B.C. Ferries – A Giffen Good?

A Giffen good is a theoretical violation of the law of demand. When the price of a good rises, the quantity purchased of that good normally declines. Sir Robert Giffen is credited by Alfred Marshall with making the observation that, under certain circumstances, price and quantity demanded may move in the same direction, not the opposite direction.

When the price of a product decreases the consumer is subjected to both substitution and income effects. The substitution effect is the result of the change in relative price. When the price of good ‘A’ falls, good ‘B’ becomes relatively more expensive. Consumers purchase more ‘A’ and less ‘B’. Consumers substitute the relatively cheaper product for the relatively more expensive product.

Consumers also face an income effect. When the price of good ‘A’ falls, the purchasing power of their nominal income rises. An increase in real income leads to an increase in the demand for normal goods and a decrease in demand for inferior goods.

When a good is normal, the substitution and income effects work in the same direction and demand curves are unambiguously downward sloping. When goods are inferior, however, it is theoretically possible that the negative income effect is greater than the positive substitution effect and demand curves are upward sloping.

A recent Victoria Times-Colonist article tells about the BCFerries Corporation’s decision to increase fares “due to rising operating costs, increased capital expenditure and lower-than-anticipated traffic levels” (italics added).

It seems that BC Ferries may be trying to increase their traffic levels by increasing their fees. Perhaps they believe that their service is a Giffen good and we can add that to rice and wheat as discussed in blogs by Greg Mankiw (July 18, 2007) and Timothy Taylor (January 4, 2102).

CAMELS: Holier Than Cows

India, as usual, is rejecting the ways and regulations of the West in favour of internal and customary Banking regulations. Currently, India is regulated by a CAMELS system which grades banks based on their reliability, compliance with regulations, and probability of default. (See article)

The problems with this system become apparent when examining the Reserve Bank of India, equivalent to the Bank of Canada or Federal Reserve, and their measurement methods. The banks within India are being assessed by a corporation that answers only to their own country. It is difficult to assign quantitative values based on the qualitative information being used to classify each bank as being either Composite 1 rating, down to Composite 5 rating. Composite 1 rating would classify the bank as sounds, safe, and reliable in their investments and deposits, and the safety and soundness of the bank decreases with the increased number, leaving Composite 5 rating used to classify a bank which is unsound, unsafe, and unreliable in their loans, with a high rate of default. Because these classifications are assigned within the country, there is no international standard with which to standardize them.

Basel III is a system that would apply internationally. It works to hold every bank within its jurisdiction to the same quantitative standards. Basel III sets percentage rates based on loan risk and total assets. Basel III removes the opportunity for asymmetrical information in the global financial market.
As it stands, CAMELS regulations, within any given country, reduces asymmetrical information, in the form of moral hazard, by holding each bank accountable to the same national standards. India is arguing that they should maintain this method of regulation, because they see the problem of moral hazard as remedied. If the banks within India are kept to the same standard, and all of their banking information is shared, the problem of moral hazard is solved.

Unfortunately, this does not provide any solution to the international problem of moral hazard. Basel III does. Basel III maintains consistent standards for all banks, and has a strict implication system which does not allow for differing classification standards within any nation. The regulators, such as the Reserve Bank of India, would now answer to a system which supersedes their classification structure, which would disallow for any asymmetrical information on the global financial market.

So, not only would the moral hazard issue within the country be resolved, because the Reserve Bank of India would still be regulating the classifications, but on an international scale, all regulators would be answering to the same banking reserve structure. The report made on India’s position, regarding the CAMELS to Basel III debate, was largely misguided, as the writer failed to see the bigger picture. Too much focus was made on an East versus West basis, and not enough was spent on the global economic picture. It’s global interaction on the financial markets that will increase the stability of every country’s economic standing, including their GDP.

Jaci MacKendrick
Nicole Hanbury
Rhonda Sandve
Michael Daigle
James Trujillo
Christie Aquino

Citigroup: Stressed OUT

On Wednesday the 19 largest banks in the United States had to undergo a stress test. The stress test was designed to see how the capital of the banks would hold up through a deep recession in a second housing crisis.  While most of them passed, there were a few that failed the minimum requirements.  The most notable of these was Citigroup Inc. whom received the largest bailout from the US government during the financial crisis ($45 billion).  Citigroup had planned on paying out higher dividends but since they failed the stress test they must now revise and resubmit their capital plans for approval by the fed.

The stress test was based on the Basel III accord which is to be implemented in 2013.  Basel III requires that the total Tier 1 capital be 6%, however during the test Citigroup’s was only at 4.9%.  Not only did this fail to meet the Basel III accord but it also failed their own requirement of 5%.

If Citigroup had not planned to pay out higher dividends they would have passed the stress test however their plan to pay it out caused them to fail the stress test and put their Tier 1 capital below the requirement of the central bank.  Citigroup scrapped their dividend payout in 2009 when they received the federal bail out.  It was only last year that they reinstated a 1 cent payout.  Citigroup would like to increase their dividends to return capital to the shareholders.  If they were to follow through with this plan it would drive their capital even lower putting them and all of the stocks at higher risk.  Paying out higher dividends would cause their owners’ equity to decrease therefor capital would decrease as well.  Lower capital results in Citigroup having less money to lend out.

By depleting the banks capital they’re creating a similar situation to what occurred in the crisis of 2007 when mortgages went bad and banks like Citigroup needed a bailout.  Citigroup will now have to revise their capital plan and pursue a lower dividend as they’re still looking to return funds to their shareholders.  If Citigroup doesn’t revise their plan they will have trouble balancing their need to meet the Basel III requirements as well as maintaining the interests of the shareholders.

Cavan Lungren
Karsten Gulbransen
Joel Francis
Andrew Nemeth
Alex Dupuis
Patrick Ascue

with articles from Bloomberg and International Law