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Financial crash: blaming the victims

by Jerome a Paris Wed Aug 22nd, 2007 at 04:10:55 AM EST

Martin Wolf has really become the spokesperson for the moneyed elites against the rest of us. After pretending that the bubble had been obvious all along despite mocking the critics along the way, he is now trying to shift the blame for the current crisis away from the neoliberal ideology he has been defending towards ... well, anybody but him.

And he he is unapologetic about is, as his title suggests: The Federal Reserve must prolong the party

The Fed can indeed be accused of being a serial bubble-blower. But this is not because it has been managed by incompetents. It is because it has been managed by competent people responding to exceptional circumstances.

Below is my deconstruction of his self-serving argumentation.


The savings glut is a palpable reality. But it is important to be precise about what it means. What one means by a global savings glut is an excess of savings over investment (or income over spending) in much of the world, largely offset by an excess of investment over savings (or spending over income) in a limited number of countries among which the US is predominant. In 2006, the current account surpluses – or excess of savings over investment – in the countries with surpluses was about $1,300bn, or a sixth of the gross savings of the world, excluding the US. The US current account deficit absorbed close to two-thirds of this surplus. The US has been the world’s spender and borrower of last resort.

Since global long-term real interest rates have been modest, the argument that profligate US spending has been crowding out spending elsewhere is not credible. It is more plausible that excess savings elsewhere have been “crowding in” US spending.

This argument is worth explaining in detail. The claim, made by Alan Greenspan and Ben Bernanke, and given credence by Martin Wolf, is that they should not be blamed for the asset price bubble, because it is not caused by them providing cheap debt and liquidity, but by the rest of the world not spending enough and needing somewhere to park that money - and given that the US is the best place to park money (the safest, or the most profitable, take your pick at the most flattering argument), the Fed simply had to provide the liquidity to do so. It was doing a public service, really, helping these silly foreigners out.

If foreigners are net providers of funds, some groups in the US must be net users: they must be spending more than their incomes and financing the difference by selling financial claims to others. The challenge for US policymakers is to ensure that these groups also spend enough to absorb the economy’s potential output. This required spending is in excess of potential gross domestic product by the size of the current account deficit.

Poor Americans, forced to spend more money than they have. Really, it's so unfair to criticize them when they are really doing us all a favor - a painful one too. (More on who's actually bearing the pain below)

Who did the offsetting spending since the stock market bubble burst in 2000? The short-term answer was “the US government”. The longer-term one was “US households”.

The US government moved massively from financial surplus into deficit, the total swing being 7 per cent of GDP, between the first quarter of 2000 and the third quarter of 2003. It is right to criticise the structure of the Bush tax cuts. Yet once the stock market bubble burst, how could a deep recession have been avoided without a fiscal boost?

See - he's a "neutral", moderate journalist, saying that "it is right to criticize" the structure of the tax cuts - not that he will do it himself. And no mention how that fiscal boost was spent, either. One million dead Iraqis is a statistic, anyway. Plus, they're brown people, who cares about them? But, hey, terrorism is a serious threat. And, again, the Bush administration was doing the world a service - by avoiding the appearance of a recession in the US.

Now look at US households. They moved ever further into financial deficit (defined as household savings, less residential investment). Household spending grew considerably faster than incomes from the early 1990s to 2006. By then they ran an aggregate financial deficit of close to 4 per cent of GDP. Nothing comparable had happened since the second world war, if ever.

And Americans did their part too. Shopping to save the planet! Kindly taking Chinese or Russian money to do so. How nice of them. An unprecedented effort!

For a period of six years – the longest since the second world war – US business invested less than its retained earnings. Businesses had become net sources, not users, of finance. One way of thinking of the private equity boom is as a tax-efficient way of extracting cash no longer needed by US (and other countries’) businesses.

And US business! Forced, again, by these damn foreigners to not invest and to "extract cash" it no longer needs and return it to shareholders in the form of extra profits and share buybacks. Really, they would have invested more if those damn foreigners hadn't forced them not to.

What has all this meant for policy? The answer is simple: the Fed has, willy nilly, pursued a monetary policy capable of inducing a huge and unprecedented financial deficit among US households.

(...)

Nothing that has happened has been a product of Fed folly alone. Its monetary policy may have been loose too long. The regulators may also have been asleep. But neither point is the heart of the matter. Assume that the US remains a huge net importer of capital. Assume, too, that US business sees no reason to invest more than its retained profits. Assume, finally, that the government pursues a modestly prudent fiscal policy. Then US households must spend more than their incomes. If they fail to do so, the economy will plunge into recession unless something else changes elsewhere.

Now, that's what I call a nice bit of revisionist history. Now let's look at things the other way round:

  • policy is focused on increasing income for the rich. That means lower taxes for the rich (the Bush tax cuts) and corporate welfare (deregulation and pork, especially associated with the invasion and occupation of Iraq);
  • monetary policy explicitly encourages asset bubbles (no regulation of the financial world and itsrisk taking; the "Greenspan put" tells markets that they will be bailed out if they lose money, and asset price inflation is not seen as inflation)
  • meanwhile, to help increase profits, wages are squeezed. Moving factories to China (or simply threatening to do so) keeps wages down everywhere and workers in line;

    As noted in the NYT yesterday, average incomes have been flat since 2000:

    And as I added in yesterday's diary by TeamsterPower, the situation is even worse for most Americans: the increase in "average" income (or in GDP) has not benefitted the average American AT ALL: while these have grown since 2002, median wages, i.e. the actual ones for middle America, have not:

  • to make this palatable to American citizens, and help them buy all the made in China junk, and avoid the otherwise inevitable recession that lower incomes would trigger, they are encouraged to keep on spending via debt - borrowing against their houses, or just consumer debt. Rates are low! Prices will go up! Thus, Americans spend money they don't have;
  • Of course, that money has to be borrowed from somewhere. China is flush with dollars generated by multinational companies investing there to provide stretched US consumers with cheap stuff. That money barely stays with the Chinese (duh - if they were paid too much, China would no longer be "competitive") - it is repatriated as profits by the multinationals, or kept by Chinese authorities as reserves, and re-invested in US treasuries to avoid inflation inside China or exchange rate appreciation. So it's not China financing its exports, but the other way round: America kindly allowing China to provide it goods for monkey money. Enough of it stays in China for it to be worth it for them, I guess. Same with Russia, Saudi Arabia and other oil producers whose exports have recently skyrocketed: they are paid in IOUs.
So the reality is that an aggressive policy to transfer money to the rich, by an all-our combination of tax cuts, irresponsible (but well targetted) spending, and lax monetary policies is at the source of all this.

The asset bubble has been doubly useful - once to enrich the minority that actually owns most assets, and twice to allow the rest of Americans to appear somewhat richer despite their crumbling incomes (caused by the very same policies) and keep on spending.

The bubble was thus a way to extent the day of reckoning (i.e. the recession that, in normal times, punishes such reckless policies) beyond its due date, and to make it, when it will actually happen, a lot worse.

Suggesting, today, that yet another bubble should be inflated to hide the mess made by the previous ones is the height of irresponsibility: it will only make things worse for the real economy under the thin veneer of asset price inflation, and make the inevitable pain even worse.

But of course, that discourse has a simple goal - to try to hide what's really been happening, and shift the blame away from the culprits - the greedy, selfish, bloated ultra minority that has been gorging while the rest have barely stayed afloat.

Let's stop blaming the Chinese, or the Europeans or anyone else for not consuming enough, and let's say it clearly: there has been an explicit policy attempt to re-establish economic feudalism, to capture wealth away from the middle class and towards the very rich, mostly via financial engineering - whereby the very rich materialize tomorrow's expected wealth, using vastly inflated hypotheses, via the complicit (and heavily bribed) financial system, and grab it for themselves, leaving us with the future liabilities.

And let's make sure that the policy lessons from the inevitable economic crunch are the right ones:

  • it's time to make bankers personally liable for the deals they get their banks into and that go wrong whether financially, legally, or at the very least reputationally;
  • it's high time to restore punitive marginal rates of taxation, to dissuade short termist wealh capture and profiteering
  • it's high time to create a separate funding mechanism for the military, based exclusively on fuel taxation - because frankly, that's all it's used for: access to energy - and restore government, shorn of that function, to concentrate on its real tasks - ensuring safety and security for its citizens, which starts by economic safety, and includes environmental safety, and essentially means regulation of corporations, not pork, and focus on long term investment in infrastructure and education.

The corporatist, classist agenda of our current elites is empoverishing us all. So yeah, it's not just the Fed's fault. It's also the administration's - and that of their enablers amongst the oh-so-reasonable punditry.

Display:
I am so fucking outraged by the nerve of these people.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Aug 22nd, 2007 at 04:11:53 AM EST
Really? I'd never have guessed.
by Colman (colman at eurotrib.com) on Wed Aug 22nd, 2007 at 04:17:19 AM EST
[ Parent ]
http://www.dailykos.com/story/2007/8/22/64054/5388
Thanks for your help.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Aug 22nd, 2007 at 07:00:44 AM EST
[ Parent ]
I'll have a go in a minute. Will you help?
(It's been raining over here)

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Aug 22nd, 2007 at 04:21:51 AM EST
I'm here for a couple of hours ...
by Colman (colman at eurotrib.com) on Wed Aug 22nd, 2007 at 04:24:51 AM EST
[ Parent ]
Did i just detect a weather comment?  If so, to complete the analysis, it's also raining here, just like the previous 11 weeks.  I'm going to have to swim to the bank spend my ridiculous savings.

"Life shrinks or expands in proportion to one's courage." - Anaïs Nin
by Crazy Horse on Wed Aug 22nd, 2007 at 05:12:02 AM EST
[ Parent ]
(to be sent to Letter and copied to Martin Wolf)


Dear Sirs,

In his article today (" The Federal Reserve must prolong the party"), Martin Wolf refuses to acknowledge one obvious origin of the current financial crisis: the explicit policies of the Bush administration, pushed with the open support of the Greenspan Fed. These policies, via targetted tax cuts, massive corporate pork made possible by a war of choice, and lax monetary and banking policies, had as sole goal to make the rich richer. Stagnant wages, made possible by weakening of corporate regulation and increased access to the Chinese labor pool, were instrumental in making higher profits possible, and lax monetary conditions allowed bubbling financial asset values. Lower taxes made capture ofthat wealth easier forthe owner class, and share buybacks (instead of investment) was one of the preferred instruments.

The debt bubble also had the great advantage of making it possible to hide from most Americans that they were not sharing in that wealth capture, by allowing them to keep on consuming - by spending money provided by easy debt instead of by actual income. The fact that spending was underpinned by debt and not by income, which is an invitable result of the neoliberal pollicies pursued, is the main cause of the American deficits and the need for the rest of the world to finance them. As US spending is directed at manufacturing based in other countries, their complicity has been easy enough to procure.

At this stage, the imbalances are totally unsustainable and need to be corrected - in fact, they should have been several years ago. That correction will be painful enough; arguing for yet another round of the bubble merry-go round, will can only lead to a worse outcome in the end, is utterly irresponsible.

Amendments, comments, ideas?


In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Wed Aug 22nd, 2007 at 04:36:06 AM EST
"sole goal" and "owner class" are probably going to be red flags for the FT.
by Colman (colman at eurotrib.com) on Wed Aug 22nd, 2007 at 04:50:41 AM EST
[ Parent ]
"sole goal" can probably be replaced by "one of its implicit goals"

"owner class" - how about "those with substantial ownership of shares and other financial assets, a small minority even in the US"

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Wed Aug 22nd, 2007 at 04:54:05 AM EST
[ Parent ]
and feel like waging class war, in spite of commies being close to the top of my hate list. But hey, they're topped by feudalist, so I guess that's that.

These policies, via targetted tax cuts, massive corporate pork made possible by a war of choice, and lax monetary and banking policies, had as sole goal to make the rich richer. Stagnant wages, made possible by weakening of corporate regulation and increased access to the Chinese labor pool, were instrumental in making higher profits possible, and lax monetary conditions allowed bubbling financial asset values.

Too many "possible" in my opinion.

capture ofthat wealth easier forthe owner class

Should be

capture of that wealth easier for the owner class

and

an invitable result of the neoliberal pollicies pursued

Should be

an inevitable result of the neoliberal policies pursued

To the barricades!

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Wed Aug 22nd, 2007 at 05:04:54 AM EST
[ Parent ]
Did someone say class war?


"If you know your enemies and know yourself, you will not be imperiled in a hundred battles." Sun Tzu
by Turambar (sersguenda at hotmail com) on Wed Aug 22nd, 2007 at 07:13:26 AM EST
[ Parent ]
Dear Sirs,
In his article today (" The Federal Reserve must prolong the party"), Martin Wolf refuses to acknowledge one obvious [cause] of the current financial crisis: the [] policies of the Bush administration, [carried out] with the open support of the Greenspan Fed. These policies, [through tax cuts targeted at the well-off , massive corporate pork made possible by a war of choice, and lax monetary and banking policies, had to making the rich richer as their goal] . Stagnant wages, made possible by weakening of corporate regulation and increased access to the Chinese labor pool, were instrumental in making higher profits possible, and lax monetary conditions allowed bubbling financial asset values. Lower taxes made capture of that wealth easier for the rich, and share buybacks (instead of investment) [have been] among the preferred instruments.

The debt bubble also had the great advantage of making it possible to hide from most Americans that they were not sharing in that wealth capture by allowing them to keep on consuming through spending money provided by easy debt instead of actual income. That spending was underpinned by debt and not by income, which is an inevitable result of the neoliberal pollicies pursued, is the main cause of the American deficits and the need for the rest of the world to finance them. As US spending is directed at manufacturing based in other countries, their complicity has been easy enough to procure.

The imbalances are totally unsustainable and need to be corrected - in fact, they should have been several years ago. That correction will be painful enough; arguing for yet another round of the bubble merry-go round, which will can only lead to a worse outcome in the end, is utterly irresponsible.

by Colman (colman at eurotrib.com) on Wed Aug 22nd, 2007 at 04:57:36 AM EST
[ Parent ]
how do I correct this bit?

"had [] making the rich richer as their goal"?

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Wed Aug 22nd, 2007 at 05:04:43 AM EST
[ Parent ]
Yes, sorry.
by Colman (colman at eurotrib.com) on Wed Aug 22nd, 2007 at 05:06:16 AM EST
[ Parent ]
the rich richer

the investment class richer - at the expense of everyone else who participates in the economy.

by spending money provided by easy debt instead of by actual income.

by hooking consumers on a habit of corrosive easy debt instead of boosting spending by improving their real incomes.

The fact that spending was underpinned by debt and not by income, which is an invitable result of the neoliberal pollicies pursued, is the main cause of the American deficits and the need for the rest of the world to finance them.

The fact that spending was underpinned by debt and not by income is an invitable result of the neoliberal pollicies pursued and the main cause of the American deficits, as financed by the rest of the world.

arguing for yet another round of the bubble merry-go round, will can only lead to a worse outcome in the end, is utterly irresponsible.

arguing for yet another round of the bubble merry-go round [will] can only lead to an even worse correction, and is utterly irresponsible.
by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Aug 22nd, 2007 at 05:28:12 AM EST
[ Parent ]
It is correct to comment on the cost of Chinese labor.

But it should be commented on as well that the Chinese have made incredible investments into their infrastructure, both in the manufacturing plants and equipment, and also in the cities and roads and subways and and and. Point being, (and I have no figures at hand to back this up), I am certain that they have been making the capital investments that the Americans have not...that the Americans have been doling out to the vulture class.

China only recently became a net creditor to the world, but they have been a net creditor to the US for quite a while. They have been buying from the EU, though again, I don't have the data stored and google is filled with too much to winnow.

Never underestimate their intelligence, always underestimate their knowledge.

Frank Delaney ~ Ireland

by siegestate (siegestate or beyondwarispeace.com) on Wed Aug 22nd, 2007 at 05:49:23 AM EST
[ Parent ]

Dear Sirs,

In his article today (" The Federal Reserve must prolong the party"), Martin Wolf refuses to acknowledge one obvious cause of the current financial crisis: the policies of the Bush administration, carried out with the open support of the Greenspan Fed. These policies, through tax cuts targeted at the well-off, massive corporate pork made possible by a war of choice, and lax monetary and banking policies, had making the investment class richer as their goal - at the expense of everyone else who participates in the economy.

Stagnant wages, made possible by weakening of corporate regulation and increased access to the Chinese labor pool, were instrumental in making higher profits possible, and lax monetary conditions allowed bubbling financial asset values. Lower taxes made capture of that wealth easier for the rich, and share buybacks (instead of investment) have been among the preferred instruments to get it done.

The debt bubble also had the great advantage of making it possible to hide from most Americans that they were not sharing in that wealth capture, by hooking consumers on a habit of corrosive easy debt which substituted for actual income increases. The fact that spending growth was underpinned by debt and not by income is an invitable result of the neoliberal policies pursued and the main cause of the American deficits, as financed by the rest of the world. With US spending directed at manufacturing based in other countries, their complicity has been easy enough to procure.

The imbalances are totally unsustainable and need to be corrected - in fact, they should have been several years ago. That correction will be painful enough; arguing for yet another round of the bubble merry-go round, which can only lead to an even worse crisis later, is utterly irresponsible.



In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Aug 22nd, 2007 at 06:32:34 AM EST
[ Parent ]
OK, sent as posted above, minus a typo or two.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Aug 22nd, 2007 at 09:29:23 AM EST
[ Parent ]
Jerome, can you not see that a deficit-based monetary system is simply unsustainable? Money has no "cost" except when it is created as a debt.

 it's time to make bankers personally liable for the deals they get their banks into and that go wrong whether financially, legally, or at the very least reputationally;

Banks as credit intermediaries are obsolete, and will be replaced by banks as service providers:

(a) managing bilateral creation of "trade" credit, backed by a mutually owned guarantee/default fund;

(b) bringing together investors in productive assets with investment in productive assets, using more efficient legal vehicles than the current nonsense.

it's high time to restore punitive marginal rates of taxation, to dissuade short termist wealh capture and profiteering

No. It's time to tax privileges such as private property in Commons such as land and therefore to redistribute Capital and unearned income.

 it's high time to create a separate funding mechanism for the military, based exclusively on fuel taxation

It's certainly time for massive fuel taxation, to be deployed in the fight for alternative energy and the fight for clean water.

Redeployment of massive military R & D budgets to such a fight would be fine with the corporations provided they thought they could make a profit out of it.

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

by ChrisCook (cojockathotmaildotcom) on Wed Aug 22nd, 2007 at 04:38:45 AM EST
I'm with HiD in his questioning of your proposals.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Aug 22nd, 2007 at 04:48:38 AM EST
[ Parent ]
Ever heard of a Real Estate Investment Trust?

That's what I'm proposing: scaleable "Pools" of property rentals, renewable energy and so on bounded by simple partnership-based protocols.

The models I am putting forward are an order of magnitude simpler, and without the conflicts,than what we have now. But there's no money in simplicity is there?

Just to reiterate:

1/ Hold bare "ownership" of assets in trust (already the case - the stock market can't operate without custodians such as Northern Trust).

2/ Divide the flow of production and/or revenues from these assets into proportional shares=units.

3/ Find investors in these units.

It's that simple, and it's already being done, imperfectly, in Canada on a massive scale. ie Income Trusts

The Blackstone IPO (units in a Limited Partnership) was essentially another (imperfect) form of the same structure.

Why risk capital by creating credit based upon it Jerome? You REALLY don't need to.

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

by ChrisCook (cojockathotmaildotcom) on Wed Aug 22nd, 2007 at 05:10:45 AM EST
[ Parent ]

No. It's time to tax privileges such as private property in Commons such as land and therefore to redistribute Capital and unearned income.

On this, I am in full agreement with you. But it is not incompatible with high marginal income tax rates. I suppose it depends whether taxes on rent would be enough for all public spending needs.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Wed Aug 22nd, 2007 at 05:06:23 AM EST
[ Parent ]
Strangely enough, even Wolf is in favour of a land value tax as the most "efficient" mechanism for taxing development gains etc.

Friedman himself took this

 The least bad tax is the property tax on the unimproved value of land - the Henry George argument of many, many years ago

view...

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

by ChrisCook (cojockathotmaildotcom) on Wed Aug 22nd, 2007 at 05:20:26 AM EST
[ Parent ]
If Wolf and Friedman are for it, it's unlikely to be a good idea.

What's wrong with a punitive super-tax rate on high-end capital gains, and closing tax loopholes to make offshoring and other avoidance scams - like leveraged buyouts - very much less profitable?

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Aug 22nd, 2007 at 05:31:38 AM EST
[ Parent ]
If Wolf and Friedman are for it, it's unlikely to be a good idea

Even broken clocks are right twice a day...

 What's wrong with a punitive super-tax rate on high-end capital gains, and closing tax loopholes to make offshoring and other avoidance scams - like leveraged buyouts - very much less profitable?

Great in principle, but not easy in practice.

The beauty about land value taxation is that land, unlike people, is not mobile.

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

by ChrisCook (cojockathotmaildotcom) on Wed Aug 22nd, 2007 at 05:41:12 AM EST
[ Parent ]
http://www.nakedcapitalism.com/2007/01/should-fed-deflate-asset-bubbles.html


In a January 17 speech, Federal Reserve governor Frederic Mishkin reiterated the Fed's view, that its job does not extend to intervening in possible bubbles. By contrast, Ian MacFarlane, who recently retired as head of Australia's Reserve Bank, and successfully intervened in that country's housing bubble, feels that the current policy framework does not recognize asset inflation as a cause of instability, and sees the threat as serious.
[...]
Yet by contrast, Macfarlane's views are vastly more forward-thinking. From the Sydney Morning Herald:

    The biggest single challenge starts with the recognition that as an economy becomes more developed, its financial side grows a lot faster than its real side. As a result, economic outcomes will depend more on what happens in asset markets and less on what happens in the real side of the economy, such as in the goods and labour markets....If a major financial shock were to occur, such as a large fall in share or property prices, the effect on the economy would be greater than before.

    So the central question is whether booms and busts in asset markets are more likely to occur in the future. No one knows, but there is no reason to believe that they will become less frequent or smaller. We know that since financial markets have been deregulated we have seen some pronounced asset price booms and busts, the most notable being the Japanese bubble of the 1980s and the high-tech share market bubble in the United States in the late 1990s. Both of these were followed by recessions. Australia had an equity and property boom and bust in the late 1980s, and a house price boom during the past decade that had many of the characteristics of a bubble, but fortunately it was not followed by a bust.

    If it is likely that asset price booms and busts will be at least as common as over the past two decades and that their effect on the economy will be larger, what can monetary policy do about it? There was a time when we felt that monetary policy, by returning the economy to low inflation, would have a stabilising effect on asset markets.... But the broader evidence does not support the view that low inflation will prevent booms and busts developing in asset markets....Some have even gone as far as to suggest that low inflation may encourage the build-up in asset prices.

    So, if low inflation does not provide any insurance, what should a central bank do if it suspects that a potentially unsustainable asset price boom is forming, particularly when the boom is being financed by debt?...

    Many people have pointed out that it is difficult to identify a bubble in its early stages, and this is true. But even if we can identify an emerging bubble, it may still be extremely difficult for a central bank to act against it for two reasons.

    First, monetary policy is a very blunt instrument. When interest rates are raised to address an asset price boom in one sector, such as house prices, the whole economy is affected. If confidence is especially high in the booming sector, it may not be much affected at first by the higher interest rates, but the rest of the economy may be.

    Second, there is a bigger issue which concerns the mandate that central banks have been given. There is now widespread acceptance that central banks have been delegated the task of preventing a resurgence in inflation, but nowhere, to my knowledge, have they been delegated the task of preventing large rises in asset prices, which many people would view as rises in the community's wealth. Thus, if they were to take on this additional role, they would face a formidable task in convincing the public of the need.

    Even if the central bank was confident that a destabilising bubble was forming, and that its bursting would be extremely damaging, the community would not necessarily know that this was in prospect, and could not know until the whole episode had been allowed to play itself out. If the central bank went ahead and raised interest rates, it would be accused of risking a recession to avoid something that it was worried about, but the community was not. If in the most favourable case, the central bank raised interest rates by a modest amount and prevented the bubble from expanding to a dangerous level, and it did so at a relatively small cost in terms of income and employment growth forgone, would it get any thanks? Almost certainly not...In all probability, the episode would be regarded by the public as an error of monetary policy because what might have happened could never be observed....

    The interest rate decision is not the only decision that a central bank has to make ....[T]here are other ways of addressing the problem. Central banks have some credibility and authority, which can be used in a public awareness campaign to make people recognise the risks they are taking in plunging into an overheated market....At the Reserve Bank, we had some success with this approach during the recent house price boom....

    But that still leaves the central bank with a very limited armoury with which to fight a potentially dangerous asset price boom - the interest rate, which it does not have a clear mandate to use, and public suasion, which is of limited effectiveness. How would it cope if it faced an asset price boom of the magnitude of those that occurred in the US in the 1920s or Japan in the 1980s? Not very well, I expect, but it would probably be held largely responsible for the distress that accompanied the bubble's eventual bursting.

    Looking back at the evolution of monetary and financial affairs over the past century shows that policy frameworks have had to be adjusted when they failed to cope with the emergence of a significant problem. The new framework then is pushed to its limits, resulting in a new economic problem. The lightly regulated framework of the first two decades of the 20th century was discredited by the Depression and was replaced by a heavily regulated one accompanied by discretionary fiscal and monetary policy. This in turn was discredited by the great inflation of the 1970s and was replaced by a lightly regulated one with greater emphasis on medium-term anti-inflationary monetary policy. This has acquitted itself well over the past 15 years and is still working effectively, but over the next decade or two will probably face the type of challenges I have outlined.

    No one is very good at picking the next major epoch, and we mainly react after the damage has been done. I am influenced by the fact that as the great inflation of the 1970s was building from the mid-1960s, no one, including the central bank, had a mandate to prevent it. As we struggled to come to grips with it, governments made decisions that effectively gave the central bank a mandate, and central banks worked out a framework that to date has been effective in dealing with it. No one has a clear mandate at the moment to deal with the threat of major financial instability, but I cannot help but feel that the threat from that source is greater than the threat from inflation, deflation, the balance of payments and the other familiar economic variables we have confronted in the past.

by Laurent GUERBY on Wed Aug 22nd, 2007 at 06:54:52 AM EST
No one has a clear mandate at the moment to deal with the threat of major financial instability, but I cannot help but feel that the threat from that source is greater than the threat from inflation, deflation, the balance of payments and the other familiar economic variables we have confronted in the past.

Now that is interesting - finally an admission that what has been happening is far more dangerous and destructive than the so-called wage inflation push of the 70s.

Can this point be worked into the LTE, perhaps?

The real issue is that this is serious - it's not even about greed any more, it's about reality-based finance and fiscal stability.

Bankers love to talk about 'prudence' and 'stability' - so let's see policies that support those aims instead of undermining them.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Aug 22nd, 2007 at 07:31:00 AM EST
[ Parent ]
Latest twist by Barry:

http://bigpicture.typepad.com/comments/2007/08/coming-soon-tru.html


Every now and again, a potentially significant story manages to slip through the cracks, barely noticed by anyone. A recent Dow Jones article by Jilian Mincer -- "Mtge Lawsuits Could Bail Out Some Borrowers" -- is just such an article. The only reason I even knew about it was because I spoke with the reporter and was quoted in it.

It is a fascinating tale that I suspect won't be ignored for long. For those few people familiar with the Federal Truth-in-Lending Act (TILA), this won't be much of a surprise. To everyone else, read on.

What happens if a buyer fails to comply with the TILA rules? The borrowers are allowed to RESCIND THE LOANS AND VOID THE MORTGAGES ON THEIR HOMES. The mortgage lender is then just another unsecured creditor, who must get in line behind everyone else who may have filed a lien on the property. Who ever files first (Credit card, auto finance, doctors, etc.) has first priority.
[...]
And, here's the real rub:    This kinda makes you wonder what sort of due diligence the secondary market actually did on these basic non-compliant loan errors in the sub-prime market. How about the CDO banking underwriters -- didn't their Legal review these docs for compliance with existing laws prior to purchasing trillions of dollars worth of the stuff? Was their fraud involvd, or did these guys just miss it?

This is basic stuff, and its amazing that in the headlong rush to write these garbage loans, no one caught very basic, banking 101 type rule.    

It just shows how little oversight by the regulators there was in this space. Hard to imagine, but the Central Bankers either never reviewed these loan documents, or never caught these basic disclosure errors.

And yes, I place some of the blame on the Greenspan Federal Reserve -- they were the regulatory authority in charge of bank mortgage lending when these junk mortgages were written . . .

Emphasis mine.

by Laurent GUERBY on Wed Aug 22nd, 2007 at 08:37:04 AM EST
To repeat myself:
The driving force in the US economy is not the consumer, it is militarism. This amounts to about a half trillion per year. Those who want to minimize this quote the amount as a percentage of the GDP, however this is irrelevant.

If you compare the size of the trade deficit, the domestic deficit and the military budget you will see a rough equivalence. In other words we are borrowing from the rest of the world in order to fund our military adventurism. This has two side effects, the most obvious is that it has sucked money out of the rest of the public sector. Falling bridges and over topped levees are only the most visible effects, but the lack of support for education and other social programs is taking its toll as well.

Second the money spent on militarism has warped national priorities. Bright people are being diverted into the death and destruction industries and away from important areas such as basic R&D in energy, materials and health.

As for the revisisonist articles that are appearing this is easy to understand. Those who have been lackeys of the administration are now seeing that they may be at risk of losing their jobs when a new group takes over. So they are reinventing themselves in the hope that they will find work under a new regime. We have seen this first with the Iraqi invasion cheerleaders (Wolfowitz, Feith, etc.) and now the economic pundits are attempting to do the same thing.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Wed Aug 22nd, 2007 at 09:29:55 AM EST
by Laurent GUERBY on Wed Aug 22nd, 2007 at 09:43:54 AM EST
it's high time to create a separate funding mechanism for the military, based exclusively on fuel taxation - because frankly, that's all it's used for: access to energy - and restore government, shorn of that function, to concentrate on its real tasks - ensuring safety and security for its citizens, which starts by economic safety, and includes environmental safety, and essentially means regulation of corporations, not pork, and focus on long term investment in infrastructure and education.

Reading the rest of your diary, this kind of seems to come out of left field.  But it's brilliant!  BRILLIANT!  Please come run my country.  Thank you.

"Pretending that you already know the answer when you don't is not actually very helpful." ~Migeru.

by poemless on Wed Aug 22nd, 2007 at 11:13:03 AM EST
Jerome, you may want to post it to his blog to get more attention, if accepted, here:

http://blogs.ft.com/wolfforum/2007/08/the-federal-res.html#comments

Thanks for writing it and you can add my name whenever you want!  This is unbearable and all I could muster would be to call him a "blank kool-aid sycophant blanker".

This idiot cannot conceive that 1. resources are finite! 2. this "growth" and purchases do not have to be replaced in another part of the world 3. all efforts must be switched to reuse in sustainable ways, or his god forbid 4. that slowing ´consumer´ spending in current crap is a positive.


Our knowledge has surpassed our wisdom. -Charu Saxena.

by metavision on Wed Aug 22nd, 2007 at 12:06:43 PM EST
From the "blog" you link to:

Comments
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The FT Economists' Forum is a discussion among a group of the world's top economists. As a general rule we accept comments from invited members only, but submissions from non-members will also be considered on merit.

Glad I haven't eaten yet.

"Pretending that you already know the answer when you don't is not actually very helpful." ~Migeru.

by poemless on Wed Aug 22nd, 2007 at 12:14:51 PM EST
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