Paul Volcker, former Chairman of the Federal Reserve System, previously wrote that “a nation’s exchange rate is the single most important price in its economy; it will influence the entire range of individual prices, imports and exports and even the level of economic activity.” Given Volcker’s analysis, the US may have cause for concern.

Forces such as rising yields on international currencies such as the Yen and the Euro and corresponding global macroeconomic growth drove investors away from the dollar in 2017. The U.S. Dollar Index, a measure of the dollar’s relative strength against the values of the currencies of several of our major trading partners, fell almost 12 percent over the last year. Considering the US dollar is the world’s most traded currency and accounts for almost 64 percent of all foreign currency reserves, a 12 percent decline is enormous.

Yet, all of this seems a bit counterintuitive. Ostensibly, there was nothing wrong with the United States economy in 2017. The recent passage of the Tax Cuts and Jobs Act, corporate earnings growth and low unemployment numbers helped the S&P 500 to a robust 24 percent gain since the time of President Trump’s inauguration last January. This represents the best annualized domestic growth realized since markets rebounded from the Great Recession in 2009. Even so, the dollar lost ground to superior growth abroad.

A number of factors, including the trade benefits from the weaker dollar and a long overdue global economic rebound from the previous recession in 2009, propelled Chinese, Korean, Indian and a number of emerging markets indices to returns greater than those seen domestically. For example, with Eurozone unemployment falling over one percentage point during 2017 to 8.7 percent, forex yields proved far more attractive overseas than at home, causing many institutions to shed portions of their dollar holdings.

A number of factors in the coming year provide evidence that the dollar rout is not over yet. The aforementioned global growth has shifted the thinking of many foreign central banks. In the European Union, the monetary policy debate has changed from ‘if” to “when” the European Central Bank should end its quantitative easing program originally designed to restart economic growth and boost asset prices after the Great Recession.

In Asia, the tone is no different. While lagging annual inflation of around 0.8 percent in 2017 has yet to signal any definitive need for a monetary policy shift, the Bank of Japan expects strong exports and quickening GDP growth to push inflation to its long term 2 percent target by early 2020. According to Reuters, Japan is ahead of schedule on eradicating the deflation seen in past years, leading many to believe an end may be near to the negative interest rates set by its central bank.

In sum, there remains ample reason to believe foreign currencies will continue to strengthen against the dollar in 2018. On the back of such data, Citibank projects a further 5 percent decline in the dollar index over the next year. All of this begs the question: what are the consequences?

While it’s true the current exchange rate climate benefits previously siloed sectors of the economy such as manufacturing and materials by effectively giving foreign buyers a discount on American goods, a weak dollar does not come without its costs. Aside from reduced spending power during travel, serious cause for concern comes from the increased prices of goods at home. Total spending on imports in 2016 amounted to a sizeable 12 percent of our $18.6 trillion dollar GDP, with the largest contributions from spending on electronics, computers and petroleum respectively.

Even though typical core inflation measures exclude the prices of more volatile commodities like food goods and petroleum, price increases on these trade items could certainly lead to inflation. Taken alongside a 4.1 percent unemployment rate — the lowest since December of 2000 — and the wage and bonus benefits given to millions of Americans by employers such as Walmart, AT&T and Capital One as a result of the recently passed tax plan, inflationary pressures seem to be rematerializing to levels not seen in recent years.

In macroeconomic terms, these numbers are significant. Current unemployment is below the Federal Reserve’s estimates of the non-accelerating inflation rate of unemployment (or NAIRU), the level at which economists expect inflation to rise. Indeed, with core inflation from last December rising to 1.8 percent according to the Bureau of Labor Statistics, the Fed’s long run target of 2 percent seems well within reach for 2018.

To counteract price pressures from the weak dollar, wage increases from unemployment below the NAIRU, and, more broadly, to maintain price stability, the Fed must look to rapidly raise rates. The aforementioned factors form the basis for the generally accepted argument that the Fed will raise rates in 2018. However, their severity will determine the answers to the more important questions such as “How soon?” and “By how much?”

According to the Federal Reserve’s most recent dot plot, which measures the Board of Governors’ opinion on future interest rates, three rate hikes of 25 basis points each is the most common expectation for 2018. This projection largely factors in what the Fed thinks will be appropriate based on their projections for the strengthening of inflation metrics. However, the consensus at the Fed belies the concerns of a more rapid return of inflation, which given the falling dollar, is entirely likely.

Moreover, the 75 basis point projection does not adequately account for the strength of the business cycle. Now almost 10 years out of the last recession, major financial institutions such as Barclays and Goldman Sachs have begun to include the possibility of a recession in their near term economic forecasts. With current interest rates at just 1.25 percent, the need to raise rates takes on more importance given the propensity to lower them during economic downturns.

Considering the uncertain success of the negative interest rates central banks used to stimulate economic activity in Europe and Japan after the Great Recession, the Fed tends to look to lower rates no further than a nominal 0.25 percent or so, which does not give it much room if it had to undertake a course of sustained easing in the near future. As a point of context, the Fed lowered rates by 5 percentage points during the last recession. Effectively, the low interest rate environment leaves the Fed with its hands tied behind its back, without the ability to further stimulate the economy.

While dovish sentiments would suggest reactionary rather than proactive measures to manage the return of inflation and fewer rate hikes rather than more to avoid the risk of steering the economy toward a recession, it is important to mind the damage untamed inflation could wreak on the economy. With market volatility at historic lows, downplaying the consequences of inflation could prove fatalistic, removing the Fed from control over powder-keg factors that could threaten the peaceful gains seen by equity markets in 2017. Four rate hikes, rather than three, and a prolonged plan for additional increases in 2019 will enable the Fed to maintain price stability and, more importantly, position it better to accommodate the next recession.

Hedge funds have been struggling recently. According to CNBC, hedge fund outflows reached $60 billion in June, with the rate of withdrawals increasing. Although the average American might not feel much sympathy for the typical hedge fund manager, the struggling hedge fund industry points to a real problem in the financial sector: the Federal Reserve’s suppression of overall volatility and the corresponding suppression of inter-asset volatility. When overall volatility (in the sense of the S&P moving up or down) is suppressed, inter-asset differentiation is also suppressed.

This should make intuitive sense – if there is a giant influx of new credit, all asset prices go up and so the relative change in price is attenuated. The relative change in price between different assets (hereafter referred to as inter-asset differentiation or inter-asset volatility) is also therefore less. The current popularity of index funds and the corresponding contemporary distaste for hedge funds both reflect this point.

Basically, because newly-printed money has to go somewhere, it distinguishes less between assets (compared to what it would have relative to the old price). By inflating assets prices basically all across the board, central bank easing has dulled the market’s price discovery mechanism.

Warren Buffet’s famous quote “Only when the tide goes out do you discover who’s been swimming naked” reflects this point well –when there is an influx of credit the markets perception of corporate value is distorted and its ability to differentiate is dulled – only when the credit cycle reverses does the market regain its ability to differentiate. When the “tide goes out” there is credit scarcity and the opposite logic applies: volatility and inter-asset differentiation spike.

Think of this effect mathematically: consider asset A and the universe of stocks with which it is compared. Both appreciate at an extra 1 percent a day because of a new influx of credit. This example expresses the process of credit expansion: since the influx of new money is gradual, valuations increase not automatically but over time as credit expansion settles its way into the market.

Theoretically, therefore, the best representation of undiscriminating credit inflows is a smooth curve. The hypothetical 1 percent move is a first derivative of that curve and can be applied to any timeframe, as long as it is continuous. The same theory can also be generalized to illustrate the entire process of credit expansion, no matter what the actual rate of that expansion is. On a day in which an asset A would have declined by 1 percent and the index risen by the same rate, asset A would now not move and the index would increase by 2 percent. Asset A’s performance is now more similar to the market’s.

The same effect happens even if the numbers are different: if asset A appreciates 2 percent and the market 3 percent, now it would be 3 percent and 4 percent, and instead of moving two-thirds of what the market moved it now would move three-fourths. The result is that the stock tracks the market more closely, and the distribution of betas is compressed. For a hypothetical market with a normal distribution of returns, graphically the effect looks like this:


Note that the overall market returns have increased, and that the distribution of betas has compressed. Returns, while increasing, cluster more closely around the market average.

A further point is that the mechanism is self-reinforcing: because assets are rising in price, the perception of relative risk (Beta, Sharpe ratio, etc.) diminishes and newly-created money is therefore more likely to flow to those artificially less risky assets, further diminishing their perceived risk and further degrading the market’s ability to differentiate.

The result is that inter-asset volatility goes down further. This effect is particularly pronounced with risk metrics like the Sharpe ratio that give greater weight to negative movements than positive ones. Across the board credit expansion impacts these ratios more severely because the relative reduction in negative movements is larger compared to the increase in positive ones. For example, a shift from 1.5 percent to -.5 percent is a much larger relative change than 1.5 percent to 2.5 percent.

Index funds are both a reflection of and reason for this trend. Index funds do not distinguish between different stocks in an index when they buy stocks – they buy a little bit of each company proportional to its size. The same logic applies as with credit expansion above: such indiscriminate buying compresses the beta distribution of all the stocks within an index. Index funds are also more profitable if inter-stock volatility is down because it is less profitable to distinguish between stocks.

What does this mean for portfolio allocations? The implication of the argument is that the market cannot distinguish as well between risky and non-risky assets during credit expansions. Therefore, returns during expansions are not as accurately risk-adjusted and so absolute returns are more similar across disparate-risk assets. Risk has been mispriced and over-bid. One should therefore decrease risk in one’s portfolio and buy assets that perform especially well when the “tide goes out.” Because of the smaller performance difference between disparate-risk assets, this should not affect returns as much if the expansion continues.

One might also want to rebalance the portfolio to include more cash, precious metals, and corporate securities with very strong balance sheets. These assets are mostly ones that perform well during periods of high overall volatility. When the market underperforms and investors rush to reduce their exposure to risk, these assets will appreciate in relative terms and perhaps even relative to cash (e.g. gold). If credit expansion continues, portfolios should not be affected as much because the rising tide will still “lift all boats” and less-risky assets should be among that tide. In any case, to paraphrase Warren Buffet, don’t get caught swimming naked when the tide goes out.

A frequently asked question on the Federal Reserve’s website is the query of what exactly it means for the Federal Reserve to be an “independent government agency.” According to the official site itself, the “Fed” is structured in a way to remain apolitical so that its monetary policy decisions “do not become subject to political pressures that could lead to undesirable outcomes.” Theoretically, the Fed should not be incorporating partisan politics into its own agenda of raising or lowering interest rates. This idealistic goal is far from the reality.

In fact, the Fed has become increasingly politically-charged, deviating from this goal. In 2016, the United States has experienced a growth in the partisan polarization around the country, which largely results from the upcoming Presidential election. The result of this election has implications not only for social issues and national security, but also for the nation’s economy.

The markets must be ready for either Clinton or Trump to take Obama’s place; that is, the markets must adjust their prices according to how investors believe the new president’s policies will impact domestic and international economic growth. Being ready for the economic future, however, is very difficult to do with two polarizing candidates such as Clinton and Trump. Investors’ outlooks for certain companies will certainly change depending on who America chooses as the next President. Mary Ann Bartels, the head of Merrill Lynch’s Wealth Management Portfolio Strategy explains that if there is “one thing markets hate, it’s uncertainty.” As such, the markets will most likely be incredibly volatile in the weeks leading up to and directly after Election Day, as it is every four years during a presidential election.

Given all these considerations, this presidential election has prevented the Fed from implementing a course of monetary policy independent from politics. Given the Fed’s apolitical nature, the members of the agency try to avoid choosing their policies based on whichever political party wins the Presidency. This attempt at remaining neutral actually creates another political decision that prevents the Fed from ever raising interest rates close to the election.

Every year, the Federal Open Market Committee (FOMC) of the Fed meets during September and November. According to MarketWatch columnist Mark Hulbert, the Fed has raised interest rates during September and November before Presidential elections only once since 1990, which was in September 2004. The 1990s being the years during which the FOMC began to publicly announce their monetary policy target interest rates.

The reason that it is so rare for the FOMC to raise its interest rate target around a Presidential Election is an inherently political one. When the FOMC raises interest rates, markets typically slow down. Higher interest rates make it more expensive for investors to acquire credit from banks, which decreases investment activity. Since the Fed is supposed to be apolitical, it will try to avoid picking political sides when the election rolls around. If it were to hypothetically raise rates if the Democratic nominee wins, its policy would slow the economy, and Democrats may accuse the Fed of playing politics and trying to make the Democrats look bad after the election (vice-versa for the Republicans). As a result of Washington’s politics, the Fed has been under pressure to avoid tightening monetary policy by raising rates.

Outside of the Election, one of the main points of discussion with regards to the Fed revolves around “Audit the Fed” movement. While the Fed already conducts its own audit, proponents for this “Audit the Fed” movement demand that more information be released. Some believe that Congress should have the power to choose the auditor. Norman Singleton, president of the Campaign for Liberty, explains how the Fed’s current audit is only “a financial audit” that “doesn’t really give you a full glimpse of the Fed’s conduct of monetary policy.”

With such distrust of the Fed in Congress, the Fed may be more reluctant to change its monetary policy course. If interest rates rise, Fed officials would undoubtedly come under fire for slowing the markets down and have to justify to political figures their reasons for doing so. While the Fed’s increased accountability certainly has its merits, Jeff Cox explains how “opponents of the ‘Audit the Fed’ movement believe the ultimate consequence will be to remove the Fed’s independence from political pressure.” For better or for worse, if the Fed were increasingly held accountable for its policy course by Congress, political independence becomes unlikely.

In addition, ever since the 2008 market crash, FOMC members have attempted to be more transparent with the public over its monetary policy decisions. These transparency measures include more public speeches by FOMC members, transcripts of these speeches, and increased media coverage of individual members. While this allows the Fed officials to more clearly communicate their rationale behind their policy, it also serves as an outlet for Fed officials to say politically-charged statements and to publicly disagree with the ideology of their colleagues.

For example, the Chairwoman of the Federal Reserve, Janet Yellen, was recently asked a question at her September 21 press conference about income inequality and the middle-class. She responded by emphasizing her prioritization of income growth and of creating better paying jobs “throughout the income distribution.” Critics of Yellen may interpret her answer as being politically liberal. One of the main pillars of the Democratic economic platform is decreasing income inequality, and it seems Yellen aligns with the Democrats on this issue. Some critics may even point at how Yellen was appointed as the Fed Chair by a Democratic President (Obama) as a reason to be wary of her political bias. Supporters of Yellen may emphasize her commitment to a data-dependent approach as proof of her non-partisanship, but there still is a loud clamor on the other side amongst Yellen critics about her supposed political bias.

While it may be questionable whether Yellen was being openly political in her statements, the reality is that increased media exposure of FOMC members allows the media to force officials to answer political questions and contort their words into having a political connotation. Current Minneapolis Fed President Neel Kashkari compared recent media coverage of the Fed to that of shark attacks. What Kashkari means, explains Greg Robb of MarketWatch, is that the media provides “a lot more hype than fact.” Today’s sensationalist media inherently puts the Fed at risk to seem partisan rather than independent.

It seems that this agency, which claims to be self structuring in a way to remain apolitical, is now overwrought with pressures on both sides of the aisle. Recently, Lael Brainard, a Governor of the FOMC, has given donations to Hillary Clinton’s presidential campaign. As explained by Craig Torres of Bloomberg, Brainard gave “$750 in three contributions to Clinton’s campaign between November and January.” Perhaps Brainard’s donations tangibly show how politics has creeped its way into the world of the Fed and monetary policy. Perhaps we are seeing the Fed’s monetary policy start to fuse with the federal government’s fiscal policy. Perhaps we are seeing the complete death of independent bureaucracy as we know it. Or perhaps the Fed may simply need a quick refresher by looking up the FAQ on its official website about political independence.

This article was featured on the DBJ Instablog on Seeking Alpha.

As the United States economy struggled to avoid complete collapse in the height of the financial meltdown, leading players in the regulatory arena, as well as those in Congress, pushed for a solution that would prevent any future downturn from escalating to the near catastrophic levels of 2009. That solution emerged in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which passed Congress on party lines and was signed by President Obama on July 21, 2010.

Dodd-Frank formed a key part of President Obama’s plan for economic recovery. The law significantly overhauls the American financial regulatory system, creating a new Consumer Financial Protection Bureau, limiting risky trading, implementing a new regulatory regime for credit agencies and insurance companies, among others. The law is arguably the biggest push for financial reform since the Great Depression, and given its length and breadth, has generated substantial opposition.

One of the most controversial provisions of Dodd-Frank is the Volcker Rule, named after former Federal Reserve Chairman Paul Volcker. The rule would ban most forms of proprietary trading, which prevents financial firms from profiting directly from trading on the market, as opposed to profiting through commissions. This rule is significant in that it can potentially prevent some of the dangerous behavior that helped cause the financial collapse. Because of the ardent opposition by banks and the limited financial resources appropriated to regulatory agencies, the Securities and Exchange Commission and other financial regulators have requested additional authority to prosecute violators and impose penalties.

But Republicans in Congress see the Volcker Rule as an unwarranted and harsh crackdown on financial activities necessary to promote healthy economic growth. Chairman of the House Financial Services Committee Jeb Hensarling (R-TX) said previously in a statement that the final version of the Volcker Rule “is just the latest example of Washington’s regulatory overkill that ends up hurting more than it helps.”

In this new Congressional session, a bill to delay the Volcker Rule failed in its first attempt to pass the House of Representatives when Republicans used a procedural rule requiring a two-thirds majority to speed up its passage. That effort failed 276-146, but ultimately, a new attempt under regular order passed by a simple majority of 271-154. While twenty-nine Democrats voted with a unified Republican caucus in support of the bill, its passage into law is doubtful given fierce Democratic opposition in the Senate and a likely presidential veto. “One day into the new Congress,” said Senator Elizabeth Warren (D-MA), one of the leading proponents of financial regulation, “House Republicans are picking up right where they left off: trying to gut Wall Street reforms so that big banks can make more risky bets using taxpayer-backed money.”

The controversy over the Volcker Rule and Dodd-Frank in general stems down to a difference in political viewpoints between Democrats and Republicans on how much regulation is necessary to prevent a future financial collapse. Democrats cite the need for increased reforms and requirements on big banks in order to safeguard consumers and prevent large financial institutions from growing to be “Too Big to Fail” and bringing down the economy in the event of bankruptcy. Republicans, on the other hand, believe these increased regulations hamper financial growth and economic recovery, and they point to deregulation as necessary to promote growth. Political consensus on this fundamental difference appears doubtful, but smaller bills have previously garnered bipartisan support, indicating the possibility for compromise in the future.

The Dodd-Frank Act is one of the most sweeping pieces of financial reform legislation ever to become law, but only time will tell whether it will have the fortitude to resist sustained attacks from the financial industry. Furthermore, many believe it has not gone far enough to prevent a future financial collapse, a reflection of the legislative process as well as sustained opposition from Republicans. Now, with a wholly Republican Congress and only two more years left in President Obama’s second term, the future of many of President Obama’s initiatives remains uncertain. As the economy approaches full recovery from the financial collapse, the impetus for additional regulations will undoubtedly diminish, as legislators move beyond the financial collapse. The debate over Dodd-Frank and the Volcker Rule will surely continue beyond 2017, and as partisan politics heighten as the 2016 election season begins, President Obama’s record will become a key component of the campaign.



The Federal Reserve has adapted a new stance on monetary policy: patience. With the federal funds rate at the zero lower bound since 2006, the Fed’s policy-setting committee, the FOMC, has delicately approached the idea of beginning to raise rates. Beginning in 2012, the Fed assured the markets that there would be a considerable time period of highly accommodative monetary policy to bolster the economy’s progression to the Fed’s dual mandate of maximum employment and stable prices.

During the last two FOMC meetings, the committee decided to exclude the language of “considerable time” from the statement and adopted a new vow to remain “patient in beginning to normalize the stance of monetary policy.” The statement assessed that labor market conditions were improving and that labor market slack, or underutilization, has continued to diminish. Following robust job gains at the end of 2014 and a significant drop in the headline unemployment rate, which is now down to 5.6 percent, a quick glance at the labor market looks more reassuring than reality.

There are still 6.8 million workers who are employed part time for economic reasons, 2.3 million workers who were marginally attached to the labor force, and 740,000 workers who were discouraged from looking for work since they did not believe there would be any employment opportunities. Over the past twelve months, there has been little change in underemployment. The U-6 alternative measure of broad labor market underutilization, which is at 11.2 percent, has remained twice the size of the headline U-3 unemployment rate. This is drastically above pre-recession norms, when there was a 3 percentage point differential in the rates compared to the 5.6 percentage point difference today.

In the past 35 years, the unemployment rate has generally been considered a good measure of labor market health (Barnes et al. 2007). However, the recent improvements in the headline (U-3) unemployment rate have overstated the health of the entire labor market. The FOMC learned this first hand. In 2012, the committee decided to target a 6-1/2 percent unemployment threshold to assure the market that rate rises would be delayed. Even with an unemployment rate nearing 5-1/2 percent, the FOMC has been forced to backtrack and recognize that this threshold was shortsighted. At the 2014 annual Jackson Hole conference, Janet Yellen claimed that the “decline in the unemployment rate over this period somewhat overstates the improvement in overall labor market conditions.”

In order to assess the amount of residual labor market slack, I created an aggregate distance function summing eight different labor market indicators from the distance of their pre-recession norms. Over the past year, Chair Yellen has mentioned that a variety of labor market indicators are on her “labor market dashboard.” Using speeches over the past year, I gathered eight different labor market indicators that Chair Yellen has highlighted when talking about labor market health. This includes: total unemployment, total underemployment (U-6), the labor force participation rate, percent of unemployed who have been out of work for over 27 weeks, employment-population ratio, hires rate, quits rate, and the job openings rate. For each indicator, I examined the pre-recession average (2005 – 2007), and then found the indicator’s proportional magnitude distance from current levels.

graph 3


As demonstrated by the indicator, there is still significant labor market slack, even though it is diminishing.  The indicator has no form of weighting between the components, and assumes no structural changes in the labor market when using the 2005 – 2007 pre-recession. However, it is interesting to determine the relationship between labor market underutilization and wage growth.  By plotting this labor market indicator against total private average hourly earnings growth, I drew a line of best-fit wage curve through the relationship of wage growth and labor market slack.

In the early 2000s, housing prices took off as subprime loans made capital accessible to nearly anyone and increased demand throughout the market. In 2008, that bubble burst. Securities backed by real estate properties were rendered worthless thereby setting off a chain of events that led to one of the greatest recessions since the Great Depression of 1929. Now, as economic growth begins to pick up and we enter our 58th consecutive month of GDP growth, economists are beginning to wonder whether we are falling right back into the same trap that beset us in 2008.

A run-up in housing prices can occur due to a combination of demand, speculation, and belief that past trends in housing prices can be used to predict what will happen in the future. To test whether rises in housing prices indicate general trends of actual bubbles, some economists compare the Home Price Index with the Rent Index. When looking at this graphically, we can distinctively see the bubble that occurred in 2008.

Peter Wallison, an economist for the American Enterprise Institute, recently wrote an article in the New York Times claiming that there are many similarities between trends in housing prices today and those of the late 1990s and early 2000s. Wallison notes that from 1997-2002, housing prices grew by six percent compared to a 3.34 percent growth of rental prices. Similarly, since 2011, housing prices have grown 5.83 percent compared to an increase of only two percent in rental prices.

Among those who believe that we may be entering another bubble, opinion remains split as to its cause. Wallison blames government policies, such as low requirements on down payments, which allow individuals to buy homes too easily. He suggests that minimum down payments be raised from the current level of three to five percent to pre-1992 levels of 10 to 20 percent. Others believe that the Federal Reserve’s tax monetary policies could be fueling the rise in housing prices. Federal Reserve Governor, Jeremy Stein, stated that the Fed must be careful using expansionary tactics when risk estimates within the bond market are excessively low. Though Stein refused to voice his opinion on the Federal Reserve’s current policy, people believe that Stein would say that the Fed is being too accommodative and should take action to prevent bubbles from forming.

While some have voiced their criticism of current Fed policies, Fed Chairwoman, Janet Yellen, does not seem to be concerned about any rumors of upcoming bubbles. Her latest addresses have not even touched upon the risk that low interest rates could cause speculative run-ups in prices. In her latest address, Yellen made clear her intentions of maintaining low interest rates until the Fed deems unemployment rate is an acceptable level.

Yellen is in the unenviable position of having to decide what acceptable level of risk the Fed is willing to bring to the United States’ economy against policies that stimulate growth. Although the United States has officially been out of the recession for almost five years now, unemployment is still relatively high (6.8 percent) and the annualized rate of GDP growth in the United States in the last quarter of 2013 was an anemic 2.6 percent.

Given these facts, Yellen’s position defensible, especially when considering that no consensus has been reached on the subject of whether or not we are looking at a real bubble. According to Jed Tulko, the chief economist of the real estate company Trulia, housing prices are still undervalued by five percent. Of the 100 markets that Trulia monitors, housing prices are overvalued in only 19, compared to in 2008 when all 100 were overvalued. Tulko also notes that most of the overvalued markets are in locations that that have witnessed a significant influx of people, causing high demand and tight supply and a natural rise in home values.

For now, the best we can do is wait and see. WIth some luck, this is a temporary blip, and housing prices will soon return to a normal rate of growth. However, if this truly is a bubble, the Fed and policymakers must be especially vigilant and must make sure to clamp it down before it reaches a catastrophic size. Fresh out of the 2008 recession, many vividly remember the consequences of housing bubble’s burst and hope it does not repeat.

The financial services industry, after stealing the spotlight during the recession, is now making headlines once again. In response to recent regulatory legislation, banks nationwide have made the controversial decision to hand consumers a whole slew of new banking fees, namely a monthly charge for using debit cards.

The announcement has since ignited a public uproar, as exasperated consumers, who are still suffering from the aftermath of the financial crisis, have no intentions of welcoming the new additions to their monthly statements.

The new federal legislation that sparked this chain of events, known as the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act, more strictly regulates the financial services industry. More specifically, the Federal Reserve now prohibits banks and credit card companies with assets over $10 billion from charging merchants more than 24 cents for processing each purchase made with a debit card.

By contrast, these banks charged retailers an average fee of 44 cents per debit card transaction prior to the new legislation. Although such a cap on interchange fees may not seem like much, it will collectively cost banks $6.6 billion in annual revenue.

By limiting the amount that banks and credit card companies can charge retailers on debit card purchases, the government ruling attempts to encourage competition and to counter the current monopolistic tendencies of the financial services industry.

However, banks have proven unwilling to accept such a substantial reduction in revenue. Still reeling from the financial crisis as well, banks like Bank of America have developed an ingenious way of thwarting the government’s attempt to slash their profits: pass the burden down to consumers. Through charging a monthly fee for debit card purchases, banks nationwide have been able to generate a new source of revenue that can counteract the Federal Reserve’s cap on interchange fees.

The larger trend of instituting a debit card fee includes even the most prominent banks. Bank of America, the nation’s biggest bank, recently announced its decision to charge a $5 monthly fee for debit card use.  Bank of America joins a growing list of financial firms that have already done the same. Other national banks, including Wells Fargo and Chase, are piloting $3 monthly debit card fees.

By instituting a $3 fee, Wells Fargo estimates it could recover over $200 million, which would partially offset the regulation’s impact. Similarly, regional banks like Regions Financial and SunTrust will be charging a $4 and $5 fee, respectively.

The most recent debit card charge is just one of several frustrating fees implemented by banks in an effort to recoup the revenues lost to legislation. Government restrictions have caused banks like Chase to now charge customers for paper statements, checking accounts, and even for online banking. In some regions, Chase levies a $15 charge for checking accounts, which is in addition to ending its debit rewards program. Bank of America is also considering applying the new debit card fee to customers who engage in automatic payments, such as monthly cable bills, gym membership fees, or car payments.

Others, like USAA Federal Savings Bank, have managed to abstain from charging such fees, but do so at the cost of having to end its debit rewards program. Citibank has avoided the fee too, though it decided to raise its monthly charge for basic checking accounts by $2. TD Bank and Bank of America now charge their customers $2 and $3, respectively, for using non-network ATM’s. Similarly, HSBC raised its ATM fee for customers using non-HSBC machines from $2 to $2.50, and is also charging a 35-cent debit card transaction fee per use.

Moreover, a string of banks have also raised the requirements necessary to qualify for services like free checking accounts, in order to amass more income in the form of fees.

The most recent legislation, while noble in theory, was accompanied by a series of unintended consequences that severely undermine its efficacy. On the one hand, the Durbin Amendment assists small businesses and retailers, by alleviating some of their financial woes.  These merchants, who are still struggling due to diminished consumer spending, aren’t passing down any of the savings to consumers, though. In doing so, merchants enjoy a reduction in costs as well as a boost in their own profit margins.

Meanwhile, consumers become the victims, and are made considerably worse off. They are left to bear the brunt of the policy’s financial repercussions, without seeing a decrease in prices. Unwittingly, the extra burden is transferred to the very people whose spending and investment have the potential to boost economic growth and put America back on its feet.

These $5 debit interchange fees, when considered collectively alongside the other new charges already put into place, will have a significant impact on consumer spending habits. In addition to being extremely irritating and exploitative, the accumulation of these additional fees will result in an unnecessary reduction in a household’s disposable income. In a time where stubborn unemployment is still an issue and households are struggling to make ends meet amid the current volatility, this disincentive to spend can considerably inhibit economic growth and recovery.

More importantly, because debit cards have become relatively more expensive, consumers will likely seek out cheaper alternatives.  However, at the moment, there doesn’t appear to be many viable options.

The inconvenience and cost of constantly using ATMs, especially out-of-network ones, coupled with fee-ridden checking accounts may cause consumers to more heavily rely on the use of credit. Doing so will likely cause a rise in household debt, particularly for those with bad credit.

The shift back to using credit rather than debit or cash could potentially be very dangerous given the current economic conditions. Furthermore, according to some estimates, the higher fees and minimum balance requirements will bring about a forced exodus of as many as 1 million low-income consumers from the banking system. Desperate for other options, a large proportion of this group will likely turn to check-cashers, credit unions, and other financial providers.

While the culprit in all of this may seem obvious at first, identifying the true perpetrator is actually more difficult. Contrary to what many consumers may believe, financial institutions should not necessarily be held entirely accountable for the spike in fees.

Yes, in an ideal world, large banks should simply accept the regulatory action and cope with decreased revenue and lower profit margins. However, in a capitalist system where firms seek to maximize profit, it can be reasonably expected that banks will lessen the financial burden by seeking new avenues of income, just as the airline industry did by charging for checked baggage. Despite what consumers are led to believe too, banks may be justified in charging high fees, in order to protect themselves against fraudulent transactions. Due to the increased restrictions, banks like Chase may have no choice but to limit debit card purchases to under $50 or $100.

America today suffers from a sluggish economy that features low consumer confidence and an unsustainable budget deficit.  Thus, in such a tenuous situation, the responsibility lies in the government’s hands to mediate all of this. The government must assume the role of overseer and ensure the more equal distribution of financial burdens during this critical stage of economic recovery.

Small business owners and consumers alike are not in secure enough positions to absorb the added costs. Thus, each segment of society must compromise and concede certain temporary sacrifices in order to benefit the greater society, such that it stimulates economic growth in all sectors in the long run. The government must also be more aware of the complexity and interconnectedness of the financial system. As shown by the extensive ripple effects stemming from this one government decision, policymakers need to more carefully assess the potential impacts of economic revitalization attempts prior to implementation.

There needs to be greater reform in the interchange network, mainly in the relationship between large banks and retailers. Under the current system, payment networks like Visa and MasterCard have managed to charge retailers processing fees that greatly exceed the actual cost of processing a transaction. According to some estimates, margins on these charges can reach as high as 400%.

Curiously, the processing fees are comparable to those in other countries, and yet the United States has one of the highest interchange fees in the industrialized world. In an effort to establish a more equitable financial burden, the financial services industry must endure lower margins, but not to the extent the Durbin Amendment calls for.

Additionally, the government must address the fallout and inequities from the new legislation. The financial services industry has evaded the cap by instead raising charges on lower-value purchases. Thus, the payment structure is such that some retailers actually endure higher fees for small-dollar transactions than they do for bigger purchases.

The government must also somehow induce retailers to lower their prices so that savings can be passed on to consumers, in order to induce greater consumer spending.  This can be accomplished either through some sort of subsidy program, by granting retailers some sort of tax incentive to do so, or by modifying the fee structures put into place by the new legislation.

Overall, the government needs to orchestrate more adjustments to break up monopolistic markets and inject a greater degree of competition into the flailing economy, so that small businesses do not continually fall victim to the larger players in the industry.

The effects of the legislation aren’t all bad, though. Consumers ultimately choose the lowest-cost provider, which could potentially galvanize the industry into having more competitive pricing schemes. Some have already withdrawn their money from banks to avoid their fees, in search of a cheaper alternative.

In theory, the market will eventually reach a competitive equilibrium that features banks charging more reasonable fees to consumers and retailers alike, which would be highly beneficial for economic stability. However, in reality, as evidenced by the repercussions from the Durbin Amendment, the expected outcome is not always realized.