I was already mundo unhappy with an Alan Greenspan op-ed in the Financial Times, which takes issue with Dodd Frank for ultimately one and only one disingenuous and boneheaded reason: interfering with the rent seeking of the financial sector is a Bad Idea. It might lead those wonderful financial firms to go overseas! US companies and investors might not be able to get their debt fix as regularly or in an many convenient colors and flavors as they’ve become accustomed to! But the Maestro managed to outdo himself in the category of tarting up the destructive behaviors of our new financial overlords.
What about those regulators? Never never can they keep up with those clever bankers. Greenspan airbrushes out the fact that he is the single person most responsible for the need for massive catch-up. Not only due was he actively hostile to supervision (and if you breed for incompetence, you are certain to get it), but he also gave banks a green light to go hog wild in derivatives land. And on top of that, he allowed banks to develop their own risk models and metrics, which also insured the regulators would not be able to oversee effectively (there would be a completely different attitude and level of understanding if the regulators had adopted the posture that they weren’t going to approve new products unless they understood them and could also model the exposures).
And the most important omission is that the we just had a global economic near-death experience thanks to the recklessness of the financial best and brightest. You’d never know that if you read the Greenspan piece, which merely argues against the idea of restricting financial activity under the guise of objecting to certain provisions of Dodd Frank.
I keep referring to this passage of a 2010 paper by Andrew Haldane, the Executive Director of Financial Stability for the Bank of England because Greenspan, the Administration, and other banking industry cheerleaders keep pretending that the crisis was a mere blip and their ongoing propagandizing needs to be countered:
Table 1 looks at the present value of output losses for the world and the UK assuming different fractions of the 2009 loss are permanent….
As Table 1 shows, these losses are multiples of the static costs, lying anywhere between one and five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.
It is clear that banks would not have deep enough pockets to foot this bill. Assuming that a crisis occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of $1.5 trillion per year. The total market capitalisation of the largest global banks is currently only around $1.2 trillion. Fully internalising the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.
In other words, the financial system as it is presently constituted is so destructive to society at large that very radical interventions are warranted to reduce the costs it imposes on others. To put it another way, it is an extraordinarily inefficient at looting. And Haldane’s core observation, that severe financial crises result in permanent output losses (more colloquially, a permanent reduction in the standard of living) is not controversial. And I’ve recently corresponded with Haldane and he stands by this rough and ready estimate.
Yet as horrific as the Greenspan piece is, he manages to sink to unimaginable new lows with the Big Lie he offers at its close:
The vexing question confronting regulators is whether this rising share of finance has been a necessary condition of growth in the past half century, or coincidence. In moving forward with regulatory repair, we may have to address the as yet unproved tie between the degree of financial complexity and higher standards of living.
In other words, the defective growth model of the last 30 years, one that rested on stagnant worker wages and relied on rising levels of debt which fueled bigger and bigger asset bubbles, is now presented as a virtue.
Consider this alternative formulation from ECONNED:
Let’s use a different metaphor to illustrate the problem. Say a biotech firm creates a wonder crop, the most amazing creation in the history of agriculture. It yields far more calories per acre than anything else, is nutritionally extremely complete, and can be planted and harvested with far less machinery and equipment than any other plant. It is tasty and can be prepared in a wide variety of ways. It is sweet too, so it can be used in place of sugar and high fructose corn syrup at lower cost. We’ll call this XCrop.
XCrop is added as a new element in the food pyramid and endorsed by nutritionists and public health officials all over the globe. It turns out that XCrop also is an aphrodisiac and a stimulant (hmm, wonder how they engineered that in) and between enhanced libido and more abundant food supplies, the world population rises at a faster rate.
Sales of XCrop boom, displacing traditional agriculture. A large amount of farmland is turned over from growing other types of produce to XCrop. XCrop is so efficient that agricultural land is taken out of production and turned to other uses, such as housing, malls, and parks. While some old-fashioned farms still exist, they are on a much smaller scale and a lot of the providers of equipment to traditional farms have gone out of business.
Twenty years into the widespread use of XCrop, doctors discover that diabetes and some peculiar new hormonal ailments are growing at an explosive rate. It turns out they are highly correlated with the level of XCrop consumption in an individual’s diet. Long-term consumption of high levels of XCrop interferes with the pituitary gland, which controls almost all the other endocrine glands in the body and the pancreas.
The public faces a health crisis and no way back. It would be very difficult and costly to put the repurposed farmland back into production. Some of the types of equipment needed for old-fashioned farming are no longer made. And with the population so much larger than before, you’d need even more farmland than before. The world population has become dependent on the calories produced by XCrop, so going off it quickly means starvation for some. But staying
on it is toxic too. And expecting users simply to restrain themselves will likely prove difficult. The aphrodisiac and stimulant effects of XCrop make it addictive.
Advanced economies have become hooked on debt technology, which, like XCrop, is habit forming and hard to wean oneself off of due to its lower cost and the fact that other approaches have fallen into partial disuse (for instance, use of FICO-based credit scoring has displaced evaluations that include an assessment of the borrower’s character and knowledge of the community, such as
stability of his employer). In fact, the current debt technology results in information loss, via disincentives to do a thorough job of borrower due diligence (why bother if you are reselling the paper?) and monitoring of the credit over the life of the loan. And the proposed fixes are not workable. The Obama proposal, that the originator retain 5% of the deal and take correspondingly lower fees, is not high enough to change behavior. And a level that would be high enough to make the originator feel the impact of a bad decision would undercut the cost efficiencies that made securitization popular in the first place. You’d have better decisions, but less lending, and higher interest rates. That’s ultimately a desirable outcome, but as in the XCrop situation, no one seems prepared to accept that a move to healthier practices will result in much more costly and less readily available debt. The authorities want to believe they can somehow have their cake and eat it too.
And in case you think this reading is a tad too downbeat, a very good piece in the National Journal by Michael Hirsh, The Resurrection, demonstrates not merely that perilous little has changed in the wake of the financial crisis, but that in many respects, the pathology has gotten even worse:
Government data indicate that lending abroad is up even as investment in plants and equipment at home continues to decline or remain flat as a percentage of GDP. FDIC-insured banks loaned nearly twice as much, $62.7 billion, to banks in other countries as of the end of 2010 as they did the year before…
Regulators in Washington, in Basel, Switzerland, and elsewhere have failed to agree on rules for the much-touted “resolution authority” in the new law. Theoretically, this rule is supposed to give the United States the right to liquidate or unwind a failing firm, no matter how big, without the systemic crash that nearly followed the Lehman bankruptcy of September 2008. The rule is still just a draft, however, and so far it doesn’t look very workable internationally.
That’s because countries are addressing the same issue in very different ways….Straddling all these fractured lines are Citi and the other big global banks. “Citibank is a $1.8 trillion company, in 171 countries with 550 clearance and settlement systems,” says one senior Federal Reserve Board regulator who would speak frankly only on condition of anonymity. “We think we’re going to effectively resolve that using Dodd-Frank? Good luck!”….Bove, a widely followed banking analyst on Wall Street, calls Dodd-Frank “the dumbest piece of legislation ever created by the U.S. Congress. They wanted the big banks to have less control, yet they built in rules that ensure the increased control of the financial sector by big banks…..“And there is nothing in Dodd-Frank that will do anything to stop a meltdown from occurring.”
We’ve been critical of the phony resolution authority as well as other features of Dodd Frank. But the reason is, as the critics Hirsh cites remind us, that the legislation failed to accomplish its stated aims and may be increasing big bank power.
Greenspan, by contrast, clearly object to the basic premise of Dodd Frank, that governments should have any meaningful say over the operation of financial financial firms. Einstein defined insanity as doing the same thing over and over again and expecting different results. But the true madness isn’t that Greenspan’s remarks border on deranged; he’s merely a useful and highly paid idiot. It’s that anything he says is still listened to after the huge cost his misguided policies have inflicted on all of us.