Ten Years After Lehman: An Interest-Rate Perspective

by Edward Chancellor*

Back in November 2002, Ben Bernanke, then a governor of the Federal Reserve, attended Milton Friedman’s 90th birthday party. In his writings, the legendary monetarist had pinned the Great Depression on policy failures of the American central bank. Bernanke was a keen disciple and apologised to Friedman on behalf of his employer, vowing that the Fed wouldn’t make the same mistake again. Less than six years later, Bernanke found himself at the helm of the Fed on that fateful day, Sept. 15, 2008, when Lehman Brothers collapsed. Another Great Depression beckoned. But now the Fed chairman was ready to make good on his promise.

Bankrupt(cy) Thoughts: Carillion’s Flaws Are Common to Many

by Edward Chancellor

The collapsed UK construction firm’s problems may look idiosyncratic. But its problems with “onerous contracts” were exacerbated by a balance sheet stuffed with intangible assets and ultimately shaky assumptions. These issues are not peculiar to Carillion.

Japan Nuclear Crisis vs. the Titanic

by Chidem Kurdas

The Fukushima Daiichi nuclear threat and the sinking of the Titanic are both disasters caused by acts of nature – earthquake and tsunami in one case, an iceberg in the other – interacting with technology. Yet they have radically different implications. The Japanese incident has made nuclear power less acceptable, whereas the sinking of a ship, no matter how immense the casualties and spectacular the failure, did not stop shipping. 

Connecting Dots to Financial Crisis

By Chidem Kurdas

There are enough books about the events of 2008-2009 to fill a library. Nevertheless, there is no coherent framework that integrates the various factors in the dramatic boom-and-bust cycle that goes back to the late 1990s and may still be with us yet.  Bruce Yandle offers a welcome synthesis in the Independent Review, centered on trust-building devices and their dissolution.

Naked Truth on NYT Finance Column

By Chidem Kurdas

Media coverage compounds the confusion about financial problems. Take a recent piece by Floyd Norris, probably the best informed of the New York Times finance columnists. 

“Credit-default swaps are, in reality, insurance,” he writes in “Naked Truth on Default Swaps”.  The seller of a credit default swap pays the buyer of the contract if there is a default on the specified bond. Mr. Norris asks: shouldn’t CDS be subject to the principle that “you cannot buy insurance on my life, or on my house, unless you have an insurable interest”?

That would mean that you should not be able to buy a default swap on a bond unless you own the bond. But this is a false deduction, because in practice even life insurance does not work on the insurable interest principle.

Three Aspects of the Volcker Rule

by Chidem Kurdas

Former Federal Reserve chief Paul Volcker and President Obama want to force banks to get rid of their proprietary trading operations, hedge funds and private equity funds. There is more to this policy initiative that meets the eye at first glance.

Mr. Volcker in effect gives two unrelated rationales. One is that “adding further layers of risk to the inherent risks of essential commercial bank functions doesn’t make sense…” So, banish speculative trading to reduce risk.

Put that way, it sounds reasonable enough. The only problem is that it has no real connection to the crisis of 2008 and would almost certainly have no role in preventing  credit cycles, of which the crisis was a manifestation. This irrelevance is presumably why it was not included in the mammoth financial regulation bill making its way around Congress.

Big Bad Bank and Little Red Trustbuster

by Chidem Kurdas

A surprising new Small-Is-Beautiful movement is afoot.  Mario Rizzo, Jerry O’Driscoll, Harry Kaufman and others make a case for  breaking up too-big-to-fail financial institutions. As Mr. Kaufman puts it, otherwise those companies will become financial public utilities backstopped by the government.

It’s not likely that the 2008 crisis would have been prevented had top investment banks like Goldman Sachs been smaller. Traditional little banks are going down in droves. They fail because real estate loans are going bad. So many depository banks have gone under that the FDIC, the federal agency that insures deposits, itself ran out of money and asked to be bailed out by prepayment of bank premiums.

The same real estate bubble-and-bust hit larger banks through mortgage-backed securities. That’s regardless of size. Moreover, the government does not just bail out big investment banks. It bailed plenty of small savings & loan associations in the 1980s. The concept of “too-big-to-fail” is remarkably elastic.  Consider that GM and Chrysler both received federal aid. Chrysler is a lot smaller, but the political preference is to treat it as too-big-to-fail. Keeping banks relatively small will not stop such bailouts.

That said, there is a serious quandary.

Fashionable Fictions

by Chidem Kurdas

Vanity Fair is not a magazine I follow, so I was taken aback when I flipped through an issue someone left behind at a café. According to the Editor’s Letter, “the chain of catastrophic bets made over the past decade by a few hundred bankers may well turn out to be the greatest nonviolent crime against humanity in history.”

Really? A few hundred bankers made millions of people live beyond their means, buy wildly over-priced houses, drive gigantic SUVs and put huge amounts of debt on their credit cards. Without those actions, the twin credit and real estate bubbles could not have inflated and hence there would have been no collapse.

“Never before have so few done so much to so many,” writes Vanity Fair editor Graydon Carter.  That’s a very convenient way of looking at it—some banker made me do it, he should pay for it and be hung, drawn and quartered. Always a handy story and right now supremely fashionable.

What Ended The Great Recession?

by Mario Rizzo  

Some business forecasters with a not-too-bad record are predicting that the recession will be over by the end of the year.  (NBER dates the beginning to December 2007.)  

Of course, the recovery in terms of real output from the Great Depression began in the 3Q of 1933 and that did not preclude high unemployment rates and a further recession in 1937. Here. Let that pass for the moment. 

If recovery begins, the discussion about why will also begin. Let’s confine ourselves to evaluating policies designed by the government to produce recovery.

OK, it’s “later” now

by Sandy Ikeda

MSNBC reports that “Evidence mounts that recession may be ending”. At the same time, in the Wall Street Journal:

[T]he central bank has been buying mortgage-backed securities and Treasurys. Through programs announced since last fall, it has bought more than $460 billion of mortgage-backed securities and more than $125 billion of Treasury bonds. But the winds turned against the Fed in recent days, as investors worry the government’s approach could lead to inflation.

Time to start crossing that bridge already?

Tarred by TARP

by Mario Rizzo

My long-time friend and coauthor, Jerry O’Driscoll, has an excellent post at Cato-at-Liberty on TARP. In a relatively few words he gets to the heart of the matter. Take a look here.

 

The Fed Against Equilibration

by Mario Rizzo

 

Reality is more complex than our models. Free-market forces are asserting themselves but the Fed is also intervening and trying to affect those forces. Real-world data is the result of both factors.

 

The Commerce Department  has issued some new data showing that house sales are rebounding (but still off their year-ago levels) and that house prices are falling. This is to be expected as supply and demand begin to equilibrate.

The Quality of Price Signals

by Mario Rizzo

In an under-appreciated book, The Foundations of Morality (1964), the Wall Street Journal and New York Times economic journalist, Henry Hazlitt, wrote that the price system does not send accurate signals in the absence of private property rights.

“It is important to insist that private property and free markets are not separable institutions… If I am a government commissar selling something I don’t really own, and you are another commissar buying it with money that really isn’t yours, then neither of us really cares what the price is” (p. 304).

The so-called Geithner (U.S. Treasury) plan to purchase toxic assets from banks disregards the relationship between an adequately functioning price system and property rights.