Posts filed under ‘Bailout / Financial Crisis’
René Stulz on Asset Bubbles
| Peter Klein |
From the HBR series “Finance: The Way Forward”:
At the same time, however, it is also critical to create conditions that make it more difficult for bubbles to emerge. This means fundamental changes in public policy. The most important change is to do everything possible to make sure that no institution is “too-big-to-fail.” We also have to do away with the Bernanke put. It is not possible for the public sector to guarantee investors against losses without creating more and more instability.
I’d add that policymakers should avoid creating bubbles in the first place, but that’s a subject for another day.
Add to: Facebook | Digg | Del.icio.us | Stumbleupon | Reddit | Blinklist | Twitter | Technorati
Raising Rivals’ Costs, Goldman Edition
| Peter Klein |
One could also call this “From the Department of ‘Duh'”:
A powerful alumni network plus bundles of campaign cash mean Goldman will get what it wants — and contrary to the media narrative, what Goldman wants is not laissez-faire.
Politico quoted a Goldman lobbyist Monday saying, “We’re not against regulation. We’re for regulation. We partner with regulators.” At least three times in Goldman’s conference call Tuesday, spokesmen trumpeted the firm’s support for more federal control. . . .
Goldman reported on the conference call that it holds 15 percent “Tier 1 capital,” meaning it is very liquid and not very risky. Goldman can play it safe, you see, without needing a regulation. But regulations prevent smaller competitors from taking the risks needed to compete with Goldman (and every competitor is smaller).
The article is also very good on Obama’s Goldman problem. (Link from Steve Horwitz via Per Bylund.)
Add to: Facebook | Digg | Del.icio.us | Stumbleupon | Reddit | Blinklist | Twitter | Technorati
Goldman in the Dock
| Craig Pirrong |
I have several reactions to the SEC’s fraud complaint against Goldman.
First, some of the more sensationalist reporting emphasizes that Goldman was short the RMBS structures that it was selling to its customers. (Yeah, it’s the NYT, basing its opinion on reporting by Wretched Gretchen Morgenson, so take it for what it’s worth–meaning not much.) Well, that’s true, but Goldman was also long. After all, it was the counterparty, the protection seller, to Paulson’s CDS. It then entered into offsetting transactions. Goldman was essentially a conduit of risk between other financial firms and Paulson. Note paragraph 66 of the complaint, which indicates that Goldman paid most of the $840 million it received on short positions in the Abacus deals to Paulson. Goldman claimed in its response to the government’s Wells Notice that it was actually long because it retained a slice of the risk; the protection it sold to Paulson was for a larger portion of the potential losses than covered by the protection it bought from ACA Capital. (more…)
The Chris Dodd Strangle Entrepreneurship Act, or, Where’s Creative Destruction When You Need It?
| Craig Pirrong |
Back in January, Tool Time star Tom Friedman lamented that Mr. Cool had turned his back on the “amazing, young, Internet-enabled, grass-roots movement he mobilized to get elected.” Friedman all but begged Obama to spur entrepreneurship and innovation:
Obama should launch his own moon shot. What the country needs most now is not more government stimulus, but more stimulation. We need to get millions of American kids, not just the geniuses, excited about innovation and entrepreneurship again. We need to make 2010 what Obama should have made 2009: the year of innovation, the year of making our pie bigger, the year of “Start-Up America.”
How’s that working out for you, Tom? With all the taxes on capital in the health care law, and the implicit tax on business expansion in the law (e.g., insurance mandates on companies with more than 50 employees), and all the taxes to come (there are murmurs of a VAT), it is becoming the year of Shut-Down America. The whole Obama program is poison to entrepreneurship.
And that’s just the start. Dodd’s banking bill explicitly targets startups:
Dodd’s bill would require startups raising funding to register with the Securities and Exchange Commission, and then wait 120 days for the S.E.C. to review their filing. A second provision raises the wealth requirements for an “accredited investor” who can invest in startups — if the bill passes, investors would need assets of more than $2.3 million (up from $1 million) or income of more than $450,000 (up from $250,000). The third restriction removes the federal pre-emption allowing angel and venture financing in the United States to follow federal regulations, rather than face different rules between states.
And just what are the apparatchiks in the SEC going to do in that 120 days? Just what knowledge and expertise can they bring to bear in evaluating the funding plans? The question answers itself; this adds costs and delay, for no perceivable benefit. And what reason is there to restrict the free flow of capital from consenting adults with over $1mm to startups? (more…)
Shareholder-Stakeholder Smackdown: Jensen, Freeman, Mintzberg, Khurana
| Peter Klein |
This looks like a fun event. Watch the Big Guys debate the future of the firm, management, and management education. It’s Fordham University’s W. Edwards Deming Memorial Conference, 11 May 2010 in New York City. Kudos to Mike Jensen for his willingness to walk into what will be, presumably, a line of fire. And remember, management theory is not to blame.
Price Level Shocks, uhm, Screwed Up Relative Prices, and Organization
| Craig Pirrong |
Peter’s post on the relation between inflation, vertical integration, and markets brings a couple of other thoughts to mind.
First, and most importantly, the number and characteristics of markets are endogenous too, and respond to changes in the amount of uncertainty in the environment, including the amount of uncertainty resulting from monetary shocks that (in Sherwin Rosen’s unforgettable in-class phrase) “f*ck up relative prices.” In particular, the number and variety of futures markets depends on the amount of uncertainty. The big boom in the creation of futures markets in the 1970s corresponds with, and was arguably caused by, the coincident inflation of that period, and the associated volatility in relative prices.
Second, although Peter’s point, and previous research, focuses on the implications of inflation on organizational choices and market vs. firm choices, in the current environment it is worthwhile pondering the implications of deflation. Certainly we have more research on the effect of inflation on the variability of relative prices due to our more recent inflationary experiences, and this was a major source of concern about inflation among Austrians, but the current situation makes it worthwhile to consider the effects of deflation on the pricing system, and firms’ responses to that.
Perhaps an examination of Japanese experience since 1990 would be worth some in-depth analysis.
Personally I am torn as to whether inflation or deflation is the greater risk in the near to medium term. The huge monetary overhang in the US and around the world (resulting from quantitative easing and other extraordinary monetary policies), and the inability of the Fed to commit credibly to drain reserves from the system when money demand picks up make me believe that it will be hard to avoid a burst of inflation. But all current indicators point to flat or declining prices.
It is hard to see things ending in a Goldilocks moment — just right. Thus, it is likely that that there will be a shock to prices generally, arguably a large one, and that this will disrupt relative prices for a variety of reasons. (Including, notably, the very likely case where these price level shocks lead to government policy interventions that distort relative prices.)
Thus, Peter’s research program may be rejuvenated, courtesy of the Fed, ECB, the Chinese Central Bank, etc. It is indeed an ill wind that blows nobody any good.
Industry-Level Effects of Government Spending
| Peter Klein |
A consistent theme of this blog’s postings on the financial crisis and recession is that the Keynesians focus on too high a level of aggregation. As economists and management scholars we care primarily about industries, firms, and individuals, not abstract macroeconomic aggregates like GDP, the “price level,” etc. Heterogeneity matters, and the way stimulus programs affect the allocation of resources across firms and industries is as important, or more important, than their economy-wide effects.
A new NBER paper by Christopher Nekarda and Valerie Ramey uses disaggregated industry-level data to examine the effect of the current US stimulus program on output, employment, real wages, and productivity. They find, not surprisingly, that increases in government spending directed toward a specific industry raise that industry’s short-term output and employment but — contrary to New Keynesian predictions — reduce that industry’s real wages and productivity.
Nekarda and Ramey note that stimulus spending has been directed disproportionately to durable-goods manufacturing and that these industries have higher returns to scale than other industries, possibly explaining how reductions in industry-level productivity could look like productivity gains in the aggregate. In other words, stimulus spending reduces efficiency in all industries, but directs resources toward industries that were more efficient to begin with, giving the appearance of a positive aggregate effect. Thoughtful and provocative.
Industrial Policy Redux
| Peter Klein |
Keynesian economics is not the only once-discredited doctrine making a comeback following the financial crisis. Despite the well-publicized failures of MITI, Sematech, and similar ventures, people are now calling for a new US industrial policy. Here’s a former Shell executive writing in the WSJ about America’s “foolhardy fondness for ‘free market’ philosophies that tell us it’s OK to export all our jobs,” and complaining that “[w]e’ve never systematically used government incentives to help U.S. industry compete across the board. It’s time we did, like everyone else.” Oy vey. A more serious, but equally troubling, proposal comes from Nobel Laureate Edmund Phelps, calling for a “First National Bank of Innovation.” Writing in HBR, Phelps and Leo Tilman worry that high-risk, long-term investments aren’t getting adequate funding, but don’t explain exactly how government funders would compute NPV on anything other than political grounds (which suggests a new acronym: Net Political Value).
Brad’s Bloviations, Part #2,235
| Peter Klein |
Brad DeLong accuses non-Keynesians (Austrians, Chicagoites, and other sensible people) of “los[ing] themselves amidst their early-nineteenth century books, one hundred and seventy years behind the state of the art in economics,” just because they think public spending and deficits might be crowding out private-market activity, making it difficult — impossible, actually — to come up with meaningful estimates of “jobs saved” by stimulus spending. If you can get past Brad’s adolescent writing style (anyone citing Bastiat, for example, is “a truly clueless idiot”), you find that he is indeed very “progressive” in his thinking — he’s made it all the way to 1950. Brad, like most Keynesians, is stuck in the C + I + G world of undergraduate macro. His argument is that the stimulus can’t be crowding out private-sector jobs because (a) wages aren’t rising (implying that stimulus-funded workers aren’t being bid away from other potential opportunities) and (b) T-bill prices aren’t falling (suggesting that private employers aren’t competing with the Feds for credit).
Leave aside for the moment that Brad has no idea what wages and bond prices would be in the absence of stimulus. The key problem with Brad’s argument, noted by Russ Roberts, is its reliance on crude macroeconomic aggregates. As pointed out here many times, heterogeneity matters. Sensible economists care not about the aggregate unemployment rate, but the effect of stimulus activity on individual labor markets. Stimulus affects the composition of employment, not just its level. (more…)
Infographic of the Day: Bailouts Around the World
| Peter Klein |
Via HBR, bank bailouts and stimulus packages as percentages of GDP. China tops (bottoms?) the list with stimulus goodies worth a whopping 47% of GDP.
Recession and Recovery: Six Fundamental Errors of the Current Orthodoxy
| Peter Klein |
A very good summary by Bob Higgs of “vulgar Keynesianism,” defined by Bob as the “pseudointellectual mishmash . . . that has passed for economic wisdom in this country for more than fifty years.” The key feature of VK is an emphasis on crude aggregates (“national income,” “the employment rate,” “the interest rate,” etc.) at the expense of relative prices, firm and industry effects, and cause and effect. Echoing one of this blog’s favorite themes, Bob highlights the VK economist’s inability to grasp the concept of capital structure, “the fine-grained patterns of specialization and interrelation among the countless specific forms of capital goods in which past saving and investment have become embodied. In [the VK] framework of analysis, it matters not whether firms invest in new telephones or new hydroelectric dams: capital is capital is capital.”
Update: See also David Henderson on aggregation.
Socialist Calculation Meets the OTC Markets
| Craig Pirrong |
A new Federal Reserve Bank of NY staff report by Darrell Duffie, Ada Li, and Theo Lubke, “Policy Perspectives on OTC Derivatives Market Infrastructure” has received a lot of attention in the press.
There are some good things in the paper. Notably, it is suitably cautionary about the potential systemic risks posed by central counterparties, and the consequent need for prudential regulation thereof. It also makes a good case for data repositories, and for the role of the Fed and other government agencies in reducing the costs that intermediaries incur to coordinate risk-reducing actions, such as portfolio compression and improvements in the process of confirming deals.
But overall the paper is extremely disappointing. Its tone is Olympian and prescriptive. The word “should” is used 61 times 21 pages of text (that includes several space-eating tables and charts).
This is extremely dangerous because these prescriptions and dictates are not based on a a rigorous analysis of costs and benefits. Most disturbingly, there is virtually no discussion whatsoever of the informational demands inherent in the prescriptions. We’re told that regulators should set the right capital and collateral requirements on non-cleared deals, and that CCPs should maintain “high collateral standards.” (more…)
Happy Keynesian New Year
| Craig Pirrong |
Keynes and Hayek were major adversaries in the 1930s, but it is interesting to note that they shared some important ideas in common, but drew diametrically opposed conclusions from them.
In particular, Hayek, and the Austrians generally, believed in radical uncertainty, in the sense that individual economic agents had too little information about the world to assess probabilities of states of the world, or even to identify the possible states. Keynes similarly believed in the inability of individuals to evaluate investments in a rigorous quantitative way. Keynes concluded that this made investors subject to radical shifts in sentiment and “animal spirits” that could cause an autonomous collapse in investment. (more…)
A Piece on Financial Derivatives Regulation in FT Alphaville
| Craig Pirrong |
FT Alphaville, one of the Financial Times’ blogs, kindly asked me to contribute a guest post on the financial-markets regulation legislation currently working it’s way through Congress. (Thanks, Stacy-Marie.) Here’s what I wrote:
Lawmakers in DC are due to resume debate on major financial-reform legislation currently working its way through the US House of Representatives. One closely watched aspect of that debate is sweeping overhaul of over-the-counter derivatives markets. Lawmakers are pushing to mandate that most derivatives be centrally cleared and traded either on exchanges or swap execution facilities. Professor Craig Pirrong of the University of Houston discusses some of the proposals.
In attempting to impose standardization on the ways that derivatives are traded, and derivatives counterparty risks are managed and shared, the legislation reflects a one-size-fits-all mentality (not to say fetish) that is sadly typical of most legislative attempts to construct markets. These standardization directives fail to recognize that market participants are diverse, with diverse needs and preferences, and that as a consequence, it is desirable to have diverse trading mechanisms to accommodate them. (more…)
Boeing and the Higgs Effect
| Peter Klein |
In their calls for greatly expanding the Federal Reserve System’s and Treasury Department’s roles in the economy, Chairman Bernanke, Secretaries Paulson and Geithner, and their academic enablers have repeatedly emphasized the temporary nature of these “emergency” measures. “History is full of examples in which the policy responses to financial crises have been slow and inadequate, often resulting ultimately in greater economic damage and increased fiscal costs. In this episode, by contrast, policymakers in the United States and around the globe responded with speed and force to arrest a rapidly deteriorating and dangerous situation,” said Bernanke in September. Yeah, no kidding. But, we are assured, the basic structure of our “free-enterprise” system remains soundly in place.
However, as Bob Higgs has taught us, “temporary,” “emergency” government measures are never that. Indeed, virtually all the major, permanent expansions of US government in the twentieth-century resulted from supposedly temporary measures adapted during war, recession, or some other “crisis,” real or imaginary. Cousin Naomi’s “disaster capitalism” thesis is exactly backward: it is socialism, or interventionism, that thrives during the crisis, and Washington, DC never looks back. I mean, does anyone seriously believe that the Fed will deny, or give back, the authority to purchase whatever financial assets it wishes at some future date when it deems the crisis officially “over”? Will the Treasury credibly commit never again to purchase equity or guarantee debt or otherwise protect some major industrial or financial firm after the economy returns to “normal”? Not a chance. Everything the authorities have done in the last two years to deal with this “emergency” will become part of the federal government’s permanent tool kit.
Today’s WSJ has a good example of Higgs’s ratchet effect, a front-pager on Boeing’s dependence on export loan guarantees from the Export-Import Bank, a federal government agency created in — you guessed it — 1934, as a temporary agency to deal with the Great Depression. “No company has deeper relations with Ex-Im Bank than Chicago-based Boeing. Without Ex-Im, aviation officials say, Boeing this year could have been forced to slash production, endangering hundreds of U.S. suppliers, thousands of skilled American jobs and billions of dollars in export contracts.” Bank official Bob Morin is described as “Ex-Im Bank’s rainmaker. His Boeing deals accounted for almost 40% of the bank’s $21 billion in business last year. To help Boeing through the credit crunch, his team has spent the past year developing government-backed bonds that promise to raise billions.” So, a massive industrial-planning apparatus, supposedly born during a temporary crisis, lives on as the lifeblood of a huge, politically connected US company.
Thank goodness all that money flowing to Goldman Sachs is only temporary!
Update: Here’s a short Higgs piece from 2000 on the Ex-Im Bank, appropriately titled “Unmitigated Mercantilism.”
My Naïveté
| Peter Klein |
I hoped Christy Romer would be a voice of reason within Obama’s economic team. What was I thinking? If yesterday’s WSJ op-ed is any indication, her role has been reduced to that of cheerleader for the President’s preposterous “stimulus” program. The editorial is a string of banalities, unsupported by argument or evidence, about the wonderful effects of stimulus and the need to “confront the challenges” that remain. For example, noting that real GDP increased slightly in the third quarter of 2009, after a sharp fall in the first quarter, she says that the “vast majority of professional forecasters attribute much of this dramatic turnaround to the fiscal stimulus.” Professional forecasters? Of course, we have no idea what GDP would have been in the absence of stimulus. And what of the secondary consequences, both short- and long-term? What of the unseen? She even praises the cash-for-clunkers program, recently skewered by my old friend John Chapman.
She knows all this. As Christy’s teaching assistant at Berkeley I saw her explain, patiently and carefully, how government programs have side effects, often unintended (she specifically used the airplane-child-safety-seat example of the Peltzman effect). All forgotten now. Some version of Lord Acton’s dictum, I guess.
Lynch ‘Em
| Craig Pirrong |
I’ve had several calls from reporters asking my opinion on the Lynch Amendment to Barney Frank’s derivatives-regulation bill. For some reason, Forrest Gump pops into my head every time that question is asked. You know, the part where he says “stupid is as stupid does.”
As I am sure you all know, the amendment, introduced by New Jersey representative Stephen Lynch, imposes restrictions on the ownership and control of the clearinghouses that the Frank bill will require the vast bulk of derivatives to be traded through. The amendment imposes similar restrictions on ownership of exchanges and swap execution facilities.
Specifically, the amendment defines a class of “restricted owners” that includes swap dealers and major swap participants, and limits the amount of a clearinghouse (or execution facility or exchange) that these restricted owners can own or control collectively to 20 percent. The justification for this limitation is to reduce conflicts of interest, the specific nature of which are not identified.
This represents yet another example of Congressional micromanagement of the organization and governance of financial institutions. In my view, it is incredibly wrong-headed. (more…)
Further My Last
| Craig Pirrong |
My previous post on the Acharya et al (AEFLS) assertion of the purported externality in bilateral OTC markets focused on whether there was actually an unpriced “bad.” I judged otherwise based on the fact that credit and counterparty risks are repriced repeatedly (and ruthlessly).
There is another reason to reject their analysis. It should be incumbent on one who justifies the existence of an externality to justify a particular policy to (a) identify the transactions costs that preclude internalization of this externality, and (b) demonstrate that their policy would create a net benefit, by, for instance, reducing transactions costs. AEFLS don’t even try to do this (another symptom of the Nirvana fallacy). And when one examines the particulars, it is highly doubtful that the costs of the purported externality are as large as AEFLS insinuate that they are.
The AEFLS story is that contracts between two counterparties to an OTC derivatives deal impose costs on other market participants, notably, the firms’ other counterparties to earlier derivatives deals, and the counterparties’ counterparties, and on and on. OTC market participants don’t take these costs into account, trade too much, and create too much risk.
Which raises the Coase Question: if these costs are so large, why don’t the affected parties craft a solution that mitigates them? If, as AEFLS argue, a central counterparty would reduce these costs, why don’t the affected parties create one to internalize the externality and enhance their welfare? (more…)
Selection à la Banks
| Lasse Lien |
Ideally, the competitive process would select for productivity. It doesn’t actually do that. Presumably it selects for expected profitability, which is close enough — assuming market power isn’t too common. What has the economy been selecting for in the past year or so? The state of low demand means that it’s harder for firms to finance operations and investment, and firms depend more than ever on external capital. For most firms this means the bank. So banks’ credit decisions will to an unusual degree decide who gets to grow and who has to shut down. Simultaneously, banks are cutting back on credit — so which firms will the banks select? Since banks have no upside, they will ration credit on the probability of losses. This is clearly a worse criterion than expected profitability because it involves a degree of risk aversion that cannot be healthy. Presumably new firms, high-debt firms, small firms, and firms with mainly intangible assets can all be selected out (or unduly constrained in their growth), not because they have low productivity or low expected profitability, but because large, established, low-productivity, low-debt, tangible-capital firms represent a somewhat lower credit risk.
Hopefully, the period of bank-driven selection will be short and expected profitability will be restored. The only thing worse, I guess, is selection by lobbying productivity (or scale).
Fed Independence and Comparative Institutional Analysis
| Peter Klein |
I’ve written before on Fed “independence” and why I don’t support it. The vast majority of economists, especially the more prominent ones, are strongly in favor of independence and against Congressional attempts to limit the Fed’s discretion in monetary and regulatory policy. The standard argument is that a “politicized” — i.e., accountable — central bank will be more expansionary than an unaccountable central bank, assuming that credit expansion affects output first and prices (inflation) second. Last week’s piece by Kashyap and Mishkin follows this script. On the face of it, this seems absurd, as — to take only the most obvious example — the Greenspan-Bernanke “independent” Fed has been the most expansionist in modern history, with a ballooning money supply throughout the 2000s and near-zero interest rates and injections of giggledysquillions of dollars into the banking sector in the last 18 months. The independence crowd cites cross-country studies finding a negative correlation between central-bank independence and inflation, but these studies are controversial (many problems with reverse causation, omitted variables, sample size, etc.).
My question today is different: Where, in those arguments, is the comparative institutional analysis? After all, in policy analysis, we are always comparing imperfect alternatives. We try to avoid the Nirvana fallacy. Craig does this in his post below, asking if a centralized financial regulator would be less bad than the competing regulatory bodies we have today.
But the macroeconomists entirely ignore this problem. Consider Mark Thoma’s defense of independence:
The hope is that an independent Fed can overcome the temptation to use monetary policy to influence elections, and also overcome the temptation to monetize the debt, and that it will do what’s best for the economy in the long-run rather than adopting the policy that maximizes the chances of politicians being reelected.
This naive wish is simply that, a hope. Where is the argument or evidence that a wholly unaccountable Fed would, in fact, “do what’s best for the economy in the long-run”? What are the Fed officials’ incentives to do that? What monitoring and governance mechanisms assure that Fed officials will pursue the public interest? What if they have private interests? Maybe they’re motivated by ideology. Suppose they make systematic errors. Maybe they’ve been captured by special-interest groups like, oh, I don’t know, the banking industry (duh). To make a case for independence, it is not enough to demonstrate the potential hazards of political oversight. You have to show that these hazards exceed the hazards of an unaccountable, unrestricted, ungoverned central bank. The mainstream economists totally ignore this question, choosing to put a naive faith in the wisdom of central bankers to do what’s right. Guys, have you never heard of public-choice theory?
Organizations and Markets 
Recent Comments