"An Absence of Oversight"

Robert Waldmann has more on bank regulation, and whether an erosion of the wall between banks and Wall Street helped to bring about the financial market crisis:

Paul Krugman Doesn't Need My Help, by Robert Waldmann: Paul Krugman doesn't need my help, but I think that Jonathan Taplin is being unfair here and is also unfamiliar with the evidence on banking regulation and banking crises.

He tells a tale of how after the Great Depression, Democrats worked to protect the banking system from runs, by enacting a split of Investment Banks and Commercial Banks.

[snip]

But never once in the whole article does he point out who yielded to the enticements of Wall Street--who was responsible for destroying the Glass-Steagall separation of Banks and Investment Banks--Bill Clinton.

Krugman didn't mention the Glass-Steagall act in his column. ...

The ... problem is not, say, that commercial banks which were allowed to own common stock gambled and lost. The way in which the Glass-Steagal act would have been relevant is if the investment banks had taken deposits. They didn't. The crisis is based on commercial banks being irrelevant, not on their being allowed to do things they couldn't do before. ...

[This also rebuts the update at the end of the post A Coordinated Effort to Destroy Effective Regulation.]

From comments:

There is reason to believe, I am again told with authority, that the problem in the financial markets has not been an absence of regulatory capability, but an absence of oversight and regulation that is part of the anti-regulatory philosophy that has steadily grown for 25 years but reached culmination with this Administration. ...

I think there's something to this. There is quite a bit of discretionary authority in the hands of regulators. As the philosophy of both parties has drifted toward a hands off approach over time, and as appointment after appointment to this or that agency has reflected that changing philosophy, the accompanying regulatory oversight has changed along with it. The changes have been more dramatic under Republican administrations, and the current administration strongly prefers a hands off approach on all matters involving economic policy (with the exception of tax cuts for the wealthy), so it's no surprise that the same philosophy has, over the last several years, filtered into the offices charged with regulatory oversight more so than in the past (and appointments based upon how much someone contributed and the strength of their ideology rather than their competence hasn't helped). To change all of this and reign in the excesses, it will take more than just changing the rules, it will also be necessary to change the people interpreting and enforcing the rules, and that won't happen without a change in party in control of the executive branch.

Robert's point is that we need to address the correct problems, and pointing fingers at the change in the Glass-Steagall act misses the mark, but once we understand where the problems are we also need the will to address them and it's hard to imagine that will existing under the continuation of this administration's economic philosophy that we would get with McCain. It's not that clear that the Democratic candidates have the will either, that was Paul Krugman's point, but at least there's some hope.

Comments

[Gabriel]

Prof. Thoma,

I read a lot on your blog about the benefits of regulation. Will I ever hear about its costs too?

Rgds, G.

[Mark Thoma]

I've discussed the costs and tradeoffs in the past, many, many times (and I have not shied away from talking about moral hazard, another cost). But right now it's time to explain the problems we are experiencing due to the failure to impose effective regulation, and explain how to prevent those costs in the future, not to divert the conversation onto other issues.

You don't ever believe that government intervention can be helpful (or nearly so), and I can understand how, when you transport these kinds of policies into the institutions you see around you in your country, and evaluate the policies from your own experience of how those institutions operate, you are very negative on government intervention. That's your experience. Mine is different.

There can be excesses on both sides - too much intervention and too little - but it's hard to make the case that the problems we are seeing are from too much government intrusion. Some will try, some have already tried to make that case (see Hassett), but I am not persuaded. For now, the main thing is to figure out how to craft an effective response taking account of (and minimizing) the most important problems associated with intervention such as moral hazard. Detailed discussions about all the other inefficiencies in government that make responses less than perfect (but in this case still surely a net benefit), can wait for another day.

[BJ Feng]

One problem is that the financial regulators have to be more knowledgeable than its participants in order to determine that a certain product is too risky or to make the claim that the bank/financial entity has an unacceptable amount of risk on its books. Most of the products that have caused the turmoil are new and past data couldn't reflect performance in a down market. I believe that equity requirements have to be modified to prevent off balance sheet transactions and to account for the different types of "AAA" products out there. I also think that there is much less need for more regulation than implied by the media. Now that we know how the new products behave in a downturn, financial entities will adjust and not extend themselves as they've done in the past. In other words, they'll learn from their mistakes as well investors. Stockholders will punish institutions that take a large amount of risk from now on, we simply did not understand the actual risk of the new innovations but we do now. I'm open to detailed proposals, but most sources just call for "more regulation" without specifying what form this regulation will take.

[Bruce Wilder]

Taplin's point is not about Glass-Steagall, per se, but about Krugman being a shameless Hill-Shill.

Robert Waldmann's point about Glass-Steagall is misdirection. The target of the Gramm-Leach-Bliley Act was the bank holding company provisions, to allow the creation of financial conglomerates. It wasn't about investment banks accessing commercial bank deposits, or any other anachronistic concern with the problems of 1929. It was about facilitating fraud, predation and the circumvention of regulations.

If you want to understand Gramm-Leach-Bliley, you need to think not about margin lending fueling wild speculation on the Stock Exchange in 1928 and 1929; you should think about Henry F. Potter, Lionel Barrymore's evil Banker character in It's a Wonderful Life. Gramm-Leach-Bliley was designed help out old man Potter, aka Sanford I. Weill, exercise his evil will at Citigroup.

The immediate issue in Citigroup's case was the firewall Glass-Steagall erected between banking and insurance, a legal separation which was, until recently, also quite common in other developed countries, including Japan and Europe. So, Waldmann's notion that Glass-Steagall was generally peculiar in its strictures is also misdirection.

[Bruce Wilder]

BJ Feng: "One problem is that the financial regulators have to be more knowledgeable than its participants in order to determine that a certain product is too risky or to make the claim that the bank/financial entity has an unacceptable amount of risk on its books."

Not true. You have no idea about how bank regulation (or financial securities or financial reporting regulation works). It is not about super-imposing the judgment of the regulator.

[reason]

BJ Feng
Sorry, maybe you want to rethink that comment. Even if you didn't misrepresent the job of regulaters, it is not necessary that they know more than market participants, they just have to have a different perspective. Market participants don't have a responsibility to avoid systemic risk.

[BJ Feng]

Granted, but regulators have to know the systematic risk to the market imparted by the various products. The risks were determined by the financial institutions based on various models and computer simulations using past data. Financial regulators would have to come up with their own models to show that the products were in fact, more risky than past history implied. That requires a lot of knowledge, and ultimately, it's a judgment call because no prior data pointed to the kinds of loses we're seeing. The institutions were obeying equity ratio laws, those probably have to be tweaked, but I'm not sure how regulators could have prevented this BEFORE the fact given the data and facts available.

[anne]

"Taplin's point is not about Glass-Steagall, per se, but about ------- being a shameless Hill-Shill."

Remember, what is important, what is always important is to show just how garbage mouthed and mean-spirited we can be. No shame in us. Say what?

[anne]

"Krugman didn't mention the Glass-Steagall act in his column," because there is no reason to believe not having Glass-Steagall has led to the liquidity problems we have been experiencing, as I am assured by, like, lawyers who, like, are trying to understand what has happened with regard to regulatory oversight that has been neglected through this Aministration.

While the economics of the matter have been described by Paul Krugman for years, the complex regulatory issues take a different kind of specialized knowlege entirely and will be understood only gradually. Krugman has however warned of the change in philsophy and regulatory climate and the problematic economic issues for years.

[hari]

B J feng is raising serious gut issues about qualification and experience of Regulators in hi fi sector. Political donars don't always qualify as best gurantors of the system, in my view. Recent SEC (non)functions demonstrate extent to which a regulatory agency can go to sleep...while markets meltdown!

I continue to feel it's now time to centralize regulatory functions of hi fi markets under Fed statutes with Fed being responsible for their professional staff and oversight and reporting to Congress. WH must be eliminated from making political appointments of regulators! Current Fed statutes, as I see it, are adequate to allow it to reform the system.

Mark may be right that separate legislation may only seek to confuse the process more and not get to the real issues - ie. effective and customary/professional oversight on markets.

The problem at present is the +30 or so Agencies which are authorized to regulate the financial markets. It's time to eliminate duplication of effort and reign in the format for regulatory regime under Fed - going forward. Similarly, Congress must remove its own obstacles by eliminating oversight by overlapping Committees - which don't help much in the process.

[hari]

In EU-27, the culture and manifest political problems linked to concept of Moral Hazard, means that a regulatory Commission is centralized and permanently staffed. All staff in EU Commission are appointed on basis of professional competition. Of course, EU tends to spread the posts across the different national/sovereign divides.

[Mark Thoma]

Is it the interpretation of the complex issues that has changed rather than the laws, rules, and regulations that are on the books?

Think of a monopoly. What is actionable by those overseeing public utilities, etc. has changed, and that has come from a change in economic philosophy/understanding of how markets work (e.g. contestability).

The issues are complex, enforcement is discretionary, and the approach is now much more hands off. Costs and benefits are evaluated differently at each little step of the complex process, and there were some important changes in the theoretical underpinnings of regulation that contributed to this (e.g., theoretical developments in market-based regulation may have been important). The change in theory, as well as the empirical tools that have entered courtrooms hearing regulatory cases over the last 25 years (which were used to replace old structures), have perhaps also made a big difference. Empirical evidence supporting new theory has been used very successfully by consultants to eliminate restrictive regulations faced by their clients.

[gordon]

This is a confusing post. Is Prof. Thoma encouraging us to believe that existing legislation is sufficient? That certainly flies in the face of what Krugman has been saying, (notably here). Is it just the institutional personnel who are at fault? Is this post a veiled attack on Greenspan?

Then there is the separate topic of Glass-Steagall. Though Krugman doesn’t mention it in his pro-regulation column “Partying like its 1929” (see link above), Waldmann says that the abolition of Glass-Steagall was irrelevant as far as the current subprime crisis is concerned. Judging from his remarks at the end of the post, it seems that Prof. Thoma agrees. Personally, I don’t agree, but the relevance is moot -Krugman’s point is that the “shadow banking system” is unregulated, not that the “official” banking system needed Glass-Steagall to work well.

I don’t see how more official diligence could have rectified problems in an unregulated sector. Officials can only go as far as legislation allows them to go.

And what is anne's "authority" for blaming people and philosophies instead of regulatory rules?

[hari]

However the bottom line is fundamental credibility of the Regulatory Regime. Once established it would be difficult to argue about its value long term. So, the current problem is raising questions which have political consequences to the governing elite, and therefore any debate on the structure and function of a future Regulatory Agency may never come to pass because of deadlock in the political process....

I suggest Fed as a centralized institution to establish the infrastructure, as you're implicitly demanding, to go forward. This will provide credibility and substance to the people in the market.

[gordon]

Is Gabriel sending us messages from the New York docks, where he is still expecting the Titanic to arrive any minute?

[hari]

Mark -

24/7 markets are the reason why current oversight is not adequate or fitting the changed times we live in. They're not created for globalization...and credit and savings have moved across the seas to Asian markets.

Regulators must also be good feedback communicators so market participants can TRUST them.

[anne]

http://www.nytimes.com/2008/03/21/opinion/21krugman.html

March 21, 2008

Partying Like It's 1929
By PAUL KRUGMAN

If depositors at one bank lose their money, depositors at other banks are likely to get nervous, too, setting off a chain reaction. And there can be wider economic effects: as the surviving banks try to raise cash by calling in loans, there can be a vicious circle in which bank runs cause a credit crunch, which leads to more business failures, which leads to more financial troubles at banks, and so on.

That, in brief, is what happened in 1930-1931, making the Great Depression the disaster it was. So Congress tried to make sure it would never happen again by creating a system of regulations and guarantees that provided a safety net for the financial system.

And we all lived happily for a while — but not for ever after.

Wall Street chafed at regulations that limited risk, but also limited potential profits. And little by little it wriggled free — partly by persuading politicians to relax the rules, but mainly by creating a "shadow banking system" that relied on complex financial arrangements to bypass regulations designed to ensure that banking was safe.

For example, in the old system, savers had federally insured deposits in tightly regulated savings banks, and banks used that money to make home loans. Over time, however, this was partly replaced by a system in which savers put their money in funds that bought asset-backed commercial paper from special investment vehicles that bought collateralized debt obligations created from securitized mortgages — with nary a regulator in sight.

As the years went by, the shadow banking system took over more and more of the banking business, because the unregulated players in this system seemed to offer better deals than conventional banks. Meanwhile, those who worried about the fact that this brave new world of finance lacked a safety net were dismissed as hopelessly old-fashioned.

In fact, however, we were partying like it was 1929 — and now it's 1930....

[James]

http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/weill/demise.html

Yes, Krugman is a Hill-shill. So in his own way is DeLong.

Its tough to have warmed your feet at the will to power, and then to be exiled again to the academy, where power is too often equivalent to pettiness. Touching almost.

A priori arguments from political biases and personal beliefs are easy to spot. Full of anecdote and assumptions. Like a classroom discussion with no required reading.

This thread was.... strangely satirical.

[paine]

mark t :

"it will also be necessary to change the people interpreting and enforcing the rules, and that won't happen without a change in party in control of the executive branch. "

it won't happen till
the wall street aid and abetters
of both party affiliations
are targeted as such and for being so
get defeated for re election

chuck schummmmzster and max booogas beware

btw
barnie f u gotta get it on not just blow your horn

[paine]

new laws and full enforcement
how is that hard to figure

with the courts constraining stayte actions
law over ride is needed
that the fed saw it rising
and could have prevented the lot bubble
is enough to establish "new people
with opposite aims are needed now in the control tower"

[Gabriel Mihalache]

Wow! Thanks for the reply!

I'm not comfortable with your experience vs. my experience explaination.

I don't want to argue that too much regulation was at fault or that regulation is always at fault or anything like that. I know too little of the US economy to comment, although I'm skeptical on principle on the merits of regulation.

I think I meant to say that I think it's a good idea to be balanced on average and to achieve that by pros and cons in each post, rather than pro posts and con posts. -- But it's getting off-topic, so don't mind me at this point, please!

[Robinia]

There are more modes than just "regulation/hands off" in the governmental toolbox. Oversight's fine, but it does in some cases give more substance than is appropriate to dying industrial sub-sectors. In a situation where bailout or protection are likely due to political pressures (finance, agriculture), too much oversight-style regulation can prevent the action of the winds of creative destruction. Excess finance (or agricultural) capacity remains to clog the arteries of the markets. Regulatory capture becomes a distinct possibility under certain administrative conditions.

What proactive action might a government take? I'm thinking a planning, market-shaping role is most appropriate (development-minded). Fully fund the Office of Technology Assessment (eliminated under Bush I, I believe, but it might have been Reagan), and begin to produce reports on the social and economic effects of the direction of technological progress, and ways in which market shape will be expected to change. If we had known that more-and-more, better-and-better-paid jobs in the finance sector were not expected from widespread adoption of technology automating financial transactions, we might have suspected some type of con...

[dd]

The Fed ought not be the central authority nor the Treasury as their mandates are about protecting "financial stability" over protecting consumers/investors/savers. The Fed's failures under HOEPA and the OCC's equal failure to reign in abusive lending are sufficient evidence that neither ought be entrusted with "balancing" financial institutional interest against consumer protections.

[paine]

most dangerous thought train in thread

"Now that we know how the new products behave in a downturn, financial entities will adjust and not extend themselves as they've done in the past'

most familiar snot nosed
auto dumbdact
dabbler's reposte

"This thread was.... strangely satirical"

[ken melvin]

Regulatory agencies should protect the consumer? What a novel idea.

says...

"I'm skeptical on principle
on the merits of regulation'

what principle ???

the uncle milty F chi- go inc
tyrolean freedom party
platform principle # 13 ???

"no corporate regs please
its bad for freedoms "

operating maxim
by those who have replaced
the iron curtain
with an iron meme

"let all limited liability
trans nats
romp free to the max
whilst a limbo gubmint
bends under
the Stigler stick"

any more tiresome
post soviet
no more stalinoid
straight jackets chitter
only gets to be like mideast chitter
from a zionist

source poisoned noise

[paine]

figure of the day

"too much oversight-style regulation can prevent

the action of

the winds of creative destruction"

rusty has felt
just that very dark breeze
blow right
up his beloved industrial heartland's
hindquarters

some times third best
is better then no best at all

[paine]

"Excess finance ... capacity "

do you mean petty loan originators ???

too many sharks chasing
too few over board sailors

[paine]

"Robert Waldmann's point about Glass-Steagall is misdirection. The target of the Gramm-Leach-Bliley Act was the bank holding company provisions, to allow the creation of financial conglomerates. It wasn't about investment banks accessing commercial bank deposits, or any other anachronistic concern with the problems of 1929. It was about facilitating fraud, predation and the circumvention of regulations"

god bless u mighty bruce

[Chuck Roast]

Wilder…
“The immediate issue in Citigroup's case was the firewall Glass-Steagall erected between banking and insurance…”

If what Wilder says is correct, then this allowed both regulated banking institutions and non-regulated investment banks to create and participate in the inscrutable and opaque market for derivatives and credit default swaps (clearly a form of quasi, or should I say pseudo-insurance). It has been written that the so-called “swaps market” has a nominal worth of $45 trillion (GNP = $13.8 trillion). Large sums of these “swaps” would have been called if Bear Stearns went into bankruptcy. And who whose door would the bankruptcy judge have been calling on to pay the insurance on the defaulted loans? Why JP Morgan’s of course. As we know, it does not end there because this would have led JP Morgan to knock on other doors to pay of on the their own default swaps.

So, if the above ruminations are a reasonable approximation, and Wilder knows what he talking about – then indeed, the Clintonoids and their enablers did us the greatest of all dis-services by crushing Glass-Steagall.

[paine]

waldmann is .....out of the real action
with no first hand grasp of the succulence
of bi partisan belt way elect- ables
creating post new deal
free pilfer zones

he's a thoughtful ironic
contrary uber-brain

but in the last analysis
still nothing but
just another side walk super intendent

[paine]

"The Fed ought not be the central authority nor the Treasury as their mandates are about protecting "financial stability" over protecting consumers/investors/savers"

i agree

but i'd rather see the congo harness its fednik creature
which since inception
has maintained vampires on the blood bank's board

the future people's fed i envision
among other august roles and practices
needs to be the job class majority's
mutt and jeff tribune
keeping a skunk eye
on the hi fi wally worlders
ever ready to facilitate
their forced return of seigniorage gains
and credit rationing rents
properly belonging to the people as a whole

[The Baron]

"too many sharks chasing
too few over board sailors"

Beautiful paine, just beautiful. Excellent analogy on so many levels.

[The Baron]

Do you get the feeling that they are looking for more boats to sink?

[paine]

mark
suggests the optimal policy path
follows the fairway

with hazards " on both sides "

" too much intervention and too little "
both lead to a bad lie

often its hard to argue against such sweet reason

but here we are in the woods off to the too low reg side
and
i say lets just take a huge hack at the ball
even if we end up on the too high reg side
i suspect we'll end up
considerably closer to the hole

[baileyman]

Markets only operate in the context of rules. So-called "free markets" are markets operating with a set of rules advocates call "free". Other rules sets are possible.

Market activity maps each rule set to a set of results. But for any desired result set there may be more than one rule set that maps to it.

[paine]

however
this side of the robinia moon
looks silvery cool to me

"What proactive action might a government take? I'm thinking a planning, market-shaping role is most appropriate (development-minded)"

[paine]

"Markets only operate in the context of rules"

its corporations that need rules not markets

why do we reify the problem of wild corporate pokes
as a "market " problem

its corporations
that make our contemporary advanced markets ...right ??

make em brake em
and by doing so
often use
that market they've built sustained and hid thru
to milk we the weebles
and bilk us too ..
bilk us and each other and
all else
but god almighty

oh the shark ness of it all

in an otherwise world....

uncle sam would in turns
massage or foot stomp
not some figment called a market

but their makers
the trolls in 3k suits
up there in the glass towers

[Noni Mausa]

B J Feng: Stockholders will punish institutions that take a large amount of risk from now on...

How will they know? Oh, they can go by gut feelings, wondering where all Enron's money is coming from, but the gut is an unreliable handicapper. Very few people can function like Freddy Arbuthnot, smelling how the market's going to move.

paine: too many sharks chasing
too few over board sailors

*snort!* My big laugh for the day, thankee!

Noni

[Cynthia]

Maybe if shadow banking, along with its financial weapons of mass destruction, are outlawed altogether, then complexity will be removed from the financial equation, making the business of regulating financial services much simpler -- not to mention less costly!

Oh sure, if shadow banking is banished from American soil, shady bankers will simply pack up all their WMD belongings and move to a shadier corner of the globe. But at least when this industry self destructs again, which it's bound to do, Uncle Sam won't get stuck with the clean-up bill!

[hari]

We can assume Libertarians have in fact brought about the demise of laissez faire jaguernaut - to the point we have to collectively acknowledge the hi fi system is naught what it was perceived as - due to its ethical/moral greed or whatnot - and we need to lay to rest the rest of the story....

Paine is demanding (rightly so) for maximum interventionist regulatory policy...in order to fix the bloody mess, I suppose.

DD is disclosing on another thread what I consider more serious and realistic about Fed under Greenspan...and why deregulation was his mantra. DD is documenting it in piecemeal and beautifully!

Knowing background of AG (analytiker of hi fi on WallStreet +30years ago) one can accept that he considered outside intervention as unnecessary...market participants are best tools for checking validity of its transactions, etc. These are not homilies but real factual life experience of the man, I'd assert. Otherwise he couldn't have written the book he just published on his life...

So, given the fact that AGs deregulated derivatives market has now come to roost the Fed, what can BBs Fed do to rescue its image and public credibility?

Again, using Paine's analogy, we can kill two birds with a single shot, if we're clever. Acknowledging Feds regulatory lapses over the past +20yrs, we now demand the restitution of its statutes governing Regulatory Oversight of the hi fi sector, not only the banking system.

Taking above into account, Congress institutes investigation into Feds hitherto (non)oversight of the deregulated markets and invokes its statutes and demands complete overall of the oversight administration under Fed, and suggests incoporating the exisitng +30 Agencies under its authority as permanent professional staff on Oversight.

Discuss now.

[paine]

cynthia

it all starts with the lot value bubble
reg that eventuality out of possible market production
and the synthetic securities never hit default risks
like we see now

as to aaa ratings

those upstanding folks
need jail time
and financial ruin
and in each one's cell
they should find
waiting for em
a regulator who didn't do his job

[dd]

The BlackRock/FED hi-fi deal to manage distressed Bear assets is very troubling. Will Penny Mac privateers itching to get their hands on distressed Bear assets purchased at face value by a Fed claiming it will squeeze profit from this mess produce yet another round of socialized risks guaranteeing privatized profits? That Penny Mac finds ex-Countrywide execs on its payroll raises more questions. Then there is the fact that BlackRock's Fink is "invented" CMOs and securitization.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aeexoSAPwr5s&refer=home

Think all this talk of regulation is good but there must be a focus on the ongoing subsidized profiteering.

[dd]

A little Congressional oversight in these matters would at least make public the terms of these deals and whether perpetrators are being rewarded rather than penalized.

[paine]

alan greenspan needs serious jail time
above all others

talking about his personal philosophy
of a optimal market economy
is like talking about ditch schultz
philosphy of beer distibution

[ken melvin]

Bunch of fat grey headed men scheming around a table in NYC ... All kinda like a book you've read or a movie you've seen but you can't remember the name.

[paine]

dd of course hits a bull's eye

these same
board room rats
will try to" make it "
just as much now the market
is "going south "
as they did
when it was " coming north"

jail baby jail

personal finacial ruin and jail

for ...10 thousand green souls at least

not another change to scoop up some more

reg/non reg produced rents

[bullbust]

Bruce
Taplin's point is not about Glass-Steagall, per se, but about Krugman being a shameless Hill-Shill.
Hear, hear.

Here is round 2 of "saving the system". Don't forget - all the "moral hazardists" and "fire and brimstone", "punishment" extremists are bad people
http://sanfrancisco.bizjournals.com/sanfrancisco/stories/2008/03/24/daily1.html

Wells Fargo CEO says he's open to conducting a Fed-assisted acquisition
Wells Fargo CEO John Stumpf said the financial crisis is presenting the bank with more acquisition opportunities.

"I would not be averse to a Fed-assisted transaction," Stumpf said in a recent interview with the San Francisco Business Times. "Fixer-uppers don't bother us."
....

James:
Yes, Krugman is a Hill-shill. So in his own way is DeLong.

Its tough to have warmed your feet at the will to power, and then to be exiled again to the academy, where power is too often equivalent to pettiness. Touching almost.

So are 99% of economists.

[Bruce Wilder]

Some, including journalists, are drawn like the moth to the flame by the bright spectacle of the mysterious rites of high finance, where fantastic fortunes accumulate, in deals no one claims to fully understand. It is a pretty fairytale, that the only problems are such arcane matters, which will have to be attended by our responsible high priests of finance in due time, after due consideration.

We are not meant to notice the extent of the predation on middle America, which has been by design. We are meant not to notice when the loan sharks of CitiFinancial replace the Savings & Loan, when credit card interest rates that would have felonious 35 years ago become standard, when payday lenders become a major industry.

Securitization of the mortgage business, in the structures of financial conglomeration, has eroded every aspect of integrity in the system. Appraisals. Mortgage brokers. Escrow. Rating services. Fannie Mae and Freddie Mac fell into financial reporting fraud a few years ago. Countrywide practically took over the Federal Home Loan Bank in Atlanta.

Prof. Thoma is surely correct that it is many subtle shifts in the rules, in the "philosophy" over many years that have added up to this debacle. I am certainly not the guy, who can authoritatively add this up, or enumerate it.

The financial markets do have important economic functions to fulfill other than as casinos, where the wealthy and clever can steal from the rest of us.

Here's a useful rant:
http://www.financialsense.com/editorials/engdahl/2008/0225.html

[Garbage-Mouthed]

James: "Krugman is a Hill-shill. So in his own way is DeLong."

No. No, no, no. DeLong is a Bama-Bot, a Bama-Bot, I say!

[Bruce Wilder]

Useful Rant

[dd]

There is no analysis of BlackRock deal or the implications. At least when the RTC was created it was empowered to investigate wrongdoing, bring civil actions and refer criminal cases. It is apparent that this current crisis will be handled in house with no oversight and if homeowners are lucky they will be thrown a few crumbs. All the efforts will be on supporting illiquid MBS and derivatives pricing no matter that the underlying collateral is worthless and homeowners defrauded.
It's Enron redux where the sap retirees lost everything but the fraudulent energy market was put on life support until it re-emerged and imploded again with Amaranth and now is safely in the hands of hedge funds. See:
http://www.michaelcovel.com/archives/000982.html

[Winslow R.]

Bank regulation is like trying to leash a charging bull to a cart with string. Enough string and the bull is subdued until, one by one the strings are cut by the bull.

The Fed retains a lasso. But the lasso becomes ineffective if tightening the noose, threatens to tip the cart the bull is pulling.

We should be asking how do we permanently neuter the bull as restraining strings are becoming less and less effective as the bull becomes internationalized?

The bull's strength comes from its ability to access the 'unlimited saver' in each nation. That strength needs to be dispersed. We allow the citizens of each nation to help pull the cart. If the cart starts moving too swiftly, the Fed throws out it's lasso and takes down the most leveraged citizens, slowing the cart.

Little need for strings when the lasso works properly.

[paine]

nice read bruce

"The models all broke down"

indeed

[paine]

i wish engdahl had it right about
the last days of wall street rex
coming fast apon us

but no such ruck palefaces

pax wall street
like pax city of london
circa 1878

has at the very least
a few more decades
of uncontestable hegemony
ahead of it

i'll state it clearly as bad as it gets
this will not be
great dep II
that requires a globe without
a hi fi hegemon

and the hi fi hegemon of today
with its
one of a kind
anywhere it wants to go
death star/ blitz machine
hasn't yet met its near match
let alone
seen its great war

[paine]

winny's lasso
castration of the hi fi bull

i'm dizzy from the vivid figure
i see the bull on the lasso

circling the cart as the lasso er in chief pivots round and round
meanwhile ...
the cart goeth no where

[Dickeylee]

As I grew up on the NE side with the likes of Civella and Comassanno, and witnessed first hand how the Mafia ran things, Bruce is right. The mob could only dream of todays credit/banking schemes! And here in town, guess who runs the payday loan shops? Why, the C's do. The only thing worse is the "reputable" bankers who fee you to death just to have the privledge of opening a checking account nowadays!
So why isn't anybody demanding usuery now? Is greed no longer one of the deadly sins?

[Dickeylee]

And isn't Phil Ghramm one of McCain's chief economic advisors? Sure makes me sleep with one eye open for that Wolf! So what's Wendy up to now days, since riding Enron down the crapper?

[Bruce Wilder]

Phil Gramm is also vice-chair of a unit of UBS, the Swiss version of Citigroup.

[Winslow R.]

paine wrote: "i'm dizzy from the vivid figure
i see the bull on the lasso

circling the cart as the lasso er in chief pivots round and round
meanwhile ...
the cart goeth no where"

The lasso er in chief started loosening the noose in August. Seems the bull was wounded but not subdued. Loosening seems to not help, as the blood flow had stopped.

The cart rumbles towards a halt as the bull circles, it's head hanging. Economists want to give the 'poor' beast a transfusion to keep him alive while figuring out how to attach a few new strings and reattach old strings that have broken.

Transfer the source of his strength to citizens and start on the road to challenge the bull with the entrepreneurial strength of millions.

The simple action of providing citizen access to the Fed TAF would start to shift world power relationships into balance, making a bull no stronger than a citizen.

[paine]

Phil Gramm
is all that's wrong with domestic amerika
made out of texas meat

[billy]

Some, including journalists, are drawn like the moth to the flame by the bright spectacle of the mysterious rites of high finance, where fantastic fortunes accumulate, in deals no one claims to fully understand

Galbraith, in his book "Money: Whence it Came, Where it Went"

"Much discussion of money involves a heavy overlay of priestly incantation. Some of this is deliberate. Those who talk of money and teach about it and make their living by it gain prestige, esteem and pecuniary return, as does a doctor or a witch doctor, from cultivating the belief that they are in a privileged association with the occult -- that they have insights that are not available to the ordinary person. Though professionally rewarding and on occasion personally profitable, this too is a well established form of fraud. .... The study of money, above all other fields in economics, is the one in which complexity is used to disguise the truth, not to reveal it. Most things in life -- automobiles, mistresses, cancer -- are important principally to those who have them. Money, in contrast, is equally important to those who have it and to those who don't. Both, accordingly, have a concern for understanding it. Both should proceed in the full confidence that they can."

[dd]

Then there is Paulson, whose regular attacks on SS are now high comedy:
Entitlement Programs Threaten Economic Outlook, Paulson Says
http://online.wsj.com/article/SB120646736800462819.html?mod=hps_us_whats_news

Yep, them safety nets for everyday citizens threaten the outlook as opposed to say hi fi credit crisis. Heckuva job Hankie.

More high comedy:
"Republican John McCain said Tuesday that government isn't in the business of saving and rewarding banks or small borrowers who behave irresponsibly though he offered few immediate alternatives to fixing the growing housing crisis."
http://online.wsj.com/article/SB120645482100762421.html?mod=hpp_us_whats_news

Nope no bailing out those small fry; just the big boy donors qualify like Charles Keating.

[Cynthia]

Delvers in derivatives oughta have learned one thing from this debacle: just 'cause math is good for figuring out the economy doesn't necessarily mean that it's good for exploiting it!

[Eric Dewey]

Fascinating. Economists and poets communicating! How many bankers out there?

I've been a Compliance Officer for banks and credit unions for 10 years. There are some great points being made above, but what is perhaps being missed is that there have been two interrelated "banking" systems co-existing: the regulated one and the "shadow" system that was off the radar.

The regulators were somewhat aware of the issues (Geithner's 2005 meetings on derivatives) but weren't really aware of the size - and also lacked the political will to dig for the tough answers and then enforce the rules.

But the real issue here is that the "shadow" banking system didn't come from nowhere - it arose in response to a perceived "need for greed" among the financial hoi polloi.

Human nature is territorial and acquisitive, and often stupid in pushing a good thing well beyond any reasonable limits.

Can you regulate that? Maybe - but it ain't easy.

My experience is that regulation is about insisting on transparency - if they know you're really looking over their shoulder, they'll find some other way to hide the peanut.

The problem is, if everyone's full of cashews, who wants to go looking for what you think is just a peanut?

[James]

Billy,

excellent quote from Galbraith and we thank you for it.

Its amazing how often vagueness is used to approximate intellect.

Oh the paine!

[op]

"Its amazing how often vagueness is used to approximate intellect."

that phrase comrade jimbo
---as much as it might to u seem inspired---
is completely incoherent

talk about an approximation.....

" a well established form of fraud"

what learnedness for hire
ultimately isn't

actually looking over this sentence

"Money, in contrast, is equally important to those who have it and to those who don't"

vagueness of contrast and parallel
born of some deeper conflicted content
may be the source of wit

[Dickeylee]

George Mason University, Dr. Wendy L Gramm, PHd, Economics, member of the Mercatus Center, along with Lawrence Kudlow and Edward Meese. Professor of Economics, Texas A&M.
Gee, you think she'd post here more often! Her, Mark, and Anne share so much in common, don't you think (snark, snark)

[dd]

Must disagree re: shadow banking. Drexel was the first go round ("exempted" junk bonds the vehicle, a holding company that mirrored the current FHC rage and relationships with risk arbitragers that are today's hedge funds; and bonus that Milken "invented" derivatives). Peanut regulators were very aware but no match for the political forces pushing laxity. It's all about what's going on at the top of the regulatory food chain and when those at the top actively seek deregulation as Greenspan and the Presidents Working Group advocated then "shadow banking" was inevitable and encouraged; especially given the Drexel and LTCM experiences.
What is important is that Greenspan promoted the derivatives myth and left Geithner with the mess:
"The use of a growing array of derivatives and the related application of more-sophisticated methods for measuring and managing risk are key factors underpinning the enhanced resilience of our largest financial intermediaries. Derivatives have permitted financial risks to be unbundled in ways that have facilitated both their measurement and their management. Because risks can be unbundled, individual financial instruments now can be analyzed in terms of their common underlying risk factors, and risks can be managed on a portfolio basis. Concentrations of risk are more readily identified, and when such concentrations exceed the risk appetites of intermediaries, derivatives can be employed to transfer the underlying risks to other entities.As a result, not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient. Individual institutions’ portfolios have become better diversified."
http://www.federalreserve.gov/boarddocs/speeches/2003/20030508/default.htm

As for the size of the size of the derivatives issue Greenspan had this to say in May, 2005:
"Perhaps the clearest evidence of the perceived benefits that derivatives have provided is their continued spectacular growth. As a consequence of the increasing demand for these products, the size of the global OTC derivatives markets, according to the Bank for International Settlements (BIS), reached a notional principal value of $220 trillion in June 2004. Indeed, the growth rate of the OTC markets was more rapid in 2001-04 than over the previous three years."
And hedge funds and shadow banking:
"Of course, much of the unease about credit risk transfer outside the banking system reflects the growing role that hedge funds play in those markets and in the financial system generally. Although comprehensive data on the size of the hedge fund sector do not exist, total assets under management are estimated to be around $1 trillion."
http://www.federalreserve.gov/Boarddocs/Speeches/2005/20050505/default.htm

[dd]

For anyone interested: November 1999
Over-the-Counter Derivatives Market and the Commodity Exchange Act
Report of the President's Working Group on Financial Markets
http://www.treasury.gov/press/releases/reports/otcact.pdf

Also PWG April 1999 report on Hedge Funds:
http://www.treasury.gov/press/releases/reports/hedgfund.pdf

[Dickeylee]

Let's see, the Commodities Futures Trading Commission, of which Wendy Gramm was Chairwoman of, that, well, exempted Enron from regulation in the trading of futures/derivatives, that Commodities Commission? The Wendy Gramm that was chair of the Enron Audit Committee, that, you know, kept tabs on Anderson's audits of Enron? Married to Phil Gramm, adviser to Sen McCain, of the Republican McCain's, as like Presidential hopeful? That McCain? The Keating Five McCain? (This could go on forever)

[BJ Feng]

DD, what do you propose, that regulators prohibit new financial products from being held by institutions? The problem isn't that there are new products, the problem is that we didn't know how these products would behave in a down market because the data didn't exist.

Greed is a natural instinct that rears its head again and again. The only way to curb greed is to punish the greedy through huge financial loses, which is happening right now. The owners of Countrywide and Bear Stearns have been taught not to overextend themselves and take on too much risk for the sake of short term profits.

How will stockholders punish companies and find out? Companies routinely publish accounts of their holdings including subprime loans and various other products. Firms like Washington Mutual have already been severely punished for holding Alt-A loans, even though those loans have only recently shown signs of problems. The first questions by analysts during conference calls are usually about the firm's holdings and risk profile. Murky reports are viewed with suspicion. Goldman Sachs had been trading at a P/E well below 10 because they could not explain how they were making so much money (broadly categorized as derivatives trading gains) and investors correctly assumed that those gains are likely to be volatile at best (hard to consistently make billions trading quarter after quarter, you're bound to have an off quarter or so). Firms like Bank of America with more stable earnings from fees and such trade at a higher multiple.

Yes, transparency is a good thing. If anything, more regulation should call for more transparency and more details. I also support the consolidation of regulators. No reason why so many different regulators exist to oversee essentially the same type of businesses. Regulators have to deal with each other and waste time over turf wars, and firms are unsure of which regulators they need to get permission from. Streamline the regulators.

[BJ Feng]

Dickylee, I don't know how else regulators should be appointed. In theory, the President will appoint the most knowledgeable and best person for the job. Presidents have done this with high profile positions like Federal Reserve positions, including Fed Chairman, Bernanke was widely regarded as the best candidate, and Paulson was an A-list top choice (most people didn't think the President could find someone of his level).

The problem is with low level committee jobs which reinforces my argument that there are too many of these regulators. No one gives a damn who is on the Commodities Futures Trading Commission because it's assumed the commission isn't going to do anything important. That allows the President to appoint political favorites over qualified individuals, not that there are many top level individuals who would want to be on such a commission over their private sector jobs. I can't imagine Bernanke or Paulson accepting such an appointment, so only talentless hacks are appointed. Get rid of these commissions and consolidate regulation so that you can get a regulator that has wide ability and can attract top talent because of its prestige and importance. That also guarantees appointment based on merit instead of political favors.

[Dickeylee]

BJ, you mean just 3 weeks after the regulatory approval for Enron to freely trade futures/derivitives that Enron then put her on it's BOD was just coincidence? Me thinks that the Republicans knew exactly what they were doing, you know, the drown the gov't in the bathtub crowd.

[dd]

There is infinite experience with gambling; the most ancient form of "investment." The difference between gambling and investment was hard won knowledge gained via the many Wall Street scandals. The crisis of 1909 revealed unreserved insurance to be nothing more than gambling (hence reserves for insurance). The 1929 stock market crash revealed uncollateralized stock bets to be gambling and hence margin requirements. There is no innovation in derivatives. They are naked bets masking as insurance with no margin or reserve; the worst of both worlds. Gambling is fine but it ought not be the repository of good faith depository.

[Francois]

"Yes, Krugman is a Hill-shill. So in his own way is DeLong."

And on that peremptory, "Magister Dixit"-like judgment, we hereby declare the matter under discussion settle once and forever...right?

Where's Harry Potter when we need him to knock off the Trolls...(sigh!)

[Lafayette]

Cutting the umbilical chord

MT: Robert's point is that we need to address the correct problems, and pointing fingers at the change in the Glass-Steagall act misses the mark, but once we understand where the problems are we also need the will to address them and it's hard to imagine that will existing under the continuation of this administration's economic philosophy that we would get with McCain.

True enough. True also that the regulatory responsibility existed in the hands of the Fed. True, finally, that that responsibility was not enacted by means of an Credit Institution auditing agency doing spot checks on the loans being made against a Standard of Loan Measures. (The foremost of which is that a person declares their Total Debt and Total Net Disposable Income (TNDI) after repayment of Present Debt. The rule is then applied that a third of the TNDI be available to obtain any new debt.)

The above cited practices are Rules of Thumb that are employed world-wide. Except America, evidently.

So, we have a colossal mess that has brought the world's financial system to a screeching halt ... and we are debating whose to blame and what to do? The first question is moot. The Fed is to blame, due to laxness under its previous Presidency.

The second question is being attended to, given the means at the Fed's disposition. The question therefore is What next?

Once confidence is restored, and it will be restored, then what happens? Is it Business As Usual? This is no joke, since Washingtonian Mistakes are very lonnngggg on this excuse. That is, bypassing the Root-Rot for as long as confidence seems to be restored. (Just look at the dot.com Boom 'n Bust for a primal example of such.)

The Root-Rot is of two kinds. First, that credit institutions (banks and other lending agents) took collective leave of their senses in selling debt to debtors unable to repay it. Second, repackaging that debt in such a manner as to resell it to world as [1] Attractive-Debt-Instruments (which was true due to their high returns) and [2] Collusion of the risk assessment agencies in assuring that the debt was "solid" since it was backed by realty value. This practice was mindlessness to the extreme. Realty Value is a highly dependent variable, far too volatile to be assumed as a valid indicator of Invariable Value underpinning risk.

It seems that Congress is addressing, belatedly, the first of the above with a National Accreditation Mechanism to avoid just-anybody-and-his-brother to sell debt. Which places America only 40/50 years behind the rest of the world ...

Secondly, however, is the manipulative way the debt was Sliced & Diced, then repackaged to be perfectly anonymous ... thereby cutting the umbilical chord between initial creditor and final debtor.

Correcting this last but most serious problem is nowhere to be seen. Except for those Corporate Captains who have fallen on their swords (for having let it happen), including the most greedy of the lot, Bear Stearns. (This class of Nouveau Riche will be smiling at their Unintended Advanced Retirement on some beach in the Caribbean, with a Pina Colada in the both hands. They has already pocketed their fortunes long before the Subprime Rot began to happen. Whilst the rest of us fools plod to work to pay our mortgage.)

[hari]

Spiegel is now reporting Germany will be HIT by E70 Billion ($111 Million) subprime loss. German CB is working overtime including weekends, it reports, and there's a lot of direct talks with Fed/BB right now and other CBs on the crisis....

So, it seems, there is no let down yet.