Market Currents
"Austerity doesn't work," is Paul Krugman's mantra, but was there an alternative? Yes, he says,...
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Friday, October 28, 2011, 2:47 PM ET"Austerity doesn't work," is Paul Krugman's mantra, but was there an alternative? Yes, he says, pointing to Iceland’s success: "Where everyone else bailed out the bankers and made the public pay the price, Iceland let the banks go bust and actually expanded its social safety net... It has managed to limit both the rise in unemployment and the suffering of the most vulnerable."
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This news story has 16 comments:
Every time I read Krugman, I feel like I'm dumber afterwards!
Your point is well taken. It is one thing for Iceland, a country with a population and size of economy comparable to a middle sized suburb of one of the second or third ranking US cities, to allow its banks to experience the full fate of the free market on failure. In these circumstances Iceland suffers significant economic disruption in the short run but stabilizes and resumes growth quite quickly thereafter. The world at large, however, doesn't by reason alone of the failure of Iceland's banks suffer a general disruption of interbank credit or of the availability of customary credit to credit worthy governments, corporations and consumers without which the modern global economy quickly grinds to a slow crawl (aka. a horrendous deflationary depression of extended duration).
Possibly Ireland could have followed a similar course in 2008 to that of Iceland without undue impact on the EU and global economies (although, being economically somewhat more than 10 times the size of Iceland and with several German, UK and other EU based major banks holding significant Irish bank bonds, the impact on the EU and global economies, and therefore back on Ireland itself, might have been significantly more pronounced than the Icelandic example suggests). Once we are talking about a larger economy with a correspondingly larger banking system intertwined with the global banking system, the analogy to Iceland weakens corresponding to the size differential.
It might be noted that Sweden, an economy well over twice the size of Ireland's, carried out a successful exercise analogous to bankruptcy for its banks when those banks failed as a direct consequence to default of sovereign debt holdings of Soviet bloc with the collapse of communism. However, Sweden did not follow the court centered bankruptcy route contemplated by free market proponents. In stead, it nationalized the banks, assumed their obligations (but not those to shareholders or bondholders with minor exceptions) most of which were to Swedish nationals and corporations, kept the banks and in particular the banks' credit facilities in full operation throughout and ultimately restructured, recapitalized and privatized these banks.
In short, as you might say, we make a serious error in comparing oranges, apples and pears in this context.
That being said, to have a free market, the speculators that make bad calls must be allowed to fail. The alternative is a never ending series of crises, requiring ever larger band-aids, as the speculative banks realize they are free to enjoy high risk profits, but are insulated from their losses.
will he go away?..I consistently wonder whether he is stupid or just pretending to be stupid..
What he doesn't seem to grasp is that there is a second serious problem called 1.4 Trillion deficit and 14-15 Trillion national debt.
So, yes the banks should have been allowed to fail. Set up a Resolution Trust authority to sell off the assets. Let the bondholders and shareholders lose all their money.
But thats apples, the national debt and the size of government is oranges as Herman Cain would say!
Cut the damn government spending and then we will be in position to actually grow again. As long as we keep making our children and grandchildren poorer there won't be an atmosphere and conditions that facilitate growth - and Krugman doesn't seem to understand that government doesn't create jobs, only the conditions that facilitate their creation.
We need to have the TBTF banks write Living Wills so that if another financial crisis hits, we will have an orderly and pre-planned way to close them down, sell their whatever assets they have, and avoid any political lobbying/in-fighting since their fate will have already been pre-determined if we reach such a stage again.
What do people think about bringing back Glass-Stegall and only allowing the new issuance of credit default swaps for entities that have actually lent money to or have borrowed money from a specific bank or insurance company (such as AIG)? I see no reason why a hedge fund should be able sell or buy CDSs on, say, B of A unless they lent them money or borrowed money from them. The nominal amount of outstanding CDS contracts is in the 70 trillions right?
CDS are impossible to regulate, unless every global financial centre decides to regulate them. I think a more workable solution would be to require financial companies that play in CDS markets to hold additional collateral. Just the need to hold collateral will curtail CDS activity, or at least slow down the pace of some of the riskier bets.
Notional annual CDS, according to DTCC, was 1.84 quadrillion in 2008. It dropped quite a bit in 2009 and then has been gaining in 2010 and this year, though still not quite at 2008 level. Confidence in the CDS market, and threat of regulation, held back activity.
Also, per your background, do you think it's good to be long RIG?
Transocean Rig (RIG) is still in need of some internal improvements to their management structure. They definitely have potential to do better, though it remains to be seen how fast the global offshore market grows. Compare their operations to Ensco and Seadrill, then weigh the revenue growth and back-log growth. At the moment I remain in Seadrill, though I am looking at more offshore construction companies.
1 Is the exchange traded solution, exchanges have tiered systems between themselves, the clearing houses and the investment banks. Each step in the system has collateral requirements, and the exchanges are known to require curious things like actual assets and funds to repay notes issued.
2. The second is a tiered CDS Solution. Non exchange traded CDS, can only be written for the first 10% of losses. This would allow investment banks to speculate all day long on any instruments' repayment probability while still allowing leverage.
A second tier of CDS can only cover 20% of losses, and those must be issued by insurance companies which fall under tight regulatory requirements, and the third tier for the final 80% can can only be written by re-insurance companies under much stricter guidelines.