By Edward Harrison of Credit Writedowns
As a writer, Matt Taibbi is a lot more vitriolic than I am. He curses, makes some pretty over-the-top personal attacks, and divines a policymaker’s intent where I don’t think he can. But, this goes mostly to style. Substantively speaking, he has a lot to say and we should take notice.
I wanted to highlight a piece he wrote yesterday called Fannie, Freddie, and the New Red and Blue. The crux of his argument is this: The partisan rhetoric is on full display in the dust-up over the unlimited liabilities coming from Fannie and Freddie thrust upon taxpayers on Christmas Eve. This rhetoric is not just beside the point, it is specifically designed to obscure the point, namely that both Democrats and Republicans, private industry and the government are culpable in the shambles our economic system has become.
Over the Christmas holiday a nasty thing happened: Tim Geithner’s Treasury Department decided to lift the cap on aid to the Government-Sponsored Entities, Fannie Mae and Freddie Mac, apparently in response to Obama administration fears that the two agencies would become insolvent. The cap was raised from $200 billion on each and government backstopping of the mortgage market will apparently now extend into infinity for at least three years, through 2012.
The move has already inspired a mini-firestorm, with several outlets delving deeply into the recent history of the GSEs and uncovering some disturbing new facts…
Sometimes I’m amazed at the speed with which highly provocative information like this GSE business can be converted into distracting propaganda in this country…
What worries me is that we’re… starting to see fault lines develop, where one side blames the government while another side blames Wall Street for the messes of the last two decades…
Everyone was involved in the mortgage scam. At the lender level the deceptions were myriad; liar’s loans, fraudulent income documentation, negative amortization loans, HELOCs, etc. The rush to get as many loans written as possible and then get those hot potatoes moved to the next sucker in the line was furious and extended from coast to coast, sinking one lender after another in Ponzoid debt and indictments….
Everyone had a hand in the bubble, from the congressmen who killed regulatory initiatives to the regulators who snoozed at the wheel to the GSEs to the Fed to the banks to the ratings agencies to the lenders. I don’t think it’s really controversial to say that, but it does seem like there’s an argument brewing about what that across-the-board complicity means.
This is kleptocracy, of course. Crony capitalism. And by that I mean the system Taibbi lucidly breaks down for us is one of privatized gains and socialized losses. Incumbent politicians and policymakers retain power by looking the other way and allowing special interests an unfair profit advantage. Usually, this goes to excess. Irrational exuberance takes over and losses ensue – losses which are not borne by the economic actors but taxpayers. That is how it always happens, but in this case it happened on a grander scale. And both Democrats and Republicans were complicit.
The question is: what can be done? Can we really spot this kind of ‘irrational exuberance” when it permeates the entirety of the social fabric? Barring another Great Depression, I don’t think any one President or one party is going to be the agent of change – Barack Obama has demonstrated this quite effectively. Both major political parties have too much at stake in the status quo. So, if the question goes to the whole Red/Blue partisan back and forth, Taibbi is right that this is a side-show. We effectively have a one-party system when it comes to investment in the present economic, power, and wealth structure.
But, the question also goes to Greenspan’s argument about not spotting bubbles, but cleaning up after the mess. Greenspan feels the Fed’s job is not to regulate and not to target asset prices as a bubble forms. Rather, the Greenspan view has the Fed acting asymmetrically by raising rates slowly so as not to cut off a boom, but cutting them quickly to forestall depression – something I see as hopelessly blinkered and outright dangerous. Greenspan, in his ideological fervor, is presenting an extreme form of an argument that has some basic merit.
Mark Thoma presents a much more sensible argument based on this same we-can’t-stop-bubbles view. In reviewing Bernanke’s recent defense of Fed policy, Thoma says the following (emphasis added):
there is blame to be placed, plenty of it, but I don’t think it should be concentrated as much as it is on Bernanke and the Fed (Greenspan may be a different story, but he was also going along with the majority of the profession, or at least the powerful voices in the profession at that time). The blame is on the entire profession, and those who study the structure of the banking industry and regulation in particular. Many of the economists who are the most critical today were among those supporting deregulation (or they said little or nothing about it).
Finally, as I’ve noted before, I have come to the same conclusion that Krugman states today, that the most important thing we can do is to reduce the effects that bubbles have when they pop. We may never be able to prevent all bubbles or other problems in the financial sector, but we can do a better job of making sure that the effects of these problems are minimized. I’d start with limiting leverage ratios, the 30 or more to 1 we saw prior to the crisis is much too high and dangerous to unwind when problems hit, and I’d also restrict the other side of that coin and increase capital requirements. The system was far too fragile before the crisis, and that’s something that we need to fix.
The key in what Thoma says – and what connects it to Taibbi’s polemic is that the blame for this bubble and collapse is widely dispersed. That should give you pause as to whether any specific policy remedies are going to prevent a recurrence of the same in future. I certainly see the boom-bust cycle as endogenous to the capitalist system in a way that is unrelated to the Federal Reserve. Remember we had the panics of 1837, 1857, 1873, 1893 and 1907 before the Fed even existed.
So, Greenspan, Bernanke, and Thoma are asking the right question. Where I disagree most with Greenspan and agree most with Thoma is in the remedy. In making a remedy one has to first diagnose the problem, prioritize goals of remedial action and affect a decent plan of implementation.
- The diagnosis seems correct: Irrational exuberance infects the very fabric of society in a way that makes boom-bust cycles impossible to prevent and little effort should be made to do so.
- The goal, in my view, should be to devise a way to prevent contagion when individual companies, sectors of the economy, or regions collapse without having a significantly negative effect on long-term growth or income and wealth distribution.
- The implementation is the tricky part.
- Commercial banks as utilities model. One view says to firewall sectors of the economy, particularly the financial sector in a way that maintains its core function but allows peripheral ‘innovative’ functions to suffer with the swings in the economy. This is the Paul Volcker view.
- Regulation-Heavy model. Another view says to forget about the firewalls as they will be ineffective at best and retarding to growth at worst. Regulate the heck out of all actors and constrain their ability to be reckless. This is the Geithner view.
- Regulatory and Resolution model. A third view says we should allow the actors to do as they wish but set up robust bankruptcy resolution process for all private sector companies, especially in the financial sector and including hedge funds and too-big-to-fail institutions.
I lean heavily toward the third view, but see a lot of merit in the first. My bias is toward a relatively free market buttressed with adequate rules as a regulatory framework and sufficient regulation of those rules. Clearly, existing rules on bank size as percentage of the deposit base and leverage would need to be enforced. But, I don’t see a need to create more rules. That would just retard growth and wouldn’t alleviate the problem of irrational exuberance. Certainly, bringing all financial agents (money market funds, insurance companies, derivatives and hedge funds) under a comprehensive regulatory umbrella is a priority but this can be done in a way that is consistent with the existing structure. Why burden the system with a system risk regulator as another layer of oversight? Better to just hive off the essential bits into a tightly regulated oasis, de-coupled from the rest as Volcker suggests.
One last note, this time on Bernanke’s views. I was struck by how much Bernanke tried to ‘defend’ Fed policy. His was not an objective assessment of a disinterested party in why we got to where we are and what we can do to fix it. It was a defense of his institution and his own role in it. No good can come of such an analysis.
Update 2100ET: A reader chastised me for not being more explicit about the Geithner proposal’s loopholes. Just to be clear about choice number two, the regulation-heavy one, just because I am labeling the Geithner approach regulation-heavy doesn’t mean I think these regulations will be substantive. They will add a layer of regulation to seem substantive but will be filled with loopholes in order to allow business as usual. An example is the loophole in derivative regulation that allows for off-exchange customized derivatives. Everyone knows that means actors will gravitate to just those products. When Byron Wien predicts that regulation will be industry friendly, that’s what he means. Also note his discovery of Barack Obama by early 2007 from this post. Obama had strong Wall Street ties from the start.
Fannie, Freddie, and the New Red and Blue – Matt Taibbi
Did the Fed Cause the Recession? – Mark Thoma
Kleptocracy definition – Wikipedia