Matthew Klein has a great, last post up over at Free Exchange.
It’s a frustrating post, because it lays out many of the themes and ideas which are floating around the world, and tries to tie them all together into a coherent whole that explains everything. It’s a long post, with lots of great charts – a must read for everyone interested in the economy.
I can’t disagree with any of the facts laid out in the post, but I will disagree with the “Doomed to Fail” premise. I don’t know what “Fail” means in this context. Minsky’s idea is restated by Mr. Klien:
“ I am sceptical that any central bank is capable of fulfilling its objectives over any meaningful length of time because, as the late Hyman Minsky explained, lower observed macroeconomic volatility in the short term encourages greater financial risk-taking. Thus, the longer the perceived good times last, the more fragile the economy becomes.”
Here is more directly from Minsky:
“Credit is the oil that makes the economic machine run more smoothly. But unless it is sufficiently well anchored, credit creation can also support unsustainable paths…Like a piece of rubber that stretches too far and eventually snaps, the self-reinforcing interaction between credit creation, asset prices and the real economy can lead to a build-up of financial imbalances that eventually derails economic activity.
The problem is that we don’t bother, not that we can’t bother. The interaction between credit creation, asset prices, and the real economy isn’t some obscure mystery, it is kinda known, or it should be known.
Most private credit creation in the United States uses real estate to back this credit. We just hide this relationship rather than be explicit about it. Banks mostly lend money to the non-financial sector against real estate and capital improvements.
“Most private credit creation in the United States uses real estate to back this credit. We just hide this relationship rather than be explicit about it. ”
Agreed, and if we effectively regulate it, ‘failure’ need not be an option, e.g.: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2215422. Also good calls from folks like John Geanakoplos re regulators monitoring and targeting systemic leverage.
P.S. Imagine if the utility sector had gotten away with the kinds of deregulatory shenanigans the financial industry did in the last 20 years…oh wait, Enron. Never mind.
As I look at the picture more, I think some huge amount of the criminal element of banking could be ended with a few small reforms.
1. end the carried interest tax advantages
2. make 20% down on residential real estate the law in the U.S.
3. Enforce existing SEC laws
4. raise the capital gains tax to match person income.
5. Lower personal income taxes
These doesn’t solve every problem in the world of banking, but it solves a bunch. Taking away the tax advantages of being a hedge fund manager makes it much less attractive. Taking away the tax advantage to capital accumulation makes the money flow around the world better.
Most bankers aren’t criminals. Even the ones that “stole” a ton of money aren’t really awful people. They were playing within the rules of the system, pushing them a bit.
I really think slight modifications to the rules of the system would have outsized impact on the accounting and economic profits flowing to banking.
What’s the obsession with hedge funds? Hedge funds are attractive to run not so much because of the lack of normal tax rates on carried interest (although that’s a nice plus) but because of the massive fees generated by 2 and 20. However, Paulson didn’t step in and through billions at hedge funds, it was thrown at regulated banks, brokers and AIG. I’m not aware of any government bailouts for hedge funds and nobody is forced to invest in them. The fees are already falling because the performance no longer justifies the 2 and 20 fees. It’s sounds nice to attack those hedge funds, but what’s your real gripe? Other than that, I like your list….
Sorry, throw not through…
Hedgefunds use a lot of leverage to speculate with don’t they? Wasn’t lending to hedgefunds that then imploded part of the reason that the banks needed bailing out? Doesn’t the leveraged speculation that hedgefunds conduct lead to economically damaging price volatility? I thought that the Asian financial crisis of 1997 was basically concocted by hedgefunds with Soros at the helm. That was just my impression, I’m happy to be corrected.
Hedge funds don’t use nearly as much leverage as banks did and do. Hedge fund implosions did not cause the banks to require bailouts. It was their own over-leveraged balance sheets that did them in. Likewise, hedge funds didn’t cause the Asian crisis in 1997. Where are you getting your info? You are overestimating their power and impact. In addition, hedge funds taken as a whole are less volatile than investing in the stock market for instance. Again, no hedge fund has even been bailed out with taxpayer money. The Feds did organize a bank buyout of LTCM but didn’t supply the funds.
Even if a hedgefund is less volatile overall than stocks are, its action may move the markets that it trades in such that they become more volatile? Also day to day volatility isn’t what matters – what matters are the extreme price movements when things go wrong.
Is this nonesense ? :
http://www.eurekahedge.com/news/07_nov_Livemint_Games_hf_play.asp
There were bubbles and crashes long before the words hedge fund even existed. The article you linked to may or may not be accurate, but any central bank that pegs their currency to another currency is taking a big risk and is involved in manipulating their currency. Is it okay when a central bank manipulates their currency but not okay when someone else does?
Also, FWIW, pension funds as a group are much bigger than hedge funds. Their trades may move markets too. Do you want to regulate their trading also?
My impression was that pensions funds don’t get a margin call that causes them to sell a market moving amount into a crash. I sort of thought pension funds were the whales that lumbered about in a harmless way and hedge funds were the sharks that fed off of them.
Joyce I agree that currency pegs are a bad idea but I guess sometimes they do facilitate trade and so may be done for well intentioned reasons?
I think you have somewhat of a comic book view of hedge funds with massive leverage roiled by margin calls. BTW, most pension funds actually invest in hedge funds to a degree and they do that primarily for diversification. So banning or crippling hedge funds is not something pensions would probably support.
Joyce Matthews, as I said, I’m happy to be corrected. LTCM perfectly fitted that comic book view though didn’t it?
If you mean over-leveraged, absolutely. But again, taxpayers didn’t bail the “geniuses” out so only its investors lost money which is the way it should be.
“Hedge funds are attractive to run not so much because of the lack of normal tax rates on carried interest (although that’s a nice plus) but because of the massive fees generated by 2 and 20. ”
True, all true, but carried interest + low cap gains tax rates really promotes Money Manager Capitalism, where the smartest people want to be hedge fund managers.
Eliminate the carried interest and then also raise cap gains, and all of a sudden hedge funders aren’t worth $4bn, they are worth $1.2bn, like other normal rich guys who start productive businesses. Lots of the people go into finance because the payoff for being good (or even just lucky for a few years) is so high.
Also, capital gains for different uses of capital could be taxed at different rates. The tax code is already extremely complicated, I am quite sure someone could figure out how investments in new factories could be taxed at a different rate than investments in equities.
Joyce
“I’m not aware of any government bailouts for hedge funds and nobody is forced to invest in them”
Maybe not directly, but you are surely not claiming that when the goverment bailed out GM, which then bailed out Delphi, Elliott Management did not profit from it.
Especially since the government’s Pension Benefit Guaranty Corporation took over paying all of Delphi’s retiree pensions. The cost to the taxpayer: $5.6 billion.
How fortunate for Paul Singer to be able to leverage into this position. I am sure he was just in the right place at the right time.
Michael
Some great starting points
2. make 20% down on residential real estate the law in the U.S.
This IMO has a much more important role, even if you remove all the criminal element of banking, the sector is still fragile if the hypocated assest backing the banks asset does not have a reasonable haircut.
It all ties back to a point I made before
“The fundamental cause of instability is the feed-back loop caused by debt use to speculate on rising asset prices. As an asset price rises, which makes the asset a better form of collateral, in turn increases the demand for more borrowing based on that collateral, which in turn boosts the asset price.
This feedback loop requires fuel to maintain and or accelerate its growth. As with all debt the main fuel is income, but this is always relative to amount of leverage a lender will allow the borrower to have on the collateral and the rate of interest they charge for the debt.”
Number two could be constructed as the maxium loan value is 10x the yearly rental equilvalant of the property being bought. Cash would have to be put down on any price above this amount.
“ I am sceptical that any central bank is capable of fulfilling its objectives over any meaningful length of time because, as the late Hyman Minsky explained, lower observed macroeconomic volatility in the short term encourages greater financial risk-taking. Thus, the longer the perceived good times last, the more fragile the economy becomes”
This reminded me of something…
“Prescribed fire (controlled burn) is used to reduce the risk of large catastrophic wildfires and increase public and firefighter safety, as well as meet a variety of resource management objectives. This planned ignition allows agencies to reduce hazardous fuels and restore habitat and ecosystems.”
http://www.blm.gov/or/resources/fire/prescribedburns/
Maybe the govt has to set off controlled burns in the economy once in a while (prescribed volatility, let’s call it) to prevent the economy from getting too fragile.
Joe Weisenthal is hyping the pre-taped debate between Krugman and Scarborough on Charlie Rose tonight. Krugman wrote in to do a fine bit of expectations lowering and mentioned this, “Oh, and Charlie raised the damned Reinhart-Rogoff 90 percent.”
Reference is to R-R theory that once a country’s GDP debt ratio exceed 90%, its population soon after is killed off by rabid wolves (however I might be confusing their thesis with this book).
http://www.nytimes.com/2012/07/17/science/searing-narrative-of-rabies-and-the-desperation-to-forget-it.html
Now THIS is a talking point.
The debate over federal government deficits and debt has consumed Washington for some time, but the arguments for the most part have focused on taxes and spending. One aspect, however, of the debate of American creditworthiness that doesn’t get discussed is what assets the federal government owns. After all, a borrower’s assets should be one of the main factors in determining the wisdom of its borrowing, but when talking about the U.S. government’s debt burden, it seems to get left out of the conversation entirely. And a recent report from the Institute for Energy Research (IER) makes some startling claims about how much U.S. taxpayers own in real assets. According to the report, the U.S. government owns:
More than 900,000 separate real assets covering more than 3 billion sq. ft.
Mineral rights, on and offshore, covering 2.515 billion acres of land, more than the total surface land in Canada
45,190 underutilized buildings, the operating costs of which are $1.66 billion annually
Oil and gas resources on and offshore worth $128 trillion, roughly eight times the national debt of the country
http://business.time.com/2013/02/05/the-federal-governments-128-trillion-stockpile-the-answer-to-our-debt-problems/?iid=obnetwork
If only we could find a way to use this wealth. Perhaps we could issue more debt or even a TDC or two.
Also, we need to remember according to Laurence Kolitkoff, we owe $100tn. That means we only have like $28 trillion to play with before we are flat busted.
And that doesn’t include the nation’s human capital stock (aka the taxpayers) which is itself hundreds of trillions of dollars, nor does it include physical capital or real estate or financial assets.
The country’s debt to assets ratio is so ridiculously low, its insane we have so much deferred maintenance of infrastructure or that Congress spends more than 10 seconds worrying about the deficit.
Clipped to Evernote. This is worthy of post, if you are open to suggestions. This nonsense comes up so often that having a link documenting the numbers would be useful.
Imagine the marginal change in value if the stock of human capital were fully employed…
Right, I think it was Keynes who made the point that no business would leave its its physical capital out in the rain to deteriorate in the way nation’s leave its human capital unemployed.
Thanks for the kind word Tom, I will make a post out of it.
Great analogy by Keynes there. I hadn’t heard it before. Bill Mitchell really drives that point home in his analysis of the consequences of unemployment, especially long term.
I think pension funds are at fault for allowing hedgefunds (and leveraged buyout funds too) to position themselves as parasitic middlemen between the pensioners and the underlying revenue stream from the underlying companies that ultimately the pensioners own. Pension funds ought to have ensured that companies are run so as to maximize earnings along an “infinite time horizon” and pay out all excess earnings as dividends so that they are received equally by all shareholders however dumb those shareholders may be. Instead all shareholder “activism” has been conducted by hedgefund managers whilst the pension funds have just rolled over and offered their belly to the wolves so to speak. As a result companies spend earnings on stock buybacks and shift the capital structure from equity to debt. To me that seems all about ensuring that the underlying revenue stream can be creamed off by those few canny shareholders who are trading most astutely. It is about converting a potential dividend stream into share price volatility. Then the pension funds own a stock who’s price bobs up and down with no overall gain and minimal dividend stream. The hedgefunds though capture that price volatility.
Not to let the financial industry off the hook (“more trouble than it’s worth,” to quote Mosler), but I think you’re really overstating certain features of it. The pension-fund and private-investment-fund worlds are fairly complex ecosystems.
I thought that an asset tax would cover that because “real investment” at least initially results in money being spent down to pay for wages, materials etc. Only if it turns out to have been a good investment does that manifest as an increase in asset value. By contrast if the money is spent purchasing pre-existing assets, then the asset value is high all along and so exposed to any asset tax. Its not just factory building – spending money on training or research and development are perhaps even more subject to that effect. From a financial point of view it currently makes more sense to just buy a pre-existing asset such as a stock or bond but doing so does little to ensure that the economy of the future will have the real capacity to meet that financial obligation in the future. I think an asset tax would mean that holding pre-existing assets would loose the perverse financial advantage as compared to the enterprise risk of real investment.