Bagehot: Hazlitt and Macaulay Were Models of Style

"His models of style were probably Hazlitt and Macaulay. Burke also he must have read with close attention, but then Burke, far more than Hazlitt, wrote in the grand style, and one suspects that Bagehot secretly felt the grand style, especially in prose, to be a breach of true English reserve. Writing so lofty, so poetic, so extravagantly passionate, could scarcely awaken emulation in a literary young business man."

-- from Walter Bagehot, by William Irvine (1939)

Richmond Fed President Lacker Discusses Stress Testing

Jeffrey M. Lacker, President of the Federal Reserve Bank of Richmond, talked about stress testing at the 2011 U.S. Monetary Policy Forum:

"I would like to close with some general comments on the use of stress tests. As I have said, they have proven their usefulness in the crisis. Quantifying the risks at large financial institutions is a complex and costly process that is vulnerable to manipulation. A disciplined and well-organized supervisory process for validating those assessments strikes me as well worth the costs. Stress tests are not a panacea, however. In a sense they are only as good as the imagination of the scenario designers, who need to resist the temptation to dismiss extreme scenarios as too far-fetched or focus too much attention on preparing for the last war.

"One critical question about stress tests is whether or not to disclose the results, and if so, at what level of detail. A good case can be made for transparency; stress tests provide quantitative assessments that are forward-looking, independently certified and methodologically comparable across institutions. On the other hand, there can be good reasons to restrict the release of bank-specific supervisory information. As is often the case in financial regulation, the answer is not as obvious as it might seem." (footnote omitted)

Bagehot: Dignified Love Letters

"A quiet body of readers are aware that in his time Walter Bagehot decently occupied a prominent position in the financial world, that he made money unobtrusively, that he gravely edited a grave journal and wielded a powerful influence in the 'City,' that he published a few sedate tomes in later years and a few dashing essays in youth, and that in middle life he wrote dignified love letters to his future wife."

-- from Walter Bagehot, by William Irvine (1939)

Overreliance on Credit Ratings - ECB Comments

The European Central Bank published a comment in response to the European Commission's public consultation on credit rating agencies, addressing a wide range of topics. For example, concerning the use of external ratings in the mandates and investment policies of investment mangers, ECB said,

"Regarding the use of external ratings in investment mandates and policies, the Eurosystem suggests that for those markets and funds where it is assessed that decisions triggered by these mandates have significant economic value for the firm and a potentially significant impact on markets, introducing a flexibility clause in the investment mandates might reduce the simultaneous and forced selling of distressed securities. The advantages of introducing a flexibility clause in investment mandates are associated with a) the relative ease and speed to implement this measure and b) the contribution to mitigating cliff effects of ratings downgrades."

Other topics addressed include the use of ratings for internal risk management purposes; application of standardised approaches under the Basel II framework; enhancing transparency and monitoring of sovereign debt ratings; enhancing competition in the credit rating agency industry; civil liability of credit rating agencies; and potential conflicts of interest due to the "issuer pays" model.

Group Says CFTC Must Weigh Costs/Benefits

The comment period expired this week for the CFTC's proposed end-user exception to mandatory clearing of swaps, with over 70 comments posted. A comment letter from the Coalition for Derivatives End-Users (from the web site of whose study agent a brace of advisor-academics recently decamped) urges a host of changes, and argues that Dodd-Frank implementing rules issued by the CFTC are subject to a cost-benefit analysis requirement, which the agency has not followed:

"Section 15(a) of the Commodity Exchange Act ('CEA') requires the Commission to evaluate the costs and benefits of any new rule promulgated under the CEA. . . . In this and previous notices of proposed rulemaking implementing the Dodd-Frank Act, the Commission has taken the position that Section 15(a) 'does not require the Commission to quantify the costs and benefits of a new regulation.' Instead, the Commission’s cost-benefit analysis consists of a recitation of the new rule’s requirements—in this case, the notification requirement—and an announcement that the cost of compliance will be 'minimal.' But the Commission has made no attempt to estimate or objectively value the costs imposed by this and other rulemakings under the Dodd-Frank Act. We believe that the Commission's current approach does not satisfy the requirements of Section 15(a). . . . Courts have not hesitated to vacate or remand agency rules founded on irrational or incomplete cost-benefit analyses." (notes omitted)

Basel III Impact - Modeling Difficulties

"Three crucial elements of the new regulatory framework are higher minimum capital ratios, higher quality of capital, and tighter liquidity requirements. To answer the questions listed in the introduction we need to 'feed' these features into the available macroeconomic models. This is all but straightforward. First, some of the models do not feature bank liquidity, or bank capital, or both. Second, even the models featuring bank capital are typically estimated or calibrated based on measures of capitalization other than the TIER 1 measure chosen in the Basel III accord. Third, even the models that feature bank liquidity adopt very simple definitions (eg the ratio of cash and government bonds to total assets), quite distant from the complex measures introduced by the new rules."

BIS Working Papers
No 338
BASEL III: Long-term impact on economic performance and fluctuations

http://www.bis.org/publ/work338.pdf

Bagehot's Lombard Street: Impartial Criticism

"I fear that I must not expect a very favourable reception for this work. It speaks mainly of four sets of persons—the Bank of England, Joint Stock Banks other than that Bank, private bankers, and bill-brokers; and I am much afraid that neither will altogether like what is said of them. I can only say that the opinions now expressed have not been formed hastily or at a distance from the facts; that, on the contrary, they have been slowly matured in 'Lombard Street' itself, and that, perhaps, as they will not be altogether pleasing to any one, I may at least ask for the credit of having been impartial in my criticism." -- from Advertisement