Former FHLB Chicago President and CEO, Alex J. Pollock, named Finzat Block Senior Advisor

Published in Markets Insider.

Finzat Block LLC., a Block One Capital portfolio company, announced that Alex J. Pollock has become a Senior Advisor to the firm.  Mr. Pollock, former President and CEO of the Federal Home Loan Bank of Chicago, will provide Finzat with guidance regarding business strategy, product innovation, and executive leadership.

“Blockchain is emerging as a potential paradigm-shifting technology in mortgage finance.  I look forward to working with Finzat Block on using blockchain to restructure the technological underpinnings of mortgage market transactions,” Mr. Pollock said.

Mr. Pollock is currently a distinguished senior fellow at the R Street Institute in Washington, DC. Previously, he was a resident fellow at the American Enterprise Institute. As President and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004, Mr. Pollock was the creator of the MPF mortgage origination program that was the first to provide community financial institutions a way to share credit risk and provide a meaningful alternative to selling mortgages to Freddie Mac and Fannie Mae.

Mr. Pollock currently serves as a director of the CME Group (Chicago Mercantile Exchange), Great Lakes Higher Education Corporation and the Great Books Foundation, and is a member of the Advisory Board of the Heller College of Business at Roosevelt University.  He was also the past-President of the International Union for Housing Finance.

Mr. Pollock has written extensively on economic cycles, risk and uncertainty, mortgage markets, central banking and the politics of finance.  His new book, “Finance and Philosophy“, is expected to be published by Paul Dry Books in October of this year.

Mr. Pollock is a graduate of Williams College. He completed his MA at the University of Chicago and MPA in international affairs at Princeton University.

“We are fortunate to have Alex’s considerable experience and mortgage market knowledge on the team as Finzat strives to bring the benefits of blockchain into the mortgage mainstream”, said Gnanesh Coomaraswamy, Finzat founder and CEO.

Did Congress just settle for less than best plan to reform housing finance?

Published in The Hill.

House Financial Services Committee Chairman Jeb Hensarling (R-Texas) has long worked to move the American housing finance sector toward private and competitive markets and away from the distortions and disasters of government guaranteed debt with huge risks to taxpayers.

His previous policy direction, exemplified in his sponsorship of the Protecting American Taxpayers and Homeowners Act, was the correct one, both economically and philosophically. But up against the many well placed interests that feast on subsidies from the government dominated system, it could not succeed politically. The history of American mortgage lending should make us modest as a country. Our housing finance system has collapsed twice in the last four decades, first in the 1980s then again in the 2000s. We should certainly try to do better going forward.

Now Hensarling, working across the aisle with John Delaney (D-Md.) and Jim Himes (D-Conn.), has introduced a discussion draft of the Bipartisan Housing Finance Reform Act, which he hopes will prove a “grand bargain” to create a “sustainable housing finance system for the 21st century” after 10 years of a stalemate in Congress. But central to this new proposal is vastly increasing the government guarantee of mortgage backed securities by using Ginnie Mae, a wholly owned government corporation whose liabilities deliver the full faith and credit of the United States. Thus, the government and taxpayers would explicitly guarantee virtually the whole secondary mortgage market.

Has Hensarling given up on his principles? No, but he has decided that, with the best choice unavailable, he will settle for what may be the second best, arguing that it would be an improvement from where we are and where we have been stuck for a decade. The new bill requires private capital to bear a junior position in mortgage credit risk, taking losses ahead of Ginnie Mae, which is to say, ahead of taxpayers. It abolishes the federal charters of Fannie Mae and Freddie Mac, while allowing them to become private credit risk takers, among other such private institutions. It also allows the Federal Home Loan Banks to aggregate mortgage loans for their members. I especially like this last idea because my team developed it while I was running the Chicago Home Loan Bank.

Consider the following series of options. The best choice is a primarily private and competitive housing finance system, but it cannot happen politically. As a second best choice, a system is proposed that uses big government guarantees, but fits in as much private risk bearing and competition as it can. A third choice would be a bad decision to stay where we are now, with Fannie and Freddie perpetually in conservatorship but dominating the housing finance system nonetheless. Finally, the worst choice is to return to the old and failed Fannie and Freddie model.

Given where we are, is it better to wish for the best and never get it, or try to move toward a second best option, which might be politically feasible? This second best strategy is understandable and reasonable. But is the structure proposed in the new bill actually the second best available? That is debatable. For example, when it comes to the key idea of having private capital bear the principal credit risk, the bill unfortunately misses an essential principle that the best place for the junior credit risk to reside is with the institution that made the loan in the first place. That is the party with the most knowledge of the credit and the only one with direct knowledge of the borrower. Keeping the credit risk there provides by far the best possible alignment of incentives for a sound housing finance system. It also spreads the credit risk bearing across the country.

This is demonstrated by the unquestionably superior credit performance through the financial crisis of the mortgage portfolio built on this principle by the Federal Home Loan Banks in their mortgage partnership finance program, the first loan of which was completed by the Chicago Home Loan Bank in 1997. The risk principle in this program provides more than 20 years of instructive experience to draw on in moving toward a better housing finance system for the United States, even if, as Chairman Hensarling has concluded, we cannot attain the best.

FR-6111-A-01 Reconsideration of HUD’s Implementation of the Fair Housing Act’s Disparate Impact Standard

Published by the R Street Institute.

Department of Housing and Urban Development

Regulations Division

Office of the General Counsel

Washington, DC 20410

www.regulations.gov

Dear Sir/Madam:

Re.: FR-6111-A-01   Reconsideration of HUD’s Implementation of the Fair Housing Act’s Disparate Impact Standard

Thank you for the opportunity to comment on this advanced notice of proposed rulemaking, which we believe has the potential to significantly improve the existing standard.  The authors of this comment each have many years of experience in housing finance, both as operating executives and as students of housing finance systems and their policy issues.

Our comments are in particular directed to your Question #6: “Are there revisions to the Disparate Impact Rule that could add to the clarity, reduce uncertainty, decrease regulatory burden, or otherwise assist regulated entities and other members of the public in determining what is lawful?”

The short answer to this question is Yes.  We recommend one major, fundamental change which would great enhance clarity and understanding, while greatly reducing uncertainty, in the concepts and operation of the rule: This is to add to the analysis of HMDA data the default rates on mortgages, organized by the same demographic categories as used in HMDA reporting.

Discussion

Applying one’s credit standards in a non-discriminatory way, regardless of demographic group, is exactly what every lender should be doing.  Is it evidence of discrimination if a lender applies exactly the same set of credit underwriting standards to all credit applicants, but this results in different demographic groups having different credit approval-credit decline ratios?  And is this result evidence of discrimination?

There is a straightforward, data-based way to tell.  It is to add the default rates on the mortgages for each group, and compare them to the approval-decline ratios by group, adjusting for ex ante credit risk factors.

If a demographic group A has a lower credit approval rate and therefore a higher credit decline rate than another group B, the revised rule should require comparing their default rates.

There are three possible outcomes:

1. If group A has the same default rate as group B, then the underwriting procedure was effective and the different approval-decline ratios were appropriate and fair, since they resulted in the same default outcome. Controlling and predicting defaults is the whole point of credit underwriting. Here there is no evidence of disparate impact.

2. If the default rate for group A is higher than for group B, that shows that in spite of the fact that group A had lower credit approval and higher decline rates, it was nonetheless being given easier credit standards. The process was evidently biased in its favor, not against it, even if this was not intended. Again, there is no evidence of disparate impact.

3. If on the other hand, group A’s default rate is lower than that of group B, that shows that group A is experiencing a higher credit standard, even if this is not intended. This may be evidence of disparate impact.

As Nobel laureate in economics Gary Becker wrote, “The theory of discrimination contains the paradox that the rate of default on loans approved for blacks and Hispanics by discriminatory banks should be lower, not higher, than those on mortgage loans to whites.”

In short, if the default rate of group A is equivalent or higher than that of group B, then the claim of disparate impact disappears.

Some discussions of the disparate impact issue have analyzed different demographic groups by household income or other credit factors, but while these factors may be indicators of future default rates, they are not the experienced reality.  Any sufficient analysis must add the reality of the actual default rates.

In sum, we need the facts of default rates to address this issue objectively.  We recommend that HUD’s revised rule should require them to be provided as an essential part of the analysis of any possible disparate impact issue.

The default data by HMDA category is not now readily available from typical mortgage servicing records, but research at the AEI Center on Housing Markets and Finance has shown that the required matching of HMDA to relevant risk and performance data is practicable, as well as theoretically required in order to, as a factual matter, determine any disparate impact.

For example, the experience of FHA loans for the years 2013 to 2017, comparing credit approval ratios to default rates by demographic group is shown in Attachment A.  In all cases, although the credit approval ratios for minorities are lower, their default rates are higher, as are their risk-adjusted default rates, indicating no disparate impact in the aggregate.

We look forward to sharing with you with the further data the Center is developing to help advance the appropriate policy considerations.

It would be a pleasure to discuss this recommendation further with you at your convenience, should you so desire.

Thank you again for the chance to participate in this timely reconsideration.

Yours respectfully,

Alex J. Pollock                                                       Edward J. Pinto

Distinguished Senior Fellow                                 Co-director

R Street Institute                                                  AEI Center on Housing Markets and Finance

Letters to Barron’s: Rediscovering Minsky

Published in Barron’s.

Hyman Minsky is featured in Randall W. Forsyth’s “Musk’s Buyout Plan May Signal Market Woes Ahead,”(Up & Down Wall Street, Aug. 11). About Hy, who was a good friend of mine and from whom I learned a lot, Forsyth says that his “insights were rediscovered after the financial crisis,” meaning the crisis of 2007-09. That is true, but Hy was previously rediscovered in the financial crises of the 1990s, and before that was discovered during the financial crises of the 1980s. The popularity of his ideas is a coincident indicator of financial stress.

Hy’s most important insight, in my opinion, is that the buildup of financial fragility is endogenous, arising from the intrinsic development of the financial system, not from some “shock” that comes from outside. I believe this key contribution to understanding credit cycles can be improved by adding that “the financial system” includes within itself all of the financial regulators, central banks, and governments. All are within the system; no one is outside it, looking down. They all are part of the endogenous process that generates the crises, which periodically cause Hy Minsky to be rediscovered again.
Alex J. Pollock
R Street Institute
Washington

Minneapolis Fed’s TBTF plan has some GSE-sized holes

Published in American Banker.

The Federal Reserve Bank of Minneapolis this winter finalized its “Minneapolis Plan to End Too Big to Fail” — that is, a plan intended to end the problem of “too big to fail” financial institutions, including both banks and nonbank financial companies.

But here is something remarkable: Fannie Mae and Freddie Mac, among the most egregious cases of “too big to fail,” appear nowhere at all in the plan.

Have the Federal Reserve Bank of Minneapolis authors forgotten how Fannie and Freddie blew masses of hot air into the housing bubble, then crashed, then got a $187 billion bailout from the U.S. Treasury? Have they not noticed that Fannie and Freddie remain utterly dependent on the credit guaranty of the Treasury, remaining TBTF to the core?

Since the plan focuses on excessive leverage as the fundamental cause of “too big to fail” risk, have they not considered that Fannie and Freddie each had capital of less than zero at the end of last year, so they had infinite leverage along with their $5.4 trillion in liabilities?

Defenders of Fannie and Freddie will cry that they can’t build capital when the Treasury takes all their profits every quarter. But whoever may be to blame does not change the overwhelming fact: the government-sponsored enterprises are “too big to fail.”

The Minneapolis plan notes that, under the current regime, firms “can continue to operate under their explicit or implicit status as TBTF institutions potentially indefinitely.” This is true — and it is especially true of Fannie and Freddie. So the plan should say instead: “Under the current regime, banks and nonbank financial firms, including notably Fannie Mae and Freddie Mac with their $5 trillion in risk exposure, can continue as TBTF institutions potentially indefinitely.”

What should be done about the TBTF nonbank companies? According to the Minneapolis Fed, the answer is for the Congress to impose a “tax on leverage” that offsets the advantages of running at high leverage and low capital. This tax on leverage will apply to any company with more than $50 billion in total assets. Since Fannie has over $3 trillion of assets and Freddie over $2 trillion, it is safe to say they would qualify.

If the secretary of the Treasury certifies that the company in question does not pose systemic risk, the tax would be 1.2 percent of liabilities under the plan. It is certainly hard or impossible to imagine that any Treasury secretary could certify that Fannie and Freddie pose no systemic risk. So in their case the tax on leverage would be 2.2 percent of total liabilities — 2.2 percent of “anything other than high quality common equity.”

Among the types of firms that the plan would consider for the leverage tax are “funding corporations, real estate investment trusts, trust companies, money market mutual funds, finance companies, structured finance vehicles, broker/dealers, investment funds and hedge funds.” Again, and amazingly, Fannie and Freddie are not on the list.

But if this proposal applies to any these entities, or indeed to anybody at all, it certainly applies to Fannie and Freddie. That is especially true since the market arbitrages across capital requirements of different financial institutions. It sends mortgages to Fannie and Freddie, not because they are most skilled at managing risk, but rather because they have the highest leverage. This was true even before they crashed, since Fannie and Freddie had charters granting them far greater leverage than any other financial institutions.

We’ve calculated how much the proposed Minneapolis tax on leverage would cost these financial behemoths. For Fannie, total liabilities are $ 3.35 trillion, so the annual tax would be 2.2 percent times that, or $74 billion. Fannie’s profit before tax for the year 2017 was $18.4 billion, so the tax in the size proposed by the Minneapolis Plan would be four times Fannie’s total pretax profit.

For Freddie, the corresponding numbers are liabilities of $2.05 trillion and a leverage tax of $45 billion, which would be 2.7 times its 2017 pretax profit.

In short, instead of paying about 100 percent of their profits to the Treasury, Fannie and Freddie together would pay Treasury well over 300 percent of their profits. This would obviously cause them to operate at a huge pro forma loss.

As a first step, we make the much more modest proposal that Fannie and Freddie should be required to pay the Treasury for its credit support, which makes their existence possible, an annual fee of 0.15 percent to 0.20 percent. Such a fee would be consistent with what undercapitalized banks must pay for a government guarantee from the Federal Deposit Insurance Corp., which is also assessed on their total liabilities. Fannie and Freddie’s effective, though not explicit, guarantee from the Treasury is extremely valuable and should be paid for, without question. As is the intent of the Minneapolis plan, charging a fair price for it would significantly reduce the capital arbitrage the GSEs exploit, reduce the distortions and vulnerabilities they introduce into the mortgage market and reduce the massive taxpayer subsidies they have heretofore enjoyed.

As the foremost “too big to fail” institutions in the country — indeed, in the world — Fannie and Freddie must be included in any TBTF reform plan that is to be taken seriously.

Booming housing market today presents serious risk for future

Published in The Hill.

We are currently in the midst of a six-year boom in home prices. Aided by a growing economy, favorable demographic trends, monetary accommodation, […]

EU Parliament report calls for CBDCs to level competition in cryptocurrency market

Published in Live Bitcoin News.

Last week, Alex Pollock, senior fellow at the R Street Institute, argued during a U.S. Congressional Subcommittee on Monetary Policy and Trade that “a central-bank digital currency is one of the worst financial ideas of recent times.” However, he added that “it’s still quite conceivable.”

US Congress: Yes to crypto, no to central bank crypto

Published in Coingeek.

Alex Pollock, a senior fellow at the R Street Institute, took to the microphone to discuss central bank-digital currency (CBDC). He said, “[To] have a central bank digital currency is one of the worst financial ideas of recent times, but still it’s quite conceivable…” He further asserted that a central bank’s digital currency would increase the power of the bank that could lead to the Federal Reserve becoming the “overwhelming credit allocator of the U.S. economic and financial system” if the Reserve were to adopt a CBDC.

Congressman says we should be banned from mining, using cryptocurrency

Published in Digital Trends.

Also brought up during the hearing was the idea of central banks issuing their own digital currency. Alex Pollock from the R Street Institute refuted the idea, as these banks would compete directly with the Federal Reserve. Having central banks issue digital currencies is “one of the worst financial ideas of recent times,” he said.

A better way to assess disparate impact

Published in American Banker.

The Department of Housing and Urban Development is currently reviewing its disparate impact regulation, and it’s possible the courts, including the Supreme Court, could take the issue up once again.

Here’s the key issue: What if a lender applies the same credit underwriting standards to all credit applicants, but this results in different demographic groups having different credit approval-credit decline ratios? Is that necessarily a problem?

One position is that applying the same credit standards to everybody, regardless of demographic group, is exactly what every lender should be doing. Yet supporters of “disparate impact” argue that if there are different ratios for loan approvals versus loan declines among groups, it must mean there is some kind of hidden, even if entirely unintended, bias in the process.

Which side is right? There is a straightforward, data-based way to tell. It is simply to add to the report the default rates on the loans in question and compare them to the approval ratios by group.

Suppose, for example, that demographic Group A has a lower loan approval rate and therefore a higher decline rate than Group B. We must also compare their default rates. There are three possibilities: Group A either has the same, a lower or a higher default rate than Group B.

If Group A has the same default rate as Group B, then the underwriting procedure and the different approval-decline ratios were fair and appropriate, since they resulted in the same default outcome. Predicting and controlling defaults is the whole point of doing the credit analysis.

If the default rate of Group A is lower than Group B, however, that shows that it is experiencing a different credit standard, which may be a higher standard, or may be one biased one against Group A, even if it is not intended.

In the third possibility, if the default rate for Group A is higher than Group B, that shows that in spite of the fact Group A had a lower approval and higher decline ratio, it was nonetheless being given easier credit standards, or that the process was biased in its favor, even if not intended.

We need the facts of default rates to objectively and calmly address this issue. Why not simply provide them as part of the regular Home Mortgage Disclosure Act reports?

Some previous discussions of this issue have analyzed the different groups by factors such as household income or standard credit ratios. But such factors are merely attempted predictions of future default rates, not the reality of the actual default rates. It is much better to use the direct reality of defaults, since controlling defaults is the whole point of credit underwriting.

As HUD addresses the issue, a resolution based on fact should be adopted: Report the default rates on relevant loans and compare them to approval-decline rates, and then draw the logically necessary conclusions. If the question gets to the courts, judges should insist on the same fundamental logic being applied.

When a bureaucracy is so independent it’s unconstitutional

Published in the Federalist Society.

In a conceptually important opinion, the 5th U.S. Circuit Court of Appeals has ruled the governance structure of the Federal Housing Finance Agency (FHFA) to be unconstitutional. This powerful agency is the conservator and regulator of the giant mortgage firms Fannie Mae and Freddie Mac, which combined have more than $5 trillion in assets, and is also the regulator of the Federal Home Loan Banks, which have more than $1 trillion in assets. That gives the FHFA broad power over $6 trillion of mortgage financing.

To meet the fundamental constitutional requirement, says the court, all elements of the government must reflect the separation of powers, or checks and balances, among the three main branches of legislative, executive and judicial. Without question, this principle is central to the constitutional order. Therefore, while agencies in the federal bureaucracy can be set up with varying degrees and modes of independence, the court finds, there is a limit to how independent they may be.

When do they have too much independence?  The answer is when “independence” of an executive bureaucracy becomes “insulation” or “isolation” from presidential control. Thus:

If an independent agency is too insulated from executive branch oversight, the separation of powers suffers…excessive insulation impairs the president’s ability to fulfill his Article II [of the Constitution] oversight obligations…

For these reasons, agencies may be independent, but they may not be isolated.

According to the circuit court, what pushes the FHFA over the constitutional line is no one factor, but multiple factors in their combined effect. These factors include:

• There is a single director of the FHFA.

• The director cannot be removed by the president except “for cause,” that is for failure to perform the job, criminal behavior or moral turpitude. The director cannot be fired for normal reasons, including taking actions contrary to the policy of the president.

• There is no bipartisan commission structure overseeing the agency.

• Its funding escapes the congressional appropriations and the power of the purse and is outside the federal budget process.

• There is an oversight board but it has no authority, only an advisory role.

Putting all of this together, the court writes:

We hold that Congress insulated the FHFA to the point where the executive branch cannot control the FHFA or hold it accountable.

That is presumably what Congress was trying to do when it created the FHFA amidst the growing financial crisis of 2008. But under the Constitution, they are not allowed to do it. So:

We conclude that the FHFA’s structure violates Article II. Congress encased the FHFA in so many layers of insulation…that the end result is an agency that is not accountable to the president… his ability to execute the laws—by holding his subordinates accountable for their conduct—has been impaired. In sum, while Congress may create an independent agency as a necessary and proper means to implement its enumerated powers, Congress may not insulate that agency from any meaningful executive branch oversight.

Considering this conclusion, another bureaucratic agency leaps to mind: the Consumer Financial Protection Bureau, or as it is now known, the Bureau of Consumer Financial Protection. It is surely unconstitutional on the same grounds!

But no, says the court, and differentiates the two cases, therefore not contradicting the recent judgment of the D.C. Circuit that the CFPB structure is constitutional. The distinction is the partial oversight of the CFPB, but not the FHFA, by the Financial Stability Oversight Council. In my opinion, the distinction is not convincing, and both bureaucracies are excessively insulated and fail the relevant test. But that is not how the opinion turned out.

The court limits its conclusions to the FHFA, finding that it is a unique case:

The FHFA is sui generis, and its unique combination of insulating features offends the Constitution’s separation of powers.

To remedy the problem, says the court, the provision limiting removal of the FHFA Director to “for cause” situations must be deleted from the chartering act, the Housing and Economic Recovery Act of 2008 (HERA). Then the life of the FHFA can go on, although its director’s job tenure becomes less secure and more subject to the judgment of the president.

“We leave intact,” the court concludes, “the reminder of HERA and the FHFA’s past actions … In striking the offending provision from HERA, the FHFA survives as a properly supervised executive agency.”

Thus the final outcome is quite narrow, though important, but the concepts of how to assess whether a federal agency exceeds its allowable independence seem possibly to open broader considerations.

The future of digital currency

Published by the House Financial Services Committee.

“There is no doubt that the digitalization of financial transactions, records, access to information, and communication will continue to increase, and that the electronic networks underlying the activity continue to grow more intense and omnipresent. But the fundamental nature of money, it seems to me, will not change… It is clear that having a fiat currency is far too precious and profitable for governments for them ever to go back to a government currency backed and convertible into actual assets, whether gold coins or otherwise… An increase of the monopoly power of central banks, which already have too much, should be avoided.” – Alex J. Pollock, Distinguished Senior Fellow, R Street Institute

Congressional hearing on the future of money & crypto: “These innovations should be fostered not smothered”

Published in Crowdfund Insider.

As previously reported, the list of witnesses included the following individuals;

Dr. Rodney J. Garratt, Maxwell C. and Mary Pellish Chair, Professor of Economics, University of California Santa BarbaraDr. Norbert J. Michel, Director, Center for Data Analysis, The Heritage FoundationDr. Eswar S. Prasad, Senior Fellow, The Brookings InstitutionMr. Alex J. Pollock, Distinguished Senior Fellow, R Street Institute[…]

Pollock quoted Hayek in his remarks. Sympathizing with the famous economist;

“Why should we not let people choose freely what money they want to use? … I have no objection to governments issuing money, but I believe their claim to a monopoly, or their power to limit the kinds of money in which contracts may be concluded within their territory, or to determine the rates at which monies can be exchanged, to be wholly harmful. … I hope it will not be too long before complete freedom to deal in any money one likes will be regarded as the essential mark of a free country.”

While adding he did not expect a “revolution in the international monetary system,” Dr. Prasad stated;

“While reserve currencies might not be challenged as stores of value, digital versions of extant reserve currencies and improved cross-border transaction channels could intensify competition among reserve currencies themselves.”

[…]

Pollock, on the other hand, called having a CBDC one the the worst ideas of the times.

Representative Barr asked if crypto could supplant US dollars as a reserve currency? And what type of implications this may have.

Michel said it is not going to happen. The US dollar has a competitive advantage of wealth storage added Pollock.

US Congressman stands against cryptos

Published by Live Coin Watch.

However, there are also many who are opposing the idea, pointing out potential risks, and not wanting to change the traditional methods. The concept reached the Wednesday’s hearing, and R Street Institute’s senior fellow, Alex Pollock, stood against it, saying that it is the worst financial idea that has been conceived lately.

US Congress hearing: Central bank digital currency ‘one of the worst financial ideas’

From Cointelegraph:

Alex Pollock, senior fellow at the R Street Institute, argued that “to have a central bank digital currency is one of the worst financial ideas of recent times, but still it’s quite conceivable…” Pollock said that central bank digital currencies would only increase the size, role, and power of the bank, adding that the Federal Reserve adopting a CBDC would result in it become the “overwhelming credit allocator of the U.S. economic and financial system.” He continued:

“I think we can we can safely predict that its credit allocation would unavoidably be highly politicized and the taxpayers would be on the hook for its credit losses. The risk would be directly in the central bank.”

Pollock explained that if fiat money becomes digitized, its nature will not be changed, and will still be issued by a central bank. While Pollock can envision some type of private digital currency backed by assets, he concluded that it will not be “private fiat currency” like Bitcoin. In Pollock’s view, cryptocurrencies are essentially the same as scrip.

“We should prohibit U.S. persons from buying or mining cryptocurrencies,” says Rep. Brad Sherman

Published in Hacked.com.

Unfortunately, Rep. Sherman’s utterances were not the only anti-cryptocurrency statements at the hearing. Specifically, Alex Pollock, a fellow from the Pro-Free Market think R Street Institute, stated his view that, “a central bank virtual currency is one of the worst ideas in recent times.”

A central bank digital currency is one of the worst financial ideas ever – US Congress hearing

Published in Smartereum.

Another member of the committee from R. Street Institute, Alex Pollock, argued that having a digital currency owned and regulated by the Central Bank is the worst financial idea in the recent times. According to Pollock, the digital currencies by the central bank would do nothing but increase the role and power of the central bank. It would also make the Central Bank an overwhelming credit allocator in the United States economy.

In Pollock’s words:

“Its safe to predict that the credit allocation of the central bank will undoubtedly become politicized. Taxpayers will be on hook for credit losses. The Central Bank will bear the risk directly.”

According to Pollock, if fiat money is digitized, the nature of the currency will not change and the Central Bank will still be responsible for issuing it. He said that cryptocurrencies are more or less the same as scrip.

Digital Money: More competition? Even more central bank monopoly?

Published by the R Street Institute.

Mr. Chairman, Ranking Member Moore and Members of the Subcommittee, thank you for the opportunity to be here today. I am Alex Pollock, a senior fellow at the R Street Institute, and these are my personal views. As part of my many years of work in banking and on financial policy issues, I have studied the history and various concepts of money, including the development of central banks and banking systems, and authored many articles, presentations and testimony on related subjects. Before joining R Street, I was a resident fellow at the American Enterprise Institute 2004-2015, and president and CEO of the Federal Home Loan Bank of Chicago 1991-2004.

Central Bank Monopoly or Privately Issued Money?

As we think about the future of money, which grows ever more digital in its transactions and records, it helps to consider the varieties of money displayed by the past. Today, we are accustomed to the Federal Reserve and other central banks having a monopoly on the issuance of each national money. A senior officer of the Bank of England has summed up the prevailing view:

The distinctive feature of a central bank derives from its role as the monopoly supplier of outside money, [that is] notes and coin and commercial bank reserve deposits. These constitute the ultimate settlement asset for an economy and mean that the central bank has a unique ability to create or destroy liquidity.

But do you have to have a central bank as the monopoly supplier of money? Historically, clearly not. For one thing, there have not always been central banks. The Bank of Canada, for example, dates only from 1934 and there was obviously money in Canada before that, as there was in the United States before the Federal Reserve was chartered in 1913 and subsequently developed its currency-issuing monopoly. Even with the Fed, there were other forms of U.S. currency existing until the 1960s—namely, silver certificates and United States notes. National banks issued their own currency until the 1930s, as authorized under the National Bank Act of 1863-64.

One of the intriguing questions posed by bitcoin and other “cryptocurrencies” (hereafter “bitcoin” for short) is whether today there can be a successful privately issued currency that is widely accepted and constantly used in settlement of purchases and sales, and thus actually serves as money. This would be a money which is not issued by the government or its central bank, and is not backed by the force and power of compulsion of the federal government.

There have been numerous historical examples of private currencies, but to my knowledge there has never been a private fiat currency. They all were claims on some kind of assets, which bitcoin and its siblings are explicitly not.

Consider a classic form of money: gold and silver coins. As the interesting book Money and the Nation State tells us, “Nothing about operating a mint requires the state rather than private enterprise to perform that function. … Private mints operated in the United States until they were prohibited during the Civil War.” Such coins, unlike all currency today, were intrinsically valuable, whether minted privately or by governments.

A common form of private money in the American 19th century were the circulating notes of state-chartered banks. So you might have carried in your wallet a $5 bill issued by something like the Third State Bank of Skunk Creek or hundreds of others. I had an acquaintance who had a huge collection of such banknotes—he gave me a copy of a $3 bill issued by the Wisconsin Marine and Fire Insurance Co., a predecessor of one of my former employers, now a tiny part of today’s JPMorgan Chase. All such notes were backed by the loans, investments and capital of the issuing bank—they were not fiat money, as bitcoin wishes it might become.

The “free banking” theory maintains that a monetary system is better when composed of competing currency issued by private banks, instead of a monopoly currency of the central bank. This is far from the dominant view, however.

Most money used in transactions today is in the form of deposits, already a kind of digital money, operated for the most part and settled electronically, in this country denominated in U.S. dollars. Deposits are also backed by the assets and capital of the issuing bank, as well as the guaranty of the federal government, which if its deposit insurance fund fails, can tax some people to make good the deposits of others. Deposits are thus a mix of private and government money.

Troubled financial times have given rise to experiments with currency. “In America’s first depression, 1819-1821,” we learn from economist Murray Rothbard, “four Western states (Tennessee, Kentucky, Illinois and Missouri) established [their own] state-owned banks, issuing fiat paper.” Unfortunately, this did not end well, as “the new paper depreciated rapidly.” In contrast, the strategy of the Federal Reserve today is to have its paper depreciate slowly and steadily.

During the Great Depression of the 1930s, many municipalities, including the financially desperate City of Detroit, issued their own currency, or “scrip,” to make payrolls. They were out of U.S. dollars and could not borrow any more. The scrip could be used to pay property and other local taxes, which gave it some currency. It often traded at discounts to regular dollars, but still could be used to buy things locally. Says one history of this emergency experiment:

Some sort of scrip was issued by several hundred municipalities, business associations, companies, banking organizations, barter and self-help cooperatives. … Cash-strapped counties and cities across the country paid their employees with scrip issued against prospective tax receipts and good for current taxes and other public fees. In the early 1930s, 25 states revised their laws to authorize the issue of scrip.

These were interesting, but temporary expedients. They do not provide much support for the monetary hopes of bitcoin enthusiasts.

Turning to theory as opposed to history, the great economist, Friedrich Hayek, in his essay, “Choice in Currency,” provided a theory congenial to the libertarian strain of bitcoin backers. Said Hayek:

Why should we not let people choose freely what money they want to use? … I have no objection to governments issuing money, but I believe their claim to a monopoly, or their power to limit the kinds of money in which contracts may be concluded within their territory, or to determine the rates at which monies can be exchanged, to be wholly harmful. … I hope it will not be too long before complete freedom to deal in any money one likes will be regarded as the essential mark of a free country.

I sympathize with these ideas, but I think that Hayek’s hope, expressed in 1975, will continue to be disappointed.

Heading Toward an Even Greater Monopoly?

Will the new and ubiquitous computing power of our time reverse the historical trend toward central bank monopoly of money and create more competition in currency? Bitcoin theorists imagine that it will, but it is easier to imagine digital currency moving us in exactly the opposite direction: toward even greater monopolization of money by the central bank.

Many central banks are interested in the idea of having their own digital currency. That means letting the general public, not only banks, have deposit accounts directly with the central bank, in addition to carrying around its paper currency. The appeal of this idea to central banks is natural: it would vastly increase their size, power and role in the economy.

In a digital age, it would clearly be possible for a central bank, in our case the Federal Reserve, to have tens of millions of accounts directly with individuals, businesses, associations, municipal governments and anybody else, which would be all-electronic. In terms of pure financial technique, there is nothing standing in the way. But would this be a good idea? Should Congress ever consider it?

In a recent article, “The Bank of Our Dreams,” Matthew Klein suggests that it would be a wonderful idea. “It is time for the largest U.S. bank to open its doors to the public,” he says. Citing the proposal of three law school professors, “A Public Option for Bank Accounts (Or Central Banking for All),” he summarizes:

Their ‘public option for bank accounts’ would offer every American household and business a checking account [though presumably there would be no paper checks] at the Fed.’ This would ‘create a frictionless system, like email.’

The Federal Reserve would be in direct competition with all private banks in such a scheme. It would certainly be a highly advantaged government competitor. It could offer “risk-free” accounts and pay a higher interest rate, if it liked, cross-subsidizing this business with the profits from its currency-issuing monopoly. It would be regulating its competitors while shot through with conflicts of interest. It would put the evolution of central banks a hundred years into reverse.

There are in the American banking system about $12 trillion in domestic deposits. Could the Federal Reserve grab half of them? Why not? That would be $6 trillion, which would expand its balance sheet to $10 trillion. A pretty interesting and unattractive vision of enhanced monopoly.

Says Klein:  “Offering Federal Reserve accounts to the general public would also reduce the taxpayer subsidy for bank risk-taking.” Actually, it would do the opposite: vastly increase taxpayer risk by putting the risk into the Federal Reserve itself.

For the Federal Reserve would have to do something with mountain of deposits—namely make loans and make investments. It would automatically become the overwhelming credit allocator of the financial system. Its credit allocation would unavoidably be highly politicized. It would become merely a government commercial bank, with the taxpayers on the hook for its credit losses. The world’s experience with such politicized lenders makes a sad history.

In short, to have a central bank create digital currency is a terrible idea—one of the worst financial ideas of recent times.

The Future of Money

There is no doubt that the digitalization of financial transactions, records, access to information and communication will continue to increase, and that the electronic networks underlying the activity continue to grow more intense and omnipresent. But the fundamental nature of money, it seems to me, will not change. It will either be:

• The monopoly issuance of a fiat currency by the central bank as part of the government, backed by the power of the government. That the whole world operates on such currencies is a remarkable—and dangerous—invention of the 20th century.

• Or if private currencies do again develop, they will, as in the past, have to be based on a credible claim to reliable assets. With Hayek, we could hope (without much hope) that this might bring competition for government fiat money.

It is clear that having a fiat currency is far too precious and profitable for governments for them ever to go back to a government currency backed and convertible into actual assets, whether gold coins or otherwise.

Government fiat currencies will operate in increasingly digitalized forms. Still, paper money will retain its advantages of secure privacy, immediate settlement without intermediaries and the ability to function when the electricity is shut down. Recently, I was amazed to find that my younger son, an up-and-coming banking officer, was walking around with the total of $1 in his wallet, but of course with a well-used debit card. As this generational difference indicates, doubtless our ideas of money will grow ever more dependent on having the electricity on at all times and everywhere.

Attempts at private fiat currencies, with no claim to any underlying assets, in my view have a very low probability of ever achieving widespread acceptance and functioning as money.

An increase of the monopoly power of central banks, of which we already have too much, should be avoided.

Thank you again for the chance to share these views.

Il Parlamento USA discute sul futuro delle crypto

Published in The Cryptonomist.

All’audizione parteciperanno il dr. Rodney J. Garratt, Maxwell C. e Mary Pellish Chairdell’Università della California a Santa Barbara, il Dr. Norbert J. Michel, Direttore del Centro per l’analisi dei dati della Heritage Foundation, il Dr. Eswar S. Prasad, Senior Fellow presso il Brookings Institution, e Alex J. Pollock, Distinguished Senior Fellow presso R Street Institute.

Is inflation “quite good” or “a thief in the night”?

Published by the R Street Institute.

“Consumer Price Inflation Hits Six-Year High,” is the headline of a July 12 economic report.  The Bureau of Labor Statistics has just reported that as of June, the Consumer Price Index was up 2.9% over a year ago, its biggest increase since 2012. Without food and energy prices, which the Federal Reserve likes to exclude, consumer prices were up 2.3% over the twelve months.  Earlier this week, financial commentator Wolf Richter helpfully reminded us of the obvious: “Consumer price inflation whittles down the purchasing power of labor.”

How should we think about that?  Let us contrast the views of high officers of the Federal Reserve at different times.

William McChesney Martin was the all-time longest serving Chairman of the Federal Reserve Board, from 1951 to 1970, spanning five different U.S. presidents.  A Federal Reserve building in Washington is named after him.

Charles Evans is the current President of the Federal Reserve Bank of Chicago.  He has held this position for more than a decade, since 2007.

Dr. Evans recently told the Wall Street Journal that he thinks the current inflation “looks quite good,” adding, “I’d like to see inflation expectations a little bit higher.”

Such language would presumably have surprised Chairman Martin, who memorably described inflation as “a thief in the night.”  A scholar of the Fed as an institution, Peter Conti-Brown, interprets Martin’s vision of the central bank accordingly: “The keeper of the currency is the one that one that has to enforce the commitment not to steal money through inflation.”

So does inflation “look quite good” or is it “a thief in the night”?

Fashions in central bank ideas change over time: Which view do you prefer?