naked capitalism

Anonymous says:

Yves,

I interpert the utility model to be an approach not yet tested because there’s never been a GSE regulator that wasn’t either weak or weak and politicized (see 93 page IG report a few years ago). Incompetent regulation and unchecked GSE arrogance allowed shareholder greed to swamp the social mission, eveidenced by eventual yield chasing buying of Alt-A and some 100% LTV loans. A utility would increase capital, lower growth expectations (minimal capital appreciation) with a modest dividend to shareholders. That has never been attempted and is entirely feasible. It is the old model in the sense that a commission would be more likely to bring into proper balance the profit-mission hybrid. The “flawed” model was allowing shareholders/mgmt to pitch the company as a growth stck. The regulator should/could have put the kabash on that in the 1990’s. Also do not forget, the banks– even before Paulson– were giant GSEs themselves in the manner of deposit insurance and lemming-like behavior (group think and market share whoring). This reminder should temper the demonizing of the GSEs that’s fashionable these days.

johnatcift says:

helpful to read the complete speech from Bernanke addressing the UC Berkeley event

http://www.federalreserve.gov/newsevents/speech/bernanke20081031a.htm

doc holiday says:

Yves,

It is nice to hear you and to read your introduction here! I agree that to synthetically support losses at the casino and to substitute free market illiquidity with artificial government bailout cash is absurd. The Fed is hellbent on buying time as it panics week-to-week and in so doing, they are essentially using every page in Japan’s 13 year recession as fast as possible. Thirteen years of denial to ignore market corruption and to keep the powers that be, connected to the same casino is just a reenactment of the same code of criminal conduct that got us into this mess.

It seems to me, that buying time has the same exact cost as accepting reality now, but for some reason the concept of the future provides the mechanism for both past and present denial. Reality is being exchanged for fantasy!

wintermute says:

I am stunned at witnessing Bernanke’s incomprehension of the root cause of the credit crisis. A few weeks ago we were shocked when Bernanke revealed that he thought the Fed could control commodity prices.

Now “shocked and stunned” can be conflated to a general condition: “Bernankeosis”

Definition: An affliction of the mind characterised by thought processes overwelmed with self-delusion, grandeur, and pseudo-scientific logic.

Example: vast amounts of cheap credit made housing prices go up – so vast amounts of cheap credit must be the solution to a housing crash.

Small l says:

You know, at some point people are going to have to face up to one small fact. You need people with income to buy goods.

Isn’t globalization wonderful. The jobs have been taken to china the consumption has been left in the USA. That would have all been OK if the consumers where left serving fries for reasonable wages.

Didn’t happen. It just might be the case you need unions to protect capitalism from itself.

luther says:

“Protect the core banking system”

but what if the core is rotten?

luther says:

“the food is fantastic”

yeah, but their food was fantastic way before the recession.

not so in the US…unless you live in a place that has fantastic japanese (among others) food.

(sometimes globalization is wonderful indeed)

otherwise, excellent point. japan in so many ways has become the usa’s future. the usa is still bound with them from our recent past. and there is still a day of reckoning awaiting between the two.

fresno dan says:

You can amputate a leg with a stroke of an axe, or do it with a rusty spoon. If you have to do it, people will choose the axe. But the rub is that people will say that you don’t really need to do it. We will do the Japan thing cause its the easiest thing.

Tom K says:

There’s something fundamentally wrong with the Fed as chaired by Bernanke. The last time I checked one of Fed’s 2 top mission is to protect the value of the US dollar by controlling inflation. Clearly the Fed has failed miserably in this mission. Which is bad enough. But lately all I heard is the Fed bail this out and bail that out. Who the hell Bernanke thinks he is? He is not charged to bail anything out!! He does not run the darn economy. He does not work for Paulson. His only job is to manage money supply and short-term interest rates to the banks.

john c. halasz says:

The GSEs were privatized due to smoke-and-mirror budgetary operations during the Vietnam era, to disguise the guns-and-butter dilemma, the same sort of operation that added SSA to the “unified budget”, which later, without malice aforethought, allowed the SSA funds to be looted in favor of tax cuts for the wealthy. In other words, there never was any good economic reason to quasi-privatize FNMA. So rather than returning them to the status of a publicly regulated private utility, why not rather “de-privatize” them,- (yes, I know the jokes have already been made),- and convert them into publicly owned utilities, (a model that has often worked much better in the past)? There would still be problems of adequate regulatory oversight, but it would be much more explicitly in the public domain and, for both domestic and foreign interests/constituencies alike, much more disciplined by relevant constraints.

A few weeks ago, I left at another site the following as a part of a longer comment:

“One more comment. The concept of insurance for credit or other financial assets doesn’t make basic logical/economic sense. Insurance depends on investing risk-adjusted premiums in financial assets to reserve against contingent liabilities as they arise, which contingencies must not be correlated with those of financial investments. But, of course, financial investments are correlated through tightly coupled financial markets with other such assets investments, and when the “insurance” is most needed during a financial crisis,- (which is not a 1 in 1000 year occurrence, but, in varying degrees, more like a 1 in 12 year event),- correlatively depreciating various asset classes, those very assets must be sold by the insurer to pay-off default claims, further adding to the downward pressure on asset prices and triggering still more defaults, thus amplifying rather than insuring against the problem. On the other hand, the illusion of such insurance generates moral hazard in the exact, proper use of the term, encouraging financial “players” to take on higher levels of risk, since it has been ostensibly laid off on other parties. (This is slightly different than the point about CDS’s being not true swaps, like interest-rate or currency swaps, but actually, as everyone knows, unregulated insurance contracts thinly disguised as swaps, which, as everyone knows, is insanely dangerous).”

My point was that there is no basic way to insure investments in financial assets, other than through an adequately diversified portfolio, and even that will be imperfect, since there is no investment without risk,- (and those risks ultimately derive from the uncertainties of real investment in the real economy, which the financial economy can, at best, imperfectly mirror and transmit). I seriously doubt that the whole “world” of derivatives, transferring and reallocating financial risks can allieviate that fact; to the contrary, they multiply (the assessment of) such risks, given the inevitable gap between the financial and the real productive economy,- (and the possibility of misallocations of investment due to that gap). In fact, they can simply serve to rationalize further underlying imbalances in the real economy, which only prolongs and increases the eventual pain. (I’m not denying that there can be some useful functions for some sorts of derivatives; it’s just that they need to be constrained and regulated, to prevent them from overflowing their actual functions and overshadowing the financial and real economies as a whole).

At any rate, I received via e-mail a reply, which I didn’t notice till this week:

“”The concept of insurance for credit or other financial assets doesn’t make basic logical/economic sense”
very good point
indeed

the proper system is to have mandatory risk premia
and have it paid to uncle sam
the only player that can make as many chips as necessary
and claw back the losese
in the next premium cycle

okay so the phoney fraudster fuckers stay one cycle up
that at least is containable and not forever

the various notional funds for each distinct financial product’s risk pool say mbs
would be just that all premia would go torwards servicing the public national debt “

As far as I can make out the correspondent’s point, the only type of financial asset insurance that makes sense is in the manner of the FDIC and the PBGC, (which scandal is just about ready to dawn on the public). But that, of course, requires oversight and regulation with respect to “moral hazard”, hence would impose further constraints on fiscal and monetary policies, to prevent financial asset inflations/bubbles from getting out of hand in relation to the productive capacities and revenues of the real economy. Perhaps Gentle Ben, in attempting to figure out how to make/revive a market for MBS, is just beginning to realize that dilemma: that it can only be done through worsening the explicit fiscal situation, which requires guarantees/confidence in the sharpened operation of subsequent fiscal constraints.

S says:

first order of business for new president should be to fire bernanke. HE is a typical academic best left to pondering on the grassy knolls of academia. PAulson should follow. And rubin and Geithner and Dimon. All of them are rotten to the core. GS should be left to implode. Isnt there something incredibly strange about Obama and the following from the monied crowd. Can’t be about change now since his proposed cabinet is a bunch of recycled hacks. Geitner for treas sec? this has to be a bad joke. This guy sat on a board with Lehman Fuld at NY Fed and was totally aware of what LEH was doing. He should be deposed and prosecuted for aiding and abetting the i banks by opening the window after bear. Geitner, rubin paulson and bernanke sadly are bad reminders of a time long since past.

Don says:

I know this won’t be popular, but here goes:

Chairman Bagehot’s Response

Chairman Bernanke gave a speech on “The Future of Mortgage Finance in the United States”:

“The financial crisis that began in August 2007 has entered its second year. Its proximate cause was the end of the U.S. housing boom, which revealed serious deficiencies in the underwriting and credit rating of some mortgages, particularly subprime mortgages with adjustable interest rates. As subsequent events demonstrated, however, the boom in subprime mortgage lending was only a part of a much broader credit boom characterized by an underpricing of risk, excessive leverage, and the creation of complex and opaque financial instruments that proved fragile under stress. The unwinding of these developments is the source of the severe financial strain and tight credit that now damp economic growth.”

The financial crisis was caused by the end of the housing boom. This boom showed problems in mortgages:
1) Poor underwriting ( True )
2) Poor credit ratings ( True )
3) Allowing subprime mortgages with variable interest ( True )

A good start. 3 obvious principles that investors forswore at their own peril.

However, the general problems are:
1) underpricing risk ( What caused this? )
2) excessive leverage ( True )
3) complex investments ( ? )
4) not transparent investments ( ? )

Okay. I think 1 and 3 and 4 go together, but that’s me. Now he says this:

“To address these issues, we must consider both the part played by securitization in the mortgage market and the role of the government and government-sponsored entities in facilitating securitization.”

Here I don’t agree. I’ve already considered securitization with the help of Derivative Dribble.

Here’s why they’re worthwhile:

“The ability of financial intermediaries to sell the mortgages they originate into the broader capital market by means of the securitization process serves two important purposes: First, it provides originators much wider sources of funding than they could obtain through conventional sources, such as retail deposits; second, it substantially reduces the originator’s exposure to interest rate, credit, prepayment, and other risks associated with holding mortgages to maturity, thereby reducing the overall costs of providing mortgage credit.”

Okay. They give:
A: Originators more sources, e.g., retail deposits
B: Originators risk decreased on:
a: interest rates
b: credit
c: Prepayment
d: Holding mortgages to maturity
And these lower costs of providing mortgage credit.

This sounds good. The only things needed for using securitization properly are:
1) Ultimate investors invest in good quality mortgages and underwriters
2) All investors in process must be able to manage risk
3) Must be transparent, because hard to price

Here’s the thing: These are all common sense and not complicated. I’m sorry, but this is investing 101.

He gives a bunch of remedies, but, I’m sorry, it wasn’t the products. It was the investors. The question is why did these investors take these risks? So, all the remedies are last year’s news to me. Go ahead and fool around with regulating these things. Good luck.

I believe that investments involving shifting risk to third parties or magnifying risk, often with complicated models, should be looked into or regulated, but the principles need to be broad to capture future innovations.

In any case, we need better investors, and having government guarantees makes that impossible.

Here’s Beranke’s conclusion:

“Conclusion
Regardless of the organizational form, we must strive to design a housing financing system that ensures the successful funding and securitization of mortgages during times of financial stress but that does not create institutions that pose systemic risks to our financial markets and the economy. Government likely has a role to play in supporting mortgage securitization, at least during periods of high financial stress. But once government guarantees are involved, the problems of systemic risks and contingent taxpayer involvement must be dealt with clearly and credibly. Achieving the appropriate balance among these design challenges will be difficult, but it nevertheless must be high on the policy agenda for financial reform.”

I agree that government has a role to play. I just gave one area above.
I agree that if government is guaranteeing these investments, they should be highly regulated and limited in risk in order to keep the risk to the taxpayer at small as possible.

Is there any better plan?

I believe that there is.
First, I accept what I call Bagehot’s Principle: If the B of E exists, it will be the ultimate guarantor, and that must be taken into account. Given the Fed and our government, they are the ultimate guarantors and must be taken into account. And, following Bagehot, I would like to see the following:

A: Real moral hazard for banks or financial entities far short of a crisis. No propping up.
B: General supervision as I recommended above. Minimal, but effective.
C: Serious penalties if these businesses need government help. I recommend effectively taking them away from them,i.e., nationalization, which is why I favored a Swedish type plan, that would divest these nationalized entities back into private concerns as soon as possible. But such conditions as TARP are not nearly onerous enough.

These principles have been known since Bagehot, and, since him, we have known that a pure free market plan is not real, as long as certain financial and government entities exist. It’s time we follow his advice.

Don the libertarian Democrat

a says:

Bernanke is suffering from Greenspanitis, a brain disease which causes delusions, specifically the belief that a central bank can solve all or most of an economy’s problems. The disease is fatal – to the economy.

Anonymous says:

ndk

thank you for your humanistic description of what happens to real people when government is committed to inflation vs employment such as our phony 6% unemployment goal, the only goal Greenspan ever saw that he liked.

If government is to try to provide stability in the economy, government’s first obligation is to provide security for those willing to play by the employment rules.

anything else is cruelty. These recent years of employment insecurity, the top able to earn enough in any given year to retire, the rest working at less than living wages, or inflated salaries, levels of commitment and hours worked living in fear of losing their jobs is, again, official cruelty …

Anonymous says:

I mostly try to analyze policy on this basic premise:

If the incentive system is set up (whether through free or regulated markets) for people to make decisions that end up with everyone worse off, everyone will end up worse off.