Ian Welsh

The horizon is not so far as we can see, but as far as we can imagine

Category: Financial Crisis Page 8 of 12

Greek and European Insolvency

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On April 28, 2010

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Haven’t commented much on this, but let’s cut to the chase.  Greece is going to default.  Period.  The only question is when.  The Europeans can hold it off a year or two if they get their act together.  All of the PIGS (Portugal, Italy, Greece, Spain and arguably Ireland) are probably going to default eventually unless the rules by which the Eurozone, which state you can’t run too high deficits, are overturned.  All of the countries in the Eurozone, all of them, have been playing shady financial games to hide the real state of their budgets.  Every single one.

Oh, and Germany needs to put a cork in it.  Trade and balance of payments are ZERO SUM.  Every nation cannot run surpluses, it is mathematically impossible.  The more countries that do, the less Germany’s surpluses will be.  Germany’s surpluses are only possible because other countries run deficits.

When the Greeks get crammed down, hard, either through readjustment packages or because they go off the Euro and default (what I would do, but my by European friends inform me this is unthinkable to all good Eurocrats), when Spain, Ireland, Italy and Portugal get crammed down, that’ll lead to a nice demand collapse, which means less imports and worse balance of payments.  Which will make things worse for everyone else—because while balance of payments and trade are zero sum games in the sense that it has to come out to zero, prosperity is not.  If overall demand drops or grows very slowly, everyone is hurt.  Refusing to deal properly with these problems by putting Europeans and American to work by using deficit financing properly (as opposed to wasting it on tax cuts, bank bail outs and badly designed “stimulus” measures) would help everyone and pay itself back, as long as it was done in a way which also dealt with the oil bottleneck at the same time.

But that ain’t happening.  So at best we get a lousy few years economic cycle where over 80% of productivity gains go to corporate profits, wages stagnate and unemployment doesn’t recover anywhere near pre-crisis levels—or we get a second downleg of this financial crisis when China and Europe both crash out.  (It ain’t about America, babes.)  I’m waiting till the end of the summer to see where I’ll put my money (literally).  In the meantime, hold on tight.  I’d tell you to pray, but I’m not sure if crashing out or stumbling around with a bloody bandage on the stump is preferable.  I suppose the bandage.  I doubt even a second crash would be enough to make the powers that be understand they need to make fundamental changes.

Meanwhile, in the US, the strongest part of the recovery comes in medical, insurance, finance and construction.  As I said long ago, the fundamental Obama play was to try and reboot the bubbles.  Yay.

Insuring Shadow Banks Without Proper Regulation Is Asking For Disaster

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On April 20, 2010

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A correspondent suggested to me that what needs to happen is to create a system like the FDIC for the shadow banking system (largely unregulated financial institutions which act like banks without being regulated like them.) The argument is that this mitigates against hysterical herd behavior and that the shadow banking system is necessary because it’s where a lot of institutions put their money.  And no one is willing to insure this system but the government.

Shadow banking didn’t always exist at these levels, institutions found places to put their money.

As I understand this, it means insurance without equivalent regulation to ordinary banks—because if you used equivalent regulation you’d just make them into banks who have to follow the same rules as retail banks.  This means investors being insured who engage in extraordinarily risky behaviour in order to get returns which normal banks can’t and don’t provide.

I should note that, in fact, other people were willing to provide the insurance.  AIG did.  They just couldn’t pay up, because only the government could afford to pay up.

So therefore shadow banks, who can’t find anyone who could possibly afford to insure their risky business model, need governments to do it?

The question is if they are willing to charge the full price for the insurance?  I’ve worked in insurance, real insurance where we worry about having enough money to pay off when the loss event occurs, and here’s the way it works: it costs more than the value of the insurance.  If there’s going to be a crisis every X years because of these fools, then we need to charge enough money to not only cover the cost of their insurance every X years, but to cover the cost of things like the stimulus to clean up their messes, the unemployment insurance costs, and so on.  Or we could move to 90% taxation on all income over a million, which would only be fair, if we’re going to have to bail the rich out again and gain.

Either way, the high cost of real insurance would mean a lot lower profits.  It isn’t going to happen that way, the real cost is not something the shadow banking system is willing to pay.

And if they know they’re insured, without proper regulation, what they’ll do is drive over the cliff again.  Why not, if they know they’ll be bailed out, and in the good times they get to pay themselves massive bonuses and wages?  Moral hazard 101: heads they win, tails the taxpayer bails them out.

Maybe there are better solutions.  Like reinstituting Glass-Steagall, forcing everyone to 10:1 leverage ratios with nothing off the books, and shutting down the majority of shadow banking, which has shown that it costs the real economy more than it can possibly be worth.  What we don’t need is investors putting money into shadow banks in attempts to pursue 15%+ returns, thus ignoring putting money into the real economy.

As for hysterical herd behaviour, the real problem was the herd behaviour involved in CDOs, CDSs and the housing bubble.

Behaviour which should simply never have been allowed to occur.

If you don’t want bad behavior, don’t insure it, just outlaw it.

Krugman is trivially right and essentially wrong

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On April 15, 2010

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When he says:

In fact, we know what a system in which banks are allowed to fail looks like: that’s how the US banking system worked before the creation of the Fed. And you know what? It wasn’t a smoothly functioning system, with sound banking enforced by market discipline; it was a system periodically wracked by “panics” that destroyed peoples’ savings and plunged the economy into recession.

Finally, because that’s what really happens when banks are allowed to fail freely, promises not to bail out banks in the future aren’t credible. Fail to reform finance now, and there will be two, three, many TARPs in our future.

Again, small banks have been allowed to fail.  Today.  In large numbers.  So it is credible that small banks will be allowed to fail in the future.  It’s not the only thing which has to be done, but it is a necessary step.

The idea is that if every bank is small, no bank knows it specifically is “too big to fail”, and no bank thinks that it might not be one of the banks allowed to fail.

Finance is not going to be reformed enough, in any case. You know it, I know it, Krugman knows it.

TARP is a distraction.  It wasn’t necessary.  What happened, that mattered, was done mostly by the Fed with Treasury’s collusion, but that 700 billion was never needed, since the Fed can pull money out of its bum (and did.)

This is misleading:

Now, in 2008-2009 the shareholders were not cleaned out, and the bondholders left untouched; in part this was a policy decision, but it was also influenced by the lack of “resolution authority”: there was no clean, well-established route for seizing complex financial institutions. We can fix that, and deal with future Citigroups (one of which, given history, is likely to be … Citigroup) the way the FDIC deals with smaller banks: protect the depositors, clean out the shareholders.

This was entirely a policy decision.  While, no, the FDIC hadn’t closed down anything as big as Citigroup before (because before Glass-Steagall was repealed it was illegal to be as large as Citigroup), it had all the authority it needed and could have taken over Citigroup any time it wanted to.

This is a Bush response.  “I fucked up and didn’t do the right thing, so I need more authority, even though I had all the necessary authority.”

Granted, better regulation is needed, but the parts of regulation which failed were prior to the financial collapse.  The necessary authority to wipe out shareholders was in place.  That was a policy decisions—a political decision.  Neither Bush nor Obama was willing to greenlight the FDIC to do its damn job.

This is perhaps the stupidest disagreement I’ve seen in some time: no one who thinks breaking up banks is necessary thinks it is sufficient.  Why is Krugman acting as if they do?  Why does he want to protect large banks from breakup?  Why are we even talking about this?

Taxing the Poor to Bail out the Rich

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On April 13, 2010

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Value Added Tax (VAT) version:

When House Speaker Nancy Pelosi told Charlie Rose last October that a value-added tax was “on the table” as a possible way to solve the nation’s fiscal woes, the remark didn’t generate much interest. But as recent budget figures have put the depth of America’s problem into black and white, and with former Federal Reserve Chairman and White House adviser Paul Volcker nearly seconding Pelosi’s view recently, the idea of a VAT — already in use in nearly 160 countries — is gaining traction.

Trillions were spent bailout bankers, and every dollar spent fixing the mess since then is also effectively caused by the failure’s of the rich.

A VAT isn’t necessarily evil, but until progressive taxation is restored, capital gains are taxed at the same level as ordinary income, corporations are forced to pay taxes on their actual profits (rather than making billions and paying no taxes) and a financial transactions tax is implemented, why is another regressive tax (one that hits the poor instead of the rich) even being considered?

Oh, yeah, because this government exists to do unpopular things Republicans want to do while allowing Republicans to vote against them, as with HCR, essentially a 1994 Republican plan.

With Democrats like these, who needs Republicans?

Insanity is Doing the Same Thing and Expecting Different Results: Real Reform Means Reinstituting Glass-Steagall at Full Strength and Breaking Up Financial Conglomerates

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On April 10, 2010

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Ok, enough already. I’m sick of people talking about modern markets as if they are something wonderful. No, they aren’t. Obama was absolutely right during the election, they completely fell down on their job, not just for the last 8 years, but for most of the last 28 —whenever Republicans were in charge, and a fair bit when Dems were in charge. Ordinary people haven’t had a raise in damn near 30 years. This is success?

I simply, completely, and utterly fail to see what is so wonderful about the process of securitization. Sure, it allows you to create more financial products. Sure, it reduces the cost of capital somewhat. But are we really better off because of securitization? Of course we aren’t. Without securitization this current market meltdown would have been a hell of a lot milder. What securitization does is take the risk and spread it from the people who might be able to understand it and control it (the people actually issuing the mortgages, for example) to a ton of people who could not possibly know the risk even if they wanted to.

Ratings agency reform is not the solution, they completely fell down on the job and even if incentives were changed they are still not in a position to know whether a mortgage from Mr. Smith is legitimate. Are they going to visit the property? Talk to Mr. Smith? Call his employer? Of course not, they can’t. The only people who can are the people who issued the original mortgage.

Nor should risk be transfered much if at all. Risk must stay with the people who issue the mortgage. If they know it’ll be off their books they won’t do proper due diligence, and no one else can do it. At most, risk should be transfered once and must be transfered in whole and understandable form, rather than taking 20 different incomes steams (or more), melding them together, chopping them into tranches and selling them to people who really have no idea what they’re buying, while you’ve booked your profit and washed your hand, so even if you sold them crap, hahahah, it’s their crap now (or so you think.) Risk must be assumed only by people who can understand it and manage it and who are exposed to the consequences of their decisions. (Ability to manage risk, but knowledge that if they don’t they will get hurt.)

Now let’s talk about this idea that the Fed should basically regulate everyone, with the SEC occasionally peeping over it’s shoulder to see whether market manipulation is ocurring. This is necessary because there are, as Obama points out, no longer clear cut differences between banks, insurance companies, investment banks, brokerages and so on. The repeal of Glass-Steagall put an end to those differences. Glass-Steagall, remember was put in place during the Great Depression to stop another Great Depression from occuring. One of the things that people who lived through the 20s believed caused the Great Depression was not having clear cut boundaries between the businesses, again so that risk was divided appropriately and so that fewer companies became “too large to fail”.

But somehow we think we know better than the people who lived through the last Great Depression; the people who lived through the 20’s and the last great market crackup. So we’ve repealed most of Glass-Steagall and allowed everyone to be in everyone else’s pockets, huge financial conglomerates to mushroom into monstrosities, and allowed unregulated “innovative” financial “products” like collateralized debt obligation (CDOs) to grow into such monstrosites that financial markets were huge multiples of the entire real world economy.

Then it all comes crashing down and people claim to be surprised.

Enough, already. Yes, the world is not exactly the same as it was in the 20’s and 30’s, but we didn’t start having these disasters till after Glass-Steagall and other Depression era securities laws started getting repealed. First set in the 80’s, followed by most of the remainder in 99.

It’s time to break up the great financial conglomerates. Force them to cut themselves up and divide back into brokerage houses, investment banks, retail banks, insurance companies and so on. Put them all under the clear control of regulaters. Reinstitute Glass-Steagall, with very mild modernization, and get rid of most complex derivatives, excessive leverage, the carry trade and so on.

Obama was right during the primaries, the philosophy of the past 28 years has been a failure. Why don’t we, why doesn’t he, treat it as so, and re-institute what worked, re-regulate, then slowly modify from there, with complete transparency and strong regulation.

Financial markets exist to serve ordinary Americans and non-financial American businesses. They haven’t been doing that properly. Time to make sure they do.

This is a repost from September 16th 2008.  Very minor changes made to indicate when Obama said it, otherwise it stands the test of time remarkably well—which should tell you that nothing has been done since then.  The greatest economic disaster since the Great Depression, and a year and half later nobody has tried to fix what caused it to happen.  Priorities, priorities…

Progressive Enablers

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On March 23, 2010

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So, these last few days we’ve seen virtually every major progressive blogger say that the health care bill was worth passing and that progressive members of Congress who promised to vote against it if it didn’t include a public option were right to do so.  (I, of course, think that the public option as offered was crap, but that’s not the point, they made explicit promises not to vote for a bill that didn’t include one.)

The argument I have heard is that of course they never meant it, “everyone” knew they were lying, and that it is unreasonable to expect them to keep to their word.

What I take from this is that most progressive bloggers believe that we should just assume that politicians are liars and not take them at their word.

Is that really what they want to argue?  That all progressive politicians, every single one, are liars who won’t keep their word?

I’m willing to agree with them, if that’s what they’re trying to say, or rather, I think they’re gutless.  I think when the pressure is put on them, they fold.

And almost every  “major progressive” forgives them, which is why they keep lying and keep folding, because they know they will be forgiven for being gutless liars.

That’s the behaviour most progressive bloggers, and everyone else making excuses for them, enables.

This entire generation, whether in media or power, is hopeless.  A write off. Gutless, stupid and liars.  They all need to go.  And forgive me, that includes most of the high ranked bloggers, many of whom I consider my friends.  Instead of being people who challenged power, who had the moral and intellectual integrity to speak from a place of principle, they have become apologists for the worst sort of craven sell-outs imaginable, constantly decided that if some group wins it’s ok to hurt other groups, including by taking away their rights.

The blogosphere I grew up in, is dead.  And the hope that the Democrats would be enough better than the Republicans to fix America, well, that too is dead.

Lowest Bank Lending since

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On February 25, 2010

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Whoever would have expected? (h/t Agonist)

U.S. banks posted last year their sharpest decline in lending since 1942

Of course, this is exactly what we warned would happen.

Can you say Japanification?  Sure you can.  Banks are impaired.  Badly.  So they don’t want to lend.  To get lending going again it was necessary to take over bankrupt banks, to siphon off bad loans, to force both bondholders and stockholders to take their losses.

Larger banks are doing better than smaller banks, which should be no surprise as they’re the ones the Feds concentrated on bailing out because if you bailed out small banks they couldn’t be bought up for cents on the dollar by Geithner and Bernanke’s friends in the financial industry.

Refusing to do the right thing has consequences.  This is one of them.

A Smart Proposal From Volcker and Obama

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On January 21, 2010

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Guess a kick in the head sometimes knocks some sense into people.  I confess I’m surprised.  Maybe they can learn.

The White House wants commercial banks that take deposits from customers to be barred from investing on behalf of the bank itself—what’s known as proprietary trading—and said the administration will seek new limits on the size and concentration of financial institutions.

… Banks shielded from risk through federal-deposit insurance, or aided in financial crises by low-interest loans from the Federal Reserve Board, would no longer be allowed to engage in trading unrelated to their customers’ interests, one senior administration official said.

Under the proposed rule, commercial banks would be prohibited from owning, investing in or advising hedge funds or private equity firms. Bank regulators would not be simply given the discretion to enforce such rules. They would be required to do so.
…
Administration officials said they also want to toughen an existing cap on bank market share. Since 1994, no bank can have more than 10% of the nation’s insured deposits. The Obama administration wants that cap to include non-insured deposits and other assets.

This is the right thing to do.  I agree with Johnson that they should also launch anti-trust investigations of the banks.  I would add, that in addition, they should launch criminal fraud investigations into bank behaviour leading up to the financial crisis.  Keep these people so tied up, and get them so scared that they want peace at any cost.

As Johnson notes, it seems unlikely this can pass the Senate.  But if Obama wants to not have a disaster in the 2010 elections, he should make these sort of actions the centerpiece of his administration for the next year.  Run against the banks, and go hardcore populist.  Because if he doesn’t, the Republicans will go faux populist, and win on it.

We’ll see, in the next few months, how serious Obama is about taking.  Is this for real and will he pursue it with all his might, making a fight of it, or he will pursue it like everything else he’s done—half-heartedly, and for show?  Will he push it hard in the Senate, or when the Senate balks, will he shrug and say ‘whatever Ben Nelson wants?”

I’m not optimistic, but at least, in a pleasing change from most of his behaviour since the election, Obama is talking about doing the right thing.

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