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LQD - A missed opportunity?

by Melanchthon Tue May 6th, 2008 at 04:16:42 AM EST

Success Breeds Failure - Paul Krugman - New York Times

Cross your fingers, knock on wood: it's possible, though by no means certain, that the worst of the financial crisis is over. That's the good news.

The bad news is that as markets stabilize, chances for fundamental financial reform may be slipping away. As a result, the next crisis will probably be worse than this one.

Let's look at the story so far.

After the financial crisis that ushered in the Great Depression, New Deal reformers regulated the banking system, with the goal of protecting the economy from future crises. The new system worked well for half a century.

Eventually, however, Wall Street did an end run around regulation, using complex financial arrangements to put most of the business of banking outside the regulators' reach.

(snip)

We now know that things that aren't called banks can nonetheless generate banking crises, and that the Fed needs to carry out bank-type rescues on their behalf. It follows that hedge funds, special investment vehicles and so on need bank-type regulation. In particular, they need to be required to have adequate capital.

(snip)

And now that the financial clouds have lifted a bit, the pushback against sensible regulation is in full swing. Even the Fed's very modest proposal to curb abusive mortgage lending with new standards is under fire, and there are worrying signs that the Fed may back down.

(snip)

And if we don't fix the system now, there's every reason to believe that the next crisis will be bigger still -- and that the Fed won't have enough duct tape to hold things together.

The Anglo Disease pandemy has not ended yet...


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Way to go!  Its business as usual!  Buy, buy, buy!  The Wall street crash was in 1929 and the Great Depression did not really hit its worst until 1932.  Let's watch this space.  Carefully.

"It's a mystery to me - the game commences, For the usual fee - plus expenses, Confidential information - it's in my diary..."
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue May 6th, 2008 at 04:26:07 AM EST
The fact is that FDR was elected in 1932 and New Deal ushered in precisely because the government did nothing (on the advice of the very serious people) for three years after 1929.

So it is entirely possible the opening for a Newer Deal in the US is in 2012, not 2008.

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes

by Migeru (migeru at eurotrib dot com) on Tue May 6th, 2008 at 06:50:30 AM EST
[ Parent ]
The full article is worth reading.

Given the governments in place in the European Union, if the financial crisis doesn't worsen, I fear no significant regulation will be implemented.

"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet

by Melanchthon on Tue May 6th, 2008 at 04:31:54 AM EST
Maybe a Democratic sweep in November can revive the cause of financial reform, but right now it looks as if we'll soon return to business as usual.

This just confirms rdf's point that

Usually there is some sort of civil unrest or revolution required to effect real change.

A language is a dialect with an army and navy.

by marco on Tue May 6th, 2008 at 04:52:20 AM EST
We now know that things that aren't called banks can nonetheless generate banking crises, and that the Fed needs to carry out bank-type rescues on their behalf.
We now know that banks have created other entities not called banks and outsourced money creation (through credit) to them, thereby depriving the central bank of control over monetary policy.
It follows that hedge funds, special investment vehicles and so on need bank-type regulation. In particular, they need to be required to have adequate capital.
Why are banks regulated? Because they are allowed to create money through credit via fractional reserve banking. How did it happen that banks were allowed to outsource this function to unregulated entities? Where the regulators asleep at the wheel or complicit?

One of the things that is needed is a crackdown on "off-balance" items and specifically to make it so that a bank can sell a loan only to another (regulated) bank, not to some unregulated off-balance-sheet entity. Or perhaps we need a complete overhaul of the money system, but don't hold your breath for that one.

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes

by Migeru (migeru at eurotrib dot com) on Tue May 6th, 2008 at 06:56:35 AM EST
Migeru:
We now know that banks have created other entities not called banks and outsourced money creation (through credit) to them, thereby depriving the central bank of control over monetary policy.

I don't think that is strictly true.

All money = credit (other than notes and coin) has been and continues to be created by private Banks. What they have done is to outsource the risk away from their own proprietary pool of Capital: totally, through securitisation; temporarily, through credit default swaps, and partially, through credit insurance.

Migeru:

Why are banks regulated? Because they are allowed to create money through credit via fractional reserve banking. How did it happen that banks were allowed to outsource this function to unregulated entities? Were the regulators asleep at the wheel or complicit?

One of the things that is needed is a crackdown on "off-balance" items and specifically to make it so that a bank can sell a loan only to another (regulated) bank, not to some unregulated off-balance-sheet entity.

Banks' economic function has essentially been to guarantee borrowers' credit, and they back this guarantee with pools of regulatory capital. Anyone else to whom such risks are outsourced in return for a premium or payment - and in particular the "Monolines" like Ambac - should indeed be much more closely monitored by regulators, who were sleeping on the job.

Migeru:

Or perhaps we need a complete overhaul of the money system, but don't hold your breath for that one.

The effect of a "Debt/Equity" swap of the type I advocate - and which IMHO offers the only viable solution to  the ongoing "Credit Crash" - is actually to monetise future land rental values.

There is no alternative to reversing the polarity of the monetary system in this way froma defcit basais to asset basis: nothing else "works" at an acceptable political cost (ie will maintain a functioning society).

Moreover, to do so requires no legislation. There is nothing stopping banks from implementing such restructuring right now.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue May 6th, 2008 at 07:45:17 AM EST
[ Parent ]
Btw I agree that one of the results is that Central Banks have indeed lost any measure of control over monetary policy as a result of this risk outsourcing.

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Tue May 6th, 2008 at 07:47:14 AM EST
[ Parent ]
But if central banks have lost control of monetary policy, what is the point of their existence?

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes
by Migeru (migeru at eurotrib dot com) on Tue May 6th, 2008 at 08:28:52 AM EST
[ Parent ]
... lost a measure of control?

The ability to set the foundation interest rate is unaffected.

Wasn't the ability to dictate any substantial part of the mark-ups on the foundation interest rate surrendered decades ago?

Once they allowed commercial banks to count capital gains for increases in the guessed-at values of assets without a market (instead of waiting until a profit has been realized on an asset) ... that is, "mark to model" ... they surrendered capital controls.

So, lost control? More like they voluntarily gave up control.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Tue May 6th, 2008 at 09:16:48 AM EST
[ Parent ]
BruceMcF:
The ability to set the foundation interest rate is unaffected.

There are essentially two tools Central Banks can use: interest rates, and reserve requirements.

The Fed, BoE etc now find that interest rates have become entirely irrelevant, and this tool has therefore been lost.

Unlike the Chinese, the Fed, BoE etc choose not to use reserve requirements as a policy instrument, and that tool was therefore given up.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue May 6th, 2008 at 12:30:33 PM EST
[ Parent ]
In what sense has interest rates become irrelevant?

Of course, if interest rates have become irrelevant, then so have reserve requirements, so that would be a two-fer.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Tue May 6th, 2008 at 12:36:50 PM EST
[ Parent ]
BruceMcF:
In what sense has interest rates become irrelevant?

The rates at which Banks are lending are increasingly parting company from the Central Bank rates. That's because the premium they charge for their implicit guarantee has gone up with the perceived likelihood of default.

Why do you say that if interest rates are irrelevant so are reserve requirements?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue May 6th, 2008 at 04:44:09 PM EST
[ Parent ]
In what sense has interest rates become irrelevant?

The rates at which Banks are lending are increasingly parting company from the Central Bank rates. That's because the premium they charge for their implicit guarantee has gone up with the perceived likelihood of default.

Yes, the mark-up over the cash rate has gone up.

How does that make the cash rate irrelevant? The mark-ups of bank lending over banks cost of funds have not been locked in place since direct regulation of bank lending rates was dropped.

Why do you say that if interest rates are irrelevant so are reserve requirements?

What do reserve requirements do? They establish the underlying leverage of central bank operations to inject and withdraw reserves, to manipulate the cash rate.

What else could they be doing? They are not contingency reserves for capital adequacy, because they are not free to be used to meet capital losses. They are not a tool to manipulate the quantity of money in the system, because the central bank cannot manipulate the quantity of credit-money in the system and already has the power to manipulate the quantity of fiat currency in the system.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Tue May 6th, 2008 at 05:05:33 PM EST
[ Parent ]
BruceMcF:
How does that make the cash rate irrelevant?

If falls in the cash rate have no effect whatever on the rate Joe Public pays on his mortgage or any other loans he takes out, I would say that makes the cash rate "irrelevant", but I guess that's just my opinion.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue May 6th, 2008 at 05:55:21 PM EST
[ Parent ]
The central banks appear to be unable to lower the general level of interest rates by lowering the "cash rate", but if they raised the cash rate presumably that would result in a raise of the general level of interest rates.

This is reminiscent of the way Peak Oil means that OPEC can no longer lower prices by raising production, but they can still raise prices by withdrawing production.

Peak Credit?

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes

by Migeru (migeru at eurotrib dot com) on Tue May 6th, 2008 at 05:59:55 PM EST
[ Parent ]
Its a floor. If the cash rate is pushed up, tomorrow, the mark-ups will remain about where they are, and the interest rates charged will increase.

On that logic, you are effectively dividing into two possible alternatives:

  • a direct, mechanical, 1-1 relationship
  • no effect

Since the reality is that the level of the floor affects the rates faced by bank customers, but is not the sole determinant, then what you've done is to leave reality in the excluded middle.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Tue May 6th, 2008 at 06:25:55 PM EST
[ Parent ]
How did it happen that banks were allowed to outsource this function to unregulated entities? Where the regulators asleep at the wheel or complicit?

Krugman answers:

Eventually, however, Wall Street did an end run around regulation, using complex financial arrangements to put most of the business of banking outside the regulators' reach. Washington could have revised the rules to cover this new "shadow banking system" -- but that would have run counter to the market-worshiping ideology of the times.

Instead, key officials, from Alan Greenspan on down, sang the praises of financial innovation and pooh-poohed warnings about the growing risks.



"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Tue May 6th, 2008 at 08:37:34 AM EST
[ Parent ]
what I like more about his new breed of ecnomists is that this narrative is becoming common wisdom in economic circles..not only here. What are they going to do (the mass mediaand the corpocrats) when they lose "very serious economists" for the cause?... I bet they will become suddenly "dangerous econo-pink" in the "mind of people"....

a pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Tue May 6th, 2008 at 12:10:29 PM EST
Krugman has loooooooooong been described as dangerously eco-pink.

He is the epitome of the serious man who cannot break into "serious people". Him, with probably the best record of forecast and analysis around, is constantly dismissed as talking trash.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

by Cyrille (cyrillev domain yahoo.fr) on Tue May 6th, 2008 at 12:20:33 PM EST
[ Parent ]
touche...

teh difference is that he is no longer alone... his views among economists are basically mainstream economic views among "elite econoist"... I still remember the time whent eh chicago school was teh so-called mainstream scientific stuff...

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Tue May 6th, 2008 at 02:47:53 PM EST
[ Parent ]
Do we close the barn door now that the horses are gone?  

--But closing the door would keep the horses from wandering back in!  

--At least we could keep the remaining bales of hay from walking out!  

An exciting debate! SRO! Buy your ticket now while you can!  

While everyone is watching the debate, the barn will be burned.  

Crisis over?  Mortgage foreclosures has not begun to unwind.  The dollar has nothing of real value supporting it:  Bad debts are not assets.  

This is a ship that has only begun to sink.  

The Fates are kind.

by Gaianne on Fri May 9th, 2008 at 03:11:28 AM EST
it's possible, though by no means certain, that the worst of the financial crisis is over.  

Yeah, like, not certain at all.

chances for fundamental financial reform may be slipping away.  

Umm . . . the thieves were like . . . almost persuaded  . . . to stop thieving?  But I guess the window on that will be closing, won't it?  

The way the NYT is spinning, we should all be clothed in silk!    

The Fates are kind.

by Gaianne on Fri May 9th, 2008 at 03:20:05 AM EST


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