Bob Carlson

April 23, 2014

Updating Europe

Filed under: Economy,Financial crisis — Bob @ 8:19 am

There haven’t been many headlines from Europe recently. The financial crisis seems to be in the past, and European stock markets generated nice gains the last few years. But that’s only the surface analysis. In fact, European leaders haven’t done anything except stabilize the continent at depression levels. Growth is very modest. Unemployment still is very high and generating a range of social problems. The structure of the continent’s governing structures make it difficult to enact any policies that will do more than provide stopgaps to the serious problems. updates the situation.

There’s a growing consensus that the European Central Bank needs to implement something similar to the quantitative easing policies of the U.S. and U.K. The ECB isn’t allowed to buy bonds the way those two central banks have. More importantly, a German court is reviewing a case in which it could sharply restrict the powers of the ECB, making it extremely unlikely that the ECB would be able to pursue aggressive policies. If the court does rule that way, it could change public perception enough to cause another panic and crisis.

Much like the U.S. Supreme Court, upon which Germany’s highest court was partially modeled after World War II, the German Federal Constitutional Court is the final interpreter of constitutional law. Accordingly, it has the last word on the legality of any treaties, agreements or actions undertaken by Germany at the European level.

The court already has challenged German involvement in some of the more creative legal acrobatics undertaken by the European Union. These include the establishment of the EU emergency bond-buying plan known as the Outright Monetary Transactions program. In that case, the German Federal Constitutional Court proceeded with caution and referred the case to the European Court of Justice. But there are strong indications that it could be more aggressive in future cases. A rejection of government moves in a landmark case, such as one involving potential German participation in a strengthened quantitative easing program, could derail the Continent’s recovery.

April 8, 2014

The Charles Keating Legacy

Filed under: Economy,Financial crisis — Bob @ 12:20 pm

Charles Keating, the leader of the savings & loan scams of the 1980s, passed away last week. Not too many people remember the damage that was done by the S&P crisis and how few of the lessons from that crisis were remembered. Instead, new scams and frauds occur with regularity. Here’s a good review of Keating’s actions by a many who tried to regulate Keating and regularly was confronted by politicians Keating had purchased through campaign contributions.

The Savings and Loan debacle was the test bed for the epidemics of accounting control fraud that drove our subsequent financial crises.  The debacle was the only one that was “successfully” contained before it could cause a financial crisis.  The debacle was widely described at the time as the “worst financial scandal is U.S. history,” so the phrase “successfully contained” is obviously one that could spark disbelief.  The critical modifier is “before it could cause a financial crisis.”  The S&L debacle did not lead to even a mild national recession.  It did hyper-inflate regional real estate bubbles that pushed parts of the Southwest region into a serious economic decline.  The Enron-era frauds substantially contributed (in conjunction with the related collapse of the dot com bubble) to a $7 trillion fall in market capitalization and the fraud epidemics hyper-inflated the largest bubble in history and drove a Great Recession that is projected to cost over $20 trillion in lost production.  The S&L debacle, therefore, allows us to understand not only went wrong, but also how to prevent things from going wrong.

April 7, 2014

How They Get Away With It

Filed under: Financial crisis — Bob @ 8:20 am

Many people wonder why after all the losses in the financial crisis so few people faced criminal prosecution. One answer is that incompetence and mismanagement aren’t crimes. But there are some instances of questionable public disclosure and other acts that could be crimes. Here’s a good example of why even those cases don’t result in prosecutions. Sometimes the prosecutors aren’t very good. Sometimes prosecutors find it to their benefit to settle cases for money instead of taking the risks of losing at trial. By settling they get to announce all the fines they collected and bad guys they pursued.

According to the complaint, Bank of America executives wrestled over whether to tell investors about the mounting Merrill losses. On Nov. 13, 2008, Bank of America’s general counsel, Timothy J. Mayopoulos, and the bank’s outside lawyers from Wachtell, Lipton, Rosen & Katz decided that the numbers would have to be disclosed in a Securities and Exchange Commission filing, according to the complaint. Then, they consulted with Joe Price, the bank’s chief financial officer, and decided to reverse their decision.

On Dec. 4, the complaint alleges, Mr. Price knew that the losses had breached the threshold that Mr. Mayopoulos had laid out as the benchmark for requiring disclosure. The shareholder vote went ahead without any filing.

March 3, 2014

Fed Minutes and the 2008 Crisis

Filed under: Financial crisis — Bob @ 6:20 pm

The minutes from the Fed meetings of 2008 are something of a gold mine for those who want to plug in the details of how the debt problems became a major calamity that spiraled almost out of control. A really good compilation is this piece from The Atlantic. It pieces together news events and the Fed minutes, starting in 2007, and shows how the majority of the Fed was worried about inflation when we were on the verge of a deflationary spiral. It’s good reading. Good title, too.

Now, the Fed actually did a good job in this first part of the crisis. It aggressively cut interest rates from 5.25 percent in September 2007 to 2 percent in April 2008. And it midwifed a deal for Bear Stearns—taking on $30 billion of its crappiest assets—to prevent an all-out panic. By April, Bernanke was justified in saying that “we ought to at least modestly congratulate ourselves.” The TED spread had come down from end-of-the-world-terrible to merely terrible levels. And though unemployment had risen to 5.4 percent, that wasn’t too bad when you considered that housing had already fallen 20 percent from its 2006 peak.

It looked like we might muddle through with something like the 1990 recession: a shallow, but long, slump, with a weak financial system, but no panic. This is the three-chapter story of why that didn’t happen, the story of the three Fed meetings that took place during the summer of 2008, whose much-anticipated transcripts were finally released last week.

February 27, 2014

Alan Greenspan Updated

Filed under: Financial crisis — Bob @ 6:20 pm

Since the financial crisis, former Federal Reserve Chairman Alan Greenspan’s been researching and writing. Mostly he’s been trying to learn what he didn’t know back when he was head of the Fed. He wrote a couple of books and some articles. Most recently, he was interviewed by the Harvard Business Review. There are a lot of interesting points in the article, including the observation that he didn’t have time to learn and do research as Fed chairman and has learned more since leaving the Fed than he did during the previous 10 years.

I can recall a lot of people at the Federal Reserve raising all of these issues. I was sitting there 18-and-a-half years, getting an extraordinary amount of advice from everybody under the sun. Every day for most of the period from let’s say late 1980s basically through the end of my term, I would get almost every week people predicting that the world was coming to an end. That the economy was going to crash. “There are imbalances. There’s too much debt. There’s too much speculation.”

After a while you begin to say that this stuff is random, because you have this same thing going on on the other side. But in retrospect, what everybody reads is five or six guys who did get it right.

You know, when [Eugene] Fama and [Robert] Shiller got the Nobel, in the New York Times, they have Fama saying about Shiller’s forecast of a decline in housing prices, “Aw yeah, he’s been saying that for years.” [Greenspan asked me to check that, and the actual line from the article was pretty close:  “Asked in 2010 about those who warned that housing prices would crash, he responded, ‘Right. For example, Shiller was saying that since 1996.’”]

Winners and Losers in the Fed Minutes

Filed under: Economy,Financial crisis — Bob @ 1:20 pm

Jon Hilsenrath of The Wall Street Journal read the Fed’s minutes from 2008 and came up with a list of officials who distinguished themselves (winners) and those who don’t look so good in retrospect (losers). Some of the losers were named by Hilsenrath because in retrospect they seemed to be wrong in their assessments of the economy and policy preferences. Others made the losers’ list because of personal qualities in the minutes that didn’t appeal to Hilsenrath. It’s an interesting piece and serves as a good summary of the minutes.

After Mr. Dudley gave a detailed presentation on Jan. 29 2008 on troubling risks in the bond insurance business – a precursor to AIG’s collapse and New York Fed-led bailout the following September – Mr. Geithner was asked by a colleague if he was in touch with the bond insurers. He responded vaguely: “We have not been in touch with them directly to get a sense about their risk profile and so forth.” Instead, he said, the New York Fed was conferring with their New York state regulator and offering it advice.

Later at that January meeting he offered this assessment of financial conditions: “In the financial markets, I think it is true that there is some sign that the process of repair is starting,” he said, pointing to capital-raising by financial firms and “pretty substantial improvement in market-functioning.” He did say later that he remained worried about a “dangerous self-reinforcing cycle” in markets which raised recession probabilities, a point he emphasized often during the year in a call for the Fed to action. Still Fed Vice Chairman Donald Kohn felt the need to gently push back in that case in January: “The repair process that President Geithner referenced among financial institutions strikes me as very fragile and quite incomplete.” Bear Stearns collapsed several weeks later.

February 25, 2014

More on the Fed Minutes

Filed under: Economy,Financial crisis — Bob @ 6:20 pm

A number of economists have been pouring over the minutes from 2008 that the Fed released last Friday. Economist Scott Sumner analyzed the minutes to highlight the real institutional problems with the Fed. Among them are that the Fed uses flawed models of the economy and its members generally adhere to the consensus of prestigious academics.

The Fed does roughly what a consensus of elite academic economists think they should be doing. I don’t recall any significant outrage in the academic community, or even among policy pundits in the press and blogosphere, as the Fed made its crucial mistakes in 2008. Matt Yglesias calls Boston Fed President Eric Rosengren a “hero” for his dissent in September 2008. I have no problem with that characterization, but of course that’s exactly the problem, isn’t it? No massive bureaucratic machine that depends on well-timed “heroics” will ever be reliable. (This is one area where I won’t have to try very hard to convince my Austrian critics!)

The real problem with policy in 2008 was not that the Fed wasn’t able to forecast the oncoming disaster; I didn’t foresee the severity of the recession until the data began to show the crash of late 2008. Rather the real problem was that policy was far too contractionary even given the real time market data that the Fed had available. This can be illustrated with a “tale of two meetings.”

February 24, 2014

The Fed’s Crisis Minutes

Filed under: Economy,Financial crisis — Bob @ 6:20 pm

On Friday the Federal Reserve released the minutes from its meetings during 2008, when the financial crisis was worsening and the economy was falling apart. It’s clear from the minutes that most of the Fed was behind the curve as events unfolded. In fact, the majority seemed to believe things were going well and inflation was the main problem. It wasn’t until a few days after the Lehman Brothers bankruptcy, after markets froze, that a majority realized extreme measures were needed. Even then, it wasn’t unanimous.

Interesting discussions raged around the bailout of Bear Stearns earlier in the year. Some later, I think correctly, attributed the severe reaction to the Lehman Brothers bankruptcy to the Fed’s having set the precedent of bailing out Bear Stearns. The bailout convinced investors the Fed always would be available to reduce risks and encouraged corporate management to continue taking risks. You can read some summaries of the minutes here and at the enclosed links.

The policy makers were shocked into action after Lehman’s bankruptcy triggered a breakdown in financial markets and the economy that they had failed to foresee. Meeting Sept. 16, 2008, a day after Lehman declared it was filing for bankruptcy, Fed officials remained unsure whether the crisis would do lasting damage to the nation’s economy.

“I don’t think we’ve seen a significant change in the basic outlook,” Dave Stockton, the Fed’s top forecaster at the time, said at that meeting. “We’re still expecting a very gradual pickup in GDP growth over the next year.”

Later, the Commerce Department determined that U.S. gross domestic product had collapsed at an 8.3 percent annual rate in the fourth quarter, the sharpest drop since 1958.

At the September meeting, officials discussed the collapse of Lehman, yet left their main interest rate at 2 percent, rebuffing calls by some investors for an immediate cut.

“I think our aggressive approach earlier in the year is looking pretty good,” Bernanke said, referring to a cumulative 225 basis-point (2.25 percentage-point) reduction in the benchmark federal funds rate during the first four months of the year. Even so, he said it was likely that the country was already in a recession, and “I think we are in for a period of quite slow growth.”

February 20, 2014

A Deleveraging Update

Filed under: Economy,Financial crisis — Bob @ 1:20 pm

The main cause of the financial crisis and our slow economy since was too much debt. Since the peak in 2007 or so, U.S. households have been deleveraging. The latest Household Debt and Credit Report (formerly the Flow of Funds report) from the Fed shows how far the deleveraging has come. You can read a summary here. The deleveraging has been slow, and much of it is due to defaults and bankruptcies instead of paying down debt. Net worths have increased to a large extent by rising stock and home prices. But the deleveraging could be over. The latest quarter shows a net increase in debt. Deleveraging causes slow economic growth, but a premature end to the deleveraging could bring us closer to the next peak.

If we look at real dollars (inflation adjusted using CPI from the BLS), then total debt is down 16.9% since 2008, mortgage debt down 20.7%, home equity debt down 32.6%, auto debt down 12.2%, and credit card debt down 27.9%. Only student debt is at a new high (up 77% since Q3 2008 in nominal terms).

February 19, 2014

How to View the Fiscal Stimulus Debate

Filed under: Economy,Financial crisis — Bob @ 9:20 am

We just marked the five year anniversary of the enactment of the fiscal stimulus package of 2009. Ideologues on both sides are making extreme arguments about the effectiveness of the package. Instead of spending your time on those arguments, or before doing so, consider this post. It quotes economist Russ Roberts who, back in 2010, said that no one could make a credible argument on the effect of the stimulus because there were too many other factors influencing the economy and provisions in the law that might offset each other.

No one has a model of the independent impact of these different factors or a way of measuring them accurately and reliably in a way that can be tested and confirmed or rejected. No one. That means everyone, on the left or the right, who claims to have evidence for the impact of one of them or who cherry-picks one of those out of the myriad to choose from and blames that one factor for the lousy pace of the recovery is either fooling himself or fooling you. Don’t be a fool. So when the E.J. Dionnes of the world tell you that government creates jobs, just ask them how they know. Their answer will be that someone with exemplary credentials says so. But there are those with exemplary credentials who say otherwise. Where does that leave us? It should leave us in ignorance and doubt. No certainty. No exclamation points. More humility.

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