Paul Krugman: Taming the Beast

Are any of the candidates serious about financial reform?

Taming the Beast, by Paul Krugman, Commentary, NY Times: We’re now in the midst of an epic financial crisis, which ought to be at the center of the election debate. But it isn’t.

Now, I don’t expect presidential campaigns to have all the answers to our current crisis — even financial experts are scrambling to keep up with events. But I do think we’re entitled to more answers, and in particular a clearer commitment to financial reform, than we’re getting so far.

In truth, I don’t expect much from John McCain, who has both admitted not knowing much about economics and denied having ever said that. Anyway, lately he’s been busy demonstrating that he doesn’t know much about the Middle East, either.

Yet the McCain campaign’s silence on the financial crisis has disappointed even my low expectations.

And when Mr. McCain’s economic advisers do speak up about the economy’s problems, they don’t inspire confidence. For example, last week one McCain economic adviser — Kevin Hassett, the co-author of “Dow 36,000” — insisted that everything would have been fine if state and local governments hadn’t tried to limit urban sprawl. Honest.

On the Democratic side, ... Hillary Clinton... like Mr. Obama, has been disappointingly quiet about the key issue: the need to reform our out-of-control financial system.

Let me explain. America came out of the Great Depression with a pretty effective financial safety net, based on a fundamental quid pro quo: the government stood ready to rescue banks if they got in trouble, but only on the condition that those banks accept regulation of the risks they were allowed to take.

Over time, however, many of the roles traditionally filled by regulated banks were taken over by unregulated institutions — the “shadow banking system,” which relied on complex financial arrangements to bypass those safety regulations.

Now, the shadow banking system is facing the 21st-century equivalent of the wave of bank runs... And the government is rushing in to help, with hundreds of billions...

Given the risks to the economy if the financial system melts down, this rescue mission is justified. But you don’t have to be an economic radical ... to see that what’s happening now is the quid without the quo.

Last week Robert Rubin, the former Treasury secretary, ... put it clearly: If Wall Street companies can count on being rescued like banks, then they need to be regulated like banks.

But will that logic prevail politically?

Not if Mr. McCain makes it to the White House. His chief economic adviser is former Senator Phil Gramm, a fervent advocate of financial deregulation. In fact, I’d argue that aside from Alan Greenspan, nobody did as much as Mr. Gramm to make this crisis possible.

Both Democrats, by contrast, are running more or less populist campaigns. But at least so far, neither Democrat has made a clear commitment to financial reform.

Is that simply an omission? Or is it an ominous omen? Recent history offers reason to worry.

In retrospect, it’s clear that the Clinton administration went along too easily with moves to deregulate the financial industry. And it’s hard to avoid the suspicion that big contributions from Wall Street helped grease the rails.

Last year, there was no question at all about the way Wall Street’s financial contributions to the new Democratic majority in Congress helped preserve, at least for now, the tax loophole that lets hedge fund managers pay a lower tax rate than their secretaries.

Now, the securities and investment industry is pouring money into both Mr. Obama’s and Mrs. Clinton’s coffers. And these donors surely believe that they’re buying something in return.

Let’s hope they’re wrong.

Comments

[Winslow R.]

Paul wrote: "Last week Robert Rubin, the former Treasury secretary, ... put it clearly: If Wall Street companies can count on being rescued like banks, then they need to be regulated like banks.

But will that logic prevail politically?"

Krugman wrote this?

What is to keep Wall Street from creating 'new' unregulated companies from being rescued during the next crisis with similar logic?

[Winslow R.]

The key is to have debt creating entities that don't need to be rescued.

If an entity (or millions of entities) defaults it should be possible to push it through bankruptcy without destroying our economic system.

[Noni Mausa]

Winslow asked: What is to keep Wall Street from creating 'new' unregulated companies...

"Walks like a duck" legislation? Regulation of anything that quacks, swims and puddle-dives like a bank, regardless of what its name happens to be?

Noni

[gordon]

Prof. Krugman knows perfectly well that the Federal Reserve is the fall-guy for this one. Neither the Democrats nor the Republicans want the Congress or the Executive to delve too deeply into what Prof. K. calls an "epic financial crisis". In those branches of Govt. public opinion might be too hard to control, whereas nobody understands what the Federal Reserve is doing, thank Heavens.

Don't hold your breath waiting for either Hilary or Barack to say anything about mortgages, MBS or the shadow banking system. Too many bodies out there.

[SGC]

Noni,

Very simple. If it borrows short and lends long it has to be regulated.

[lonesome moderate]

Paul wrote: "Last week Robert Rubin, the former Treasury secretary, ... put it clearly: If Wall Street companies can count on being rescued like banks, then they need to be regulated like banks.

But will that logic prevail politically?"

Krugman wrote this?

What is to keep Wall Street from creating 'new' unregulated companies from being rescued during the next crisis with similar logic?

If the system remains as corrupt as it is at present, nothing. When legislation can be bought and sold, rule of law doesn't exist.

[esb]

The only way to tame this beast is to emasculate it.

The best way to accomplish that deed is to make the relationship between a broker/dealer and any account holding client that of a fiduciary.

What the hell, if someone gives you their money to hold and manage, why should they not expect a fiduciary duty?

Who the hell wants to give his/her wealth to a salesman or any other category of con man?

Oh, and the chance of such an act passing this or any other Congress ...

zero.

[Gil]

Good point esb.

[chris]

Americans have come to believe that the best way to handle an economic crisis is to ignore it and maybe it will go away. Seems to work; at least as Krugman says, this crisis isn't really very much in the news. Obama's pastor's viewpoints are much more important. As well as Tibet. In spite of there not being many Tibetans in the US, Americans seem very upset about Tibet.

[dissent]

I have begun to think of this country as not a democracy, but a dictatorship of elites. What they want, they get. Do they want financial regulation? NO.

The noises in the press about how the public is against free trade or inequality or what not avoids the issue: it doesn't matter what the public thinks or feels.

And the white middle and working classes have made this possible, by voting against their economic interests and for Republicans.

The death of enlightened self interest is the death of democracy.

[cb]

Unsurprising, in a sadly funny way, that Hassett thought the answer was more suburban sprawl. That seems to be a touchstone for right-wingers all over the world.
But considering some of the worst busts are happening in sprawl havens like Inland Empire and Las Vegas, it doesn't fit the facts at all.

[Winslow R.]

SGC, properly written regulation might even last a few years longer than the Glass-Steagall Act especially if globalization collapses just as it did in the 30's.

Then simply repeat, lather and rinse...

The structure needs to change. Perhaps not this time, or the next, but it must change (really! nation-state survival in a globalized world depends upon it changing). Meantime, government will keep sending the 'one world' financial industry bailout checks.

[Bruce Wilder]

Clinton, of course, has protested against populism, that lobbyists are people, too. And, I am sure there's some consciousness of, how shall we say?, 'sensitivities' in the financial community. I don't know enough to say if a Chicago Senator hears a different story from what New York Senator hears.

But, I would think the campaigns are even more focused on what polling shows people, who vote in Democratic primaries, expect to hear and will respond to, and what independents, who are too dumb to know whether they prefer McCain to one of the Democrats, will respond to.

Barack Obama, I am sure, made his speech connecting Iraq to the economy, because polling clearly shows that a large fraction of the American people instinctively feel that that's true. It is a line of causality that they are ready to believe. Far be it for little ol' me to tell the great economist that they might be right -- the effect of deficit spending on employment notwithstanding. Great Powers have been known to ruin themselves in war, the positive effects on employment notwithstanding, and they were not fighting a war that drives up the price of their principle fuel, they were just ruining their credit, as we are.

As for reform plans, I've always thought politicians were supposed to be slaves to academic scribblers in these things. Does Krugman think solid reform can come down to a couple of tell-tale features, like mandates in the Krugman version of health care reform?

Because as a practical matter, devising a reform and enacting it is a matter of shepherding proposals through Congress and the thicket of existing agencies, public and private -- a very complex affair. No candidate proposal of a page or two, or even a 25-page white paper is going to give much of an indication of how good a shepherd the President (or the President's Treasury Secretary, SEC chairman, Fed Chairman, etc.) are going to be.

From the Clinton campaign website: "Hillary will ask for regular status reports on the progress Wall Street is making in converting unworkable mortgages into loans families can afford." No hint as to who will be producing these status reports. I wonder how this will work out.

Relief on foreclosure is easier for a Presidential candidate to propose, precisely because you can claim to be calling for action, while leaving ambiguous the niggling detail of who is going to get screwed and by how much. Relief on foreclosure can end up being a boon to banks, in their role as mortgage servicers, as well as a bailout for investors.

Both candidates have proposals on the table -- Obama's are more extensive and detailed, and more oriented to relief or aid for poorer people, for whatever that's worth. And, Obama is more concerned about clearing up fraudulent and predatory real estate and r.e. lending practices.

Krugman, himself, has been cavalier about giving Fannie Mae and Freddie Mac an explicit guarantee -- never mind that that could just about double the marketable portion of the national debt overnight. I really do not know how one could fairly evaluate the situation of those two government-sponsored entities, but the projected downturn in home prices is large enough that it is certainly conceivable that both be pushed in insolvency.

I would imagine in the brave new world of Wall Street, key issues in any regulatory reform would be financial accounting and disclosure rules, especially as they apply to various vehicles, options and swaps. If the goal is to leave the electorate confused and bored to tears, these are certainly the topics to debate in the campaign. I can't wait for Obama's "Cross of Derivatives" speech at the convention.

[TigerPaw]

American politics - the best money can buy.

The aristocracy shouldn't complain, after all they got what they paid for. They didn't want regulation and they didn't get it. Course they're also hypocrits, now that their brilliant scheme has blown up in their face they want to be bailed out.

The perfect world, socialism for the rich, and the let the poor eat cake.

Where's Mme Guillotine when we need her?

[Affordable or Not Affordable]

"...everything would have been fine if state and local governments hadn’t tried to limit urban sprawl."

Overly simplistic, but it contains a kernel of truth. The purpose of subsidized loans is to enable more people to afford homes. The purpose of many non safety zoning regulations is to increase the cost of homes, thus keeping out the less well to do. The two policies work against each other.

With an inadequate ability to expand supply (until enough new homes exist so that everyone who wants one has a home), subsidized loans instead wind up driving up the cost of existing homes in an area. Eventually, prices rise beyond the level new potential buyers are willing to pay. At that point, the subsidized loans are often too high to be repaid, and the system collapses.

As a nation, we are going to have to decide if we want to make home owning sufficiently affordable so everyone who wants one can own one, or make home owning expensive so the less well to do stay out. We can't have it both ways. Policies that conflict with each other are bound to create problems.

[save_the_rustbelt]

The candidates, at the behest of hoards of consultants and spin doctors, have worked very hard to avoid discussions of substance, and discussions including policy details. It is apparently the nature of the beast.

In their partial defense, none of them know exactly what they will be inheriting next January, so perhaps some caution is justified.

Not a good system.

[anne]

"In retrospect, it’s clear that the Clinton administration went along too easily with moves to deregulate the financial industry."

The Financial Modernization Act of 1999 allowed banks, especially Citigroup to become multipurpose financial houses from investment banks to insurance companies. Citigroup had become a multipurpose house before the Act became law, but what was law-breaking was ignored since there was so much gathering support for the Act.

What I have never understood, is why the Act should have in any way weakened oversight and regulation since increasing the division of Citigroup did not remove any division from supervision and actually added all divisions to supervision by the Federal Reserve. Whether the problem is a need for additional regulatory legislation or simply attention to the legislation that already exists is not clear.

[save_the_rustbelt]

Sadly, the most important number today is a simple one:

4,000

[anne]

Should multipurpose banks such as Citgroup then be broken up division by division, or should we look to whether and why regulation has been evidently lax? The indication I have from 2 lawyers I have asked, is the problem lies both within regulatory agencies and an unwillingness by an increasingly Republican Congress to support regulation by government agencies. Republican philosophy has become increasingly pervasive these 25 years, and has been increasingly against financial regulation even when regulation has always been readily possible with existing legislation.

[anne]

STR:

"The candidates, at the behest of hoards of consultants and spin doctors, have worked very hard to avoid discussions of substance, and discussions including policy details."

As far as I can tell, this is precisely the case. Possibly I am missing the substance, but where I had hoped a tough campaign would lead to increasing policy definition I am disappointed.

[anne]

STR:

"Sadly, the most important number today is a simple one:

4,000."

[save_the_rustbelt]

I intend to ask my auditing seminar to consider the following:

The 12/31/07 financial statements are worthless at this point. The statements may have been worthless when completed.

Can we design an accounting and reporting model that will work properly in the 24/7 global market place.

Sometimes the answer is better tools. I think our tools are out-of-date.

[ECONOMISTA NON GRATA]

PK:

Most certainly correct about McCaine.

I would equate the investment banking community's enthusiasm for reform and regulation to that of the sexual predator community's enthusiasm for MSNBC's To Catch a Predator.

I'm sorry if I may have offended anyone, however, I don't know who's worse. This whole situation makes me sick. The flip side is, that it has also made me very rich.

Best regards,

Econolicious

[anne]

STR:

"I intend to ask my auditing seminar to consider the following:

"The 12/31/07 financial statements are worthless at this point. The statements may have been worthless when completed.

"Can we design an accounting and reporting model that will work properly in the 24/7 global market place.

"Sometimes the answer is better tools. I think our tools are out-of-date."

Warren Buffett has for years complainee that complex derivatives can be impossible to value properly, while as early as February 1994 the actual problem of valuing derivatives became clear in valuing what were supposedly highly conservative bond portfolios.

[anne]

Again, specialists must carefully ask and argue whether the need is new legislation, new accounting rules or oversight and enforcement of already existing procedures. Do accounting rules have to be subject to legislation or updating by the board of standards or simply by compliance with existing standards?

There is obviously reason to be angry.

[bakho]

It would help to collect a lot of the money sloshing around the financial system as taxes and put it to work building workforce and infrastructure. That alone would start to reduce the problem of too much money chasing too few investment opportunities that creates an environment where scam artists can thrive.

[jamzo]

i applaud the discussion about restoring a healthy level of regulation in the financial industry

i wonder where the money and credit that fueled the wave of speculation that fueled the dot.com bubble, the housing bubble and the still operatuve commodity bubble came from

who had the money and the credit to speculate

whose hands regulated the money and credit spigots

[anne]

Paul Krugman:

"America came out of the Great Depression with a pretty effective financial safety net, based on a fundamental quid pro quo: the government stood ready to rescue banks if they got in trouble, but only on the condition that those banks accept regulation of the risks they were allowed to take.

"Over time, however, many of the roles traditionally filled by regulated banks were taken over by unregulated institutions — the 'shadow banking system,' which relied on complex financial arrangements to bypass those safety regulations.

"Now, the shadow banking system is facing the 21st-century equivalent of the wave of bank runs..."

Here are the passages I am trying to better understand. Have shadow banks been beyond regulation, or were they just not actually regulated? What of a shadow bank controlled by a traitional bank?

[anne]

Evidently, where I only thought that Morgan-Chase had gotten a valuable deal in buying Bear Stearns, the deal was as significantly undervalued as investors indicated in buying Bear shares at multiples of $2 after the initial deal was announced.

[save_the_rustbelt]

Anne:

Accounting rules would need some government approval (due to Sarbanes-Oxley), but many changes could be made by the profession.

Problem is, what changes to make?

In the financial sector transactions may be moving so quickly, and with so much fluctuating risk, that conventional accounting and auditing standards and procedures are near worthless.

So what is Bear Sterns worth today? How much equity do they have or not have? There may be no answer, which is a little scary.

One solution, by the way, is to simply admit that conventional accounting no longer can be applied to some financial organizations, and that investors should analyze risk accordingly. Adds complications though.

[save_the_rustbelt]

BREAKING NEWS:

Senator Clinton wants some sort of commission co-chaired by Greenspan and Rubin to lead us from this financial wilderness.

Bad idea? Good idea?

Check the news for more details.

[Chris]

What is wrong with the government becoming the lender? Why not cut out the middle man in this transaction. Since we as taxpayers are always, in the end, assuming the risk why don't we position ourselves to reap the rewards as well. Instead of capitalizing the profits and socializing the losses we can socialize the profits AND socialize the losses. What a concept.

There may even be an easier way. Instead of offering free cash bailouts to investment banks how about trading for a controlling interest in the company's stock? This would be a form of nationalization I think but instead of forcing the companies into it they would come along willingly because they have no excuse and beggars can't be choosers.

[Jake S.]

In reply to ECONOMISTA NON GRATA:

If the whole system comes down, and the country goes completely to the crapper, your riches aren't worth much unless you've been buying gold my friend.

[ddt]

STR - I hoped that you were kidding. No such luck.

Yes, by all means lets get Rob "strong dollar" Rubin and Alan "easy money" Greenspan on the job. let's turn hair of the dog into a full blown bender. that always works.

[Cynthia]

If US regulators can't (or just won't) shed some light on the stock market as a whole letting it become as shadowy as its banking sector is today, then I propose that Wall Street relocate to the streets of Abu Dhabi. After all, US taxpayers are less likely to get burned over there than here when these shadows become overshadowing by light!

[Phillip Folkler]

What is a "healthy level of regulation" as opposed to a 'strangling level of regulation'? Which god-like figure or group will be able to determine this?

The real issue is the current "regulatory" environment.

Regulators and the regulated are in bed together. The public pie is theirs to divide. No matter how "true and just" the regulators today are, eventually this delegation of power will gravitate to the fraudulent and unjust. Why? That is precisely the type who covet power over others. Your only safety is not to delegate this power.

Why not propose an end to government bailouts and regulation? Why not propose putting bankers in jail for fraud?

Was it not gross fraud for the CEO of Bear Sterns to proclaim on 3/11 how sound Bear Sterns was, only to be bankrupt by 3/14?

It is precisely the protection from failure and liability we have these crises. You can regulate any way you wish, but the regulations will either start with holes for the unscrupulous or will be 'ammended' soon after.

Lysander Spooner wrote extensively on the laws which removed the personal liability from bankers for their actions. This was later applied to many other industries as well. [There are, after all, plenty of congressmen to 'appeal to'.]

In the financial world, it is the strict regulation of "reserve banking" which has allowed banks to loan untold billions of dollars which they simply do not have.

Who would put their money in a bank which due to real competion, listed a reserve rate of 20% on their door? Or their tradition of rolling those reserves again and again, trivializing the whole concept of banking reserves? Yet as we all know, modern banks maintain reserve rates far below 20%.

What would happen if bankers [or other business 'leaders'] knew they were personally liable? I would hazard a guess they would be no more criminal or fraudulent than the rest of us at that point.

If there was no "lender of last resort", banks would risk failure, bank officers would risk prosecution for fraud, and banks would very quickly become 'conservative' again.

But everyting is ok, The Federal Reserve says so...

[James]

We have to turn to the Brits to hear the words that no Democrat dare speak, but which they are all surely thinking.

http://jessescrossroadscafe.blogspot.com/2008/03/save-pigmen.html

[dissent]

"...everything would have been fine if state and local governments hadn’t tried to limit urban sprawl."

What a joke.

I just read that one reason that builders go for sprawl, single family homes in the burbs, is due to Fannie Mae and Freddie Mac, who won't buy mortgages for developments that mix retail and business with residential.

So there you have it: sprawl encouraged by govt policies.

Now what's going to happen to all those fringe dwellers after gas doubles or triples from where it is now?

The govt should NEVER have been in the business of subsidizing sprawl.

[Gerard MacDonell]

Sorry for the cut and paste, but I needed to expose this fool to some criticism. This is a local low, even for Hassett.

Commentary by Kevin Hassett
March 24 (Bloomberg) -- During the 2004 presidential election, Yale University economist Ray Fair became a media sensation.
Fair had developed an econometric model that predicted the outcome of presidential elections with stunning accuracy, missing the percentage of the vote by the winning candidate by an average of only 2.5 points going back to 1916. Much to the chagrin of the chattering classes, his model relied mostly on economic data. In good times, the incumbent's party tended to win. In bad times, control of the government usually switched.
Defying conventional wisdom at the time, Fair's model implied that George W. Bush would post an easy win. Typical of the media response was an interview of Fair by Deborah Solomon of the New York Times.
``Are you saying that the war in Iraq will have no influence on the election?'' an incredulous Solomon asked.
Fair responded, ``Historically, issues like war haven't swamped the economics. If the equation is correctly specified, then the chances that Bush loses are very small.''
Solomon tried again: ``But the country hasn't been this polarized since the '60s, and voters seem genuinely engaged by social issues like gay marriage and the overall question of a more just society.'' Fair refused to back down.
While the Bush win was tighter than Fair predicted, the
2004 election was clearly another feather in his cap.

Plug In Data

So what is his model saying about this year's election?
Fair, the social scientist's social scientist, has posted his latest results on his Web page and even provided a handy calculator that allows readers to plug in their own economic forecasts and see how they affect the election.
As of the end of January, Fair's model was suggesting a tight presidential race, with a slight lead for the Democrats, who he says will receive about 52 percent of the vote.
That forecast might be too optimistic for the Republicans.
Back in January, Fair predicted real gross domestic product growth for the first three quarters of 2008 would be 1.8 percent. With the odds of recession soaring, that number may seem a stretch. What if the data are worse than that?
According to his model, the Democratic candidate can expect
53 percent of the vote if real per capita GDP growth is only 0.5 percent during that same time period, as it might be if we just barely avoid a recession. The Democratic percentage climbs to 54 percent, if the real per capita GDP expansion averages negative
1 percentage point, as it well might if we enter a recession.

Tight Election?

If the data turn out to be better than expected, then the numbers change dramatically. If real per capita GDP growth averages 3.5 percent over the first three quarters of the year, which might happen if all the monetary and fiscal stimulus measures in the pipeline take effect, then the Democratic candidate's vote share would drop to just below 49 percent.
The moral of the story is that the Fair model, perhaps the best science-based forecaster of presidential elections, will predict a tight election unless we clearly enter a recession between now and November. With a whisper number for first- quarter GDP growth between 1 and 2 percentage points, it is anyone's guess whether the data will turn enough to become the story of this election.
The Fair model has made some big errors over time. In 1992, Bill Clinton's share of the vote was 5.1 percentage points more than Fair foresaw. If we enter a recession, might one expect a similar mistake this time around?

Tax Remedies

That's quite possible for a number of reasons. First, the economic programs of both Democratic candidates include policies, such as tax increases and expansion of the welfare state, that are unlikely to help the economy. Just as questionable is whether they can be sold to the public as sound responses to a recession. Bill Clinton ran against a recession with tax cuts, rather than increases in 1992.
Second, it may not be possible for the Democrats to portray the Republican candidate, who has taken his own principled stands on any number of issues throughout the past seven years, as a virtual incumbent. Hence, Senator John McCain may be spared the typical negative incumbent bounce in a recession.
These considerations add another level of uncertainty.
With McCain surging in national surveys, such as last week's Rasmussen poll that showed near double-digit leads over Senators Barack Obama and Hillary Clinton, the Fair model's prediction will again become the counterpoint to conventional wisdom.
So here is one prediction you can put big money on: Ray Fair will be a media sensation again in this election cycle.

[kthomas]

"...the Beast."

PK knows how to use symbols.

[save_the_rustbelt]

ddt:

Sorry, Sen. Clinton is on the cable news explaining her plan.

Sort of like hiring Jack Abramoff to teach ethics seminars?

[ddt]

Gerard - Don't be a hater.

I'm thankful for Mr. Hassett's valuable contributions to the field of excremental analysis.

[save_the_rustbelt]

from Forbes.com

Countrywide Reconstructed: PennyMac
Ruthie Ackerman, 03.24.08, 12:45 PM ET

Countrywide Financial


As the largest mortgage lender in the United States, many believe Countrywide Financial helped fuel the subprime mortgage mess with its no-holds-barred approach to mortgage lending. Now a group of former Countrywide executives are looking for a new way to get paid: buy distressed mortgages at rock-bottom prices and resell them for a pretty penny......

Ugh.

[ECONOMISTA NON GRATA]

In response to Jake S.

Exactly...! I've been long gold since Bush got elected.... It was a timely and well thought out hedge.... I've also had a great year trading S&Ps, mostly from the short side.... I'm eying the short side of the 10 and 30 year treasuries, when they go, LOOK OUT BELOW....! However, not quite ready yet.....

ALL OF THIS IS MEANINGLESS...... 4,000 of our sons and daughters have paid the ultimate price in Iraq and that is causing me a great deal of grief.... All the money in the world could not cheer me up right now.... It is indeed a solemn moment for America.

My best regards to all,

Econolicious

[anne]

There was actually nothing wrong with Kevin Hassett's analysis, beyond whether a person may or may not happen to agree with it. Gutter language in depicting the analysis however is expressly designed to destroy discussion, and in that there is something dreadfully wrong.

Can we try now for some more disgusting analogies, just to show the sort of fine people we really are?

[acerimusdux]

"Both Democrats, by contrast, are running more or less populist campaigns. But at least so far, neither Democrat has made a clear commitment to financial reform."

According to the traditional and original meaning of the word, you really can't be a "Populist" without favoring financial reform. For near a century now, however, the powers that be have been trying their best to change, confuse, or pollute the meaning of the word "Populist" in order to better quelch the idea behind it.

It's amazing how few know what a Populist really is any more.

[ddt]

anne, sorry for the language, but Hassett deserves nothing but ridicule.

[anne]

Agreed completely.

[anne]

Acerimusdux:

"It's amazing how few know what a Populist really is any more."

That is a useful comment, and reminds me of a Princeton specialist on populism who I hope to remember during the day but possibly someone else will remember and reference.

[anne]

http://www.pbs.org/moyers/journal/02292008/transcript2.html

February 29, 2008

BILL MOYERS: Populism grew up in America. During the first gilded age - back at the turn of the 19th century huge discrepancies in income and power separated a minority of very rich people who ran the country and everyone else. Then the disparities led to strikes, riots, labor unions, and government regulation of big business.

And today -- Well, that's what I want to put to Nell painter, one of our country's distinguished historians. Her grassroots history of the populist and progressive era in American life - STANDING AT ARMAGEDDON -- will soon be out in a second edition. It's a sweeping account of America's shift from a rural and agrarian society to an urban and industrial one, when regular people had to fight for their place in the new order. Nell Painter has retired from Princeton University where she was long one of the most popular teachers, but she's active on many fronts, and serves as President of the Organization of American Historians.

Welcome to THE JOURNAL.

NELL PAINTER: Thank you.

BILL MOYERS: Everybody's throwing around the word populism. Do you think they know what they're talking about?

NELL PAINTER: It sounds as if people who are throwing it around are throwing it around as a dirty word. And if it is a dirty word, they don't know what they're talking about.

BILL MOYERS: Why do they think it's a dirty word?

NELL PAINTER: I think they think it's a dirty word, because it pits Americans against each other, as if we would all be hand in hand if it weren't for populist agitators.

BILL MOYERS: What are Hillary Clinton and Obama saying that makes people invoke the word populism?

NELL PAINTER: They're probably talking in very veiled terms about class issues. Class is the dirty little secret in the United States. We're so much happier talking about race. Black people are this. And white people are that. The unspoken is that white people are middle class and black people are poor. So, black people are kind of the proxy for poor people in much of our dialogue. So, when politicians get past that, and they talk about what's interesting or needed for working people, or heaven for bid, poor people even, remember working people, or heaven forbid, poor people are probably about three-quarters of our population, at least. But when you talk about that group of Americans as having interest that are different from the people who have a lot of money, then for many who are critics of populism, that's a bad thing to point out....

[lonesome_moderate]

Last week Robert Rubin, the former Treasury secretary, ... put it clearly: If Wall Street companies can count on being rescued like banks, then they need to be regulated like banks.

But will that logic prevail politically?

Of course not. The mandate of most of the current crop of politicians is happy talk and corruption.

What disturbs me more than anything else is that practically no economists are willing to predict exactly what is going to happen in the future if things continue down their current path. The impression I have of Krugman is that he is so confused about the numbers coming out of the current situation that he doesn't feel equipped to say anything specific. That is scary.

[anne]

"According to the traditional and original meaning of the word, you really can't be a 'Populist' without favoring financial reform."

But, what does this mean?

[acerimusdux]

Phillip Folkler says...
"Why not propose an end to government bailouts and regulation? Why not propose putting bankers in jail for fraud?"

Phillip, after you've eliminated all regulation, I'm not sure how you are going to put bankers in jail for something you've just legalized. :)

Not all regulation is contrary to market principles. Anything that limits the freedom of market participants in any way, including their freedom to lie or mislead, involves some form of regulation.

While I've seen one or two proposals of things that might adversely impact markets in some way-interest rates freezes are certainly a debatable concept for example-most of what proponents of regulation are talking about are ways of making markets more efficient, not less.

As efficient market theory depends on "perfect information" for example, anything that improves the quality of information available to market participants can strengthen markets. This includes regulations against fraud, financial disclosure regulations, and requiring sound accounting principles be followed.

Currently, hedge funds have very little of this type of regulation applied to them, compared to what is required of, for example, a publicly traded mutual fund.

Another area of potential market failure is that truly efficient markets also require "perfect competition". Because unregulated markets in many cases tend to develop towards domination by monopolies, this often requires regulation as well. Not only anti-monopoly regulation, but conflict of interest regulations, such as rules requiring investment banks and commercial banks be separate entities, also help to increase competition and market efficiency.

Finally, even for some of those things which you would normally want markets to decide, such as interest rates, it can sometimes help to set some limits to prevent the more extreme failures. Capping credit card (or for that matter mortgage) rates at 30% might be one example. The arms length transaction at which a 40% interest rate is really justified and truly beneficial to both parties is somewhat hard to imagine.

[acerimusdux]

Anne:

Yes, Populism has something to do with class issues, but, it was also I think a generally moderate and pragmatic reform movement. Compared to left wing class conscious movements like Marxism and Socialism, which were becoming popular in Europe at the time, Populism was quite tame. Rather than reject Capitalism , they mostly proposed reforms to make it fairer and more efficient, alongside reforms designed to make the government more responsive to the electorate and less susceptible to corruption by corporate dollars.

They proposed breaking up monopolies, a non-partisan civil service system, a progressive income tax, the adoption of elections by secret ballot, the outlawing of corporate subsidies, the direct election of Senators, initiative and referendum, term limits for the President and Vice President, and government operation of some industries that were natural monopolies, like railroads and telegraph. Most importantly, they wanted an end to the gold standard, and the creation of a government banking system, rather than allowing private banks the power to control the creation of money.

From the 1892 platform:

"We believe that the money of the country should be kept as much as possible in the hands of the people, and hence we demand that all State and national revenues shall be limited to the necessary expenses of the government, economically and honestly administered. We demand that postal savings banks be established by the government for the safe deposit of the earnings of the people and to facilitate exchange."

Populism is often portrayed as representing something on the fringe, but the truth is that most all of what the original Populists demanded in 1892 was actually passed within the next 20 years.

This hardly looks like a dangerous fringe left movement to me, although it certainly wasn't in the interests of the corporate elites of the time, who even then controlled most of the newspaper coverage, especially in the east. And so it was portrayed with a great deal of hostility, as a movement of dangerous and ignorant hick farmers who didn't have any understanding of matters of finance or governance.

It seems clear to me that it was a movement of reform of both the political and financial systems to make them more responsive to the needs of the people.

And, for the most part, those financial reforms proposed were market oriented. It was not a Socialist or Marxist movement by any means. I don't think those more European movements were ever too popular with the individualist farmers of the American West.

[anne]

Thank you:

http://www.let.rug.nl/usa/D/1876-1900/reform/populist.htm

July 4, 1892

Populist Party Platform

The conditions which surround us best justify our cooperation; we meet in the midst of a nation brought to the verge of moral, political, and material ruin. Corruption dominates the ballot-box, the Legislatures, the Congress, and touches even the ermine of the bench. The people are demoralized; most of the States have been compelled to isolate the voters at the polling places to prevent universal intimidation or bribery. The newspapers are largely subsidized or muzzled, public opinion silenced, business prostrated, homes covered with mortgages, labor impoverished, and the land concentrating in the hands of capitalists. The urban workmen are denied the right of organization for self-protection, imported pauperized labor beats down their wages, a hireling standing army, unrecognized by our laws, is established to shoot them down, and they are rapidly degenerating into European conditions. The fruits of the toil of millions are boldly stolen to build up colossal fortunes for a few, unprecedented in the history of mankind; and the possessors of these, in turn, despise the Republic and endanger liberty. From the same prolific womb of governmental injustice we breed the two great classes-tramps and millionaires.

The national power to create money is appropriated to enrich bond-holders; a vast public debt payable in legal-tender currency has been funded into gold-bearing bonds, thereby adding millions to the burdens of the people....

[anne]

http://www.pbs.org/moyers/journal/02292008/transcript2.html

NELL PAINTER: One thing-- one thing I would definitely like us to remember is that the ideas that the populists put forward in the 1890's were considered harebrained.

BILL MOYERS: Harebrained?

NELL PAINTER: Harebrained. Crank ideas. But by the early 20th century, they were the ideas that came into, even our U.S. Constitution. Because we had to have amendments to make it possible to have an income tax, or the direct election of senators. The whole regulatory state of the mid-20th century grows out of roots in the 90's with populism.

BILL MOYERS: They wanted--

NELL PAINTER: --are.

BILL MOYERS: --they-- they wanted the monopoly's control, right? They wanted government to step in and balance the power of the industrial giants--

NELL PAINTER: That's the very fundamental point that in a moment of what we call laissez-faire, that is to say that the government was not very involved, and certainly was not involved with every day people, that the populists were saying, "People control the government. And people should have the benefit of the power of the government." All of those were populist ideas saying that the power of the people through the government should serve the people, not just the corporations or the very wealthy.

BILL MOYERS: What do you see happening to ordinary people today?

People are waking up to what has happened to our country, not just in the last eight years, but probably almost since the end of the Cold War, maybe even before. That our interest as a security state, and as an empire are not necessarily our interest as citizens. We have become what my colleague Elizabeth Cohen calls, "A consumer republic." The populists talked about a producers republic. And our interest as consumers and our interest as citizens may be different. So I live in New Jersey, where the state of our infrastructure is very much in the forefront of our politics. Are we going to pay for infrastructure?

Pay for bridges, pay for roads and for intellectual infrastructure, pay for education, pay for colleges. These are not the kinds of things that Americans are going to go buy as consumers. But we need them as citizens of a polity. So many of the people who make the decisions, and finally, so many of us who vote those people in or out of office, so many of the people who are making the decisions don't need those services in the way many of us ordinary people need them....

[dd]

This Bear bailout is devolving into a farce:
"BlackRock Inc will manage the $30 billion portfolio of Bear's less liquid assets under guidelines established by the New York Fed.
Those guidelines are "designed to minimize disruption to financial markets and maximize recovery value," the New York Fed said.
The Fed said it would reap any gains that accrue from the portfolio."
http://www.guardian.co.uk/feedarticle?id=7408594
Wonder what fees will be paid, how exactly will the taxpayer benefit from this arrangement and how much more BlackRock will benefit?
"Money management firm BlackRock Inc (BLK.N: Quote, Profile, Research) and hedge fund Highfields Capital Management are backing a new firm that will buy up distressed mortgages, betting that investors are ready to snap up bargains in the beaten down sector.
The new company, Private National Mortgage Acceptance Company, which will be known as PennyMac, plans to raise capital from private investors and will help borrowers restructure loans to avoid foreclosure."
http://www.reuters.com/article/bankingFinancial/idUSN2433664220080324

Nice puff piece here:
http://www.reuters.com/article/ousiv/idUSN2433735620080324

No worries as everything is fine. Who needs regulation when BlackRock is on the case?

[Cynthia]

"It's amazing how few know what a populist really is any more."

I'll second that, Acerimusdux!

And a few folks around here have mentioned that populists and progressives are diametrically opposed. But to me, these two arms of the liberal movement can operate in tandem to tame the beastly plutocrats.

[anne]

Cynthia:

"And a few folks around here have mentioned that populists and progressives are diametrically opposed."

http://economistsview.typepad.com/economistsview/2008/03/we-are-not-ther.html#c108137672

Ah; populism and progressivism were distinctly linked in ways I had not thought about, such as racially or in terms of civil rights possibilities. What I want to find out about beyond such a link is the populist influence on Teddy Roosevelt.

[anne]

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 Aministration.

Paul Krugman has not well developed this issue yet, which strikes me as increasingly complex, and needs to listen to a discussion from a lawyer's perspective. The fault is not at all in Krugman, but in somewhat coming to understand in technical terms what has happened to a regulatory philosophy.

[dd]

The issues are not complex at all. Anyone reading this blog the last few years knows the issues. Greenspan knows better than anyone as his speeches lay out a consistent anti-regulatory tirade.
The Fed's BlackRock deal is more of the same. Everyday consumers, investors, wage earners and savers are at grave risk; but the financial system will be saved.

[rod]

Paul Krugman continues his cynical and opinionated commentary against Obama, with occasional dyspeptic asides against all other politicians. Meanwhile, he doesn't research what Obama or others have actually advocated as measures to deal with the financial and economic problems of the country. He doesn't have any evidence to support his shotgun blast of attacks. And he doesn't have any particular proposal, brewed up by any economists, for what actually should be done by government; he just knows that whatever he recommends would not be adopted by anyone because no one is smart or pure enough to do so.

[Bruce Wilder]

very, very well put, rod

[anne]

"Greenspan knows better than anyone as his speeches lay out a consistent anti-regulatory tirade."

Please reference an example.

[Patricia Shannon]

Winslow R. says...

The structure needs to change. Perhaps not this time, or the next, but it must change (really! nation-state survival in a globalized world depends upon it changing). Meantime, government will keep sending the 'one world' financial industry bailout checks.

The structure may need to change. Maybe it will. But because it is needed doesn't ensure it will happen.

[anne]

I have found no constructive response by Barack Obama on the economic difficulties we are experiencing, and that have been building long before the current liquidity problem. Criticism is due. Hillary Clinton did address the subprime mortgage problem effectively earlier, though to no avail. Policy is important, and beyond Paul Krugman's suggestions which have been myriad for years I am waiting for meaningful economic policy from Obama.

[anne]

The continual absurd and mean-spirited criticism of Paul Krugman for asking policy definition from a Presidential candidate, simply tells me there is no policy to be had from the candidate.

Krugman has been discussing these matters for years, in detail and depth and cogently. Enough of the absurd defensiveness. Where is a hint of understanding from Obama's advisers all these months, not on liquidity issues but on a faltering in growth?

[anne]

There are several issues here, a faltering economy, a dramatic loss of wealth for so many in a loss of value in homes, a liquidity crisis that the Federal Reserve will have to handle alone and which Ben Bernanke is handling as well as any bank leader possibly could, a regulatory issue that is highly complex an will take intense study which is only beginning in the midst of an Administration hostile to regulation.

[save_the_rustbelt]

As of this month, 1 of every 10 Ohioans is receiving food stamps, and as many as 500,000 may be eligible and not signed up.

This can be traced very directly to offshoring of maybe 200,000 manufacturing jobs (some of the econo-guessers tell us it is technology, yet almost every empty factory has a forwarding address in Asia).

Hey, this globalization stuff really works neat.

[Bruce Wilder]

anne, I am not going to take a brief against Clinton or for Obama on policy proposals. I remain skeptical on what would be a proper method for systematically evaluating, side-by-side, the policy proposals of Presidential candidates. I am not saying that policy proposals do not tell us something, but when the policy instincts of two candidates are so closely parallel, I think it is challenging to see daylight.

But, I did both candidates the courtesy of actually going to the issues sections of their campaign websites, and reading what is there about the economy and about the mortgage crisis.

I find no support at all for your criticism of Obama in comparison to Clinton on these issues. None at all.

Are you thrilled, as I am most certainly not, by these proposals from Clinton:

Democrat Hillary Rodham Clinton proposed several remedies to the nation's home mortgage problems Monday, including one tool more often associated with Republicans than Democrats.

The New York senator proposed greater protections for lenders from possible lawsuits by investors, a variation of so-called tort reform. . . .

Clinton also called on President Bush to appoint ''an emergency working group on foreclosures'' to recommend new ways to confront housing finance troubles. She said the panel should be led by financial experts such as Robert Rubin, who was treasury secretary in her husband's administration, and former Federal Reserve chairmen Alan Greenspan and Paul Volcker. . . .

Clinton's remarks built on earlier proposals on the housing issue. Last week she called for a new stimulus package to include $30 billion to help state and local governments buy foreclosed properties, restructure mortgages and undertake ''anti-blight programs.''

Clinton also has called for a five-year freeze on interest rates for all subprime mortgages, which often go to borrowers with poor credit ratings.

None of these things would actually make me reject Clinton, but the tenor grates on me, and suggests a tin ear for economic issues and the self-interested behavior of powerful, but corrupt interest groups.

[George]

Ron Paul talks a lot about the financial crisis and is very bright and clear on how he would solve it.
George

says...

save_the_rustbelt says...

"BREAKING NEWS:

Senator Clinton wants some sort of commission co-chaired by Greenspan and Rubin to lead us from this financial wilderness."

Actually, one of the really interesting things about the Populist movement, is that one of the central issues was in fact monetary policy, with Bryan and his "cross of gold" speech. While it perhaps wasn't discussed and debated at the most sophisticated level, it does seem that the topic was in some ways popularly understood better than it is today.

As for Hillary's proposal that Greenspan and Rubin address the financial crisis, I'm not optimistic. While both I'm sure are decent, well meaning fellows, and both quite knowledgeable about economics, it is definitely not a very populist duo.

Rubin, the former COO of Goldman Sachs, it seems to me, doesn't have that much different an outlook from Greenspan. It seems to me they were both fiscal conservatives who each favored both deregulation and the strong dollar to some degree. How is this panel any different from what we might expect to see appointed by a President McCain?

One comment above suggested, that Greenspan was responsible for "easy money," and that this wold suggest something for the two to fight over. But I'm not convinced of it. It seems to me there would have likely been more currency printed over the last 5 years if we had been on the gold standard.

I believe the dollar has begun to weaken recently more as a result of a loss of confidence in the financial system. I don't really see the evidence for an easy monetary policy.

Currency, M0, and M1 have all been rather tight. Where there has been some moderate expansion has been in M2, driven entirely by money flowing into retail money funds. Especially notable though has been the expansion in the now discontinued M3.

What M3 includes that M2 doesn't are large accounts, specifically large time deposits and institutional money funds. Is there any evidence that this expansion could be the result of any Fed policy apart from the lack of sufficient regulation?

I find it interesting that there has been no great expansion in "money" in currency, demand deposits, checkable deposits, savings accounts or small time deposits-that is, nothing held typically by most ordinary people.

But institutional money funds, part of the M3 series that is still kept, have just about doubled in the last three years, from $1.06 trillion to $2.11 trillion. What I'm not sure I understand is where exactly these $1 trillion new dollars are coming from.

Is it from these institutions recklessly lending to one another using over valued assets for collateral? They do have the ability to create "money" in this way, in the absence of reserve requirements and other regulation.

A flight to safety from riskier assets? well, if I sell an asset, it shouldn't create "new dollars" unless it is purchased on credit. If you buy my house for cash, the amount of cash stays the same, it just goes from your account to mine. If you get a loan though, that creates new dollars that I can put into my account.

A sell off of dollars in foreign currency markets? Maybe. I'm not sure how dollars held in reserve by foreign central banks are accounted for.

[Taking it to the streets]

Krugman has identified an even greater moral hazard. The real danger is that the Feds real time testing of economic "science" might actually work. Bernanke's bailouts might save us from the worst recession since the 1930s. Everyone will then be happy as their jobs and houses are saved and liberals will be blamed for crying wolf. As a consequence, there will be no populist backlash and no clamoring for a regulatory rennaissance or a brand new New Deal. No politician, Democrat or Republican, will risk angering the moneyed classes unless the grass roots can be stirred to real anger, and that won't happen unless some real pain is felt by the man and woman on the street.

[Winslow R.]

Take wrote: "Krugman has identified an even greater moral hazard. The real danger is that the Feds real time testing of economic "science" might actually work. Bernanke's bailouts might save us from the worst recession since the 1930s."

Economic "science" has failed several times already, just the latest when the Fed opened up to nonbanks. We are deep into the realm of 'unconventional' monetary policy. No one doubts that the Fed controlled printing press, when used unconventionally, can save anyone it desires from the real danger of financial ruin.

The manifestations of the Fed's desires have become the moral problem.

[Hank]

Here's the program that got Huey Long assassinated:
http://historymatters.gmu.edu/d/5109/
==================

Here is what we stand for in a nutshell:

Number one, we propose that every family in America should at least own a homestead equal in value to not less than one third the average family wealth. The average family wealth of America, at normal values, is approximately $16,000. So our first proposition means that every family will have a home and the comforts of a home up to a value of not less than around $5,000 or a little more than that.

Number two, we propose that no family shall own more than three hundred times the average family wealth, which means that no family shall possess more than a wealth of approximately $5 million—none to own less than $5,000, none to own more than $5 million. We think that’s too much to allow them to own, but at least it’s extremely conservative.

Number three, we propose that every family shall have an income equal to at least one third of the average family income in America. If all were allowed to work, there’d be an income of from $5,000 to $10,000 per family. We propose that one third would be the minimum. We propose that no family will have an earning of less than around $2,000 to $2,500 and that none will have more than three hundred times the average less the ordinary income taxes, which means that a million dollars would be the limit on the highest income.

We also propose to give the old-age pensions to the old people, not by taxing them or their children, but by levying the taxes upon the excess fortunes to whittle them down, and on the excess incomes and excess inheritances, so that the people who reach the age of sixty can be retired from the active labor of life and given an opportunity to have surcease and ease for the balance of the life that they have on earth.

We also propose the care for the veterans, including the cash payment of the soldiers' bonus. We likewise propose that there should be an education for every youth in this land and that no youth would be dependent upon the financial means of his parents in order to have a college education.
=============================

[Taking it to the streets]

Winslow R., No argument from me on the failure of economic "science". I put in quotes only to express my skepticism. I admire Krugman, but even he has admitted recently on his blog that he may have to rewrite his textbook because of the apparent inability in the current environment of the Fed to reach its target interest rate through open market operations. So, the basic tool of monetary policy doesn't work when you need it? Can anybody explain what that's all about?

[Tony Wikrent]

Why not let the U.S. financial system collapse? Can't we save the economy without it? The U.S. financial system is not really providing any net addition of value to the economy. It's more parasite that anything else at this point.

Would the collapse of Bear Stearns really have brought down the whole economy? Or just the financial system?

What do we need to accomplish in this crisis? We want to ensure that credit is flowing to people who need it to conduct real economic activity. If a bunch of speculators and hedge funds are unable to get credit, why should anyone care? The speculators and hedge funds are not going to use it for real economic activity. Putting them out of business would be a good thing, actually.

So, let the financial system collapse. Is there not a way that we can force the trillions of dollars sloshing around the globe looking for the highest return to become “patient” and start pouring into the “green” rebuilding of the U.S. industrial economy, such as building mass transit systems that will help free us from fossil fuel dependency, or helping everyone replace their current vehicle with either hybrids or with high mileage vehicles, like the Aptera, which get 240 miles per gallon (yes, two four zero).

As it stands now, Bear Stears is saved and the financial system lives on to keep playing its funny money games, while the underlying problem is not addressed, and is not being addressed: the credit mechanism of the economy is being mis-used for speculation, rather than for funding real economic activity. Which means that another financial crisis is inevitable. So lets start asking questions “outside the box” with a view to radically transforming the financial system and forcing it to start doing something useful.

[Bruce Wilder]

"As for Hillary's proposal that Greenspan and Rubin address the financial crisis, I'm not optimistic. While both I'm sure are decent, well meaning fellows, and both quite knowledgeable about economics, it is definitely not a very populist duo."

No, to anyone, who really knows who these individuals are, this is not a particularly inspiring proposal.

My problem is that I don't what is a fair criticism, or a fair inference (as a potential supporter). The proposal is meant, primarily, to serve a symbolic purpose, to be an example of how Clinton would respond as President, calling together famous "experts" -- for campaign purposes, it is more important to name people with high name recognition than it is to name people, who might actually be appropriate to name to such a commission.

Now, a real President, including a real President Hillary Clinton, might very well appoint a commission, but would (I hope) use other criteria to stack such a commission, especially if she wanted it to do real work.

But, what criteria? Is fair to infer anything from the names she pulled out of the air, when she may be choosing the names to serve her immediate purpose, understandably without the time to devote to ersatz responsible consideration?

I don't think anyone would appoint Alan Greenspan to a commission that was going to be expected to do real work. He is a deeply prejudiced ideologue, and a very, very old man -- two major strikes against him on a working commission.

I could spin out an anti-Clinton story, here, but I am just not certain it is fair. I am left just slightly disappointed, wishing Clinton had a better campaign, and Clinton's campaign had a better candidate. But, I don't really feel like I know much for sure, about whether she would be a better candidate or a better President than Obama.

[Winslow R.]

Patricia wrote: "The structure may need to change. Maybe it will. But because it is needed doesn't ensure it will happen."

I believe the structure will change. How it will change will be determined in the continuing power struggle.

If we remain on the current path, as Diks pointed out, we are headed along the path of a European Union, Asian Union, NAFTA etc. to an eventual global union if world peace is not shattered in the process.

Why should we care?

The resulting wealth consolidation of the last 30 years should make us perk our ears and start to listen to what is going down.

My gut says Rubin, Clinton, Delong, and perhaps Krugman find acceptable the idea of a single global currency overseen by a coalition of economic unions controlled unofficially by bankers, with nominal national government oversight. This is the direction we have been heading.

If this is a distortion of their long-term view, I'd like to be called on it.

Krugman's latest 'coordinated' push (with Rubin and Clinton) for increased national regulation of nonbanks rather than banks is an diversion. As nonbanks fail, banks will start to fail, implying they too need national regulation.

We should pay attention and see that even through these cycles, the power of the bank monopoly increases as it becomes further internationalized and therefore increasingly avoids the national regulation meant to contain its power.

Understand international tax avoidance will flourish under such a system and hence will strangle the nation-state. The Fed (and IRS), in theory, works against this movement.

[Bruce Wilder]

George: "Ron Paul talks a lot about the financial crisis and is very bright and clear on how he would solve it."

But, when people learn that his chief economic adviser is a Púka, some skepticism arises.

[Winslow R.]

Take wrote:"Fed to reach its target interest rate through open market operations. So, the basic tool of monetary policy doesn't work when you need it? Can anybody explain what that's all about?"

Krugman's chart is the result of 'unconventional' policy.

The Fed's 'unconventional' TAF is flooding the market with zero interest paying reserves. The ultimate holders of these reserves look for maximum safe yield preferably at the same term length as the TAF (28 days). These purchases drive down rates of all short-term treasuries creating Krugman's mystery.

To solve the problem the Fed has created the TSLF which will supply sufficient treasuries to drive up the treasury yields while absorbing 'excess' zero interest paying reserves.

The problem is the Fed has chosen to funnel these transactions through the primary dealers. The primary dealers had no 'conventional' collateral the Fed would accept. Rather than opening up the TSLF to all banks as it has done with the TAF, the Fed instead chose to accept questionable MBS from the primary dealers as an intermediary step.

The TSLF had the potential to break the primary dealer monopoly but the opportunity was missed.

[walkingtheline]

> Is it from these institutions recklessly lending to
> one another using over valued assets for collateral?
> They do have the ability to create "money" in this way,
> in the absence of reserve requirements and other
> regulation."

Yes. Investment funds have flowed into credit derivative markets for higher rates of return and booked paper-profits that constitute much of the value of the hedged derivative market. There has been fraud regarding some of the underlying assets which were not market-threatening in a growing market.

Now the perceived risk of the entire class of derivatives (hedged or not) has spiked and new investment has stopped flowing into the market. Liquidity is drying up until either the underlying assets clear or it becomes clear there is no underlying asset. We have a major liquidity crisis preceding what may or may not be a major solvency crisis. It is a bit like a ponzi scheme, except that participants may be holding something of value at the end of the day.

Dropping the federal funds rate below inflation is simply encouraging a "flight to quality" that is driving up commodity prices and endangering productive but debt-leveraged firms. The problem is that the Fed doesn't have any way to stimulate the money base that doesn't involve dealing with players trapped by earlier investments in the derivatives market.

[acerimusdux]

Rod:

You are correct, this is another ignorant hatchet job from Krugman as it concerns Obama. When I first saw your comments I didn't know what you were referring to. Then I clicked through to the original, and realized that Mark had wisely excised the offending passages from his quote. It's a shame the NY Times editor didn't show the same good judgement.

Sure there are many things Krugman has discussed in the past congently, in depth and detail. So what does this prove? It proves he isn't stupid. It proves he isn't really this obtuse. It proves he is simply an asshole.

[acerimusdux]

"So, the basic tool of monetary policy doesn't work when you need it? Can anybody explain what that's all about?"

I think the simplest explanation there is that, with interest rates near zero on short term bills, they are pretty much economically near the same thing as dollars. A highly liquid instrument that pays no return.

At that point, open market operations, which involve exchanging dollars for treasury bills, have almost no economic effect.

Why not buy long bonds and reduce long term rates? Because doing so would also increase inflation expectations, which then increases those same interest rates. So another catch-22; possibly little impact.

As to how those interest rates got so low, it's a massive flight to safety in the market. If you don't trust anything else, and think banks may even be failing, the safest place to be is short term US government bonds.

I tend to think they should have been more aggressive with open market operations all along. Target an inflation level higher than 2%. But the Fed has apparently been more concerned with preventing the dollar from falling even further.

[acerimusdux]

"We have a major liquidity crisis preceding what may or may not be a major solvency crisis. It is a bit like a ponzi scheme, except that participants may be holding something of value at the end of the day."

Well yes, I suspect it's a solvency crises. The only market really lacking liquidity is the market for worthless junk. But, some of this has been going on for awhile, and those balances haven't come down yet. Does this mean they have yet to write down the bulk of these bad loans to insolvent hedge funds, et. al.? As long as they keep calling it a liquidity crisis, maybe they can keep putting off the write downs.

If that's the case, I think I'm with Tony above, let 'em fail. For the most part.

[anne]

"The only market really lacking liquidity is the market for worthless junk."

I would suggest, like, reading. And the idea of allowing the financial to fail is both idiocy and fortunately an impossibility. Now, let us all insult Paul Krugman.

[anne]

"So what does this prove? It proves he isn't stupid. It proves he isn't really this obtuse. It proves he is simply an --------------------."

Remember, what is important, what is always important is to use the language of the gutter to show just how we think, we must use the language of the gutter to show the sorts of people we are. We are not stupid, we are not obtuse, we are people of the gutter; follow us.

[anne]

"---- ------- continues his cynical and opinionated commentary against -----, with occasional dyspeptic asides against all other politicians."

Noticve how infectious mean-spirited idiocy can be. Now, let us return to the gutter.

[anne]

Months ago, understanding the community and personal damage being done, Hillary Clinton proposed a temporary freeze on foreclosures and a re-setting of subprime high-cost mortgage rates at conventional levels for a period of several years. The Administration has not been interested in such a proposal, however much needed. A current proposal to purchase faltering mortgages has been echoed by economists thinking back to resolution of mounting mortgage failures during the New Deal.

Beyond the current liquidity problems effecting market on market and which must be resolved to at all protect the economy, my concern has been over an extended period of slow growth that could be a far more severe problem.

[dd]

Anne, those references to Greenspan's adamant opposition to regulation are littered across this blog and have posted many times. Yes, it is couched in famous Greenspanese; but the attitude toward regulation is clear:
a. Financial Modernization and end of FDR protections:
"There is no disagreement--and there has been no disagreement for many years--that the Glass-Steagall Act must be repealed."
http://www.federalreserve.gov/boarddocs/testimony/1998/19980617.htm

"The Board is a strong advocate of financial modernization in order both to eliminate the inefficiencies of the current Great Depression regulatory structure and to create a system more in keeping with the technology and markets of the 21st century."
http://www.federalreserve.gov/boarddocs/testimony/1999/19990428.htm

b. Derivatives regulation:
"In conclusion, the Board continues to believe that, aside from safety and soundness regulation of derivatives dealers under the banking or securities laws, regulation of derivatives transactions that are privately negotiated by professionals is unnecessary. Moreover, the Board questions whether the CEA as currently implemented is an appropriate framework for professional trading of financial futures on exchanges. The key elements of the CEA were put in place in the 1920s and 1930s to regulate the trading of agricultural futures by the general public. The vast majority of financial futures traded simply are not as susceptible to manipulation as agricultural and other commodity futures where supplies are more limited. And participants in financial futures markets are predominantly professionals that simply do not require the customer protections that may be needed by the general public. Regulation that serves no useful purpose hinders the efficiency of markets to enlarge standards of living. In choosing a particular regulatory regime it is important to remember that no system will fully eliminate inappropriate or illegal activities. Banking examiners, for example, find it difficult to unearth fraud and embezzlement in their early stages. Securities regulators have difficulty ferreting out malfeasance. Even trading on exchanges does not in itself eliminate all endeavors at manipulation, as the Hunt brothers' 1979-80 fiasco in silver demonstrated. The primary source of regulatory effectiveness has always been private traders being knowledgeable of their counterparties. Government regulation can only act as a backup. It should be careful to create net benefits to markets."
http://www.federalreserve.gov/BOARDDOCS/TESTIMONY/1998/19980724.htm

c. Hedge Funds: No direct regulation
"Fourth, does the fact that investors have lost most of their capital and creditors may take some losses on their exposure to LTCM call for direct regulation of hedge funds? It is questionable whether hedge funds can be effectively directly regulated in the United States alone. While their financial clout may be large, hedge funds' physical presence is small. Given the amazing communication capabilities available virtually around the globe, trades can be initiated from almost any location. Indeed, most hedge funds are only a short step from cyberspace. Any direct U.S. regulations restricting their flexibility will doubtless induce the more aggressive funds to emigrate from under our jurisdiction. The best we can do in my judgment is what we do today: Regulate them indirectly through the regulation of the sources of their funds."
http://www.federalreserve.gov/boarddocs/testimony/1998/19981001.htm
d. Mortgage Securitzation:
"As a general matter, we rely in a market economy upon market discipline to constrain the leverage of firms, including financial institutions. However, the existence, or even the perception, of government backing undermines the effectiveness of market discipline. A market system relies on the vigilance of lenders and investors in market transactions to assure themselves of their counterparties' strength."
http://www.federalreserve.gov/boarddocs/testimony/2004/20040224/default.htm

e. Enforcement of Mortgage authority
The Federal Reserve under Greenspan's leadership never proposed regulations to combat predatory lending under the Home Ownership Equity and Protection Act of 1994; although it had ample power:
1. "The Federal Reserve has a broader power than any other regulator to ban unfair or deceptive mortgage lending, but it has never used that authority. And for a long time, there were signs that the wheels were coming off the train in the mortgage business."
http://www.npr.org/templates/story/story.php?storyId=17371534

2. "Edward M. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.
But when Mr. Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman."
http://www.nytimes.com/2007/12/18/business/18subprime.html?_r=1&oref=slogin

f. Federal Oversight under Gramm Leach:
The Act:
"Provides for Federal bank regulators to prescribe prudential safeguards for bank organizations engaging in new financial activities."
"Provides for a "jump ball" rulemaking and resolution process between the SEC and the Federal Reserve regarding new hybrid products."
Bear Stearns must be the first "jump ball."

[dd]

References to Greenspan’s anti-regulatory stance and opposition to FDR investor protections:

a. Financial Modernization and end of FDR protections:
"There is no disagreement--and there has been no disagreement for many years--that the Glass-Steagall Act must be repealed."
http://www.federalreserve.gov/boarddocs/testimony/1998/19980617.htm

"The Board is a strong advocate of financial modernization in order both to eliminate the inefficiencies of the current Great Depression regulatory structure and to create a system more in keeping with the technology and markets of the 21st century."
http://www.federalreserve.gov/boarddocs/testimony/1999/19990428.htm

b. Derivatives regulation:
"In conclusion, the Board continues to believe that, aside from safety and soundness regulation of derivatives dealers under the banking or securities laws, regulation of derivatives transactions that are privately negotiated by professionals is unnecessary. Moreover, the Board questions whether the CEA as currently implemented is an appropriate framework for professional trading of financial futures on exchanges. The key elements of the CEA were put in place in the 1920s and 1930s to regulate the trading of agricultural futures by the general public. The vast majority of financial futures traded simply are not as susceptible to manipulation as agricultural and other commodity futures where supplies are more limited. And participants in financial futures markets are predominantly professionals that simply do not require the customer protections that may be needed by the general public. Regulation that serves no useful purpose hinders the efficiency of markets to enlarge standards of living. In choosing a particular regulatory regime it is important to remember that no system will fully eliminate inappropriate or illegal activities. Banking examiners, for example, find it difficult to unearth fraud and embezzlement in their early stages. Securities regulators have difficulty ferreting out malfeasance. Even trading on exchanges does not in itself eliminate all endeavors at manipulation, as the Hunt brothers' 1979-80 fiasco in silver demonstrated. The primary source of regulatory effectiveness has always been private traders being knowledgeable of their counterparties. Government regulation can only act as a backup. It should be careful to create net benefits to markets."
http://www.federalreserve.gov/BOARDDOCS/TESTIMONY/1998/19980724.htm

more to follow

[dd]

c. Hedge Funds: No direct regulation
"Fourth, does the fact that investors have lost most of their capital and creditors may take some losses on their exposure to LTCM call for direct regulation of hedge funds? It is questionable whether hedge funds can be effectively directly regulated in the United States alone. While their financial clout may be large, hedge funds' physical presence is small. Given the amazing communication capabilities available virtually around the globe, trades can be initiated from almost any location. Indeed, most hedge funds are only a short step from cyberspace. Any direct U.S. regulations restricting their flexibility will doubtless induce the more aggressive funds to emigrate from under our jurisdiction. The best we can do in my judgment is what we do today: Regulate them indirectly through the regulation of the sources of their funds."
http://www.federalreserve.gov/boarddocs/testimony/1998/19981001.htm

d. Mortgage Securitzation:
"As a general matter, we rely in a market economy upon market discipline to constrain the leverage of firms, including financial institutions. However, the existence, or even the perception, of government backing undermines the effectiveness of market discipline. A market system relies on the vigilance of lenders and investors in market transactions to assure themselves of their counterparties' strength."
http://www.federalreserve.gov/boarddocs/testimony/2004/20040224/default.htm

more to follow

[dd]

e. Enforcement of Mortgage authority
The Federal Reserve under Greenspan's leadership never proposed regulations to combat predatory lending under the Home Ownership Equity and Protection Act of 1994; although it had ample power:
1. "The Federal Reserve has a broader power than any other regulator to ban unfair or deceptive mortgage lending, but it has never used that authority. And for a long time, there were signs that the wheels were coming off the train in the mortgage business."
http://www.npr.org/templates/story/story.php?storyId=17371534

2. "Edward M. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.
But when Mr. Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman."
http://www.nytimes.com/2007/12/18/business/18subprime.html?_r=1&oref=slogin

f. Federal Oversight under Gramm Leach:
The Act:
"Provides for Federal bank regulators to prescribe prudential safeguards for bank organizations engaging in new financial activities."
"Provides for a "jump ball" rulemaking and resolution process between the SEC and the Federal Reserve regarding new hybrid products."
Bear Stearns must be the first "jump ball."

[anne]

Thank you; that is excellent.

Whether having or not having Glass-Steagall is important, I am in no way sure. I am told by lawyers I expressly asked that not having Glass-Steagall is not a regulatory problem as long as the broader banking companies formed on removal are actually regulated by the Feeral Reserve since these broader companies are still banks.

What DD is arguing, however, is that Alan Greenspan may have been philosophically opposed to broad regulation even when possible or even part of the Federal Reserve mandate. I have heard the same argument by anecdote from a bank president with whom I run.

[anne]

DD is arguing the case for a long term philosophical bent against regulation by Alan Greenspan, that would seem to be supported by an apparent unwillingness of Greenspan even to tighten banking oversight and regulation from 1987 on through assorted problems in financial markets.

Ben Bernanke as a Federal Reservbe Board member under Alan Greenpan made no apparent attempt to strengthen oversight and regulation over mortagage extension or investment, while Bernanke as Fed chair did not act even to tighten lending standards for at least a year.

[anne]

http://www.nytimes.com/2007/12/19/opinion/19wed1.html

December 19, 2007

A Crisis Long Foretold

A truism of crisis management is that most seemingly out-of-the-blue disasters could have been prevented if someone had paid attention.

An article in The Times on Tuesday by Edmund L. Andrews leaves no doubt that the twin crises of the subprime lending mess — mass foreclosures at one end of the economic scale and a credit squeeze afflicting the financial system — are rooted in the willful failure of federal regulators to heed numerous warnings.

The Federal Reserve is especially blameworthy. Starting as early as 2000, former Fed Chairman Alan Greenspan brushed aside warnings from another Fed governor, Edward M. Gramlich, about subprime lenders who were luring borrowers into risky loans. Mr. Greenspan's insistence, to this day, that the Fed did not have the power to rein in such lending is nonsense.

In 1994, Congress passed a law requiring the Fed to regulate all mortgage lending. The language is crystal clear: the Fed "by regulation or order, shall prohibit acts or practices in connection with A) mortgage loans that the board finds to be unfair, deceptive, or designed to evade the provisions of this section; and B) refinancing of mortgage loans that the board finds to be associated with abusive lending practices, or that are otherwise not in the interest of the borrower."

Yet, the Fed did nothing as junk lending proliferated — including loans that were unsustainable unless house prices rose in perpetuity, riddled with hidden fees and made to borrowers who could not repay. Mr. Greenspan has said that the law was too vague about the meaning of "unfair" and "deceptive" to warrant action.

The Fed has also disappointed since the current chairman, Ben Bernanke, took over in early 2006. It was not until the end of June 2007 — after the damage was done — that the Fed and other federal regulators issued official subprime guidance. On Tuesday, the Fed issued another set of proposals. Among those, subprime lenders would have to verify a borrower's ability to repay and include mandatory tax and insurance costs in the monthly payment. In at least one key respect — enforcing the ability-to-repay standard — the proposal is weaker than earlier Fed guidance....

[Tony Wikrent]

anne says...
And the idea of allowing the financial to fail is both idiocy and fortunately an impossibility. Now, let us all insult Paul Krugman.

This comment is less than useless. In point of fact, the financial system has already failed, which is why we are having a discussion about how and why to save it.

And here is the more important point. Not just has the financial system failed in the sense that since August 2007 a number of financial markets have ceased functioning, and now credit is becoming scarce for real economic activity. The financial system has failed, and has been failing for a number of years, as a general credit mechanism to supply credit to needed areas of the economy, such as infrastructure maintenance and development (see comments by the CEO of United Parcel Service that “The US must reinvest in its ageing, overused transportation networks or risk losing ground to the world's other leading economies.”).

How do we prevent credit from going into speculation and arbitrage and "trading for own account" and back into real economic activity.

Look, we MUST end our dependence on fossil fuels. The deregulated financial system of Wall Street is not only failing to help that national goal, it is actually hindering it by mis-allocating credit away from furtherance of that national goal. There are bio-fuel companies and electric vehicle manufacturers and high-mileage vehicle manufacturers such as Aptera that are fighting and clawing to raise a few miserly millions of dollars in financing. How do we restructure and re-incentivize the financial system so that credit is flowing, nay flooding, into those efforts, and not into a resumption of massive speculation and arbitrage?

Or think of it this way: how do we make capital patient enough that the one or two percent return on funding a new nuclear power plant looks like a great return?

What good is it to save the financial system if we allow society to collapse? Unless your goal is to so enrich a number of bankers and speculators that they can survive a social collapse.

[acerimusdux]

"I would suggest, like, reading. And the idea of allowing the financial to fail is both idiocy and fortunately an impossibility."

The point is that the only real failures out there would be in the very high risk segment. Such as hedge funds using ungodly leverage to yield higher returns buying debt instruments. I don't see any great risk in allowing some failures there.

The Fed and FHLB combined are providing a couple hundred billion of additional liquidity to markets for higher quality MBS. That ought to be enough for those markets. Liquidity problems will continue mostly in segments with some solvency issues.

To the extent there are really still large problems in the higher risk segments, yes the market needs to absorb those losses. The government shouldn't be putting capital at risk to defend anything that is truly of questionable value.

So how much excessive leverage is really still out there?

I also wonder if these new participants, Black Rock and Penny Mac, will be any more responsible in their use of debt as they start buying up mortgage bargains.

[dd]

There BlackRock deal is simply the Paulson SIV plan via an LLC with the Fed instead of private funding. It would make sense that the "assets" will be sold at a deep discount to BlackRock/Highfield's Penny Mac at some time in the future. No doubt much leverage will be used in acquiring the distressed assets. That looks to be the deal; but its difficult to discern given the scant information.
http://www.newyorkfed.org/newsevents/news/markets/2008/rp080324b.html

This is an extraordinary measure equal to the Bear Stearns bailout; but there has been little analysis of the impact other than other banker's clamoring for the same opportunities.
http://www.bizjournals.com/sacramento/stories/2008/03/24/daily6.html

[acerimusdux]

anne says...

"Remember, what is important, what is always important is to use the language of the gutter to show just how we think, we must use the language of the gutter to show the sorts of people we are. We are not stupid, we are not obtuse, we are people of the gutter; follow us."

I'd rather call it what it is. I think that's far less insulting than Krugman's couching of petty insults in false arguments with a shallow pretense of civilized debate over issues.

If I wanted to respond to his supposed points, I could have pointed out:

1. He starts with the straw man that Obama has suggested that the "is responsible for our economic troubles". Obama has suggested the war has raised oil prices. He has suggested that both war spending and the Bush tax cuts have increased the debt. He has suggested that some of this money could have instead been spent addressing some economic problems. But he certainly never suggested the war was exclusively the problem.

2. We have already discussed several weeks ago here, the econometric evidence which contradicts Krugman's implication that the war is not also responsible for a drain on economic growth. Yes, in the short run, war spending has a stimulative impact. But we are five years in now. We are past the point where some modeling shows a slowing economy as a result of such war spending.

But, is it really necessary to respond politely to Krugman at this point regarding Obama? He is so transparently wrong, with regularity, on the topic that it isn't much worth spending a lot of words correcting it.

Better to ignore it, as Mark did, and focus on the more substantive portions of his column. No need to follow Krugman down into that particular gutter. It's just Krugman being Krugman.