Archive | Financial Crisis

Prospect Magazine’s Top 25 Brains of the Financial Crisis

The UK’s Prospect magazine – a genial, well-edited left-liberal take, by American standards, on politics – offers its list of the 25 leading public intellectuals offering commentary and sage advice in the financial crisis (in some cases action, too – Ben Bernanke is included).  The list is full of worthy commentators, and I wouldn’t disinvite anyone off the list – but it does seem to me a tad skewed to one direction, and not just with the natural weight given to UK people and, err, log-rolling in our time, i.e., Prospect contributors.

I was going to frame the question, “Who would you add to this list if you want to make it just as brainy but a bit more ideologically balanced?”  I’m not sure, however, looking back over it again, that I do think that everyone on this list should be here.  So let’s reframe it.  Twenty-five max.  For every name you nominate to go on, name who you vote off the island.

Interruption:  Changed my mind … season of peace on earth, good will toward men, etc., etc.  No voting off the island.  Add up to ten names of your own to these and say why; no criticism of the existing list.

(In another post, but not this one, I’ll ask how you would set up a reality show involving economists and desert islands and, no, not where they all get eaten by hungry baboons – or each other.  Not this post.)

1. Simon Johnson. Professor at MIT, Peterson Institute fellow, former IMF chief economist, blogger, troublemaker and scourge of once-mighty banks—a worthy winner in 2009.

2. Avinash Persaud. Financial liquidity analyst, adviser to governments around the world, the man who has studied “herd” behaviour in finance, and now the man trying to stop it.

3. Adair Turner. An

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Threat of Greek Sovereign Bankruptcy and Possible Consequences for the Eurozone

Der Spiegel has an informative story on the possibility that a Eurozone country might default on its sovereign debt, with economic, political, and legal consequences that could be anything from serious to dire.  The country is Greece:

Greece has already accumulated a mountain of debt that will be difficult if not impossible to pay off. The government has borrowed more than 110 percent of the country’s economic output over the years, and if investors lose confidence in the bonds, a meltdown could happen as early as next year.

That’s when the government borrowers in Athens will be required to refinance €25 billion worth of debt — that is, repay what they owe using funds borrowed from the financial markets. But if no buyers can be found for its securities, Greece will have no choice but to declare insolvency — just as Mexico, Ecuador, Russia and Argentina have done in past decades.

This puts Brussels in a predicament. European Union rules preclude the 27-member bloc from lending money to member states to plug holes in their budgets or bridge deficits.

And even if there were a way to circumvent this prohibition, the consequences could be disastrous. The lack of concern over budget discipline in countries like Spain, Italy and Ireland would spread like wildfire across the entire continent. The message would be clear: Why save, if others will eventually foot the bill?

On the other hand, if Brussels left the Greeks to their own devices, the consequences would also be dire. Confidence in the euro would be shattered, and the union would face a crucial test. What good is a common currency, many would ask, if some of the member states pay their debts while others do not?

Furthermore, there is a threat of a domino effect. If one euro member

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In (Limited) Praise of Right-Wing Populism

I am no fan of populism of either the left or right-wing variety. In my view, most populist movements exploit voter ignorance and irrationality to promote policies that tend to do far more harm than good. That said, I have been pleasantly surprised by the right-wing populist reaction to the economic crisis and Obama’s policies. With rare exceptions, right-wing populists such as Glenn Beck, Rush Limbaugh, Mark Levin, and the Tea Party protesters, have advocated free market approaches to dealing with the crisis, and have attacked Obama and the Democratic Congress for seeking massive increases in government spending and regulation. They have not responded in any of several much worse ways that seemed like plausible alternatives a year ago, and may still be today.

True, much of their rhetoric is oversimplified, doesn’t take account of counterarguments, and is unfair to opponents. But the same can be said for nearly all political rhetoric directed at a popular audience made up of rationally ignorant voters who pay only very limited attention to politics and don’t understand the details of policy debates. On balance, however, the positions taken by the right-wing populists on these issues are basically simplified versions of those taken by the most sophisticated libertarian and limited-government conservative economists and policy scholars. There has been relatively little advocacy of strange, crackpot ideas or weird conspiracy theories. Indeed, efforts to paint the Tea Partiers and others as merely closet racists usually have to rely on unsupported claims about “unspoken” assumptions and subtexts. Most, if not all, of the right-wing populists would have reacted in much the same way if the policies advocated by Obama had instead been put forward by a hypothetical President Hillary Clinton or President John Edwards.

Things could have been a lot worse. For example, the right-wing [...]

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Goldman Sachs and Its Small Business Fund Ploy

I am a fan of Goldman Sachs.  It is one of the few individual stocks I own, running against all my standard corporate finance professor ‘buy index funds!!’ instincts.  Although we have had a surfeit of bankers and a surfeit of talent in financial engineering rather than, say, robotics, it is very scary to see the “silver linings” analyses talking about how it is such a good thing that smart Harvard or MIT students will no longer go to Wall Street, but will instead enrich elementary education or nursing or mountain-guiding.  While they might not be efficiently deployed in finance, it is a mistake to rejoice that the credit crash, deficit, tax rates, and other disincentives to innovation through risk-taking will push, through sheer lack of opportunity, smart people into things that do not take full advantage of their talents to the ultimate benefit of everyone.  I do a lot of development finance in the developing world, and the misallocation of talent simply from inability to supply opportunity is heartbreaking and worse.

The work of allocating capital in the capital markets, if not precisely God’s work, is so crucially important to men and women on earth that there is something wrong with these days having to defend it.  The little pieces of paper are vastly more efficient to steering rivers and seas of capital to and among enterprises – little gates and sluices in which small movements on paper can create immense movements in real life – than trying to do it by, what exactly?  Physical occupation of the premises as the sign of ownership?  Holding of hostages as collateral for a loan?  So I am untroubled by Goldman bankers getting rich, provided that their services serve efficient allocation; the problem is rules of a game that reward many wrong [...]

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Bush Continues His Uncanny Imitation of Herbert Hoover

In this January post, I noted some of the uncanny parallels between George W. Bush and Herbert Hoover: Both were president during a time of economic crisis; both presided over vast expansions of government that helped cause the crisis or at least make it worse than it might have been otherwise; finally both were (inaccurately) portrayed by their political opponents as dogmatic free market advocates, when in fact both were highly statist. After leaving the presidency, Bush is unconsciously imitating Hoover in yet another way – by rhetorically supporting free markets and criticizing the even more interventionist policies of his Democratic successor (which in both cases built on the expansions of government initiated by the Republicans who preceded them):

Former President George W. Bush, outlining plans for a new public policy institute, on Thursday said America must fight the temptation to allow the federal government to take control of the private sector, declaring that too much government intervention will squelch economic recovery and expansion….

“As the world recovers, we will face a temptation to replace the risk-and-reward model of the private sector with the blunt instruments of government spending and control. History shows that the greater threat to prosperity is not too little government involvement, but too much,” said Mr. Bush…

Bush’s belated support for free markets follows in Hoover’s footsteps. After leaving office in 1933, Hoover wrote books and articles defending free markets and criticizing the Democrats’ New Deal. Some of his criticisms of FDR were well-taken. Many New Deal policies actually worsened and prolonged the Great Depression by organizing cartels and increasing unemployment. But by coming out as a free market advocate, the post-presidential Hoover actually bolstered the cause of interventionism because he helped cement the incorrect impression that he had pursued free market policies while [...]

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Reading While Traveling, Hard Copy and No Internet

I’ve been traveling recently, and so have been away from posting.  One of the enforced virtues of traveling – one of the few virtues of traveling for me these days – is the plane flight with no internet.  And if the big guy in front of me reclines his seat, as he always does, I can’t even get to my computer.  So I read  on flights.  I should have some reading gadget, Kindle or whatever, but I’m not that far along yet, and for that matter I should get an economy class friendly little word-processor to use on flights, but I’m cheap.  Here’s a selection across the varied reading on my flights.  No particular theme or order, I’m afraid (on account of the mixed-up topics here, I think I won’t open to comments; too jumbled to be productive). [...]

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A New Soros Initiative on the Economics Profession?

Michael Hersh describes a new $50 million George Soros initative to try and remake the economics profession so to reclaim it from “free market fundamentalists.”  The fund will be run by Robert Johnson, formerly a managing director of Soros Fund Management; it hopes to raise $200 million in matching funds.  (H/T Instapundit; also Mark N is right in the first comment to raise Cato as a better point of comparison in the (lengthy) discussion below the fold.)

Large swaths of economics are going to have to be rethought on the basis of what’s happened.” So said Larry Summers, President Obama’s chief economic adviser, in an interview in the weeks after the markets crashed a year ago. Yet to a remarkable degree, economic thinking hasn’t changed very much at all.

Now financier George Soros is announcing a $50 million effort to speed things along. This week Soros is gathering some of the leading practitioners of the market-skeptic school, who were marginalized during the era of “free-market fundamentalism,” among them Nobelists Joseph Stiglitz, George Akerlof, Michael Spence, and Sir James Mirrlees. He’s also creating an “Institute for New Economic Thinking” to make research grants, convene symposiums, and establish a journal, all in an effort to take back the economics profession from the champions of free-market zealotry who have dominated it for decades, and to correct the failures of decades of market deregulation. Soros hopes matching funds will bring the total endowment up to $200 million. “Economics has failed not only to predict and explain what happened but has also failed to protect society,” says Robert Johnson, a former managing director at Soros Fund Management, who will direct the new institute. “That’s what the crisis revealed. The paradigm has failed. There is no guidance.”

I am curious what professional and academic economists [...]

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”When GM Took Federal Dollars, They Lost Some of Their Autonomy”

Does government interference inevitably follow government ownership of private companies?  It sure seems that way.  As a WSJ article reports: “Companies in hock to Washington now have the equivalent of 535 new board members — 100 U.S. senators and 435 House members.”  Specifically, the story reports on efforts by various lawmakers to inflence the business decisions at GM.  The story begins:

Montana Rep. Denny Rehberg was no fan of the $58 billion federal rescue of General Motors Co., saying he worried taxpayer money would be wasted and the restructuring process would be vulnerable to “political pressure.” Now the lawmaker says it’s his “patriotic duty” to wade into GM’s affairs.

Along with Montana’s two Democratic senators, the Republican congressman is battling to get GM to reinstate a contract with a Montana palladium mine nullified in bankruptcy court. “The simple fact is, when GM took federal dollars, they lost some of their autonomy,” Mr. Rehberg says.

And later in the story:

“I was elected to represent the interests of Montana, not General Motors, which is something that GM should have considered before letting the federal government assume control of their company,” Rep. Rehberg said recently.

Alas, this is but one of many tales of political interference in the once-proud automaker’s affairs detailed by the WSJ, many of which involve efforts to save politically connected auto dealerships. Stuff like this doesn’t make it likely my next car will be a GM. [...]

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Rating Agencies Doing Fine, Thanks

The Lex column in the Financial Times reports that the rating agencies – Standard & Poor’s and Moody’s – are doing financially just fine and, well, even better than fine:

McGraw Hill this week showed the ratings business is on the increase …  Its Standard & Poor’s credit ratings agency, which accounts for the vast majority of the publisher’s profits, produced its first quarterly rise in revenues in two years.

In a business with large fixed costs, any upturn makes a substantial impact on the bottom line. Profitability in McGraw Hill’s financial services division, which includes lower-margin data and research businesses as well as ratings, never hit the lofty peaks of rival Moody’s with an operating margin of some 55 per cent. Nevertheless, S&P still managed to reach a 40 per cent margin, having merely dipped to 34 per cent at the end of 2008.

I have found it remarkable how little scrutiny has been focused on the rating agencies, and how little has been done – sensibly or foolishly – to revamp their incentives and business models.  There was some discussion of cutting off the implicit regulatory monopoly created by regulations specifying their services; I am not sure even that has gone anywhere, though I haven’t checked recently.  However, Lex adds this cheerful thought:

In spite of widespread gnashing of teeth over rating agencies’ role in the crisis, both companies are even thought to have increased their fees this year. Furthermore, proposed regulation looks less onerous than first feared. McGraw Hill estimates that extra regulatory costs, such as more compliance personnel, will be half what it originally thought.


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McDonald’s Out of Iceland

Just when you thought the global financial crisis was subsiding, with returns to growth in most leading economies, including the US, Europe, China, etc., we have a counter-indicator.  The Financial Times reports today that McDonald’s is closing its three outlets in Iceland, citing the difficult economic environment:

Iceland edged further towards the margins of the global economy on Monday whenMcDonald’s announced the closure of its three restaurants in the crisis-hit country and said that it had no plans to return.

The move will see Iceland, one of the world’s wealthiest nations per capita until the collapse of its banking sector last year, join Albania, Armenia and Bosnia and Herzegovina in a small band of European countries without a McDonald’s.

The FT gives some background on why the environment for selling Big Macs in Iceland is so difficult:

McDonald’s blamed the closures on the “very challenging economic climate” and the “unique operational complexity” of doing business in an island nation of just 300,000 people on the edge of the Arctic Circle.  Most ingredients used by McDonald’s in Iceland are imported from Germany – leading to a doubling in costs as the krona has collapsed while the euro has strengthened.

The FT cites the Big Mac index, a purchasing power parity index for comparing the valuations of currencies based on the comparative price of a single, uniform basket of goods, in this case a Big Mac, drink, and fries (as I recall).  The Economist dreamed it up as whimsy many years ago, but it has proved oddly robust at least for certain comparisons:

Magnus Ogmundsson, managing director of Lyst, the McDonald’s franchise holder in Iceland, said that price rises of at least 20 per cent were needed to produce an acceptable profit. That would have pushed the price of a Big

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Market Discipline? What Market Discipline?

The New York Times reports that Congress and the administration might soon reach some kind of view on legislation for addressing “too big to fail” institutions.  Off the table is Paul Volker’s proposal to re-establish some line between commercial banking and proprietary trading – some updated Glass-Steagall demarcation.  On the table is the Treasury’s proposal to designate various institutions as “too big to fail” in various degrees and subject them to greater capital requirements, limits on risk-taking, and in addition require a so-called “living will” that would make clear how to disentangle these institutions from others in a crisis.  I think the “living will” idea is not a bad one on its own, as long as we all understand the limits of what it gets you.

Much, much more puzzling to me is this description in the Times, quoting Michael S. Barr, assistant Treasury secretary for financial institutions (italics added to show the quote):

The White House plan as outlined so far would already make it much more costly to be a large financial company whose failure would put the financial system and the economy at risk. It would force such institutions to hold more money in reserve and make it harder for them to borrow too heavily against their assets.

Setting up the equivalent of living wills for corporations, that plan would require that they come up with their own procedure to be disentangled in the event of a crisis, a plan that administration officials say ought to be made public in advance.

“These changes will impose market discipline on the largest and most interconnected companies,” said Michael S. Barr, assistant Treasury secretary for financial institutions. One of the biggest changes the plan would make, he said, is that instead of being controlled by creditors, the process is controlled

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Dividing Financial Institutions into Utilities and Casinos?

One proposal for addressing too big to fail, or to systemically interconnected to fail, among financial institutions is to separate out the proprietary trading and other “casino” activities from the “utilities” business of commercial banking with the public.  In some ways (not all) it is a revival of the Glass-Steagall approach.  Paul Volker has urged such a policy, as have others.  The Obama administration has not so far shown any appetite for such it, preferring, in its Treasury blueprint for reform, to allow the functional interconnections within holding company structures, and identifying institutions that are regarded as too big or too systemically interconnected to fail and apply “regulation and last resort lending” to apply to them.

Something like the same debate is taking place in Britain, and the Financial Times’s Martin Wolf makes a comment on why one could see the functional separation desirable, but also why it is hard to do and hard to ensure that it actually reduces the systemic risk.  In response to a recent speech by Mervyn King of the Bank of England calling to separate out the “casinos” from the “utilities,” Wolf says:

it is evident why this distinction is appealing. If we define the utility parts of the financial system narrowly, as management of the payment system, it works like clockwork. It is in the management of risk (and the advice given to its clients) that the financial system fails. The limited liability businesses at the heart of our credit-based monetary system have a tendency to mismanage risk (and uncertainty), with devastating results.

However, he ultimately says that he is unpersuaded that a modernized form of Glass-Steagall can work as a structural solution to systemic risk:

Yet I remain unpersuaded that the structural solution – the separation of utility from casino finance – is

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Peter Wallison on the Role of Government in Causing the Mortgage Crisis

In a recent post, I discussed how the Federal Housing Administration’s subsidization of dubious mortgage loans is repeating one of the key errors that helped cause the financial crisis of 2008. In this Wall Street Journal op ed, Peter Wallison (who presciently warned of the danger posed by these policies back in 2005) summarizes the evidence showing that the federal government played a decisive role in promoting the vast majority of the dubious mortgages involved in the mortgage crisis, which in turn helped cause the broader financial collapse:

When Fannie and Freddie were finally taken over by the government in 2008, more than 10 million subprime and other weak loans were either on their books or were in mortgage-backed securities they had guaranteed. An additional 4.5 million were guaranteed by the FHA and sold through Ginnie Mae before 2008, and a further 2.5 million loans were made under the rubric of the Community Reinvestment Act (CRA), which required insured banks to provide mortgage credit to home buyers who were at or below 80% of median income. Thus, almost two-thirds of all the bad mortgages in our financial system, many of which are now defaulting at unprecedented rates, were bought by government agencies or required by government regulations.

Even some of the bad mortgages that were initiated by the private sector acting independently may have been influenced by Fannie and Freddie’s apparent willingness to purchase them at a later time should things go bad. Obviously, some private lenders and borrowers made mistakes of their own, and there were plenty of errors that cannot be blamed on the feds. However, absent the federal policy of promoting dubious mortgages and offering implicit government guarantees for them, the number of such mortgages would have been far smaller, and it is highly [...]

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Repeating the Mistakes of the Mortgage Crisis

The Federal Housing Administration seems intent on repeating one of the key policy errors that played a major role in causing last year’s financial crisis. One of the main causes of the mortgage crisis that led to the broader financial crisis of 2008 was government subsidization of risky mortgages for people who were unlikely to be able to pay them back if real estate prices fell. Investors bought up dubious mortgages supported by Fannie Mae and Freddie Mac because they correctly perceived these “government-sponsored entities” as having an “an implicit government guarantee.” See this account by Charles Calomiris and Peter Wallison. Wallison also presciently warned of the possible dangers back in 2005. Government backing for dubious mortgages was a bipartisan policy backed by many Republicans as well as Democrats. President Bush, for example, sought, in his words, to “use the mighty muscle of the federal government” to expand homeownership by giving GSEs incentives to ease credit requirements.

Unfortunately, policymakers have still not learned their lesson. As columnist Steve Chapman points out, the FHA is again subsidizing the same types of dubious mortgages that the federal government backed with disastrous results in the years leading up to 2008:

Watching Washington policymakers in action, I sometimes think they make mistakes because of unrealistic goals, flawed thinking, blind obedience to party, or dubious information. And sometimes I think they make mistakes because they are—how to put this?—clinically insane.

There is no other way to explain what is going on at the Federal Housing Administration, which provides federal guarantees for home mortgages. Given the collapse in real estate prices, the weak economy, and the epidemic of foreclosures, banks are acting with more caution than before. They now commonly require home buyers to make down payments of 20 percent to qualify for

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