Very informative, and entertaining to boot!
Posted by Samprimary (Member # 8561) on :
good take on both positions, and its charitable of them to end on austrian economics.
Posted by MightyCow (Member # 9253) on :
I just got schooled, son!
It's true, our public schools need to include more practical knowledge in the curriculum, particularly of the economic stripe.
Posted by Lyrhawn (Member # 7039) on :
Very entertaining, and informative.
I think for a high school student, this would require a little bit of background knowledge in the history of economics to really get the opposing viewpoints. But once they did, this would be a cool way to jump into the debate.
Posted by AvidReader (Member # 6007) on :
"Fear the boom" indeed. While I see the need for Keynes, it sounds like Hayek's the one we should have heeded for most of the past couple decades.
I'll definitely have to read up on him. I don't remember him being mentioned at all in my macroeconomics class.
Posted by TomDavidson (Member # 124) on :
quote:While I see the need for Keynes, it sounds like Hayek's the one we should have heeded for most of the past couple decades.
*laugh* That's the propaganda working! Posted by Orincoro (Member # 8854) on :
quote:Originally posted by Samprimary: good take on both positions, and its charitable of them to end on austrian economics.
Especially considering this piece was written by Adam Davidson, Russ Roberts, Alex Blumberg, and the other NPR/PRI Planet Money people. I don't there's a one of them that's an Austrian schooler, and most of them are pretty strong Keynsians.
Posted by Orincoro (Member # 8854) on :
quote:Originally posted by TomDavidson:
quote:While I see the need for Keynes, it sounds like Hayek's the one we should have heeded for most of the past couple decades.
*laugh* That's the propaganda working!
Yeah... we sort of did follow Hayek for the past couple of decades- part of the quirky politics of American conservatism is that while they followed the Austrian school, they also madly scrambled to maintain Keynes as a bugbear whose influence could be found everywhere, destroying our society. That's kind of the reason Americans have one of the weakest social welfare states in the developed world, and actually think that what they have is exceptionally cumbersome- cumbersome perhaps, exceptionally so, not really.
Posted by Samprimary (Member # 8561) on :
quote:Originally posted by AvidReader: "Fear the boom" indeed. While I see the need for Keynes, it sounds like Hayek's the one we should have heeded for most of the past couple decades.
This current crisis is the product of market non-regulation (see: commercial paper market, CDS's) so hayek would have been of little use.
Posted by BlackBlade (Member # 8376) on :
That was well written and quite entertaining. Economists have always been powerful, but they've never been cool before. Posted by fugu13 (Member # 2859) on :
quote:This current crisis is the product of market non-regulation (see: commercial paper market, CDS's) so hayek would have been of little use.
This is as much nonsense as the assertion the current crisis is a product of the existence of central banking.
Posted by Mucus (Member # 9735) on :
Elaborate?
Posted by Lisa (Member # 8384) on :
The "boom bust cycle" is caused by artifically screwing with the economy.
Posted by Lisa (Member # 8384) on :
quote:Originally posted by fugu13:
quote:This current crisis is the product of market non-regulation (see: commercial paper market, CDS's) so hayek would have been of little use.
This is as much nonsense as the assertion the current crisis is a product of the existence of central banking.
It is.
Posted by King of Men (Member # 6684) on :
Which is why it was so powerful in the laissez-faire nineteenth century. That said, the current problems are traceable, not so much to too much regulation or too little regulation, but to very bad regulation, full of little loopholes which a big company can jump through. Of course, that sort of thing is more likely when there are lots of regulations - complicated rules are more difficult to enforce and more difficult to make loophole-less.
Posted by Orincoro (Member # 8854) on :
quote:Originally posted by Lisa: The "boom bust cycle" is caused by artifically screwing with the economy.
:snort: You've never demonstrated here that you have any reasoned understanding of economics- may I suggest that if you want people to listen to you, perhaps you should depart from one-line definitive statements about such a complex topic? Or are you able to speak intelligently on this subject?
I find your choice of words to be interesting here, for example: "artificially" screwing with the economy, as opposed to what? Naturally screwing with the economy? Because out of all the economics I've studied, and all the theories of cause and effect I have tried to absorb, the one constant I find is that economic harm is wrought by the unchecked interest of either governments, or businesspeople.
I would love, Lisa, if you would be so kind as to explain why the housing bubble was caused by "artificially screwing with the economy." Are you arguing that the US government caused it? That China's government caused it? If so, how do you work against a systemic problem in China if you are a US regulator? What is the antidote to a socialist system investing too much capital in your market? See, the first failing of Hayek, in my opinion, is that the people who follow him can't seem to wrap their heads around the involvement of international political interests in the workings of domestic economies. How does a person give the market free reign when it is being attacked on all sides by concerted efforts to take advantage of its relative stability?
Posted by Raymond Arnold (Member # 11712) on :
While I don't have sources on hand, I have heard from multiple places I respected that a major source of the current recession was laws passed by democrats that made it easier to get housing loans than it should have been, or something along those lines. I don't claim to be an expert though.
Posted by Lyrhawn (Member # 7039) on :
That's a reference to Freddi Mac loans, I believe. I don't pretend to know as much about the housing catastrophe as I'm sure others here do, but from what I have read, two of the biggest factors were low interest rates set by the Fed, and banks making awful loans to obviously unqualified people. People didn't much care about interest only loans that would skyrocket in a few years because they either didn't understand it, or they didn't plan to be there, since the 90s and 00s were about flipping houses, rather than living in them long term.
I'm not entirely sure what banking regulation looks like a decade ago, so I don't know what role deregulation played in this mess, but it seems to me that it was a combination of extremely poor lending practices and straight out fraud on the part of lenders on how they marketed and sold these mortgages and subsequently packaged and profited off them in the aftermath, and also some extreme ignorance on the part of borrowers. I think I blame the "you can get something for nothing" crowd more than those who actually believed it, so I put a great deal of the onus on private lenders, rather than the government, but they still had a role in it from what I can tell.
Posted by Orincoro (Member # 8854) on :
quote:Originally posted by Raymond Arnold: While I don't have sources on hand, I have heard from multiple places I respected that a major source of the current recession was laws passed by democrats that made it easier to get housing loans than it should have been, or something along those lines. I don't claim to be an expert though.
*Sort of.* In truth the housing boom and bust was not a partisan issue at all. It was a combination of poor regulation (note, neither really under or over-regulation, just very weak institutions), and a huge influx of capital that caused overspeculation in the housing market.
You couldn't call that the *source* though. The source of the recession was ultimately a runaway influx of capital (largely from China) that caused too much money to be released into, among other things, the housing market, which drove prices up until the bottom fell out. So it's kind of like you have this huge high pressure line full of steam, and you blame one part of it for blowing up because it was poorly constructed. True, but the steam had to go somewhere, since China ultimately doesn't have the markets in place to keep its capital moving in its own domestic economy. The point though, is that while those weaknesses are definitely present in our economy, and some of them were put there by democrats, some by republicans (for reasons that seemed like good ones at the time, and may actually have been), a total lack of regulation would not improve that situation, and it would most likely make it much worse next time.
Also, you have to keep in mind that you are talking about "democratic" economic policies which, though they have not been altogether superseded in the last 3 decades, have been so poorly pursued as to be mere parodies of themselves- regulations in name only. That's why, among other things, the FCC was so ineffectual during this boom cycle at detecting and responding to major fraud, even when reports with detailed evidence were submitted, such as in the case of Bernie Madoff. The problem was that the FCC was staffed with lawyers- their mission had altered so radically that they were reduced to making sure forms and licenses and contracts were correctly filed, not ever finding out whether any of the things financial firms said what the were doing were actually being done. So essentially the advantages of offering loans remained, while disincentives against wild speculation and outright fraud were removed or preferably allowed to whither. Ultimately that situation is even worse than total deregulation, because it causes a hugely false sense of investor security.
But on the other hand, certain well run federal regulatory institutions like the FDIC weathered the crisis in better shape than could have been expected- their existence stopped an even more massive banking crisis from happening, and as a result there have been no major runs on smaller American banks in the last few years. That's a very, very good thing.
Posted by fugu13 (Member # 2859) on :
Importantly, it wouldn't have mattered nearly so much that people acted riskily if they didn't have access to such easy money to do so. Also, people would have been much less likely to buy risky homes if even their base interest rate (and thus base payments) was several percentage points higher (which it would have been without so much cheap money from the Fed). I think there still would have been a recession, but it would have been several times less bad.
Other factors include:
That the FMs were strongly encouraged by Congress and the President to expand into subprime loans (and without the FMs buying up loans, the bubble could never have gotten as big).
The existence of the mortgage tax credit -- when home debt is cheaper than other kinds of debt, people put a lot more wealth in mortgages.
Capitalization requirements that special-classed AAA rated assets as fulfilling them . . . and requirements that the one issuing the asset pays for the rating. This made organizations subject to those capitalization requirements seeking more and more elaborate instruments to reach AAA rating, but have increased returns, and gave financial instrument creators the means to manipulate the ratings process in order to provide them.
And numerous others.
On the flip side, the unwinding of CDSs has actually resulted in very few losses, because most firms held positions on both sides (or really had them as hedges). Nominal CDS value is almost unrelated to actual money on the line; the market looks huge, but so do numerous other derivative markets that aren't actually.
I'm not even sure why the commercial paper market was mentioned. There's nothing about the weakness there that had anything to do with lack of regulation; indeed, it is so incredibly not seen as being caused by lack of regulation that the new bill isn't doing a single thing to change regulation, as far as I can tell. The problems in the commercial paper market seem to have been largely symptomatic, rather than causal, and in large part overblown. Companies turned out to be able to get the cash they needed, they just had to pay higher rates (with a few exceptions, mostly of companies that were bankrupt when it was realized what the state of many securities was). It was a re-evaluation of how cheap money was (a lot of money was being destroyed, so that meant money had to become more expensive). That it was very sudden made things uncertain, and the problem wouldn't even have come up if money hadn't been so cheap (having a direct influence + increasing the size of the recession).
Posted by The Rabbit (Member # 671) on :
quote:I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.
-- Alan Greenspan
When the most prominent and powerful proponent of deregulating markets admits that it was a mistake, people continuing to believe in the religion of self regulating free markets should pay attention.
Posted by fugu13 (Member # 2859) on :
quote:The source of the recession was ultimately a runaway influx of capital (largely from China) that caused too much money to be released into, among other things, the housing market, which drove prices up until the bottom fell out.
The controlling factor was how expensive money was, not the amount of China's spending. China had revalued recently, by about as much as people had been clamoring for, and it didn't change our situation. They're probably still undervalued, but that's a problem for their economy, not ours.
I generally agree that it was bad regulation, not too much or too little. I'm generally in favor of simplifying regulations, but most in favor of picking regulations that don't create perverse incentives (such as putting more and more debt into homes . . . one of the worst debt instruments to have a crash in, due to the impact on mobility).
The importance of this is especially clear when you realize that, however well-intentioned and empowered regulators are, almost nobody is willing to tell people to stop making money during a boom.
I saw a recent piece on early Chinese banking, and I think there are some ideas that could be adopted re: internal shares and external shares, where directors hold stocks that only gain appreciable value well after they stop being directors (and can be forfeited under certain situations).
The FDIC was definitely well run, but they had some major problems. They very stupidly stopped collecting the fees they do, because they thought they had more than enough money.
We don't actually know if there have been any major runs on smaller American banks, actually. There's been some interesting work on researching the larger bank failures, and people have been finding that runs were occurring, you just couldn't see them unless you looked. It also seemed to be very bank-focused runs, which aren't really a big problem -- they happened to banks that really did have serious problems. Without doing a lot of financial forensics, I'm not sure you can say there haven't been any runs on smaller banks.
Posted by Samprimary (Member # 8561) on :
quote:I'm not even sure why the commercial paper market was mentioned.
Really? The commercial paper market was what was imperiled to the point of practically necessitating government intervention. It locked up in a period of hours.
The This American Life eps that were recently reposted here talk about it in depth.
Posted by fugu13 (Member # 2859) on :
Of course, it is also worth keeping in mind that Greenspan had a strong incentive not to blame his own actions, which were arguably responsible for the single largest slice of the problem (since lower interest rates have a huge effect due to multipliers of available money).
But anyways, self-regulating free markets is an oxymoron in any large economy (iceland appears to have had one for a little while . . . when it had a few tens of thousands of people living there). Laws about contracts, and fraud, and many more things essential to a free economy are regulations.
Btw, Greenspan was hardly the most prominent proponent of deregulating markets; as a Fed chair, he was extremely conservative in what he said in public. Numerous other proponents were much more prominent. He was arguably the most powerful, of course, but his power only existed in distorting the free market for money, which he did aggressively -- one could hardly call that being a powerful proponent of free markets, except insofar as the words "powerful" and "proponent" are completely unrelated.
Oh, I should mention that there's very little evidence that any deregulation undertaken as a matter of law in the last couple of decades had anything much to do with the situation. Informal deregulation, where regulators were encouraged to be more lax, did have considerable effect, though.
Posted by fugu13 (Member # 2859) on :
quote:Really? The commercial paper market was what was imperiled to the point of practically necessitating government intervention. It locked up in a period of hours.
Read the rest of what I wrote. See: symptomatic, not due to lack of regulations, et cetera. There were big problems in the commercial paper market, but lack of regulation in the commercial paper market is not a culprit. You seemed to be asserting it was.
Posted by AvidReader (Member # 6007) on :
quote:Originally posted by The Rabbit:
quote:I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.
-- Alan Greenspan
When the most prominent and powerful proponent of deregulating markets admits that it was a mistake, people continuing to believe in the religion of self regulating free markets should pay attention.
Right. I don't think Hayek would be right completely, but the Keynesisn idea that we can just borrow our way out of debt doesn't make much sense to me. Like in the video, it seems like the hair of the dog, and how healthy is that?
Slowing down a boom is probably as important as figuring out how to regulate big companies now that the point isn't to pass it on to the next several generations. Just like mortgage lending is about to under go a revolution as we're finding that people with plenty of money are willing to default on perfectly reasonable loans. My credit union has never had to reposess a home in its 53 years, but we might have to forclose on 15 this year.
I'm not sure how much regulation we need, but I definitely think we need different regulation.
Posted by Samprimary (Member # 8561) on :
quote:Originally posted by Lisa:
quote:Originally posted by fugu13:
quote:This current crisis is the product of market non-regulation (see: commercial paper market, CDS's) so hayek would have been of little use.
This is as much nonsense as the assertion the current crisis is a product of the existence of central banking.
It is.
A one liner economic disagreement from you actually works to my credit, yanno
Posted by scholarette (Member # 11540) on :
In Texas, my understanding is the state had stricter regulations on the home market. We never boomed and we never burst. At the same time, we deregulated the energy business, allowing a lot of expansion and new wind market there that other states didn't have. So, finding the right balance of regulation and deregulation kept us pretty insulated from the effects (not completely but really, not too bad).
Posted by Orincoro (Member # 8854) on :
quote:]Right. I don't think Hayek would be right completely, but the Keynesisn idea that we can just borrow our way out of debt doesn't make much sense to me. Like in the video, it seems like the hair of the dog, and how healthy is that? [/QB]
The map is not the territory. Hair of the dog is unhealthy, but the economy is not a living thing with a lifespan- its health is an evolving state.
You have to take as an underlying assumption of Keynsian economics that the books never end up balancing. You never reach a point where you're collecting exactly as much money as you spend- you're increasing the power of the government to continue to push consumption and move money in the economy when the market experiences setbacks. The idea is to smooth the famine/feast cycle inherent in markets by injecting liquidity when it isn't there, and pulling some liquidity out when there is too much.
From the more anecdotal side, certain Keynes inspired (inspired quite loosely) government programs have increased the prospective quality of life in the modern world in nearly unimaginable ways. The US space program for instance, has had an economic benefit astronomically greater than the spending required to support it. The GI bill, the Marshall plan, the New Deal, etc, have all contributed enormously in primary, secondary, and tertiary effects in literally every sector of the economy, and those of other nations. Part of the psychological difficulty of Keynsianism is that the benefits its yields are often very easily attributed elsewhere, and often for good reasons. But the fact is that if the US government played a zero-sum game at all times with the budget, the US would not be the power it is today- those massive spending programs gave us things infinitely more valuable than money- a way of life, education, technology, a national infrastructure, and on and on. It's difficult to write all that down in a ledger and value it, but it's there. I find for my part that I detect little in deregulation that gives us these kinds of rewards.
Posted by fugu13 (Member # 2859) on :
quote:Right. I don't think Hayek would be right completely, but the Keynesisn idea that we can just borrow our way out of debt doesn't make much sense to me. Like in the video, it seems like the hair of the dog, and how healthy is that?
Slowing down a boom is probably as important as figuring out how to regulate big companies now that the point isn't to pass it on to the next several generations.
Yep, Keynesianism only works, even assuming it is correct about how the economy works, if the government also takes in more revenue during a boom, decreasing the growth of the economy and paying off the debts incurred when "juicing" a bust. Since the government clearly has no moral will to do that, applying Keynesianism as the solution is less than clearly appropriate (since it isn't being applied properly even under its own best assumptions).
Posted by Mucus (Member # 9735) on :
quote:Originally posted by fugu13:
quote:This current crisis is the product of market non-regulation (see: commercial paper market, CDS's) so hayek would have been of little use.
This is as much nonsense as the assertion the current crisis is a product of the existence of central banking.
Still curious about this one. Precisely what is "as much" nonsense here? Are you referring to the part that the crisis was a product of non-regulation (as opposed to informal deregulation that you seem to note as just being a factor in exacerbating the problem) or is it the Hayek part? (Or both?)
Posted by AvidReader (Member # 6007) on :
I think the real problem is that Orincoro and fugu are probably both right. Posted by fugu13 (Member # 2859) on :
Oh, sorry I wasn't clear enough. Simplistically calling the crisis the product of market non-regulation is wrong, just as it is wrong to say the existence of central banking caused it. The particular actions of our particular central bank had significant input, so it is not completely wrong, but it is very far off the mark. While there quite likely would have been a recession without the actions of the central government (my personal suspicion is that some sort of business cycle is pretty much inevitable in any sufficiently free economy -- and that insufficiently free economies are even worse off), the actions of the central government were very large contributors to the situation. I doubt it would have been called a crisis without them.
For a simple thought exercise, imagine how many fewer people would have bought houses if the initial payments (before ARM reset) were a couple hundred dollars higher. Imagine how much less money would have been destroyed if that were the case. All that would have taken would be another couple percent on the interest rates, and the interest rates almost certainly would have been there if the Fed hadn't been taking steps to keep interest rates low. The economy would have grown more slowly, but that's the point, and things are more complicated than I'm making them sound, of course, but the broad effect definitely existed.
This means that Hayek would have been of more than a little use, at least in places. He would have thought artificially keeping interest low like that was an awful idea, for instance. Also, Hayek is frequently misunderstood as being for the almost entire abandonment of government regulation. He was more than fine with government requiring information disclosure (or publishing information itself), certain sorts of monetary intervention, labor laws, and all sorts of other things. Imagine if under his guidance more information about the fundamental assets underlying securities had been required to be disclosed. He's hardly a poster child for Lisa's brand of libertarianism.
AvidReader: certainly a lot of what Orincoro and I are saying is not incompatible.
Posted by Mucus (Member # 9735) on :
Ok, thanks for explaining.
Posted by AvidReader (Member # 6007) on :
So are there any economists who've combined the two ideas to help us find a balance between saving and spending - if I'm even right that that's kind of the main point of the two?
Posted by fugu13 (Member # 2859) on :
Nope, that's not really the main point of the two at all. For instance, Keynes was all for spending, and all for saving, just in two specific regimes. Hayek wasn't really all for saving, either; his insight is about how people act. He even sort of agrees that, if the government could make the right spending, they could reduce the effects of busts. He just argues that they cannot make the right spending (institutionally), and that the spending they do make ends up being worse in the long run.
But even moreso, he talks about what causes a big bust -- a boom leading to too much cheap money (which certainly happened recently, and probably accounts for most of the worst busts, at minimum). Heck, in the case of a particularly bad bust he might even be okay with a decent amount of government spending, because the most problematic thing has already occurred, and it is just down to damage control.
His big, big insight is that, to keep busts from being large, don't keep interest rates too low. Interest rates will naturally rise as economic activity increases and higher return uses of money decrease. This will naturally slow the economy, and it is a good thing. Heck, he's even okay with putting on the brakes a little pro-actively. So, his big prescription isn't about spending or saving, but about the price of money.
He pretty much definitely has a better account of the causes of large busts than Keynes does (he doesn't really have one -- his boils down to "sometimes, people act stupidly", which isn't very satisfying, since sometimes when people act stupidly we get very small busts, and other times we get much larger ones). Keynes arguably has the most politically feasible (and at least somewhat effective) recipe for dealing with busts; that recipe unfortunately only works if you use his politically infeasible recipe for dealing with booms. Raising taxes and taking in revenue is very unfashionable for governments. Hayek's prescription has a better chance of being possible to follow through booms and busts, IMO.
Posted by The Rabbit (Member # 671) on :
quote:Keynes arguably has the most politically feasible (and at least somewhat effective) recipe for dealing with busts; that recipe unfortunately only works if you use his politically infeasible recipe for dealing with booms.
People keep saying its politically infeasible, but only a decade ago we had a government that was raising taxes and paying down the debt during an economic boom. It's also worth noting that this policy was popular enough that the democratic candidate won the popular vote in the 2000 election. Those who say its politically infeasible are too cynical. In fact, if you look at national debt as a function of GDP for the past century, up until 1980 the government was quite fiscally responsible at controlling the debt during good times. Since that time, the national debt has skyrocketed whenever the republicans held the presidency and was only brought under control under Clinton. Its kind of ironic to hear people talking about Keynes being politically feasible only during busts when Obama is taking far more flack for running a deficit during a major economic crisis than Clinton did for leaving office with a big budget surplus.
The crux of the problem as I see it is that since Reagan, the right wing has favored (in practice at least) lowering taxes, deficit spending and cuts to non-military spending during both booms and busts. It basically boils down to classical economics during booms and Keynesian economics during busts. That's a recipe that is fundamentally unsound from any economic perspective.
Posted by fugu13 (Member # 2859) on :
quote:People keep saying its politically infeasible, but only a decade ago we had a government that was raising taxes and paying down the debt during an economic boom. It's also worth noting that this policy was popular enough that the democratic candidate won the popular vote in the 2000 election.
Oh, come on. While Clinton managed to raise taxes a small amount and briefly close the deficit gap, he never managed to make any significant movement the other way, which is absolutely required for Keynes' approach to work even under its own best assumptions. 'Controlling the debt' during good times is not sufficient -- to prevent the big busts (which still happened in the time you're indicating), which is presumably the goal (otherwise, why bother with all the extra spending, when we can just let busts happen anyways) it is necessary to decrease spending/raise taxes enough to significantly buffer against busts and slow booms.
The Clinton projected budget surplus (which depended on certain overly rosy assumptions, so wasn't even as large as projected) was large only in comparison to the opposite choice, budget deficits. It was not sufficient to even begin to meet the requirements of Keynes. Especially as it took too long -- by the time we were projected to have a decent surplus, a recession had already set in. That's when we don't want a surplus (edit: again, taking Keynes on his own best assumptions).
[ April 27, 2010, 09:37 AM: Message edited by: fugu13 ]
Posted by The Rabbit (Member # 671) on :
quote:Originally posted by AvidReader: Right. I don't think Hayek would be right completely, but the Keynesisn idea that we can just borrow our way out of debt doesn't make much sense to me. Like in the video, it seems like the hair of the dog, and how healthy is that?
It doesn't make sense because it's not what Keynes said. Its simplified to the point of absurdity.
One key problem with markets is that they have all kinds of positive feed back loops that tend to drive them out of equilibrium. For example, when the markets are up, people jump on the bandwagon which drives them up even higher. When markets begin to fall, people bail out causing greater declines. Both Hayak and Keynes are addressing mechanisms for countering that kind of instability. What Keynes actually recommends is that the government should operate in a way that counters what's happening in the private sector. When the private sector is expanding, the government should contract, raise taxes, and pay down debt, so that when the private sector contracts the government can lower taxes and expand.
The central bank maintaining artificially low interests during an economic boom isn't something either Hayak or Keynes would have recommended.
I think one of central problems globally is poor economic indicators. (or at least poor understanding and use of economic indicators). For example, if rises in the cost of housing were more effectively incorporated into inflation statistics (the cost of housing is after all a big part of the cost of living), the central bank would have been less likely to keep interest rates so low. As a second example, keyl economic indicators don't take into account depreciation of infrastructure and depletion of resources. This allows nations to hide economic losses in ways that would be considered criminal for corporations.
Posted by AvidReader (Member # 6007) on :
Thanks, everyone. This conversation has been way more informative than my required economics class in high school. Posted by Samprimary (Member # 8561) on :
quote:Originally posted by fugu13: Oh, sorry I wasn't clear enough. Simplistically calling the crisis the product of market non-regulation is wrong, just as it is wrong to say the existence of central banking caused it.
To clarify, I don't use that simplistic assessment to describe the financial downturn in general. Probably, the 'crisis' theme I use needs to be explained. I use it strictly for the crisis event that occurred at the start of this whole mess, wherein there was a lockup of the commercial paper market that pretty much necessitated a governmental intervention, which Bush delivered.
The history of that issue goes back strictly to an issue of non-regulation (apparently, instead of de-regulation, which I initially thought) where elements such as credit default swaps were made into time bombs with the blessing of the Clinton administration and the at-the-time congress. The number of dissenters to the bills in question from either party could be counted on one hand.
Posted by fugu13 (Member # 2859) on :
quote:The history of that issue goes back strictly to an issue of non-regulation (apparently, instead of de-regulation, which I initially thought) where elements such as credit default swaps were made into time bombs with the blessing of the Clinton administration and the at-the-time congress.
This is very confused. I can't tell what you mean in the least. Could you clarify with which specific acts credit default swaps (which turned out not to have been the major cause of just about anything; they've been fairly innocuous, overall, but complicated) were blessed for making into time bombs by the Clinton administration and at-the-time Congress?
Posted by Samprimary (Member # 8561) on :
quote:Originally posted by fugu13: Could you clarify with which specific acts credit default swaps (which turned out not to have been the major cause of just about anything; they've been fairly innocuous, overall, but complicated)
Um ... hmm. Okay, I'll dig up the info on the exact session and vote that left CDS's unregulated, but I want to see where you're coming from on this. You say this, so, let's contrast it against how the subject is described in the NYT topics section:
quote:Credit default swaps are financial instruments that serve to protect against a default by a particular bond or security. They were invented by Wall Street in the late 1990s as a form of insurance. Between 2000 and 2008, the market for such swaps ballooned from $900 billion to more than $30 trillion. In sharp contrast to traditional insurance, swaps are totally unregulated. They played a pivotal role in the global financial meltdown in late 2008. More recently, swaps have emerged as one of the most powerful and mysterious forces in the crisis shaking Greece and other members of the euro zone.
The original purpose of swaps was to make it easier for banks to issue complex debt securities by reducing the risk to purchasers. It is similiar to the way the insurance a movie producer takes out on a wayward star makes it easier to raise money for the star's next picture. Here is a more detailed but still simplified explanation of how they work, given by Michael Lewitt, a Florida money manager, in a New York Times Op-Ed piece on Sept. 16, 2008:
"Credit default swaps are a type of credit insurance contract in which one party pays another party to protect it from the risk of default on a particular debt instrument. If that debt instrument (a bond, a bank loan, a mortgage) defaults, the insurer compensates the insured for his loss. The insurer (which could be a bank, an investment bank or a hedge fund) is required to post collateral to support its payment obligation, but in the insane credit environment that preceded the credit crisis, this collateral deposit was generally too small. As a result, the credit default market is best described as an insurance market where many of the individual trades are undercapitalized."
Swaps proved to be very profitable — in the short term. Banks and other companies that issued them earned fees for insuring events they thought would never happen, like the bottom falling out of the market for mortgage-backed securities. As a result, the losses produced by the end of the housing bubble were multiplied manyfold, as the issuers of swaps found themselves faced with huge liabilities they had not prepared for. It was this cycle that brought down the American International Group, the insurance giant, which eventually needed $180 billion in taxpayer support.
Swaps also became something traded in and of themselves, as a form of speculation. That kind of trading also landed investment banks in multiple and seemingly conflicted roles, as when Goldman Sachs helped sell bundles of mortgage-backed securities and then used swaps to bet that they would go belly up.
The role of banks like Goldman also became the focus of criticism as Greece, Spain and other southern European countries found themselves facing a debt crisis. Over the last decade, Goldman and others helped the Greek government legally mask its debts so the nation appeared to comply with budget rules governing its membership in the euro, Europe's common currency. In that role, Goldman advised Greece and, in return, collected hundreds of millions of dollars in fees from Athens.
But, just as the true extent of Greece debts began to worry investors, Goldman put on another hat. Last July, it sent clients a 48-page primer on credit-default swaps entitled "C.D.S. 101." The report said that credit-default swaps enabled investors "to short credit easily" — that is, to bet against certain borrowers. The report made no mention of Greece. But its disclosure in March 2010 fueled the suspicions of European officials who have called for investigations into the role swaps have played in the current crisis.
Obviously you disagree with this assessment, if you describe CDS's as having been 'not the cause of just about anything' and 'fairly innocuous' ...
I believe that what you are saying is not actually true; CDS's were not proved to be 'innocuous' but rather to have had a smaller market, so, the complications provided by CDS's was really more potent.
Even the NPOV Wikis, reuters AND ap wires on CDS's prominently mention the established netting effect as well as all the other mechanisms which caused their effect to be so disastrous during the crisis phase in 2008.
In order for me to significantly change my assessment on the role that CDS's played in the crisis to be more like what you attest, I'd need to see some resources from whichever financial/market experts or groups determined CDS's to have been 'innocuous' especially considering that current events involving greece are intensifying criticism against them via the demonstration of more of their negative effects to markets.
Posted by Samprimary (Member # 8561) on :
More from Newsweek
quote:So much of what's gone wrong with the financial system in the past year can be traced back to credit default swaps, which ballooned into a $62 trillion market before ratcheting down to $55 trillion last week—nearly four times the value of all stocks traded on the New York Stock Exchange. There's a reason Warren Buffett called these instruments "financial weapons of mass destruction." Since credit default swaps are privately negotiated contracts between two parties and aren't regulated by the government, there's no central reporting mechanism to determine their value.
and the story on the act that precipitated the unregulated nature of CDS's
quote:During a lame-duck December session, while the media was focused on the recounts and court cases, Gramm and Ewing sought to strike a compromise on the Commodity Futures Modernization Act. The day after the Supreme Court ruled in favor of Gov. Bush, December 14, Ewing introduced a new version of the Commodity Futures Modernization Act. On December 15, with little warning or fanfare—aside from the overshadowed discussions on the floors of Congress—the new, compromise version was included as a rider to the Consolidated Appropriations Act for FY 2001, an 11,000 page omnibus appropriations conference report.
HedgeWorld Daily News, a trade publication for hedge funds and one of the few news outlets following the bill, stated, “Details of the final language are not immediately available. Congressional aides said Sen. Gramm did succeed in getting additional language protecting the legal certainty of swap, especially those traded by banks, which are the main users of the products.”
The final language, which the public was hardly aware of, contained some new sections not in the original Ewing bill that, for all intents and purposes, exempted swaps and derivatives from regulation by both the CFTC, which had already implemented rules that it would not regulate swaps and derivatives, and the SEC. Also, hidden within the bill was an exemption for energy derivative trading, which would later become known as the “Enron loophole” – this loophole would provide the impetus for Enron’s nose dive into full blown corporate corruption.
Ultimately, while the unregulated market in derivatives and swaps did not cause the economic downturn itself, it was a propellant of the crisis, accelerating the collapses of major financial companies across the globe. As of June 30, 2008, the global derivatives market had exploded to $530 trillion, while credit default swaps had grown from mere insignificance to $55 billion. When the credit crisis and the mortgage meltdown began to take hold, major firms found out the swaps made their investments far riskier than they could handle.
Bear Stearns, Lehman Brothers, and American International Group (AIG) all collapsed due to problems with the unregulated market of credit default swaps. The major banks were also heavily involved with credit default swaps. A report from the Comptroller of the Currency recorded in the third quarter of 2007 that the top banks in the credit default market were JP Morgan Chase, Citibank, Bank of America and Wachovia. Wells Fargo purchased Wachovia after it collapsed. Bank of America has received approximately $45 billion in TARP funds from the Treasury Department, mostly to offset losses from its acquisitions of Countrywide Financial in 2007 and Merrill Lynch in 2008. Citibank’s parent company Citigroup faced a complete meltdown during the end of 2008, received $50 billion in TARP funds from Treasury, and is breaking apart into smaller companies. JP Morgan Chase, while weathering the crisis far better than the other banks, still received $25 billion in TARP funds.
quote:The CFMA’s treatment of credit default swaps has received the most attention for two issues. First, former New York Insurance Superintendent Eric Dinallo has argued credit default swaps should have been regulated as insurance and that the CFMA removed a valuable legal tool by preempting state “bucket shop” and gaming laws that could have been used to attack credit default swaps as illegal. In 1992, the FTPA had preempted those state laws for financial derivatives covered by the CFTC’s “swaps exemption.” As described in Section 1.1.2 above, however, a “gap” in the CFTC’s powers prohibited it from exempting futures on “non-exempt securities.” This “loophole” (which was intended to preserve the Shad-Johnson Accord’s prohibition on single stock futures) meant that, before the CFMA, the CEA’s preemption of state gaming and “bucket shop” laws would not have protected a credit default swap on a “non-exempt security” (i.e. an equity security or a “non-exempt” debt obligation that qualified as a “security”). As before 1992, the application of such state laws to a credit default swap (or any other swap) would depend upon a court finding the swap was a gambling, “bucket shop”, or otherwise illegal transaction.
Greece's problems have nothing to do with CDSs. Greece is deep in debt, with far too much public spending, and with huge internal resistance to reductions in public spending. The existence of CDSs doesn't change that calculus one way or the other. Greece's situation quickly stabilized after the revelation of their hidden debt, and only went back downhill after the government was unable to come up with a plan to restructure their economy.
Sure, Greece has been blaming CDSs, but the real problem is that they tried to move their debt off balance books, it didn't work, and they got called on it. When their real levels of debt became clear, everyone reacted to move out. The people who had CDSs against Greece were already protected; this is a positive thing, since Greece's economy is in serious trouble. What's more, people are largely only willing to keep investing in Greece because it is possible to hedge against them. Note: CDS have parties on both sides -- there are plenty of people willing to bet for Greece at the right price.
Notice how the Greece, the recent situation that's still heavily under analysis, is the only thing they try to pin concretely on CDS (in a topic article that's about CDS in general). What about all those CDS problems people were talking about earlier? There's a reason they don't bring them up in any concrete way: because those problems were drastically over exaggerated. Estimates are that the net cashflows after Lehman's collapse were on the order of $7 billion. A lot, but hardly earth-shaking on the scale of other losses during that time (probably well over a trillion was lost on MBS). AIG's might have been a bit higher than Lehman's (the government is being mum), but that's because they're paying out 100%, when standard practice in the case of a bankruptcy would be to give the counterparties haircuts (don't you love the terminology?).
There's definitely some use to providing structure to the CDS market, but it is nowhere near the 'cause of disaster' you seem to be alluding to.
Lehman brothers died, not because they were in CDSs, but because they were overleveragd. A few of their clients insisted on increased capital to secure deals they had, and suddenly they were broke. This can happen even with the most regulated securities around -- leverage is an independent consideration. While I've long been leery of maximum leverage levels, they've had an important regulatory purpose . . . until this recent proposal for required convertible bonds for large financial institutions, which would be a perfect response.
And it was Lehman Brothers' death that lead to the lockup of the commercial paper market, because they made a couple major money market funds that were overexposed on them break the buck (and a few others get bailed out to large sums of money), leading to runs on the other money market funds (I might point out that money market funds are highly regulated institutions), focused on those money market funds with exposure to commercial paper (of the sort they were overexposed to Lehman on), leading to a flight to longer-term bonds at higher rates, largely from non-financial companies.
It is worth noting that, while the commercial paper market dried up, the situation was not nearly as dire as it sounds. I haven't seen a full post mortem, but numerous companies turned out to have secured funding by long term bonds at somewhat higher rates.
Posted by fugu13 (Member # 2859) on :
Posted my last before your latest.
quote:So much of what's gone wrong with the financial system in the past year can be traced back to credit default swaps, which ballooned into a $62 trillion market before ratcheting down to $55 trillion last week—nearly four times the value of all stocks traded on the New York Stock Exchange.
Completely irrelevant comparison. Nominal values of CDS contracts are not the values paid out, plain and simple. Even in the collapse of a massive CDS holder, the payout can be as low as a few billion (see above, re: Lehman).
Nobody thought any existing agency could regulate CDS anyways, so passing a law clarifying that they aren't regulated by any existing agency is hardly a sweeping deregulation. Look at the article itself, it makes quite clear that this was a clarification, not a policy change, despite trying to make CDS look like villains.
The argument that states would have regulated them with gaming laws is grandstanding after the fact. I haven't seen any evidence that states had any interest in regulating CDS prior to the financial difficulties.
Note: I'm not arguing that CDS couldn't stand some standardization. I've mentioned several times that it makes sense to do more of that. However, the degree they've been turned into demons is ludicrous and not based on actual evidence of significant harm.
Posted by Samprimary (Member # 8561) on :
quote:There's a reason they don't bring them up in any concrete way: because those problems were drastically over exaggerated.
You'll have to show me some expert analysis of the markets by some sort of financial research group or something which has come to this conclusion. I get that you absolutely disagree that there was any evidence of 'significant harm' but at this point it's basically your word against the established comprehensive analysis of the crisis (see again, This American Life's two episodes on the collapse). At THIS point, I know which side I'm going to take as being more credible. If you find something to leverage your opinion with, I'm amenable to change.
quote:Nobody thought any existing agency could regulate CDS anyways
It's not about whether they knew then that they were going to be a problem. it's about the fact that they turned out to BE a problem.
Posted by fugu13 (Member # 2859) on :
quote:You'll have to show me some expert analysis of the markets by some sort of financial research group or something which has come to this conclusion. I get that you absolutely disagree that there was any evidence of 'significant harm' but at this point it's basically your word against the established comprehensive analysis of the crisis (see again, This American Life's two episodes on the collapse). At THIS point, I know which side I'm going to take as being more credible. If you find something to leverage your opinion with, I'm amenable to change.
Of course, you've only shown anecdotes and have stated you're relying on journalists to analyze the financial crisis (and I certainly like This American Life, but financial analysis it is not). What's more, the sources you've actually offered often haven't backed up your position. Try rereading the Times' summary with a critical eye (note: I have provided a source citing prominent financial experts that CDS are, if anything, helping Greece. The Times has been quoting politicians).
All the numbers I've mentioned are readily available. The financial instruments Lehman Brothers was overleveraged in were CDS (as I acknowledge, above). However, I'll lay out my case, again, that CDS weren't the core of the problem. Feel free to point out any logical flaws or any points you disagree with. If you have access to such good financial analyses, it shouldn't be a problem, assuming I'm wrong
1) Over leveraging is a problem no matter what sort of instrument one's assets are in.
2) The actual losses related to Lehman Brothers' credit default swaps were not particularly large for the failure of such a large institution ( http://www.ft.com/cms/s/0/25137702-972d-11dd-8cc4-000077b07658.html , note the comparison to the sizes of transactions that are typical in the fields Lehman operated in). Coincidentally, though not important to this argument, this is proof that Lehman Brothers' CDS were fairly well hedged, rendering the 'naked CDS' concern moot.
3) Since, even in the second-worst CDS related failure (AIG's was bigger, by around an order of magnitude, but the government didn't make counterparties take any haircut. With a typical haircut, AIG's losses would have been smaller, most likely), the losses due to CDS were not particularly large, there is no particular reason to attribute Lehman's collapse to anything other than its extreme overleveraging -- any moderately substantial increase in capital requirements on a leveraged deal (likely due to risk changes) would have wiped them out.
4) If CDS had not existed as a convenient vehicle to be highly leveraged in, Lehman would have been leveraged in something else (after all, they weren't required to not be leveraged, plus money was cheap).
5) While CDS against Lehman resulted in large money transfers, all of those transfers were zero sum between the large financial institutions. Some became worse off, but others became better off. And the amount they did so was based on the degree to which they accurately anticipated market moves. This is a positive aspect of CDS, not a negative one.
I'll even add a little argument:
6) The proposed regulations that might pass (luckily, a ban on naked CDS isn't one of these -- CDS are very important for hedging risks that aren't represented by assets you hold, but are proxied for by assets other people hold -- such as with Greece, where the CDS market is making financial firms much more willing to buy greek bonds) don't do anything to prevent a company from building up a large portfolio of CDS just as they did already, making the ways you seem to be attributing problems to CDS not something that will be stopped.
For a few worthwhile perspectives on why CDS are not nearly so bad as bandied about, including from notable sources:
By the way, I'm not really hoping you'll agree. There is legitimate disagreement on the issue, definitely; there are several aspects of my argument that might be wrong. The better criticisms of CDS talk about how they made financial relationships cloudier, making too many financial institutions react by "turtling". This is why so many of the regulations being proposed by experts center around increased CDS market transparency, not any cut back in use.
Your demonization of CDS, and what you've ascribed to them (insofar as I've been able to divine -- I'm actually having a very hard time discerning what you think happened, in specifics, as I've mentioned a few times), however, is something that can be well argued against. All I'm hoping for out of the argument is convincing a few people, maybe including you, that maybe, just maybe, CDS are a useful financial instrument that will, with improved transparency, continue to be an important part of international finance.
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