Jeremy Stein, a new FOMC nominee

Stein is one of the most creative contemporary economists, with some truly interesting and first-rate papers in the early to mid 1990s.  He has kept up his quality and creativity since then.  Most of the early papers are in mid-brow theory, industrial organization, and signaling.  Here is one of his very recent papers on macroprudential regulation; it stresses the importance of dynamic bank recapitalization. He is a very smart and still underrated economist; he’s one of the few where I will more or less automatically start reading his papers when I run across them.  I have no idea how he would do in the all-important political side of the job.  From the paper, an excerpt:

If significant increases in capital ratios have only small consequences for the rates that banks charge their customers, why do banks generally feel compelled to operate in such a highly-leveraged fashion, in spite of the obvious risks this poses? And why do they deploy armies of lobbyists to fight against increases in their capital requirements? By way of contrast, it should be noted that non-financial firms tend to operate with much less leverage than financial firms, and indeed often appear willing to forego the tax (or other) benefits of debt finance altogether. In Kashyap, Stein and Hanson (2010) we argue that the resolution of this puzzle has to do with the unique nature of competition in financial services. Unlike in many other industries, the most important (and in some cases, essentially the only) competitive advantage that banks bring to bear for many types of transactions is the ability to fund themselves cheaply. Thus if Bank A is forced to adopt a capital structure that raises its cost of funding relative to other intermediaries by only 20 basis points, it may lose most of its business. Contrast this with, say the auto industry, where cheap financing is only one of many possible sources of advantage: a strong brand, quality engineering and customer service, and control over labor and other input costs may all be vastly more important than a 20 basis-point difference in the cost of capital.

Here he argues for a very gradual phase-in of tough capital requirements.  In this paper he argues for a credit-based channel of monetary transmission, and here.  This puts him in an alliance with early Bernanke.  Here is his paper on the cyclical effects of Basel capital standards; he has done a lot of work with Anil Kashyap in that area.  Here is his overly optimistic paper on the eurozone.  In this paper he lays out his generally positive view of the efficacy of monetary policy, with a nod to Hyman Minsky on the debt issue.


If he is bright and competent, Shelby will block him

Shelby would block his own appointment because anyone Obama appointed must be blocked to defeat Obama.

If this reason for higher capital ratios were true, then presumably banks would acquiesce to lower capital ratios if *all* banks were required to abide by them. Is that the case? It seems that banks try to fight lower capital ratios even in international agreements.

It's not a mystery. If a bank sells stock to raise capital, typically the price of its bonds goes up as default becomes less likely. That increase in value had to come from somewhere: it comes out of the hide of the existing stockholders. Another way to think of this is that higher capital, by making default less likely, decreases the value of government guarantees of the bank's liabilities.


You are arguing that if a more highly capitalized bank gets lower interest rates on its debt so it can now win more loan business due to its lower cost of money and also have higher margins, the bank stockholders will suffer from the higher dividends they get paid out of the higher profits??

Or are you arguing that the stockholders will suffer because the high bond prices will drive the bank CEO to sell more and more bonds because of the high prices he gets from the bonds, and will tell his employees to put the money to work by writing ninja nodoc loans so the CEO can get big bonuses, ultimately resulting in bankruptcy??

Although I had to read it a few times, I think he is just stating that, ceteris paribus, as capital stock (the first loss piece) is added, the riskiness of the liability holders of the firm decreases, since the risk of loss has been shifted marginally to the capital stock holders.

To be technical, he is a nominee for the Federal Reserve Board of Governors. That does also make him a member of the FOMC automatically.

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