Economics

Because it Worked So Well Last Time

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Bloomberg:

Treasury Secretary Henry Paulson proposed the broadest overhaul of U.S. financial regulation since the Great Depression, saying the system for overseeing American capitalism needs to be better prepared for "inevitable market disruptions."

"Our major financial services companies are becoming larger, more complex and more difficult to manage," Paulson said in remarks at the Treasury in Washington. "The real threat to market stability is below ground, at the root level where the health of financial firms is intertwined." […]

The Treasury recommended that the Fed share authority over banks, securities firms and insurers in monitoring corporate disclosures, writing rules and stepping in to prevent economic crisis.

"To do its job as the market stability regulator, the Fed would have to be able to evaluate the capital, liquidity and margin practices across the financial system and their potential impact on overall financial stability," Paulson said. […]

"The Fed would have the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability," Paulson said.

"The Fed will collect information from commercial banks, investment banks, insurance companies, hedge funds, commodity- pool operators," he added. "Rather than focus on the health of the particular organization, it will focus on whether a firm's or industry's practices threaten overall financial stability."

A good idea? I rather doubt it. Aside from the merits (and lack thereof) of this particular case, the American track record of ambulance-chasing bureaucratic and regulatory overhauls is not a very pretty sight. See, for example, Brian Doherty on Sarbanes-Oxely in January 2006, James Bovard on post-9/11 airline security in February 2004, and Julian Sanchez on the PATRIOT Act in July 2005. We will be hearing a lot in the coming months about how "complexity" needs to reined in by sober-minded government managers.

In an unrelated story, Housing and Urban Development Secretary Alphonso Jackson is reportedly stepping down amid criminal allegations that he awarded federal contracts to his pals.

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  1. Our major financial services companies are becoming larger, more complex and more difficult to manage

    Maybe that is evidence you shouldnt be trying?

    The real threat to market stability is below ground, at the root level where the health of financial firms is intertwined.

    Stability is overrated. Im not even sure if its a positive thing.

    Hail Eris!

  2. Not to mention the disastrous fixes that Herbert Hoover proposed at the start of the Great Depression that attempted to prevent the required economic contraction.

    The price controls and production boards he put in place, which were then expanded by FDR, gave us 20 years of economic stagnation, poverty and war. Not to mention setting the foundation of the drug war.

    I just love corporatism; they want to keep the profits, but the moment the losses appear they want the taxpayers to be forced to bail them out…

  3. Oh shit! We need to do something!

    Always leads to government at its worst.

  4. Oh shit! We need to do something!

    Always leads to government at its worst.

    Yep. I think there needs to be a 1 year moratorium between a problem and government even thinking about solving it. For example, the Patriot Act couldnt have been introduced until September of 2002.

    If we wait until at least next year, see how the financial industry shakes out, and analyze it with a cold, distant eye, there MIGHT be a regulation of two that makes sense without super unintended consequences.

    Sarbanes-Oxley was done to fast too.

  5. My prediction: the newly expanded Fed will attempt to prevent the failures of the past. In it’s over-regulating zeal to do so, financial firms will find new ways of doing business that allow them skirt the new regulations. This ensures that eventually, a new threat to stability will arise that the Fed is unable to foresee, prevent, or adapt to. When Crash 3.0 looms, whichever fucking moron is heading Treasury will propose a new system of regulation that won’t address any future problems.

    All of this fails to address the underlying issue that if you do stupid things with money, you deserve to fail and nobody should bail you out.

  6. One of the unremarked reforms of the post-Depression era was the separation of the insurance, equity, and banking markets under Glass-Steagal. They were not allowed to own large shares of each other. This was based on the sound premise that business cycles were inevitable and it was best not to allow one sector’s collapse to bring all the others down with it.

    Today, the philosophy is “too big to fail”: we lump huge entities together on the theory that together they are too large and strong to all collapse at once.

    If they turn out to be wrong, the consequences are going to be horrific.

  7. The post from ropb was me. I only got a B+ in high school typing and that was 20 some odd years ago.

  8. I think TallDave nails it on the head. Maybe we should be seriously discussing re-instating Glass-Steagal.

  9. I thought the Fed was a bank. What’s all this regulatory power doing in a bank?

  10. What’s all this regulatory power doing in a bank?

    It’s in the vault, so they can keep it safe from us pesky citizens.

  11. Well at least we can be assured that our “free market” system is still superior to any of those attempts at “central planning” that the Soviets tried.

  12. The Fed has done such a bang-up job until now, we should give it more regulatory powers, right?

  13. Here’s a question for those of you who are either involved in the business on a daily basis (or have a better recollection of the historical timeline):

    Investment banks, as I recall, used to be partnerships. Was that changed at the same time as the repeal of Glass-Steagall?
    My suspicion is that a great deal of “financial innovation” was driven by, or at least coincided with, the change from partnership to corporation.

    Get thee behind me, Dave W!

  14. The reality of the situation is that human beings are too stupid to have government.

  15. The Federal Reserve’s claim that higher interest rates stem inflation is contradicted by the fact that, during their monetarist “reign of error,” inflation has eroded the value of the dollar by over 80 percent.

  16. Bring on another depression. It’s good to clean out the system and get rid of the bad blood. People–and their rotten little kids–who make bad decisions–should suffer the consequences. You got cancer? You shouldn’t have fucking smoked. No medical intervention for you, asshole. Oops, wrong topic.

  17. I love it. When bad government policy causes undesirable outcomes (http://en.wikipedia.org/wiki/Community_Reinvestment_Act), their solution is to add more bad policy. I’m afraid America will never find its way out of its now socialist machinery.

  18. Smalley D – This problem was brought about by far deeper problems than just the CRA.

  19. P Brooks-
    I’m sure I meet neither of your criteria, but my guess is the trend for partnerships to corporate structure is part of the larger trend that followed by many companies in diverse industries.

    And my assumption for the basis of the broader trend is the increased availability, globalization, and democratization of capital.

  20. I can’t get over that you never heard about the Fed until Dr. Paul talked about it, and now you read about it every day in the paper.

  21. “I’m afraid America will never find its way out of its now socialist machinery.”

    Yeah, we’re all enslaved now. SWAT teams barge into every second home looking for drugs. Very soon we’ll all be wearing Mao suits and making forced visits to government health clinics. All we can do is form militias and head for the hills before they take our guns away.

  22. Poor, bitter MK2. What is he bitter about? I have no idea. Who cares?

  23. I’m bitter about the government and its relentless assualt on our freedoms, man. I tremble at the thought of government intervention to ease the burden of morons who let themselves be tricked into buying houses they can’t pay for. It’s a short step from there to the gulag.

  24. Kolohe-

    You’re right, but my possibly faulty recollection is that there was a specific change in the law which allowed investment banks to abandon the partnership structure, and assume corporate limited liability.

  25. Geez, guys, don’t you know that the solution to too much government is more government?

    It’s American Politics 101.

  26. You fools. This is completly different. All those previous examples you brought up are inconsequential. NOW, we have the RIGHT people in charge.

  27. GOVERNMENT has brought us into this cesspool of socialist enslavement and made us the hapless tools of the STATE, and now THEY want to impose more GOVERNMENT on us in the form of REGULATIONS. When one bank is regulated no man is free. TO THE BARICADES!

  28. No matter the problem, more government is the solution.

  29. Yer doin’ a heckuva job, Feddy!

  30. Oh, fuck.

  31. “GOVERNMENT” is being harnessed to protect the holders of over $400 trillion of Credit Default Swaps (aka derivatives”) – the I-banks and commercial banks who are playing a giant game of pick-up sticks with financial instruments that would completely disintegrate if one of the players lost his “steady” hand.

    The canard that 10-year old low-income mortgages are imploding ‘en masse’ is a way for simpletons to drop the problem on one of their favorite whipping boys.

    Some one got it right earlier – this is pure corporatism – Mussolini would be proud.

  32. Government is so unnatural. We humans are by nature free and averse to hierarchies of any kind. We just like to exchange stuff and take care of ourselves. Government has been imposed on us by aliens from outer space (probably aided by Mossad). Down with alien government! Up with human freedom!

  33. I’m not sure we’re going to make it out of 2008 without nationalizing the banks, collectivizing agriculture, etc.

    Socialize our losses or your whole economy gets it!

  34. The economy won’t go into a depression unless there is a major war or another major terrorist attack. Too many people are drinking the kool-aid and they don’t want to stop. Someone here likened it to when cartoon characters run on air and they don’t fall until they look down.

  35. To paraphrase:

    “Those who would give up Essential Free Markets to purchase a little Temporary Stability, deserve neither Free Markets nor Stability.”

  36. MK2/Edward

    Switch to decaf.

  37. Mussolini would be proud.

    Absolutely! Statists love to use sophistry to dream up distinctions between so-called liberal democracy and fascist or socialist dictatorships. But they are exactly the same. Facists and communists impose taxes, and so does our government. Fascists and communists intervene in the economy, and so does our government. Don’t be fooled by smooth-talking “intellectuals” into making false distictions. Mussolini could wake up here and feel right at home (he might be critical of the pasta) We live under a fascist dictatorship.

  38. We humans are by nature free and averse to hierarchies of any kind.

    Erm, not really, MK2.

    Humans are basically social animals, and all social animals are wired for hierarchy. Every pack has an alpha, every herd a leader, and a pecking order strung out below them all the way down.

  39. I’m guessing it’s spring break this week at the junior high MK2 attends.

  40. R C Dean

    You sound like a government apologist to me.

  41. But to pretend that bureaucratic consolidation is tantamount to reform is dishonest. But the New York Times parrots the Administration’s story line:

    The proposal is part of a sweeping blueprint to overhaul the nation’s hodgepodge of financial regulatory agencies, which many experts say failed to recognize rampant excesses in mortgage lending until after they set off what is now the worst financial calamity in decades.

    In reality, the biggest single culprit was a lack of willingness of major regulators, in particular the Fed, to intervene in a securitization process that, as long as it beefed up housing prices, was seen to be virtuous.

    the guys at nakedcapitalism don’t seem terribly impressed.

  42. Brian Courts

    You think I attend a fascist/socialist government school! I’m home schooled, buddy. No state-employed commie teacher is going to shove evolution down my throat.

  43. Let’s see if I’ve got this straight: The Fed creates a boom and housing bubble, the bubble then bursts, so the Fed gets rewarded by being granted new power.

  44. Today, the philosophy is “too big to fail”: we lump huge entities together on the theory that together they are too large and strong to all collapse at once.

    Plus we add a gold-plated government guarantee just in case.

    Isn’t that what Dad used to call “Putting all your eggs in one basket?” I thought so.

  45. Incidentally, all of this WAS foreseen – witness the Orwellian-sounding ‘Consumer Protection Act’ of 2004.

    In that legislation, banks/creditors were granted the right to foreclose on mortgages where the homeowner was in arrears on his/her UNSECURED credit card debt.

  46. Brandybuck

    Tell me again how the Fed created the housing bubble. Lack of regulation?

  47. Tell me again how the Fed created the housing bubble.
    By dropping the FFR to 1% for a year to help various IB and CB paper over their losses from the dot.com era and the Enron/Wolrdcom/Adelphia/etc. collapses. Essentially giving away free money with no risks to any institution that needed it.

  48. MK2 –

    The Fed created the housing bubble by attempting to avoid recession following the 9/11 attacks.

    Lowering the discount rate to historic lows created an asset bubble in real estate.

    Everyone wants to bitch about how this crisis is the result of a lack of regulation, but regulation would not have helped. Securitizers promulgated lending standards based on the performance of existing subprime bonds. Those bonds were performing extremely well in the period from 1998 – 2005. Every year that they continued to perform, underwriting standards were loosened. Politicians like Barney Frank who claim that regulation would have prevented this apparently believe that regulators would have prevented securitizers from issuing bonds that were performing, based on a common-sense evaluation of loan underwriting standards that wasn’t being captured by existing performance data. And there is absolutely zero reason to believe that would have been the case.

  49. ahhh – I don’t post here often but Fluffy sounds like a smart guy.

    The Bear stock price was the symptom – the eroding bond values were the disease. A simple FASB rule (is that socialist?) would force the debt holders to mark the value appropriately – thus bypassing the myopia of the rating agencies.

  50. PBrooks,

    Investment banks all became public corporations in the 80’s – 90’s — at least I think that they all did. American Express bought out the partners at Lehman (remember Shearson-Lehman-Hutton?) and it went public after it was sold off. Goldman Sachs went public in 1999. Salomon (now part of Citi) was bought by Phibro in the 1980’s but was a partnership beforehand. DLJ was bought by Credit Suisse in 2000 but had been majority owned by AXA previously. Morgan Stanley went public in 1986…

    I used to work for Lehman Brothers and for a couple of commercial banks’ “investment bank” (i.e. securities) wings (Chase and JP Morgan — each pre-merger and for JP Morgan post)

  51. You sound like a government apologist to me.

    Nope, just a realist.

    People are social, hence hierarchical, hence political animals. Pretending they aren’t is only an impediment to creating and maintaining a decent society.

  52. I almost forgot:

    Bear went public in 1985

  53. Pro-market enthusiasts are in a double bind. When things go bad, folks cry out for government assistance and regulation. Things inevitably go bad, and it takes the market some time to sort them out. Those on the short end of the stick don’t want to wait. To keep intervention and regulation from spiraling out of control, we need a social safety net to keep the clamor for assistance and regualtion at bay. By refusing to abide a social safety net, free market enthusiasts are cutting their own throats and ensuring the market will be even more regulated. What to do? Read some good novels, enjoy life. Don’t exaggerate the downsides of a mixed economy. Celebrate reality. If being part of a futile little cult of purists is what turns you on, go for it, but don’t expect to be taken seriously.

  54. R C Dean

    So if you’re a realist, what the fuck are you doing here?

  55. By refusing to abide a social safety net, free market enthusiasts are cutting their own throats and ensuring the market will be even more regulated.

    Who here is against a social safety net? We’re just against a government provided social safety net. Huge difference.

  56. T

    You’re a moron.

  57. MK2: Stop posting you stupid fucking twit. Your attitude is obnoxious and you obviously have no intention of engaging in any sort of actual discourse.

  58. “Tell me again how the Fed created the housing bubble. Lack of regulation?”

    Explanations thus far have been a little advanced for what is your apparenet educational level in economics/finance, no offense. I’ll put it in layman terms:

    The Fed controls monetary policy by setting interest rates. The interest rate is simply the cost of borrowing. However, since the Fed is setting it, it is basically price-fixing money and credit. This creates either a shortage of credit (if the interest rate is above where the market equilibrium rate is) or a suprlus (if the interest rate is below the equilibrium rate). Shortly after 9/11, the Fed lowered interest rates, creating a surplus of credit. Basically no one was saving because they weren’t getting s*** for it, and everyone was borrowing because it was cheap (low rates). In the aggregate (macro level), this creates an overabundance of borrowing, such as mortgages. This, combined with government subsidies in the mortgage industry to begin with (FHA loans), drove many people to buy houses when they otherwise wouldn’t have. This drove up real estate prices and created a bubble in our economy, all financed either through inflation or international debt.

    See, had the Fed not existed in the first place, the interest rates would have been set by the market and there would be no shortage/surplus of credit, and thus no bubble. You can thank John M. Kaynes for this one.

  59. @MK2: Wow. An ad hominem attack! Well you must be correct. Everyone knows that ad hominem attacks prove the speaker correct.

    Your logic is flawless!

  60. We’ll never get out of this boom & bust cyclical economy as long as the Federal Reserve is around. Politicians don’t care about wants in the long term best interest of the economy they only care about the economy till the next election. So they love having a Federal Reserve board they can pressure into lowering or raising interest rates to temporarily prop up the economy so they can get re-elected. They don’t care about poor people’s money being inflated or that they’re screwing over future generations. The politicians will long be dead and out of power by the time they’re old enough to vote.

  61. It’s kind of sad that all the great Classical Liberal economists are no longer with us. We really need some modern versions of Mises, Hayek, & Friedman.

  62. “It’s kind of sad that all the great Classical Liberal economists are no longer with us. We really need some modern versions of Mises, Hayek, & Friedman.”

    Worth repeating!

  63. Mises, Hayek, & Friedman are so yesterday.

  64. What are you driving at, Bingo?

  65. How do you get people to sign up for the armed forces when we are in wars?

    Make them poor.

  66. Government is so unnatural. We humans are by nature free and averse to hierarchies of any kind. We just like to exchange stuff and take care of ourselves. Government has been imposed on us by aliens from outer space (probably aided by Mossad). Down with alien government! Up with human freedom!

    What have the Romans ever done for us?

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