Sunday, August 01, 2010

Crisis and Leviathan p. MCXLLII

1970 had one of the largest financial debacles since the 1930s. The top 10 computer, technology, and conglomerates stocks lost about 85% in 1969-70. The Penn Central Railroad company was a prominent issuer of Commercial Paper, and when they went into default many worried that companies that lent to them might go default as well, leading to contagion of default.

John Kenneth Galbraith once quipped there were two types of economists: those who don't know, and those who don't know they don't know. Yet early in 1970, Galbraith wrote a New York Times article drawing a series of parallels between the then current situation and that of 1929: excessive speculation, too much leverage, inflated investment funds, funds that invested in other funds, etc. He seemed to have granted himself an exception, implicitly forecasting another Great Depression (however, like all good prognosticators, without actually saying so, so he's never wrong). In any case, his diagnosis highlights that every recession make public minded people think: we shouldn't let this happen again!

In response to the crisis, congress created Securities Investor Protection Corporation, or SIPC. They used funds provided by the securities industtry to protect customers against losses when their brokers went broke. I think it's fair to say that the SIPC has been ineffectual. For that matter, so were the FDIC, SEC, OCC, OFHEO, the Fed, and state insurance regulars, each of which was born around some crisis of confidence, the idea that a committee of far-seeing technocrats in Washington would surely prevent the current cataclysm. The new Consumers Financial Protection Agency hopes to be more relevant primarily by having a broader mandate, but it's rather naive to think that a program that does not work, would work if only it had more on its plate.

As per Penn Central, it happened right after the venerable Pullman Railroad Company failed, and led many to believe that rail transportation would be dealt a fatal blow. In response Congress passed and President Richard Nixon signed into law the Rail Passenger Service Act. This gave government funding to assure the continuation of passenger trains. It also create Amtrak, a hybrid public-private entity that would temporarily receive taxpayer funding and assume operation of intercity passenger trains. Amtrak has lost money perpetually, and its onerous work rules created a bloated, inefficient industry that did not reverse rail traffic decline.

The new government-owned GM, and the new Consumer Financial Protection Agency are just more permanent government agencies of irrelevance, similar to previous attempts to rectify identical problems in the past.


Dave said...

The FDIC has been ineffectual? It seems to have been one of the federal agencies that has operated fairly effectively since the crisis began. What am I missing?

Eric Falkenstein said...

Well, you can credit them for a lack of bank runs that would have happened otherwise...who knows how many that would have been...But debit them for the S&L crisis, part of the mortgage crisis. But, you're correct that, the case for the FDIC, among financial regulators, is strongest, mainly because it has a pretty focused mandate.

newt0311 said...

@Eric and Dave

I would argue that the FDIC is by far the worst govt. agency in the finance market by far.

It removes all competition based on careful management of risk as customers no longer care about how well the bank guards the deposits --- after all the FDIC will make them (the customers) whole. As a result, banks take way too much risk and the response to this distortion by government is...even more distortion by government in the form of capital requirements and accounting regulations. Of course, banks are filled with some of the smartest minds in the country so the regulations are barely worth the paper they are written on. Is it any surprise that banks turn out to be chronically over leveraged?

michael webster said...


No agency has learned to stop or even slow the simplest of confidence games - the selling of fraudulent business opportunities.

We shouldn't expect much out of any new agency, until past failure is acknowledged.

Anonymous said...

No agency has learned to stop or even slow the simplest of confidence games - the selling of fraudulent business opportunities.

We shouldn't expect much out of any new agency, until past failure is acknowledged.
Articles are meaningful, and your blog is nice!
Cheap New Era Hat
Cheap Coogi Cap
Cheap Dolce Gabbana Cap
Cheap Abercrombie Fitch Cap
Wholesale LRG Cap
Wholesale Polo Cap
Wholesale Puma Cap
Wholesale Enyce Cap
Wholesale Bape Cap
Wholesale Gucci Cap
Wholesale louis vuitton cap
Wholesale Prada Cap
Wholesale Christian Audigier Cap
Wholesale G_Unit Cap
Wholesale Chanel Cap
Wholesale Ed Hardy Cap
Wholesale Diesel Cap
Wholesale Burberry hats
Wholesale Red Monkey Cap
Wholesale Gino Green Global Cap
Replica Nike Jordan Shoes

Dave said...


I think as long as you have fractional reserve banking, an FDIC or something like it will be necessary to prevent bank runs. But, speaking for myself, I still consider a bank's prudence and safety when establishing an account there. I picked my bank after seeing it listed as one of the strongest banks in America in Dr. Ravi Batra's book "The Great Crash of 1990".

newt0311 said...


Historical evidence says otherwise. The Banks in England used fractional reserve banking for a considerable period of time without any DI. Yes, there were a large number of bank runs in the US during the great depression but note that the US had severe branch restrictions on banks at that time. In comparison, there were no bank failures in Canada which at that time also had no DI but also had no branch restrictions. The solution to risk from bank runs is greater consolidation of banks with more careful money management, not the FDIC with the attendant moral hazard.