What happened to the global economy and what we can do about it
Category: Commentary
By James Kwak
“I’ve given lectures on incivility around the globe. When I ask audiences whether anyone considers sending e-mail or texts during meetings uncivil, almost everyone raises their hand.
“Then, when I ask whether anyone in the audience sends texts or e-mail during meetings, about two-thirds acknowledge the habit. (Presumably, there are still more who don’t want to admit it.)”
That’s Christine Pearson, from her article in The New York Times.
By Simon Johnson
On Thursday evening, the Lehrer Newshour ran my discussion with Paul Solman on American financial history and previous attempts to constrain the power of big banks – covering the main points in chapter 1 of 13 Bankers. On Paul’s part of the Newshour website, we also talk about “astroturf” organizations that pretend to be reformist but are really just stalking horses for corporate interests opposed to reform.
We covered a lot of ground (and much of Manhattan) in 8 minutes, but we missed one potential irony. At the American Museum of Natural History, above the Teddy Roosevelt statue (and not readable, it turns out afterwards, in any of the shots) there was a huge banner celebrating an exhibit made possible in part by David Koch (a trustee and major funder of their dinosaur wing).
Teddy Roosevelt would have loved the irony of appearing under a banner with Mr. Koch’s name.
Continue reading “13 Bankers: Lehrer Newshour Edition – And Another Connection”
This guest post was contributed by engineer27, a longtime reader of and frequent commenter on this blog. (I had exams this past week, which is why I haven’t posted in a while.)
This Thursday, the Senate added two amendments to the Financial Regulation in process that deal with Nationally Recognized Statistical Rating Agencies (NRSROs), which are blamed for being a factor in the financial crisis of 2008. The most widely cited problem with the NRSROs is the inherent conflict of interest which resides in the “issuer pays” model currently in use. However, even supporters of doing something are stymied when trying to envision a workable solution. The two (perhaps contradictory) amendments each try to implement a proposed solution that runs into some of the critiques. The Franken amendment has rating agencies assigned to debt issues by a neutral arbiter; critics maintain that lack of competition may reduce the quality of analysis. The LeMieux amendment removes legal mandates to obtain a NRSRO rating and the preferential treatment those issues currently receive. However, it leaves out details about whose advice agencies and public trusts should seek out instead.
This is not such a difficult problem. We already have an example of a successful private rating agency, whose imprimatur is desired or in some cases required by law, that is paid for by fees on the seller, and has been operating since 1894: Underwriters Laboratory. The UL publishes safety standards for almost 20,000 different types of products, many of which are adopted by other standard-setting organizations like ANSI (American National Standards Institute) and Canada’s IRC (Institute for Research In Construction). Although generally not actually required by federal law, the sale of many types of products in the US would be difficult without UL listing. Also, many local jurisdictions responsible for building and fire codes mandate the use of UL approved products. In all cases, the manufacturer must submit samples and pay fees to UL in order to win approval.
By Simon Johnson
Look forward. The holy grail of any serious financial market player must now be: Become Too Big To Fail. You can do it is as a megabank – this part is obvious. But you can also do it as a hedge fund or some other lightly regulated pool of capital – this, after all, is the lesson of Long Term Capital Management that has never been addressed.
And quantitative trading, while in principle just one approach to investing or even only set of tools, greatly increases the complexity and opaqueness of markets – further allowing you to become big (in any future sense) relative to the political and economic system, and moving us closer to a more complete version of the stock market shut-down we saw on May 6.
For more on this, see my review of Michael Lewis’s The Big Short and Scott Patterson’s The Quants – now in The New Republic’s on-line book section.
By Simon Johnson, co-author, “13 Bankers: The Wall Street Takeover and The Next Financial Meltdown“
Update: link to Senator Kaufman’s speech yesterday
Senator Ted Kaufman (D, DE) is best known these days for arguing that, as part of comprehensive financial reform efforts, our biggest banks need to be made smaller. His advocacy on this issue helped build support around the country and forced a Senate floor vote on the Brown-Kaufman amendment, which was defeated 33-61 last Thursday.
Senator Kaufman has also pushed strongly the idea that in recent years there was a pervasive “arc of fraud” within the mortgage-securitization-derivatives complex. This thesis also seems to be gaining traction – according to the WSJ today, the criminal probe into this part of the financial sector continues to develop.
But the Senator’s biggest home run has been on a different issue: his warnings about the dangers of high-speed trading, involving “dark pools” of money, appear to have been completely vindicated – ironically enough, also last Thursday. Continue reading “Senator Kaufman Was Right – Our Financial System Has Become Dangerous”
The following guest post was contributed by Jennifer S. Taub, a Lecturer and Coordinator of the Business Law Program within the Isenberg School of Management at the University of Massachusetts, Amherst (SSRN page here). Previously, she was an Associate General Counsel for Fidelity Investments in Boston and Assistant Vice President for the Fidelity Fixed Income Funds.
It’s about time. Yesterday, by a vote of 96 – 0, the U.S. Senate passed a ground-breaking amendment to the financial reform bill. Introduced by Senator Bernie Sanders of Vermont, this amendment would require an audit of all emergency actions taken by the Federal Reserve since December 1, 2007. In addition, the amendment mandates that by December 1, 2010, the Fed reveal those who received $2 trillion in zero or near zero interest Fed loans and what those institutions did with the money.
This was the second recent “yes we can” show of bipartisanship. Last week, by a 96 -1 vote, the Senate approved an amendment introduced by Senator Barbara Boxer of California. The Senator described its purpose was to “protect taxpayers” through the creation of an “orderly process to liquidate failing financial firms and ensure that Wall Street pays to clean up its own messes.” Whether the amendment can live up to that promise is a good question. The answer depends less upon government intervention once a firm nears collapse and far more upon government prevention of the excesses that lead both to widespread failure and government support.
Continue reading “Supporting Swap Desk Spinoffs Just Got Easier”
By Simon Johnson
Eighteen months ago, on October 24, 2008, Peter Boone, James Kwak and I published an opinion piece in the Guardian (UK), “Start by Saving the Eurozone“. We argued that the recession would put a great deal of pressure on the eurozone, because of flaws in its design.
Our proposals for addressing these issues, and preventing a broader global crisis, included:
“2. Create a European Stability Fund with at least €2tn of credit lines guaranteed by all Eurozone member nations and potentially other European countries with large financial systems such as Switzerland, Sweden and the UK. This fund should provide alternative financing to member countries in case market rates on their government debt become too high. This will prevent a self-fulfilling cycle of rising interest rates. The fund should be large enough to have credibility; countries could access the fund automatically, but should then adopt a 5-year program for ensuring financial stability, subject to peer review within the Eurozone.” Continue reading “Our Eurozone Call In October 2008 And Banking Reform Today”
By Simon Johnson
In today’s Financial Times, Peter Boone and I have an op-ed with proposals for reforming how the eurozone operates. The current arrangements have proved unstable – encouraging countries to run excessive budget deficits while also giving banks an incentive to both finance profligate governments and also fuel real estate bubbles.
Addressing these problems would require creating a “core” of countries that keep the euro, agree to much more unification of fiscal policy, and put in a place a single strong bank regulator/supervisor. A move in this direction may not seem likely in the short-term, but the pressures are still building.
By Peter Boone and Simon Johnson
The eurozone self-rescue plan announced last night has three main elements:
At first pass this package might seem to be in with what we recommended a week ago and again on Thursday.
But the European central banks have come in very early – with government bond prices still high – and there is no sign yet of credible fiscal adjustment for Spain and Portugal. The eurozone apparently did not even discuss the situation in Ireland, which seems increasingly troubling.
This is a whole new level of global moral hazard – the result of an alliance of convenience between troubled governments in the south of Europe and the north European banks (and implicitly, north American banks) who enabled their debt habit. The Europeans promise to unveil a mechanism this week that will “prevent abuse” by borrowing countries, but it is hard to see how this would really work in Europe today.
Overall, this is our assessment: Continue reading “Eurozone: The Kitchen Sink Goes In – Now It’s All About Solvency”
By James Kwak
I recently deleted most of my personal information in my Facebook account. (I am keeping the Baseline Scenario page up for the convenience of people who want to read the blog within Facebook, and I need to have my personal account in order to manage that page.) This is only a tiny bit related to the fact that, for several days recently, Facebook was blocking access to this blog. It’s mainly because I’ve decided that the costs of Facebook outweigh the benefits.
First, take a look at this fantastic graphic by Matt McKeon (hat tip Tyler Cowen). You have to click on it to advance through time; it shows what information is, by default, available to whom, and how that has changed over time. (Click on the link to the “image-based version” if you’re having trouble.) Then come back here.
By Simon Johnson, 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown
The bank lobbyists have the champagne out – the Brown-Kaufman amendment, which would have capped the size and leverage of our largest banks – was defeated in the Senate last night, 33-61. Feeling ascendant, the big banks swarm forward to take on their next foe – the Kanjorski amendment (that would greatly strengthen the power of regulators to break up megabanks), which they plan to gut in the backrooms.
This is overconfidence – because the consensus against them is beginning to shift significantly. Partly this is the result of great efforts by Senator Ted Kaufman, Senator Sherrod Brown, and their colleagues over recent months and weeks. Partly this is due to all the people who came on board and pushed hard.
But, as in many such cases, it is also a question of luck – and timing. Continue reading “Falling Back On Waterloo”
By Peter Boone and Simon Johnson
Europe needs a new recovery plan, bigger and broader than anything put together so far. This weekend is the perfect time to put such a plan together. But be wary of committing official resources too early in this market downdraft – smart policymakers will calmly let the markets fall further, in order to benefit from the rebound potential.
In the last few days, bond markets have decided that the deflationary adjustments – cutting wages and prices — needed in large parts of the eurozone are not politically feasible. The deflationary spiral that will come with fiscal cuts causes political turmoil and reduces revenues – that in turn makes it ever harder to service debt; see Greece this week. Eurozone countries running large budget deficits with substantial outstanding public debt are finding they are cut off from credit markets as a result. This is a solvency issue, not a liquidity issue.
But do not rush into this gap. If the European Central Bank (ECB) were to start buying Spanish debt today, for example, they would find an abundance of sellers because the bonds are fundamentally overvalued. Continue reading “The Agenda For Emergency Economic Strategy Discussions This Weekend”
By James Kwak
Bernie Sanders’s “audit the Fed” amendment, which expands the ability of the Government Accountability Office to review Federal Reserve operations, seems to be gaining some momentum. Opponents, including the Obama administration and Fed chair Ben Bernanke, are mounting a defensive effort. There are two main arguments that I have heard.
The first is that publicizing which banks take advantage of Fed lending facilities will stigmatize those banks and could increase panic in the midst of a financial crisis. I’m not particularly convinced by this argument, since most supporters of the amendment are fine with releasing such information with a delay. Section 1152(a)(2) of the amendment eliminates the provision in 31 U.S.C. 714(b) that shields from audit monetary policy decision-making and financial transactions by Federal Reserve banks, but replaces it with this:
“Audits of the Federal Reserve Board and Federal reserve banks shall not include unreleased transcripts or minutes of meetings of the Board of Governors or of the Federal Open Market Committee. To the extent that an audit deals with individual market actions, records related to such actions shall only be released by the Comptroller General after 180 days have elapsed following the effective date of such actions.”
Continue reading ““A Process That Only We Fully Understand””
By Simon Johnson, co-author of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown
When you strip away the disinformation, false promises, and wishful thinking, this is where we are on really reigning in the power of the country’s largest – and most dangerous – banks.
Senators Sherrod Brown and Ted Kaufman have proposed the SAFE Banking Act, which is an entirely reasonable and responsible way of limiting the size of our largest banks. It should be adopted as an amendment to the main financial reform bill now before the Senate.
As the New York Times points out today, there is growing support for this approach. But note that this article – while entirely accurate – was relegated to page B3; Sewell Chan’s original piece on this topic was a front page story on April 20.
The opposition to Brown-Kaufman at the highest levels of government (legislature and executive branches) is so strong that it is increasingly unlikely the amendment will even get an up-or-down vote on the Senate floor. Continue reading “Brown-Kaufman Amendment: The State Of Play”
By Peter Boone and Simon Johnson
The Greek “rescue” package announced last weekend is dramatic, unprecedented, and far from enough to stabilize the eurozone.
The Greek government and the European Union (EU) leadership, prodded by the International Monetary Fund (IMF), are finally becoming realistic about the dire economic situation in Greece. They have abandoned previous rounds of optimistic forecasts and have now admitted to a profoundly worse situation. This new program calls for a total of 11% of GDP in terms of “fiscal adjustments” (i.e., reduction in the budget deficit; now meaning government spending cuts mostly) in 2010, 4.3% in 2011, and 2% in 2012 and 2013. The total debt to GDP ratio peaks at 149% in 2012-13 before starting a gentle glide path back down to sanity.
This new program is honest enough to show why it is unlikely to succeed. Daniel Gros, an eminent economist on euro zone issues based in Brussels, has argued that for each 1% of GDP decline in Greek government spending, total demand in the country falls by 2.5% of GDP. If the government reduces spending by 15% of GDP – the initial shock to demand could be well over 30% of GDP. Obviously this simple rule does not work with such large numbers, but it illustrates that Greece is likely to experience a very sharp recession – and there is substantial uncertainty around how bad the economy will get. The program announced last weekend assumes Greek GDP falls by 4% this year, then by another 2.6% in 2011, before recovering to positive growth in 2012 and beyond.
Such figures seem extremely optimistic, particularly in face of the civil unrest now sweeping Greece and the deep hostility expressed towards Greece in some north European policy circles. Continue reading “It’s Not About Greece Any More”
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