Well, it’s my turn to listen to a Obama Speech. Those speeches usually have the same dizzying effect on me that tennis matches do. Instead of watching balls go back and forth rhythmically while lulling me to sleep, I get to watch the head of the President. Teleprompter Right, 1,2,3 to Teleprompter left, 2, 3 …
So the speech is on bank reform which is something I’ve been on about for months now. It’s the anniversary of Lehman’s demise. Stories abound on the Grey Lady today including this call by Dr. Tyler Cowen of George Mason University. He’s a little libertarian for my taste on policy–even managing a h/t to Ayn Rand and Atlas Shrugged–but he gets it all in a way that only an economist could.
But we are now injecting politics ever more deeply into the American economy, whether it be in finance or in sectors like health care. Not only have we failed to learn from our mistakes, but also we’re repeating them on an ever-larger scale.
Lately the surviving major banks have reported brisk profits, yet in large part this reflects astute politicking and lobbying rather than commercial skill. Much of the competition was cleaned out by bank failures and consolidation, so giants like Goldman Sachs and JPMorgan had an easier time getting back to profits. The Federal Reserve has been lending to banks at near-zero interest rates while paying higher interest on the reserves the banks hold at the Fed. “Too big to fail” policies mean that the large banks can raise money more cheaply because everyone knows they are safe counterparties.
President Dwight D. Eisenhower warned of the birth of a military-industrial complex. Today we have a financial-regulatory complex, and it has meant a consolidation of power and privilege. We’ve created a class of politically protected “too big to fail” institutions, and the current proposals for regulatory reform further cement this notion. Even more worrying, with so many explicit and implicit financial guarantees, we are courting a bigger financial crisis the next time something major goes wrong.
We should stop using political favors as a means of managing an economic sector. Unfortunately, though, recent experience with health care reform shows we are moving in the opposite direction and not heeding the basic lessons of the financial crisis. Finance and health care are two separate issues, of course, but in both cases we’re making the common mistake of digging in durable political protections for special interest groups.
I have to admit that I’ve written about similar concerns, however, I can tell Cowen and I may differ on how to correct the situation. That’s typically true of most economists. We agree on the root causes because of our grounding in shared theory but argue which policy might be best based on our political bent. I continue to argue for the role of government as rule setter and referee. However, I really do prefer independent bureaucrats in the position of auditor and enforcer. Congress, however, still has to write the law. This action, to date, has been missing.
So, MarketWatch has provided a pre-speechification programme so that we can get our score card ready. The speech is supposed to “rekindle” interest in regulatory restructuring. I’m not sure we need restructuring so much as we need laws that recognize the systematic problems we’ve developed in financial markets since quants have turned asset pricing into a physics exercise, financial innovations have become exotic, and the entire set up is now one big cartel waiting to pounce on the unsuspecting business sector and consumer. We now have a small number of banks capable of funding the really big capital undertakings and who knows what priorities or friends they’ll choose to fund over positive net present value projects? This should be enough to send any capitalist running for government regulation. Also, get ready for lack of services and fees that would make a loan shark blush. This should make any advocate for the little guy scream for the same. Today, I am the jade dakini. It’s happening in Europe but I doubt it will happen here.
So, what is Obama said to be inkling tomorrow that will be undoubtedly be sacrificed to the demons of political expediency down the road?
I’m at the end of my semester which is the time when students that should’ve showed up in my office months ago suddenly feel they can negotiate a different result than the one listed in my syllabus and on my grade sheet. I’ve noticed this pattern in all my years of teaching. I get about a handful of them right after the first test that say, sheesh, I don’t think I get this what can I do? I get more than a handful the week before finals, when their grades are pretty much a given, saying, sheesh, I don’t think I can get this, what can you do for me?
There’s an implicit contract between me and my students and a good deal of it is stated in the syllabus which all of them get at the beginning of the semester. Over the years, it’s grown to being a pamphlet of sorts. Much of this has to do with either accreditation or legal requirements (like what to do if you’re disabled and need help with things). A lot of it is me trying to be absolutely, positively clear that we agree on the expectations we have in this class. I spend the entire first day going over all of these things and they all nod in agreement, don’t ask many questions, and hope they can leave early.
Why do I feel like the Fed is waving a syllabus in front of a few recalcitrant banks over the results of the so-called stress test? Are they asking why didn’t you come to us sooner when you had a problem? How much of a softie is the Fed going to be when a few of them want to renegotiate what it means to get an A,B,C, D, or F?
From the Federal Open Market Committee’s (FOMC) policy statement earlier today:
Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession. Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.
In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.
In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
It goes on to state that its goal is to bring long term rates down farther by buying “up to an additional $750 billion of agency mortgage-backed securities”, “$300 billion of longer-term Treasury securities over the next six months” and “agency debt this year by up to $100 billion”. The Fed is aggressively using its balance sheet to inject liquidity into the financial system since the already low fed funds rate target is technically as low as it can get now. The Fed is hinting that we may be looking at the recession’s trough soon. Given the release of today’s 1st Quarter GDP, we can only hope and pray.
From Market Watch:
The central bank’s Federal Open Market Committee said that spending has stabilized and that the pace of the downturn appeared to be somewhat slower. The economy could remain weak in coming month but policy actions and “market forces” were aligned to create a gradual upturn, the statement said.
Fed watchers saw little drama in today’s announcement.
“The only major difference between today’s statement and the previous one on March 18 is that today’s cited the fact that most evidence points to a slowing rate of economic decline. Anyone with two eyes and a brain knows this to be the case,” wrote Josh Shapiro, chief U.S. economist at MFR Inc. in a note to clients.
Economists had expected the policy-setting panel to maintain the status quo. The FOMC kept its target interest rate unchanged at an ultra-low 0%-to-0.25% range.
The economy has fared dismally over the past six months — collapsing by the sharpest rate in more than 50 years. The unemployment rate has spiked and business investment has slowed.
Somebody must have a lot of time on their hands to write a song called “Hey, Paul Krugman” but still, if the angsty, artsy fartsy creative class that foisted this POTUS on us is finally waking up, then Twitter me when the Revolution comes. I’ve even read the orange cheeto place and seems even a few of them are beginning to see the writing on their blackberries.
So, Paul is still appalled and speaking out against the Zombie Plan. I’d say this is another sfz! warning to the White House. What I can’t repeat enough is that it’s not just Paul. It’s not just me. It’s everyone with any knowledge of macroeconomics and the financial system.
Why am I so vehement about this? Because I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second. So it’s just horrifying that Obama — and yes, the buck stops there — has decided to base his financial plan on the fantasy that a bit of financial hocus-pocus will turn the clock back to 2006.
I don’t know if you’ve ever sat in an economics class, but most of you who have will attest that few economics professors are what you would call the dramatic, excitable types. However, I’ve seen more animation out of them recently than I’ve seen in all recent Marvel Comic Books.
From “Reasons Why The Obama Administration will not solve this crisis by the end of 2009” at The Underground Investor:
Consider that President-elect Obama voted FOR the horrible $700 billion bailout plan that accomplished less than zero in fixing the global economy while only transferring wealth from people that were struggling the most to the unethical financial executives that created this problem. These were my exact words in October, 2008, verbatim, about the eventual effect of the bailout plan: “Don’t believe the media spin. This will fix nothing. Even if and when the government overpays Wall Street and US banks by 300%, 500% and 1000% for their toxic assets, this temporarily recapitalizes these financial institutions but only creates A MUCH BIGGER PROBLEM for the future.” If I understood why the bailout plan would most definitely fail, as I blogged here, and the next President of the United States could not, that is a scary thought. On the other hand, if President Obama understood that the bailout plan would likely accomplish nothing but the transference of wealth from hard-working citizens to corrupt financial executives and still voted for the bill, then this action needs no further discourse.
From FT’s Willem Buiter:
Why are the unsecured creditors of banks and quasi-banks like AIG deemed too precious to take a hit or a haircut since Lehman Brothers went down? From the point of view of fairness they ought to have their heads on the block. It was they who funded the excessive leverage and risk-taking of banks and shadow banks. From the point of view of minimizing moral hazard – incentives for future excessive risk taking – it is essential that they pay the price for their past bad lending and investment decisions. We are playing a repeated game. Reputation matters.
Three arguments for saving the unworthy hides of the unsecured creditors are commonly presented:
- Unless the unsecured creditors are made whole, there will be a systemic financial collapse, with dramatic adverse consequences for the real economy.
- If the unsecured creditors are forced to take a hit, no-one will ever lend to banks again or buy their debt.
- The ultimate ‘beneficial owners’ of these securities – notably pensioners drawing their pensions from pension funds heavily invested in unsecured bank debt and owners of insurance policies with insurance companies holding unsecured bank debt – would suffer a large decline in financial wealth and disposable income that would cause them to cut back sharply on consumption. The resulting decline in aggregate demand would deepen and prolong the recession.
I believe all three arguments to be hogwash.
Well, the Obama administration has decided to take the Zombie route which is something I’ve repeatedly argued against. But why just take my word for it? Let’s start with Nobel prize winning economist Paul Krugman reporting on his NY Times blog today in a thread aptly titled Despair over Financial Policy.
The Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved.
Just about every economist and financial blog on the web, especially the progressive ones, have warned against this option since similar plans put Japan into its lost decade of recession, high deficits, unemployment, and financial malaise. This is worse than I even expected of the Obama administration. This basically means more BIG subsidies for BIG investors. It is nothing less than a massive transfer of wealth to the people and institutions most responsible for this mess from those of us that will suffer the most and have the most to lose. This threatens our jobs, our children’s future, and our country’s standing as the world’s largest single country economy. This is THE single worst possible decision.
This from Calculated Risk:
With almost no skin in the game, these investors can pay a higher than market price for the toxic assets (since there is little downside risk). This amounts to a direct subsidy from the taxpayers to the banks.
From Yves Smith Naked Capitalism:
The New York Times seems to have the inside skinny on the emerging private public partnership abortion program. And it appears to be consistent with (low) expectations: a lot of bells and whistles to finesse the fact that the government will wind up paying well above market for crappy paper.
The three-pronged approach is perhaps the most central component of President Obama’s plan to rescue the nation’s banking system from the money-losing assets weighing down bank balance sheets, crippling their ability to make new loans and deepening the recession….
The plan to be announced next week involves three separate approaches. In one, the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money that those partnerships will need to buy up troubled assets that banks want to sell.
Yves here. If the money committed to this program is less than the book value of the assets the banks want to unload (or the banks are worried about that possibility), the banks have an incentive to try to ditch their worst dreck first.
In addition, it has been said in comments more than once that the banks own some paper that is truly worthless. This program won’t solve that problem. Back to the piece:
In the second, the Treasury will hire four or five investment management firms, matching the private money that each of the firms puts up on a dollar-for-dollar basis with government money.
Yves here. Hiring asset managers to do what? Some investors get 85% support (more as is revealed later), others get dollar for dollar? This makes no sense unless very different roles are envisaged (but how will the price for assets given to the asset managers be determined? Or are these for the off balance sheet entities that should be but are still not yet consolidated, like the trillion dollar problem hanging around at Citi?) Back to the article:
In the third piece, the Treasury plans to expand lending through the Term Asset-Backed Secure Lending Facility, a joint venture with the Federal Reserve.
Yves again. While the first TALF deal got off well, Tyler Durden points out its capacity is 2.7 times pre-credit mania annual issuance levels, which means the $1 trillion considerably overstates its near term impact. And credit demand by all accounts is far from robust. Cheap credit is not enticing in an environment of weak to falling asset prices and job uncertainty.
And notice the utter dishonesty: a competitive bidding process will protect taxpayers. Huh? A competitive bidding process will elicit a higher price which is BAD for taxpayers!
Dear God, the Administration really thinks the public is full of idiots. But there are so many components to the program, and a lot of moving parts in each, they no doubt expect everyone’s eyes to glaze over.
Later in the article, there is language that intimates that the banks will put up assets and take what they get. However, the failure to mention a reserve (a standard feature in auctions) does not mean one does not exist. Or the alternative may be, since bidding will almost certainly be anonymous, is to let the banks submit a bid, which would serve as a reserve. That is the common procedure at foreclosure auctions, when the bank puts in a bid equal to the mortgage value (so either a foreclosure buyer takes the bank out or the bank winds up owning the property).
From Financial Armageddon:
No Surprise to Anyone
If there is anything to be learned from the current crisis, it is the fact that Washington has a habit of screwing things up.
From setting up corrupt and self-serving government-sponsored enterprises that fail to accomplish their stated goals, to ill-conceived and underfunded insurance schemes, guarantee programs, and safety nets that don’t provide the benefits claimed, to rules and regulations that leave those who are “protected” high and dry, it’s amazing how often good intentions go wrong when the politicians are in charge.
From George Washington’s Blog:
Does a single independent economist buy the Geithner-Summers-Bernanke approach?
On the left, you have:
- Nobel economist Joseph Stiglitz saying that they have failed to address the structural and regulatory flaws at the heart of the financial crisis that stand in the way of economic recovery, and that they have confused saving the banks with saving the bankers
- Nobel economist Paul Krugman saying their plan to prop up asset prices “isn’t going to fly”. He also said:
At every stage, Geithner et al have made it clear that they still have faith in the people who created the financial crisis — that they believe that all we have is a liquidity crisis that can be undone with a bit of financial engineering, that “governments do a bad job of running banks” (as opposed, presumably, to the wonderful job the private bankers have done), that financial bailouts and guarantees should come with no strings attached. This was bad analysis, bad policy, and terrible politics. This administration, elected on the promise of change, has already managed, in an astonishingly short time, to create the impression that it’s owned by the wheeler-dealers.
- Prominent economists like Nouriel Roubini, James Galbraith, Dean Banker, Michael Hudson and many others slamming their approach
On the right, you have:
- Leading monetary economist Anna Schwartz saying that they are fighting the last war and doing it all wrong
- Former Assistant Secretary of the Treasury and former editor of the Wall Street Journal Paul Craig Roberts lambasting their approach
- Economist John Williams saying “the federal government is bankrupt … If the federal government were a corporation … the president and senior treasury officers would be in federal penitentiary.”
- Prominent economist Marc Faber and many others tearing their approach to shreds.
Sure, the economists for the banks and other financial giants which are receiving billions at the government trough think that the Geithner-Summers-Bernanke approach is swell.
And perhaps a couple of economists for investment funds which use their giant interventions into the free market to make some quick money.
But other than them, no one seems to be buying it.
I may be one of the few in the chorus singing soprano, but I’m in a very huge chorus singing sfz! that this is the worst possible of ALL choices. This is nothing more than a wealth transfer that will accomplish nothing other than keeping banks and financial institutions that are basically bankrupt on live support long enough to drain the daylight out of any recovery. This President is AWOL from his job. Not only is he AWOL, but he is incompetent. He can go on Leno, he can go on sixty minutes, he can give lavish St Patrick’s Day parties and he can hold town meetings in California but he is totally incapable of staying in Washington and doing his job. By allowing this, he will have stolen more from every single honest taxpayer in this country than even Darth Cheney and the Texas Village idiot did with their adventures in nation building and subsidy of the oil and gas industries and the military industrial sectors. If somebody in Congress doesn’t act to stop this, I say we start calling them to demand impeachment proceedings. We’ll be lucky if we come out of recession by the time my daughters reach retirement.
There I said it. If President Obama doesn’t stop this nonsense now he should be impeached for criminal misuse of tax payer’s money.
The market seems to have stabilized for awhile as Ben Bernanke has been giving speeches and making appearances every where he can. For those of you that really want to take on empirical studies in Economics (econometrics and all), this is a part of a strategy he outlined in Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment. (Bernanke and Reinhardt 2001). It’s 113 pages long so be prepared to spend some time with it like I did last year. However, my guess is you can read the front parts and the back parts and skip the methodology and findings and be just as happy. It is basically the Chairman’s take on the Japanese Lost Decade and monetary policy at the time. It talks about quantitative easing which is the new approach that even the Bank of England is using now. That is when the Central Bank uses its balance sheet to buy and sale various financial assets to try to unclog lending channels. Since this is the first time the acting Chairman of the Federal Reserve Bank has ever appeared on any major news channel to have a fire side chat as in last night’s appearance on Sixty Minutes, I thought I’d point you to the motive behind the method. It’s outlined in that academic paper. Bernanke and Reinhard argue that Federal Open Market Committee (FOMC) announcements of policy and other announcements by the Fed shape market expectations and results. (Yes, I know El Presidente told us we shouldn’t care about the DJ but the FED chair still does because he knows IT MATTERS.)
Has the Federal Reserve’s policymaking body, the Federal Open Market Committee, historically exerted any influence on investors’ expectations about the future course of policy? Although members of the FOMC communicate to the public through a variety of channels, including speeches and Congressional testimonies, official communications from the Committee as an official body (ex cathedra, one might say) are confined principally to the statements that the FOMC releases with its policy decisions.
The FOMC has moved significantly in the direction of greater transparency over the past decade. Before 1994, no policy statements or description of the target for the federal funds rate were released after FOMC meetings. Instead, except when changes in the federal funds rate coincided with changes in the discount rate (which were announced by a press release of the Federal Reserve Board), the Committee only signaled its policy decisions to the financial markets indirectly through the Desk’s open market operations, typically on the day following the policy decision. In February 1994, the FOMC began
to release statements to note changes in its target for the federal funds rate but continued to remain silent following meetings with no policy changes. Since May 1999, however, the Committee has released a statement after every policy meeting.
The FOMC statements have evolved considerably. In their most recent form, they provide a brief description of the current state of the economy and, in some cases, some hints about the near-term outlook for policy. They also contain a formulaic description of the so-called “balance of risks” with respect to the outlook for output growth and inflation. A consecutive reading of the statements reveals continual tinkering by the Committee to improve its communications. For example, the balance-of-risks portion of the statement replaced an earlier formulation, the so-called “policy tilt”, which characterized the likely future direction of the federal funds rate. Much like the “tilt”statement, the balance of risks statement hints about the likely evolution of policy, but it does so more indirectly by focusing on the Committee’s assessment of the potential risks to its dual objectives rather than on the policy rate. The relative weights of “forward looking”and “backward-looking” characterizations of the data and of policy have also changed over time, with the Committee taking a relatively more forward-looking stance in 2003 and 2004.
Of course, investors read the statements carefully to try to divine the Committee’s views on the economy and its policy inclinations. Investors’ careful attention to the statements is prima facie evidence that what the Committee says, as well as what it does,matters for asset pricing.
I’ve highlighted that last paragraph because it is extremely important in explaining both the Chairman’s sudden interest in TV appearances and the market’s relief rally recently. Bernanke has been out there saying that the Fed will not let major banks fail, he dislikes then entire AIG thing and wants to ensure it never happens again, he’s been asking the senate committees he visits for more regulation, and he’s repeatedly said that the FED expects the recession to experience the trough later this year. We’ve not seen any meaningful discussion about the type of recovery to expect (L shaped or otherwise). We have however, seen more upbeat statements geared to appease the markets and their role in asset pricing.
Much speculation has been made recently about the possible similarities between Japan’s lost decade and financial crisis during the 1990s and the current US Financial crisis. It’s impossible to get through any graduate program in either finance or economics without spending time with the mounds of research the decade ignited. Since many folks are talking and writing about this period in the popular business press and speculating on the chance of an L-shaped recovery similar to the one experienced by Japan, I thought I’d focus some on Japan’s Lost Decade. There are some similarities but some important differences too.
About a month ago, The Economist asked if America’s crisis could rival Japan’s. Their answer was yes. This article examines something we’ve looked at twice before. That would the IMF study of banking crises. Both the Nordic banking crisis and the Japanese banking crisis are including in the database and highlighted by the study. The experience of these rich country crashes have both been bandied about as possible road maps to financial system recovery. Sweden nationalized its banks. There was also the lesson from South Korea. This country recovered after two years. The there was Japan. It let its banks languish. Japan became infamous for its decade of economic stagnation. Are we turning Japanese?
Japan’s property bubble burst in the 1980s and its run up prior to the bubble was smaller than ours. Additionally, Japan has a high domestic savings rate. America is the world’s largest debtor.
Judged by standard measures of banking distress, such as the amount of non-performing loans, America’s troubles are probably worse than those in any developed-country crash bar Japan’s. According to the IMF, non-performing loans in Sweden reached 13% of GDP at the peak of the crisis. In Japan they hit 35% of GDP. A recent estimate by Goldman Sachs suggests that American banks held some $5.7 trillion-worth of loans in “troubled” categories, such as subprime mortgages and commercial property. That is equivalent to almost 40% of GDP.
The authors of The Economist articles see both other differences too.
Japan’s central bank took too long to fight deflation; its fiscal stimulus was cut off too quickly with an ill-judged tax increase in 1997; and it did not begin to clean up and recapitalise its banks until 1998, almost a decade after the bubble had burst. But the history of bank failures suggests that Japan’s slump was not only the result of policy errors. Its problems were deeper-rooted than those in countries that recovered more quickly. Today’s mess in America is as big as Japan’s—and in some ways harder to fix.
Let’s look at the first statement about deflation. We’re not experiencing deflation in all sectors. The latest numbers from the BLS still show slight inflation. However, we are looking at some tax increases in the near future. Both Japan and the Roosevelt administration in 1937 instituted tax increases before both of these major financial crisis had be solved. In 1937, it led to a second economic and financial market down turn. In 1997 Japan, it slowed down recovery.
Our dollar is strengthening as the financial crisis impacts the global economy. Japan’s yen is similarly a strong world currency. The dollar is still seen as a safe-haven asset. However, Japan is a net exporter while the US is a net importer. Japan is not a debtor nation, but a creditor nation. Japan could still rely on exports to deliver some economic stimulus. The US does not have that luxury. However, while South Korea and Sweden’s currencies weakened and helped make their exports look cheap, Japan’s yen stayed somewhat strong. This crippled Japan’s ability to fully use exports as stimulus making its recovery much longer than either those of South Korea or Sweden. The dollar continues to strengthen which also makes any exports we send to the rest of the world relatively expensive. It also continues our reliance on imports as they stay relatively cheap.
In some ways America’s macroeconomic environment is even trickier than Japan’s. America may have a big current-account deficit, but the dollar has strengthened in recent months. America’s reliance on foreign funding means the risk of a currency crash cannot be ruled out, however. That, in turn, places constraints on the pace at which policymakers can pile up public debt. And even if the dollar were to tumble, the global nature of the recession might mean it would yield few benefits.
I already mentioned that Japan’s households were historically good savers. This meant only the Japanese corporations had to ‘deleverage’ or get rid of debt during the Japanese crisis. I remember watching Japanese commercials at the time from the government extolling patriotic Japanese households to go spend like crazy at the same time the US government was telling Americans to consider saving. Well, that trend is reversing. Japanese households are beginning to decrease their savings rates, while Americans have rediscovered thrift. This is also something we’ve talked about. Here’s how that played in Japan and could play out differently here.