derryl

Swindlers' Heaven

Thanks for the link John. I printed out the entire 18 page Taibbi article. His investigative journalism has provided what should be indisputable evidence that Wall Street's capture of its regulators is complete. Readers will have to read the article themselves to understand what justifies Taibbi in saying,

"Wall Street has turned the economy into a giant asset-stripping machine, one whose purpose is to suck the last bits of meat from the carcass of the middle class."

"Our economy is so completely fucked, the rich are running out of things to steal."

"If you squint hard enough, you can see that the derivative driven economy of the past decade has always...been about counterfeiting."

"The major players on Wall St, who for years had confined this sort of insider rape to smaller companies, had begun to eat each other alive."

Taibbi shows how naked short selling has become actual counterfeiting of stocks, with "phantom shares" showing up, for e.g., as 1.3 million shareholder votes in a company who has only issued 1 million shares of stock. Bear and Lehman were taken down by counterfeiting their stock and circulating dismal rumors about them.

When the economy started runing out of real investments decades ago Wall St got busy creating counterfeit investments. Mortgages are sold over and over to multiple buyers just like counterfeit stocks create a scenario where 2 or more stockholders both think they own the same stock. This is a whore's nest of corruption on a scale never before seen on the face of our narrow planet, a travesty of Biblical proportions.

I don't even know where to begin suggesting solutions. Annihilation seems to be the only solution sufficient to the scale of the problem.

Financial Greed and Christianity

Did the Goldman guy at least drop a few $billion into the collection box at St Paul's?

On Russia, Sovereign Debt Defaults and Fiat Currency

Alan,
I think the point is that excessive taxation leads to either state default or state money printing. There are limits to the amount of tax revenue any government can collect. Beyond those limits you get currency problems that are much worse than the problems you were trying to solve with higher taxes. Capital flight could indeed happen in the USA, with the same kinds of consequences.

Corrupted by the Treasury

Every system has its own internal logic. Players within that system act rationally towards achieving the system's ends. Competent and ethical players "do good", as defined by moving towards the specified ends.

Treasury officials and megabank CEOs both obey the internal logic of their organizations. To the extent that they achieve their ends they "do good". It is only from an external perspective that we can judge whether their ends are good or bad. If we judge that their ends or the means by which they move towards them have harmful exogenous effects then we say the organization is bad and its players are doing harm, but of course the players inside don't see it that way.

This is why external legislation is required to try to ensure that the ends of organizations like megabanks do not harm the economy or the nation as a whole. The nation is the big picture "system" that all sub-systems operate within and it is in the national interest to regulate and control sub-systems within it.

Some people argue that assisted suicide is a good thing. Others argue that it is murder. We have laws against murder as being contrary to the national interest. We have laws against fraud and other kinds of predatory economic behavior. Murderers and fraudsters are sub-systems that we have decided not to accept, even though within the ranks of the 'murderers' we find many who think their 'victim' needs to die or has the right to die. They think they are "doing good", but we disagree and legislate against them.

This is the context in which financial system regulation should be seen. Obama was duly elected so the ends that his Treasury department are pursuing are democratically legitimate even though many of us think they are wrong. But his Treasury officials are "doing good", so of course they do not come across as evil monsters out to enrich banksters and socialize America.

The correct forum for deciding which ends the nation should pursue is the ballot box. Obama was elected at the height of the panic when nobody knew what should be done. Now that a number of things have been done and we see the consequences we can make a cooler assessment of the kinds of ends we want to achieve and the means by which we should pursue them. 2010 offers the first chance for Americans to express their opinion of the current administration's direction.

Politics is not a consensus-achieving arena. It is where competing opinions battle for the right to try out their ideas as public policy. By 2010 it will be clear enough where Obama's ideas are leading America to. Anyone who doesn't like that direction should get busy laying out a realistic course that can take America in a better direction.

Consequences of Current U.S. Monetary Policy

chap,
Don't be so hard on the young fella. He has his equations right but neglects the real world details that you filled in. It is actually excessively low domestic interest rates that led to the excessive capital formation of US$ among foreigners that is finding its way back into the US system to inflate the asset bubbles.

The money began its life as US mortgages. Artificially low mortgage rates led to excessive demand for real estate. When the mortgage money was used to buy real estate it became incomes in the hands of the real estate, construction and home products industries. Those incomes contributed to excess demand for foreign oil and Chinese consumer goods. Oil exporters and the Chinese then recycle their dollars into US investment vehicles like Treasuries and stocks. So it really is low domestic interest rates that generated the excess demand for investments. As you put it,

"We do not need more funds for investment - we need some viable things to invest them in."

Amen to that.

Have We Reached the End of the Private Sector Economy?

VennData wrote, "Your language "...today, we are literally witnessing the death of the private sector ..." is called hyperbole."

Al Gore thinks "hyperbole" is a perfectly acceptable rhetorical tool when the simple facts fail to motivate the people to believe in your sales pitch. I'm no Gorian or Gorite or Goremonger or whatever Al's fans call themselves and I don't share his faith in the legitimacy of hyperbole, but I don't think Graham is using it.

For over 20 years all the economic growth has occurred in the corporate sector, especially financials, and government. If we describe the private sector as competitive free market businesses who do not receive legislative favors or other forms of government protections, then I think Graham is simply stating the facts. The truth, in this case, is itself hyperbolic.

The Mother of All Asset Price Bubbles.

Kimball wrote, "But how else do we deflate asset price bubbles?"

How indeed. The usual remedy to our kind of wholesale asset inflation is asset price collapse combined with massive bankruptcy and banking system failure and economic paralysis. "Depression". But the world's monetary and fiscal authorities seem determined to keep the bubble pumped up and afloat. Meanwhile, as Kimball observes, the asset inflation is being exported to all countries.

If I was a conspiracy theorist I would think the plan is to wait until everyone's economy depends on the bubble valuations, then let it pop so the world goes into panic mode, then ride in to the rescue with a new world currency to save us all.

Financial Innovation vs. Economic Growth: Scholes and Reynolds vs. Grantham and Me

Thanks for the clear-eyed look into this complex and too often emotionally charged and politicized issue of "financial innovation".

Zero Interest Rate Policy: The Cruelest Tax of All

"Saving" is not an unmitigated good thing. Saving can only generate real returns if it is invested in productive capital formation. The only other ways of getting a return on savings is through wealth redistribution and/or the fantasy return of inflation. Nominally you 'earn' 5% interest, but if your savings did not generate a 5% increase in goods production all you have done is transfer buying power from borrowers to savers, no different than winning bets at a casino. Or someone somewhere added an additional 5% of money into the system to inflate the money supply and devalue your money's buying power by 5%. Without increased real economy production there can be no real return on money. If savers "save" by way of buying some land that they can grow food on and live cheaply they can escape the boom and bust cycles of the economy. There is no other way.

Sarel wrote, "I want to concentrate on the tax though the plight of the saver haunts me when I interview desperate pensioners who are forced into risk assets in the hope of making up for a loss of interest income. Often they lose capital in this game of risk taking with savings, into a downward spiral of despair."

This is the ancient conundrum of "excess savings" or a "savings glut". It is why the Hebrews instituted "Jubilee Year" every 50 years, to clear out the imbalances that inevitably develop due to the fact that some people are very good acquisitors and they end up owning everything. Read the prophet Isaiah who lived about 650 BC, "Woe to you who add house to house and field to field until you live alone in the land." Isaiah is talking about "savers" and "investors".

If there has been so much monetary accumulation in the hands of savers/investors that the amount of money is greater than the amount of productive investments to absorb that money profitably, profit levels and interest rates shrink. John Stuart Mill describes this in "Principles of Political Economy" published in 1848:

After a good economic run savers end up with lots of investable money competing for a limited stock of profitable investments (over time technological advances increase the stock of profitable investments, but in the short term we can assume stasis). Investment demand becomes too high, so in an attempt to gain acceptable levels of return investors turn to speculative ventures.

For awhile this can fuel asset price inflation and some gains for those who bought early and sold late, but ultimately there comes a "revulsion" in which all of the misallocated money is lost by the speculators, asset values collapse, and the economy eventually starts up again from a lower price level. The economy can only recover after those excess savings are redistributed via malinvestment and loss. The savers lose their money.

Mill is writing about England's gold standard economy of the 19th century so there is no question of QE or other species of money creation confusing the mechanics of this 'capitalist cycle'. The supply of money is assumed to be fixed throughout the cycle.

Sarel wrote, " I have concluded that a deflationary depression will follow once the debt channels for private and public debt becomes saturated with the economy stuck in stasis. The deflationary depression can be converted into a hyperinflationary depression with concerted central bank money creation and particularly Quantitative Easing which will “inflate away the debt” at the cost of economic structural destruction (a very high price)."

This is the phase of Mill's capitalist cycle that our monetary and fiscal authorities are currently desperately trying to prevent. To purge the malinvestment we have to accept Andrew Mellon. "Liquidate them all. Purge the rot from the system." The values of all those speculative assets--in our case houses and stripmalls--collapses. Anybody who invested in them goes broke and loses everything. You get a deflationary depression. Or if the government chooses to avoid that route via excessive QE, you can get a hyperinflationary depression. Bernanke and friends are trying to discover a middle way that does not include "depression" and I hope they succeed. But maybe it's not possible, I don't know.

If "poor pensioners" did not accept .25% interest from their bank and joined the speculators to try to get higher returns, in a world where there was too much money chasing too few real investments, then the poor pensioners get liquidated along with everyone else. After all the speculative money is wiped out and asset prices and the economy collapse, the economy can begin to offer some real investments again and a new round of economic activity and capital formation begins. It will end just like all the other rounds have ended, in tears.

Money is just numbers. Unless it is employed to generate real wealth money is sterile. Money in a sock generates no returns. Money in an unbalanced economy, where spenders have no money to spend and savers want to invest rather than spend, generates no spendable incomes and thus no demand for consumption and business capital formation and thus no returns. "Saving" is not an unmitigated virtue. At the micro level of individuals it is virtuous and prudent, but at the macro level of the economic system it is fatal. Hence Keynes' "paradox of thrift". Whatever else Keynes was wrong about, he nailed this one.

What Rebalancing of Chinese and American Consumption?

It's not just China that needs a more balanced distribution of the national income. Since 1982, the "Great Moderation" era, virtually all of the gains of globalization have concentrated into corporate profits. Poor workers do not own stocks and earn dividends. It is disproportionately people who already have significant savings/investable 'excess' incomes who share in the corporate profits.

So as Mt. Pettis says of China, a better distribution of dividends merely puts more money in the hands of people who already consume as much as they want to. To revive the consumption levels that ultimately drive economic production a nation needs a large portion of its population earning enough money so that they can save what they feel is prudent and still consume enough to absorb their nation's productive capacity. The alternative is trade imbalance where you have to export the 'excess' production, which is just another way of saying workers are not paid enough to buy what they produce.

Henry Ford had the right idea, the idea that built America's middle class--the people who built American prosperity. Ford wanted his workers to be able to afford the cars they built. It's the right goal if you want a sustainably balanced economy.

Ford's workers could afford cars on their earned incomes. Great Moderation middle class Americans could afford cars only by taking on debt and spending more than they earned. They borrowed that 'excess' consumption from their own future, the future where they have to consume less than their income as they devote more of their earnings to repaying their debts. That future is now.

I have no sympathy for people who leveraged their lifestyle to include an Escalade in the driveway of their McMansion, and who are now suffering the inevitable paying of the piper. But in our credit driven monetary system SOMEBODY has to keep taking on new debt or else the system seizes up, due to leakage of money out of the borrow and spend, produce-and-consume economy and into financial markets and other monetary eddies that absorb but do not release trillions of dollars of 'investment' money. Savers end up with all the money, spenders end up with all the debts, and money ceases flowing which seizes up the economy.

An alternative solution would be a monetary policy innovation by which debt-free money is released into the system at whatever rate is found to be beneficial via a program of naked money creation by the Fed and Treasury. From "lender of last resort"--creator of even more debt to add to the already unpayable debt levels; the Fed would become free money creator of last resort. As long as the money was directed towards people who would spend it--poor people and the overindebted middle class--it should stimulate the real economy and allow for significant household debt deleveraging.

Of course this money would also ultimately end up in the hands of people who save and invest rather than spend it, which would merely exacerbate asset inflation and lower interest rates due to "excess savings", but Mr. Pettis has touched on some of the fiscal measures that are capable of dealing with that aspect of the imbalance problem.

Will Canada Be Next to Raise Interest Rates?

"A few weeks ago, Canada’s big banks raised mortgage rates.

I suspect this was done at Mark Carney’s request. A brilliant move IMO. It put’s a lid on Canada’s housing bubble, while at the same time keeping rates low for the broader economy."

A few weeks ago I opined that the B of C was not even trying to slow the loonie's rise because it would be too expensive to buy enough greenbacks and futile in any event. The next day Carney jawboned the loonie down by a full cent, and he has subsequently talked it down even further.

I share your theory that Carney may have persuaded the bankers to raise mortgage rates ahead of what may be a far-future B of C rate increase. The housing heat can be doused without harming exporters. This is monetary fine tuning. Carney is proving to be a master at his trade.

ChiNext: A Wild West Poker Table

Well, that $1.2 trillion in new money the Chinese banks lent out in 2009 had to end up somewhere. "a V.I.P. table built on top of a casino" sounds like a sure bet to suck up a goodly share of it. Gentlemen, place your bets.

"a V.I.P. table built on top of a casino". I love that line!

After Securitization: Who Owns America Now?

Great article Andrew. A very crisp perception of our recent financial history, starring MBS and its red headed stepchild CDS, and brought to you of course by the good folks at GS et al.

Re: Banker's Pay - The Paper of the Year

"Now in one sense the defenders of high Wall Street pay are correct: people are probably getting roughly what they could make if they walked across the street and went to another bank. But that doesn’t answer the question of whether the whole industry is making a mistake and transferring wealth to employees that should go to shareholders."

All oligopolies tend to harmonize both their cost structure and their pricing structure. Oil companies pay essentially the same rates for exploration leases and the same rates for office space and they pay the same rates to drilling contractors and they offer essentially the same compensation packages to their employees, and they charge the same prices for gas at the pumps. But it has NEVER been the case that 1000s of employees of a single oil company ALL receive an average of $600k 'bonus' for a single year's work.

Yet Goldman Sachs is able to do just that. Among oil companies there is at least a passing degree of competition that keeps prices and employee pay realistic. If the oil industry shared a new miracle technology that allowed them to produce the same amount of energy at one one hundredth of the cost then maybe for a year or two they could pay all their employees 6 figure bonuses. After that they would either drop the price of their energy to match its new low production cost, and eliminate the 'bonuses', or they would be nationalized and clawed back and lynched and drawn and quartered, just as a warmup to the real nastiness they would be subjected to.

Wasn't it you, James, who explained that prices in an efficient industry go down, in contrast to finance where prices for services keep going up? If the megabanks justify their bonuses on the grounds of how productive their workers are, then wouldn't those benefits disperse into the broader economy over a couple of years by way of lower prices and a reversion of megabank profitbability back down to reality?

The only other economic sector where prices and wages always go up is government, and they do it by exercising monopolistic power over us backed up by the exercise of deadly force. We didn't elect the megabankers. We have the right and the obligation to regulate them. We do not have to let them financially pillage our economy and share the spoils among themselves. It's bad enough having elected governments doing that. We don't need private sector copycats.

Breaking Up the Big Banks: Ackermann vs. Hoenig

Many commenters have been pointing out that we're barely into the first stages of this financial crisis. First came the desperate bailing out of the sinking ship of finance. Now that the threat of imminent catastrophe is past we are starting to take a cooler look at what caused the crisis and how to ensure the ship is made more seaworthy.

During the early panic phase the money center banks were indeed too big to fail, we had to keep the ship afloat. But now that the ship is floating the consensus is emerging that a main contributor to the severity of the crisis was that the financial system was way too top heavy. The listing of just a couple of the too bigs threatened to capsize the whole boat. The solution is to reduce their height and spread their mass around more evenly. These behemoths are not seaworthy. They need to be broken up and their business spread around more horizontally.

We tried big and in the past 10 years, after Glass-Steagall and other limiting regulations were repealed, we tried too big. We were told that economies of scale enjoyed by too big banks would make our financial ship more seaworthy, not less. They were wrong. They nearly sunk us all. I think we can now safely agree with Mr. Johnson and Mr. Hoenig. "Too Big Has Failed".