John Cochrane on Banking, Expert Forecasting

1. He liked Admati and Hellwig more than I did.

Ms. Admati and Mr. Hellwig do not offer a detailed regulatory plan. They don’t even advocate a precise number for bank capital, beyond a parenthetical suggestion that banks could get to 20% or 30% quickly by cutting dividend payments. (I would go further: Their ideas justify 50% or even 100%: When you swipe your ATM card, you could just sell $50 of bank stock.)

I think he is being careless. My own essay tries to consider why households would prefer to hold bank debt rather than bank equity. Keep in mind, however, that all of us agree that the relationship between government and banks is problematic, and that the problems are not solved by regulation.

2. He cites a nice essay by Alex Pollock listing statements by regulators prior to the housing crisis that showed their mindset before the crisis. They thought they had everything under control. In 2009, they changed their minds. Now, with Dodd-Frank, they tell us they have everything under control again. Note that Pollock could have included many more pre-crisis quotes, such as the “before” quote from Ben Bernanke.

Of course, Bernanke still believes that we live in mediocristan. On the outlook for long-term interest rates, the other day He said,

While these forecasts embody a wide range of underlying models and assumptions, the basic message is clear–long-term interest rates are expected to rise gradually over the next few years, rising (at least according to these forecasts) to around 3 percent at the end of 2014. The forecasts in chart 4 imply a total increase of between 200 and 300 basis points in long-term yields between now and 2017.

Of course, the forecasts in chart 4 are just forecasts, and reality might well turn out to be different. Chart 5 provides three complementary approaches to summarizing the uncertainty surrounding forecasts of long-term rates. The dark gray bars in the chart are based on the range of forecasts reported in the Blue Chip Financial Forecasts, the blue bars are based on the historical uncertainty regarding long-term interest rates as reflected in the Board staff’s FRB/US model of the U.S. economy, and the orange bars give a market-based measure of uncertainty derived from swaptions. These three different measures give a broadly similar picture about the upside and downside risks to the forecasts of long-term rates. Rates 100 basis points higher than the expected paths in chart 4 by 2014 are certainly plausible outcomes as judged by each of the three measures, and this uncertainty grows to as much as 175 basis points by 2017.

Pointer from Mark Thoma.