The President and Congress just don’t get it!
Financial reform is in the air! The bad guys did it and they need to be brought to account! Protect Main Street and go after those that are on Wall Street!
Unfortunately, this is not going to produce the results that the President and Congress want.
Unfortunately, we are not going to get helpful results until the President and Congress develop an understanding about finance and what their current philosophies about economic policy are doing.
Unfortunately, I don’t see this happening in the near term.
Just two points this morning, but points that I have made before.
The first point pertains to the understanding…or misunderstanding…of what finance is all about. This misunderstanding is captured in the lead editorial in the New York Times this morning titled “After Goldman” (http://www.nytimes.com/2010/04/22/opinion/22thu1.html?hp). In this editorial we read: “The Goldman deal was nothing more than a bet on the mortgage market…WITHOUT ‘INVESTING’ ANYTHING IN THE REAL ECONOMY.”
Guess what? That is what finance ultimately is. Finance is nothing more than information and millions and millions of people operate with this kind of information every day.
What is your dollar bill? A piece of paper…a piece of information.
Well, but it is legal tender!
Right, according to the government you have to accept a dollar bill in payment for debt. What has this got to do with THE REAL ECONOMY?
And, what about the demand deposit account you have at your commercial bank? It is just 0s and 1s in some computer. What has this got to do with THE REAL ECONOMY?
By the way, you are betting that you will be able to access that money when you need it? Is it safe?
Well, you say, the deposit account has insurance on it, doesn’t it? The Federal Government has guaranteed that you will not lose these funds and will not be inconvenienced by a delay in access to them. You have a promise! But, what has that got to do with THE REAL ECONOMY?
What are loans? Well, they are cash flows. Say, an initial cash outflow to the borrower and then a series of cash inflows back to the lender. Just 0s and 1s through bank accounts.
But, I put up a house to back the loan, didn’t I? The house is a real asset.
Yes, but the loan agreement is in terms of cash flows and the house is there for security in case you don’t pay the returning cash flow. Furthermore, that house is 25% underwater now, another piece of information, so how does this impact the cash flows?
Furthermore, it was the government that showed us how to “slice and dice” cash flows in order to tailor cash flows so that potential purchasers would find those “new” cash flows more attractive and purchase them. The first mortgage-backed security was issued by the Federal Government in 1970. The mortgage market went from playing a zero role in world capital markets to becoming, by the middle of the 1980s, the largest component of world capital markets. (See Michael Lewis’ “Liar’s Poker”.)
Thank you Washington for teaching us that cash flows are just bits of information! No real world
here.
Now Washington wants to bring the herd of cats it has unleashed under control. Good luck!
The second point has to do with government policy and how it creates the environment for all else that goes on in the economy. Some of this discussion can be related to the David Wessel’s column in the Wall Street Journal this morning, “Mapping Fault Lines of Crises,” (http://online.wsj.com/article/SB20001424052748704133804575198080507492968.html#mod=todays_us_page_one). Wessel, in his column, discusses the work of Raghuram Rajan, a professor at the University of Chicago and former chief economist at the International Monetary Fund.
Rajan argues that “The U. S. approach to recession-fighting and its social safety net are geared for fast recoveries of the past, not jobless recoveries now the norm. That puts pressure on Washington to do something: tax cuts, spending increases and very low interest rates. This leads big finance to assume that the government will keep money flowing and will step in if catastrophe occurs.”
This philosophy of government was first incorporated into government policymaking in the early sixties and has continued as the foundation for economic policy ever since. A consequence of this has been that the purchasing power of the dollar has gone from $1.00 in January 1961 to $0.15 in 2010. And, as we know, a sustained inflationary environment is one that produces massive debt creation and increasing financial leverage along with extensive amounts of financial innovation.
This leads us to another part of Rajan’s argument: “As incomes at the top soared (in the last half of the 20th century), politicians responded to middle-class angst about stagnant wages and insecurity over jobs and health insurance. Since they couldn’t easily raise incomes, politicians of both parties gave constituents more to spend by fostering an explosion of credit, especially for housing.” And, Wessel states, Rajan goes back in history to support the fact that this is not an atypical reaction.
The latter move not only contributed to general inflation, but eventually led to asset price bubbles in specific sectors of the market which could not be sustained. Hence the financial crisis!
Finance has never really been connected to THE REAL ECONOMY. Take a look at Niall Ferguson’s book “The Ascent of Money.” (See my review, http://seekingalpha.com/article/120595-a-financial-history-of-the-world.) This is especially true since the growth in finance and financial innovation, historically, has been connected with government’s financing of wars and, in the 20th century, the social system.
Furthermore, finance, in the future, is going to be even more connected with the idea of information and the exchange of information. For example, see the book “The Quants” (http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson). And, this concept is spreading beyond financial markets. An amazing amount of research efforts and publications are connected with “Information Markets” which are not related to financial markets. Bob Shiller of “Irrational Exuberance” has produced a lot in this area: see his books “Macro Markets” and “The New Financial Order.”
The point is, again, that the President and Congress are fighting the last war. But, the last war is history!
Showing posts with label Main Street. Show all posts
Showing posts with label Main Street. Show all posts
Thursday, April 22, 2010
Thursday, December 17, 2009
Will Bernanke Never Learn?
The report from the Federal Reserve yesterday was positive. The headline in the Wall Street Journal was typical: “Fed More Upbeat, but Keeps Lid on Rates.” In other Federal Reserve news we hear that the Fed is going to phase out the special facilities set up during the financial crisis.
So, what else is new? (http://seekingalpha.com/article/178117-federal-reserve-exit-watch-part-5)
Our fearless leader, Time’s Person of the Year, POTY, Chairman Benjamin Shalom Bernanke, was an avid supporter of Alan Greenspan and low, low interest rates earlier this decade, rates that spurred on the credit bubble in housing and elsewhere. In 2007, Chairman Bernanke was late in identifying the fact that the economy was slowing and that there was a looming financial crisis on the horizon. Then, Time’s POTY seemingly panicked after the bailout of AIG in September 2008 and this resulted in the rushed passage of TARP. (http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic)
Once it was finally accepted that there was a financial crisis, POTY saw to it that just about everything that could be thrown against the wall, was...thrown against the wall. In this he has been deemed a savior. The balance sheet of the Fed ballooned from about $900 billion to roughly $2.1 trillion.
Now, POTY is seeing that the target rate of interest for the conduct of monetary policy can hardly be differentiated from zero and this target has been maintained since December 16, 2008.
WOW! The Fed’s zero target rate of interest was one year old YESTERDAY!
Excess reserves in the banking system have gone from about $2 billion to over $1.1 trillion!
And, what is the result?
Big banks are eating this up! There are two articles in the morning papers that attest to this. See the column by John Gapper in the Financial Times, “How America let banks off the lease”: http://www.ft.com/cms/s/0/0ad195f8-ea7a-11de-a9f5-00144feab49a.html. Gapper writes, “As the FT reported on Wednesday, banks and hedge funds have made huge profits in distressed debt trading in the past year, aided by the Federal Reserve keeping short-term interest rates low. Meanwhile, the banks that turned out to be too big to be allowed to fail are bigger than ever.”
Next, the op-ed piece in the Wall Street Journal by Gerald P. O’Driscoll, Jr., “Obama vs. the Banks”: http://online.wsj.com/article/SB20001424052748704398304574597910616856696.html#mod=todays_us_opinion. O’Driscoll states “that banks can raise short-term money at very low interest rates and buy safe, 10-year Treasury bonds at around 3.5%. The Bernanke Fed has promised to maintain its policy for ‘for an extended period.’ That translates into an extended opportunity for banks to engage in this interest-rate arbitrage.” He then asks, “Why would a banker take on traditional loans, which even in good times come with some risk of loss?” Seems like I have been arguing this point for at least six months now in assorted blog posts.
But, of even more importance is the attitude of the bankers toward financial innovation.
There is no better environment for financial innovation than the one that we are now experiencing. I would argue very strongly that financial innovation is taking place right now even though we may not see all the different forms the innovation is taking. And, the current round of financial innovation is coming at the expense of regular borrowing and lending. And, the financial innovation is benefitting the large, financially savvy financial institutions and not the small- and medium-sized organizations that don’t have the resources, or, the inclination, or, the freedom, since they still have plenty of questionable assets to deal with. Hail, Wall Street! See you later Main Street!
For the past fifty years or so, the government of the United States has basically followed an expansionary economic policy that has provided a safety-net to the financial system, and established an inflationary bias within the economy. There is no better environment for financial innovation than this!
The banks, the financial system, the non-financial system, and governments have innovated like mad during this time period.
The current federal government is just continuing to underwrite this practice at the present time.
POTY and the current administration are just exacerbating the situation they are so heavily criticizing.
And, as Gapper states, "the banks that turned out to be too big to be allowed to fail are bigger now than ever."
POTY and the current administration may win, politically, in the short run because the big bankers seem to have a deaf ear: See http://seekingalpha.com/article/178269-defining-the-banking-situation-as-a-political-issue.
In the longer run, the victory may go to another side. Paul Volcker seems to be taking the other side of the argument. See the article by Simon Johnson in The New Republic: “Is History on Paul Volcker’s Side?” http://www.tnr.com/blog/the-plank/history-paul-volckers-side.
The bottom line, however, is that Benjamin Shalom Bernanke doesn’t seem to get it…once again! Time after time, the Fed Chairman has seemed to miss the mark. Because of this record, one, I think, can seriously ask the question: “Why should we expect Bernanke to be correct this time?”
In nominating the Chairman for another term, President Obama seems to believe that Bernanke will be correct this time. More than anything else the president has done, even sending more troops into Afghanistan, his bet on the re-appointment of Chairman Bernanke may determine how his presidency is perceived by future historians. A lot is riding on Chairman Bernanke.
So, what else is new? (http://seekingalpha.com/article/178117-federal-reserve-exit-watch-part-5)
Our fearless leader, Time’s Person of the Year, POTY, Chairman Benjamin Shalom Bernanke, was an avid supporter of Alan Greenspan and low, low interest rates earlier this decade, rates that spurred on the credit bubble in housing and elsewhere. In 2007, Chairman Bernanke was late in identifying the fact that the economy was slowing and that there was a looming financial crisis on the horizon. Then, Time’s POTY seemingly panicked after the bailout of AIG in September 2008 and this resulted in the rushed passage of TARP. (http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic)
Once it was finally accepted that there was a financial crisis, POTY saw to it that just about everything that could be thrown against the wall, was...thrown against the wall. In this he has been deemed a savior. The balance sheet of the Fed ballooned from about $900 billion to roughly $2.1 trillion.
Now, POTY is seeing that the target rate of interest for the conduct of monetary policy can hardly be differentiated from zero and this target has been maintained since December 16, 2008.
WOW! The Fed’s zero target rate of interest was one year old YESTERDAY!
Excess reserves in the banking system have gone from about $2 billion to over $1.1 trillion!
And, what is the result?
Big banks are eating this up! There are two articles in the morning papers that attest to this. See the column by John Gapper in the Financial Times, “How America let banks off the lease”: http://www.ft.com/cms/s/0/0ad195f8-ea7a-11de-a9f5-00144feab49a.html. Gapper writes, “As the FT reported on Wednesday, banks and hedge funds have made huge profits in distressed debt trading in the past year, aided by the Federal Reserve keeping short-term interest rates low. Meanwhile, the banks that turned out to be too big to be allowed to fail are bigger than ever.”
Next, the op-ed piece in the Wall Street Journal by Gerald P. O’Driscoll, Jr., “Obama vs. the Banks”: http://online.wsj.com/article/SB20001424052748704398304574597910616856696.html#mod=todays_us_opinion. O’Driscoll states “that banks can raise short-term money at very low interest rates and buy safe, 10-year Treasury bonds at around 3.5%. The Bernanke Fed has promised to maintain its policy for ‘for an extended period.’ That translates into an extended opportunity for banks to engage in this interest-rate arbitrage.” He then asks, “Why would a banker take on traditional loans, which even in good times come with some risk of loss?” Seems like I have been arguing this point for at least six months now in assorted blog posts.
But, of even more importance is the attitude of the bankers toward financial innovation.
There is no better environment for financial innovation than the one that we are now experiencing. I would argue very strongly that financial innovation is taking place right now even though we may not see all the different forms the innovation is taking. And, the current round of financial innovation is coming at the expense of regular borrowing and lending. And, the financial innovation is benefitting the large, financially savvy financial institutions and not the small- and medium-sized organizations that don’t have the resources, or, the inclination, or, the freedom, since they still have plenty of questionable assets to deal with. Hail, Wall Street! See you later Main Street!
For the past fifty years or so, the government of the United States has basically followed an expansionary economic policy that has provided a safety-net to the financial system, and established an inflationary bias within the economy. There is no better environment for financial innovation than this!
The banks, the financial system, the non-financial system, and governments have innovated like mad during this time period.
The current federal government is just continuing to underwrite this practice at the present time.
POTY and the current administration are just exacerbating the situation they are so heavily criticizing.
And, as Gapper states, "the banks that turned out to be too big to be allowed to fail are bigger now than ever."
POTY and the current administration may win, politically, in the short run because the big bankers seem to have a deaf ear: See http://seekingalpha.com/article/178269-defining-the-banking-situation-as-a-political-issue.
In the longer run, the victory may go to another side. Paul Volcker seems to be taking the other side of the argument. See the article by Simon Johnson in The New Republic: “Is History on Paul Volcker’s Side?” http://www.tnr.com/blog/the-plank/history-paul-volckers-side.
The bottom line, however, is that Benjamin Shalom Bernanke doesn’t seem to get it…once again! Time after time, the Fed Chairman has seemed to miss the mark. Because of this record, one, I think, can seriously ask the question: “Why should we expect Bernanke to be correct this time?”
In nominating the Chairman for another term, President Obama seems to believe that Bernanke will be correct this time. More than anything else the president has done, even sending more troops into Afghanistan, his bet on the re-appointment of Chairman Bernanke may determine how his presidency is perceived by future historians. A lot is riding on Chairman Bernanke.
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