Let's Not Emulate the Hoover Administration 31 comments
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Some of the headlines from last week’s Federal Reserve conference sounded like they were written in the 1930’s when the Hoover Administration encouraged liquidation of assets and banks as a way to fix the economy. Willem Buiter, a former official of the Bank of England and European Bank for Reconstruction and Development, sounded like Andrew Mellon when he criticized the Fed’s policies last week (Andrew Mellon was Herbert Hoover’s Secretary of the Treasury). Buiter argues that the Fed is rescuing Wall Street at the expense of Main Street and forgets that Main Street and Wall Street have a co-dependent relationship. The last time Washington took the co-dependency for granted, the Great Depression resulted.
Buiter thinks that the Fed is sacrificing inflation, creating moral hazard and hurting systemic integrity. Just like Andrew Mellon and his “liquidationist” theories, Buiter’s prescription fixing the system will result in destruction of money supply and GDP. Buiter is correct that the system needs to be fixed and rules enforced, however monetary policy is the wrong policy level for this task.
Like Mellon, Buiter makes several fatal analytical errors. Three are highlighted below.
Error #1 – “Output contractions can be reversed easily through expansionary policies.”
When Buiter writes “reversed easily,” I doubt if he has considered the economic calamity of the 1930’s. Despite the efforts of smart and conscientious public officials, it took a combination of fascism, genocide, the destruction of several countries and tens of millions dead (i.e., WWII) to get the U.S. and Europe out of the Depression. Buiter writes 144 pages criticizing the Fed and other central bankers, but in a single sentence is able to dismiss 20 years of human suffering as “reversed easily”. He forgets that the Great Depression is widely regarded as having been a Fed creation when it didn’t respond appropriately to the destruction of the monetary stock caused by a real estate, Wall Street and banking crisis.
Error #2 –Non-bank financials can take up the slack of a failing banking sector.
Buiter is in error when he compares the financial system of the 1920s and 1930s to the current financial system and concludes that a collapse of the banking sector won’t kill the economy. He believes that unlike the 1930s the growth of the non-bank financial services sector provides some sort of a safety net to the economy that can take the place of banks. Unfortunately, Buiter’s analysis of how the crisis unfolded (which is actually pretty good) contradicts his assumption that catastrophic losses in the banks won’t cause catastrophic losses in the rest of the economy.
By the way, I doubt if Buiter understands where non-bank financial companies deposit their money, how they transaction their business or who acts as an intermediary to get cash to non-bank financial companies. In all three cases it is banks. Non-bank financial companies cannot survive without banks and cannot thrive without a healthy banking sector.
Error #3 – Crashing home prices just aren’t as important as the Fed thinks.
Buiter badly underestimates the effect of falling house prices. With myopic focus, he focuses on short term consumption implications of falling house prices and the immediate household wealth effect and misses longer term implications of housing stock destruction.
While Buiter agrees falling house prices are bad for construction (and by implication builders and the companies that support builders), he ignores the effect of changes in consumption patterns and potential population migration (which has many precedents in the last 100 years). Other affected industries that Buiter ignores include appliance and building materials manufacturers, mortgage and real estate professionals (lawyers, appraisers, brokers, bankers, etc), utilities, transportation, schools, government, health care, retail distribution, communications and other ancillary infrastructure. In short, almost everyone is hurt or will have a relative who is displaced if the housing contraction continues. The Fed isn’t overreacting.
It’s a good thing that Fed officials have studied history and know that Buiter has provided a step by step instruction book on “how to” create a depression. The Fed can’t afford to get policy wrong and must err on the side of economic stability and not in favor of “teaching the bums a lesson”.
While I am as angry as everyone else (and have been a constant and consistent advocate of enforcement of current rules, regulations and criminal laws which the Bush Administration doesn’t do), monetary policy isn’t the proper policy lever for regulatory enforcement. The SEC, Justice Department, OCC, FDIC, state banking regulators, state attorney generals and Fed (in its role as the primary regulator of bank holding companies but not in its role as central banker) need to enforce current laws and regulations and punish individuals and companies that violate these rules.
Let’s not repeat the mistakes of the Hoover Administration and destroy confidence in ourselves and our economy. Buiter work should be studied as an example of what not to do and how not to do it.
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This article has 31 comments:
A similar "nick" to the psyche could be said of today -- as homeowners see their equity apparently evaporate with every "median housing price" report, the confidence in their future becomes cautious. One example of note is the decline in large [ balance ] order purchases at a leading, national home supply chain. If a homeowner believes his home is worth less, will he be more inclined or disinclined to put more discretionary money into it ? Is it really worth it to install those granite counter tops ? Apparently, with the deflating of the bubble, the answer is increasingly "no."
I agree with your first contention but not your 2nd or 3rd. The normal savings and loan, or thrift bank who was shut out of the housing boom because of the mega-banks ability to undercut smaller banks business through securitization are still around. They will continue to make loans to people, with higher underwriting requirements. Once people start to realize that Mortgage Backed trusts have proven to be a disastrous financial instrument, its just a matter of unwinding them and passing them to loan servicers and a return to portfolio lending. Yes, the price of borrowing will increase - but is that a bad thing? Yes, people will have to pay for more houses in cash - but with our negative savings rate of the past two years, is that a bad thing? I would rather have the government step in to shore up the FDIC to save a few megabanks customers than continually pump money into the biggest banks which will just turn it over to the trading floor and not pass a lower cost of mortgages to the consumer, the people we are supposed to be helping in the end, right?
As to the last point, we have used every trick in the book to prop up the housing bubble. First we had Greenspan with the easy money, telling people that ARMs were a good idea. Next we had CBOs and hijacking municipal bond insurers to rate these internet-driven, anonymous, highly portable mortgages, all supposed to create huge returns with no risk. The entire concept was unsustainable, hindsight being 20/20. Do I feel sorry for the 95 attorneys laid off by Cadwalader, Wickersham and Taft because there is no more market for CBO underwriting? They will land on their feet, unlike the people who cannot modify their onerous loan terms with a CBO as the original underwriter went out of business and the Bank Trustee has a fiduciary responsibility to the certificate holders, not to society as a whole.
Finally, remember that you can't have the phrase "falling home prices" without the word "home." As in, "where you live". If you are living in your home, the daily rise and fall doesn't matter. Warren Buffet on CNBC last Friday said "If you are going to buy a farm, and you know there are two drought years out of ten, you should try and buy a farm in a drought year." I am sorry that real estate brokers will have to turn in their Mercedes, and home builders will be forced to through smaller "Sweet Sixteens" for their kids, but c'est la vie! There is always dental school. People will always have rotten teeth. If you want security, join a union or get a job at the post office.
The point is, when we say a "bank collapse", we don't mean the actual physical bank collapses. The building remains, the teller windows are there, the ATMs are there. It's just that management and its employees go under, and the investors lose out. But take hope! There are legions of new enterprising MBAs leaving our business schools every day to man those crow's nests of enterprise, to rally the troops to man the teller windows, and even some humiliated management will come aboard and swab the decks of the SS Banking System again. We will not trade gold nuggets for cups of coffee. We will just STOP SUBSIDIZING FAILURE. The good news is photosynthesis will continue, and life on the farm will continue as before. This may be hard news for people still hoping Yahoo will climb into triple digits again but they will never ever believe otherwise and should be ignored accordingly.
“As early as 1925, then-Secretary of Commerce Hoover had warned President Coolidge that stock market speculation was getting out of hand. Yet in his final State of the Union Address, Coolidge saw no reason for alarm. "No Congress...ever assembled has met with a more pleasing prospect than that which appears at the present time"...said Coolidge early in 1929.”
95 years of Federal Reserve central banking and crony capitalism are responsible for this mess. Recovery can only begin when the Federal Reserve and the IRS are abolished.
Also it is difficult to pin the 1930-33 contraction on bank failures that affected 2.5% of deposits . Banking services were hardly in scarce supply. In fact the deposit/output ratio actually increased, loans fell less than output and the stock of loans relative to GNP also rose during 1930-33 period.
Furthermore, bank holdings of federal securities increased and credit spreads for good borrowers changed little. For high risk borrowers credit spreads increased less than the average for a post war recessions despite higher default rates.
Lastly, if banks were curtailing their lending to firms then one would expect retained earnings to increase as firms substitute to internal financing out of bank financing. In fact during the 1930-33 period retained earnings fell and went negative.
If banks were cutting financing why were firms reducing their cash holdings? I'd like to hear the author explain these facts and why banking failures caused the Great Depression.
How strange that a government backed banking cartel built to allow fraud and deceit by your local commercial bank should lead to an unstable economic system. Could it be there really is something to the Ten Commandments?
Great article!
In Mr. Sunshine's world:
Reckless, well connected banksters reaping consequences of their own bad, greed-driven decisions = Bad.
Taxpayer-financed bailouts and Fed-induced commodities inflation = Good.
Oh, and if the rest of us *don't* bail out the speculators at the top of our economic pyramid, it'll mean a Mad Max future for everyone. Chaos, ruin, bread lines, misery! CEOs having to sell used yachts, 12th vacation homes, and paring down to... (*gasp*) ONE supermodel girlfriend!
The horror --careful what you wish for! (LOL)
If deflation is so "much harder to stop than inflation", then why haven't we experienced it since the G.D.? Is it that hard to 'print money' these days (or more accurately, increase the money supply via fractional reserve lending)? Seems like our "always choose inflation" Fed has been highly successful at "stopping" it since that time. The astonishing ~94% drop in the value of a dollar since then is ample proof that the Fed has vanquished the "deflation dragon".
And for the record, deflation is nothing to fear for the (admittedly few) Americans who have been living within their means and saving/investing prudently the past several years. In fact, if you're a responsible saver, deflation is your friend. If you're a profligate, irresponsible debt-junkie, on the other hand...
"Mark Sunshine is the President of First Capital and the President and CEO of Siemens First Capital....
Mr. Sunshine is a regular guest commentator on FOX Business"
You are wrong about deflation. When it hits (look at Japan, for Pete's sake!) you can print all money you want, it just doesn't go into circulation. Milton Friedman thought that you can throw money down from helicopters, but if it goes directly into mattress, same thing. Responsible saver can go bust if he has uninsured money in the bank, cause banks fail in deflation/depression. And it's a big question if he has anything to save, with high unemployment rate he (or she) can be out of work with high probability. Nobody wins in deflation. Deflation wasn't that bad in 19th century, when most people had to spend more than 80% of income for necessities. Now, when discretionary spending supports more than 50% of economy, situation is different. BTW, 4000 square feet house is discretionary.
First, I do not believe that "bailouts" are fair or should have to happened. I believe that it has been the gross refusal of the banking regulators, the SEC and the Justice Department to enforce laws and regulation that caused the moral hazard which has resulted in the current problems. I am all for NOT bailing out the "bad guys" but I don't want to see the good guys go down the drain when the bad guys are punished. I am amazed by the lack of criminal and civil enforcement by the current Adminstration and think that the bums should be put in jail. So, please, who ever reads this blog and comments, do not assume that I think it is OK for banks and other public companies to lie to their shareholders and investors and act in an irresponsible manner.
Second, the regulatory failure that exascerbated the GD was the sudden drop in money supply (approximately 1/3 drop) caused by bank failures. Dramatically crashing money supply causes the economy to tank. The losses in the banking sector, if left unchecked, could have caused a $2 trillion drop in money supply which was about 20% of the total monetary stock. The results could have been catestrophic. I use the word "could" because maybe they wouldn't have been catestrophic but there is a pretty good chance that the result of a drop in monetary stock could have killed the economy and caused another depression. If the odds are only 20%, that is like playing Russian Roulette with a gun that has live rounds in the chamber. The Fed has tried to not have the economy see if it will "blow its brains out" in a game of economic Russian Roulette. Maybe nothing terrible would have happened but there is a decent chance that something bad would have happened if the Fed hadn't acted to stop money supply from falling.
Third, Europe came out of the Depression because of the rise of facism and the military buildup that resulted in WWII. The commenter forgot that by 1940 Euorpe was in flames, millions were dead and genocide had begun.
Finally, I welcome your comments and appreciate your taking the time to read my article.
Come the burst of the tech bubble in '01ish, our economy and the markets were booming. Coming out of '03, our corporations found it hard to sustain solid year-over-year bottom line growth: our economy as a whole had overstrode its sustainable growth rate, even in the face of a ghastly trade, budget, and savings deficit.
There's a standoff of interests here: put simply, the CEOs and the shareholders want bottom line growth (for earnings); the economy wants top line growth (for GDP). The CEO controls the company, so he'll do whatever the rules and regs allow to get his job done, which meant overleveraging to amplify a 1% growth opportunity into a 5% leveraged upside.
Yeah, a lot of immoral stuff has happened, but is our economy worse off for it? Our markets are right where they were in '03, but instead of seeing valuable Soverign Wealth Funds and FDI--which continue to finance our deficits--flee a stagnant US economy, we [sinisterly?] entertained the global economy with growth in our markets and our economy for the past 5 years, and we tied down that much more hot money in infrastructure... at the cost of the current, painful unwinding/correction.
Whatdaya think? That's painfully underdeveloped in the interest of space, but...
Will anyone ever learn that insolvency can't be fixed with the hammer of a bailout? Fact is that all of these bailouts are supporting failed entities, and the only result will be a GINORMOUS national debt that eventually will destroy the dollar and drive us to depression anyway. Let's have a humdinger of a recession, get it all cleaned up and marked to market (as opposed to allowing the ENRON/WCOM style level 3 marks to legally continue). Sure, it's gonna hurt....but it's a hell of a lot better than a bonafide great depression. All this meddling by the boneheaded FED and Treasury (along with a heavy dose of SEC looking away while it's all going on) is only going to make matters dramatically worse. For everyone who has any feeling for the next generation, this financial delay game must stop. Mark to market now and flush insolvency out of the system. If it's true that there are some banks and other institutions that truely are solvent, the market will reward them handsomely. However, it's pretty obvious that the number of solvent institutions are much ...much fewer than the insolvent, so this is why we need to bail pretty much everyone out. What a shameful mess this all is, and my only hope is that first Greenspan (the author of much of the mess), and his protege Bernanke (who supposedly rose as cream to the top of the replacement list because of his depression knowledge), both will bear the full brunt of the history books. These folks are a shameful bunch who claim to be concerned about moral hazard and our dollar, but in deed care only about delaying the inevitable credit crunch and subsequent hard landing. If they don't give up soon and let the market fix this mess, Bernanke's knowledge of the depression will get a new lesson. Personally, I believe regardless of his meddling, he's only making matters worse.
It is the honest thing. Fractional reserve banking is the cause of the business cycle according to the Austrian Economists.
They didn’t share their king’s bonuses with the rest of us during the reign of gambling arrogance, and today we’re being extorting us for possibly more than a TRILLION in taxpayer handouts. That’s outrageously immoral and it’s hard for me to believe that you weren’t part of this.
The fact is that after LTC your peers knew they could ignore risk management and be handsomely rewarded by placing irresponsible bets because they had an ace in the hole-- the fed and the taxpayer. It’s time to draw a line in the sand and say we’re not bailing you out this time because next time the crisis will be much worse.
I don't understand why "bailouts" get such a knee-jerk reaction from other commenters. Failures of large institutions and corporations do not happen in a vacuum. If the failures are big enough they can take the economy down with them. If a bailout prevents a recession from becoming a depression, then everyone benefits from the bailout not just the direct recipients of the bailout.
I agree with most of what has been posted about how we got here and why. It was mismanagement, bad public policy and terrible errors (and I think illegal behavior). And, my response to that is so what does that have to do with making sure that we don't have bread lines in the US ever again.
We need to change how we do things in the future. Check out my other blog articles on Seeking Alpha. I have some simple suggestions that I think will stop the moral hazard cycle in its tracks and make it no longer acceptable to management teams to engage in the "race to the bottom" that they have participated in for the last decade or so. And, the idea of raising reserve levels is a good one. It is part of what the Fed should have done in its role as a regulator with derivative intstruments regardless of what the rating agencies rated those instruments (please don't forget that the Fed is the primary regulator of bank holding companies and decides on required capital levels of bank holding companies and their subsidiaries).
But, the Fed in its monetary policy and the US Department of Treasury can't take the risk of bread lines as they transition the US to a new regulatory paridigm (and by the way a paridigm where they merely enforce the laws on the books).
Buiter's assumption that a output contractions can be easily reversed is a bad assumption that underpinned the errors of the Hoover Administration. If there is even a 10% chance of a repeat of a liquidity trap like in the 1930's then we can't take the chance.
Thanks.
Perish the thought that they are just once more spending others money.
If negative M1 growth caused the depression why didn’t the economy return to normal growth as M1 was expanding during the 1933-39 period. Secondly, the M0 only declined in 1930 and increased thereafter so it was not a negative factor in the depression.
Lastly, it is a generally subscribed theory that money shocks affect the economy through Keynes nominal wage rigidity. However, despite Hoovers 1929 attempt to stop industrial nominal wages from being cut they were actually quite flexible after 1930.
Another problem with rigid wage explanation is that as employees are laid off the remaining employees become more productive. This is counter factual, labour productivity actually fell by 15% form 1930 to 1933 and real wages were below normal.
Banking failures and the M1 contraction had a role in the Great Depression but the explanations of their roles are weak
While I agree that raising capital reserve requirements is a necessary tool at the disposal of the Fed, why do they force banks to instantly meet the mark? Typically, the targeted bank must liquidate assets to meet hightened requirements, which subjects banks to price taking on the open market: they must begrudgingly accept the offer (instead of a market) price. At such huge volumes as bank liquidations can occur, they trigger sell-offs and asset corrections that mark lower lows instead of marking-to-market.
Issue a cease & desist order and regulatory monitoring to banks who aren't showing progress in meeting capital requirements after they're decreed, but don't trigger sell-offs and panick among that bank's shareholders by demanding a fire-sale. Yay, nay?
Bring on the new valuations and new owners of these assets!
Starting in earnest with the Reagan Budgets of the 80's, these folks born before 1960 were told we had too much debt, too much leverage, too much borrowing from the future.
But did they find the courage & fortitude to do the right thing? No.
The chose to let the siren call of 'don’t worry, some other generation will foot these bills' seduce them.
And when they saw their own assets balloon in value, they truly believed the lies & whispers that they would 'escape' with all their ass(ets) intact, into a golden-age of luxury or overly-comfortable retirement. Or at least into a comfortable dementia.
The good news is that as the unwinding and deleveraging continues, it keeps everyone’s ‘skin in the game’ and thus puts growing pressures on boomers & their elders (as business leaders, politicians, policymakers, as well as workers & consumers) to come to the ‘negotiating table’ and work on some long-avoided solutions to the problems of household debt, corporate debt, and public debt and unfunded long-term obligations.
It may unfold as one of the rare times that life does something that is ‘fair’.