Banks, automakers, and sovereign debt are not too big to fail. But NGDP is too big to fall.

Matt Yglesias directed me to this post from London Banker:

I have never understood why Financial Stability should be an objective of public policy. . . . One strength of the US banking system from the 1930s to the 1980s was that failures were dealt with quickly and certainly. Foreclosed properties had to be sold by banks within two years of repossession, leading to a quick and certain reallocation of assets from failed borrowers to new owners. The FDIC swiftly and mercilessly shut down failed banks. New owners – often buying at distressed prices – were encouraged to invest in making the assets productive and profitable. It was this simple recycling from failed managers to better managers that was largely behind the short recessions and strong recoveries during this period of American economic history. With forbearance now institutionalised at all levels of the US economy, we are seeing Japanification instead of recovery. And it is even worse just about everywhere else where dominant banks are much more influential.

Read the whole thing.  And here is Matt’s response:

What’s ironic about the current state of affairs is that this was all conventional wisdom in the United States at the time. Throughout the 1990s, the American powers that be thought the problem in Japan was that they had to stop propping up banks with regulatory forebearance and start deploying monetary stimulus to ensure that real resources weren’t going idle. Then when our own financial system saw tumbling property prices lead to banking problems, the powers that be went and did exactly what they’d spent a decade criticizing Japan for — focusing central bank activity on propping-up banks up while paying scant attention to idling of workers and real resources.

Yup.


Tags:

 
 
 

27 Responses to “Banks, automakers, and sovereign debt are not too big to fail. But NGDP is too big to fall.”

  1. Gravatar of David Pearson David Pearson
    10. December 2011 at 07:09

    Scott,
    I think you understate the connection between systemic banking risk and NGDP. I can understand how your expectations-centric thesis downplays the importance of the monetary transmission channel. In your model, the Fed flips the expectations “switch”, and actors’ behavior falls into line. One of the main criticisms of MM is that this “switch” is less than credible in the absence of a mechanism that actors can “expect” to work.

    Bernanke identified the lapse of the transmission channel as one of the principal vectors for Great Depression unemployment. There is a fiscal role here: banks have to be recapitalized or de-levered. The latter creates deflation; the former requires either bondholder losses (which creates deflation) or a transfer of wealth from taxpayers to bondholders. One can understand why governments are reluctant to do either.

    IMO, the expected inflation rate that convinces actors to ignore systemic banking risk charges an extremely high penalty on the hoarding of cash. “2% more NGDP for two years,” is not such a rate.

  2. Gravatar of Bill Woolsey Bill Woolsey
    10. December 2011 at 07:25

    “Bernanke identified the lapse of the transmission channel as one of the principal vectors for Great Depression unemployment. There is a fiscal role here: banks have to be recapitalized or de-levered. The latter creates deflation; the former requires either bondholder losses (which creates deflation)”

    Why can’t banks delever without deflation?

    Why do bondholder losses create deflation?

    Who are you assuming holds more money balances? How are you assuming money is destroyed.

  3. Gravatar of dwb dwb
    10. December 2011 at 07:34

    if the general public got to vote for a little extra inflation (to prevent a debt-deflationary spiral) to allow banks to fail, or tight money and to-big-to-fail banks, I strongly suspect the general consensus would be for the former. Who am I to blow against the wind. Lots of productive, distressed, assets are bought out of bankruptcy if someone is willing to provide financing (and, long term expensive contracts get renegotiated or abrogated). but the flip side of course is strong policy by the central bank. Of course,there is this “moralizing” that bankruptcy is immoral. personally, devaluing currency by 30% vs. default-and-restructuring whereby principal is reduced 30% – that is a distinction without a difference to me. as an investor I get 70% either way. yet somehow, the former is ok, the latter is immoral.

    I think some FOMC members should be elected officials and directly acountable, not political hacks.

    and more good news, eurozone leaders now hope the banks will leverage up on sovereign debt. borrow at 1% and lend at 7%. how (subprime) could that (subprime) possibly (subprime) go wrong (subprime).

    http://www.ft.com/intl/cms/s/0/a6d2fd4e-228f-11e1-acdc-00144feabdc0.html#

    FT: EU banks slash sovereign holdings

    Nicolas Sarkozy, French president, on Friday outlined what he expected would happen as a result of the central bank’s move.

    “Italian banks will be able to borrow [from the ECB] at 1 per cent, while the Italian state is borrowing at 6-7 per cent. It doesn’t take a finance specialist to see that the Italian state will be able to ask Italian banks to finance part of the government debt at a much lower rate.”

  4. Gravatar of mbk mbk
    10. December 2011 at 09:20

    DWB, since the ECB can’t bail out governments directly, someone obviously came up with this pathway of the ECB bailing out governments via a bank detour, providing extra profits for the banks in lieu of recapitalization as a side bonus.

    I dimly remember Scott claiming in these pages that in the 80′s, the US regulators also quietly ignored the undercapitalization of US banks after South America’s debt troubles and quietly allowed them to rebuild capital through profits. This ECB bank loan deal looks somewhat similar. In essence it looks as though it’s just what so many have been asking for, the ECB bailing out everyone. Just not directly.

  5. Gravatar of ssumner ssumner
    10. December 2011 at 09:27

    David, Your comment is not consistent with what Bernanke has been saying. He says the Fed is not out of ammo, and could boost nominal aggregates if they wished to. I take him at his word. I claim that if (in 2008) he’d promised to return NGDP to trend in 2011, the late 2008 collapse never would have occurred.

    You said;

    “IMO, the expected inflation rate that convinces actors to ignore systemic banking risk charges an extremely high penalty on the hoarding of cash. “2% more NGDP for two years,” is not such a rate.”

    Hoarding of cash isn’t the problem–even at zero rates Americans aren’t hoarding much cash. With faster expected NGDP growth they’d be hoarding even less. The big problem is ERs.

    The Fed can follow whatever NGDP target path it wants to. For some odd reason they have publicly admitted that they don’t think we need more AD, that we do not need to return to the pre-2008 trend line. I’m not sure why they think we don’t need more AD, but that is the problem. It’s not banking; we had very rapid NGDP growth in 1933 with much of the banking system completely shut down.

    dwb, Just to be clear, I have never argued that the Fed should adopt a more expansionary policy to help out debtors. I’ve always claimed they should adopt a stable policy, exactly the same NGDP growth after 2008, as before 2008.

  6. Gravatar of ssumner ssumner
    10. December 2011 at 09:30

    mbk, You said;

    “This ECB bank loan deal looks somewhat similar. In essence it looks as though it’s just what so many have been asking for, the ECB bailing out everyone. Just not directly.”

    Good point, but I’d amend that slightly. They’ll bail out everyone except the public–NGDP is still going to fall well below trend, so the eurozone economy will still “suck” (to use the technical term my students like.)

  7. Gravatar of David Pearson David Pearson
    10. December 2011 at 09:55

    Scott,
    Perhaps I erred in saying actors are hoarding “cash”. They are hoarding “safe assets”. They are doing so because a long list of formerly safe assets has become, in Gorton’s terms, “information sensitive”. Holders of those assets faced an asymmetric payoff: large losses if the assets went bad, small gains if they were okay. The correct response to uncertainty surrounding such a payoff structure is to sell those assets and move to information insensitive ones. This was the mechanism by which the shadow banking system contracted, and with it velocity. You state that Bernanke believes the Fed is not “out of ammo” to shoot at velocity to make it rise. I know he says that, but his actions are quite different. He seems to believe to get velocity to rise carries risks. While he is notoriously vague on the subject, the only risk he could be referring to is the risk of un-anchoring inflation expectations. Thus, I would argue Bernanke agrees with me: they can counteract the damage done to the monetary transmission channel only by risking significantly higher long term inflation (or NGDP, if you wish). There is no MM “free lunch” by which a promise to prudently increase NGDP by a couple of points results in a significant change in the behavior of actors.

    BTW, in 1933 asset prices had suffered a severe adjustment, and real returns to even the safest investments were sky-high. Into that environment, FDR threw a hand grenade of the most reckless policy anyone at that time could imagine: abandoning the gold standard. The situation today is not different by degree; it is different altogether. The Fed has attempted to avoid asset price adjustments, and real returns to safe assets are the lowest in recent history; further, even the most ardent MM advocates propose, not a reckless policy, but a prudent policy of 5% long term NGDP growth.

    I think the problem is people confuse the ex ante with ex post in 1933. Ex post, we know inflation did not go out of control. Ex ante, actors believed that it might as a result of FDR’s radical policy.

  8. Gravatar of marcus nunes marcus nunes
    10. December 2011 at 10:39

    Scott
    “Then when our own financial system saw tumbling property prices lead to banking problems, the powers that be went and did exactly what they’d spent a decade criticizing Japan for — focusing central bank activity on propping-up banks up while paying scant attention to idling of workers and real resources”.
    That´s vintage Bernanke´s “creditism”. Release a “neutron bomb” to save the “banking houses” and never mind the number of “deaths” (unemployed)that ensue!

  9. Gravatar of Becky Hargrove Becky Hargrove
    10. December 2011 at 11:31

    Several years ago I learned to distinguish between active and passive forms of ownership, and the London Banker article really made me think about that. It would seem that the intent of much ‘financial stability planning’ is to replace the means of wealth creation with the end result, or what really is a static impossibility that ends up destroying the wealth itself (also true at local levels). The evening news recently ran a story on the farmers who got taken by MF Global. Many from this generation will no longer want to depend on finance in the future, a fact that will not change until further generations who do not remember what is happening now, take part in the markets. Apparently that is what makes it so easy to question the role of finance now. Perhaps some good can come of all this.

  10. Gravatar of marcus nunes marcus nunes
    10. December 2011 at 12:13

    Scott
    I show that the US and the EZ are “observationally equivalent”. In that case what are the hopes for the EZ if it is “shackled” in a way that the US isn´t, but “pretends to be”!
    http://thefaintofheart.wordpress.com/2011/12/10/no-way-out-the-euro-is-doomed/

  11. Gravatar of Morgan Warstler Morgan Warstler
    10. December 2011 at 12:52

    Matty supported propping up banks. When he admits he was wrong, his point will matter.

    Nuff said.

  12. Gravatar of Benjamin Cole Benjamin Cole
    10. December 2011 at 13:35

    Dead on post. Again.

  13. Gravatar of Lee Kelly Lee Kelly
    10. December 2011 at 14:54

    I am constantly reminded of philosophers. Their great conceit was that some arcane method existed which could preclude all error. By following the magic formulae — logical deduction, pure intuition, sense experience, or whatever — we could be absolutely certain of being correct. Doubt was not a check on their hubris, a reminder of our pervasive fallibility, but a demon to be slayed by unimpeachable authorities.

    Of course, the method they sought was an illusion. They had it backwards. Error is inevitable. The point is to encourage customs, habits, institutions, and methods that can, with luck, correct mistakes as painlessly as possible. Popper had it right when he said that our ideas should die in our stead; his emphasis was not on avoiding problems but dealing with them.

    I constantly see parallels to this situation in the debate surrounding financial regulation. The foolish or wishful think that by some opaque financial trickery, one can prevent problems from occurring. The implicit assumption, albeit absurd, is that regulators somehow know the solutions to all the problems nobody expects. It’s a fantasy. A dangerous fantasy. Problems are inevitable.

  14. Gravatar of Steve Steve
    10. December 2011 at 17:27

    Scott / David Pearson,

    I agree with both of you subject to certain conditions.

    I think Scott is right that NGDP targeting would have prevented the financial crisis IF it were in place well before the acute phase of the banking crisis. The reason is that markets would be conditioned to look for “offsets” in other areas of the economy every time a negative shock hit the real estate or credit sectors, and this would have cushioned the downside. It’s ironic that people criticize the “Greenspan put” because NGDP targeting would produce a similar bounce in the markets around crisis events.

    However, I agree with David Pearson that once the financial accelerator is pushed too hard, it becomes hard to stop. Few people realize that the IG corporate bond markets hit record wide spreads in the wake of the FDIC’s Wamu takeover in late September, NOT the Lehman BK, and NOT the stock and economic crash from October 08 to March 09. Bank bonds froze when Sheila Bair decided to flip Wamu to JP Morgan and use the extra bond capital to protect the FDIC’s reserves. Sheila Bair wanted a preemptive takeover because she didn’t want to risk calling Timothy Geithner and asking for a loan if markets turned worse. It was widely perceived as unfair at the time and led to a seizing up of bank fundraising abilities, which in turn froze bank lending. IG Bond investors are used to collecting 2% or so credit spreads so they are VERY sensitive to the possibility of total wipeouts, especially if there is the slightest risk that the wipeout is motivated by regulators and politicians who view bond capital as a honey pot. This is a real world example of the “Gorton” example that Pearson references. The bond markets forced the gov’t to bail out the banks because the markets no longer trusted their senior claims on the banks assets; in a real sense bank bailouts were the price to pay for NOT having NGDP targeting in place beforehand.

    A similar process may be under way in Europe right now. The decision to haircut private Greek debt holders 50% and NOT call it a credit event was deeply unfair. It led to record wide spreads in Italy and Spain. There’s now a perception that European sovereign markets are toxic especially for non-European investors. That’s why the EFSF couldn’t get funding — it might be an attempt by Germany to confiscate non-European funds by creating a non-guaranteed structure that could leverage into sovereigns up to the point where Germany is ready to declare a haircut.

    It’s also worth pointing out that the money lost by mid-western farmers’ ‘segregated’ accounts at MF Global probably did end up somewhere: as PROFITS for the ECB. The ECB was buying Italian and Spanish sovereigns at steep haircuts at the same time MF Global was being forcibly liquidated. Assuming that Spain and Italy eventually get made whole, those profits (farmer’s money) will get distributed back to the shareholder banks of the ECB, of which the Bundesbank is the largest.

  15. Gravatar of StatsGuy StatsGuy
    10. December 2011 at 18:10

    “Then when our own financial system saw tumbling property prices lead to banking problems, the powers that be went and did exactly what they’d spent a decade criticizing Japan for — focusing central bank activity on propping-up banks up while paying scant attention to idling of workers and real resources.”

    Scott, this is precisely true – what I struggle with is the explanation that TPTB simply forgot what they had been telling Japan. In political economy, people don’t “forget” things, unless there is a reason for them to forget things.

  16. Gravatar of Peter N Peter N
    11. December 2011 at 04:46

    The word of the month seems to be rehypothecation, and a very dirty word it is. Apparently the UK has no limits on the process. So, if you want to evade the US rules, you set up a UK subsidiary like, maybe, MF Global UK. Now you can play roulette with your customers’ money.

    Yet another way to print your own money, but, since Scott would prefer to reserve the word money for things like M1 and M2 we need another word. This would include any securities rehypothecated or used as repo collateral. Since this form of money has an unpleasant habit of melting away when it becomes “information sensitive”, I was thinking of calling it Tinkerbell money, but I decided on a short portmanteau word combining funny and money. Thus Munny. This is the stuff the financial system brews up when it needs more liquidity than the Fed provides, so they can increase leverage, safe in the knowledge that if it all goes south, taxpayers will cover the losses while they get to keep the profits.

    The Euro is seizing up because of the loss of over 1 trillion Euros of Munny liquidity. Tight Munny, if you will. The European banks are insolvent. The ECB is propping them up.

    Whatever you think of the principle the Bernanske bailout was fairly elegantly done. The Euro bailout – not so much.

    How not so much, we’ll soon see.

    BTW if farmers now can’t trust our trading system not to steal their money when they hedge, the consequences could be rather bad.

  17. Gravatar of ssumner ssumner
    11. December 2011 at 06:59

    David, I said Bernanke is correct, that the Fed is not out of ammo. You say he is lying, and that what he really believes is a false model of the economy. But my interpretation is more plausible, because it is 100% consistent with what he said as an academic. If he felt he needed to lie for political reasons (and I agree government authorities do feel that way sometimes) then his current views would be inconsistent with what he said as an academic.

    You said:

    “There is no MM “free lunch” by which a promise to prudently increase NGDP by a couple of points results in a significant change in the behavior of actors.”

    This doesn’t address market monetarism, which favors level targeting. If they were following market monetarist proposals they would not have stopped doing QE2, they would have lower IOR, and more importantly, THEY WOULD HAVE SET AN EXPLICIT TARGET FOR THE PATH OF NGDP. There is no risk of an inflationary overshoot when you are doing level targeting.

    The FDR case is very different from what you describe. people didn’t believe it was going to produce high inflation. Markets didn’t believe it was going to produce high inflation (prices never even got back to 1929 levels until well into the 1940s.) A few stupid pundits said we’d have high inflation, that’s all.

    Your comment does raise an interesting point. It points to the scandalous incompetence of the press. Why don’t they ask Bernanke “If you think the economy could benefit from more demand, why not have the Fed provide it?” Pin him down!

    Marcus, I agree. And thanks for the link, that’s a very good post.

    Becky, I agree.

    Morgan, I suppose he’d say “do both.”

    Thanks Ben.

    Lee Kelly, You said;

    “Problems are inevitable.”

    Except in Canada. Seriously, I agree, although a better regulatory scheme (not more regulation) would make the problems smaller. So would NGDP targeting. For instance, with no Fannie and Freddie there would have been no bailout of the GSEs. With no FDIC there would have been no bailout of FDIC.

    Steve, Those are very interesting points. But I still believe that if the Fed had done aggressive stimulus in their meeting 2 days after Lehman failed, instead of standing pat, the asset market crash would have been much milder.

    Statsguy, What is TPTB?

    Peter, I always assumed there was some sort of insurance if Fidelity went bankrupt with all my mutual funds. Is that no longer true?

    I actually don’t call M1 and M2 ‘money’, I call the monetary base money. Bank accounts are credit.

  18. Gravatar of John Thacker John Thacker
    11. December 2011 at 07:26

    the powers that be went and did exactly what they’d spent a decade criticizing Japan for

    There’s a lot of truth to this. But also note that Japan spent much of that decade spending lots of money on infrastructure intended to be stimulus as well, and in general ran enormous deficits. Anyone who goes to Japan can see gleaming infrastructure (especially in rural areas) that failed to boost the economy.

    This only boosts the argument that the US has spent time doing exactly what we criticized Japan for doing; fiscal profligacy combined with raising rates anytime NGDP started to rise at all, along with too great concern for not letting banks fail.

  19. Gravatar of David Pearson David Pearson
    11. December 2011 at 07:58

    Steve,
    I disagree with one aspect of your well-considered response. NGDP targeting would, in theory, create the sectoral “offsets” that you describe. The problem is that it would also increase leverage and systemic risk. Stability-seeking regimes directly influence optimal leverage through universally-employed VAR models. Macroprudential policy might have a role in containing the resulting risk, but the evidence shows that it fails repeatedly to stem banking crises during periods of leverage growth.

    In short, for any given free put on liquidity and maturity risk issued by the Fed, actors will maximize the value of that put by employing more and more leverage in speculative trades.

  20. Gravatar of dwb dwb
    11. December 2011 at 08:45

    Just to be clear, I have never argued that the Fed should adopt a more expansionary policy to help out debtors. I’ve always claimed they should adopt a stable policy, exactly the same NGDP growth after 2008, as before 2008

    Nor am I. My point is merely that in my mind that there is no economic distinction between devaluation/inflation, and default (one is considered immoral, one not). Pretend for a second we live in a world where debt is real, not nominally denominated. What would that look like? Probably I would borrow a share of my income. I would probably do something like commit a permanent share of my income to housing and mortgage my income share based on that. Now, it would be extremely hard for me to default on this loan – as long as the share was small, unless I simply strategically defaulted and abrogated the loan, or committed fraud and lied about my income. Even if my income declined for exogenous reasons, I could still pay the bills and eat.I would have no excuse.

    I prefer to think of what risky behavior, moral hazard, and too-big-to-fail looks like in this pretend world. In the actual world the fact that debt is in nominal terms makes it very difficult to distinguish between “bad behavior” (strategic default, fraud, etc) and income declines for exogenous reasons. In the pretend world, bank capital is driven by exposure to people who are more likely to engage in risky behavior (fraud, overextension, strategic defaulters etc.)

    Now, in the actual world, when there is a large AD shock everyones debt burden needs to decline as a share of income. That can happen through inflation or default / restructure. It is not “bad behavior” in my mind because nominal income is uncertain/stochastic. The trouble is, we(I) want banks to fail for engaging is risky behavior and stupidity, not for merely being exposed to the overall economy (which to a bank, should be exogenous). Whether its 2000 S&Ls or 2-3 large banks, when there is a large AD shock there will need to be a restructuring.

    So, when I say “people will vote for a little extra inflation (to prevent a debt-deflationary spiral) to allow banks to fail, or tight money and to-big-to-fail banks…” I am being fast and loose, but really I mean that I think that most people intuitively understand that debt share needs to decline when there is a large AD shock, so its better to allow higher inflation but also tightly regulate banks to force the right ones to close, rather than forcing tight money and allowing the sharp knife of deflation to cut them all good and bad the same. Even better of course is stable nominal income. But my point is that I see tight bank regulation and stable nominal income as two sides of the same coin. cant have one without the other. bailing out banks imposes a obvious, direct cost on taxpayers, but so does inflation. The question is, are we bailing out the right banks. Ex-post, it is extremely hard to differentiate “risky” behavior when everyone’s incomes have declined.So while I am being fast and loose, all i am saying is that I think that people intuitively get that bailing out banks imposes a cost, as does inflation, and I would trust a democratic voting process make the judgement as to which is more costly.

    Part of the problem with selling NGDP targeting IMO is that it sounds an awful lot like helping debtors and banks unless one is extremely precise. I think that it is almost certainly true that NGDP targeting “helps out debtors” by allowing more inflation in the events where debt as a % of income needs to decline (devalue) because of adverse shocks (productivity, or whatnot)…. but thats not to say we are “bailing out” debtors or banks who engaged in risky behavior. It is merely short-circuiting a nominal rigidity (nominal debt). More to the point, I think it allows a more effective way to differentiate those who engaged in truly risky behavior from the rest of us because when nominal income declines in aggregate it punishes the innocent and guilty alike..

  21. Gravatar of dwb dwb
    11. December 2011 at 09:27

    “This ECB bank loan deal looks somewhat similar. In essence it looks as though it’s just what so many have been asking for, the ECB bailing out everyone. Just not directly.”

    no, no, no. Banks are not going to lend at 7% and borrow at one percent just because the spread looks good. If there is a chance the loan will default with a recovery of 35% (or will be paid back in a currency thats worth 35% less), the “spread” is a really bad deal. It not a “backdoor” to what people have been asking for, because it does not eliminate the proximate cause of bank retrenchment: the probability of a default or devaluation. Yields will continue to stay high as long as the market-implied-probability of devaluation is high, and banks are not going to be holding enough capital to take the risk, no matter what the spread says. Banks need to be holding enough capital so that even if there is default/devaluation then they still survive… bank presentations I have seen imply a 30% devaluation for example for Italy, which means that for every euro they lend they have to hold at least 70 euro-cents capital to survive. ask yourself: at what probability x of devaluation can I borrow .7, lend 1 at a 6% net interest margin), get a 10% return on my invested capital of .3, to make the deal worth it. If my subjective probability of devaluation is less than x, i lend, otherwise I hold back. now test different scenarios for the 30% devaluation, and you will start to understand why the ECB lending facility is insufficient.

  22. Gravatar of Peter N Peter N
    11. December 2011 at 12:21

    “Peter, I always assumed there was some sort of insurance if Fidelity went bankrupt with all my mutual funds. Is that no longer true?”

    Mutual funds, themselves appear to be safe, if they can’t hold short positions, don’t allow lending of securities, and don’t speculate in commodities. They’re protected from bankruptcy of the parent, and implicitly guaranteed by the parent against violation of the fiduciary relationship by the fund.

    Money market funds OTOH while they are not directly exposed to rehypothecation risk, since they are lenders, are exposed to counterparty risk, and the counterparty could buy securities and repo them. The repo counterparty might be able to rehypothecate. It depends on the repo agreement.

    US stock brokerage margin account agreements permit rehypothecation of collateral up to a limit. UK brokerage account have no limit. Any limit must be negotiated with the customer. If your US brokerage agreement allows the account to be held by its UK subsidiary, it gets interesting. I think you would still be covered by the SIPC up to $500,000.

    As a commodities broker, it’s very possible that M F Global did nothing illegal. I doubt this gives its customers much satisfaction. It’s still not clear exactly what happened to the money or even the legal consequences of some of the possibilities. There is, however, an M F Global UK, which suggests certain possibilities.

    When hedge funds borrow (which they do quite a bit of, since their secret sauce is usually some form of leverage), their collateral is usually subject to rehypothecation.

    These links should make this less unclear. They also discuss how you get tight munny, which is then translated to tight money through the banks’ loss of lending capacity. You can see the effect of the high velocity of munny relative to money.

    http://www.imf.org/external/pubs/ft/wp/2010/wp10172.pdf

    http://newsandinsight.thomsonreuters.com/Securities/Insight/2011/12_-_December/MF_Global_and_the_great_Wall_St_re-hypothecation_scandal/

  23. Gravatar of mbk mbk
    11. December 2011 at 17:29

    DWB, “no, no, no”, Well, I was pointing out what I believe is the intent of this ECB policy now. I respect your point, but as with all things how it will play out eventually depends on various factors playing together. Subjective default risk is one thing – but that risk changes when other factors change, for instance this kind of novel measures.

    As I read the story, much of the default risk comes from the abysmal interest rates say Italy is paying now, since it is running a primary budget surplus. And that’s a positive feedback loop, more perceived risk, higher interest rates, leading to more perceived risk. (No engineer would be allowed to build a hair trigger thing as lethal as the financial “system” with its death spiral positive feedbacks, its abrupt breaking points, razor thin margins of error etc).

    Political pressure on domestic banks is another thing. Domestic banks may well be “invited” to support their governments in this way with the promise of profitability and the stick of some loss of support in some form. etc.

  24. Gravatar of dwb dwb
    11. December 2011 at 19:05

    Domestic banks may well be “invited” to support their governments in this way with the promise of profitability

    oh yeah, absolutely. business and politics makes poor bedfellows, and there is invariably regret afterwards.

  25. Gravatar of MMJ MMJ
    12. December 2011 at 07:21

    “One strength of the US banking system from the 1930s to the 1980s was that failures were dealt with quickly and certainly”

    that’s sarcasm, correct? when the latam debt crisis made the US banking system insolvent, the solution was years of regulatory forbearance. this has been documented by the FDIC – no conspiracy theories required.

  26. Gravatar of Jeff Jeff
    12. December 2011 at 08:56

    David Pearson,

    In 1998 regulators engineered the LTCM and thereby convinced many financial market participants that Too Big To Fail had become policy. Over the next decade, the shadow banking system grew enormously, but the US economy did not. The obvious question this raises is: If the economy of the 1980′s and 1990′s did fine without a humongous shadow banking system, why can’t we do the same now? The evidence would seem to suggest that the large shadow banking system is mostly useless, except to those whose very large compensation packages depend on their ability to get taxpayers to bail them out.

    Most Market Monetarists would say, let ‘em crash while supporting the actual economy via an expected nominal GDP rule. Where is the evidence that letting foolish lenders go under would be such a bad thing?

  27. Gravatar of ssumner ssumner
    12. December 2011 at 08:59

    John Thacker, I agree.

    David, Macroeconomic stabilization does not prevent individual failures. There would still be risk. But it would be the good kind of risk, which we should welcome, not the bad kind of risk.

    dwb, I can’t emphasize enough that NGDP targeting does NOT help debtors or creditors. The average inflation rate is exactly the same with either regime. All that differs is inflation volatility. Both groups gain from less risk, but there is no redistribution.

    You said;

    “But my point is that I see tight bank regulation and stable nominal income as two sides of the same coin. cant have one without the other.”

    I’d say they are alternatives–you have one or the other.

    Peter N, I’m no expert, but they used customer money to pay off creditors. Why isn’t that illegal?

    MMJ, Isn’t that a different issue; how banks were dealt with after they failed? But it’s not my area of expertise, so you may be right.

Leave a Reply