Shiller: What of the Next Financial Crisis?

Robert Shiller, like Alan Greenspan, says we need a "well-articulated policy" to manage the next financial crisis. In particular, we need to update our laws and institutions - he says bankruptcy law is  good place to start - to handle the complexities inherent in modern financial markets, and to recognize systemic risk:

Crisis Averted. What of the Next One?, by Robert Shiller, Economic View, NY Times: ...Given the threats posed by the financial crisis, a better framework for dealing with systemic crises is urgently needed. The policies recently instituted by the Treasury and the Federal Reserve to deal with financial crises seem improvised, rather than part of a consistent, well-articulated policy.

There is still a risk that financial dominoes will begin to fall. ...[T]his ... is worth some careful thought. If the Bear Stearns crisis had such a potential for disaster, what will we do if a major hedge fund fails or if several crises happen at once? ... What if the next case is worse? No one in government seems to feel a responsibility for warning about such possibilities and formulating a detailed policy for dealing with them.

Bankruptcy law is a good place to start. After all, the dreaded financial meltdown would amount to a wave of bankruptcies.

Preventing Bear Stearns from becoming the responsibility of the bankruptcy courts was one reason the Fed felt that it had to act so quickly. Current bankruptcy law was not written with the perspective of systemic risk in mind. There is a big problem — a discontinuity in macroeconomic outcomes — when large financial institutions are at the margin between solvency and insolvency. The formal declaration that an important financial institution is insolvent could threaten the whole economy...

Jay L. Westbrook, a bankruptcy scholar ... at the University of Texas School of Law, has called for extensive study of the systemic financial issues related to bankruptcy law. He said the law might be changed in innovative ways so that in times of financial crisis, when more is at stake than the fate of individual companies and their stakeholders, troubled companies could be kept functioning longer. A subsidized system of triage would be needed to identify which companies should be saved, with the main criterion being the possible economic impact of their liquidation.

In this country, we seem to get things right eventually. ... We learned how to deal with the systemic effects of bank runs — but it took a couple of hundred years. In the 19th century, periodic banking crises were the major cause of economic crises. By the 1930s, we had a four-pronged approach to deal with the banking variety: regulation, direct discount-window lending by the Fed, deposit insurance and processes for orderly resolution of insolvencies.

Now the financial system is much more complex. It includes a variety of entities that resemble banks in their vulnerability to panics, though we don’t fully understand the crisis potential. Hedge funds, for example, do not need to disclose much about what they are doing, yet they are starting to play a role in our economy that resembles that of 19th-century banks.

What would happen to the economy if hedge funds had to liquidate, one after another, in a financial crisis? We need to rethink the theory and practice of bankruptcy, given the new complexities.

Current bankruptcy law, and the system of bankruptcy courts, were put in place by Congress with the help of organizations like the American Bankruptcy Institute, the International Swaps and Derivatives Association and the Securities Industry and Financial Markets Association. It’s not shocking that these groups seem to have approached the problem of bankruptcies largely as narrow specialists, thinking mostly of the interests of their clients, rather than of the economy as a whole. We can’t expect securities lawyers to focus on issues like threats to consumer confidence or, for that matter, disruptions in the labor market.

But someone needs to do it.

Comments

[Bruce Wilder]

"to handle the complexities"

Ah, the complexities. Would that be anything like rapacious fraud and predation? Shall we completely ignore wildly inflated compensation for managers and executives?

I expect "we", meaning the government, will not prepare. There will be a next time, precisely because no reform or remedy can get past the powers that benefitted so mightily from this time.

It is only after the government and country are so weakened by the parasites of Corporate America and Wall Street that no effective bailout is possible, that, amid the ruins, realistic reform can be considered. If it starts well, it will start with prison terms; reform that doesn't start with criminal prosecution is going nowhere. That hopeful era is not our era, clearly.

[Blissex]

«Ah, the complexities. Would that be anything like rapacious fraud and predation?»

To add to this, Shiller's entire argument is based on the deeply flawed assumptions that great financial crises just happen, are acts of nature ("There is still a risk that financial dominoes will begin to fall"), and that can be solved with the proper technical means, prepared by enlightened experts ("Jay L. Westbrook, a bankruptcy scholar").

Both implicit assumption are of course propaganda, as financial crises are intimately political affairs, and their resolution is an even more political affair, as both involve (few big) winners and (many small) losers, and the winners clearly have every incentive (and follow them) to game the system.

Sure, there are financial issues that do not arise out of deliberate political plans to help a few "friends and sponsors" make a quick buck or a billion, but even those develop a political dimension as accidental creation of (few big) winners and (many small) losers.

Eventually, all of Usian politics depends on the clear convinction of 60% that they will end up in the top 1% of winners, and screw everybody else, and this means that financial bubbles in particular are seen by them as a huge opportunity to realize that entitlement, not as a potential threat to their jobs and security.

[Prevent Speculative Excess, Prevent Subsequent Crises]

A stable currency (zero inflation), and positive real interest rates would help prevent credit excesses that are dangerous to the system. We need to finance new business expansion to keep the economy going. Real businesses earn a profit, and thus can pay reasonable interest rates.

Super low or negative real interest rates promote speculative excess. Speculative loans are not paid back, which then starves legitimate small business loans. Too low interest rates in the 1920s led to too much stock margin, which could not be paid back. Too low interest rates in the early 2000s led to too much real estate margin, which cannot be paid back.

The key is to consistently make sensible loans. Loans to small businesses, and for reasonable consumer purchases. This means a stable currency, and real reasonable interest rates. This limits loans to people who can use them profitably, and are more likely to have the means to pay the loans back. No credit bubble, no subsequent crises.

A stable currency, and reasonable real rates also helps balance savings/credit in a nation. Borrowing everything from overseas savers is not a viable long term strategy.

[Blissex]

«A stable currency (zero inflation), and positive real interest rates would help prevent credit excesses that are dangerous to the system.»

I'll insist: this is not a technical discussion where disinterested, enlightened scholars (from UofChicago of course :->) argue as to the best means to achieve the best of the possible worlds.

Credit excesses have winners and losers, vested interests that create them. Shiller and the comment above are rather pointless because they massively disregard the political dimension.

[ken melvin]

If history serves: There'll be a collapse then a Baruch or Kennedy type step in and tell us how they did and what needs be done to prevent such in the future.

If no one knows how hedge funds and such work and few good reasons can be given for their existence, maybe they shouldn't exixt.

[Ex-Worker]

Anything that would address "systemic" issues would focus regulation on largest institutions.

Since these same large institutions (hedge funds, NY banks, Fannie Mae, etc.) have well bought off both parties, regulatory initiatives will not address "systemic risk", since such an effort would imply a level of regulatory forebearance for smaller players. How unfair it would be to subject poor Citigroup to a different standard than a $250mm regional institution?

Instead, we will likely get another Sarb-Ox with large costs imposed arbitrarily throughout the real economy, borne primarily by innocent parties. The fraudsters who created the problem will become further entrenched.

The Citibanks of the world love regulation, but only when it can be used to bludgeon smaller competitors and create barriers to entry in their business.

[bakho]

"Eventually, all of Usian politics depends on the clear convinction of 60% that they will end up in the top 1% of winners, and screw everybody else, and this means that financial bubbles in particular are seen by them as a huge opportunity to realize that entitlement, not as a potential threat to their jobs and security."

Insiders set up the game to where they win big and everyone else is left holding the bag. In the 90s the big scam was the IPO. Even our ex-presidents like GHW Bush were cut in on the action. By giving some of the winnings to politicians or ex-politicians the rules are kept friendly. Blissex is correect. Bubbles are a feature for the greedheads, not a bug.

Wherever individuals are extracting huge amounts of money out of any enterprise (leveraged buyouts (whatever)) rest assured a lot of losers are being created. Instead of clamoring for regulations to close the loophole and stop the greedheads, the American Sucker yells the "Me want mammoth meat!" war cry and jumps into the trap.

[hari]

Let's start with a definition of *truth telling* by academics and specially socalled libertarians about the nature and function of American capitalism.

Without going into details...

Compared to what we've historically experienced, in Western Europe, America is still a hinterland for white-collar free market capitalist corruption due to lack of any or no *defense* against power of money ....

Get your house of finance, first, in order by studying how we've succeeded in learning from mercantile monopolists and whatnots. The structures we've put in place are not coming from academic high-flying theories but practical experience with disasters of one type or another.

Start from the Oval Office -> get rid of the +500 political appointees and replace them with a permanent professional staff with competence and subject to Congressional oversite.

Reduce turnover of senior policy-making staff based on electoral cycles. This is a stupid receipie for more disasters to come....because there is hardly any national *objective criteria* left in decision-making. ALl is reduced to party politics. How in the world do you expect things to get better with such a corrupt system of political junkies?

PS>There are no political appointees in the EU Commission in Brussels. All have to compete publically to get a job based on their professional background and experience for the job. The appointments are long term with security of employment and compensation (non-taxable).

[hari]

However, don't read me wrong...

Even inside EU, today, we have corruption from time to time which makes headlines in national press (mostly UK) due to their opposition to Brussels diktat.

BTW - The diktat of Brussels, in terms of decision-making, is not final unless approved by the Council (which includes Heads of States who're the political bosses of the Commission). Alternatively, they (Members-States) demand and Commission delivers based on its professional competence.

[kthomas]

"...Shiller and the comment above are rather pointless because they massively disregard the political dimension."

EXACTLY. And if America stopped voting Republican so much, we would not be - repeadtedly - in these predicaments.

[Ex-Worker]

"Stop voting Republican"

Simplistic argument with a grain of truth.

The dot com boom was clearly a Republican plot, orchestrated by those stalwart Republican strongholds of CA & NY, enabled by the undercover Republican operatives Rubin and Clinton.

I very much suspect the next bubble will have something to do with alternative energy, driven primarily by the non-Republican's.

[donna]

The problem at this point is that we have the top 1 percenters now preying on what is left of the incomes of the top 5 percenters, and we top five percenters are really pissed off about it. We're the ones that have to demand regulation of the top level s of greed before our entire life savings goes down the tubes in these Ponzi schemes.

I for one am voting for anyone who promises to regulate the hell out of these bastards who care for nothing but their own damned pocketbooks.

[Alice C. Linsley]

Here is a minimal just compensation for those who have suffered the effects of fraud and predation: expunge bankruptcy from the credit reports of all such persons.

[Bruce Wilder]

Ex-Worker: "The dot com boom was clearly a Republican plot, orchestrated by those stalwart Republican strongholds of CA & NY, enabled by the undercover Republican operatives Rubin and Clinton."

I really hate stupid. Smart-ass "conspiracy theory" ridicule, in the service of obscuring real political responsibility, I hate as a special, ugly brand of stupid.

Making the dotcom bubble -- which was a genuine speculative bubble sparked by fin de siecle optimism and particular, real innovation -- into an analogue for the "housing bubble" is a way of lying about the economics, as well as the partisan responsibility.

If there was any point of economic policy cause in common between the two events, it was the loose money policy of Alan Greenspan, a right-wing Republican.

But, regardless, the economy, and its behavior -- no matter how complex -- is always almost entirely artifactual. The complexity means that outcomes are not entirely under collective, intentional control, but what happens is always directly a product of what people -- millions of people, sometimes, hundreds sometimes, dozens even sometimes -- do.

Gramm-Leach-Bliley, which "deregulation" set up the pre-conditions for the current debacle, was not a conspiracy for you to falsely ridicule -- it was a bill passed by Congress and signed by the President -- Clinton as it happened. But, it took Bush's discretionary deregulation of banking and years of corruption building up at the GSEs, as well as Magic Alan's free money, to build up our current bonfire of the vanities.

Are there Democratic fingerprints on the current debacle? Sure, there are. (I would not give spit for the Clinton-led DLC.) But, that's no excuse for ignoring the driving forces in the politics of deregulation and corruption.

Politics is about policy. Policy has consequences. Our current banking crisis is a consequence of policy. Anything that distracts from this realization is just the know-nothing politics of stupid, which Krugman was talking about.

[btg]

"A stable currency (zero inflation), and positive real interest rates would help prevent credit excesses that are dangerous to the system"

Funny, but if I recall correctly, the period from the 1860s to 1900 - when you had a stable currency (because of the Gold Standard), and positive real interest rates because prices were stable (and because of the Gold Standard, much of the money supply was essentially fixed), or actually declining, was one of the periods when there were the greatest booms and busts in US economic history.

In the end, the only way out of the current "Gordian knot" (high budget deficits, trade deficits, foreign borrowing, inflationary pressures, economic stagnation, ...) is to let inflation go up, and the dollar go down - for a year or two, and then to bring inflation down once that is the only problem left... just as FDR realised that the only way out of the depression was to buck the conventional wisdom and to forget about balancing the budget.

[Lafayette]

The above comments seem to indicate that the problem is systemic. I beg to differ.

The root of all these problems are the capital gains marginal tax rates lowered by Reagan, which let the foxes into the hen-house. Why should anyone want to trick the system if it were not for personal gain?

I reiterate: Make Capital Gains taxes confiscatory above a certain limit, which leaves a motivational element for risk to be taken and rewarded, and the greedy scheming will stop the day after.

The solution is Draconian. But, isn't the problem as well? Then the means justify the ends.

[Prevent Speculative Excess, Prevent Subsequent Crises]

"...the period from the 1860s to 1900..."

That was the Civil War (the only major war fought on our soil) and Reconstruction period. With Sherman's troops destroying southern infrastructure, then the subsequent rebuilding of same, wild swings were unavoidable. Even during this trying period, we never had anything like the Great Depression, which was caused by 1920s credit excess leading to just too many loans that could not be repaid.

[Ex-Worker]

Bruce,

Gramm-Leach-Bliley had minimal impact on the current housing scandal. Gramm does not leave the same fingerprints that St Germain (D-Rhode Island) left on the S&L crisis, from a policy perspective.

Technology is far more important than deregulation in creating the current crisis. Think how you might create a CDO or model a leveraged buy-out prior to Microsoft Excel or modern computing power.

In your view, the problem is not deregulation, but rather that regulation did not keep up with the pace of technological change in the finance. I surely agree there have been failures here, not the least of which was Greenspan. But also, the failure to regulate "systemic risk", the topic of this thread.

But let's be honest- there was no golden era of regulation that would have kept technology from driving many of the macro trends in finance- financial engineering, globalization, consolidation, securitization at bay. Thus there was no evil deregulatory plot that culminated in the housing crisis. In fact, by volume there is far MORE regulation of financial services now than prior to Reagan.

Securitization existed long before Gramm Leach Bliley. So did mortgage brokers. Arguably the biggest shysters of the housing bubble banks (Bear Stearns) did not even control a depository institution, one of the policy changes allowed by Gramm. The other source of deregulation with which you probably object is preemption of state rules. But seriously, do you think having 50 states regulating financial institutions makes any sense as a modern regulatory framework?

As a policy argument, those who reflexively blame all ills on vague themes like "deregulation" without understanding the industry might consider claiming "a special sort of stupid" from tongue in cheek conspiracy theorists.

[dmg555]

Yves Smith from naked capitalism has correctly pointed out that oil prices have moved from 147 to 114 over the last few weeks and there hasn’t been a peep of disruption or threats to the financial system i.e. the Federal Reserve having to come to the rescue of the major oil companies or E&P companies. This is because oil is traded on an exchange where third party clearing is not an issue because counterparties have to come up with margin requirements daily. The types of contracts which brough bear stearns down are OTC derivative contracts. It is estimated by Deutsche Borse Group in a white paper that the total notional amount of OTC derivatives was 457 trillion, 383 trillion of which is OTC traded. They estimate that the Gross market value of these contracts is considerably smaller at 10 Trillion which is still significantly larger than the funds needs to shore up Bear Stearns. It is my belief that these OTC products need to move to exchange traded products, where the intermediary of an exchange prevents the boys in the back room from carrying the trade in the hopes that it will turn around. I welcome all comments

[nobody you know]

Reasoning by analogy, we should not reward people who load up a ship until it sinks and walk away happy with insurance proceeds.

History on this corrupt practice, how it was stopped, and what to watch for in countries where regulation isn't yet done.

The analogy to financial vessels should be obvious to anyone except a financial expert:

http://www.victorianweb.org/history/plimsoll.html

_____excerpt follows_____

By the mid-1800's, the overloading of cargo ships had become a major problem. By 1836 public concern about the loss of ships and crews reached the point where Parliament was forced to appoint a committee to investigate the growing number of shipwrecks. In 1850 legislation was passed to create the Marine Department of the Board of Trade: one of its duties was to enforce the laws governing the manning, crew competence and operation of merchant vessels.

Despite calls for regulation, the British government avoided direct interference with ship operators until 1870 when Samuel Plimsoll (1824-1898), a member of Parliament from Derby, headed a campaign to require that vessels bear a load line marking indicating when they were overloaded, hence ensuring the safety of crew and cargo. Plimsoll exposed what he described as "coffin ships" created by overloading. He drafted a bill to improve conditions on merchant vessels. Gladstone's government set up a Royal Commission to investigate merchant marine practices and conditions; the report exposed many malpractices committed by unscrupulous owners. A Bill introduced in 1875 was defeated.

Plimsoll's violent speeches aroused the House of Commons and his book, Our Seamen, shocked the public. It also earned him the hatred of many shipowners who started a series of legal battles against him. Undeterred, Plimsoll fought until finally, in 1876, Parliament was forced to pass the Unseaworthy Ships Bill into law. The Act required a series of 'lines' to be painted on the ship to show the maximum loading point. Unfortunately, the Act allowed the shipowners to paint the line where they saw fit and some chose to paint it on the funnel of the ship. It was not until 1890 that Board of Trade officials applied the regulations that Plimsoll had intended.
....
-----end excerpt------

Penalty for overloading and sinking a financial instrument?
$$Profit$$ and walk away.

[btg]

"That was the Civil War (the only major war fought on our soil) and Reconstruction period. With Sherman's troops destroying southern infrastructure, then the subsequent rebuilding of same, wild swings were unavoidable. Even during this trying period, we never had anything like the Great Depression, which was caused by 1920s credit excess leading to just too many loans that could not be repaid."

Much of it was railway overbuilding, and speculation more to do with the West than the South.

See wikipedia for:

Panic of 1873
Panic of 1893

also of interest

Panic of 1837
Panic of 1907

[Ex-Worker]

"Reasoning by analogy, we should not reward people who load up a ship until it sinks and walk away happy with insurance proceeds."

Right on. If the financial firms do not learn from this lesson and adjust their compensation accordingly, they will merit much more stringent regulation. Everyone should be wise to this game by now.

A big problem in the last 2 bubbles was the Fed, specifically Greenspan. The bubbles were pretty obvious to all 1-2 years before they burst. Policy intervention, at least regulatory power calling a spade a spade could have helped deflate with less damage.

[Bruce Wilder]

Just a reminder about this Economic Crisis: "In the second quarter, acquisitions of American-owned companies by foreign businesses tallied $130.2 billion, making it the highest total for any second quarter recorded and 29 percent higher than the 2007 period, according to research firm Dealogic."

Yes, indeedy, folks, we are selling off business assets at a record pace. I wonder, can you sustain a economy, taking in laundry?

[Bruce Wilder]

Ex-worker: "As a policy argument, those who reflexively blame all ills on vague themes like "deregulation" without understanding the industry . . ."

Excuse me for not providing a 50,000 word history of U.S. banking in a blog comment.

The history of banking crises in the U.S. since 1920 has been the history of malfeasance by the Republican Party. Everything else is just detail. And, Phil Gramm, UBS vice-chairman, has his fingerprints all over this debacle; he makes Jake Garn look like an innocent babe.

[Bruce Wilder]

dmg555: "It is my belief that these OTC products need to move to exchange traded products, where the intermediary of an exchange prevents the boys in the back room from carrying the trade in the hopes that it will turn around."

I have said as much repeatedly. I think it obvious. What's not obvious, is why it is not more of a standard feature of critiques and reform proposals given wide circulation in the Media.

[Bruce Wilder]

Prevent: "Even during this trying period, we never had anything like the Great Depression, which was caused by 1920s credit excess leading to just too many loans that could not be repaid."

BTG has suggested Wikipedia. Anyway, Prevent, you are simply wrong, on both counts. The depressions that followed the Panics of 1873 and 1893 were severe, and greatly exacerbated by the monetary deflation attendant on adhering to the Gold Standard, at a time when gold production was lagging well behind expansion of the economies of the U.S. and other industrializing countries. You have no idea what caused the Great Depression.

[Arctec]

Here is a list of Banks that may fail and go bankrupt.

http://bankruptbanks.blogspot.com/

[Lafayette]

Vague Themes

Ex-W: As a policy argument, those who reflexively blame all ills on vague themes like "deregulation"

Perhaps, but nothing of what you say/argue proves the opposite either.

Deregulation is a "vague theme"? When the Glass-Steagall Act was ended and Commercial Banking was able to merge with Investment Banking, a firewall was put down. One that had worked for 36 years preventing a necessarily high-risk business from menacing an intentionally low-risk business.

Is all the marvel of Financial Engineering, brought about by deregulation, really and truly worth the Subprime Debacle that is throwing people out of house and home as well as the Credit Seizure that has put the EU and the US into an economic downturn?

Who made the real benefit from financial deregulation, if not the Golden Boys who asked for it? Who abused it?

Hardly a "vague theme", that.

[Lafayette]

Ex-W: If the financial firms do not learn from this lesson and adjust their compensation accordingly, they will merit much more stringent regulation. Everyone should be wise to this game by now.

I would suggest that they merit it anyway. And, some will enjoy a perp walk for fraud, to boot.

[cm]

Blissex: "convinction of 60% that they will end up in the top 1% of winners, and screw everybody else, and this means that financial bubbles in particular are seen by them as a huge opportunity to realize that entitlement, not as a potential threat to their jobs and security"

I disagree -- many of those 60% believe one version or other of "hard work" and "virtue" getting them there -- the rubes if you will (a good number of them probably wisens up at some point).

OTOH I have occasionally heard the sentiment you are alluding to expressed -- "bring on the layoffs", expecting "other heads" to roll.

But then there is always the caveat that there is a chance I have only interacted within the other 40%, and simply don't know what I'm talking about ...

[paine]

"If it starts well, it will start with prison terms"

exactly

[paine]

"There is a big problem — a discontinuity in macroeconomic outcomes — when large financial institutions are at the margin between solvency and insolvency. The formal declaration that an important financial institution is insolvent could threaten the whole economy..."

ie
systemic changes
in a crisis
require a comprehensive " insurance system"

not clear if
even bright lights like schiller here
know his analysis carried out to it's
full set of implications
are short hand
for an end to private equity only
(at risk ) style hi fi capitalism

[kthomas]

"....know his analysis carried out to it's
full set of implications
are short hand
for an end to private equity only..."

Wow, I did not interpret so radically. paine, you are a warrior.

[Bruce Wilder]

paine: "not clear if
even bright lights like schiller here
know his analysis carried out to it's
full set of implications
are short hand
for an end to private equity only"

It could be that it is just an end to American ownership. As I read the terms of the financing, which is keeping the Citibank dreadnought afloat, the Arab equity eats the rest by about 2011.

[Invisible Hand]

Shiller is way over-simplifying to think bankruptcy overhaul can prevent the major threat to the economy caused by unregulated hedge funds, unregulated CDOs, and "too big to fail" financial companies. The first needed reform is to regulate these unregulated institutions before the taxpayers have the bail them out.

[Ex-Worker]

Lafayette,

Glass-Steagall at the time was a revolutionary commonsense regulatory response to the problem at hand. 70 years later, it was not so relevant. There was some marginal ramping of risk due to elimination, but this effect was minimal compared to other factors- industry structure and technology change.

You can't pin the blame for housing on deregulation, and especially not on the elimination of Glass-Steagall.

You can blame our failure to adopt aggressive new regulation. Of course, this assumes the regulators would have crafted the right policies/ responses.

In fact, our pols/ regulators did create a major new regulatory structure in the form of Sarb-Ox, along with research/banking/ fund management conflict rules, replete with multi-billion dollar settlements and perp walks (most well deserved). But these regulations, especially Sarb-Ox, COMPLETELY MISSED THE MARK of this crisis despite hoisting hundreds of billions (up to a trillion) in costs on the real economy.

Meanwhile, exactly the same politicians (Sarbanes and Oxley both) foisting Sarb-Ox on us specifically killed any meaningful regulation of Fannie and Freddie, even though they were clearly disasters in the making. I am not blaming the housing crisis on Fannie/Freddie, but rather emphasizing our pols/ regulators inability/ refusal to implement intelligent policy.

So while we can all claim we saw this coming and should have regulated investment banks, limited the mortgage market, and tamped the housing bubble (I sold my home in April 06, due to the bubble and have rented since then), blaming "deregulation" fits well Krugman's definition of the "Know Nothing Politics", looking for simple soundbite answer to complex problems.

The problem was not deregulation, or even a lack of regulation generally, but rather the failure to implement intelligent regulation. This failure is clearly bi-partisan in the US, crossing ideological lines.

Good review of commonsense changes required by Phil Purcell (run out of Morgan Stanley) in today's FT.

http://www.ft.com/cms/s/aed2f888-66f8-11dd-808f-0000779fd18c.html

"Investment banks made the same mistakes and incurred enormous losses under very different regulatory regimes."

[Ex-Worker]

Bruce,

Gramm has his fingerprints on this crisis? Funny that you accuse me of perpetuating stupid "conspiracy theories"!

What about Dodd, Frank (Frank I admire as a very intelligent honest guy), Schumer, and most of the Democratic party who held up any regulation of the largest financial institutions, Fannie/ Freddie.

Nor was there any serious Democrat initiative to regulate private investment banks prior to this crisis. Isn't Chuck Shumer running the Democratic campaign? Come on. Schumer's a wholly owned subsidiary of Citibank.

The large banks are bipartisan rent-seekers who give the majority of their contributions to the party in power, now the Dems.

All 20th century financial scandals are Republican? So why is the US taxpayer backstopping the losses of Fannie/ Freddie's $5 TRILLION balance sheet? And how/ why did their liabilities grow to $5 TRILLION in the first place? Just because the privatization of profits in Fannie/ Freddie accrues to the Democrat operatives in DC that manage the companies doesn't make it right or different than Citibank/ hedge funds.

The common thread of Fannie/Freddie/Citi is that their business model 1) deploys massive leverage and 2) privatizes profits and socializes losses.

Of all ironies, in the incompetent crony-driven Bush administration, James Lockhart (an Andover friend of GW's), director of Fannie/ Freddie regulator OFHEO, fought for more regulatory powers.

I have not heard any real criticism of his leadership (ignoring whines to lay-off from Fannie clients in Congress a few years ago). But for him, Fannie and Freddie would be in a far worse position than they are now.

[Prevent Speculative Excess, Prevent Subsequent Crises]

Jay Cooke and Company (bank) funded both Civil War debt and railroad expansion, so both factors were involved in the panic of 1873. Once a panic starts, action is needed to keep credit flowing. However, it is large scale default that precipitates the panics in the first place. Super low rates during boom times magnify the subsequent problem.

[paine]

Glass-Steagall

yes it grew irrelevent
but throwing it away and letting he free winds blow
was the precisey wrong
move
from a society wide perspective
the G-S system needed to be vastly extended
to all the new free fire zone "hi fi markets
and organizations " not scrap piled

at a barely tolerable minimum
reg down the pri-equity crowd
put heavy equity leg irons on em
btw
this is an analogue
to a corporate induced "national preference"
for universal mandated health
with a fangled inefficient
pub/pri provisioned
set up
over
clean lean and ....a dream
single payer

[paine]

ex worker
i like your take on the donkey team

the problem with the big Fs
the tiny pri sec equity tail
got to waggin'
the giant pub sec debt dog

[paine]

our task
(us dilleantes of the ultra left)
draft up a nest of notions
one might call

competitive socialism

case in point

how to efficiently incentivize
agents of a pub sec provided
universal security insurance
setting up n competiting
independent pub sec security insurance funds
that pay their agents
on long run peformance ...

pretty hollow frame work eh ???

[paine]

"It could be that it is just an end to American ownership"

well thats a start
tthe sooner we the weebles
learn to alienize our capitalist benefactors
the better

but then again
i recall the nasty fool's gold substitution
of an international jewish conspiracy
for rapidly emerging
cross border hi fi capitalism
a hundred years ago

[paine]

maybe this is a worth while
general heuristic
pri sec capital is groping toward its own sublation

lets remember not ...not ...to throw out
the ugly duckling baby
( "institutional innovations ")
with the pri profit drive
poluted bath water

[Mr Duncan]

If you add Fannie and Freddie's assets, they total under $2 trillion. The $5 trillion number is a political scare number, and reflects the total value of all mortgages on the books or guaranteed by the GSEs. Clearly, not all of these houses are going to disappear. When borrowers default, there is a house to sell to recover some, usually most, of the money in the mortgage. I shouldn't have to explain that to you.

The GSEs were capitalized with the express purpose of holding or guaranteeing a large share of the mortgages in the country. That is how we "allowed" that to happen -- by design.

We can discuss a lot about the performance of the GSEs, but to say that they weren't basically fulfilling their mission by getting very big is a bit ludicrous.

[paine]

dunc

i agree f and f
went up and .....off
pretty much as their archetects and helmsmen
intended
or based on feed back
re intended

[btg]

"Jay Cooke and Company (bank) funded both Civil War debt and railroad expansion, so both factors were involved in the panic of 1873"

From what I have read in response, while it is true that Cooke underwrote the civil war debt and marketed it, the crisis had nothing to do with the debt which had been issued more than 10 years earlier and wasn't due for another 10 years - I doubt that Cooke actually had any substantial holdings of this debt, or that it played much of a role.

Horse flu, railway debt, and changes in government policy regarding silver, were the triggers.

[Ex-Worker]

Right- I mixed the $5 trillion total liabilities with the balance sheet size. Still, who knows how all of the derivative positions these Fan/Fred hold (off balance sheet) might react to out of the ordinary interest rate inversions. Could be more. Their recent track record is not inspiring.

Question: why did they grow their balance sheet to $2trillion when they could have sold off the "guaranteed" mortgages to eager buyers and fulfilled their mission?

Answer: because they were busy taking on as much risk/ leverage as possible, to raise their equity profitability. Exactly like the i-banks, except their taxpayer back-stop is more explicit.

Maybe they could have displaced some of the garbage Wall Street spun out to meet demand for "safe" dollar denominated assets. Regardless, they are the same beast as BS, Citi, Lehman, etc. I fully expect they would have been spinning the same sh*t if they hadn't been under pressure of OFHEO/ investigation for accounting fraud through most of the bubble.

No reason to have any more faith in the financial modelling brilliance of Fan/Fred's MBA's than S&P's MBA's? Notice how an MBA's "once in a million year probability events" happen about every seven years?

I like Paine's description of the small private equity tail wagging the big public sector dog.

Big public sector debt dog should bite back.