Every Consensus Must End

The prevailing consensus on any economic policy is a fascinating beast.  For years it can stay put, seemingly immovable, and even – in some cases – becoming enshrined in legislation or central bank statute.  One day it begins to shake, ever so slightly; under the pressure of events, a wider range of serious opinion develops.  And then, all of a sudden, the consensus breaks and you are running hard to keep up.

We saw this last year with regard to discretionary fiscal policy – fiscal stimulus – in the US.  Eighteen months ago, very few mainstream economists or other policy analysts would have suggested that the US respond to the threat of recession with a large spending increase/tax cut.  The consensus – based on long years of experience and research – was that discretionary fiscal policy generates as many problems as it solves.  To argue against this consensus was to bang your head against a brick wall, while also being regarded as not completely serious. 

At some point in November/December 2007, this consensus began to shake.  The history may prove controversial but my perspective at the time and in retrospect is that Marty Feldstein was the first heavyweight economist to question the consensus (including in interactions on Capitol Hill), and he was followed closely by Larry Summers’ influential writings in the Financial Times.  Within a month or so, the consensus broke.  Not only did we get a fiscal stimulus in early 2008 for the US, but the IMF quickly adopted the same pro-stimulus line globally and the terms of the debate changed everywhere.  This fed into a process out of which came at least a temporary new quasi-consensus: a large US fiscal stimulus is part of the sensible policy mix today.

The consensus on banking just broke cover.  For some weeks it has been under intense pressure.  At least since the fall, serious people have been informally floating various new ideas on how to deal with the technical problems surrounding toxic assets and presumed deficient bank capital.  But since mid-January, the mainstream consensus – that we should protect existing large banks and keep them in business essentially “as is” – seems to have cracked.

Paul Romer and Willem Buiter favor an approach that emphasizes the creation of new banks. Roger Farmer wants to go in a completely different direction.  These are just a few examples of the great (and completely constructive) new dispersion of ideas around banking – post links to your favorite new ideas in comments below.

Advocates for the previous consensus – and the status quo – seem to be located mostly in the financial sector itself (e.g., Lloyd Blankfein).  The Administration’s view, as I discussed with Bill Moyers last week, is apparently still up for grabs.  And I understand “what next” for banks will be a central theme for debate among staffers on Capitol Hill this week.

On the technical details, I could support any number of schemes.  My main concern is limiting taxpayer downside and making sure the taxpayer gets as much upside participation as possible.  We have a proposal on the table, but other ideas have merit and the US debate in this regard seems likely to be productive – in striking contrast with Europe, where denial is still the name of the game.

There is only one point on which I would insist.  The banking lobby has become too powerful, in large part because big banks have balance sheets that are too big relative to the size of the economy.  If a bank has total assets of over 10% of GDP, it is obviously too big to fail.  Of course, the smart people who run these banks know this and act – politically and economically – accordingly.

We need a strong system of financial intermediation, and this must feature people willing to take risks with their own capital.  In that context, there may be efficiency arguments in favor of relatively large deposit-taking/lending banks (although I’m far from convinced), but it is the political economy considerations that are overwhelming.  When all is said and done, if we still have large banks with great political power, we will eventually find ourselves in even bigger trouble.

58 responses to “Every Consensus Must End

  1. “… there may be efficiency arguments in favor of relatively large deposit-taking/lending banks…”
    One thing that’s changed is that the retail payments system used to consist of cash and cheques. Now it’s cash and credit cards. When did you last sign a cheque? I would guess that commercial payments have also shifted to transfers. So any economies of scale in cheque-processing have become unimportant. Visa and Mastercard are essential oligopolies in the payments system, but they are plainly clearing-houses not banks.

  2. I read a book by Kevin Phillips titled “Bad Money” that predicted the financial meltdown very accurately. I then found it amusing to go back and read “The Lexus and the Olive Tree” by Thomas Friedman. At the beginning of 2000 he had his head in the clouds over the way money was being used to create new wealth and how Enron was paving the way to new business models. I have always been offended with Friedman and his reports of what is going on in the world as seen from 5 star hotels around the world. It would be better if he viewed the world from it’s junkyards.It would give him a clue about things that aren’t working.
    The most reliable path to creating wealth has always been in growing things, making things and adding value to products the world needs. When banking turns into usury, Ponzi schemes or just plan fraud, it’s time to step in and change the rules.
    Don Bell

  3. Jaroslav Tyman

    My favorite new consensus seems to be the growing interest in the tried and true economic recovery plans: loads of government spending (public works, WWII) to recover earned income along with a solid dose of inflation to reduce the burden of debt. In some European countries during the Great Depression governments even set prices for many goods to protect both producers and consumers. When money runs out, we all knee jerk to reduced spending and push for reduced prices which further exacerbates the situation. That money that isn’t spent is less money to make the economy work.

    Tax payer downside is an increased public debt, but then that will let us unload private debt setting us up for another boom. The challenge then is to later safely reduce public debt so we have a sufficient buffer with which to attack the next crisis.

    See Krugman’s Decade at Bernies:
    http://www.nytimes.com/2009/02/16/opinion/16krugman.html?_r=1&partner=rssnyt&emc=rss

    Don: Growing things and adding value work great, but if we double the value in the world without doubling the money supply, then money increases in value (relative to what we can buy), debts are harder to pay off (need to produce more to get the same dollar), and effective income is reduced. Without inflation there’s less reason to move private net worth into assets since just stuffing your mattress and waiting means your purchasing power increases. I agree though about big banks run amok, the last few months have shown when banks carelessly issue more debt the effect was inflation based solely on increased debt instead of an increase in the money supply. Banks can control a contraction in money supply, but when debts start going bad there’s only so much they can do to stem the evaporation of wealth.

  4. The “phantom wealth” (coined by David Korten) has to be washed out. Some call this deleveraging. Replacing the losses created by bankster gamblers in back rooms is not the solution to the current problem. Let them fail. Let the chips land where they may. In the meantime, the government can set up a temporary bank to serve as a source of credit, until the washout is completed, and the smaller responsible banks fill the gap. That would be a far way to use the taxpayer dollars.

    Long ago Mises asserted that monetary intervention was the actual cause of booms and busts of this size. Many economists today are still followers of Fisher and those who believe markets are rational (i.e. devoid of innumerable psychological and social short-and-long-term influences). That is just bizarre.

    But here we are still looking to those who created this mess to clean it up.

    NObama 2012!

  5. Simon,

    “The Administration’s view, as I discussed with Bill Moyers last week, is apparently still up for grabs.”

    I don’t know why you’d conclude that there’s any lack of stated purpose in Obama Administration banking policy. Geithner has made absolutely clear his commitment to the private banking system. Nationalization or intervening importantly in it has been ruled out. On the question of Geithner, I’ll link to the commentary of Mike Whitney at Counterpunch last week:

    http://www.counterpunch.org/whitney02132009.html

    Geithner is simply a creature of the system and some of the lobbying interests that elected Obama. Getting rid of the influence of lobbys will require getting rid of Geithner and Obama both. May we hope?

  6. I’m a fan of Bagehot, and earlier thought that a serious application of his principles might suffice going forward. However, since we do have a central bank, echoing Bagehot, there is, in essence, an implicit Lender of Last Resort guarantee, no matter what we do. Insurance against systemic risk will either carry ludicrous premiums or be seen to be insufficient should a real crisis arise. Therefore, I’m currently pushing a revamped two tiered system, relying on Narrow/Limited Banks for the banking side of the system:

    http://blogs.ft.com/economistsforum/2009/01/putting-an-end-to-financial-crises/#more-315

    “Apply the moral to banks and the regulatory prescription is clear. Don’t let banks take risky positions. Make banks stick to their two critical functions – mediating the payments system and connecting lenders to borrowers.

    To safeguard the payment system, banks must hold 100 per cent reserves against their deposits either in cash or short-term US treasuries. With 100 per cent reserves, banks runs will be history.

    This is not true of the current system, notwithstanding Federal Deposit Insurance Corp insurance. The FDIC’s potential liability exceeds $4 tn; its assets are less than $50 bn. A run on the banks would require massive money creation and engender greater economic panic.

    To ensure their second function – the uninterrupted connection of suppliers of and demanders for funds – banks should be limited to a) packaging conforming mortgages and conforming business loans (commercial paper) within mutual funds and b) marketing these mutual funds to the public. The model here is Fidelity, not Lehman Brothers.

    Yes, this proposed banking system is not your father’s Oldsmobile. But Jimmy Stewart is not your banker. Some overpaid chief executive thousands of miles away is deciding whether to foreclose your home and shutter your business. The clerk running your branch isn’t applying personal knowledge in deciding to lend you money or call your loan. He’s plugging your credit rating, collateral, and loan amounts in a computer and conveying the answer.

    With the government ready to absorb losses, banks are talking outrageous risks knowing that Uncle Sam will cover them if things go south. Raising the trivially low capital requirements of banks, as Paul Volker’s Group of Thirty Commission just proposed, won’t change this behaviour.

    What will change this behaviour is to not let it happen. Banks should be allowed to initiate only conforming, i.e., government-approved, AAA-rated mortgages and business loans. These would be long-term, fixed-rate loans with 20 per cent-down and payments below 25 per cent of income.

    The government, via the Federal Financial Authority, would use tax records to verify loan payment-to-income ratios. It would also spot check collateral. Once approved, the banks would bundle and sell “their” loans within mutual funds.

    Again, traditional bank runs wouldn’t arise. And today’s bank runs, which entail lenders and equity investors avoiding risky banks, wouldn’t either. Why? Because banks would bear zero risk. Mutual fund owners would bear risk, but not the banks. And these lenders would know they were buying government-approved AAA-rated loans, not Bear Stearns‘ CDOs.

    This limited purpose banking is a modern version of narrow banking proposed by Frank Knight, Henry Simons, and Irving Fisher. Banks would hold deposits, cash checks, wire money, originate loans, and market mutual funds, including money market funds with no guarantee of par value redemption.

    With limited purpose banking, financial crises would largely disappear. Banks would never fail, never stop originating loans, never expose the public to massive liabilities, and never see their stock values evaporate. Banks would be stable, boring economic cogs – like gas stations.

    The Fed would also gain full control of the money supply. To expand the money supply, the Fed would continue buying treasuries from the public and supplying cash. But banks wouldn’t be multiplying and contracting M1 (cash plus demand deposits) based on their ever changing decisions about lending deposited funds.

    Milton Friedman, who also advocated narrow banking, blamed the Depression on the Fed’s failure to offset the M1 money multiplier’s collapse. In the past year the M1 multiplier has contracted by over 40 per cent, forcing the Fed to double base money. If the multiplier shoots back up, we could see the money supply and prices explode.

    What about investment banks, brokerage firms, hedge funds, and insurance companies? What’s their right financial order?

    Again, regulate to purpose. Investment banks take companies public and assist in mergers and acquisitions. They shouldn’t be permitted to invest in their clients’ companies. Brokerage firms are here to help us buy and sell assets, not to gamble on spreads. Hedge funds are here to help limit risk exposure. They aren’t here to insure these risks themselves. Finally, insurance companies are here to diversify risk, not write insurance against aggregate shocks.

    The FFA and “less is more” limited purpose banking won’t prevent asset markets from occasionally going nuts. But the functioning of financial markets will no longer be in question. Nor will con artists, parading as “financial engineers,” ever again be free to wreak havoc on the nation’s finances and its citizenry.

    Christophe Chamley is a member of Boston University and the Paris School of Economics. Laurence J. Kotlikoff is professor of economics at Boston University”

    And Taleb, via Arnold Kling:

    “Taleb, like me, wants to get rid of risk-taking by banks, and leave non-insured institutions free to take whatever risks they want, as long as they are not creating risks for others. His solution is to nationalize banks.”

    I’m hoping Narrow Banking could help us leave government out of this.

    Finally, back to the banks. I’m arguing just the opposite point that you are. Most of these proposals come to more or less the same thing, that is wiping out the shareholders and seizing the banks. I care less about how we actually do it, than that we definitely call it nationalization, because it sends shudders down bankers and shareholders spines. They will daily pray to never hear it uttered about banks again. I agree you about the banking lobby, but, after all, that’s our system.Banks are simply one part of it. It’s amazing people aren’t aware of it.

    It’s wonderful to hear people mention Fisher, my guide through all of this. Apparently, many people were unaware of him. However, Bernanke was, which makes me wonder why he went along with letting Lehman fail. By the actions taken during the rest of that week, it’s obvious that he understood that a Calling Run ( Debt-Deflation Spiral ) could result from this mess. I’m still puzzled by his decisions throughout this crisis. Again, he should have been one of the people most attuned the down side.

  7. I would say that an honest appraisal is that those who run the current financial system are oligarchs, and our system of government has turned into an oligarchy. The question is whether Obama has the desire or power to throw these oligarchs out.

  8. Is it really “the political economy considerations” that are most important – and “limiting taxpayer downside”? Or is the top priority to get a well-functioning banking system that supports efficiency and growth in the real economy?

    Of course, it would be ideal if the two coincide, and in some ways they probably do. An equitable solution for the taxpayer should help to offer the right long-term incentives for stability, proper weighting of risk and so on; which in the long run is the correct way for the financial system to interact with the rest of the economy.

    But let’s say that the technically correct decision, to minimise direct government expenditure, is to confiscate large amounts of bank equity and give most bank creditors a big haircut. And let’s imagine (not implausibly) that this would cause severe disruption to the workings of the banking system and knock-on effects on the economy, tipping us into a real depression.

    Wouldn’t we hold our breath and accept a larger taxpayer downside as the price of keeping the rest of the economy working?

  9. you’ve got your years wrong: 2007 should read 2008, and 2008 should read 2009.

  10. Leigh Caldwell – You must be a banker.

    You say: “But let’s say that the technically correct decision, to minimise direct government expenditure, is to confiscate large amounts of bank equity and give most bank creditors a big haircut.”

    When you consider tier 2 & 3 “assets,” there is effectively NO NET EQUITY in the banks in question. It is a complete hoax. These banks are completely insolvent.

    It is time to end the fraud, end the game, walk away from the poker table.

    NObama & NOBanksters 2012!

  11. When someone walks away from their alcoholic and/or abusive mate (use whatever term you like) he or she may suffer a financial and “security” setback, but they gain their self-respect and the ability to chart a new, healthier, course. This is exactly what needs to happen with the current banking & economic situation. Yes, it IS that simple.

    Even taken to an extreme, there will still be air, water, trees, minerals, the sun, people, oil, gas, animals, seeds, and everything else we need to create necessities and more. And no, it won’t necessarily be easy to reorganize, but it can be done.

  12. On Meet The Press yesterday, David Gregory asked David Axelrod about nationalization. It was a brief but telling exchange. Apparently, having a private banking sector is a “long-term goal”.

    http://www.msnbc.msn.com/id/29209460/page/3/

    MR. GREGORY: Will it be a–necessary to nationalize major U.S. banks at some point to keep them healthy?

    MR. AXELROD: Our goal is to have a strong, vibrant private sector of financial system. And that’s, that is our assumption and that’s what we’re working towards.

    MR. GREGORY: So nationalization is not something you anticipate?

    MR. AXELROD: Well, we will do what we need to do, but our long-term goal is to have a strong private sector banking and financial system.

  13. I find it very interesting to watch how ‘fringe’ opinions on blogs seem to have quickly become mainstream in the last two years.
    I wonder if this means consensus change might occur more rapidly today than a few years ago – or decades ago?

  14. Oh, and to Leigh Caldwell:

    “Millions for defense, not a penny for tribute.”

  15. @b traven –

    I tend to agree. Insolvency is the corpse they keep tip-toeing around. Those in charge want to keep us in the dark as to the extent of the bundled unsecured “assets” that are now effectively worth zero. Moreover, there will likely be a decade of unwind litigation as various parties fight over clear title to whatever tangible assets of of whatever residual value remain.

  16. What I would like to know is the following:-
    Assume the toxic assets are bought by private funds the Geithner plan, what is in place to prevent the vulture funds from suing the Fed for the full amonut? This happened to to countries that were granted debt relief and the debt bought by vulture funds.

  17. wally – I hope you are correct, in that the information highway will lead to an acceleration in the change of concensus on important issues. Theoretically, it should be easier to reach the 100th monkey stage.

    Of course, there are downsides as well, such as false rumors taking hold, and highly volatile “markets.”

    Think of how internet communication might have sped up the contributions of “fringe” folks such as Einstein, Ghandi, Edison, Susan B. Anthony, Jesus, Buckminster Fuller, ML King, and many others.

  18. I’d like to see government ownership of existing or new banks transferred to individuals in the form of seed shares of non-voting stock in tax-free Universal Savings Accounts as proposed by President Clinton. The investment will seem real to taxpayers when they see that their tax money is returned to their retirement accounts immediately, and then grows rapidly in value over a decade.

  19. BobbyG and Aliena –

    Good points. For better or worse, the legal profession will generally be very lucrative in times of turmoil and conflict.

  20. Pingback: What Guru’s are Saying : Readings 02/16/09

  21. RE the comment: “When all is said and done, if we still have large banks with great political power, we will eventually find ourselves in even bigger trouble.”
    The whole purpose of the Federal Reserve System is to foster such concentrated power & monopoly control! Until the Fed is eliminated, nothing will change.

  22. Assuming we have to spend taxpayer money to kickstart the enconomy and create jobs; what would give more bang for the buck?
    Forcing Detroit to restructure and go green?
    Or, bailing out bankers?

  23. Pingback: Every Consensus Must End - Smart Taxes Network

  24. Aliena –

    1st – You cannot spend your way to prosperity.

    2nd – We cannot kickstart the economy. What has been “the economy” over the past 2+ decades was living on credit/debt. That game cannot go on forever. We are close to the endgame.

    3rd – The only solution is to wash out all that “phantom wealth” – in my opinion, that means to let it default. Then, after putting in new rules and regs to prevent this kind of concentrated power and gambling to go on, we can start to build and grow again. There will be plenty of people chomping at the bit to get their new ideas, products, and services into the marketplace. Government won’t need to, and shouldn’t, attempt to play that “decider” role.

    4th – The only way a Capitalist economy can work is to ensure competition remains in the marketplace (whether goods, services, or workforce). That should be the government’s primary role in the economy. The steps involved in accomplishing that are subject to some debate, but my thoughts are: Strong anti-trust laws and enforcement, an educated populous, progressive taxation, loans for small business and R&D, and providing easy access to accurate information for decision-making. * I’ll stop here.

  25. Pingback: Readings 02/16/09 | Venture Capital Bloggers Network

  26. Jaroslav Tyman

    b traven:
    I would argue there are other solutions.

    One other solution is to inflate (devalue) money to bring the dollar value of assets back in line to where they were before. Debts become more manageable for borrowers, lenders are more secured as the debts will be sufficiently collateralized again. Through smart policies we can strongly encourage the rest of the world to do much the same.

    The government has started that process, as Don the libertarian pointed out, by doubling base money. That money needs to be distributed to businesses asap. We did that before by paying businesses to build tanks we sent off to destroy in wars; it really doesn’t matter what product we get out of it (we’d like to get something useful), the goal is to turn the government into a buyer to increase jobs and bring the newly printed money into the marketplace. You devalue cash which increases value of assets and makes debts more manageable and jump start the jobs creation process by putting people to work. Bring jobs back and you quickly stop the bleeding in the housing market which brings a floor to bank’s losses in the mortgage market.

    But “wiping out” phantom wealth will have some rather negative effects. Consider that as the population grows and we get better at creating valuable goods people want to buy, the world becomes more “valuable.” Without added money to represent that value, each dollar starts to represent more value, and you end up with what is essentially deflation.

    I do like your ideas under the 4th point. Small businesses are an under-represented yet extremely important component of our economy. If you’re looking for bang for your buck, look at small business.

  27. whats the deal with people writing comments longer than the article-
    Instead of the FED putting up 8 trillion in loans and backing to bad banks, that many say are insolvent, the government should have opened its own bank and started lending, this way we bypass bad banks, dont neeed, em, let them fix their own problems,
    and secondly lets split up big banks into 100 pieces each, so next time if you fail you close up, if your too big to fail your too big,
    -i read a plan being circulated to help with foreclosures, mortgages renegotiated for the new market value, but when you sell you are obligated to pay the bank money to make up for there current loss, sounds good to me, every one wins in the end, the consumer wins today, banks tommorrow, and the country wins with less foreclosures,
    oh yea, lets throw a couple hundred government watchdogs, wall street bankers, and accountants in jail!!!!!!!!!

  28. all the solutions seem to deal with the symptoms and non deal with the disease,we need

    -jail time
    -more regulation
    -smaller banks
    -accountability

  29. Peter Carvapai

    For a return to the status quo ante to be possible there is a need to implement an effective regulatory regimen. Some economists, including Willem Buiter, have serious doubts about the possibility of any regulatory authority being able to implement such a scheme.
    Bearing this in mind, there seems to be only one solution. The nationalization of the core of the financial system for a long period of time with private capital filing in the gaps with the understanding that it can take whatever risks it likes, but without recourse to bailout monies as under this arrangement there would be no private institution too big to fail.
    You have the example of France whose banking system operated like that between 1947 and 1984.

  30. Dear Mr Johnson,

    You are wrestling with the problems of credit only because you have failed to accept its true nature,

    Credit is fraudulent money, and is always to some degree damaging,

    The question is to what extent this fraud should be tolerated, if any,

    Finance must be linked to a gold standard, fractional Fiat and credit fraud must never break free of this discipline,

    The conceit and security of the bankers rides on the back of much of the public who also gained money for nothing and know they are complicit in this fraud,

    The power of the bankers will collapse only when the public realise they have lost their ill gotten gains,

  31. i read krugman’s piece in the ny times today and it’s an interesting one….looks like to me that obama and his team tend towards etablishing some new wealth with a little inflation later in the process….it looks to me that they are more ready to do this than cater to wallstreet….i wonder if they crunched some numbers to see how the stimulus bill and its content affects the inflation rate 3-4 years down the line….interest rates must stay low in the interem to encourage biz investments, etc but i would think they have idea of how and when to raise int rates…

    on the banks issue,,,they can’t be allowed to fail in my opinion….maybe the idea of putting these execs in the spotlight will force them to make some changes and take some risks….if they don’t,,,gov’t taking control of them is an option….only time will tell how these banks are going to act….

  32. I like the idea of framing the solution in terms of trustbusting rather than nationalization. One can make the case that trustbusting is as American as apple pie thanks to Teddy Roos. and the folks who dismantled Ma bell, whereas nationalization — justifiably or no — still retains that vague European odor.

    I mean, if Morgan Stanley can call a year end bonus a “retention award”, than progressive policy advocates should look for ways to rebrand a takeover/dismantling of the large banks in terms that call to mind the brawny, take-no-prisoners sheriff archetype, rather than the 110-pound bespeckled weakling bureaucrat image called forth by “nationalization.”

    If there’s one thing the Bush years taught us, it’s that aggressive appeals to America’s fragile masculinity go a long way to toward getting people on board.

  33. Well, one thing proven last week is that if you fly on autopilot through a ice storm, you are in for a hell of a crash. Limits. There is no way we can go back to the status quo ante, Blankfein is dreaming. So we need to find a new way.

    We need to have limitations — thrift, loyalty, disinterestedness, duty. But we also need to set limits on limitations. Imposed restrictions will always be resented. But if we can impose limitations on ourselves first, and then manage to achieve something modest, then others may follow our example. We need to take a hard look at the backbone of morality.

  34. Repeal the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (http://www.answers.com/topic/riegle-neal-interstate-banking-and-branching-efficiency-act-of-1994). Return to a decentralized banking structure that will contain failures to specific regions and not introduce systemic failure to the nation or the world all at once.

  35. stefan,,,you are correct….the housing thing was pure greed…from the real estate agent to the morgage broker to the banks to the buyer….and it’s not because of our education system as the most educated caused this mess….what makes this situation so difficult is that no-one can predict human psyche….i think that the past eight years were a total experiment AND backed by many democrats…i see politicians parade on tv talking about the most silly points====>it’s purely political…they all have our interest at heart and the republicans know that their past gamble failed….we have to remember that we are a relatively young nation…..econ is theory and will always be…..the recent crisis moves us toward science but will take centuries to achieve…we will learn from this and move forward…

  36. On New Banks, my 5 cents worth is at Angry Bear here.

  37. @ Jaroslav –

    So you are all for punishing the responsible people, savers, and those on fixed incomes — all to help the debtors (including Uncle Same). I see.

    Given the majority are debtors, I imagine that is what we will see. It’s a crime and amoral, but that is what I truly expect.

  38. ian and gordon: I agree with both of you – for what that is worth (hopefully, more than a toxic asset.)

  39. When Reagan was president, his guy Donald Regan re-wrote the rules for Savings and Loans. That set the system up to be gamed by the gangsters. After the bail-out, the stage was set for the criminal element to go after the entire banking system. No one loses when the Fed pays. Let’s look at the schools and philosophies that brought us our current economic system. In most other countries they would be taken back behind the barn and shot. These people are criminals. Let’s stop dancing around the issue and get rid of the whole structure. The local manager at my bank branch has more common sense and basic honesty. Put on a board with a half dozen of her neighbors, she could manage a loan portfolio better than the Harvard School of Biz gangsters that want their money back from the croupier after they crapped out.

  40. Jaroslav Tyman

    b traven: I’m with you on the moral hazards of any recovery plan. As a saver myself, inflation is the least of the evils I’ve seen so far. Actually, with inflation, interest rates on savings will likely go up, not to mention that those who held savings in the form of equity benefit as well.

    As far as fixed income, inflation is a known risk and to rely solely on fixed income is just as risky as the speculators that relied on increasing land values.

    The win-win situation isn’t very good right now just because of how deep we’re in; we’re all going to feel pain if we don’t feel it already. If the choice is inflation or defaulting debt, I think there’s much more pain for many more people in a debt-default scenario. Savers could be hurt if their savings were in debt based equities (bonds) banks that crumble or other forms of equities, fixed income could be hurt if fixed income is based on debts (paybacks of bonds, wikipedia actually has a thorough list of risks for fixed income which include both inflation and default).

    My thinking is that at least with inflation lenders aren’t outright rewarded (they are holding fixed debts), and those of us that tried to tread the good path of saving and diversifying for rainy days can have some of our most devestated assets recovered while increasing our earning potential relative to debts (debt is not bad in all cases). Punishing and rewarding may not be the best ways to frame the debate, I would suggest we frame the debate in regards to what we can do now to return to prosperity (or at least minimize hurt).

  41. I had to get down to ear3 to find the obvious and well-tested answer to believing that some institutions that are “too big to fail”

    s/he said,
    “I like the idea of framing the solution in terms of trustbusting rather than nationalization.”

    I’ve seldom seen the concept “anti-trust” in current discussions. Is there any good reason to not practice the strategy of trustbusting?

  42. don b,,,don’t fret my friend….nationalzation of our biggest banks and then dividing/selling as a lessor player is viable….the swede model is something that our prez and cronies are looking at (imho)….the ball is in the bankers court….i learned a long time ago….don’t “F” with the u.s. govn’t…..

  43. What is too big to fail is too big to survive. I know this is someone else’s line, but hearing it the first time turned on a light in my head.

    We’ve systematically underappreciated the diseconomies of scale in all sorts of areas – banking and agriculture perhaps most obviously.

    I hope the consensus moves quickly – it surely needs to.

  44. Pingback: Irish Left Review · Every Consensus Must End " The Baseline Scenario

  45. truthynesslover

    This is no accident.They knew what they were doing.Remember what ENRON and DICK cheney did to california?Well the banks with the assisitance of bush and co.are doing the same thing to us and the world.
    See grover nordquist and his quote about shrinking the govt. to the size he could get it into the bathtub and drown it.
    What other institutions could do that?Worldwide?

  46. Which part of the word “taxpayer” don’t you get?

    Clue: think of the “woolpayer” (the animal formerly known as “sheep”).

  47. Easy solution for keeping big banks from getting too big: have FDIC insurance apply only for banks below a certain size. Maybe define size by how much the bank has loaned out so the bank can have lots of assets but once it gets beyond a certain threshold in loans it loses eligibility for FDIC insurance. When that happens notify the account holders and watch them scramble for other smaller banks.

  48. a cap on loans is a good idea with fdic insurance….it worries me that the quantity of loans would slim down….can our smaller banks handle the extra biz? we need to make as many quality loans as possible to get this beast turned around….i bet someone can crunch some numbers to see if smaller banks can handle the distribution….they would love the biz if they are not maxed out….also,,need better rates so these banks can get some capital…a little inflation never hurt anyone,,,especially in a deflationary spiral that we are in…

  49. It’s Not Our National Debt!
    Washington has bailed out the banks, Wall Street & their Washington special interests and the cost is added to the national debt to by paid by this and future generations. This is after they created a credit bubble which has burst into depression and the result is 50% losses in our stock portfolios and almost as much on our homes and real estate investments.

    The Campaign to Cancel the Washington National Debt By Constitutional Amendment is starting now in the U.S. See the following URL for more information: http://www.facebook.com/group.php?gid=67594690498&ref=ts

  50. Yeah right, increase inflation to rid of debt. Wipe out the responsible people who actually saved money, after they’ve been shafted making sure they can never buy a house ever again.

    Guess what. Do that and I guarantee my money will LEAVE THIS ECONOMY. I will not spend one cent over what you are already stealing from me in taxes to support the greedy who moved into mansions on a hairdresser salary while I sit there waiting patiently to accumulate 20% for a downpayment.

  51. Here’s for a new consensus!

    Stop trying to prop up house prices. They are not in touch with reality. Mortgages are waay higher than rents, that is not normal. They are also out of proportion compared to salaries, that is an indicator that the asset prices are too high.

    If we “stabilize house prices” the way they are, we will fondly remember this as the last decade a worker could actually afford to buy a house on the salary.

    Create new banks, fund them with the TARP money which will unlock 10-12 times as much credit (using “normal” leverage).
    http://market-ticker.denninger.net/archives/622-Fiscal-Cat-5-Hurricane-Warning.html

    Here’s a more recent and exhaustive laundry list of proposed changes:
    http://market-ticker.denninger.net/archives/791-To-The-Republicans.html

  52. Pingback: Links 18/02/09 « Bounded Rationality

  53. At this point, inflation is the only answer. It will either happen deliberately, or will be forced on the US when it approaches debt default (which will be vastly worse than if inflation happens now).

    The only question is how much damage will be done to the economy until those in power accede to this necessity. The answer appears to be far more than was initially expected, given the six months that have passed since the crisis hit full throttle and the fourteen months since the recession began.

    Couple points: monetary policy does not create the boom/bust cycle. The cycle existed before that. Read up on the Tulip Mania. We had depressions (not recessions, the D word) in the 1800s every 20 years or so. This myth is plainly stupid, yet hard-money ultra-con fanatics perpetuate it everywhere. This is a pretty good tip-off that the person writing is intellectually deficient. While one can make legitimate arguments in support of hard money, lying about history is not one of them.

    Point 2:

    We’re currently in a classic prisoner’s dilemma. The only path out of growth is the expectation of future growth. Other than another world war, it’s hard to foresee what will spur this.

    Allowing house and asset values to continue to plummet further means wiping out 20%-40% of households’ net worth. Nominal and real values must approach parity, and that can be done either through massive bankruptcy or reflation.

    The consequences of massive bankruptcy are more extreme than one would expect. The size of the federal debt would continue to balloon as it _borrows_ money to pay off the increasing size of depositors and creditors, not to mention insurance companies going bust. Tax revenues drop like a rock. US Govt. loses its credit worthiness. Everything literally implodes. Unwilling to watch mass starvation, you can bet that governments will intervene and we will see MORE government control over the economy rather than less.

    The interesting and uniquely American dynamic here is that everyone is so terrified that Joe and Jane down the street might get more than their fair share, that they would rather the entire economy burn. Hard money fanatics have been pumping the notion of “letting the dead wood burn so we can regrow from a stable base” or one of a dozen variations on this concept. They either have no clue or truly believe that suffering is a good thing.

    BTW, it’s not that hard to not reward people who got locked into loans they could not afford. Place liens on houses that accept support – as incomes rise, so do payments. When the house is sold, the govt. recovers any future gain in asset values. The legal ssytem already supports this mechanism.

  54. the political aspect of manufacturing inflation worries me….this stuff is going to get uglier it looks like…..will the ave joe buy thier rates going up? and they do vote…i can tell you this housing plan will be controversial….i just returned from the grocery store where the check out clerk (black lady) was furious that some of people were going to get help with mortgage and she said that she paid her 1k per month mortgage just fine…it’s a necessity but looks like a pr nightmare….will be a gut check for the decision makers….

  55. just want to add that if we are to get thru this,,, we will….please look at history….my three year old son took a nap today on the couch….i have a two dollar bill (framed) with Thomas Jefferson’s picture on the front…..he woke up crying and pointing to the two dollar bill….the clue’s on how to solve this are in the history books…..good luck!!!!if there is a God,,,,he will guide if meant to be…

  56. Where was government during the dot-com busts, when 80% of people’s investments vanished ? We ate that loss and learned something from it.

    Since when it’s the government’s job to backstop people who take too much risk ? Since when is a government requirement to keep people in houses they cannot afford ?

    All the government help talk centers around how bad it would be if the houses were allowed to correct to normal levels. But that’s not a given. And it doesn’t sound like government intervention is doing much beyond dragging this crisis for (conceivably) another decade while the losses continue to compound.

    If one cannot afford a house, one rents. It’s not the end of the world. Like the rest who aren’t “homeowers” yet. It might even be better for them that they remove a 20-year burden they cannot possible sustain, one could rent a house for a lot less than what they pay for mortgage now.

    Mark my words. This is not for the people. This is for the banks and the financial world. So the banks do not have to recognize a loss. To prevent people from “walking away” from underwater mortgages which would force them to admit the loss on the books.

    Because so many banks leveraged so much that they would be considered immediately insolvent if investors learned how flaky their “A-grade” collateral is and how little the mortgage-backed securities are really worth.

    It’s not for the little man. The little man gets to continue paying all his income into the system. He won’t have more money to “help the economy”. But the banks will be ok.

    And your children will never afford a house, ever again, as long as house prices are maintained disconnected from the salaries.

  57. Pingback: On the Contrary » Blog Archive » The Enemy Within, The Enemy Without

  58. The Keynesian spending is not a new consensus really. It’s just that the usual monetary tool (lowering interest rates) is no longer available.

    If interest rates were higher and lowering them would bring the credit markets and the economy back, then this huge spending would not be occurring.