Jul 252014

It might be the dog days of summer, but regulators and policy makers continue to make headlines. The key stories from this past week were the SEC’s ruling on money market reform, the fourth anniversary of Dodd-Frank and President Obama announcing planned steps to stem the rising number of corporate inversions for tax purposes.  As CFP Director, Russ Wermers commented on the money-market reform ruling – it will be interesting to see how all of this plays out over the coming months.

Next week, monetary policy returns to forefront as the Federal Reserve meets on Tuesday and Wednesday.  Little is expected to change on the surface of the statement, but markets will be watching to see if she starts to lay the groundwork for the months ahead as the bond program expires.  CFP Special Fellow and Professor of International Economic Policy, Phillip Swagel, commented on this in his WSJ Op-Ed last week.


Weekly News Round-Up

 Dodd-Frank’s Four Years of Doing Nothing


Dodd-Frank at a Crossroads


 Obama Says Tax Law Needs to Stop ‘Corporate Deserters’


 SEC’s long path to money market fund reform ends in compromise


 IMF Lays Out Own Fed Exit Strategy


NYT: The Importance of Shedding Some Light on Dark Pools


SIFMA Publishes Recommendations for Enhancing Fairness, Stability and Transparency in US Equity Markets


Jul 242014

Thoughts from CFP Director Professor Russ Wermers:

Yesterday, by a 3-2 vote, the SEC Commissioners approved a rule to require money market mutual funds in the “prime institutional” category to mark their share price to market each day, rather than holding a fixed $1 per share (as they have for decades).  This change is meant to remind large institutional investors that these cash accounts have some risk, albeit very small during normal times, so that they will hopefully not be overly surprised when an event happens (such as the Lehman default) that impairs the value of their fixed-income assets.  Other, lesser-binding components of the rule include the ability of funds to shut down redemptions or charge a fee for redeeming money fund shares during a crisis.

There are two interesting issues to watch:  First, will institutional investors accept this change, or will they move their money to other cash accounts (such as unregistered vehicles or banks)?  Second, will the floating share price really work to inhibit mass redemptions during a big market event, or will it serve to speed up the revelation of which funds are holding impaired assets (i.e., reveal the “good banks” vs. “bad banks”)?  Fund management companies have two years to comply.  This will be an interesting experiment to watch.


Professor Wermers Research:  ”Runs on Money Market Funds”


Reuters Coverage:





Jul 232014

by Phillip Swagel, CFP Senior Fellow and Professor of International Economic Policy at the Maryland School of Public Policy

Read the full paper here:  Economic_Contributions_of_Fraternal_Benefit-Societies.pdf


Executive Summary

For more than one hundred years, lodge-based fraternal benefit societies have enriched the lives of millions of people across the United States while making immense contributions to the U.S. economy and society.   Since the mid-19th century, individuals have joined others with a common bond to establish a local lodge and pool resources to provide insurance protection to their membership.   Modern fraternal benefit societies have evolved into member-owned, not-for-profit mutual aid organizations structured under state and federal law that (1) have a fraternal purpose, (2) operate under a lodge system, and (3) insure members and their families against death, disease, disability.  The charitable and social activities of the more than nine million fraternal members organized in local lodges across the United States today are made possible by the resources generated through providing  insurance products to fraternal members, as required under Section 501(c)(8) of the Internal Revenue Code and various state laws.  These resources support a vast network of ready member-volunteers and ample opportunities to help others and give back to their communities.

This study measures these benefits to society from the charitable and voluntary activities of fraternal benefit societies using a rigorous economic framework originally developed in a September 2010 Georgetown University McDonough School of Business study authored by Phillip Swagel, currently a Professor at the University of Maryland School of Public Policy.  Dr. Swagel previously served at the White House Council of Economic Advisers in the administrations of presidents George W. Bush and Bill Clinton, and was a senior official at the U.S. Treasury Department under President George W. Bush from 2006 to 2009.

From 2007 to 2011, even during a severe recession, fraternal benefit societies produced more than $3.8 billion in benefits on average to the U.S. economy each year, for a total of nearly $19 billion over the five-year period.  In direct contributions alone, fraternal benefit societies together produced $2.4 billion in charitable and community assistance from 2007 to 2011, an average of $478.3 million per year.  Members of fraternal lodges also volunteered nearly 400 million hours of their time during the five-year period considered in this study, with a direct on average value of $1.6 billion in each year. 

In addition to direct economic contributions of time and money, this study demonstrates how fraternal benefit societies generate enormous indirect economic benefits by creating social capital, which encompasses the bonds between individuals that deepen reciprocity and trustworthiness within a community.  The creation of social capital generates quantifiable economic and societal benefits.  When members of fraternal benefit societies gather together to help others, volunteer to improve the lives of children and families, or carry out any of their myriad other activities, they bring communities together to deepen societal interconnections and generate social capital that benefits both individuals and communities as a whole.  The efforts of members of local fraternal lodges improve people’s lives today and into the future.

During the five years studied, fraternal benefit societies generated social capital valued at an average of $1.7 billion annually, or $8.6 billion total.  These enormous contributions vastly outweigh the estimated foregone $50 million annual cost of the federal tax exemption that makes the fraternal model possible, producing a 76-to-1 return on the public investment.  The support of the tax code gives rise to immense benefits to society, thanks to the efforts of the members of fraternal benefit societies.

Moreover, these benefits are above and beyond the positive impact fraternal insurance protection has on the individuals that purchase it.  In addition to providing financial security and a safety net for millions of fraternal members and their families, research shows that individuals with a sense of financial security are significantly more willing and able to participate in service activities and help others in their communities.  The fraternal model embodies this concept: fraternals help their members achieve financial security while the network of local lodges offers the opportunity for fraternal members to give back their time, talents and resources to help others in their local communities and beyond.

Without the current tax rules in place that govern fraternal benefit societies, the $19 billion in total benefits that this study finds that fraternals provide society over five years would be at risk.  These benefits are impossible to replicate by corporations or government agencies, because they arise out of the public-spirited acts of fraternal members coming together for the common good.  Indeed, changes to the tax code that put the fraternal system at risk would add great pressures to already stretched local, state and federal government budgets or leave more needs in communities unmet.   Considering the extraordinary return on the public investment in their model, fraternal benefit societies represent a tax policy solution with an enormously positive ratio of benefits to costs.


* This paper is an update to a previously published paper:


Jul 212014

Center for Financial Policy Senior Fellow, Dr. David Kass, recently published his notes from the annual Berkshire Hathaway meeting on his widely followed blog dedicated to the oracle of Omaha.  The meeting touches on a variety of topics from executive compensation to corporate governance.  The full text can be found here.

Here’s an excerpt on Berkshire’s views on the mortgage market:

Audience: Should the U.S. change the way it finances home purchases and is there a role for Berkshire?

Buffett: The 30 year fixed loan is good for home owners.  It kept costs down.  Government guaranteed part to keep cost down.  No private organization can do it.  It is an $11 trillion market.  Private industry cannot do it, rates would be higher.  How do you keep government in the picture without politics?  Fannie and Freddie did some dumb things on their own, but they were also prodded into doing dumb things by politicians.  I wrote an article when the savings and loans were falling apart.  I suggested the FDIC get the private sector into pricing and evaluating, with the government as the main insurer.  There might be a way that model works in terms of home mortgage insurance.  Berkshire likely would not be a player.  Others would be more optimistic in setting rates.  Private industry might price 5% and the government 95%, and maybe guaranteeing the privates if they went broke.  It is important to get the correct national policy.  It is being worked on.  It is unlikely that Berkshire would play any role.

Munger: When private industry was allowed to take over the system, we got the biggest thieves screwing it up.  As much as I hate government, I’m not trustful of private industry in this field.  The existing system is probably sound.  At the moment, Fannie and Freddie are being conservative and I think that is okay.  I’m not anxious to go back to the race to the bottom with investment banks creating phony securities.  Let them keep doing what they are doing.

Buffett:  The one thing that led Fannie and Freddie astray was serving two masters trying to deliver double digit earnings increases. It would have been fine if they just insured rather than buying portfolios and turning themselves into big hedge funds, and just borrowed cheap and lent long.

Munger:  I think it is a mistake to have private companies taking over the whole mortgage market.  There is no need to have private portfolios. I think that particular experiment in privatization was a total failure.  And we made a billion dollars out of it.  (Note:  Berkshire purchased a large stake in Freddie Mac in 1989 and sold it in 2000.)

Buffett:  I was not going to mention it.


Jul 172014

If booming asset prices go bust, the central bank’s credibility would be severely damaged.

by Phillip Swagel, Professor in International Economic Policy, Maryland School of Public Policy and Academic Fellow, Center for Financial Policy and Marc Sumerlin, Managing Partner at Evenflow Macro

This post was originally published as an Opinion in the July 17, 2014 edition of the Wall Street Journal which can be found here.

Federal Reserve Chair Janet Yellen in her testimony on Capitol Hill this week was candid, as she has been in the past, in telling lawmakers that the biggest economic risk she sees facing the country is the possible emergence of a new permanent class of unemployed workers.

To head off this possibility, the Fed is holding monetary policy accommodative longer than traditional monetary models would recommend. Opinions on the wisdom of this policy are split, but the Fed’s openness about its policy is heralded almost universally as a desirable development.

We are not so sure.

In today’s world the heads of the central bank determine what is immediately deemed common knowledge, and only investors with long time horizons (and a strong stomach) can resist their pronouncements. Ms. Yellen sees considerable labor-market slack, believes this will hold down inflation, and therefore pronounces that the Fed’s near-zero interest-rate policy will continue far into the future. The conventional wisdom is that low rates and low inflation are consistent with an environment in which asset prices rise, so that is what has happened.

This is now the third episode in the past 15 years in which asset-price growth has significantly outstripped income growth. From 1997 to 2000, the net worth of American households rose 40% while national income grew 20%, and in 2002-07, net worth grew 60% as national income grew 30%. Asset prices corrected after each of these rapid increases.

Janet Yellen, chairman of the U.S. Federal Reserve, from left, and Federal Reserve governors Daniel Tarullo, Sarah Bloom Raskin, Jeremy Stein, and Jerome Powell attend an open meeting of the Board of Governors of the Federal Reserve in Washington, D.C.., on Feb. 18, 2014. Bloomberg News

Over the past two years, net worth has grown more than 20% (a similar annual pace as the past two episodes) during a period when national income struggled to grow 6%—and interest rates are still near zero. When the Federal Reserve signals that monetary conditions will remain easy, behavior shifts and a self-fulfilling rise in asset prices is the result.

On Tuesday the Fed stated in its semiannual Monetary Policy Report that valuations were “substantially stretched” in some sectors like biotechnology and social media. Ultimately, however, asset prices should reflect expectations of future income, making them vulnerable to correction when they become too high relative to income.

A problem of having too much certainty on monetary policy is that once the market has come to accept the Fed’s views, changes in the story can be unnecessarily disruptive. Harvard economist Jeremy Stein, a former Fed governor and its leading thinker on financial stability before returning to teaching at the end of May, articulated in his final speech why the Fed’s change in rhetoric in the spring of 2013 was so disruptive.

Mr. Stein noted that a number of investors perceived that quantitative easing would essentially last forever, and they repositioned abruptly when then Fed Chairman Ben Bernanke suggested the program could be finished in a year’s time. The Fed is not responsible for investors who take losses, but the centrality of monetary policy to investment returns leads people to put too much weight on their predictions of Fed actions and too little on fundamental analysis of individual investments.

Mr. Stein warned that “the market is not a single person” and that there might be a similar event if the Fed alters its view on interest rates. This is the big risk for the market now. Ms. Yellen has successfully defined conventional wisdom as a future in which the Fed keeps overnight rates near zero even while inflation and employment approach their respective targets. Indeed, the success of the Fed’s communications in convincing investors that rates will remain low has contributed to low volatility across asset classes, encouraging yet higher valuations. If there is less slack than the Fed believes, monetary accommodation will reverse at a more rapid pace than markets expect.

Imagine a swimmer drifting easily with an ocean current who suddenly discovers he is a long way from shore. Asset prices could be in for a sharp correction. If the U.S. economy were to go through another asset bust cycle, the Fed’s credibility would be severely damaged, and its strategy on reducing unemployment would backfire.

Many monetary experts refer to the 2000 equity crash as a benign event. But the unemployment rate rose by 2½ percentage points after the decline, and the monetary policy response to that rise in unemployment contributed to the housing bubble and the 2008 financial crisis. The Fed will not achieve the stability that it seeks until financial stability concerns are given an equal weight when determining monetary policy.

 Mr. Sumerlin, former deputy director of the National Economic Council (2001-02), is managing partner of Evenflow Macro, where Mr. Swagel, former assistant secretary of Treasury for economic policy (2006-09), is an adviser.