Submitted by Rolfe Winkler, publisher of OptionARMageddon
In an interview with Charlie Rose on Tuesday, Tim Geithner admitted the bubble was caused by Greenspan’s easy money policy. Unfortunately, Charlie didn’t ask the obvious follow-up: “why will this time be different? Why will Bernanke’s easy money policy lead to different results?” Here was the crucial exchange:
Rose: “Looking back, what are the mistakes and what should you have done more of? Where were your instincts right, but you didn’t go far enough?”
Geithner: “…I would say there were three types of broad errors of policy and policy both here and around the world. One was that monetary policy around the world was too loose too long. And that created this just huge boom in asset prices, money chasing risk. People trying to get a higher return. That was just overwhelmingly powerful.”
Rose: “It was too easy.”
Geithner: “It was too easy, yes….
What makes Geithner’s admission so frustrating is that the government is engaged in the same disastrous policy today, to fight the same bogeyman: deflation.
As Geithner makes plain, a huge side effect was that investors seeking meaningful returns inflated the bubble taking flyers on overpriced, risky securities. Toxic structured products are the obvious example. Credit rating agencies get lots of blame as enablers, rating trash “AAA.” But fixed-income investors wanted an excuse to invest in riskier stuff that carried slightly higher yields; hell, artificially low interest rates meant many needed an excuse.*
Truly low risk securities like Treasurys and money market instruments were yielding so little, they were of no use to portfolio managers trying to match assets with liabilities.
But what happens when low-risk fixed-income securities yield 0% or close to that? Asset managers are more or less forced to seek higher interest rates through riskier investments.
So what are the results of our latest experiment with rock-bottom rates? Investors are piling back into risky investments across the board. Taking just one example, FT noted this week that high-yield debt is skyrocketing. The “experts” cited in the article claim this is proof that we’ve come through the worst of the recession. In their brains, markets operate efficiently, so running bulls must reflect improving fundamentals.
First of all, efficient market theory doesn’t apply to asset markets the way it applies to goods markets. But even if it did, how can folks pretend that any market with fixed prices is operating efficiently? With their stranglehold on interest rates via open market ops, central banks everywhere are engaged in a massive price fixing scheme that distorts investor incentives across all asset markets.
Geithner admits such a policy was a disaster before, that the “overwhelmingly powerful” force of low rates inflated the bubble. So how can he/Bernanke justify the same approach this time ’round? No doubt they’d argue they’ve no other choice: a ponzi system “relying on credit” needs credit to flow or else it will collapse. It doesn’t occur to these guys that the system itself is flawed, that we need a gut renovation, not just another layer of paint.
No doubt de-leveraging would be quite violent if the Fed left rates higher. But de-leveraging is the only solution to the crisis. God forbid Bernanke’s easy money policy actually “works;” God forbid he “rescues” the economy by reflating the credit bubble. De-leveraging is coming, whether we want it to or not. Better to rip the band-aid off quickly…
[The guest writer’s blog can be viewed here.]
*Not that CRAs are blameless. They deserve every ounce of criticism they’ve received.
We are attempting to solve all the problems by repeating and encouraging the very actions that created this crisis. The solution to the problem caused by putting too much money into the hands of entities deemed too big to fail is to flood the system with cash and encourage those behemoths still breathing to assume the carcasses of those who have died. So will we be surprised when this all blows up again?
Volcker probably said the same thing. The rest of Team Obama told him not to be a party pooper and marginalized his sorry ass.
That’s the problem when the team is made up of lawyers. When the only tool you know how to use is the law, every problem looks like one of legislation.
The sad part is Bernanke. He ought to know better and he probably does, but his ego is getting in the way so he believes his wishful thinking rather than knowledgable, logical thinking. He ain’t the fist, he won’t be the last. The folly of authority.
Geithner doesnt seem to be able to make the difference between “savings” and “money”.
Money is just an electronic tag that represent that you owe something to somebody. Savings is actual real world goods that you have actually produced but had not consumed.
You cannot build an excess capacity of housing and stimulate GDP growth from “money”, you can just push the prices up.
You need “savings” to achieve stimulation in the real economy and Greenspan obviously cant create savings on the order of 3-400 billion a year.
China, Japan and Saudi Arabia can.
I don’t see that there has been any deleveraging whatsoever.
► Household debt is no longer growing, but has not fallen either, being essentially flat.
► Ditto business debt.
► Federal Government debt is exploding.
► The net is that total non-financial sector debt is not growing as fast as it was six quarters ago, but it is still growing at a healthy clip.
► Ditto financial sector debt–still growing, just not as fast.
See file d3:
C:\Documents and Settings\Owner\Local Settings\Temporary Internet Files\Content.IE5\HJU84RSS\z1r-2.zip
Even more troubling is the fact that, even though the financial sector is able to borrow money at almost 0% interest, easing its borrowing costs, there are signs the reduced interest rates are not trickling down to households and businesses. In fact, the interest rates and fees households and businesses pay may actually be going up. This is in an environment where falling profits and falling wages mean less money available to service debt.
Congress and the Obama administration are throwing a lifeline to the financial services sector, who are using it to blow yet another bubble in securities, while leaving households and businesses to bite the big one.
Sounds like a recipe for social unrest, if not revolution, to me.
¨What makes Geithner’s admission so frustrating is that the government is engaged in the same disastrous policy today, to fight the same bogeyman: deflation¨
¨No doubt de-leveraging would be quite violent if the Fed left rates higher.¨
I think you filled in the answer to Charlie´s missed follow-up question: without applying the same very low interest policy the correction would be very violent. It could even have resulted in an overcorrection.
Though off course not at all comparable, one might compare it to homeopathy: if a person is sick, the stuff that causes a healthy person to develop the sickness, might cure the patient.
And while the purpose of the Greedscam almost ZIRP was to inflate assets, sustaining the intrinsically weak economy by feel-good-debt-consumers (and to get Bush/Cheney reelected), the purpose of the Bernanke ZIRP is to reduce the fall in asset prices.
Bernanke however, has shown time and again that he has a limited view of economics, so it remains very worrisome that he is at the helm of the FED. Bernanke has not admitted to the FED´s foolish almost ZIRP. On the contrary, last month he blaimed the savers of the world, as they forced the US banks to invest.
I think the response to why this time is different would be that this time they won’t leave rates too low for too long. This time they will raise rates at the right moment instead of leaving them too low.
Not that I buy that, but I think that would be their obvious response. The nightmare remains that their fix “works” and we never do get around to deep reforms. The housing bubble barely lasted us five years and threw us into this crisis on a terrible footing. Another quick bubble and bust would give us a worse crisis and on a worse footing to deal with it.
Right about now we need a dose of both Roosevelts (trust-busting and redistribution of wealth/power) but in the absence of direct action to pressure the government we will likely have neither.
DownSouth 11:05 has it right, as does X 11:57 and others. Obama is no FDR.
The Merchants of Debt are selling more than ever. Right now it is their turn to promote Government debt. Since that is going to be what they sell for some time to come, they will be reluctant to allow a bear market in such debt yet. Right now, the real return on the 5 and 10 year bondds is positive: thus no bubble. Things could get crazy as in the NAZ in the 1990s. We might see lots of Govt debt sold at negative real returns. Don’t think it can’t happen, because it might.
In addition to the fine input and output today here @ NC, I have also enjoyed reading stuff from Henry C K Liu (related to this matter at hand):
MONETARISM ENTERS BANKRUPTCY, Part 3
Credulity caught in stress test
Systemic risk and credit rating
Thus there were two dimensions to the cause of the current credit crisis. The first was that unit risk was not eliminated, merely transferred to a larger pool to make it invisible statistically. The second, and more ominous, was that regulatory risks were defined by credit ratings, and the two fed on each other inversely. As credit rating rose, risk exposure fell to create an under-pricing of risk. But as risk exposure rose, credit rating fell to exacerbate a further rise of risk exposure in a chain reaction that detonated a debt explosion of atomic dimension.
Page 2 of 4
The whole argument about how the Fed’s low interest rates were responsible for the crisis is founded, of course, on the assumption, that there is a strong causal link from the Fed’s interest rates to market interest rates, inflation and GDP growth. But is there? Why, for instance, do you think the Fed funds target rate significantly determines the interest rates to be paid for a mountain of credit of more than 50 trillion US-dollars? Such a causal link would have to be proven first. I don’t think is has so far.
I believe there are a couple of things that are different this time that might give Bernanke a little more control over the monetary situation than what Greenspan had (assuming they both use the same toolkit–control of interest rates and the monetary base–and rule out the use of regulation).
It seems some years back the banking system bifurcated into 1)the traditional banking system and 2)the shadow banking system:
Robert Marks, an enterprising New York economist, devoted a page in Barron’s to an intiguing and disconcerting thesis: that by 2004, the unprecedented magnitude of credit and debt in the United States had made irrelevant the traditional focus of the Federal Reserve Board on the nation’s money supply. Total nonfiancial credit-market debt in the $23 million range, he argued, had effectively supplanted the $3 trillion money supply as the best guide to the actual economy.~
–Kevin Phillips, American Theocracy~
My question then is this: If the Fed elects to eschew regulation, as Greenspan did, does that not then limit its control to the traditional banking system, and to only two tools–control of interest rates and control of monetary base?
Greenspan did start curtailing the growth in the rate of the monetary base beginning in the fall of 2002. He began raising interest rates in about the middle of 2004.
However, the money supply kept on growing. Was that not so because of what was going on in the shadow banking system?
If we take a look at these charts from Brad Setser’s post, we see that capital flows from foreign sources to purchase U.S. corporate bonds began to increase precipitously starting towards the end of 2004.
Were those capital flows not all occurring within the shadow banking system? It seems the only way to have slowed down or put a stop to those movements would have been through regulation, which, because of Greenspan’s libertarian/neoliberal theology, was unthinkable.
But things may be different now. It is my understanding (see May 12, 2009 Guest Post: Is Inflation Inevitable? submitted by Leo Kolivakis) that the shadow banking system is in tatters. Foreigners are no longer buying U.S. corporate bonds. If that is so, and remains so, then would Bernanke not have comparatively more control over the monetary situation using the traditional tools of interest rates and monetary supply?
Geithner, Summers, and Bernanke are trying to resurrect the system which failed. That system based on bubblenomics failed because bubbles burst, and the bigger the bubble the bigger the burst.
Now to anyone interested in fixing the economic system what they are doing is crazy and incoherent. But if you look at it from their perspective the system isn’t broken. It just needs more fuel.
This is also why as long as Geithner, Summers, Bernanke, and those like them are heading our economic and financial efforts, there can be no sustainable recovery. This is not to say that their efforts won’t have an effect. Trillions, even mostly wasted, will still have an effect. There should be some moderation of conditions in 2010 (how much if any is open to question) but it is extremely unlikely these effects will last much into 2011, and what then? We will have higher government debt, still high non-government debt, and so fewer tools to get us to recovery. The people I really feel sorry for, besides ordinary Americans and people around the globe, are the guys who are going to come in after Geithner, Summers, and Bernanke have left the scene. They will face bigger problems and have less time, and as I said above, tools to deal with them.
Correction: The last sentence to my last post should read: “using the traditional tools of interest rates and monetary base?”
All this was called for head of times by Austrian economists.
A pity to discover that US that currently has the best minds in this respect – Austrian economic thinking – has been so effective in voiding their message, both at academic and political level. Great achievement allowing for a disaster to occur.
I can see Yves Smith progressively getting Austrian. Knowingly or not, this is finally not of major importance.
Thanks for such this tremendous reporting.
“But fixed-income investors wanted an excuse to invest in riskier stuff that carried slightly higher yields; hell, artificially low interest rates meant many needed an excuse.*”
“Asset managers are more or less forced to seek higher interest rates through riskier investments.”
I agree with you about the search for higher yields, but there is no such thing as “more or less forced”. Actual human beings made decisions and gave advice that was either negligent or criminal, in many cases. Wanting to achieve higher returns with less risk is silly. Lower interest rates cannot “cause” any sentient being to do anything. An incentive is just that. It is not a command or irresistible urge. This is a mechanistic explanation of human behavior.
“to fight the same bogeyman: deflation”
Not only is it not a bogeyman, it is far worse than inflation. A Debt-deflationary Spiral has no natural stopping point. From my view, that’s what Fisher’s paper showed, and the current crisis validates Fisher’s theory.
Nevertheless, I liked your post, because you made plain the assumptions you are working under, which allow me to understand your argument and why you believe it. Many differences come from different assumptions.
Don the libertarian Democrat
Don….you're right, my argument doesn't land hard enough on asset managers who clearly made mistakes chasing yield. But they deserve little credit to begin with so I didn't chose to dwell on them.
I guess my larger point is that central bankers should expect investors to behave like sheep. They should understand markets will respond in distorted fashion to distorted incentives.
I agree very much that a debt-deflationary spiral can be catastrophic, but such spirals are simply unavoidable in credit-based economies. The best thing to do is to let the credit cycle happen. Delaying it only causes additional pressure to build within the system. Eventually it explodes.
Maybe Bernanke & Co. can successfully avert a deflationary spiral for another year or two. But if so, only at the cost of a more violent spiral later.
That is the lesson of the Greenspan put. He never let the economy heal from sickness, he just drugged it up to hide its symptoms…
X writes: I think the response to why this time is different would be that this time they won’t leave rates too low for too long. This time they will raise rates at the right moment instead of leaving them too low.The propeller heads at the FED who generate the inputs for Bernanke & Co. seem to look at the monetary system as a kind of servomechanism that responds to feedback-feedforward, P-I-D gain tuning, etc for which they think they know and have appropriately weighted all the variables. They are in their own way just as bad as the quants who set up the conditions for the crash. It was said by an Austrian schooler that economists should study mathematics since it would teach them how little mathematics has to do with economics.
“Geithner has a record of being a failure at every step of his career” ~ Bill Black
catch the Bill Black interview at Rolfe’s earlier post here
You can watch the clip here.
Thanks for that Bill Black clip John B.
Of course when he says that, he’s taking Geithner’s mission at face value. If the real objective is to preserve ponzi finance at all cost (which I think it is), Geither is a huge success, a bland faced team player.
At the risk of sounding quaint,…..
How CAN it be different this time, from last time or the time before that, or the time before that………., or NEXT time?
Please repeat after me, and then think about it.
In the fractional reserve debt-money system of the private Federal Reserve Bankcorporation system, ALL MONEY is created as a debt.
No debt, no money.
Please ponder the words of the Atlanta Fed’s Credit Manager Robert Hemphill here:
” This is a staggering thought. We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve.
We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is.
It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.”
OK, now, Charlie Rose or Geithner, or Doc or DownSouth, or Yves.
It is the debt-money system that is broken.
We are without a permanent money system.
Our civilization may collapse unless the defects are remedied very soon.
The way to remedy those defects is a new money system, permanent, debt-free at issue, by the government.
As in The Chicago Plan for Monetary Reform.
Otherwise, let’s do it all again.
With the same results.
Until the defects are remedied.
This is just utter nonsense. Pardon me for the following unkind observation, but Charlie Rose is an amaiable light weight who was out of his depth, and so do did not catch shifty eyed Turbo Tim out with a few pointed questions such as:
How do you justify what you have been and are doing at Treasury given your admission that “easy money” was one of the keys to our present lamentable state.
To wit: given the fact that the marginal productive capacity of debt reached zero early in this decade how can you not allow bad debt in the banking sector to be cleared from the system.
Why haven’t profligate and irresponsible institutions like Citi, BOA etc. been dealt with the way insolvent institutions are meant to be dealt with which does not include being propped up via massive public money.
Mr. Rose, were he at all astute in these matters, would have done some real research into Mr. Geithner’s activities as N.Y. Fed chief and would have subsequently asked hard if not impossible questions.
Instead the world is treated to yet another another Carlie Rose puff interview.
I think you are being a tad unfair to Charlie. He has always been very nice to everyone of the financial orthodoxy, and very mean to everyone opposed to it. Naomi Klein and Elizabeth Warren were both treated pretty shabbily.
It isn’t that he’s necessarily a lightweight.
His brother in law is John Mack, CEO of Morgan Stanley.
What bothers me most about all the finger-pointing at the fed’s monetary policy is that it essentially leaves the highly compensated, exceptionally well educated capitalists on Wall Street blameless in all of this.
People on Wall Street made astronomical amounts of money piling up that large mountain of “toxic assets” on the books. Were they witless idiots forced to spend money hand over fist by a government bureaucrat holding a gun to their head?
The dealmakers are the ones who went crazy with the money – the idea that the fed’s policy mistakes gives capitalists a free ride to act like irresponsible teenagers on spring break spree at Fort Lauderdale is absurd.
So, something I’d posted at RGE last July touches on one of your points:
worldwide, less than $1 trillion of paper dollars last year while, as you know, the totality of dollar denominated claims far far exceeds that amount. what i was referring to was the inflation in mass of pure credit money that’s taken place through reductions in bank reserve reserve ratios in 1990 and 1992, the de facto ending of reserve ratios as traditional banks began generalized use of ‘sweep accounting’ in 1994, the rise in non-bank banks such as MMFs, the role played by government sponsored enterprise lending, interacting of these with each other and foreign lenders, etc, until by 2002, i think it was larry lindsey who termed the whole process one of ‘nuclear credit fission’.
put differently, a regime of potentially unlimited credit money creation had come into existance but, since this money is created through lending and since debt service ultimately depends on conditions in the real economy, the process hits limits, breaks down. that’s my short answer; hopefully makes sense.
Thank you very much for your response.
It sounds like you are delving into how the shadow banking system came to dwarf the traditional banking system. If Robert Marks is correct, that by 2004 the shadow banking system amounted to $23 trillion vs. $3 trillion for the traditional banking system, then by that time the traditional banking system had already become all but insignificant. And all indications are that the shadow banking system was an outlaw (can we say like in the Wild, Wild West?), operating completely outside the purview of the traditional regulatory framework.
I’m extremely interested in the nuts and bolts of how this shadow banking system came about. And no, I don’t know how that happened. So if you have references that explain how this happened I would very much appreciate your passing them along.
My suspicion is that the growth of the shadow banking system was closely linked to the spread of neoliberalism (and its commandment that “Thou shall pass no laws imposing restrictions on capital flows”), the concommitant rise of neoconservatism and its creed calling for the militarization of the United States. Neoliberalism is not something that the people of other countries accept volunarily. So, as the neocon pundit Max Boot put it, “imposing the rule of law, property rights and other guarantees at gun point if need be” is something that dovetails with the need for a powerful military, and also the philosophy that it be deployed with no questions asked. It comes as no surprise then, with the diminished military prestige of the U.S. that followed in the wake of Iraq, that Latin America is in open revolt against the Washington Consensus. We saw this manifested at the 2005 Summit of the Americas Conference, especially in Dr. Nestor Kirchner’s opening remarks:
Kirchner’s remark that even though the Washington Consensus had thus far only visited its evils upon the weak, but that some day, some how would also visit those evils upon the powerful (and here he was undoubtedly talking about the U.S.), proved to be quite prophetic.
Now that Kirchner’s prediction has come to pass, we see the U.S. reluctant to impose the same neoliberal tough love upon its own people that it was willing to impose upon the peoples of other countries. Of course the American right-wing is still committed to imposing unadulterated neoliberalism upon the American people. But I think it will soon become evident that, just as in Latin America, that can only happen “at gun point.”
Which brings us to the question of morality. In “Love, Law and Civil Disobedience” Martin Luther King wrote:
What do you mean when you say that a law is unjust, and a law is just? Well, I would go on to say in more concrete terms that an unjust law is a code that the majority inflicts on the minority that it is not binding on itself. So that this becomes difference made legal. Another thing that we can say is that an unjust law is a code which the majority inflicts upon the minority, which that minority had no part in enacting or creating, because that minority had no right to vote in many instances, so that the legislative bodies that made these laws were not democratically elected.~
The moral lesson here is that, if the Washington Consensus is something that the people of the United States are not willing to inflict upon themselves, then certainly it is morally indefensible to inflict it upon the peoples of other countries.
You are quite right, it’s not so much that Rose is out of his depth, but rather that he is a stooge/tool of the fast faltering establishment.
Neoliberalism/Washington Consensus can, at one level, best be seen as an ideology used to justify imposition of ‘the market knows best’ types of policies which, at base, have to do with the personifications of capital’s – and the hegemonic State’s – attempt to maximize rate of profit within a progressively more profit constrained global environment.
The constraint I refer to develops as part of an over-accumulation of production capital which is to say that the total mass of capital grows more rapidly than the labor created surplus required to perpetuate that mass as capital, i.e. to valorize it.
[Which also has quite a bit to do with why business cycles are inherent to the capital system and, IMO, also helps explain ‘long waves’ in the rate of profit].
During the 19th and earlier part of the 20th centuries, overcoming such constraints was pretty much left to systemic counter-tendencies such as expansion into undeveloped areas, the driving down of raw material costs and a greater rate of exploitation of labor.
But all the main counter-tendencies are also inherently limited — at a point, the capital system reaches absolute global limits and requires increased State [or in the case of neo-liberalism, state and supranational] intervention if expanded systemic reproduction is to continue.
I would posit that recovery from the great depression brought us much closer to that ‘point’ and that neo-liberal policies have been in reaction to the ending of that long expansionary wave [which does not mean the perpetrators have been particularly, or at all, aware…though Margaret Thatcher’s slogan “there is no alternative” might indicate some marginal consciousness].
But what to do if the Thatcher et al ‘alternative’ fails? [Which on global growth data from Maddison or the IMF it very certainly did]. Well, what has come naturally many times before: to increasingly turn towards financial and speculative activities, which has also been a become-institutionalized substituting of fictitious profit for real, not all so different than something the head of the Minneapolis Fed mentioned in that bank’s 1974 annual report:
we have substituted credit expansion for savings as the means to finance the growth of consumer and business spending. Another dose of the old medicine would only worsen the disease, in the longer run if not immediately.
It is important to understand that this conclusion rests basically on the argument that credit-financed expansion, beyond a certain point, leads to instability rather than further expansion. The conclusion does not rest on the dubious premise that the world is running out of resources.[The Limping Giant: The American Economy 1974-75]
Much more complex and longer story short, the capital system has been attempting to overcome its own limits through means which, as we’ve begun to see, contradict just the at least supposed ends.
One aspect of this whole process has been the rise of the ‘shadow banking’ system, a rise facilitated, if not based on, exactly financial liberalization which can be traced back into the 1970s [even Volker’s rate hikes were not disconnected from anti-inflation demands by institutional bondholders, and you know that these hikes helped trigger the 1982 debt crisis].
I’m a big believer in context and hope the above captures part of why we are where we are. [An additional element would be that of unequal exchange between different world regions as ‘the developed’ has been able to appropriate more labor for less through both trade and finance].
Insofar as ‘the nuts and bolts’, very much has been documented in Doug Noland’s weekly Credit Bubble Bulletin. I wish the attached was a complete archive but it only reaches back to January 2003:
“The Best of Doug Noland”
[As a quasi-Austrian, Doug and I may disagree on theory but he is very accurate in his data]
Another would be some of “Pulse of Capitalism’s” issues: