The Financial Times give us yet another sorry update in the bankster vs. the general public saga, and the banksters continue to gain ground. Their latest about-to-be-cinched victory is beating back a pro-reform idea sponsored by Senator Dodd (yes, even he can have the occasional “Nixon Goes to China” moment). Dodd had wanted bank regulation to be stripped from the Fed and housed in a new agency.
While that model can be argued to have led to some fumbled passes in the UK during the early stages of the crisis (most notably, the Northern Rock run), many observers contend that the flaw was the failure to hash out certain operational details, rather than the structure being inherently unworkable (in general, any organization structure is going to have particular shortcomings; you therefore need to have other mechanisms in place to compensate for them).
Perhaps most important in the case of the US, the Fed is far and away the most captured, the most asleep at the switch of the banking regulators. Keeping them in charge of bank regulation is like reappointing a fire commissioner who let half the town burn down.
And the “compromise” settled upon is to allow the banks most in need of tough supervision, ones with more than $100 billion in assets (which amounts to the biggest 23, and thus includes all the 19 TARP recipients) to remain the wards of the supine Fed. Yet these are the ones that pose the biggest systemic risks. Heck of a job, Brownie.
The notion that makes this guaranteed-to-continue-to-be-weak oversight OK is that the big banks will be permitted to fail. While that may be credible for some of the really big banks (Fifth Third, for instance, is large but not systemically important) any large capital markets player is an integral part of crucial debt market operations. Those large firms in turn are deeply enmeshed via counterparty relationships, most notably repos and credit default swaps. How, pray tell, do you shut down a trading firm in an orderly fashion? You can’t freeze positions, which is what you need to do in an unwind, and not create pain and inconvenience for the counterparties. Are we going to have a firm in default (presumably with emergency credit lines) continue trading? I haven’t heard a credible solution to this rather major conundrum from the officialdom.
Ex starting a serious program to reduce the connectedness of these firms, I see only one of two likely outcomes: either a Lehman 2.0 (a firm will be allowed to fail because it will be politically necessary to have one fail, it will prove to be a mess, and then the officials, in a panic, will start bailing out the ones impacted by the unforeseen blowback) or a successor Administration will not trust the resolution procedures and will go directly to bailout (not doubt with a few punitive measures, like some forced divestitures of non-core businesses, to allow them to claim that it was not a bailout, but a new version of resolution lite).
Andy Xie reminds us that regulatory reform is a key precondition to a sustained recovery. His piece takes up one of our favorite themes: how the story of Japan’s colossal lost decades has been airbrushed here, to argue that the big Japanese mistake was insufficiently aggressive fiscal and monetary stimulus. By contrast, it is seldom reported here that the Japanese themselves believe that their big failure was not reforming their financial system in the initial years after the implosion. No one here wants to admit that we are following the failed Japanese playbook, and for the very same reasons: politicians are unwilling to take on powerful, entrenched financiers. From Xie (hat tip Crocodile Chuck):
Last year, in a moment of panic over the global financial crisis, central banks and governments poured monetary and fiscal stimulus into the global economy. The side effects of these misguided policies are already showing up….Despite the visible need for tightening, the consensus is demanding a slow and delayed exit. Japan’s “early withdrawal” is touted as an example of what could happen otherwise.
Japan has experienced two decades of economic stagnation since the collapse of the infamous bubble it suffered in the 1980s. The most popular explanations are that Tokyo wasn’t aggressive enough in stimulating the economy after the bubble burst, or that it withdrew its stimulus too early – or both. This line of thinking is popular among elite economists in the US, where it is rarely challenged. But few Japanese analysts buy it.
The Americans liken an economy in a slide to a car with a dead battery: it can be jump-started with a forceful enough push. But there’s no sound logic behind such thinking. After a big bubble bursts, an economy suffers a terrible misalignment between supply and demand. Through high prices, a bubble diverts investment and labor to unneeded activities. It takes time for an economy to normalize. The bigger the bubble, the longer it takes to heal.
The argument to “stimulate until prosperity returns” is popular because it doesn’t hurt anyone in the short term….. Japan’s tale is just a nice story that seems to support the argument.
At the peak of Japan’s bubble, the biggest in history, the excess value of its property and stock markets was more than five times its gross domestic product – more than the entire world’s gross domestic product at that time. In comparison, the excess asset value in the US bubble was less than twice its GDP, or half the global GDP. So how is it possible to just stimulate an economy back to health after such a massive correction?
Japan has run up the national debt equal to 200% of GDP — the greatest Keynesian stimulus program in history — all in the name of stimulating the economy back to health. It has failed miserably. Japan’s nominal GDP is about the same as when the stimulus began. Those who advocated the policy blame Japan’s failure on either the stimulus being too small or not being sustained for long enough – that is, the dosage, not the medicine itself, was at fault.
The bankruptcy of Japan Airlines is a sobering reminder of what is still wrong with Japan….Zombie companies that have first claims to resources have trapped the Japanese economy in stagnation for decades. The lack of shareholder rights has given the moribund companies the luxury of being able to disregard capital efficiency….
What ails Japan is a lack of reforms, not stimulus….
The crisis happened because financial professionals had incentives to bet other people’s money in a game they could not lose. With so many getting in on the act, the liquidity they threw into the trades made them effective, turning bankers into heroes, but only for a while.
The crisis showed that their behavior was indeed rational: while the losses to shareholders and taxpayers surpassed all the accounting profits that Wall Street reported during the bubble, those who made the trades are still rich, because they paid themselves bonuses in cash, not derivatives.
Obama has not been well-advised. His so-called accomplishment — stabilizing the financial system — comes from throwing trillions of taxpayers’ dollars at financial firms. He has behaved like a Wall Street trader: spending other people’s money with no thought of consequences. Anyone can do that…
Reform, not stimulus, is the solution. Only by limiting financial speculation can the foundations be laid for a healthy recovery, and to prevent another crisis.