Rethinking the international financial architecture. The next WEA Conference

from Maria Alejandra Madi 

The existing international financial architecture, left over institutions from the Bretton Woods period, proved useless to prevent or warn against the 2007-2008 crisis, or even less, solve it. Only when a new presidential grouping (G20) meeting was called for in London in March 2009, the issues of how to coordinate countercyclical policies and inject resources into the economies were discussed. At that time, a UN high level Commission was created to propose reforms to the international financial architecture. The results of what became known as the Stiglitz Commission came to light in April 2010; the Commission’s recommendations were, however, shunned by some large UN member countries due to their rejection of the principle of global solutions for global problems. Indeed, some European countries and the US still insist on national solutions, that is on the use of local regulatory agencies in the international financial field.

Finance in America: Promoting inequality and waste

from Dean Baker

In the crazy years of the housing boom the financial sector was a gigantic cesspool of excess and corruption. There was big money in pushing and packaging fraudulent mortgages. The country paid a huge price for the financial sector’s sleaze.

Unfortunately, because of the Obama administration’s soft on crime approach to the bankers who became rich in the process; the industry is still a cesspool of excess and greed. Just to be clear, knowingly issuing and packaging a fraudulent mortgage is a crime, the sort of thing for which people go to jail. But thanks to the political power of the Wall Street, none of them went to jail, and in fact they got to keep the money.

Since the penalties for ripping off people are trivial to non-existent, the financial sector finds this to be a much more profitable line of business than actually providing financial services. The New York Times recently reported on the boom in the subprime market for auto loans featuring many of the same abusive practices we saw in the subprime mortgage market during the bubble years. Lenders are slapping on extra fees, changing the terms after contracts are signed, and doing all the other fun things we have come to expect from leaders in finance. The used car industry was sufficiently powerful that it was able to gain an exemption from being covered by the Consumer Financial Protection Bureau.

Did the banks have to commit fraud?

from Dean Baker

Floyd Norris has an interesting piece discussing Citigroup’s $7 billion settlement for misrepresenting the quality of the mortgages in the mortgage backed securities it marketed in the housing bubble. Norris notes that the bank had consultants who warned that many of the mortgages did not meet its standards and therefore should not have been included the securities.

Towards the end of the piece Norris comments:

“And it may well be true that actions like Citigroup’s were necessary for any bank that wanted to stay in what then appeared to be a highly profitable business. Imagine for a minute what would have happened in 2006 if Citigroup had listened to its consultants and canceled the offerings. To the mortgage companies making the loans, that might have simply marked Citigroup as uncooperative. The business would have gone to less scrupulous competitors.”

This raises the question of what purpose is served by this sort of settlement. Undoubtedly Norris’ statement is true. However, the market dynamic might be different if this settlement were different.

Investors — people knowing almost nothing whatever about what they are doing

from Lars Syll

How far the motives which I have been attributing to the market are strictly rational, I leave it to others to judge. They are best regarded, I think, as an example of how sensitive – over-sensitive if you like – to the near future, about which we may think that we know a little, even the best-informed must be, because, in truth, we know almost nothing about the more remote future …

The ignorance of even the best-informed investor about the more remote future is much greater then his knowledge … But if this is true of the best-informed, the vast majority of those who are concerned with the buying and selling of securities know almost nothing whatever about what they are doing … This is one of the odd characteristics of the Capitalist System under which we live …

It may often profit the wisest to anticipate mob psychology rather than the real trend of events, and to ape unreason proleptically … (The object of speculators) is to re-sell to the mob after a few weeks or at most a few months. It is natural, therefore, that they should be influenced by the cost of borrowing, and still more by their expectations on the basis of past experience of the trend of mob psychology. Thus, so long as the crowd can be relied on to act in a certain way, even if it be misguided, it will be to the advantage of the better informed professional to act in the same way – a short period ahead.

 

 

Keynes on speculators taking advantage of mob psychology

from Lars Syll

How far the motives which I have been attributing to the market are strictly rational, I leave it to others to judge. They are best regarded, I think, as an example of how sensitive – over-sensitive if you like – to the near future, about which we may think that we know a little, even the best-informed must be, because, in truth, we know almost nothing about the more remote future …

The ignorance of even the best-informed investor about the more remote future is much greater then his knowledge … But if this is true of the best-informed, the vast majority of those who are concerned with the buying and selling of securities know almost nothing whatever about what they are doing … This is one of the odd characteristics of the Capitalist System under which we live … 

The Fed, Ben Bernanke, and the rotten Libor

from Dean Baker

The case of the rigged Libor turns out to be the scandal that just keeps on giving. It reveals a great deal about the behavior of the Federal Reserve Board and central banks more generally.

Last month, Federal Reserve Board Chairman Ben Bernanke gave testimony before Congress in which he said that he had become aware of evidence that banks in England were rigging the Libor in the fall of 2008. According to Bernanke, he called this to the attention of Mervyn King, the head of the Bank of England. Apparently Mervyn King did nothing, since the rigging continued, but Bernanke told Congress there was nothing more that he could do.

The implications of Bernanke’s claim are incredible. There are trillions of dollars of car loans, mortgages, and other debts, in the United States, tied to the Libor. There are also huge derivative contracts whose value depends on the Libor at a moment in time. People were winning or losing on these deals not based on the market, but rather on the rigged Libor rate being set by the big banks. 

Real World Economists Must Lead

from Robert R Locke

I think the people in this blog need to show more leadership. That might be hard to understand for those who are use to thinking of the economy as a self-regulating mechanism and of economists as observers and thinkers. But the economic crisis is too important to be left to passivity.

The problem area is not difficult to identify. It is not socialism versus capitalism or free enterprise versus government, as neoliberal, tea party ideologues would have it. The problem that real world bloggers need actively to investigate and manage is a massive system of private investor capitalism at the heart of today’s economy. It emerged from five post WWII mostly noneconomic phenomena: First the information revolution that spun out of the Pentagon during the Cold War, which allows twenty-four hour a day trading of financial packages on money markets worldwide. Two, the end of the Cold War, which opened up vast stretches of the former Communist world to private investor capitalism in an integrated system of stock markets and financial service, Three, the growth of institutional investors in associations like private pension funds that funnel unprecedented amounts of money into private equities, hedge funds, and investment banks. Four, the rapid growth of business schools and departments of finance economics that preach an ideology of unrestrained private investor capitalism and furnish investor capitalism’s skilled labor force, and Five, the development of neoliberalism in economics that justifies the ethical bankruptcy of investor capitalism. 

Gigo

from David Ruccio

Once you’ve stated the obvious point that the financial sector “has grown to an unprecedented share of the economy,” how do you make sense of that growth?

Well, if you’re Paul Krugman, you send us to Thomas Philippon’s unpublished essay, “Has the U.S. Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation” (pdf) [ht: br]. And that’s when the fun—or the horror—begins. 

Break up the banks. Please.

from Peter Radford

How do I say this delicately?

The banking system, and in particular the biggest banks, were central players in the development of the crisis; they then played a major role in spreading contagion around the world; they then collapsed due to mismanagement, poor regulation, and endemic greed; this required that they be propped up beyond their normal subsidy by the taxpayer; the cost of propping them up transformed a private debt catastrophe into a sovereign debt catastrophe; this undermined national budget across the globe; which, in turn, induced a wave of austerity-driven debt reduction by governments; which has now ensured that the crisis has become a depression.

Well done banks. 

Banking and orthodox economics: an ugly brew

from Peter Radford

Nothing that has emerged about the JP Morgan losses announced last week has altered my original conclusion. This was a basic failure of governance, of regulatory oversight, and of control. Oh, and of orthodox economics. Again.

Yes there were rules in place to prevent such losses. They were ignored. Vanity, hubris, call it what you will, stopped the bank from exercising self-restraint. What appeared to be highly risky, complex, and very large transactions were allowed to take place despite the fact that they were risky, complex, and very large.

The bank thought it was more clever and sophisticated than it was. It turns out to have been dumb. Very dumb.

The oddity here is that these kinds of dumb plays are what brought the banks to their knees back in the crisis. Obviously no one at JP Morgan learned the lesson.

The Facebook Follies

fromo Dean Baker

The big business news last week was that Facebook is going public with an initial public offering (IPO) that is likely to place the market value of the company in the range of $100 billion. This price would put Facebook among the corporate giants in terms of market value.

By comparison, Goldman Sachs, of vampire squid fame, has a market value of $55 billion. Ford’s market value is less than $16 billion. With its current market value near $106 billion, Facebook would even give a serious run to Verizon, the giant telephone company.

While the implied value of Facebook is impressive, a question that was raised in several stories was whether the company would really be worth this much money. Some simple back of the envelope calculations show that Facebook would have to gain an enormous share of advertising expenditures over the next 5-10 years in order to generate the sort of profits needed to justify this current price.

Monetary innovations for eco-friendly production and economic stability

Discussions about improved prudential regulation, changing the incentives that players in the financial sector face and the possibility of a financial transactions tax as means of reviving the economic system have tended to overlook innovative monetary proposals that focus on changing the nature of credit money itself. Some of these have come from outside academic economics and aim to promote eco-friendly paths of economic recovery. In this post I hope to stir up some discussion by presenting a guide to some of these proposals and

Crash Tax: Reparations to the 99%

from Edward Fullbrook

With the continuing fallout from the Global Financial Collapse and the global upsurge of real democratic sentiments, support seems to be growing for a Tobin or financial transactions tax.  Yesterday AlterNet stated the case for it as follows.  

Wall Street caused the crash. It caused devastating unemployment. It exacerbated deficit problems in the United States, Greece, Ireland, Portugal, Spain and Italy. If the market hadn’t crashed, sustained higher tax revenues would have prevented these difficulties from intensifying.
……. 
The crash tax is, essentially, a sales tax on financial transactions. The middle class pays sales tax on all the stuff it purchases. There should be no special exceptions. The 1 percent should be paying sales tax on the purchase of risky derivatives and on bets that derivatives will fail. This is equity. This is simple fairness. 

S&P Rubbish

from Peter Radford

As an afterword on the whole downgrade silliness, the world has been full of S&P critiques. Quite why we need to add to the very obvious fact that S&P is clueless as to risk, and very likely corrupt to boot, seems beyond me. Anyone who believed the magical stardust sub-prime mortgage lead into AAA gold alchemy is clearly incapable of even the most simple analytical process. Alchemy is alchemy no matter how you dress it up, and no matter how many MIT economics PhD’s devote their mathematical skills to the problem.

Downgrade Reaction

from Peter Radford

Yesterday’s slide in stock prices around the world is not due to the downgrade of US bonds. It is due to the final realization, by hitherto myopic analysts, that we are on the brink of another recession, and that for all the talk of recovery over the last year or so, what growth we have experienced was fragile enough to wither when stimulus was withdrawn.

This was entirely predictable, and should surprise only those who pay no attention. Unfortunately that includes most of Wall Street and Washington.

There are two sources of this renewed crisis.

Headed to recession?

from Peter Radford

Well it didn’t take long for the stock and credit markets to vote on the efficacy of American economic policy. Judging by last week’s massive stock market sell off, coupled with the steady decline of bond rates, the vote is clearly a negative one. The markets are giving us the collective thumbs down. Evidently sentiment is gathering behind the notion that the economy is weak, that we have no leadership, that we have no corrective policy, and that the risk of another recession is rising by the hour. To make matters worse there is an epidemic of economic incompetence worldwide, not least in Europe where the leadership seems determined that we need a re-run of 1937. Because, presumably, the first time through was such a thrill.

Insider Trading and Wall Street’s [Un]Ethics

from Peter Radford

I’m bored with debt defaults. No one seems to worry about them, so I won’t.

How about insider trading? That sounds like fun.

The much heralded Galleon case and the guilty finding against a well respected money manger has confused Wall Street. The boys and girls down there are throwing a hissy fit. How can someone with a little bit of information not be expected to try to make a buck? After all the whole point of getting those special hints, clues, and facts is to end run the market, make a fortune, preen in fancy restaurants, and retire early in order to serve the public as an official in the Treasury Department. Well, maybe not that last bit.

The point is information is the grist that makes the market work. So he, or she, who has information, has a nugget worth a great deal. Since sharing is not a gene found in these folk’s DNA, they naturally like to hoard and then deploy these nuggets to their own advantage. 

World Stock Market Capitalization: 4 graphs

1. World Stock Market Captialization 1980 – 2007
2. World Stock Market Captialization 1996-  2010
3. Dow Jones World Stock Index 1998 – Oct 24 2008
4. Stock Market Capitalization Around the World 

IMF and Capital Controls

The Tyranny of the Bond Markets

from Kevin Gallagher

Credit rating agencies played a big role in creating the financial crisis. Now they are slowing the recovery. Financial regulatory reform legislation in the US has finally put the agencies on the radar screen, but the proposals don’t go far enough.

It is now legendary that the mortgage-backed securities structured in the shadow banking system all had AAA stamps of approval by the rating agencies. Of course when the mortgage bubble that propped up those assets burst, we learned that such assets were indeed “toxic” and unworthy of such high grades. The world couldn’t handle the truth and spun into the worst financial crisis since the Depression.