The Federal Reserve has some—make that many—of the best economists in the world who are capable of doing the most sophisticated statistical and econometric studies and using the most sophisticated models for forecasting. The shortcomings of Fed forecasting, in my opinion, are due more to the inherent impossibility of the task than to human failure. People know this.
What some people may not fully appreciate is the valuable supplemental role anecdotal information plays in informing Fed policymaking. I was reminded of this by the latest release of the Fed’s Beige Book. Each Reserve Bank has people who work diligently and systematically in compiling the information that goes into the Beige Book. They don’t just make a few random phone calls to gather on-the-ground information. They have a well-designed formal list of respondents they call regularly to ascertain whether inventories are rising or falling, what’s happening to sales, hiring, pricing power, and many other things. These surveys are structured by industry and by geography.
Reserve Banks take turns compiling and composing the information for the national summary—with staff at the Board of Governors looking over their shoulders. The final result—the Beige Book—is more helpful in detecting early “straws in the wind” than one might expect, especially at inflection or turning points before official statistics record the change.
The Reserve Bank presidents also have regular conversations with members of their Boards of Directors and various advisory committee members, not to mention people in the community they interact with daily. All this anecdotal information, while often more ambiguous than government statistics, is more timely and thus just as valuable.
When I became a policymaker in 1991, this type of information, especially from the directors of our four offices, was particularly valuable in detecting the credit crunch early. If bank lending is turning down, for example, anecdotal information is needed to help sort out whether the primary cause is reluctance to lend, a reduction in loan demand, or what combination of the two.
People on the outside sometimes denigrated such “anecdotal information” not worthy of serious consideration. Once in frustration, I threatened to have a tee shirt made that said on its back “Life is Anecdotal.”
I’ve been retired from the Fed since November 2004, but some of my old contacts still touch base now and then and, of course, I have new ones through my work at NCPA and from my board and advisory work. While the sample is much smaller, and much too small to rely on, I’m hearing some things about banking at the ground level that don’t square with official pronouncements. I keep hearing about the difficulty of business borrowing even at banks they’ve done successful business with for many years. They report that their banker friends are very skittish about the current and future environment, both economic and political, which has made them much more reluctant lenders.
We hear from the top of the regulatory hierarchy that bank examiners should not overreact to the recent problems and shouldn’t be overly conservative in reviewing bank loan and securities portfolios. In particular, I’ve heard they’ve been asked not to write down the value of a performing loan, simply because its collateral has declined in value. Even that small degree of forbearance, however, is not evident in practice. We still hear stories of rigid examiner attitudes on such matters.
The consensus seems to be that no examiner and no examination unit want to see a problem develop in the future that they hadn’t anticipated and flagged first. The incentive structure for examiners in the field is one-sided and differs from the incentives facing Chairman Bernanke, for example, during Congressional testimony.
As I railed over and over in blogs, speeches and TV appearances prior to April 2009, the strict application of mark to market accounting to banks had a devastating impact on bank capital during the early stages of the financial crisis. In many cases, banks’ capital was already depleted before the bank started realizing actual losses. Congressional pressure eventually caused FASB (the Financial Accounting Standards Board) to relax slightly their rules on mark to market accounting as applied to banks. They relaxed the rules as little as they could get away with, mainly by not making their modest changes retroactive. It’s like a promising treatment for cancer was developed, but it would only be available to new cases. It was no coincidence, in my opinion, that the stock market recovery, led by financials, coincided with the minor changes in mark to market rules in March 2009.
Now, in a jaw dropping display of hubris, FASB rides again. This time they are proposing tough mark to market standards not only on bank investments, but also on bank loans as well. FASB wants to subject the banks’ entire balance sheet to frequent re-marks. I don’t even know how that could work. What I do know is that bankers are stunned. Just as they are coming out of the old nightmare, they face the prospect of a new one.
This threat also coincides with the possible loss of trust preferred securities as a component of Tier One capital, which recently was added to regulatory reform. I’m omitting many outrages in the war on banks because I’m focusing here only on small community banks. I don’t have room to cite all the threats facing large banks in regulatory reform.
Just as important as the specific threats is the idea of a continuing, relentless war on banks being waged by the administration and Congress to appeal to anti-bank populist sentiment that they helped stoke by their own misinformation.
What misinformation? Well, for starters, the broad use of the word bank—there are about 8,000 of them you know—when referring to the sins of a handful of Wall Street Investment banks. Wall Street Investment banks are not the same as Main Street Commercial Banks, but grand-ma doesn’t know that. Heck, most of my neighbors don’t know that. But those who hope to gain politically from the confusion do know better, which makes their behavior all the worse.
Sometimes, good economics is not rocket science. It’s not brain surgery. Fairy tale economics will suffice. The lesson to be learned is not to kill the goose that lays the golden eggs. It’s that simple. So, will someone please tell me why we still have the continued misinformed and misguided war on banks at a time when bank lending is so much needed to keep the fragile economic recovery going? The statistics tell us that bank lending is inadequate. The anecdotal information tells us why.
Disclosure: No positions