Posts Tagged ‘Federal Reserve’

Wall Street’s enormous profits are evidence of a poorly functioning market (cont.)

Wednesday, April 21st, 2010

This is something that really needs to get more attention. William Cohan in the New York Times:

The easiest and most profitable risk-adjusted trade available for the banks is to borrow billions from the Fed — at a cost of around half a percentage point — and then to lend the money back to the U.S. Treasury at yields of around 3 percent, or higher, a moment later. The imbedded profit — of some 2.5 percentage points — is an outright and ongoing gift from American taxpayers to Wall Street.

H/t Ezra Klein.

I also came across this from James Kwak at the Baseline Scenario:

[I]f you see a company that has very high profits over a sustained period, there are two possibilities: either it is benefiting from a non-competitive market (e.g., it is a monopoly), or it is simply exceptional at innovating and staying ahead of the competition for years on end. If you see a whole industry that has sustained high profits, however, the latter explanation cannot hold, and you should immediately suspect a lack of competition.

[T]he thing that we should celebrate is not high profits, but competition. The pursuit of high profits is what motivates competition; but if a whole industry achieves high profits, then what you are seeing is not competition, but its opposite.

Worrying About Downside Risk

Tuesday, January 26th, 2010

Ezra Klein points out a fundamental aspect of his this White House approaches problems, especially in comparison to George “drain the swamps,” “deficits don’t matter” Bush:

The White House thinks a lot about downside risk. Nationalization might have had the opportunity to be better policy than muddling through, but if it went wrong, everything would blow up. Similarly, there’s a good argument for nominating someone more concerned with employment, but if a bad election and some congressional opposition force them to let go of Bernanke and then the markets freak out and the Republicans hold up the new Federal Reserve nominee which further circumscribes the Federal Reserve’s ability to act and further unsettles the markets, that could be a seriously bad scene.

You can see this in the Afghanistan decision, in the form the health care bill took, in their overall legislative approach, and in their national security policy. They make changes slowly, gradually – very aware of the potential downsides of their actions – while making the case against the status quo.

[Image not subject to copyright.]

Playing BrickBreaker While the Financial System Burned

Wednesday, November 25th, 2009

The weekend of September 12 through September 14 – before the collapse of Lehman Brothers on Monday, September 15, 2009 and the near collapse of the world financial system that followed – was a frenzied one in the financial world. By this point, everyone knew huge events would occur: perhaps massive government bailouts, or perhaps multiple mergers of titans of finance, or if all else failed, a cascading series of major business failures. Treasury Secretary Hank Paulson, New York Federal Reserve Chairman Tim Geithner, and Securities and Exchange Commissioner Chris Cox thus convened a meeting of the “heads of the families” – the CEOs and top management of the big Wall Street firms – at the Federal Reserve Bank of New York on Liberty Street in downtown Manhattan to try to, through collective action, stave off disaster.

Paulson and Geithner seemed to be trying to recreate the “Drama at the Library” that averted the Panic of 1907, in which J. P. Morgan almost single-handedly averted a financial catastrophe by himself, as he used his own fortune and cajoled other major bankers to inject liquidity into the stock markets and bond markets to keep them active. The high point occurred when Morgan locked the bankers and the trust company officials in his library to force them to reach a consensus on how to save the insolvent trust companies. A few years later, the Federal Reserve was created in a large part to mimic what J. P. Morgan had done in managing that financial crisis.

As options for Lehman began to dwindle on this September weekend, and its moment of insolvency came closer, Paulson and Geithner summoned the heads of the current elite of Wall Street to a room and told them to come up with a plan – if necessary using their own money to aid another company in the purchase of Lehman. These were the men (and some women) who were paid the big bucks to make the big decisions – all put in the same room with the goal to avert the disaster that they could all see would rock their industry. Yet despite all the power and the extraordinary circumstances, these top bankers were reluctant to help a competitor unless they could see their own upside, and were convinced that Washington would step in. As Andrew Ross Sorkin, reporter for the New York Times and author of Too Big to Fail, reported, conversations took place in which these top bankers made it clear that even as they felt a responsibility to the world at large, their first responsibility was to their shareholders. Systematic risk was the responsibility of the federal government, they felt.

Even with all these decision-makers gathered in a room, Sorkin explained that the “CEOs and their underlings” felt that “Despite the grave assignment they’d been given, there was little they could actually accomplish on the spot.” The top executives knew that the people with “real expertise” to figure out what could be done were doing their work elsewhere – the numbers people working for them who could understand high finance and Lehman Brothers’ balance sheet – and would let their bosses know their conclusions.

So, the executives, twiddling their thumbs, did what they could to pass the time. They did “vicious imitations of Paulson, Geithner, and Cox:

“Ahhhh, ummmm, ahhhh, ummmm,” one banker muttered, adopting Paulson’s stammer. “Work harder, get smarter!” another shouted, mocking Geither’s Boy Scoutish exhortations. A third did his best Christopher Cox, whom they all were convinced had little understanding of high finance: “Two plus two? Um – could I have a calculator?”

And of course:

Colm Kelleher, Morgan’s CFO, had begun playing BrickBreaker on his BlackBerry, and soon an unofficial tournament was under way, with everyone competitively comparing scores.

No word yet on what top score won the tournament.

As well all know, several days after the BrickBreaker tournament, Paulson, Bernanke, Geithner, and the Congress gave in and bailed out the executives in the room as they realized though these executives controlled vast amounts of capital, they were not willing or able to save their competitors and preserve the financial system in order to save themselves.

Most of the information from page 326 of Andrew Ross Sorkin’s Too Big to Fail. Quite an interesting book – well worth a read.

[Image by Cyndie@smilebig! licensed under Creative Commons.]

Obama and the Technocrats

Monday, August 3rd, 2009

Last week I wrote about Obama’s focus on using technocratic institutions to tackle the nation’s most intractable problems. I attributed to Obama a particular attitude towards our current media-political system – one consistent with many reformists – and then explained how Obama was seeking to push the change he had campaigned on, the difficult choices, onto these technocratic institutions, thus solving his political and policy problems at once. But by outsourcing significant authority to these bureaucratic and independent (and thus not quite accountable) organizations – from IMAC to the Federal Reserve to the National Infrastructure Bank – Obama was bleeding authority from elected institutions. At the same time, I tend to agree with the reformist critiques that recount the massive failures of our current media-political system to tackle most (if not all) long-term structural problems.

But since I’ve written this, I have come across a number of pieces challenging this idea from various perspectives on the left.

Mark Schmitt, an editor for the progressive The American Prospect, saw Obama’s approach as the opposite of what I did – though he focused on national security and justice issues. Schmitt agrees with the reformist attitude I attribute to Obama, writing:

[T]he idea that America’s “existing democratic institutions are strong enough to deliver accountability” flies in the face of all observed reality. For at least eight years, those institutions consistently failed to deliver accountability, and the Department of Justice and courts likewise failed to punish some of the greatest abuses of power in our history.

But he is himself frustrated that Obama does not share it. He concludes:

It takes some discipline to understand that organizational culture, not organizational structure, determines success or failure. And it takes a lot of patience to wait for an organizational culture to turn around and resist the temptation to add a commission here, a new agency there. Obama’s organizational discipline was the hallmark of his campaign, and we can only hope that his unyielding insistence that “our existing democratic institutions are strong enough” will eventually make them so.

Benjamin Wallace-Wells writing in The New Republic strongly disputes any attempts to link Obama’s technocrats with Kennedy’s technocrats (as I did) – writing that the Kennedy men weren’t brought down by their knowledge and rationality, but instead:

Their error was an excess of ideology; they were not empirical enough.

He concludes that the brilliant men of the Kennedy administration are different from the brilliant individuals of Obama’s:

Kennedy chose as his defense secretary the president of a car company. Obama chose the sitting secretary of defense. Obama’s brainiacs–people like Larry Summers and Tim Geithner and Peter Orszag–come from a different meritocracy than Kennedy’s did. They are not brilliant generalists. For better or for worse, they are experts.

It is clear that Obama’s technocrats are of a different sort than Kennedy’s – and I made that point as well. It also seems that many of them are students of history and have attempted to learn the lessons of their predecessors – from John Kennedy’s and Lyndon Johnson’s “best and brightest” to Clinton’s New Democrats. But I’m eager to see some commentary dealing with the fact that Obama has found an elegant solution to many of these intractable and politically fraught problems – from global warming to health care to financial regulation to infrastructure spending – an independent, technocratic institution that removes political considerations from these decisions and thus receives relatively broad bipartisan support. (I believe the independent agency proposed to tackle each of these problems has some bipartisan history.) And then to tease out what the potential implications and pitfalls of this are.

Because while Schmitt and Wallace-Wells make good points in disagreement with my thesis – their supporting facts do not undermine my point, just their broader generalizations from these facts.  Clearly – Obama respects existing institutions more than I gave him credit for – especially in the areas of national security and justice (and even financial regulation you could argue.) But it’s also clear that Obama’s solutions to many difficult domestic policy questions are to outsource the hardest decisions to incrementalist, technocratic, independent institutions.

[This image is not subject to copyright.]

The Federal Reserve, Henry Gates, Popular Policies, Health Care, Krugman on Cap and Trade, and High Times

Friday, July 24th, 2009

1. Down with the Fed! William Greider suggests we “dismantle the temple” that is the Federal Reserve in a piece this week. Greider is not only one of my favorite authors and one of the best writers on economics, he is also one of the foremost experts on the Federal Reserve. They key problem for Greider is that the Federal Reserve is an essentially anti-democratic institution:

The Federal Reserve is the black hole of our democracy – the crucial contradiction that keeps the people and their representatives from having any voice in these most important public policies.

Ezra Klein gives the piece a symapthetic audience, but then explains his reservations:

[F]or a period of time, Ben Bernanke ran our economy under a monetarist’s version of martial law. And the really problematic thing is that it probably worked. It may be all that saved us. You could argue that in the absence of the Federal Reserve, Congress would have been a whole lot more aggressive and responsible because Bernanke wouldn’t have been there to backstop them. But would you really want to bet the U.S. economy on it?

2. Sanity on the Henry Gates Controversy. Jacob Sullum in Reason‘s Hit ‘n’ Run blog gives what I think to be the essential take-away from the Gates fiasco:

[E]ven if we accept the facts as presented by Crowley, it’s clear he abused his authority, whether or not the color of Gates’ skin had anything to do with it.

Let’s say Gates did initially refuse to show his ID (an unsurprising response from an innocent man confronted by police in his own home). Let’s say he immediately accused Crowley of racism, raised his voice, and behaved in a “tumultuous” fashion. Let’s say he overreacted. So what? By Crowley’s own account, he arrested Gates for dissing him.

3. The Appearance of Bipartisanship Creates Popularity. Matt Yglesias has an interesting piece exploring the difference between how the media treats the relationship between public opinon, Congress, and policy issues and how that relationship actually works.

4. Imitation is the Sincerest Form of Flattery. Ezra Klein points out that one passage from Obama’s speech Wednesday night seemed to be taking arguments directly from articles by Steven Pearlstein and David Leonhardt this week that got a lot of traction in the blogosphere. Both columns are worth reading even independent of their apparent influence on the Obama administration’s tactics.

5. Krugman on Cap and Trade Speculation. Paul Krugman takes on doubters encouraged by Matt Taibbi’s piece describing cap-and-trade as a giant scheme:

The solution to climate change must rely to an important extent on market mechanisms — it’s too complex an issue to deal with using command-and-control. That means accepting that some people will make money out of trading — and that yes, sometimes trading will go bad. So? We’ve got a planet at stake; it’s crazy to cut off our future to spite Goldman Sachs’s face.

6. A Laid-back Beat. Lastly, I came across this song in an episode of the British series Skins this week:

[Photo by me.]

Theories of the Financial Crisis: Animal Spirits

Monday, May 11th, 2009

David Brooks is a reliable barometer of the opinions and beliefs of the Washington establishment (and I don’t mean that as an insult.) The figure he cuts is a rather odd combination of an amateur (but insightful) anthropologist and a insider protecting the system. All of this makes it significant to note that David Brooks has on several occasions stated that the root of this financial crisis is a “loss of confidence.” He has stated this in several of his columns, including his one immediately following the September 15 freefall:

At its base, the turmoil wracking the world financial markets is a crisis of confidence.

Many of Geithner’s critics have said that he is treating the financial crisis primarily as a liquidity crisis – which is defined as “a ‘general feeling of mistrust in the banking system’ conducting to a temporary disappearance of credit.” This is a common form that a crisis of confidence in the financial system takes.  

The Congressional Oversight Panel in their report [pdf] written to evaluate the TARP bailouts, for example, described what they saw as one of Geithner’s asusmptions :

One key assumption that underlies Treasury’s approach is its belief that the system-wide deleveraging resulting from the decline in asset values, leading to an accompanying drop in net wealth across the country, is in large part the product of temporary liquidity constraints resulting from nonfunctioning markets for troubled assets. The debate turns on whether current prices, particularly for mortgage-related assets, reflect fundamental values or whether prices are artificially depressed by a liquidity discount due to frozen markets – or some combination of the two.

Paul Krugman has also often made this point – stating that Geithner seems to be acting as if we were in a liquidity crisis – in which the loss of confidence is the cause of the problem – instead of a solvency crisis – in which the loss of confidence is a symptom of the problem. 

Geithner, for his part, rejects this assertion that he is treating the problem as a liquidity crisis. When asked, he said it was, as all financial crises are, a combination of the two.

If this is primarily a crisis of confidence, there have been a number of historic examples of how these were contained. For example, this is a description of the resolution of the Panic of 1907 – in which J. P. Morgan’s timely intervention demonstrated how this could be done:

Shipments of gold were on the way from London to New York, and confidence had returned to the French Bourse, “owing,” reported one paper, “to the belief that the strong men in American finance would succeed in their efforts to check the spirit of the panic.” During a panic, confidence is almost as good as gold.

As politicans saw how these crises could be contained – and as they realized Morgan who had successfully beaten back several of these panics was getting near his end – they created the Federal Reserve to officially take on the role Morgan had been unofficially occupying, the lender of last resort and de facto regulator. 

As panics are short, they generally do not affect the fundamentals of the economy – but in a liquidity crisis such as this, restoring confidence is a more delicate task. It involves restoring what John Maynard Keynes referred to as “animal spirits” – those positive energies that cause people to be trusting and optimistic that are essential to a thriving economy. As Keynes wrote in his seminal work, The General Theory of Employment, Interest, and Money:

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. [my emphasis]

This idea of animal spirits has created an opening for what appears to be Obama’s favorite branch of economics – behavioral economics. While economics generally treats human beings as homo economics, rational, self-interested (indeed, selfish), individuals who act entirely to serve their best interest (and who know what their best interest is) – behavioral economics takes a more scientific view of human beings. They try to understand human behavior through testing and real-life examples rather than through theoretical models. Some of Obama’s top advsiors from Cass Sunstein to Austan Goolsbee are known to be proponents of behavioral economics. And a recent article by Chrystia Freeland in the Financial Times, suggests that Obama’s administration may be using behavioral economics to solve this crisis, describing how “emotions might yet save the economy“:

Judging by the upbeat economic message we have been hearing from the White House, the Treasury and even the Federal Reserve over the past six weeks, that is a shrewd guess. The authors argue that “we will never really understand important economic events unless we confront the fact that their causes are largely mental in nature”. Our “ideas and feelings” about the economy are not purely a rational reaction to data and experience; they themselves are an important driver of economic growth – and decline.

I don’t have the expertise to judge if this crisis is one of solvency or confidence or whatever else it may be. But at this point there is a feeling – almost of a wind at the back of the economy. (I certainly hope this is the case.) It does seem to me that the lack of confidence is a major cause (rather than merely a symptom) of this crisis; and Obama’s gradualist approach, with every move telegraphed and thus predictable – seems to be generating confidence.