GOP leaders urge Fed to back off from more stimulus

Four Republican leaders sent a letter to Federal Reserve Chairman Ben S. Bernanke ahead of the central bank’s meeting this week, urging him to avoid “further extraordinary intervention” in the economy.

The letter, reported by the Wall Street Journal on Tuesday, shows the pressure Bernanke is facing from the GOP as the Fed considers whether to try to bolster economic growth with additional monetary stimulus.

The letter was signed by House Speaker John Boehner of Ohio, Sen. Minority Leader Mitch McConnell of Kentucky, Sen. Minority Whip Jon Kyl of Arizona and House Majority Leader Eric Cantor of Virginia, the Journal said.

Fed policymakers will wrap up their meeting on Wednesday and are widely expected to announce a new bond-buying plan specifically aimed at pulling longer-term interest rates lower.

Bernanke has signaled that the Fed could resurrect a move it undertook in the 1960s known as Operation Twist: The Fed, which owns $1.6 trillion in Treasuries, could shift that portfolio by selling shorter-term debt and using the proceeds to buy longer-term bonds.

The net effect would be to twist the so-called yield curve, meaning the level of longer-term interest rates compared with short-term rates. In theory, by adding to demand for longer-term Treasury bonds, the Fed could pull those rates down further. That could translate into lower rates on corporate, municipal and mortgage bonds, for example.

If the Fed commits to a new Operation Twist, it would be the third bond-buying program it has launched since November 2008. The last one was a $600-billion purchase program completed in June.

The difference this time is that most analysts believe that the Fed wouldn’t print new money to fund its purchases. If the central bank merely swaps shorter-term Treasuries for longer-term securities, the net amount of its holdings won't change.

That would allow the Fed to say that it isn’t engaging in so-called quantitative easing -- pumping more money into the financial system -- and therefore that the bond purchases wouldn’t threaten to stoke inflation.

Whether that would be enough to appease GOP leaders isn’t clear.

From their letter to Bernanke, according to the Journal:

Respectfully, we submit that the board should resist further extraordinary intervention in the U.S. economy, particularly without a clear articulation of the goals of such a policy, direction for success, ample data proving a case for economic action and quantifiable benefits to the American people.

It is not clear that the recent round of quantitative easing undertaken by the Federal Reserve has facilitated economic growth or reduced the unemployment rate. To the contrary, there has been significant concern expressed by Federal Reserve Board members, academics, business leaders, members of Congress and the public. Although the goal of quantitative easing was, in part, to stabilize the price level against deflationary fears, the Federal Reserve’s actions have likely led to more fluctuations and uncertainty in our already weak economy.

We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy. Such steps may erode the already weakened U.S. dollar or promote more borrowing by overleveraged consumers. To date, we have seen no evidence that further monetary stimulus will create jobs or provide a sustainable path towards economic recovery.

The Fed will issue its post-meeting statement at about 11:15 a.m. PDT on Wednesday.

RELATED:

Fed expected to launch new bond-buying program

U.S. poverty totals hit 50-year high

Texas Gov. Rick Perry takes a shot at Bernanke

-- Tom Petruno

Photo: House Speaker John Boehner, left, and Senate Minority Leader Mitch McConnell. Credit: Karen Bleier / AFP / Getty Images

California sells $2.4 billion of bonds amid falling yields

California on Tuesday wrapped up its first long-term debt sale of 2011, paying interest rates substantially below what it paid on bonds last November -- a savings for taxpayers.

The drop in yields curbed demand for the bonds from individual investors, but buying by institutional investors such as mutual funds allowed Treasurer Bill Lockyer to issue nearly the full amount planned.

The state said it sold $2.37 billion of tax-free general obligation bonds to refinance previously issued bonds and pay off other debt.

Individual investors put in orders for $655 million of the bonds on Friday and Monday. Institutions bought $1.74 billion of the deal on Tuesday, which is when final yields on the securities were set.

When it issued bonds in November the state paid an annualized tax-free yield of 4.23% on 10-year securities in that offering. This time around Lockyer set the yield on 10-year bonds at 3.17%, more than a full point less. Yields were lower across the board on bonds of other maturities as well.

Although California’s credit rating remains the lowest of any state, the budget passed by the Legislature in June has given investors more comfort about the state’s fiscal outlook, Lockyer spokesman Tom Dresslar said. “We believe the budget has helped constrain the price” of borrowing, he said.

Credit rating firm Standard & Poor's in early July raised its outlook for the state’s rating to “stable” from “negative,” saying the state's plan to balance its budget was "largely realistic."

It also has helped California that muni bond interest rates in general have tumbled this year, along with yields on U.S. Treasury bonds, as the economy has weakened and many investors have favored bonds over stocks for safety. The 10-year Treasury note yield was at 1.94% on Tuesday, down from 3.30% at the start of the year.

But falling yields have pushed some individual investors to the sidelines because they believe the returns aren’t high enough to justify the risk, analysts say. Small investors are “deeply unhappy” with muni yields now, said Matt Fabian, analyst at research firm Municipal Market Advisors.

Orders from individual investors in Tuesday’s California bond sale were well below the nearly $1 billion they put in for the November sale, although this time around bonds of certain maturities were available only to institutions. The state said it raised yields on bonds maturing between 2013-2016 and 2022-2028 by as much as 0.05 percentage points from its initial estimates to get the deal done.

With the steep drop in muni yields this year “the market is not very conducive to doing a bang-up retail business,” Dresslar said. Still, he said, the state was “very pleased” with the demand it saw.

The state plans another general obligation bond sale in mid-October, although the amount hasn’t been determined, Dresslar said.

Some investors may be shying away from muni bonds because of President Obama’s proposal to limit the amount of muni bond interest that high-earners can exclude from their taxable income beginning in 2013. The proposal would help pay for the economic-stimulus program in the jobs bill Obama sent to Congress earlier this month.

But Congress could quash the idea. Lockyer and other state officials already have raised objections, warning that the move could mean investors would demand higher yields on muni bonds, driving up state and local governments' cost of issuing debt.

RELATED:

California sells out $5.4-billion short-term note sale

Muni bond market was a big winner as stocks dived

Fed expected to launch new program to push long-term interest rates lower

-- Tom Petruno

Inset photo: Treasurer Bill Lockyer. Credit: Armando Arorizo/Bloomberg News

Solyndra execs to take 5th, refuse to testify before House panel [Updated]

 
Solyndra Inc.'s chief executive officer and chief financial officer will invoke their 5th Amendment rights and not answer questions during a Friday hearing before a House investigative committee, their attorneys said.

Attorneys for Solyndra Chief Executive Brian Harrison and W.G. “Bill” Stover, the company’s chief financial officer, sent letters to the House Energy and Commerce Committee’s investigative subcommittee Tuesday saying the two executives would not answer any questions during the hearing.

“I have advised Mr. Harrison that he should decline to answer questions put to him by this subcommittee based on his rights under the Fifth Amendment,” Harrison’s attorney, Walter F. Brown Jr., said in a letter to Rep. Clifford B. Stearns (R-Fla.), the committee’s chairman, and Rep. Diane DeGette (D-Colo.).

“This is not a decision arrived at lightly, but it is a decision dictated by current circumstances,” Brown said in the letter.

Agents with the FBI and Energy Department’s inspector general executed a search warrant at Solyndra’s Fremont headquarters on Sept. 8, two days after the company declared bankruptcy despite receiving $528 million in federal loans. The FBI and Energy Department have declined to say what prompted the investigation or who it is targeting.

Stover's attorney, Jan Nielsen Little, said in a letter to the committee that the criminal investigations prompted the decision for Stover to decline to testify. Stover still intends to appear at the hearing, Little said.

"Under these circumstances, Mr. Stover must invoke his rights under the Fifth Amendment of the U.S. Constitution," Little wrote. "It would be irresponsible for anyone in his position not to do so."

Solyndra was the first recipient of Energy Department loans under the Obama administration intended to spur economic growth and create jobs through investments in green technology. To date it is the only DOE loan recipient to cease operations.

[Updated at 2:37 p.m. Solyndra released a statement that acknowledged the executives' plans to take the Fifth, but said the company "is not aware of any wrongdoing by Solyndra officers, directors or employees in conjunction with the DOE loan guarantee or otherwise, and the company is cooperating fully with the office of the United States Attorney for the Northern District of California in its investigation." The company also said it "believes that the record will establish that Solyndra carefully followed the rules of the competitive application process, starting in December 2006 under the Bush administration and continuing under the Obama administration."]

 RELATED:

Lawmakers want to question Solyndra investors about its collapse

Solyndra: House committee grills officials over failed solar firm

Democrats say Solyndra scandal touches Republicans, too

--Stuart Pfeifer

Photo: FBI agents leave Solyndra with boxes of records during Sept. 8 search. Credit: Associated Press

Solyndra execs to take 5th, refuse to testify before House panel

 
Solyndra Inc.'s chief executive officer and chief financial officer will invoke their 5th Amendment rights and not answer questions during a Friday hearing before a House investigative committee, their attorneys said.

Attorneys for Solyndra Chief Executive Brian Harrison and W.G. “Bill” Stover, the company’s chief financial officer, sent letters to the House Energy and Commerce Committee’s investigative subcommittee Tuesday saying the two executives would not answer any questions during the hearing.

“I have advised Mr. Harrison that he should decline to answer questions put to him by this subcommittee based on his rights under the Fifth Amendment,” Harrison’s attorney, Walter F. Brown Jr., said in a letter to Rep. Clifford B. Stearns (R-Fla.), the committee’s chairman, and Rep. Diane DeGette (D-Colo.).

“This is not a decision arrived at lightly, but it is a decision dictated by current circumstances,” Brown said in the letter.

Agents with the FBI and Energy Department’s inspector general executed a search warrant at Solyndra’s Fremont headquarters on Sept. 8, two days after the company declared bankruptcy despite receiving $528 million in federal loans. The FBI and Energy Department have declined to say what prompted the investigation or who it is targeting.

Stover's attorney, Jan Nielsen Little, said in a letter to the committee that the criminal investigations prompted the decision for Stover to decline to testify. Stover still intends to appear at the hearing, Little said.

"Under these circumstances, Mr. Stover must invoke his rights under the Fifth Amendment of the U.S. Constitution," Little wrote. "It would be irresponsible for anyone in his position not to do so."

Solyndra was the first recipient of Energy Department loans under the Obama administration intended to spur economic growth and create jobs through investments in green technology. To date it is the only DOE loan recipient to cease operations.

RELATED:

Lawmakers want to question Solyndra investors about its collapse

Solyndra: House committee grills officials over failed solar firm

Democrats say Solyndra scandal touches Republicans, too

--Stuart Pfeifer

Photo: FBI agents leave Solyndra with boxes of records during Sept. 8 search Credit: Associated Press

Airlines protest fee increase plan

 

The airline industry is protesting the Obama administration's plan to increase fees and taxes on commercial passengers and corporate jets to help battle the nation's debt crisis.

Two of the world's largest airline trade groups say the proposed fees and taxes would hurt the economy and force the industry to eliminate jobs.

To help cut the nation's debt, the Obama administration has suggested doubling the aviation security fee imposed in response to the Sept. 11, 2001, terrorist attacks. Each passenger is now charged $2.50 for each leg of a trip, with a maximum of $5 for a one-way trip. Under the proposal, the charge would be replaced with a standard $5 per trip fee, with annual increase of 50 cents from 2013 to 2017.

The fee could collect an additional $8.8 billion over five years and $24.9 billion over 10 years.

The administration also wants to raise a per-flight fee from $60 to $100 for all corporate planes that fly in controlled airspace, generating an estimated $11 billion over 10 years.

The Air Transport Assn., the trade group for the nation's largest airlines, said the industry already pays more than its share of taxes.

"We oppose any new taxes on airlines or their passengers," said ATA President Nicholas E. Calio.

The International Air Transport Assn., the trade group for the world's airlines, also issued a statement Tuesday, objecting to the proposed new fees.

“Airlines and their passengers are being asked to pay for national security, although it clearly is a responsibility of government,” said IATA Director General Tony Tyler.

When it comes to adding new fees on passengers, however, the nation's airlines have not been reluctant to act.

The nation's largest airlines collected $1.38 billion for charging passengers to check baggage and change reservations in the first three months of the year, a 4% increase over the same period in 2010, according to the U.S. Bureau of Transportation Statistics.

Related items:

Airlines collect $1.38 billion in baggage, reservation fees

Ryanair's latest fee: You don't want to know

Imagining more new airline fees

-- Hugo Martin

Photo: Airplanes landing and departing at Los Angeles International Airport. Credit: Los Angeles Times

20% of Americans expect to be millionaires by 2020

Even with a turbulent economy, 20% of Americans expect to become millionaires in the next decade.

But the majority –- 62% -- still believe it’s “very unlikely” that they’ll reach the threshold by 2020, according to a new poll from the Associated Press and CNBC. Just 8% of U.K. residents believe they’re on the millionaire track.

And last year, only 5% of Americans reached the million-dollar mark -– which two in ten believe is the minimum amount of money for a comfortable retirement.

Volatility in the stock market, along with stalled job openings, dropping home values and low consumer confidence likely prevented more Americans from shooting for millionaire status.

Even with that amount of money, respondents said they would save or invest nearly a third of the pot while spending less than 15%. The rest would go to family, debt payments, real estate and charitable donations.

Still, the number of U.S. millionaires is rising, set to double to 20.5 million in 2020, according to the Deloitte Center for Financial Services. The combined worth of the group would soar to $87 trillion from $39 trillion this year.

RELATED:

Is meanness a moneymaker? Nice guys are paid less, study finds

College graduates earn 84% more than high school grads, study says

-- Tiffany Hsu

Photo credit: Scott Eells / Bloomberg

Consumer Confidential: Airline fees, hot toys, less Coke

Here's your to-sir-with-love Tuesday roundup of consumer news from around the Web:

--If you're traveling abroad, don't pack too much. A USA Today survey of airline fees shows that some carriers have hit or surpassed the $400 mark for international passengers traveling with overweight baggage. On most international flights, Continental is charging $400 for a bag weighing 71 to 100 pounds. United Airlines similarly charges $400 for bags weighing 71 to 99.9 pounds on intercontinental flights. American Airlines will charge you $450 for overweight luggage bound for Asia. The reason, AA spokesman Tim Smith told USA Today, is to both defray fuel costs and to dissuade passengers from checking such heavy bags in the first place. Call it tough love.

--Is it too soon to think about what toys you'll be buying for Christmas? Of course not. Toys R Us, for one, is betting that 15 toys ranging from a flying, inflatable remote-control fish to tiny collectible monsters will be big hits this season. Making the right picks early is crucial for toy sellers so they have the right mixture of toys at the right prices to lure shoppers. The holiday season can account for about 40% of a toy seller's annual profit. In 2010, U.S. toy sales rose 2% to $21.87 billion, according to the NPD Group. Toys on the Toys R Us list include: Air Swimmers Extreme by Animal Planet, $49.99; Lalaloopsy Silly Hair dolls by MGA Entertainment, $34.99; and Monster High Fearleading 3-Pack by Mattel, $42.99.

--Coca-Cola thinks less may be more. The company will announce this week the launch of 12.5-ounce, 89-cent bottles to accompany the 16-ounce, 99-cent bottles it rolled out nationally last year as an alternative to 20-ounce bottles in U.S. convenience stores. It will also slash the suggested retail price on its recently introduced eight-pack of 7.5-ounce Coke "mini'' cans in supermarkets by about 20% to $2.99 to try to lure more customers. The proliferation represents a departure from years of relying heavily on three basic packages -- 20-ounce bottles in convenience stores and two-liter bottles and cases of 12-ounce cans in supermarkets -- as it battled rivals Pepsi and Dr Pepper in the $75-billion U.S. retail soda market. But sugar water is still sugar water, no matter how modest the serving.

-- David Lazarus

Photo: You may want to travel light to avoid higher baggage fees. Credit: Rainier Ehrhardt / Associated Press

 

Barry Minkow heads back to prison

Barry Minkow's twisting road through life will carry the former San Fernando Valley teen tycoon back to prison Wednesday to serve his second sentence for securities fraud.

In an email to The Times, Minkow said federal prison authorities had ordered him to begin his five-year sentence at a Lexington, Ky., facility that "from the outside looks like Leavenworth Penitentiary" rather than the minimum-security prison camp he had hoped for and a judge had recommended.

Minkow burst onto the national stage in the 1980s after starting ZZZZ Best, a carpet-cleaning company, in his parents' garage in Reseda. He wound up spending more than seven years in prison after it was revealed that ZZZZ Best was a sham built on credit-card fraud and fabricated work orders.

Expressing remorse, he reinvented himself as head pastor at San Diego's Community Bible Church and founded the Fraud Discovery Institute, a detective shop that set out to expose Ponzi schemes and corporate wrongdoing.

But in March he pleaded guilty to one count of conspiring to damage Lennar Corp. by attacking the Miami-based home builder in reports he acknowledged were filled with falsehoods. He had been hired by a San Diego County developer whose partnership with Lennar in Rancho Santa Fe had soured.

Minkow told U.S. District Judge Patricia Seitz in Miami that he had become addicted to narcotic painkillers he used to treat his migraine headaches, finally kicking the habit when he realized he was under criminal investigation.

He also told the judge that abusing steroids as a teenage weight lifter had rendered him unable to produce sperm or testosterone, saying he needs constant treatments to limit his body's production of the female hormone estrogen.

Seitz granted his request to be placed in a prison program for treating addiction. She also recommended that Minkow be placed in a work camp at Maxwell Air Force Base in Alabama, but the federal Bureau of Prisons decided camp wasn't appropriate.

"The Feds found a way to be a bit punitive and put me in an 'administrative medical facility' which houses inmates of all levels," Minkow said in his email.

His attorney, Alvin Entin, said the decision was made because of "mental issues" as well as Minkow's "physical problems." 

In any case, Minkow said, "I deserve it and will be fine."

He noted that the prison is much nearer to the small town in Tennessee where he has lived recently with his wife and two adopted sons.

"Lisa and the boys will have a much easier time driving three and a half hours rather than eight hours to Maxwell," Minkow said.

RELATED:

Barry Minkow is sentenced to five years in prison

Minkow seeks leniency in latest securities fraud case

Inside a high-end real estate deal gone bad

--E. Scott Reckard

Photo: Barry Minkow in his church office, 2009. Credit: Bloomberg / Sandy Huffaker

Wall Street: Stocks rise at the open; gold up

Gold: Trading now at $1,787 an ounce, up 0.6% from Monday. Dow Jones industrial average: Trading now at 11,431.30, up 0.3% from Monday.

Mixed news. U.S. stock markets wavered at the open; there was disappointing news about the housing market, but that was tempered by speculation that the Federal Reserve may announce a new stimulus plan.

Morgan Stanley's feud. Wall Street has become increasingly divided between its trading operations and its more traditional investment banking operations -- and at Morgan Stanley, this division has become personal.

Downgrade insiders. The Securities and Exchange Commission is reportedly probing whether some big trading firms took advantage of last month's downgrade of the United States' credit rating by Standard & Poor's.

Rogue trader. UBS executives will meet later this week in Singapore to review the fallout from the disclosure of a rogue trader's $2.3-billion losses.

Quiet protest. Protesters are continuing their demonstrations on Wall Street, but their numbers and strength have not been overwhelming.

-- Nathaniel Popper in New York
Twitter.com/nathanielpopper

Photo credit: Stan Honda / Getty Images

U.S. ambassador warns China: Foreign businesses feel unwelcome

U.S. Ambassador to China Gary Locke has been something of an enigma to the Chinese in the month he's been in Beijing.

His no-frills style of traveling coach on planes and buying his own coffee at an airport Starbucks has divided observers used to seeing pampered Chinese officials. Is it a publicity stunt or something local leaders should emulate, many wondered.

Still, one of the remaining questions about the third-generation Chinese American was whether he would be more sympathetic toward Chinese interests. Although such a query may seem fringe in the U.S., it's not out of the ordinary in China to equate race with loyalty. As one popular saying goes, "You can't betray your ancestors."

But speaking to American executives Tuesday in the Chinese capital, the former Washington governor showed no hint of softening U.S. demands. He called on Beijing to appreciate its currency, eliminate trade and investment barriers and strictly enforce intellectual property rights.

Locke also echoed growing concerns from foreigners that China was becoming an increasingly unwelcome place to do business.

"China's current business climate is causing growing frustrations among foreign business and government leaders, including my colleagues in Washington," Locke said in the speech, which outlined his vision of the U.S.-China economic and trade relationship.

Locke warned if China's economy didn't allow wider foreign access, "it will mean less innovations from Chinese businesses, fewer opportunities for the Chinese people [and] slower growth for the Chinese economy."

The ambassador cited regulations in industries such as mining, banking, energy and transportation as being unduly restrictive and, as a result, "creating seeds of doubt in the minds of foreign investors as to whether they are truly welcome in China."

He offered credit cards as an area in which foreign banks could play a larger role to help boost sorely needed domestic consumption in China. Chinese banks are mostly geared toward serving state-owned companies and aren't permitted to compete in interest rates. A recent survey by the accounting firm KPMG showed profits of foreign banks lagging behind their Chinese counterparts.

Discussing intellectual property, Locke cited rampant software piracy as a significant problem.

"In the United States, for every $1 in computer hardware sales, there is about 88 cents in software sales," he said.  “But in China, for every dollar in hardware sales there is only eight cents in software sales."   

The reason, Locke said, was that 80% of software in China was believed to be counterfeit.

A debate last week between Locke and one of China's most famous economists, Li Daokui, underscored just how far apart the two countries are on the issue of intellectual-property protection.

Li, an advisor to the central bank, said he disagreed a growing economy required such legal protections. Instead, the laissez-faire environment was good for young entrepreneurs hoping to get established, Li said, according to the Wall Street Journal.

In his speech Tuesday, Locke again rejected Li's idea, saying China neglected intellectual property protection at its own peril.

"I have heard from so many Chinese-owned companies who have devoted significant resources to develop new products and technologies. And they complain they were almost wiped out by others illegally copying their ideas and technology," Locke said. "For every foreign company calling for stronger IP protection, there are many more Chinese companies demanding the same."

RELATED:

Why airport photo of Ambassador Gary Locke went viral in China

Ambassador nominee raises strong emotions in China

Unlicensed Angry Birds attraction opens in Chinese theme park

-- David Pierson
Twitter.com/dhpierson

Photo: U.S. Ambassador to China Gary Locke speaks to U.S. business executives in Beijing on Tuesday. Credit: Lintao Zhang / Getty Images

U.S. Ambassador to China says foreign businesses frustrated, feeling unwelcome

U.S. Ambassador to China Gary Locke has been something of an enigma to the Chinese in the one month he’s been in Beijing.

His no frills style of traveling coach on planes and buying his own coffee at an airport Starbucks has divided observers used to seeing pampered Chinese officials. Was it a publicity stunt or something local leaders should emulate, many wondered.

Still, one of the remaining questions about the third-generation Chinese American here was whether he would be more sympathetic toward Chinese interests or not. While such a query may seem fringe in the U.S., it’s not out of the ordinary in China to equate race with loyalty. As one popular saying goes, “You can’t betray your ancestors.”

But speaking to American executives Tuesday in the Chinese capital, the former Washington governor showed no hint of softening U.S. demands. He called on Beijing to appreciate its currency, eliminate trade and investment barriers and strictly enforce intellectual property rights.

Locke also echoed growing concerns from foreigners that China was becoming an increasingly unwelcome place to do business.

“China’s current business climate is causing growing frustrations among foreign business and government leaders, including my colleagues in Washington,” Locke said in the speech, which outlined his vision of the U.S.-China economic and trade relationship.

Locke warned if China’s economy didn’t allow wider foreign access, “it will mean less innovations from Chinese businesses, fewer opportunities for the Chinese people [and] slower growth for the Chinese economy.”

The ambassador cited regulations in industries such as mining, banking, energy and transportation as being unduly restrictive and, as a result, “creating seeds of doubt in the minds of foreign investors as to whether they are truly welcome in China.”

He offered credit cards as an area foreign banks could play a larger role to help boost sorely-needed domestic consumption in China. Chinese banks are mostly geared toward serving state-owned companies and aren’t permitted to compete in interest rates. A recent survey by the accounting firm KPMG showed profits of foreign banks lagging behind their Chinese counterparts.

On intellectual property, Locke cited rampant software piracy as a significant problem.

“In the United States, for every $1 in computer hardware sales there is about 88 cents in software sales,” he said.  “But in China, for every dollar in hardware sales there is only eight cents in software sales.”   

The reason, Locke said, was that 80% of software in China was believed to be counterfeit.

A debate last week between Locke and one of China’s most famous economists, Li Daokui, underscored just how far apart the two countries are on the issue of intellectual property protection.

Li, an advisor to the central bank, said he disagreed a growing economy required such legal protections. Instead, the laissez-faire environment was good for young entrepreneurs hoping to get established, Li said, according to the Wall Street Journal.

In his speech Tuesday, Locke again refuted Li’s idea, saying China neglected intellectual property protection at their own peril.

“I have heard from so many Chinese-owned companies who have devoted significant resources to develop new products and technologies. And they complain they were almost wiped out by others illegally copying their ideas and technology,” Locke said. “For every foreign company calling for stronger IP protection, there are many more Chinese companies demanding the same.”

RELATED:

Why airport photo of Ambassador Gary Locke went viral in China

Ambassador nominee raises strong emotions in China

Unlicensed Angry Birds attraction opens in Chinese theme park

--David Pierson  

twitter.com/dhpierson

Photo: U.S. Ambassador to China Gary Locke spoke to U.S. business executives in Beijing Tuesday, outlining his vision of the U.S.-China economic relationship. Credit: Lintao Zhang / Getty Images.

How deposit insurance reduces financial stability

Deposit insurance will not help to stabilise the banking industry. (Photo: AFP)

In a classic 2005 paper from the highly authoritative Journal of Monetary Economics, Asli Demirgüç-Kunt and Enrica Detragiache investigated the question "Does Deposit Insurance Increase Banking System Stability?"  Their answer, based on an empirical study of a large panel of countries from 1980 to 1997, was that it does not; in fact, as they put it: "explicit deposit insurance tends to be detrimental to bank stability".  This was a well-established notion amongst money and banking academics.  When I used to lecture in money and banking, our standard textbooks made much of the failures of deposit insurance in the Savings and Loan crisis in the US in the 1980s.  I had actually developed the somewhat naive idea that everyone whose opinion counted in the US and UK understood this.  That was, after all, why in the UK we never had any form of deposit insurance until 1979, even thereafter only had what was required of us by EU directives, and even up to 2007 only the first £2,000 of deposits was insured.  (There was 90 per cent insurance of the next £33,000, but since even in the epic US banking collapses of the 1930s, depositors typically recovered more than 80 per cent, a 90 per cent level of insurance only in practice provided very marginal additional protection of a few per cent.  I didn't like it; but it wasn't appalling.)

Given how destructive deposit insurance was – I thought – understood by informed opinion to be, you will appreciate that I was aghast and taken aback that in September 2007 the government introduced blanket 100 per cent deposit insurance in the UK.  Subsequently, though the blanket protection has, mercifully, been removed (with the failure of the Southsea Mortgage and Investment Company this June, where around 5 per cent of the depositors were not insured or otherwise bailed out), the deposit insurance threshold has been raised to £85,000.  I hope that can be taken down to around £10,000, one day, but for now it wreaks its damage – not as bad as unlimited insurance, but damaging nonetheless.

I was reminded of this today when reading the latest Bank of England Quarterly Bulletin.  For in the Demirgüç-Kunt and Detragiache 2005 paper, they suggest that (in addition to the loss of incentive for depositors themselves to shop around for low-risk banks) a key reason why deposit insurance damages financial stability is that the higher and the more explicit are deposit insurance thresholds, the more tempting it is for the government to bail out other creditors such as bondholders.  In the Quarterly Bulletin, there is an article on "Bank resolution and safeguarding the creditors left behind".  This notes that, under the current rules, when a bank goes bust its depositors will typically be transferred to another bank, along with some matching assets.  But under current insolvency law, depositors rank equally with bondholders.  Transferring away the assets to match the deposits might leave bondholders worse off than they would be under standard insolvency proceedings.  So to make sure that no creditor left behind is worse off, the state-backed deposit insurance scheme (the Financial Services Compensation Scheme) pays the bondholders the money it would have paid to insure depositors, had they lost out.  So as a direct consequence of deposit insurance, the state ends up responsible for paying other creditors.

Because the state is responsible for paying other creditors if it lets the bank go into solvency, the temptation to bail out the bank in advance, with the off-chance that it trades its way out of the trouble and the government actually makes money rather than losing it, will often be overwhelming.

The Vickers report contained two useful measures to help with this.  The first is the principle called "depositor preference".  That means that, in insolvency, depositors rank ahead of bondholders.  So the government would not make any bondholder worse off by selling off the deposits with matching assets – and the obligation mentioned above would vanish.  Secondly, and intimately connected with this, is the concept of a bail-in, whereby bank bonds are semi-automatically converted into equity in a failed bank, reducing the temptation for the government to bail them out.

These measures will help.  But they will not solve the ultimate problem.  Deposit insurance – a measure intended by its fans to reduce financial instability by reducing the likelihood of bank runs – actually achieves the opposite.  Bank runs are not a consequence of depositors having a rational fear of losing significant amounts of their capital – depositor capital losses in failed banks are only ever very small.  Bank runs are the consequence of depositors fearing they will lose access to their money (they lose liquidity, not capital).  Deposit insurance works, to the extent that it does, because when there is deposit insurance governments are much more likely to bail banks out, keeping them running, so depositor liquidity access is guaranteed.  But the implicit promise to bail banks out destroys financial stability, by inducing banks to take big risks, leveraging themselves up and making high-risk loans.  By reducing the likelihood 0f bank runs, deposit insurance also means that bank staff receive much higher pay and much greater bonuses than they would otherwise – high financial sector pay is a direct consequence of deposit insurance, as detailed in the famous Journal of Finance paper by Diamond and Rajan, "A Theory of Bank Capital".  It is not a mystery why bank bailouts lead to high bank pay and high bank bonuses – theory told us, all along, that that was a consequence.

There should be totally insured deposits – just not in fractional reserve banks.  Until the mid-1980s we used to have savings banks, 100 per cent backed by government bonds.  The government could insure these, without limit, without damaging financial stability.  If the government wants to ring-fence some parts of banks in response to the Vickers Review, it should ring-fence an old-style savings bank inside every fractional reserve bank.  Then we could have deposit insurance without inducing high pay, high bonuses, high leverage, high risk-taking, and financial instability – and all this without either destroying universal banking (an industry in which the UK excels) or excessive, invasive regulation.