David R. Henderson  

Questions for Luigi Zingales

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Over at Marginal Revolution, Tyler Cowen has asked people to propose questions for him to ask Luigi Zingales next week. I'm a big fan of Zingales's book A Capitalism for the People: Recapturing the Lost Genius of American Prosperity. I reviewed it positively in Policy Review in December 2012. (There are a lot of typos in the linked review that were not there originally.)

Rather than suggesting questions on issues on which Zingales and I agree, I'll quote from the parts of my review of his book where I disagree. I think some of the questions that would follow will be fairly obvious but I will pose them anyway.

I was disappointed that Zingales didn't address other regulations that promote fraud in companies -- two in particular. Section 13(d) of the Williams Act of 1968, for example, requires that investors who garner five percent or more of the shares of a company must announce that fact within ten days. That one law makes it virtually impossible for an entity that wants to take over another company to do so cheaply. Once it is known that an investor has over five percent, the price of the company's shares rises because there is now a higher probability of a takeover attempt. The increase in share prices of the target company discourages people from attempting takeovers in the first place. Also, a slew of state anti-takeover laws passed in the 1980s also make takeovers harder. Why does this matter? Because takeovers and threatened takeovers are a way of disciplining firms that are destroying shareholder value, fraudulently or otherwise.

Question: Do you favor repeal of Section 13(d) of the Williams Act of 1968? If not, why not?
So, what is Zingales's case for reintroducing Glass-Steagall? He hints at a reason: A mandatory separation would undercut the financial industry's lobbying clout -- a clout that I agree has been, on net, bad. In a recent op-ed, Zingales gave another reason. He admitted that a better way to deal with excessive risk-taking by banks is to remove deposit insurance. His only argument against doing so is that he doubts that "commercial banks are ready for that." But so what? Does Zingales, who is an outspoken enemy of cronyism, advocate that we cave to the banking lobby? Moreover, even if we worry, as he does, about political feasibility, there's another way to make banks and depositors bear more risk from banks' bad lending decisions: Leave the depositor with some of the risk. Marc Joffe and Anthony Randazzo of the Reason Foundation, for example, advocate adding "a 10 percent co-insurance feature to fdic insurance for deposits above $10,000." Under their proposal, depositors with $11,000 in a failed bank would receive $10,900, and those with a $250,000 balance would get $226,000. That would give depositors an incentive -- they have virtually none now -- to monitor the banks that hold their deposits.

Question: You have argued that commercial banks are not ready for removing deposit insurance. Do you think that is a good enough reason not to do so?
Ironically, one interesting piece of evidence for Zingales's idea that even a smart ethical person can let biases creep in is a section of this very chapter in which Zingales himself pulls his punches. He quotes a Federal Reserve governor who, in December 2006, pooh-poohed housing-price data on the grounds that such data, because they're imperfect, are not very useful. Zingales does not name the Fed governor, but does footnote the web site where one can find out. It was Randall Kroszner. Why is that demurral significant? Because Kroszner is one of Zingales's colleagues.

Question: Why did you not name your colleague, Randall Kroszner, as the Fed governor who pooh-poohed housing-price data in 2006?
When he ventures outside his expertise, though, Zingales sometimes makes important mistakes. For example, he states that the antitrust law was passed in the late 19th century to increase competition. But Loyola University economics professor Thomas DiLorenzo, in some pathbreaking research in the 1980s, showed the opposite. Between 1880 and 1890, he found, while real gross domestic product rose 24 percent, real output in the allegedly monopolized industries for which data were available rose 175 percent, seven times the economy's growth rate. In six of those seven industries, inflation-adjusted prices fell, which is strong evidence against the view that the large firms were monopolizing. DiLorenzo shows that a key faction lobbying for antitrust laws were small firms that had trouble competing with big firms with large economies of scale, and these small firms wanted less competition, not more. It's still true today that some of the main bringers of antitrust suits are companies suing their competitors. They don't want their competitors to charge even lower prices.

Question: In light of research by Thomas DiLorenzo and similar work by your University of Chicago colleague Lester Telser (A Theory of Efficient Cooperation and Competition), do you still think that antitrust law was passed in the late 19th century to increase competition?


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COMMENTS (6 to date)
Justin Merrill writes:

I haven't read his book, but I have read his works on money and banking, and I'm not a fan.

If I had his ear, I'd get into a wonkish debate over his support for Glass-Steagall and other banking regulations and macro-prudential policies he supports.

For example, this paper builds an unrealistic economy with bad assumptions, then uses it to come to real world conclusions, damn the historical evidence:

http://isites.harvard.edu/.../icb.../Hart_0414.pdf

Robert D. writes:
Marc Joffe and Anthony Randazzo of the Reason Foundation, for example, advocate adding "a 10 percent co-insurance feature to fdic insurance for deposits above $10,000." Under their proposal, depositors with $11,000 in a failed bank would receive $10,900, and those with a $250,000 balance would get $226,000. That would give depositors an incentive -- they have virtually none now -- to monitor the banks that hold their deposits.

I don't think this is a completely bad idea, but how would the average depositor go about monitoring and evaluating their bank?

David R. Henderson writes:

@Robert D.,
I don't think this is a completely bad idea, but how would the average depositor go about monitoring and evaluating their bank?
It wouldn’t be the average depositor. It would be the big depositors. Banks would have an incentive to reveal details about their loan portfolios because depositors would demand that information. It’s important not to get stuck basing your thoughts on a system you’ve grown up with in which that incentive does not exist.
Also, see Kaufman, “Deposit Insurance."

Charlie writes:

"real output in the allegedly monopolized industries for which data were available rose 175 percent, seven times the economy's growth rate. In six of those seven industries, inflation-adjusted prices fell, which is strong evidence against the view that the large firms were monopolizing."

This analysis seems mostly wrong. Price declines and output increases often occur in a monopolistic setting, because industries prone to market power often have high fixed cost and low marginal costs. Really the demand elasticity will determine the growth in output and price. There is nothing that says a company facing a declining marginal revenue won't find it beneficial to increase output and lower prices, but price would still be above marginal cost. Were these companies earning large economic profits? Maybe there is a reason this DiLorenzo work isn't more influential?

ThomasH writes:

Do you think deposit insurance promotes excessive leverage of banks, particularly those in the "too big to fail" range? I understand the theory of depositor vigilance, but it seems a pretty weak reed, especially the small coinsurance rate proposed. Maybe its a good idea but I doubt it would affect bank leverage very much.

I think variable capital ratios -- higher when the Fed might otherwise be tempted to depart form its NGDPL target because is was worried about asset bubbles or was concerned that low Federal funds rates were leading folks to "reach for yield" -- would be more effective. Not that I think the Fed ought to be worry about asset bubbles and "reach for yield," but the variable capital would be less damaging than departing from the NGDP rule.

Shayne Cook writes:

David:

I would like to know if Zingales is asked, and answers, your first questions on the repeal of the Williams Act - and what his answers are.

(As an investor, I know how I would answer both.)

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