Imagine there's no credit market
It's easy if your try
John Lennon (if he'd lived long enough)
[Money] is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order. J.S Mill
Centuries ago there were these things called markets. At the end of a harvest farmers would take their produce to a common area and (hopefully) exchange their goods for other goods or money. In some cities remnants of this history still exist, like civil war battle re-enactments. We call some of these "farmer's markets".
Over time, the word, "market" was applied to any process wherein people exchanged things, even if there was no designated place to meet and most of the exchanges were done by proxy. Thus we use phrases like "credit markets", for instance, which, unlike today's farmer's markets, don't exist. There is no common place to go when one has savings one wishes to lend to meet up with borrowers and haggle over terms.
If I told some friends the financial capital of the nation was allocated in Narnia, Middle Earth or Hades, they might think I needed some time in a rubber room. Yet I could tell the same people the financial capital of the nation is allocated in credit markets, and seem wise despite the fact that Narnia and credit markets are both simply mental constructs. They don't exist.
One of Ludwig von Mises' great contributions to Economics was his focus on human action as the quantum of economics. Aggregates (like GDP), averages (like median income), and credit markets (like the US bond market) are mental constructs, nothing more. When people talk about the US economy, for instance, they are talking about an idea, for such a thing does not exist.
We, humans, exist (sidestepping valid, but for our purposes, irrelevant philosophical issues). We live, breathe, eat, sleep and act, and in so doing, we change the world, which also exists, and are changed by it. This idea we call "an economy" is a construct we imagine to be composed of the actions of millions of people, making, working, buying, selling, and saving.
Confusion over this key point is rife. Politicians talk about saving the economy and speculators talk about freeing the markets, but neither exists to be saved or freed. People all over the world think their investments are worth what a bunch of intermediaries say it is worth, instead of what it eventually returns.
A general sense is seemingly shared by many- when an aggregate measure (GDP) expressed in currency, mind you, not tons of steel, bushels of wheat, etc. of a non-existent construct (the US economy) rises, times are thought to be good. It seems to me, however, there is no time but our time, lived individually, not collectively. The economy to each of us is the sum of our actions conditioned by the sum of all others'.
I had the above points in mind while devising yesterday's model of a grain market with speculators. Instead of conceiving of it as a motion picture- a series of frames projected faster than the human eye samples, thus creating an illusion of continuous motion, or reality- I focused on the frames, which, in the case of markets, are transactions or exchanges.
I wrote that the model could be used for any exchange and as I've gotten some requests, here's the model applied to monetary exchanges, what we call credit markets.
As in our grain market model, there are producers, consumers and middle-men. Producers have money, consumers want money, and the middle-men bring the two together. The producers lend their money to consumers in hopes of future repayment plus some profit, what we call interest. As in our grain market model, profits are allocated based on individual transactions. Usually producers lend their money to middle-men who, in turn, lend it to consumers.
Let's imagine a farmer who had such a bumper crop he ended up with 2000 pieces of silver. Let's imagine a town administrator who wished to borrow 2000 pieces of silver to pay workers to build a bridge over a nearby river and thus increase tax revenue during the local market season. The administrator bets he can collect an extra 2100 pieces of silver during next year's harvest market.
In a small town, the administrator might visit the farmer and agree to borrow his silver and repay it next year plus 100 pieces in interest (not a bad deal as the taxes would be collected each year the bridge was still working). In a larger town, the farmer might bring his money to a bank, and the banker might lend it to the administrator and take, say, 30 pieces of silver for his trouble.
As in our grain market model, the middle-man/banker doesn't increase the total profit of the transaction, nor does he decrease the risk the bridge won't be completed and tax revenues won't be collected. If the administrator defaults on his obligation, the banker is still obliged to repay the farmer, from his own pocket, if need be, or he goes out of business (unless, of course, he's a TBTF banker who gets government to impose an additional tax on citizens to pay for his errors in judgment).
In the above model, the banker provides "liquidity" to the farmer, borrowing his money at a rate somewhat lower than he believes he can lend it to the administrator. Today, hordes of commercial paper and bond traders do exactly the same thing. Perversely, their liquidity providing actions, as they trade with each other waiting for a new producer with money to lend, or consumer, wanting to borrow it, has come to be called "credit markets" when real credit market action only occurs when new money is lent.
Thus, when people speak of "rescuing the credit markets" they really mean to say rescuing the liquidity providers who failed to assess lending risks so profoundly they can't make required payments. When people talk of German restrictions killing the credit markets, they really mean killing the middle-men (which may or may not have a deleterious effect on government borrowing).
German restrictions on certain types of equity and credit transactions are not aimed at reduced government borrowing. They are aimed at reducing the amount (and means of capture) of profit "earned" by middle-men in the transaction- profits, mind you, as per our model, in the case of government borrowing, come either as a result of the money's original owner getting less interest than a direct deal would generate, the government paying more interest (which only comes from higher tax revenues) than a direct deal would generate, or some combination thereof.
Like all markets, credit markets create nothing (which I suspect, is a big problem with naked CDS, from whence do the profits come in the event of default?), they merely distribute. As per J.S. Mill, their purpose is increased efficiency of a task that would otherwise occur.
If all of the TBTF banks were put of business tomorrow by government decree, and forced to distribute whatever capital and deposits they could, there would still be people with money willing to lend, and borrowers willing to borrow (most likely at rates far higher than are apparent today).
Some might argue such would be the end of the credit markets, which, leaving aside debate over the termination of a figment of one's imagination, might not be such a bad thing.
Let's play along with John Lennon and imagine no market for government bonds. Let's imagine a government, like mine in the US, which, instead of announcing an auction of $113B in 2-year notes to be mediated by direct dealers (there's a neat contradiction in terms) simply lists its borrowing needs and potential terms on an internet site, which willing borrowers could view and perhaps post their desired terms. These days, an auction program could perform most of the same functions the direct dealers do- putting together sellers and buyers- at a small fraction of the
cost.
There are, of course, some things auction programs can't do, like sell toxic debt at low rates to unsuspecting people, but we might not really miss that.
Some eager bond traders would likely argue the above scenario would lead to more volatile interest rates. I agree. Prices of exchanges like the above would be much more responsive to current events. Countries like Greece would have gotten a much earlier warning of trouble ahead, which, in hindsight, seems a good thing.
In sum, liquidity providing actions of "credit market" middle-men has run amok. As per J.S. Mill, that credit markets are exerting a distinct and independent influence of their own means they are out of order. With increasing frequency, credit is mispriced or unwisely extended and liquidity, the raison d'être of these people, dries up when it is needed most. Yet the middle-men who fail in their tasks expect to be rescued from their failures, and given even more ways to profit from lending other people's money, while the pool of available savings shrinks.
Sad.
p.s. In one sense I'm quite happy about all of the financial sector bail-outs governments have provided these credit-market middle-men. Before the bail-outs, one had to argue that finance was like a tax on monetary exchange, now this point is clear, finance is, in fact, a tax- and a growing one at that.
Showing posts with label Greece. Show all posts
Showing posts with label Greece. Show all posts
Thursday, May 20, 2010
Tuesday, May 11, 2010
Money-Theism, The Faith That Failed
Future historians may well find post-modern man's faith in the power of money as perplexing as Cortes and his men found the faith of MesoAmerica. It is, I believe this curious faith in money's power that allowed finance to become as protected a practice as any in Christianity. How else could three men who kept markets functioning be proclaimed as "saving the world"? Why else, but for this faith, would politics allow their preeminent position to be usurped by banking?
Dedicated to Dr. Chan whose questions sparked this line of thought.
Human sacrifice. To the modern (i.e. late 15th Century on) mind, the notion of ritual human sacrifice earning the favor of the Gods seems absurd. While Hernán Cortés and his men had few qualms about killing people to achieve earthly goals, they were horrified by the MesoAmerican penchant for the practice during the Mayan and Aztec conquests.
Yet, I'm sure the Mayans and Aztecs "believed" in the virtues of human sacrifice, with some literally believing Gods' favor would follow while others, taking a more practical perspective, assumed the practice scared neighboring tribes or conditioned the population's acceptance of the regime's power.
Today, no doubt, some purists still pray to the money God, while others are motivated by more practical concerns, like Big Bonuses. So it is with all man's faiths.
Alas, for the MesoAmericans, their appeased Gods did not defend them from Cortés and his minions (or Cortés won them over with his greater blood-lust). The Gods failed.
Post-modern man has his Gods too. He worships, inter alia, technology, democracy and, in particular, money. The money worship to which I refer has little to do with the desire therefore, but rather, the faith in money's power over nationalist warfare and thus as means to world peace.
Future historians may well find post-modern man's faith in the power of money as perplexing as Cortes and his men found the faith of MesoAmerica. It is, I believe this curious faith in money's power that allowed finance to become as protected a practice as any in Christianity. How else could three men who kept markets functioning be proclaimed as "saving the world"? Why else, but for this faith, would politics allow their preeminent position to be usurped by banking?
Pedantic Pause:
One wonders how long it will be before an elected official complains, "Will no one rid me of this troublesome banker?" and then does penance at the slain man's tomb. My sense; if it doesn't happen quickly, the odds of seeking penance are small. Alternatively, some Jack Cade type might gain power and take the advice of a friendly butcher, but direct his ire at bankers instead of lawyers.
Paraphrasing the bard: Is not this a lamentable thing, that of the body of an innocent tree should be made paper? that paper, being scribbled o'er, should undo a man?
One can trace the growing faith in the money God in both the continued trend of US decisions in favor of monetary globalization at the expense of sound domestic growth and the rush to implement European Monetary Union (EMU) before political harmonization. A common money (call it money-theism), it was believed, would end centuries of European and even world conflict. Remember the joy of the Neo-Cons (inter alios) as the Russian and Chinese economies "dollarized"?
It was proclaimed to be The End of History.
You could almost hear the Neo-Cons chanting, Tolkein-fashion: One money to rule them all, one money to find them, one money to bring them all and in the darkness bind them.
History, a decade hence, might borrow a line from Mark Twain and suggest, "rumors of my demise have been greatly exaggerated."
Ironically, the Gods of Mount Olympus have demonstrated the weakness of money-theism. Greek dissatisfaction with EMU rules (20 years ago, Greek officials would have just let the Drachma slide) supports "economist" over "monetarist" visions of the power of money which emerged on the road to Euro.
In 1970, the Werner Report forged a compromise of sorts between these two groups debating the means to create EMU. As Matthias Kaelberer details:
The major policy clash was between the "monetarists" and the "economists". The "monetarists"- a position forcefully presented by France- argued in favor of quick progress on monetary cooperation, which would then serve as a tool to harmonize economic policies. The "economists"- reflecting the position of Germany- argued in favor of prior convergence of economic policies before moving to a monetary union.
His critique of the monetarist position (written in 1993) was prescient:
Had the monetarist position succeeded, it would have offered deficit and high-inflation countries a free ride: In a complete EMU, Germany would have either had to finance the balance of payments [BoP] of the deficit countries or it would have had to accept a higher inflation rate.
In the event, "monetarists" won the battle but "economists" won the war. The PIGS went on a free ride and Germany (and the rest of core Europe), to keep EMU, must either finance the PIGS' BoP deficits or accept higher inflation.
On a wider stage, the ongoing battle between China and the US over exchange rates is another sign that money-theism, the current theme of globalization, has failed. The virtues of unified money will have to wait unless and until national political system aims and means converge. We might even discover the drive for monetary union ignites rather than extinguishes war, but I hope I'm wrong.
It is, I believe, the end of an era.
But, my psychologists/editors at Seeking Alpha (an inside joke) are probably saying, "Where's the beef? What action should our readers take?"
The days of banker-glorification will soon be behind us. Politicians will retake the high ground and bankers will no longer be protected from the technology revolution. How much do you pay in ATM fees each year? The division of national corporate profits will shift back in favor of the real sector. If I was still trading at a Hedge Fund, I'd be short all the big banks.
The intensifying battle between bankers and politicians will likely lead to increased sovereign funding problems. States, once again, will have to pay a fair price to borrow.
I wouldn't be surprised to see double digit western sovereign bond coupons in the not too distant future. (In other words, sell western sovereign bonds).
While the theme of globalization has been exposed as false, the virtues of increased trade (which should accrue at a faster pace, once cleared of banker-parasites) are clear. The world, in my view, is not yet ready for a common money, but begs a flexible international financial architecture. Specie, as the recent rallies in Gold and Silver demonstrate, is making a comeback and may yet be resurrected as a basis, in one manner or another, of the next system.
Full Disclosure: Long Gold and Silver
Time Disclosure: I'm no longer a "trader" but an "investor". I think, when investing, in units of decades, not weeks, days or hours. In other words, those looking for the next 10/32nds in bonds are in the wrong place.
Dedicated to Dr. Chan whose questions sparked this line of thought.
Human sacrifice. To the modern (i.e. late 15th Century on) mind, the notion of ritual human sacrifice earning the favor of the Gods seems absurd. While Hernán Cortés and his men had few qualms about killing people to achieve earthly goals, they were horrified by the MesoAmerican penchant for the practice during the Mayan and Aztec conquests.
Yet, I'm sure the Mayans and Aztecs "believed" in the virtues of human sacrifice, with some literally believing Gods' favor would follow while others, taking a more practical perspective, assumed the practice scared neighboring tribes or conditioned the population's acceptance of the regime's power.
Today, no doubt, some purists still pray to the money God, while others are motivated by more practical concerns, like Big Bonuses. So it is with all man's faiths.
Alas, for the MesoAmericans, their appeased Gods did not defend them from Cortés and his minions (or Cortés won them over with his greater blood-lust). The Gods failed.
Post-modern man has his Gods too. He worships, inter alia, technology, democracy and, in particular, money. The money worship to which I refer has little to do with the desire therefore, but rather, the faith in money's power over nationalist warfare and thus as means to world peace.
Future historians may well find post-modern man's faith in the power of money as perplexing as Cortes and his men found the faith of MesoAmerica. It is, I believe this curious faith in money's power that allowed finance to become as protected a practice as any in Christianity. How else could three men who kept markets functioning be proclaimed as "saving the world"? Why else, but for this faith, would politics allow their preeminent position to be usurped by banking?
One wonders how long it will be before an elected official complains, "Will no one rid me of this troublesome banker?" and then does penance at the slain man's tomb. My sense; if it doesn't happen quickly, the odds of seeking penance are small. Alternatively, some Jack Cade type might gain power and take the advice of a friendly butcher, but direct his ire at bankers instead of lawyers.
Paraphrasing the bard: Is not this a lamentable thing, that of the body of an innocent tree should be made paper? that paper, being scribbled o'er, should undo a man?
One can trace the growing faith in the money God in both the continued trend of US decisions in favor of monetary globalization at the expense of sound domestic growth and the rush to implement European Monetary Union (EMU) before political harmonization. A common money (call it money-theism), it was believed, would end centuries of European and even world conflict. Remember the joy of the Neo-Cons (inter alios) as the Russian and Chinese economies "dollarized"?
It was proclaimed to be The End of History.
You could almost hear the Neo-Cons chanting, Tolkein-fashion: One money to rule them all, one money to find them, one money to bring them all and in the darkness bind them.
History, a decade hence, might borrow a line from Mark Twain and suggest, "rumors of my demise have been greatly exaggerated."
Ironically, the Gods of Mount Olympus have demonstrated the weakness of money-theism. Greek dissatisfaction with EMU rules (20 years ago, Greek officials would have just let the Drachma slide) supports "economist" over "monetarist" visions of the power of money which emerged on the road to Euro.
In 1970, the Werner Report forged a compromise of sorts between these two groups debating the means to create EMU. As Matthias Kaelberer details:
The major policy clash was between the "monetarists" and the "economists". The "monetarists"- a position forcefully presented by France- argued in favor of quick progress on monetary cooperation, which would then serve as a tool to harmonize economic policies. The "economists"- reflecting the position of Germany- argued in favor of prior convergence of economic policies before moving to a monetary union.
His critique of the monetarist position (written in 1993) was prescient:
Had the monetarist position succeeded, it would have offered deficit and high-inflation countries a free ride: In a complete EMU, Germany would have either had to finance the balance of payments [BoP] of the deficit countries or it would have had to accept a higher inflation rate.
In the event, "monetarists" won the battle but "economists" won the war. The PIGS went on a free ride and Germany (and the rest of core Europe), to keep EMU, must either finance the PIGS' BoP deficits or accept higher inflation.
On a wider stage, the ongoing battle between China and the US over exchange rates is another sign that money-theism, the current theme of globalization, has failed. The virtues of unified money will have to wait unless and until national political system aims and means converge. We might even discover the drive for monetary union ignites rather than extinguishes war, but I hope I'm wrong.
It is, I believe, the end of an era.
But, my psychologists/editors at Seeking Alpha (an inside joke) are probably saying, "Where's the beef? What action should our readers take?"
The days of banker-glorification will soon be behind us. Politicians will retake the high ground and bankers will no longer be protected from the technology revolution. How much do you pay in ATM fees each year? The division of national corporate profits will shift back in favor of the real sector. If I was still trading at a Hedge Fund, I'd be short all the big banks.
The intensifying battle between bankers and politicians will likely lead to increased sovereign funding problems. States, once again, will have to pay a fair price to borrow.
I wouldn't be surprised to see double digit western sovereign bond coupons in the not too distant future. (In other words, sell western sovereign bonds).
While the theme of globalization has been exposed as false, the virtues of increased trade (which should accrue at a faster pace, once cleared of banker-parasites) are clear. The world, in my view, is not yet ready for a common money, but begs a flexible international financial architecture. Specie, as the recent rallies in Gold and Silver demonstrate, is making a comeback and may yet be resurrected as a basis, in one manner or another, of the next system.
Full Disclosure: Long Gold and Silver
Time Disclosure: I'm no longer a "trader" but an "investor". I think, when investing, in units of decades, not weeks, days or hours. In other words, those looking for the next 10/32nds in bonds are in the wrong place.
Friday, May 07, 2010
Dancing On A (Financial) Volcano
The bank lobbyists have the champagne out – the Brown-Kaufman amendment, which would have capped the size and leverage of our largest banks – was defeated in the Senate last night, 33-61. Simon Johnson
Mr. Johnson describes the pro-TBTF (Too Big To Fail) "victory" in a Pyrrhic sense and suggests their opponents, like Wellington, have fallen back to Waterloo.
It's an apt metaphor. Yet, I think the situation may be more dire than that (as, I suspect, does he, after all, we commentators only have so much time to mine for metaphors).
Just prior to the French Revolution of 1830, Talleyrand attended a ball, at which, he was reported to remark, "We are dancing on a volcano."
Moving back in time a few millennia, the flourishing Minoan civilization, inhabitants of which, ironically, liked to leap over bulls, actually were dancing on a volcano, on the island of what is now called Santorini. I don't know if the bull leaping was a mental reflection of their life on the volcano-beast but that beast did erupt (sometime around 1600 BC) and gore their civilization.
There are two aspects to the current volcano- popular unrest, such as was evident in Greece this week (discomforting, related note: one in 5 American men between 25-44 is unemployed) , and the increasingly volatile financial markets themselves. TBTF lobbyists, like the Minoan bull-jumpers, are engaged in risky business, risking both populist anger, and an eruption of the financial volcano (might rising market implied volatility be seen in a tectonic light?).
Those of us watching the spectacle, in delight, admiration, trepidation or horror, (depending on perspective) from afar may soon find, like the Minoans, worse things- deeper, more profound things- to fear, than the bulls.
Some might wonder if it would have been better to dance on the volcano as it erupted instead of, like the Minoan survivors of the eruption and resultant tsunami, trying to pick up the pieces afterward.
We'll see, soon enough.
Or not. After all, this is just a metaphor, my attempt, in a sense, to dance on the volcano, which may, in the event, not even exist (but my gold investment- my bet on the volcano- is an attempt to stay well clear of "Santorini")
Happy Dancing!
Here endeth the mind-bending Minoan metaphor. Next week (hopefully) I'll get back to more con-Crete (couldn't resist) analysis.
Mr. Johnson describes the pro-TBTF (Too Big To Fail) "victory" in a Pyrrhic sense and suggests their opponents, like Wellington, have fallen back to Waterloo.
It's an apt metaphor. Yet, I think the situation may be more dire than that (as, I suspect, does he, after all, we commentators only have so much time to mine for metaphors).
Just prior to the French Revolution of 1830, Talleyrand attended a ball, at which, he was reported to remark, "We are dancing on a volcano."
Moving back in time a few millennia, the flourishing Minoan civilization, inhabitants of which, ironically, liked to leap over bulls, actually were dancing on a volcano, on the island of what is now called Santorini. I don't know if the bull leaping was a mental reflection of their life on the volcano-beast but that beast did erupt (sometime around 1600 BC) and gore their civilization.
There are two aspects to the current volcano- popular unrest, such as was evident in Greece this week (discomforting, related note: one in 5 American men between 25-44 is unemployed) , and the increasingly volatile financial markets themselves. TBTF lobbyists, like the Minoan bull-jumpers, are engaged in risky business, risking both populist anger, and an eruption of the financial volcano (might rising market implied volatility be seen in a tectonic light?).
Those of us watching the spectacle, in delight, admiration, trepidation or horror, (depending on perspective) from afar may soon find, like the Minoans, worse things- deeper, more profound things- to fear, than the bulls.
Some might wonder if it would have been better to dance on the volcano as it erupted instead of, like the Minoan survivors of the eruption and resultant tsunami, trying to pick up the pieces afterward.
We'll see, soon enough.
Or not. After all, this is just a metaphor, my attempt, in a sense, to dance on the volcano, which may, in the event, not even exist (but my gold investment- my bet on the volcano- is an attempt to stay well clear of "Santorini")
Happy Dancing!
Here endeth the mind-bending Minoan metaphor. Next week (hopefully) I'll get back to more con-Crete (couldn't resist) analysis.
Tuesday, May 04, 2010
Collapse of Occult Economics and US$ Based World
I see bad libor rising
I see trouble on the way
I see market crashes and (near) defaults
I see bad times today
Don't go 'round tonight
For it's bound to take your cash
There's a bad libor on the rise
Ex-Fed Chairman Greenspan has been accused of occulting (hiding from people's view) dissent from the Fed's panglossian housing market forecasts in 2004. While I'd love for that to be true, I'm with Felix Salmon, who, after reading the whole transcript (always a good idea before jumping to an opinion) discerned the offensive quote (see below) referred to debate over Fed transparency and not the housing market.
We run the risk, by laying out the pros and cons of a particular argument, of inducing people to join in on the debate, and in this regard it is possible to lose control of a process that only we fully understand. Fed Transcript
To my mind, a more interesting quote can be found in Ms. Minehan's discussion of US economic growth at the same meeting: And like everybody else, I don’t know why the pace of hiring has been as slow as it has been or whether it will get slower or speed up more quickly than we expect.
There's an admission worth noting, she, like everyone else at the table didn't know why the pace of hiring had been as slow as it had been (perhaps because Fed liquidity had gone more to overseas markets than at home would be my guess). In other words, the only occulting that occurred at Fed meetings was the far less sinister, but much more ominous blind leading the blind.
I think the same phenomenon lies behind TPM's discovery of occult practices at the US Treasury in their dealings with Congress (Ms. Pelosi has recently reported the meeting to first request funds came at her, not the Treasury's, request) prior to the request for TARP funds. It isn't sinister, it's just a case of enforced ignorance, as in, let's try whistling past the graveyard, it might work.
Neither Greenspan, nor Rubin, nor Summers (whose financial prescience was shown to be flawed at Harvard) nor Blankfein nor any other of the financial big wigs knows what's going to happen in the financial world because they believe this time is different. (If they did know they would have run for the hills long ago) They have thrown away the only tool that allows economic forecasting, the assumption that the rules of economics always operate (qualifying the proper conditions as they relate to the past being the tricky part of the game, whether I've done so accurately this time remains to be seen).
The collapse of occult economics to which I refer is the apocalypse (Greek for unveiling) of the US$ based system as operating under the same rules of finance that have always operated, specifically the fact that true provision of global liquidity can only come (in a US$ based trading system) through increased US$ supply, a.k.a. Triffin's Dilemma.
As I've previously discussed, Robert Triffin noted the dilemma at the heart of the US$ based global trading system- in order for the world to get the liquidity it wants US$ balances overseas will have to grow, thus eventually weakening the US$ such that it could no longer serve as global reserve currency.
Two events are conspiring to unveil Triffin's Dilemma to the world, the coming economic slowdown in China as a result of previous credit over-extension and current tightening and the current emerging crisis in the Euro periphery- the "G"-less PIGS (Portugal, Italy, Greece (who've gotten their bail-out), and Spain). The "G"-less PIGS must have felt a bit left out of the liquidity party for Greece this past weekend and are now clamoring for their own rescue package.
As an aside, I'm only partially facetious when I suggest a most profitable Hedge Fund theme, find liquidity deprived countries to invest in a fund that will blow out your spreads (CDS and swaps) and create the need for a bail-out. As an added bonus, the rescue deal will likely include a fully funded financial rescue package.
As always there are options available to policy makers. They could allow defaults to occur but that is the "it" (being deflation) Bernanke promised wouldn't happen here (in the US, and by extension, the world), and that option too would likely lead to the end of the US$ based trading system. The other option, the option that has become the rule is more liquidity, and in this case, barring a significant decline in the Euro and RMB vs. the US$, the Fed will have to supply that liquidity at a time when they would prefer to begin unloading some of the toxic securities they bought from the TBTF banks.
Unlike the 2008, 2000-2001 and 1997-1998 crises, however, Fed Funds are already near zero. Quantitative easing, in the form of continued declines in acceptable collateral for Central Bank discounting will be the tool- monetization of poor credit, in large amounts.
At that point, I suspect, Gold will begin to soar against all currencies, and the search for a new global international reserve will being in earnest.
The signs of impending crisis are already manifesting: 1) global stock markets are rolling over 2) credit default swap prices for the "G"-less PIGS are rising rapidly 3) the pace of decline in US$ swap rates has eased.
In the not too distant future, if stock markets continue to weaken, US$ swaps rates will rise. US$ liquidity will, once again, be in short supply and the Fed will be called on to rescue the world.
Let the unveiling commence.
p.s. the primary rule of economics that, in my view, has been occulted from view, because it is so distasteful (to some) is the no free lunch rule...just my, rapidly depreciating, two cents
p.p.s yes, I'm way out on a limb on this one, but what the heck, I'm just a pajama-wearing blogger
Full Disclosure: Long lots of Gold
I see trouble on the way
I see market crashes and (near) defaults
I see bad times today
Don't go 'round tonight
For it's bound to take your cash
There's a bad libor on the rise
Ex-Fed Chairman Greenspan has been accused of occulting (hiding from people's view) dissent from the Fed's panglossian housing market forecasts in 2004. While I'd love for that to be true, I'm with Felix Salmon, who, after reading the whole transcript (always a good idea before jumping to an opinion) discerned the offensive quote (see below) referred to debate over Fed transparency and not the housing market.
We run the risk, by laying out the pros and cons of a particular argument, of inducing people to join in on the debate, and in this regard it is possible to lose control of a process that only we fully understand. Fed Transcript
To my mind, a more interesting quote can be found in Ms. Minehan's discussion of US economic growth at the same meeting: And like everybody else, I don’t know why the pace of hiring has been as slow as it has been or whether it will get slower or speed up more quickly than we expect.
There's an admission worth noting, she, like everyone else at the table didn't know why the pace of hiring had been as slow as it had been (perhaps because Fed liquidity had gone more to overseas markets than at home would be my guess). In other words, the only occulting that occurred at Fed meetings was the far less sinister, but much more ominous blind leading the blind.
I think the same phenomenon lies behind TPM's discovery of occult practices at the US Treasury in their dealings with Congress (Ms. Pelosi has recently reported the meeting to first request funds came at her, not the Treasury's, request) prior to the request for TARP funds. It isn't sinister, it's just a case of enforced ignorance, as in, let's try whistling past the graveyard, it might work.
Neither Greenspan, nor Rubin, nor Summers (whose financial prescience was shown to be flawed at Harvard) nor Blankfein nor any other of the financial big wigs knows what's going to happen in the financial world because they believe this time is different. (If they did know they would have run for the hills long ago) They have thrown away the only tool that allows economic forecasting, the assumption that the rules of economics always operate (qualifying the proper conditions as they relate to the past being the tricky part of the game, whether I've done so accurately this time remains to be seen).
The collapse of occult economics to which I refer is the apocalypse (Greek for unveiling) of the US$ based system as operating under the same rules of finance that have always operated, specifically the fact that true provision of global liquidity can only come (in a US$ based trading system) through increased US$ supply, a.k.a. Triffin's Dilemma.
As I've previously discussed, Robert Triffin noted the dilemma at the heart of the US$ based global trading system- in order for the world to get the liquidity it wants US$ balances overseas will have to grow, thus eventually weakening the US$ such that it could no longer serve as global reserve currency.
Two events are conspiring to unveil Triffin's Dilemma to the world, the coming economic slowdown in China as a result of previous credit over-extension and current tightening and the current emerging crisis in the Euro periphery- the "G"-less PIGS (Portugal, Italy, Greece (who've gotten their bail-out), and Spain). The "G"-less PIGS must have felt a bit left out of the liquidity party for Greece this past weekend and are now clamoring for their own rescue package.
As an aside, I'm only partially facetious when I suggest a most profitable Hedge Fund theme, find liquidity deprived countries to invest in a fund that will blow out your spreads (CDS and swaps) and create the need for a bail-out. As an added bonus, the rescue deal will likely include a fully funded financial rescue package.
As always there are options available to policy makers. They could allow defaults to occur but that is the "it" (being deflation) Bernanke promised wouldn't happen here (in the US, and by extension, the world), and that option too would likely lead to the end of the US$ based trading system. The other option, the option that has become the rule is more liquidity, and in this case, barring a significant decline in the Euro and RMB vs. the US$, the Fed will have to supply that liquidity at a time when they would prefer to begin unloading some of the toxic securities they bought from the TBTF banks.
Unlike the 2008, 2000-2001 and 1997-1998 crises, however, Fed Funds are already near zero. Quantitative easing, in the form of continued declines in acceptable collateral for Central Bank discounting will be the tool- monetization of poor credit, in large amounts.
At that point, I suspect, Gold will begin to soar against all currencies, and the search for a new global international reserve will being in earnest.
The signs of impending crisis are already manifesting: 1) global stock markets are rolling over 2) credit default swap prices for the "G"-less PIGS are rising rapidly 3) the pace of decline in US$ swap rates has eased.
In the not too distant future, if stock markets continue to weaken, US$ swaps rates will rise. US$ liquidity will, once again, be in short supply and the Fed will be called on to rescue the world.
Let the unveiling commence.
p.s. the primary rule of economics that, in my view, has been occulted from view, because it is so distasteful (to some) is the no free lunch rule...just my, rapidly depreciating, two cents
p.p.s yes, I'm way out on a limb on this one, but what the heck, I'm just a pajama-wearing blogger
Full Disclosure: Long lots of Gold
Monday, May 03, 2010
Bail-Outs for Screw Ups: Oil and Greece
In the not-to-distant future I wouldn't be surprised to read the following from the IMF: Negotiators over the weekend wrapped up details of the package, involving budget cuts, a freeze in wages and pensions for three years, and oil price increases to address British Petroleum's fiscal and debt problems as a result of the Gulf Oil Spill, along with deep reforms designed to strengthen BP's competitiveness and revive stalled corporate growth.
The above is paraphrased from the IMF's press release announcing the Greek Rescue Package. This, and other press releases, describe the crisis as "economic" when "financial' seems to me more apt (should we describe the oil spill as a "geologic" rather than "drilling" problem?), and proclaim the creation of a, fully funded, mind you, Financial Stability Fund. Greek Banks which failed to see the crisis coming are going to be shielded from the effects thereof.
Imagine if major Greek Banks, instead of investing anywhere from 2-3 times their equity into Greek Government Debt, had invested in safer securities. Just as deep-sea oil drillers have to devise safe (i.e. non-toxic) ways to extract oil, imagining some of the potential problems before they occur, shouldn't banks be devising safe (i.e. non-toxic) ways to extract profits from the seas of finance? If they fail in this task, should they be shielded from the effects of their failure?
One of the essential qualities of capitalist success, agreed upon after decades of careful study is the use of profits as arbiter for continued existence as a financial entity. Implicit in this view is belief that there will always be other competing firms/investors ready and willing to pick up the slack.
I'm pretty sure, just as there are many companies waiting to pick up the business slack caused by BP's error and potential financial distress, so too there are many Greek Banks with stronger balance sheets that would be willing to pick up the slack caused by the major banks' error in crisis forecasting.
Over at The Baseline Scenario Simon Johnson asks (of the decision to support too big to fail banks, instead of breaking them up): What is the basis for major policy decisions in the United States? Is it years of careful study, using the concentration of knowledge and expertise for which this country is known and respected around the world?
He suggests a possible (alternative) answer: I would not have a problem with the administration’s top officials saying, “we can’t take on the biggest banks because (a) they are too powerful in general, and (b) they would cut us off from the campaign contributions that we need for November.” This would at least be honest...
Honest, yes. Wise? not in my view.
BP's oil spill is horrific, but a fairly rare occurrence. Finance, at least in its current "liberal" form has a far worse track record. How long would the world tolerate current drilling techniques if such disasters occurred every couple of quarters all around the world? How long would public sector officials feeding from that trough survive?
Those in the public sector need to realize their interests are not aligned with TBTF finance. Can you imagine some BP-financed politician running in Louisiana any time soon?
Public sector monetization of financial sector errors coupled with support of the liberal banking techniques that created the problem will only accelerate currency devaluations in regimes that follow this policy and the brunt of the complaints will fall on the public sector and finance. In layman's terms, bail-outs for financial screw-ups will continue to cause higher prices, and higher prices will only inspire more anger.
Ideally, reward systems like capitalism should favor the prescient over the screw-up. Doing the opposite will likely have undesirable effects for all involved.
To wit; in an interesting irony, while the IMF is engaged in selling its gold it bails-outs the financial screw-ups who make it such a useful asset on a balance sheet.
The above is paraphrased from the IMF's press release announcing the Greek Rescue Package. This, and other press releases, describe the crisis as "economic" when "financial' seems to me more apt (should we describe the oil spill as a "geologic" rather than "drilling" problem?), and proclaim the creation of a, fully funded, mind you, Financial Stability Fund. Greek Banks which failed to see the crisis coming are going to be shielded from the effects thereof.
Imagine if major Greek Banks, instead of investing anywhere from 2-3 times their equity into Greek Government Debt, had invested in safer securities. Just as deep-sea oil drillers have to devise safe (i.e. non-toxic) ways to extract oil, imagining some of the potential problems before they occur, shouldn't banks be devising safe (i.e. non-toxic) ways to extract profits from the seas of finance? If they fail in this task, should they be shielded from the effects of their failure?
One of the essential qualities of capitalist success, agreed upon after decades of careful study is the use of profits as arbiter for continued existence as a financial entity. Implicit in this view is belief that there will always be other competing firms/investors ready and willing to pick up the slack.
I'm pretty sure, just as there are many companies waiting to pick up the business slack caused by BP's error and potential financial distress, so too there are many Greek Banks with stronger balance sheets that would be willing to pick up the slack caused by the major banks' error in crisis forecasting.
Over at The Baseline Scenario Simon Johnson asks (of the decision to support too big to fail banks, instead of breaking them up): What is the basis for major policy decisions in the United States? Is it years of careful study, using the concentration of knowledge and expertise for which this country is known and respected around the world?
He suggests a possible (alternative) answer: I would not have a problem with the administration’s top officials saying, “we can’t take on the biggest banks because (a) they are too powerful in general, and (b) they would cut us off from the campaign contributions that we need for November.” This would at least be honest...
Honest, yes. Wise? not in my view.
BP's oil spill is horrific, but a fairly rare occurrence. Finance, at least in its current "liberal" form has a far worse track record. How long would the world tolerate current drilling techniques if such disasters occurred every couple of quarters all around the world? How long would public sector officials feeding from that trough survive?
Those in the public sector need to realize their interests are not aligned with TBTF finance. Can you imagine some BP-financed politician running in Louisiana any time soon?
Public sector monetization of financial sector errors coupled with support of the liberal banking techniques that created the problem will only accelerate currency devaluations in regimes that follow this policy and the brunt of the complaints will fall on the public sector and finance. In layman's terms, bail-outs for financial screw-ups will continue to cause higher prices, and higher prices will only inspire more anger.
Ideally, reward systems like capitalism should favor the prescient over the screw-up. Doing the opposite will likely have undesirable effects for all involved.
To wit; in an interesting irony, while the IMF is engaged in selling its gold it bails-outs the financial screw-ups who make it such a useful asset on a balance sheet.
Wednesday, April 28, 2010
Breaking Up Is Hard To Do: TBTF, the Euro and Gold
Perhaps this is one reason why Gold has not reacted in recently "normal" fashion to Greek crisis inspired Euro weakness. Perhaps, the new thinking may go: Monetary Union's loss (in its many forms) is Gold's gain. If the drive to a monolithic world currency has stalled and currency competition comes back into vogue, Gold's track record is tough to beat.
Recent news about Greece's financial travails reminded me of a conversation I had with Helmut Schlesinger as the Asian Crisis was unfolding in 1997. Over a few drinks at the Long Bar in Singapore's Raffles Hotel, Mr. Schlesinger regaled me with his views on inflation, monetary integration and "realignments" (devaluations). I don't know whether it was the drinks, the ambiance of the historic Long Bar, or the impending realignment of Asian currencies to the US$, but Mr. Schlesinger was in a mood to talk, and I, to listen.
As President of the Bundesbank from 1991-93 Mr. Schlesinger had a wealth of experience on monetary integration (with East Germany), realignment within the ERM (European Exchange Rate Mechanism), and disintegration (as Britain left the ERM). On the side of the "economists" in the debates over EMU, he argued, presciently, as the Greek situation demonstrates, that the "monetarists'" view- monetary integration prior to complete political integration wouldn't be a problem- was not historically grounded. Nor was he sanguine about the German reunification of East with West- 13 years hence East Germany continues to lag the West.
For Mr. Schlesinger, "flexibility" was a key component of economic integration. Adjustments in the terms of trade between economic parts, he told me, would always be necessary. Thus integration which didn't maintain some potential for flexibility-which assumed the combined parts would always thereafter be a unified whole- risked disaster. Perhaps this explains, to some extent, his comments about potentially necessary ERM realignments in 1992 that acted as catalyst to the GBP (British Pound) and ITL (Italian Lira) devaluations, and withdrawal of the GBP from the ERM.
There seems to me a lesson to be learned from both the recent EU and TBTF problems on either side of the Atlantic- breaking up, in the sense of making necessary adjustments in the terms of trade (a phrase that usually refers to the relation between import and export prices between nations, but can more broadly refer to the agreed upon bases of exchanges (prices, credit access, etc.) between and amongst any and all economic units), is hard to do. Flexibility has been lost in the pursuit of economic monolithism (if you will).
Previously, situations like Greece, or the TBTF banks in the US, would have begged a period of disintegration and adjustment in the terms of trade, either via devaluation in the case of Greece, or disintegration (perhaps bankruptcy) of certain units of the TBTF banks, in the case of the US.
To wit, US financial sector reform, in my view, needs to, inter alia, restrict discount window borrowing privileges to commercial banking (i.e. adjust the terms of trade within finance), leaving derivatives and proprietary trading to stand or fall on their own merits. This is virtually impossible within the current system of financial monolithism.
The cost of the new approach of economic monolithism, is increasing bailouts- dilution of the common currency- which distributes the losses system wide, and slows the necessary adjustments in the terms of trade.
It is not surprising to me that the Germans, where fears of a Weimar style inflation remain strong, are loathe to dilute the Euro to bail-out Greece. After Greece, who else will need a bail-out?
Perhaps what the EU needs is a divorce (perhaps temporary separation, might be more apt) clause- a means to make the necessary terms of trade adjustments. This, in a sense, is that US financial reform seeks- a procedure to disintegrate (temporarily, or permanently) the financial sector to make equally necessary terms of trade adjustments.
The issues noted above, Greece and the TBTF banks, combined with the broader issue of relations between sovereign states and the international whole suggest that the world has, for the time being at least, reached a point of diminishing returns on economic integration. We may need more currencies, and certainly greater economic flexibility between the parts than currently exists.
Perhaps this is one reason why Gold has not reacted in recently "normal" fashion to Greek crisis inspired Euro weakness. Perhaps, the new thinking may go: Monetary Union's loss (in its many forms) is Gold's gain. If the drive to a monolithic world currency has stalled and currency competition comes back into vogue, Gold's track record is tough to beat.
Recent news about Greece's financial travails reminded me of a conversation I had with Helmut Schlesinger as the Asian Crisis was unfolding in 1997. Over a few drinks at the Long Bar in Singapore's Raffles Hotel, Mr. Schlesinger regaled me with his views on inflation, monetary integration and "realignments" (devaluations). I don't know whether it was the drinks, the ambiance of the historic Long Bar, or the impending realignment of Asian currencies to the US$, but Mr. Schlesinger was in a mood to talk, and I, to listen.
As President of the Bundesbank from 1991-93 Mr. Schlesinger had a wealth of experience on monetary integration (with East Germany), realignment within the ERM (European Exchange Rate Mechanism), and disintegration (as Britain left the ERM). On the side of the "economists" in the debates over EMU, he argued, presciently, as the Greek situation demonstrates, that the "monetarists'" view- monetary integration prior to complete political integration wouldn't be a problem- was not historically grounded. Nor was he sanguine about the German reunification of East with West- 13 years hence East Germany continues to lag the West.
For Mr. Schlesinger, "flexibility" was a key component of economic integration. Adjustments in the terms of trade between economic parts, he told me, would always be necessary. Thus integration which didn't maintain some potential for flexibility-which assumed the combined parts would always thereafter be a unified whole- risked disaster. Perhaps this explains, to some extent, his comments about potentially necessary ERM realignments in 1992 that acted as catalyst to the GBP (British Pound) and ITL (Italian Lira) devaluations, and withdrawal of the GBP from the ERM.
There seems to me a lesson to be learned from both the recent EU and TBTF problems on either side of the Atlantic- breaking up, in the sense of making necessary adjustments in the terms of trade (a phrase that usually refers to the relation between import and export prices between nations, but can more broadly refer to the agreed upon bases of exchanges (prices, credit access, etc.) between and amongst any and all economic units), is hard to do. Flexibility has been lost in the pursuit of economic monolithism (if you will).
Previously, situations like Greece, or the TBTF banks in the US, would have begged a period of disintegration and adjustment in the terms of trade, either via devaluation in the case of Greece, or disintegration (perhaps bankruptcy) of certain units of the TBTF banks, in the case of the US.
To wit, US financial sector reform, in my view, needs to, inter alia, restrict discount window borrowing privileges to commercial banking (i.e. adjust the terms of trade within finance), leaving derivatives and proprietary trading to stand or fall on their own merits. This is virtually impossible within the current system of financial monolithism.
The cost of the new approach of economic monolithism, is increasing bailouts- dilution of the common currency- which distributes the losses system wide, and slows the necessary adjustments in the terms of trade.
It is not surprising to me that the Germans, where fears of a Weimar style inflation remain strong, are loathe to dilute the Euro to bail-out Greece. After Greece, who else will need a bail-out?
Perhaps what the EU needs is a divorce (perhaps temporary separation, might be more apt) clause- a means to make the necessary terms of trade adjustments. This, in a sense, is that US financial reform seeks- a procedure to disintegrate (temporarily, or permanently) the financial sector to make equally necessary terms of trade adjustments.
The issues noted above, Greece and the TBTF banks, combined with the broader issue of relations between sovereign states and the international whole suggest that the world has, for the time being at least, reached a point of diminishing returns on economic integration. We may need more currencies, and certainly greater economic flexibility between the parts than currently exists.
Perhaps this is one reason why Gold has not reacted in recently "normal" fashion to Greek crisis inspired Euro weakness. Perhaps, the new thinking may go: Monetary Union's loss (in its many forms) is Gold's gain. If the drive to a monolithic world currency has stalled and currency competition comes back into vogue, Gold's track record is tough to beat.
Sunday, April 11, 2010
The Tyranny of Financial Technicians (and its demise)
The people always have some champion whom they set over them and nurse into greatness. This and no other is the root from which a tyrant springs; when he first appears he is a protector. Plato - The Republic
One of the earliest civilizations of which we still have record, Ancient Egypt, was, in a sense, run as a Technocracy (rule by technical experts). Technicians of that period were revered as priests and studied not money or credit, but time. Their worship of the sun set them apart from other cultures which used the more frequent lunar cycles to track time. By tracking the sun's movement in the sky the priest-technician forecast the coming of the Nile flood on which Egyptian food production was based.
These days the reverence accorded the ancient priests of time seems silly. Children with a few years of school can explain how the earth's revolution around the sun, and the earth's axial tilt leads to seasonal change. The basic secrets of the temple of time can be known by any who wish.
In modern times, the secrets of the temple of money, however, despite demystification attempts by William Greider, et alios, are still considered secret. Financial Technicians are revered perhaps as much as were the Time Technicians of old. Just as the Pharaohs of Egypt thought twice about confronting his priests our rulers think twice about confronting ours.
The Passover season just passed commemorates, from one perspective, the freedom gained from the ancient technocracy of Egypt, who, in the story, weren't as prescient in their forecasting as they professed. In that light, the timing of this op-ed, taking a modern technocrat to task for his lack of prescience, was perfect.
In modern times, internet connectivity makes the secrets of the temple of money far more open than was the case in ancient times. The big secret of the temple of money is that there is no secret. Men like Blankfein, Paulson, Rubin, Dimon, Greenspan, Bernanke, and (perhaps especially) Geithner, are not possessed of intellect and wisdom not found in many thousands of others. Moreover, their judgments, even granting solid "market sense" might be detrimental to the people and corporations that make up the nation (and whose actions are the ultimate determinants of the market).
Louis Brandeis, in his Other People's Money: and how the bankers use it, speaks to this issue: Prominent in the banker-director mind is always this thought: "What will be the probable effect of our action upon the market value of the company's stock and bonds, or indeed, generally upon stock exchange values?" The stock market is so much a part of the investment-banker's life, that he cannot help being affected by this consideration, however disinterested he may be. The stock market is sensitive. Facts are often misinterpreted "by the street" or by investors. And with the best of intentions, directors susceptible to such influences are led to unwise decisions in the effort to prevent misinterpretations. Thus, expenditures necessary for maintenance, or for the ultimate good of a property are often deferred by banker-directors, because of the belief that the making of them now would (by showing smaller net earnings), create a bad, and even false impression on the market. Dividends are paid which should not be, because of the effect which it is believed reduction or suspension would have upon the market value of the company's securities. To exercise a sound judgment in the affairs of business is, at best, a delicate operation. And no man can successfully perform that function whose mind is diverted, however, innocently, from the study of, "what is best in the long run for the company of which I am director?"
Like the Ancient Egyptians waiting for the flood, a critical mass of modern people, many of whom dream of a comfortable retirement, are willing to revere those who promise market prices supportive of their financial expectations, and ignore those who don't. The market concerns of the investment banker described by Brandeis have increasingly became a major factor on policy.
As one example, consider the changed IMF perspective of capital flows (and its analog in the 2008-09 US Financial Rescue package) detailed by Raymond Mikesell, who attended the Bretton Woods Conference: Both White and Keynes believed that the IMF's assistance to members should not finance capital flight. However, the IMF has not maintained this position. The IMF's loans in response to the financial crises in the East Asian countries during the 1990s were primarily for the purpose of helping members restore confidence in their securities markets and currencies, rather than for financing imports. Moreover, according to a recent statement by Secretary of the Treasury Lawrence E. Summers, emergency loans to countries facing currency crises should be the principal lending function of the IMF (Kahn 1999).
Ultimately the Tyranny of Financial Technicians is the Tyranny of the Markets. Admittedly, I've employed hyperbole to make my point. The object of people's fascination varies over time. Following WWII, the people revered war heroes and elected Eisenhower and Kennedy. Their Treasury Secretaries did not come from Wall St. (or even close) and finance was but one of many technical skills deemed useful, and not the most popular.
In all likelihood, the modern fascination with our Technocracy will fade when the promises are seen to be empty. And empty they will prove to be so long as finance is primarily concerned with the markets and not the real sector on which they are based.
** Late addition: In further support of the Investment-Banking mind driving policy thesis, consider the following argument in favor of EU and IMF support for Greece, granted at below market rates: Jean-Claude Juncker, the Luxembourg prime minister and eurogroup president, said he hoped the agreement would calm the markets and help to avert the crisis facing Greece and the single currency. "This is the step of clarification the markets are waiting for," he said. "It shows there is money behind this."
One of the earliest civilizations of which we still have record, Ancient Egypt, was, in a sense, run as a Technocracy (rule by technical experts). Technicians of that period were revered as priests and studied not money or credit, but time. Their worship of the sun set them apart from other cultures which used the more frequent lunar cycles to track time. By tracking the sun's movement in the sky the priest-technician forecast the coming of the Nile flood on which Egyptian food production was based.
These days the reverence accorded the ancient priests of time seems silly. Children with a few years of school can explain how the earth's revolution around the sun, and the earth's axial tilt leads to seasonal change. The basic secrets of the temple of time can be known by any who wish.
In modern times, the secrets of the temple of money, however, despite demystification attempts by William Greider, et alios, are still considered secret. Financial Technicians are revered perhaps as much as were the Time Technicians of old. Just as the Pharaohs of Egypt thought twice about confronting his priests our rulers think twice about confronting ours.
The Passover season just passed commemorates, from one perspective, the freedom gained from the ancient technocracy of Egypt, who, in the story, weren't as prescient in their forecasting as they professed. In that light, the timing of this op-ed, taking a modern technocrat to task for his lack of prescience, was perfect.
In modern times, internet connectivity makes the secrets of the temple of money far more open than was the case in ancient times. The big secret of the temple of money is that there is no secret. Men like Blankfein, Paulson, Rubin, Dimon, Greenspan, Bernanke, and (perhaps especially) Geithner, are not possessed of intellect and wisdom not found in many thousands of others. Moreover, their judgments, even granting solid "market sense" might be detrimental to the people and corporations that make up the nation (and whose actions are the ultimate determinants of the market).
Louis Brandeis, in his Other People's Money: and how the bankers use it, speaks to this issue: Prominent in the banker-director mind is always this thought: "What will be the probable effect of our action upon the market value of the company's stock and bonds, or indeed, generally upon stock exchange values?" The stock market is so much a part of the investment-banker's life, that he cannot help being affected by this consideration, however disinterested he may be. The stock market is sensitive. Facts are often misinterpreted "by the street" or by investors. And with the best of intentions, directors susceptible to such influences are led to unwise decisions in the effort to prevent misinterpretations. Thus, expenditures necessary for maintenance, or for the ultimate good of a property are often deferred by banker-directors, because of the belief that the making of them now would (by showing smaller net earnings), create a bad, and even false impression on the market. Dividends are paid which should not be, because of the effect which it is believed reduction or suspension would have upon the market value of the company's securities. To exercise a sound judgment in the affairs of business is, at best, a delicate operation. And no man can successfully perform that function whose mind is diverted, however, innocently, from the study of, "what is best in the long run for the company of which I am director?"
Like the Ancient Egyptians waiting for the flood, a critical mass of modern people, many of whom dream of a comfortable retirement, are willing to revere those who promise market prices supportive of their financial expectations, and ignore those who don't. The market concerns of the investment banker described by Brandeis have increasingly became a major factor on policy.
As one example, consider the changed IMF perspective of capital flows (and its analog in the 2008-09 US Financial Rescue package) detailed by Raymond Mikesell, who attended the Bretton Woods Conference: Both White and Keynes believed that the IMF's assistance to members should not finance capital flight. However, the IMF has not maintained this position. The IMF's loans in response to the financial crises in the East Asian countries during the 1990s were primarily for the purpose of helping members restore confidence in their securities markets and currencies, rather than for financing imports. Moreover, according to a recent statement by Secretary of the Treasury Lawrence E. Summers, emergency loans to countries facing currency crises should be the principal lending function of the IMF (Kahn 1999).
Ultimately the Tyranny of Financial Technicians is the Tyranny of the Markets. Admittedly, I've employed hyperbole to make my point. The object of people's fascination varies over time. Following WWII, the people revered war heroes and elected Eisenhower and Kennedy. Their Treasury Secretaries did not come from Wall St. (or even close) and finance was but one of many technical skills deemed useful, and not the most popular.
In all likelihood, the modern fascination with our Technocracy will fade when the promises are seen to be empty. And empty they will prove to be so long as finance is primarily concerned with the markets and not the real sector on which they are based.
** Late addition: In further support of the Investment-Banking mind driving policy thesis, consider the following argument in favor of EU and IMF support for Greece, granted at below market rates: Jean-Claude Juncker, the Luxembourg prime minister and eurogroup president, said he hoped the agreement would calm the markets and help to avert the crisis facing Greece and the single currency. "This is the step of clarification the markets are waiting for," he said. "It shows there is money behind this."
Thursday, April 08, 2010
Financial Regulation: Then and Now (Busting TBTF)
Like the internet, finance would benefit from redundancy, and competition, not just in the sense of distributed shareholdings (which is already the case) but viewpoints (which is not helped when directors merely “rubber stamp” CEO opinion, and Fed, Treasury, and other financial regulatory officials are always on loan from GS and the rest of Wall Street). Like minded-ness, if you will, is the issue here and "restraint of trade" the lever. TBTF engenders the myopia which leads men like Greenspan to argue, “nobody saw it coming.” Quite a few did, but they were, in a sense, crowded out of the market.
Simon Johnson and James Kwak of 13 Bankers and The Baseline Scenario, urge President Obama, in a recent Washington Post Op-Ed, to channel Teddy Roosevelt’s defiance of Wall Street, exemplified by the break-up of Northern Securities in 1904 in order to clean up the US financial system.
I agree with Johnson and Kwak’s call to arms, and am sure their views are far more nuanced than a space limited op-ed can relate, however, my examination of the Progressive period in US history, of which the chapter on US financial regulation is but a part, suggests that repetition of that period is most unlikely, and hopefully unnecessary. While there are many similarities between then and now, both the context and issues of concern are, in certain key respects, different.
The Federal Government during the Gilded Age bore little resemblance to that existing today. As a financial entity, in the main, the government collected customs’ duties, which were more than half its receipts, paid interest on the debt, the bulk of which was incurred during the Civil War, and fought the Native Americans and Spain (wars were much cheaper then, additional Army and Navy costs for the 1898 Spanish American War came to $190M).
The malefactors of great wealth, as the industrial and financial titans of the day were known, controlled commerce and finance. They mined iron and made steel, connected the nation via railroads, telegraphs and telephones, and controlled the banks. They set prices and controlled the supply of money, credit and raw materials, which gave them the power to “shake down” people and firms of which they didn’t approve, competitors and frauds alike.
Unlike today, the leading banks which emerged at the end of the Gilded Age weren’t Too Big To Fail, they were Too Solvent To Fail. They owned much of the US gold stock, then the basis of money, and were seemingly immune from the Panics which shook the rest of the nation every decade or so, more often than not, it was claimed, at their instigation.
I’m confident if JP Morgan were running the Fed, credit growth would have been restrained long ago. There is some merit to having someone "own" an issue- unlike Greenspan, Geithner, Rubin et alios, who claim no responsibility. Thus, some believe we need more regulatory officials rather than better ones.
When the government was running dangerously short of gold reserves, in 1895, they went to Wall Street for help- call it a reverse bail-out- and had the Treasury supply replenished. A very small group of unelected men, in effect, owned the government.
This small group of men directed the transformation of America from a disconnected agrarian to a connected soon to be industrial society- from the states united to the United States. In the process, however, they paved the ground for the Progressives to use the power, not of money, but of public opinion, via the ballot box, to usurp their control.
The government that almost died in 1895, was reborn in 1901, when the assassination, by an anarchist (love the irony), of President McKinley, made Teddy Roosevelt President.
Teddy Roosevelt’s Trust Busting kicked off a vigorous 20 year period for the new government. Progressives, who had pushed potentially transformative legislation through Congress from 1885-1900 finally had an executive willing to use it, and his big stick, for change. The Rough Rider took the de jure power of the Interstate Commerce and Sherman Anti-Trust legislation, which had hitherto been used against labor, and prepared to make it de facto, against big business.
The Federal Government, as we know it today, was born. It was a small child about to battle grown men. US Federal Government receipts totaled $670M in 1900 (JP Morgan bought the Carnegie Steel Company around that time for $487M). In 1904, Northern Securities, a railroad trust owned by JP Morgan, JD Rockefeller et alios, was ordered to break up. The precedent, after appeal, was set and many other trusts followed. In 1911, after more than a decade of court battles, the Supreme Court dissolved Standard Oil, making JD Rockefeller, according to some, the richest man in the world, in cash.
He and the other Titans got rich, but lost control of their businesses. Like the Titans of Greek Mythology, they are, for good or ill, only going to appear once.
The child was growing quickly. In 1913, the Federal Reserve was created and the 16th Amendment, which made income taxes Constitutional, was ratified. Four years hence, the US entered World War I. At war’s end, the child had given way to the man. By 1920, receipts had grown to $23B. The Federal Government was now the biggest guy in town.
On one level, this growth of government is like that of Gilded Age business-built on the destruction of competition. There are, however, two key differences: 1) government didn’t “swallow” competitors, they dissolved them into smaller pieces, diluting their control 2) Gilded Age businesses were dynastic and decision-making was concentrated into few hands, government officials were (and are) popularly elected, operate within a system of checks and balances, and change more frequently.
The context in which Progressives operated was, as I’ve hopefully made clear, very different from today. The Federal Government then was, at least in a critical mass of minds, like a Deus ex machina, come to save the day. It didn’t tax the average citizen, but was likely to tax the wealthy and promised to not only break up the trusts, but also to open the credit spigot much wider. One hundred years hence, the bloom is off the Federal Government's rose. Increased taxation to fund another government expansion seems most unlikely.
Back then, the “money question”, as the debate between those who favored deflation or inflation was called, was one which brought people to the ballot box (I can’t imagine President Obama giving a Cross of Gold type speech). Elastic money seems to me the deciding factor which cemented Woodrow Wilson’s support of the Fed’s take-over of financial regulation.
Before turning to the present period, a few words about the Fed’s creation. There were two competing visions for the proposed central banking system, the Aldrich plan, which kept bankers in control, but allowed banks, at their discretion, access to government created liquidity (thus the need, under either vision, for the government, as financial entity, to grow, via increased taxes), The Bryan plan wanted government totally in control of a Central Bank which regulated the banks, and, at its sole discretion, could also supply liquidity.
The creature, as some call it, which emerged, was a compromise: government top down control of some key board members, banker control of others, the controlling board would be in D.C., thus demoting NY bankers, banks had access to liquidity, but the national liquidity level was at the board’s discretion.
Fortunately, unlike Johnson and Kwak, I’ve had the luxury of virtually unlimited internet space to flesh out the history. Unfortunately, I’ve probably lost most readers in this exercise of pedantry.
For those few that remain, let’s soldier on.
A Progressive solution, for our era, would involve for the creation of an empowered, taxing, global government with its own central bank, empowered with regulating all banks. This is, in a sense, the Nietzsche solution, fight monsters by creating bigger monsters. The United Nations (which replaced the earlier League of Nations) could be seen, in a Progressive dream, as the US Federal Government during the Gilded Age, an institution that, under direction of charismatic individuals, should become the biggest monster on the block, and maintain world order.
In my view, such a solution would but buy time in the same way that, 100 years from the empowering of the US government, many of the old problems remain. Ideas and conviction, not power, seem to me the missing elements. Further, the newly empowered Federal Government of a century ago was battling individuals, not national governments with armies, which would be the objects to be brought under control of any world government. If national governments begin to collapse, or fail to restrain growth of their internal monsters, however, I wouldn’t be surprised to see this “solution” emerge.
Supporters of continued US sovereignty within our borders, and the big bankers themselves, who might win the battle against US regulation only to risk eventually losing the war to world regulators (as the NY banks won the battle against state regulator but lost the war to the Feds) should take note. Men like Rockefeller and Carnegie, who ultimately submitted to government restraint, financed legacy institutions like the Trilateral Commission and its ilk to lay the basis for these bigger monsters. For a preview, consider: The IMF and the EU are currently battling for control in Greece, which seems willing to trade sovereignty rather than restrain its appetites via default.
Today, as then, the issue of size is key in one sense. Our regulators were seduced by “economies of scale” arguments and allowed a few financial institutions to grow beyond the ability of an indebted government to restrain. The 1895 analog is striking and, in that sense, Johnson and Kwak’s call to channel Roosevelt seems right on the mark. Terms like charisma and force of personality are often used to explain Teddy Roosevelt’s ability to bend people, ostensibly possessed of more power, to his will.
In the event, it took more than Roosevelt’s charisma to beat Morgan and his crew (or his charisma, and fear of popular backlash, was such that he bent a critical mass of the Supreme Court, to his will). US vs. Northern Securities was decided 5-4, with Chief Justice Fuller and Justices White, Peckham and Holmes dissenting. From a financial perspective, David, in the form of the US Government, had slain Goliath, a Trust whose capitalization was almost 2/3 of US revenues.
The basis of the decision, which, after appeal, and modification, became unanimous, however, was not bigness, but restraint of trade, via the stifling of competition. As Justice Holmes wrote in his dissent, “Size has nothing to do with the matter.”
Justice Harlan, writing in the affirmative: The Government charges that, if the combination was held not to be in violation of the act of Congress, then all efforts of the National Government to preserve to the people the benefits of free competition among carriers engaged in interstate commerce will be wholly unavailing, and all transcontinental lines, indeed the entire railway systems of the country, may be absorbed, merged and consolidated, thus placing the public at the absolute mercy of the holding corporation.
Adding: it need not be shown that the combination, in fact, results or will result in a total suppression of trade or in a complete monopoly, but it is only essential to show that, by its necessary operation, it tends to restrain interstate or international trade or commerce or tends to create a monopoly in such trade or commerce and to deprive the public of the advantages that flow from free competition;
Having read both sides, I understand the dissenting view; until trade is restrained, monopoly, per se, isn’t a crime, and might even lead to reduced consumer costs. Should there always be at least two rail options for every possible route? I assume, however, that the objects sought by President Roosevelt were a precedent, and distributed control and profits, not a strict reading enforcement.
I dwell on the decision to suggest a legal challenge to the current concentration of financial control into very few hands. Contrary to the above, financial concentration has already restrained trade, and imposed additional costs to all. Financial support (and even the expectation thereof) of TBTF firms also restrains trade in that potential (and actual) competitors who avoided (or even profited by) the declines in certain asset markets were restrained in gaining increased market share. Surely one of the benefits of competition is the weeding out of the short-sighted.
Fortunately, I don’t think we need new legislation, we just need to enforce what’s already on the books.
Like the internet, finance would benefit from redundancy, and competition, not just in the sense of distributed shareholdings (which is already the case) but viewpoints (which is not helped when directors merely “rubber stamp” CEO opinion, and Fed, Treasury, and other financial regulatory officials are always on loan from GS and the rest of Wall Street). Like minded-ness, if you will, is the issue here. TBTF engenders the myopia which leads men like Greenspan to argue, “nobody saw it coming.” Quite a few did, but they were, in a sense, crowded out of the market.
The need for redundancy would become more apparent if we held as self-evident the belief that there is no magic cure for financial overextension (bubbles) and their dissolution (busts) in a fractional reserve banking system. It will happen, again and again. Mitigation, as should now be clear, is not just an issue of additional liquidity but also a financial industry comprised of smaller, and more numerous, competing firms. It might also help to examine the books of any firm (including the Fed) which promotes the notion that “this time is different.”
I hold no illusions about being the sharpest knife in the drawer, as the Brits say, and thus assume others have considered similar legal arguments against financial concentration. Given the obvious trade restraining effects of TBTF, why isn’t the Supreme Court hearing arguments?
Like the Federal Government in 1895, ours too needs a bail-out. While the big financial firms can no longer provide such support, they can keep the Feds afloat by selling bonds as Primary Dealers, and, if needed, increase their own holdings thereof (particularly after the Fed has graciously relieved them of toxic mortgage, et alia, assets). If the Federal Government is ever to restrain finance, they need to break this dependency, and prepare to take their lumps, so to write, for poor fiscal management. If they were crafty they would blame the firms they were about to break up…just a thought.
This will require either skillful diplomacy or a good deal of charisma from some in power, and a good deal of conviction that this problem cannot be fixed without radical solutions, and will only worsen if left to fester. The "break-up" strategy from the early trust busting days may well prove effective today, and increase the number of balance sheet managers in the bargain. It will also, I suspect, require inflation ($ debasement) as a self-administered bail-out. President Obama might need to channel William Jennings Bryan, as well as Teddy Roosevelt to get the US out of this mess.
Perhaps President Obama can deliver a Cross of TBTF speech at the next Democratic convention.
Simon Johnson and James Kwak of 13 Bankers and The Baseline Scenario, urge President Obama, in a recent Washington Post Op-Ed, to channel Teddy Roosevelt’s defiance of Wall Street, exemplified by the break-up of Northern Securities in 1904 in order to clean up the US financial system.
I agree with Johnson and Kwak’s call to arms, and am sure their views are far more nuanced than a space limited op-ed can relate, however, my examination of the Progressive period in US history, of which the chapter on US financial regulation is but a part, suggests that repetition of that period is most unlikely, and hopefully unnecessary. While there are many similarities between then and now, both the context and issues of concern are, in certain key respects, different.
The Federal Government during the Gilded Age bore little resemblance to that existing today. As a financial entity, in the main, the government collected customs’ duties, which were more than half its receipts, paid interest on the debt, the bulk of which was incurred during the Civil War, and fought the Native Americans and Spain (wars were much cheaper then, additional Army and Navy costs for the 1898 Spanish American War came to $190M).
The malefactors of great wealth, as the industrial and financial titans of the day were known, controlled commerce and finance. They mined iron and made steel, connected the nation via railroads, telegraphs and telephones, and controlled the banks. They set prices and controlled the supply of money, credit and raw materials, which gave them the power to “shake down” people and firms of which they didn’t approve, competitors and frauds alike.
Unlike today, the leading banks which emerged at the end of the Gilded Age weren’t Too Big To Fail, they were Too Solvent To Fail. They owned much of the US gold stock, then the basis of money, and were seemingly immune from the Panics which shook the rest of the nation every decade or so, more often than not, it was claimed, at their instigation.
I’m confident if JP Morgan were running the Fed, credit growth would have been restrained long ago. There is some merit to having someone "own" an issue- unlike Greenspan, Geithner, Rubin et alios, who claim no responsibility. Thus, some believe we need more regulatory officials rather than better ones.
When the government was running dangerously short of gold reserves, in 1895, they went to Wall Street for help- call it a reverse bail-out- and had the Treasury supply replenished. A very small group of unelected men, in effect, owned the government.
This small group of men directed the transformation of America from a disconnected agrarian to a connected soon to be industrial society- from the states united to the United States. In the process, however, they paved the ground for the Progressives to use the power, not of money, but of public opinion, via the ballot box, to usurp their control.
The government that almost died in 1895, was reborn in 1901, when the assassination, by an anarchist (love the irony), of President McKinley, made Teddy Roosevelt President.
Teddy Roosevelt’s Trust Busting kicked off a vigorous 20 year period for the new government. Progressives, who had pushed potentially transformative legislation through Congress from 1885-1900 finally had an executive willing to use it, and his big stick, for change. The Rough Rider took the de jure power of the Interstate Commerce and Sherman Anti-Trust legislation, which had hitherto been used against labor, and prepared to make it de facto, against big business.
The Federal Government, as we know it today, was born. It was a small child about to battle grown men. US Federal Government receipts totaled $670M in 1900 (JP Morgan bought the Carnegie Steel Company around that time for $487M). In 1904, Northern Securities, a railroad trust owned by JP Morgan, JD Rockefeller et alios, was ordered to break up. The precedent, after appeal, was set and many other trusts followed. In 1911, after more than a decade of court battles, the Supreme Court dissolved Standard Oil, making JD Rockefeller, according to some, the richest man in the world, in cash.
He and the other Titans got rich, but lost control of their businesses. Like the Titans of Greek Mythology, they are, for good or ill, only going to appear once.
The child was growing quickly. In 1913, the Federal Reserve was created and the 16th Amendment, which made income taxes Constitutional, was ratified. Four years hence, the US entered World War I. At war’s end, the child had given way to the man. By 1920, receipts had grown to $23B. The Federal Government was now the biggest guy in town.
On one level, this growth of government is like that of Gilded Age business-built on the destruction of competition. There are, however, two key differences: 1) government didn’t “swallow” competitors, they dissolved them into smaller pieces, diluting their control 2) Gilded Age businesses were dynastic and decision-making was concentrated into few hands, government officials were (and are) popularly elected, operate within a system of checks and balances, and change more frequently.
The context in which Progressives operated was, as I’ve hopefully made clear, very different from today. The Federal Government then was, at least in a critical mass of minds, like a Deus ex machina, come to save the day. It didn’t tax the average citizen, but was likely to tax the wealthy and promised to not only break up the trusts, but also to open the credit spigot much wider. One hundred years hence, the bloom is off the Federal Government's rose. Increased taxation to fund another government expansion seems most unlikely.
Back then, the “money question”, as the debate between those who favored deflation or inflation was called, was one which brought people to the ballot box (I can’t imagine President Obama giving a Cross of Gold type speech). Elastic money seems to me the deciding factor which cemented Woodrow Wilson’s support of the Fed’s take-over of financial regulation.
Before turning to the present period, a few words about the Fed’s creation. There were two competing visions for the proposed central banking system, the Aldrich plan, which kept bankers in control, but allowed banks, at their discretion, access to government created liquidity (thus the need, under either vision, for the government, as financial entity, to grow, via increased taxes), The Bryan plan wanted government totally in control of a Central Bank which regulated the banks, and, at its sole discretion, could also supply liquidity.
The creature, as some call it, which emerged, was a compromise: government top down control of some key board members, banker control of others, the controlling board would be in D.C., thus demoting NY bankers, banks had access to liquidity, but the national liquidity level was at the board’s discretion.
Fortunately, unlike Johnson and Kwak, I’ve had the luxury of virtually unlimited internet space to flesh out the history. Unfortunately, I’ve probably lost most readers in this exercise of pedantry.
For those few that remain, let’s soldier on.
A Progressive solution, for our era, would involve for the creation of an empowered, taxing, global government with its own central bank, empowered with regulating all banks. This is, in a sense, the Nietzsche solution, fight monsters by creating bigger monsters. The United Nations (which replaced the earlier League of Nations) could be seen, in a Progressive dream, as the US Federal Government during the Gilded Age, an institution that, under direction of charismatic individuals, should become the biggest monster on the block, and maintain world order.
In my view, such a solution would but buy time in the same way that, 100 years from the empowering of the US government, many of the old problems remain. Ideas and conviction, not power, seem to me the missing elements. Further, the newly empowered Federal Government of a century ago was battling individuals, not national governments with armies, which would be the objects to be brought under control of any world government. If national governments begin to collapse, or fail to restrain growth of their internal monsters, however, I wouldn’t be surprised to see this “solution” emerge.
Supporters of continued US sovereignty within our borders, and the big bankers themselves, who might win the battle against US regulation only to risk eventually losing the war to world regulators (as the NY banks won the battle against state regulator but lost the war to the Feds) should take note. Men like Rockefeller and Carnegie, who ultimately submitted to government restraint, financed legacy institutions like the Trilateral Commission and its ilk to lay the basis for these bigger monsters. For a preview, consider: The IMF and the EU are currently battling for control in Greece, which seems willing to trade sovereignty rather than restrain its appetites via default.
Today, as then, the issue of size is key in one sense. Our regulators were seduced by “economies of scale” arguments and allowed a few financial institutions to grow beyond the ability of an indebted government to restrain. The 1895 analog is striking and, in that sense, Johnson and Kwak’s call to channel Roosevelt seems right on the mark. Terms like charisma and force of personality are often used to explain Teddy Roosevelt’s ability to bend people, ostensibly possessed of more power, to his will.
In the event, it took more than Roosevelt’s charisma to beat Morgan and his crew (or his charisma, and fear of popular backlash, was such that he bent a critical mass of the Supreme Court, to his will). US vs. Northern Securities was decided 5-4, with Chief Justice Fuller and Justices White, Peckham and Holmes dissenting. From a financial perspective, David, in the form of the US Government, had slain Goliath, a Trust whose capitalization was almost 2/3 of US revenues.
The basis of the decision, which, after appeal, and modification, became unanimous, however, was not bigness, but restraint of trade, via the stifling of competition. As Justice Holmes wrote in his dissent, “Size has nothing to do with the matter.”
Justice Harlan, writing in the affirmative: The Government charges that, if the combination was held not to be in violation of the act of Congress, then all efforts of the National Government to preserve to the people the benefits of free competition among carriers engaged in interstate commerce will be wholly unavailing, and all transcontinental lines, indeed the entire railway systems of the country, may be absorbed, merged and consolidated, thus placing the public at the absolute mercy of the holding corporation.
Adding: it need not be shown that the combination, in fact, results or will result in a total suppression of trade or in a complete monopoly, but it is only essential to show that, by its necessary operation, it tends to restrain interstate or international trade or commerce or tends to create a monopoly in such trade or commerce and to deprive the public of the advantages that flow from free competition;
Having read both sides, I understand the dissenting view; until trade is restrained, monopoly, per se, isn’t a crime, and might even lead to reduced consumer costs. Should there always be at least two rail options for every possible route? I assume, however, that the objects sought by President Roosevelt were a precedent, and distributed control and profits, not a strict reading enforcement.
I dwell on the decision to suggest a legal challenge to the current concentration of financial control into very few hands. Contrary to the above, financial concentration has already restrained trade, and imposed additional costs to all. Financial support (and even the expectation thereof) of TBTF firms also restrains trade in that potential (and actual) competitors who avoided (or even profited by) the declines in certain asset markets were restrained in gaining increased market share. Surely one of the benefits of competition is the weeding out of the short-sighted.
Fortunately, I don’t think we need new legislation, we just need to enforce what’s already on the books.
Like the internet, finance would benefit from redundancy, and competition, not just in the sense of distributed shareholdings (which is already the case) but viewpoints (which is not helped when directors merely “rubber stamp” CEO opinion, and Fed, Treasury, and other financial regulatory officials are always on loan from GS and the rest of Wall Street). Like minded-ness, if you will, is the issue here. TBTF engenders the myopia which leads men like Greenspan to argue, “nobody saw it coming.” Quite a few did, but they were, in a sense, crowded out of the market.
The need for redundancy would become more apparent if we held as self-evident the belief that there is no magic cure for financial overextension (bubbles) and their dissolution (busts) in a fractional reserve banking system. It will happen, again and again. Mitigation, as should now be clear, is not just an issue of additional liquidity but also a financial industry comprised of smaller, and more numerous, competing firms. It might also help to examine the books of any firm (including the Fed) which promotes the notion that “this time is different.”
I hold no illusions about being the sharpest knife in the drawer, as the Brits say, and thus assume others have considered similar legal arguments against financial concentration. Given the obvious trade restraining effects of TBTF, why isn’t the Supreme Court hearing arguments?
Like the Federal Government in 1895, ours too needs a bail-out. While the big financial firms can no longer provide such support, they can keep the Feds afloat by selling bonds as Primary Dealers, and, if needed, increase their own holdings thereof (particularly after the Fed has graciously relieved them of toxic mortgage, et alia, assets). If the Federal Government is ever to restrain finance, they need to break this dependency, and prepare to take their lumps, so to write, for poor fiscal management. If they were crafty they would blame the firms they were about to break up…just a thought.
This will require either skillful diplomacy or a good deal of charisma from some in power, and a good deal of conviction that this problem cannot be fixed without radical solutions, and will only worsen if left to fester. The "break-up" strategy from the early trust busting days may well prove effective today, and increase the number of balance sheet managers in the bargain. It will also, I suspect, require inflation ($ debasement) as a self-administered bail-out. President Obama might need to channel William Jennings Bryan, as well as Teddy Roosevelt to get the US out of this mess.
Perhaps President Obama can deliver a Cross of TBTF speech at the next Democratic convention.
Friday, March 26, 2010
Helping the Fed Solve the Problem of Excess Reserves
The key to the game is your capital reserves. You don't have enough, you can't pee in the tall weeds with the big dogs. - Gordon Gekko
Ben Bernanke and the brain trust at the Federal Reserve have been working overtime trying to solve the problem of excess reserves in the US banking system. "How," they wonder, "can we drain these reserves from the system without destabilizing the markets?" Their fears of destabilizing markets are, I believe, justified, which seems odd given that the Fed, in the past, has been able to drain reserves, although the quantity drained was admittedly much smaller.
To the extent there is no way to drain these reserves without upsetting the markets the solution to the problem might not be one of action, but of thought. As Norman Vincent Peale said, "Change your thoughts and you change your world." Instead of trying to drain the excess reserves let's admit that they are not, in fact, "excess", but rather, "prudent", or even, as I suspect, "insufficient."
How do we determine if reserve levels are prudent, excess or insufficient? The determination is a process of thought. If financial assumptions about the future are perfectly accurate, there is no need of reserves- correctly valued assets will, under that head, always generate income sufficient to pay liabilities.
Reserves, then, are a safety measure in the event assumptions about the future are inaccurate- if assets are, in fact, not correctly valued. The more inaccurate prior assumptions of future events prove to be the wiser it would have been to increase reserves before the inaccuracies come to light.
The apparently resolved crisis in Greece seems a case in point (as, it seems to me, was the US crisis of 2008). The Greeks didn't simply decide, out of the blue, to borrow an additional 50 or 100 billion Euros, they, at certain levels of government, knew their fiscal position. Why then the crisis?
Simple. They made poor assumptions about either the value of their assets relative to liabilities (what economists call the primary fiscal balance) or the duration of the deceit which, in part, allowed them to borrow in sufficient quantities at favorable rates. In their case the latter seems more of an issue, as tends to be the case when crises "suddenly" manifest.
Like the homeowner who lied about his income to get a home or the Ponzi schemer who claims to own more than he does, the Greeks had been living on borrowed time. The question in that case about a crisis is not if but when.
Deceit, of course, is a loaded term as it connotes intent. Bernie Madoff is in jail because he admitted to such. In other instances a more appropriate phrase would be willfully ignorant. Those in charge hope for an outcome more objective, but equally educated persons deem unlikely, or impossible. Traders call this, talking your book.
Regardless of intent, the effects are the same. Reserves bridge the gap between projected and actual income relative to liabilities whether the gap is a function of deceit or ignorance (willful or otherwise). Sufficiently higher levels of reserves (other things equal) would have kept Mr. Madoff out of jail and obviated the Greek crisis.
Gordon Gekko had it right.
Returning to the issue du jour- the proper level of reserves in the US banking system- the difficulty of imagining a plausible future scenario with the reserves drained strongly suggests to me that current levels are minimally prudent. That is, if draining reserves would cause rates to rise, decrease real sector activity, or some combination thereof such that bank incomes wouldn't cover required payments then they shouldn't be drained.
Why then does the Fed seem so intent on draining? Perhaps they aren't as intent on draining them as some might think. Perhaps their intent is simply to maintain the illusion that the reserves are considered excess. If they told the world the level of reserves was considered prudent this would likely send a message that the financial state of US banks is not as healthy as otherwise advertised. This, in turn, might exacerbate future gaps between bank income and outflow, requiring even higher levels of reserves than currently exist, or, as was the case in Greece and with Mr. Madoff, precipitate a crisis.
Perhaps the only way to keep the real sector operating such that bank assets perform is to increasingly dilute the currency (since any increase in reserves would most likely be "borrowed" from the Fed as happened during the last crisis). Perhaps Mr. Kinsley's nightmare scenario of impending substantial inflation and even hyper-inflation is much nearer that truth than the Fed or Mr. Krugman would have us believe. Perhaps the classification of reserves as excess has more to do with what the Fed wishes others (i.e. those who lend money to the US) to assume than what they assume, which edges ever closer to Greek deceit.
The Fed could, of course, prove me wrong by draining the reserves deemed to be in excess without precipitating a crisis.
I won't, however, be holding my breath.
Ben Bernanke and the brain trust at the Federal Reserve have been working overtime trying to solve the problem of excess reserves in the US banking system. "How," they wonder, "can we drain these reserves from the system without destabilizing the markets?" Their fears of destabilizing markets are, I believe, justified, which seems odd given that the Fed, in the past, has been able to drain reserves, although the quantity drained was admittedly much smaller.
To the extent there is no way to drain these reserves without upsetting the markets the solution to the problem might not be one of action, but of thought. As Norman Vincent Peale said, "Change your thoughts and you change your world." Instead of trying to drain the excess reserves let's admit that they are not, in fact, "excess", but rather, "prudent", or even, as I suspect, "insufficient."
How do we determine if reserve levels are prudent, excess or insufficient? The determination is a process of thought. If financial assumptions about the future are perfectly accurate, there is no need of reserves- correctly valued assets will, under that head, always generate income sufficient to pay liabilities.
Reserves, then, are a safety measure in the event assumptions about the future are inaccurate- if assets are, in fact, not correctly valued. The more inaccurate prior assumptions of future events prove to be the wiser it would have been to increase reserves before the inaccuracies come to light.
The apparently resolved crisis in Greece seems a case in point (as, it seems to me, was the US crisis of 2008). The Greeks didn't simply decide, out of the blue, to borrow an additional 50 or 100 billion Euros, they, at certain levels of government, knew their fiscal position. Why then the crisis?
Simple. They made poor assumptions about either the value of their assets relative to liabilities (what economists call the primary fiscal balance) or the duration of the deceit which, in part, allowed them to borrow in sufficient quantities at favorable rates. In their case the latter seems more of an issue, as tends to be the case when crises "suddenly" manifest.
Like the homeowner who lied about his income to get a home or the Ponzi schemer who claims to own more than he does, the Greeks had been living on borrowed time. The question in that case about a crisis is not if but when.
Deceit, of course, is a loaded term as it connotes intent. Bernie Madoff is in jail because he admitted to such. In other instances a more appropriate phrase would be willfully ignorant. Those in charge hope for an outcome more objective, but equally educated persons deem unlikely, or impossible. Traders call this, talking your book.
Regardless of intent, the effects are the same. Reserves bridge the gap between projected and actual income relative to liabilities whether the gap is a function of deceit or ignorance (willful or otherwise). Sufficiently higher levels of reserves (other things equal) would have kept Mr. Madoff out of jail and obviated the Greek crisis.
Gordon Gekko had it right.
Returning to the issue du jour- the proper level of reserves in the US banking system- the difficulty of imagining a plausible future scenario with the reserves drained strongly suggests to me that current levels are minimally prudent. That is, if draining reserves would cause rates to rise, decrease real sector activity, or some combination thereof such that bank incomes wouldn't cover required payments then they shouldn't be drained.
Why then does the Fed seem so intent on draining? Perhaps they aren't as intent on draining them as some might think. Perhaps their intent is simply to maintain the illusion that the reserves are considered excess. If they told the world the level of reserves was considered prudent this would likely send a message that the financial state of US banks is not as healthy as otherwise advertised. This, in turn, might exacerbate future gaps between bank income and outflow, requiring even higher levels of reserves than currently exist, or, as was the case in Greece and with Mr. Madoff, precipitate a crisis.
Perhaps the only way to keep the real sector operating such that bank assets perform is to increasingly dilute the currency (since any increase in reserves would most likely be "borrowed" from the Fed as happened during the last crisis). Perhaps Mr. Kinsley's nightmare scenario of impending substantial inflation and even hyper-inflation is much nearer that truth than the Fed or Mr. Krugman would have us believe. Perhaps the classification of reserves as excess has more to do with what the Fed wishes others (i.e. those who lend money to the US) to assume than what they assume, which edges ever closer to Greek deceit.
The Fed could, of course, prove me wrong by draining the reserves deemed to be in excess without precipitating a crisis.
I won't, however, be holding my breath.
Thursday, March 18, 2010
Will the US sell Manhattan?
Those who face insolvency, Mr. Schlarmann, a senior member of Germany's Christian Democrats, said, must sell everything they have to pay their creditors. Thus, he said, Greece, given its debt problems, should consider selling some of its uninhabited islands to cut its debt.
The headline in the Bild newspaper took the argument a bit further, "Sell your islands, you bankrupt Greeks - and the Acropolis too!"
I guess we might call this the Andrew Mellon approach to sovereign debt crises- liquidate, liquidate, liquidate, on a national scale. It's a strategy which, if Niall Ferguson's argument-which contains the wonderful line, US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941- that the US, and other western nations, may soon follow Greece into crisis, proves prescient, might inspire calls for the US to sell some islands, like Manhattan.
Perhaps selling the island outright might be a bit much. Yet, while the Chinese Government isn't a fan of the Dalai Lama it might appreciate the Karmic touch of leasing Manhattan from the US for, say, 99 years. Imagine the road signs, "Now Entering New Hong Kong."
In a sense, assuming Wall St. and the NY Fed were included in the lease, it would be the ultimate "pump and dump"- temporarily stabilize the financial system, in large part with money from Asia, and then dump it, and the derivatives portfolios contained therein, on China. Why wait for the next financial crisis to go hat in hand to Asia. Let's sell Citibank at $4 instead of waiting for it to fall under a buck.
The world might even benefit from such an arrangement. Yesterday, Paul Volcker told the House Financial Services Committee that regulators, like the NY Fed, are unlikely to rein in excessive Wall St. speculation. If the Chinese get the NY Fed, and thus oversight of financial markets, their no-nonsense approach to dealing with corruption, which includes the death penalty, might help finance get back on the "straight and narrow." I'd love to see Lloyd Blankfein testify to the Chinese Communist Party.
A man can dream, can't he? And who knows what the future will bring. I doubt the Ottoman, Mughal and Manchu Empires could have imagined that the West would take over administration of their territories.
Fortunately, at least for Wall Streeters wary of Chinese justice, the German proposal fell on deaf ears. Yet, the seemingly intractable problem of many western governments' unsustainable debt levels remains.
Niall Ferguson argues that the problem is the welfare state- perhaps he should take on Keynes with a new book, The Economic Consequences of the Welfare State. I suspect, however, improper- to the extent such policies are seen as wise means of avoiding social unrest- welfare state funding is but a symptom of an apparently widely held view by many in both public and private sector positions of power that, in the words of Dick Cheney, deficits don't matter.
War finance and Wall St. bail-outs played at least as large a part as welfare spending in US Federal Debt doubling since 2001. Those bail-outs, in turn, were made necessary by Wall St.'s take on Cheney's wisdom, which they express as, too big to fail.
Contra Mr. Cheney, deficits, which add up to debt over time, do matter. Contra Wall St., no insitution is too big to fail. Both views are, in my view, effects of a broader issue. There is no agreed upon method, barring adoption of island sales, for sovereign debt resolution. In decades past when nations retained currency sovereignty devaluation was always an option, and fear of devaluation kept investors on their toes. The more recent desire for supra-national currencies turns countries like Greece into states like California with very limited options.
If current trends continue, nations like Greece and states like California might simply be absorbed into larger bodies. Greece could become a special administrative region of the EU and California could become a district of the US Federal Government. Yet this would simply buy time, making the ultimate sovereign debt problem that much harder to resolve.
If the world is ever to reform global finance it will need, first and foremost, to agree upon a method of debt resolution applicable to all large institutions, public and private. So long as those running large institutions feel there are no consequences to deficits, debt problems will continue to mount. If we are going to use money to drive the world, we need to take it seriously.
The headline in the Bild newspaper took the argument a bit further, "Sell your islands, you bankrupt Greeks - and the Acropolis too!"
I guess we might call this the Andrew Mellon approach to sovereign debt crises- liquidate, liquidate, liquidate, on a national scale. It's a strategy which, if Niall Ferguson's argument-which contains the wonderful line, US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941- that the US, and other western nations, may soon follow Greece into crisis, proves prescient, might inspire calls for the US to sell some islands, like Manhattan.
Perhaps selling the island outright might be a bit much. Yet, while the Chinese Government isn't a fan of the Dalai Lama it might appreciate the Karmic touch of leasing Manhattan from the US for, say, 99 years. Imagine the road signs, "Now Entering New Hong Kong."
In a sense, assuming Wall St. and the NY Fed were included in the lease, it would be the ultimate "pump and dump"- temporarily stabilize the financial system, in large part with money from Asia, and then dump it, and the derivatives portfolios contained therein, on China. Why wait for the next financial crisis to go hat in hand to Asia. Let's sell Citibank at $4 instead of waiting for it to fall under a buck.
The world might even benefit from such an arrangement. Yesterday, Paul Volcker told the House Financial Services Committee that regulators, like the NY Fed, are unlikely to rein in excessive Wall St. speculation. If the Chinese get the NY Fed, and thus oversight of financial markets, their no-nonsense approach to dealing with corruption, which includes the death penalty, might help finance get back on the "straight and narrow." I'd love to see Lloyd Blankfein testify to the Chinese Communist Party.
A man can dream, can't he? And who knows what the future will bring. I doubt the Ottoman, Mughal and Manchu Empires could have imagined that the West would take over administration of their territories.
Fortunately, at least for Wall Streeters wary of Chinese justice, the German proposal fell on deaf ears. Yet, the seemingly intractable problem of many western governments' unsustainable debt levels remains.
Niall Ferguson argues that the problem is the welfare state- perhaps he should take on Keynes with a new book, The Economic Consequences of the Welfare State. I suspect, however, improper- to the extent such policies are seen as wise means of avoiding social unrest- welfare state funding is but a symptom of an apparently widely held view by many in both public and private sector positions of power that, in the words of Dick Cheney, deficits don't matter.
War finance and Wall St. bail-outs played at least as large a part as welfare spending in US Federal Debt doubling since 2001. Those bail-outs, in turn, were made necessary by Wall St.'s take on Cheney's wisdom, which they express as, too big to fail.
Contra Mr. Cheney, deficits, which add up to debt over time, do matter. Contra Wall St., no insitution is too big to fail. Both views are, in my view, effects of a broader issue. There is no agreed upon method, barring adoption of island sales, for sovereign debt resolution. In decades past when nations retained currency sovereignty devaluation was always an option, and fear of devaluation kept investors on their toes. The more recent desire for supra-national currencies turns countries like Greece into states like California with very limited options.
If current trends continue, nations like Greece and states like California might simply be absorbed into larger bodies. Greece could become a special administrative region of the EU and California could become a district of the US Federal Government. Yet this would simply buy time, making the ultimate sovereign debt problem that much harder to resolve.
If the world is ever to reform global finance it will need, first and foremost, to agree upon a method of debt resolution applicable to all large institutions, public and private. So long as those running large institutions feel there are no consequences to deficits, debt problems will continue to mount. If we are going to use money to drive the world, we need to take it seriously.
Sunday, February 21, 2010
The Mask of Solvency
On reading the news of Goldman Sach's involvement in the Greek Government's heretofore successful plot to negatively obscure their fiscal position from the rest of the world (with the notable exception of Goldman Sachs, it seems worth noting) a vision sprang to mind. In it, a group of Greek Finance Officials are seated on one side of one of those over-long conference room tables found in the upper floors of modern office buildings facing two people from Goldman Sachs- Europe's Chief Institutional Derivatives Salesman and his mid 20s blond bombshell assistant.
After the obligatory pleasantries are completed the assistant distributes folders to the Greek Officials, bending over slightly in front of each man in the process. "As I was saying on the phone, Gentlemen," the GS salesman interjects, interrupting the not well concealed ogling, "we at Goldman Sachs can structure a portfolio of derivatives to hide your true fiscal position from both potential investors and the prying eyes of the European Central Government. We call it, 'The Mask of Solvency' portfolio."
Fade out.
What an interesting name, and notion; The Mask of Solvency- a means for the insolvent to appear to all but the most discerning observer as solvent as the best AAA credit, e.g. the US Government (irony intended).
The invented-but-still-possibly-accurate name of the GS ploy reminds me of a book on Psychopaths by Psychiatrist Hervey Cleckley, The Mask of Sanity. The depiction of Psychopathology seems to me a most useful prism through which to view current financial affairs.
To wit (from the book): It must be remembered that even the most severely and obviously disabled psychopath presents a technical appearance of sanity, often one of high intellectual capacities, and not infrequently succeeds in business or professional activities for short periods, sometimes for considerable periods.
More often than not, the typical psychopath will seem particularly agreeable and make a distinctly positive impression when he is first encountered. Alert and friendly in his attitude, he is easy to talk with and seems to have a good many genuine interests. There is nothing at all odd or queer about him, and in every respect he tends to embody the concept of a well-adjusted, happy person. Nor does he, on the other hand, seem to be artificially exerting himself like one who is covering up or who wants to sell you a bill of goods. He would seldom be confused with the professional backslapper or someone who is trying to ingratiate himself for a concealed purpose. Signs of affectation or excessive affability are not characteristic. He looks like the real thing. Very often indications of good sense and sound reasoning will emerge and one is likely to feel soon after meeting him that this normal and pleasant person is also one with high abilities. Psychometric tests also very frequently show him of superior intelligence. More than the average person, he is likely to seem free from social or emotional impediments, from the minor distortions, peculiarities, and awkwardnesses so common even among the successful.
The idea of a mask of solvency must have seemed like a stroke of genius to those whose masks of sanity had faded as far from conscious awareness as breathing. Successful arbitrageurs, after all, are well practiced in accepting the facsimile of a thing as the true thing itself. Thus, for most, the S&P 500 future is seen as identical to a portfolio of those 500 stocks, even though it only delivers (or takes) cash on settlement. As with the psychopath itself, only careful observation of behavior in all facets of life distinguishes the arbitraged facsimile from the true thing.
Usually, the distinguishing characteristics only manifest, i.e. the masks slips, as seems the case with Greek debt, when the damage has been done.
Or is damage done? Is there a difference in experience between merely the appearance of a thing, or quality, like solvency or sanity, and that thing or quality in truth?
It seems man has been pondering this question for Millennia, which is to write that it is a question each person apparently needs to answer for his or her self. In Plato's Republic Socrates asks if there is a difference between a man who appears Just but is not and a man who is truly Just. Athens too, it seems, had its share of Psychopaths in positions of influence inspiring such questions.
In our modern, financially centered system, Solvency, not Justice is the issue. Recasting Socrates' question, Is there a difference between a financial entity which appears solvent but is not, and one that is truly solvent? Would it not be better, as Socrates' listeners asked (about Justice) in the Republic, to enjoy the extra consumption afforded those who can mask their insolvency?
Socrates argued against such a view, while admitting that those so masked might reap temporary benefits. His reward for such truth-seeking views was death ordered by an Athenian Government which was in the process of devolution from the core of a great empire to a city with little sovereignty.
Whether the question has been answered accurately is up to everyone to individually decide.
One wonders if any of the Greek Finance Officials recalled Socrates' views when offered the Mask of Solvency. Regardless, I suspect Socrates' wisdom is now evident to them.
After the obligatory pleasantries are completed the assistant distributes folders to the Greek Officials, bending over slightly in front of each man in the process. "As I was saying on the phone, Gentlemen," the GS salesman interjects, interrupting the not well concealed ogling, "we at Goldman Sachs can structure a portfolio of derivatives to hide your true fiscal position from both potential investors and the prying eyes of the European Central Government. We call it, 'The Mask of Solvency' portfolio."
Fade out.
What an interesting name, and notion; The Mask of Solvency- a means for the insolvent to appear to all but the most discerning observer as solvent as the best AAA credit, e.g. the US Government (irony intended).
The invented-but-still-possibly-accurate name of the GS ploy reminds me of a book on Psychopaths by Psychiatrist Hervey Cleckley, The Mask of Sanity. The depiction of Psychopathology seems to me a most useful prism through which to view current financial affairs.
To wit (from the book): It must be remembered that even the most severely and obviously disabled psychopath presents a technical appearance of sanity, often one of high intellectual capacities, and not infrequently succeeds in business or professional activities for short periods, sometimes for considerable periods.
More often than not, the typical psychopath will seem particularly agreeable and make a distinctly positive impression when he is first encountered. Alert and friendly in his attitude, he is easy to talk with and seems to have a good many genuine interests. There is nothing at all odd or queer about him, and in every respect he tends to embody the concept of a well-adjusted, happy person. Nor does he, on the other hand, seem to be artificially exerting himself like one who is covering up or who wants to sell you a bill of goods. He would seldom be confused with the professional backslapper or someone who is trying to ingratiate himself for a concealed purpose. Signs of affectation or excessive affability are not characteristic. He looks like the real thing. Very often indications of good sense and sound reasoning will emerge and one is likely to feel soon after meeting him that this normal and pleasant person is also one with high abilities. Psychometric tests also very frequently show him of superior intelligence. More than the average person, he is likely to seem free from social or emotional impediments, from the minor distortions, peculiarities, and awkwardnesses so common even among the successful.
The idea of a mask of solvency must have seemed like a stroke of genius to those whose masks of sanity had faded as far from conscious awareness as breathing. Successful arbitrageurs, after all, are well practiced in accepting the facsimile of a thing as the true thing itself. Thus, for most, the S&P 500 future is seen as identical to a portfolio of those 500 stocks, even though it only delivers (or takes) cash on settlement. As with the psychopath itself, only careful observation of behavior in all facets of life distinguishes the arbitraged facsimile from the true thing.
Usually, the distinguishing characteristics only manifest, i.e. the masks slips, as seems the case with Greek debt, when the damage has been done.
Or is damage done? Is there a difference in experience between merely the appearance of a thing, or quality, like solvency or sanity, and that thing or quality in truth?
It seems man has been pondering this question for Millennia, which is to write that it is a question each person apparently needs to answer for his or her self. In Plato's Republic Socrates asks if there is a difference between a man who appears Just but is not and a man who is truly Just. Athens too, it seems, had its share of Psychopaths in positions of influence inspiring such questions.
In our modern, financially centered system, Solvency, not Justice is the issue. Recasting Socrates' question, Is there a difference between a financial entity which appears solvent but is not, and one that is truly solvent? Would it not be better, as Socrates' listeners asked (about Justice) in the Republic, to enjoy the extra consumption afforded those who can mask their insolvency?
Socrates argued against such a view, while admitting that those so masked might reap temporary benefits. His reward for such truth-seeking views was death ordered by an Athenian Government which was in the process of devolution from the core of a great empire to a city with little sovereignty.
Whether the question has been answered accurately is up to everyone to individually decide.
One wonders if any of the Greek Finance Officials recalled Socrates' views when offered the Mask of Solvency. Regardless, I suspect Socrates' wisdom is now evident to them.
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