Deregulation epoch of the US capitalism with the dominant ideological doctrine
of Market Fundamentalism (Reaganomics) if often known under the nickname of Casino
Capitalism. It lasted more then a quarter of a century. Sometimes it was
called
financial capitalism as opposite to industrial capitalism. Addition of
the societies to disastrous politico-economical doctrines are similar to additions
to alcohol and drugs in individuals. It is not easy to recover from it and it take
a long, long time and a lot of misery.
According to Susan Strange transformation of industrial capitalism into casino
capitalism involved five trends all of which increased the systemic instability
of the system:
According to Strange, Casino Capitalism was implemented from above. It was government
decisions (or rather non-decisions) that brought on the present state of financial
instability and economic disorder. In other words casino capitalism has distinct
"Made in the USA" and "Government property" marks. It was the USA elite, who refused to act responsibly in
the face of changing circumstances resulting from its own actions, and instead chose
to try to perpetuate, by whatever means it had at its disposal, the institutional
advantages that it had vis-a-vis its main economic rivals, stemming from the role
of dollar as international reserve currency.
For Strange the speed at which markets work combined with their now, near-universal
pervasiveness results in a volatility that extends globally. Approximately $1.5
trillion dollars are invested daily as foreign transactions. It is estimated
that 98 per cent of these transactions are speculative. In comparison with
this casino Las Vegas looks like a aborigine village in comparison with Manhattan.
This idea of "casino capitalism" as a driver of financial instability was developed
further in the book The Crisis of Global Capitalism by George Soros (1998), who
highlights the potential for disequilibrium in the financial system, and the inability
of non-market sectors to regulate markets.
From the historical view Reaganomics also can be considered to be the US flavor
of Lysenkoism with economics instead of
genetics as a target. Like it was the case in Bolshevism the ideology was
developed and forced upon the society by a small group of players. The key ideas of Casino Capitalism were formulated
and implemented by Reagan administration with some contribution by Nixon (the role
of rednecks aka "moral majority", "silent majority" as an important part of republican
political base, which can be attracted to detrimental to its economic position policies
by the smoke screen of false "moral" promises).
It was supported by each president after Reagan (paradoxically with Clinton having
the most accomplished record -- he was the best Republican President in a very perverted
way). Like in case of Lysenkoism opponents were purged and economic departments
of the country were captured by principless careerists ready to tow the party line
for personal enrichment. Like in case of Bolshevism. many of those special
breed of careerists rotated from Republican Party into Fed and other government
structures. Classic example of compulsive careerists that were used by finance sector
to promote its interests is Alan Greenspan.
Among early critiques of casino capitalism was John K. Galbraith. He promoted
a pretty novel idea that the major economic function of Governments is to strengthen
countervailing powers to achieve some kind of balance between capital and labor.
It may well be that the renewed support of unions right efforts to organize could
make a big contribution to a revised, post subprime/derivatives/shadow_banking
crisis of capitalism.
One of the key ideas of Reaganomics was the rejection of the sound approach that
there can be a balance between too much government regulation and too little and
that government role is important for smooth functioning of the market. In this
area Reagan and its followers can be called Anarchists and their idea of 'free market"
is a misnomer that masks the idea of "anarchic market" (corporate welfare to be
exact -- as it was implemented). Emergence of corporate welfare Queens
such as GS, Citi, AIG, are quite natural consequence of
Reaganomics.
There might be some geo-strategically motives as well as the US elite in late
80th perceived that competitiveness is slipping out of the USA and the danger of
deindustrialization is real. Many accuse Reagan with the desire to ride dollar
status as a world reserve currency (exorbitant privilege) until the horse is dead.
That's what real cowboys do in Hollywood movies...
The most interesting part of Reaganomics was the power of this ideology which
conditioned "working class" and middle class to act against their own economic interests
and permitted stagnation of wages during the whole 25 years period. This makes
it in many ways very similar to Bolshevism as a whole, not just Lysenkoism
(extremes meet or in less flattering way: "history repeats, first as a tragedy,
then as farce).
Along with the term Reaganimics which implicitly stresses the deregulation, the
other close term "market fundamentalism" is often used. Here is how market
fundamentalism is defined (Longview
Institute):
The huge boost of Casino Capitalism was given by the collapse of the USSR in
1991.
Some level of government coercion (explicit or implicit ) is necessary
for proper labeling of any pseudo-scientific theory with the term Lysenkoism.
This holds true for both Market Fundamentalism (after all Reagan revolution was
"revolution from above" and hired guns from academia just do what powers that be
expected) and, especially, supply side economic. In this sense the
Repulican Party plaiyed the role very similar to the Communist Party of the USSR.
For example supply side economics was too bizarre and would never survive without
explicit government support. This notion is supported by many influential
observers. For example, in the following comment for Krugman article (Was
the Great Depression a monetary phenomenon):
Extreme deregulation and extreme regulation (Brezhnev socialism) logically meets
and both represent a variant of extremely corrupt society that cannot be sustained
for long (using bayonets as in the case of USSR or using reserve currency and increasing
leverage as is the case of the USA). In both cases the societies were economically
and ideologically bankrupt at the end.
Actually, elements of market fundamentalism looks more like religious doctrine
than political philosophy — and that bonds its even closer to Lysenkoism. In both
cases critics were silenced with the help of the state. It is interesting
to note that Reaganomics was wiped into frenzy after the dissolution of the USSR,
the country which gave birth to the term of Lysenkoism. In a way the
last act of the USSR was to stick a knife in the back of the USA. As a side note
I would like to stress that contrary to critics the USSR was more of a neo-feudal
society with elements of slavery under Stalin. Gulag population were essentially
state slaves; paradoxically a somewhat similar status is typical for illegal immigrants
in industrialized countries. From this point of view this category of "state slaves"
is generally more numerous that gulag inmates. Prison population also can be counted
along those lines.
It look like either implicitly or explicitly Reagan's bet was on restoration
of gilded Age with its dominance of financial oligarchy, an attempt to convert the
USA into new Switzerland on the "exorbitant privilege" of dollar status as the global
fiat currency.
Casino Capitalism is characterized by political dominance of FIRE industries
(finance, insurance, and real estate) and diminished role of other and first of
all manufacturing industries. It was also accompanied by the drastic growth
of inequality (New Gilded Age). Its defining feature is "the triumph of
the trader in assets over the long-term producer" in
Martin
Wolf's words.
The other problem with Reagan counter-revolution is that it restored the power
of financial oligarchy typical for Gilded Age. In the influential Atlantic Monthly
article The Quiet
Coup Simon Johnson argues that this power now needs to be broken:
Hyman Minsky argued that a key mechanism that pushes an economy towards a crisis
is the accumulation of debt. He identified 3 types of borrowers that contribute
to the accumulation of insolvent debt: Hedge Borrowers; Speculative Borrowers; and
Ponzi Borrowers. That corresponds to three stages of Casino Capitalism of increasing
fragility:
The instability and volatility of active markets can devalue the economic base
of real lives, or in more macro-scenarios can lead to the collapse of national and
regional economies. In a very interesting and grotesque way it also incorporates
the key element of Brezhnev Socialism in everyday life: huge manipulation of reality
by mass media to the extend that Pravda and the USSR First TV Channel look pretty
objective in comparison with Fox news and Fox controlled newspapers. Complete poisoning
of public discourse and relying on the most ignorant part of the population as the
political base (pretty much reminiscent of how Bolsheviks played "Working Class
Dictatorship" anti-intellectualism card; it can be called "Rednecks Dictatorship").
Over a period of fifteen years (from 1991 till 2007 -- the epoch after collapse
of the USSR) casino capitalism evolved from a financial structure dominated by hedge
financing to Ponzi financing. The shift toward speculative positions occurs
as a logical, objective development because of the way in which success in a boom
enhances expectations. The shift from speculative toward Ponzi finance was
speed up by increased corruption of major players.
Erosion of manufacturing base and the level of dominance of FIRE industries
cluster reached in the USA quite dramatic proportions. For example Chicago
which was a manufacturing center since 1969 lost approximately 400K manufacturing
jobs which were replaced mainly by FIRE-related jobs, In 1995 over 22% of those
employed by FIRE industries (66K people) were working in executive and managerial
positions. Another 17% are in marketing, sales and processional specialty
occupations (computer system analysts, PR specialists, writer and editors).
According to the Center for Responsive Politics, the FIRE sector was and is the
biggest contributor to federal candidates in Washington. Companies cannot give directly,
so they leave it to bundlers to solicit maximum contributions from employees and
families. They might have been brought down to earth this year, but they’ve given
like gods: Goldman Sachs, $4.8 million; Citigroup, $3.7 million; J.P. Morgan Chase
& Co., $3.6 million; Merrill Lynch, $2.3 million; Lehman Brothers, $2.1 million;
Bank of America, $2.1 million. Some think the long-term effect of such contributions
to individual candidates was clear in the roll-call votes for the bailout.
Take the controversial first House vote on bailout of major banks on Sept. 29,
2008. According to CRP, the “ayes” had received 53 percent more contributions from
FIRE since 1989 than those who voted against the bill, which ultimately failed 228
to 205. The 140 House Democrats who voted for the bill got an average of $188,572
in this election cycle, while the 65 Republicans backing it got an average of $185,461
from FIRE—about 23 percent more than the bill’s opponents received. A tinkered bill
was passed four days later, 263 to 171.
The Ponzi scheme stage of the current FIRE development started with the subprime
mortgages scam which served as a catalyst for unfolding of a unprecedented derivatives
mess. The latter was created by systematic deregulation and proliferation
of purely speculative market players as exemplified by hedge funds.
There is no question that Reagan and most of his followers (Greeenspan, Rubin,
Donaldson, Phil Gramm, etc) were rabid radicals blinded by ideology. But they
were radicals of quite different color then FDR. They were close to what can be
called financial terrorists inflicting huge damage to the nation and I wonder if
RICO can be use to prosecute at least some of them.
While the essence of Reagonomics was financial deregulation, the other important
element was restoring the Gilded Age status of financial oligarchy which influence
was mortally wounded by FDR reforms. In this sense we can say that Reagan revolution
was essentially a counter-revolution: an attempt to reverse the New Deal restrictions
on financial sector and restore its dominance in the society. Like NYT times
noted about Phil Gram (The
Reckoning - Phil Gramm, Unswayed Champion of Deregulation - Series - NYTimes.com):
The Number 1 idea ("reduce government spending") was essentially a scam, a smoke
screen designed to attract Rednecks as a powerful voting block. In a way this was
a trick similar to one played by Bolsheviks in Russia with its "worker and peasants
rule" smokescreen which covered brutal dictatorship. In reality all administrations
which preached Reagonomics (including Clinton's) expanded the role of state and
government spending.
It is pretty interesting to see how people carefully filter information
to fit their biases. For example, the key facts about repeal of Glass-Steagall law
are (BTW Joe Biden voted for it):
But you will never find discussion of flaws and adverse consequences Phil Gram
(or Greenspan for a change) initiatives in Heritage Foundation and other right-wing
think tanks publications.
No. 1: Reagan Fires Fed Chairman Volcker and Replaces Him With Greenspan
in 1987:
Here he refers to bad accounting, the failure to address problems with stock
options, and the incentive structures of ratings agencies like Moodys that led them
to give high ratings to toxic assets.
The flawed economic philosophy brought by Reagan, and embraced by so many, brought
us to this day. Ideas have consequences, especially when we stop empirically
testing them. Republican economics have created great pain to America and
harmed our national interest.
The flaw that Greenspan found was always there. Self regulation does not
work. As Stiglitz said:
Yes, for all their claims to science, the premise conflicts with tendencies of
people.
Attempts of theoretical justification of Reaganomics are called voodoo economics.
They fall into two major categories:
But do not blame the pigs; they are expected to act as swine nature dictates.
The fault lies entirely with the farmers, those authorities entrusted by the people
to oversee the farm because they supposedly knew better. While the pigs were rampaging
and tearing the place apart, they were assuring us all that farms function best
when animals are free to do as they please, guided solely by invisible hooves. No
regulation, no oversight, no common sense. Oh yes, and pigs fly..
In other words, the focus from now on should be on adding value by means of work
and savings (capital formation), instead of inflating assets and borrowing.
Furthermore, we should realize that in a world already inhabited by close to
7 billion people and beset by resource depletion and environmental degradation,
defending growth for growth's sake is a losing proposition. The wheels are already
wobbling on the Permagrowth model; pumping harder on the accelerator is not going
to make it go any faster and will likely result in a fatal crash.
Debt, and finance in general, should be left to re-size downwards to a level
that better reflects the carrying capacity of our world. The Fed's current actions
are shortsighted and "conservative" in the worst interpretation of the words: they
are designed to artificially maintain debt at levels that myopically projects growth
as far as the eye can see.
What level of resizing may be necessary? I hope not as much as at Bear Stearns,
which got itself bought by Morgan at buzz-saw prices: $2 per share represents a
98% discount from its $84 book value. What scares me, though, is the
statement by Morgan's CFO, who said the price reflected the risk the firm was
taking, even though he was comfortable with the valuation of assets in Bear's books.
It "...gives us the flexibility and margin of error that's appropriate given the
speed at which the transaction came together", he said.
If it takes a 98% discount and the explicit guarantee of the Fed for a large
portion of assets to buy one of the largest investment banks in the world, where
should all other financial firms be trading at? ....Hello? Anyone? Is that a great
big silence I hear, or the sound of credit imploding into a vacuum?
The Korea Herald
Borlaug provides an opportune moment to reflect on basic values and on our
economic system. Borlaug received the Nobel Peace Prize for his work in
bringing about the "green revolution," which saved hundreds of millions
from hunger and changed the global economic landscape.
Before Borlaug, the world faced the threat of a Malthusian nightmare:
growing populations in the developing world and insufficient food supplies.
Consider the trauma a country like India might have suffered if its population
of a half-billion had remained barely fed as it doubled. Before the green
revolution, Nobel Prize-winning economist Gunnar Myrdal predicted a bleak
future for an Asia mired in poverty. Instead, Asia has become an economic
powerhouse.
Likewise, Africa's welcome new determination to fight the war on hunger
should serve as a living testament to Borlaug. The fact that the green revolution
never came to the world's poorest continent, where agricultural productivity
is just one-third the level in Asia, suggests that there is ample room for
improvement.
The green revolution may, of course, prove to be only a temporary respite.
Soaring food prices before the global financial crisis provided a warning,
as does the slowing rate of growth of agricultural productivity. India's
agriculture sector, for example, has fallen behind the rest of its dynamic
economy, living on borrowed time, as levels of ground water, on which much
of the country depends, fall precipitously.
But Borlaug's death at 95 also is a reminder of how skewed our system
of values has become. When Borlaug received news of the award, at four in
the morning, he was already toiling in the Mexican fields, in his never-ending
quest to improve agricultural productivity. He did it not for some huge
financial compensation, but out of conviction and a passion for his work.
What a contrast between Borlaug and the Wall Street financial wizards
that brought the world to the brink of ruin.
They argued that they had to be richly compensated in order to be motivated.
Without any other compass, the incentive structures they adopted did motivate
them -- not to introduce new products to improve ordinary people' lives
or to help them manage the risks they faced, but to put the global economy
at risk by engaging in short-sighted and greedy behavior.
Their innovations focused on circumventing accounting
and financial regulations designed to ensure transparency, efficiency, and
stability, and to prevent the exploitation of the less informed.
There is also a deeper point in this contrast: our societies tolerate
inequalities because they are viewed to be socially useful; it is the price
we pay for having incentives that motivate people to act in ways that promote
societal well-being. Neoclassical economic theory, which has dominated in
the West for a century, holds that each individual's compensation reflects
his marginal social contribution -- what he adds to society. By doing well,
it is argued, people do good.
But Borlaug and our bankers refute that theory.
If neoclassical theory were correct, Borlaug would have been among the wealthiest
men in the world, while our bankers would have been lining up at soup kitchens.
Of course, there is a grain of truth in neoclassical theory; if there
weren't, it probably wouldn't have survived as long as it has (though bad
ideas often survive in economics remarkably well). Nevertheless, the simplistic
economics of the 18th and 19th centuries, when neoclassical theories arose,
are wholly unsuited to 21st-century economies. In large corporations, it
is often difficult to ascertain the contribution of any individual. Such
corporations are rife with "agency" problems: while decision-makers (CEO's)
are supposed to act on behalf of their shareholders, they have enormous
discretion to advance their own interests -- and they often do.
Bank officers may have walked away with hundreds of millions of dollars,
but everyone else in our society -- shareholders, bondholders, taxpayers,
homeowners, workers -- suffered. Their investors are too often pension funds,
which also face an agency problem, because their executives make decisions
on behalf of others. In such a world, private and social interests often
diverge, as we have seen so dramatically in this crisis.
Does anyone really believe that America's
bank officers suddenly became so much more productive, relative to everyone
else in society, that they deserve the huge compensation
increases they have received in recent years? Does anyone really believe
that America's CEO's are that much more productive than those in other countries,
where compensation is more modest?
Worse, in America stock options became a preferred form of compensation
-- often worth more than an executive's base pay.
Stock options reward executives generously even when shares rise because
of a price bubble -- and even when comparable firms' shares are performing
better. Not surprisingly, stock options create strong incentives for short-sighted
and excessively risky behavior, as well as for "creative accounting," which
executives throughout the economy perfected with off-balance-sheet shenanigans.
The skewed incentives distorted our economy and our society. We confused
means with ends. Our bloated financial sector
grew to the point that in the United States it accounted for more than 40
percent of corporate profits.
But the worst effects were on our human capital, our most precious resource.
Absurdly generous compensation in the financial
sector induced some of our best minds to go into banking.
Who knows how many Borlaugs there might have been among those enticed by
the riches of Wall Street and the City of London? If we lost even one, our
world was made immeasurably poorer.
Joseph E. Stiglitz, a professor at Columbia University and winner
of the 2001 Nobel Memorial Prize, served as chairman of the Commission on
the Measurement of Economic Performance and Social Progress. -- Ed.
(Project Syndicate)
A singular characteristic of an emerging
market heading for deep trouble is a seemingly suicidal tendency to become
overly indebted to foreign creditors. That tendency underlay
the spectacular collapse of the Thai, Indonesian and Korean currencies in
1997. It also led Russia to default on its debt in 1998 and plunged Argentina
into its economic depression in 2001. Yet we too seem to have little difficulty
becoming increasingly indebted to the tune of a few hundred billion dollars
a year. To make matters worse, we do so to countries like China, Russia
and an assortment of Middle Eastern oil producers -- none of which is particularly
well disposed to us.
Like Argentina in its worst moments, we never seem to question whether
it is reasonable to expect foreigners to keep financing our extravagance,
and we forget the bad things that happen to the Argentinas or Hungarys of
the world when foreigners stop financing their excesses. So instead of laying
out a realistic plan for increasing our national savings, we choose not
to face up to the Social Security and Medicare crises that lie ahead,
embarking instead on massive spending programs
that -- whatever their long-run merits might be -- we simply cannot afford.
After experiencing a few emerging-market crises, I get the sense of watching
the same movie over and over. All too often, a tragic part of that movie
is the failure of the countries' policymakers to hear the loud cries of
canaries in the coal mine. Before running up
further outsized budget deficits, should we not heed the markets that now
see a 10 percent probability that the U.S. government will default on its
sovereign debt in the next five years? And should we not be paying close
attention to the Chinese central bank governor's musings that he does not
feel comfortable with the $1 trillion of U.S. government debt that the Chinese
central bank already owns, let alone adding to those holdings?
In the twilight of my career, when I am hopefully wiser than before,
I have come to regret how the IMF and the U.S. Treasury all too often lectured
leaders in emerging markets on how to "get their house in order" -- without
the slightest thought that the United States might fare no better when facing
a major economic crisis. Now, I fear time is running out for our own policymakers
to mend their ways and offer real leadership to extricate the United States
from its worst economic calamity since the 1930s. If we insist on improvising
and not facing our real problems, we might soon lose our status as a country
to be emulated and join the ranks of those nations we have patronized for
so long.
Desmond Lachman, a fellow at the American Enterprise Institute, was
previously chief emerging market strategist at Salomon Smith Barney and
deputy director of the International Monetary Fund's Policy and Review Department.
Econoshmuks ;-) "The scary thing is the level
at which they are wrong: these are all freshman
(ok, sophomore) mistakes"
David K. Levine of Washington University in St. Louis:
"It is a daunting task to bring you [Paul Krugman] up to date on
the developments in economics in the last quarter century. I know that
John Cochrane has tried to educate you about what we've learned about
fiscal stimulae [sic][1] in that period..." and "But the stimulus plan?
How can you be arguing for more? Since we are recovering before most
of the stimulus money has entered the economy--isn't that evidence it
isn't needed? How can you write as if you are proven right in supporting
it?"
John Cochrane of the University of Chicago:
"[That spending can spur the economy] is not part of what anybody
has taught graduate students since the 1960s. They are fairy tales that
have been proved false. It is very comforting in times of stress to
go back to the fairy tales we heard as children but it doesn’t make
them less false..." and "Paul [Krugman's]’s Keynesian economics requires
that people make logically inconsistent plans to consume more, invest
more, and pay more taxes with the same income..."
Robert Lucas of the University of Chicago:
"Christina Romer--here's what I think happened. It's her first day
on the job and somebody says, you've got to come up with a solution
to this--in defense of this fiscal stimulus, which no one told her what
it was going to be, and have it by Monday morning.... [I]t's a very
naked rationalization for policies that were already, you know, decided
on for other reasons..." and "If we do build the bridge by taking tax
money away from somebody else, and using that to pay the bridge builder--the
guys who work on the bridge -- then it's just a wash... there's nothing
to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge
builders, then you've got to apply the same multiplier with a minus
sign to the people you taxed to build the bridge. And then taxing them
later isn't going to help, we know that..."
Edward Prescott of Arizona State University:
"I don't know why Obama said all economists agree on [the need for
a stimulus bill]. They don't. If you go down to the third-tier schools,
yes, but they're not the people advancing the science..." and "the period
of the '20s was one of healthy growth, until Hoover's anti-market, anti-globalization,
anti-immigration, pro- cartelization policies were instituted, brought
this expansion to an end, and created a great depression..."
Eugene Fama of the University of Chicago:
"Sorry, but I’m not familiar with [Hyman] Minsky’s work" and "Haven't
seen it [Paul Krugman's article]. I pay no attention to him..." and
"Government bailouts and stimulus plans seem attractive when there are
idle resources - unemployment. Unfortunately, bailouts and stimulus
plans are not a cure. The problem is simple: bailouts and stimulus plans
are funded by issuing more government debt. (The money must come from
somewhere!) The added debt absorbs savings that would otherwise go to
private investment. In the end, despite the existence of idle resources,
bailouts and stimulus plans do not add to current resources in use.
They just move resources from one use to another..."
Luigi Zingales of the University of Chicago:
"Keynesianism has conquered the hearts and minds of politicians and
ordinary people alike because it provides a theoretical justification
for irresponsible behaviour. Medical science has established that one
or two glasses of wine per day are good for your long-term health, but
no doctor would recommend a recovering alcoholic to follow this prescription.
Unfortunately, Keynesian economists do exactly this. They tell politicians,
who are addicted to spending our money, that government expenditures
are good. And they tell consumers, who are affected by severe spending
problems, that consuming is good, while saving is bad. In medicine,
such behaviour would get you expelled from the medical profession; in
economics, it gives you a job in Washington..." and "Among the 37 Economics
Nobel prize winners in the last 20 years, four received the prize for
their contributions to macroeconomics. None of these could be considered
Keynesian. In fact, it is hard to find academic papers supporting the
idea of a fiscal stimulus..."
Michele Boldrin of Washington University in St. Louis:
"It is a fantasy that the economic profession at large finds the
"stimulus" and the "bank bailout" plans sensible and adequate. Most
economists we know oppose them.... Outside the administration, the convinced
supporters of the plans are a small minority among academic economists
working in those fields. Both plans contradict four decades of research
and are designed to please special interest groups..." and "Is there
a case for borrowing now to finance a stimulus package? People are worried
about the future and are sensibly reducing their spending. Does this
imply the government should step in and do the spending for them? Put
that way, the idea seems like a non-starter..."
In case there is any doubt:
- Paul Krugman is reasonably up-to-date on research in macroeconomics
over the past quarter century (Levine);
- that spending can spur the economy is part of what everyone who
teaches their graduate students about the dot-com boom of the 1990s
or about the housing-led expansion of the 2000s says, and the government's
spending is as good as anyone else's as far as this is concerned (Cochrane);
- Christina Romer played a significant role in the design of the ARRA
(Lucas);
- there is certainly debate over whether "advancing the science" means
what Ed Prescott thinks it means (Prescott);
- Eugene Fama really ought to have paid a little attention to Minsky-Kindleberger
at some point in his career (and really ought to be paying attention
to Krugman now) (Fama);
- Luigi Zingales needs really, really badly to read John Maynard Keynes's
"How to Pay for the War" before he embarrasses himself further (Zingales);
and
- I don't think "working in those fields means what Michele Boldrin
thinks that it means (Boldrin).
And in case there is any doubt:
- the fact that macroeconomic market failures are no longer getting
rapidly worse is not a reason for immediately abandoning all of the
policies to deal with thsoe failures (Levine);
- there is nothing logically inconsistent with models in which aggregate
planned expenditure is different from income, and indeed Milton Friedman's,
Knut Wicksell's, and David Hume's economic models are all of this type
(Cochrane);
- even full Ricardian equivalence does not keep changes in government
purchases from affecting total spending (unless government purchases
are perfect substitutes for private consumption) (Lucas);
- Herbert Hoover was on the right wing of the American political spectrum
and tried as best he could to follow pro-market, pro-globalization,
pro-competition economic policies (Prescott);
- the savings-investment identity is an equilibrium condition, not
a behavioral relationship. Thus it says nothing about how and whether
changes in one form of spending will or will not call forth changes
in the flow of spending as a whole (Fama);
- it is in fact rather easy to find academic papers supporting the
idea of fiscal stimulus under appropriate conditions, if you look (Zingales);
and
- when the prices of private bonds collapse and the prices of government
bonds soar, that is a very powerful market signal that private businesses
should borrow (and spend) less and the government should borrow (and
spend) more (Boldrin).
The scary thing is not that Levine, Cochrane, Lucas, Prescott, Fama,
Zingales, and Boldrin are wrong--people are wrong all the time.
The scary thing is the level at which
they are wrong: these are all freshman
(ok, sophomore) mistakes--yet the seven include two past (and
a year ago I would have said three future Nobel laureates in Economics).
If this doesn't frighten you, you aren't paying attention...
REIJI YOSHIDA Staff writer
Every few years, politicians, bureaucrats and construction
company bigwigs get embroiled in bid-rigging scandals — and the public's
faith in government sinks deeper.
In bid-rigging, or "dango," corporations ostensibly
competing for a government contract ferret out the secret ceiling bid price.
With that knowledge, they conspire to decide which among them will win the
bid. Members of the circle take turns winning, or being "chanpyon" (champions).
The shady practice has a long history, and while it
is most pervasive in the construction industry, other sectors have been
involved as well, including defense contractors. Although company profits
can be reduced by illegally skirting competition, the burden on taxpayers
mounts.
In the latest dango affair, Agriculture, Forestry and
Fisheries Minister Toshikatsu Matsuoka last month committed suicide amid
a burgeoning investigation into suspected bid-rigging involving ministry-backed
corporation Japan Green Resources. Separate bid-rigging scandals led to
the arrest last year of the governor of Wakayama, and the former governors
of Fukushima and Miyazaki.
Following are some basic facts about bid-rigging:
How common is bid-rigging and how much money does it
cost the public?
Experts say bid-rigging occurs in every region of Japan.
It is particularly rampant in construction because of the public's difficulty
monitoring and understanding the cost structure of bids for public contracts.
The Japan Citizen's Ombudsman Association, a corruption
watchdog, estimates local governments might have overpaid up to 1.16 trillion
yen in public work budgets in fiscal 2005 alone due to big-rigging. Throw
in decades of infrastructure-related projects that have drawn bid-rigging
allegations, ranging from airports to subway systems to tunnels and highway
bridges, and the tab the taxpayer has had to foot is incalculable.
Recently, however, heavier fines and more competitive bidding
have apparently led to a decline in dango.
How can bid-rigging be detected?
According to the watchdog organization,
one indication is a winning bid extremely close to the secret ceiling set
by the government for a public contract.
If the winning bid is 95 percent or more of the secret
price ceiling, "there is an extremely strong possibility" it was rigged,
according to a report by the association.
In a study of major works bids across all 47 prefectures
that was conducted in 2002 by the association, the average ratio of winning
prices to government-set price ceilings was 95.3 percent — a damning sign
of widespread corruption.
According to the association, however, recent increased
competition in bidding has pushed prices down, causing the ratio to start
declining in 2003, falling to 91 percent in fiscal 2005. Nagano Prefecture,
which has taken especially robust steps to impose competition, boasted the
lowest rate — 74.8 percent — that year.
What measures are in place against bid-rigging?
Article 96 of the Penal Code stipulates that any party
compromising the fairness of public bids, by force or fraud, must be punished.
Dango can be punished under the Antimonopoly Law, which
prohibits cartels, and the Penal Code, which prohibits bid-rigging and acts
of hindering fair public bidding in general. If public servants are involved,
they can be punished by another law specifically targeting bureaucrats.
The Antimonopoly Law was revised in January 2006 to raise
fines. A construction company can now be fined the equivalent of 10 percent
of the sale it raised through bid-rigging, up from 6 percent before the
revision.
The fines, however, are still criticized as too low and
thus a disincentive to fair play, compared with those in other countries,
prompting a government expert panel to recommend further hikes in its latest
report submitted last month to Chief Cabinet Secretary Yasuhisa Shiozaki.
Are big fish ever caught?
Officials at almost all major constructions firms — including
Kajima Corp., Taisei Corp. and Shimizu Corp. — have been convicted of bid-rigging.
The biggest scandals were in 1993 and 1994, when 32 people
from various companies, including Kajima, and from public offices were arrested
for either giving or receiving bribes in connection with bid-rigging.
Among the disgraced was former Construction Minister Kishiro
Nakamura, who was convicted of accepting a 10 million yen bribe from a vice
president of Kajima Corp. to pressure the Fair Trade Commission not to file
criminal charges against a suspected construction bid-rigging circle in
Saitama Prefecture.
The Ibaraki and Miyagi governors, the mayor of Sendai and
top executives at other leading general contractors were also arrested.
Of the 32, 30 have been convicted. Two former Kajima Corp.
executives are still on trial, while former Ibaraki Gov. Yukio Takeuchi's
trial was dropped after he died in September 2004.
The crackdown is believed to have helped weaken the shady
financial ties between ruling-bloc politicians and construction companies.
What role do various power holders play?
Bureaucrats can exert great influence on the bidding processes,
making government agencies hotbeds of corruption. Some become even greater
sources of corruption by retiring and landing lucrative key positions in
industries they once oversaw. This is known as "amakudari," literally "descent
from heaven."
Most public bids at the central and local governments are
based on the "designation-bid" system, in which construction firms are ranked
by the government based on their technical capabilities and financial condition.
The government or government-affiliated agencies use the
ranking to designate which companies can submit bids and set a specific
limit. The standards of designation, however, are often criticized as opaque
and arbitrary.
Perhaps more problematic is the tendency for corrupt bidders
to build close ties with bureaucrats as a means of learning the secret ceiling
price for public-works projects. Bidders that overshoot that price are disqualified.
Politicians, meanwhile, can exert power over bureaucrats
through appointment of monitors overseeing bidding, prompting bureaucrats
to favor contractors that contribute to their coffers.
How have bureaucrats achieved such such strong control?
In the years just after World War II, bureaucrats were
unrivaled in their ability to estimate costs for large construction projects.
The bidding system was designed to enable them to ensure smooth budgeting
and expedite public projects.
Industry insiders and ministry officials, however, say
that in recent years the government has lost its edge in accurately determining
project costs because it now lags behind the private sector in knowledge
of cost-reducing technological developments.
As a result, budgets often end up inflated, favoring contractors
but costing the public dearly.
The Weekly FYI appears Tuesdays (Wednesday in some areas). Readers are
encouraged to send ideas, questions and opinions to
National
News Desk
August 3, 2009
Satyajit Das, of Traders, Guns & Money
fame, is
keeping tabs on what he calls GFC plot lines, or what one might also
call The Search For The Guilty.
The latest caught in the dragnet is...economists! But Das thinks some of
the books still miss key issues.
From Das:
Just when I had finally worked out that the GFC had been caused by beer
swilling, cocaine snorting, lap dancing club habitues who were irresistible
to the opposite sex, I find I was wrong! It seems that the GFC was the
work of economists who wish that they were beer swilling, cocaine snorting,
lap dancing club habitues irresistible to the opposite sex.This quartet
of books focuses on the political economy of the GFC.
Andrew Gamble, Professor of Politics at Cambridge, in The Spectre at
the Feast (2009; Palgrave MacMillan), provides a succinct overview of
the economic background to the GFC. Gamble traces the shift in economic
thinking and policy from Keynes/ Hayek through to the Friedman/Chicago
School and its impact of the global economy. Gamble also assesses some
of the current policies designed to restore the economy to health. A
lively and eminently readable text provides the reader with a guide
to how the present crisis is merely another chapter in the progression
of the “dismal science” and familiar cycles driven by “animal spirits”.
Restoring Financial Stability: How to Repair a Failed System (2009;
John Wiley) is a collection of readings lightly edited by Viral Acharya
and Matthew Richardson on the GFC. Organised around seven loose themes
(causes; financial institutions; governance; derivatives; role of the
Fed; the bailout; international coordination), the 18 policy papers
of varying quality propose ambitious ‘market based’ solutions to the
problems revealed by recent events.
Fifty years ago, C.P. Snow, in his “Two Cultures” lecture, identified
the divide between literary and scientific intellectuals. Restoring
Financial Stability reveals a similar divide between theoretical economics
and market practitioners. The tired nostrums that are put forward rehash
age-old proposals for more capital, increased transparency and ‘better’
regulation that have failed repeatedly in the past.
Many of the problems in financial markets revealed by the GFC relate
to the detailed plumbing and interconnectedness of financial markets.
Some of the essays show a fundamental lack of understanding of critical
micro-structure issues of how financial markets operate that detract
from the proposed solutions. As Yogi Berra once remarked: “In theory
there is no difference between theory and practice but in practice there
is.”
Richard Khoo’s The Holy Grail of Macroeconomics: Lesson from Japan’s
Great Recession (2009; John Wiley) and the Gary Saxonhouse and Robert
Stern edited Japan’s Lost Decade: Origins, Consequences and Prospects
for Recovery (2004; Blackwell Publishing) provide fascinating insights
into the problems of Japan that, despite protestations from Western
officials, have striking similarities with the GFC. It seems that we
are all in danger of turning Japanese.
Originally published in 2008 and now updated, Khoo argues that there
are two phases in an economy – the “yang” ordinary phase when the private
sector maximises profits and the “yin” post-bubble phase when the private
sector moves to reduce debt and repair balance sheets. Khoo’s interesting
thesis is that conventional economic policy may not work in the yin
phase. This essential insight is crucial in understanding the evolution
of a post-GFC world and the impact of aggressive government policy actions
and their eventual withdrawal.
Japan’s Lost Decade, published earlier, provides a series of short perspectives
on the collapse of equity and real estate markets bubbles and their
relationship to Japan’s persistent economic problems. Both books provide
insights into the effect of price shocks, deflationary pressure and
the failure of policies in Japan that hold important lessons for everybody
in the aftermath of the GFC.
The GFC poses important challenges in our understanding of economic
processes and policy options. The economy may simply be too complex
and unstable to be controlled by simplistic government intervention.
There may be inevitable boom-bust cycles that cannot be easily eliminated,
as a whole generation of economist assumed. As Keynes observed “the
difficulty lies not so much in developing new ideas as in escaping from
old ones”.
Rep. Ron Paul usually stands far outside the mainstream in
Congress, particularly in his campaign to kill the Federal Reserve.
But the Texas Republican now has the bulk of his colleagues
standing alongside him in
a fight against the central bank’s autonomy.
His bill to audit the Fed,
just three pages long, has 274 co-sponsors — every House
Republican and almost 100 Democrats — and counting. “People
are upset,” he says. “People are demanding more transparency
of the Fed, and they’re supporting me on this.”
The longtime Fed critic would prefer an economy without a
central bank, where the market sets interest rates and troubled
firms are left to sink. He blames the Fed for the past century’s
financial bubbles and worries about its ability to monetize
debt to finance government spending, even though Fed officials
insist they’d never allow it.
Mr. Paul sees transparency as a first step in making the
public more aware of the Fed’s ability to electronically print
money to support the banking system. The revelations from an
audit will “expose to the American people exactly how the Federal
Reserve operates,” he says. “Because when they fully understand
how they operate, what they do, how they manipulate monetary
policy and interest rates, they will finally figure out that
it’s the Fed that has caused all the mischief.”
Most of the lawmakers who have signed on as co-sponsors of
the legislation don’t share Mr. Paul’s anti-Fed stance. They
say Congress has an oversight role and needs a full accounting
of how much money the Fed has lent — and to whom.
Some lawmakers signed up as an expression of disapproval
after learning more about the Fed’s decisions to lend money
to firms such as AIG. Many others say greater scrutiny is critical
before any discussion of expanding the Fed’s authority in other
areas, as the Obama administration proposes. “Bringing transparency
and accountability to the Federal Reserve through an audit will
help ensure that tax dollars are not wasted,” said Rep. John
Boehner of Ohio, the House’s top Republican.
Rep. Brad Sherman, a California Democrat, says none of the
Depression-era lawmakers who gave the Fed its power to lend
to nonfinancial institutions “ever thought it would involve
trillions of dollars.” He said the Fed system’s unique structure,
with private officials leading the regional Fed banks, also
needs a review by congressional auditors. “Anyone exercising
governmental power should be subjected to governmental oversight.”
Even lawmakers who are less eager to sign on acknowledge
the momentum. If the Fed gets added responsibilities, “there
wouldn’t be any question in my mind that a bill would be passed,”
said Rep. Paul Kanjorski, a senior Democrat who has not taken
a position on the legislation. “They would have to buy into
much more regular audit control of the Fed.”
Mr. Paul recognizes that his movement to audit the central
bank ultimately may help the Obama administration expand
the Fed’s oversight role in the economy.
“I think what they’ll do is they’ll give in to some of the
transparency at the same time they’ll give them more power,”
Mr. Paul said. “We’re going to be bugging you a lot more. We’re
going to be keeping eyes on you. That might be the way. Maybe
inadvertently I’ll help them get more power at the Fed.”
Isn't this special?:
Cashing
In, Again, on Risky Mortgages, by Peter Goodman, NYTimes:
... ... ...
“Our job was to get the money in and then we’re done,” said Paul Pejman,
a former sales agent... He recounted his experience, he said, because “I
really feel bad.”
“I had people calling me crying, and we were telling them, ‘You can pay
me or you can lose your house,’ ” Mr. Pejman said. “People were giving me
every dime they had, opening credit cards. But I never saw one client come
out of it with a successful loan modification.” ...
FedMod is among dozens of similar companies that have been accused by
state and federal authorities of fraudulent business practices. ... Many
of the companies formerly operated as mortgage brokers... The three original
partners brought in [a lawyer] to gain a crucial asset: his law license.
Having a lawyer in charge enabled them to market their venture as a law
firm and thus collect upfront payments under California rules. ...
Mr. Pejman, 22, ... had worked at three wholesale mortgage brokerages.
Now, a trainer emphasized he was at a law center.
“Our big sales pitch was that an attorney could do a better job with
your loan modification,” Mr. Pejman said. “If you told them these were basically
washed-up people from the mortgage industry, or just people sending in paperwork,
they would say, ‘Well, why bother? I might as well do this myself.’ ” He
went on: “It was misleading to the client. Attorneys never touched those
files.”
Among the 700-plus full-time employees who worked for FedMod this spring,
only nine were lawyers...
Mr. Pejman and his fellow agents urged homeowners to send FedMod $3,495;
the agents were promised a 30 percent commission for fees they took in.
... “They basically told us, ‘Do whatever you need to do,’ ” he said. “
‘It’s a sales floor. You’re here to sell.’ People would quote success rates
and just pull them out of thin air. People would say 60 percent, 80 percent,
90 percent. ...
“I’d hear people say, ‘Would you pay $1,000 to save your home? To save your
marriage? Your kids’ education?’ ” he recalled. “I’d hear people say, ‘Yeah,
we’re the federal government.’ There were a lot of corrupt people working
there.” ...Each case manager was responsible for as many as 200 files at
a time... “You’re paying the sales agent upfront,” ... “So what motivation
does he have to get it closed?” .See, the anti-regulation types are right.
Selected comments
bar exam purgatory says...
We already have the agency, actually we've got several. It's called the
FTC, and they go after these types. We also have 50 state AG's offices.
We don't need a consumer financial protection agency. We have one. FTC ACT
section 5 covers everything these guys do.
At the FTC, the conservatives political forces kept the enforcement down,
not to mention its underfunded, and understaffed. Also finance regs have
their turf carved out. Even better than the CFPA idea, the FTC handles a
wide range of industries. Thus, no industry capture. Give it time and the
CFPA will join the views of Wall Street.
Also, in most states, the attorney's are, by my read, violating the PR
rules. But who knows...
Asia
Times
The world's monetary and fiscal authorities appear by their feckless
policies to have pulled off a feat that I didn't think was possible:
resuscitating a bubble that came close to wrecking
the world economy, and may still do so on a delayed-action basis.
John Allison, chairman of BB&T Group (about the best-run major US regional
bank), spoke on Thursday to the Competitive Enterprise Institute, saying
that apart from a gold standard (which he thought unlikely), the financial
services business and the country in general needed to change its motivations
from short-termism and altruism to enlightened long-term self-interest.
While his altruism/self-interest point is a long-standing one (which to
the extent that it means not making "affordable housing" loans to people
who can't afford housing, I agree with), the long-term/short-term point
is different. It's a product of environment,
not of innately bad philosophies. If a country's government engineers market
conditions that lavishly reward foolish short-termism, foolish short-termism
is what that country will get. Only by changing market structures, rules
and incentives will behavior be changed.
In a well-run financial system, the free market automatically rewards
prudence and punishes short-term greed and folly. That's not the system
the United States has had since at least 1995, and it's certainly not the
system that has been produced by the multiple bailouts and stimulus packages
since last autumn.
... ... ...
...By rewarding incompetence in this way (for example allowing Vikram
Pandit to keep both his job and the $600 million with which Citi purchased
his failing hedge fund), the government has insured that we will get more
of it, since the benefits from the juicy bonuses in good times are so great
and the slaps on the wrist when the structure comes crashing down so painless.
Jeff Skilling of Enron was given a 25-year jail sentence for Enron's failure;
that was grossly disproportionate to his offense but did ensure that future
Enron perpetrators would be discouraged. The fate of Pandit, Ken Lewis of
Bank of America and the AIG honchos offers no such deterrent to incompetent
looting of the financial system.
A further effect of the TARP process has been to cause a number of perfectly
healthy banks to slash their dividends - notably US Bancorp and Allison's
BB&T. Should management of those banks, which have now repaid TARP, fail
to restore their dividend forthwith while engaging in empire-building acquisitions
of battered competitors, the "widows and orphans" who traditionally invest
in bank shares because of their reliable income will be further discouraged,
and shareholder control of banks will be left
still more tightly in the hands of hedge funds and other cowboys.
Finally, we come to monetary and fiscal policy during the crisis.
Monetary policy, which had been far too loose
for the preceding 13 years, bore a large part of the responsibility for
the period's excesses. If the monetary system is managed so that leverage
is perpetually rewarded, it's not surprising that intelligent and aggressive
bankers will devise new and ever more unsound means to create excessive
leverage.
However, monetary policy has been loosened unimaginably further since the
crisis, with the monetary base being more than doubled.
It is very clear that only evidence of rampant
inflation - which we can expect the Bureau of Labor Statistics to suppress
for as long as possible - will cause the Fed to return to an appropriately
tight monetary policy.
Thus the incentives for Wall Street to indulge in endless speculative games
will still be present, complete with the implied taxpayer bailout when it
goes wrong. No wonder Goldman Sachs is thinking
of abandoning its banking license - why dawdle along with only 15-to-1 leverage
when you have tasted the heady joys of 30-to-1 at taxpayer expense.
It's also unsurprising that hedge funds have
enjoyed their best month for nine years - for dodgy short-term
speculators, Happy days are indeed here again!
Asia
Times
It was after the fall last September 15 of Lehman Brothers and the horrifying
stock market declines that ensued that the government of president George
W Bush and Treasury secretary Henry Paulson, then only trying to wheeze
its way out of office, realized that it had to do something to deal with
the financial system's troubles in a systematic fashion. Since bad mortgage
and mortgage-derived debt was the problem, why not just initiate a huge
government program to buy it out of the banks' vaults, cleaning them out
so as to free the banks to conduct new lending?
What was wrong with the plan? In short - everything. A popular grassroots
resistance movement grew up overnight by people opposed to giving "our tax
dollars" to greedy New York bankers. This smashed something of the begrudging
bipartisan consensus in favor of the proposal; it wasn't until early October
that the TARP bill passed, on its second attempt, through the US House of
Representatives.
But then Paulson, having stuck his finger into the air to gauge the political
winds and finding his digit nearly cut off, changed his mind. With TARP
so unpopular, it became obvious that both pundits and politicians were desperately
searching for any type of financial system support initiative that did not
include the government's purchase of toxic assets. When, in mid-October,
British Chancellor of the Exchequer Alistair Darling came up with one, namely,
for his government to take ownership stakes in tottering private banks through
the purchase of stock in them, and when Nobel economics laureate and New
York Times columnist Paul Krugman wholeheartedly backed the measure, the
writing was on the wall for toxic asset disposals.
Paulson announced a short-term delay for toxic asset sales in October, then
a longer-term delay (that is, until after the inauguration of Barack Obama,
the only timeframe that anybody in the Bush administration then cared about)
in November.
The equity injection initiative involved the immediate usage of $250 billion
of TARP's $700 billion for the purpose of the government purchasing the
preferred stock and common stock warrants, similar to long-term call options,
of the banks in question. Over the previous six months, the world had watched
modern-day electronic mobs initiate bank runs that toppled at least two
major US financial institutions - Bear Stearns and Lehman Brothers, so the
government had no intention of painting a big red "I'm weak! Shoot me!"
bull's eye on any potential number three.
The banks would be forced to sell the preferreds and take the government's
money, which was generally thought to be intended for new lending. Also,
in a mostly failed attempt to at least drum up some sort of popular support
for the program, salary and income caps would be placed on the executives
of institutions receiving the largesse. If the Paulson Treasury, which by
then unofficially included future Obama Treasury Secretary Timothy Geithner,
had been sufficiently outside of the American financial elite's governing
superstructure so as to be able to see it in its full entirety, it would
have seen that this, the pay caps, would eventually doom the TARP with more
certainty than any initiative to run sumo wrestlers as jockeys in the Kentucky
Derby.
As the Bush administration panted out of office and the full force of crisis
hit the new Obama administration like an open furnace door, bhe Bush administration
announced that funds from the program would be used to give emergency financial
support to General Motors and Chrysler. Early in its time, the Obama administration
announced that, although it didn't know just how it was going to do so just
yet, when it finally did come around to addressing the toxic bank assets
issue, TARP monies would be involved, as they would with the new administration's
initiative to provide mortgage relief to US homeowners threatened with foreclosure.
Of course, using the TARP as a sort of all-purpose
financial crisis Swiss army knife was nothing but a technique of bypassing
any role in the matter by the US Congress, now obviously too hopelessly
rent by extreme partisanship to do anything constructive on these issues.
By any measure, the TARP was providing capital to the banks on extremely
generous terms; the only cost was a 5% dividend coupon payable to the government
on the preferreds, and the warrants that would allow the government to pick
up equity, stock, in the banks should the stock start to rise. Last October,
these were very generous terms indeed, as those were the days that only
while wearing a hazmat suit would anybody deal with an institution operating
in the financial markets without an explicit government guarantee.
But as late winter ticked towards spring, the appreciation for the emergency
assistance turned into something more akin to "Well, what have you done
for me lately?" begrudgement, even though it was still obvious that many
of the institutions, especially the large ones, would collapse should the
government withdraw its explicit and implicit promises of support.
More executive pay restrictions on those institutions receiving TARP funds
were implemented in late January and early February that, along with the
crucifixes bearing AIG officials that Congress put along the Acela train
route from Wall Street to Capitol Hill, put the Masters of the Universe
well in the mood to make a meal out of the hand that was feeding it.
The only way that the banks could get out of the TARP pay restrictions was
to give the money back, and also to come to an agreement valuing the warrants
the banks had to buy back from the government. This would certainly be a
challenge, as back then the markets hardly believed that bank balance sheets
would support gum purchases from the newsstands in the lobby, let alone
a good portion of the $250 billion the banks received in TARP.
Still, the banks wanted to be out from under the government's thumb immediately
if not sooner; they were in no mood to wait for some manner of economic
recovery that would inflate their balance sheets and fill their vaults.
In short, the banks had to fool the markets into believing that the banks
were a lot stronger than they seemed.
As Charles Baudelaire once said, "Speak of the
devil, and the devil appears." Suddenly, mark-to-model bank asset accounting
was added to the Newspeak financial dictionary, and mark-to-market cast
out to the dustbin of history.
I've written before about how many free-market conservatives, believing
that nothing so wrong as what we see in the present could possibly go wrong
with their visions of endless laissez-faire paradises, chose instead to
blame it all on an obscure accounting rule called "mark-to-market", contained
in an industry document called FAS 157. The Obama administration had no
cause to support free market fantasies, but, after everything else they
were trying along the lines of bank rescue were either not getting off the
ground or dying still-born, they realized that repealing mark-to-market
in favor of letting the banks use computer models that produced current
values to their liking was just about the easiest, cheapest thing they could
do, at least in the short term. (See
Bankers get a model rush, Asia Times Online, April 9, 2009).
Then, since the prospect and actual implementation of mark-to-model had
done so much to support bank share prices during the late winter and early
spring, the Obama administration decided to go for the gusto once more.
They allowed the new, flexible accounting standards to be used in the so
called bank "stress tests" being given to see if the banks and other financial
institutions had sufficient capital for ongoing and forward operations.
Voila! By being able to report mortgage loan and mortgage loan derivative
values at levels far in excess of what they would receive in the actual,
traded markets, the "stress tests" came in far more favorable for the banks
than previously expected. (See
Oh, impotent Washington!, Asia Times Online, May 14, 2009.)
... ... ...
Therefore, with the TARP's function now degraded to be nothing much more
than an income support operation for banking CEOs, it can hardly be surprising
that the original function of the program, buying up toxic mortgage assets,
is once again falling by the wayside. Recent reports have it that Geithner's
Public Private Initiative Program (PPIP), designed to use leveraged TARP
money to deal with the toxic assets problem, is on hold; the banks are,
if anything, using their questionable mark-to-model valuations to demand
even higher prices for the still, in reality, depreciating assets. "After
all", Mr Bank Bigshot must be thinking, "If you're gonna pay me like it's
2007, my assets must be worth what they were in 2007."
The Economist magazine places these events within the context of something
it calls "TARP revisionism". This is the new spin the bankers are weaving
- that they were just sitting quietly and productively in their office when
WHAM! - the government forced them to take all this money they really didn't
want.
Like the fictions produced by the Ministry of
Truth in George Orwell's 1984, these lies
serve myriad purposes. It sends down the memory hole the real experience
of last September, with the entire banking system perhaps just hours away
from extinction due to the bankers' mendacities, in favor of fibs much more
to the industry's liking, with, strong, determined, Ayn Rand-type banking/capitalist
avatars steering through the rough seas of commerce, while shallow government
guttersnipes forever blocked their path.
This, it is hoped, will forestall what the bankers really fear - the introduction
of new banking and financial system regulations designed to prevent what
the industry most wants, another gloriously irrational but wildly popular
and profitable financial bubble. With the very real possibility that the
Obama administration may simply run out of political time before its dream
of an economic recovery based not on more financial leverage but on investments
in infrastructure and green energy can be realized, the banking oligarchs
may very well get their wish. As the oligarchs always do. It's a rare week
that the people only suffer one shellacking from the elite, and last week
was not a rare week.
Ben Stein
Conservatives have steadfastly blocked any attempt to hold accountable
Wall Street's major investment banks and blue-chip brokerage houses for
corrupt market practices. They ignore the evidence that these firms have
repeatedly abused the trust of investors by deceiving them about the value
of investments and placing their own profits above the interests of investors
(think Drexel- Milliken junk bond scam; Savings-and-Loan debacle; tech-stock
bubble of the 1990s; today’s subprime disaster).
Ben Stein says Wall Street corruption threatens free-market capitalism
itself:
Without trust, there can be no free-market capitalism. [Fiduciary duty]
standards of care required that those handling someone else's money
behave with extreme rigor and honesty. Trustees always had to behave
with the interests of the trustor [investor] uppermost. In the United
States, the trustee had to disclose every fact or belief that might
influence an intelligent, reasonable investor. But by the 1980s, the
laws of fiduciary duty started to break down in a major way. Basically,
a crossroads was passed in the Drexel-Millikan scandals. Although hundreds
and perhaps thousands of men and women were profiting from misconduct,
only a few went to prison. Today, in the midst of the mortgage mess,
we see people breaching their fiduciary duty and getting away with it,
while the ordinary stockholders are pauperized because of the losses.
We surely cannot remain a republic under law if there is no law except
the axiom from Richard II that "they well deserve to have, that know
the strong'st and surest way to get."
Free Market is a misnomer.
John Lee said,
It's a regulated market, and without regulations, there can be no trust.
It's just a market
lucidity said,
That bugs me too -- liberals using the term "the free market." It's just
"a market," and there's nothing inherently free about it. Conservatives
are the ones who want it to be free, in the sense of completely unregulated.
Every time a Dem talks about "the free market" I want to slap them.
March 18, 2009 | The New Republic
We're going to need a bigger Federal Register.
As the United States faces its biggest economic crisis since the Great
Depression, Barack Obama and his team have been looking to Franklin Delano
Roosevelt for help. The influence so far is obvious: The stimulus measure
passed by Congress in February includes money for building infrastructure,
strengthening unemployment insurance, and helping state governments--all
reminiscent of FDR's New Deal.
It is now necessary for Obama to take the model one step further. In
addition to spending, there was a less visible but equally important element
of FDR's program: stringent financial regulation to drive what the president
called "unscrupulous money-changers" from the temple. While Obama recently
spelled out some admirable principles on that score, there are still obstacles
to success. His pick to head the Securities and Exchange Commission (SEC),
Mary Schapiro, is far better qualified than her Bush-appointed predecessor.
But she seems less formidable than any of FDR's first three SEC chairmen:
Joe Kennedy, whose stellar performance laid the foundation for the Kennedy
political dynasty; Jim Landis, the chief draftsman of the major securities
laws (and later dean of Harvard Law School); and William O. Douglas, who
went from the SEC to become the longest-serving Supreme Court Justice in
the nation's history. What's more, Obama will face stiff opposition from
a political party that has depended very heavily on contributions from the
industries he needs to regulate.
Putting money into people's pockets and into institutions is politically
easy and economically sensible. But, if we don't reinvigorate regulation
as well, the credit system will remain sick, banks won't fully recover,
and investors and borrowers will keep on believing--correctly--that they've
been hoodwinked and fleeced. Only a thorough repair of the agencies that
handle securities and banking regulation--a repair FDR's model can help
us achieve--can prevent new crises down the road. Without this reform, other
shady financial practices will emerge, just as they've done throughout history,
and the money poured into stimulus will have been wasted.
Like Obama, FDR inherited his economic problems. The
1920s were prosperous but were also wild and free-wheeling, a time when
dubious mergers and rickety holding companies multiplied. The stock market,
almost wholly unregulated, soared to record levels, and a self-satisfied
Herbert Hoover predicted that "poverty will be banished from this Nation."
Then came the Great Crash, and, by 1933, the task confronting the New Deal
could hardly have been more daunting: The Dow Jones hovered in the fifties,
down from a high of 381 in 1929. Issues of new corporate stocks and bonds
totaled only $161 million for the entire year 1933, a decline of 98 percent
from 1929. Unemployment stood at 25 percent.
In this state of emergency, the New Dealers
quickly set out not only to stimulate the economy but also to create an
effective regulatory system. Their goal, above all, was transparency,
which FDR understood as the key to restoring consumer and investor confidence.
Without that confidence, consumers would keep their money out of banks and,
as FDR put it, "under the mattress." Investors, too, would refuse to buy
stocks and bonds to finance business expansion. So FDR called for a Banking
Act to assure depositors that their money would be safe, and securities
legislation that, in his words, "adds to the ancient rule caveat emptor
the further doctrine, 'let the seller also beware.'"
Sellers who did not beware could end up in jail.
Both the Banking Act and the Securities Act were passed during the New
Deal's first hundred days in 1933. The Banking Act, known as "Glass-Steagall,"
created the Federal Deposit Insurance Corporation (FDIC), which protected
bank deposits and, almost by itself, stopped the epidemic of bank runs.
Glass-Steagall also forced the separation of commercial banking from investment
banking, thereby reducing bankers' ability to
speculate with "other people's money," as FDR called it, quoting Louis Brandeis.
The Securities Act compelled all companies issuing new stocks or bonds
to disclose hitherto secret information: their balance sheets and income
statements, the pay and perquisites of their top managers, and reams of
other data. This was a radical move toward transparency, the more so because
the act required that all reports be certified for accuracy by independent
public accountants. Next came the crucial Securities Exchange Act of 1934,
which extended these same requirements to every company whose shares were
already being traded on exchanges--essentially the several thousand most
important firms in the country. The 1934 act also created the SEC to enforce
the new laws and to regulate the New York Stock Exchange and all other exchanges.
Drafted with meticulous care, the Securities
Act and Securities Exchange Act thrust the affairs of corporate America
into the sunshine for the first time in the nation's history. The strategy
of transparency was now firmly in place.
Four years later, Congress also brought under SEC control the "over-the-counter
market"--that is, trading not done through an exchange. This informal operation
had been run by thousands of brokers and dealers, many of them swindlers.
Under SEC sponsorship, the industry created the National Association of
Securities Dealers (NASD, which set up its own effective regulatory branch
and, later, the nasdaq exchange). With all this legislation, administered
by the elite civil servants who enforced it, the New Deal created the finest
system of financial regulation in the world's history.
The obstacles to change, however, had been substantial. The new laws
were very technical, and Wall Street and most other players fought regulation
every step of the way. The easiest opponents to bring into cooperation were
the accountants, whom the SEC courted aggressively. At first, accountants
were terrified by the new legislation, which imposed criminal penalties
for misrepresentation of "material fact" not only by corporations submitting
reports but also by accountants who certified their accuracy. Historically,
accountants had been cowed by corporate executives into shading their numbers
according to the executives' wishes. The SEC pointed out that the new laws
gave the profession its first chance to achieve real independence, and accountants
embraced the opportunity with great enthusiasm.
The New Deal's conquest of the accounting profession and the over-the-counter
market was far easier than its victory over Wall Street, investment banks,
and exchange-traded corporations. For both the Stock Exchange and the big
investment banks, opacity was the tradition:
Their money and power came from their virtual monopoly on information about
companies' operations. If the monopoly on information were
broken, then individual investors--and, later, mutual funds, pension funds,
charitable trusts, and university endowments--could make their own informed
judgments about securities, and the expensive advice of investment bankers
would be less necessary.
After three years of struggle, the SEC finally won this fight in 1937,
with the help of a major scandal. Richard Whitney, an aristocratic pillar
of Wall Street and the former president of the New York Stock Exchange,
was found to have embezzled millions of dollars from his clients to cover
losses from his own speculations. In a matter of weeks, he was sent to Sing
Sing prison. With Whitney's disgrace, as SEC Chairman Douglas put it, "the
Stock Exchange was delivered into my hands." The revolution in financial
regulation was now complete.
Over the next four decades, the SEC built a reputation as the most effective
of all federal regulatory agencies. It was respected and feared by nearly
everyone involved in the trading of stocks and bonds, the issuance of new
securities, and the governance of corporations. Even the Reagan transition
team reported in December 1980 that "the SEC, with its 1981 requested budget
of $77. 2 million, its 2,105 employees and its deserved reputation for integrity
and efficiency, appears to be a model government agency."
But no revolution lasts forever.
Starting in the 1970s, the New Deal's regulatory
triumphs were systematically undermined. As a result, we
have witnessed one scandal after another: Michael Milken's junk-bond operations;
the savings-and-loan fiasco of the 1980s; the collapse of Long Term Capital
Management in 1998; the failure in 2001 of Enron, whose house of cards not
even its own lawyers and accountants could understand; the uncontrolled
growth of the real-estate bubble; the invention of ever more complex derivatives--sliced
and diced mortgage securities, collateralized debt obligations, credit-default
swaps; the Bernard Madoff affair; and, finally, the meltdown of the whole
financial system in 2008.
Many elements were responsible for the backsliding
that led to these scandals, not least the Republican Party.
The decline of regulation began in earnest with Ronald Reagan's inaugural
address, in which he famously noted that "government is not the solution
to our problem; government is the problem." Guided by excessive faith in
"the free market," regulators in the SEC, the Fed, the nasd (which merged
in 2007 with the regulatory arm of the New York Stock Exchange to form the
Financial Institution Regulatory Authority), and other
agencies had simply stopped doing their jobs.
Even during the Clinton administration, the craze for deregulation had so
worked itself into the national culture that Congress blocked major accounting
reforms pertaining to stock options, and, in 1999, Clinton's financial advisers
supported the very ill-advised repeal of Glass-Steagall. Worse, in 2000
they accepted the catastrophic exemption of credit-default swaps from any
regulatory oversight at all. By the time George W. Bush became president
in 2001, the SEC's strategy of transparency had been thoroughly undermined.
The return of opacity was in full swing. The elements of a perfect storm
were in place, and, by 2007, Bush's policies had brought them all together
for the explosion of 2008.
While all this deregulation was going on, the financial services industry
had found even more new ways to circumvent transparency. An unregulated
shadow banking system arose, through hedge funds, private-equity funds,
off-balance-sheet operations, offshore tax havens, and the widespread trading
by money managers in completely opaque instruments, especially credit default
swaps. Because of the enormous profit potential in these securities, the
movement of vast sums from the regulated sunshine to the unregulated shadows
became inevitable.
Today, banks and other institutions have a very uncertain idea of what
their holdings of the new instruments are actually worth. Therefore, they
cannot accurately calculate their own assets and liabilities, let alone
those of others. This is why they are so reluctant to lend, and why the
nation's credit system remains in gridlock despite the $700 billion bailout.
Opacity has thus turned inward upon the very institutions that created it,
which would be an ironic farce if its consequences weren't so tragic.
Obviously, there is much work to be done. The SEC still
has an acceptable structure, but it needs robust infusions of talent, expertise,
and money. The staffs of both the Fed and its twelve regional banks are
far more sophisticated now than they were during the 1930s, and the fdic
is working well under Sheila Bair, one of the few people who began warning
years ago of potential catastrophe. But banking regulation remains extremely
fragmented, with far too many players: the Fed, the fdic, the Comptroller
of the Currency (a part of the Treasury Department), dozens of state banking
commissions, and still other agencies. They are in desperate need of better
coordination and, possibly, consolidation. What's more, the regulatory talent
emblematic of the New Deal is not gone altogether, but it is thinner to
the point of anorexia. After years of ideological hiring, large clusters
of ineptitude bedevil the SEC, the Commodity Futures Trading Commission,
the Department of Justice, and many other federal bodies. Nearly every important
agency has long been starved of resources--and even of the elementary belief
that regulation is necessary.
The political opposition to reform will be stiff.
The Republican Party will likely fight every
step of the way. So will the financial services industry,
some of whose stalwarts are Democrats. Even now, Wall Street remains in
deep denial: The lavishing of billions in executive bonuses by firms that
received federal bailout money is all we need to know about this industry's
feral determination to protect its outrageous pay scales.
Fiscal stimulus is the first priority now, but only with reinvigorated
regulation can the economy operate effectively over the long term. Capitalism
depends on credit, credit depends on transparency, and transparency depends
on illumination. It's that simple. If the new administration can accomplish
what the New Deal did in bringing finance into the bright light, it will
be one of Barack Obama's greatest legacies, just as it is one of FDR's.
Thomas K. McCraw is a Pulitzer Prize-winning historian and the author
of Prophet of Innovation: Joseph Schumpeter and Creative Destruction.
Selected Comments
Posted by toritto
5 of 12 |
warn tnr | respond
Once upon a time (maybe 25-30) years ago there were lots of strong, well
capitalized commercial banks. They were highly regulated and rarely failed.
They had low leverage (by today's standards) of maybe 9 or 10X. A well performing
bank earned 1%+ on total assets and 10%+ on equity. They loaned out perhaps
80% of their deposit base to local or regional customers. They rarely funded
themselves with "hot" money. They paid solid if uninspiring dividends to
the little old ladies and local businessmen who owned their stock. There
were thousands of these banks from the largest cities to the most rural
area. They operated in virtually protected franchises as hostile take-over,
or virtually any take-over for that matter that didn't involve a failing
bank was not an option. Banking regulators simply wouldn't allow it. Branching
was severely restricted by state statues, protecting smaller banks from
intense competition from major metropolitan area banks. There was plenty
of credit available and plenty of banks from which to choose. Banks developed
their own specialities in order to effectively compete.
Bank of Boston had vast trading contacts in Latin America. Irving Trust
was the largest commercial factor in America. Morgan Guaranty was the premier
corporate bank. Citi was NYC's largest retail bank. Regional banks dominated
their geographic areas as branching restrictions kept others away. North
Carolina allowed state-wide banking which nurtured NCNB, First Union and
Wachovia.
The largest commercial bank failure during that period was Continental
Illinois of Chicago. Illinois was a "unit" bank state - no branches were
allowed. Continental Illinois was housed in one building in downtown Chicago.
As a result of the Illinois branch restrictions, Continental had a relatively
small retail deposit base. It funded itself each day in the overnight markets.
It was a risky strategy. When it ran into credit difficulties its sources
of funding dried up. It was seized by the FDIC and liquidated. The last
real estate crisis brought down a few banks - Republic of Dallas, Texas
Commerce - but nothing that would threaten the stability of the banking
system as a whole. The system worked fine even if it could be criticized
as dowdy. Banking was not the most exciting profession to be in.
Then came deregulation. Branching and nation-wide banking came into existence.
With it came the hostile take-over. Glass-Steagle was revoked. Suddenly
there was money to be made in bank stocks.. It all began when Bank of New
York put a take-over offer in front of the Board of Irving Trust. Irving
rejected th offer. BONY sweetened it. It was rejected again. Irving was
counting of the Fed and regulators to do what they had always done - reject
hostile takeovers. But the wind of change was in the air. Wall Street smelled
defeat for Irving.
After battling BONY for a year Irving lost in court and the Regulators
gave approval. The rout was on. Chairman Rice of Irving Trust caved the
day after losing in Court and Irving was acquired. Rice immediately retired.
Thus was set in motion the creation of the banking system we have today.
Plenty of money was made by Wall Street, bank stockholders and insiders
holding shares and options, including me. The major regional banks were
acquired and disappeared along with thousands of jobs. "Growth, growth,
growth!" was the mantra. "Marketing" rather than credit worthiness became
the norm as loans were marketed as if selling soap.
Credit insurance from AIG made it possible to shovel billions of dollars
into mortgage assets without worrying about the loans themselves - after
all, they were insured by AIG and carried a Moody's/S & P investment grade
ratings. Trading rooms expanded from foreign exchange and interest rate
swaps to betting on credit derivatives - mark to market transactions which
today can't be valued and are off balance sheet. Within all of the major
banks in trouble today there were those who had serious doubts about how
business was being conducted. "Nay-sayers". "Old fashioned". "Not up to
date". They were ignored. There was no money in their Cassandra prognostications;
not for "business development officers", executive management or shareholders.
What was the matter with the old system? Not much. Deregulation, the revocation
of Glass-Steagle and the cowboy mentality of growth brought us to where
we are. Unfortunately, the banking system somehow needs to be rescued. It
is more than the system deserves.
"Hired" = "Bought". Levitt was up for some regulatory posts, and when
he was the head of the SEC, exhibited a bit of backbone, enough so that
he got perilously few board seats when he stepped down.
OK, I admit it: I missed seeing it the first time around. Regardless, as
I was doing my usual search-and-sift for information and insights on the
current crisis, I came across an interesting document, published in March
by the Consumer Education Foundation, a California-based non-profit, non-partisan
consumer research, education and advocacy organization.Entitled
"Sold Out:
How Wall Street and Washington Betrayed America," the 231-page report
makes the case that the current mess is the direct result of bad behavior
on Wall Street and the corrupt connection between the powerful moneyed interests
and those who make policy in Washington (and elsewhere).
Although I think there is a much more to it than that -- as I've noted
in Financial Armageddon, many people played a role in getting us
to this point, including ordinary Americans -- and that there are plenty
of honest, hard-working people on Wall Street (and maybe even in our nation's
capital), the argument certainly has merit.
Below is the report's "Executive Summary":
Blame Wall Street for the current financial crisis. Investment banks,
hedge funds and commercial banks made reckless bets using borrowed money.
They created and trafficked in exotic investment vehicles that even
top Wall Street executives—not to mention firm directors—did not understand.
They hid risky investments in off balance- sheet vehicles or capitalized
on their legal status to cloak investments altogether.
They engaged in unconscionable predatory lending that offered huge
profits for a time, but led to dire consequences when the loans proved
unpayable. And they created, maintained and justified a housing bubble,
the bursting of which has thrown the United States and the world into
a deep recession, resulted in a foreclosure epidemic ripping apart communities
across the country.
But while Wall Street is culpable for the financial crisis and global
recession, others do share responsibility. For the last three decades,
financial regulators, Congress and the executive branch have steadily
eroded the regulatory system that restrained the financial sector from
acting on its own worst tendencies.
The post-Depression regulatory system aimed to force disclosure of
publicly relevant financial information; established limits on the use
of leverage; drew bright lines between different kinds of financial
activity and protected regulated commercial banking from investment
bank-style risk taking; enforced meaningful limits on economic concentration,
especially in the banking sector; provided meaningful consumer protections
(including restrictions on usurious interest rates); and contained the
financial sector so that it remained subordinate to the real economy.
This hodge-podge regulatory system was, of course, highly imperfect,
including because it too often failed to deliver on its promises.
But it was not its imperfections that led to the erosion and collapse
of that regulatory system. It was a concerted effort by Wall Street,
steadily gaining momentum until it reached fever pitch in the late 1990s
and continued right through the first half of 2008. Even now, Wall Street
continues to defend many of its worst practices. Though it bows to the
political reality that new regulation is coming, it aims to reduce the
scope and importance of that regulation and, if possible, use the guise
of regulation to further remove public controls over its operations.
This report has one overriding message: financial deregulation led
directly to the financial meltdown.
It also has two other, top-tier messages.
First, the details matter. The report documents a dozen specific
deregulatory steps (including failures to regulate and failures to enforce
existing regulations) that enabled Wall Street to crash the financial
system.
Second, Wall Street didn’t obtain these regulatory abeyances based
on the force of its arguments. At every step, critics warned of the
dangers of further deregulation. Their evidence-based claims could not
offset the political and economic muscle of Wall Street. The financial
sector showered campaign contributions on politicians from both parties,
invested heavily in a legion of lobbyists, paid academics and think
tanks to justify their preferred policy positions, and cultivated a
pliant media—especially a cheerleading business media complex.
Part I of this report presents 12 Deregulatory Steps to Financial
Meltdown. For each deregulatory move, we aim to explain the deregulatory
action taken (or regulatory move avoided), its consequence, and the
process by which big financial firms and their political allies maneuvered
to achieve their deregulatory objective.
In Part II, we present data on financial firms’ campaign contributions
and disclosed lobbying investments. The aggregate data are startling:
The financial sector invested more than $5.1 billion in political influence
purchasing over the last decade.
The entire financial sector (finance, insurance, real estate) drowned
political candidates in campaign contributions over the past decade,
spending more than $1.7 billion in federal elections from 1998-2008.
Primarily reflecting the balance of power over the decade, about
55 percent went to Republicans and 45 percent to Democrats.
Democrats took just more than half of the financial sector’s 2008
election cycle contributions.
The industry spent even more—topping $3.4 billion—on officially registered
lobbying of federal officials during the same period.
During the period 1998-2008: • Accounting firms spent $81 million
on campaign contributions and $122 million on lobbying; • Commercial
banks spent more than $155 million on campaign contributions, while
investing nearly $383 million in officially registered lobbying; • Insurance
companies donated more than $220 million and spent more than $1.1 billion
on lobbying; • Securities firms invested nearly $513 million in campaign
contributions, and an additional $600 million in lobbying.
All this money went to hire legions of lobbyists. The financial sector
employed 2,996 lobbyists in 2007. Financial firms employed an extraordinary
number of former government officials as lobbyists. This report finds
142 of the lobbyists employed by the financial sector from 1998- 2008
were previously high-ranking officials or employees in the Executive
Branch or Congress.
* * *
These are the 12 Deregulatory Steps to Financial Meltdown:
1. Repeal of the Glass-Steagall Act and the Rise of the Culture
of Recklessness
The Financial Services Modernization Act of 1999 formally repealed
the Glass-Steagall Act of 1933 (also known as the Banking Act of 1933)
and related laws, which prohibited commercial banks from offering investment
banking and insurance services. In a form of corporate civil disobedience,
Citibank and insurance giant Travelers Group merged in 1998—a move that
was illegal at the time, but for which they were given a two-year forbearance—on
the assumption that they would be able to force a change in the relevant
law at a future date. They did. The 1999 repeal of Glass-Steagall helped
create the conditions in which banks invested monies from checking and
savings accounts into creative financial instruments such as mortgage-backed
securities and credit default swaps, investment gambles that rocked
the financial markets in 2008.
2. Hiding Liabilities: Off-Balance Sheet Accounting
Holding assets off the balance sheet generally allows companies to
exclude “toxic” or money-losing assets from financial disclosures to
investors in order to make the company appear more valuable than it
is.
Banks used off-balance sheet operations—special purpose entities
(SPEs), or special purpose vehicles (SPVs)—to hold securitized mortgages.
Because the securitized mortgages were held by an off-balance sheet
entity, however, the banks did not have to hold capital reserves as
against the risk of default—thus leaving them so vulnerable.
Off-balance sheet operations are permitted by Financial Accounting
Standards Board rules installed at the urging of big banks.
The Securities Industry and Financial Markets Association and the
American Securitization Forum are among the lobby interests now blocking
efforts to get this rule reformed.
3. The Executive Branch Rejects Financial Derivative Regulation
Financial derivatives are unregulated. By all accounts this has been
a disaster, as Warren Buffet’s warning that they represent “weapons
of mass financial destruction” has proven prescient. Financial derivatives
have amplified the financial crisis far beyond the unavoidable troubles
connected to the popping of the housing bubble.
The Commodity Futures Trading Commission (CFTC) has jurisdiction
over futures, options and other derivatives connected to commodities.
During the Clinton administration, the CFTC sought to exert regulatory
control over financial derivatives.
The agency was quashed by opposition from Treasury Secretary Robert
Rubin and, above all, Fed Chair Alan Greenspan. They challenged the
agency’s jurisdictional authority; and insisted that CFTC regulation
might imperil existing financial activity that was already at considerable
scale (though nowhere near present levels). Then-Deputy Treasury Secretary
Lawrence Summers told Congress that CFTC proposals “cas[t] a shadow
of regulatory uncertainty over an otherwise thriving market.”
4. Congress Blocks Financial Derivative Regulation
The deregulation—or non-regulation—of financial derivatives was sealed
in 2000, with the Commodities Futures Modernization Act (CFMA), passage
of which was engineered by then-Senator Phil Gramm, R-Texas.
The Commodities Futures Modernization Act exempts financial derivatives,
including credit default swaps, from regulation and helped create the
current financial crisis.
5. The SEC’s Voluntary Regulation Regime for Investment Banks
In 1975, the SEC’s trading and markets division promulgated a rule
requiring investment banks to maintain a debt-to-net-capital ratio of
less than 12 to 1. It forbid trading in securities if the ratio reached
or exceeded 12 to 1, so most companies maintained a ratio far below
it. In 2004, however, the SEC succumbed to a push from the big investment
banks—led by Goldman Sachs, and its then-chair, Henry Paulson—and authorized
investment banks to develop their own net capital requirements in accordance
with standards published by the Basel Committee on Banking Supervision.
This essentially involved complicated mathematical formulas that imposed
no real limits, and was voluntarily administered. With this new freedom,
investment banks pushed borrowing ratios to as high as 40 to 1, as in
the case of Merrill Lynch. This super-leverage not only made the investment
banks more vulnerable when the housing bubble popped, it enabled the
banks to create a more tangled mess of derivative investments—so that
their individual failures, or the potential of failure, became systemic
crises. Former SEC Chair Chris Cox has acknowledged that the voluntary
regulation was a complete failure.
6. Bank Self-Regulation Goes Global: Preparing to Repeat
the Meltdown?
In 1988, global bank regulators adopted a set of rules known as Basel
I, to impose a minimum global standard of capital adequacy for banks.
Complicated financial maneuvering made it hard to determine compliance,
however, which led to negotiations over a new set of regulations. Basel
II, heavily influenced by the banks themselves, establishes varying
capital reserve requirements, based on subjective factors of agency
ratings and the banks’ own internal risk-assessment models. The SEC
experience with Basel II principles illustrates their fatal flaws. Commercial
banks in the United States are supposed to be compliant with aspects
of Basel II as of April 2008, but complications and intra-industry disputes
have slowed implementation.
7. Failure to Prevent Predatory Lending
Even in a deregulated environment, the banking regulators retained
authority to crack down on predatory lending abuses.
Such enforcement activity would have protected homeowners, and lessened
though not prevented the current financial crisis.
But the regulators sat on their hands. The Federal Reserve took three
formal actions against subprime lenders from 2002 to 2007.
The Office of Comptroller of the Currency, which has authority over
almost 1,800 banks, took three consumer-protection enforcement actions
from 2004 to 2006.
8. Federal Preemption of State Consumer Protection Laws
When the states sought to fill the vacuum created by federal nonenforcement
of consumer protection laws against predatory lenders, the feds jumped
to stop them. “In 2003,” as Eliot Spitzer recounted, “during the height
of the predatory lending crisis, the Office of the Comptroller of the
Currency invoked a clause from the 1863 National Bank Act to issue formal
opinions preempting all state predatory lending laws, thereby rendering
them inoperative. The OCC also promulgated new rules that prevented
states from enforcing any of their own consumer protection laws against
national banks.”
9. Escaping Accountability: Assignee Liability
Under existing federal law, with only limited exceptions, only the
original mortgage lender is liable for any predatory and illegal features
of a mortgage—even if the mortgage is transferred to another party.
This arrangement effectively immunized acquirers of the mortgage (“assignees”)
for any problems with the initial loan, and relieved them of any duty
to investigate the terms of the loan. Wall Street interests could purchase,
bundle and securitize subprime loans—including many with pernicious,
predatory terms—without fear of liability for illegal loan terms. The
arrangement left victimized borrowers with no cause of action against
any but the original lender, and typically with no defenses against
being foreclosed upon. Representative Bob Ney, R-Ohio—a close friend
of Wall Street who subsequently went to prison in connection with the
Abramoff scandal—was the leading opponent of a fair assignee liability
regime.
10. Fannie and Freddie Enter the Subprime Market
At the peak of the housing boom, Fannie Mae and Freddie Mac were
dominant purchasers in the subprime secondary market.
The Government-Sponsored Enterprises were followers, not leaders,
but they did end up taking on substantial subprime assets—at least $57
billion. The purchase of subprime assets was a break from prior practice,
justified by theories of expanded access to homeownership for low-income
families and rationalized by mathematical models allegedly able to identify
and assess risk to newer levels of precision. In fact, the motivation
was the for-profit nature of the institutions and their particular executive
incentive schemes. Massive lobbying—including especially but not only
of Democratic friends of the institutions—enabled them to divert from
their traditional exclusive focus on prime loans.
Fannie and Freddie are not responsible for the financial crisis.
They are responsible for their own demise, and the resultant massive
taxpayer liability.
11. Merger Mania
The effective abandonment of antitrust and related regulatory principles
over the last two decades has enabled a remarkable concentration in
the banking sector, even in advance of recent moves to combine firms
as a means to preserve the functioning of the financial system. The
megabanks achieved too-big-to-fail status. While this should have meant
they be treated as public utilities requiring heightened regulation
and risk control, other deregulatory maneuvers (including repeal of
Glass-Steagall) enabled these gigantic institutions to benefit from
explicit and implicit federal guarantees, even as they pursued reckless
high-risk investments.
12. Rampant Conflicts of Interest: Credit Ratings Firms’
Failure
Credit ratings are a key link in the financial crisis story. With
Wall Street combining mortgage loans into pools of securitized assets
and then slicing them up into tranches, the resultant financial instruments
were attractive to many buyers because they promised high returns. But
pension funds and other investors could only enter the game if the securities
were highly rated.
The credit rating firms enabled these investors to enter the game,
by attaching high ratings to securities that actually were high risk—as
subsequent events have revealed. The credit ratings firms have a bias
to offering favorable ratings to new instruments because of their complex
relationships with issuers, and their desire to maintain and obtain
other business dealings with issuers.
This institutional failure and conflict of interest might and should
have been forestalled by the SEC, but the Credit Rating Agencies Reform
Act of 2006 gave the SEC insufficient oversight authority. In fact,
the SEC must give an approval rating to credit ratings agencies if they
are adhering to their own standards—even if the SEC knows those standards
to be flawed.
* * *
Wall Street is presently humbled, but not prostrate. Despite siphoning
trillions of dollars from the public purse, Wall Street executives continue
to warn about the perils of restricting “financial innovation”—even
though it was these very innovations that led to the crisis. And they
are scheming to use the coming Congressional focus on financial regulation
to centralize authority with industry- friendly agencies.
If we are to see the meaningful regulation we need, Congress must
adopt the view that Wall Street has no legitimate seat at the table.
With Wall Street having destroyed the system that enriched its high
flyers, and plunged the global economy into deep recession, it’s time
for Congress to tell Wall Street that its political investments have
also gone bad. This time, legislating must be to control Wall Street,
not further Wall Street’s control.
This report’s conclusion offers guiding principles for a new financial
regulatory architecture.
Click here
to read the rest of the report (in PDF format).
The clout of the press has decayed enormously over the last 40 years. The
fourth estate was feared, resented, and begrudgingly respected in the corridors
of power. But rule by beancounters, savvy media spin, and access journalism
(journalists who write pointed stories get frozen out) have largely leashed
and collared the press. Indeed, a friend who grew up in Eastern Europe when
it was Communist said as of roughly 2000 that the news felt controlled.
So to see a front page, and super long story in the New York Times honing
in on Geithner's close, as in overly close, relationship with Wall Street
executives, is a stunner. In the old days, a report critical of a prominent
public official would be a leading indicator that they were at least facing
headwinds, perhaps in bona fide trouble. But given the new rules of the
game, one has to assume a story of this sort is a lagging indicator, that
Geithner is perceived to be sufficiently at risk to be fair game.
Thus what is surprising about tonight's New York Times story, "Member
and Overseer of the Finance Club," on Timothy Geithner is not its content,
but that it was written at all, and moreover (as of now) is a front page
item. It's extraordinarily long for a weekday story. the number of column
inches usually reserved for natural, not bureaucratic disasters.
Any reader of any remotely plugged in econoblog, or savvy enough to read
between the lines of MSM reports will know that Geithner is a creature of
the financial establishment. Probably the most
important element in his pedigree is that he is a protege of Larry Summers
and Bob Rubin. It also appears that he and Summers are working
fist in glove (witness the marginalization of Paul Volcker).
At a minimum, Geithner crony capitalist policies
are finally leading to a hard look at his loyalties. There is no reason
to think Geithner is personally corrupt (well, there was his little tax
problem) but rather that he is as die hard a believer of finance
uber alles as Alan Greenspan,
albeit without the libertarian zealotry.
Of course, if one were Machiavellian, this move may be Team Obama realizing
rather late that they have made the success of Obama's presidency contingent
on the Summer/Geithner program, and now they are trying, even more so than
before. to pin the policies on Geithner. That may work tactically but in
the end, the banking mess is too central a problem for Obama to try to shift
blame of policy failures onto his team. He picked the chefs, he has to eat
the cooking. If the economy is still a mess in 2012, he will not escape
the taint.
And as much as this piece signals that Geithner
may be starting to be perceived as a liability, it seems unlikely that he
is in serious trouble yet. Sadly, the programs have to flounder
first (although with the PPIP, that could happen sooner rather than later.....).
And while the Times piece finally points to
the elephant in the room, namely, how bankster friendly the new regime has
been, it is far less pointed than it could have been. I suppose
one has to treat Treasury secretaries with kid gloves The questionable incidents
and relationships are diluted by a lot of narrative. But recall we never
saw anything remotely like this treatment (save lots of grumblings) about
Hank Paulson. Of course, handouts to the big end of town was standard operation
in the Bush administration, so it was hard to work up much outrage about
it (at least until the heinous TARP).
From the
New York Times:
Last June, with a financial hurricane gathering force, Treasury Secretary
Henry M. Paulson Jr. convened the nation’s economic stewards for a brainstorming
session. What emergency powers might the government want at its disposal
to confront the crisis? he asked.
Timothy F. Geithner, who as president of the New York Federal Reserve
Bank oversaw many of the nation’s most powerful financial institutions,
stunned the group with the audacity of his answer. He proposed asking
Congress to give the president broad power to guarantee all the debt
in the banking system, according to two participants, including Michele
A. Smith, then an assistant Treasury secretary.
The proposal quickly died amid protests that it was politically untenable
because it could put taxpayers on the hook for trillions of dollars.....
Yves here. The story fails to note this was almost assuredly the most bank
friendly program possible. Back to the story:
But in the 10 months since then, the government has in many ways embraced
his blue-sky prescription....
And more often than not, Mr. Geithner has been a leading architect of
those bailouts, the activist at the head of the pack. He was the federal
regulator most willing to “push the envelope,” said H. Rodgin Cohen,
a prominent Wall Street lawyer who spoke frequently with Mr. Geithner.
Rodg Cohen is the managing partner of Sullivan & Cromwell, which has long
had an extremely close relationship with Goldman. Rodg is also considered
to be the top bank regulatory lawyer in the US. It may seem like too much
inside baseball to point out who Rodg is in more detail, but the fact that
the Times quoted him as a defender of Geithner is telling. Back to the article:
Today, Mr. Geithner ....finds himself a locus of discontent... range
of critics — lawmakers, economists and even former Federal Reserve colleagues
— say that the bailout Mr. Geithner has
played such a central role in fashioning is overly generous to the financial
industry at taxpayer expense.
An examination of Mr. Geithner’s five years as president of the New
York Fed, an era of unbridled and ultimately disastrous risk taking
by the financial industry, shows that he forged unusually close relationships
with executives of Wall Street’s giant financial institutions....
His actions, as a regulator and later a
bailout king, often aligned with the industry’s interests and desires,
according to interviews with financiers, regulators and analysts and
a review of Federal Reserve records.
In a pair of recent interviews and an exchange of e-mail messages, Mr.
Geithner defended his record, saying that from very early on, he was
“a consistently dark voice about the potential risks ahead, and a principal
source of initiatives designed to make the system stronger” before the
markets melted down.
Yves here. Revisionist history. See
here and note the date of the speech. Back to the article:
Traditionally, the New York Fed president’s intelligence-gathering role
has involved routine consultation with financiers, though Mr. Geithner’s
recent predecessors generally did not meet with them unless senior aides
were also present, according to the bank’s former general counsel.
By those standards, Mr. Geithner’s reliance on bankers, hedge fund managers
and others to assess the market’s health — and provide guidance once
it faltered — stood out.
His calendars from 2007 and 2008 show that those interactions were a
mix of the professional and the private.
He ate lunch with senior executives from Citigroup, Goldman Sachs and
Morgan Stanley at the Four Seasons restaurant or in their corporate
dining rooms. He attended casual dinners at the homes of executives
like Jamie Dimon, a member of the New York Fed board and the chief of
JPMorgan Chase.
Yves here. Presumably someone who was or is at the NY Fed who was plenty
upset at the goings-on provided the calendar. Anyone who knows the NY Fed
is encouraged to comment, but for a private company, this would be a major
breech, and the Fed has to be at least as secretive.
The Times has
open sourced Geithner's calendar and is asking
for further remarks. Back to the article:
...for all his ties to Citi, Mr. Geithner repeatedly missed or overlooked
signs that the bank — along with the rest of the financial system —
was falling apart. When he did spot trouble, analysts say, his responses
were too measured, or too late.
In 2005, for instance, Mr. Geithner raised questions about how well
Wall Street was tracking its trading of complex financial products known
as derivatives, yet he pressed reforms only at the margins.....
To Joseph E. Stiglitz, a Nobel-winning economist at Columbia and a critic
of the bailout, Mr. Geithner’s actions suggest that he came to share
Wall Street’s regulatory philosophy and world view....
In theory, having financiers on the New York Fed’s board should help
the president be Washington’s eyes and ears on Wall Street. But critics,
including some current and former Federal Reserve officials, say the
New York Fed is often more of a Wall Street mouthpiece than a cop.
Willem H. Buiter, a professor at the London
School of Economics and Political Science who caused a stir at a Fed
retreat last year with a paper concluding that the Federal Reserve had
been co-opted by the financial industry, said the structure ensured
that “Wall Street gets what it wants” in its New York president: “A
safe pair of hands, someone who is bright, intelligent, hard-working,
but not someone who intends to reform the system root and branch.”....
Throughout the spring and summer of 2007, as subprime lenders began
to fail and government officials reassured the public that the problems
were contained, Mr. Geithner met repeatedly with members of Citigroup’s
management, records show.From mid-May to mid-June alone, he met over
breakfast with Charles O. Prince, the company’s chief executive at the
time, traveled to Citigroup headquarters in Midtown Manhattan to meet
with Lewis B. Kaden, the company’s vice chairman, and had coffee with
Thomas G. Maheras, who ran some of the bank’s biggest trading operations.
(Mr. Maheras’s unit would later be roundly criticized for taking
many of the risks that led Citigroup aground.)
His calendar shows that during that period he also had breakfast
with Mr. Rubin. But in his conversations with Mr. Rubin, Mr. Geithner
said, he did not discuss bank matters. “I did not do supervision with
Bob Rubin,” he said.
Yves here. Of course not. Rubin knew nothing about anything bad and was
determined to keep it that way. Back to the piece:
In a May 15, 2007, speech to the Federal Reserve Bank of Atlanta, Mr.
Geithner praised the strength of the nation’s top financial institutions,
saying that innovations like derivatives
had “improved the capacity to measure and manage risk” and declaring
that “the larger global financial institutions are generally stronger
in terms of capital relative to risk.”
Two days later, interviews and records show, he lobbied behind the scenes
for a plan that a government study said could lead banks to reduce the
amount of capital they kept on hand.
The story continues with many of the key decisions of the crisis. The narrative
detail has the effect of somewhat dliuting the focus on what Geithner did
when, but it also highlights some now largely forgotten incidents like no-bid
contracts to BlackRock (most notably, managing the assets the Fed took on
in the Bear Stearns deal). And it has some new revelations:
A bill sent recently by the Treasury to Capitol Hill would give the
Obama administration extensive new powers to inject money into or seize
systemically important firms in danger of failure. It was drafted in
large measure by Davis Polk & Wardwell, a law firm that represents many
banks and the financial industry’s lobbying group. Mr. Geithner also
hired Davis Polk to represent the New York Fed during the A.I.G. bailout.
Treasury officials say they inadvertently used a copy of Davis Polk’s
draft sent to them by the Federal Reserve as a template for their own
bill, with the result that the proposed legislation Treasury sent to
Capitol Hill bore the law firm’s computer footprints. And they point
to several significant changes to that draft that “better protect the
taxpayer,” in the words of Andrew Williams, a Treasury spokesman.
But others say important provisions in the original industry bill remain.
Most significant, the bill does not require that any government rescue
of a troubled firm be done at the lowest possible cost, as is required
by the F.D.I.C. when it takes over a failed bank.
This is damaging in the eyes of the great unwashed. But there is nothing
here that was presumably not fully known by the Obama vetters. This storm,
like the tax fracas, will pass. But Geithner is nevertheless looking more
and more like damaged goods.
This story now makes official what only those who kept tabs on these matters
knew, that Geithner is captured by the industry. It will now be much easier
for Obama to cut Geithner loose should that prove necessary. But with Summers
still in the mix, I'm dubious that even an outster of Geithner would produce
much of a change in policy direction.
Submitted by Edward
Harrison of the site
Credit Writedowns
I don't much like Ken Lewis. It should be fairly obvious to everyone that
he is a man who has only his own interests at heart. But, his revelation
that BofA bought Merrill Lynch for the agreed-upon September price, despite
Merrill's having an additional $7 billion in losses is grounds for legal
action.
Let's review the situation.
In September, Hank Paulson, Ben Bernanke, and Tim Geithner committed the
financial blunder of the century in allowing Lehman to fail spectacularly
without any contingency plan for the probable market fallout. (Yes, Tim
Geithner was a
principal actor in this fiasco.) Now, there was nothing wrong in letting
Lehman Brothers fail. However, there was something very wrong with bailing
out Fannie Mac and Bear Stearns and allowing everyone on Wall Street to
believe Lehman was too big to fail. And there was even more wrong in having
no contingency plan for the fallout.
So as a direct result of that fallout, Merrill Lynch was poised to be the
next to go under. Enter Ken Lewis, our White Knight. I have to admit to
being idiot enough to have thought
the Bank of America - Merrill deal was a good one. It seemed all was
well when Ken Lewis plunked down $44 billion in September (even though Barclays
got much of the Lehman assets for a song days later). But, as markets
went into freefall, so too did Merrill Lynch, hemorrhaging losses. So why
did Ken Lewis buy the company without at least trying to negotiate a lower
price tag?
Answer: self-dealing.
It was the real thing. The banker, as you may have guessed, is Ken Lewis,
CEO of Bank of America. And the bad guys harassing him are Hank Paulson,
then Treasury secretary, and Ben Bernanke, head of the Federal Reserve,
aided and abetted by shadowy henchmen.
The script for this stranger-than-fiction melodrama was provided by
that rabid (and fiercely ambitious) bulldog New York state attorney
general, Andrew Cuomo. Mr. Cuomo, back in February, had been grilling
Mr. Lewis on what his keen canine eye detected as another indignity
-- the awarding of $3.6 billion to employees of Merrill Lynch, the giant
brokerage firm acquired by BofA on Jan. 1 of this year.
What had Mr. Cuomo frothing at the mouth was that the $3.6 billion was
shelled out even though Merrill suffered losses upwards of $15 billion
in 2008's fourth quarter alone.
We must point out how fortuitous it was that losses had not reached,
say, $30 billion, since by the peculiar calculus being used to reward
red-ink, that would have boosted Merrill's bonus tab to $7.2 billion.
And enraging the chronically enraged Mr. Cuomo all the more was that
the bonuses were distributed even while the losses manifested themselves
but were not disclosed, least of all to the bank's shareholders.
According to Mr. Cuomo's dour narrative, the product of four hours of
interrogation of Mr. Lewis, the merger with Merrill was proposed in
September after two days of due diligence (sounds more like due negligence
to us). It gained approval of shareholders of both companies on Dec.
5. Barely a week later comes the revelation: Merrill's losses were spiraling
ever higher, causing an increasingly frantic Mr. Lewis to weigh calling
the marriage off.
He reckoned he could legally do so thanks to MAC (material adverse event),
recognizing that $7 billion more in losses than had been projected when
the merger was agreed to was a very big MAC, indeed. He diffidently
informed the powers-that-were of his plan to nix the nuptials and was
summarily summoned to powwow with them in Washington that very evening.
And it was there that Messrs. Bernanke and Paulson put the screws to
him to not break the deal lest he trigger a systemic calamity.
On Dec. 21, Mr. Lewis, still of a mind to ditch the merger, communicated
his determination to Mr. Paulson, who bluntly warned that he would give
the boot to Mr. Lewis and his board unless the acquisition went through.
To that bald threat, Mr. Lewis' retort was a resounding purr: "That
makes it simple. Let's de-escalate."
And de-escalate he did. The merger became a done deal right on schedule.
To help salve any hurt feelings, Bank of America got $118 billion in
loan guarantees from rich Uncle Sam to absorb any potential losses from
Merrill.
To me, this sounds like a deal was worked out whereby BofA got a bailout
if it went through with the deal. But, it should be plain from the events
above that Ken Lewis did NOT have his fiduciary responsibilities for his
shareholders top of mind.
So, let's recap.
- Paulson, Bernanke and Geithner blow Lehman up and everybody panics.
- Merrill looks ready to blow up and take the system down with it.
- Bank of America steps in - or better yet,
is coerced in - and pays $44 billion for Merrill.
- But, the market freefall continues, taking WaMu, AIG and Wachovia
down with it. Merrill loses its shirt in this disaster.
- By December, Ken Lewis is ready to pull out of the deal, citing
the MAC (material adverse change) clause as grounds.
- Paulson and Bernanke go ballistic (Geithner was prepping to be Treasury
Secretary) and get Ken Lewis to do something he thinks is bad for shareholders
- By February, BofA needs to be bailed out again to the tune of tens
of billions more government money from Tim Geithner. BofA's stock tanks
- shareholders are looking at 90%+ losses.
- Now, the
SEC is investigating.
This whole episode stinks to high heaven and Ken Lewis doesn't even look
the worst of the lot here. That honor goes to Paulson and Bernanke.
But, what about the shareholders? Oh, those people, right. Don't they deserve
better? Yes, they do. But, they are not going to get better because mega-corporations
are run by managers who are in it for their own enrichment and shareholders
have zero say. This is a classic principal-agent conflict.
The essence of the principal-agent problem comes when a principal (let's
call them the owners) hires an agent (we'll call them the managers) to act
on her behalf. Often times, one is just too busy - or too inexperienced
- to manage a business or negotiate a contract or what have you. So, one
hires a professional steeped in experience to do it.
For instance, sports agents, made famous by the film
Jerry Maguire, are the classic agents to the sports stars principal.
As it happens, the agent has his own agenda - and this may or may not be
the same as the principal's employing him. You will recall the 2007 incident
when Alex Rodriguez negotiated his own contract with the New York Yankees
baseball team in order to make sure the result was one that was most favorable
to his wants and needs (See
NY Times article here.)
In business, the same dynamic is at play. While a dry cleaner can be the
owner-proprietor of his own store, he cannot run two stores or ten stores
at the same time (think
George Jefferson). George needs to hire managers to run those stores
- and he better hope those managers don't have their hand in the till.
In today's age, corporations are absolutely enormous, globe-spanning enterprises
whose owners - the shareholders - individually have no influence over decision-making.
What's more is, the larger the organization, the less likely anyone is to
have sway over the company's managers. Supposedly, that's why there is a
board of directors, right?
A board of directors is a body of elected or appointed persons who jointly
oversee the activities of a company or organization. The body sometimes
has a different name, such as board of trustees, board of governors,
board of managers, or executive board. It is often simply referred to
as "the board."
A board's activities are determined by the powers, duties, and responsibilities
delegated to it or conferred on it by an authority outside itself. These
matters are typically detailed in the organization's bylaws. The bylaws
commonly also specify the number of members of the board, how they are
to be chosen, and when they are to meet.
In an organization with voting members, e.g., a professional society,
the board acts on behalf of, and is subordinate to, the organization's
full assembly, which usually chooses the members of the board. In a
stock corporation, the board is elected by the stockholders and is the
highest authority in the management of the corporation. In a nonstock
corporation with no general voting membership, e.g., a university, the
board is the supreme governing body of the institution.
So, where was
Bank of America's Board of Directors? Didn't they see that Merrill had
imploded. Why did they allow this travesty to take place? Shareholders
had approved the merger on 5 Dec 2008, 16 days BEFORE Ken Lewis had
said he was willing to back out. So they obviously had no say here.
Only the board of directors could have stopped Ken Lewis consummating a
merger that should never have taken place or that had been re-negotiated.
You should notice that this is the exact same run of events that we
witnessed in the Countrywide transaction as well.
But, in the end, the deal went ahead as planned and Bank of America shareholders
got their clocks cleaned as a result.
Failed Establishment
The problem isn’t that Blankfein or anyone else did something wrong in
the decade before the collapse began, although they well may have done so.
The problem is that the nation’s banks and credit extenders failed to do
what was safe, conservative of others’ interests, and above board. The result
has been cataclysmic– leading former Washington Post finance writer
and author William Greider to surmise — the old order that’s been running
the American establishment for the last generation has demonstrably and
miserably failed.
But so did we all — and, it now seems, so is our new president who is
knowingly and one might presume intentionally trying to restore the old
order establishment. There are many good reasons for doing so. Among them
are stability, predictability and risk avoidance to an economy still in
peril. Those who favor installing an new order are becoming more vocal in
their assertions that perpetuating the systems and institutions that failed
only treats the symptoms of what is clearly a potentially fatal disease.
What Matters Most Goes Unknown, Thus Unheeded
In a generation seemingly absent responsible adults, we knowingly and
cheerfully chose to have a grand party at the expense of our children and
grandchildren. In the doing, we effectively destroyed our great institutions
of finance, journalism, education, banking, manufacturing, insurance, transportation
and athletics.
As a nation our errors were of commission and omission. Our errors of
commission were largely based on tilting the economic playing field to favor
the wealthy and powerful among us by lessening governmental regulation and
control. Deregulation became a game in which immense wealth was transferred
from the nation’s middle class to the mighty, rich and powerful. Absent
responsible adults to remind us that American capitalism rests on a foundation
of checks and balances, we systematically deregulated ourselves into disaster.
And now reality has set in, what matters most has become clear and painful.
Over reliance on laissez-faire thinking, and the invisible hand first postulated
by Adam Smith has failed. Neither we, nor the world around us is happy with
the result. We know someone did us wrong and we rightly demand retribution.
Until we accept the reality that as a nation we got exactly what we asked
for, substantive change remains unlikely.
Angry And Confused
Angry Banker Protests In Britain
But we’re mad as hell — and rightfully so. Our sense of betrayal is universal
at home and abroad. Bankers we once held in high esteem we now flagellate
as thieves and criminals. We overlook, for the moment, our own contributions
to the problem. For as we collectively invested billions in market holdings
based on short term earnings performance, our personal flight from reality
sent our own jobs overseas, destroyed effective corporate governance and
freed our bankers to do other, more risky things with our savings.
Our banks turned into failed enterprises by way of corrupt behavior and
failed oversight because we, you, me all of us, sought to live better, become
wealthier, or profit from failed governance. As long as deregulation favored
our interests, our jobs, and our investments, we went along. We did so by
permitting ourselves to be made ignorant of what matters most, to be herded
to political extremes, and corrupted by single-issue thinking that concealed
what was being done in our name. We allowed
ourselves to be seduced by those who pandered to our desires and our need
to be needlessly entertained. It it we who disdained things that really
mattered — things we knew little about and cared less to know.
It was our making that produced a one party system comprised of two warring
extremes. It was our demand that someone else do the work, take the risk,
give of their lives so that we might prosper that made us a debtor nation.
It was we who demanded that our once mighty financial empires be turned
into wild-eyed speculators cunningly running criminal enterprises.
Our government was permitted to run-amuck by failed political
institutions, failed oversight, failed governance and the disembowelment
of long respected journalistic institutions by people and organizations
that surely knew better.
April 22, 2009 | Crooked Timber
The set of ideas that has dominated public policy around the world for
the last thirty years has been given a variety of names – neoliberalism[1],
economic rationalism, the Washington Consensus, Reaganism and Thatcherism
being the most prominent. Broadly speaking, this set of ideas combines support
for free market (or freer market) economic policies with agnosticism[2]
about both political liberalism and the relative merits of democracy and
autocracy. Since demands for definition are inevitable, I’ll point to mine
here.
A striking feature of all of these terms is that they are currently used
almost exclusively by opponents of the viewpoint being described, to the
point where any use of such terms invariably provokes protests about unfair
labelling (this is true even of the most neutral term I can find, “economic
liberalism”). Even more striking is the fact that these terms were originally
used in a broadly positive sense by supporters of the ideas concerned. I’ve
done the story on
economic rationalism, Don Arthur covers
neoliberalism (with links to more from
Taylor Boas
and Jordan Gans-Morse (pdf) and you can check Wikipedia for the others.
Why is it that neoliberalism seems to be subject to a political version
of the euphemism treadmill? A look at the history will help a bit.
For each of the sets of ideas in question, two things happened. First,
the ideas described by the terms evolved in the direction of a more tightly
defined and hardline free-market ideology – this happened both because (positive)
users of the term became more consistent in their ideology over time and
because some with more moderate views ceased to identify with the term.
Second, advocates of neoliberalism gained political power without, in
general, convincing the majority of the public. In Australia and New Zealand,
there was a bipartisan elite consensus in support of economic rationalism
during the 1980s and early 1990s. In the UK, Thatcher won a series of elections
with minority support thanks to a weak and divided Opposition. In Latin
America, neoliberal policies were implemented by dictators like Pinochet,
and quasi-dictatorial strongment like Fujimori.
Finally, as this process took place, the term was taken up by critics,
who needed a descriptive label for the set of ideas they were criticising,
and, soon afterwards, abandoned by its original advocates. In Australia,
the crucial event was Michael Pusey’s book Economic Rationalism in Canberra.
In the case of neoliberalism, the change occurred after the Pinochet coup.
"So now we can recognize that 'oligarch' is a word in America as well. Excellent!!
Identifying the ailment is the first part of getting well."
In a fascinating piece in the latest issue of
The Atlantic,
Simon Johnson, former chief economist at the International Monetary Fund,
outlines what he sees as the alarming influence of Wall Street firms over
the American economy. He expounds on his thesis in our interview, making
several points:
America’s Crisis Resembles that of Emerging Markets:
While at the IMF, Johnson saw so many financial crises that the core problem
became old hat: In the free-wheeling growth years of an economic boom, the
politicians and oligarchs of an emerging market like Russia or Argentina
would get so close that eventually they would meld into a politico-industrial
complex. As long as the boom lasted, this cozy relationship never bothered
anyone--because everyone was getting rich. Fast forward to the latest market
crisis--the one in the United States. The pattern is exactly the same, Simon
Johnson says, with a mutually beneficial money-and-power corridor now running
between Washington and the modern oligarchs Wall Street.
But There Are Key Differences: In the emerging markets,
eventually, the bubble would burst. The banks and corporations would collapse,
and suddenly it would be up to the government to seize and restructure the
insolvent banks. In America, though, there will be no such defining collapse,
nor a quick recovery, he argues. Instead, we face a “painful” L-shaped recovery,
drawn out over 3-5 years.
Wall Street: “It’s Too Big, Too Powerful. It’s Dangerous”
Simon argues that the U.S. should invoke anti-trust laws to break up Wall
Street, whose power poses a material threat to the American economy.
Simon Johnson is a
senior fellow
at the Peterson Institute and a professor at MIT’s Sloan School of Management.
He is a co-founder of the popular economics blog,
BaselineScenario.
Selected Comments
Yahoo! Finance User - Tuesday April 21, 2009 08:02AM EDT
A voice of reason. America is enduring this economic downturn because
of greed, disdain for law and regulation by those who control private business
and financial systems, and less than honest politicians who receive wealth
in return for their legislative cooperation. Johnson has a valid point,
and he hits a home run, because wall street and pols are the cause of this
recession - not the "liars" - like so many are convinced.
tenbips - Tuesday April 21, 2009 08:26AM EDT
I am your Robin Hood! If you want to stop the banks from raiding the Treasury
direct and via the Federal Reserve Corp the answer is simple. At the next
rally Taxpayers are staging bring up two important elements. Tell every
informed citizen to immediately transfer their accounts from these large
commercial banks to community or State chartered thrifts that did not leverage
deposits 50 - 1. Call your local congressperson and tell them that a better
plan exists which includes the immediate revocation of the Federal Reserve
Corp's charter. Until the citizens of this Country unleash themselves from
the FRC's fractional banking methods why should other banks even bother
to take notice. The true problem is that currency creation pinnacled in
2000 and again in 2005. the first time we had a convenient war to stimulate
lending and the second time we removed M3 as a GDP factor. if we do not
know how much the FED is flooding, how can we tell how the economy is reacting.
If you want transparency we must remove the cloak from the top to the bottom.
This will take a major change in how the US creates currency and will hurt
a few extremely wealthy folks that are not even Americans. The coming carry-trade
crisis, pension fund problems and commercial paper fall-out will make the
residential paper mess look like a walk in the park. Many trillions to go
guys. The commercial banks will require almost a trillion a quarter for
the rest of the year to even suggest solvency (farce). Give me 4 trillion
and a 39 cent Bic and I can churn out an operating profit too! Easily!
Bill W - Tuesday April 21, 2009 08:27AM EDT
Goldman Sachs owns this country and maybe most part of world, if Goldman
short a company, that company can not alive. Like what he said, Goldman
has not only super cash power, political power but also media power. They
hire many many Analysts, economists and writers, to either hype a company
or kill a company to their best interests. Many examples can be listed.
Citi is one of the victim. Goldman probably still have numerous short position
in Citi and many other companies.brucebango - Tuesday April
21, 2009 08:39AM EDT
It's all about making sales commissions. Making 5% on a mortgage was not
enough they had to build a ponzi, selling and reselling mortage securities
to the point the paper was 40 to 1. They knew it was going to burst. And
they knew they would get bailed. Reason: The gov't and wall street are all
the same business. Now the wallstreeters want to take over the insurance
sales business. Since everyone is putting money into annuities, SEC just
ruled that indexed securities will soon become a security. You must be licensed
security broker to sell securities... So soon wallstreeters will take all
that annuity business from insurance sales people. It won't belong that
in order to sell food you'll need broker dearlers license. They want all
the commissions. All industries of the US, who have salespeople, do not
have these advantages. These guys make up paper products out of nothing
and grow them getting rich. There really needs to be an all industry wide
revolution against the financial industry as they've ruined all other industries
for their own interests.larry.pullin@sbcglobal.net - Tuesday
April 21, 2009 08:42AM EDT
Why arn't the RICO anto racketeering laws applicable here for say Mr. Fuld,
CEO of the once most trusted name on Wall ST, Lehman Brothers. The original
Lehman Brothers must be spinning like tops in their graves at what this
dunce/thief did to their company and clients. He engaged in out and out
fraud and moved money gleaned from illegal activiteis across state and national
lines. I assume at some point he used the mail system in his racket so he
seems a prime candidate for a racketeering charge. Where the heck is the
IRS anyway as he probably has money hidden somewhere he isn't reporting.
number_6@rocketmail.com - Tuesday April 21, 2009 08:50AM EDT
Great ideas! The fatal flaw: It would require people to cooperate and work
together. Read some of the comments and do the math. The United States is
foo-ked and will carry this burden for the next 2 generations. The Tea Parties
were great bitch sessions that did absolutely nothing. The American voter
still has yet to grasp the concept that when re-electing the same people,
you continue to get the same results. This fascination the American voting
public has on Democrats and Republicans is self destructive. One is not
any better than the other. Bush is voted out and replaced by Obama and the
economy still blows. Hey, did it occur to the voting public that maybe the
people in Congress should have been voted out as well? Duh! It's like right
now with the "stress test". Many people do not believe the results, but
no one does shit about it. The Tea Parties are passed off as right-wing
conspiracies and Obama asks for .0002% departmental cuts while signs a PORK
bill blaming, no kidding, Bush for all the PORK??? All you party hangers
sit back are either too stupid, or blind to figure out the politicians are
screwing us are all excited about ... what? Continue believing what you
want, but until the Tea Parties turn into something significant and people
like Chris Dodd, Geithner, Frank and whomever continues to serve, America
goes no where. At the very least Chris Dodd should be impeached and brought
before the Senate Ethics Committee to explain his actions... But, as I have
said, that would mean the taxpayers are united .... until then, please be
quiet and take the beating you asked for and are receiving.
Keith Moser - Tuesday April 21, 2009 09:03AM EDT
Listen to what he says about oligarchs. He's not necessarily wrong about
the rest, but that's not the most important point in the article (that this
blog is about). Just remember the oligarchs, and when people start complaining
that the USA is becoming a socialist state, let them know the truth: America
has been taken over by fascists (aka oligarchs). Trust busting is exactly
what is needed, but the pols are all owned by the fascists, who allow them
their pet projects so they can continue to buy votes.
Yahoo! Finance User - Tuesday April 21, 2009 09:08AM EDT
This is news?! A few powerful companies at the center of the political and
economic universe. Say it isn't so! Next I supposed we all be "shocked"
to learn that the media, government, and our education system are all linked
together to f* over the American people. What ever. But hey, at least the
guy has the balls to write it down. As far as congress changing anything..good
greif. Congress couldnt wipe themselves without tiolet paper from a lobbyist.
Vinny - Tuesday April 21, 2009 09:14AM EDT
Actually it's not Wall Street that's too powerful, it's the Federal Reserve
and the international influences who run it. Wall Street is an after thought.
This propaganda distracts us from the fact that the enter credit expansion
and inflation which turn this country into a credit and debt free for all
is at the hands of the Federal Reserve. Support HR1207 and lets get our
country back. Write your Congress person and demand they cosponsor HR1207.
Audit the Fed.
Back in the '90s and through the mid-'00s, major figures from Goldman
Sachs such as
Robert Rubin, Gary Gensler and
Hank Paulson stood fast against derivatives regulation (Rubin and Gensler)
and lobbied successfully for higher leverage ratios so they could bet more
of their capital on the market boom (Paulson). When those policies came
to grief and
Wall Street imploded, and the Feds scrambled to rescue stricken insurance
giant AIG, Goldman CEO Lloyd Blankfein was reportedly the only bank executive
invited to an emergency meeting at the New York Federal Reserve (convened
by then-Fed president
Tim Geithner).
Now Treasury Secretary Geithner—a Rubin protégé, of course—has assigned
two more ex-Goldman men to fix the vast mess their colleagues helped to
create.
They are
Steve Shafran, a former favorite of Paulson's, and
Bill Dudley, Goldman's former chief economist and now the successor
to Geithner as head of the New York Fed. Shafran and Dudley have been given
the mind-bending task of resurrecting the market for securitized assets,
a policy that is linked to an effort to lure the private market back in
to bid on the toxic securitized assets that sit like dead weight on major
banks' balance sheets. This vast project is being designed in two parts.
First, revive the asset securitization market, frozen since last year's
crash, through the TALF, the Term
Asset-Backed Securities Loan Facility (don't try to say this at home!),
started up on Tuesday. This program will bundle triple-A-rated loans into
new securities and market them. Second, begin to sell off the toxic assets
to private funds, in hopes that some day the TALF-revived securitization
market will create demand for the lower-rated assets as well. According
to a Treasury spokesman, the TALF plan and the troubled-asset buy-up program
are "operating on parallel tracks."
The key now is to bring in hedge funds and other hoards of private capital
by giving them government guarantees limiting their potential losses. The
pitfall is that if the American public, already riled to populist fury over
Wall Street's postcrash perks, finds out what a sweet deal these new investors
are getting—without any limitations on executive compensation like those
imposed on banks—people might get more upset.
This is not to speak ill of Shafran and Dudley or, for that matter, Geithner.
The plan his Treasury team is working on is intricate, and it may well be
the only way to bring the private sector back in—and get the rest of us,
the taxpayers, out. A Treasury spokesman says that Shafran and Dudley are
not the only ones working on the plan, which Geithner is personally overseeing.
"It's been a group effort," he says, adding that there are no price guarantees.
The private funds and the government will "share" first losses and profits,
though details haven't been fleshed out. Nor should we ignore the fact that
Goldman's "best and brightest" have sometimes dug us out of holes in the
past. Former Treasury Secretary Robert Rubin, for example, is often criticized
these days (by me, among others) for quashing then-Commodity Futures Trading
Commission Chairwoman Brooksley Born's 1998 proposal to discuss derivatives
regulation. What is rarely noted is that Rubin, at the time, was in the
middle of resolving the Asian financial contagion, and he was justly concerned
with sending a chilling message to Wall Street.
Still, the omnipresence of Goldman Sachs does make one wonder about the
insularity of this world—what economist Jagdish Bhagwati once called the
"Wall Street–Treasury complex." Or as another joke has it, Goldman is so
politically savvy in Washington, it should be called "Government Sachs."
Is there no one else to fix the crisis but specialists from the company
that helped create it? According to a new report out by the public advocacy
group the Consumer Education Foundation, over the past decade Wall Street
investment firms, commercial banks, hedge funds, real-estate companies and
insurance conglomerates forked over $1.725 billion in political contributions.
They spent another $3.4 billion on lobbyists.
"Our government has been misappropriated by Goldman Sachs," says Christopher
Whalen of Institutional Risk Analytics, a long-time critic of Geithner,
whom Whalen likens to Chauncey Gardiner, the clueless hero of "Being There,"
who is manipulated by everyone around him. And if Wall Street elites continue
to make government policy, will the new regulatory controls we hear so much
about—the ones that are supposed to prevent this from happening again—ever
really be adopted?
This is the critical question. Despite continued public support for
President Obama and early signs that Geithner's various rescue plans—including
the $75 billion mortgage bailout scheme announced this week—may be starting
to reassure the markets, there is little sign
as yet that the administration is engaged in the kind of fundamental rethinking
of financial safety and soundness that we need. The problem
is not just that Wall Street giants like Goldman,
Citigroup and AIG ran wild over the past 20 years, it is that they exist
in their current form at all. These institutions are too big and too systemic
to be allowed to fail according to normal free-market rules, and if they
remain that way we will inevitably find ourselves in a situation where taxpayers
must rescue them once again.
We have been through this nightmare before, almost step by disastrous
step. From 1932 to 1934 the Senate banking and currency committee held hearings
on the 1929 crash and found that commercial banks had misrepresented to
their depositors the quality of securities that their investment-banking
sides were underwriting and promoting. According to a history posted by
the Federal Deposit Insurance Corp. on its Web site, among the culprits
was First National City Bank (now Citigroup), which was found to have repackaged
the bank's Latin American loans and securitized them without disclosing
its own confidential findings that the loans posed adverse risks. Sound
familiar? The response of the government in that era was decisive: the Glass-Steagall
Act, which separated commercial banking from investment banking. It is a
supreme historical irony that 65 years later it was Citigroup, grown monstrous
again, that pushed hardest for the destruction of the Glass-Steagall reforms.
And it had a big assist from Goldman grads such as Bob Rubin, who was soon
afterward hired as chairman of Citi's executive committee.
As the new Consumer Education Foundation report concludes: "Glass-Steagall
was a key element of the Roosevelt administration's response to the Depression
and considered essential both to restoring public confidence in a financial
system that had failed and to protecting the nation against another profound
economic collapse." Even if we believe that the economic and financial system
may be stabilizing five weeks into Obama's presidency, it's hard to conclude
that fundamental confidence has been restored.
Perhaps the Obama administration will see the light and at some point
forthrightly address the "too big to fail" problem that even Federal Reserve
chairman Ben Bernanke said again this week was "enormous." But it is hard
to imagine that a team composed largely of Wall Street's former finest will,
all by themselves, push for the breakup of the firms that nurtured and enriched
them. And there is scant evidence that Geithner is now soliciting advice
from others on the outside, including the new panel led by Paul Volcker—a
diehard skeptic of Wall Street's agenda—that Obama set up precisely for
this purpose. Who is the Treasury secretary
relying on? We don't really know, but certainly one close adviser must be
Mark Patterson, Geithner's new chief of staff. Patterson is the former Washington
lobbyist for Goldman Sachs.
April 14, 2009 |
FT.com
... In
an article in the May issue of the Atlantic Monthly, Prof Johnson
compares the hold of the “financial oligarchy” over US policy with that
of business elites in emerging countries. Do such comparisons make sense?
The answer is Yes, but only up to a point.
“In its depth and suddenness,” argues Prof Johnson, “the US economic
and financial crisis is shockingly reminiscent of moments we have recently
seen in emerging markets.” The similarity is evident: large inflows of foreign
capital; torrid credit growth; excessive leverage; bubbles in asset prices,
particularly property; and, finally, asset-price collapses and financial
catastrophe.
“But,” adds Prof Johnson, “there’s a deeper and more disturbing similarity:
elite business interests – financiers, in the case of the US – played a
central role in creating the crisis, making ever-larger gambles, with the
implicit backing of the government, until the inevitable collapse.” Moreover,
“the great wealth that the financial sector created and concentrated gave
bankers enormous political weight.”
Now, argues Prof Johnson, the weight of the financial sector is preventing
resolution of the crisis. Banks “do not want to recognise the full extent
of their losses, because that would likely expose them as insolvent ...
This behaviour is corrosive: unhealthy banks either do not lend (hoarding
money to shore up reserves) or they make desperate gambles on high-risk
loans and investments that could pay off big, but probably won’t pay off
at all. In either case, the economy suffers further, and, as it does, bank
assets themselves continue to deteriorate – creating a highly destructive
cycle.”
Does such an analysis make sense? This is a question I thought about
during my recent three-month stay in New York and visits to Washington,
DC, now capital of global finance. They are why Prof Johnson’s analysis
is so important.
Unquestionably, we have witnessed a massive rise in the significance
of the financial sector. In 2002, the sector
generated an astonishing 41 per cent of US domestic corporate profits (see
chart). In 2008, US private indebtedness reached 295 per cent of gross domestic
product, a record, up from 112 per cent in 1976, while financial sector
debt reached 121 per cent of GDP in 2008. Average pay in the sector rose
from close to the average for all industries between 1948 and 1982 to 181
per cent of it in 2007.
In recent
research, Thomas Philippon of New York University’s Stern School of
Business and Ariell Reshef of the University of Virginia conclude that the
financial sector was a high-skill, high-wage industry between 1909 and 1933.
It then went into relative decline until 1980, whereupon it again started
to be a high-skill, high-wage sector.* They conclude that the prime cause
was deregulation, which “unleashes creativity and innovation and increases
demand for skilled workers”.
Deregulation also generates growth of credit, the raw stuff the financial
sector creates and on which it feeds. Transmutation of credit into income
is why the profitability of the financial system can be illusory.
Equally, the expansion of the financial sector will
reverse, at least within the US: credit growth and leverage masked low or
even non-existent profitability of much activity, which will disappear,
and part of the debt must also be liquidated. The golden age of Wall Street
is over: the return of
regulation is cause
and consequence of this shift.
Yet Prof Johnson makes a stronger point than this. He argues that the
refusal of powerful institutions to admit losses – aided and abetted by
a government in thrall to the “money-changers” – may make it impossible
to escape from the crisis. Moreover, since the
US enjoys the privilege of being able to borrow in its own currency it is
far easier for it than for mere emerging economies to paper over cracks,
turning crisis into long-term economic malaise. So we have
witnessed a series of improvisations or “deals” whose underlying aim is
to rescue as much of the financial system as possible in as generous a way
as policymakers think they can get away with.
I agree with the critique of the policies adopted so far. In the debate
on the Financial Times’s
economists’ forum on Treasury secretary Tim Geithner’s “public/private
investment partnership”, the critics are right: if it works, it is because
it is a non-transparent way of transferring taxpayer wealth to banks. But
it is unlikely to fill the capital hole that the markets are, at present,
ignoring, as Michael Pomerleano
argues. Nor am I persuaded that the
“stress tests” of bank capital under way will lead to action that fills
the capital hole.
Yet do these weaknesses make the US into Russia? No. In many emerging
economies corruption is egregious and overt. In the US, influence comes
as much from a system of beliefs as from lobbying (although the latter was
not absent). What was good for Wall Street was
deemed good for the world. The result was a bipartisan programme of ill-designed
deregulation for the US and, given its influence, the world.
Moreover, the belief that Wall Street needs to be preserved largely as
it is now is mainly a consequence of fear. The view that large and complex
financial institutions are too big to fail may be wrong. But it is easy
to understand why intelligent policymakers shrink from testing it. At the
same time, politicians fear a public backlash against large infusions of
public capital. So, like Japan, the US is caught between the elite’s fear
of bankruptcy and the public’s loathing of
bail-outs. This is a more complex phenomenon than the “quiet coup” Prof
Johnson describes.
Yet decisive restructuring is indeed necessary. This is not because returning
the economy to the debt-fuelled growth of recent years is either feasible
or desirable. But two things must be achieved: first, the core financial
institutions must become credibly solvent; and, second, no profit-seeking
private institution can remain too big to fail. That is not capitalism,
but socialism. That is one of the points on which the right and the left
agree. They are right. Bankruptcy – and so losses for unsecured creditors
– must be a part of any durable solution. Without that change, the resolution
of this crisis can only be the harbinger of the next.
*Wages and Human Capital in the US Financial Industry 1909-2006, January
2009,
www.nber.org
FT.comUseless finance
A derivative is a contingent claim whose payoff depends on the performance
of some other financial instrument or security. For instance, an American
equity call option gives the purchaser of the call the right (but not the
obligation) to buy a share of equity from the issuer or writer of the call
option at or before some future date at a price determined today.
A credit default swap (CDS) is a credit derivative contract between two
(counter)parties in which the holder makes periodic payments to the issuer
in return for a payoff if the underlying financial instrument specified
in the contract defaults.
A derivative contract is formally identical to a lottery, a (simple or
compound) bet or gamble. Like any financial claim, any derivative
is an ‘inside asset’ - it is in zero net supply. Because pay-offs
associated with a derivative contract are functions of observable properties
of other financial claims (prices, interest rates, default states), the
derivative contract either re-packages existing underlying uncertainty or
creates additional ‘artificial’ uncertainty. It would create additional
extraneous uncertainty if it added some noise of its own to the fundamental,
exogenous uncertainty that is presumably reflected in the features of the
underlying security that determine the pay-offs of the derivative contract.
If the creation and trading of derivatives were costless, derivatives
result in zero-sum redistributions of wealth between the issuers and the
owners of the derivative contracts. Costless derivatives would be
redundant if markets were complete. When markets are incomplete, as
they are in our unfortunate universe, introducing derivatives can either
lead to an increase or to a reduction in efficiency and social welfare.
Lower efficiency and social welfare are possible even if creating and trading
derivatives were costless. Derivatives may improve the allocation
of risk, but there is no guarantee that they will. It is my contention
that the unbridled explosion of certain categories of derivatives has done
considerable harm, and that it is necessary to regulate all derivatives
trading.
How can creating lotteries, even if they only mirror fundamental underlying
uncertainty, be welfare increasing? The usual argument involves examples
where there is a given quantum of ‘objective’ or ‘exogenous’ uncertainty
in the world, e.g. uncertainty about endowments, technology and tastes (all
assumed exogenous - only economists would treat technology and taste as
exogenous, of course!). Markets for risk trading are incomplete and
creating derivatives markets does not alter the objective/exogenous uncertainty
in the world. Creating and trading derivatives is costless.
In such a world one can imagine a pension fund that wishes to hold default
risk-free 10 year government securities, but unable to find them in the
market, instead holding 10 year AAA corporate bonds and CDS to cover the
default risk of these corporate securities. Provided the writer of
the CDS is creditworthy, the pension fund could achieve its preferred portfolio
mix. If the writer of the CDS has the appropriate capital structure
and balance sheet, it could be both willing and able to bear the default
risk on the corporate bonds than the pension fund. For the lottery
created by a derivative contract to be welfare-increasing, it will have
to produce a positive monetary pay-off for the purchaser of the derivative
in exactly those ‘states of nature’ where the purchaser will be worst off,
while at the same time ensuring that the corresponding negative monetary
pay-off for the writer of the derivative does not hurt the writer of the
derivative too badly.
It would of course be more direct to draw up contracts contingent on
the exogenous uncertainty directly. If the pension fund’s ‘endowment’
were to be negatively correlated with that of some other legal entity, and
if the two endowments could be observed and verified, an endowment-sharing
rule could be specified that would make both parties better off. You
would not start looking for contracts specifying payments that are contingent
on endogenous risk, such as default risk or the behaviour of some price
or interest rate.
Derivatives, insurance and gambling
Consider the CDS. The purchaser pays a premium to the writer of
a CDS. That is the price of the lottery ticket, or the price of the
betting slip. If the underlying security specified in the contract
defaults, the writer of the CDS pays the owner of the CDS a specified amount
of money. That’s the lottery prize, or the winnings of the bet.
In the UK where there are more legal forms of gambling than in most other
countries, many conventional financial instruments or securities have been
‘re-engineered’ as formal bets. Spread betting on exchange rates,
interest rates, stock prices and now also house price indices is a popular
form of investment. The reason is that earnings from gambling are
not taxed. The government presumably does not tax the gains and losses
from gambling because (ignoring the value added of the gambling industry)
gambling winnings equal gambling losses, so if the tax code allows loss
offsets, there is not much point (ignoring progressivity of taxation & other
complications) in taxing the gains and losses from gambling.
Derivatives can be used to provide insurance (paying a premium to buy
protection against a possible loss) or to gamble (paying a premium to acquire
the opportunity to benefit from a possible gain). CDS can provide
either insurance against loss or an opportunity to gamble. This is
because the buyer of a CDS does not need to own the underlying security
or other form of credit exposure. The buyer does not have to suffer
any loss from the default event and may in fact benefit from it.
When purchasing an insurance contract, the insured party is generally
expected to have an insurable interest in the event against which
he takes out insurance. This simply means that he cannot be better
off if the insured against event occurs than if it does not occur.
Determining what constitutes an insurable interest is often complicated
in practice, but simple in principle: you have an insurable interest if,
when (a) the future contingency you insure against occurs and (b) the insurance
contract performs (something you cannot necessarily count on, without assistance
from the tax payer, if you buy your CDS from AIG), you are not better off
than you would be if the insured-against future contingency did not occur.
Clearly, CDS contracts don’t require an insurable interest to be present.
Many other derivatives likewise don’t require an insurable interest to be
present. Short selling a share of common stock in the hope/expectation
of a fall in the price of the equity without either owning or borrowing
the stock (naked short selling) is an example of a derivative contract without
an insurable interest.
Why should the state care about gambling through derivative contracts?
Harmful finance
(1) Gambling is addictive
Like all forms of gambling (deliberate risk-seeking), gambling in the
derivatives markets can be addictive. This may create a paternalism-based
argument for regulating, restricting or even banning the activity.
Having observed derivatives writers, purchasers and traders in action, it
is clear that the thrill of the gamble is part of the motivation behind
this activity. The monetary gains and losses figure prominently, of
course, but the bungee-jumping, sky-diving, tight-rope-walking-without-a-net
dimensions of derivatives trading definitely play a role. It cannot
be a coincidence that there are so many more male than female traders and
other operators in the financial markets. Testosterone is not underrepresented
in the trading room. And the thrill of taking a wide-open position
can be addictive. I wouldn’t be surprised if Gamblers Anonymous
had a special chapter for derivatives gambling.
I am generically underwhelmed by arguments for protecting compos
mentis adults against themselves based on paternalism, but the list
of arguments would not be complete without it.
(2) Moral hazard or micro-level endogenous risk.
This is the familiar argument already mentioned before, that if the insured
party (the purchaser of a CDS, for instance) can influence the likelihood
of the insured-against contingency (the default of the underlying security)
occurring without the writer of the insurance contract (the issuer of the
CDS) being aware of this, there is an obvious case of market failure and
potential source of inefficiency. It’s also likely to be an illegal
form of market manipulation.
(3) Derivative contracts as “bearer lottery tickets”
Unlike most conventional lotteries, the lottery tickets created as part
of many derivatives contracts are traded in secondary markets, sometimes
over the counter (OTC markets), sometimes on organised exchanges.
These lottery tickets or betting slips are not just traded after they are
issued (sold by the writer in the ‘primary issue market’), most of these
derivative contracts are bearer securities: their ownership is
not registered. The owner is anonymous. Listed common stock,
by contrast, is an example of what I have called a ‘registered security’.
There is an ownership register, which is, at least in principle, in the
public domain. Clearly, establishing the beneficial ownership of an
equity share may not be a simple matter of looking in the shareowners register
in the jurisdiction where stock is listed, but with bearer securities the
task is hopeless.
The writer of the derivative contract does not in general know the identity
of the current owner of the contract. If the writer does not know
this, the supervisor and regulator, or the state agency in charge of macro-prudential
supervision (typically the central bank) does not know it either.
There is therefore absolutely no way to determine whether the current distribution
of the ownership of derivative contracts is systemically stabilising or
destabilising, whether it is too concentrated or too dispersed. When
a notional gross $60 trillion worth of CDS outstanding at the peak (yes,
I know it’s ‘only’ $30 trillion now and much of it is ‘offsetting’ in some
ill-defined way) and possibly around $400 trillion gross outstanding of
total derivatives, we are talking ignorance on a cosmic scale.
(4) Risk-seeking by the over-confident
Even if the secondary markets for derivatives functioned properly (no
bubbles, no liquidity seizures, no wide-spread defaults), these secondary
markets can, like the primary issue market, redistribute the additional
risk represented by any derivative either in a way that improves the ultimate
allocation and sharing of risk or worsens it. Once a new derivative
market is created, this market can either be used to hedge existing risk
or to take on additional risk. I have seen no reliable statistics on the
identities of the counterparties in the leading derivatives markets.
My best guess is that most of the activity is not between households and
financial intermediaries or between non-financial enterprises and financial
intermediaries, but among financial intermediaries, mainly among different
banking or shadow-banking player. Much of this trading appears to be driven
by overconfidence and hubris. I have yet to meet a trader who did
not believe that he or she could not beat the market. Because collectively
these traders effectively are the market, they are collectively irrational,
as they cannot beat themselves. So the risk ends up being concentrated
not among those most capable of bearing it, but among those most willing
to bear it - those most confident of being able to bear it and profit from
it.
(5) Churning
The collective hubris of the banking sector (broadly defined to include
all the shadow-banking sector institutions like hedge funds, private equity
funds, SIVs, conduits, other investment funds, AIG-style insurance companies
etc.) means that enormous volumes of bets are placed on the behaviour of
endogenous variables. The first consequence of this is that, since
derivatives trading is not costless, scarce skilled resources are diverted
to what are not even games of pure redistribution. Instead these resources
are diverted towards games involving the redistribution of a social pie
that shrinks as more players enter the game.
The inefficient redistribution of risk that can be the by-product of
the creation of new derivatives markets and their inadequate regulation
can also affect the real economy through an increase in the scope and severity
of defaults. Defaults, insolvency and bankruptcy are key components
of a market economy based on property rights. There involve more than
a redistribution of property rights (both income and control rights).
They also destroy real resources. The zero-sum redistribution characteristic
of derivatives contracts in a frictionless world becomes a negative-sum
redistribution when default and insolvency is involved. There is a
fundamental asymmetry in the market game between winners and losers: there
is no such thing as super-solvency for winners. But there is such
a thing as insolvency for losers, if the losses are large enough.
The easiest solution to this churning problem would be to restrict derivatives
trading to insurance, pure and simple. The party purchasing the insurance
should be able to demonstrate an insurable interest. CDS could only
be bought and sold in combination with a matching amount of the underlying
security. Ideally, it ought to be possible to for me to buy a CDS
by demonstrating an insurable interest in terms of my “utility”, i.e. by
demonstrating that, should the underlying security default, I would be worse
off in one way or other, not necessarily because I own the underlying security.
In practice, this would be wide open to abuse and manipulation.
(6) Macro-endogenous risk
Financial markets are inefficient in any of the ways specified by James
Tobin in a great 1984 paper - information arbitrage efficiency,
fundamental valuation efficiency, functional efficiency or
Arrow-Debreu full insurance efficiency.[1]
Financial markets even often are technically inefficient.
A market is technically or trading efficient if it is liquid and
competitive, that is, it is possible to buy or sell large quantities with
very low transaction costs, at little or no notice and without a significant
impact on the market price. We have seen many examples, from the ABS
markets and the commercial paper markets to the interbank markets of massive
and persistent failures of technical or trading efficiency.
Even in those financial markets that are reasonably technically efficient,
like the US stock market, the foreign exchange markets and the government
debt markets, Tobin saw frequent departures from efficiency in the less
restricted senses of the word. He accepted that financial markets
possessed what he called ‘information arbitrage efficiency’ that
is, that they were informationally efficient in the weak and semi-strong
sense. You cannot systematically make money
trading on the basis of generally available public information. Clearly,
however, trading profitably on the basis of insider information is possible.
He did not believe that financial markets consistently possessed ‘fundamental
valuation efficiency’: financial asset prices do not necessarily reflect
the rational expectations of the future payments to which the asset gives
title. Key financial markets, including the stock market, the long-term
debt market and the foreign exchange market are characterised both by excess
volatility and persistent misalignments, that is, prices deviating persistently
from fundamental valuations.
Tobin also contested the notion that the financial markets delivered
‘value for money’ in the social sense. “the services of the system do
not come cheap. An immense amount of activity takes place, and considerable
resources are devoted to it.” (Tobin [1984, p. 284]). Tobin referred
to this aspect of efficiency as ‘functional efficiency’. Finally,
the system of financial markets can be efficient in the technical, information
arbitrage, fundamental valuation and functional senses without possessing
what Tobin called Arrow-Debreu full insurance efficiency, that
is, without supporting Pareto-efficient economy-wide outcomes. The
reason is that real world financial markets interact with labour and goods
markets that are inefficient in every sense of the word.
When financial markets are inefficient, the distinction between fundamental,
exogenous variables and endogenous variables disappears. CDS prices
can become quasi-autonomous drivers of the bond prices. The tail can
wag the dog. The redistributions of wealth associated with the execution
of derivatives contracts can trigger margin calls, mark-to-market revaluations
of assets and liabilities, forced liquidations of illiquid asset holdings
through fire-sales in dysfunctional markets, defaults and bankruptcies.
Activities in derivatives markets, including futures markets, can feed back
on sport markets and real production, consumption and storage decisions.
Unbridled derivatives markets may be liquid, but the question is, to
what purpose? If, as I believe, there is no economic rationale for
‘naked’ CDS positions (that is, CDS that do not insure an open default position
in the underlying security), then liquidity of the CDS market only serves
those who want to trade naked CDS. This, in my view, only wastes real
resources through (a) churning and (b) unnecessary bankruptcies.
Useful finance
I want to end on an upbeat note. I believe that effective and efficient
financial intermediation is a necessary condition for prosperity.
To those who doubt this, I recommend a reading of two books about the true
microfoundations of financial intermediation, Hernando de Soto’s, The
Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere
Else, New York: Basic Books (2000) Prosperity Unbound: Building
Property Markets with Trust, by
Elena Panaritis (Palgrave
MacMillan 2007). If you have only time for one, read the shorter work
by Elena Panaritis. It describes the fascinating story of how personal
possessions (characterised through informal, insecure property rights) were
turned into secure property rights and thence into productive capital through
a World Bank project in Peru. The book shows the importance of local
knowledge and of a deep understanding of the institutional prerequisites
for a successful market economy based on collateralisable wealth (especially
real estate). To raise the quality of the rule of law in the property
sector to the point small businesses can credibly offer land and other real
estate as collateral for formal sector finance requires a formal titling
authority, a state capable of reliably maintaining property records, a functional
judicial system, corruption levels bounded from above etc.
The world described in these books, where the foundations of a productive
market economy are being put in place, appears light years removed from
the world of Wall Street and the City of London. In Peru, access to
formal sector finance on reasonable terms thanks to the newly created ability
to offer collateral and perfect security interest, has lifted many out of
grinding poverty. In Wall Street and the City of London, massive resources
and lobbying power were devoted to turning complex, long-term relationships
into tradable securities - preferably into tradable bearer securities, even
when the informational preconditions for this transformation to be effective
were not satisfied. Increasingly, as in the case of bearer instruments
like mortgage-backed securities for instance, the ultimate issuer and the
current owner of the instrument knew nothing about each other. And
even with simpler bearer securities, most of the time no-one knows who the
current owner is, not even the supervisor and regulator.
The endless churning of contingent claims, including derivatives, when
the purchaser has no identifiable insurable interest, turns financial intermediation
into a market-mediated betting shop. Then the betting slips become
bearer securities and are themselves traded, either OTC or on organised
exchanges, and the derivative transactions volumes expand to dwarf the transactions
in the markets for the underlying financial claims (let alone the markets
for the underlying real resources). At that point, the betting tip
of the financial tail of the real economy dog does all the wagging.
It does not create value but redistributes it in a way that consumes real
resources and exposes the real economy to unnecessary risk. It’s time
to tame the tiger.
[1] Tobin, James [1984],
“On the Efficiency of the Financial System”, Fred Hirsch Memorial Lecture,
New York, Lloyds Bank Review, No. 153, July, pp. 1-15, reprinted
in Tobin [1987], Policies for Prosperity; Essays in a Keynesian Mode,
Edited by Peter M. Jackson, Wheatsheaf Books, Brighton, Sussex. pp. 282-296.
Selected Comments
Many posts here seem to feel that as long as the act of gambling helps
the market in price discovery, there are no economic reasons to control
it. In my opinion they overlook one major assertion Prof Buiter made, that
markets are not frictionless. If the outcomes of the bets exact no social
costs, we wouldn't have to burden ourselves with moral suasions to regulate
the market. This, as we have seen, is also not the case (AIG bailouts being
case in point). I don't profess to have the answer, but what do to with
the derivatives market is a question worth asking. To pin it on 'real people
who misued these instruments' and believing that holding them to account
will right the ship, is akin to saying murders won't happen as long as the
police arrests the murderers.
===
Willem,
this is an excellent article. I wish there were more academics making the
plain case that:
- Derivatives unlike equity where real companies create real value are just
a zero sum game.
- Churn only profits the intermediaries who make transactional commissions
(keep the fight Willem, those who criticize you are clearly in that category).
- Let's stop the joke about price discovery:
I recommend a fantastic article from John Dizard in the FT last year: "Put
the credit default swaps market out of its misery" (google that name to
find the full article)
"The value of CDS for price discovery. Bad joke. Price discovery is a useful
economic function; that's the rationale for commodities markets. But CDS
are derivative instruments, whose price is "discovered" these days as a
function of equity volatility, since buying equity puts is one way to dynamically
hedge the illiquid legacy books. So CDS dealer sales of Citigroup equity
through derivatives means higher equity volatility, then higher CDS spreads,
leading to more margin calls, leading to more sales of bank stocks . . .
This has become a system-wide tail-swallowing exercise in lunacy. If the
default rates implied in investment grade CDS spreads were to occur, the
only economic activity would be court-supervised reorganisation.
The CDS market has been preventing efficient
price discovery."
No one needs to sell insurance on my house to
10 different gamblers to help my mortgage lender figure out how much my
house is worth.
- Unless you own the underlying asset, dealing with derivatives = casino
style banking.
- What is wrong with all that? Absolutely nothing, as long as the taxpayer
does not have to foot the bill! The regulation we need is one that makes
sure that no derivative player is too big to fail.
We should operate a break down now, to carve out gamblers from deposit banks.
May I also quote George Soros in "We Need to Regulate the Financial Instruments
That Took AIG Down", FT, March 25 2009
"CDS came into existence as a way of providing insurance on bonds against
default. Since they are tradable instruments, they became bear-market warrants
for speculating on deteriorating conditions in a company or country. What
makes them toxic is that such speculation can be self-validating.
[...] Many argue now that CDS ought to be traded on regulated exchanges.
I believe that they are toxic and should only be allowed to be used by those
who own the bonds, not by others who want to speculate against countries
or companies. "
===
-
Note: typical libertarian nonsense that
ignore question of parasitic finance altogether:
If these arguments are to be taken seriously, we should also ban
interest-rate swaps, currency forwards, call and put options on equities,
index futures, bond futures, currency futures, commodity futures and
options. Many of these have been around for hundreds of years, and are
an important way to control risks, express relative value insights (making
the market more efficient) and provide liquidity.
Credit derivatives are useful just like these other forms; it would
probably be better to have them traded on an exchange, and other reforms
are probably needed, including regulation.
But these instruments are not mere lottery tickets, and WB's draconian
reforms (similar to those who want to ban shorts in stocks) are surprisingly
misguided for someone who is usually so wise and whose ideas are well
thought out.
Posted by: UberDave
|
April 13 06:42pm |
-
. UberDave,
this is a way to easy attempt to ridicule serious people attemplting
to provide solutions to a real problem.
We understand the role of commodity futures (for farmers, ore producers...)
and currency futures (for international companies).
I believe that $170 billion of CDS related losses at AIG footed by the
US taxpayer is a real problem, don't you think?
Willem, just like George Soros is not suggesting to get rid of those
instruments but to regulate them.
In the case of CDS the proposal is to have them allowed only to be used
by those who own the bonds.
That some are just speculating on derivatives (be it commodities, currency
- and I guess Mr Soros knows about that one- or CDS) is fine as long
as society does not have to bail any market participant out. We have
witnessed failure on a massive scale. Something needs to be done. Willem's
proposal makes full sense to me. Do you have a better one?
-
Bill Hodgson |
April 13 08:44pm |
Report this comment
-
. One problem
with the CDS market is that there is a conflict between requiring an
'insurable interest' and providing a thick market in which there are
a large number of (hopefully competitive) trades. In many cases it is
not possible to buy a CDS on the bond that the investor actually holds
- instead the settlement rules state that in the event of default the
holder of the CDS can deliver a range of bonds issued by the firm concerned.
This is a bit like saying that I can buy insurance on my car, and be
paid off if I deliver a 'similar' car to the insurance company. It's
open to manipulation - I have seen statements that when Freddie Mac
collapsed investors tried to deliver principal-only bonds (which, because
of the zero coupon, would trade well below par even if there were no
default) and demand full repayment at par. But if there were a separate
CDS market for each bond (and each tranche of every CDO) there would
be very few participants in each market.
Those who operate in the CDS market must decide if they are providing
something like home insurance (individual-specific, nonassignable, contracts
which require an insured interest) or gambling facilities (standardised,
and assignable between individuals - I can buy another punter's betting
slip). At the moment it seems to me that they want the best of both
worlds - to operate like bookies, but to be bailed out as if they were
responsible insurance companies.
===
As you say "In the UK where there are more legal forms of gambling than
in most other countries, many conventional financial instruments or securities
have been ‘re-engineered’ as formal bets. Spread betting on exchange rates,
interest rates, stock prices and now also house price indices is a popular
form of investment"
I agree except with the last word, 'punt' might be more appropriate than
'investment'. The reality is that gambling seems to be endemic in the UK,
encouraged by this government I might add, who wish the UK to be the gambling
capital of Europe. Derivatives are largely a zero sum game. As is marketing
these derivatives to retail investors through spread betting. A recipe for
disaster for the customers, which is why it is reported that 4 in 5 lose,
and 15% develop serious gambling problems. No wonder that spread betting
firms have no need to hedge much of the bets made with them. Let's reverse
the trend of the gambling culture. In the city and in the home. Or does
the government think that the UK economy should be based on a nation of
buy to let landlords, indebted homeowners, and gamblers. Given all are a
zero sum game as well who is paying the price?
===
-
About non-naked CDS as insurance:
Look, you better have a fire insurance
on your house: you need a place to live and the small chance of a burned-down
house comes with a price tag too high for most.
But why-oh-why would one need insurance
on the bonds you hold? The comparison to your house fails,
as you can easily get rid of those bonds or of bonds altogether. If
for whatever reason you consider these bonds too risky, you sell. You
may sell at a loss, but then next time you hopefully invest more prudently.
Some time ago I read a blog explaining that
CDS as a bond insurance cannot even work: a reasonable (from the point
of view of the insurer) price for the insurance fee would be such that
the net yield of these bonds would make them unattractive for the buyer.
Hence we better get rid not only of naked CDS, but of all CDS (the world
was a much better place before this particular financial innovation).
Also: ¨Key financial markets, including the stock market, the long-term
debt market and the foreign exchange market are characterized both by
excess volatility and persistent misalignments, that is, prices deviating
persistently from fundamental valuations.¨
Bravo! As I commented before: why the recent outrage about not rigidly
holding on to mark-to-market? (FASB rule relaxation: with e.g. many
market values for stocks decreasing/increasing by more than 50% in just
3 weeks, there is no need to enhance the already huge problems by toppling
financial institutions which still have enough cash flow, but mark-to-market
¨deviating persistently from fundamental valuations¨ paper losses.)
Posted by: carol
|
April 14 10:16pm |
Report this comment
-
. Wasn’t going
to post this, but felt obliged to add to Ming’s mirth.
It seems as though the first two commenters, Don and Warfield, either
did not read Buiter’s post or were not equipped to understand it. The
third, Ming, focused on some of the key points, but not the basic logic
of the argument. According to Buiter:
“When financial markets are inefficient, the distinction between fundamental,
exogenous variables and endogenous variables disappears.”
To translate this out of econ-speak, this means: We have every reason
to believe that the prices produced by derivative markets are wrong.
This leads rather immediately to the following conclusion:
“Unbridled derivatives markets may be liquid, but the question is, to
what purpose? If, as I believe, there is no economic rationale for ‘naked’
CDS positions (that is, CDS that do not insure an open default position
in the underlying security), then liquidity of the CDS market only serves
those who want to trade naked CDS.”
In other words, to the degree that prices move because of derivative
trades (and I challenge the “price discovery” crowd to demonstrate that
these movements are meaningful in a fundamental sense) those price movements
may well be of value only to the price discoverers themselves. As long
as they were passing money amongst themselves nobody cared, but when
the taxpayer got involved, they proved indisputably that their activities
were a negative-sum game.
Ming’s existential approach would be fine, if – and only if – the taxpayers
were not involved.
As for commenter #4, Nuti: “But the cost of derivatives markets can
be deemed to be covered by transactors; otherwise derivatives markets
would be closed down.” It is precisely because the costs of the markets
were not covered by transactors that the taxpayers are considering closing
them down.
Posted by: atlarg
|
April 15 07:09am |
Report this comment
with 134 comments
The case for keeping banks in something close to their current structure
begins to take shape. It’s not about traditional claims that big banks
are more efficient, or
Lloyd Blankfein’s argument that this is the only way to encourage risk-taking,
or even the House Financial Services Committee view that immediate resumption
of credit flows is essential for preserving jobs.
Rather, the argument is: those opposed to banks and bankers are angry
populists who, if unchecked, would do great damage. Bankers should
therefore agree to some mild reforms and more socially acceptable behavior
in the short-run; in return, the centrists who control economic policymaking
will protect them against the building backlash. This is a version
of
Jamie Dimon’s line: “if you let them vilify us too much, the economic
recovery will be greatly delayed.”
There are three problems with this argument: it is wrong, it won’t work,
and it doesn’t move the reform process at all in the right direction.
The “center vs. the pitchforks” idea fundamentally misconstrues the current
debate. This is not about angry left or right against the center.
It’s about centrist technocrat (close to current big finance) vs. centrist
technocrat (suspicious of big finance; economists, lawyers, nonfinancial
business, and - most interestingly - current/former finance, other than
the biggest of the big, particularly people with experience in emerging
markets.)
Just as an example, a broad range of entirely centrist people (including
in and around the IMF; former Treasury; you’d be amazed) are expressing
support for the ideas in our Atlantic article. People on the left
are, not surprisingly, also in line with this view; but we’re also hearing
convergent thoughts from some on the right - many who emphasize improving
the environment for entrepreneurship don’t see big finance as their friend.
So far, the only person who called to complain works for an “oligarch.”
You might think the “anti-pitchfork” strategy might work, particularly
as it has in the past (e.g., in the early Clinton years). The problem
for this strategy now is not just the fragile state of banks - by itself
this can be ignored for a long while through forbearance, behind a smokescreen
of complicated schemes with confusing acronyms - but the ways in which the
markets they created now operate.
Just as global financial liberalization created the potential for capital
to move violently across countries and greatly facilitated speculative attacks
on currencies, so financial deregulation within the United States has made
it possible for capital markets to attack - or, in less colorful terms,
go short or place massive negative bets on - the credit of big banks and,
in the latest developments, the ability of the government to bailout/rescue
banks.
The
latest credit default spreads data for the largest banks show a speculative
run underway. As the system stabilizes, it becomes more plausible
that a single big bank will fail or be rescued in a way that involves large
losses for creditors. This would like trigger further speculative
attacks on other banks, much as the shorting of countries’ obligations
spread
from Thailand to Indonesia/Malaysia and then to Korea in fall 1997.
The government’s own policies are facilitating these attacks, because
as the Fed and Treasury make progress towards easing credit conditions,
this makes it easier and cheaper for large hedge funds and others to take
large short positions. And keep in mind the underlying loss of confidence
is self-fulfilling: as you lose confidence, you want to go short, and selling
the credit causes further loss of confidence - and banks are forced out
of business.
The government’s entirely reasonable and long overdue request for a resolution
authority will set up runs on that authority. If the authority is
not granted, the runs will be on the government’s low and failing ability
to save banks - given that the trust of Congress has been lost and no more
cash for bailouts is likely forthcoming (presumably until there are large
further shock waves or until Goldman Sachs itself is on the line.)
The continuing pressure on banks has nothing to do with populism and
everything to do with the internal contradictions of the house of cards
they built. Now they will scramble to limit short selling or find
other emergency measures that will protect their credit. Such partial
fixes would do nothing to stop the underlying deterioration of their credit;
think about how countries facing currency attacks
throw up futile defenses, try to change the rules, and squander their reserves
on the way down.
You can see where this is going, but do not cheer. The likely result
will be misery for many and further financial chaos around the world.
The big issue is of course the financial sector reform process.
Some of my colleagues expressed great satisfaction with the progress made
by the G20. But progressing down a blind alley is not something to
be pleased about. I have yet to hear a single responsible official
in any industrial country state what is obvious to most technocrats who
are not currently officials: anything too big to fail is too big to exist.
If the bankers were just stupid, as
suggested by David Brooks, then regulatory fixes might make some sense.
But we know that bankers are smart, so it is their organizations that became
stupid. What is the economic and political power structure that made
it possible for such stupid organizations to become so large relative to
the economy? Answer this and you address what we need to do going
forward.
At a high profile conference in the run-up to this crisis, someone destined
to become a leading official in the Obama Administration responded to a
sensible technocratic critique of the financial system’s incentive structure
(from the IMF, no less) by
calling it “Luddite”. By all accounts, this is the prevailing
attitude in today’s White House.
But the right metaphor is not breaking productive machines, or peasants
with pitchforks, or even the poor vs. the rich. It’s as if the organizations
running the nuclear power industry had shown themselves to be stupid and
profoundly dangerous. You might wish to abolish nuclear power, but
that is not a realistic option; storming power plants makes no sense; and
the industry has captured all regulators ever sent after them.
The technocratic options are simple, (1) assume a better regulator, of
a kind that has never existed on this face of this earth, (2) make banks
smaller, less powerful, and much more boring.
By Simon Johnson
Selected Posts
-
I find Simon’s analysis compelling, as usual. I also find a few points
of convergence with David Brooks, except for his last statement about
inbred oligarchs vs. dufusness, (is that a word?).
Not to sure about the inbreeding, that was more during the days of
monarchies, but the CEOs of Bank of American, et al, are for sure, oligarchs.
In fact, in the various companies I’ve worked for in the IT industry
over the last 28 years, (with the conspicuous exception of Digital Equipment
Corporation under Ken Olson, may it rest in peace), the boards of these
big companies behave and live as oligarchs as well.
This was especially notable under Lou Gerstner when I was with IBM,
(in one year, he took away $20 million in just stock options, forget
his multi-millon dollar salary). That same year, I got layed off and
was out of work for 25 months, went broke, and got a different view
of the world.
I think Lou did ok, though, thank goodness. He also spent 2.2 billion
buying Price Waterhouse Cooper to replace the group I was in that was
getting whacked. This all happened in 2001, and just as Enron tanked.
In a lot of ways, I did not really see the U.S. recover from the
tech and Y2k bubble, we just moved into a housing bubble with cheap
money and greedy investors that allowed the financial industry to complete
their going completely nuts with money.
“And - here - we - go!” - The Joker
Just my 2 cents,
- Simon wrote:
“The “center vs. the pitchforks” idea fundamentally
misconstrues the current debate. This is not about angry left or right
against the center.”?
Not yet, anyway. But there is more brewing (in the States, anyway)than
meets the eye. As long as people keep thinking that most of what they
have lost will eventually come back, things will be heated, but non
violent. But if it begins to dawn on people (correctly or not) that
that 401K plan, and that job, and that pension, and the value of that
house, and that health insurance policy, are not coming back, there
will be big, big, trouble.
April 7, 2009
James Bone in New York
The hedge fund manager J Ezra Merkin, a pillar of New York society, was
accused of fraud yesterday for allegedly funnelling investors' money to
Bernard Madoff, the Wall Street swindler.
New York State alleged that Mr Merkin, president of the wealthy Fifth
Avenue synagogue founded by his father, had failed to tell his well-known
clients — including Elie Wiesel, the Nobel laureate and Holocaust survivor
— that he was placing their money with Madoff.
The state's complaint alleged that Mr Merkin had channelled about $2.4
billion (£1.63 billion) to Madoff, while collecting $470million in fees
and performance bonuses.
“Merkin duped individual investors, non-profits and charities into believing
he was responsibly managing their investments, when in actuality he was
dumping them into history's largest Ponzi scheme,” Andrew Cuomo, the New
York attorney-general, said.
The civil charges also allege that Mr Merkin mingled his personal funds
with the accounts of Gabriel Capital Group, his management company, and
used some of the company's money for personal purchases, including $91million
worth of artwork for his Park Avenue apartment.
There's a popular Sicilian proverb:
Cu è surdu, orbu e taci, campa cent'anni 'mpaci.
"He who is deaf, blind, and silent will live a hundred years in peace."
Enron, WorldCom, HealthSouth, Tyco, Parmalat, Adelphia...You would think
enough lessons had been learned. The financial markets are a mess and the
capitalist system threatened. The systems in place to anticipate and preempt
market risk failed completely. Financial firms leveraged their capital to
an unprecedented extent with no checks and balances. Companies took on enormous
risks with minimal disclosure to their shareholders.
And the largest global public accounting firms -- KPMG, PricewaterhouseCoopers,
Deloitte, and Ernst & Young -- again failed to prevent, warn, or mitigate
the desperate financial situation, the national crisis of significant proportions
we now find ourselves in.
"...There were systematic failures in the checks and balances in the
system, by Boards of Directors, by credit rating agencies, and by government
regulators..."
Even the
US
Treasury Secretary doesn't hold the public accounting firms accountable
for the problems we now face. The Big 4 public accounting firms haven't
yet been asked the hard questions by governments, legislators, or regulators.
They're getting a free pass.
The global public accounting firms have worldwide, government-sanctioned
franchises as market watchdogs. They are supposed to be working to protect
shareholders' interests. Financial statement audits are required by most
global exchanges -- to provide a seal of approval on the financial disclosures
of public companies. The accounting firms employ accountants, licensed by
local authorities and trained as auditors. These "professionals" audit the
financial statements of public and private companies, governments, and not-for-profit
organizations worldwide. Public accountants must express an opinion on those
financial statements.
In the United States, certified public accountants are the only authorized
non-governmental type of external auditors who may perform audits of financial
statements and provide reports of those audits for public review, submission
to the SEC, and to comply with exchange listing standards. In the United
States, the firms and their licensed professionals are required to be independent
of the entities being audited.
The Big 4 public accounting firms are very big business themselves. As
an industry, the top firms generate more than $100 billion in total revenues
globally and employ hundreds of thousands of people. As auditors and advisors,
they work inside the banks, brokerage firms, auto manufacturers, mortgage
brokers, and homebuilders. They're "in the know" about every public company
and most large private companies, earning millions of dollars in fees, for
audit opinions that have ultimately proved worthless. They were right there
in the boardrooms when the US government took over Fannie Mae, Freddie Mac,
and AIG. They are still at executives' right hands, earning more fees
helping the US federal government under TARP to organize and control
the taxpayers' new investments in subprime loans, non-liquid assets, and
exotic financial instruments. The public accounting firms make money whether
companies thrive or whether they fail. The Big 4 firms are now charging
billions to advise each other's clients as those companies file for bankruptcy
protection.
According to
a study by David L. Carter, Ph.D. at Michigan State University's School
of Criminal Justice, the basic characteristics of organized crime are:
• Profit accumulation • Longevity • An organizational structure that
facilitates criminal activity • Efforts to corrupt government officials,
police, and corporate official • The use of violence
Profit accumulation
Big 4 firms continued to see significant double-digit growth in top line
revenue during 2007-2008, even though the recession had already started.
Who else besides pimps, loan sharks, and illegal gambling had such a great
year last year? Such monopolistic growth and profit is due in large part
to the lack of competition within the industry. The largest four global
public accounting firms audit almost 99% of public company revenue in the
United States and all but one of the UK's top 350 companies.
Since the passing of the Sarbanes-Oxley legislation in 2002, public companies
have complained that audit fees have tripled or even quadrupled. They are
still increasing, albeit at a slightly decreasing rate. But the combination
of mandated audits and the addition of Sarbanes-Oxley requirements prompted
many companies to use words like "extortion" and "protection money" to describe
their feelings regarding the cost of pieces of paper that seemed to provide
so little tangible value to shareholders. Paying for an audit, defined as
broadly by the auditors as they chose, became an "offer you can't refuse."
Longevity
The Big 4 public accounting firms are loose confederations, combinations
of firms, many of which started all the way back in the late 19th Century.
Firms have merged and grown, some dying along the way, and others becoming
predators of the weaker ones. The largest four firms compete on paper, yet
coexist in a cooperative manner -- much like the five New York City crime
families: the Bonannos, the Colombos, the Genoveses, the Gambinos, and the
Luccheses -- in order to achieve common objectives via industry lobbyists
such as the
Center for
Audit Quality.
An organizational structure that facilitates criminal activity
The public accounting firms are organized as partnerships, like law firms.
They recruit and promote less like a business, based on merit, and more
like a
secret society or fraternity.
"Becoming a made member of La Cosa Nostra requires serving an apprenticeship
and then being proposed by a Boss. This is followed by gaining approval
for membership from all the other families."
Acceptance and success in the Big 4 public accounting firms requires
selection based on university credentials, referrals from professors, family
background, and business ties, as well as having political beliefs and economic
philosophies that are aligned with firm values. Internal operations are
conducted in a secretive manner. Financial results and common business metrics
are minimally disclosed to the outside and on a "need to know" basis internally.
There's a type of Big 4
omertà,
the extreme form of loyalty and solidarity in the face of authority usually
attributed to the Mafia. Once initiated into firm culture, survival requires
adoption of this informal oath of allegiance that makes it shameful to betray
even one's deadliest enemy, your competitors, to legal and regulatory authorities.
Examples of this extreme sense of loyalty to even those who've disgraced
the profession can be found when partners that have been sanctioned by the
SEC, forbidden to audit public companies, are later reinstated by the SEC.
Deloitte, for example, maintained the partners responsible for Adelphia
and Navistar on their payroll during their SEC suspension and they lived
to audit another public company another day.
Efforts to corrupt government officials, police, and corporate
officials
All the public accounting firms spend a lot of time and money publicizing
their good works. There's a ton spent on volunteerism and donations to foundations.
There's a press release a day about some or another warm and fuzzy diversity
initiative in spite of the documented lack of progress in getting women
and minorities to partner positions in proportion to their numbers in universities
and entry level positions. They spend a bucketful of money to erase the
fact that they're otherwise sucking money out of the economy for essentially
worthless audit opinions.
There's also a big spend on political campaigns. For example, all of
the US based public accounting firms like US Senator Christopher Dodd. It's
not the man, his party, or his politics, but his position that attracts
the dollars. The Chairman of the Senate Banking Committee has significant
influence over the legislation affecting the Big 4 public accounting firms.
Another big recipient of the audit firms' largesse is US Senator Charles
Schumer. Early in the subprime crisis, he was heard demanding action from,
of all people, the accounting firms. This is comical. After all, the public
accounting firms pay Schumer to protect their interests, not the other way
around.
Ernst & Young is one of his all time career big donors.
Deloitte is one of his largest campaign contributors. As a matter of
fact, E&Y and Deloitte are in his top 20 all time greatest contributors.
The use of violence
Violence is the only thing left that the firms haven't depended on to
accomplish their goals. That we know of... However, their labor practices
have been the subject of
class action lawsuits in the US and Canada during the last few years.
It appears they do not pay overtime when they should and work their professionals
like the interns on TV's ER.
We've all seen what sleep deprivation can to do the quality of medical
care. Imagine what being overworked and underpaid does to the quality of
accounting and audit work performed by thousands of new college graduates
hired each year. These are the foot soldiers doing the hands-on work to
insure the accuracy of the financial information published by your employer
or the companies in your 401k. There's even a case from 2007 when a
poor young woman in Romania working for Ernst & Young died from exhaustion.
She was working long hours without rest under pressure to keep her job.
The Ratings Agency Circle Jerk
Controlling and making money from all sides of a transaction is another
potential sign of a criminal organization at work. In the aftermath of the
financial crisis, the press, global legislative bodies, and regulators all
got sidetracked by concerns over the issue of culpability of the ratings
agencies. What they missed is the unholy alliance between the rating agencies,
the auditors of the ratings agencies, the companies whose bonds were being
rated, and the auditors of those bond issuers.
• The public accounting firms certified financial statements and gave
clean audit opinions for companies that issued mortgages and mortgage-backed
securities.
• The ratings agencies counted on these audit opinions and performed
no further due diligence to ascertain those opinions were justified.
• The public accounting firms audit the ratings agencies. The three largest
ratings agencies, Standard & Poor's (part of McGraw-Hill), Moody's, and
Fitch (part of Fimalac, a French company) are all public companies that
are required to have their financial statement audited by KPMG, PricewaterhouseCoopers,
Deloitte, or Ernst & Young.
• The public accounting firms audited the failed companies that issued
the mortgages such as New Century, Countrywide, Northern Rock, and American
Home.
• They also audit the firms such as Bear Stearns, Citibank, Bank of America,
and Merrill Lynch that created, marketed and invested in the packaged mortgage
securities -- many of which ended up off balance sheets. And they audit
the monoline credit risk insurance providers MBIA and AMBAC.
The public accounting firms and their hundreds of thousands of auditors
should be an investor's first line of independent defense. But these firms
turned a blind eye to the excesses, mismanagement, and fraud of executives
managing their client firms. The public accounting firms issued clean financial
opinions for all of the firms that eventually, most less than a year later,
failed, were taken over, or nationalized. And the regulators slept.
There's something about the Big 4 public accounting firms, and to a lesser
extent their next tier firm colleagues, that allows them to make money,
to thrive, in spite of failure all around them. They continue on, oblivious
to accelerating rates of litigation against them and the realistic threat
of a catastrophic lawsuit.
Their solution to the legal threats resulting from their clients' frauds
and failures?
Liability caps.
Governments all over the world are protecting and shielding the public
accounting firms from failure under any circumstances, even in the face
of repeated failure on their part. The current business model for global
public accounting firms no longer promotes the safeguarding of shareholder
interests in the modern publicly traded multinational. Shareholders, and
other stakeholders, are being shafted. The firms and their partners may
be corrupt. They are unequivocally self-interested.
When it comes to the Big 4 public accounting firms, the official word
is still, "Too few to fail. Too powerful to call to account."
Steve Waldman makes
some bold
claims in tonight's post:Work
makes a comeback
A "lifetime" of work has until recently usually meant just that, with no notion
that it be followed by retirement and ease. The West's baby boomers, their pensions
disintegrating just as they were coming into reach, are very painfully about
to rediscover history.
In two recent Surowiecki posts (here and here), Surowiecki points out that
during the banking crises of the early eighties and early nineties, banks
were arguably as insolvent as our banks are today, but hey, with a little
time and without any radical changes, everything turned out great....
The fundamental difference between my perspective and Surowiecki's is that
I don't think those previous recoveries were real. My view is that the crisis
that we're in now is precisely the same crisis we've been in since at least
the S&L crisis. We've had a cancer, with some superficial remissions, but
fundamentally, for the entire period from the 1980s to 2008, our financial
system in general and our banks in particular have been broken. They have
profited from allocating capital poorly, from funneling both domestic loans
and an international deficit into poor investments (current consumption,
luxury housing) rather than any objective that might justify arduous promises
to repay. We all got a reprieve during the 1990s, because internet enthusiasm
persuaded many investors to fund our consumption via equity investment,
which we could wash away relatively painlessly in a stock market crash.
Debt investors don't go so quietly. Thanks to the cleverness of our banking
system, we have a very great many lenders, both domestic and foreign, who've
invested in trash but who demand to be made whole at threat of social and
political upheaval. That is the failure of our banks. That they are insolvent
provides us with an occasion to hold them accountable, and to reshape them,
without corroding the rule of law or respect for private property...
There are profound economic problems in the
United States and elsewhere that our financial system has proved adept at
papering over rather than solving. Those of us who've played
Cassandra over the years have been regularly ridiculed as just not getting
it, as economic illiterates and trade atavists. Unfortunately, as Dean Baker
frequently points out, the people who could
never see the problems are the only ones invited to the table when the world
cries out for solutions. The solutions on that table are
those Surowiecki tentatively endorses, weather the storm, take some time
to repair, the temple is structurally sound.
But the temple is not sound. We either build a decent financial system,
or suffer real consequences, in unnecessary toil and lost treasure, in war
and conflict over false promises set down in golden ink.
The banking crisis and the high unemployment rate are not the crisis, they
are symptoms. This is not "dynamo trouble", it is a progressive disease,
and what is failing is the morphine. Those of us who believe that financial
capitalism is a good idea, that it could be the solution, not the problem,
do their cause no favors by resisting radical changes to a corrupt and dysfunctional
facsimile of the thing. We need to approach financial capitalism as engineers,
and to largely rearchitect a crumbling design. If we don't, we may be so
unfortunate as to suffer yet another superficial remission. But error accumulates,
and error on the scale now perpetrated by national and international financial
institutions are unlikely to be without consequence.I'd love him to tease
this out further, and I am a bit too fried to give this a long form treatment,
but let me volunteer a few thoughts:
- A very short and grossly simplified history of banking in the last
40 years is banks used to be tightly controlled, profitable, and not
(for the most part) able to do much damage. For instance, deposit rates
were regulated. Nevertheless, very creative banks nevertheless managed
to get themselves in lots of trouble (Citibank and its buddies in the
sovereign lending crisis, for instance).
- The inflation of the 1970s created a huge mess for this model. Even
with regulated deposits (and depositors were very unhappy with negative
real yields and aggressively sought other cash-stowage options), many
banks also funded some of their balance sheet in the money markets.
You had spectacles like banks bleeding on
their credit card portfolios (and remember, those yielded
a lot better than a lot of other types of loans) because short term
rates shot up to 22%.
- Various aspects of banking were deregulated (deposit rates, usury
ceilings, interstate banking, the division between banking and securities
was chipped away at over years, with the playing field pretty much open
before Glass Steagall was formally abolished in the late 1990s).
But the interest rate volatility was and still is a real mess for banks.
From what I can tell, the hedges (using product design to put more of the
risk back on customers, explicit hedges, astute asset liability management)
only partly remedy this problem. In an increasingly
competitive environment, my impression is banks have not been able to extract
enough additional margin for assuming this risk. Anyone know
of any work in this area?
Second is that investment banks ate commericial banks lunches for a very
long time. I read from time to time that the
reason securitization became more prevalent was that banks felt it was less
attractive to hold assets on their balance sheets, i.e., this was an opportunistic
move.
While technically, that isn't wrong, that isn't how I'd frame it. I recall
when I was at McKinsey in the mid 1980s and securitization was taking off
that one of the standard charts showed banks that securitization was cheaper
than on balance sheet intermediation due to the cost of bank equity and
FDIC insurance. That was seen as a bad thing for banks back then because
it meant they were losing market share big time to investment banks.
Third is bank consolidation proved to be a very bad idea, and I see NO ONE
addressing this issue. It isn't simply because it created huge concentration
and too many too big to fail banks (a lot of countries have highly concentrated
banking systems, such as Canada and Australia, but their banks are kept
on shorter leashes).
The reason is that bank consolidation delivers NO economic benefits. The
big lie is big banks are more efficient. They aren't. Every study ever done
of banks in the US has found that once banks reach a certain size threshold,
they exhibit a slightly increasing cost curve, meaning they are more expensive
to operate.
But you might protest, when those banks buy each other, they may big noises
about cutting costs. Right. They could have taken those costs out without
a merger. It just gave cover for measures that would be too painful to execute
in stand-alone entities.
The real reason for bank mergers is CEO pay
is highly correlated with a bank's total assets (and the CEO of the acquired
bank is enriched sufficiently to get his acquiescence).
And worse, big banks have completely abandoned the notion that the knowledge
that local managers have by virtue of being in a community (in terms of
improving lending decisions) has value and can be leveraged. Instead, they
all went full bore for FICO and other faux-science credit scoring models,
and have perilous little to fall back on now that those have proven to be
badly flawed.
I do think Waldman is on to something here, and hope his post elicits further
comment. I'd be particularly curious to see
John Hempton pick this one up, since he keeps defending the native earning
power of US banks.
Cuomo said in a Feb. 10 letter that Merrill “chose to make millionaires
out of a select group of 700 employees,” and that a smaller group was awarded
“gigantic bonuses.”
The top four recipients received $121 million, the next four a combined
$62 million, and the next six a combined $66 million, he said.
Overall, the top 149 people who got bonuses received a total of $858
million, according to Cuomo’s letter. He said 696 people got bonuses of
$1 million or more.
Thain was dismissed in January by Bank of America Chief Executive Officer
Kenneth D. Lewis. The move came after disclosure of the bonuses and
Merrill’s fourth-quarter loss.
The case is People v. Thain, 400381/2009, New York state Supreme Court
(Manhattan).
Selected comments
- Anonymous said...
- My father worked for the Coc during the 80's.
He couldn't believe that anyone would want to BUY and securitized mortgage.
On selling them, he was also less than thrilled. Why, if you believe
it was a good loan, would you sell it?
I heard about this when I was young. He spoke of banks that when they
had to sell loans, sold the best they had, in order to maintain the
reputation of the bank among its peers.
What happens when they don't have peers? Or equity?
My favorite line from him I have repeated several times before here-
Don't buy bank stock, put your money in the bank, its much safer.
He also added that if you had enough money in the bank, soon enough
you could end up as an owner of the bank anyway, at a much better price.
-
March 14, 2009 4:29 AM
- Buffet clearly seemed to subscribe to Surowiecki's
view during this marathon CNBC interview. Obviously, Buffet is talking
his book. But Geithner et. al. seem to have embraced the idea that with
interest rates so low and spreads so wide, banks will have tremendous
earning opportunities in the next year or so (despite the McKinsey report
to the contrary), and that if Treasury gives the banks enough capital
to tide themselves over, they can earn their way out of their holes.
Hoping your problems will go away is not a policy. And we do need to
fundamentally reform the banking system. Hopefully Obama will start
listening to Volcker (assuming Summers doesn't completely marginalize
him).
http://hedgedbet.blogspot.com/2009/03/buffet-hints-at-geithners-plan.html
-
March 14, 2009 4:54 AM
- Hempton won't pick up on Waldman's theme because
he doesn't see or care about the issue raised. Hempton's (and Geithner's,
Summer's, Bernancke's) principle concern is restoring the financial
system status quo, making sure all debt holders are kept whole even
if it impoverishes the debtors, and profiting on the rising share prices
of re-capitalized banks. It's a great trade for folks with money.
Waldman, Simon Johnson, Chris Whalen and others are primarily concerned
about something else - restoring integrity and transparency to the financial
system and clearing the enormous moral hazard the Fed and Treasury have
wrapped around the system. That is hard work - it can't be fixed by
printing money - and is either beyond the abilities of Geithner and
Bernancke or, more likely, they are so captured by the kleptocracy they
will resist any real reform.
I have to laugh when wing nuts complain that Obama is a socialist. He
isn't even a progressive - picking Geithner and Summers proved that.
A progressive would have folks like Joe Stiglitz and Michael Hudson
on his team.
- Anonymous said...
- «I have to laugh when wing nuts complain that Obama is a socialist.»
Well, Real Americans obviously know better: he is upholding what they
see as a regime of Communist terror and extortion with holdups like
the minimum wage, and letting taxes on the productive, deserving Real
Americans go back up to the punitive levels they had under Clinton.
«He isn't even a progressive - picking Geithner and Summers proved
that. A progressive would have folks like Joe Stiglitz and Michael Hudson
on his team.»
My hope is that he is playing a long game. He probably knows that the
first 2 years will be hell, so he has nominated all his best enemies
to take the heat of those and get burned out.
Would you appoint your best team to get their reputation shredded and
their stamina stressed out by being pummeled by the aftermath of 8 years
of unrelenting Bushness?
He may hope that containing trouble in the next 2 years will burn out
Gates, Hillary, Geithner, Summers and the other culprits, and then he
will bring out when there is hope for a rebound and a chance to fix
things instead of just trying to contain the mess.
- The roots of the banking crisis founded in
events of the 1980s fits with another important event. Abandonment of
the gold standard in 1972. "The inflation of the 1970s created a huge
mess for this model." Exactly - once the discipline of the gold-standard
was completely abandoned - simple bread-and-butter banking became a
broken model - leading to all the distortions still seen today.
The perceived "failure" of the gold-standard since the 1930s is really
governments breaking out of the money supply structures of the gold-standard.
A breakout which produced a multi-decade credit-bubble boom, doomed
from the beginning.
- The 80s S&L event, was a miami coke dream that,
after the first years high, ran into the manic stage of addiction or
SDOs and their party friends. I still look at the tall piles of coke..I
mean buildings in down town miami, as the power of one drug that still
echos in time or the opening bell on wall st.
Grosse pointe...damm my batt score and that little white paper I signed
in the accustic tiled room FTA.
- "Mr Welch argues that focusing solely on quarterly
profit increases was “the dumbest idea in the world”. “Shareholder value
is a result, not a strategy,” he says. “Your main constituencies are
your employees, your customers and your products."
In other words, stock price is not the 'purpose' of the business.
Business schools have been teaching that shareholder value comes first
since the 1980s.
And, I believe, CFO responsibility to shareholder value became the law.
(the excuse for perpetuating the university teaching against all common
sense)
The debate for regulation of stock options for compensation and violation
of insider rules has begun. That's my hope. For without it, now that
gov is in on it (Citi exec insider gains on leaked info openly), the
destruction of trust of America and its markets can only gain momentum
with consequences for everyone, not just shareholders.
Welch's statement could also mean we can look forward to the end of
Congressional posturing about caps on compensation and get on with real
regulation of stock options to eliminate short term incentives at the
expense of economic stability and real value to consumers and workers.
Stock options for executive compensation is a conflict of interest and
incentive for the legal looting as well as the 500X disparity in executive
pay that has taken place the last couple of decades.
LeeAnne
- So this is somewhat related.
If there is such an opportunity in banking why isnt there private capital
being put together to form a brand new bank that is unemcumbered by
the past.
Shouldnt it be able to go around picking up some bad banks and working
them out OR grow organically by picking off the customers of the nasty
banks?
Just curious why this doesn't seem to be happening if the at an industry
level the opportunity is so attractive.
- The point about bank mergers is an excellent
one, and one that not enough people are talking about.
It's not just bank mergers but PE, and LBOs, that have created most
of the entities being bailed out these days. From that perspective the
governments activity over the last year starts to look more and more
like a rescue of the LBO industry. Why is hard to fathom, but methinks
invidious comparison is at the root of it.
It is beyond hilarious that the 'market always knows best' has become
'there really is a 'true' value not reflected in the price' in the mouths
of the very same people and economic/political actors. The clear implication
is that what we are really going through is the attempt (for whatever
reason) to prop up investment values, and in particular, stock prices.
That is to say, to make the world safe for those who would become billionaires
by buying and selling little strips of white paper.
- Waldman is talking forest, but Yves is responding
tress. Bit of a disconnect....
- Interesting post for its broader perspective,
more like this are needed that are even broader in nature ...
The very noticeable shift in the past forty plus years has been politically
driven and willfully intentional. And if one looks carefully it is more
global in nature and effects all sectors of all societies ... it is
a shift from plain old fashioned vanilla greed to a newer more vile
gangrenous elite greed ... a shift in the ruling class from the driving
force of the profit motive to the driving force of the control motive
...
It is that shift in the ruling class that has caused the attendant societal
motivation to be changed from one of desire and opportunity as the norm
of the world’s zeitgeist, to fear and anxiety being the norm. That very
intentional zeitgeist shift has been, and is now, meant to create perpetual
conflict in the masses so as to effect a ruler and ruled world societal
model.
Unsustainability of consumption and the role of increased population
was recognized long ago. Those now in control have very skillfully acted
upon those insights by hijacking and co-opting key components of world
governments and societal sectors through deception.
We need to “rearchitect” a new system. It begins with removing the controlling
ruling elite. But first the deceptions need to be exposed and we must
deprogram from those deceptions.
Even at this point it is still possible to have a sustainable and harmonious
world. It won’t happen if scamericans occupy their valuable time watching
the deflective antics of Cramer and Stewart ...
Deception is the strongest political force on the planet.
I on the ball patriot
- If the banking system is sick it seems to have
infected everything else and that makes forecasting especially perilous.
Yes, the banks COULD make a lot of money based on their interest spreads
but to whom do they make these loans? A year ago oil and gas
seemed to be a sure bet. Building a natural gas pipeline from Alaska
to the US would've have been a sure
thing? Until... now. A Toyota plant
in Mississippi? Can't miss, er, oops don't need it anymore.
We've seen every hot thing be it housing, commercial construction, LBO's,
mining, drilling, LBO's, ethanol, bio-diesel, railroads,etc. etc. go
from best bets to total write offs in months.
You can't make loans with the world in such chaos and have any assurance,
absent government guarantees, that the project you lend money to today
will be viable by the time it is completed.
- I think Waldman is making a fundamental point,
and here's an attempt at teasing it out.
The economic rationale for banks arises from information asymmetry and
the agency problem. In a nutshell, borrowers have the knowledge (about
their own risk) and incentive to game lenders. Banks exist to obtain
enough information about borrower risk to eliminate this asymmetry.
For this act, they earn a profit.
Of course, you can argue that banks long ago gave up their ability to
assess credit risk. Sure they credit departments, but these arguably
have been taken over by "blind" decision rules and models. Essentially,
credit departments, in competition with securitization, decided that
if you can't beat them, join them.
The result was chronic mis-allocation of credit. The more that the growth
in leverage pumped up the economy, the more mis-allocation occurred,
the more systemic risk accumulated.
So Waldman implies that banks should go back to the business of assessing
credit risk. This argues for smaller banks taking discrete (rather than
pooled) risks at a higher cost (credit assessment and monitoring is
expensive).
- This brings to fore two of my pet issues: The
demise of the small independent bank under a bank holding company and
Paul Volcker's role in the destruction of US industry.
The small bank under a bank holding company was a result of a lot of
abuses of large banks and their many branches during the period surrounding
the Great Depression. Minnesota, Iowa and and a number of midwestern
states banned branch banking as a result of the rapacious removal of
wealth from farmers and small communities by large money center banks.
The result of the ban of branch banking, was a robust system of small
banks that either had a correspondent relationship with a money center
bank or partial ownership. These banks were not unlike today's credit
unions and were independent in their policies regarding loans and business
relationship. They were very agile, as compared to today's monster banks
with rigid procedures, and hamstrung managers, or worse yet buccaneer
managers that are bonused on next quarter's loan production quotas.
The large branch banks are unmanageable and unable to deal with local
needs and problems. They collapsed because of their detachment from
risk, and inabilty to foster real local industrial and retail development
instead of the faux housing and retail booms.
As for Volcker, he is completely responsible for the credit explosion.
His push to higher interest rates, demise of usury bans, and rescue
of the dollar in the face rising imports pushed wealth into money center
monster banks, denuding the countryside of productivity and wealth.
I think that summarizes my regard for branch banking and Volcker.
- «Of course, you can argue that banks long
ago gave up their ability to assess credit risk. [ ... ] credit departments,
in competition with securitization, decided that if you can't beat them,
join them.»
That's a fairly large misunderstanding of what went on. It is not that
credit assessment became too expensive compared to securitization...
It is that it became too expensive compared to the cheap cost of money
and the ability to buy AAA ratings for any loan. If you can borrow at
0% (Japan) or 1% (USA) before inflation, and your friendly rating agency
gives AAA to any MBSes, how can you justify wasting money that could
go to enrich your bonus on assessing borrowers?
- Need to add one more point on the issue of
branch banking.
One key point is that banning branch bank actually means less regulation
of banking than more. By banning branch banking, banking excesses are
self limiting to a small bank, and those failures can easily be covered
by FDIC. With large branch banks, excesses require massive regulation
and supervision, and massive insurance.
We can see that internal branch bank supervision is wholly inadequate.
Federal supervision would need to be of such a massive scale, it would
take the US Air Force and its personnel. Federal insurance is wiping
out Federal finances today. Even all of FDIC is inadequate.
The only viable solution to managing bank excesses is not regulation,
but limitation on banking reach, and overreach.
PS, two of the most profitable current large banks, Wells Fargo (formerly
Northwest Bank), and US Bank (former First Bank) were bank holding companies
in the Midwest.
- «the rapacious removal of wealth from farmers
and small communities by large money center banks.»
In Real America, losers' money is there for the taking...
«buccaneer managers that are bonused on next quarter's loan production
quotas.»
...by the winners.
How does it feel for midwesterners to be the new Indians?
Those small farmers and communities have been in a depression for the
past 20-30 years; the bonused managers are enjoying their early retirements
in very comfortable wealth.
That comparison is all that matters in Real America. How many of those
midwestern small farmers and communities have been voting steadfastly
for the Republicans?
- «By banning branch banking, banking excesses
are self limiting to a small bank,»
Sure, and mortages losses are always uncorrelated! The whole of Texas
never had a simultaneous slump, and so on.
The S&L crisis was a totally random event, and the large percentage
of small thrifts that went all busts at the same time was a statistical
oddity, not because they were run by a herd of greedy idiots responding
to the same perverse incentives in the same way...
If there are good reasons to prefer small banks to large ones they are
that they are more efficient, and usually they have less political power,
and less market power.
Yesterday's lonely defense of Federal Reserve actions
during the gestation period of the largest asset and credit bubble in the
planet's history by the man once called "The Maestro" seems to have
gone over like a lead balloon if today's reactions are any indication.
Following the op-ed piece adamantly titled
The Fed Didn't Cause the Housing Bubble, long-time critics again sharpened
their pencils and did their best to encourage the former Fed chief to just
fade away from the spotlight, a graceful exit now clearly out of the question.
Caroline Baum at Bloomberg offered up this
commentary earlier today:
Even if one missed the headline (“The Fed
Didn’t Cause the Housing Bubble”) and the byline (Alan Greenspan) on
the op-ed in yesterday’s Wall Street Journal, there could be no confusion
over authorship: That “Master of Garblements” and former Federal Reserve
chairman was back to defend his legacy.
Greenspan lays out his case that the Fed’s easy money policies can’t
possibly be to blame for “the U.S. housing bubble that is at the core
of today’s financial mess.” It is long-term interest rates that determine
“the prices of long-lived assets,” such as housing, he writes. And those
rates, which stayed low as a result of a “global savings glut,” are
out of the Fed’s control.
Yes, the well documented "conundrum" caused by millions of laborers coming
down from the mountains in rural China that left the second most powerful
man in the world powerless to prevent a housing boom from turning into what
increasingly looks like another depression.
Putting a little meat onto the bones of yesterday's
Alan Greenspan still hasn't got a clue when it comes to the argument
of just how much long-term rates factored into the mid-decade housing mania,
Caroline notes the following:
Banks and other mortgage lenders were happy to arbitrage the spread
between the free money provided by the Fed and the rate they charged
for an adjustable-rate mortgage. The share of ARMs as a percentage of
total mortgage loans averaged 10 percent in 2001; by 2004, it was 32
percent, according to the Mortgage Bankers Association. The dollar volume
swelled to more than 50 percent that year.
It was Greenspan who sang the praises of ARMs from his Fed pulpit in
a Feb. 23, 2004, speech. American consumers “might benefit if lenders
provided greater mortgage product alternatives to the traditional fixed-rate
mortgage,” which may be “an expensive method of financing a home,” he
said.
There's much more over at Bloomberg, though the image conjured up by Northern
Trust's Paul Kasriel of 'ol Greenie sitting down to read Charles Kindleberger’s
classic "Manias, Panics and Crashes" is beyond my ability to comprehend.
Tom Petruno consulted Ian Shephardson of High Frequency Economics in debunking
the saving's glut/conundrum defense in an
article at the LA Times today.
Shepherdson wrote:
"The single biggest driver of the recession today is the meltdown
in the adjustable-rate mortgage market, and in particular the subprime
adjustable-rate mortgage market. The explosive growth in that market
is directly attributable to Fed
policy.
"When the Fed cut to 1% in mid-2003 -- we said at the time it was
an enormous mistake -- it pulled into the adjustable-rate mortgage
market millions of people who liked the rates but did not understand
the adjustable part of the deal."
Adjustable-rate loans typically were priced off short-term interest
rates, including the one-year Treasury bill yield and the London Interbank
Offered Rate, or LIBOR.
As housing bubble inflated, Shepherdson notes:
"Mr. Greenspan lauded lenders’ ‘innovations.’
The number of subprime ARMs rose more than ninefold from late 2000
until the peak in mid-2007, with three-quarters of the increase
coming between mid-2003 and mid-2005.
"The delinquency rate on these loans, by the way, now stands at
24.2% and it is still rising rapidly. Prime fixed-rate deliquencies
are at 3.92%.
"Mr. Greenspan ought to have used the pages of the Journal to apologize
to the nation. Instead, his piece will stand as a testament to his
hubris, or perhaps his delusions."
Don't look for an apology anytime soon - the guy will probably go to his
grave believing that he did nothing wrong.
History will not be kind.
Links to more reactions are provided below and, for those of you who might
be interested, more are likely to appear at this
Alan Greenspan News website.
•
Greenspan: Fed could not have stopped US housing bubble - Telegraph
•
Who's to Blame for the Economy? The Fed TheStreet.com
•
Greenspan: Fed Not to Blame for Recession - Fox News
•
Greenspan’s Denial - The Big Picture
•
Alan Greenspan: "Don't Blame Me" - Baltimore City Paper
•
Greenspan Yet Again Blames Others for Housing Bubble - Seeking Alpha
•
Greenspan Responds to My Blog Post on the Financial Crisis - US News
If anyone comes across any positive reactions, please leave a note in the
comments section.
John Berry:
If Tax-Cut Lapsing Is Class Warfare, Let’s Fight, by John M. Berry,
Commentary, Bloomberg: If letting top income-tax rates go back to
where they were in 2000 is class warfare against the rich, I’m ready
to snap to attention with my old M1 rifle on my shoulder.
What a ridiculous label, class warfare. It’s hardly aggression against
any class to have a progressive income-tax system in which fairness
and ability to pay are important considerations in setting rates for
different income groups.
As far as the top tax rates are concerned,... The law already calls
for today’s 33 percent rate to go to 36 percent and the 35 percent rate
to rise to 39.6 percent, in 2011.
Why did a Republican Congress and President George W. Bush countenance
the 2011 expiration dates in the 2001 tax-cut bill? It was one of several
deceitful provisions that made rate reductions temporary to hold down
estimates of revenue loss. Of course, the GOP intended all along to
make the rate cuts permanent.
Obama would let the Bush rate cuts expire only for couples with incomes
above $250,000 ... and raise the rates for them on capital gains and
dividends to 20 percent from 15 percent.
Unfair? I don’t think so, given these earners’ relatively greater
ability to bear the added burden. There’s no doubt that a larger share
of the nation’s income has become concentrated at the very top of the
distribution.
The extra revenue would be used to help finance the government’s
necessary role in dealing with the dangers of climate change and improving
access to health care and control of its costs. ...
The Obama plan would give most taxpayers small reductions in tax
liabilities...
When Clinton proposed raising the top rates to 36 percent and 39.6
percent in 1993, there were plenty of predictions that the higher marginal
rates would hurt Americans’ willingness to work and invest. Some economists
argued that so many people would opt for leisure instead of work that
the higher rates would raise no additional revenue.
Instead, a boom ensued in the latter 1990s... What did Bush’s lower
rates produce? Mediocre growth, very large deficits and financial-market
manipulation.
The reality is that tax rates aren’t nearly as powerful a force as
some people think they are. ...
Dave says...
I would have thought a better definition of "class warfare" was putting
$700 bn into the pockets of bankers and their equity-holders, not to mention
the untold billions paid in undeserved "performance bonuses" over the last
ten or more years.
Class warfare is alive all right - perpetrated by society's wealthiest
echelon on the common man.
hari says...
American politics is still hiding its head in the sand behind egregious
ideological pretense - in an age of post-industrial global developments
- forgetting what equity and fairness mean in terms of social policy.
In Europe we've passed that stage of (infantile) political pretense and
foolishness because class warfare is no longer a political solution going
forward in a globalized world.
VAT is universal form of consumption tax
(15-19%). Taxation is progressive by objective social-economic criteria
in a national political economy - more or less imitating progressive Scandinavian
social politics and trends.
Me thinks, although US is still +200 yrs old and getting morbidly moderate,
historical trend lines indicate US will eventually duplicate OECD/European
macroeconomic developments and social policy.
reason says...
Republican war on science? How about the even more dangerous Republican
war on language?
James Kroeger says...
This is actually kind of amusing. Class warfare has been waged continuously
over the past 30 years by wealthy Republicans with little response from
the lower classes they've victimized. They don't even realize it, but they
are guilty of investing themselves in
collectivist schemes that seek to improve the welfare of all affluent
individuals in utter defiance of market realities:
Perhaps now it is easier to see the folly of Collectivist Schemes. What
kind of schemes are we talking about? Well, there's the "everybody needs
a tax cut" ploy. What happens if all taxpayers receive an income tax
cut [in a way that preserves all taxpayers' rankings within the hierarchy
of disposable income distribution]? Answer: none of them experiences
any real gain in purchasing power. We can be certain that prices
will rise in the marketplace until all of the extra 'purchasing power'
is nullified (because sellers can always be counted on to charge whatever
prices the markets will bear).
Likewise, it is also true that increasing the income tax obligations
of all citizens in a way that preserves each taxpayer's ranking within
the hierarchy of disposable income distribution ensures that none
of them experiences any real loss in purchasing power. Prices will
drop until all citizens can afford what they would have been able to
afford if they had not had to pay more in taxes. The Progressive Income
Tax is widely misunderstood today because people do not realize that
it collects money from taxpayers in a way that ensures that each is
spared the decline in purchasing power she would otherwise have experienced
if only she had paid the tax.
Another example of collectivist folly is the legislation passed by
Congress that seeks to help all businesses by reducing their costs.
If all firms benefit from the same kind of government-sponsored
cost reduction (like a tax cut), then none of them ultimately
benefits. A firm can increase its market share only by obtaining
more disposable cash than its competitors. If all firms experience
the same gain in profits, then prices in asset/resource markets will
simply be bid up until the "gain" that every firm received is
wiped out. In business, the only way it is really possible to get ahead
in a competitive environment is by cutting your costs more than
your competitors.
Likewise, when government edicts force an increase in costs on
all firms, they are all spared the hurt that each of them would
have experienced if only they had been forced to absorb the cost.
For example, we know that if/when an individual firm gives all of its
employees an extra week of paid vacation, its costs increase in a way
that could put it at a competitive disadvantage. But if all firms
are forced to give all of their employees an extra week of paid vacation,
then none of them is actually hurt by the requirement. Either
(1) they will all be able to pass on the extra cost to their customers
or (2) they will all have to accept lower profits. In the latter case
none of them would lose out because all would be experiencing the same
drop in net profits, which means price levels in resource markets would
drop to levels they could afford.
Business owners in a market economy need to focus on two things if
they want to optimize their "Real Wealth enjoyment": (1) They must optimize
society's overall productive output generally, while (2) seeking also
to minimize their own costs (maximize their own disposable incomes)
vis-à-vis their rich peers/competitors. If they seek instead to increase
the disposable incomes of all rich people in a way that does
not directly help to eliminate unemployment, then they reveal themselves
to be deluded fools who end up victimizing themselves as well
as others through their ineptitude.
Yes, I would never criticize a rich person for being Smart Selfish, but
only for being a Stupid Selfish Republicansewells says...
Class warfare is mainly accomplished by people pulling the levers of
government power to favor particular interests. Bush 43, for instance, abused
the power of imminent domain to screw a family farmer to get the land for
his ballpark. He didn't have money of his own to speak of before that. Regular
welfare, so often the object of contempt and revulsion on the part of the
well-off pales in comparison to the corporate welfare that is doled out
on a regular basis. Collectivize losses and privatize profits seems to be
the order of the day.
It seems axiomatic to me that the more powerful government becomes the
more of this that will go on. It's the basic freeloader problem. People
gaming the system reap concentrated benefits and those screwed experience
diffused losses. The people gaming the system will always have higher motivation
to game than the screwed will have to resist right up to the point that
the whole system comes crashing down.
Beezer says...
Class warfare? That battle's been long lost. The rich won.
Unfortunately, it will turn out to be a very bitter victory because as
the pendulum swings in reaction to basic unfairness, the real warfare will
return with a vengeance and all will suffer. Rich and poor.
Life is dynamic and complicated, but the concepts of virtue and honesty
aren't. We all need to take a step back and undergo an "attitude adjustment"
about what's truly important in life.
From my little, unimportant seat in life, I see Obama as someone who
has strong beliefs about virtue and honesty, but needs a little more experience.
Fortunately, I'm pretty certain he's a quick learner
bakho says...
Nate Silver has some great charts showing the changes in who pays the
top rate over time. He asks what happened to the $ Million tax bracket?
http://www.fivethirtyeight.com/2009/03/missing-1000000-tax-bracket.html
eightnine2718281828mu5 says...
http://angrybear.blogspot.com/2007/03/eightnine2718281828mu5-on-taxes-and.html
The left claims that economic mobility isn't what it used to be, and
complain about the fairness of a system that locks people in place based
on their birth status. The right claims that this is nonsense; that economic
mobility is alive and well in the US.
Well, let's take the right at their word. I propose that we increase
taxes on high income individuals (income taxes, payroll taxes, social security
taxes) and lower them for the low income individuals since the right claims
that these are just the same folks at different periods of their lives.
It therefore all balances out since a single individual gets the benefits
of low taxes early in life, which allows them to accumulate capital quickly
so as to be more productive and engage in risk taking/wealth-generating
activities earlier than they would otherwise.
And later, when they are reaping the benefits of their accumulated wealth,
we raise their taxes so that we can extend the same courtesy to those coming
up the ladder behind them.
If there is true mobility, no one should complain since they reap the
benefit at one stage of their life and pay the costs at a later stage of
life.
Calculated Risk
"Everyone in the media is focused on consumer foreclosures,"
said Ivy Zelman, a housing analyst at Zelman & Associates. "What they're
not focused on is the builder-developer foreclosures, which are only in
the early innings and which will continue to wreak havoc as these assets
are liquidated at depressed prices. Until they are cleared, there can't
be a stabilization in home prices."
Rob Dawg says:
Thus starts the negative feedback loop as failed CRE projects are
resold at firesale prices stressing any other properties in a a glutted
market.
Rob Dawg says:
Some of these projects I read are applying for stimulus money.
I'll finds a link. The argument here is that they will create retail
jobs. YAY
The Charlie Rose interview was fascinating in that it revealed
the basic assumption of the current administration: Preserve the existing
system.
The current system is broken. They are advocating the retention
of dysfunction. Not "fix," not "change," not "replace." Rather "preserve."
The Rolling Stones had a song "19th [1920s] Breakdown" that talked about
the same thing. How did that work out?
Dust Bowling for Dollars says:
I second that this is an outstanding CR post. When this s blows up
the recovery in 2H09 it will take everyone by surprise... except the
CR faithful.
Jas says:
very good read... The Looting of America’s Coffers
http://www.nytimes.com/2009/03/11/business/economy/11leonhardt.html?_r=2&ref=business&pagewanted=print
“Sixteen years ago, two economists published a research paper
with a delightfully simple title: “Looting… “The investors displayed
a “total disregard for even the most basic principles of lending,”
failing to verify standard information about their borrowers or,
in some cases, even to ask for that information. The investors “acted
as if future losses were somebody else’s problem,” the economists
wrote.”
Amazing! For five years I was warning about “the System of the Crooks,
by the Crooks, and for the Crooks.”
Manhattan is a breeding ground for fraud. Evildoers like Greenspan,
Rubin, Summers, Paulson and Bernanke, as Fed Chairman and Treasury Secretary,
were simply looking the other way because they wanted the looting to
go on for the simple reason that they were, and still are, agents of
what I had called, in 2003, Bankrupters and Fraudsters of New York City.
These people were “raised in a culture of fraud” and until that culture
is exterminated there will be no economic prosperity in America again.
Unfortunately, democracy is not unto the task and some form of dictatorial
regime, even first elected democratically, not unlike Hitler, will take
on these perennial Crooks and parasites.
Also, for eleven years I have been warning about “It is the debt,
Stupid!” Jas
March 11th, 2009
Since I’ve been critical of the unstable monetary policy of Greenspan,
Bernanke and the Fed for many years, I can’t help myself but to respond
to Greenspan’s editorial today in the Wall St Journal, where he pleads ‘not
guilty’ for causing the housing bubble. His main thesis being that since
he only controlled the fed funds rate, he had little influence on longer
term rates which are directly correlated to mortgage rates and it was the
“decline in long term interest rates across a wide spectrum of countries”
that was the “most likely major cause of…the global housing price bubble.”
He specifically points out ‘global’ to further distance himself from what
the Fed specifically did.
What the Fed did under his stewardship and with great influence from
Bernanke in response to the 2001-2002 recession was cut rates from 6.5%
in Dec ’00 to 1% in June ’03 and left them there for one year even as the
economy was averaging 4% growth (including 7.5% in Q3 ’03 alone) before
raising rates in June ’04 to 5.25% over time through June ’06. The 1% rate
was predicated on the belief that deflationary pressures were strong and
thus gave the Fed leeway to be extremely accommodative with its policy.
This deflation forecast which reached its pinnacle in mid ’03 was in the
face of the CRB index having already rallied by 26% off its Oct ’01 lows.
The 10 yr bond yield began its fall in Dec ’00 from over 5% to a low of
3.17% in June ’03 and the average 30 year mortgage rate fell from over 7%
to below 5%. It was this that set the stage for the housing bubble in addition
to the artificially low rates that penalized savings and resulted in an
unprecedented binge of US spending that perpetuated the boom and enhanced
the wealth effect that further exaggerated the bubble.
Lever up was Greenspan’s goal for the rest of us.
The more goods Americans bought from overseas where the US trade deficit
exploded, the more foreign money was parked in US Treasuries. In addition,
Greenspan’s debasement of the US$ with his rate cuts in combination with
the export led growth in China, India, etc.., where the US consumer became
20% of global GDP, led to the rise in commodity prices which buoyed all
commodity producing nations, who then parked more money in US Treasuries,
thus keeping a lid on longer term interest rates even in the face of the
Fed raising rates beginning in June ’04 and thus giving the housing market
further rope. Foreign holdings of US Treasuries rose 21% in ’04 and 23%
in ’05.
The point being is that the seeds of the bubble were planted way before
the extremes in ’06 and ’07 and longer term rates remained contained due
to the ‘savings glut’ that the US consumer helped to put in the hands of
overseas investors through more borrowing and spending who in turn parked
it back in the US. The global search for yield began with artificially low
short term rates induced by the Fed and resulted in a massive misallocation
of capital through more and more risk and higher and higher leverage that
of course blew up and foreign banks and consumers couldn’t help themselves
either as trade and credit became more globalized. With credit (booze) free
flowing, many abused it and did stupid things but it was Greenspan and Co
that brought the excess credit (booze) to the party.
Source:
The Fed Didn’t Cause the Housing Bubble
ALAN GREENSPAN
WSJ, MARCH 11, 2009
http://online.wsj.com/article/SB123672965066989281.html
PERMALINK
|
COMMENTS (52)
By Richard Layard
Published: March 11 2009 20:02 | Last updated: March 11 2009 20:02
What is progress? The Organisation for Economic Co-operation and Development
has been asking this question for some time and the current crisis makes
it imperative to find an answer. According to the Anglo-Saxon Enlightenment,
progress means the reduction of misery and the increase of happiness. It
does not mean wealth creation or innovation, which are sometimes useful
instruments but never the final goal. So we should stop the worship of money
and create a more humane society where the quality of human experience is
the criterion. Provided we pay ourselves in line with our productivity,
we can choose whatever lifestyle is best for our quality of life.
And what would that involve? The starting point is that, despite massive
wealth creation, happiness has not risen since the 1950s in the US or Britain
or (over a shorter period) in western Germany. No researcher questions these
facts. So accelerated economic growth is not a goal for which we should
make large sacrifices. In particular, we should not sacrifice the most important
source of happiness, which is the quality of human relationships – at home,
at work and in the community. We have sacrificed too many of these in the
name of efficiency and productivity growth.
Most of all we have sacrificed our values. In the 1960s, 60 per cent
of adults said they believed “most people can be trusted”. Today the figure
is 30 per cent, in both Britain and the US. The fall in trustworthy behaviour
is clear in the banking sector but can also be seen in family life (more
break-ups), in the playground (fewer friends you can trust) and in the workplace
(growing competition between colleagues).
Increasingly, we treat private interest as the only motivation on which
we can rely and competition between individuals as the way to get the most
out of them. This is often counterproductive and does not generally produce
a happy workplace since competition for status is a zero-sum game. Instead,
we need a society based on positive-sum activities. Humans are a mix of
selfishness and altruism but generally feel better working to help each
other rather than to do each other down.
Our society has become too individualistic, with too much rivalry and
not enough common purpose. We idolise success and status and thus undermine
our mutual respect. But countries vary in this regard, and the Scandinavians
have managed to combine effective economies with much greater equality and
mutual respect. They have the greatest levels of trust (and happiness) of
any countries in the world.
To build a society based on trust we have to start in school, if not
earlier. Children should learn that the noblest life is the one that produces
the least misery and the most happiness in the world. This rule should apply
also in business and professional life. People should do work that is useful
to society and does not just make paper profits. And all professions – including
journalism, advertising and business – should have a clear, professional,
ethical code that its members are required to observe. It is not for nothing
that doctors form the group most respected in our society – they have a
code that is enforced and everyone knows it.
So we need a trend away from excessive individualism and towards greater
social responsibility. Is it possible to reverse a cultural trend in this
way? It has happened before, in the early 19th century. For the next 150
years there was a growth of social responsibility, followed by a decline
in the next 50. So a trend can change and it is often in bad times (such
as the 1930s in Scandinavia) that people decide to seek a more co-operative
lifestyle.
I have written a book about how to do this and there is room here for
three points only. First we should use our schools to promote a better value
system – the recent
Good Childhood report sponsored by the UK Children’s Society was full
of ideas about how to do this. Second, adults should reappraise their priorities
about what is important. Recent events are likely to encourage this and
modern happiness research can help find answers. Third, economists should
adopt a more realistic model of what makes humans happy and what makes markets
function.
Three ideas taught in business schools have much to answer for. One is
the theory of “efficient capital markets”, now clearly discredited. The
second is “principal agent” theory, which says the agents will perform best
under high-powered financial incentives to align their interests with those
of the principal. This has led to excessive performance-related pay, which
has often undermined the motive to work well for the sake of doing a good
job and introduced unnecessary tension among colleagues. Finally, there
is the macho philosophy of “continuous change”, promoted by self-interested
consulting companies, which disregards the fundamental human need for stability
– in the name of efficiency gains that are often not realised.
We do not want communism – as research shows, the communist countries
were the least happy in the world and also inefficient. But we do need a
more humane brand of capitalism, based not only on better regulation but
on better values.
Values matter and they are affected by our theories. We do not need a
society based on Darwinian competition between individuals. Beyond subsistence,
the best experience any society can provide is the feeling that other people
are on your side. That is the kind of capitalism we want.
Lord Layard is at the London School of Economics Centre for Economic
Performance. He has written ‘Happiness’ (2005) and co-authored ‘A Good Childhood’
(2009)
The latest wrinkle, which generated a flurry of press reports, was that
Cuomo had taken a new tack, charging that Merrill had misled Congress as
to when the payments would be made. But for my money, the juiciest bit came
at the end in the New York Times story:
Mr. Cuomo claimed that Merrill traders had mismarked their books as
of early December in an effort to get higher bonuses.
“It appears that some of these losses may have been booked by Merrill
employees who marked down their portfolios only after their 2008 bonuses
were set,” the attorney general wrote in the filing. “Despite the gargantuan
unexpected losses, Merrill did not reconsider its bonus awards” and
Bank of America did not request or demand that Merrill reduce its bonus
pool, he wrote.
This is a particularly strong and damaging claim. I've read repeatedly of
people who worked with traders saying that they would engage in strategies
(not clearly described) that would lead them to show high profits though
year end that they would wind up giving back (and often more) early in the
next year. The idea was that they'd make so much on their trumped up performance
that it didn't matter if they were fired next year. But a lot of types of
behavior could produce this result, so it's hard to know what sort of trader
chicanery was afoot. And without names, or descriptions of the nefarious
deeds, its too vague to treat as substantiated.
But here, if Cuomo is correct, we have what amounts to fraud, and brazen
to boot. And the exaggerated profits would also seem to be a books and records
violation for senior management.
This could get very interesting. The investigations are finally getting
to where the rubber hits the road.
Recommended Links
- Anonymous said...
- We used to catch traders booking 'hedge' deals
with variable spreads to take advantage of subtle distortions they had
entered in market data.
When the market data was corrected (often something obscure like a 3D
vol surface skew or SABR parameter) the P/L on their books would disappear
like tax money in the hands of Hank Paulson.
Ken Lewis should be fired for getting snookered by one of the oldest
tricks in the books.
-
sk said...
- This provides dramatic evidence for that research
piece on the looting type of behavior that occurs in these circumstances
- by Akerlof and Romer that you've highlighted in your blog a few times.
- Anonymous said...
- "I've read repeatedly of people who worked
with traders saying that they would engage in strategies (not clearly
described) that would lead them to show high profits though year end
that they would wind up giving back (and often more) early in the next
year. The idea was that they'd make so much on their trumped up performance
that it didn't matter if they were fired next year."
Frank Partnoy ex trader and now a law professor at the University of
San Diego had these very tactics in his book FIASCO (1999). As a trader,
he helped to put together "securities" that would book quick profits
for Japanese fund managers but would blow up later on. All the managers
cared about was the year end bonuses, knowing they would be moving on
probably to other jobs in the next year.
FIASCO illustrated many of the Wall Street abuses that led to this Crash
and Burn. But we kill the Canaries rather than listen to them.
- Boat52 said...
- We can only hope that Cuomo is cleaner than
clean and that the dark force doesn't try to unseat him before victory.
Never before in history have so few taken so much from so many in such
a short period of time.
- Anonymous said...
- This is Cuomo as Claude Raines in Casablanca
- shocked to find traders mismarking their positions. Such reliable
features of human nature are the reason internal control procedures
were established.
The clear target here should be Ken Lewis - he struck a bad deal that
failed to protect his shareholders at the time, as well as his future
shareholders the American taxpayer.
By all means fire the traders for being dirtbags, and strip them of
their illegitimate bonuses. But however wrong individual positions may
have been, the failure to focus on the relevant details of an M&A deal
that was done on the fly over a weekend is the true criminal act here.
A revenue neutral change that makes taxes more progressive increases work
effort. That is, when taxes on the middle class go down by a dollar and
taxes on the wealthy go up by a dollar, the increase in work effort by middle
class workers more than offsets and fall in work effort by the wealthy:
So, based on my research, if a need to raise some revenue means tax
rates have to be increased for someone, raising them on the wealthiest
will result in a smaller reduction in work effort than raising tax rates
on the middle class.
That's
Julie Hotchkiss reporting on her research in macroblog. There is a catch:
An additional relevant question remains: What is the implication
of changing work effort for GDP growth? The relationship between work
effort and value of output is not necessarily the same across income
levels. In other words, one hour of high-income (higher education) labor
is expected to yield a higher value of output in the economy than one
hour of labor from a middle-income (lower education) worker. A complete
analysis of the aggregate impact of the administration's tax plan would
have to also take this into account.
However, the effect on growth is only one metric by which to judge this
policy, e.g. the benefits to the household that come from one more hour
of work may also differ across income levels, particularly if the additional
money is used to buy necessities in one case, and luxuries in the other.
Posted by Mark Thoma on Wednesday, March 11, 2009 at 10:08
AM
Alan Greenspan takes on John Taylor's claim that the Fed caused the housing
bubble, and he warns against "micromanagement by government" regulators.
Greenspan says the Fed couldn't have caused the housing bubble because it
lost control over long-term interest rates once financial markets became
globalized, and those were the rates that caused the problem:
The
Fed Didn't Cause the Housing Bubble, by Alan Greenspan, Commentary,
WSJ: ...The Federal Reserve became acutely aware of the disconnect
between monetary policy and mortgage rates when the latter failed to
respond as expected to the Fed tightening in mid-2004. Moreover, the
data show that home mortgage rates had become gradually decoupled from
monetary policy even earlier...
[T]he presumptive cause of the world-wide decline in long-term rates
was the ... surge in growth in China and a large number of other emerging
market economies that led to an excess of global ... savings... That
... propelled global long-term interest rates progressively lower between
early 2000 and 2005.
That decline in long-term interest rates across a wide spectrum of
countries statistically explains, and is the most likely major cause
of ... the global housing price bubble. ... I would have thought that
... such evidence would lead to wide support for ... a global explanation
of the current crisis.
However, starting in mid-2007, history began to be rewritten, in
large part by ... John Taylor... Mr. Taylor unequivocally claimed that
had the Federal Reserve from 2003-2005 kept short-term interest rates
at the levels implied by his "Taylor Rule," "it would have prevented
this housing boom and bust." This notion has ... taken on the aura of
conventional wisdom.
Aside from the inappropriate use of short-term rates to explain the
value of long-term assets, his statistical ... analysis carries empirical
relationships of earlier decades into the most recent period where they
no longer apply.
Moreover,... the "Taylor Rule" ... parameters and predictions derive
from model structures that have been consistently unable to anticipate
the onset of recessions or financial crises. Counterfactuals from such
flawed structures cannot form the sole basis for successful policy analysis
or advice, with or without the benefit of hindsight. Given the decoupling
of monetary policy from long-term mortgage rates,... the Fed ... could
not have "prevented" the housing bubble. ...
It is now very clear that the levels of complexity to which market
practitioners at the height of their euphoria tried to push risk-management
techniques and products were too much for even the most sophisticated
market players to handle properly and prudently.
However, the appropriate policy response is not ... heavy regulation.
That would stifle important advances in finance that enhance standards
of living. ... The solutions for the financial-market failures ... are
higher capital requirements and a wider prosecution of fraud -- not
increased micromanagement by government entities. ... Adequate capital
and collateral requirements ... will not be overly intrusive, and thus
will not interfere unduly in private-sector business decisions.
If we are to retain a dynamic world economy capable of producing
prosperity and future sustainable growth, we cannot rely on governments
to intermediate saving and investment flows. Our challenge in the months
ahead will be to install a regulatory regime that will ensure responsible
risk management..., while encouraging them to continue taking the risks
necessary and inherent in any successful market economy.
We seem to have a disagreement on the scope of regulation. Ben Bernanke:
Bernanke
Calls for Broader Regulations, WSJ: Federal Reserve Chairman Ben
Bernanke said regulators should be given broad new powers to oversee
financial markets... Among his recommendations were tougher capital
requirements for big banks, limits on investments by money-market mutual
funds, and the introduction of some mechanism that would allow the U.S.
to wind down big financial institutions and possibly run them temporarily.
...
The recommendations were largely consistent with measures being pushed
by House Financial Services Committee Chairman Barney Frank (D., Mass.),
who is expected to be a key architect of the new financial regulation.
...
Mr. Bernanke ... also pushed for much tougher policies over ... big
companies. "Any firm whose failure would pose a systemic risk must receive
especially close supervisory oversight of its risk-taking, risk management
and financial condition, and be held to high capital and liquidity standards,"
Mr. Bernanke said. ...
I'm in agreement with Greenspan's response to Taylor to the extent that
following the Taylor rule wouldn't have stopped the crisis, but I think
the low interest rate policy pursued by the Fed is part of the story and
served to magnify other factors. As for regulation, relying mainly upon
enhanced capital requirements as Greenspan proposes isn't enough, so I'm
at least where Bernanke with respect to close supervisory oversight of firms
who pose a systemic risk. But I'd go even further and - to the extent possible
- break up the firms into smaller entities and sever their interconnections
until they no longer posed a threat to begin with. This is harder than it
sounds, or so I'm told, but I'd still pursue the option.
Selected Comments
- Anonymous said...
- Obama will dally,
Obama will dither,
As the gullible submit plans,
While their bank accounts wither ...
When are all the marks living in la la land going to wake up and realize
that tendering remedial plans to a disingenuous non responsive government
that has been hijacked by the wealthy elite golden collar crowd is a
waste of precious time.
Who do you think is listening? These wasted efforts are beginning to
look like the ignored baby tantrum - just crying and whining in the
crib.
The ‘rule of law’ in scamerica is a selectively enforced farce that
is owned and controlled by the gangsters that bought it from the crooked
politicians.
It is the middle class bubble that is intentionally being popped right
now as we speak. And there are other rationales for this intentionally
created crisis, and darker forces at work, that need investigative attention.
Stop crying and start roaring! Start planning the demonstrations, protests
and the new banker-less America that will return money to its basic
utility function and provide a level competitive playing field. Shun
the corrupt system and its sell out twits that got us all here. Be more
skeptical!
Deception is the most powerful political force on the planet.
i on the ball patriot
The economists were George Akerlof, who would later win a
Nobel Prize, and Paul Romer, the renowned expert on economic growth.
In the paper, they argued that several financial crises in the 1980s, like
the Texas real estate bust, had been the result of private investors taking
advantage of the government. The investors had borrowed huge amounts of
money, made big profits when times were good and then left the government
holding the bag for their eventual (and predictable) losses.
In a word, the investors looted. Someone trying to make an honest profit,
Professors Akerlof and Romer said, would have operated in a completely different
manner. The investors displayed a “total disregard for even the most basic
principles of lending,” failing to verify standard information about their
borrowers or, in some cases, even to ask for that information.
The investors “acted as if future losses were somebody else’s problem,”
the economists
wrote.
“They were right.”
On Tuesday morning in Washington,
Ben Bernanke, the
Federal Reserve chairman, gave a
speech that read like a sad coda to the “Looting” paper. Because the
government is unwilling to let big, interconnected financial firms fail
— and because people at those firms knew it — they engaged in what Mr. Bernanke
called “excessive risk-taking.” To prevent such problems in the future,
he called for tougher regulation.
Now, it would have been nice if the Fed had shown some of this regulatory
zeal before
the worst
financial crisis since
the Great Depression. But that day has passed. So people are rightly
starting to think about building a new, less vulnerable financial system.
And “Looting” provides a really useful framework.
The paper’s message is that the promise of government bailouts isn’t merely
one aspect of the problem. It is the core problem.
Promised bailouts mean that anyone lending money to Wall Street — ranging
from small-time savers like you and me to the Chinese government — doesn’t
have to worry about losing that money. The
United States Treasury (which, in the end, is also you and me) will
cover the losses. In fact, it has to cover the losses, to prevent a cascade
of worldwide losses and panic that would make today’s crisis look tame.
But the knowledge among lenders that their money will ultimately be returned,
no matter what, clearly brings a terrible downside. It keeps the lenders
from asking tough questions about how their money is being used. Looters
—
savings and loans and Texas developers in the 1980s; the
American International Group,
Citigroup,
Fannie Mae and the rest in this decade — can then act as if their future
losses are indeed somebody else’s problem.
Do you remember the mea culpa that
Alan Greenspan, Mr.
Bernanke’s predecessor,
delivered on Capitol
Hill last fall? He said that he was “in a state of shocked disbelief” that
“the self-interest” of Wall Street bankers hadn’t prevented this mess.
He shouldn’t have been. The looting theory
explains why his laissez-faire theory didn’t hold up. The bankers were acting
in their self-interest, after all.
The term that’s used to describe this general problem, of course, is
moral
hazard. When people are protected from the consequences of risky behavior,
they behave in a pretty risky fashion. Bankers can make long-shot investments,
knowing that they will keep the profits if they succeed, while the taxpayers
will cover the losses.
This form of moral hazard — when profits are privatized and losses are
socialized — certainly played a role in creating the current mess. But when
I spoke with Mr. Romer on Tuesday, he was careful to make a distinction
between classic moral hazard and looting. It’s an important distinction.
With moral hazard, bankers are making real wagers. If those wagers pay
off, the government has no role in the transaction. With looting, the government’s
involvement is crucial to the whole enterprise.
Think about the so-called liars’ loans from recent years: like those
Texas real estate loans from the 1980s, they never had a chance of paying
off. Sure, they would deliver big profits for a while, so long as the bubble
kept inflating. But when they inevitably imploded, the losses would overwhelm
the gains. As Gretchen Morgenson has
reported,
Merrill Lynch’s losses
from the last two years wiped out its profits from the previous decade.
What happened? Banks borrowed money from lenders around the world. The
bankers then kept a big chunk of that money for themselves, calling it “management
fees” or “performance bonuses.” Once the investments were exposed as hopeless,
the lenders — ordinary savers, foreign countries, other banks, you name
it — were repaid with government bailouts.
In effect, the bankers had siphoned off this
bailout money in advance, years before the government had spent it.
I understand this chain of events sounds a bit like a conspiracy. And
in some cases, it surely was. Some A.I.G. employees, to take one example,
had to have understood what their credit derivative division in London was
doing. But more innocent optimism probably played a role, too. The human
mind has a tremendous ability to rationalize, and the possibility of making
millions of dollars invites some hard-core rationalization.
Either way, the bottom line is the same:
given an incentive to loot, Wall Street did so. “If you think
of the financial system as a whole,” Mr. Romer said, “it actually has an
incentive to trigger the rare occasions in which tens or hundreds of billions
of dollars come flowing out of the Treasury.”
Unfortunately, we can’t very well stop the flow of that money now.
The bankers have already walked away with their profits (though many more
of them deserve a subpoena to a Congressional hearing room).
Allowing A.I.G. to collapse, out of spite, could cause a financial shock
bigger than the one that followed the collapse of
Lehman Brothers. Modern economies can’t function without credit, which
means the financial system needs to be bailed out.
But the future also requires the kind of overhaul that Mr. Bernanke has
begun to sketch out. Firms will have to be monitored much more seriously
than they were during the Greenspan era. They can’t be allowed to shop around
for the regulatory agency that least understands what they’re doing. The
biggest Wall Street paydays should be held in escrow until it’s clear they
weren’t based on fictional profits.
Above all, as Mr. Romer says, the federal government needs the power
and the will to take over a firm as soon as its potential losses exceed
its assets. Anything short of that is an invitation to loot.
Mr. Bernanke actually took a step in this direction on Tuesday. He said
the government “needs improved tools to allow the orderly resolution of
a systemically important nonbank financial firm.” In layman’s terms, he
was asking for a clearer legal path to nationalization.
At a time like this, when trust in financial markets is so scant, it
may be hard to imagine that looting will ever be a problem again. But it
will be. If we don’t get rid of the incentive to loot, the only question
is what form the next round of looting will take.
Mr. Akerlof and Mr. Romer finished writing
their paper in the early 1990s, when the economy was still suffering a hangover
from the excesses of the 1980s. But Mr. Akerlof told Mr. Romer — a skeptical
Mr. Romer, as he acknowledged with a laugh on Tuesday — that the next candidate
for looting already seemed to be taking shape.
It was an obscure little market called credit
derivatives.
In case readers haven't figured it out, I am a big Willem Buiter fan. Even
when he is wrong, he is at least forthright and colorful. He does have an
appetite for showing off his formidable intellect. Nevertheless, his best
qualities are his willingness to take on orthodoxies and authorities, and
his vivid, trenchant style. It was Buiter who at the last Jackson Hole conference
accused the Fed of "cognitive regulatory capture," eliciting a firestorm
of criticism.
Today Buiter takes up one of my favorite causes: the need to leash and collar
bankers. He dismisses the canard so often trotted out in the US, that too
many restraints might inhibit financial innovation. Paul Volcker deemed
the most important financial innovation in the last 30 years to be the ATM
machine. Nassim Nicolas Taleb has dismissed the supposed advantages conferred
by the development of the Black-Scholes option pricing model.
Given the considerable costs gambling innovation hath wrought,
the calls to shackle bankers seem completely warranted. If any other class
had done this much damage, they'd almost certainly be in jail.
Note the timing of this post. This is pre the G-20, where the Euro crowd
is pushing for more financial regulation, particularly with new international
mechanisms, while the US is arguing for more coordinated fiscal stimulus.
The US does not want to (and won't as long as the dollar holds as reserve
currency) cede control over its institutions. But a good deal more "harmonisation"
and coordination is in order.
Buiter provides a long list of reform ideas. I've extracted the ones I found
most interesting, and I encourage readers to look at the full roster. Be
sure to read his comments on self regulation.
From VoxEU:
Financial regulation is a now-or-never proposition as the sector’s lobbying
power is greatly diminished. This column argues that we should embrace
robust regulation now, risking over-regulation. Correcting mistakes
later would be better than risking another era of “self-” or “soft-touch”
regulation.
Over-regulate now
It is necessary, for political economy reasons, to rush new comprehensive
regulation of the financial sector. While it would be better, holding
constant the likelihood of the measures being adopted and implemented,
not to act in haste, there is now a unique window of opportunity – a
period of extraordinary politics, in the words of Balcerowicz – to actually
get the thorough regulatory reform we need. The reason is that the private
financial sector is on its uppers – down and out – and will not be able
to put together much of a fight, let alone its usual boom-time massive
lobbying effort to veto radical measures. It is better to over-regulate
now and subsequently correct the mistakes than to risk another era of
self-regulation and soft-touch under-regulation of financial markets,
instruments and institutions.
Macro-prudential regulation
The objective of macro-prudential regulation is systemic financial stability.
This has a number of dimensions:
Preventing or mitigating asset market and credit booms, bubbles
and busts
Preventing or mitigating market illiquidity in systemically important
markets
Preventing or mitigating funding illiquidity for systemically important
financial institutions
Preventing or managing insolvencies of systemically important financial
institutions
Other micro-prudential considerations (abuse of monopoly power; consumer
protection; micro-manifestations of asymmetric information) should be
left to the micro-prudential regulator(s).
Comprehensive regulation
Regulation will have to be comprehensive across instruments, institutions,
markets and countries. Specifically, we must:
R
egulate all systemically important highly leveraged financial enterprises,
whatever they call themselves: commercial bank, investment bank,
universal bank, hedge fund, SIV, CDO, private equity fund or bicycle
repair shop.
Regulate all markets for systemically important financial instruments.
Regulate all systemically important financial infrastructure or
plumbing: payment, clearing, settlement systems, mechanisms and
platforms, and the associated provision of custodial services.
Do it all on a cross-border basis.
Self-regulation
Self-regulation is to regulation as self-importance is to importance.
The notion that markets, including financial markets could be self-regulating,
by properly incentivising CEOs and Boards of Directors and through market-discipline,
is prima facie suspect. We decide to regulate markets because of market
failure. Then we let the market regulate the market. This is an invisible
hand too far. The concept of self-regulation is especially ludicrous
for financial markets. Finance is trade in promises expressed in units
of abstract purchasing power (money). It scales up and down ferociously
quickly. If Airbus or Boeing wishes to double the size of its operations,
it takes 4 or 5 years to put in place another set of assembly lines.
If a bank wishes to scale its balance sheet and operations ten-fold,
all it has to do is to add a zero in the right places. Given enough
optimism, trust, confidence and self-confidence, financial activity
can, through leverage, be scaled up alarmingly quickly. Once optimism,
trust, confidence and self-confidence disappear and are replaced by
pessimism, mistrust, lack of confidence and fear/panic, the scaling
down of bank activities can occur even faster. Such an industry cannot
be left to its own devices.
The importance of public information
Regulation can only take place on the basis of independently verifiable
(public) information. Regulators cannot rely on information that is
private to the regulated entity. This means that the capital adequacy
of the first pillar of Basel II has to be overhauled radically, as its
risk-weighting of assets relies in part on internal bank models that
are private to the banks...
Regulation financial innovation
Financial innovation in products and institutions is potentially beneficial
and potentially harmful. There is a need to regulate financial innovation.
I propose the model used in the US by the Food and Drug Administration
for pharmaceutical and medical products.
First, there is a positive list of financial instruments and institutions.
Anything that is not explicitly allowed is forbidden.
To get a new instrument or new institution approved, there will
have to be testing, scrutiny by regulators, supervisors, academic
specialists and other interested parties, and pilot projects. It
is possible that, once a new instrument or institution has been
approved, it is only available ‘with a prescription'. For instance,
only professional counterparties rather than the general public
could be permitted.....
Clearly, this approach to financial innovation would slow down financial
innovation. It may even kill off certain innovations that would have
been socially useful. So be it. The dangers of unbridled financial innovation
are too manifest.
Yves here. The FDA has recently come under a lot of criticism (deservedly)
but that is due in large measure to a lack of commitment to its mandate
from deregulation-minded Administrations, budget cuts, and its conflicted
position (40%+ of its budget comes from fees paid by the industry for new
drug applications, an arrangement created during the Bush Senior presidency.
Too high a turndown rate would deter applications. The problems with the
FDA are due to a significant degree to nearly 20 years of efforts to undermine
its role. And that is not my just my view; I've heard this sort of thing
from FDA lawyers and former FDA commissioners). Back to Buiter:
Narrow banking vs. investment banking
The distinction between public utility banking/narrow banking vs. investment
banking; (the rest) has to be re-introduced. I advocate a form of Glass-Steagall
on steroids, with a heavily regulated and closely supervised narrow
banking sector, engaged in commercial banking (taking deposits and making
loans) and benefiting from lender of last resort and market maker of
last resort support. The investment bank sector will also be regulated
and supervised, but more lightly, and according to the same principles
as other systemically important highly leveraged non-narrow bank institutions.
Universal banking has few if any efficiency advantages and many disadvantages.
Economies of scale and scope in banking are soon exhausted. They tend
to be fat to fail, have a lack of focus, and suffer from span-of-control
negative synergies etc. Universal banks or financial supermarkets use
their size to exploit market power and try to shelter their risky, non-narrow
banking activities under the LLR and MMLR umbrella of the narrow bank
that's hiding somewhere inside the universal bank....
Mixed public-private ownership
Given the manifest failure of the efficient market hypothesis, it is
not at all obvious that systemically important financial institutions
should be allowed to be listed companies. Financial institutions' stock
market valuations have been notorious will-o'-the wisps and have, through
stock options and other stock-market valuation-related executive remuneration
components, contributed to the excessive risk taking during the recent
boom. Partnerships, mutual ownership, cooperative ownership, and various
forms of public and mixed public-private ownership may be more appropriate
for financial institutions. Perhaps we should even consider removing
limited liability for investment banks!
The economics profession appears to have been unaware of the long
build-up to the current worldwide financial crisis and to have significantly
underestimated its dimensions once it started to unfold. In our view,
this lack of understanding is due to a misallocation of research efforts
in economics. We trace the deeper roots of this failure to the profession’s
insistence on constructing models that, by design, disregard the key
elements driving outcomes in real-world markets. The economics profession
has failed in communicating the limitations, weaknesses, and even dangers
of its preferred models to the public. This state of affairs makes clear
the need for a major reorientation of focus in the research economists
undertake, as well as for the establishment of an ethical code that
would ask economists to understand and communicate the limitations and
potential misuses of their models.
Introduction
The global financial crisis has revealed the need to
rethink fundamentally how financial systems are regulated. It has also
made clear a
systemic failure of the economics profession. Over the
past three decades, economists have largely developed and come to rely
on models that disregard key factors—including heterogeneity of decision
rules, revisions of forecasting strategies, and changes in the social
context—that drive outcomes in asset and other markets. It is obvious,
even to the casual observer that these models fail to account for the
actual evolution of the real-world economy. Moreover, the current academic
agenda has largely crowded out research on the inherent causes of financial
crises. There has also been little exploration of early indicators of
system crisis and potential ways to prevent this malady from developing.
In fact, if one browses through the academic macroeconomics and finance
literature, "systemic crisis" appears like an otherworldly event that
is absent from economic models. Most models, by design, offer no immediate
handle on how to think about or deal with this recurring phenomenon.2
In our hour of greatest need, societies around the world are
left to grope in the dark without a theory. That, to us, is a
systemic failure
of the economics profession.
The implicit view behind standard models
is that markets and economies are inherently stable and that they only
temporarily get off track. The majority of economists
thus failed to warn policy makers about the threatening system crisis
and ignored the work of those who did. Ironically, as the crisis has
unfolded, economists have had no choice but to abandon their standard
models and to produce hand-waving common-sense remedies. Common-sense
advice, although useful, is a poor substitute for an underlying model
that can provide much-needed guidance for developing policy and regulation.
It is not enough to put the existing model to one side, observing that
one needs, "exceptional measures for exceptional times". What we need
are models capable of envisaging such "exceptional times".
... ... ...
There are a number of possible explanations for this failure to warn
the public. One is a "lack of understanding" explanation--the researchers
did not know the models were fragile. We find this explanation highly
unlikely; financial engineers are extremely bright, and it is almost
inconceivable that such bright individuals did not understand the limitations
of the models. A second, more likely explanation, is that they did not
consider it their job to warn the public.
If that is the cause of their failure, we believe that it involves
a misunderstanding of the role of the economist, and involves an ethical
breakdown. In our view, economists, as with all scientists,
have an ethical
responsibility to communicate the limitations of their models and the
potential misuses of their research. Currently, there is
no ethical code for professional economic scientists. There should be
one.
This part of AIG was nothing more than a giant structured finance
hedge fund. Despite the fact this hedge fund had no rating, no supervision
or oversight, it managed to trade off of the Triple AAA rating of the
regulated half of the firm. Somehow, it was treated as if it was Triple
AAA, regulated and guaranteed by the government.
It was exempt from any form of regulation or supervision, thanks
to the Commodities Futures Modernization Act. This ruinous piece of
legislation was sponsored by former Senator Phil Gramm (R), supported
by Alan Greenspan (R), former Treasury Secretary (and Citibank board
member) Robert Rubin (D), and current presidential advisor Larry Summers
(D). It was signed into law by President Clinton (D). It was the
single most disastrous piece of bipartisan legislation ever signed into
law.
Selected comments
March 3, 2009 |
FT.com
The unfortunate uselessness of most ’state of the art’ academic
monetary economics
The Monetary Policy Committee of the Bank of England I was privileged
to be a ‘founder’ external member of during the years 1997-2000 contained,
like its successor vintages of external and executive members, quite
a strong representation of academic economists and other professional
economists with serious technical training and backgrounds. This turned
out to be a severe handicap when the central bank had to switch gears
and change from being an inflation-targeting central bank under conditions
of orderly financial markets to a financial stability-oriented central
bank under conditions of widespread market illiquidity and funding illiquidity.
Indeed, the typical graduate macroeconomics and monetary economics training
received at Anglo-American universities during the past 30 years or
so, may have set back by decades serious investigations of aggregate
economic behaviour and economic policy-relevant understanding.
It was a privately and socially costly waste of time and other resources.
Most mainstream macroeconomic theoretical innovations since the 1970s
(the New Classical rational expectations revolution associated with
such names as Robert E. Lucas Jr., Edward Prescott, Thomas Sargent,
Robert Barro etc, and the New Keynesian theorizing of Michael Woodford
and many others) have turned out to be self-referential, inward-looking
distractions at best. Research tended to be motivated by the internal
logic, intellectual sunk capital and esthetic puzzles of established
research programmes rather than by a powerful desire to understand
how the economy works - let alone how the economy works during times
of stress and financial instability. So the economics profession
was caught unprepared when the crisis struck.
Complete markets
The most influential New Classical and New Keynesian theorists all
worked in what economists call a ‘complete markets paradigm’. In a world
where there are markets for contingent claims trading that span all
possible states of nature (all possible contingencies and outcomes),
and in which intertemporal budget constraints are always satisfied by
assumption, default, bankruptcy and insolvency are impossible.
As a result, illiquidity - both funding illiquidity and market illiquidity
- are also impossible, unless the guilt-ridden economic theorist imposes
some unnatural (given the structure of the models he is working with),
arbitrary friction(s), that made something called ‘money’ more liquid
than everything else, but for no good reason. The irony of modeling
liquidity by imposing money as a constraint on trade was lost on the
profession.
Both the New Classical and New Keynesian
complete markets macroeconomic theories not only did not allow questions
about insolvency and illiquidity to be answered. They
did not allow such questions to be asked.
It is clear that, when searching for an appropriate simplification
to address the intractable mess of modern market economies, the starting
point of ‘no markets’, that is, autarky or no trade, is a much better
one than that of ‘complete markets’. Goods and services
that are potentially tradable are indexed by time, place and state of
nature or state of the world. Time is a continuous variable, meaning
that for complete markets along the time dimension alone, there would
have to be rather more markets for future delivery (infinitely many
in any time interval, no matter how small) than you can shake a stick
at. Location likewise is a continuous variable in a 3-dimensional
space. Again rather too many markets. Add uncertainty (states
of nature or states of the world), never mind private or asymmetric
information, and ‘too many potential markets’, if I may ruin the wonderful
quote from Amadeus attributed to Emperor Joseph II, comes to mind.
If any market takes a finite amount of resources (however small) to
function, complete markets would exhaust the resources of the universe.
Beyond this simple ‘impossibility of
complete markets’ proposition, there is the deeper point, that the assumption
of complete markets in most of the New Classical and New Keynesian macroeconomics
assumes away the problem of contract enforcement. This
problem is especially acute in trade over time or intertemporal trade,
where the net value to each party to a contract of fulfilling the terms
of the contract varies over time and can change sign.
In a world with selfish, rational, opportunistic
agents, able and willing to lie and deceive, only a small set of voluntary
transactions will ever be observed, relative to the universe of all
potentially feasible transactions.
The first set of voluntary exchange-based transactions we are likely
to see are self-enforcing contracts - those based on long-term relationships,
repeated interactions and trust. There are some of those, but
not too many. The second are those voluntarily-entered-into contracts
that are not self-enforcing (say because interactions between the same
sets of agents are infrequent and market participants have a degree
of anonymity that prevents the use of reputation as a self-enforcement
mechanism) but are instead enforced by some external agent or third
party, often the state, sometimes the Mafia (sometimes it’s hard to
tell who is who). Third party enforcement of contracts is again
often complex and costly, which is why it covers relatively few contracts.
It requires that the terms of the contract and the contingencies it
contains be third-party observable and verifiable. Again, only
a limited set of exchanges can be supported this way.
The conclusion, boys and girls, should be that trade - voluntary
exchange - is the exception rather than the rule and that markets are
inherently and hopelessly incomplete. Live with it and start from
that fact. The benchmark is no trade - pre-Friday Robinson Crusoe
autarky. For every good, service or financial instrument that
plays a role in your ‘model of the world’, you should explain why a
market for it exists - why it is traded at all. Perhaps we shall get
somewhere this time.
The Auctioneer at the end of time
In both the New Classical and New Keynesian approaches to monetary
theory (and to aggregative macroeconomics in general), the strongest
version of the efficient markets hypothesis (EMH) was maintained.
This is the hypothesis that asset prices aggregate and fully reflect
all relevant fundamental information, and thus provide the proper signals
for resource allocation. Even during the seventies, eighties,
nineties and noughties before 2007, the manifest failure of the EMH
in many key asset markets was obvious to virtually all those whose cognitive
abilities had not been warped by a modern Anglo-American Ph.D. eduction.
But most of the profession continued to swallow the EMH hook, line and
sinker, although there were influential advocates of reason throughout,
including James Tobin, Robert Shiller, George Akerlof, Hyman Minsky,
Joseph Stiglitz and behaviourist approaches to finance. The influence
of the heterodox approaches from within macroeconomics and from other
fields of economics on mainstream macroeconomics - the New Classical
and New Keynesian approaches - was, however, strictly limited.
In financial markets, and in asset markets, real and financial, in
general, today’s asset price depends on the view market participants
take of the likely future behaviour of asset prices. If today’s
asset price depends on today’s anticipation of tomorrow’s price, and
tomorrow’s price likewise depends on tomorrow’s expectation of the price
the day after tomorrow, etc. ad nauseam, it is clear that today’s
asset price depends in part on today’s anticipation of asset prices
arbitralily far into the future. Since there is no obvious finite
terminal date for the universe (few macroeconomists study cosmology
in their spare time), most economic models with rational asset pricing
imply that today’s price depend in part on today’s anticipation of the
asset price in the infinitely remote future.
What can we say about the terminal behaviour of asset price expectations?
The tools and techniques of dynamic mathematical optimisation imply
that, when a mathematical programmer computes an optimal programme
for some constrained dynamic optimisation problem he is trying to solve,
it is a requirement of optimality that the influence of the infinitely
distant future on the programmer’s criterion function today be zero.
And then a small miracle happens. An optimality criterion from
a mathematical dynamic optimisation approach is transplanted, lock,
stock and barrel to the behaviour of long-term price expectations in
a decentralised market economy. In the mathematical programming
exercise it is clear where the terminal boundary condition in question
comes from. The terminal boundary condition that the influence
of the infinitely distant future on asset prices today vanishes, is
a ‘transversality condition’ that is part of the necessary and sufficient
conditions for an optimum. But in a decentralised market economy
there is no mathematical programmer imposing the terminal boundary conditions
to make sure everything will be all right.
The common practice of solving a dynamic general equilibrium model
of a(n) (often competitive) market economy by solving an associated
programming problem, that is, an optimisation problem, is evidence of
the fatal confusion in the minds of much of the economics profession
between shadow prices and market prices and between transversality conditions
that are an integral part of the solution to an optimisation problem
and the long-term expectations that characterise the behaviour of decentralised
asset markets. The efficient markets hypothesis assumes that there
is a friendly auctioneer at the end of time - a God-like father figure
- who makes sure that nothing untoward happens with long-term price
expectations or (in a complete markets model) with the present discounted
value of terminal asset stocks or financial wealth.
What this shows, not for the first time, is that models of the economy
that incorporate the EMH - and this includes the complete markets core
of the New Classical and New Keynesian macroeconomics - are not models
of decentralised market economies, but models of a centrally planned
economy.
The friendly auctioneer at the end of time, who ensures that the
right terminal boundary conditions are imposed to preclude, for instance,
rational speculative bubbles, is none other than the omniscient, omnipotent
and benevolent central planner. No wonder modern macroeconomics
is in such bad shape. The EMH is surely the most notable empirical fatality
of the financial crisis. By implication, the complete markets
macroeconomics of Lucas, Woodford et. al. is the most prominent theoretical
fatality. The future surely belongs to behavioural approaches
relying on empirical studies on how market participants learn, form
views about the future and change these views in response to changes
in their environment, peer group effects etc. Confusing the equilibrium
of a decentralised market economy, competitive or otherwise, with the
outcome of a mathematical programming exercise should no longer be acceptable.
So, no Oikomenia, there is no pot of gold at the end of the rainbow,
and no Auctioneer at the end of time.
Linearize and trivialize
If one were to hold one’s nose and agree to play with the New Classical
or New Keynesian complete markets toolkit, it would soon become clear
that any potentially policy-relevant model would be highly non-linear,
and that the interaction of these non-linearities and uncertainty makes
for deep conceptual and technical problems. Macroeconomists are brave,
but not that brave. So they took these non-linear stochastic dynamic
general equilibrium models into the basement and beat them with a rubber
hose until they behaved. This was achieved by completely stripping
the model of its non-linearities and by achieving the transsubstantiation
of complex convolutions of random variables and non-linear mappings
into well-behaved additive stochastic disturbances.
Those of us who have marvelled at the non-linear feedback loops between
asset prices in illiquid markets and the funding illiquidity of financial
institutions exposed to these asset prices through mark-to-market accounting,
margin requirements, calls for additional collateral etc. will
appreciate what is lost by this castration of the macroeconomic models.
Threshold effects, critical mass, tipping points, non-linear accelerators
- they are all out of the window. Those of us who worry about
endogenous uncertainty arising from the interactions of boundedly rational
market participants cannot but scratch our heads at the insistence of
the mainline models that all uncertainty is exogenous and additive.
Technically, the non-linear stochastic dynamic models were linearised
(often log-linearised) at a deterministic (non-stochastic) steady state.
The analysis was further restricted by only considering forms of randomness
that would become trivially small in the neigbourhood of the deterministic
steady state. Linear models with additive random shocks we can
handle - almost !
Even this was not quite enough to get going, however. As pointed
out earlier, models with forward-looking (rational) expectations of
asset prices will be driven not just by conventional, engineering-type
dynamic processes where the past drives the present and the future,
but also in part by past and present anticipations of the future.
When you linearize a model, and shock it with additive random disturbances,
an unfortunate by-product is that the resulting linearised model behaves
either in a very strongly stabilising fashion or in a relentlessly explosive
manner. There is no ‘bounded instability’ in such models.
The dynamic stochastic general equilibrium (DSGE) crowd saw that the
economy had not exploded without bound in the past, and concluded from
this that it made sense to rule out, in the linearized model, the explosive
solution trajectories. What they were left with was something
that, following an exogenous random disturbance, would return
to the deterministic steady state pretty smartly. No L-shaped
recessions. No processes of cumulative causation and bounded but
persistent decline or expansion. Just nice V-shaped recessions.
There actually are approaches to economics that treat non-linearities
seriously. Much of this work is numerical - analytical results
of a policy-relevant nature are few and far between - but at least it
attempts to address the problems as they are, rather than as we would
like them lest we be asked to venture outside the range of issued we
can address with the existing toolkit.
The practice of removing all non-linearities and most of the interesting
aspects of uncertainty from the models that were then let loose on actual
numerical policy analysis, was a major step backwards. I trust
it has been relegated to the dustbin of history by now in those central
banks that matter.
Conclusion
Charles Goodhart, who was fortunate enough not to encounter complete
markets macroeconomics and monetary economics during his impressionable,
formative years, but only after he had acquired some intellectual immunity,
once said of the Dynamic Stochastic General Equilibrium approach which
for a while was the staple of central banks’ internal modelling:
“It excludes everything I am interested in”. He was right.
It excludes everything relevant to the pursuit of financial stability.
The Bank of England in 2007 faced the onset of the credit crunch
with too much Robert Lucas, Michael Woodford and Robert Merton in its
intellectual cupboard. A drastic but chaotic re-education took
place and is continuing.
I believe that the Bank has by now shed the conventional wisdom of
the typical macroeconomics training of the past few decades. In
its place is an intellectual potpourri of factoids, partial theories,
empirical regulaties without firm theoretical foundations, hunches,
intuitions and half-developed insights. It is not much, but knowing
that you know nothing is the beginning of wisdom.
March 3, 2009 1:37pm in
Culture,
Economics,
Financial Markets,
Monetary Policy,
Politics,
Religion |
12 comments
Selected Comments
Don the libertarian Democrat
"The future surely belongs to behavioural
approaches relying on empirical studies on how market participants
learn, form views about the future and change these views in response
to changes in their environment, peer group effects etc. Confusing
the equilibrium of a decentralised market economy, competitive or
otherwise, with the outcome of a mathematical programming exercise
should no longer be acceptable."
I agree, and I'm reminded of a quote from my favorite philosopher,
J.L. Austin:
"...our common stock of words embodies all the distinctions men
have found worth drawing, and the connections they have found worth
marking, in the lifetime of many generations: these surely are likely
to be more numerous, more sound, since they have stood up to the
long test of survival of the fittest, and more subtle, at least
in all ordinary and reasonable practical matters, than any that
you or I are likely to think up in our armchair of an afternoon
– the most favorite alternative method."
I think that a Wittgensteinian/Austinian anlysis of the presuppositions
and assumptions of Economic Models would be a worthwhile endeavor.
Many of the models seem to presuppose a crude Behaviorism, although
it's hard to tell, since it's not clear that they're claiming to
be anything more than modelers.
I can't help but wonder if the desire to be scientific and professional
has led to a sterile pursuit of clearly limited problems, much as
it has in philosophy.
John
Congratulations! The admission to oneself
of an error is the first step to a better understanding: a public
admission also helps other people to that end.
It would take too long to answer this fully
(even though I shall omit my own errors which are irrelevant) but
I should like to make a few comments.
Firstly EMH
is not empirical: it is an academic hypothesis invented by some
American academics to reduce the complexity of markets by a few
orders of magnitude so that they could develop some theories (a
few of which are actually useful) called Modern Portfolio Theory.
I was pointing out, while you were still at Yale, that EMH does
not correspond to reality because it ignores DEATH and taxes (it
also ignores frictional costs (not all of which are taxes), investment
fashion, herd instinct and, now relevant but then insignificant,
short selling). I have demonstrated from empirical data on more
than one occasion that EMH is false (as have others - I make no
claim to be Newton or Kepler). I have never seen any empirical data
to support it (I have seen reports that in most years the average
- NOT the good - actively-managed fund underperforms the index but
since ALL index funds underperform the index EVERY year, this merely
tells us that custodian's and auditors' charges are non-zero and
nothing about the validity or otherwise of EMH).
EMH does not rely on "an Auctioneer at the
End of Time" because it assumes a positive real return on investment
so the value at the end of time becomes vanishingly small: please
remember that EMH was invented by a bunch of American academics,
not the MPC of the BoE under a Labour government. EMH does not handle
the concept of a continuing negative real long-term return on investment
because in that context there are no rational retail investors and
(in the USA) no stock market.
I believe that an "Inefficient Markets"
hypothesis comes far closer to reality that either EMH or a "No
Markets" hypothesis: of course this will be hated by academics because
it makes it horrendously difficult to produce any numbers to illustrate
or support their theories (hence the invention of EMH).
Thirdly most contracts are small and belong
in the category that you call "self-enforcing" but as a natural
English speaker (so less grammatical with poorer syntax) I regard
as those supported by rational/ enlightened self-interest . Most
people belong to a network of small communities and so choose to
deal fairly, or to appear to do so, with members of intersecting
communities as well as their core community.
Fourthly, computers do not and cannot think:
they merely calculate. I think that reintroducing the stocks might
do more to improve the quality of macroeconomic economic advice
that reliance on the most sophisticated computer programmes. It
is possible to solve by algebra and analysis some problems that
cannot be handled by computers
In Light of Nihilism
"I can't help but wonder if the desire to
be scientific and professional has led to a sterile pursuit of clearly
limited problems, much as it has in philosophy."
Academia is a sterile beast. Most academics begin to smell like
old farts by their late 20's. Several fields of thought are finished.
Such as logistics, psychology, sociology etc.
As for modern philosophy, I wouldn't worry. I know of no great philosopher
thats actually received formal philisophical training. If there
is one, I'm sure he thought it was the garbage.
I'm happy if mankind produces one great philosopher every 100 years.
Be Happy,
N
Gary Marshall
Hello Mr. Buiter,
When you write these long tracts, I find it is because you want
to send as much of a confused message as possible. Congratulations,
you have succeeded again.
The reason that monetary policies or academic monetary economics
do not work is because they are founded on an absurdity: That a
nation's central bank controls or greatly influences interest rates.
Not one monetarist has ever shown me how these secretive institutions
perform such miracles even after being hounded. You have yet to
comply with my requests made numerous times. I guess the above is
finally a hint in the right direction; that monetary economics is
an impotent and bizarre little fellow.
-
naked capitalism
- Anonymous said...
- Majorajam said; “Hemant makes a great point. What is very much
undersppreciated here are the foreign policy considerations, and
their implications for this crisis.”
What is really under appreciated here are the foreign policy considerations
that intentionally created this crisis;
Excerpt;
“Given this storied history and two years of congressional testimony
on oil trading skullduggery, one would expect to find volumes of
current information available about this oil trading juggernaut.
Instead, this company’s activities are so secret that its web site
(www.phibro.com) is a one page affair and lists only the addresses,
phone and fax numbers of its offices in the U.S., London, Geneva,
and Singapore. No officers’ names, no bios, no history, no press
releases. And while the Wall Street firms of Goldman Sachs and Morgan
Stanley have been fingered by Congressman Bart Stupak (D-Mich) for
gaming the system, Phibro has completely escaped scrutiny during
a seven year period when crude oil has risen an astonishing 697%.
Phibro is the old Philipp Brothers trading firm that has resided
secretly and quietly on Nyala Farms Road in Westport, Connecticut
as a subsidiary of the banking/brokerage behemoth, Citigroup, since
the merger of Traveler’s Group and Citicorp (parent of Citibank)
in 1998. Traveler’s Group owned Phibro at the time of the merger.
Despite the fact that Phibro has provided Citigroup with $2 billion
in revenue over the past three years, the 205-page annual report
for Citigroup in 2007 carries only the following one-sentence footnote
on commodity income that acknowledges the existence of this company.
“Primarily includes the results of Phibro Inc., which trades crude
oil, refined oil products, natural gas, and other commodities.”
Combing through government archives, the first noteworthy appearance
of Phibro occurs on April 6, 2001, when the Wall Street law firm
of Sullivan & Cromwell sent a letter to the Commodity Futures Trading
Commission (CFTC), the Federal regulator of oil and other commodity
trading, acknowledging that it was representing “the Energy Group.”
The letter was noteworthy because it delineated just who had teamed
up to grease the oil rigging in Washington: namely, two investment
banks (Goldman Sachs and Morgan Stanley); a house of cards that
would later collapse (Enron); a proprietary trading firm inside
a Frankenbank (Phibro inside Citigroup); and two real energy firms
(BP Amoco and Koch Industries).
What the Energy Group had long lobbied for and finally received
from its Federal regulator was the breathtaking ability to trade
oil contracts and oil derivatives secretly in the over- the-counter
(OTC) market, thus avoiding the scrutiny of regulated commodity
exchanges, their CFTC regulator, and Congress. The April 6, 2001
letter was essentially to say thanks and interpret the new rules
as favorably as possible for the Energy Group.
The change in the law occurred via the
Commodity Futures Modernization Act of 2000 (CFMA) and is called
the Enron Loophole. (Since Enron’s trading room went
belly up along with the company, and Phibro is still trading oil
secretly all over the world, it should perhaps now be called the
Phibro Loophole.)
What the CFTC also granted the big Wall Street trading firms was
a license to sneak under the radar by using computer terminals located
in the U.S. while trading oil on foreign exchanges like the Intercontinental
Exchange (ICE) located in London but owned by an Atlanta, Georgia
outfit that was funded and launched by Wall Street firms and big
oil.
On June 3 of this year, Dr. Mark Cooper, Director of Research for
the Consumer Federation of America, correctly outlined the problem
to the Senate Committee on Commerce, Science and Transportation:
“The speculative bubble in petroleum markets has cost the economy
well over half a trillion dollars in the two years since the Senate
hearings first called attention to this problem…Public policies
have made these markets the playgrounds of the idle rich, while
consumers suffer the burden of rising prices for the necessities
of daily life. We have made it so easy to play in the financial
markets that investment in productive long term assets are unattractive…
-
- The most blatant mistake occurred
when Congress allowed the Commodity Futures Trading Commission to
forego regulation of over the counter trading in energy futures…
-
- Because there is no regulation of this huge swatch of activity,
regulators have little insight into what is going on in energy commodity
markets…
-
- Large traders who trade in commodities in the U.S. ought to
be required to register and report their entire positions in those
commodities here in the U.S. and abroad…
-
- If traders are unwilling to report all their positions, they
should not be allowed to trade in U.S. markets. If they violate
this provision, they should go to jail. Fines are not enough to
dissuade abuse in these commodity markets because there is just
too much money to be made.”
The only correction I would make to the otherwise flawless argument
above is that Wall Street is far from the playground of the “idle”
rich. Wall Street executives spend every waking minute (and I’ve
heard even dream about) how they can separate us from our money,
our homes and a voice in Washington. How appropriate that Citigroup’s
slogan is “the Citi never sleeps.”
Let’s say the CFTC was not a compromised regulator, was not an audition
stage and revolving door for million dollar jobs in the industry
it regulates. Let’s say it genuinely wanted to report back to Congress
on just how big a player Citigroup is in the oil markets. According
to a February 22, 2008 filing with the Securities and Exchange Commission
(SEC), Citigroup has over 2,000 principal subsidiaries (meaning
it really has more but it’s not naming them). Of these, a significant
number are secret offshore entities where records are unavailable
to regulators. (For a mind boggling look at this sprawling octopus
click here: http://www.sec.gov/
)
So the CFTC can’t get its hands on all records and even in jurisdictions
where it can, it first has to know under what names, out of a possible
2,000, Citigroup is trading oil and then aggregate the positions.
On May 6 of this year, Tyson Slocum, Director of the Energy Program
at the nonprofit watchdog, Public Citizen, testified before Congress
on yet another roadblock preventing a meaningful investigation of
oil price manipulation:
“Thanks to the Commodity Futures Modernization
Act, participants in these newly-deregulated energy trading markets
are not required to file so-called Large Trader Reports…
-
- These Large Trader Reports, together with the price and volume
data, are the primary tools of the CFTC’s regulatory regime…So the
deregulation of OTC markets, by allowing traders to escape such
basic information reporting, leave federal regulators with no tools
to routinely determine whether market manipulation is occurring
in energy trading markets…
-
- The ability of federal regulators to investigate market manipulation
allegations even on the lightly-regulated exchanges like NYMEX New
York Mercantile Exchange is difficult, let alone the unregulated
OTC market.”
Next comes what can only be described as an act of insanity on the
part of the Federal Reserve. After allowing for the repeal in 1999
of the depression era investor protection legislation known as the
Glass-Steagall Act in order to let Citigroup house retail bank deposits,
investment banking, insurance, stock brokerage and speculative proprietary
trading under one roof (the perfect storm that intensified the Great
Depression) the Federal Reserve decided on October 2, 2003 that
Citi wasn’t scary enough. It needed to allow this company that had
already been named in hundreds of lawsuits for securities frauds
and manipulations and could not remotely manage itself as a financial
firm to ramp up its oil trading business by allowing it to take
possession of crude oil on tankers because it would “reasonably
be expected to produce benefits to the public.” Here are excerpts
from the Fed’s release suggesting the expansive plans Citi had in
the oil storage and transport business:
“…Citigroup has indicated that it will adopt additional standards
for Commodity Trading Activities that involve environmentally sensitive
products, such as oil or natural gas. For example, Citigroup will
require that the owner of every vessel that carries oil on behalf
of Citigroup be a member of a protection and indemnity club and
carry the maximum insurance for oil pollution available from the
club. Citigroup also will require every such vessel to carry substantial
amounts of additional oil pollution insurance from creditworthy
insurance companies. Furthermore, Citigroup will place age limitations
on vessels and will require vessels to be approved by a major international
oil company and have appropriate oil spill response plans and equipment.
Moreover, Citigroup will have a comprehensive backup plan in the
event any vessel owner fails to respond adequately to an oil spill
and will hire inspectors to monitor the loading and discharging
of vessels. Citigroup also has represented that it will have in
place specific policies and procedures for the storage of oil… The
Board believes that Citigroup has the managerial expertise and internal
control framework to manage the risks of taking and making delivery
of physical commodities… For these reasons, and based on Citigroup’s
policies and procedures for monitoring and controlling the risks
of Commodity Trading Activities, the Board concludes that consummation
of the proposal does not pose a substantial risk to the safety and
soundness of depository institutions or the financial system generally
and can reasonably be expected to produce benefits to the public
that outweigh any potential adverse effects.”
Voting in favor of this unprecedented
action was then Federal Reserve Chairman Alan Greenspan as well
as current Chairman, Ben Bernanke.”
Link, more;
http://www.mail-archive.com/cia-drugs@yahoogroups.com/msg10493.html
Deception is the strongest political force on the planet.
i on the ball patriot
February 23, 2009
What "Nationalize the Banks" and the "Free Market" Really Mean
in Today's Looking-Glass World
"Banking shares began to plunge Friday morning after Senator
Dodd, the Connecticut Democrat who is chairman of the banking committee,
said in an interview with Bloomberg Television that he was concerned
the government might end up nationalizing some lenders “at least
for a short time.” Several other prominent policy makers – including
Alan Greenspan, the former chairman of the Federal Reserve, and
Senator Lindsey Graham of South Carolina – have echoed that view
recently.”
--Eric Dash, “Growing Worry on Rescue Takes a Toll on Banks,”
The New York Times, February 20, 2009
How is it that Alan Greenspan, free-market lobbyist for Wall
Street, recently announced that he favored nationalization of America’s
banks – and indeed, mainly the biggest and most powerful? Has the old
disciple of Ayn Rand gone Red in the night? Surely not.
The answer is that the rhetoric of “free markets,” “nationalization”
and even “socialism” (as in “socializing the losses”) has been turned
into the language of deception to help the financial sector mobilize
government power to support its own special privileges. Having undermined
the economy at large, Wall Street’s public relations think tanks are
now dismantling the language itself.
Exactly what does “a free market” mean? Is it what the classical
economists advocated – a market free from monopoly power, business fraud,
political insider dealing and special privileges for vested interests
– a market protected by the rise in public regulation from the Sherman
Anti-Trust law of 1890 to the Glass-Steagall Act and other New Deal
legislation? Or is it a market free for predators to exploit
victims without public regulation or economic policemen – the kind of
free-for-all market that the Federal Reserve and Security and Exchange
Commission (SEC) have created over the past decade or so? It seems incredible
that people should accept today’s neoliberal idea of “market freedom”
in the sense of neutering government watchdogs, Alan Greenspan-style,
letting Angelo Mozilo at Countrywide, Hank Greenberg at AIG, Bernie
Madoff, Citibank, Bear Stearns and Lehman Brothers loot without hindrance
or sanction, plunge the economy into crisis and then use Treasury bailout
money to pay the highest salaries and bonuses in U.S. history.
Terms that are the antithesis of “free market” also are being turned
into the opposite of what they historically have meant. Take today’s
discussions about nationalizing the banks. For over a century nationalization
has meant public takeover of monopolies or other sectors to operate
them in the public interest rather than leaving them so special interests.
But when neoliberals use the word “nationalization” they mean a bailout,
a government giveaway to the financial interests.
Doublethink and doubletalk with regard to “nationalizing” or “socializing”
the banks and other sectors is a travesty of political and economic
discussion from the 17th through mid-20th centuries. Society’s basic
grammar of thought, the vocabulary to discuss political and economic
topics, is being turned inside-out in an effort to ward off discussion
of the policy solutions posed by the classical economists and political
philosophers that made Western civilization “Western.”
Today’s clash of civilization is not really with the Orient; it is
with our own past, with the Enlightenment itself and its evolution into
classical political economy and Progressive Era social reforms aimed
at freeing society from the surviving trammels of European feudalism.
What we are seeing is propaganda designed
to deceive, to distract attention from economic reality
so as to promote the property and financial interests from whose
predatory grasp classical economists set out to free the world. What
is being attempted is nothing less than an attempt to destroy the intellectual
and moral edifice of what took Western civilization eight centuries
to develop, from the 12th century Schoolmen discussing Just Price through
19th and 20th century classical economic value theory.
Any idea of “socialism from above,” in
the sense of “socializing the risk,” is old-fashioned oligarchy – kleptocratic
statism from above. Real nationalization occurs when
governments act in the public interest to take over private property.
The 19th-century program to nationalize the land (it was the first plank
of the Communist Manifesto) did not mean anything remotely
like the government taking over estates, paying off their mortgages
at public expense and then giving it back to the former landlords free
and clear of encumbrances and taxes. It meant taking the land and its
rental income into the public domain, and leasing it out at a user fee
ranging from actual operating cost to a subsidized rate or even freely
as in the case of streets and roads.
Nationalizing the banks along these lines would mean that the government
would supply the nation’s credit needs. The Treasury would become the
source of new money, replacing commercial bank credit. Presumably this
credit would be lent out for economically and socially productive purposes,
not merely to inflate asset prices while loading down households and
business with debt as has occurred under today’s commercial bank lending
policies.
How neoliberals falsify the West’s political history
The fact that today’s neoliberals claim to be the intellectual descendants
of Adam Smith make it necessary to restore a more accurate historical
perspective. Their concept of “free markets” is the antithesis of Smith’s.
It is the opposite of that of the classical political economists down
through John Stuart Mill, Karl Marx and the Progressive Era reforms
that sought to create markets free of extractive
rentier claims by special interests whose institutional
power can be traced back to medieval Europe and its age of military
conquest.
Economic writers from the 16th through 20th centuries recognized
that free markets required government oversight to prevent monopoly
pricing and other charges levied by special privilege.
By contrast, today’s neoliberal ideologues
are public relations advocates for vested interests to depict a “free
market” is one free of government regulation, “free” of anti-trust protection,
and even of protection against fraud, as evidenced by the SEC’s refusal
to move against Madoff, Enron, Citibank et al.).
The neoliberal ideal of free markets is thus basically that
of a bank robber or embezzler, wishing for a world without police so
as to be sufficiently free to siphon off other peoples’ money without
constraint.
The Chicago Boys in Chile realized that markets free for predatory
finance and insider privatization could only be imposed at gunpoint.
These free-marketers closed down every economics department in Chile,
every social science department outside of the Catholic University where
the Chicago Boys held sway. Operation Condor arrested,
exiled or murdered tens of thousands of academics, intellectuals, labor
leaders and artists. Only by totalitarian control over the academic
curriculum and public media backed by an active secret police and army
could “free markets” neoliberal style be imposed. The resulting privatization
at gunpoint became an exercise in what Marx called “primitive accumulation”
– seizure of the public domain by political elites backed by force.
It is a free market William-the-Conqueror
or Yeltsin-kleptocrat style, with property parceled out to the companions
of the political or military leader.
All this was just the opposite of the kind of free markets that Adam
Smith had in mind when he warned that businessmen rarely get together
but to plot ways to fix markets to their advantage. This is not a problem
that troubled Mr. Greenspan or the editorial writers of the New York
Times and Washington Post. There really is no kinship between their
neoliberal ideals and those of the Enlightenment political philosophers.
For them to promote an idea of free markets as ones “free” for political
insiders to pry away the public domain for themselves is to lower an
intellectual Iron Curtain on the history of economic thought.
The classical economists and American Progressives envisioned markets
free of economic rent and interest – free of rentier overhead
charges and monopoly price gouging, free of land-rent, interest paid
to bankers and wealthy financial institutions, and free of taxes to
support an oligarchy. Governments were to base their tax systems on
collecting the “free lunch” of economic rent, headed by that of favorable
locations supplied by nature and given market value by public investment
in transportation and other infrastructure, not by the efforts of landlords
themselves.
The argument between Progressive Era reformers, socialists, anarchists
and individualists thus turned on the political strategy of how best
to free markets from debt and rent. Where they differed was on the best
political means to achieve it, above all the role of the state. There
was broad agreement that the state was controlled by vested interests
inherited from feudal Europe’s military conquests and the world that
was colonized by European military force. The political question at
the turn of the 20th century was whether peaceful democratic reform
could overcome the political and even military resistance wielded by
the Old Regime using violence to retain its “rights.” The ensuing political
revolutions were grounded in the Enlightenment, in the legal philosophy
of men such as John Locke, political economists such as Adam Smith,
John Stuart Mill and Marx. Power was to be used to free markets from
the predatory property and financial systems inherited from feudalism.
Markets were to be free of privilege and free lunches, so that people
would obtain income and wealth only by their own labor and enterprise.
This was the essence of the labor theory of value and its complement,
the concept of economic rent as the excess of market price over socially
necessary cost-value.
Although we now know that markets and prices, rent and interest,
contractual formalities and nearly all the
elements of economic enterprise originated in the “mixed economies”
of Mesopotamia in the fourth millennium BC and continued
throughout the mixed public/private economies of classical antiquity,
the discussion was so politically polarized that the idea of a mixed
economy with checks and balances received scant attention a century
ago.
Individualists believed that all that shrinking central governments
would shrink the control mechanism by which the vested interests extracted
wealth without work or enterprise of their own. Socialists saw that
a strong government was needed to protect society from the attempts
of property and finance to use their gains to monopolize economic and
political power. Both ends of the political spectrum aimed at the same
objective – to bring prices down to actual costs of production. The
common aim was to maximize economic efficiency so as to pass on the
fruits of the Industrial and Agricultural Revolutions to the population
at large. This required blocking the
rentier class of interlopers from grabbing the public domain
and controlling the allocation of resources. Socialists
did not believe this could be done without taking the state’s political
and legal power into their own hands. Marxists believed that a revolution
was necessary to reclaim property rent for the public domain, and to
enable governments to create their own credit rather than borrow at
interest from commercial bankers and wealthy bondholders. The aim was
not to create a bureaucracy but to free society from the surviving absentee
ownership power of the vested property and financial interests.
All this history of economic thought has been as thoroughly expunged
from today’s academic curriculum as it has from popular discussion.
Few people remember the great debate at the turn of the 20th century:
Would the world progress fairly quickly from Progressive Era reforms
to outright socialism – public ownership of basic economic infrastructure,
natural monopolies (including the banking system) and the land itself
(and to Marxists, of industrial capital as well)? Or, could the liberal
reformers of the day – individualists, land taxers, classical economists
in the tradition of Mill, and American institutionalists such as Simon
Patten – retain capitalism’s basic structure and private property ownership?
If they could do so, they recognized that it would have to be in the
context of regulating markets and introducing progressive taxation of
wealth and income. This was the alternative to outright “state” ownership.
Today’s extreme “free market” idea is a dumbed-down caricature of this
position.
All sides viewed the government as society’s “brain,” its forward
planning organ. Given the complexity of modern technology, humanity
would shape its own evolution. Instead of evolution occurring by “primitive
accumulation,” it could be planned deliberately. Individualists countered
that no human planner was sufficiently imaginative to manage the complexity
of markets, but endorsed the need to strip away all forms of unearned
income – economic rent and the rise in land prices that Mill called
the “unearned increment.” This involved government regulation to shape
markets. A “free market” was an active political creation and required
regulatory vigilance.
As public relations advocates for the vested interests and special
rentier privilege, today’s “neoliberal” advocates of “free”
markets seek to maximize economic rent –
the free lunch of price in excess of cost-value, not
to free markets from rentier charges. So misleading a pedigree
only could be achieved by outright suppression of knowledge of what
Locke, Smith and Mill really wrote. Attempts to regulate “free markets”
and limit monopoly pricing and privilege are conflated with “socialism,”
even with Soviet-style bureaucracy. The aim is to deter the analysis
of what a “free market” really is: a market
free of unnecessary costs: monopoly rents, property rents and financial
charges for credit that governments can create freely.
Political reform to bring market prices in line with socially necessary
cost-value was the great economic issue of the 19th century. The labor
theory of intrinsic cost-value found its counterpart in the theory of
economic rent: land rent, monopoly price gouging, interest and other
returns to special privilege that increased market prices purely by
institutional property claims. The discussion goes all the way back
to the medieval churchmen defining Just Price. The doctrine originally
was applied to the proper fees that bankers could charge, and later
was extended to land rent, then to the monopolies that governments created
and sold off to creditors in an attempt to extricate themselves from
debt.
Reformists and more radical socialists alike sought to free capitalism
of its egregious inequities, above all its legacy from Europe’s Dark
Age of military conquest when invading warlords seized lands and imposed
an absentee landlord class to receive the rental income, which was used
to finance wars of further land acquisition. As matters turned out,
hopes that industrial capitalism could reform itself along progressive
lines to purge itself of its legacy from feudalism have come crashing
down. World War I hit the global economy
like a comet, pushing it into a new trajectory and catalyzing its evolution
into an unanticipated form of finance capitalism.
It was unanticipated largely because most reformers spent so much
effort advocating progressive policies that they neglected what Thorstein
Veblen called the vested interests. Their Counter-Enlightenment is creating
a world that would have been deemed a dystopia a century ago – something
so pessimistic that no futurist dared depict a world run by venal and
corrupt bankers, protecting as their prime customers the monopolies,
real estate speculators and hedge funds whose economic rent, financial
gambling and asset-price inflation is turned into a flow of interest
in today’s rentier economy. Instead of industrial capitalism
increasing capital formation we are seeing finance capitalism strip
capital, and instead of the promised world of leisure we are being drawn
into one of debt peonage.
The financial travesty of democracy
The financial sector has redefined democracy by claiming claims that
the Federal Reserve must be “independent” from democratically elected
representatives, in order to act as the bank lobbyist in Washington.
This makes the financial sector exempt from the democratic political
process, despite the fact that today’s economic planning is now centralized
in the banking system. The result is a regime of insider dealings and
oligarchy – rule by the wealthy few.
The economic fallacy at work is that bank credit is a veritable factor
of production, an almost Physiocratic source of fertility without which
growth could not occur. The reality is that the monopoly right to create
interest-bearing bank credit is a free transfer from society to a privileged
elite. The moral is that when we see a “factor of production” that has
no actual labor-cost of production, it is simply an institutional privilege.
So this brings us to the most recent debate about “nationalizing”
or “socializing” the banks. The Troubled Asset Relief Program (TARP)
so far has been used for the following uses that I think can be truly
deemed anti-social, not “socialist” in any form.
By the end of last year, $20 billion was used to pay bonuses and
salaries to financial mismanagers, d
Keith D. Says: 
John Galt Says: