as expected because criminals aren’t good at thinking about the future; criminal types have problems forecasting and they have difficulty regulating their emotions and controlling their impulses. … As if that weren’t bad enough, by exposing more people to criminal peers and by making it increasingly difficult for felons to reintegrate into civil society, longer sentences increased recidivism.

Instead of thinking about criminals as rational actors, we should think about criminals as children. … So what is the recommended parenting approach? … one thing all recommendations have in common is that the consequences for inappropriate behavior should be be quick, clear, and consistent.

Credit Default Swaps

In a set of slides from Deutsche Bank Research (from 2011), Kevin Körner discusses credit default swaps and the sovereign default probabilities implied by these swaps.

The CDS spread amounts to the insurance premium a protection buyer pays to the protection seller; it is quoted in basis points per year of the underlying security’s notional amount; and it is paid quarterly. In the event of a default on the underlying security, the protection seller effectively must pay one minus the recovery rate on the security (the protection seller pays the notional amount and receives the security).

Example: A CDS spread of 339 bp for five-year Italian debt means that default insurance for a notional amount of EUR 1 m costs EUR 33,900 per annum; this premium is paid quarterly (i.e. EUR 8,475 per quarter).

“In equilibrium,” the present discounted value of premium payments (up to the maturity of the underlying security) corresponds with the present discounted compensation payments by the protection seller (up to maturity).

Current data.

Effects of Fiscal Tightening on Growth

In a Peterson Institute policy brief, Paolo Mauro and Jan Zilinsky argue that

the evidence is mixed: Those who hold a prior that fiscal adjustment is harmful for growth may find their beliefs confirmed, whereas those who believe a prior that the link is weak may find the evidence unconvincing (even aside from valid concerns about causality). To the extent that the case of Greece involves unique features beyond large fiscal adjustment, the data reveal that drawing conclusions from empirical associations that include this specific case requires caution.

Policy Priorities of French National-Front Majors

The Economist identifies three main policies that National-Front politicians implement in municipalities after they get to power:

  • Reaffirmation of Christianity,
  • security clamp-downs, and
  • spending cuts.

Residents in towns run by a NF major “are happy with their mayor, citing cleanliness and security as chief reasons.”

Three Trillion Trees

There are about 3 trillion trees on Earth, or roughly 400 per capita, according to estimates published in Science. Nearly half of the trees stand in tropical or subtropical forests. In a typical year, 15 billion trees are cut down. At the start of human civilization, the number of trees was approximately twice as high as today.

Time

In a science brief, The Economist covers the mystery of time.

In 1887, Albert Michelson and Edward Morley found to their surprise that the speed of light traveling in different directions relative to the movement of the earth’s surface is constant. In 1905, Albert Einstein provided an explanation—his special theory of relativity—for the constancy of the speed of light. Time is “malleable, passing differently in different places, depending on how those places are moving with respect to one another. Indeed, at the speed of light, it stops altogether.” In 1915, Einstein argued in his general theory of relativity that space and time are connected and that they interact with mass.

As a consequence of the second law of thermodynamics (temperature differences tend to vanish, Ludwig Boltzmann, 1877) “any system will become more disordered as time passes. That applies as much to two gases mixing as it does to a teenager’s bedroom.” In 1927, Arthur Eddington drew the conclusion that time is unidirectional: There is a fundamental asymmetry between a system moving towards the future (increasing disorder) or the past (decreasing disorder).

Time travel is possible—in particular if one has easy access to “wormholes”—or so it appears. But the grandfather paradox lurks: Can one travel back in time and kill one’s ancestor in order to render one’s one birth impossible …?

Why Does Music Give Chills?

David Shariatmadari suggests some answers in The Guardian.

  • What’s happening? An “autonomic nervous system arousal, the evolutionarily ancient preparation for fight or flight.” Plus a positive emotional component, related to brain activity and dopamine release.
  • To whom? Not to everybody. According to some estimates, only to every second non-musician.
  • Why? Emotional experiences can be related to specific musical structures like “enharmonic changes” or “appoggiaturas” (examples given in the article), connected with unexpected, dramatic shifts that force the listener to pay attention. Add to this memories and “feelings of transcendence.” Maybe music helps to form bonds with other human beings or it played a role in the development of language. “Music simply taps into [linguistic ability] in the same way that drugs tap into a system that wasn’t designed for drugs”.
  • Example: “The last few minutes of Bach’s Mass in B Minor, the last page or so of the Dona Nobis Pacem.”

Family Constellations

A documentary on (German-language TV channel) SWR looked into “family constellations,” a

method which draws on elements of family systems therapy, existential phenomenology and Zulu attitudes to family…. a Family Constellation supposedly attempts to reveal a previously unrecognized systemic dynamic that spans multiple generations in a given family and to resolve the deleterious effects of that dynamic by encouraging the subject to accept the factual reality of the past. (Source: Wikipedia)

The documentary covers one session. It does not report on the substantial controversy surrounding the method and its proponents.

Some information in German: therapie.de; Wikipedia.

Corporate Taxes: Difficult International Coordination

The Economist discusses proposals for improved consistency of international company taxation with the aim to counter firms’ “profit shifting.” Harmonization does not seem to constitute a Nash equilibrium. Tax rates on “patent boxes” typically are much lower than the headline rates.

Real Estate as Retirement Asset?

How many years of care in a nursing home does a typical single family house buy? In Der Spiegel, Christina Elmer, Patrick Stotz und Achim Tack have done the math for Germany. Accounting for price variation in care and real estate yields large regional differences: 3 years in poor regions in Eastern Germany versus 40 years in downtown Munich (see the map in the article).

 

“Politico-Economic Equivalence,” RED, 2015

Review of Economic Dynamics 18(4), October 2015, with Martín Gonzalez-Eiras. PDF.

Traditional “economic equivalence” results, like the Ricardian equivalence proposition, define equivalence classes over exogenous policies. We derive “politico-economic equivalence” conditions that apply in environments where policy is endogenous and chosen sequentially. A policy regime and a state are equivalent to another such pair if both pairs give rise to the same allocation in politico-economic equilibrium. The equivalence conditions help to identify factors that render institutional change non-neutral and to construct politico-economic equilibria in new policy regimes. We exemplify their use in the context of several applications, relating to social security reform, tax-smoothing policies and measures to correct externalities.

Ukraine Restructures Its Debt

In the FT, Elaine Moore and Neil Buckley report that Ukraine secured a restructuring deal with its creditors. The deal includes a 20% haircut on some bonds as well as new GDP-linked securities. The FT writes:

The IMF alluded to the uncertainty in early August when it reiterated that although it expected Ukraine’s debt operation to be completed, it was willing to support the country even if debt discussions failed and a moratorium was imposed. However, the repercussions of Ukraine defaulting on its debt would have been severe. Ukrainian bonds, issued under English law, contain cross-default clauses that mean missed payments on one can trigger default on all, allowing bondholders to demand repayment, drag a country into lengthy legal battles and exacerbating existing economic problems. … If Ukraine succeeds in a debt restructuring it could plausibly return to international debt markets within a yea r… Market prices for Ukrainian bonds have recovered in recent weeks as hopes rose that the country would avoid default …

EU Tax Blacklist

The Economist reports (somewhat belated) about a blacklist put together by the European Union. The EU list aggregates lists of member states which applied different criteria and in parts were outdated. The Economist writes:

As pressure has mounted, however, Brussels has backtracked. At a meeting with the 30 ostracised states last month, it agreed to make clearer reference to efforts that some of them have made to adhere to new tax-transparency standards—though it is not clear if it will ditch the “non-co-operative” label.

Commuting into Switzerland

In the NZZ, Simon Gemperli reports about updated statistics on “Grenzgänger,” people residing outside of Switzerland but commuting into the country for work (press release by the Federal Statistical Office). About 300’000 people fall into that category. Since 2001, their number has doubled while the number of resident foreigners in Switzerland has increased by 25 percent and the total resident population has grown by 12 percent.

At the end of 2014, 8.2 million people resided in Switzerland; 2.0 million of them were non-Swiss (source).