Global Bubbles: The Geithner-Brown Split

There are two broad views on our newly resurgent global bubbles – the increase in asset prices in emerging markets, fuelled by capital inflows, with all the associated bells and whistles (including dollar depreciation).  These run-ups in stock market values and real estate prices are either benign or the beginnings of a major new malignancy.

The benign view, implicit in Secretary Geithner’s position at the G20 meeting last weekend, is most clearly articulated by Frederic (Ric) Mishkin, former member of the Fed’s Board of Governors and author of ” The Next Great Globalization: How Disadvantaged Nations Can Harness Their Financial Systems To Get Rich”, in the Financial Times this morning.

“The second category of bubble, what I call the ‘pure irrational exuberance bubble, is far less dangerous because it does not involve the cycle of leveraging against higher asset values.  Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage”

In other words: keep monetary policy right where it is, and don’t worry about financial regulation.

The second view is much more skeptical that “benign” bubbles stay that way.  Remember that most damaging bubbles – or debt-based over-exuberance, if you prefer – during the past 40 years have involved two elements.

  1. Borrowers in emerging markets (Latin America and Eastern Europe in the 1970s; Mexico in the early 1990s; Russia, Ukraine, East Asia, Brazil and many others in the early-mid 1990s; Eastern Europe in the 2000s).
  2. Citibank (and its descendants), i.e., a bank that was large and global before any other US institution was so inclined.  Rather than bringing us the wonderful benefits of financial globalization, Citi has almost failed at least twice – and been rewarded for its incompetence with gold-plated bailouts at least four times.

Of course, other banks from other countries have become involved at various moments, but the point is that the lending organizations behind every bubble come from more “developed” financial markets – even when the origin of the capital flows is elsewhere (e.g., recycling oil surpluses in the 1970s).  And the borrowers are always in places where the rules become lax during a boom – in this sense, the US became just like a classic emerging market after 2001 (and arguably earlier).

After months of painful procrastination, Gordon Brown has finally recognized that Adair Turner – head of the UK Financial Services Authority (FSA) and astute critic of Big Finance – is on to something in this regard. 

At St. Andrews on Saturday, Brown actually proposed (and his mandarins briefed in private) on the need for a tax on financial transactions – a version of the “Tobin tax”.

Brown knows full well that such a tax is unlikely to get traction in the current environment, partly as it would be hard to implement (i.e., the scope for evasion through off-shore financial centers is enormous). 

But the point of his announcement was to shock and awe finance ministers – and this worked.  Secretary Geithner was provoked into uncharacteristically sharp pushback, which came across as the sort of rebuke that a minister of finance seldom directs at a head of government.

Brown and his team have at last understood that reigning in the financial sector needs to be front and center of the international agenda – and the troika structure of the G20 allows them (as outgoing chairs) to keep this issue hot.

It also provides political cover for the IMF, which is working hard on a tax for “excess risk taking” in finance.  Dominique Strauss-Kahn (head of the IMF and leading candidate of the left for the next French presidential election) astutely provided more details in the aftermath of the Brown remarks – thus making it harder for the US to oppose the IMF technocrats (and the French), who now seem so very moderate compared to Brown.

And how we will measure “excess risk taking”?  Volumes of technical papers are being written, much math has already been wasted, and ponderous reports will soon appear.  But, at the end of the day (which is the G20 summit in June 2010) there is one central criterion around which you can get your hands: size.

Bigger banks pose more system risk, mega-banks pose the most risk, and all bubbles can quickly go bad in the presence of such gigantic institutions.  They must face appropriately higher taxes — in fact, so high that the biggest voluntarily break-up in anticipation.

The ideas underlying Bernie Sanders’s bill are becoming mainstream.

By Simon Johnson

39 thoughts on “Global Bubbles: The Geithner-Brown Split

  1. Just to focus on the political aspects and timing of Brown’s advocacy of the tax it seems to be a reflection of the turning of the tide for UK financial autonomy and the increasing influence of the EU’s financial regulatory powers.
    The ratification of the Lisbon treaty is giving rise to a growing sense in the UK that the days of London being able to pretend to be a good euro citizen whilst carrying on with all of the shenanigans of being the largest onshore tax haven and “light touch” are coming to an end.
    It was not widely acknowledged in the recent announcements about new funding for RBS and Lloyds that the re-structuring was a direct result of the EU’s ability to apply pressure on the internal financial arrangements of all member states.

    The gradual drift by the UK from unfettered Anglo-Saxon capitalism, as it has to take its commitments to its EU membership more seriously, could mean that the US may be in the process of losing its special relationship with a like minded and mega-banker friendly partner on the other side of the Atlantic

  2. Not for big banks.

    But, the horse is out of the barn. How are 600 trillion (possibly 1,600 trillion according to 0Hedge's%20Pyramid.png) going to be defused. By treasury estimates (Table 3 here 200 trillion of these derivatives roost here in the US.

    Look, people like Geithner are so f*$%ing stupid they should wear helmets. This isn’t bubbling, this is flight from the dollar(s). This is a three headed horse race, jockied by m*rons, nose one is resideintial real estate, nose 2 is CRE and nose 3 is the dollar.

    Any nose crosses that the line will end the race, it matters only how this will play out (Currency crisis, market crash, flight to perceived safety, no flight to perceived safety.)

    The US has north of 100 trillion in debt and off balance sheet obligations, it is as insolvent as the zombie banks and or Enron.

    Race over!

  3. do these “resurgent asset bubbles” mean we should be tightening monetary policy?

    how much impact would a Tobin tax have on “resurgent asset bubbles”?

    If we broke up the mega banks into small banks, how much impact would that have on “resurgent asset bubbles”? By how much would the quantity of investors borrowing in dollars to buy emerging market assets, be reduced?

  4. I’d “Google” Minsky and bubbles before I started tossing around the word “bubble”. This is NOT a bubble. This is a flight from faith.

    There is a critical difference. Bubbles have stages and components.

  5. If only…

    Ahem… Gordon wont be here next summer, and, while there is no certainty, I wouldnt like to bet that the guys who take his place will be strong on tackling big finance, or strong on cecding power to the EU…

  6. Simon said: “And how we will measure “excess risk taking”? Volumes of technical papers are being written, much math has already been wasted, and ponderous reports will soon appear.”

    First recognize that it is not a math problem it is a book-keeping problem. Book-keeping is a grammatical language that formally balances relationships as subject|predicate, value|potential relationships.

    Return to the book-keeping framework of 50 years ago as it was refined by large industries (before computer software screwed it up). That book-keeping framework would draw a clear distinction between value based investments versus gambling.

    Then tax the gambling element. Value based investing will take care of itself.

    But in order to understand this framework the present financial services community must come to terms with software that does not know what a proper double-entry framework is today, nor what it did for proper financial services for the prior 620 years.

    Simply put, today’s financial culture is broken. There will be no solution until its history is reviewed and returned to normal.

  7. My view — which so far I have not encountered elsewhere — is that these irrational activities of our financial system arise in part from unacknowledged fear of the ecological cliff we are about to march over. As one can see in any compulsive pack-rat, greed and fear are closely linked in the psyche — and there is a LOT of fear flowing in the underground rivers of our race. There is something almost hysterical about the greed of Wall Street. When we cannot face our environmental realities, fear/avoidance rules, leading to frenzied greed, and with it, the failure of compassion — the loss of overarching civility which keeps financial activity sane. Bull and Bear become toad and alligator.

  8. A Tobin tax is one of the more idiotic ideas, to come along in a long time. Excessive risk taking occurred because the big banks thought they they were protected, and so far they were right, unfortunately.

    Despite Tyler Durden’s estimates of hundreds of trillions of dollars in derivatives, ( and maybe because of), we still need to bite the bullet and take down the five spokes of the oligarchy.

    A whole bunch of people on Wall Street need to be at least bankrupt and likely put in jail. Wall Street and other areas of our society have lived in a consequence free zone for too long. There will never be any substantial recovery until this mess is cleaned up. ( See Japan). If we keep on this path, we will all soon become slaves and serfs to our new masters, the big banks.

  9. Rather than fighting this, and trying to save the un-savable system, for grins, let’s go the other way. Let’s see how massive and conglomerated and unmanageable our banks can get for fun-let’s remove all impediments and let them run wild and free. Let’s delay or repeal all superficial reforms already enacted like credit card regs. Let’s extend the special tax breaks enjoyed by hedge funds to all derivatives investors. Let’s underwrite and finance the investment in derivatives, at the expense of small business investment, by offering historically low interest rates at the Fed’s discount window. Let’s allow everybody who’s anybody (TBTF) to immediately morph into whatever corporate form they see fit, at any time, and back again, like your kids Transformers, of course with the ability to regulator shop. Let’s enjoy the G20 meetings and focus on the important things-looking good, issuing vague statements with big words, and Fois Gras.

    In essence, let’s crash the entire global financial system sooner rather than later, and make sure we get a much bigger splash this time. Come to think about it, we’re already doing all of the above-so we have a good start….

    I’ll remind everyone here that Alcoholics need to hit rock bottom before they become open to recovery, and become ready to complete the hard work required (assuming of course that they survive the ordeal). It is the painful chinese water torture-esque anticipation that terrorizes those who care. Let’s get on with it! Let’s guarantee everything, offer free money, impose no regulation, and replace their scotch with 151………

  10. It is that double-entry book-keeping had been the de facto control language for commercial trade for 670 years. It has had a number of refinements as commercial cultures grew more complex.

    However, for the past 50 years, and particularly for the past 30 years, the book-keeping framework that would support a proper set of controls has been abandoned by computer software developers. We are today in an anything goes state of commercial desires.

    Economists, who are running the show today, need to return to the basics and understand this fundamental control language. There is no alternative.

    Once book-keeping tells that factual story, then the math guys can play with the numbers. But without a real time auditable history that a proper book-keeping tells, we will continue to have the circus of the past 30 years.

    And, of course, getting more violent with each bubble’s burst.

  11. As far as Frederic Mishkin, anybody who writes a book with a title that ends “…… Get Rich” I can’t believe ONE damned word they say.

    I think the tax is a way for banks to weasel their way out of real regulations.

    Big banks should tell us their REAL plan for bank regulation is that all middle class Americans become arhats and we meditate on bank purity. Big banks had another bank regulation plan titled “Twiddle Your Thumbs While We Steal Depositors/Taxpayers Money” but that was a little too obvious and so the arhat plan won out.

  12. Simon’s comment on Bloomberg:“The arrogance, I’m afraid of these people, this hubris, is a huge slap in the face to the Obama administration and I don’t think they are going tolerate that,” Johnson said. The White House and Treasury Department must be “feeling rather miffed,” he said.

    What are they going to do about it? Obama, Geithner, Summers and Bernanke have all pointed to the equity markets as proof their plan is working. Obama, foolishly commented on DOW 10K as further proof. Any pushback to their gods will “roil” the markets and show that their comments regarding the effectiveness of their actions weren’t and aren’t valid. As Nader said, Obama is a frightened man. A frightened man that due to his actions, has painted himself into a corner on many very important issues.

  13. “The benign view, implicit in Secretary Geithner’s position at the G20 meeting last weekend, is most clearly articulated by Frederic (Ric) Mishkin, former
    member of the Fed’s Board of Governors and author of The Next Great Globalization: How Disadvantaged Nations Can Harness Their Financial Systems To
    Get Rich, in the Financial Times this morning.
    The second category of bubble, what I call the pure irrational exuberance bubble, is far less dangerous because it does not involve the cycle of
    leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage.”

    The following is an example of Miskin’s insight and forecasting skills:

    “More recently, developments in the subprime mortgage market have raised some additional concern about near-term prospects for the housing sector…. While these problems have caused undeniable hardship for many families and communities, spillovers to other segments of the mortgage market or to financial markets in general appear to have been minimal.

    Variable-interest-rate loans to subprime borrowers account for a bit less than 10 percent of all mortgages outstanding, and at this point the expected losses are relatively small. Moreover, because most subprime mortgages are securitized, the risks associated with these loans are spread widely.

    Banks and thrift institutions that hold mortgages are well-capitalized, and exposures of individual banks to possible subprime losses do not appear to be large. On the whole, some borrowers may find credit more difficult to obtain, but most borrowers are not likely to face a serious credit constraint.”

    Fed speech Aril 10, 2007

  14. President Obama, are you calling Barney Frank on a daily basis to check on the draft legislation for financial reform?? President Obama what are you doing about credit default swaps?? President Obama are you protecting the masses of people who voted for you, not caring your skin color, not caring the lies and innuendoes and rumors that were told about you?? Are you making sure the people who believed in your heart and your deep mind are not giving their futures for a Bank executive’s drinks in Maui???

  15. Wow — great find!

    This stuff is like the Iraq War. Somehow, the people who got it most wrong in the past are still the ones with the most credibility in the mainstream press and in government — the only ones who can be taken to be “serious people” — while those who were most right are still the least serious and credible. Go figure.

  16. The Fed is now seeking intellectual validation for the policy they are now pursuing – rescuing the US economy through bidding up asset prices. They now view the dot com bubble as benign ??? They used the same as an excuse to keep rates low for years and blow the bigger bubble in 2002-2005. Deflation was the enemy when Ben Bernanke gave his helicopter speech and proposed buying treasuries in June 2003. What is wrong with these people? Will they get it before they blow up the fiat currency system? Will they get it if another bubble bursts with more collateral damage to the real economy? I do not think so. We need reform, most urgently at the Fed. There will not be reform at Citi if the Fed remains who they are.

  17. The Mishkin piece had me wondering whether monetary policy is really the only way to deal with prospective asset bubbles. To believe Mishkin, the only two options seem to be either to raise interest rates or to do nothing. Can that possibly be true?

  18. I’m not sure what you wish to see as an example. That the present crisis is not healing is the best example. That each ten year crisis, Savings & Loan, DotCom, and Mortgage bond scandal, have grown by a magnitude or more in intensity is another.

    Understanding the nature of the book-keeping crisis is not going to be explained on this forum. But do know that if the book-keepers of 50 years ago, when I learned the model could come back today and view the damage, they would not believe their eyes.

  19. Estimates of hundreds of trillions of dollars in derivatives? Why don’t you want to tax them? I do not think that is hard to implement and we cannot reasonably imagine to move this mass to off-shore places just to avoid to pay the tax…If you tax inflows and outflows there is no way you can evade, sooner or later you are back to US or EU…

  20. A minuscule Tobin Tax, a little bump on the road, to help “slow down” the financial traffic and incentivize the second thought if it can be implemented, is not idiotic at all.

    Capital requirements for banks based on perceived risks, which help to “divert” the financial flows into areas just because they are supposedly risk-free even though they could also be absolutely useless, that is truly idiotic.

  21. Well if there is room for Superman and General Zod here I guess then there is also room for me to talk about some of that kryptonite that the regulators have spread around and which affects most those we count most to help us out of this crisis creating the jobs we need, namely the entrepreneurs and the small businesses, the clients of most of our “so small they can be allowed to fail” banks.

  22. Simon-While I am inclined to agree that the size of the banks contributes to the problem I think it is more complicated than that. After all the savings and loan crisis involved a large group of relatively small institutions. One part of the problem has been the relaxing of traditional accounting standards for things like capital requirements. Another part of the problem is based in bad corporate governance law. It is very difficult for stockholders to challenge sitting board members further, unlike in Britain. American stockholders are not allowed to vote on management pay. An additional problem is that here in the U.S. we don’t have a proper civil service making any serious sort of regulation difficult. Of course politicians taking huge amounts of money from the companies they are expected to regulate doesn’t help either.

    Sure for a true competitive market you need a very large number of participants, transparency and low start-up costs, among other conditions, and none of these exist in investment banking and breaking up the big banks would help. But it is just a first step.

  23. Let’s think about the 1950’s, when the highest marginal income tax rate was 90%. That can be the beginning of our Leave It To Beaver argument, when people had one car, one television, and one job per household, where mothers stayed at home with their kids, and the middle class was THE class. Sure, there were millionaires, and also poverty, but foreclosures were incredibly rare, as were bankruptcies. Those were the days, when everyone still remember the two incredible traumas of the two prior decades: the Great Depression, and World War II. We were happy, as a nation, generally, and then we forgot.

    The new world which has emerged is a world of substantial polar extremes, but which is controlled by the wealthiest and most powerful to the detriment of those who are not.

    I feel like I am watching the last act of a world gone crazy and working its way to December 21, 2012, the date the Mayan Calendar stops. Globally, we’re in deep manure with no boots, and it’s just getting worse. When was the last time the US fought a war that should have been fought: nearly 70 years ago. When was the last time a CEO was paid what he was really worth: my guess: about 40 years ago. Why is it necessary for those with three yachts and four homes to receive multimillion dollar bonuses: answer: it’s not.

  24. Are you making an argument that smaller banks should have LOWER capital requirements??? That would mean you’re playing the part of Non in Superman II.

  25. I completely agree and I have not yet read a single convincing and economic argument not to implement it immediately. I had been posting and commenting in the econ blogsphere and nobody can explain plainly why we cannot do it. Brazil has just imposed a similar tax of 2% on inflows of portfolio investments and nothing happens. Let’s just raise revenue and make the polluters pay principle applicable to the finance industry.

  26. I am making the following point:

    Large banks delve more with those “perceived risk categories” that have been benefited with very low capital requirements e.g. operations involving AAA rated companies that have a 1.6 percent bank capital requirement while small banks are more prone to be dealing with local BB+ or less rated or unrated clients which require 8 percent. This, plus the fact that they can use their own internal risk assessment programs is one of the reasons the too big to fail grow even larger.

    And so, since I want to lower the requirements on those clients that are more typical of smaller and community banks, well yes in this sense this would mean, temporarily lowering the capital requirements for those small banks… that never got us into this crisis.

    But it also means that larger banks, while they are rebuilding their capitals, could find it easier to carry the clients we really want and need them to carry. As I have said many times, our banks should not even be in AAA territory… that is for the capital markets.

  27. Careful there, just in case, I am talking about “minuscule” tax that does not produce any major distortions (or revenues).

    The Brazilian 2 percent tax on the other hand has the purpose of counteract what they perceive is a distortion, namely too much hot money entering Brazil. I think the old Chilean way of freezing the funds entering the country for one year, so as to ascertain the seriousness of their intentions, no one night fling there, is a better way than the Brazilian 2 percent… but that is a different debate.

  28. Dean Baker writes “Since the financial sector is the source of the country’s current economic and budget problems it also makes sense to have this sector bear the brunt of any new taxes that may be needed”.

    Indeed you can go that route if you have a job and some good savings and can therefore afford to satisfy your lust for revenge, but if you do not have a job you should be more concerned with making sure your banks help you to create the jobs that are needed.

    By the way I have no problem with the example Baker gives of the UK 0.25 percent tax on the sale or purchase of (all) stock but going from there to a “We can raise more than $140bn a year taxing financial transactions, an amount equal to 1% of GDP.”, sounds to me like pure political posturing and intellectual dishonesty.

  29. Banks are laying off and not contributing to creation of jobs at all. I do not see how a tax on their transactions or even windfall tax could affect their creation of jobs. Could we have more economic argument? Do you really think that is better to raise revenues elsewhere than the finance industry or the part of it that actually destroyed wealth and jobs?

  30. You ask: Do you really think that is better to raise revenues elsewhere than the finance industry or the part of it that actually destroyed wealth and jobs?

    I have over the last decade been very clear on that those who actually destroyed wealth and jobs were the financial regulators, by means of giving special incentives to banks to finance supposedly low-risk AAA sector, a sectors where the jobs of tomorrow are not created and a sector that could also turn into an unsafe place if too much capitals go there. You see our regulators had nothing but keeping the banks from failing on their agenda and that is why the banks were failing society even while they were not failing.

    A windfall tax… on what banks? Your small community banks with their “risky” clientele base of small businesses or entrepreneurs which had absolutely nothing to do with this crisis but that are now paying the highest price as they get crowded out from access to bank credit? I do not think so.

    If anything place a special tax on all those transactions that have been subsidized by mean of the very low capital requirements they imposed on the banks because they were supposed to be not risky. Call it a transaction tax on the AAA rated if you want. That would also target the too big to fail problem because it is in this AAA sector of the economy that the largest have grown.

  31. Mishkin: “The second category of bubble, what I call the ‘pure irrational exuberance bubble, is far less dangerous because it does not involve the cycle of leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage”

    Johnson: “In other words: keep monetary policy right where it is, and don’t worry about financial regulation.”

    Really? It sounds to me like regulate leverage.

    That jives with what I was told when I was a kid: Too much leverage caused the Great Depression.

  32. Miskin: Some Bubbles Are “Far Less Dangerous”

    So there are good bubbles and bad bubbles. A good bubble is one where the benefits outweigh the costs. So public policy should not intervene to manage good bubbles, and by implication are endorsed.

    Endorsing good bubbles implies either:

    policy-makers can identify in advance which bubbles will turn out out to be good and which ones will be bad. Even if this is possible, the success of a series of good small bubbles comes with the potential addiction to same , which may eventually be dwarfed by the tsunami effect of a tail good bubble gone bad.


    policy-makers cannot identify in advance which bubbles will be good, but a bubble which looks like it might turn bad can be controlled, to keep it good. This also presumes that the steps taken can be implemented in a timely manner, and that the benefits outweigh the costs.

    It all sounds like more “fed-speak” to me.

Comments are closed.