How to Break the Boom and Bust Cycle

Like a pet gerbil running endlessly on a circular wheel, Government leaders are putting all of us on the economic treadmill of serial failure. Calls for an immediate investigation into what went wrong and why are going largely unheeded as government leaders claim that a witch hunt is the last thing we need now.

Well, I disagree. We need to hunt down the demons that tanked the economy and exorcise the system of the evil forces that have brought us down. I think that what is needed is a combination of (i) immediate and aggressive enforcement of existing law and regulation and (ii) a bi-partisan investigation of what needs to change so that there isn’t another banking collapse during our lifetime.

By doing nothing the political leaders are setting us up to repeat the mistakes of the last 5 years and guarantee another crisis within a few years. Unfortunately, I have little hope of anything happening before the Presidential election.

Policy makers have set the global economy up for a crash in a few years. They are reinflating the banking sector with massive monetary and fiscal stimuli but not changing the underlying system that was unable to deploy the relatively benign stimulus that was pumped in after 9/11.

The Federal Reserve has dropped the Federal Funds rate to almost the post 9/11 level of 1.00% (currently it is at 1.50%) and dramatically increased money supply. It is also pushing “qualitative” monetary stimuli by using its balance sheet to lend to banks, non-bank corporate borrowers and other central banks. And, the largest Keynesian stimuli package ever is being used to prop up the economy. Ever since the New Deal ended policy makers have avoided fiscal and monetary stimuli on the scale that is being attempted by Paulson and Bernanke. In the process of getting us out of this crisis they are creating the conditions for a massive investment and leverage bubble starting in late 2009 and extending into 2010 and 2011.

However, the fundamental regulatory and oversight system that enabled the 2007 bubble remains essentially unchanged. As examples, there has been no material commitment on the part of the SEC to enforce laws and regulations, the Federal Reserve still doesn’t act as if it is the primary regulator of bank holding companies and, despite widespread and obvious fraud, the Justice Department hasn’t managed to indict a single senior mortgage banker in connection with bad mortgages that caused the sub-prime mortgage mess.

Conventional wisdom states that the Bush Administration is “kicking the can down the road” on regulatory reform and enforcement so that the next President and Treasury Secretary will be forced to deal with the reform and enforcement problem. Unfortunately, we don’t have the luxury of time to wait until the next administration takes office and learns its job. Unless the next President has an urgent timeframe for action, as a practical matter it will be the summer of 2009 before regulatory reform and enforcement will begin. And, by then the banking system will be well on its way to inflating the next bubble.

In less than three weeks either McCain or Obama will be President Elect. I think that whichever candidate wins, his first order of business must be to appoint the next Secretary of Treasury and the next Chairman of the SEC (Chris Cox has indicated that he intends to resign in January, 2009). The transition team must begin working with Paulson and his team immediately to get up to speed and begin the process of fixing the underlying issues in our financial and capital markets system.

We must break the boom and bust cycle of the banking sector before it breaks us.

Comments

[JasonC:]

"The risk of disobediance is the condition for free conduct under the law. Take away the risk and you take away the freedom. And then you don't need any law." - Sam Ervin

The guilty culprits are approximately everyone. Mainstreet borrowers, mainstreet bank depositers, central bankers, regulators, legislators, GSE managers, major wall street firms, investment innovators, new companies, hedge funds, speculators domestic and foreign --- you name it.

Now shall we all shoot each other in the head and call it an improvement? Or man up and face the fact that everybody made a buck on the boom, one way or another, and everybody screwed up some aspect of it, one way or another?

You can't remove the possibility of failure without removing the freedom that let's men sometimes fail.

No, the all knowing all wise gubmint won't do it better, it did half of it, itself. No, the virtuous little people of main street won't fix it all if only whatever they want is done instead - they are the ones who just stiffed their lenders with $1.4 trillion in loan losses. The bankers didn't stiff them.

For the millionth time, you cannot have economic security. Full stop. Economic security does not exist. Everything you do depends for its value and soundness on everything everyone else does, as well. And those others are free, and fallible.

You can't attain safety by clapping them all in irons. You only attain poverty, and your own enslavement.

Economic crisis in endemic to capitalism. It has been going on since 1720 at least, 288 years and counting. None of the chaos of occasional financial crisis has prevented it from being the most successful economic system in world history, and the *only* one, I mean the *only* one ever, to advance the material well being of everyone, down to the most common day laborer.

Delusions of perfection are just that, delusions. Men are free to make mistakes. If you leave men free, they will make mistakes, some of them large, some of them big enough to inconvenience you as well as themselves.

Tough freaking toenails. Grow up.

2008 Oct 20 11:53 AM

[Joe1234987:]

Get rid of Fractional Reserve Banking and inflation would cease forever and bubbles would virtually disappear!

2008 Oct 20 12:53 PM

[moonbat1775:]

Joe is correct. FRB with a monopoly currency is not only unstable it is also DISHONEST. With competing currencies it is suspect but at least one has other choices.

2008 Oct 20 01:35 PM

[Smarty_Pants:]

Author is correct on one count. Trying to prevent them from failing will only cause bigger problems down the road.

Stop regulating. Stop guaranteeing. Get the gub'mint out of banking entirely and let the failures fail. The successes will pick up the pieces and move forward that much the wiser.

2008 Oct 20 02:31 PM

[Paul Fekula:]

I am not sure if regulation is the effective answer. After 1929, everyone said: "Never again," and sure enough there was a regulation overhaul that worked pretty well... until now. Nevertheless, I am not sure if that explicit, government regulation made so much of a difference. At the end of the day, we are seeing the deflation of a 20-odd year credit bubble. However, that had more to do with monetary policy than it did with bank regulation. Regardless of what kind of regulations we impose on banks, at the end of the day, lending standards are going to be tighter for decades to come, and banks will probably be less leveraged. We still have a lot of pain to come in this crisis, and the banks left standing at the end of it all are going to remember it for a long time. I figure that's at least as good as any regulation congress could try to impose.

2008 Oct 20 03:09 PM

[JasonC:]

We have financial crises long before we had a Fed. That is nothing but an Austrian smear. Governments inflated without fiat currencies, and without fractional reserve anything. Merchants inflated with nothing but bills of exchange, and governments inflated by alloying metal currencies with base metals - hence "debase".

Free men are going to engage in credit transactions, and you can't stop them with anything less than draconian tyranny and central planning. Which aren't a libertarian anything. Free banking would be superior but did and would again lead to widespread bank failure with losses to depositers routine. You can't get rid of the possibility of destabilizing, trend following speculation without removing economic freedom.

And the game isn't worth the candle. Economic freedom and the economic growth that comes with it we actually can have. Economic security only exists between the ears of ideologues, or in static agrarian societies whose entire wealth consists of assort pile of manure.

2008 Oct 20 06:05 PM

[zanardm:]

The $250 M bailout should be used to retire Fannie Mae and Freddie Mac debt. It would be a counter balance to the Fed's generosity. The public is deleveraging, and so should the government, since it was such excesses (public and private) that led to the present debacle. One could have a domestic auction, and see what might 'fly' for some of low yield debt. In other words, some want out. For example, if the gov paid 50 cents on the dollar, then one could retire 1/2 trillion dollars of debt! Thus setting a precedent for incoming administration, and acknowledging the wisdom of the people and their no vote to more debt and to bail out.

2008 Oct 21 01:45 AM

[derryl:]

JasonC:
Hallelujah! A voice of realism crying out in the wilderness of 'never again' wishful thinking.

After so many decades of politicians promising security the credulous population has been infantilized to think that some Big Daddy is all wise and all powerful enough to actually ride in and clean things up. We can make changes to our monetary system that will remove systemic flaws (i.e. our system of creating money as bank debt at interest, where the money to pay the interest is NEVER created except as new loans with new interest), but human nature will always be with us. As Max Weber said, "There are no permanent solutions in politics." Maybe we should grow up like our grandparents had to and recognize that our own security is up to us to work out on our own.

2008 Oct 21 12:17 PM

[carey_jim:]

It's like the story of the three pigs.

One piggy built his house out of straw.

The second piggy built his house out of wood.

The third piggy built his house out of brick.

We know how the story ended:

There was global warming which caused a severe drought and the third piggy roasted in his brick house.

The second piggy searched the parched land for food but found none and starved to death.

The first piggy ate his straw house and survived in the empty wooden house, while waiting for the storm that the wise men predicted.

When the storm arrived, the first piggy moved into the brick house and survived.

The moral of the story is: We need piggy wisdom in this crazy world.

2008 Oct 21 01:29 PM

[alajac:]

You can't get transparency when the government is guaranteeing the losses. FDIC and every other kind of government guarantee has to go.

Make the banks earn the bailout by giving them the money via equal-dollar distribution to every legal US resident ($700B divided by 350M=$2000 ea.) Then no other stimulus is needed. They'll have to get transparent and extend credit to earn the deposits.

When all governments do the same, there will be no illegal immigration problem.

alan jacquemotte

2008 Oct 21 02:51 PM

[alajac:]

You can't get transparency when the government is guaranteeing the losses. FDIC and every other kind of government guarantee has to go.

Make the banks earn the bailout by giving them the money via equal-dollar distribution to every legal US resident ($700B divided by 350M=$2000 ea.) Then no other stimulus is needed. They'll have to get transparent and extend credit to earn the deposits.

When all governments do the same, there will be no illegal immigration problem.

Write-in Alan Jacquemotte for US President

to show support for this plan,

and your disdain for the other candidates.

2008 Oct 21 02:54 PM

[PainfullyAware:]

The world we live in is filtered mostly by others. Most of reality is perception. However, Reality will be reality whether believed in or not.

Banking Collapse 1340s – the more things change the more they stay the same. – Long but interesting

www.schillerinstitute....

"Between 1250 and 1350, Venetian financiers built up a worldwide financial speculation in currencies and gold and silver bullion, similar to the huge speculative cancer of “derivatives contracts” today. This ultimately dwarfed and controlled the speculation in debt, commodities, and trade of the Bardi, Peruzzi, et al. It took all control of coinage and currency from the monarchs of the time.

The banks of Venice were deceptively smaller and less conspicuous than the Florentine banks, but in fact had much greater resources for speculation at their disposal. The Venetian financial oligarchy as a whole, which ruled a maritime empire through small executive committees under the guise of a republic, centralized and supported its own speculative activities as a whole."

2008 Oct 21 06:27 PM

[Chris B:]

Actually, the govt. did a lot to encourage this bubble:

-Repeal of the depression-era Glass-Steagal Act in '99 was within 8 years followed by another depression-style investment banking collapse.

-The Bush tax cuts on capital gains and dividends encouraged house flipping, REITs, precious metal flipping, stock flipping, mortgage backed securities (dividends!), and commodity futures flipping. Meanwhile, conducting business or doing productive work was and still is taxed at much higher rates.

-Finally, Bush placed people in the SEC with a mandate not to "interfere" with business - that is, not to enforce the law. This trend continues as the author points out.

2008 Oct 22 05:43 PM