Mercantilism in Spain
[This article is excerpted from An Austrian Perspective on the History of Economic Thought, vol. 1, Economic Thought Before Adam Smith. An audio version of this Mises Daily, read by Jeff Riggenbach, is available as a free download.]
The seeming prosperity and glittering power of Spain in the 16th century proved a sham and an illusion in the long run. For it was fuelled almost completely by the influx of silver and gold from the Spanish colonies in the New World. In the short run, the influx of bullion provided a means by which the Spanish could purchase and enjoy the products of the rest of Europe and Asia; but in the long run, price inflation wiped out this temporary advantage.
The result was that when the influx of specie dried up, in the 17th century, little or nothing remained. Not only that — the bullion prosperity induced people and resources to move to southern Spain, particularly the port of Seville, where the new specie entered Europe. The result was malinvestment in Seville and the south of Spain, offset by the crippling of potential economic growth in the north.
But that was not all. At the end of the 17th century, the Spanish Crown cartelized the developing and promising Castilian textile industry by passing over 100 laws designed to freeze the industry at the current level of development. This freeze crippled the protected Castilian cloth industry and destroyed its efficiency in the long run, so that it could not become competitive in European markets.
Furthermore, royal action also managed to destroy the flourishing Spanish silk industry, which centered in southern Spain at Granada. Unfortunately, Granada was still a centre of Muslim or Moorish population, and so a series of vindictive acts by the Spanish Crown brought the silk industry to its virtual demise. First, several edicts drastically limited the domestic use and consumption of silk. Second, silks in the 1550s were prohibited from being exported, and a tremendous increase in taxes on the silk industry of Granada after 1561 finished the job.
Spanish agriculture in the 16th century was also crippled and laid waste by government intervention. The Castilian Crown had long made an alliance with the Mesta, the guild of sheep farmers, who received special privileges in return for heavy tax contributions to the monarchy. In the 1480s and 1490s, enclosures that had been made in previous years for grain farming were all disallowed, and sheepwalks (cañadas) were greatly expanded by government decree at the expense of the lands of grain farmers.
The grain farmers were also hobbled by special legislation passed on behalf of the carters' guild — roads being in all countries special favorites for military purposes. Carters were specially allowed free passage on all local roads, and heavy taxes were levied on grain farmers to build and maintain the roads benefiting the carters.
Grain prices rose throughout Europe beginning in the early 16th century. The Spanish Crown, worried that the rising prices might induce a shift of land from sheep to grain, levied maximum-price control on grain, while landlords were allowed unilaterally to rescind leases and charge higher rates to grain farmers. The result of the consequent cost-price squeeze was massive farm bankruptcies, rural depopulation, and the shift of farmers to the towns or the military. The bizarre result was that, by the end of the 16th century, Castile suffered from periodic famines because imported Baltic grain could not easily be moved to the interior of Spain, while at the same time one-third of Castilian farm land had become uncultivated waste.
Meanwhile, shepherding, so heavily privileged by the Spanish Crown, flourished for the first half of the 16th century, but soon fell victim to financial and market dislocations. As a result, Spanish shepherding fell into a sharp decline.
Heavy royal expenditures and taxes on the middle classes also crippled the Spanish economy as a whole, and huge deficits misallocated capital. Three massive defaults by the Spanish king, Philip II — in 1557, 1575 and 1596 — destroyed capital and led to large-scale bankruptcies and credit stringencies in France and in Antwerp. The resultant failure to pay Spanish imperial troops in the Netherlands in 1575 led to a thoroughgoing sack of Antwerp by mutinying troops the following year in an orgy of looting and rapine known as the "Spanish Fury." The name stuck even though these were largely German mercenaries.
The once free and enormously prosperous city of Antwerp was brought to its knees by a series of statist measures during the late 16th century. In addition to the defaults, the major problem was a massive attempt by the Spanish king, Philip II, to hold on to the Netherlands and to stamp out the Protestant and Anabaptist heresies.
In 1562, the Spanish king forcibly closed Antwerp to its chief import — English woolen broadcloths. And, when the notorious duke of Alva assumed the governorship of the Netherlands in 1567, he instituted repression in the form of a "Council of Blood," which had the power to torture, kill, and confiscate the property of heretics. Alva also levied a heavy value-added tax of 10 per cent, the alcabala, which served to cripple the sophisticated and interrelated Netherlands economy. Many skilled woolen craftsmen fled to a hospitable home in England.
Finally, the breakaway of the Dutch from Spain in the 1580s, and another Spanish royal default in 1607, led to a treaty with the Dutch two years later, which finished Antwerp by cutting off its access to the sea and to the mouth of the River Scheldt, which was confirmed to be in Dutch hands. From then on, for the remainder of the 17th century, decentralized and free-market Holland, and in particular the city of Amsterdam, replaced Flanders and Antwerp as the main commercial and financial centre in Europe.
Keynes Was a Keynesian
Keynes Was a Keynesian
[The State of Interpretation of Keynes • By John B. Davis, ed. • Boston: Kluwer Academic Publishers, 1994. This review was originally published in the Review of Austrian Economics (1996)]
A half-dozen papers together with formal comments and an introduction have been assembled to help establish the state of interpretation of Keynes. The contributors to this volume are ideologically like-minded but geographically diverse (Australia, Brazil, Canada, Great Britain, Italy, and the United States are represented). Their book, whose title belies a certain narrowness of focus, is not for everyone; it reflects the concerns of one particular Keynesian school, best described, in my judgment, as post-Keynesian fundamentalism.
Academics who continue to be amused and intrigued with the still-growing literature on the economics of John Maynard Keynes have had to learn to distinguish among the several different schools that draw inspiration from the master.
Hyphenated or adjectival Keynesianism includes, for instance, both neo-Keynesianism, which is based on an assumed wage and price stickiness, and new Keynesianism, which attempts to explain the stickiness. Neo- and new Keynesianism share certain methodological presuppositions with neo- and new classicism but do not share in the judgment that markets are generally self-equilibrating.
Interpreters who prefer to blend Keynes's ideas with those of the old classical school, which featured a cost-based production theory, have adopted "post" as their adjective of choice.
Readers of this literature have been asked to maintain a distinction between "post Keynesianism" and "post-Keynesianism" — a distinction as subtle as the difference in labeling.[1] But whatever the particular labeling, most interpreters have come to see as virtual opposites Keynesian Economics and the Economics of Keynes, as contrasted in the title of Axel Leijonhufvud's 1968 book.
Murray Rothbard used to proclaim gleefully that "Keynes was a Keynesian."[2] He took great pleasure in the irony that by so proclaiming he set himself apart from most all modern interpreters. Keynes favored monetary manipulation and fiscal activism, deficit finance and income redistribution, all for the purpose of spending our way out of depression. When his attention turned from short-run policy to long-run reform, his enthusiasm for these stop-gap measures gave way to his anticipations of a future utopia — and to schemes for ensuring and hastening its arrival.
The inherent uncertainty of the future, in his view, gave centralized decision making a clear advantage over the decentralization that characterizes market economies. Keynes advocated the "socialization of investment" and the "euthanasia of the rentier." The rate of interest, which "rewards no genuine sacrifice," could and should be driven to zero, at which point capital would cease to be scarce and the distribution of income would be more equitable. In a matter of two generations, the economic problem of scarcity can be solved, such that our grandchildren can occupy themselves with questions of aesthetics rather than questions of economics.[3]
This is the uninterpreted Keynes. Post Keynesians emphasize Keynes's vision of utopia and the associated reform proposals almost to the exclusion of his diagnosis of depression and prescription of short-run, demand-management policies. In fact, standard textbook Keynesianism, whose graphics and equations make the case for monetary and fiscal activism, are repeatedly described in the Davis volume as "bastardized Keynesianism" (Joan Robinson's term) so as to provide an appropriate contrast with the more radical Keynesianism adopted by the volume's contributors. If "post Keynesians" did nothing but embrace these utopian aspects of Keynes, they would more accurately be described as Keynesian fundamentalists.
But they do more. They add to the chronic demand deficiencies featured in Keynes's General Theory the ideas about supply first articulated by the classical economists and subsequently exhumed by Piero Sraffa just before the Keynesian Revolution. Sraffa's Production of Commodities by Means of Commodities, written during the 1930s, though not published until 1960, is offered as the supply-side counterpart to Keynes's demand-side theorizing.
Michael Lawlor's contribution, "The Own-Rates Framework as an Interpretation of the General Theory: A Suggestion for Complicating the Keynesian Theory of Money," identifies Sraffa's (ill-tempered) review of Hayek's Prices and Production as the foundation underlying this new approach to monetary theory adopted by Keynes. As a duo, however, Sraffa and Keynes give us an unlikely and ill-fitting rendition of supply and demand.
Post Keynesians typically — but not in the volume under review — suggest still more complications: a dual market structure consisting of both competitive and oligopolistic firms, mark-up pricing (practiced by the oligopolists) to finance new investment, and Marxian class conflict. The Davis volume avoids what would otherwise appear to be a hopeless grab bag of ideas by focusing on Keynes — his vision, philosophy, methods, analyses, and tactics.
One of the formal comments (Allin Cottrell's) even includes a warning against perceiving Keynes as "a closet post Keynesian, harboring all kinds of heresies but suppressing them for the sake of perceived polemical advantage!"
Another comment (Robert Prasch's) questions the idea that Sraffian supply fits well with Keynesian demand. If Keynes thought it did fit well, why did he not say so? Why did he say, instead (in his often quoted letter to George Bernard Shaw), that "when my book has been duly assimilated and mixed with politics and feelings and passions,… the Ricardian foundations of Marxism will be knocked away"? Prasch is persuasive that what Keynes believed would be "knocked away," here, was Sraffa. If the grab-bag features of post Keynesianism are left undiscussed while the relevance of Sraffa is in some doubt, then the term post-Keynesian fundamentalism seems appropriate.
Further, the volume's editor, if not all the contributors, may not be so tightly bound to the "post," in which case we would be back to the uninterpreted utopian Keynes.
It is one thing to proclaim that Keynes was a Keynesian, (again) as Rothbard so often did; it is quite another to treat Keynes's vision as a relevant or fruitful reflection of economic reality. But The State of Interpretation of Keynes will strike the reader as something of a stocktaking; the papers constitute background reports that form the basis for updating the post Keynesians' research agenda. As explained in the editor's introduction, Keynes's ideas deserve — and now may get — a fresh hearing.
The particular occasion for this stocktaking, together with the particular focus of several of the papers, is both curious and revealing. There are two circumstances that have combined to put the original Keynes back in the limelight.
First, there is the crumbling of bastardized Keynesianism, with its graphical apparatus and algebraic expression of government-spending multipliers and tax multipliers and all that. Neoclassical modes of thought have long restricted the thinking of mainstream economists and have made Keynesian economics look very un-Keynesian.
Recent trends, according to Davis, have been in the direction of flouting the strictures imposed by formal neoclassicism and exploring a number of issues, including those of power and entrepreneurship. Methodological permissiveness may allow economists to look beyond the formalized income-expenditure relationships and get a fresh view of the General Theory.
Second, Keynes's ideas seem to Davis to have a certain relevance in Keynes's time and in ours — a relevance that may have been lacking during most of the post–World War II period. The decades-long capitalist-communist stalemate separated two periods characterized by political pluralism, relative disorder, and internationally based uncertainties. So the time is right, once again, to focus on the expectations that govern the economic process in the face of uncertainty and to think about the institutional arrangements most conducive to a healthy economy.
Davis finds similarities in the 1930s and the 1990s in terms of global political turbulence. He fails, however, to give due weight to the key difference between these two periods. In the 1930s the world was moving rapidly in the direction of centralization; in the 1990s it is undergoing substantial decentralization.
Ironically, the perceived similarities of circumstances then and now cause Davis and several other contributors to this volume to rethink the meaning of Keynes's call for "a somewhat comprehensive socialization of investment."[4]
A healthier reading of world history might have caused these scholars to rethink the meaning of Ludwig von Mises's claim of the "impossibility of economic calculation under socialism."[5] In fact, the very concepts that Davis hopes to see back in play, such as the concepts of power and entrepreneurship, help to bolster Mises's case for decentralized decision making.
As with almost every other aspect of Keynes's writing, the phrase "socialization of investment" is in for some interpreting. What did Keynes have in mind? While no one believes that he was thinking of outright state ownership of the means of production, other possible meanings involve further questions that neither Keynes nor his followers have adequately addressed. It is clear in his discussion following the call for socialized investment that Keynes is concerned with the "volume" and not the "direction" of employment.
Keynes argues as if the government — or rather, "forces outside the classical scheme of thought"[6] — could control the volume without affecting any other aspect of the market economy. What sort of powers would government have to wield to be able to exert such a force? And how would the quality of entrepreneurial decisions be affected if entrepreneurs had to anticipate the use — and possible misuse — of such powers? There are no answers to these questions that put socialization in a favorable light.
The simple fact is that the conceptually distinct aspects of "volume" and "direction" as applied to employment or output are governed by a single set of market forces. Joan Robinson, who recognized the actual unity of these market forces but favored a more wholesale form of socialization, chided Keynes for even wanting to control volume without controlling direction. Direction, in her view, needed some controlling, too.[7]
In an alternative interpretation, one discussed in Hans Jensen's contribution, "forces outside the classical scheme," are not exerted by the state per se but rather by semipublic bodies. Keynes seemed to have envisioned large, privately owned firms with public-spirited managers. Readers of Keynes or of the Davis volume can only wonder what kind of power the state needs in order to maintain a public-spiritedness among these managers — and, again, what this kind of power might do to the entrepreneurial spirit among them and others.
A discussion by Robert Dimand offers still another interpretation of the socialization of investment. Several years before the General Theory, Keynes had proposed a "National Investment Board" that would give the government some control over the volume of investment. An NIB, though, sounds suspiciously like a peacetime version of the United States' War Industries Board of the World War I era.
Rothbard is noted for identifying the WIB as an important precursor of the subsequent New Deal policies, which came to be closely identified with so-called bastardized Keynesianism.[8]
The post Keynesians seem to be seriously concerned about what, exactly, Keynes may have had in mind. Many of the contributors, and especially Davis himself in his discussion of "Keynes's Philosophical Thinking," employ a what-did-he-know-and-when-did-he-know-it strategy in their attempts to sort things out. Davis also warns against a careless mixing of Keynes's philosophy and economics: Ideas are not easily transplanted whole across decades and disciplines.
The alternative that none of the contributors considers is the simplest one — though not the most satisfying for those who consider Keynes the fountainhead of economic wisdom: Keynes himself did not know what he meant. Keynes did not know what the appropriate supply-side counterpart to his theory was. He did not think through the implications — or recognize the virtual impossibility — of a zero rate of interest.
He did not know how, exactly, a comprehensive socialization of investment could be implemented. Neither, we might add, did the more radical socialists have any clear ideas on the particulars of the economic mechanisms in a socialist state. These and similar answers to many other questions seem to be the most plausible basis for understanding the General Theory.
The viability of Keynesian economics, bastardized or otherwise, may be as hotly contested now as it was in Keynes's own time. And the post Keynesian interpreters, with or without the hyphen, may never discover just what, exactly, Keynes meant.
But as interpretations continue to proliferate, this collection of papers provides its readers a close encounter with the original Keynes. The experience may cause them to doubt whether Keynesianism in any of its guises can provide a healthy understanding of economic reality or a suitable guide to prescribing policy or proposing reform.
"Deficit Financing" and Inflation
"Deficit Financing" and Inflation
[Excerpted from Ludwig von Mises on Money and Inflation: A Synthesis of Several Lectures, compiled by Bettina Bien Greaves. This lecture was given at the Foundation for Economic Education (FEE).]
I assume that you know how the banking system developed and how the banks could improve the services rendered by gold, by transferring assets from one individual to another individual in the books of the banks. When you study the development of the history of money you will discover that there were countries in which there were systems in which all the payments were made by transactions in the books of a bank, or of several banks. The individuals acquired an account by paying gold into this bank. There is a limited quantity of gold, so the payments which are made are limited. And it was possible to transfer gold from the account of one man to the account of another.
But then the governments began something which I can only describe in general words. The governments began to issue paper, which they wanted to serve the role, perform the service, of money. When people bought something they expected to receive from their bank a certain quantity of gold to pay for it. But the government asked, What's the difference whether the people really get gold or whether they get a title from the bank that gives them the right to ask for gold? It will be all the same to them.
So the government issued paper notes, or gave the bank the privilege to issue paper notes, which gave the receiver the right to ask for gold. This led to an increase in the number of paper banknotes that gave to the bearer the right to ask for gold.
Not too long ago, our government proclaimed a new method for making everybody prosperous: a method called "deficit financing." Now that is a wonderful word. You know, technical terms have the bad habit of not being understood by people.
The government and the journalists who were writing for the government told us about this "deficit spending." It was wonderful! It was considered something that would improve conditions in the whole country. But if you translate this into more common language, the language of the uneducated, then you would say "printed money." The government says this is only due to your lack of education; if you had an education you wouldn't say "printed money;" you would call it "deficit financing" or "deficit spending."
Now what does this mean? Deficits! This means that the government spends more than it collects in taxes and in borrowing from the people; it means government spending for all those purposes for which the government wants to spend. This means inflation, pushing more money into the market; it doesn't matter for what purpose. And that means reducing the purchasing power of each monetary unit. Instead of collecting the money that the government wanted to spend, the government fabricated the money. Printing money is the easiest thing. Every government is clever enough to do it.
If the government wants to pay out more money than before, if it wants to buy more commodities for some purpose or to raise the salaries of government employees, no other way is open to it under normal conditions than to collect more taxes and use this increased income to pay, for instance, for the higher wages of its employees. The fact that people have to pay higher taxes so that the government may pay higher wages to its employees means that individual taxpayers are forced to restrict their expenditures.
This restriction of purchases on the part of the taxpayers counteracts the expansion of purchases by those receiving the money collected by the government. Thus, this simple contraction of spending on the part of some, the taxpayers from whom money is taken to give to others, does not bring about a general change in prices.
The thing is that the individual cannot do anything that makes the inflationary machine and mechanism work. This is done by the government. The government makes the inflation. And if the government complains about the fact that prices are going up and appoints committees of learned men to fight against the inflation, we have only to say, "Nobody other than you, the government, brings about inflation, you know."
On the other hand, if the government does not raise taxes, does not increase its normal revenues, but prints an additional quantity of money and distributes it to government employees, additional buyers appear on the market. The number of buyers is increased as a result, while the quantity of goods offered for sale remains the same. Prices necessarily go up, because there are more people with more money asking for commodities which had not increased in supply.
The government does not speak of the increase in the quantity of money as "inflation;" it calls the fact that commodity prices are going up "inflation." The government then asks who is responsible for this "inflation," that is, for the higher prices? The answer — "bad" people; they may not know why prices are going up but nevertheless they are sinning by asking for higher prices.
The best proof that inflation, the increase in the quantity of money, is very bad is the fact that those who are making the inflation are denying again and again, with the greatest fervor, that they are responsible. "Inflation?" they ask. "Oh! This is what you are doing because you are asking higher prices. We don't know why prices are going up. There are bad people who are making the prices go up. But not the government!"
And the government says: "Higher prices? Look, these people, this corporation, this bad man, the president of this corporation…" Even if the government blames the unions — I don't want to talk about the unions — but even then we have to realize what the unions cannot do is to increase the quantity of money. And, therefore, all the activities of the unions are within the framework that is built by the government in influencing the quantity of money.
The situation, the political situation, the discussion of the problem of inflation, would be very different if the people who are making the inflation, the government, were openly saying, "Yes, we do it. We are making the inflation. Unfortunately we have to spend more than people are prepared to pay in taxes." But they don't say this. They do not even say openly to everybody, "We have increased the quantity of money. We are increasing the quantity of money because we are spending more, more than you are paying us." And this leads us to a problem which is purely political:
Those into whose pockets the additional money goes first profit from the situation, whereas others are compelled to restrict their expenditures. The government does not acknowledge this; it does not say, "We have increased the quantity of money and, therefore, prices are going up." The government starts by saying, "Prices are going up. Why? Because people are bad. It is the duty of the government to prevent bad people from bringing about this upward movement of prices, this inflation. Who can do this? The government!"
Then the government says, "We will prevent profiteering, and all these things. These people, the profiteers, are the ones who are making inflation; they are asking higher prices." And the government elaborates "guidelines" for those who do not wish to be in the wrong with the government. Then, it adds that this is due to "inflationary pressures." They have invented many other terms also which I cannot remember, such silly terms, to describe this situation — "cost-push inflation," "inflationary pressures," and the like. Nobody knows what an "inflationary pressure" is; it has never been defined.[1] What is clear is what inflation is.
Inflation is a considerable addition to the quantity of money in circulation.… And this system can work for some time, but only if there is some power that restricts the government's wish to expand the quantity of money and is powerful enough to succeed to some extent in this regard. The evils which the government, its helpers, its committees, and so on, acknowledge are connected with this inflation, but not in the way in which they are discussed.
This shows that the intention of the governments … is to conceal the real cause of what is happening. If we want to have a money that is acceptable on the market as the medium of exchange, it must be something that cannot be increased with a profit by anybody, whether government or a citizen. The worst failures of money, the worst things done to money, were not done by criminals but by governments, which very often ought to be considered, by and large, as ignoramuses but not as criminals.
And man made life
Synthetic biology
And man made life
Artificial life, the stuff of dreams and nightmares, has arrived
TO CREATE life is the prerogative of gods. Deep in the human psyche, whatever the rational pleadings of physics and chemistry, there exists a sense that biology is different, is more than just the sum of atoms moving about and reacting with one another, is somehow infused with a divine spark, a vital essence. It may come as a shock, then, that mere mortals have now made artificial life.
Craig Venter and Hamilton Smith, the two American biologists who unravelled the first DNA sequence of a living organism (a bacterium) in 1995, have made a bacterium that has an artificial genome—creating a living creature with no ancestor (see article). Pedants may quibble that only the DNA of the new beast was actually manufactured in a laboratory; the researchers had to use the shell of an existing bug to get that DNA to do its stuff. Nevertheless, a Rubicon has been crossed. It is now possible to conceive of a world in which new bacteria (and eventually, new animals and plants) are designed on a computer and then grown to order.
That ability would prove mankind’s mastery over nature in a way more profound than even the detonation of the first atomic bomb. The bomb, however justified in the context of the second world war, was purely destructive. Biology is about nurturing and growth. Synthetic biology, as the technology that this and myriad less eye-catching advances are ushering in has been dubbed, promises much. In the short term it promises better drugs, less thirsty crops (see article), greener fuels and even a rejuvenated chemical industry. In the longer term who knows what marvels could be designed and grown?
On the face of it, then, artificial life looks like a wonderful thing. Yet that is not how many will view the announcement. For them, a better word than “creation” is “tampering”. Have scientists got too big for their boots? Will their hubris bring Nemesis in due course? What horrors will come creeping out of the flask on the laboratory bench?
Such questions are not misplaced—and should give pause even to those, including this newspaper, who normally embrace advances in science with enthusiasm. The new biological science does have the potential to do great harm, as well as good. “Predator” and “disease” are just as much part of the biological vocabulary as “nurturing” and “growth”. But for good or ill it is here. Creating life is no longer the prerogative of gods.
Children of a lesser god
It will be a while, yet, before lifeforms are routinely designed on a laptop. But this will come. The past decade, since the completion of the Human Genome Project, has seen two related developments that make it almost inevitable. One is an extraordinary rise in the speed, and fall in the cost, of analysing the DNA sequences that encode the natural “software” of life. What once took years and cost millions now takes days and costs thousands. Databases are filling up with the genomes of everything from the tiniest virus to the tallest tree.
These genomes are the raw material for synthetic biology. First, they will provide an understanding of how biology works right down to the atomic level. That can then be modelled in human-designed software so that synthetic biologists will be able to assemble new constellations of genes with a reasonable presumption that they will work in a predictable way. Second, the genome databases are a warehouse that can be raided for whatever part a synthetic biologist requires.
The other development is faster and cheaper DNA synthesis. This has lagged a few years behind DNA analysis, but seems to be heading in the same direction. That means it will soon be possible for almost anybody to make DNA to order, and dabble in synthetic biology.
That is good, up to a point. Innovation works best when it is a game that anyone can play. The more ideas there are, the better the chance some will prosper. Unfortunately and inevitably, some of those ideas will be malicious. And the problem with malicious biological inventions—unlike, say, guns and explosives—is that once released, they can breed by themselves.
Biology really is different
The Home Brew computing club launched Steve Jobs and Apple, but similar ventures produced a thousand computer viruses. What if a home-brew synthetic-biology club were accidentally to launch a real virus or bacterium? What if a terrorist were to do the same deliberately?
The risk of accidentally creating something bad is probably low. Most bacteria opt for an easy life breaking down organic material that is already dead. It doesn’t fight back. Living hosts do. Creating something bad deliberately, whether the creator is a teenage hacker, a terrorist or a rogue state, is a different matter. No one now knows how easy it would be to turbo-charge an existing human pathogen, or take one that infects another type of animal and assist its passage over the species barrier. We will soon find out, though.
It is hard to know how to address this threat. The reflex, to restrict and ban, has worked (albeit far from perfectly) for more traditional sorts of biological weapons. Those, though, have been in the hands of states. The ubiquity of computer viruses shows what can happen when technology gets distributed.
Thoughtful observers of synthetic biology favour a different approach: openness. This avoids shutting out the good in a belated attempt to prevent the bad. Knowledge cannot be unlearned, so the best way to oppose the villains is to have lots of heroes on your side. Then, when a problem arises, an answer can be found quickly. If pathogens can be designed by laptop, vaccines can be, too. And, just as “open source” software lets white-hat computer nerds work against the black-hats, so open-source biology would encourage white-hat geneticists.
Regulation—and, especially, vigilance—will still be needed. Keeping an eye out for novel diseases is sensible even when such diseases are natural. Monitoring needs to be redoubled and co-ordinated. Then, whether natural or artificial, the full weight of synthetic biology can be brought to bear on the problem. Encourage the good to outwit the bad and, with luck, you keep Nemesis at bay.
An unappetising menu
Mexico and the United States
An unappetising menu
Mr Calderón goes to Washington
WHEN Barack Obama invited his Mexican counterpart, Felipe Calderón, to be his guest in Washington for only the second state visit of his presidency, he was underlining that the two neighbours have become friends. Yet the timing of the trip, on May 19th, has turned out to be unfortunate. It comes amid a furious row on both sides of the border over a law approved in Arizona last month, which requires state police to check the immigration status of any “suspicious” individuals, apparently meaning Mexicans. And on May 14th a senior member of Mr Calderón’s conservative National Action Party (PAN), Diego Fernández de Cevallos, went missing from his ranch. It seems he had been abducted.
At least Mr Calderón and Mr Obama had plenty to talk about over dinner at the White House, even if the issues—migration and the drug “war”—are depressingly familiar. When Mr Calderón visited Washington shortly before Mr Obama’s inauguration, the two leaders proclaimed a new era of partnership. But relations between their two countries often seem stuck in a pattern of flare-ups and make-ups: over American protectionism, human-rights abuses by Mexico’s army, drug violence spilling over the border and the southward flows of guns and cash.
The Arizona law marks a new nadir. Mr Calderón called the measure “backward” and “discriminatory”. His government issued a travel alert, which will discourage citizens from visiting the state. The governors of Mexico’s border states said they would boycott a routine meeting with their American counterparts in Phoenix.
Will the state visit break the pattern? Diplomats from both countries note that their daily collaboration has improved. Co-operation on security is probably closer than it has ever been. American officials have begun searching southbound traffic and seizing illicit cargo. The Mérida initiative, a scheme under which the United States has offered Mexico modest anti-drug aid, has been extended and tweaked to emphasise strengthening institutions, such as the judiciary. Mexico has extradited suspected narcos in unprecedented numbers. Mr Obama shares Mr Calderón’s opposition to the Arizona law, calling it “misguided”. He would like to enact a comprehensive immigration reform.
As so often, the main obstacle to further progress is domestic politics in both countries. Many Americans in border states support cracking down on illegal migrants, and Mr Obama’s Democratic Party faces difficult mid-term elections in November. If Mexico protests too much, it risks galvanising the law’s backers, which could lead other states to copy Arizona’s policies.
Meanwhile, Mr Calderón’s party was routed in Mexico’s mid-terms last July, and will have to confront voters again in local elections this summer. He has almost no chance of obtaining the big policy reforms needed to address the country’s economic and security troubles.
Polls suggest that Mexicans are becoming sceptical of Mr Calderón’s insistence that he is beating the drug gangs. They may not be reassured by the recent leaking of an internal government estimate that 23,000 people have been killed in the violence since 2006. That is well above the 18,000 previously reckoned by the press.
The traffickers are getting ever more brazen. In March they gunned down three people with ties to the American consulate in Ciudad Juárez. Although several local politicians have been killed by the mafias, Mr Fernández de Cevallos is a far more prominent figure. He was a former presidential candidate, highly influential in the pan and close to Mexico’s security establishment. If he has indeed been murdered—or if he were to be held hostage for months—the pressure on Mr Calderón to rethink the intensity of his assault on the drug gangs might well grow. And so might the concern in Washington.
Flying too high for safety
Brazil's booming economy
Flying too high for safety
A burst of Chinese-level growth cannot be sustained. But it hints at Brazil’s new-found strength, and is perfectly timed for the presidential election
NEW skyscrapers are going up along Avenida Faria Lima in the business district of São Paulo. Sales of computers and cars are booming, while a glut of passengers has clogged the main airports. Brazil created 962,000 new formal-sector jobs between January and April—the highest figure for these months since records began in 1992. Everything indicates that over the past six months the economy has grown at an annualised pace of over 10%. Even allowing for an expected slackening, many analysts forecast that growth in 2010 will be 7%—the highest rate since 1986.
The problem is that while it may be growing at Chinese speeds, Brazil is not China. Because it still saves and invests too little, most economists think it is restricted to a speed limit of 5% at the most, if it is not to crash. The growth spurt is partly the result of the stimulus measures taken by President Luiz Inácio Lula da Silva’s government when the world financial crisis briefly tipped the country into recession late in 2008. The trouble, say critics, is that much of the extra government spending is turning out to be permanent—and so the economy is starting to resemble a Toyota with the accelerator stuck to the floor.
The strain is showing. Businesses are chasing after scarce skilled labour. Inflation for the 12 months to April reached 5.3%, above the Central Bank’s target of 4.5%. Imports are set to top exports this year, for the first time since 2000, and the current-account deficit should widen to 3% of GDP.
The authorities are starting to worry. Last month the Central Bank raised its benchmark Selic interest rate by 0.75%, the first rise in nearly two years. Many economists in São Paulo believe that this one will be followed by others, taking the rate from its low of 8.75% to 13% by next year.
The government’s critics say that lax fiscal policy is making the Central Bank’s task harder, increasing the risk of the boom ending in a sharp slowdown next year. When he became president in 2003, Lula stuck to the sound fiscal policies he inherited from his predecessor, Fernando Henrique Cardoso. Thanks to faster growth and higher tax revenues, between 2003 and 2008 Lula’s government managed to keep public debt in check even while expanding spending. By treating the recession as “a licence to spend”, the government is now undermining the credibility it piled up, says Raul Velloso, a public-finance specialist in Brasilia.
Officials share those concerns—up to a point. The government has withdrawn nearly all of the tax breaks it enacted to boost demand during the recession. On May 13th ministers declared that they would shave 10 billion reais ($5.4 billion) from the running costs of the federal government this year. That followed a similar announcement of another 21 billion reais of cuts in March. But this hardly amounts to slamming on the brakes. The cuts are to the generous (and notional) budget approved by Congress. Even if implemented in full, they will merely slow the rate of increase in government spending, keeping it constant or slightly lower as a share of GDP, concedes Nelson Barbosa, a senior finance official.
The government is still injecting money into the economy in two controversial ways. First, the National Development Bank (BNDES), whose loans cost about half the Selic rate, has expanded its lending by almost half. It has been able to do this because the treasury granted it two long-term credits totalling 180 billion reais. Those credits, for which the BNDES has offered IOUs, have led to accusations of creative accounting. While adding to the government’s gross debt, they have not driven up the more closely watched figure for public debt, net of assets: at 42.7% of GDP, this is back to its level of mid-2008, and is much lower than the debt burdens of European countries.
Second, the government has jacked up its payroll spending. The number of federal civil servants has increased fairly modestly since 2003 (by around 10%). But they have been treated generously: the total federal wage bill more than doubled in nominal terms between 2003 and 2009, while inflation was less than 50%. Lula has pushed up the minimum wage much faster than inflation too. That has helped to make the income distribution less skewed, and boosted consumer demand. But it has a knock-on effect on pension benefits.
Mr Barbosa insists that faster growth will allow the government to squeeze payroll and pension spending gently over the coming years. The BNDES helped sustain investment when the financial markets seized up. The latest bout of financial turmoil has seen the real depreciate by 5% or so this month. But Brazil’s stockpile of international reserves means it is well-placed to withstand market panics. Mr Barbosa says that the critics should look at the long-term trend, under which real interest rates (ie, after inflation) have fallen from up to 20% in 2003 to between 5% and 10%. Once the new monetary squeeze is over they will fall further, he says.
Certainly many Europeans would love to have Brazil’s problems. Its economy has acquired underlying strength. Companies are scurrying to satisfy the demand for consumer goods of a rapidly expanding lower-middle class, while China continues to suck in Brazil’s exports of raw materials. Productivity is rising. Costs per unit of labour are increasing at only about half the rate of real wages, reckons José Roberto Mendonça de Barros, a consultant and former finance official.
But commodity prices are starting to weaken. Faster growth would be more assured if the government made room for lower interest rates and installed better infrastructure. The next president, elected in October, will have to tackle this. The economy’s red-hot start to the election year has increased the chance that it will be Lula’s candidate, Dilma Rousseff, who gets the chance to try.
The wrong targets
The Alternative Investment Fund Managers Directive
The wrong targets
A pointless tussle over regulating hedge funds and private equity
Osborne finds something laughableA WEEK after the virtual closure of Europe’s government-bond markets and a dramatic bail-out for countries on the periphery of the euro, you might have thought the European Parliament’s Economic and Monetary Affairs Committee would have urgent things to discuss. It could have debated ways of restoring investors’ trust in the region’s bond markets, perhaps, or tried to understand why European money markets are freezing up. The same might be said of a committee of European finance ministers, which also met this week.
Curiously, both committees thought their time would be well spent agreeing on tough new rules for an industry that has had remarkably little to do with the financial crisis. On May 17th and 18th the two committees agreed to proposals that are intended to govern “alternative investment funds”, a long-winded name for hedge funds and private-equity funds, two sectors that in the eyes of many exemplify the ugly face of free-market capitalism. Confusingly the drafts contradict each other in some important respects; both differ, too, from a draft law proposed by the European Commission, Europe’s executive branch.
Even so the proposals were greeted triumphantly in Berlin, which has long campaigned against both hedge funds and the “locusts” of private equity, and with dismay in London, home to 80% of the industry in Europe. George Osborne, Britain’s new finance minister, did manage to lodge reservations which must now be taken into account as the various proposals are reconciled.
The most contentious element concerns the access that funds based outside Europe will have to European markets. At issue are questions over whether foreign funds should have to apply to each EU country to do business, or whether, as the parliamentary draft proposes, they could get a European “passport” that would enable them to sell their wares throughout the EU. In theory a passport regime should please the industry, but it comes at a high price. Funds would not just have to satisfy the EU about the quality of their home regimes in areas such as money-laundering and tax, but their home supervisors would also have to ensure that funds comply with EU rules. The parliamentary draft appears to ban EU investors from placing money with any offshore funds that do not meet European rules.
Other areas of concern include proposals to impose bank-like limits on the pay of fund managers—ostensibly to limit risk-taking even though the risks they take are anything but bank-like—as well as constraints on how much funds can borrow. Investors are also worried by measures to increase the liability that custodian banks have for the assets they look after. Pension funds and others fear they will be charged a higher premium by custodians as a result.
Not all these proposals will survive the reconciliation process. What seems likely to emerge is a messy compromise that will not drive the industry out of business or out of Europe, but will do little to improve financial stability either. There are surely more pressing issues.
Almost there
Financial reform
Almost there
The Senate votes for financial reform, but some important issues remain unresolved
FINANCIAL reform is coming to America. On May 20th, after more than three weeks of often rancorous debate, the Senate approved the biggest overhaul of the financial system since the Great Depression, by 59 votes to 39. Its bill must now be reconciled with one passed by the House of Representatives in December. The result will be Barack Obama’s second big legislative victory of the year, after the passage of health-care reform in March.
Tim Geithner, Mr Obama’s treasury secretary, praised Chris Dodd and Harry Reid, the Democratic senators who steered the 1,500-page Restoring American Financial Stability Act to a successful vote, for their “tremendous leadership”. The administration has reason to be pleased, since the bill largely mirrors the reform blueprint it had been pushing.
As with most bills, this one has its share of pork and irrelevant provisions, including one requiring buyers of Congolese minerals to prove that the money they hand over is not being used to fund militant groups. But there is much meat at its heart. The bill would beef up the system for monitoring systemic risks. It would empower the Federal Deposit Insurance Corporation to wind down failing financial giants, imposing losses on creditors as well as shareholders. It would create an independent consumer financial-protection bureau. And it would toughen up oversight of derivatives, requiring most contracts to be channelled through clearing houses and traded on exchanges or exchange-like platforms.
Could this bill have prevented the crisis? Not by itself. Some of the most important reforms are outside its purview. Toughened-up capital and liquidity standards for banks will be hammered out by regulators from around the world in Basel. The Obama administration’s proposed tax on big banks will likely be advanced in different legislation. One glaring omission from the Senate and House bills is a plan to deal with Fannie Mae and Freddie Mac, the giant, accident-prone mortgage agencies now under government conservatorship.
The most important component aimed at preventing another crisis is “resolution authority”, under which any big financial company, not just a bank, can be seized and wound down in an orderly way. Lack of such authority led to the shambolic failure of Lehman Brothers and the controversial bail-out of AIG. To win Republican support, however, Mr Dodd made the process so harsh for unsecured creditors that they might flee if they sense panic building—forcing the authorities, again, to use ad-hoc measures. Left unanswered is how bail-outs will be paid for. The House version of the bill requires banks to chip in to a $150 billion up-front fund. The Senate bill envisages the costs being recouped afterwards, another concession to Republicans.
The new consumer-protection bureau should help to close the gap between well-regulated banks and poorly regulated mortgage brokers and finance companies, which led the race to the bottom in loan-underwriting standards. But many firms, most significantly small banks, are exempted from its authority. And the industry gripes that there is remarkably little independent oversight of the bureau, should it run amok with new regulations that stifle legitimate products. The Senate bill puts the bureau inside the Federal Reserve, though it gives the Fed little say in its direction; in the House version, the bureau stands alone.
Surprisingly, given the depth of congressional animosity towards it, the Fed emerges as a big winner. It keeps all its existing bank-supervision powers (except for consumer protection) and gets new ones over systemically important non-banks. In a crucial victory, the Fed and the White House fought off a provision that would have allowed intrusive congressional audits of the central bank’s most delicate monetary-policy decisions. However, such a provision remains in the House version of the bill.
As for Wall Street itself, the outcome is worse than initially expected but better than it might have been—though uncertainties remain. Bankers had hoped that the bill emerging from the Senate-usually the more measured of the two chambers-would be more bank-friendly than the House version. But a flurry of draconian amendments was offered in recent weeks amid a surge in anti-bank sentiment (fuelled by fraud charges against Goldman Sachs) and political populism in the run-up to congressional primaries. Among those approved was one requiring the Fed to regulate debit-card fees, another setting minimum mortgage-underwriting standards (and banning no-documentation “liar loans”) and a third requiring credit ratings of asset-backed securities to be assigned by a board within the Securities and Exchange Commission. But a proposal to cap banks’ maximum size was defeated, as was one that would have placed restrictions on credit-card interest rates.
But some of banks’ biggest worries remain unresolved. They are resigned to accept some form of the “Volcker rule”, which would restrict their proprietary trading and investment in hedge funds and private equity. A particularly tough version of the rule was rejected just before the Senate vote, but its authors hold out hope that it can be inserted during the weaving-together of the House and Senate bills. The Volcker rule and other looming restrictions could collectively cut large banks’ profits by as much as 15-20% (not counting returned capital from shed businesses), reckon analysts at Morgan Stanley.
Wall Street’s biggest concern is a provision banning deposit-takers from trading credit-default swaps, interest-rate swaps and the like. Introduced by the head of the Senate Agriculture Committee some weeks ago, it was expected that this would fall by the wayside during debate. But it proved stubbornly persistent, making it into the bill as passed. Ostensibly aimed at raising a firewall between run-of-the-mill retail banking and “casino” activities, such a prohibition would hinder risk management as well as speculation, banks argue.
All eyes will now be on the “conference” process that will likely be used to iron out differences between the two bills over the next week or two. This will provide one last lobbying opportunity to Wall Street, which has already spent hundreds of millions trying to influence lawmakers, to the president’s chagrin. Banks will focus much of their effort on reversing the swap-dealing ban (which is also opposed by their regulators). Where the two chambers differ, the Senate prevails as a rule—though Barney Frank, the architect of the House bill, has said he will fight to preserve some of his provisions. Once Mr Obama signs the law, many of its vaguer provisions will have to be fleshed out by financial regulators, a process that could take many months. There are plenty of ambiguities to be tackled, for instance the bills’ loose definition of “swap” and “major swap participant”.
After the Senate bill was passed, Mr Obama pledged to “ensure that we arrive at a final product that…secures financial stability while preserving the strengths and crucial functions of a financial industry that is central to our prosperity and ability to compete in a global economy.” That remains to be seen. If the history of financial legislation is a guide—just think Sarbanes-Oxley—the new law will have more than a few unintended consequences. For now, though, the White House can revel in a political triumph that a year ago seemed to many to be beyond reach.
Finance-Overhaul Bill Would Reshape Wall Street
Finance-Overhaul Bill Would Reshape Wall Street, Washington
By Bloomberg News
May 21 (Bloomberg) -- The legislation passed by the Senate yesterday would reshape the U.S. financial industry and its regulators with a sweep unseen since the aftermath of the Great Depression.
It would change the way banks manage their balance sheets, hedge their interest-rate bets and invest their proceeds. It would chip away at the secrecy of the Federal Reserve, create a council of regulators and make it easier for investors to sue credit raters. It would cut the fees debit-card issuers collect from merchants.
Senator Christopher Dodd, the Connecticut Democrat who shepherded the legislation as chairman of the Banking Committee, said: “Any one of these sections of the bill could stand almost as a piece of landmark legislation in and of themselves.”
Wall Street has a different view. The Senate bill’s provisions could cut the profits of the largest U.S. banks by 13 percent, Goldman Sachs Group Inc. said in a May 17 report. The biggest impact would come from stricter rules on derivatives and the powers of a new consumer agency to write regulations affecting mortgage fees and other financial products. Each of those provisions would hurt bank incomes by 4 percent, Goldman analysts estimated.
House and Senate negotiators must now reconcile their bills. Lawmakers said they expect most of the language in the Senate bill to survive unchanged. What follows are details of the scope and impact of a dozen of the major provisions in the Senate bill:
Derivatives
The derivatives language that ended up in the Senate financial overhaul bill contained stricter rules than were originally proposed. A requirement that banks separate swaps- trading operations from commercial banking set off a round of lobbying from the industry and drew opposition from regulators and the Obama administration. It remains in the bill.
Derivatives took a central role in the debate over Wall Street regulation after losing bets on swaps tied to mortgage- backed securities pushed New York-based insurer American International Group Inc. to the brink of bankruptcy in 2008. Derivatives are contracts whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or the weather.
The Senate legislation would push most of the $615 trillion in over-the-counter derivatives onto regulated exchanges or similar electronic systems, a measure that would make it easier for the market and regulators to track the trades. It would mean higher margin costs on some transactions.
Regulators also would be required to impose heightened capital requirements on companies with large swaps positions, and limit the number of contracts a single trader can hold.
Businesses that use derivatives to hedge risk from producing or consuming commodities, deemed “end users,” would be exempt from the clearing requirements as long as the swap met generally accepted accounting principles for hedging, and the firm wasn’t “predominantly” engaged in financial activities.
For U.S. commercial banks, the stakes are high. The five biggest dealers in the largely unregulated market -- JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp., Morgan Stanley and Goldman -- earned $28 billion from trading operations last year, according to reports collected by the Fed and people familiar with the matter.
Dodd, who wrote the overall bill, largely bowed to his colleagues from the Senate Agriculture Committee for the final derivatives language, crafted by Senator Blanche Lincoln, an Arkansas Democrat who heads the panel.
Lobbyists and lawmakers alike said they believed the swaps- desk provision would be stripped before the bill was final. Negotiations continued throughout the floor debate. Senate aides said some lawmakers were unwilling to risk public anger if they were seen as watering down an anti-bank provision. The Democrats also were mindful that Lincoln was in a primary fight with a liberal opponent.
After weeks of anticipation, Dodd made the move to find a compromise on May 19, minutes before the amendment filing deadline. He offered a measure to delay implementation of the Lincoln push-out rule for two years and give the Treasury secretary authority to eliminate it if he or she found the rule would “have a material adverse effect on the financial markets and economy.”
The banking industry and liberal Democrats in the Senate bristled at the idea, with Wall Street complaining that it would politicize the final decision process and create uncertainty in the markets. The Democrats said it was watering down reform. The next day, Dodd’s spokeswoman, Kirstin Brost, told reporters that he wouldn’t be offering the amendment.
The language may still be changed in a House-Senate conference committee.
“There have been some significant technical questions that we’ve had to try and work out,” said Senator Jack Reed, a Rhode Island Democrat who led the Senate Banking Committee derivatives negotiations. “Because of the complexity of this issue, we’ve needed a lot of work to harmonize the bill with current practice and to avoid any unintended consequences.”
Consumer Financial Protection
Dodd’s bill would create a consumer financial-protection bureau at the Fed to police banks and other financial-services businesses for credit-card and mortgage-lending abuses. The plan is scaled back from the stand-alone agency in the House bill, an idea supported by President Barack Obama and one that Representative Barney Frank, chairman of the House Financial Services Committee, expects to revive in a House-Senate conference.
Under the Senate bill, the new bureau could require credit- card lenders, including JPMorgan and Citigroup, to reduce interest rates and fees. Mortgage lenders, including Bank of America, may be subject to tougher rules including more upfront disclosures to borrowers about loan terms and loan structures that help borrowers keep up with payments.
Automobile dealers were among industries that lobbied for an exemption from bureau oversight. The dealers, who said the rules would place unnecessary restrictions on their financing business, won an exemption in the House bill but not in the Senate’s.
The idea for a new agency grew out of criticism from lawmakers and consumer groups that bank regulators, including the Fed, failed to properly exercise their consumer-protection authority during the housing boom. The consumer bureau would take over most of that oversight. Rules could be overridden by the new Financial Stability Oversight Council if the council decided that they threatened the safety, soundness or stability of the U.S. financial system.
The bureau, to be led by an independent director appointed by the president and confirmed by the Senate, would write consumer-protection rules for all banks and non-banks that offer financial services or products. It would have authority to examine and enforce rules for banks and credit unions with more than $10 billion in assets. Bank regulators would continue examining consumer practices at smaller financial institutions.
Dodd’s initial draft included a stand-alone agency. Senator Bob Corker, a Tennessee Republican, offered the idea of housing the agency at the Fed, which Dodd incorporated into his bill in an effort to draw Republican support for his legislation.
The financial-services industry lobbied against the new bureau, saying it would raise costs, limit choice, and improperly separate oversight of consumer issues and safety and soundness. JPMorgan Chief Executive Officer Jamie Dimon called the proposed agency “just a whole new bureaucracy,” while Bank of America CEO Brian Moynihan has said he won’t oppose the idea.
Smaller businesses such as doctor’s offices and jewelers would be exempted from oversight by the bureau. The Senate on May 12 approved the exemptions as part of an amendment offered by Senator Olympia Snowe, a Maine Republican, amid GOP objections that the measure included businesses that didn’t cause the financial crisis.
The amendment exempts companies that sell non-financial products and don’t securitize consumer debt. The businesses, including florists and builders, said they are already regulated by the Federal Trade Commission and subject to existing federal and state consumer-protection laws.
Credit and Debit Cards
The Fed would have authority to limit fees that merchants pay to accept debit cards, under an amendment by Senator Richard Durbin. The biggest component of those fees, called interchange, is collected by card issuers including Bank of America, Wells Fargo & Co. and JPMorgan.
The Senate’s 64-33 vote for the amendment was a setback for Visa Inc. and MasterCard Inc., the biggest payment networks, which set interchange rates on debit and credit cards and pass that money along to issuers. The fees average about 2 percent on credit cards and 1 percent for debit cards, generating more than $40 billion a year for U.S. lenders.
The industry fought off earlier efforts to regulate interchange fees, including a Durbin-sponsored bill that remains in committee, by saying they are needed to compensate for the risk of lending money. That argument doesn’t apply to interchange on debit cards, which tap funds in consumer checking accounts.
The focus on debit may have helped win over some of the 17 Republicans who voted for his amendment, including Senator Susan Collins of Maine. “It seems to me the scaled-down version that Dick Durbin came up with is a reasonable approach,” Collins said.
Durbin’s amendment would direct the Fed to ensure that debit-swipe fees are “reasonable and proportional” to the cost of processing transactions. That provision would take effect a year after enactment.
The amendment would let retailers offer discounts for cash, checks or debit cards, or for a certain card brand, and allow merchants to set minimums and maximums for card purchases.
Durbin altered his proposal to exempt lenders with assets of less than $10 billion, or 99 percent of U.S. banks. That was opposed by trade groups representing community banks and credit unions. They said the measure would make their cards more expensive compared with those issued by the biggest lenders.
Financial Stability Oversight Council
The Senate voted to establish a super-regulator that will monitor Wall Street’s largest firms.
The nine-member Financial Stability Oversight Council could impose higher capital requirements on lenders such as Bank of America, the biggest by assets in the U.S., or place broker- dealers and hedge funds under the authority of the Fed, according to the legislation. The council would have the authority to force firms such as New York-based Goldman Sachs to divest holdings if their structure posed a “grave threat” to U.S. financial stability, the bill says.
The council would be led by the U.S. Treasury secretary and include regulators from the Fed, Securities and Exchange Commission, Federal Housing Finance Agency, Commodity Futures Trading Commission and other banking agencies.
Trade groups including the American Bankers Association supported the measure. Consumer groups including the Center for Responsible Lending and industry analysts objected to the council’s power to overrule the new consumer financial protection bureau, which the bill would establish and place within the Fed.
“The council’s override is presumably meant to rein in a putatively hyper-aggressive consumer bureau,” said Raj Date, a former Deutsche Bank AG managing director and now executive director of the Cambridge Winter Center for Financial Institutions Policy, a New York-based research group. “Consumer protection is usually not related to systemic risk.”
The Federal Home Loan Banks, a co-operative financing system for mortgage lenders, fought unsuccessfully for an exemption from council oversight, saying limits on credit concentration would cut their lending ability in half.
‘Volcker Rule’ and Bank Size
Dodd’s bill incorporates Obama’s ban on proprietary trading by U.S. banks, named the Volcker rule after former Fed Chairman Paul Volcker. Banks, their affiliates and holding companies would also be barred from sponsoring or investing in hedge funds and private-equity funds. Hedge funds control about $1.67 trillion in assets, according to Chicago-based Hedge Fund Research Inc.
The House bill would empower the Fed to ban proprietary trading at a financial holding company only if the central bank determined the activity posed a threat to the safety and soundness of the company or the U.S. financial system.
Under the Dodd bill, the Financial Stability Oversight Council would be given six months to study how to implement the ban. Rules would be issued by federal agencies within nine months and go into effect two years later. Industry lobbyists want the council to first study whether a ban is needed, and then have the option of imposing one.
Dodd’s bill also would bar banks from acquiring or merging with competitors if the resulting entity’s liabilities exceed 10 percent of the total in the U.S. banking system. The three largest U.S. banks by assets -- Bank of America, JPMorgan and Wells Fargo -- are already above the threshold and wouldn’t be able to expand further through acquisitions.
The Senate version of the ban on proprietary trading could reduce the 2011 profits of the eight biggest global banks by $11 billion, New York-based JPMorgan estimated in a February report. The hardest-hit firm would be Goldman Sachs, with a $2.3 billion drop in earnings, according to the report.
Goldman Sachs has said that proprietary trading, in which a firm bets its own money, generates about 10 percent of its annual revenue. The firm made $1.17 billion in 2009 from “principal investments,” which include stakes in companies and real estate, according to a company filing.
JPMorgan’s pretax income could fall by $3.2 billion if it were forced to comply with the rule, Goldman Sachs has said.
Bank Capital Rules
The bill may force hundreds of smaller U.S. banks, and possibly some subsidiaries of foreign-owned lenders, to shore up capital, the result of an amendment from Collins, the Republican of Maine.
One new rule would eliminate the ability of bank holding companies to keep less capital than their bank subsidiaries. That would have an impact on the use of trust preferred securities, known as TRUPs.
TRUPs count toward equity when calculating capital ratios - -- the bank’s cushion against losses -- while being treated like bonds for tax purposes, which means interest payments are deductible. The Collins rule would force banks to replace these securities with common equity or shrink their balance sheets to meet capital requirements.
U.S. bank holding companies have about $330 billion in TRUPs, the ABA estimates. Regional banks such as Capital One Financial Corp. and M&T Bank Corp. that rely heavily on TRUPs would be hurt most, according to Richard Bove, an analyst for Rochdale Securities.
“We’re very concerned about the potential impact of this amendment,” said ABA Executive Vice President Mark Tenhundfeld.
The FDIC backed the Collins amendment. “Bank holding companies should be a source of strength for their banking subsidiaries,” said Paul Nash, FDIC’s deputy for external affairs. “During the crisis, many ended up being sources of weakness. This amendment aims to remedy that.”
The Collins language also would require the U.S. holding companies of non-U.S. banks to comply with the same capital rules as domestic lenders. For now, they’re exempt as long as their foreign parents are regulated by an entity recognized by the U.S., such as the U.K.’s Financial Services Authority.
U.S. units of global banks such as HSBC Holdings Plc and Barclays Plc may be affected. The Institute of International Bankers, which represents foreign banks in the U.S., didn’t return calls seeking comment.
The Collins amendment would get ahead of new capital rules being negotiated by regulators and central bankers of the 27 countries that make up the Basel Committee on Banking Supervision. The proposed Basel rules foresee the elimination of TRUPs for use as capital.
The Basel Committee aims to complete discussions by the end of this year. The FDIC and four other U.S. regulators are Basel members.
Federal Reserve
The Fed emerged from the Senate negotiations with its supervisory scope broadened while threats to its independence and oversight powers were defeated.
Chairman Ben S. Bernanke would have a seat on the Financial Stability Oversight Council. The new body in turn would deputize the Fed to set tougher standards for disclosure, capital and liquidity. The rules would apply to banks as well as non-bank financial companies, such as AIG, that pose risks to the overall financial system.
The Fed would keep authority over about 844 community banks thanks to an amendment by Senator Kay Bailey Hutchison, a Texas Republican. Earlier drafts of the Dodd bill would have limited the Fed’s supervision to 36 bank holding companies with assets over $50 billion, stripping away current oversight for almost 5,000 bank holding companies and the 844 state member banks. Under the bill, the Fed would continue to supervise not only large banks like Bank of America and Goldman Sachs, but smaller firms such as Central Virginia Bankshares Inc., with assets of $473 million.
U.S. central bankers face a one-time audit of the emergency programs they put in place since 2007, under an amendment offered by Bernard Sanders, a Vermont independent. A separate amendment offered by Louisiana Republican David Vitter would have mimicked a provision in the House financial reform bill allowing for repeated congressional audits of Fed policies. The chamber rejected Vitter’s measure in a 62-37 vote.
“They got to regulate community banks and they dodged a pretty meaningful bullet on the audit provision,” said Tom Gallagher, senior managing director at International Strategy & Investment Group in Washington. “The Fed has done a better job escaping the backlash compared with the rest of the financial sector.”
Credit Raters
Moody’s Corp. and McGraw Hill Cos.’ Standard & Poor’s unit are potential losers in the Senate legislation because it gives regulators a hand in determining who gets paid to grade asset- backed securities and makes it easier for investors to sue credit-rating companies.
Profits grew at Moody’s and S&P during the U.S. housing boom because Wall Street paid them to assess the credit- worthiness of mortgages packaged into bonds. Revenue at Moody’s almost quadrupled to $2.26 billion in 2007 from $602.3 million seven years earlier, according to regulatory filings. S&P’s revenue almost tripled to $3.08 billion over the same period.
After the housing market collapsed in 2007, pension funds and banks that lost money on the securities faulted Moody’s and S&P for assigning the assets their highest AAA rankings.
The amendment offered by Senator Al Franken, a Minnesota Democrat, creates a ratings board overseen by the SEC that would assign a company to provide the initial ranking on a security made up of mortgages, car loans or credit-card debt. Ten companies have SEC authorization to rate asset-backed debt.
Franken said his provision aims at eliminating the conflict of interest under which Moody’s and S&P are paid by banks selling bonds rather than by the investors who buy them. It does so by preventing Wall Street firms from shopping around for the highest rating, he said.
The amendment would require the board to conduct an annual assessment of firms to scrutinize the accuracy of their ratings and methods for assessing bonds. Credit-rating companies would determine fees, unless the board decided to regulate payments. The SEC would also have authority to make sure fees are “reasonable.”
Franken’s amendment didn’t stipulate how the ratings board would keep pace in assigning firms to rate bonds. The asset- backed securities market averaged 38 new transactions a week from 2003 through 2007, according to S&P data.
A separate provision in the Senate bill may make judges less likely to dismiss lawsuits against credit-rating companies.
Litigation would proceed if investors can show a firm “knowingly or recklessly” failed to conduct a “reasonable” examination of what a securities underwriter stated about a bond, according to the Senate measure. Investors currently have to demonstrate that they were intentionally misled.
Legislation approved by the House in December goes even further in exposing Moody’s and S&P to litigation risk. Investors who sue would have to show only that a ratings company was “grossly negligent” in grading a bond to avoid dismissal.
Moody’s and S&P argued that the liability provisions in the Senate and House measures would have unintended consequences. Plaintiffs’ lawyers will consider filing a lawsuit every time a ratings company changes its ranking, the firms said. As a result, S&P and Moody’s said they will respond by rating fewer offerings, making it harder for businesses to raise money.
Hedge Funds
The $1.67 trillion hedge fund industry lobbied for the main new requirement that would be imposed on it: registration with the SEC. Venture capital and private equity funds are exempted altogether.
Hedge funds, private pools of capital which are only open to investors with net worth of more than $1 million, pointed out to lawmakers that they did nothing to cause the financial crisis. Nor were any hedge funds bailed out by taxpayers.
Registration subjects the funds to periodic inspections by SEC examiners. Any firm with $100 million or more in assets -- for example, ESL Investments Inc. and Soros Fund Management -- would be covered by the law.
Hedge funds would be on the hook to report information to the SEC about their trades and portfolios that is “necessary for the purpose of assessing systemic risk posed by a private fund.” The data, kept confidential, could be shared with the Financial Stability Oversight Council that the legislation sets up to monitor potential shocks to the economic system.
Should the government determine a hedge fund has grown too large or is too risky, the fund would be placed under Fed supervision.
Restrictions on banks’ ability to own hedge funds and trade for their own accounts would likely benefit the lesser-regulated private pools. The bill could push new investment and trading talent toward hedge funds. Limits on leverage and stiffer capital requirements for banks would give hedge funds an edge landing investors chasing bigger returns.
Unwinding Failed Firms
The Senate bill would give the Federal Deposit Insurance Corp., which already has authority to liquidate failed commercial banks, power to unwind large failing financial firms whose collapse would roil the economy.
The measure would give regulators clout they lacked during the financial crisis, when instead of seizing flailing companies such as AIG the government kept them afloat with a $700 billion taxpayer-funded bailout. Had such authority existed in September 2008, it might have been applied to Lehman Brothers Holdings Inc., whose bankruptcy that month froze credit markets and helped spur Congress to approve bailouts under the Troubled Asset Relief Program.
Dodd initially proposed creating a $50 billion fund, paid for by the financial industry, to cover the government’s cost of unwinding failing firms. Bank lobbyists opposed the fund, and Republicans argued the provision would create a permanent taxpayer bailout of Wall Street banks. Dodd agreed to drop the fund to allow debate on the bill to begin. Under the revised measure, the costs of unwinding firms would be borne by the financial industry. The bill explicitly bars the use of taxpayer funds to rescue failing financial firms.
The Senate measure contains other provisions that would apply to systemically important firms that run into trouble. Under the bill, the Fed could use its emergency lending authority to help only solvent firms. Congress would have to approve the use of debt guarantees. Regulators could ban managers and directors of failed firms from working in the financial industry.
Risk Retention
The Senate bill would force lenders, with the exception of some mortgage providers, to hold a stake in debt they package or sell. The provision is designed to rein in the trade in easy credit blamed for fueling the financial crisis.
The rule would affect credit-card debt, auto loans and some mortgages. Issuers of asset-backed debt and the originators who supply them with pools of loans, including credit-card companies such as Discover Financial Services, would be forced to retain at least 5 percent of the credit risk. The goal is to align the issuers’ interests with those of the investors who buy their financial products.
Lawmakers granted an exemption for most mortgage lenders after lobbying by small mortgage brokers and community banks, who said forcing big lenders such as Bank of America to keep loans on the books would tie up capital and lead to higher interest rates. The exemption wouldn’t apply to mortgage pools including risky features such as negative amortization, interest-only payments and balloon payments.
Sellers of commercial mortgage-backed securities won language that gives regulators flexibility to tailor risk- retention rules to specific products. Regulators could set underwriting standards as a form of risk retention, for example.
“Mandating additional one-size-fits-all risk retention would have only further destabilized the already fragile real estate markets,” said Robert Story Jr., chairman of the Mortgage Bankers Association.
Insurance Industry
Senators deferred action on a proposal to exempt insurers from a provision that would bar financial firms from hedging and proprietary trading with assets in their general accounts.
Senator Scott Brown, a Massachusetts Republican, joined Democrats in approving the broader financial-rules overhaul after receiving assurances that his proposed changes would be considered in the Senate-House conference on the bill. Brown said subjecting insurers and custody banks to Volcker rule restrictions would place an undue burden on those companies.
Insurers’ “fundamental business model requires them to invest the company’s own money in order to ensure a healthy portfolio for paying customer benefits and prudently running the company,” Frank Keating, chief executive officer of the American Council of Life Insurers, wrote in an April 19 letter to the Senate.
Senators voted to include a measure that will impose collateral requirements on previously written derivatives.
Warren Buffett’s Berkshire Hathaway Inc., which has more than $60 billion at risk on derivative bets tied to stock indexes, municipal bonds and corporate debt, had requested that legislation shield contracts written in the past. David Sokol, one of Buffett’s top executives, told CNBC in April that the company wants to maintain the “sanctity of contract.”
The Senate’s derivatives proposal was designed to ensure there is cash backing bets on the direction of stocks and commodities prices. AIG needed a $182.3 billion U.S. bailout in 2008 after failing to reserve for obligations on credit-default swaps tied to subprime home loans.
The bill includes a measure creating a federal insurance office through the Treasury Department that would have the power to negotiate international treaties covering the industry.
Reinsurers based in Europe, including Ace Ltd., Lloyd’s of London and Swiss Reinsurance Co., said a federal regulator should be able to override state rules that force the companies to post more collateral than U.S.-based competitors.
“We believe that collateral should be based on the financial strength of a reinsurer, not its place of domicile,” Ace CEO Evan Greenberg said in an e-mailed statement in April.
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