Bitter Harvest

In a recent post, Rafe quoted Frank Shostak as one of the dissenters who are critical of the bailout proposal, not only in its particulars, but in principle. Shostak sees all interventions of this kind as economically damaging as well as adding to the already existing mountain of moral hazard. His recommendation, in brief, is that markets be allowed to find their own way, however painful that path may appear in the short term.

My natural inclination is also to trust the market to sort out most problems. Indeed, had they been allowed to do so over recent decades, we wouldn’t be in this mess. As Shostak rightly says, it was a persistent unwillingness to suffer short term and necessary pain (in other words, to let creative destruction to do its job) that over time utterly distorted risk perceptions and so enabled things to reach such a state.

While I share his view that it would be preferable if both financial institutions and their customers were left free to act (and to bear all the consequences), I struggle to see how this will ever be the case in a social democracy. The political pressure to respond to pleas for help will always, I suspect, be just a bit too strong. At any rate, so long as that unwillingness persists, financial markets should remain fairly heavily regulated. They’re far too important to be given daddy’s credit card with which to conduct extravagant experiments.

Anyway, all of that is now history and can’t be unwritten.

Were Shostak’s advice followed, I think the US would soon be deep in depression. It may, indeed, be unavoidable even with the very best policies. The fundamentals that traditionally make such a calamity possible (extremely high gearing, heavily inflated asset prices, severe misallocation of capital and profound international imbalances) are all present, and supplemented, unfortunately, by a few new twists like the opaque and ubiquitous world of OTC derivatives. This toxic mix has been brewing for a long time.

The process of debt deflation that lies in wait once system wide leverage is high enough (and, Lord, knows, it’s never been anywhere near so high before) would sweep through the economy like a hurricane. Banks would disappear wholesale, lending would dry up almost entirely, the markets would be in complete disarray and firms would be falling like leaves from autumn trees. Oh, and asset prices would of course be in the tank.

Now, I think Frank (assuming he broadly agreed about the fundamentals) would point out that if all prices were free to adjust as credit is destroyed in such a debt deflation, then things might in fact work out moderately well after an absolutely traumatic 6-12 months. Assets and businesses would be priced at mouth watering levels and those who still had some capital could start rebuilding from a far sounder base.

And I’d agree with him, save for one thing. Prices would not be allowed to adjust, particularly not wages. More than anything else, this was, I think, what turned the 1929 crash into the Great Depression. All the attempts to hold up prices and wages were precisely the wrong thing to do. They should have been allowed to decline with the prices of assets, which of course fell along with the broader money supply in a reflexive process. Only then would the relative prices have enabled profitable, soundly based business to once again be done.

Without that flexibility, the US is faced with a different but equally unhappy dilemma. Do they allow things to take their course in the financial markets (as Shostak suggests) and perhaps have to endure levels of misery and unemployment that could match those of the Great Depression, lingering year after year as successive governments try all the usual nostrums but refuse to let the wider economy also adjust? Or do they try the Japanese route, keeping things apparently intact, socialising losses, trying to hold up prices, taking on vast new public debt and effectively appropriating private sector savings to spend on various make work schemes? Or will they hit upon, more likely, some uniquely American mixture of the two?

It’s by no means certain, in any case, that the US has the option of taking the Japanese route. When their hard times hit in 1990, they were a substantial net creditor and ran a decent trade surplus. Whether it was good policy or not, they could at least afford to finance their own bailout. No such luck for the US. It’s deep in the hole and has, as yet, shown no signs of finding a way out.

This is a very large problem, perhaps even a catastrophic one, and its origin, nature and eventual resolution will be debated and analysed for decades, perhaps centuries, to come. I agree with Shostak’s underlying argument about its causes and would dearly love to see these issues broadly debated. With greater understanding, the day might even come when we no longer need suffer such monstrous booms and busts (although I can’t say I’d put a bet on it).

In the meantime, though, I think the financial system does need to be helped down from its high perch. No one, in the years leading up to this crisis, was told to prepare themselves for a sauve qui peut world. To impose laissez faire rules now, out of the blue, would in my view be profoundly destabilising, not only for the markets, but more importantly, for the whole social fabric. In any case, since the markets wouldn’t be allowed to properly adjust to debt deflation any more than they were last time around, we’d still likely end up with a total mess.

I think the best we can hope for are least bad solutions, which will only grow out of holding a few principles in mind. Amongst them would be the recognition that: insolvency is the real problem, not illiquidity; asset prices should be allowed to fall to where they bear a sustainable relationship to their earning capacity; wherever possible, those who took the risks should bear the costs; the market is best equipped to set prices and manage assets unless in particular cases this becomes impossible; the conversion of debt to equity ought to be encouraged (and where necessary enforced) and, where the state has to take a direct stake, it should aim to establish an incentive structure that discourages opportunistic plundering of its resources while also providing it with some upside.

Finally, all the relative innocents who responded to the many official and other inducements to lever up and join in the American Dream should be helped to better survive the great unwinding. Not only, or even particularly, for reasons of fairness (which is in any case damnably difficult to determine) but to avoid a possible plunge into true social discord.

As for the vital discussion about why, and how, all this came to be (and how we can best avoid yet another repetition in a generation or two), one can only hope it will develop in parallel and that this bitter harvest may thereby bear at least some edible fruit.

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44 Responses to Bitter Harvest

  1. NPOV says:

    “My natural inclination is also to trust the market to sort out most problems. Indeed, had they been allowed to do so over recent decades, we wouldnt be in this mess.”

    Ingolf, what specific examples of the market not being allowed to “sort out most problems” over the last 8 years did you have in mind?

  2. Ingolf says:

    A few fairly recent examples (prior to the last year’s rich harvest) are the NYFRB brokered bailout of LTCM in 1998, the extended 1% Fed funds rate in 2002-3 and Bernanke’s explicit invocation of the “electronic printing press” during a speech at the height of the credit market woes in late 2002. The latter prefigured today’s unfolding reality. Consider this little excerpt, all the while bearing in mind the speech is being given by a Governor of the Federal Reserve Board:

    But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.

    More generally, though, these fit into a persistent culture of official risk amelioration which over many decades built a deeply embedded belief that the Fed et al had the market’s back. During Greenspan’s tenure, as I’m sure you know, this was encapsulated in the phrase “the Greenspan put”.

  3. NPOV says:

    Well I would certainly agree that we will never live in a world where governments will never step in to, as you say, “ameliorate risk” as they see fit. But it’s not as though such government actions are nothing to be avoided – I don’t doubt for a moment, for instance, that if the executives of AIG knew precisely how high the risk of government bailout was given its business practices, it would’ve modified its practices in an attempt to avoid such a bailout, which was surely hardly any better for them than the company collapsing into bankruptcy.
    So yes, there’s an element of moral hazard, but I think it’s easy to overstate – and impossible to prove that it necessarily overrides other considerations.

    As for the “extended 1% Fed funds rate”, well I think almost everybody now agrees that it was pretty irresponsible – but if markets were truly made up of largely rational players, it shouldn’t really have mattered all that much, no?
    “Bubbles” almost by definition are a form of market failure – where large numbers of people act irrationally, all expecting to personally profit over and above any real underlying growth in wealth. So assuming it’s possible via regulation and intervention to temper and/or contain the formation and growth of bubbles then I would happily put it forward that governments have a responsibility to do so.

  4. melaleuca says:

    I think moral hazard is seriously overrated as a causal factor in the US financial crisis. Surely the senior executives who run major companies are primarily interested in their own welfare, that being future earning potential and prestige. If they send a company to the wall their reputations are destroyed and their future earning capacity markedly reduced *even if* they have good reasons to assume the Government will step in and save the company. This may not totally negate moral hazard but I’m surprised at how many commentators uncritically apply this concept.

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  6. Ingolf says:

    Moral hazard has two possible dimensions. One is the very basic variety to which you’re both alluding, namely the belief that individual firms will in some way be saved in the event of a crisis. Like you, I don’t think it carries much (if any) weight. As you both rightly point out, the cost of failure applies even if there is such a bailout. Besides, who in their right mind would consciously drive their firm to the brink on the off chance it might be saved from oblivion?

    The important one is what I’d term systemic moral hazard. It’s what I was referring to in saying “it was a persistent unwillingness to suffer short term and necessary pain (in other words, to let creative destruction to do its job) that over time utterly distorted risk perceptions and so enabled things to reach such a state.” This deeper, more insidious version only takes root once the PTB (in addition to providing such garden variety protections as deposit insurance) have for decades shown their determination to backstop downturns while letting bull markets run free. Only then can the animal spirits that create bubbles run so wild and leverage up so exuberantly as to threaten the system itself.

    NPOV, given we both accept that a true “hands off” attitude from government isn’t likely anytime soon, how best to regulate and intervene so as to “temper and/or contain the formation and growth of bubbles” is one of, if not the crucial question. So no real argument on that one.

  7. Ken Parish says:

    Many thanks for these posts Ingolf. I don’t have enough economic or financial market knowledge to untangle all the arguments for myself, but your two posts are models of clarity and make more sense to me that just about anything else I’ve read on the Huge Financial Crisis (although Paul Keating’s take on tonight’s Lateline was also excellent, I thought).

  8. SJ says:

    Ingolf, there’s a third very obvious form of moral hazard that you’ve neglected.

    If I can either set up a hedge fund or capture the top job at a corporation, then collect a salary upwards of $100m for a single year, it’s obviously in my interest to do so, and I really couldn’t care less what happened to the hedge fund investors, the corporation’s future, or my future job prospects, as long as I get to keep the money and no-one seems interested in prosecuting me.

  9. JC says:

    Excellent, excellent take Ingolf. Here’s a thoughts I have. see what you think.

    In 2003 the SEC in it’s infinite (lack of) wisdom decided to allow the I-banks to increase leverage from around 12:1 to between 25 to 35:1. The genesis of this decision has an interesting pedigree as I believe it goes right back to the early 90’s when the rage then was to pursue securitization at all costs.

    It was S&L crisis that brought this to head as both the regulators and Wall Street felt that one of the many problems that caused the crisis was balance sheet illiquidity. Securitization was supposed to be the panacea to this illness as it was supposed assist in spreading risk rather than concentrate it. In other words you could sell securities to investors like the Manly Councilif worse came to worse:-). The other decision that came with securitization the mark to market principle.

    Fast forward a decade and a bit and you’re seeing Wall Street securitizating the size of underwear if they were able to and this leads to the fatal 2003 SEC decision allowing I banks to take more risk. The argument used at the time was that I-banks balance sheets were extremely liquid compared to regular commercial banks (as they carried very little unsecuritized debt on their books). It was therefore widely understood by all that the ability to run for cover even with an expanded balance was greatly increased, as you could sell the securities fast paced. This was the big mistake of the decade as it was assumed there would always be an orderly market for this stuff.

    Let’s not forget that in the regulators eyes these remaining I-banks were the survivors of the 80’s and 90’s screw ups and they always showed up with next to no scratches on their backs. Believe it or not, Bear Stearns was seen as one of the most risk averse/ intelligent risk takers of the I-banks at one stage. So there was a great deal of understandable hubris going on both at the I-banks themselves and with the oversight crowd. Keep in mind these weren’t under-regulated firms as you had external/internal audit, compliance, various futures bodies auditors, stock exchange examiners, and even confidential whistleblowers phone numbers for any employee that saw wrongdoing.

    Now it gets interesting:

    Let’s also set the scene in the early part of the decade. The Fed keeps interest rates on the low side far too long which was an understandable reaction to the tech crash and 911. Add in:

    1. the SEC’s decision to allow much, much higher leverage at the I-banks,

    2. a securitization market that’s just blazing away;

    and we’re off to the races.

    This last part is what i believe set everything up for the fall and which is where trusty old Mises comes into it. A credit expansion has it’s gensis in the bowels of the central bank through monetary expansion or in this case an interest rate structure that is far too low.

    Adding all this up:

    1. We have the love for the weird and wonderful securitization that was supposed to greatly reduce risk

    2. Mark to market that came with it

    3. Expansion of the money supply experienced through low interest rates

    4. SEC’s decision to expand the balance sheet capacity of the I-banks

    5. Retail and wholesale market gone crazy to borrow money.

    6. Fred and Fannie are out of control building up their balance sheets and offering guarantees to mortgage security holders for their own securities such as I-banks and the rest of the gang.

    7. AIG and the kids see Fred and Fannie printing money by guaranteeing the paper that rested on collateral (homes) that never went down.

    Commercial banks.

    going from memory Basle treats tradeable securities far more kindly than a straight loan so they were also going at it hammer and tongs with expanded capacity to meet demand.

    The greed factor.

    I see this as playing almost no part in this mess, as people are greedy all the time. Rich people are greedy and poor people are too, so bankers and traders are no different either in lean years or great years. Perversely bankers and traders are actually greedier in the bonanza years as in the lean years they’re fearful of losing their jobs and the big years is when they are given insurance money in the form of bonuses:-)

    Bankers are no greedier than the local coffee shop owner as they both respond to the same sort of stimulus. What banks responded to in this case is demand and their capacity (room in the balance Sheet) to meet loan demand. In other words if banks have room to make a loan as long as it meets their credit criteria, they’ll make the loan. After all that is what they do for a living. Suggesting they were too greedy is like suggesting to the coffee shop they should only make 100 coffees a day instead of 150 if they have ample capacity. No one for instance expects BHP to stop raising their capacity to meet China’s demand. That’s silly.

    In addition the return on equity expected from banks is really no different from the return on equity expected of any large firm on a risk adjusted basis.

    So we had monetary expansion occurring at the same time we saw a huge expansion in balance sheet capacity for both the I-banks and the commercial banks with the effects of securitization. Meanwhile the demand side rose enormously as a result of the Fed’s low interest rate policy.

    Add all this together and you end up with a bunch of suit case nukes going off at the same time.

    (I have been thinking about all this for a little while and basically working on my recollection of things and tried to put this fiasco together.

  10. JC says:

    umm sorry about some missing words and misspells should have have it beforehand.

  11. NPOV says:

    JC, good to see a libertarian-type prepared to accept that certain instances of deregulation played a role in the crisis.

    But as for whether greed played a part – you say “humans have always been greedy”, sure, but surely “being greedy” essesntially means “acting in on one’s short-term interest, with insufficient concern for the long term interest of everyone, self included”. If humans weren’t so prone to such behaviour (and there are almost certainly good evolutionary responses why we are), then bubbles wouldn’t happen either. What matters here is the degree to which humans can usefully voluntarily alter their instinctive behaviour based on lessons of the past: i.e. would it be helpful to mandate that the sorts of college courses that those who go into investment banking typically take include a “history of financial collapses” subject that is designed to warn of the perils of excessive short-term self-interest? Though I happen to also agree that the greed was certainly not limited to Wall St – Lateline had a fascinating story on Las Vegas last night where a Realtor basically came out and said “his customers were being too greedy, and have paid the price”.

  12. NPOV says:

    One question I have – from my understanding of what defines a “market failure”, and what defines a “bubble”, a bubble would surely classify as a type of market failure (bubbles result in horribly inefficient allocations of resources, after all). Yet no google search I can think of reveals anyone seriously classifying bubbles as market failures, and even the search “”bubble * a * market failure” only comes with about 2 examples of somebody claiming that a bubble was a market failure (and one of somebody claiming that the popping of the bubble is a market failure – which seems completely indefensible).
    So why are bubbles not generally considered a type of market failure among economists? And no thanks to any answers from those that don’t believe either such thing exists.

  13. Rafe Champion says:

    I suppose economists don’t regard bubbles as examples of market failure because the market (actually the activity of buyers and sellers, bearing in mind that the market is just something that happens when people buy swap and sell) will correct the bubble in due course. The longer the bubble is sustained by political pressures and interventions (and moral hazard) the worse it gets. As we see.

    It looks as though one of the factors in this case is the illusion of regulation with layers on layer of rules and regulations as noted by JC and others, but a lack of transparency so bad debts were hidden from sight in big bundles. The bundles passed from hand to hand like the game of pass the parcel, then the music stopped and some big players have been caught holding the parcel

  14. NPOV says:

    Rafe, but any market that operates by constant bubble inflation and popping is surely highly inefficient. It may well even be that most forms of government intervention aimed at controlling bubbles tried so far have been counterproductive (though I’m not convinced the evidence for this claim is terribly compelling), but it’s surely worth continually striving to find effective means of tempering their worst excesses. I.e., if we know that humans have a tendency to engage in short-sighted self-centered behaviours that lead ultimately to results where everybody pays the price, then it’s foolish not to use our ability to construct a framework of rules that helps to contain such tendencies. Which is why it frustrates me when I see obviously intelligent people jumping through all sorts of hoops in an attempt to prove that “it’s all the fault of government intervention, or too much regulation”. We all know govenrments make mistakes, and sometimes delibately distort markets for their own ends, and regulations occasionally backfire, and are subject to rorting. But it’s simply a logical fallacy to then conclude we’d be necessarily better off with far less intevention and regulation.

  15. pedro says:

    NPOV, I agree it is clear that brewing and bursting bubbles is not efficient, though I am not sure you can stop it happening. Obviously expectations of value growth can get away from reality even without governments feeding bubbles with low interest rates and such.
    Your proposition is that we know people are stupid so we should try and find sensible rules to limit the potential for dangerous explosions of stupidity. I cannot think of a philosphical argument against that. I do have difficulty seeing just how one could set rules that provide an institutional leavening of wisdom to the various sillinesses to which we are all prone. At best one can look at particular problems and write rules designed to prevent that problem happening again. Which is of course what has been going on for yonks. The difficulty is that each problem ends up being different, so the tail chase continues and the existing rules often enough create new problems of their own because our hindsight is better than our foresight.
    One on going problem seems to be that each new set of rules/system of oversight becomes the basis for the new bout of confidence that helps feeds the next bubble.
    Sadly there are no easy answers and probably no difficult answers.

  16. Ken Parish says:

    I have problems with both the rigid ideologically driven extreme viewpoints about markets evident on thie thread. Rafe believes conclusively that markets are grouse and magically self-regulating in all circumstances if only stupid lefty regulators would leave them alone. At the other extreme, NPOV sees any glitch in smooth market operations as a “market failure” necessitating heavy-handed regulatory intervention i.e. markets are inherently and conclusively suspect and only the omniscient nanny state can save us.

    In fact, markets are human constructs, both created and governed by a complex and dynamic combination of social and legal rules/norms/expectations. They do not magically survive or thrive without such rules and norms, nor are the norms self-evident, self-generating or unchanging.

    OTO the nature of entrepreneurial psychology (on which I recently tried unsuccessfully to provoke discussion here at Troppo) is such that entrepreneurs need the “elbow room” to make their own decisions, take risks, make mistakes and triumph when their risk-taking and hard work pay off. Thus heavy-handed regulation and the sort of kneejerk suspicion of markets and determination to find ‘market failures’ as an excuse for overbearing state intervention are fatal to entrepreneurial activity and therefore the Schumpeterian “creative destruction” that makes capitalism such an extraordinarily powerful engine of productive endeavour.

    However, risk-taking and entrepreneurial activity have seemingly been irretrievably perverted in world financial markets, because the “Masters of the Universe” have operated on the assumption that governments will have no choice but to bail them out if anything goes drastically wrong and their risk-taking comes badly unstuck as has now occurred. It appears that the Masters’ arrogant assumption that they would be able to capitalise their profits and socialise their losses come what may is about to come true, and just about everyone whose views I can understand seems to be saying that there’s no choice but to bail the arseholes out to avoid the rest of us going down the plughole with them. I’m prepared to defer to their greater wisdom and understanding, but we certainly need to find a way to ensure that risk is recoupled to adverse consequences for stupidity from now on i.e. that the “Masters” and their shareholders must cop the consequences of irresponsible risk-taking and that systemic safeguards are constructed to ensure that the rest of us can’t be pulled down the plughole with them. Exactly how such a system of assured accountability can be (re)constructed is a long way beyond my non-existent expertise. However, I’m sure it’s not beyond human wit to devise, and I’m equally sure that it won’t be achieved either by dogged belief in the magical power of markets in all circumstances or by NPOV’s polar opposite nanny state perspective. It will need evidence-based pragmatism.

  17. NPOV says:

    Ken I do fairly strongly object to your caricaturing my position as “NPOV sees any glitch in smooth market operations as a market failure necessitating heavy-handed regulatory intervention i.e. markets are inherently and conclusively suspect and only the omniscient nanny state can save us”, though to be fair you fairly well caricatured Rafe’s position to.

    In fact from everything I’ve read your position is much the same as mine. I’m curious what makes you think I support “heavy handed regulation” and an “omnisicient nanny-state”? Indeed the only person in this thread who used the phrase “heavily regulated” is Ingolf in his initial post. I actually disagree anything should be “heavily regulated” per se: governments should continually strive for whatever level of regulation leads to the best results. And I’m far more concerned about the quality of the regulation, the degree to which it is meaningful enforced, and the degree to which nobody is unfairly benefitting from it than whether it is “heavy” or “light”.

  18. Ingolf says:

    Thanks for the kind comments, Ken. I must see if I can get a transcript of the interview with Keating.

    JC, much appreciate your comment too. Lovely summary, which strikes me as pretty much spot on. I first heard about the SEC’s relaxation of leverage limitations on the largest investment banks only a few weeks ago. Talk about a fateful error; without it, the big five would probably still be with us (for better or worse!). I’d never understood how they could run 25-35 to 1 books and hope to survive long term. There’s just no real margin for error at that level. Perhaps, as you say, just good old-fashioned hubris, sprinkled of course with a soupcon of “greed” (see below).

    It’s also a good example of the degree to which the real financial and monetary action took place outside “normal” channels over the last decade. The Fed was in many ways an onlooker for much of the noughties. The heavy lifting was done elsewhere: by the GSEs (particularly during the tech meltdown and the last year when in both cases they kept the mortgage markets going almost on their own); by foreign central banks (especially China) who issued torrents of their own currencies and bought dollars with the proceeds (which is where the real “monetisation” took place until recent dramas forced the Fed out of the closet); and finally of course, as you say, by the whole ABS industry. I had a look at the figures again the other day. Just astounding; over the last decade, ABS issuer assets went from $1.15 trillion to $4.36 trillion. Taken together with the GSEs (which as the quasi-official version of the same thing went from $3.4 trillion to $8.1 trillion), it comes to almost $8 trillion in credit growth there alone. Fooken amazing . . .

    I also agree with you on greed. Citing it as a contributing factor is simply a truism. Besides, for the moment there’s more reason to worry about its wobbly twin, fear. What really matters (as NPOV is saying) is seeking a reasonable (and realistic) balance between carrot and stick such that the damage that’ll sooner or later spring from our many foibles is kept within tolerable limits.

  19. pedro says:

    The point of the intervention is surely to save the innocent victims and there should be no undeserved benefits. I believe various people have suggested ways in which the intervention could be structured to ensure this.

  20. Ingolf says:

    Seems the discussion moved on while I was tapping away.

    NPOV, you make a good point. On reflection, the blunt phrase “heavily regulated” is a bit of a shocker. What I actually meant to imply with that adjective is that leverage should be tightly constrained. Quite how, given my choice of words, I expected anyone else to understand that distinction, well . . . . .

    Ken, great comment, though you’ve clearly put NPOV into a box where he doesn’t feel at all happy. No matter, he defends himself well.

    Finally, looking back through the earlier comments, I see I missed the one from SJ. No argument at all. In fact, a very good point and one that has become increasingly relevant in a world of skewed incentive structures. A lot of the hedge fund strategies (and indeed those of all but the most experienced and skillful writers of financial risk insurance) are in fact premised on earning current income by assuming long term, often unquantifiable risks. In any real terms, as you suggest, it’s a scam.

  21. MikeM says:

    With impeccable timing, The Economist has just posted online its report from Nov 23rd, 1929, “Reactions of the Wall Street slump”.

    It begins:

    It’s an ill wind that blows nobody any good. The fall of Bank rate on Thursday by another half per cent is an outward and visible sign that the dramatic and precipitous slump of the last three weeks in Wall Street has definitely relieved the pressure on the world’s money markets which the New York situation has been exerting so continuously for the last two years.

    It concludes:

    [The return to cheap money conditions] should assist trade recovery throughout the world, which has been handicapped for so many months past by the abnormal financial conditions in New York. If we are justified in assuming that the setback in American industry will only be temporary, we may look forward to steady development in 1930, free from the incubus that has of late been hampering world conditions.

    Make of it what you will.

  22. Rafe Champion says:

    Ken, I object to your misrepresentation of my position as well.

    Quite likely I have not explained it carefully enough but I seem to recall saying something like “here we have common ground to work towards effective regulation”.

    The common ground is the understanding that markets are not perfect (who ever said they are?) and at the same time, intervention is fraught with the risk of unintended consequences.

    For what it is worth, I suspect that the record of major interventions is worse than the record of free markets, if you just take some examples like (1) Soviet system, (2) the causes of the Great Depression (3) nationalisation of industry in Britain and (4) quite likely the major causes of this current bubble.

    The problem is that you can’t say everything about a complex situation at the same time, especially on the run.

  23. NPOV says:

    Rafe, I’m generally wary of major interventions too. But perhaps the only way to prevent them is with occasional minor interventions.

  24. Ingolf says:

    Great find, MikeM, thanks. Interesting use of “incubus” in this context . . . . .

  25. Ken Parish says:

    Noting the objections of both Rafe and NPOV, I still assert that my characterisations of both of your positions is fair. Both of you occasionally qualify your respective positions, but both fundamentally start and finish in an ideologically rigid predetermined attitude. I’ve been reading both of you for quite a while now, and nothing I’ve seen from either of you suggests I’m misrepresenting you, although I think NPOV appears marginally less rigid and more open to opposing ideas than Rafe. Rafe is “four legs good, two legs bad” while NPOV is “two legs good, four legs might have their uses but only if they’re tied together tightly in splints so they can’t kick us two leggeds to death”.

    I hope that you do manage to find some common ground in this discussion, but I won’t be holding my breath. I’m conscious that accusing both of you of ideological rigidity may well raise the temperature of the thread for little or no useful purpose, but OTO I doubt that I’m the only reader who gets seriously exasperated by such predictable tunnel visioned responses.

  26. NPOV says:

    I’m sorry you feel that way Ken, but I’ve noted your tendency at reaching strange conclusions about other’s general ideological positions before (I think it was you that claimed that John Humphrey’s “hated the poor”).

    Do I have an ideology? Of course. Am I rigidly attached to it? Considering I’ve changed my views somewhat over the last few years (generally moving towards the view that economic liberalisation is, on balance, a good thing – but having briefly been attracted to idea that near-complete liberalisation is actually quite justifiable on a number of grounds, wound somewhere around the centre) then I don’t believe such a criticism is justified.

    Again, I don’t believe I’ve ever read a post of yours regarding your views on markets and government intervention that I didn’t largely agree with, so I’d like to know which of my points you specifically disagree with.

  27. Ingolf says:

    Ken, you’re undoubtedly far more familiar with Rafe and NPOV than me. I am, after all, a relative newcomer to Troppo.

    Still, on the evidence, it seems to me both have been making a real effort to listen and communicate on this thread. In other words, to act more or less in accordance with the ideal we all from time to time nurture for this revolutionary new conversational medium.

    We all tend to defend the territory with which we’re most familiar and I don’t think that’s ever likely to change. Surely the best way to reduce the irritation and increase the pleasure of these sorts of debates is to work hard at reducing misunderstanding. So much disagreement flows from not having agreed terms and definitions before lighting into some opponent.

    I think some real progress along those lines was being made here. “Natural” regulators and libertarians were talking to each other, rather than past each other. Certainly, I’ve been enjoying the process.

    Be a shame to see that go up in smoke because everyone suddenly feels compelled to head back into their respective bunkers.

  28. NPOV says:

    Actually Ingolf you’ve been posting here considerably longer than I have: according to Google since at least March last year. I’ve only been here since about February *this* year.

  29. JC says:

    I think most people made the mistake I initially made. I went to a few right sites, read the WSJ for their views and came away at first thinking the Dems were the culprits. It’s really hard to dismiss the fact that there were several short vids of Barney Frank &co to “prove” it. Others may have gone to left wing sites and I’m sure there were plausible explanations too that the GOP was at fault.

    However after some digging and thinking you come to realize that the entire political establishment was involved going back to Bush 1. Well not the political establishment but the entire government apparatus.

    Reality is that they’re all involved but no one is entirely responsible. I liken it to a plane crash where a cascading set of events and pilot actions and omissions caused the crash and not one single thing was responsible.

    No political group or regulatory agency has gone out of its way to deliberately undermine the system. However all were inadvertent players.

    I think the real issue how we make sure the central banks really do take away the punch bowl.

  30. Rafe Champion says:

    NPOV and I might live in different ideological houses but we are doing better than the fishwives who Samuel Johnson or some wit observed shouting at each other across the street. “They will never agree” he said to his companion “They are operating from different premises”.

    I entirely agree with NPOV’s idea of small preventive interventions. How much more can I do to demonstrate flexibility? The point is to intervene in ways that actually produce the desired effects.

    Given the haste, size and complexity of the legislative package it is a good bet that it will do more harm than good. Time may tell, but of course the analysis will be totally obfuscated by the process of political point scoring and finger pointing.

    I merely insist that the current failure is not the failure of a market that was free of regulations and political intervention and interference. And the fault lies on both sides of the house of course, as JC pointed out. The instinct for big government interference is bipartisan in the US and probably everywhere else as well, given the extent to which the democratic process has been subverted by the vote-buying motive (buying votes with other people’s money, nice work if you can get it!)

    Anyway, I think this has been a very worthwhile exchange and it justifies the existence of Troppo as a place where diverse voices can speak.

  31. Ingolf says:

    Spot on, JC, although I think it’s safe to include a good deal of the private sector along with the government apparatus. Posterity is unlikely to judge many participants kindly. It was, and is, as the Americans are fond of saying, a clusterf**k. Maybe even a CFUBAR, which apparently is a Clusterf**k Beyond All Repair.

    As you imply, the blame game is only useful in so far as it helps us better understand some aspect of what really happened. In which case, of course, it’s no longer the blame game.

    Lovely anecdote, Rafe. Like you, I fear this package may well do more harm than good. There are some interesting discussions on that topic unfolding right now at Naked Capitalism.

  32. JC says:

    Read the Naked Cap blog pieces, Ingolf. Very interesting
    The Bailout is fascintating in lots of ways particularly from a flow of funds perspective.

    I originally thought the funds were going to monetized…. the Treasury printed the cash or in these modern times credited the Fed’s in return for bonds (that’s how monetization takes place these days, I think) However they’re going to borrow the money from the bond markets or as one guy suggests at NC, through the short end of the curve. It’s going to be like a bull elephant in a china shop wherever they go on the duration curve as it’s going to distort the yield curve to no end even if as I’m sure they will do it in tranches. It’s a huge amount of money! You could buy countries with that amount :-)

    The nasty effects is going to be experienced across all markets. Perversely it places a giant bid for the US Dollar as you see money going to the US, maybe reluctantly but heading that way all the same. So we now are going to have the spectacle of the dollar strengthening dramatically (possibly) when the US may need a weakish dollar or a dollar that isn’t artificially strengthened by this “ginormous” money flow.

    Buy the US dollar and sell gold is my bet.

    I think though they may have to monetize at some stage once they see the effect it’s going to have and when that happens the US Dollar and commodities reverse course.

    This is the most interesting market of all time.

  33. Ingolf says:

    Yes, JC, keeping track of the Fed is no longer a doddle, that’s for sure. The whole game changed in the last month.

    As I’m sure you know, Treasury has already made a decent start. Under the newly created Supplementary Financing Program it’s sold (as of last Wednesday) $158.9 billion of treasuries above and beyond its normal needs and deposited the proceeds with the Fed. Not a bad start, but as you say, this programme hasn’t yet directly involved monetisation and as I understand things, the intention is to do much the same under an eventual bailout programme. Intentions can of course change pretty quickly in this kind of environment . . . .

    Still, as far as I can make out, the Fed has monetised about $80 billion in the last three weeks (as reflected in reserve balances) and its balance sheet in the same period expanded by over $300 billion. That’s thirty-five percent in three weeks.

    I have mixed feelings about the dollar (and gold). You could well be right about the dollar in the short term, if nothing else because the realisation is sinking in that the ROW isn’t exactly in great shape either and so there’s room for a realignment of perceptions. Still, it has huge fundamental headwinds to tack into in the medium to long term. Gold? Well, I guess it could take another big hit if the deflationary story gets more legs but it may also be on the cusp of decoupling from commodities more generally and donning its monetary robes.

    And yes, absolutely the most interesting markets ever.

  34. JC says:

    Still, as far as I can make out, the Fed has monetised about $80 billion in the last three weeks (as reflected in reserve balances) and its balance sheet in the same period expanded by over $300 billion. Thats thirty-five percent in three weeks.

    The one I watch like a hawk is the monetary base which went up by $76 billion, so that must be part of the 80 billion washing around through the aggregates you mention.

  35. Ingolf says:

    Yes, I’m sure it’s the same thing, JC. Any discrepancies would be due to timing differentials. The H.4.1 release I got my figures from gives the actual figure as at the previous Wednesday in addition to providing the averaged daily figures the H.3 is based on.

    Do you know where they account for the dollar swap facilities with other central banks?

  36. JC says:

    Donno, Inglof.

    I presume the Fed swaps/lends the Bank of Switzerland dollars and they (Fed) get a corresponding amount/loan back in swiss francs. So I think the swiss francs go into the same account the Fed used to disburse the the US Dollars.

    It is an increase in the global money supply, though i think, however temporary as those dollars are put out in the market.

  37. Ingolf says:

    I think you must be right about the money supply, JC.

    I had a quick look on the FRB site and couldn’t find the info in any of the releases; hence the question. Oddly enough, the only mention I did find was in the US Reserve Assets report (3.12) where a note said “Excludes outstanding reciprocal currency swaps with the European Central Bank and the Swiss National Bank.” That was at the end of July.

    Anyway, no matter. It was just sheer curiosity more than anything.

  38. JC says:


    Did I say “bank of Switzerland”? I am getting older.

    I gotta stop reading Roubini as he turns me quasi suicidal as in:

  39. JC says:


    Trichet is absolutely insane. In fact the whole board of the ECB ought to be placed in strait jackets. The ECB left rates alone.

    “We discussed extensively the recent intensification of the financial market turmoil and its possible impact on economic activity and inflation, recognising the extraordinarily high level of uncertainty stemming from latest developments,” he said.

    “In this context, we stressed the crucial importance of keeping inflation expectations firmly anchored in line with our objective.”

  40. Ingolf says:

    Wonder if Roubini will be able to turn his views around when it’s finally warranted (not that I think he need be in any great rush)? My guess would be yes but that kind of flexibility is a tough call.

    Nope, inflation worries wouldn’t seem a priority concern right now. Looks like they’re busy fighting the last war instead of, as some wag said, the one before last.

    Never a dull moment.

  41. rog says:

    Our electd reps may need to look at separation of powers with regards to the economy – with political interference Fannie and Freddie bypassed normal governance procedures and operated under a different set of rules. Pork barreling not only misspent taxpayers funds it poisoned the global well, so to speak.

    Greenspan was adamant that it was vital for global security to flood the world with liquidity post fall of USSR. Is that the function of the Fed?

  42. JC says:

    Greenspan was adamant that it was vital for global security to flood the world with liquidity post fall of USSR. Is that the function of the Fed?

    I have a theory with regards to Greenspans’s easiness, Rog. He copped a lot of shit he went to tight in the late 80’s and early 90’s and copped a ton of shit from almost everyone for being too slow to cut with the onset of the recession of 91/92. He was so gradual, cutting rates .25% 22 times before finally stopping.
    After that I always thought he erred on the easy side as that period spooked the hell out of him.

  43. JC says:


    You may wanna take a look at this chart and see what the fed has done with its balance sheet.

    I can’t confirm it’s right, but if it is the last thing anyone would want to be doing is going into cash if you’re a US resident as the Fed is attempting to stealthily socialize the problem by depreciating the value of the buck through inflation.

    It’s pretty frightening if this is true.

    Perversely you want to be borrowing dollars at the present time to buy hard assets in US dollars.

  44. Ingolf says:

    No, it’s right enough, JC.

    As per the 4.1 release, the Treasury Supplementary Financing Account finished Wednesday at $344.5 billion, up $185 billion from last week while Reserve Balances hit $171.5 billion, up $83.5 billion.

    I’m not sure about the description “stealthy”! As for the intent, I’d guess at this stage it’s just about preventing the system from seizing up entirely.

    Despite the spectacular sums, I don’t think it’s safe to assume all these efforts will be enough to halt debt deflation. After all, there’s almost $50 trillion in debt outstanding in the USA. The more aggressive they get, the more unhappy a lot of debt holders will eventually become (after any first flush of relief peters out). The deflationary effects of higher interest rates (if the market begins to fear the authorities will “go all the way”) could so easily overwhelm their reflationary efforts.

    FWIW, my best guess is they’ll remain behind the eight ball for at least a while longer.

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