EconSouth (Fourth Quarter 2006)

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Volume 8, Number 4
Fourth Quarter 2006


Housing, Energy Loom Large in '07

Southeastern Economy to Grow Modestly in 2007

Global Outlook Generally Bright in '07

Carpeting on a Roll in Georgia


Fed @ Issue

Q & A

Research Notes & News

Southeastern Economic Indicators




Research Notes and News

Research Notes and News highlights recently published research as well as other news from the Federal Reserve Bank of Atlanta.

Cooperatively owned FHLBs face risks as specialized mortgage lenders
Founded in 1932, the 12 Federal Home Loan Banks (FHLBs) have historically provided long-term funding to specialized mortgage lenders. But legislative changes in the wake of the 1980s' thrift crises spurred the FHLB System to expand in both size and scope. The FHLB System now has over $1 trillion in total assets, including a substantial investment in mortgages and mortgage-backed securities.

Like Fannie Mae and Freddie Mac, the FHLB system is a government-sponsored enterprise that funds itself largely with federal agency debt obligations that investors perceive to be implicitly guaranteed by the U.S. government. In a recent Atlanta Fed Economic Review article, authors Mark J. Flannery and W. Scott Frame identify some differences in risk-taking incentives between the cooperatively owned FHLB system and investor-owned Fannie Mae and Freddie Mac.

Cooperative ownership itself does not reduce FHLB risk-taking incentives because, unlike many mutual depository institutions, which are owned by their depositors, the FHLB system does not bundle its equity and debt claims, the authors write. Also, the fact that each FHLB guarantees the debt obligations of its sister institutions, coupled with a lack of equity market discipline, may heighten FHLB risk-taking incentives.

However, the FHLBs cannot avail themselves of equity-based managerial compensation, which creates high-powered risk-taking incentives in investor-owned firms. Overall, the authors conclude, it is unclear whether the FHLBs' risk-taking incentives are necessarily weaker than Fannie Mae's and Freddie Mac's.
Economic Review
Third Quarter

Does the no-surcharge rule benefit the payment system?
The no-surcharge rule has been a controversial aspect of payment cards. The rule, which is part of the contract between the card provider and a merchant, states that the merchant cannot charge more to a customer who pays by card than a customer who pays by cash. Critics of the card companies maintain that the rule fosters inefficiency in the payment industry by inducing customers to use forms of payment that are more expensive, especially credit cards, rather than less expensive forms of payment, especially currency. Indeed, some countries have banned the no-surcharge rule as a form of collusive price-fixing.

A recent working paper by Cyril Monnet and William Roberds explores the role of the no-surcharge rule on the payment system. They consider a card-based payment system that has cash available as a means of payment and also includes a no-surcharge rule. In their model, the no-surcharge rule is in effect even though using cards is more expensive than using cash.

Monnet and Roberds's research finds that the no-surcharge rule is an advantageous feature of the payment system. They suggest that by encouraging the use of cards as a means of payment, thus allowing people to easily tap their lines of credit in a convenient and straightforward way when needed, the rule can play a socially beneficial role.
Working Paper 2006-25
November 2006

Why do banks make promises they cannot always honor?
Banking panics are the underlying reason for banking regulation, including deposit insurance, bank examinations, and much more. In a banking panic, depositors attempt to withdraw their funds because they are afraid that the bank will not be able to honor all of its promises. This fear can be unfounded or, as in the large majority of historical instances, well founded. When a banking panic occurs, the economic consequences can be severe.

Underlying a banking panic is a seemingly innocuous promise: When you give the bank a dollar, the bank promises to give you a dollar any time you want it. Generally, the bank can honor this promise by holding fractional reserves of deposits, as they have done for many years.

Why do banks make such a promise, which both the banks and the depositors know cannot be honored if many people simultaneously try to withdraw their funds, as has actually happened? A recent working paper by Gerald P. Dwyer Jr. and Margarita Samartín explores various economic theories about why banks make a promise to pay par on demand. They also review banking history in ancient Greece, medieval Turkey, pre-Westernized Japan, and the United States. They conclude that each of the theories they consider explains some of the periods and none of the theories explain all of them.
Working Paper 2006-26
November 2006