naked capitalism

Carrick says:

I don't know how to phrase this, or present this comparison, without causing some offense, but I'll throw it out there — food for thought.

1,500 farmers in the Indian state of Chattisgarh were driven by systemic problems (debt & poverty, disastrous Govt enviro/devl plannig, usury), to commit suicide.

This was also the day that Bush's torture memos were released. Twice as many people died on sept 11, and we turned the world upside down (preemptive war, loss of international compassion/goodwill/support, abandonment of the Geneva Convention, etc — U.S. Govt sanctioned torture of prisoners, some unintentionally unto death), responding to it.

Even if the India event wasn't an intentional protest, it is a cry for attention. It didn't get a spot of ink in any US papers, or a blip from the 24/7 cable news yapfests. Which is why its hard to know whether this was a real "mass suicide" protest, or just a popular trend there.

Either way.. two large losses of life – both born of poverty and systemic problems. One, we turned the world upside down for, the other doesn't even see a bullet point on A16. Both born out of poverty, for the most part. There is something to be drawn out from this (I don't know what), about how one group destroys itself in protest, while the other destroys the outside world — one gets ignored, and the other sees heaven & earth moved to return its misery. Both end with dead poor people — neither response shows a recognition of the relationship between systemic poverty and horrendous violence.

Richard Kline says:

I read through Janet Yellen’s speech on the actions of and proactions against asset price bubbles with considerable interest. From my own reading on the historical instances over twenty years ago, it was apparent from my perspective that bubbles are exceedingly costly in the mid and long-term, and that it should be a principle charge of public financial authorities to prevent them, if necessary erring on the side of caution when their early stages might not be easy to assess. (Their middle stages are evident to anyone who cares to see them, though yes, judging their inception is no _certain_ thing.) From the mid-90s, I was flabbergasted in a word that Alan Greenspan, and for that matter most other Ango-American appointed or trained regulators felt no such necessity, the recent instance of the Savings and Loan _BUBBLE_ notwithstanding. To me, home prices were already dangerously bloated in the late 90s, with bubble behaviors in effect such as homeowners regularly doing refis to pull out equity for other speculation. But no, we had to live this one out.

Yellen’s discussion is thorough and credible in all its points, and worth the time of anyone who wants to read it through. I want to draw attention to two points only within it. The first is that this is the first instance of a major policy actor in the US—Janet Yellen is the Pres. of the SF Fed, and one of the better minds in public finance in the country—saying, in effect, ‘Yes, the powers that be _should_ intervene to stop bubbles in action.’ Even two years ago, two, such a remark would have drawn howls of derision and condemnation from all the neoliberal cheerleaders of deregulation and “Let them get rich,” who have controlled both public financial policy and the debate about its conduct. Someone has to be first, but the change in tune, and one here well reasoned, is significant. It must be a charge of public financial authorities to _proactively_ prevent bubbles from occurring.

The second point is more complex, and an expansion on what is, to me, the most salient of her remarks on how bubbles should be restrained/contained by the public authorities. Yellen makes a good point concisely that monetary policy—interest rate manipulation—is not a particularly apt tool for this purpose. All one could get the last twenty years of neoliberals to discuss was where to target the rate, as if they had no fingers but only thumbs. But interest rates are slow to act, effect the real economy widely beyond whatever financial system modality is pumping the bubble, and can be circumvented to a degree by things like the carry trade finance as we have seen. So this point is a further important concession that public authorities cannot simply sit on their hands while nodding at rates. Yellen points out that regulatory and supervisory interventions are likely to be better brakes on bubbles, though qualifying the utility of supervisory actions (scrutinizing a firms books) as sufficient alone.

I would say, though, that it is important to see bubbles happening in a ‘financial space’ defined in aggregate by the variables that constrain or enable speculative activity in a particular asset class. To use the variables that Yellen mentions here alone, we have a rate variable, a regulatory requirement matrix variable, and a supervisory variable. To contain something as active and widespread as a bubble mania, it will be necessary to contract the condition space _as a whole_. In my view, if one simply tightened up regulations before hand, or even had some useful requirements that scaled in, the bubble mania would push sideways along the variable dimension that is not contained. [I'm sorry if this is dense folks, but there are only so many ways to talk about this.] This was what happened with SIVs at regulated banks like Citi, for example. They were not allowed to carry some assets on their books above a certain amount, but with credit so widely available they chartered legally distinct entities using their own ‘guarantees’ to keep the costs down, and bubbled up their purchasing around the regulation. Supervisorial scrutiny of Citi’s books in 2006 would not have adequately weighted those SIV guarantees, because with money cheap the vehicles could arguably rollover their financing indefinitely.

One has to represent the entire space of major variables behind a bubble, or more broadly behind an asset price trajectory. I’m not really talking about 20-30 variables here, but take a look at a half-dozen or less that make that price trajectory possible. To constrain change, overt action has to be made on all of them, or the speculation will simply slide. This does not mean necessarily, returning to the three dimensions pirated from Yellen’s example, that rates must rise, too. But the financing costs to entities speculating in the asset class _must_ rise as those prices enter bubble levels, the entities speculating become dangerously large, or either one. Yes, this requires government regulators to *horrors* tell private actors what they can and can’t do rather than taking a ‘push all boats thusward via rates’ approach. In the US, this is thought to be, well _communism_ or something. But the key variable in the recent bubble was, in fact, excessive credit creation, and extremely east access to it by major players in the bubble such as mortgage brokers at one end and securitization desks at the other. No amount of regulation or supervision would have constrained ‘bubble-like’ outcomes with such easy credit. At the same time, if the public authorities chose henceforth to make credit difficult to get for certain kinds of transactions—as for instance in making high margin requirements for purchasing stock after the 29 Crash—but did not otherwise have, say, close supervisorial scrutiny, we simply create opportunities for more Enrons to shuffle large-scale shell games.

Constraining actions must move proactively on all dimensions of an asset price dysfunction. Some dimensions are much more important for some kinds of dysfunctions, yes. I might even go so far as to say that case by case historical judgments would likely have to be made as to which levers are the best ones to pull on. But if we only pull on two or three when the financial event space runs to five or six, the bubble will just flow sideways. As a final not cribbed from the series of posts on systemic actions for the financial system last May, it is best not to think of such interventions as on-off switches. Regulation on/regulation off. Easy credity/no credit. It’s better to have interventions which _scale into effect_ as situations change. If entity A does more than X business per quarter in said speculative asset, their costs need be increased per transaction, and their reserves indexed up a step. Small steps, but ones that increase exponentially as their involvement and exposure increase. Willem Buiter’s cogent remart that the scaling of reserve requirements could be used as an inherent ‘governor’ on the size increases of large financials is exactly of this kind. No regulator needs t make the jugement call, the levels are preset, and all market participants can see when, if, and as they are scaled in. And so on. They are automatic, and the judgment call, if any, involves _delaying_ their implementation for which cause must be shown.

Yellen’s remarks are a good first step, however.

LeeAnne says:

raising margin rates when a market gets over heated isn’t rocket science.

It was routine before Greenspan. Greenspan is a devotee of a dangerous cult.

a stranger says:

Nemo & Yves –

Equity offering is not true anymore, even with the term sheet. Read the American and Recovery Investment Act. Section VII. The original act was amended to:
‘‘(g) NO IMPEDIMENT TO WITHDRAWAL BY TARP RECIPIENTS.—
Subject to consultation with the appropriate Federal banking agency (as that term is defined in section 3 of the Federal Deposit Insurance Act), if any, the Secretary shall permit a TARP recipient to repay any assistance previously provided under the TARP to such financial institution, without regard to whether the financial institution has replaced such funds from any other source or to any waiting period, and when such assistance is repaid, the Secretary shall liquidate warrants associated with such assistance at the current market price."

All they require is that the regulators approve of it, which can be with or without an equity offering.

Ramesh says:

BTW, the source for the suicide rates is the WHO:

http://www.who.int/mental_health/prevention/suicide/suiciderates/en/

Mrs. Watanabe says:

Heartbreaking to read, but it’s a problem of overpopulation.

emca says:

In response to Richard Kline’s above comments on regulation, while I agree that market regulation should be part of a broader approach to problem of hyperactive speculation, restrictions placed through regulation on certain players alone might have been enough to avoid the woe we’re seeing. Who are those players? The many people who took on mortgages that, in a more reflective environment, would not have permitted. These are not people with sophistication, expertise or time to move sideways or circumnavigate regulatory obstacles. With the enforcement of very simple qualifications of 1/3 verified income, 20 down and fix 30 yr, there would have been no shaky assets to broker and leverage. True this would have not prevent other potential bubbles (as such the dot.com), but it is real estate speculation that has been the historic worst case culprit of unrealistic expansion of wealth and the resultant return to reality and that’s what we need to look to.
Again this isn’t saying your observations lack merit, only that in face of the tiger, those at the source of cycles marked by asset inflation, will tread no further. Regulation in these cases, in and of itself, will work.

Justin says:

Isn’t the trouble with that Indian suicide article that “mass suicide” doesn’t describe what the article says? Mass suicide is something like Jonestown or the Heaven’s Gate people. What happened in Chattisgarh is a massive increase in the suicide rate, not a mass suicide.

Richard Kline says:

So emca, no and yes. I have no problem with raising downpayments and simplifying terms for mortgages for most folks. There were reasons why there was a standard 30-year for most home mortgages. But really, you have the cart before the horse with what you are arguing. Going uphill.

Point one: speculation in home prices over a generation had pushed even the lowest home prices out of the reach of normal incomes. This was not new, and had been underway long before lending standards were completely corrupted. I’m all for more restrictive terms if we also constrain the market in such a way that there is a reasonable supply of housing that can be purchased on those terms. In my town, for example, you could buy a home in the city limits as of 2006 and afford it unless you had two six-figure incomes in your family. Even now, all they build are ‘luxury condos.’ That’s a market problem separate from my above remarks, but it influences the reality situation which leads individuals to try for more house than they can afford. You call it irresponsibility; in may cases it was excessive optimism borne of rising prices and no options. Consider that.

Then there is the more salient issue of ‘Whose malfeasance?” The mortgage brokers offering confidence man terms are far more to blame, in my eyes than the marks who were fooled. Regulations to ‘prevent fools’ seldom work, but in this case would be misplaced as well. Regulations to ‘jail predatory lenders’ work rather better: they can be identified before the fact and the supply dries up as the big fish dry on the rack. Were those folks taking option arms with 0% down fools? Of course. They didn’t cause this crisis, so blaming them principally suggests a serious misunderstanding of the nature of the present problem, to me.

Subprime didn’t cause this crisis; they are a symptom. Prime mortgages are starting to default, I might note. Their putative value doubled in many areas, but has not snapped back toward half. The resulting neg eq is breaking the legs of those badly placed for the loss, even if they could afford their original purchase. I won’t detail this, because _prime_ buyers didn’t cause this crisis, either.

Maladaption of securitization caused this crisis. Bondtraders onselling rotten bales were the real bubble. Shadow banking system demand for ‘product’ abetted by shadow banking system vaporbucks are what made it possible. Housing was simply the principle modality. In case you didn’t notice, my friend, we have what would be a mid-size bubble _on its own_ in securitized LBO debt, with a nasty carbuncle on it of securitized credit card debt. This is an area were regulation, per Janet Yellen, would be the appropriate modality for future remediation. But also that endless credit provision would have to be constrained or it would simply flow to another area. If not houses, than something else.

I return to my main point, though: to constrain a bubble a-building containment on all principal parameters has to be kept constantly in mind, or the bubble will just flow sideways. Not as severely, perhaps but still. After all, in the mid-90s, the bubble was in equities, with home real estate just a sideline. When equities went bust-away, the bubble flowed sideways into the readiest modality for bond desk speculation. When even home mortgages were proving insufficient by, say, 2005, mal-securitization surged into securitized LBO debt. Choking off one parameter is insufficient. But again, restraining interest rates would impact the real economy more than this speculative process, since the carry trade and the ability to onsell the ASBs offshore where of principal importance in growing the bubble to its eventual size. This internationalization of capital flows is another reason why _national_ regulations alone will be insufficient to restrain subsequent bubbles.