RBI Governor resigns

The resignation of Dr. Urjit Patel was a surprise. The public had assumed that the risk of his mid-term resignation had passed.

It is an embarrassment to the Government that the RBI Governor resigned midway (2/3 of the way) through his term, even though officially it is for personal reasons.

Human nature – and the nature of the media – is to connect things chronologically and then call it cause and effect. A happened before B and therefore A must have caused B. That is how we (humans) make decisions.

In that sense, there was a public spat; there was a rumour of resignation linked to the public spat and then he resigned. So, the public spat was the cause of the resignation. This may or may not be true. There may be genuine personal reasons but this is how it will be perceived.

Of course, the spat became public because of DG Viral’s speech and that the speech was encouraged by the Governor, as per DG Viral’s footnote. Before that, the disagreements between GoI and RBI were rumoured or speculated upon but not officially confirmed by the Government.

DG Viral’s speech confirmed the disagreement. The government did not join the argument in public except for tweets by some in the government or close to the government.

But, the government did not deny the differences. The government was right in some of the issues it had with the central bank. The RBI Balance sheet reserves are excessive but Prompt Corrective Action and the tightened norms for ecognition of bad loans should continue. Demands to dilute them should be dropped. Structural reforms to the banking system are necessary. For public consumption, the government and RBI coud have played the good cop-bad cop routine with communication lines open on either side.

Further, the government cannot report 7.0% to 8.0% GDP growth and yet demand substantial easing of monetary policy. Either the growth numbers are wrong or that the demand is unjustified. I had mentioned this on a few occasions and more recently in last week’s column.

All that being said, as I had written in my blog, in a public dispute between politicians and so-called ‘disinterested’ technocrats, sympathies will be with the technocrats or they will be orchestrated in favour of technocrats. They will be seen as defenceless, vulnerable and hence the underdog.

Given these circumstances, the resignation of the Governor of the RBI will be viewed as the triumph of the bully, whether justified or not, whether reasonable or not and whether true or not.

The earlier Governor did not seek a second term after (not necessarily because of that) a spate of relentless criticism from leaders identified with the ruling party. Coming on top of that, this resignation, rightly or wrongly, will be viewed as the inability of the present government to handle so-called independent institutions with maturity.

Going forward, the Government has to handle the situation carefully; it should not make any defensive statements but acknowledge that the resignation of the governor of the central bank with nine months to go in term 1 is not in the best interests of macroeconomic stability of the country.

The government has to state the following:

We have worked hard to restore macroeconomic stability to the country in the last four years after the turmoil and economic mismanagement of the previous five years. We attach paramount importance to its preservation and continuity. It is critical for achieving sustained high economic growth and employment generation. We will not do anything to destroy macroeconomic stability.

We understand that the credibility and competence of the central bank are critical to the maintenance of macroeconomic and currency stability. We support unequivocally and stand for maintaining the integrity, competence and credibility of the central bank.

We will soon appoint a Governor who will enhance the well-deserved reputation of the Reserve Bank of India for competence, integrity and policy independence.

Then, it needs to make the next appointment that reinforces and vindicates the above sentiments.

A dispassionate look at RBI revaluation reserves and other demands of GoI

On November 19, the Board of Directors of the Reserve Bank of India met and agreed to constitute an expert committee to determine the appropriate level of economic capital that the central bank must hold. So, now, all of us have the time to evaluate the issue more objectively.

Niranjan Rajadhyaksha (former Senior Editor at MINT and a good friend) wrote a column in MINT which basically gave the following message:

  1. The equity plus contingency reserves have hardly increased
  2. Revaluation reserves have reflected growing FX holdings
  3. Comparisons with other countries is really not useful unless we understand the specific institutional arrangements.
  4. The government has really not given us a solid argument other than RBI has more capital as a proportion of BS than other CBs.

Few days later, just on the day of the RBI Board Meeting, MINT published an excellent interview with economist Indira Rajaraman. 

She said the following:

I think in a lot of what RBI does, there is this sense—I am not attributing it to the present governor—an institutional sense that there are things that have to be done in public interest which the public cannot quite comprehend. That has to go. I think there has to be a sense that the public can understand if they are made to understand.

The questions that North Block is raising exhibit a fairly nuanced understanding of a number of issues. Let’s say the 12 issues that were raised by the government in the three letters to RBI. I was quite surprised at the depth of understanding in North Block of the various issues and in particular on the reserves issue. I think it was time the question was asked and RBI was made to defend its particular level of reserves.

Mr. Malegam, who is considered a high priest on the reserves issue as he has been on the board for so many years and has chaired a couple of committees on it, has said that under Article 58 of the RBI Act, there is no provision for transfer of reserves to the government. I do not agree with him there.

Yes; of course, in Article 58, there is no explicit provision for transfer of reserves, but then again, there is no provision that reserves must not be transferred. There are a lot of things unsaid in the legislation and for the government to have identified that hole and to say that there is possibility of transfer and tell us why you cannot transfer. 

In addition, there have been many regulatory lapses during the last year which have led to a sense among the ministry of finance and educated watchers that the regulatory plumbing needs to be overhauled.

For instance, the RBI annual report is a submission of the board of RBI to the ministry of finance and not of the RBI management to the ministry of finance as was the general impression.

The annual report used to be placed in the draft form for a 15-minute examination by the board before it was pulled away for finalization. I used to speak up and tell my board members that this is going from us and we should read this. In the four years, I was probably the only one who insisted on a draft and having a video link with RBI in Mumbai with my comments on every page of the draft.

I am sure I was considered a nuisance but I took my responsibilities seriously as a board member of RBI and wanted that the annual report should be accurate portrayal of RBI’s functioning.

The board for a long time was not aware of its powers. In a certain sense, this confrontation has brought to the fore the role of the board, its powers and responsibilities and made the management more aware that they are accountable.

RBI has to engage as its actions impinge on everyone in the country. There has to be more transparency and more willingness to talk to people who do not understand the intricacies but are still in need of an explanation.

I don’t think they are just motivated by the fiscal concern. There is the liquidity concern also which could be termed as in the public interest.

The important thing is that RBI has to look into each issue on its merit.

For instance, on the liquidity issue, the government asking for a calculation of the liquidity squeeze, or asking why does the central bank think that liquidity is adequate; I think the ministry of finance is perfectly justified in it. [Link]

Given her intellectual depth and breadth of experience, her own previous association with RBI and her final wish for this institution to be nourished and cherished lend her criticism of RBI a far greater authenticity and credibility than that of the many unthinking, reflexive defences of RBI.

Revaluation Reserves:

Revaluation Reserves are gains accruing from the rise in the value of the foreign currencies and gold agaisnt the Indian rupee. That is why it has swelled to about 25% of the Forex and Gold Reserves.

In general, for India, the revaluation reserve will only keep rising. The rupee has a history of depreciation and for the right reasons. India is productivity and scale challenged. Hence, it is export-challenged and hence, it is current-account challenged.

Therefore, the risk that a sharp appreciation of the rupee will erode the value of the foreign currency assets that RBI holds and hence, it should be adjusted against the revaluation reserves is rather remote for the foreseeable future.

Revaluation reserves have reflected growing FX holdings – that is factually correct. Revaluation profits will keep occurring with a currency that is a ‘depreciating unit by default’. India’s revaluation reserves at about 26% of RBI’s Foreign Currency and Gold Reserves is too high.

Bank of Brazil’s revaluation reserves are a very tiny portion of its foreign exchange reserves. Indeed, Bank of Brazil’s overall equity (capital + reserves) is rather modest. [Link]

In contrast, Bank of Russia’s capital is nearly 37% of its balance sheet size! Bank of Russia does not give breakdown of its capital into capital and reserves.

People’s Bank of China Balance sheet for 2017 shows that the bank has far too tiny a capital base and no revaluation reserves.  The Chinese yuan does appreciate more often and in greater magnitude than the Indian rupee does. It has a huge cache of foreign exchange reserves which loses value whenever the yuan appreciates. Yet, they do not have revaluation reserves. See here.

So, the question arises as to why India has such a large revaluation reserve of around 26.2% of its total foreign assets (INR6916.41 billion against total foreign securities of INR7983.89 billion + INR18366.85 billion as of June 30, 2018). On top of this, there is a contingency reserve of INR2321.08 billion. [Link]

There is an interesting article in ‘India Express’ (ht Usha Thorat, former RBI Deputy Governor) published on November 19, 2018, written by P. Vaidyanatha Iyer:

In June 1994, while finalising its balance sheet, the RBI realised it was unable to provide for the exchange loss liability on account of a foreign currency deposit scheme offered by banks since 1975. …

The scheme was called the Foreign Currency Non-Repatriable Deposit Scheme, or FCNR-A, and was introduced to attract capital inflows and help finance deficit in the current account. Prodded by the government, banks offered interest rates higher than what they offered on local deposits. These deposits ballooned in the 1980s.

The RBI had agreed to provide exchange guarantee on these deposits. It didn’t think too much into the future then, and had a simple rationale: the dollars were added to foreign currency assets, these were revalued when the rupee depreciated, and so the revaluation gains would be available for meeting losses during repayment of principal. The interest to be paid on the FCNR-A deposits would be met through earnings on the dollars invested abroad.

But then, India was hit by a Balance of Payments crisis in the late 1980s. According to sources familiar with the developments then, the forex assets depleted fast and even the $1.1 billion of assets in 1991 represented dollars sold forward under a separate swap arrangement with State Bank of India. The losses from 1991 till 1994 were met by drawing from the Exchange Equalisation Account and the Contingency Reserve of the RBI. By 1994, both these reserves were fully depleted, and there was no source for providing for exchange losses on $10-billion worth dollar liabilities under the FCNR-A scheme.

The FCNR-A liabilities comprised $5 billion in principal and $5 billion in accrued interest. The average rate at which these dollars were bought was about Rs 16 a dollar. In 1994, the exchange rate was almost double at Rs 31.37, meaning the RBI had to bear a loss of Rs 15 more on every dollar. The total loss added up to Rs 1,500 crore. [Link]

Now, we understand the situations for which the revaluation reserves and contingency reserves were put to use, earlier.  But, since then, RBI does not offer exchange rate guarantees. Commercial banks bear the risk when they attract dollar deposits.

The ‘Usha Thorat Committee’ had recommended a total of 18% of assets for both revaluation reserves and contingency reserves. Actually, the denominators are slightly different. The ‘Currency and Gold Revaluation Reserve Account’ of 12-13% is calculated against foreign curency assets and gold holdings whereas the Contingency Reserve of 5% is on overall assets. Foreign currency assets constituted roughly 73% of total RBI assets as of June 30, 2018.

I understand from reliable sources that contingency reserves are held by the Reserve Bank of India for the following reasons:

  • when market intervention operations cost more than the anticipated;
  • for shortage in deposit insurance fund;
  • for any cyber security risk;
  • for ‘lender of last resort’ function and
  • if there is no transfer to GoI because of above contingencies, then it could affect fiscal math -hence some minimum profit transfer to GoI had to be assumed by RBI each year for better fiscal management by the Government

The Economic Survey of 2015-16 had recommended that total reserves be 16% of RBI assets, reduced from 32% (Box 1.6, Chapter 1, p. 19, Economic Survey 2015-16) and wanted the ‘excess reserve’ be used for bank recapitalisation. [Link]

So, even if the government fiscal math was behind the recent clamour for RBI’s ‘excess’ reserves, it is not unreasonable because the fiscal math was not undone by any reckless spending on the part of the government but because of the introduction of Goods and Services Tax, because of the failure of investment cycle to kick in, leading to higher economic activity and tax revenues, etc. Further, although bank recapitalisation charges were not reckoned with for fiscal deficit calculations, interest paid on the amounts would be added to the government expenditure.

Indian newspapers today have flagged a recent Bank of America – Merrill Lynch report which mention the excess reserves that RBI could potentially transfer to the Government of India. The report puts the figure between 1,00,000 crores of rupees and 3,00,000 crores of rupees (INR 1.0 trillion to INR3.0 trillion). See here.

So, there is a case for cooler heads and some transfer of excess reserves from the Reserve Bank of India to the Government of India.

How does RBI pay this to GoI?

My proposal is this:

Let a certain portion of the Revaluation Reserves be written back to the Income Statement every year, over 3 to 5 years. Then, it can be paid along with the profits for the year to GoI. To be sure, during this period, the revaluation reserves may increase if the rupee depreciates. Then, the duration may get lengthened. So, be it. Amortizing the payment to GoI over a period is the least-disruptive way to reduce the Revaluation Reserves from its current ‘excessive’ level to a comfortable level and also avoid the accusation that it is a short-term expedient for the present Government.

What about the other demands of the Government of India?

Ananth Narayan has neatly listed the government demands in his latest article in ‘Economic Times’:

  • The government wants the RBI to relax lending restrictions on the notionally weak banks that are under RBI’s Prompt Corrective Action (PCA) framework.
  • It wants RBI to provide forbearance (in other words, to close its eyes) on stressed loans, particularly to the power and micro, small and medium enterprise (MSME) sectors.
  • It wants to access the capital on RBI’s balance sheet.
  • Finally, it wants the RBI to provide relief to stressed non-banking financial institutions (NBFIs).  [Link]

We have dealt with no. 3 in the list in this blog post.

On the other three demands, my suggestion is that the Government should bite its lips and not interfere with the central bank’s current stances. After all, they are the extension of the structural reforms that the Government itself had undertaken – willingly or otherwise.

It did demonetisation; it introduced the Goods and Services Tax; it enacted the Insolvency and Bankruptcy code and it passed the Real Estate Regulation Act. All these mean discontinuity with the status quo that had prevailed for the previous sixty-seven years. Similarly, regulatory forbearance has been the practice of the previous sixty-seven years. In these areas, RBI is wanting to signal a change. It is welcome. It is painful in the short-term. The government has to bite its lips and face the short-term growth disruption and the complaints of its core constituencies who might be affected.

To offset the political damage, the government must take the case to the people, as it did in the case of demonetisation. It must market itself as the champion of long-term structural reforms for the good of the nation, sacrificing its own personal and political interests in the short-term for the good of the nation.

Not easy but do-able. 

What should RBI do on its part?

It must come off its high horse and admit to failings in its regulatory architecture and practice. It should listen to Indira Rajaraman. As Dr. Y.V. Reddy said in a speech in February, it must come out with a white paper on non-performing assets, detailing its own failings. It must accept to regulatory shortcomings with respect to detecting frauds such as the one that happened in Punjab National Bank. The case of IL&FS highlighted failures in the regulation of non-banking finance corporations. It must be candid; admit to its inadequacies and failures, resolve to address them and outline steps it will be taking to do so, with clear timelines. It must report to the public on the progress of the redressal measures and close them within a reasonabel time-frame. 

As importantly, it must use the opportunity to address consumer issues as highlighted by Debashis Basu in this article in ‘Business Standard’ recently.

Why did RBI make the dispute public?

I had written my MINT column on the speech by Viral Acharya on Saturday in Mumbai wherein he had teased, taunted and dared the government to undermine RBI independence, warning that the financial market dogs would ferociously leap on it, if it dared to do so. It was way over the top. Plus, independence is not just about independence from the political executive but also from financial market interests. Most global central banks are captured by finance.

Someone formerly associate with RBI liked the last line of my column but said that the RBI might have been pushed into a corner. I still think that a public fight does both of them no good and that country is the loser. Therefore, the country is the loser. Someone has to be wiser and  more mature and rise above their egos and turf issues and patiently whittle down the resistance.

But, that said, the government has made tactical errors. It has failed to realise that it simply cannot emerge the winner in a public battle with the central bank. That is probably the reason why Viral Acharya took it public, at the behest of the Governor, perhaps.

The optics are simply not in favour of the government. It will be seen always as a bully, abusing its powers, for its short-term political gains, riding roughshod over innocent professionals, with no political axe to grind, quietly performing national service and taking care of the country’s long-term interests. It is an unequal battle and public sentiment will seldom be on the side of the bully.

OF course, it is more so in the case of the suited-booted folks who would always come down on the side of ‘people like ’em’. There again, the government will lose in the battle for the affection of the so-called ‘opinion-makers’.

The Congress Party had internalised it very well. They were sophisticated. Their pressures were silent and subterranean. Remember what Rakesh Mohan wrote in ‘Business Standard’. I had blogged on it. He said that the number of government nominees on the Board was increased in 2012 when Department of Economic Affairs was split and the Department of Financial Services was created. It did not have a discussion in Parliament. I mention it in the MINT column too.

Then, there are substantive issues. By no stretch of imagination can it be said that there is no bad debt problem in India and that it is the concoction of RBI by its reckless application of Basel norms.  It won’t fly anywhere. The evidence is overwhelmingly against such an outrageous claim.

Second, if the government claims that it is the world’s fastest growing large economy, why is it worried about liquidity tightness?

Third, the government should actually be working with RBI quietly and even claiming that it is sacrificing short-term political gains for the long-term by pushing for the culture of bad, reckless and ill-judged lending by public sector banks, to end. Thus, it should back ‘prompt corrective action’ and make a virtue out of it.

This is what I said in my BloombergQuint interview and they had misrepresented it in the headline but got the bullet points mostly right:

Government Can Use RBI As A Shield, Says V Anantha Nageswaran

The government is using the central bank as a shield to get reforms in place,

(I said: the government should use RBI as a shield – fire from behind them, sort of, and use it as a bulwark to make the long-term case) instead of using it as a bulwark to make the case for long-term priorities, said V Anantha Nageswaran, the dean of IFMR Business School (Krea University).

  • Pressure on the RBI must be very high for Viral Acharya to have made the speech
  • Benefit of doubt will always go to central bankers, and not to political leaders
  • There’s a way to guide the central bank with finesse, without creating a crisis
  • The real issue with RBI’s reserves
  • The government wants comfort on fiscal deficit, RBI wants to maintain sufficient reserves
  • Government should be using the RBI as a bulwark to make the case for long-term priorities
  • In fact, the government can use RBI as a shield, to get reforms done
  • There are issues to reflect on from the RBI’s point of view
  • Obvious that both sides should react with more maturity [Link]

Fourth, regardless of whether the RBI has excess reserves, it cannot be returned to the government through a public dispute and through fractious Board meetings. Softly, softly has to be the approach. Having battering rams in the Board won’t help but hurt the image, hurt the currency and hurt the bond price, handing a defeat to the government in more ways than one.

All this being said, I liked the pieces by Mythili Bhusnurmath, by Saugata Ghosh and T.T. Rammohan on the ongoing dispute.

But, I think I have understood why RBI brought the issue to the public, no matter how bad it is for the national image. The government cannot win in a public battle because a public battle is a perception battle. The government has to show finesse and sophistication. But, those are two more of the deficits of this government – along with talent – and, come to think of it, they could be India’s deficits too.

Two years of Patel, the RBI Governor

My friend Gulzar Natarajan drew my attention to an article by Andy Mukherjee and an Edit in MINT on the second anniversary of Dr. Urjit Patel as the Governor of the Reserve Bank of India. I had read the Mint Edit myself.

Andy’s piece is an interesting one. I do not recall readily if he had been critical of the RBI Governor’s role in demonetisation and in the ‘Reverse Bank of India’ moniker that was slapped on the institution in the initial weeks and months of the demonetisation exercise. My vague recollection is that he was. But, in any case, this amounts to a retraction of such criticisms, if he had made them earlier.

More substantively, the Governor has breathed some credibility into the Monetary Policy Committee (MPC) and the Non-Performing Asset (NPA) resolution mechanism. Arguably, he had to take tougher decisions on these than his predecessor. During RR’s period, the NPA problem was beginning to come to light. Very few had a clear idea of either the dimensions or the complexity of the problem. Of course, RR took the bold call to order Asset Quality Reviews (AQR) which allowed both of the above to be revealed. That was very important at that time. Now, Dr. Patel has to navigate the political economy of resolution which is perhaps a stiffer challenge than the political economy of disclosure. May be, I am just splitting hairs, here.

Also, the other challenge that Dr. Patel is facing is the Fed tightening and an ‘election-mode’ government both of which, collectively, bring pressure on the fiscal, current account balances and consequently on the Rupee. Popular commentary on the Rupee weakness is unhelpful to the Governor.  It bleats about the Rupee weakness as though it is a problem in and of itself. It is not. The problem is with the underlying low productivity of the economy – especially in its farm and factory sectors. On top of them, fiscal policy has quietly but steadily slipped at a general government level.

Collectively, the farm loan waivers announced by State governments – BJP and Congress-Ruled – have been more than two and half times the farm loan waiver that the UPA-1 government had announced in 2007-08. The general government fiscal deficit for 2017-18 is 7.0% as per IMF estimates. The two rate increases in June and August announced by the RBI are very important and may prove to be very important and useful in ensuring monetary and exchange rate stability.

As for macroeconomic stability, it is in the hands of the Government and not the RBI. Raghuram Rajan was right to stress its importance going into an election, in his Bloomberg interview at Jackson Hole recently.

In short, yes, the Governor has quietly re-established his personal credibility and that of the institution he heads and that can only be good news for the country.

[Post-script: Tamal Bandyopadhyay adds his two cents worth of tribute to Urjit Patel while Amol Agrawal provides the much-needed alternative perspective]

The hole in Jackson Hole

Read the speech delivered by Jerome Powell, the Fed chairman at the Kansas City Symposium – an annual jamboree of central bankers in Jackson Hole, Wyoming. He has said all the right things only to either discount them later or to ignore them.

For example, he recalls the Brainard principle:

Brainard principle, which recommends that when you are uncertain about the effects of your actions, you should move conservatively. In other words, when unsure of the potency of a medicine, start with a somewhat smaller dose.

This is perfectly valid in the case of QE. But, precisely that is what he goes on to defend, in the next sentences.

He correctly notes:

in the run-up to the past two recessions, destabilizing excesses appeared mainly in financial markets rather than in inflation. Thus, risk management suggests looking beyond inflation for signs of excesses.

But, he reserves the brave words ‘whatever it takes’ only to fight unanchored inflation expectations and financial crises of the type we encountered in 2008. If financial excesses precipitated the last two recessions, one would expect the Fed leadership to pledge to do whatever it takes to avoid building up financial excesses. But, he did not say that.

In the meantime, signs of financial excess abound. We documented one yesterday.  Here is another:

Before the financial crisis, about a quarter of the leveraged loan market was termed “covenant-lite”; today it stands at almost 80 per cent, according to Moody’s. Almost two-thirds of the entire market now has a lowly credit rating of B2 or worse, up from 47 per cent in 2006. In other words, an already junky market has deteriorated further…..

More than half of loan issuers have zero “unsecured” debt that could insulate lenders from the pain of a debt default, AllianceBernstein pointed out in a report this week. [Link]

Alliance Bernstein pointed out,

investment-grade credit quality got worse. Today, 48% of the bonds in the index are rated BBB, the lowest rung on the investment-grade ladder, up from 33% at the end of 2008. A-rated bonds declined from 50% to 41% over that time. [Link]

Channelling Greenspan for risk management makes one wonder if the Federal Reserve has learnt anything from the mistakes it made in the last twenty years because ‘the once in a lifetime improvement in productivity’ that Greenspan swore by, proved to be a chimera.

But, there are cheerleaders for a policy approach that avoids dealing with financial excesses. See this, for example.

John Authers of FT thinks that the overall message of Mr. Powell’s testimony at Jackson Hole was dovish in tone. May be, he is right.

The more things change, the more they remain the same.

Monstrous non-sense

Martin Sandbu, I think, outdoes himself in his latest column. He says that central banks were not loose enough in the years following the crisis as, even after the latest Trump tax cut stimulus in the US, inflation rates are not picking up and therefore, spare capacity was much higher. If only central banks had been bolder, the negative output gap would have closed much earlier!

The certitude here is indeed breathtaking. It took my breath away for a minute. I just did not know where to begin.

The simple truth is that monetary policy has been completely orthogonal to the real economy developments after the crisis. The economies of America and Europe have recovered on their own because monetary policy has been so loose for so long that such a belated recovery cannot be attributed to policy effectiveness.

It is wrong to argue that central banks had not done enough. By April 2010, the S&P 500 had nearly doubled (up 81%) from its low in February 2009. The 10-year bond yield had crashed from 4.0% to 2.0%. Everytime it threatened to rise above 4.0%, the Federal Reserve did QE2 and QE3. It did not raise rates in 2014. In 2015 and in 2016, it raised rates by 25 basis points each – 0.5% in total in two years! Mr. Sandbu thinks that they were not bold enough?!

Monetary policy operates through financial market variables. Where was the wealth effect from these reactions in bond yields and in the stock market? Nothing.

Had the Federal Reserve been more reckless, it would have sent financial assets to even greater heights but to what effect on the real economy?

It would have only widened the inequality and the angst among the middle and lower classes. Hasn’t he seen the UK Housing Affordability Index released by the Office for National Statistics for 2017?

On average, full-time workers could expect to pay around 7.8 times their annual workplace-based earnings on purchasing a home in England and Wales in 2017, a significant increase of 2.4% since 2016.

Workplace-based housing affordability significantly worsened in England between 2016 and 2017, but there were no significant changes in Wales.

Housing affordability has worsened significantly in 69 local authorities in England and Wales over the last five years, with over three-quarters of these being in London, the South East and the East.

All but five London boroughs had significant worsening of affordability since 2012.

House prices and earnings increased in all English regions and Wales, but the two regions with the largest increase in house prices (the East (10%) and the South East (6.9%)), were the two regions with the significant differences over the year. This suggests that house prices are driving the significant worsening in affordability.

The affordability ratio has more than doubled for every property type in England from 1997 to 2017. [Link]

Right after the Brexit vote, the Bank of England had taken out a pre-emptive monetary policy accommodation insurance on top of the ultra-loose monetary policy that prevailed. Yet, Mr. Sandbu thinks that policy wast not loose enough!

Given continuously worsening affordability caused by asset price increases which are a consequence of monetary policy, does he reckon with the social and economic costs of his implicit recommendation that central bankers should have been more reckless than they already were? May be, Brexit would have been forced on David Cameron than him calling for a referendum on the matter.

May be, Trump would have won with an even bigger margin or Bernie Sanders would have won the Democratic Primaries notwithstanding all the attempts to stop him from winning it.

The Chicago Fed Financial Conditions Index is hovering near the easiest despite the Federal Reserve hiking interest rates gradually since 2015 (data as of July 27, 2018 was available at the time of writing this blog post). It only shows that the normalisation is proceeding at such a glacial pace that it is hardly registering on the financial conditions.

Graeme Wheeler, then Governor of the Reserve Bank of New Zealand said this in October 2015:

Monetary policy is, however, relatively powerless to influence the decisions that determine long-run economic performance and distributional outcomes. For example, over the long run, monetary policy can do little to generate higher spending by households and firms. Even in the shorter term, monetary policy’s influence may be low in an environment where debt levels are high and where there is considerable uncertainty about economic prospects.

Monetary policy can influence risk-taking in asset markets, but this does not necessarily translate into risk taking in long term real assets – requiring the investment and entrepreneurial decisions that underpin productivity growth and hence long-run improvements in living standards. [Link]

A gentleman (Ben Carlson) had posted a comment under Martin Sandbu’s column implicitly supporting him by providing a link to his blog post.

My comments on that are as follows:

(1) The Fed’s remit is, officially, not the stock market index

(2) Earnings improvements were a functioning of low interest rates as top lines did not improve much for quite some time after 2009. Federal Reserve policy was powerless to influence aggregate demand and real economy. See Graeme Wheeler’s comments.

(3) Most ordinary people save through bank deposits. They were robbed of their incomes even as asset prices went up.

(4) Household debt has fallen but corporate and other debt have risen significantly. Overall leverage of the U.S. economy has only increased despite the crisis having been caused by leverage

(5) The improvement in household networth says nothing about its distribution. For that, check out the work (‘A lost generation’) by the Federal Reserve Bank of St. Louis on whose networth has improved. Mr. Ben Carlson’s stock market performance would not make a difference to them.

(6) If one taunts the Fed sceptics that their criticism was a reflection of ‘sour grapes’, it is equally possible that one’s approval of Fed policy is a reflection of their personal riches. Social and public welfare consequences be damned.

Resilience of human irrationality, a I wrote in my MINT column two weeks ago, is remarkably strong.

Dodd-Frank and Matt Taibbi

Matt Taibbi will, forever, be remembered for the label, ‘Vampire Squid’ that he came up with, for Goldman Sachs. No matter what else he writes.  In passing, I should mention that Pratap Bhanu Mehta will be remembered for writing, ‘While we were silent’ in 2013 no matter how many times we disagree with what he writes.

Matt Taibbi’s take on the two major political parties in the United States features flawed logic. In fact, it contradicts his earlier piece on how Democrats helped pass the Bill that diluted the Dodd-Frank Act. More on that later.

The reality is that one can smell Republicans (the political party in the USA)/Conservatives from a distance: they want status quo to continue. No disturbances or perturbations (a jargon that economists love to use) to the staus quo. ‘Do not interfere’ is their message to the government – on social and on economic affairs.

Democrats, on the other hand, were supposed to be the party of the underdogs. Instead, they favoured Wall Street interests. They repealed Glass-Steagall and they helped pass Commodities Futures Modernisation Act that kept many financial products out of regulatory purview. They became a party of elites, by stealth. That is fradulent. In fact, he should go back and re-read his own piece, titled, ‘Obama’s Big sellout’ written in December 2009 or early 2010. It is no longer available in the ‘Rolling Stone’ site. But, I found an extract here.

Hence, calling Republicans a party of ‘open con’ does not cut it. It was and is open, all right. It is no con game. We know their agenda.

He then wrote a piece about “The Economic Growth, Regulatory Relief and Consumer Protection Act (Pub.L. 115–174, S. 2155), signed into United States federal law by President Donald Trump on May 24, 2018.”. It amended the Dodd-Frank Act or the Financial Stability Act, 2010.

He was right on some of the factual details. The word, ‘may’ has been changed to ‘shall’ in one place. True. Some limits have been increased from 50bn. to 100 bn. to 250 bn. US dollars, etc. But, he did omit some key aspects that lead us to a different interpretation.

The amendments do include the following:

(b) Rule Of Construction.—Nothing in subsection (a) shall be construed to limit—

(1) the authority of the Board of Governors of the Federal Reserve System, in prescribing prudential standards under section 165 of the Financial Stability Act of 2010 (12 U.S.C. 5365) or any other law, to tailor or differentiate among companies on an individual basis or by category, taking into consideration their capital structure, riskiness, complexity, financial activities (including financial activities of their subsidiaries), size, and any other risk-related factors that the Board of Governors deems appropriate; or

(2) the supervisory, regulatory, or enforcement authority of an appropriate Federal banking agency to further the safe and sound operation of an institution under the supervision of the appropriate Federal banking agency. [Link]

There is also a provision for ‘globally systemically important bank holding companies’:

(f) Global Systemically Important Bank Holding Companies.—Any bank holding company, regardless of asset size, that has been identified as a global systemically important BHC under section 217.402 of title 12, Code of Federal Regulations, shall be considered a bank holding company with total consolidated assets equal to or greater than $250,000,000,000 with respect to the application of standards or requirements under. [Link]

In plain English, S.2155 does not prevent the Federal Reserve from exercising its authority with respect to Bank Holding Companies where it deems necessary. The real issue is whether the Federal Reserve is keen. See here and here.

Amendments to the Dodd-Frank Act will not cause the next crash. That train has already left the station. If at all they do cause banks to take on more risks, it will be because theri capital requirements have not been raised enough and because the Federal Reserve has allowed monetary policy to remain too loose and interest rates to remain too low for too long.

Ultimately, it is all about appropriate pricing of capital and pricing it too cheaply and way below fair, risk-adjusted level is the biggest gift that the Federal Reserve continues to shower on the financial industry.

In another article, Taibbi makes the case for a Financial Transactions Tax in the United States. I endorse that, wholheartedly. He is right. But, he is pushing the envelope on facts when he writes that the European Union has already ’embraced’ it. That simply is not true. I wish it were true. It isn’t.

Read what he writes here and decide for yourself:

A financial transactions tax might help incentivize Wall Street to once again emphasize true long-term investment, as opposed to spending all day moving piles of money around. As with Medicare-for-all, it might take a while for Americans to accept an idea already embraced in Europe. [Link]

It is still in the works. Lo and behold, Brexit is supposed to have gummed it up, because it will be difficult to enforce in the UK that won’t be part of the European Union and hence financial transctions would migrate there. That is the logic for the dealy. So, FTT in Europe is still coming.

The lesson is that it has become impossible to read anyone and take what they write at face value, without doing some fact-checking oneself. Well, if you are reading this, remember that it applies to this blogger too!

So, caveat emptor!