Hoenig’s comments are not based on rocket science. Most people familiar with Basle II’s volution have seen these arguments many times before. In defense of Basle II (which I clearly do not regard as an optimal piece of regultion) it should be noted that there is more than just models. There is also process and lots of scope for responsible national supervisors to be as tough as they want to be.

The trouble is that the Basle II process got hijacked in its early stages by lobbyists from ISDA (If ever an organization should be held responsible for the current crisis (not solely of course), it is this strange beast made up of overeducated and underexperienced science people plus rather unscrupulous financial entrepreneurs) plus misguided senior banking executives unhappy whith the nature of their business: that of a rather boring utility where cost is the main variable to be managed..

But Basle II is better that Basle I and also better than the traditional US capital ratios, which are clearly unsuitable for an era in which it is impossible to separate commercial and investment banking effectively. As to the end of Glass Stegall, I think that was unavoidable, but it should simply have led to bringing all large financial institutions under a single federal charter, a single set of accounting rules (specific to financial institutions and set by the federal gvt), a single set of approved quantitative models (let banks estimate their own default frequencies, but centralize correlations, key parameters for market risk and collateral vatuation, etc. It is ridiculous that under the current rules banks are largely free to write many of the rules that determine capital adequacy (of course the regultor can challenge, but not impose uniformity without breaching confidentiality). Finally, product innovation should simply be as slow as the regulators can approve the required risk management methodologies. As said, none of this is rocket science, anyone risking his own money (whilst not yet gambling for resurrection) would not even dream of allowing his (contingent) debtors so much slack.

p.s. perfect example of 2fish’s trick #157: this wkd w/the G20.

‘ there s this

Federal Reserve Bank of Kansas City President Thomas Hoenig said the central bank has “done about as much as it can do” to revive the economy, which has worsened faster than he expected.
“The focus should be on protecting the intermediation process and payments mechanism,” Hoenig said today
Authorities need to impose leverage ratios for financial institutions, Hoenig said. Basel II, an international accord geared toward allocating capital on the basis of risk, is complex, easy to evade and “pro-cyclical,” he said.
Hoenig said he would support a rule linking the suspension of dividends to the loss of earnings.

+ more

I don’t think that recovery is the key concept. Right now the key is damage mitigation and post-disaster cleanup.

DJC: This is nothing more than a short-covering rally and the American currency is likely to witness an epic crash in the future.

I don’t think so. People that have been betting on a dollar crash have lost their shirts over and over and over again.

DJC: There is no way you can have a strong currency when you are the greatest debtor nation in the world (debt of US$54 trillion).

Way. The problem is that when the US economy crashes everyone gets hit worse so a crisis in the US has the paradoxical and perverse affect of strengthening the dollar and making it easier for the US to borrow.

Anything bad that happens to the US economy does makes everyone else economy worse, even if that damage is self-inflicted.

It’s perverse, it’s probably unfair, but it is an accurate explanation of what is going on and has been going on for the last seven years.

This may not be such a good idea because 1) the Fed is in charge of monetary policy and 2) if you have all of these agencies involved, you run the very real chance that nothing will get done and 3) you are leaving out the state regulators.

My one feeling is that the Christopher Cox and the SEC seriously dropped the ball as far as financial regulation goes. If you had put Cox both in charge of the SEC and in charge of the Fed, then he could have paralyzed both the Fed and the SEC.

Bureaucratic trick #157: Getting people that you know don’t agree with each other and then putting them on a board in which they have to reach consensus is a sure way of making sure nothing gets done.

it is very possible to finance a large fiscal deficit domestically. Japan does it. So does Germany. Both have fiscal deficits and current account surpluses. It does tho require that a country’s private sector save more than it invests. And while the US isn’t known for its savings, i do expect savings to rise and investment to fall, effectively freeing up financing for the us government.

as for the impact of higher interest rates, tis true that if the treasury had to pay more on its short-term borrowing, it would increase the fed’s funding costs – and might require that the fed charge more.

on the other hand the fed is taking on more risk and likely making more (so long as it gets paid back), as it has replaced long-term treasury bonds with higher-yielding (one assumes) assets on its balance sheet. moreover, the fed intrinsically makes money as many of its liabilities (cash) do not pay any interest. so in effect the fed could cross subsidize the portion of its lending financed by short-term treasury sales with the profits on the portion of its lending that is financed by issuing cash.

bottom line — the real risk from higher interest rates comes elsewhere. it would increase the treasury’s borrowing cost — making it harder to finance a large fiscal deficit. and higher treasury rates mean higher mortgage rates and that won’t help housing recover.

You are getting too hung up on the exchange rates. Given that both central banks are committed to the forward re-exchange, and default by either party would raise far more serious problems than merely financial ones, the exchange rates at the beginning and end of the swap are almost irrelevant. Only the difference between them matters. If you lend me $100 for a year at 2% against (the security of) a paper clip, then you could see yourself as getting a poor exchange rate at the start of the swap and a fantastic closing exchange rate ($102 per paper clip). But you are committed to the re-exchange, and if default is out of the question for either of us, the exchange rates hardly matter. I dare say that the only reason that the central banks go through the formality of the swap is that the Fed does not have the vires to lend unsecured to a foreign central bank.

The exact same thing happened in Japan in the 1990’s. It also happens at personal level in which there are people who would rather starve than have the stigma associated with taking a “handout” from the government.

The way around this is to make sure that rich people get money from the government as much as poor people so there is no stigma attached. This is why social security and medicare is not means tested, and why Treasury did its recapitalization by giving a lump sum to all of the banks.

DJC : i have read the article quoted by you in full, and it sets out precisely the point of view that i have repeatedly disagreed with. the reasoning in it is simplistic. it ignores the last 30 years of the oil price graph which bears no relation to the total global oil reserves over that period. it assumes that reduced supply – of oil, food, whatever – equals skyrocketing price. what is the price of bottled water in the sahara ? what was the price of potatoes in the irish potato famine ?

it repeats the mistake of king midas – forgetting that if money is worthless and you turn all to gold, what then will you turn gold into ? worthless money once again ? at what point ?

about four years ago approaching christmas 2004 i think, we had a debate over the dollar collapsing. living in the euro zone i see that from a eurozone perspective. just for fun i bought $100 in my local bank. the dollar was at about $1.33 to the euro. now it is at about $1.27. i put the notes in a drawer and recently found them still there.

i suspect that forecasters treating the dollar as if it behaves according to the rules of small national currencies (argentina, iceland ?) always risk miscalculation.

study the chinese mind. is there any evidence there of red hot anxiety to spend their ‘worthless’ greenbacks before they melt away ? if there is, i cannot see it.