Opps!... I did it again.
Can't you see that I'm a fool in so many ways?
But to lose all my senses?
That is just so typically me.
- Britney Spears.
Over the past few weeks Martin Lowy and I have been jousting over the conditions consistent with financial crises, and the extent of government's role ex ante and ex post.
I find that when discussions reach such an intricate level, misunderstanding often is the result of a lack of careful semantics. Let me begin by taking more care with the word "cause." In the philosophy of science, notably in the work of Bertrand Russell, the word has been trashed. In Russell's words:
The law of causality, I believe, like much that passes muster among philosophers, is a relic of a bygone age, surviving, like the monarchy, only because it is erroneously supposed to do no harm.
The modern use of the word, due to econometrician Clive Granger, transmutes causation to a humbler "Granger-causing" event or events in advance of another "Granger-caused" event. Granger causation is characterized by the presence of correlation between early instances of the g-caused event; but an absence of correlation of the G-caused event in advance of the G-causing event. I haven't done the statistical work in the case of government intervention and financial crisis so I'll drop the word.
My view of Government culpability: The implication of Russell's repeal of causation for this debate with Lowy is that my opinion regarding government error and government success, expressed more correctly, goes something like this:
Government decisions that alter the allocation of resources in an inappropriate way, namely: without a vote in which a majority of voters chose, though their elected representatives, to overrule market allocation through transfer payments; are often one of the significant factors altering resource allocation in advance of a crisis. They are never the sole factor misallocating resources. In other words, government is never the sole cause of a crisis. It's a major contributing factor.
Human aggressiveness and attendant error are always a factor as well. The human factor is inevitable. The government factor is to be resisted.
On the other hand, following a crisis, government payments to facilitate the survival of financial institutions are a necessary condition for a minimum loss of permanent income.
In this light, the decision to let Lehman Brothers fail was badly mistaken. The information necessary to conclude that if provided funds, Lehman could not have repaid them, was simply unavailable. Ergo the disastrous costs of the Lehman failure did not have sufficient payoff in terms of prevention of moral hazard.
I find the principals' apology for their actions in letting Lehman fail during the Crisis insulting. Unanimously hiding behind the argument that funding Lehman was not within the government's power is transparently duplicitous - as proven in the equity investment in AIG weeks later. That the principals actually include this illegality argument in their memoirs is testament either to self-deception or a mistaken underestimation of their readers.
Thoughts about Dodd Frank and the Rescue. Dodd Frank gets lumped together with the disposal of assets during the aftermath of the Crisis, including by me. But here let me separate the two more carefully.
The disposal of assets: One can debate whether several specific transactions at the outset of the crisis were government-motivated, or decisions of private sector financial institutions. While the Wells Fargo (NYSE:WFC) acquisition of Wachovia clearly was Wells-motivated, other deals such as Bank of America's (NYSE:BAC) acquisition of Merrill Lynch seem to have been conducted under government pressure; likewise, JP Morgan Chase' acquisition of Bear Stearns.
Dodd Frank: So at the outset of the crisis, government decision-making encourages and abetted, at minimum - more likely demanded - the creation of much larger banks. It then proceeded to rail at their own creation, "Too Big to Fail!" And pass a bill that assures the Big Boys continued size and longevity, but by stuffing both sides of their balance sheets with assets producing anemic returns, also minimized the likelihood that anything productive would be the result of these activities.
This is all much to the glee of the senior management of said banks. Now it matters little what they actually decide, since there is so little left to decide. Yet, since they are managing such large entities, their compensation must be of commensurate size.
And, to cap the whole thing off, as Lowy and others suggest, the Fed's Comprehensive Capital Analysis (CCAR) should, as Dodd Frank mandates, include scenarios chosen by the Fed. Why? Because we must protect the Big Boys from their ignorance of likely future risks. The Fed is much better at predicting the future, goes this argument. Let me provide you with a fine example of Fed perspicacity: the negative interest rate scenario the Fed includes as a CCAR scenario. In my opinion, to the Fed, CCAR is a parlor game.
What is the sum total of the effect of Dodd Frank?
First the positives, about which Lowy and I agree. Flooding the banks with federal liquidity was not a bad idea at the outset of the crisis, as a temporary companion to a temporary set of Bernanke Fed-inspired monetary policy initiatives. We are agreed that the combined policies put domestic economic growth on a plane above that of the rest of the world during the past decade.
Then the negatives, about which Lowy and I differ. My characterization of the negatives is that Dodd Frank and the Bernanke monetary policy initiatives were "sticky." Like Br'er Rabbit's experience with the tar baby, once attached to all these government loans to support government-approved activities, it's difficult to get un-stuck. We have created something very close to Minneapolis Fed President Neel Kashkari's heart's desire: government utilities, not the aggressive risk-tolerant innovative financial institutions that create increased economic growth - and sadly, in this veil of tears, necessarily creates associated future financial crises.
But no matter. As we discuss this topic Risk is having its way. It accommodates the investors of SA, who seek alpha. It will find a home somewhere in our financial system. Among the spinners of ETFs, such as BlackRock (NYSE:BLK) and State Street (NYSE:STT). Among the thousands of FinTech startups. In the markets for common shares, fixed income, currencies and commodities. Where there is human ambition, there will be risk.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.