Economic Dreams - Economic Nightmares

Financial "Rock, Paper, Scissors"

Let the rock be gold, the paper be money, and the scissors, a shredder. We have a stage set for "financial rock, paper, scissors". From a historical perspective, we can easily trace the most recent path from gold to paper money (or fiat currency) as it has played out on the world stage—officially beginning in 1971 when President Richard Nixon officially declared the US to be off the gold standard. Numerous books have been written on the matter. Here is a very short history that begins in 1913 titled "Privatize the Gains, Socialize the Losses", by Peter Treadway. Paper covers rock! {Note: Treadway's paper isn't the best short history around, and may replace it with something else, but I do like the title.}

What is just now playing out is the predicted credit bust that predates the shredding of the paper money when market cycles turn ugly. Or maybe it doesn't precede shredding (partial shredding via inflation really), but someone will have to explain to me just how we get out of this mess otherwise. Oh, I almost forgot Mosler's Law: "There is no financial crisis so deep that a sufficiently large increase in public spending cannot deal with it." I'll post more on the "Chartalist fix" soon.

Numerous blogs are now tracking the debt bubble that is still building (and shifting from "private" to "public") in the wake of the credit bubble. Few are offering acceptable resolutions to the debt problem. At least I'm not finding them—or accepting them. Here are a few places that track the problem: Doug Noland's Credit Bubble Bulletin, Steve Keen's Oz Debtwatch, Edward Harrison's Credit Writedowns.

Paul Krugman, among other Keynesian economists, advocates higher inflation to create more space for interest rate cuts in times of stress. Of course "higher inflation" for awhile would help the government out from under some of the debt burden too. But at the expense of those on fixed incomes, unless tax policy or other means were used to make "fixed incomes" types whole again.

Many on the "right" seem to want to blast Krugman for advocating that we inflate our way out of the crisis, as if that were (1) true, and (2) the only tool Krugman advocates for. Yet the Feb 12 IMF paper, "Rethinking Macroeconomic Policy" (pdf) Krugman points to in a recent post, talks through various tools to try to find a path forward, including

• Raising the Inflation Target
• Combining Monetary and Regulatory Policy
• Higher Inflation Targeting and Foreign Exchange Intervention
• Providing Liquidity More Broadly
• Creating More Fiscal Space in Good Times
• Designing Better Automatic Fiscal Stabilizers

Neo-chartalists, at least some of them, advocate what I'll call an "modern-day alchemy fix" to the debt problem, remember: "There is no financial crisis so deep that a sufficiently large increase in public spending cannot deal with it."

In any supposed "fix" there will be winners and losers, with the government in the middle of the mess. Scary times ahead! Both the Keynesian and the Chartalist approach suggests inflation. But how much? Scissors cut paper! Out come the shredders, figuratively, to cut up the paper. Inflation to counter deflation? Or runaway inflation? What other ideas are worth looking at? Maybe it is as simple as re-regulation — as if that were simple — but I doubt it.

If the "scissor act" is too flagrant, as it may well be given the size of the debt we are dealing with, we will see a substantial loss of faith in US currency. Such could trigger wide-spread panic and subsequent worldwide Depression. At minimum we would see at least some countries try to mimic the US move, which might set a stage for hyperinflation. What China and the Arab states might do in response is an open question, particularly if we repudiate the debt outright apply Mosler's Law as some Neo-Chartalists advocate.

The point of this little note is to suggest that in the wake of inflationary actions to deal with the debt bubble, we will likely see — already are seeing, e.g."We are All Austrians Now" — calls for a return to what might be called 21^st century gold standard. If that were to become a political necessity, we will have come full circle: Rock crushes scissors!

I hope that we can stay with fiat currency and find means to deal with the mess at hand. But I am outclassed by most of the economists and finance experts I follow. So I watch and read, and occasionally comment. The "mess" is once-again center stage as the PIIGS threaten default. And California and other messes closer to home will prove interesting to watch as this year unfolds. This is a Wicked Problem of global proportions. But that is a story for another day.

Fed to Consider Preventative Medicine re: Asset Bubbles

I have never understood the unwavering reluctance by the Fed to lean against emerging asset bubbles. Now — in the wake of the worst financial mess since the Great Depression— it looks like that reluctance is disappearing:

Bernanke Weighs Limiting Consolidation, Asset Bubbles, Craig Torres: Oct. 15 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said the central bank will consider discarding its long- standing aversion to interfering with asset-price bubbles and warned that the banking business may be concentrated in too few companies.

Officials should review how supervision and interest rates can minimize the "dangerous phenomenon" of bubbles in housing, stocks and other assets that risk bringing the financial system and economy down with them when they burst, Bernanke said.

"There is no doubt that as we emerge from the current crisis that we are all going to look very hard at that issue and what can be done about it," he told the Economic Club of New York in his broadest remarks on future regulatory changes since the credit crisis deepened last month.

The comments signal that the 54-year-old chairman, while trying to quell the worst market turmoil since the 1930s, is crafting an agenda for greater oversight. Policy makers will toughen their response to "excessive leverage," give more weight to financial stability in economic analysis and examine ways to strengthen the system of trading and settlement behind complex derivative securities, he said.

The U.S. faces "a very serious too-big-to-fail problem," in which the insolvency of a large financial company could threaten a market collapse, Bernanke said in reply to an audience question. "There are too many firms that are in some sense systemically critical." …

Butier Responds to Greenspan's Latest Attempt to Rewrite History

{Updated, April 9}
At maverecon Willem Butier counters Alan Greenspan's latest claim the he and the US Fed not be held responsible, in large part, for our current mess. Butier's eight policy "tragedies":

1. The Greenspan Fed (August 1987 - January 2006) did indeed contribute, through excessively lax monetary policy, to the US housing boom that has now turned to bust.
2. The Greenspan-Bernanke put is real. It is an example of an inappropriate monetary policy response to a stock market decline.
3. The Greenspan Fed focused erroneously on core inflation, rather than using all available brain cells to predict underlying headline inflation in the medium term.
4. The Greenspan Fed failed to appreciate the downside of the rapid securitisation during the first half of this decade and acted exclusively as a cheerleader for its undoubted virtues.
5. The Greenspan Fed displayed a naive faith in the self-regulating and self-policing properties of financial markets and private financial institutions.
6. The Greenspan Fed, by enabling the rescue of Long Term Capital Management in 1998, acted as a moral hazard incubator.
7. The failure of the Greenspan Fed to press, before or after LTCM, for a special insolvency resolution regime with prompt corrective action features for all highly leveraged private financial institutions that were likely to be deemed too big and too systemically important to fail, demonstrates either bad judgement or regulatory capture.
8. During his years as Chairman of the Federal Reserve Board, Mr. Greenspan's statements reflected a partial (in every sense of the world) understanding of how free competitive markets based on private ownership work. This partial understanding guided his actions as monetary policy maker and financial regulator. Mr Greenspan's theories have been comprehensively refuted by the financial crises of 1997/98 and 2007/08.

Butier elaborates on each. We will bring forward only one, dealing with possibilities for moral hazard. But before we do, I just found Martin Wolf's counter-balancing position, Ft.com, April 8, still praising Greenspan, while fearing that over-zealous regulatory reform spaned by a Greenspan "blame game" will kill the "good" that free-er (my word, Wolf uses "free) market mechanisms bring. Whereas Butier lists eight "tragedies" of Fed policy/practice, Wolf highlights two: (1) regulators should have been "tougher", in subprime and elsewhere, and (2) monetary policy should have been tigher, not looser — to lean against prevailing winds of excess instead of leaning with them.

David Beckworth, via Macro and Other Musings, adds insight into why Butier's critique is on target:

… [T]he Federal Reserve is a monetary hegemon. It holds the world's main reserve currency and many emerging markets are pegged to dollar. Thus, it's monetary policy is exported across the globe. This means that the ECB, even though the Euro officially floats, has to be mindful of U.S. monetary policy lest its currency becomes too expensive relative to the dollar and all the other currencies pegged to the dollar. The Fed's loosening, therefore, of monetary policy in the early-to-mid 2000s triggered a global liquidity glut that set the stage the subsequent housing boom-bust cycle. This is not to say the 'saving glut' and financial innovation had no role, but rather that loose monetary policy was a key factor behind the boom. …

Back To Butier:

The Greenspan Fed: a tragedy of errors, Willem Butier, maverecon:Financial Times, April 8: Mr Greenspan's apologia pro vita sua in the Financial Times of Monday, April 7 2008 fails to convince. …

Fed's 'Historic Steps' into Uncharted Waters

Unless I'm mistaken, the Fed just took a first step toward Thomas Palley's suggested solution to our current mess:

Central Bank Offers Loans To Brokers … Historic Steps, Greg IP, WSJ, March 17: … It took a unanimous vote by the Fed's five governors yesterday to invoke a Depression-era clause in the Federal Reserve Act to waive the usual prohibition on Fed loans to nonbanks. A Fed official told reporters today's circumstances couldn't have been envisioned when the Fed was created, and noted newer central banks like Europe's have many of these powers. But these steps also take the central bank into uncharted territory with new and potentially troublesome risks.

Those risks include the possibility that with the credit crunch showing no sign of lifting, the Fed will be called on to lend to other troubled firms and end up a major creditor of Wall Street, even if at present the risk of any substantial loss appears small. Another risk is that while the Fed used a loophole yesterday in the Federal Reserve Act to expand its lending to nonbanks in "unusual and exigent" circumstances, it has in effect expanded the federal safety net with no political debate. However, the Fed sought and received agreement over the $30 billion loan from Treasury Secretary Henry Paulson, who informed President Bush.

Bigger Test

For now, though, the bigger test will be how the markets greet the initiatives today: with relief at the bold steps taken to shore up the financial system, or with alarm at how unstable the financial system had to be to invite such action.

Officials appear to hope the initiatives will restore enough confidence to markets to allow a smaller rather than larger rate cut tomorrow, but they acknowledge it will depend partly on how markets evolve over coming days.

On Wall Street, there is likely to be some relief that the Fed has finally opened the discount window to securities dealers, something they have long clamored for. The Fed has been reluctant because the move was outside its explicit mandate. "This is a five-vodka event," said a senior executive at one big brokerage firm that previously didn't have access to this funding source. "Liquidity is no longer an issue."

Federal Reserve Bank of New York President Timothy Geithner told reporters: "This is designed to help get liquidity to where it can help play an appropriate role in helping address the range of challenges" in the markets, especially in the mortgage-backed securities market.

Mr. Paulson said in a statement, "I appreciate the additional actions taken this evening by the Federal Reserve to enhance the stability, liquidity and orderliness of our markets."

For all their creativity, the Fed moves are also an acknowledgment that its previous steps have failed to stem the collapse in investor confidence, forcing it to abandon many of its original principles, such as not favoring particular firms or market sectors and sticking within its explicit statutory authority.

Last Tuesday, it announced what Wall Street called its most creative initiative yet: It lent up to $200 billion of its much-sought Treasurys to investment banks starting March 27 in return for a like amount of now-shunned mortgage backed securities for up to 28 days. The announcement led to a huge rally in stocks. But within days dealers were telling the Fed it didn't go far enough. They wanted longer term, more immediate funding against a broader range of collateral.

It also came too late to save Bear Stearns. On Thursday evening, Bear Stearns informed the Securities and Exchange Commission and Fed that it had experienced a dramatic loss of cash reserves and now saw no option other than to file for bankruptcy protection Friday morning. Fed officials at that point saw just two options. They could try to wall off the rest of the financial system. If the environment had been less tumultuous they might have chosen that option.

But in the current period they feared that a failure by Bear to make good on billions of dollars of contracts could severely dislocate critical markets, especially garden-variety repo loans -- overnight loans secured by various collateral that are the grease of the credit markets.

Too Interconnected

Officials grimly concluded that while Bear Stearns wasn't too big to fail, it was too interconnected to be allowed to fail in just one day. They spent Thursday night going over Bear's books and huddling with the SEC and Treasury. By Friday morning it had settled on its second option: a 28-day secured loan via J.P. Morgan to give time for a sale or wind up of the firm.…

Not Your Father's Expansion - Or Recession

Max Wolff offers up a reasoned explanation of why we aren't going to get out of our mess easily, or soon. Soundbite: "Our recent economic performance was the offspring of financial innovation, low interest rates, massive consumer borrowing and asset price inflation. All is running in reverse now. The mechanics of the boom have become the engine of the bust." More:

Credit Crunch and Asset Deflation Recession, Max Fraad Wolff, Huffington Times, Feb. 12: … I believe that our post 2001 economic boom was uniquely and imprudently based on consumer credit and asset inflation. Equities rebounded and performed well- particularly outside the US -- since 2003. American home prices surged. All of this was based on consumer credit. Employment and personal earnings growth was weak across the last few years. Thus, it would not be shocking to see less profound earnings and employment downturn as recession begins. If you boom on house price inflation and consumer credit, you bust when they bust. They are busting now.

How bad is the housing scene? There was a 53% increase in the value of American homes as assets from 2002-2007. The price of all homes increased from $14 trillion to $21 trillion [PDF]. These are paper gains that rise and fall. Now they are falling and likely will decline by at least 15%, or over $3 trillion, before the end of 2009. Across the same period there was a 73% or $4.4 trillion increase in home mortgage debt. [PDF] This isn't going away. In fact, thanks to teaser intro rates and balloon options mortgages, it will rise. Consumer credit borrowing increased by $492 billion or 25%. We borrowed so much and so fast against our inflating homes that the average American went from owning 56% of their home in 2002 to owning 50% in 2007 [PDF]. As prices fall and debt levels remain the same, this percentage will fall further. Very soon the Average American family will own less than the half the value of their home!

From 2002-2007 there was a 55% -- $16 trillion -- increase in financial asset prices, from $29trillion to $45 trillion. [PDF] The prices of financial assets tend to be sensitive to corporate profits and credit conditions. Over the last 4-5 years corporate profits have risen sharply and are at 77 year highs as a percentage of national income. Corporate profit performance has been the mirror image of employee compensation. It has outperformed averages and surged to all time highs. Low interest rates and financial innovation allowed greater profitability and opportunity to corporations, particular those engaged in the booming credit and housing markets. Our recent economic performance was the offspring of financial innovation, low interest rates, massive consumer borrowing and asset price inflation. All is running in reverse now. The mechanics of the boom have become the engine of the bust.

This was not your father's expansion. It was not based on excellent overall economic growth. It was not based on salary and wage growth. There was only a 31%, $2.4 trillion, in disposable income over the last 6 years. Consumer debt increased by $2.4 trillion more than disposable personal income from 2002-2007. Housing and financial price inflation ran at many times the rate of income growth. Debt growth fueled consumer borrowing. A financial asset and housing boom based on easy money and financial innovation created a national economy dependent on assets and home price increases and further credit access. We are now faced with declining housing prices, falling asset prices and squeamish lenders fearful of overly indebted consumers. This is why I believe we are already in a recession or near recession. The near term future will be defined by significant economic weakness.

We don't see particular weakness in jobs and earnings because the recent recovery 2003-2007 was spectacularly weak in terms of job and income growth. The average wage and salary annual percentage gain across 55 years of expansions ran at about 3.8%. Our recent expansion has seen only 1.9% growth in wages and salaries. This is half the average annual wage and salary growth. That is how we reached the dubious low water mark for wages and salaries as a percentage of national income in 2006. In 2006 only 51.6% of national income went to wages and salaries, this is the lowest percentage since 1929 when data collection began. [PDF] We will have to wait to see weakness in the already limping areas of employment and earnings. I don't see how this bodes well for the near term future or acts to dispute our recessionary trajectory?

We are in the early to middle stages of asset price deflation and credit limitation. This is where we found growth and it will be where we find pain in the coming year. More important than the general forecast is the specific policy lesson that our inorganic and unusual recovery offers. It is unsafe, inequitable and fragile to build and base economic performance on asset price inflation and debt. This economic arrangement produces redistribution of wealth from debtors to creditors and creates a very delicate and poorly shared expansion. Sadly, the weakness that comes from the end of the boom falls heavily on the shoulders of those who gained little from the expansion. It must be with this in mind that we make policy and rebuild.

Financial Crisis: '20 Years in the Making'

Doug Noland tells us — preaching to the choir, since no one else will listen — that the stage for the mess now unfolding was built on a foundation laid over 20+ years by US Federal Reserve policy, cheerled by Wall Street finance. Noland says, "The unfolding financial and economic crisis has been more than 20 years in the making. It's a creation of flawed monetary management; egregious lending, leveraging and speculating excess; unprecedented economic distortions and imbalances on a global basis. And I find it rather ironic that Wall Street is so fervidly lambasting the Fed. For twenty years now the Fed has basically done everything that Wall Street requested and more." Here's more:

More than 20 Years in the Making, Doug Noland, Credit Bubble Bulletin, Jan. 25: … When the junk bonds, LBOs, S&Ls, and scores of commercial banks all came crashing down beginning in late-1989 to 1990, the Greenspan Fed initiated an historic easing cycle that saw Fed funds cut from 9.0% in November 1989 all the way to 3.0% by September 1992. In order to recapitalize the banking system, free up system Credit growth, and fight economic headwinds, the Greenspan Federal Reserve was more than content to garner outsized financial profits to the fledgling leveraged speculator community and a Wall Street keen to seize power from the frail banking system. Wall Street investment bankers, all facets of the securitization industry, the derivatives market, the hedge funds and the GSEs never looked back — not for a second.

In the guise of "free markets," the Greenspan Fed sold their soul to unfettered and unregulated Wall Street-based Credit creation. What proceeded was the perpetration of a 20-year myth: that an historic confluence of incredible technological advances, a productivity revolution, and momentous financial innovation had fundamentally altered the course of economic and financial history. The ideology emerged (and became emboldened by each passing year of positive GDP growth and rising asset prices) that free market forces and enlightened policymaking raised the economy’s speed limit and increased its resiliency; conquered inflation; and fundamentally altered and revolutionized financial risk management/intermediation. It was one heck of a compelling — alluring — seductive story.

But, as they say, "there's always a catch". In order for New Age Finance to work, the Fed had to make a seemingly simple — yet outrageously dangerous — promise of "liquid and continuous" markets. Only with uninterrupted liquidity could much of securities-based contemporary risk intermediation come close to functioning as advertised. Those taking risky positions in various securitizations (especially when highly leveraged) needed confidence that they would always have the opportunity to offload risk (liquidate positions and/or easily hedge exposure). Those writing derivative "insurance" — accommodating the markets' expanding appetite for hedging — required liquid markets whereby they could short securities to hedge their risk, as necessary. There were numerous debacles that should have alerted policymakers to some of New Age Finance's inherent flaws (1994's bond rout, Orange Co., Mexico, SE Asia, Russia, Argentina, LTCM, the tech bust, and Enron to name a few). Yet the bottom line was that the combination of the Fed's flexibility to aggressively cut rates on demand; ballooning GSE balance sheets on demand; ballooning foreign official dollar reserve holdings on demand; and insatiable demand for the dollar as the world's reserve currency all worked in powerful concert to sustain (until recently) the U.S. Credit Bubble — through thick and thin.

Despite his (inflationist) academic leanings and some regrettable ("Helicopter Ben") speeches as Fed governor, I do believe Dr. Bernanke aspired to adapt Fed policymaking. His preference was for a more "rules based" policy approach of setting rates through some flexible "inflation targeting" regime, while ending Greenspan’s penchant for kowtowing to the markets. Today, it all seems hopelessly naïve. Inflation is running above 4%, while the FOMC is compelled to quickly slash the funds rate to 3%. And never — I repeat, never — have the financial markets been more convinced that the Federal Reserve fixates on stock prices while is permissive when it comes to inflationary pressures. Today, the contrast to the ECB and other global central banks could not be starker. The Fed has climbed way out on a limb, and it is difficult at this point to see how they regain credibility as inflation fighters or supporters of the value of our currency. It is not only trust in Wall Street-backed finance that is being shattered.

The greatest flaw in the Greenspan/Bernanke monetary policy doctrine was a dangerously misguided understanding of the risks inherent to their "risk management" approach. Repeatedly, monetary policymaking was dictated by the Fed's focus on what it considered the possibility of adverse consequences from relatively low probability ("tail") developments in the Credit system and real economy. In other words, if the markets (certainly inclusive of "New Age" structured finance) were at risk of faltering, it was believed that aggressive accommodation was required. The avoidance of potentially severe real economic risks through "activist" monetary easing was accepted outright as a patently more attractive proposition compared to the (generally perceived minimal) inflationary risks that might arise from policy ease. As it was in the late 1920s, such an accommodative ("coin in the fuse box") policy approach is disastrous in Bubble environments.

The Fed's complete misconception of the true nature of contemporary "inflation" risk was a historic blunder in monetary doctrine and analysis. To be sure, the consequences of accommodating the markets were anything but confined to consumer prices. Instead, the primary — and greatly unappreciated — risks were part and parcel to the perpetuation of dangerous Credit Bubble Dynamics and myriad attendant excesses. Importantly, the Fed failed to recognize that obliging Wall Street finance ensured ever greater Bubble-related distortions and fragilities — deeper structural impairment to both the financial system and real economy. In the end, the Fed's focus on mitigating "tail" risk guaranteed a much more certain and problematic "tail" — a rather fat one at that.

Fundamentally, the Greenspan/Bernanke "doctrine" totally misconstrued the various risks inherent in their strategy of disregarding Bubbles as they expanded — choosing instead the aggressive implementation of post-Bubble "mopping up" measures as necessary. They were almost as oblivious to the nature of escalating Bubble risk as they were to present-day complexities incident to implementing "mop up" reflationary policies. "Mopping up" the technology Bubble created a greatly more precarious Mortgage Finance Bubble. Aggressively "mopping up" after the mortgage/housing carnage in an age of a debased and vulnerable dollar, $90 oil, $900 gold, surging commodities and food costs, massive unwieldy pools of speculative global finance, myriad global Bubbles, and a runaway Chinese boom is fraught with extraordinary risk. Furthermore, the Fed's previously most potent reflationary mechanism — Wall Street-backed finance — is today largely inoperable. …

It is also as ironic as it was predictable that Alan Greenspan — Ayn Rand "disciple" and free-market ideologue — championed monetary policies and a financial apparatus that will ensure the greatest government intrusion into our Nation’s financial and economic affairs since the New Deal. Articles berating contemporary Capitalism are becoming commonplace. I fear that the most important lesson from this experience may fail to resonate: that to promote sustainable free-market Capitalism for the real economy demands considerable general resolve to protect the soundness and stability of the underlying Credit system. …

Catching up on Financial 'Interesting Times'

Let's begin with Paul Krugman's Dec 14 Authors@Google Series video on how we got into our current financial mess and some "mysteries" on how we might get out of it this side (or the other side) of a 'hard landing.' In this very good hour with Krugman, he covers the previous Long Term Capital Management induced mess, the Nasdaq "tech bubble", the housing bubble, the Fed, "financial innovation", and more. Good insights for we who don't spend 24/7 dealing with matters financial:

Krugman believes that the housing mess is with us for about the next six years, guessing, based on early '90s S. California housing bust, with an average 30% price drop (in "real" dollars) from "bubbleicious" peaks. In a blog post today, Unknown Housing Territory, Dec 19, Krugman gives us more:

… The bubbles in the most bubbleicious areas were bigger than anything we've ever seen — and there's every reason to think that the required fall in prices in those areas will be much bigger than anything we've seen since the Great Depression. …

In the video, Krugman admits being surprised by the enormous impacts of the housing and related credit crunch have on the "financial system". He highlights how the Fed has been 'behind the curve' on dealing with this latest crisis, naïvely believing that the same medicine that 'solved' the LTCM mess years ago would suffice here. Since that medicine didn't work this time, Krugman gives us glimpses of the newer approaches central bankers are trying to put into play.

One Highlight: Glassman's law, as a correlary to Stein's law (also from Bubble Denial, Dec 10 on Krugman's blog):

… [B]ack in 2005, when I started writing about the housing bubble — it didn't take much to see that something was way out of whack.

So how come the housing crisis has come as such a surprise to so many people?
Part of it was the usual bubble psychology. Economists like to cite Stein's Law: "If something cannot go on forever, it will stop." I think it needs to be paired with another law — let's call it Glassman's Law — along the lines of "If something unsustainable goes on for a while, there will be people claiming it can go on forever."

According to Krugman, everybody looks to the 1998 'fix' for the Long Term Capital Management debacle as a model for this episode. Problem is, that strategy doesn't seem to be working this time. The 'fix' as applied last August, seemed to work for awhile, but 'trouble' is now welling up again. So the Fed and other Central Bankers are now trying hard to funnel short- to medium-term liquidity into the system.

Krugman is hoping this latest, belated effort from central bankers will work, although he suggests there are no 'quick fixes' to this mess — adding that we still don't even know the size and extent of the mess. "Steve Cechetti is hopeful but has his doubts", says James Hamilton in his Monetary Policy Using the Asset Side of the Fed's Balance Sheet, Dec 16. Whatever you read from these extended hyperlinks, don't miss Cechetti's The Art of Crisis Management: Auctions and Swaps, Dec 16.

Noruiel Roubini is even less sure that even this latest easing will help , although he has been advising central bank "easing" for some time. See Roubini: First, Central Banks Are Getting Desperate in Dealing with the Liquidity Crunch …, Dec 18, and second, Why Monetary Policy Easing is Warranted Even in the Current Insolvency Crisis, Dec 15

Finally, Michael Shedlock (as an interesting member of the Libertarian Right) is apoplectic, not only at what he considers continuing mis-steps by the Fed, but also since Roubini, whom he admires as a forecaster, doesn't buy Shedlock's particular brand of 'free market fundamentalism': asking for the Fed to be abolished and for a return to the gold standard and private banking. See Shedlock's Missing the Boat on Monetary Easing, Dec 18.

Quite a bunch of interesting stuff out and about! Mostly I just sit back and read from the really good commentators I track on my sidebar (and my Google Reader). I don't pretend to be in the same league as they are on matters of finance and geopolitics. But I do like to try to sort out some of it, second hand. Ocasionally I even help others in their own sorting, and that makes this little hobby of mine worthwhile.

Happy Holidays to those who are celebrating such during this season.

Noland Debunks Greenspan's "No particular regrets" remarks

While I'm not yet ready to throw verbal rocks at Ben Bernanke, I certainly share Doug Noland's disdain for Alan Greenspan's behavior during the last decade and more. Here, with a few highlights, is Noland's latest view or where we stand and how we got here—cheerled by the US Fed:

No Regrets, Doug Noland, Credit Bubble Bulletin, Nov 23: November 23 – Bloomberg (Robin Wigglesworth and Craig Stirling): "Former Federal Reserve Chairman Alan Greenspan said he has 'no particular regrets' about his time at the central bank, adding that the deepening U.S. housing-market slump isn't result of his policies. 'Markets are becoming aware of the fact that the decline in house prices is not stopping,' Greenspan said… I have no particular regrets. The housing bubble is not a reflection of what we did, as it is a global phenomenon.'"

November 18 – Bloomberg (Anthony Massucci): "Former Federal Reserve Chairman Alan Greenspan said the dollar's decline hasn’t affected the global economy and is a 'market phenomenon.' 'So long as the dollar weakness does not create inflation, which is a major concern around the globe for everyone who watches the exchange rate, then I think it's a market phenomenon, which aside from those who travel the world, has no real fundamental economic consequences'…"

I don't know which of the two above quotes this week from Alan Greenspan I find more astounding. They are somehow equally despicable. The Greenspan Fed's fingerprints are all over the housing Bubble — at home and abroad. And they're everywhere when it comes to heightened global dollar and currency market tumult. Our much revered former Fed Chairman is making a fool of himself, a spectacle not all too supportive of confidence in our policymakers, Credit system, or currency.

Whether he will admit it or not, mortgage Credit inflation was central to the Federal Reserve's post-tech Bubble reflationary strategy. It really was a "Great Experiment" in inflationist monetary policy and, predictably, it failed miserably. The Fed and some notable Wall Street "strategists" feigned a system-wide "price level" that the Fed was obligated to adeptly manipulate to ensure that that evil “deflation” was not allowed to take root. What a crock. The risk was, then as it is now, U.S. Credit Collapse — and certainly not a somewhat deflating price level. Accommodating history’s most reckless Credit expansion over the past six years then ensured that the risk of collapse grew significantly greater while countermeasures turned increasingly unavailing.

I'll assume that the Fed simply lost control of mortgage Credit excesses. And as the risk of a devastating housing bust escalated, the Greenspan/Bernanke Fed became more ideologically intransigent in their opposition to pricking asset Bubbles. In this regard, Dr. Bernanke was Greenspan’s ideal surrogate. Unfortunately, we’re about to experience the consequences of the fundamentally flawed policy of ignoring Bubbles while they are inflating, choosing instead to wait for post-Bubble "mop up" duties. It was Greenspan himself decades ago that placed responsibility for the Great Depression on the Fed for repeatedly inserting "Coins In the Fusebox" during the Roaring Twenties. How differently would the world look today had the Fed not cut rates to 1% and left them at ultra-low levels for several years? How different would it be if the GSEs had kept their power dry, retaining financial resources to assist the mortgage market during this downturn instead of shooting all their bullets and more perpetuating the fateful Mortgage Finance Bubble? How differently would it be today if the dollar were fundamentally strong, instead of a currency carelessly debased to perpetuate an Economic Bubble?

As gatekeeper for the world's reserve Credit system and currency, to pass off our unfolding housing and financial messes as "global phenomena" would be laughable if it weren't so serious. "No particular regrets" Somewhere along the line the Federal Reserve lost sight of its fundamental mandate and responsibility — to protect the soundness and stability of our financial system and economy. Doubling our entire stock of mortgage debt in just over six years is certainly not consistent with price stability, financial stability, or economic stability — no matter what the reading on "core" CPI. And $800bn Current Account Deficits are an abomination and talk of a global "savings glut" shameful economics.

Moreover, it was our Credit system that led the world in the proliferation of securitizations, derivatives, leveraged speculation, Credit guarantees/insurance and highly tangled debt structures. And throughout his 18-year reign, Mr. Greenspan was the most vocal proponent of "Wall Street finance." He was the head cheerleader for securities-based risk intermediation, derivatives, dynamic hedging strategies, leveraged speculation and, generally, Credit Bubble Turned Global Financial Fiasco. If he were any kind of statesman, he would today at least be willing to admit where mistake were made.

U.S. mortgage excesses blighted the world. Credit systems around the globe adopted Wall Street securitization and derivatives practices, while incorporating uniform "risk management" strategies. Wall Street cut loose leveraged speculation to overrun financial systems around the world, while our Current Account Deficits were often "Recycled" back to high-yielding "structured products." And while not commonly recognized, U.S. mortgage Credit excesses and attendant Current Account Deficits concurrently debased the dollar while unleashing Credit systems globally. A complete lack of discipline — evolving into outright recklessness — at the "Core" nurtured rampant Credit and speculative excesses at the "Periphery". Bad "money" for the "reserve currency" equated to bad "money" proliferating throughout. And, let there be no doubt, monetary toxicity has progressed to the point where it has severely affected global Economic Structures. The situation will not be rectified by central bankers and an even greater bout of Credit inflation.

It is no coincidence that Greenspan made such ridiculous comments this week. As it has become increasingly apparent to the world that U.S. mortgage finance and the dollar are impending fiascos, our former Fed chairman is compelled to disavow responsibility. The housing Bubble is a "global phenomenon" and dollar weakness a "market phenomenon" with "no real fundamental economic consequences." It's stunning, and I can only contemplate how such nonsense sits with central bankers at the ECB, The People's Bank of China, The Reserve Bank of New Zealand, other European central banks, in the Middle East, and in Asia.

Outside of radically shifting financial, economic and geopolitical power away from the U.S. to the rest of the world, perhaps our policymakers' neglect of our currency hasn’t been of real consequence. Historians will look back at this period and have difficulty comprehending how a nation could have so indecorously squandered the benefit and privilege associated with reigning over the world’s reserve unit of exchange. Especially when it comes to energy resources, dollar devaluation has had momentous real consequences. Our vulnerabilities have been further exposed, while the standing of our competitors has been enhanced and our enemies empowered. Worse yet, the leading beneficiary of U.S. inflationism has been, not coincidently, the most unstable tinderbox region of the world. It is precisely these types of momentous inflation and economic consequences that manifest into financial and economic upheaval and calamitous global conflicts.

It was a short but eventful week. The Credit disaster unfolding at the GSEs came into clearer focus with the release of earnings from Freddie Mac. Agency debt and MBS spreads widened markedly. The mortgage implosion was at the brink of a major turn for the worst, with liquidity concerns spurring significantly wider Credit default swap prices for Rescap, GMAC, Countrywide, the Credit insurers, and financial institutions generally. The dominoes are lined up. Yet it is this type of acute stress that has always in the past extorted aggressive policymaker action. The Fed's traditional tool box, however, is woefully deficient to deal with impending Credit Collapse. I can only assume they're now diligently at work crafting new implements. [emphasis added]

Stiglitz on Greenspan's Mess

Greenspan 'Made a Mess' and U.S. Risks Recession, Stiglitz Says, Reed V. Landberg and Paul George, Bloomberg, Nov 16 … "Americans have been taking money out of their houses to finance a consumption binge," [Nobel-prize winning former World Bank economist, Joseph Stiglitz] said. … [The U.S. faces] "a very major slowdown, maybe recession."'

"Alan Greenspan really made a mess of all this,'" Stiglitz said. "He pushed out too much liquidity at the wrong time. He supported the tax cut in 2001, which is the beginning of these problems. He encouraged people to take out variable rate mortgages. That helped create the subprime crisis."

Squandered Trust

Those wishing to understand why systems seemingly as corrupt as ours here in the US seem so resilient and resistant to change, ought to read or re-read John Kenneth Galbraith's The Great Crash 1929 — as I have recommended before. Yesterday, over at Information Arbitrage, Roger Ehrenberg suggested that our financial system is badly in need of governance both at the corporate and government levels. Ehrenberg asked, then answered this fundamental question: "Who is at fault? Everybody." I agreed, in follow-up comments, noting that:

Maybe, finally the shit has hit the fan in a big enough way that people will demand change — eventually after enough pain has been felt by enough people — as they did after the mess that began in the eurphoria of the 1920s and ended with the mess of the 1930s. Only after a big-enough mess will the corruption within the various, connected systems be dealt with and cleaned up. … Good governance is needed from within (corporations) and from without (government, press, academia).

After the cleansing, if and when we get such, we can once again expect honesty from corporations and government agencies who will be trying hard to win back the respect they have squandered during [the] "looting" — the "main play" of the recent-past era (assuming that it began to end in August (and continued to end this week)).

"Everybody" includes corporate boards, managers, investors, auditors, appraisers, "rating agencies", the Press, government overseers (e.g. the Congress, the Administration, federal agencies, the Fed).

Ehrenberg noted in another recent post, again echoing my own sentiments, that the problem is one of squandered trust. Ehrenberg and I disagree on minor points, like the national debt being such a big problem, but we do see eye to eye that many have squandered much-needed trust in our systems — and not just our financial systems!

Here is a little added perspective from Galbraith's The Great Crash 1929 that I left as a comment on James Hamilton's Econbrowser early this year, responding to his post, The New Deal and the Great Depression:

[Me:] It proves interesting to reread John Kenneth Galbraith's The Great Crash 1929. It is as though history is being rewritten before our eyes. Substitute hedge funds for "investment trusts" and it reads pretty much parallel. Frightening! I keep hoping to see daylight beyond what I perceive to be a gathering storm. Daylight will indeed be forthcoming [sometime after] a storm, but the interim may be ugly.

The Great Crash 1929
Chapter II, "Something Should Be Done":

"…like all booms, it had to end. When prices stopped rising—when the supply of people who were buying for an increase was exhausted—then ownership on margin would become meaningless and everyone would want to sell. The market wouldn't level out; it would fall precipitately.

"All this being so, the position of the people who had at least nominal responsibility for what was going on was a complex one. One of the oldest puzzles of politics is who is to regulate the regulators. But and equally baffling problem, which has never received the attention it deserves is who is to make wise those who are required to have wisdom.

Some of those in positions of authority wanted the boom to continue. They were making money out of it, and they may have had an intimation of the personal disaster which awaited them when the boom came to an end. "But there were also some who saw, however dimly, that a wild speculation was in progress and that something should be done. For these people, however, every proposal to act raised the same intractable problem. The consequences of successful action seemed almost as terrible as the consequences of inaction, and they could be more horrible for those who took the action.

… "The real choice was between an immediate and deliberately engineered collapse and a more serious disaster later on. Some one would certainly be blamed for the ultimate collapse when it came. "There was no question whatsoever as to who would be blamed should the boom be deliberately deflated. …

… "Clearly the Federal Reserve was less interested in checking speculation than in detaching itself from responsibility for the speculation.


Chapter III, "In Goldman, Sachs We Trust"

… ""The most notable piece of speculative architecture of the late twenties, and the one by which, more than any other device, the public demand for common stocks was satisfied, "was the investment trust or company. The investment trust did not promote new enterprises or enlarge old ones. It merely arranged that people could own stock in old companies through the medium of new ones. …

"Knowledge, manipulative skill, or financial genius were not the only magic of the investment trust. There was also leverage. … Leverage, it was later to develop, works both ways.”

Chapter IV, "The Twilight of Illusion"

… "To a few alarmed observers it seemed as though Wall Street were by way of devouring all the money of the entire world. However, in accordance with the cultural practice, as the summer passed, the sound and responsible spokesmen decried not the increase in brokers’ loans, but those who insisted on attaching significance to this trend. There was a sharp criticism of the prophets of doom." (empahsis added)

{Update, Nov 9}

I might as well add Bill FLeckenstein's gloom to this already gloomy post:

Yesterday's Flip Flop, William Fleckenstein, Nov 9, Minyanville … I've talked about a dislocation [or "crash"] fairly often and it hasn't happened. Such events have an extremely low probability of occurring. But for folks to think it's not possible would be wrong. The stage has been set, such that the low probability is far, far higher than "normal."

That is thanks to the reckless policies pursued by the Greenspan Fed for the last decade and a half, which have enabled the risks to pile up while rewarding folks for ignoring them. The Fed's efforts to stave off small forest fires from happening has only guaranteed that we will have a gigantic one.

So, we are at a moment in time where a crash is far more likely to happen than at any time before. Does this mean it will happen? Not necessarily. But for folks to think it's not possible would be wrong. It feels to me like that could be right around the corner.

I am not rooting for this, but it seems to be inevitable. What I am rooting for is the return of sanity, which is something that only a large wipeout might bring about. "We have to stop the cycle of bailing out risk-takers, and that is where we are now. At some point, "too big to fail" will become "too big to bail out." And it feels like we may be at that point.