Irish Austerity: "Crimes and Mistakes"

(Modern) History Quiz

"You have to wonder what it will take for serious people to realize that punishing the populace for the bankers' sins is worse than a crime; it's a mistake."

Who said the above, about what?

A. President Obama, about TARP, zero percent interest rates, and other Wall Street bailouts.
B. FDR about investment bankers, circa 1933.
C. Paul Krugman, about the so-called IMF bailout of Ireland.
D. William Jennings Bryan, about the Gilded Age bankers.

Answer: C. (See, 'Eating the Irish" in today's NYT).

"A." is just wishful thinking; "B." and "D." never happened -- but could have.

How Peter Lynch Would Reform Wall Street

Too Big to Fail? Try, Too Complex to Reform

Banks are like the heart that pumps blood — credit — to our country’s corporate muscles. If that heart is malfunctioning, any recovery will be anemic. But heart surgery is a very complex thing. You wouldn’t want yours done by a plumber or a politician.

--Thomas L. Friedman, "When Economics Meets Politics"; The New York
Times (2/3/10)

Of all the canards Wall Street has sold to would-be reformers, regulators, and at least one NY Times columnist, the biggest (and most self-serving) is that it is . . . inherently complex --"a beating heart," if you will.

Because Wall Street finance is so complicated, you need a Wall Street financier to oversee it. Or lots of them.

Eventually, *Wall Street insiders (vs. public-spirited civil servants, in the Paul Volcker mold) are running the Treasury Department, policing the securities markets, and serving as senior advisors to the President.

Sound familiar?

"The Complexity Canard"

The solution to Wall Street excess only partially lies in making too-big-to-fail firms smaller.

The other piece is to make the financial system simpler ("boring," if you prefer Paul Krugman's term).

Famed investor Peter Lynch famously advised, "invest in a business that any idiot can run -- because sooner or later, any idiot probably is going to run it."

My corollary for reforming Wall Street would be:

"Design a financial system that any idiot can regulate -- because sooner or later, any idiot is probably going to regulate it."

*Of course, FDR appointed a quintessential Wall Street insider, Joseph Kennedy, to head the newly created Securities and Exchange Commission. But Kennedy wielded his power on behalf of investors, not Wall Street. Imagine that . . .

Robins, Flamingos, and Penguins

What Does a "Bird" Look Like?

Before you pose the question, "What does a well-designed financial system look like?," first ponder the question, "what does a bird look like?" Seriously.

Robins, flamingos, and penguins bare little resemblance to one another.

Yet scientists classify each as birds, and each could be called an environmental "winner": endowed by evolution with a cluster of traits and survival strategies that make it well-adapted to its particular environment.

So it should be no surprise that there can be different models for successful banking systems.

Consider Paul Krugman's take on the Canadian model:

Canada’s experience seems to support those who say that the way to keep banking safe is to keep it boring — that is, to limit the extent to which banks can take on risk.

More specifically, Canada has been much stricter about limiting banks’ leverage, the extent to which they can rely on borrowed funds. It has also limited the process of securitization, in which banks package and resell claims on their loans outstanding — a process that was supposed to help banks reduce their risk by spreading it, but has turned out in practice to be a way for banks to make ever-bigger wagers with other people’s money.

--Paul Krugman, "Good and Boring"; The New York Times (2/1/2010)

Krugman goes on to note that Canada's "boring" financial system has held up just fine even though, with just five, dominant banking groups, "essentially all the Canadian banks are too big too fail."

Sweden is another country that has accepted a highly concentrated -- albeit heavily regulated and "boring" -- banking industry.

Unfortunately, we in the U.S. have ended up with the worst of both worlds: dangerously -- recklessly -- big and inter-connected financial players on the one hand, and light to non-existent oversight on the other.

You might call such a combination a "Turkey" of a design.

Or a Dodo bird . . .

"The Joy of Sachs"*

And Then There Were Two

Goldman and Morgan were assisted in a rather violent industry consolidation. They remain, more than ever, officially “too big to fail” (TBTF), so they know they can always request tax funds directly from the Treasury Department and elevate risks above competitors. With their enormous profits they can buy out any remaining politicians and expand their direct appropriation of taxes, pensions, and anything else they might want. They really should be congratulated. It isn’t easy toppling a large nation with barely a shot fired.

--post, Floyd Norris blog , "A Great Time to be a Banker"; (NY Times; 7/16/09)

No, the author of this post isn't Matt Taibbi (the "poster" is someone named Nelson Alexander).

And, yes, his analysis of what has transpired the last 18 months or so seems startlingly accurate (and depressing, and enraging).

Or, maybe it's just that I agree with it.

Here's my post on Mr. Norris' blog in response (yes, I occasionally contribute to other blogs):

Once upon a time, corporate charters were granted stingily, directly by the sovereign, on the condition that the recipient serve the interests of the commonweal. Can anyone argue that that’s what Goldman Sachs and JP Morgan Chase are doing today? Or have done the last 2 years — or twenty?

Forget the inevitable class actions suits to come, kicked off by CALPERS’ against the credit rating agencies. The judgments will be years in the coming, then appealed even longer (think, Exxon Vadez). Maybe it’s time to go for their jugular; they sure know how to go after ours!

--"A Great Time to Be a Banker", Floyd Norris blog (see, comment #28)

Want a more succinct take on all this? Try *Paul Krugman:

Goldman is very good at what it does. Unfortunately, what it does is bad for America.

--Paul Krugman, "The Joy of Sachs"; The NY Times (7/17/09)

Weighing the Risk of Inflation

Rebutting Paul Krugman on Inflation

If you don't know whether to worry more about inflation or deflation -- economists seem to be evenly split at the moment -- a good technique is to parse the arguments being made by the two camps.

Here is the case made by Paul Krugman, a leading proponent of the "worry more about deflation" school ("The Big Inflation Scare"). As you'll see from my rebuttals (in parentheses), I don't find him persuasive.

PK: At the moment, all the leading price indices show that inflation is quite modest. If anything, the direction of prices is deflationary (especially home prices).

Rebuttal: Three days before Katrina hit, the weather in New Orleans was sunny. Simply extrapolating from current conditions doesn't constitute rigorous forecasting.

PK: Historically, very few countries have purposely used inflation to pay off a runaway national debt. For example, France after WWI. On the other side of the ledger, countries such as Japan, Canada, and Belgium have serviced national debts that, relative to the size of their economies, were even bigger than the U.S. debt is soon projected to be.

Rebuttal: Canada? Belgium? How does the experience of these countries -- literally a fraction of the size of the U.S. -- portend anything for the U.S? Even Japan's experience is a dubious precedent for the U.S.: it is a nation of savers, and traditionally has run huge trade surpluses. The U.S. is by far the world's biggest economy, and now has the dubious distinction of being the biggest debtor nation -- by far -- in history.

PK: At the moment, all the money stuffed into banks to repair holes in their balance sheets is just sitting there, rather than funding new loans. So, at least at the moment, the Fed's decision to "monetize" the banks' bad debts isn't inflationary.

Rebuttal: So what? A warehouse full of dynamite isn't safe just because there aren't any matches around at the moment.

Echoes of LTCM

Ultimately, what I find most unsettling about the arguments advanced by Krugman et al is their assumption that, simply because something is historically rare, therefore, it's unlikely.

That sounds a lot like the thinking baked into the models used at Long-Term Capital (Mis)Management ("LTCM"), the Nobel laureate-advised investment fund that famously blew itself up in 1998 -- and threatened to take the U.S. financial system with it.

Or, much more closer to home (pun intended), the arguments economists made to justify perpetually rising housing prices, or at least a long-term plateau.

As recently as 2006, they argued -- correctly -- that U.S. housing prices had never fallen in aggregate on an annual basis since The Depression.

So much for that one . . .

The Hippo in the Coal Mine

California's Financial Mess

You have to wonder if California’s political paralysis foreshadows the future of the nation as a whole.

--Paul Krugman, "State of Paralysis"; The New York Times (5/25/09)

Just in case you've been enjoying a blissfully off-line Memorial Day weekend, the big story percolating on the leading op-ed pages and blogs at the moment is California's financial predicament. As in, it's out of money. Very soon.

Apparently, its three options are: 1) federal bailout; 2) bankruptcy; or 3) a dramatic cut in services coupled with tax increases. Or all three.

As Krugman notes, if it's true that, as California goes, so goes the country . . . we're in trouble.

Unfortunately, while there is only one Freddie Mac and Fannie Mae, and a handful of too-big-to-fail banks, auto makers, and insurers -- there are 49 other states, hundreds of big cities, thousands of counties, etc.

Bad Precedent

There really is no philosophical reason to extend aid to California and not to Colorado, or New Mexico, or . . . you get the idea.

So, what inexorably bubbles back up to the top of the agenda: the need for structural reform.

As cited in this blog and many others, the good news is, there's surprising consensus about the appropriate package of economic and political prescriptions (address the phenomenon of "regulatory capture," wield the nation's foreclosure laws as they were intended, open up the nation's sclerotic, two-party political system, etc.).

The bad news is, it's far from clear that doing any of the above -- on any realistic kind of timetable -- is politically viable.

Krugman again: "What’s really alarming about California, however, is the political system’s inability to rise to the occasion."

Is California "us??"

Required Reading

"Who's Who" Discussion of Financial Crisis

Best read of the weekend: a roundtable called "The Crisis and How to Deal With It."

Participants are a "who's who" of finance and public policy: Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, and George Soros.

Warning: their (quite sober) analyses are not for the easily spooked or faint of heart. Here's an excerpt from Nouriel Roubini:

There are only a few ways of resolving a [huge national] debt problem: either you default on it as countries like Argentina did; you use the inflation tax to wipe out the real value of the debt; or you have to raise taxes and cut government spending.

As depressing as the mess, its causes, and likely solutions are . . it's encouraging that someone out there has got a handle on what to do about it.

Now, if only they were in charge . .

Bank "Stress Test" Results

The "Muddle-Through Strategy"

What we’re really seeing here is a decision on the part of President Obama and his officials to muddle through the financial crisis, hoping that the banks can earn their way back to health . . . maybe we can let the economy fix the banks instead of the other way around.

--Paul Krugman, "Stressing the Positive"; The New York Times (5/8/09)

No, there's been no official pronouncement, but as Krugman details, the administration has clearly adopted what pundits are calling "the muddle-through strategy."

A similar approach worked in the early '90's, after U.S. banks suffered from the collapse of commercial real estate.

Will it this time?

Again, Krugman cuts to the quick.

Whether or not you benefit from Washington's solicitous approach to the big banks "depends on who you are: a banker, or someone trying to make a living in another profession."

Krugman: 'Only One Parachute'

Fixing the Financial System

If . . taxpayer funds end up providing windfalls to financial operators instead of fixing what needs to be fixed, we might not have the money to go back and do it right. And the lesson of Ireland is that you really, really don’t want to put yourself in a position where you have to punish your economy in order to save your banks.

--Paul Krugman, "Erin Go Broke," The New York Times; 4/20/09

Too often, op-ed pieces discussing the financial system are impenetrable. Written by economists for economists, they leave the general public in a fog.

Krugman is one of the few economists whose pieces are (in my opinion) both consistently on target, and readily accessible -- none more than today's. (I'm not automatically a fan of every economist who has a Nobel prize on his mantle, but in Krugman's case, it's well deserved.)

If you don't understand what's been happening, Krugman boils it down to as succinct a two-sentence summary as I've seen (the rest of the piece discusses Ireland's terrible predicament, whose ultimate financial sin was "being just like us, only more so").

Obama's "Goldilocks" Approach

Obama's Fiscal Stimulus
Splits the Difference

"Obama's economic plan falls well short of what's needed."
--Paul Krugman, "The Obama Gap" (NYT, 1/9/09)

"Obama has vowed to do everything at once . . this will be the most complex piece of legislation in American history."
--David Brooks, "The Confidence Surplus" (NYT, 1/9/09)

Depending on who you believe, President-elect Obama has devised a $1 trillion(!) fiscal stimulus plan that either: a) is much too modest in scope; or b) wildly overreaches.

So far, so good . . .

Mortgage Rate Disconnect

Dropping Mortgage Rates
Still "Artificially" High

Where should mortgage rates be right now? If historical relationships held, the rate on a 30 year mortgage would be 3.5%(!).

No, that's not a typo; going back a decade or more, long-term mortgages cost typically cost about 150 basis points more than the 10 year U.S. Treasury Bond yield. The yield on the latter now is barely over 2%.

An increasing number of commentators are joining the camp -- I've long been in it -- that closing that gap would do much to staunch the bleeding in the national housing market. In turn, stabilizing housing would do wonders for the broader economy.

In his blog post today, "Mortgage rates are still too high," economist and New York Times columnist Paul Krugman is only the latest to emphasize this link:

http://krugman.blogs.nytimes.com/2008/12/26/mortgage-rates-are-still-too-high/?hp

Lower rates have two, huge benefits: 1) they instantly increase prospective home buyers' purchasing power; and 2) they allow millions of existing homeowners to refinance, lowering their monthly payments and freeing up money for other things (like food, gas, and utility bills!).

The problem with mortgage rates, like almost everything else related to the credit markets, is that normal market mechanisms aren't working now. Instead, through its web of guarantees, bailouts, and cash infusions, the federal government is essentially deciding who can borrow, who can lend, and at what rates.

In such a command-and-control environment, the price of virtually everything credit-related could be said to be "artificial" (government-set), vs. market-determined.

If that's the case, Washington might as well "go all in" and make life easier for millions of American consumers -- not just Wall Street investment banks, too-big-to-fail insurers, automakers, etc.