Economic Dreams - Economic Nightmares

Reinstate Glass-Steagall: Roubini says yes

I have been keeping an eye on various proposals to "reinstate" Glass-Steagall for quite some time. Sometime I ought to post a more comprehensive list as to who is in favor (and in what sense) and who is opposed. Clearly the folks at New Economic Perspectives (from Kansas City and Beyond) are so inclined. So too Nouriel Roubini, as reported by Tech Ticker, 4/11:

Roubini supports the 'Volcker Rule' which would force banks to stop proprietary trading. "Why should you use taxpayer money to essentially subsidize risky prop trading?," he asks.

Roubini goes even further, saying Congress should reinstate Glass-Steagall which separated commercial banking from investment banking. "If Goldman Sachs wants to be a hedge fund, so be it, but there should be a level playing field," he argues. "Other hedge funds don't borrow at zero rate with the guarantee of the government."

For more on the "Volcker Rule", and financial reform: 5/13 CNN Money video featuring Senator Ted Kaufman, D-Del that is worth a look, and 5/11 link featuring Nouriel Roubini.

Paul Krugman's ideas seem to differ a bit, and seem to be where the Obama Administration is trying to lead Congress. Here's Krugman, Financial Reform 101, 4/1:

It's easy to see where concerns about banks that are "too big to fail" come from. In the face of financial crisis, the U.S. government provided cash and guarantees to financial institutions whose failure, it feared, might bring down the whole system. And the rescue operation was mainly focused on a handful of big players: A.I.G., Citigroup, Bank of America, and so on.

This rescue was necessary, but it put taxpayers on the hook for potentially large losses. And it also established a dangerous precedent: big financial institutions, we now know, will be bailed out in times of crisis. And this, it's argued, will encourage even riskier behavior in the future, since executives at big banks will know that it’s heads they win, tails taxpayers lose.

The solution, say people like Mr. Volcker, is to break big financial institutions into units that aren’t too big to fail, making future bailouts unnecessary and restoring market discipline.

It's a convincing-sounding argument, but I'm one of those people who doesn’t buy it.

Here's how I see it. Breaking up big banks wouldn’t really solve our problems, because it’s perfectly possible to have a financial crisis that mainly takes the form of a run on smaller institutions. In fact, that’s precisely what happened in the 1930s, when most of the banks that collapsed were relatively small — small enough that the Federal Reserve believed that it was O.K. to let them fail. As it turned out, the Fed was dead wrong: the wave of small-bank failures was a catastrophe for the wider economy.

The same would be true today. Breaking up big financial institutions wouldn’t prevent future crises, nor would it eliminate the need for bailouts when those crises happen. The next bailout wouldn’t be concentrated on a few big companies — but it would be a bailout all the same. I don’t have any love for financial giants, but I just don’t believe that breaking them up solves the key problem.

So what's the alternative to breaking up big financial institutions? The answer, I'd argue, is to update and extend old-fashioned bank regulation.

And this is exactly what the Senate is now doing. Sort of. Economics of Contempt (EoC) is generally OK with regulatory reform that doesn't get too bizarre. On the other hand, EoC is particularly against the Sen. Blanche Lincoln's "Section 106" proposal as per derivatives. To EoC, 5/8:

Bloomberg has an excellent story on the origins of Blanche Lincoln's disastrous swaps proposal (the infamous "Section 106") — Bloomberg: How ‘Hard to Fathom’ Derivatives Rule Emerged in U.S. Senate. Short version:

The idea arose from a mix of policy debate, campaign politics and personal relationships -- and little consideration of the business or economic implications, according to interviews with Senate aides, administration officials and industry lobbyists.

Read the whole article. Oh by the way, Paul Volcker has now also come out against Section 106. Sheila Bair penned a letter to Lincoln sharply criticizing Section 106 last week, and the Fed circulated a memo on the Hill a couple weeks ago arguing that Section 106 should be deleted. …

The whole point is that Section 106 doesn't distinguish between prop trading and market-making. It bans banks from doing both. [Robert] Reich clearly has no clue what Lincoln's Section 106 proposal is even about — and yet he's already declared that failing to support it would be "pandering to Wall Street."

Look, this isn't difficult. Swaps are a critical part of modern banking. Just like normal commercial lending requires banks to serve as intermediaries between savers and borrowers, the swaps market also requires intermediaries (known as dealers, or market-makers). These intermediaries borrow short and lend (through swaps) long; they are susceptible to runs; and their disorderly failure can cause severe collateral damage to the real economy. Pretending that swap dealers aren't engaged in an important banking function by refusing to call them "banks" is not just delusional, it's also dangerous. And yet this is what Blanche Lincoln's Section 106 proposal aims to do.

Maybe Section 106 won't last long. According to one source, 5/12 "Reuters was reporting Monday that … Section 106, is going to get excised, perhaps this week."

Export Our Way Out of Debt?

Over at Fed Watch, Tim Duy reminds us to be keenly aware of the subtleties of international finance — and simpleton thinking that there are quick fixes. If everybody tries to export their way out of their finance problem all will lose. So too if even a bunch of countries try. It is one thing to be rightfully worried about Europe and the PIIGS, but we need also add in worries later this year about the USA and California, NY, and other states (also counties and municipalities). For those of us who have lived long enought to have assets, where do we find a "safe haven"?  Or do we? At Clusterfuck Nation, James Howard Kunstler believes that it is "over," meaning Western Civilization. Kunstler believes that we have finally pumped up the ultimate bubble, government debt pretty much worldwide, and that all bets are now off. We'll see!  To Duy, We Can't All Be (Net) Exporters 4/29:

The Greek crisis, which helped further extend the Dollar's uptrend in place since the beginning of the year, is a reminder that global imbalances are still with us - and, if not corrected, will eventually threaten the sustainability of the global recovery. Indeed, how sustainable can any recovery be if the vast majority of nations are pursuing an export oriented growth strategy? After all, clearly that is not a game all can play - there needs to be a net importer to offset the net exports. Who wants to fill that role? If the US is pushed into filling that role, we have simply come full circle over the past three years.

The Administration is clearly aware of this challenge, but concerns are growing that any action will fall short of what is necessary to bring about real change. From Sudeep Reddy at the Wall Street Journal:

President Barack Obama's goal of doubling U.S. exports over the next five years will be difficult to meet, business leaders and economists say, because of the lack of momentum on demolishing trade barriers and the shift by more American companies toward producing overseas.

U.S. exporters want Washington to put more pressure on trading partners to eliminate tariffs, crack down on intellectual-property violations and take a harder line on trading partners' currency policies. American firms say stronger action by the federal government could substantially boost prospects for U.S. exports.

Policymakers argue that it is far too early to admit defeat:

Christina Romer, chair of the White House Council of Economic Advisers, calls the administration's export target "an ambitious but reasonable goal."

"Going up 100% over a five-year period is not such a radical idea when you think about historical experience," she said, noting that exports increased more than 75% between 2003 and 2008. "It is going to be a gradual process. We are just starting the concrete steps in terms of what we can do to lower the fixed costs associated with exporting through trade promotion and commercial diplomacy."

… Am I the only one that finds the Administration's focus on doubling exports somewhat disingenuous? Economic growth depends on net exports - doubling exports is a fine goal, as long as import growth is contained, such that the net effect is positive. But with the economy bouncing back, will import growth remain contained? Recent signs are not supportive - the recovery so far has ended the improvement in the real trade gap….

[A]s the broad global financial crisis continues to fade, nations will increasingly attempt to withdraw fiscal support for their economies - even more so with the Greece example now so vivid - and attempt to rely on external growth to compensate. It is not a game everyone can win. But if it deteriorates into competitive devaluations, it is a game everyone can lose. 

Creeping hyperinflation anyone? As frightening as that prospect seems, Jim Kunstler spins it into something more immediately ominous. In And Chicks for Free, 5/10 Kunstler says:

[I]mbalances of global finance are so grotesque now that the whole money system is hanging together with nothing but spit and prayer. I get rafts of e-letters every week warning of a supposedly-coming global currency -- a companion idea to the notion of a one-world government. Both are idiotic fantasies. Events are taking the nations of the world in the other direction: towards break-up, down-sizing, down-scaling. Likewise, if major currencies such as the Euro and the dollar blow up, they're much more likely to be replaced by more local bank-notes backed by gold than by some hypothetical Amero or Globo-buck.

At seven a.m. Eastern time, the European stock markets were zooming, and Bloomberg even carried a wonderfully mysterious headline saying Greek Bonds Rally. That was especially rich -- like, who in the fuck is going to load up on Greek bonds now? Is there a pension fund somewhere run by such dimwits that they would sell their positions in the Goldman Sachs issued Timberwolf CDO in order to get in on the new bargain in ten-year Greek sovereigns? I hope those pensioners are prepared to spend what remains of their lives selling chestnuts from pushcarts on the streets of Oslo, because they sure won't be clipping coupons in front of any World Cup telecast.

As if life in the USA wasn't surreal enough last week. Once upon a time, the stock market was a  place where people with capital went to look for productive activity to invest in -- say, a company devoted to making soap flakes, an underpants factory. Now the market is a robot combat arena where algorithms battle for supremacy of the feedback loops.  Thursday's still-baffling fifteen-minute "crash" was an excellent demonstration of the diminishing returns of technology. People too-clever-by-half, aided greatly by computers, have now gamed the investment indexes so successfully that these markets no longer have anything to do with investment -- they're just about shaving micro-points of profit at high volumes by micro-milliseconds off mere differentials in... math! This is truly quant heaven, a place where only numbers matter and there is no correspondence to anything in the real world. In other words, last Thursday's bizarre action was a warning that the American stock markets have flown up their own aggregate ass.

So there you have it! If you find a safe place to hide assets, let me know. Goldbugs want you to buy gold. Rick Bookstaber (3/8) tells us that gold too is a bubble. According to Felix Salmon, 5/7, PIMCO's El-Erain is hyper-bearish and wants you to send money to them so they can out-compete all others.  So does Goldman Sachs.  Or maybe you are too small a fish for Goldman to bother with. In any case, Happy Tuesday.

Lingering question: Is there any way short of Jubilee (Jubilee Debt Coalition) to end this era of global imbalance? See, e.g.  Niall Ferguson: Bring on the debt jubilee!, 2/13/2009.

[End Note: I'm not a big fan of Debt Jubilee.  I believe people (and nation states) ought to be accountable for their debt. On the other hand I believe that institutions, e.g. financial institutions (government and private) ought to be accountable for setting up arrangements that are understandable to those who use them.  We have a big problem on our hands and seemingly no answers. This post is a bid dark, even for me.  Oh well, I categorized it under "irrational pessimism"--mine.]

The Government Debt Problem

I've been thinking about the public debt problem lately. Is the problem really a non problem or at minimum a problem of creeping gradualism, as many Keynesians seem to argue? Or is the problem acute: the next big bubble to burst, as argued lately by Doug Noland in various posts on at Credit Bubble Bulletin, most recently Tuesday April 27, 2010. A snip:

From my analytical perspective, the system has found its way into another "terminal phase" of excess – this time emanating from the Global Government Finance Bubble. Intoxicated yet again by the effects of loose “money,” the bulls see (inflating) markets as confirmation of sound system underpinnings. I, in contrast, see another policy-induced absolute mess in the pricing and distribution of finance throughout the entire system. As always, calling the timing of a Bubble’s demise is a perilous proposition. But I can sure see the makings of acute systemic fragilities.

Today, while wading through too many emails, I found a nice little tidbit from Bill Bonner, which should give us pause. Of course it won't give any pause to those who we might libel "inflationists". To Bonner, US Deficit Spending and Why Governments CAN Go Broke, The Daily Reckoning, April 30:

The private sector is de-leveraging...as near as we can tell. Private businesses cut their payrolls. They trimmed expenses. They protected their profit margins - generally.

But the public sector figures it has a different role to play...a countercyclical role. While the private sector eases off, the public sector puts the pedal to the metal.

That's been the story for the last year and a half. The government pays more. Hires more. And floats deeper in the water.

Walter Wriston once commented that the "government can't go broke." But that just shows you why the banking sector is in such trouble; Wriston ran Citibank…

The trouble with most people in economics and finance these days is that they study too much math and not enough history. If they read more history they'd know that governments go broke all the time. They'd probably get a hint about why governments go broke too - they pay too much; hire too many people; give away too much money on bread and circuses; and they get involved in too many costly foreign wars.

What's new?

Nothing really. But the fab finance is an innovation. Now, with the debt spread among so many unaware debtors…we can all go broke in a much bigger way. [Hyperlink added]

So, we will all watch as first Greece, then Spain, then the other PIIGS (and the rest of Euro-land) try to find a way out of the mess. And we'll watch later as the US tries to deal with California and about 5 other states, along with a bunch of big cities who are also in one hell of a fiscal mess.

For those like me who may have thought that their federal pensions were a safety net, we might want to think again! [Note: I never thought that I would get to keep all my federal pension benefits. I heard/read about the Great Depression, Native American "treaties" with the US Government, etc. long ago and realize that promises are the stuff of words. The link between word and deed is always and everywhere tenuous.]

Tragedy of the Commons: Finance edition

When Garrett Hardin first proposed The Tragedy of the Commons, Science Dec. 1968, he used an example of nomadic herdsmen overusing land held in common without the "protection" of property rights. The problem posed by Hardin was that without some kind of social contract to prohibit over-selfishness, each individual would gain by adding additional grazing animals to a common pasture. Without some form of social restraint, the pasture would eventually be ruined by overgrazing. No one would have incentive to stop the plunder. All incentives would work toward ruin. Hardin's tragedy was cast up then, and is applicable now to much beyond a commonly held pasture. [Note: Hardin's main message was about unbridled human population growth, pollution of the world's air and watersheds, and other potential environmental horrors. Hardin used the common pasture example only to introduce his broader message.]

In the early 1990s Hardin, along with Herman Daly used the "tragedy" metaphor in the context of common pools of capital. I wonder whether either foresaw the mess that American-led financial titans, along with ideologically blind and/or Bush-Administration-wounded regulators, along with blind politicians, rating agencies that had interests in pumping-up ratings, etc. would lead the world into. Interestingly, Hardin used a bank-robber metaphor in his 1968 article:

The man who takes money from a bank acts as if the bank were a commons. How do we prevent such action? Certainly not by trying to control his behavior solely by a verbal appeal to his sense of responsibility. Rather than rely on propaganda we … insist that a bank is not a commons; we seek the definite social arrangements that will keep it from becoming a commons. That we thereby infringe on the freedom of would-be robbers we neither deny nor regret.

Today (as in times past) bank robbers come in two forms. The "blue collar" variety we all think of when we talk about armed "bank robbers," and the other "white-collar crime variety" that ever-more-frequently seem to be those we fear theses days. William Black's book, The Best Way to Rob a Bank is to Own One comes to mind.

George Ackerlof and Paul Romer refer to this emergent process as "looting," in The Economic Underworld of Bankruptcy for Profit. Many bloggers and commentators spent the better part of the "naughties", 2000-2008 warning of the impending doom, and tracking the misdeeds of the looters. I tracked some of these Cassandras right here from 2005 forward, thinking that I might help a wee bit to the discussion, and that I might learn a bit by forcing myself to write about it. I noted in early 2007 that the Cassandras were growing weary of trumpeting the impending doom. I too was growing weary, and increasingly gloomy about the prospects going forward. Soon enough the wait would be over, and now so many track the mess situation that I have trouble just reading through my Google Reader, some of which I mark as shared.

Meanwhile another group (not bloggers, but bankers and hedge fund managers) was busying themselves preparing to capitalize on the impending doom — prepping to loot the commons for private gain. Matt Taibbi recently covered some of this in Will Goldman Sachs Prove Greed is God?, The Guardian, April 27, portraying some of Wall Street's cleverest as Ayn Rand ideologues, interested only in themselves. These clever few (some herald them as the brightest minds on Wall Street) had figured out a way to finance a continuing string of bets against the market — the bubble housing market basket of collateralized debt obligations, credit default swaps, etc. — by constructing and selling the very debt instruments they were shorting. Clever indeed, and likely perfectly legal, albeit morally reprehensible. We'll see as to the legality of it all, as the Goldman Sachs (and other yet-to-emerge) lawsuits play out. John Cassidy offers a perspective different from Taibbi's in, Goldman Sachs and Rational Irrationality, The New Yorker, April 26. Cassidy also does a good job of explaining "rational irrationality". Just as Garrett Hardin did, 40 years ago.

The few who figured out a self-financing way to play the "shorts" game found a way around Keynes warning that, "Market can stay irrational longer than you can stay solvent." Unfortunately, their game kited the markets along while they waited patiently for the inevitable decline. Their actions, arguably, made the crash worse — much worse perhaps — than it would otherwise have been. See, e.g. Goldman Sachs, Magnetar, and Outrage, The Economist, April 19. And to add insult to injury, we and our children will all get to pay for the crash, if not now then later when the bill will be even bigger.

The fix, if there is one, may again be one that Hardin would endorse. In a May 1998 piece titled Extensions of "The Tragedy of the Commons", Hardin says: "the way to avoid disaster in our global world is through a frank policy of 'mutual coercion, mutually agreed upon.'" Hardin elaborates, again building from bank-robbing:

The morality of bank-robbing is particularly easy to understand because we accept complete prohibition of this activity. We are willing to say "Thou shalt not rob banks," without providing for exceptions. But temperance also can be created by coercion. Taxing is a good coercive device. To keep downtown shoppers temperate in their use of parking space we introduce parking meters for short periods, and traffic fines for longer ones. We need not actually forbid a citizen to park as long as he wants to; we need merely make it increasingly expensive for him to do so. Not prohibition, but carefully biased options are what we offer him. A Madison Avenue man might call this persuasion; I prefer the greater candor of the word coercion.

Coercion is a dirty word to most liberals now, but it need not forever be so. As with the four-letter words, its dirtiness can be cleansed away by exposure to the light, by saying it over and over without apology or embarrassment. To many, the word coercion implies arbitrary decisions of distant and irresponsible bureaucrats; but this is not a necessary part of its meaning. The only kind of coercion I recommend is mutual coercion, mutually agreed upon by the majority of the people affected.

To say that we mutually agree to coercion is not to say that we are required to enjoy it, or even to pretend we enjoy it. Who enjoys taxes? We all grumble about them. But we accept compulsory taxes because we recognize that voluntary taxes would favor the conscienceless. We institute and (grumblingly) support taxes and other coercive devices to escape the horror of the commons.

Let's hope that when all is said and done regarding impending finance re-regulation we have not forgotten Hardin's advice. Like many others, Hardin would likely advocate for much fuller disclosure, simpler financial instruments, higher capital requirements, much lower leverage limits, and disallowing people from betting on others' impending disasters. Legislative and administrative reform measures will have to be developed carefully so as to avoid being either unduly regulatory restrictive or unduly lax. The next couple of months (years? decades?) will prove instructive. [Note: Need to look further to see who has advocated what re: "simpler financial instruments" (terms used by Rick Bookstaber in A Demon of our own Design)]

In the meantime we could do worse than to ponder Joseph Stiglitz's Capitalist Fools, and think of the roles played by various actors in building the mess we now find ourselves in.