Across the United States and Europe there was a wave of layoff announcements this week, with more than 70,000 job cuts announced on Monday alone. Another 11,500 job cuts were announced on Tuesday, bringing the total to a little more than 200,000 layoffs announced during the first month of the year (announced layoffs January 2009). Also, the U.S. Bureau of Labor Statistics (BLS) reported Wednesday that job losses in December 2008 associated with mass layoff events (those that involve at least 50 initial claims for unemployment insurance) were up 55 percent versus a year earlier. During January, layoffs have spread to more industries and to companies from Microsoft to Starbucks to the world's largest manufacturer of construction equipment, Caterpillar, all of whom announced layoffs this week.
While layoffs have received quite a bit of attention, they were only part of the story of labor market problems in 2008—which makes the accelerating layoff reports especially bad news.
According to the latest data from the BLS Job Openings and Labor Turnover Survey (JOLTS), the layoff rate (as a percent of total employment) increased from 1.3 percent at the start of the recession in December 2007 to 1.6 percent in November 2008. Over the same period, the rate at which workers quit their jobs declined from 1.8 percent to 1.4 percent—likely a result of uncertain job prospects. On net, the overall rate of job separation toward the end of 2008 was similar to what it was at the beginning of the year. The total number of separations stood at about 4.3 million in November 2008, compared to 4.4 million in December 2007.
While the rate of total separations was relatively steady during 2008, a more notable change can be seen in the hiring rate (as a percent of total employment), which declined from 3.4 percent to 2.6 percent. The level of hiring is estimated to have been about 3.5 million in November 2008, compared with 4.7 million in December 2007.
The chart below highlights the rapid decline in hiring relative to layoffs.
Not only have firms been letting people go, they apparently have taken down the help wanted signs at an even faster rate. As a result, the unemployed have fewer employment options, and this development has exacerbated the duration of unemployment. From the BLS household survey, in December of 2008 the average duration of unemployment was 19.7 weeks, compared with 16.5 weeks in December of 2007. This lengthening in the duration of unemployment is also reflected in the Department of Labor weekly claims data released yesterday that showed the four-week average number of continuing claimants for unemployment insurance at 4.63 million during the week of January 16, compared to 2.65 million in mid-December 2007 (see the chart below).
Unfortunately, the growing indication is that "furlough, wage reductions, hiring freezes and shorter hours simply did not do enough" to deal with weak business conditions. Barring a pick-up in job creation—which is unlikely given the recent pattern of continuing claims for unemployment insurance—it is hard to paint a very positive portrait of the labor market in the near term.
By Menbere Shiferaw and Sandra Kollen, senior economic analysts at the Atlanta Fed"
Me:The subtitle is Congo, The Rwandan Genocide, and the Making of a Continental Catastrophe and yes the book truly explains all of these things or at least gives it a noble try. The author is Gérard Prunier. I've been stunned by how much I've learned from this book, which is clear without denying the underlying complexities. I rate it as one of the two excellent books of the year so far, the other being Ted Gioia's book on the history of the blues.
You'll find a very critical review of the book here but I was more impressed by the book than by the review. I liked this excerpt:
Interviewer: What model of democracy do you see as suitable?
Kabila: I cannot say now, you are asking too much. Being a head of state is not like being in a restaurant. I have to have time to think about it.
Me:I'd like to recommend a few blogs:
http://stopthewarinnorthkivu.wordpress.com/
http://blogs.lesoir.be/colette-braeckman/
http://blogs.reuters.com/africa/
Posted by: Don the libertarian Democrat at Jan 31, 2009 5:01:03 PM
Zimbabwe’s opposition Movement for Democratic Change has agreed to join a unity government with President Robert Mugabe, breaking a crippling deadlock four months after the political rivals reached a power-sharing deal.
The decision could improve Zimbabwe’s prospects of recovering from economic collapse and easing a humanitarian crisis in which more than 60,000 people have been infected by cholera and more than half the population needs food aid.
Zimbabweans have long wished for a new leadership that can ease the world’s highest inflation rate and severe food, fuel and foreign currency shortages. Millions have fled the suffering to neighbouring countries, straining regional economies.
Western aid and financial assistance tied to the creation of a democratic government and economic reform could be crucial to rescuing what was once one of Africa’s most promising countries.
South Africa’s President Kgalema Motlanthe was optimistic and told Reuters in Davos that his country would help rebuild Zimbabwe.
But Senegal’s President Abdoulaye Wade and Kenyan Prime Minister Raila Odinga cast doubt on whether the deal would work and said President Mugabe must go.
Will this decision work? Will it bring change and help ease the suffering of ordinary Zimbabweans? What do you think?"
This has to be one of the more obvious political conclusions that we can make.
- Posted by Don the libertarian Democrat Your comment is awaiting moderation."His assurances are also predicated on a ‘hope’ and ‘assumption’, but not much more, namely that countries (I see Germany is included!) affected by a substantial fall in their exports to the USA would not retaliate."
I think that he's on to something. The Spender Country / Saver ( Exporter ) Country Symbiosis is going to be hellishly hard to break apart without serious social dislocation and disruption. I expect to see some form of agreed upon default by the Spender Countries. The choices include:
1) Let the Spender Countries export more
2) Allow some debt cancellation
3) Allow the Spender Countries to inflate their currency
I'd like to be proven wrong, but getting the Chinese, savers who've just seen the negative consequences of spending to spend, is a difficult task.
Don the libertarian Democrat
Gavin Kennedy said...Hi Don
Apologies. I wrote a response but must have deleted it before posting. Ny PC has been on and off today as I have had family chores and I always switch it off when absent.
I wrote something like this:
I don’t think this is a runner, as my racing friends would say.
The issue is any arrangement that worsens some trading partners at the expense of others is bound to provoke retaliation by edict, which once started becomes uncontrollable. This started the decline in world trade in the 1930s once the depression was underway, i.e., reciprocal ‘beggar thy neighbour’ trade wars, making the depression deeper and longer lasting.
For ‘spenders’ to export more, the question is to whom are they exporting more and of what?
Who allows what ‘debt cancellations’, for how much and for how long?
Inflation is a monetary phenomenon – a currency is worth what I is worth in terms of other currencies.
Chinese savers can act in China only; their government decides its exchange rates.
I am inclined to think that there will be “serious social dislocation and disruption”, especially from what Pete Murphy proposes.
The US is not a free-trade economy, neither is Europe, nor China and India, or Brazil. Becoming even less free is a high-risk ‘solution’ for which the precedents are not kind to optimists.
The UK is the most vulnerable economy in the G7 because the financial sector is so important, because the housing boom was so large and because household debt is sensationally high, and we are also highly dependent on the rest of the world which is suffering a recession too. And our underlying fiscal position related to these vulnerabilities is much worse than anyone thought 2 years ago.It's interesting that the fact of a recession is the problem - that is, a reduction in GDP, rather than the actual level of output or consumption. If the UK has benefited (as it undoubtedly has) from huge growth in the financial sector and housing-related investment over the last ten years, and we now have a brief slowdown from a peak of economic activity, you might think it isn't something to regret.
Politicians undoubtedly get that there is a massive cyclical downturn, but people don't get that it's a structural change. 2006 is not coming back with its consumer-led debt boom driven by the English-speaking countries. We might get back to past growth - I hope we will - but the world will have to be rebalanced. Governments are doing a good job of short-term stimulus and saving the banking system. A sensational level of stimulus! But for stability, healthy private sector demand is needed. Lots of changes are needed that China, the US and UK don't yet get, but they are essential in getting back to a healthy economy.I guess the message here is that China is storing up too many claims on the US and UK economies, which are likely to lead to problems in the future. The US and UK (among other countries) are consuming China's output now, and instead of paying for it now by exchanging our own services, we are exchanging promissory notes to pay later. Fair enough, and the Chinese are willing to let us do it, but there must be a risk in this.
[The changes are beyond most people's understanding] We need to protect emerging economies now - change the way we finance them and expand the IMF; and have a serious, intelligent dialogue with the Chinese to make their growth more compatible with the global economy - the US and UK need to change too, and make the world financial system work better - because it has worked terribly.
"So perhaps we need to figure out what we have to offer the Chinese consumer."
The younger generation in China were beginning to become spenders as opposed to savers, but this crisis has shifted their perceptions. And that's the big problem: You're asking savers who have seen the spenders bring on a crisis to become spenders. I don't see it.
I think that there has to be some allowed default by the spender countries, either through debt cancellation or allowing us to use inflation to get out of this. Other solutions lead, and I hate to say this, to social disruptions and dislocations. Fortunately, the alternatives we face aren't as bad as in the 30s.
Don the libertarian Democrat
The game changer: George Soros joins the CDS demonizers, but adds some substance to their arguments.
Nouriel Roubini Partying With Intellectual Peers: Where's Julia Allison's high-tech name badge? Maybe her cleavage suffices.
Ben Stein to Deliver Commencement Address: At the University of Vermont. I wonder how that's going down with the faculty, especially the ones who teach evolution.
Deep Market Thoughts…CNBC MUST be Stopped to end this Bear Market! Lindzon: "The loudest, most broken funnel of noise and misinformation is CNBC... CNBC is a cancer in this country."
Going short on bonds by buying a CDS contract carries limited risk but unlimited profit potential; by contrast, selling credit default swaps offers limited profits but practically unlimited risks.Umm, no. Protection buyers' profit is limited to the notional amount insured. Similarly, protection sellers' risk is also limited to the notional amount insured. "
The whole post is off. He claims the following:
"Putting these three considerations together leads to the conclusion that Lehman, AIG and other financial institutions were destroyed by bear raids in which the shorting of stocks and buying of CDS amplified and reinforced each other."
My understanding is that we are in Debt-Deflation. A Calling Run. The run started when there was a foreclosure tsunami based on fraudulent and poor loans. At that point, anyone who had the ability to call cash from the owner's of these loans started doing so, since it wasn't clear how many foreclosures there would be nor how low home prices would fall. CDSs and CDOs were only some of the investments effected. As for AIG, at the point of this tsunami, they were downgraded, and needed to get capital. The only way to do this would be to sell assets for huge losses, which they didn't want do. In essence, they came to the government for a bridge loan. That's what Liddy said in November.
I don't see shorting as the problem. It was an actual Calling Run based on the mortgages. What am I missing?
Don the libertarian Democrat
A well chosen name wins an argument by assuming its conclusion. Label cash subsidies to foreign government as "foreign aid" and who can be so hard hearted as to oppose them. Call subsidies to the public schools "aid to education" and you neatly skip over the question of whether additional spending in the public school system results in more education. Label something "pollution" and is no longer necessary to offer evidence that it is bad, since everyone knows pollution is bad—even thermal pollution, otherwise described as warm water. Occasionally we even get dueling names. Both "right to life" and "pro-choice" are obviously good things; how could anyone be against either?
"A dollar I spend in government securities floated to fund the deficit is a dollar I don't invest in a private firm."
A Dollar spent is better than a dollar saved if you're trying to avoid Debt-Deflation. There's no a priori way to determine who spends anything better. To say that, in general, A spends better or more effectively than B, says just that. In general. For me, it's really a question of ownership. I'd like most resources to be in private hands, that way, if they are spent foolishly, at least it's their foolishness. Also, in the real world, governments rely on people's acceptance or acquiescence of it. One has to try and determine what can keep the system stable during a crisis. However perfect your ideas might appear to you, no one is bound to follow them. Hence, we often compromise our theories for irenic and justificatory reasons.
That's what the stimulus is. It's a product of Political Economy, which involves other factors than economic efficiency, even in you're right about that.
"Insofar as it has any effect on the ability of firms to borrow, it makes it harder, since public borrowing is competing with private borrowing."
So competition makes it harder. So what? Doesn't all competition do that? Isn't that the point?
"It simply consists of borrowing very large amounts of money and spending it."
You speak of names. How about we change "spending" to "investing"?
Does that change anything?
"Another part of it is that the credit crunch seems to bear at least a family resemblance to what Keynesians expected to see, indeed believed they had seen, as the cause of depressions"
That's it. It's a narrative. A story that we can tell ourselves to feel better about getting out of this. In truth, it's a lot of trial and error, which is how things usually work out.
By the way, there's also been a lot of talk about Helicopter Money. People are reaching for any idea that seems to help.
"Firms are eager to borrow money and invest."
In fact, employers have been proactively shedding jobs since the end of November and reducing investment. There has been a massive change in investment.
"The problem is not that we have exhausted investment opportunities but that lenders don't know what borrowers, or what intermediaries, to trust,"
Here I completely agree. But government has a role in rebuilding that trust.Why? I don't know, but people expect the government to help build it, and that's a good reason to do so. Sadly, it will probably overshoot. Take a look at the new Trust Index. Bankers are pretty low on that.
If you want to help capitalism and the free market, a good way to begin is to make sure that people understand that we have a welfare state. That way, capitalism and the free market might not be blamed for this mess. Now there's a good example of the problem of names.
Don the libertarian Democrat
Bruce Springsteen
“A lot of the core of our songs is the American idea: What is it? What does it mean? ‘Promised Land,’ ‘Badlands,’ I’ve seen people singing those songs back to me all over the world. I’d seen that country on a grass-roots level through the ’80s, since I was a teenager. And I met people who were always working toward the country being that kind of place. But on a national level it always seemed very far away.
“And so on election night it showed its face, for maybe, probably, one of the first times in my adult life,” he said. “I sat there on the couch, and my jaw dropped, and I went, ‘Oh my God, it exists.’ Not just dreaming it. It exists, it’s there, and if this much of it is there, the rest of it’s there. Let’s go get that. Let’s go get it. Just that is enough to keep you going for the rest of your life. All the songs you wrote are a little truer today than they were a month or two ago.”
Refrain from The Promised Land:
The dogs on main street howl,
'cause they understand,
If I could take one moment into my hands
Mister, I ain't a boy, no, I'm a man,
And I believe in a promised land.
Don said...I love The Boss. Since you're into probability, what's the answer to this:
Is a dream a lie if it don't come true
Or is it something worse
Don the libertarian Democrat
Is a dream a lie if it don't come true
Or is it something worse
Don, nice :-)
Nothin' feels better than blood on blood
The Bank of England's policy. From Walter Bagehot (1873), Lombard Street, p. 73:
Jeremiah Harman: We lent [cash] by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power.."I am still a follower of Bagehot:
"Bagehot's Principles"( MY VERSION ):
1) If the Fed exists, it will be the Lender Of Last resort, and that has to be taken in to account in real world Political Economy. It should lend freely in a crisis to solvent banks.
2) The rules for LOLR( from here on down this includes any government guarantee ) intervention should be clear, public, and followed, otherwise Moral Hazard is ineffective. All guarantees must be explicit.
3) The terms must be onerous.( THIS IS WHY WE MUST NATIONALIZE SOME BANKS. IT'S THE ONLY THING THAT THEY REALLY FEAR IN THE US. THEY'LL HOARD MONEY TO AVOID NATIONALIZATION. NEED I SAY MORE. )
4) The LOLR should get something valuable in return.
Here are a few others:
5) The taxpayer's interests should come first.
6) Moral Hazard needs to be constantly applied by quickly liquidating problem banks in normal times.
7) Any entity receiving a guarantee will have to be supervised or regulated effectively, and violations should be quickly and severely punished.
8) There is no doubt that any entity receiving a LOLR guarantee will need to be more conservative in its practices in order to limit the liability of the taxpayer.
9) There should be a class of financial concerns that can act more freely, but they should not receive LOLR guarantees. They will be strictly supervised or regulated though, and are subject to laws against fraud, etc."
Lombard Street can be read here:
http://bagehot.classicauthors.net/LOMBARDSTREET/LOMBARDSTREET9.html
We’re talking, of course, about John Paulson. He’s the incredibly prescient guy who made a fortune shorting the mortgage industry in 2007. And last year he did it again, largely by shorting financials.
Some highlights from the 20-page annual report for Paulson & Company that was obtained by the New York Times. (You can read the entire report here.)
Of course, no one is perfect. Several investments lost money. Which ones? Basically, the long portfolio. Paulson, it seems, just wasn’t negative enough.
So what’s next for Paulson? Here’s how DealBook describes it:
The biggest opportunity Mr. Paulson sees this year is in buying distressed debt and the firm has targeted about half the Advantage Fund’s assets to that strategy. His firm’s two credit funds were up about 19 percent and 16 percent respectively last year as they resisted the temptation to buy distressed debt such as mortgages and leveraged loans even though they were trading at what appeared to be attractive prices.
“We remain bearish on the outlook for the U.S. economy and believe the recession will extend into late 2009 and likely into 2010,” Mr. Paulson said in the letter. “The sharp contraction in the global economy, the instability of the global financial system and the ongoing credit contraction are unlikely to be resolved in the first half of 2009.”
The Washington Post must be shooting for the Pulitzer for incredibly bad reporting. How else can one explain an article on plans for bailing out the banks that never once conveys the basic fact to readers that many, if not most, of our banks are in fact bankrupt.
Instead the article uses euphemisms to conceal this fact. For example, it tells readers that the scope of the toxic asset "problem" has reached $2 trillion. What does this information tell readers. Do the people reading this article know that this sum vastly exceeds the capital of the banking system?
That seems unlikely. So most readers would not know that the Robert Rubins of the world are sitting on bankrupt banks. In other words, they would be shut down and put out of business if we let the market run its course.
Instead the Obama administration is looking to hand taxpayer dollars to the banks through a variety of complex mechanisms. The main reason for using complex mechanisms (rather than simply seizing bankrupt institutions) seems to be to conceal the fact that we are handing taxpayer dollars to bank shareholders and the wealthy executives who run them.
The Post is obviously eager to assist in this effort. At one point, it even is so polite to tell us that the administration doesn't want to limit executive compensation as part of getting welfare from taxpayers because "officials" are worried that such limits would discourage banks from participating.
Isn't it neat how the people who work in the Obama administration don't have names. Are they called "official 1," "official 2" etc.? Since "officials" are not always entirely truthful in what they tell reporters, it is important for readers to know who made such claims.
Who cares if some banks don't participate in getting handouts? Citibank, Bank of America, and many other major banks have no choice. They will go bankrupt without assistance. If some banks actually can get by without the government's assistance, why would we want to force it on them?
If their toxic assets have really frozen lending, although not actually jeopardized their solvency, then the shareholders would have a great lawsuit against any bank executive who refused to act in the interest of the shareholders in order to preserve their own high pay. Such instances would presumably be rare, but could nonetheless provide a great source of free entertainment to a nation suffering through a severe downturn.
In short, there is good reason to believe that the Obama administration is trying to slip hundreds of billions of dollars to bank shareholders and their top management. The Washington Post seems to be helping.
--Dean Baker"
And I say:Right now, these shareholders are backing these bankers because they are at the point of being wiped out. But, when that happens, you might well see lawsuits for fiduciary mismanagement, collusion, fraud, and negligence.
In allowing such ghastly management by bankers, the shareholders must take some of the blame. But, given the situation the bankers have left their banks in, does anybody really doubt that there are grounds for some my listed complaints?
I'm going to belabor the obvious here. I hate to do it, but somebody needs to and nobody else is:
*Calling something a stimulus package doesn't make it one. This one doesn't come close. Read it here.
*If you are headed in the wrong direction, speed is not your friend. Neither is size.
*The rescue of financial institutions is more urgent than a stimulus package and less expensive to taxpayers.
*Illiquid assets can be purchased, held, and later resold, possibly at a profit, while money spent is money gone. One is "investment;" the other is spending.
*Money spent with borrowed money raises future interest costs to future taxpayers.
*Rescue investing by the Fed and Treasury probably provide more stimulus than stimulus spending helps the financial system.
*You don't have to have a stimulus package to get stimulus. The recession is triggering automatic stabilizers - more spending and lower tax payments. The budget deficit is growing rapidly without a stimulus bill.
*Since the beginning of September, Fed operations have speeded up the growth of bank reserves and money. As velocity normalizes, much stimulus will be unleashed. The trick will be winding it down.
*Tax-rate cuts would result in immediate reductions in withholding and impact the economy faster while letting the public allocate their own funds.
*"Buy American" provisions are crazy. Has anyone heard of Smoot-Hawley? Do we not understand retaliation?
*Did someone say Davis-Bacon would apply to construction contracts? The best I can say about it is that it's well named.
*This is no time to poke a stick in our biggest international creditor's eye.
*What some people are calling "manipulation" used to be the official policy of the U.S. and other countries under Bretton Woods.
*I see that while we were focused on these issues, the trial lawyers just got a whole new playing field - equal pay."
Me:
- Don the libertarian Democrat Says: Your comment is awaiting moderation.
January 31st, 2009 at 1:57 amHere’s my plan, just so you know where I’m coming from:
1) $100 Billion Infrastructure ( In order to show that we have the confidence to invest in the future )
2) $100 Billion Tax cuts targeted toward investment ( To attack the fear and aversion to risk )
3) $200 Billion Sales Tax decrease or Payroll Tax decrease which will be phased out ( To battle the possibility of Debt-Deflation )
4) Social Safety Net spending, which I’m assuming that you’re calling automatic stabilizers
Now, you seem to believe that 1 is bogus. Infrastructure cannot be considered an investment. I find this view strange. If you do consider it so, surely then some part of it you agree with. How much?
The plan has tax cuts and increases in 4 which I approve of. Now, I have to assume that your main objection is 1. But is that enough to vote down a compromise bill? It’s not my plan, but I would have voted for it.
As for the real stimulus, I would use monetary policy. I happen to be a follower of Irving Fisher, although I am more behaviorally oriented. But I’m bewildered by the idea that this plan has nothing good in it for the GOP. I simply don’t credit that view. It’s bad faith. At most, some of 1 is a bother to them. But how much and where? And what would a compromise be? I guess that compromise is very bad in the GOP’s eyes. Let me quote my hero Burke:“All government, indeed every human benefit and enjoyment, every virtue, and every prudent act, is founded on compromise and barter. ”
Too bad there are no Burkeans in the GOP.
~~~~ “There are a variety of things that we need to do in order to win the trust and confidence of the American people,” Axelrod said. “And we’ll address these other issues down the road, but right now, we’ve got to work with what we’ve got.” ~~~~
Yes, Mr. Axelrod… it’s critical that the Administration take real steps to distance themselves from the influence of the largest banks in this country as the new government considers what options might be the most effective in mitigating the financial crisis.
The new administration must exclude these institutions from the deliberations. The management of these companies are the ones which have brought us to this place. They do not deserve access to the decision making about the restructuring of the financial system.
US banks have already received hundreds of billions of dollars of US Treasury and Federal Reserve support. Transparency and oversight of this process has been pitiful. Officials have cited “the urgent need to stabilize the financial system” as the reason for secrecy and obfuscation.
But the real question is who has access to the decision making process? And how do we know that the interests of the American taxpayers are being fully protected?
Let’s name the recipients of federal funds — from The New York Times Bailout Tracker:
| Bank | New York | $50,000 | ||||
| U.S. cities | N.A. | $50,000 | ||||
| Bank | Charlotte, N.C. | $45,000 | ||||
| Insurer | New York | $40,000 | ||||
| Bank | New York | $25,000 | ||||
| Bank | San Francisco | $25,000 | ||||
| Automaker | Detroit | $14,284 | ||||
| Bank | New York | $10,000 | ||||
| Bank | New York | $10,000 | ||||
| Bank | Pittsburgh | $7,579 | ||||
| Bank | Minneapolis | $6,599 | ||||
| Specialty lender | New York | $5,000 | ||||
| Bank | Atlanta | $4,850 | ||||
| Automaker | Auburn Hills, Mich. | $4,000 | ||||
| Bank | McLean, Va. | $3,555 | ||||
| Bank | Birmingham, Ala. | $3,500 | ||||
| Bank | Cincinnati | $3,408 | ||||
| Insurer | Hartford, Conn. | $3,400 | ||||
| Specialty lender | New York | $3,389 | ||||
| Bank | Winston-Salem, N.C. | $3,134 | ||||
| Bank | New York | $3,000 | ||||
| Bank | Cleveland | $2,500 | ||||
| Specialty lender | New York | $2,330 | ||||
| Bank | Dallas | $2,250 | ||||
| Bank | Boston | $2,000 | ||||
| Bank | Des Moines, Iowa | $2,000 | ||||
| Bank | Milwaukee | $1,715 | ||||
| Bank | Chicago | $1,576 | ||||
| |
The Hill.com reports… ~~~~ “A group of lobbyists is — not surprisingly — lobbying against new Treasury Department rules designed to curb K Street’s ability to influence how billions of dollars in financial bailout money is distributed.
In a letter to Treasury Secretary Timothy Geithner, the American League of Lobbyists questioned the constitutionality of new lobbying restrictions, noting the First Amendment grants citizens the right to petition the government for redress of grievances.” ~~~~
Don the libertarian Democrat wrote:I notice that they focus on the constitutionality, and ignore decency and propriety. That’s why I say that we need to nationalize. Anything less is a victory for the banking lobby.
The NYT's Dealbook has obtained a copy of John Paulson of hedge fund Paulson & Co.'s year-end letter, and it is a must-read. Paulson blew the doors off last year, heavily shorting financials, both directly and via credit default swaps, turning in 37.6% return net of fees. That is beyond outstanding in a year that destroyed many other other funds' reputations.
Looking forward to 2009, Paulson remains highly bearish. Here is his general strategy, he says, for the first half:
The letter is at the NYT."
And me:A heavy burden is on the shoulders of Jamie Dimon - as probably the only American banker of seniority whose reputation has not been smashed to smithereens by the crash of '08.
Unlike so many of his battered peers, the chairman of JP Morgan has had the courage (or chutzpah?) to show his mug in Davos. And, by all accounts, he's been saying worryingly sensible things in those private bankers' meetings that are being held to provide finance ministers and government heads with the financial industry's view on how to save the global economy.
I am told that at the World Economic Forum's so-called governors' meeting yesterday - in which the banks, brokers, private equity firms and hedge funds tried to draw up a common agenda for reform - he warned against placing too much faith in the possible creation of a central clearing system for financial transactions between banks.
The proponents of such a system believe that it would restore confidence to inter-bank lending - which has been sadly lacking for most of the past 18 months and has been a massive contributor to the implosion of the global machine for creating credit.
The reason it could restore confidence is that it would involve the establishment of what's known as a central counterparty, which would in effect insure banks against loss if another bank was unable to honour commitments.
If there were a central counterparty, fnancial institutions that lend to each other would have less reason to fear that - in extremis - they could not get their money back.
Which would appeal to most bankers (as if you needed telling), especially in this era of high anxiety.
Except that Dimon posed the question whether it would really be sensible to reduce the requirement for bankers to think long and hard about who they're lending to and why.
After all, the mess we're in stems from bankers placing too much faith in computer models and the opinion of third-party credit-rating agencies when deciding where to make their loans and investments.
The debt bubble that precipitated the current debt drought and global recession was caused in large part by bankers abdicating their very basic responsibility to know their borrowers properly and to assess whether these borrowers had the remotest chance of being able to repay their debts.
So if we're going to try to prevent bankers messing up our economy again, do we want them to take greater responsibility for their actions, or less?
Surely in the new world economic order which will be built - though Davos has been disappointingly short of coherent visions of what will be constructed from the rubble - we need bankers to know their customers and to propely evaluate the risks of lending.
But the more that they're insured against losses on lending, the less incentive they will have to lend responsibly.
Which brings us to the Great Paradox (capital "G", capital "P") of our government's measures to restore the flow of credit to real businesses and households.
All of these schemes involve taxpayers' insuring away some of the risks for banks and financial institutions of lending and investing.
In respect of new lending, this is the effect of the Bank of England's new asset purchase scheme, the proposed state guarantee for asset-backed securities, and assorted guarantees for bank lending to businesses.
Taxpayers are even taking on the liability for banks' dodgy old loans and investments, through the establishment of the new public sector insurer of banks' toxic debts, which should probably be christened "The Imprudential".
In other words it is explicit government policy to reduce bankers' responsibility for their actions, their lending, even more than was already the pernicious case.
We're in this mess because too much was lent by too many in a wholly irresponsible way.
And ministers are now encouraging more of this lending by further reducing the responsibility of the lenders for their actions.
It's the economic policy equivalent of curing a drug addict by giving the addict a prescription for the drug of choice.
It might work. Or it might just make our economy's dependence on unsustainably high levels of debt even worse - and thus cause us even more pain when we're ultimately weaned off the addiction.
UPDATE: Here are some thoughts of mine from today's The World at One on how banks could become "good" again.
Me:"We're in this mess because too much was lent by too many in a wholly irresponsible way"
Then why are we leaving them in charge? We should nationalize them and chuck them out.
2) The rules for LOLR( from here on down this includes any government guarantee ) intervention should be clear, public, and followed, otherwise Moral Hazard is ineffective. All guarantees must be explicit.
3) The terms must be onerous.
"Who can forget the end of "Planet of the Apes" when Charlton Heston, kneeling before the half-buried remains of the Statue of Liberty, slams his fists into the sand and cries, "You maniacs! You blew it up! Ah, damn you ... damn you all to hell!"
Now imagine the same scene, but with a half-buried Morgan Stanley building standing in for Miss Liberty and a time-traveling Walter Bagehot playing the lead and you've got the perfect Hollywood dramatization of the real-life tragedy that, with luck, is having its denouement on Wall Street.
Bagehot? The great Victorian man of letters, best remembered today as the second and most celebrated editor of the British magazine The Economist, wasn't exactly a hunk. But he certainly could have delivered those futile last lines with real conviction, for he was among the first to recognize the vast destructive potential of that newfangled weapon of Victorian finance: the modern central bank.
Bagehot first alerted readers to this potential and offered his suggestions for containing it in an article that appeared in The Economist after the great panic and credit crisis of 1866. That panic witnessed the spectacular collapse of Overend, Gurney & Co., which had long been Great Britain's premier investment house.
Bagehot understood that, during such panics, the Bank of England alone commanded the confidence needed to serve other financial firms as a "lender of last resort." But as Bagehot put it later in his book "Lombard Street: A Description of the Money Market" (1873), the bank's "faltering way" -- its arbitrary and inconsistent use of its unique lending powers -- tended only to make things worse.
"The public," Bagehot wrote, "is never sure what policy will be adopted at the most important moment: it is not sure what amount of advance will be made. ... And until we have on this point a clear understanding with the Bank of England, both our ability to avoid crises and our terror at crises will always be greater than they would otherwise be."
The ultimate source of trouble, Bagehot believed, was the very existence of the Bank of England and the special privileges it enjoyed. But because nothing save a revolution seemed likely to do away with the "Old Lady of Threadneedle Street," as it was called, Bagehot's preferred, practical solution was for the bank expressly to commit itself to lending freely during crises, though on good collateral only, and at "penalty" rates.
The restrictive provisions were supposed to limit aid to otherwise solvent firms panic had rendered illiquid.
Bagehot's recommendation has since become a sort of master precept of central banking -- albeit one that's mainly honored in the breach by central bankers.
To be fair to today's central bankers, there's never been much agreement on how to apply Bagehot's rule in practice. Just what do "good collateral" and "penalty rates" mean in times like these?
While no one might precisely be able to define good collateral -- and one can debate whether the rate at which banks offer to lend unsecured funds to other banks, known as the London Interbank Offered Rate, or LIBOR rate, plus 8 percent constitutes a "penalty" rate -- who even pretends that recent central bank lending has been based on good collateral?
But rescuing insolvent firms is the least of it. The real damage comes from the Treasury's utter lack of any consistent last-resort lending rule. The recently enacted financial institutions bailout bill does little to clarify this.
That's just the sort of thing that troubled Bagehot almost a century and a half ago, when central banks were still in their swaddling clothes. Yet central bankers and governments still don't get it, despite the lip service they pay to this great thinker from our past."
Neither Barack Obama nor John McCain had much of value to say about the financial crisis as it raged through the headlines this fall. Rather than shred their campaign strategies, they played it safe, as most politicians would have. But in the name of justice we ought to recall that there was one candidate who did foresee our predicament with considerable accuracy when it still lay far in the future. Ron Paul, in almost every speech he made during the Republican primaries, spoke of bubbles, reckless credit growth, and the "unsustainability" of present policy. So why isn't there more demand for the common-sense solutions he put forward? Because common sense is not much use in a financial panic. This was the great discovery of Walter Bagehot, the prolific 19th-century essayist and journalist, who was editor of the Economist from 1860 to 1877. (His name rhymes with gadget.) Ninety-nine percent of the time, common sense is a synonym for practicality. But in a serious banking crisis, doing the commonsensical thing--hunkering down and counting your pennies--has proved to be not practical at all. Bagehot's Lombard Street is an insider's look at the Bank of England, and at the principles on which political and financial leaders act when advanced economies come under pressure. Those principles are depressing in the extreme for anyone with an uncomplicated idea of how a democracy works. But they are effective. That is why, in the so-called Anglo-Saxon world, Bagehot's book still provides the bedrock of policy thinking during financial emergencies, including our present one. Lombard Street was published in 1873, seven years after the sudden collapse of Overend, Gurney & Co., a bank that lost £11 million, spread panic among investors, sparked a run, and became "the model instance of all evil in business." The crisis made such a deep impression on British finance and government that the country did not have another bank run for 141 years--not until Northern Rock collapsed in the summer of 2007. (English investors must have longer memories than American ones. Most of our own noxious subprime mortgages were contracted, and the securities built on them concocted, after Enron became our own model instance of evil in 2001.) It was the Bank of England that took charge of averting panic, during the Overend, Gurney crisis and thereafter. It did so by injecting credit into the economy, by bailing people out. Bagehot approved of this. Many ordinary retailers could not pay their suppliers until they got the money for the things they sold. Without credit, they would be ruined, and the ruin would spread to those to whom they owed money. This was not a question of moral failing, it was just the way a modern economy worked. But the modern economic system interacts with the modern political system--democracy--in a rather uncomfortable way. Indeed, at more than one juncture in Lombard Street, Bagehot framed the problem of booms and busts as part of the "increasingly democratic structure of English commerce." People in a democracy are most comfortable when their institutions do the same things that they would do as individuals. In a crisis, banks--like everyone else--reflexively hoard their money. But a central bank must do the opposite. It must lend freely. This was the most basic affront to common sense that the Bank of England presented, but it was not the worst. The worst was that the bank could carry out its necessary duties as a lender of last resort only by breaking the law. The basis of the bank's operating procedure--and of its soundness--was the Bank Act of 1844. We would call it a regime of sound money. It included stringent caps on the ratio of notes issued to reserves held. These caps were hewed to when the economy was running smoothly. Yet at the time Bagehot was writing, a quarter century later, the law had already been suspended three times. Not just that. "No similar occasion has ever yet occurred," Bagehot wrote, "in which it has not been suspended." So the law on which the solvency of the British nation rested was ironclad, except when someone felt a need to break it. Stranger still, never did the Bank of England acknowledge its duty as the lender of last resort. Some of its governors even denied that any such duty existed. Bagehot thought the bank should come clean about what it really was:
But there was a reason for the central bankers' dissembling. If the bank ever acknowledged a duty to rescue banks by generous extensions of credit, it would create a form of moral hazard. Thomson Hankey, a Bank of England director whom Bagehot much admired (and to whom the financial writer James Grant devotes an admiring essay in his new book Mr. Market Miscalculates), called Bagehot's lender-of-last-resort views "the most mischievous doctrine ever broached in the monetary or banking world in this country." In practice, Bagehot was right and Hankey was wrong. The bank was beyond question the lender of last resort. In principle, Hankey was right and Bagehot was wrong. Unless there was a real, credible threat that a bank would be allowed to fail, the guarantee of rescue would simply get priced into any financial bubble that developed, making things worse when the bubble popped. The situation required what we would now call "strategic ambiguity"--both Hankey's doctrine and Bagehot's practice, which contradicts it. The situation today requires the same mix. Central banking is thus often a high-stakes game of chicken. And sometimes, when banks enter the game insufficiently scared, it will be played out to the end. It certainly was in September when the U.S. Treasury terrified the financial world by not coming to the rescue of Lehman Brothers. This was a catastrophe in terms of Bagehot's practice, but it will produce benefits in terms of Hankey's principle. It will discourage people from paying more than is reasonable for assets on the belief that they come equipped with an insurance policy (the promise of a central bank rescue) that has been underwritten by taxpayers. The Republicans who nearly derailed the Treasury's Troubled Assets Relief Program in September played a similar role. A final problem is that there are limits to how accountable a central bank can be. Everyone is always hollering for clear rules and transparency. But a dirty secret of regulation is that it frequently influences conduct most effectively when it is capricious and opaque. Any regulatory system will reveal its vulnerabilities over long use. If it addresses economic problems in a predictable way, savvy investors will find a way to "game" that predictability. You can draw an analogy with antidepressant drugs. There is no permanent right match of medication for a depressive. Antidepressants work only until the mind (or is it the brain?) finds a way around them, at which point a new, unfamiliar drug must be substituted. In the same way, no matter how good the content of a regulatory regime, it must change periodically if big market players are to be kept from profiting off it. As Bagehot outlined his system, he was conscious that the practical realities of banking required him to heap paradox upon paradox. There is a hint of both Andrew Jackson and Thomas Aquinas in the way he referred to central banking as an "unnatural" thing in its very conception. "The business of banking ought to be simple," he wrote. "If it is hard it is wrong." If it is hard, the banker is either delegating poorly or has entangled his institution in complex transactions where it has no business. According to Bagehot, "Adventure is the life of commerce, but caution, I had almost said timidity, is the life of banking." Centralizing a society's cash reserves is complicated, reckless, and artificial:
In his ideas of company size, Bagehot harkened back to the 18th century rather than ahead to our own. To modern eyes, Bagehot is, as a factual matter, simply wrong. The natural tendency under free-market conditions is towards consolidation, and even monopoly. If you want small firms, you must protect them through government--whether this means Teddy Roosevelt-ian trust-busting, French-style subsidies to tobacconists, the EU's hounding of Microsoft, or the NIMBY anti-Wal-Mart campaigns aimed at preserving Mom-and-Pop stores. Bagehot sometimes contradicted himself on this point, noting also that "a large bank always tends to become larger, and a small one tends to become smaller," but his application of the word unnatural to a large central bank was frequent and must be taken as his settled view. It is curious that Bagehot, a contemporary of Marx, came to the opposite (and false) conclusion about how firms evolve. Where Bagehot would agree with Marx is in his belief that there is something predictably destabilizing about modern economies. You don't need banks to have a precarious economy, or one liable to speculation--Bagehot noted that there were no banks, as we would understand them, in 1720, at the time of the South Sea Bubble and the Mississippi Scheme. But modern banking is precarious by design. "In exact proportion to the power of this system is its delicacy," he wrote. "I should hardly say too much if I said its danger." The power, delicacy, and danger all have the same source. In fact they are just different names for the same thing: leverage. At the very opening of the book, Bagehot illustrates with exquisite simplicity how, at least in a boom economy, traders on margin can "harass and press upon, if they do not eradicate, the old capitalist." The old capitalist in question is the poor sap who believes all this stuff about neither-a-borrower-nor-a-lender-be and is foolish enough to be using his own cash:
Later, Bagehot showed that this need for leverage is no different for those selling money than it is for those selling dry goods. The banker can no more choose not to lend than the merchant can choose not to borrow:
In finance, once you can have leverage, you must have leverage. Once you have some leverage, getting more of it than your competitors is a matter of survival. And when governments and central banks debate whether to loosen or tighten up money, they face a constant clamor from the financial world to permit more leverage still. That is why, even in democracies, the instruments of monetary policy tend to be kept far from the influence of voters, and even hidden from view. Otherwise, credit tends to spiral. Bubbles result. Nothing could be more foolish than to assume that this process of spiraling speculation is unleashed by "greed," unless by greed you mean human nature. Credit spirals are a darker aspect of the world Adam Smith described in The Wealth of Nations and Bernard de Mandeville did in the Fable of the Bees. Just as society can be improved by the uncoordinated action of the selfishly motivated, an economy can collapse for reasons having nothing to do with anybody's cupidity. We should be moral in the way we think about money, but a credit system tends to make a mess of moral accounting. Bagehot described London's financial district as "a sort of standing broker between quiet saving districts of the country and the active employing districts." Decent, puritanical Suffolk farmers want to put their money in a safe place; Lancashire entrepreneurs want money to put to work. Thanks to London bankers, both can follow their wishes and make a profit in the process. We have an idea that the Suffolk dairyman is the "moral" party here (he's saving) and the Lancashire speculator the "immoral" one (he's gambling). But, once a banking system intervenes, they are both gambling and they are both saving. In good times you are welcome to mouth the folkloric cliché that holds farmers to be better people than financiers. When depression looms, you had better realize that the rain falls on the just and the unjust. Many Americans who have wound up underwater on their houses and maxed out on their credit cards are greedy, climbing, brand-intoxicated, materialistic shopaholics who thought the world owed them a living. But just as many of them are not. They are trapped, as surely as financial institutions are, in a system based on wild borrowing. Participation in this system is not exactly required, but it is not exactly optional, either. One's quality of life is determined not just by one's purchasing power but also by one's relative economic standing. Chagrin at seeing one's neighbors get richer faster may be a sign of bad character, but do not for a minute assume there is nothing to feel chagrin about! When it comes to the very goods people deem most essential--the proper mate; the schooling of one's children; the size, location, elegance, and comfort of one's house--relative standing is more important than absolute wealth. Those who kept their money in savings banks in the 1990s lost out to those who did things we are supposed to disapprove of, like "spending money they didn't have," borrowing profligately to invest in stocks and even bonds, which appreciated at an average of 15 percent a year over the decade. Among rich people, how one entered the present decade had more to do with how one had done in the stock market than with how one had done in the labor market. Is that just? Of course it's not! It's easy to see now. But while the boom was going on there was all sorts of rationalizing about why it was okay that the social hierarchy should be reordered through stock and housing speculation. One line of argument was that people who did not have a ton of money in stocks, as well as those who rented rather than bought the houses they lived in, were foolish. This line of argument peaked at the turn of the decade, when Americans elected a president who had argued that the public was foolish for not launching its retirement savings onto the open seas of the stock market. Bagehot saw that a speculative mania eventually sweeps up everyone in its path. "Every great crisis reveals the excessive speculations of many houses which no one before suspected," he wrote, "and which commonly indeed had not begun or had not carried very far those speculations, till they were tempted by the daily rise of price and the surrounding fever." Avaricious people get hurt, but it is in the nature of crashes that they are not the ones who get hurt most. A tragic figure present in almost every historic account of speculation and collapse in history is the person who believed, year after year, that the boom was an illusion, and held himself aloof until, at the very last minute, whether out of self-doubt or deference to the opinions of his fellow man, he entered the fray and was (having bought at the top, rather than the bottom, of the market) wiped out. What a wicked irony! His punishment is as much for his long and wise forbearance as for his momentary weakness. So the "cultural contradictions of capitalism" run deeper than we thought. The classic idea, as laid out in their different ways by the economist Joseph Schumpeter and the sociologist Daniel Bell, is that capitalism rewards diligence; diligence produces wealth; wealth begets idleness; and idleness undermines capitalism. But when, as now, push comes to shove, we can ask whether there is really anything particularly capitalist about the virtues of diligence and self-restraint. The real capitalist virtues appear to be optimism and luck. From a central-banking perspective, the cultural contradictions are not results of capitalism but elements of it. The problem with central banking is that it reacts to a system that has been mismanaged by rewarding the managers. That is why objections to central banking, although they can come from the right (Ron Paul, Jim Bunning) or the left (Barney Frank, William Greider), tend to be populist. Bagehot was no populist. He was comfortable with the idea that what some people think should be more important than what other people think:
Although he would surely fault Treasury Secretary Hank Paulson for many things, the criticism most often heard at present--that Paulson is too close to former colleagues on Wall Street, where he worked for years as CEO of Goldman Sachs--would strike Bagehot as misplaced. Because it is on Wall Street, alas, that "the state of credit" is to be determined:
To be blunt, credit is successfully reestablished when financial elites say, "When." Credit is close to a synonym for the mood of the ruling class. To say an economy is based on credit is to say it is based on animal mysteries. Glamour, prestige, élan, sprezzatura, cutting a figure . . . that is what the economy is made of. It is a rather terrifying thought. Viewed as Bagehot viewed it, from the perspective of a central bank in a crisis, an advanced economy looks an awful lot like a primitive economy." |
"Loyal readers, please take a moment to check out Gretchen Morgenson’s column this week. She’s taken a close look at the buyout of Bear Stearns organized by the Federal Reserve, and she has come to an intriguing conclusion: that the Fed not only wanted to prevent financial havoc - it also wanted to deter speculators who were betting on big banks to fail.
Adherents of the Walter Bagehot school of central banking - and I have been among them at times - have cried foul at the sight of big bailouts and the granting of emergency credit at low interest rates. The Bagehot argument is that emergencies that arise from the risks that banks have chosen to take should not be treated with overwhelming sympathy. Emergency credit should be offered, yes, but at rates that will make banks think twice about using the safety net again. That’s not the case this time around (neither in the United States nor in Britain, and probably not in Europe either by the time the folks in Brussels are finished), so the central banks may be telling financial institutions that they can take silly risks without fear of disaster.
But if Morgenson is right, there is a long-term purpose here, too: to reduce the winnings of those who bet on failure, and thus to reduce the incentives to bring that failure to pass. And let’s face it, the speculators aren’t operating in a vacuum; their bets can start to snowball with market sentiment, as they did against Lehman Brothers last week. Still, the Bagehot argument (often called moral hazard) is also a powerful one - which one do you agree with?"
Federal Reserve Chairman Ben Bernanke, who has read his Bagehot and kept a copy in his Princeton office when he was a professor, responded to recent developments first by pumping money into the markets through the New York Fed’s open-market operations and then last week by easing the terms on loans to banks from the Fed’s discount window.
Bagehot (pictured at right) still makes for good reading at times like this.
“What is wanted and what is necessary to stop a panic is to diffuse the impression, that though money may be dear, still money is to be had. If people could be really convinced that they could have money if they wait a day or two, and that utter ruin is not coming, most likely they would cease to run in such a mad way for money. Either shut the Bank at once, and say it will not lend more than it commonly lends, or lend freely, boldly, and so that the public may feel you mean to go on lending. To lend a great deal, and yet not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies; but it is the policy now pursued.”
Robert Feldman, Morgan Stanley’s chief economist for Japan, writes in a note today that it’s key to distinguish between internal discredit — private domestic lenders retreating — and external discredit, which Bagehot defined as a foreign drain on a bank’s money. (Bagehot’s solution to the problem of external discredit is to still lend freely but “at very high rates.”) That doesn’t apply in today’s floating rate system, Feldman says, and exchange rates don’t provide a good substitute, with the dollar’s drop against the yen suggesting we have external discredit while the strengthening against the euro saying we don’t.
Feldman writes: “My view is that the modern counterpart of ‘external discredit’ is moral hazard. The credit of the U.S. IS a problem, since no one knows how big the subprime and related housing market problems really are. Given how poorly banks know their clients, the ‘high rates’ part should come into play. There is no way to re-establish confidence unless those who have made loans to questionable borrowers pay a price for rash lending. Only then will markets regain confidence that risk is under control.
“The next stage of the credit problem — and whether it affects the real economy seriously — depend on eliminating the moral hazard,” Feldman says. “The faster the moral hazard in eliminated, the less impact on the real economy.”
Fed officials are acutely aware of the moral hazard, having resisted action for weeks to not be seen as bailing out risky investments. But they also don’t want a crisis to feed on itself. The Fed stressed its statement, in lowering the discount rate for banks, that it would accept “a broad range of collateral…including home mortgages and related assets.” The central bank sought to reassure a market that had been roiled by risky investments in subprime mortgages.
That’s how the Bank of England halted a panic in 1825, as Bagehot recounts: “A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to ‘this man and that man,’ whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them. The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. ‘We lent it,’ said Mr. Harman, on behalf of the Bank of England, ‘by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power.’ After a day or two of this treatment, the entire panic subsided, and the ‘City’ was quite calm.”
"Bagehot advocated in 1873 that a Lender of Last Resort in a crisis should lend at a penalty rate to solvent but illiquid banks that have adequate collateral. The doctrine has been criticised as having no place in our modern interbank market, but this is wrong. Bagehot’s prescription aims to eliminate the coordination problem of investors at the base of the crisis. It is still a useful guide for action when the interbank market stalls.1 It makes clear that discount-window lending to entities in need may be necessary in a crisis.
Bagehot's doctrine, however, is easy to state and hard to apply. It requires the central bank to distinguish between institutions that are insolvent and those that are merely illiquid. It also requires them to assess the collateral offered. Central banks, because of information limitations, are bound to make mistakes, losing face and money in the process. This doesn’t mean they should not try.
Poor collateral versus massive liquidity
The collateral should be valued under “normal circumstances”, that is, in a situation where the coordination failure of investors does not occur. This involves a judgment call in which the central bank values the illiquid assets. A central bank that only takes high quality collateral will be safe, but will have to inject much more liquidity and/or set lower interest rates to stabilise the market. This may fuel future speculative behavior. Some of this may have happened in the Greenspan era, in the aftermath of the crisis in Russia and LTCM, and after the crash of the technological bubble. The ECB and the Federal Reserve have accepted now partially illiquid collateral that the market would not. This seems appropriate and releases pressure to lower interest rates to solve the problem, something that should be done only if there are signs of deterioration in the real economy. The problem is that central banks are extending the lender of last resort facility outside the realm of traditional banks to entities, like Bear Stearns, that they do not supervise and, therefore, over which they do not have first hand information. How does the Fed know whether Bear Stearns or other similar institutions are solvent? It seems that the Fed is not following Bagehot’s doctrine here.
Finally, if banks and investors are bailed out now, why should they be careful next time? This is the moral hazard problem: help to the market that is optimal once the crisis starts has perverse effects in the incentives of market players at the investment stage. The issue is that only when the moral hazard problem is moderate does it pay to eliminate completely the coordination failure of investors with central bank help. When the moral hazard problem is severe, a certain degree of coordination failure of investors - that is, allowing some crises - is optimal to maintain discipline when investing and, amending Bagehot, some barely solvent institutions should not be helped."
To repeat Bagehot's Rule: "very large (domestic) loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain." The Fed, and the U.S. government more generally, have so far got it only half right."
http://findarticles.com/p/articles/mi_m2751/is_56/ai_55015114/pg_6"In a number of recent blog contributions, we have sketched the role of a modern central bank as ‘market maker of last resort’ (MMLR). This MMLR is the analogue, in a world where intermediation is increasingly through financial markets, to Bagehot’s lender of last resort (LOLR) in a world where most intermediation took place through banks (see e.g. Willem H. Buiter and Anne C. Sibert “The Central Bank as the Market Maker of last Resort: From lender of last resort to market maker of last resort"; Willem H. Buiter “Central banks as market makers of last resort, again”; Willem H. Buiter and Anne C. Sibert “A missed opportunity for the Fed”).
The market maker of last resort function can be fulfilled in two ways. First, the central bank can make outright purchases and sales of a wider range of securities than they currently do. Second, central banks can accept a wider range of securities as collateral in repos, and in collateralised loans and advances at the discount window than they currently do. Following Bagehot’s rule, the MMLR should buy these securities outright or accept them as collateral only on terms that would imply a stiff financial penalty to the owner. The central bank of course already applies a liquidity ‘haircut’ even to liquid instruments offered as collateral in repos or at the discount window. Because the MMLR would have to establish a buying price ‘in the dark’, that is, unaided by recent relevant market prices, and would inevitably take on much more credit risk than central banks have become accustomed to, the ‘haircuts’ should be severe – a financial version of ‘short back and sides’.I doubt a week has gone by since last summer during which I haven't seen some pundit or other trot out Walter Bagehot's dictum that in the event of a credit crunch, the central bank should lend freely at a penalty rate. More often than not, this is contrasted with the actions of the Federal Reserve, which seems to be lending freely at very low interest rates.
Ben Bernanke, in a speech today, addressed this criticism directly:
What are the terms at which the central bank should lend freely? Bagehot argues that "these loans should only be made at a very high rate of interest". Some modern commentators have rationalized Bagehot's dictum to lend at a high or "penalty" rate as a way to mitigate moral hazard--that is, to help maintain incentives for private-sector banks to provide for adequate liquidity in advance of any crisis. I will return to the issue of moral hazard later. But it is worth pointing out briefly that, in fact, the risk of moral hazard did not appear to be Bagehot's principal motivation for recommending a high rate; rather, he saw it as a tool to dissuade unnecessary borrowing and thus to help protect the Bank of England's own finite store of liquid assets. Today, potential limitations on the central bank's lending capacity are not nearly so pressing an issue as in Bagehot's time, when the central bank's ability to provide liquidity was far more tenuous.
I'm no expert on Walter Bagehot, and in fact I admit I've never read Lombard Street. But I'll trust in Bernanke as an economic historian on this one, unless and until someone else makes a persuasive case that Bagehot's penalty rate really was designed to punish the feckless rather than just to preserve the Bank of England's limited liquidity."
"So, we have, what I will call "Grant's Graham For Investing":
1) Decent Size
2) Current Assets Exceed Liabilities By Two Times
3) 10 Continuous Years Of Profit
4) 20 Continuous Years Of Dividends
5) 10 Years Of Earnings Growth Exceeding 33%
6) Price To Earnings Ratio Less Than 15
7 ) Price To Book Ratio Less Than 1.5"The Government will succumb and will lend taxpayers' money to non-financial companies.
In a way, there's no choice, because we'll be hobbled for years as an economy if our few remaining manufacturers and exporters are wiped out."
"Trader's Narrative's Due Diligence":
"The process of investigation undertaken by an party to gather material information on actual or potential risks involved in a financial transaction or relationship."
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My own view is that, starting in late November, businesses starting shedding jobs proactively:
http://www.reuters.com/article/GCA-CreditCrisis/idUSTRE50P5OS20090126
"It's hard to estimate when markets will bottom and then how long they'll be there," Cutler said in an interview. "The management team has been through multiple recessions, and knows you have to attack cost structure very early. If you don't attack them early, you can never get ahead of them."
Is there any way that I can gauge this thesis?
Posted by: Don the libertarian Democrat | January 31, 2009 at 10:47 PM