During his campaign for President in 1980, George Bush famously dubbed Ronald Reagan's platform "voodoo economics." He must have been on the right track for in its wake we now see the mythic creations of voodoo doctors walking among us- Zombies.
We have Zombie Banks, Zombie Corporations, a Zombie currency and, if I may go so far, Zombie Economics.
There is, of course, nothing new in this observation. Others have beaten me to the punch. Banks and other corporations which should be dead are still walking, ergo, they are Zombies- blindingly obvious. Yet, just as a miner skilled in deep extraction might buy a vein most think of as "played out" I'm going to deep mine this well used metaphor.
There are many aspects of Zombie lore, from the aforementioned voodoo doctors to the film genre inspired by George Romero's Night of the Living Dead. In Romero's Mythos, Zombies don't do the bidding of their voodoo masters. Instead, they shuffle around in search of the living- to eat. Further, the living bitten by a Zombie become Zombies themselves.
Combining the two mythic strands, Reagan's Voodoo Economics, which manifested in the mind of Dick Cheney as "deficits don't matter" created, by allowing debt levels to rise beyond that which which could easily be extinguished in a normal bankruptcy, the Zombie Banks and other corporations which don't serve their creators but instead feed, not on people, but capital, creating more Zombies in the process.
Unlike those in Romero's films, however, we are not trying to rid ourselves of these Zombies. We are incorporating them in our economic policies. Thus we have Zombie Economics.
In a recent round table discussion, George Soros opined: There are two features that I think deserve to be pointed out. One is that the financial system as we know it actually collapsed. After the bankruptcy of Lehman Brothers on September 15, the financial system really ceased to function. It had to be put on artificial life support.
The problem with the "artificial life support" of the financial system is that the voodoo doctors (government regulators) decided to play Frankenstein- a violation of the laws of capitalism as profound as re-animating dead flesh is to the laws of biology- instead of transplanting the dead banks' useful parts into living organisms.
In a sense, the problem begins at birth. To incorporate is to embody, or give substance to. Nature both incorporates the living and ensures that they die. Modern Man, however, at least the American variant thereof, seems loathe to allow its creations to follow suit.
The "creative destruction" aspect of Capitalism has been aptly described as an evolutionary process- the strong procreate and the weak are culled. Within a Capitalist framework, then, zombie corporations have as little place as zombie humans would in real life.
In Romero's films the living are eventually consumed by the zombies and if we are not careful the same could happen to us. Financially mediated trade has risen, flourished, and died many times in human history- e.g. Roman commerce gave way to Dark Age feudalism. I often wonder if the much more recent experience of Mao-ism (a taste, if you will, of feudalism) informs the Chinese perspective of the virtues of financially mediated trade. They seem amazed that we would flirt with such an outcome.
American leadership, reminiscent of Kubrick's Dr. Strangelove- perhaps Dr. StrangeCapitalist, or how I learned to stop worrying and love Zombies, would be more apt- now faces the daunting tasks of rewriting the rules of Capitalism and convincing our creditors that Zombies are normal. Most recently, Treasury Secretary Geithner visited China and assured them our Zombie currency (the US$) wouldn't consume the capital they create and store therein.
On the home front, Zombies are not just consuming capital, they are, in a sense, consuming Capitalism.
In an ironic twist worthy of Greek Tragedy, the supposed proponents of free markets who refuse to let bankrupt corporations die are engendering the very regulations they worked so hard to remove. They have forgotten one of the essential aspects of capitalism- free markets cut both ways. You are free to succeed AND free to fail.
Complaints over executive compensation, or even transportation weren't credible until those executives decided to turn their corporations into Zombies instead of letting them die. Bankruptcy and dismemberment are the check and balance of Capitalism. Without that check and balance we are left with Zombie Economics and, apparently ever-increasing regulations. The longer we allow Zombies to walk among us the more intrusive will state regulations become.
There is another, more mundane sense of the word Zombie which also seems to apply to the current situation- a person without an animating force, just going through habitual motions.
This last sense seems to aptly describe the US economy in in the 21st Century. While the Clinton years were not without problems, there was an animating force driving the economy beyond the desire to just "make money"- we were getting on the "information super-highway." Yes, it's a cliché, but it worked. Economic growth was, in a sense, a function of, inter alia, getting the country "wired." While the guys doing the "wiring" were getting rich in the process it, at least to me, seemed as if people were excited about more than just money- they had a dream of a wired world in their minds and they manifested it in the real world.
Could it be that Capitalism which aims solely to make money is indeed soul-less?
I believe so.
This isn't a knock on Capitalism, but rather a recognition that the system is a means to an end, not an end in itself. Policies that aim to re-invigorate growth by re-invigorating growth will likely fail. It seems to me that there needs to be a greater goal to engender durable economic growth, be it the desire to save ourselves from Nazi-ism, pave the country for our new cars or wire it up.
Let me try to explain this view from a different perspective. Finance, per se, creates nothing. Finance used in pursuit of a goal can be extremely helpful so long as the goal is not merely making money (at which point the financial system, as seems obvious, becomes parasitic). Finance, in a sense, is a Zombie requiring an animating force, be it the desire to "go green" (by retooling our transportation and energy production sectors), make America beautiful (by rebuilding infrastructure), or some other desire.
We need, it seems to me, a goal, a dream, or we're just going to keep shuffling around like a Zombie.
Wednesday, June 10, 2009
Tuesday, May 19, 2009
The Cult of the Uber-Banker
The tendency in the media and the Congress has been to blame the current depression on "stupid, greedy, and reckless" bankers. I believe that that is a mistake. I know bankers. They are not stupid; most of them are smart, and many of them are brilliant. If they are "greedy," it is largely so in the sense in which most Americans (most anyone, I imagine) could be called "greedy": they like money a lot. I read somewhere recently that bankers (a word I use loosely to cover financiers in general) derive their job satisfaction entirely from their monetary compensation, unlike other workers. But that is wrong. Rich bankers derive satisfaction not only from making a lot of money but also from a sense of outsmarting competitors, and in that respect they are not unlike highly paid athletes; in both cases the money the stars are paid do not merely enhance personal welfare, but also are indicators of relative performance. Money is a scorecard of success. Richard Posner
Rudyard Kipling famously argued, If you can keep your head when all about you are losing theirs....you'll be a man. Of course, it is only in hindsight that one can be sure one is keeping one's head.
Perhaps the Bankers really are Nietzchean Supermen? Perhaps intelligence is no longer manifested by following the wisdom of Daedelus but rather by flying high like Icarus?
Then again, perhaps not.
Richard Posner, whose prose in his new book A Failure of Capitalism: The Crisis of '08 and the Descent into Depression and blog suggests a gifted and learned mind, argues the former position.
Bankers, to him, are akin to athletes richly rewarded to push the envelope- to be reckless.
I agree with the comparison, but will argue that this is NOT a sign of intelligence, but of the ignorance of youth.
When I was a bank options trader in my early 20s I chased profits as ardently I chased women- recklessly and without much thought of consequence. I was Icarus and the fear of falling was obscured by the joy of soaring.
I eventually learned that I could fall.
Our Uber-Bankers have been resistant to this lesson, ably assisted in this regard by the Cult thereof. Otherwise intelligent people cheer our Uber-Bankers on like fans in the stadium.
Mr. Posner claims to know bankers. I wonder if he knows athletes? I wonder if he has really thought through his apology for their actions?
In addition to being a banker, I've been an athlete, albeit one who was never paid. In my youth I played Ice Hockey in front of crowds of 100s and it was quite a rush. While I was never the star player when I played competitively, I know the feeling that comes from a roar of the crowd when scoring a goal or body checking an opponent into the boards. Desire for that feeling drives many athletes to actions a saner man would view as mad.
There is a term for people like this- adrenaline junkies- and while they can excite crowds of on-lookers today in much the same way Gladiators of old excited the Romans, to consider them "smart" or worse, able managers of of a vital social function seems to me a bit strange.
To wit, while we might admire the recklessness of a NASCAR driver, we wouldn't want our cab drivers to follow their lead. While we might admire the nerve of a Chuck Yeager, we don't want our commercial air pilots finding out how fast or how high a 767 can go. Should we equip all seats on commercial airlines with ejector buttons and parachutes? It would certainly extend the obligatory safety instructions- in the event the pilot decides to escape the stratosphere and fails you will be expected to hit the ejector button....please wait to deploy your chute until you are clear of all other passengers.
Banking, and finance in general, despite the efforts of CNBC et. al. is not a spectator sport.
I think the Uber-Bankers Mr. Posner glorifies are not smart, nor, in that regard at least, are those who cheer them on and apologize for their excesses as sports agents apologize for the excesses of the athletes in their "stable." They, like Icarus, don't understand that their function is to ensure a safe flight.
Sadly, they have been piloting the US$ 767 Jumbo Jet. I hope you remembered the safety instructions. The ejector button is the golden one on the right but they're not enough to go around so you might want to beat the rush.
Rudyard Kipling famously argued, If you can keep your head when all about you are losing theirs....you'll be a man. Of course, it is only in hindsight that one can be sure one is keeping one's head.
Perhaps the Bankers really are Nietzchean Supermen? Perhaps intelligence is no longer manifested by following the wisdom of Daedelus but rather by flying high like Icarus?
Then again, perhaps not.
Richard Posner, whose prose in his new book A Failure of Capitalism: The Crisis of '08 and the Descent into Depression and blog suggests a gifted and learned mind, argues the former position.
Bankers, to him, are akin to athletes richly rewarded to push the envelope- to be reckless.
I agree with the comparison, but will argue that this is NOT a sign of intelligence, but of the ignorance of youth.
When I was a bank options trader in my early 20s I chased profits as ardently I chased women- recklessly and without much thought of consequence. I was Icarus and the fear of falling was obscured by the joy of soaring.
I eventually learned that I could fall.
Our Uber-Bankers have been resistant to this lesson, ably assisted in this regard by the Cult thereof. Otherwise intelligent people cheer our Uber-Bankers on like fans in the stadium.
Mr. Posner claims to know bankers. I wonder if he knows athletes? I wonder if he has really thought through his apology for their actions?
In addition to being a banker, I've been an athlete, albeit one who was never paid. In my youth I played Ice Hockey in front of crowds of 100s and it was quite a rush. While I was never the star player when I played competitively, I know the feeling that comes from a roar of the crowd when scoring a goal or body checking an opponent into the boards. Desire for that feeling drives many athletes to actions a saner man would view as mad.
There is a term for people like this- adrenaline junkies- and while they can excite crowds of on-lookers today in much the same way Gladiators of old excited the Romans, to consider them "smart" or worse, able managers of of a vital social function seems to me a bit strange.
To wit, while we might admire the recklessness of a NASCAR driver, we wouldn't want our cab drivers to follow their lead. While we might admire the nerve of a Chuck Yeager, we don't want our commercial air pilots finding out how fast or how high a 767 can go. Should we equip all seats on commercial airlines with ejector buttons and parachutes? It would certainly extend the obligatory safety instructions- in the event the pilot decides to escape the stratosphere and fails you will be expected to hit the ejector button....please wait to deploy your chute until you are clear of all other passengers.
Banking, and finance in general, despite the efforts of CNBC et. al. is not a spectator sport.
I think the Uber-Bankers Mr. Posner glorifies are not smart, nor, in that regard at least, are those who cheer them on and apologize for their excesses as sports agents apologize for the excesses of the athletes in their "stable." They, like Icarus, don't understand that their function is to ensure a safe flight.
Sadly, they have been piloting the US$ 767 Jumbo Jet. I hope you remembered the safety instructions. The ejector button is the golden one on the right but they're not enough to go around so you might want to beat the rush.
Monday, May 18, 2009
Hitting the Niall on the head
Human beings are as good at devising ex post facto explanations for big disasters as they are bad at anticipating those disasters. It is indeed impressive how rapidly the economists who failed to predict this crisis — or predicted the wrong crisis (a dollar crash) — have been able to produce such a satisfying story about its origins. Yes, it was all the fault of deregulation.
There are just three problems with this story. First, deregulation began quite a while ago (the Depository Institutions Deregulation and Monetary Control Act was passed in 1980). If deregulation is to blame for the recession that began in December 2007, presumably it should also get some of the credit for the intervening growth. Second, the much greater financial regulation of the 1970s failed to prevent the United States from suffering not only double-digit inflation in that decade but also a recession (between 1973 and 1975) every bit as severe and protracted as the one we’re in now. Third, the continental Europeans — who supposedly have much better-regulated financial sectors than the United States — have even worse problems in their banking sector than we do. Niall Ferguson
I envy Niall Ferguson's command of the facts of history. Reading his books or essays, leavened with historical yeast, reminds me of the limits of my own sense of history.
Yet, for some odd reason, despite the, apparently, appropriate leavening, the "bread" of his arguments never seems to rise, for me. Jumping to a new metaphor, his arguments are like cloth from a weaver with the strongest, most vivid and varied thread, but a broken loom.
The loom on which a storyteller weaves his fact-threads into cloth is his perceived experience. If his experience-loom comports with the reader's the story seems to come alive. If not, the story will prove inaccessible to the reader.
Similarly, arguments in essays require a shared loom of premises, else they too fall short.
To accept Mr. Ferguson's argument the deregulation was NOT the problem, we would have to accept that policy changes 29 years ago alternatively have no impact on today's events or have a negative impact which must be balanced by the intervening good. We would also have to accept that the depths of the current event have been plumbed, else the comparison with the 70s might, in the future, obviate his argument.
In the arena of history, the view that the Treaty of Versailles's punitive imposition of reparations on Germany led, in part, to the rise of Hitler and WWII is reasonably well accepted. Should we, a la Ferguson, deny that a policy choice decades prior can have no effect on today's events, or that the intervening good- no war and a France rebuilt on Germany's dollar (or mark)- negated the flaws in the Treaty?
Has the fraud and theft of Mr. Madoff been negated by the years of income he did provide his investors, or the fact that his choice to "go Ponzi" occurred decades ago?
To me, though, the most egregious error in Ferguson's reasoning is his ridicule of the dollar crashers and sense that the depths of the current crisis have been plumbed.
Reality, it seems to me, has yet to fully unfold on this crisis. When it does, in the event that, as I suspect, the US$ loses it's place as global reserve currency the wisdom of retaining the old (or similar) regulations on finance will become evident.
Borrowing a phrase from his essay, for reasons to do with human psychology, regulations of certain activities has proven effective. These regulations are often capable of significant improvement, but their absence....well, when this story ends we'll find out the true cost of their absence.
There are just three problems with this story. First, deregulation began quite a while ago (the Depository Institutions Deregulation and Monetary Control Act was passed in 1980). If deregulation is to blame for the recession that began in December 2007, presumably it should also get some of the credit for the intervening growth. Second, the much greater financial regulation of the 1970s failed to prevent the United States from suffering not only double-digit inflation in that decade but also a recession (between 1973 and 1975) every bit as severe and protracted as the one we’re in now. Third, the continental Europeans — who supposedly have much better-regulated financial sectors than the United States — have even worse problems in their banking sector than we do. Niall Ferguson
I envy Niall Ferguson's command of the facts of history. Reading his books or essays, leavened with historical yeast, reminds me of the limits of my own sense of history.
Yet, for some odd reason, despite the, apparently, appropriate leavening, the "bread" of his arguments never seems to rise, for me. Jumping to a new metaphor, his arguments are like cloth from a weaver with the strongest, most vivid and varied thread, but a broken loom.
The loom on which a storyteller weaves his fact-threads into cloth is his perceived experience. If his experience-loom comports with the reader's the story seems to come alive. If not, the story will prove inaccessible to the reader.
Similarly, arguments in essays require a shared loom of premises, else they too fall short.
To accept Mr. Ferguson's argument the deregulation was NOT the problem, we would have to accept that policy changes 29 years ago alternatively have no impact on today's events or have a negative impact which must be balanced by the intervening good. We would also have to accept that the depths of the current event have been plumbed, else the comparison with the 70s might, in the future, obviate his argument.
In the arena of history, the view that the Treaty of Versailles's punitive imposition of reparations on Germany led, in part, to the rise of Hitler and WWII is reasonably well accepted. Should we, a la Ferguson, deny that a policy choice decades prior can have no effect on today's events, or that the intervening good- no war and a France rebuilt on Germany's dollar (or mark)- negated the flaws in the Treaty?
Has the fraud and theft of Mr. Madoff been negated by the years of income he did provide his investors, or the fact that his choice to "go Ponzi" occurred decades ago?
To me, though, the most egregious error in Ferguson's reasoning is his ridicule of the dollar crashers and sense that the depths of the current crisis have been plumbed.
Reality, it seems to me, has yet to fully unfold on this crisis. When it does, in the event that, as I suspect, the US$ loses it's place as global reserve currency the wisdom of retaining the old (or similar) regulations on finance will become evident.
Borrowing a phrase from his essay, for reasons to do with human psychology, regulations of certain activities has proven effective. These regulations are often capable of significant improvement, but their absence....well, when this story ends we'll find out the true cost of their absence.
Friday, May 15, 2009
You can't get a little bit "fiat"
As you likely know, the administration is proposing to lend $100bn to the IMF, as part of that organization’s increase in resources following the G20 summit. Peter Orszag, head of OMB, argued that there was zero probability of this money being lost, so $100bn should be “scored” for budget purposes as $0bn – which is how this kind of transaction has been handled in the past. As the IMF likes to say, it is “the lender of last resort, but the first to be repaid.”
After considerable back and forth, the scoring issue was referred to the CBO. The CBO has reportedly decided there is a 5 percent probability of default by the IMF. This is an extraordinarily important statement. Most informed people just assume that the risk of IMF default is zero, because that would essentially constitute a complete breakdown of the global economy and payments system. But nothing is zero probability, particularly in a world of massive financial panics, incipient protectionism, and improvised global governance. Baseline Scenario
Another day, another example of monetary confusion.
To what do I refer? I'm (once again) noticing the apparently widespread view that "credit risk" only occurs in the event of default- a view that seems to me a "residual monetary image" from the days of fixed exchange rates to specie.
When money was defined as a fixed amount of Gold or Silver, "credit risk" could be conflated with the risk of default- either you got your specie (or equivalent) or you didn't.
However, we haven't had such a link to specie for decades. The value of fiat money fluctuates, which is both the blessing and curse of that policy. The risk of, say, a default by the US Treasury, which was a concern of France before the link to Gold was severed, is now almost nil because the only obligation is to pay US$s, which the Fed can print.
In other words, the risk of default inherent in a fixed specie exchange system has been replaced- at least for countries that can issue debt in their own currency- by the risk of devaluation.
There isn't, as the old saying goes, any free lunch. To borrow a concept from physics, risk, like matter and energy (combined), is never created nor destroyed, it just changes form.
It seems to me this residual monetary image- the view that money, specifically the US$, is a thing unto itself and not merely a share of output divided by the stock thereof- is the last bit of foundation holding the house of cards together.
Human conception is a curious thing. I can remember quite a few instances when I was sure I knew something only to later find out I did not. I didn't, for various reasons, take in all the consequences. I thought, to use another old adage, one could get a little bit pregnant- an adage that has lost some of its punch with the availability of abortions.
One also can't get a little bit fiat. Either there is a fixed exchange to specie or there isn't. The most pressing risk in funding the IMF is not whether they will be repaid in US$s, on which I agree with the CBO's assessment, but what those US$s will buy when repaid.
After considerable back and forth, the scoring issue was referred to the CBO. The CBO has reportedly decided there is a 5 percent probability of default by the IMF. This is an extraordinarily important statement. Most informed people just assume that the risk of IMF default is zero, because that would essentially constitute a complete breakdown of the global economy and payments system. But nothing is zero probability, particularly in a world of massive financial panics, incipient protectionism, and improvised global governance. Baseline Scenario
Another day, another example of monetary confusion.
To what do I refer? I'm (once again) noticing the apparently widespread view that "credit risk" only occurs in the event of default- a view that seems to me a "residual monetary image" from the days of fixed exchange rates to specie.
When money was defined as a fixed amount of Gold or Silver, "credit risk" could be conflated with the risk of default- either you got your specie (or equivalent) or you didn't.
However, we haven't had such a link to specie for decades. The value of fiat money fluctuates, which is both the blessing and curse of that policy. The risk of, say, a default by the US Treasury, which was a concern of France before the link to Gold was severed, is now almost nil because the only obligation is to pay US$s, which the Fed can print.
In other words, the risk of default inherent in a fixed specie exchange system has been replaced- at least for countries that can issue debt in their own currency- by the risk of devaluation.
There isn't, as the old saying goes, any free lunch. To borrow a concept from physics, risk, like matter and energy (combined), is never created nor destroyed, it just changes form.
It seems to me this residual monetary image- the view that money, specifically the US$, is a thing unto itself and not merely a share of output divided by the stock thereof- is the last bit of foundation holding the house of cards together.
Human conception is a curious thing. I can remember quite a few instances when I was sure I knew something only to later find out I did not. I didn't, for various reasons, take in all the consequences. I thought, to use another old adage, one could get a little bit pregnant- an adage that has lost some of its punch with the availability of abortions.
One also can't get a little bit fiat. Either there is a fixed exchange to specie or there isn't. The most pressing risk in funding the IMF is not whether they will be repaid in US$s, on which I agree with the CBO's assessment, but what those US$s will buy when repaid.
Tuesday, May 12, 2009
When Interests Collide
I followed the rules as I always have. Stephen Friedman, on his purchase and previous holdings in GS
2500 years ago Euripides observed, Whom the Gods would destroy, they first make mad. Having risen beyond the confines of the rules of men, big finance, forgetting that the rules of true finance and economics apply to all, will fall by their own hand.
The case of Stephen Friedman, who, while owning a stake in GS, chaired the NY Fed Board which approved their application to become a bank holding company and thus have access to government bail out funds- a shift denied to Lehman Brothers- is a perfect example of the "rules don't apply to me" perspective.
This perspective doesn't end with Mr. Friedman. Fed Vice Chairman Donald Kohn, according to the WSJ, The Fed's logic was that the conflict wasn't created by any action of Mr. Friedman, the financial system was in crisis, and the New York Fed needed a new president if Timothy Geithner became Treasury Secretary. So Fed officials say Mr. Kohn concluded that the benefit from the continuity of keeping Mr. Friedman outweighed the conflict of interest.
The virtues of continuity outweighed the conflict of interest, eh? In other words, maintaining the status quo- a policy which doesn't seem to comport with creative destruction- is more important than the judgment clouding effects of a large monetary stake in the outcome of a bureaucratic decision.
On the topic of the virtues of continuity, the big banks appeared to pass their "stress tests" with satisfactory grades, although they'll need to raise some extra capital because the rest of the economy isn't pulling its weight. I wonder if the policy of maintaining the status quo in finance, or even more mundane issues like a large financial stake in the outcome, might have influenced that assessment.
To wit, according to the Fed Report: At the end of 2008, the 19 BHCs held $1.5 trillion of securities, more than one‐half of which were Treasury, agencies, or sovereign securities, or high‐grade municipal debt, and so are subject to no or limited credit risk. This is, I sense we are to assume, a good thing. If there was any credit risk in sovereign securities (including Treasuries), agencies, or hi-grade munis the BHCs would have to raise a couple $100B more in capital. We'll leave aside the obviously silly concern that there actually is credit risk in such securities. No government has ever defaulted or devalued nor has mortgage debt ever led to a loss.
Right?
The other thorny issue of such an assessment- marking to market securities which few apparently hazard to value- was easily ignored with these words: The adherence of SCAP to current practices is important because the majority of assets at most of the BHCs participating in the SCAP are loans that are booked on an accrual basis. As a result of the loss recognition framework for assets in the accrual loan book, the results of this exercise are not comparable with those that would evaluate such assets on a mark‐to‐market basis.
In other words, if we marked these loan books to market the BHCs would need to substantially raise capital levels, far beyond those recommended by the Fed. The virtues of continuity must be great indeed- outweighing the concerns of sovereign credit risk and virtues of marking to market- all in one report, mind you.
I wonder if our foreign creditors are aware of continuity's great virtues. Given recent talk about changing the global financial architecture, I suspect they aren't, mainly because the virtues are not universal.
Sometimes interests collide.
To wit, theft is virtuous for the thief but not for he from whom the goods were stolen. The owner's interests are not aligned with the thief's. Nor, it seems to me, are our foreign creditors' interests aligned with our BHCs'.
Continuity is only in the interests of those within the system in question in the event that different, more efficient modes of thought and action cannot be implemented for less than the cost of maintaining that continuity- a view which seems to have escaped the men at the Fed.
Perhaps the Financial Powers That Be have, as is the wont of those who use econo-metric models, gotten confused by recent history. In the early 90s, during the last reliquification of Big Finance- remember the job-less recovery- Japan was in the role China plays today. If Japan had a Army, instead of a US military base on Okinawa, they too might have called for changes to the global financial architecture.
China, unlike Japan, has an Army. Like Japan, China sees the virtues of trading internationally in one's own currency. Unlike Japan, whose talk of "internationalizing" the Yen never came to much, China is internationalizing the RMB.
Returning to the early 90s experience, the resolution had 3 main facets: 1) raise capital 2) use the capital to take non-performing assets off bank balance sheets 3) maintain a large spread between short and long rates for an extended period of time to raise bank profits. In my view, global economic growth during that period was sluggish, in part, because the banks increased the "vig."
I suspect a similar strategy is in play in the sense that the BHCs will need a wide spread for an extended period of time. Thus the key question arises. Will our foreign creditors, who might (or might not) be willing to purchase an equity stake, also agree to pay the increased "vig" in the form of a wider than normal spread, to use US$s?
Side note: Would we be willing to sell an equity stake big enough to make a difference, can sufficient capital be raised without loss of control?
Perhaps, but only if the Fed is right about the lack of credit risk in Treasury Securities. If inflation returns, as I suspect it will, the cost benefit analysis of continuity in the global financial system changes radically.
At some point the cost of a devaluation would exceed that of creating a new system, although the cost of creating a new system increases dramatically if a war is required to "align everyone's interests."
I truly hope the powers that be can manage this mess, for it seems to me a collision of interests is imminent. The more success China has in RMB based international trade, the less willing they will be to use US$s and thus the longer will recovery take. In a sense, expansion of US$ use in the 90s dug the BHCs out of a hole. A decline in US$ use while trying to dig out of a much deeper hole seems to me a desperate situation.
2500 years ago Euripides observed, Whom the Gods would destroy, they first make mad. Having risen beyond the confines of the rules of men, big finance, forgetting that the rules of true finance and economics apply to all, will fall by their own hand.
The case of Stephen Friedman, who, while owning a stake in GS, chaired the NY Fed Board which approved their application to become a bank holding company and thus have access to government bail out funds- a shift denied to Lehman Brothers- is a perfect example of the "rules don't apply to me" perspective.
This perspective doesn't end with Mr. Friedman. Fed Vice Chairman Donald Kohn, according to the WSJ, The Fed's logic was that the conflict wasn't created by any action of Mr. Friedman, the financial system was in crisis, and the New York Fed needed a new president if Timothy Geithner became Treasury Secretary. So Fed officials say Mr. Kohn concluded that the benefit from the continuity of keeping Mr. Friedman outweighed the conflict of interest.
The virtues of continuity outweighed the conflict of interest, eh? In other words, maintaining the status quo- a policy which doesn't seem to comport with creative destruction- is more important than the judgment clouding effects of a large monetary stake in the outcome of a bureaucratic decision.
On the topic of the virtues of continuity, the big banks appeared to pass their "stress tests" with satisfactory grades, although they'll need to raise some extra capital because the rest of the economy isn't pulling its weight. I wonder if the policy of maintaining the status quo in finance, or even more mundane issues like a large financial stake in the outcome, might have influenced that assessment.
To wit, according to the Fed Report: At the end of 2008, the 19 BHCs held $1.5 trillion of securities, more than one‐half of which were Treasury, agencies, or sovereign securities, or high‐grade municipal debt, and so are subject to no or limited credit risk. This is, I sense we are to assume, a good thing. If there was any credit risk in sovereign securities (including Treasuries), agencies, or hi-grade munis the BHCs would have to raise a couple $100B more in capital. We'll leave aside the obviously silly concern that there actually is credit risk in such securities. No government has ever defaulted or devalued nor has mortgage debt ever led to a loss.
Right?
The other thorny issue of such an assessment- marking to market securities which few apparently hazard to value- was easily ignored with these words: The adherence of SCAP to current practices is important because the majority of assets at most of the BHCs participating in the SCAP are loans that are booked on an accrual basis. As a result of the loss recognition framework for assets in the accrual loan book, the results of this exercise are not comparable with those that would evaluate such assets on a mark‐to‐market basis.
In other words, if we marked these loan books to market the BHCs would need to substantially raise capital levels, far beyond those recommended by the Fed. The virtues of continuity must be great indeed- outweighing the concerns of sovereign credit risk and virtues of marking to market- all in one report, mind you.
I wonder if our foreign creditors are aware of continuity's great virtues. Given recent talk about changing the global financial architecture, I suspect they aren't, mainly because the virtues are not universal.
Sometimes interests collide.
To wit, theft is virtuous for the thief but not for he from whom the goods were stolen. The owner's interests are not aligned with the thief's. Nor, it seems to me, are our foreign creditors' interests aligned with our BHCs'.
Continuity is only in the interests of those within the system in question in the event that different, more efficient modes of thought and action cannot be implemented for less than the cost of maintaining that continuity- a view which seems to have escaped the men at the Fed.
Perhaps the Financial Powers That Be have, as is the wont of those who use econo-metric models, gotten confused by recent history. In the early 90s, during the last reliquification of Big Finance- remember the job-less recovery- Japan was in the role China plays today. If Japan had a Army, instead of a US military base on Okinawa, they too might have called for changes to the global financial architecture.
China, unlike Japan, has an Army. Like Japan, China sees the virtues of trading internationally in one's own currency. Unlike Japan, whose talk of "internationalizing" the Yen never came to much, China is internationalizing the RMB.
Returning to the early 90s experience, the resolution had 3 main facets: 1) raise capital 2) use the capital to take non-performing assets off bank balance sheets 3) maintain a large spread between short and long rates for an extended period of time to raise bank profits. In my view, global economic growth during that period was sluggish, in part, because the banks increased the "vig."
I suspect a similar strategy is in play in the sense that the BHCs will need a wide spread for an extended period of time. Thus the key question arises. Will our foreign creditors, who might (or might not) be willing to purchase an equity stake, also agree to pay the increased "vig" in the form of a wider than normal spread, to use US$s?
Side note: Would we be willing to sell an equity stake big enough to make a difference, can sufficient capital be raised without loss of control?
Perhaps, but only if the Fed is right about the lack of credit risk in Treasury Securities. If inflation returns, as I suspect it will, the cost benefit analysis of continuity in the global financial system changes radically.
At some point the cost of a devaluation would exceed that of creating a new system, although the cost of creating a new system increases dramatically if a war is required to "align everyone's interests."
I truly hope the powers that be can manage this mess, for it seems to me a collision of interests is imminent. The more success China has in RMB based international trade, the less willing they will be to use US$s and thus the longer will recovery take. In a sense, expansion of US$ use in the 90s dug the BHCs out of a hole. A decline in US$ use while trying to dig out of a much deeper hole seems to me a desperate situation.
Wednesday, May 06, 2009
Losing the Exorbitant Privilege
I don't think there's any prospect of any big shift in portfolio preferences of foreign investors right now. Ben Bernanke
The bank stress tests are beginning to create a perception problem, but not – as you might think – for banks. Rather the issue is top level Administration officials’ own optics (spin jargon for how we think about our rulers).
At one level, the government’s approach to banks – delay doing anything until the economy stabilizes – is working out nicely. This is the counterpart of the macroeconomic Summers Strategy and in principle it is brilliant. “Don’t just do something, stand there,” is great advice in any crisis – eventually everything bottoms out and you can take the credit, justified or not (unless an election catches up with you first; check with Herbert Hoover.) Simon Johnson
Harry Truman, who famously wished for a one-handed economist, would, I suspect, be quite pleased with Mr. Bernanke and Mr. Summers, both of whom, according to the passages above, are singularly concerned with restoring US citizen's faith in finance.
Summers and Bernanke seem to have forgotten the wisdom of Machiavelli; For a prince should have two fears: one, internal concerning his subjects; the other, external, concerning foreign powers. These princes of finance apparently have no fear of external powers.
The America Economy is, I believe, a wondrous thing, a powerful engine of production. Despite what I believe to have been a lack of need, the US added a turbo-charger to the economic engine- the, in the words of Valery Giscard D’Estaing, exorbitant privilege of issuing debt to foreigners in our own currency. The exorbitant privilege will not be retained by restoring US citizens' faith in finance, but rather by restoring the faith of external powers.
Without the exorbitant privilege the US would already be deep in the throes of a currency crisis familiar to many banana republics. Without the exorbitant privilege big finance would have no bargaining chip with the state and as President Obama is reported to have said, My administration is the only thing between you and the pitchforks.
While it might be fear of the pitchfork wielding public that drove Summers and Bernanke to one-handed-ness I suspect a bigger factor is residual self-image from the heady End of History days. Summers' Don’t just do something, stand there policy implicitly accepts what Bernanke explicitly stated, no prospect of shifts in foreign investors' portfolio preferences. I can almost imagine these two advising the Pope during Martin Luther's time- "there's no prospect of a shift in sinners' desires to buy indulgences from us."
The genius of Paul Volcker, informed by current problems, becomes clearer by the day. Mr. Volcker didn't just break the back of inflation, at great risk of angering the pitchfork wielding public, he maintained the exorbitant privilege. He understood that one needs to compete to stay at the top. With Russia (in 1979) flexing its muscles and Iran breaking free of US control, US$ dominance wasn't assured, as Volcker learned during an IMF meeting in Belgrade that year. US policy needed to ensure the $ was a solid store of value.
Sadly, the Obama administration seems to be listening to Mr. Summers rather than Mr. Volcker. The most recent G20 meeting was, in my view, another Belgrade- a warning that US$ dominance is not a given.
I think we, and even his backers in big finance, will greatly regret this summer with Summers. The recovery for which he waits might be driven by China, and the pitchforks his backers fear might yet be brandished- made in China and purchased with RMB.
The bank stress tests are beginning to create a perception problem, but not – as you might think – for banks. Rather the issue is top level Administration officials’ own optics (spin jargon for how we think about our rulers).
At one level, the government’s approach to banks – delay doing anything until the economy stabilizes – is working out nicely. This is the counterpart of the macroeconomic Summers Strategy and in principle it is brilliant. “Don’t just do something, stand there,” is great advice in any crisis – eventually everything bottoms out and you can take the credit, justified or not (unless an election catches up with you first; check with Herbert Hoover.) Simon Johnson
Harry Truman, who famously wished for a one-handed economist, would, I suspect, be quite pleased with Mr. Bernanke and Mr. Summers, both of whom, according to the passages above, are singularly concerned with restoring US citizen's faith in finance.
Summers and Bernanke seem to have forgotten the wisdom of Machiavelli; For a prince should have two fears: one, internal concerning his subjects; the other, external, concerning foreign powers. These princes of finance apparently have no fear of external powers.
The America Economy is, I believe, a wondrous thing, a powerful engine of production. Despite what I believe to have been a lack of need, the US added a turbo-charger to the economic engine- the, in the words of Valery Giscard D’Estaing, exorbitant privilege of issuing debt to foreigners in our own currency. The exorbitant privilege will not be retained by restoring US citizens' faith in finance, but rather by restoring the faith of external powers.
Without the exorbitant privilege the US would already be deep in the throes of a currency crisis familiar to many banana republics. Without the exorbitant privilege big finance would have no bargaining chip with the state and as President Obama is reported to have said, My administration is the only thing between you and the pitchforks.
While it might be fear of the pitchfork wielding public that drove Summers and Bernanke to one-handed-ness I suspect a bigger factor is residual self-image from the heady End of History days. Summers' Don’t just do something, stand there policy implicitly accepts what Bernanke explicitly stated, no prospect of shifts in foreign investors' portfolio preferences. I can almost imagine these two advising the Pope during Martin Luther's time- "there's no prospect of a shift in sinners' desires to buy indulgences from us."
The genius of Paul Volcker, informed by current problems, becomes clearer by the day. Mr. Volcker didn't just break the back of inflation, at great risk of angering the pitchfork wielding public, he maintained the exorbitant privilege. He understood that one needs to compete to stay at the top. With Russia (in 1979) flexing its muscles and Iran breaking free of US control, US$ dominance wasn't assured, as Volcker learned during an IMF meeting in Belgrade that year. US policy needed to ensure the $ was a solid store of value.
Sadly, the Obama administration seems to be listening to Mr. Summers rather than Mr. Volcker. The most recent G20 meeting was, in my view, another Belgrade- a warning that US$ dominance is not a given.
I think we, and even his backers in big finance, will greatly regret this summer with Summers. The recovery for which he waits might be driven by China, and the pitchforks his backers fear might yet be brandished- made in China and purchased with RMB.
Tuesday, May 05, 2009
Bank Stress Test Results Released
US Treasury Department Recommendation: Economic growth must be lifted slightly (but not too much) to validate bank balance sheet solvency
What a pleasant surprise to read an interview with President Obama this weekend which contained the following:
What I think will change, what I think was an aberration, was a situation where corporate profits in the financial sector were such a heavy part of our overall profitability over the last decade. That I think will change. And so part of that has to do with the effects of regulation that will inhibit some of the massive leveraging and the massive risk-taking that had become so common.
Now, in some ways, I think it’s important to understand that some of that wealth was illusory in the first place.
If he could just share this view with Mr. Geithner and Mr. Bernanke who, according to the WSJ, have a different view: the news [of the stress tests] sparked concern among investors and depositors that the results would be used to shut down or nationalize some of the country's weaker institutions. But Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner assured investors that none of the banks undergoing stress tests would be allowed to fail and that all would have access to government funds if needed.
If, as President Obama argues, some of the wealth created by the financial sector was illusory, financial sector profits need to shrink relative to the rest of the corporate sector and leverage in the sector must be reduced, why won't banks be allowed to fail?
For how much longer will the economy be the tail wagged by the financial sector dog- a tail, mind you, which can only wag in ever smaller amplitudes to avoid overturning that dog? If the Auto sector was viewed as the Financial sector is the response to their troubles would have been a $20K stimulus check such that each family could buy a new car.
What a pleasant surprise to read an interview with President Obama this weekend which contained the following:
What I think will change, what I think was an aberration, was a situation where corporate profits in the financial sector were such a heavy part of our overall profitability over the last decade. That I think will change. And so part of that has to do with the effects of regulation that will inhibit some of the massive leveraging and the massive risk-taking that had become so common.
Now, in some ways, I think it’s important to understand that some of that wealth was illusory in the first place.
If he could just share this view with Mr. Geithner and Mr. Bernanke who, according to the WSJ, have a different view: the news [of the stress tests] sparked concern among investors and depositors that the results would be used to shut down or nationalize some of the country's weaker institutions. But Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner assured investors that none of the banks undergoing stress tests would be allowed to fail and that all would have access to government funds if needed.
If, as President Obama argues, some of the wealth created by the financial sector was illusory, financial sector profits need to shrink relative to the rest of the corporate sector and leverage in the sector must be reduced, why won't banks be allowed to fail?
For how much longer will the economy be the tail wagged by the financial sector dog- a tail, mind you, which can only wag in ever smaller amplitudes to avoid overturning that dog? If the Auto sector was viewed as the Financial sector is the response to their troubles would have been a $20K stimulus check such that each family could buy a new car.
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