Sunday, November 28, 2010

Michiko Kakutani's Top Ten

Super Reviewer Michiko Kakutani has one economics book in her 'top ten' list for 2010, and it's Nouriel Roubini's book Crisis Economics. I have a strange fascination with her because I remember having to distinguish between Brouwer and her dad's fixed point theorems, and now can't remember the difference (other than Kakutani's is a generalization of Brouwer). You can use these fixed point theorem's to prove John Nash's non-cooperative equilibrium, which was rather clever, and unfortunately suggested that many important economic proofs can be found via abstruse mathematics. Alas, this was the exception, not the rule.

If Crisis Economics was not written by a famous man like Roubini, who convinced many that his permabear stance was vindicated by the events of 2008, this book would never be read. It's filled with vapid analysis and exaggerations. Kakutani seems to buy Roubini's claim that he predicted the 2008 housing crisis in September 2006, but that speech is conveniently no longer available anywhere, probably because it actually contains a large number of qualifiers and tens of other things that could happen. Basically, the same speech he had been giving for 15 years.

The idea that regulatory arbitrage, the ability of banks to choose whether they are state chartered or nationally chartered, was a big deal, is not true. These different regulatory bodies (OCC vs. FDIC) had significantly different regulations. Further, all regulators were encouraging, not discouraging, home lending of all sorts via the target of disadvantaged homeowners. The period prior to 2007 was hardly one of free-market fundamentalism, as finance was a relatively highly regulated industry, with lots of different regulators (SEC, the Fed, OCC, FDIC, OTS, SEC, etc.) at work. His focus on meaningful financial reform centers on bringing back the anachronistic Glass-Steagall, and strengthening the clueless SEC, as if that would have made any difference.


Anonymous said...

And your alternate diagnosis or solution would be? You can't say its a bad book simply because you don't happen to agree with it.

Keep up like that and you will end up voting Palin in 2012. Can't say I like the man myself but at least have a proper go at him.

Eric Falkenstein said...

That's a strange filter. If Y happens, I may not know why, but I can still evaluate explanation X. His diagnosis I found not very deep, and noted that regulatory arbitrage, free market fundamentalism, and general 'excess' to be simply too vague, too perennial, to be very powerful.

I've posted before on my diagnosis, and can't fit it here.

praxis22 said...

Given I'm an avowed Keynesian, and a believer of Minsky's Financial instability hypothesis I don't think anything could have stopped the crash, because the longer the gravy train got the fewer were the people that would speak out against it.

That said however I do think the "anachronistic" Glass-Steagall act would have actually slowed it down. It had stopped the primary/commercial banks getting into trouble for the 46 years it was in force. Until the high priest of the new economic elite Bob Rubin acceded to the wishes of the bankers in abolishing it, (prior to going to citigroup to watch it implode.) Indeed the same guys blocked Brooksley Born's (CTFC) attempts to regulate derivatives. Again this may not have stopped the crash but it would have slowed it down.

As would've stopping regulatory arbitrage, and the forbearance of things like off balance sheet accounting and SIV's, etc.

Personally I have nothing against free market fundamantalism, I just don't think we've ever had it. The system is rigged, this is what "too big to fail" is all about.

The reality is we are all culpable to some degree. Our Pension funds went out looking for yield, and they found in in a securitisation machine that is slowly unravelling in the robo-signed mortgage mess, and the Global belief that property would continue to rise, as sucker would always buy your property from you to allow you to trade up.

You're right, it is vague, because there is no silver bullet, no smoking gun, no single thing thing you can point at and say "that was the cause" If you find you can do that then you haven't fully understood the problem.

My solution is simple enough, "Narrow banking" separate the casino from the utility. 100% reserve banking for the payment system, while the investment banks, hedge funds, etc. are walled off and kept small, that way they can fail, no rules, no limits, no support. Enforce real Darwinian competition. Winner stays on.

That way money will still be fed to the "deserving" which is the service that banking is supposed to provide, while utility banks can get on with the boring and minimally profitable business of lending money to people who can afford to pay it back.

Simple, brutal & efficient.

Like I said, I don't think that in the current system, given the skewed incentives, that the crash was avoidable, but we could have slowed it down. The same way we slowed it down from 1933 and the inception of Glass-Steagall. It took less than eight years after the repeal, for the banks high on cheap money from the Fed, to bring the house down.

Patrick R. Sullivan said...

Glass-Steagall wasn't repealed. It's 'anachronistic' provisions were changed to relax the rules against 'affiliations' between banks and brokerages, but they're functionally still separate

I.e., your casino and utility are kept apart. Banks can't use their FDIC insured deposits to underwrite securities and brokerages can't accept such deposits. And, if a bank owns a brokerage its investment has to be written off totally, so that investment can't contaminate the bank's balance sheet.

praxis22 said...

That's a semantic argument, the thing that Glass-Steagall did, the separation of church and state. (cross subsidies from commercial to investment banking) were what changed. Had that prohibition remained in place it is my contention that the crisis would not have been able to happen as quickly as it did.

As to my solution, what I'm talking about is taking an axe to any relationship. you're one or the other. One is boring, the other "exciting" and small, say 10-50 million, something that won't cripple the system if it implodes.

Patrick R. Sullivan said...

praxis, you're living in the distant past. Technology rendered some of Glass-Segall moot, which smart guys like Bill Clinton and Larry Summers recognized. In the ink and paper world of the 1930s you couldn't instantaneously transfer money from one account at a bank to another account at a brokerage, by 1999 you could...all by your li'l ol' self at your PC. The changes of Gramm, Leach, Blilely merely recognized that reality.

Which had nothing to do with why we had a financial crisis; that was entirely the end result of the government's assault on the home lending industry in the early 90s.

praxis22 said...

Wasn't ignoring this had other things to do...

I'm living in the past? Maybe, but as George Santayana so memorably said:

"Those who do not remember the past are condemned to repeat it."

Entirely the result of Government mischief in the 90's?

Living in the past as I do, for me the origins of all this start with Nixon and abandoning Breton Woods to win an election in 1971. I could insert the obvious Keynes quote here, but I'm sure you know the one I mean...

In drawing attention to cross subsidy I don't mean things we have laws for, I mean, regulatory capture things that fall through the gaps. I'm thinking here especially of AIG, the way the US Govt chose to recapitalise the banking system post Lehman. 1 day post Lehman to be precise. My point is that Gramm, Leach, Blilely was something the banking system wanted, and something we should not have given them. It sent a signal, the wrong signal.

For my primary motif, the NYT has a good argument here about breaking up banks:

Though I would agree with the sentiment that as we're still asking the question, it tells you who the sucker in this game is. Namely, Main street.

For my own point against the banks I'll point to Citigroup and JPMorgan. I chose them as they are/were the 2 biggest recipients of FED money with the TSLF, (could be TALF, alphabet FED soup :) at least according to the data the FED was forced to release.

Morgan is being run by Dimon, Dimon Learned from Weil, Weil ran Citi.

Citi grew big both by acquisition, (Travellers, etc.) and buy slight of hand, the SIV that allowed them to keep liabilities off balance sheet and thus appear smaller than they were, in addition to bolstering earnings, etc.

Citi, of whom Chuck Prince said:

"as long as the music is playing, you've got to get up and dance"

Only by then the music had stopped playing.

They were either blind or stupid, even after two Bear funds imploded, and had to be bailed out internally, Citi still thought it couldn't happen to them. they were still "dancing"

I can't say I agree with everything she says but I'm down with this from Janet Takavoli:

Morgan's exposure to derivatives is huge orders of magnitude larger than everything else.

It's size that's the issue, cut them off at the knees, make them simpler, when a business student can understand their balance sheet, it's simple enough.