The cause of the financial crisis: government policies

[oddlots]

Re: The cause of the financial crisis: government policies

If AIG had been allowed to fail, I suspect the market for CDS today would be much different.

I think you could equally and perhaps more constructively say that if CDS were allowed only if sufficient collateral were posted to show that the entity "insuring" (used loosely) the bond was actually good for it (i.e., actually insuring it) then the "market for CDS would be much different today, i.e., much, much smaller and much less dangerous. In other words, for these instruments to actually serve a useful purpose - incidentally the "hedging" purpose that is constantly wheeled out as the trojan horse to be immediately followed, once the coast is clear, by speculative purposes, a massive increase in leverage system-wide, accompanying massive profits and bonuses, then crash and the public pays for round two - regulation is required almost a priori.

Now you could say that the Fed enables this kind of looting and I'd agree with you that it has - think Greenspan and the de-regulators - but not that it must by it's very nature. I think that's tantamount to saying that a publicly funded dam that exists to prevent flooding (think a liquidity crisis) exists to be hijacked and used as a weapon against the town that funded it (think a solvency crisis presented falsely as a liquidity crisis, as of late.) That logic is entirely screwy to me. There is a perfectly legitimate public utility function to the dam. The fact that the dam broke because Johnny banker blew it up - because he wanted get paid off on his insurance scam on his lake-front mansion and is crying because he's homeless - does not make the dam the problem.

[Mashuri]

Re: The cause of the financial crisis: government policies

The fact that the dam broke because Johnny banker blew it up - because he wanted get paid off on his insurance scam on his lake-front mansion and is crying because he's homeless - does not make the dam the problem.

Keeping the dam analogy consistent with what it's being compared to:

No but, since the dam wasn't necessary in the first place, the creators of the dam are responsible for creating such a monumental hazard to the community.

EDIT: For clarity, I'm assuming the dam represents government guarantees for banking solvency.

[oddlots]

Re: The cause of the financial crisis: government policies

Keeping the dam analogy consistent with what it's being compared to:

No but, since the dam wasn't necessary in the first place, the creators of the dam are responsible for creating such a monumental hazard to the community.

EDIT: For clarity, I'm assuming the dam represents government guarantees for banking solvency.

No. There should be no government guarantees of solvency. If it's not a liquidity problem then it's bankruptcy. Have we seen a bank holiday in the current mess?

Re. the dam wasn't necessary: if not, why does every sovereign nation on earth have one? If you can't tell the difference between an argument against the Fed and Central Banking per se then you need to broaden your horizons IMHO.

[oddlots]

Re: The cause of the financial crisis: government policies

Interesting point. Then again, Panama is kind of an outlier, no? One might make the same argument about the Cayman Islands: if you are capitalism's holiday home it's unlikely that the model can scale.

[Sharky]

Re: The cause of the financial crisis: government policies

The point Sharky's making is that CDS, among other things, could never have become such a large problem without government intervention. Socializing bank losses (FDIC insurance, bailouts, etc) create a moral hazard for banks to take huge risks. Forcing interests rates too low creates boom/bust cycles. Asking for regulations to control these is asking to treat symptoms and not root causes.

Exactly. Thanks for the support.

Re. the dam wasn't necessary: if not, why does every sovereign nation on earth have one? If you can't tell the difference between an argument against the Fed and Central Banking per se then you need to broaden your horizons IMHO.

Central banks are a necessary corollary to fractional reserve banking (FRB). Because FRB is inherently unstable, central banks exist primarily to back up the large banks (the FDIC is only effective for small banks).

Using your example with a dam, it's as though the government first distorted and twisted a large river to the point where it became unsafe, and then claimed that a large dam was needed to solve the problem, and encouraged everyone to live under the dam, knowing that there was a chance that it would eventually fail. Yes, the dam provides economic value, but at what cost?

[oddlots]

Re: The cause of the financial crisis: government policies

Are you familiar with the no-true-scotsman fallacy?

Wiki:

No true Scotsman is an intentional logical fallacy, an ad hoc attempt to retain an unreasoned assertion. When faced with a counterexample to a universal claim, rather than denying the counterexample or rejecting the original universal claim, this fallacy modifies the subject of assertion to tautologically exclude the specific case or others like it.[citation needed] The truth or falsehood of the new claim does not follow from the presence or absence of this fallacy.

The term was advanced by philosopher Antony Flew in his 1975 book Thinking About Thinking: Do I sincerely want to be right?.[1]
Imagine Hamish McDonald, a Scotsman, sitting down with his Glasgow Morning Herald and seeing an article about how the "Brighton Sex Maniac Strikes Again." Hamish is shocked and declares that "No Scotsman would do such a thing." [Brighton is not part of Scotland.] The next day he sits down to read his Glasgow Morning Herald again and this time finds an article about an Aberdeen man whose brutal actions make the Brighton sex maniac seem almost gentlemanly. [Aberdeen is part of Scotland.] This fact shows that Hamish was wrong in his opinion but is he going to admit this? Not likely. This time he says, "No true Scotsman would do such a thing."
—Antony Flew, Thinking About Thinking (1975)

I've given you a case - CDS - where the principle of allowing the market to regulate itself has been strenuously heeded. The result has been that CDS has been turned into a kind of ultimate weapon of the "privatise the gains / socialise the losses" type (i.e., exactly what capitalism is not supposed to be.) And somehow you think this is a problem of regulated markets? This by virtue of the fact that central banking exists at all? Frankly, that's cult-like thinking. Where will it end? The markets will never be free enough. There will always be some - imagined or not - pocket of resistance to allow the free market platonic ideal to wriggle free.

I find abstract arguments useful. They can clarify a principle to be applied. But they don't entitle one to ignore the complexity of their application or to argue at every juncture that the abstraction rises above the particular instance and remains inviolate (and apparently also somewhat useless.)

Using your example with a dam, it's as though the government first distorted and twisted a large river to the point where it became unsafe, and then claimed that a large dam was needed to solve the problem, and encouraged everyone to live under the dam, knowing that there was a chance that it would eventually fail. Yes, the dam provides economic value, but at what cost?

As I've said before, you've got the causality backward here. As far as I understand the history the free-market was able to "distort and twist" the river to a tortuous degree all on its own way before the fed saw the light of day. In fact the FED emerged from precisely such a private market crisis. Making it now the source of all private market problems seems a bit rich to me.

Have you read any Mynsky?

[Sharky]

Re: The cause of the financial crisis: government policies

Are you familiar with the no-true-scotsman fallacy?

Yes.

I've given you a case - CDS - where the principle of allowing the market to regulate itself has been strenuously heeded.

"Strenuously heeded"? How could the CDS market truly regulate itself with a legislatively imposed backstop in the form of the Fed that minimized the perceived risk of failure, or without market-based influence over the ratings agencies?

The result has been that CDS has been turned into a kind of ultimate weapon of the "privatise the gains / socialise the losses" type (i.e., exactly what capitalism is not supposed to be.) And somehow you think this is a problem of regulated markets?

It's a combination of over-regulation and fraud. How can losses be privatized without government intervention? And didn't the creators of these instruments know about the possible privatization of losses in advance?

This by virtue of the fact that central banking exists at all?

Central banking is only one part of the problem. There's also the government controlled rating agency monopoly, the SEC, FinRegs galore, etc, etc.

Frankly, that's cult-like thinking. Where will it end? The markets will never be free enough. There will always be some - imagined or not - pocket of resistance to allow the free market platonic ideal to wriggle free.

Why is it cult-like thinking to want a free market that is free of force and fraud? I'd guess I'd rather be a freedom-loving cultist than a freedom-hating statist.

Do you deny that the Fed, the FDIC, the SEC and Freddie & Fannie have created extensive moral hazards in the economy?

As I've said before, you've got the causality backward here. As far as I understand the history the free-market was able to "distort and twist" the river to a tortuous degree all on its own way before the fed saw the light of day. In fact the FED emerged from precisely such a private market crisis. Making it now the source of all private market problems seems a bit rich to me.

I think the bank failures the led up to the creation of the Fed were a healthy thing; failures are an important part of a truly free market.

The Fed is not the source of all private market problems, as I said above (including in the OP); there are many other factors at play.

The Fed emerged because the government decided that the large banks practicing FRB could not be allowed to fail. Without government support, in a free market, FRB would probably not have existed for much longer, nor would it have developed the power it has today, because it's not a stable system.

This is a typical pattern for government intervention: when something bad happens, gov steps in and creates laws that on the surface attempt to prevent it from happening again. But laws rarely fix the problem; at best, they paper over it temporarily while putting more-and-more power into the hands of bureaucrats. When the next problem comes up, the laws become even more controlling. The natural endpoint is some form of dictatorship, where every step anyone takes is monitored and controlled (look at TSA as an example of the trend). The cure is to go the other direction: to let people and institutions fail; to not try to protect people from themselves or from bad decision-making; you are not your brother's keeper.

To put it another way: why shouldn't it be enough for government to ban the use of force, fraud or coercion, and to uniformly and rigidly enforce those bans? What additional benefits do the reams of regulations provide? One argument is that regulations are there to enforce some sense of morality. However, you can't legislate morality; it simply doesn't work.

Have you read any Mynsky?

No. Why?

[Verrocchio]

Re: The cause of the financial crisis: government policies

It's a combination of over-regulation and fraud. How can losses be privatized without government intervention? And didn't the creators of these instruments know about the possible privatization of losses in advance?

Perhaps we're getting somewhere. I would agree with you if your claim is that over-regulation is undesirable and leads to problems, but you would first need to state your argument in more specific terms.

Do you deny that the Fed, the FDIC, the SEC and Freddie & Fannie have created extensive moral hazards in the economy?

That's an easy question, isn't it? I would agree that each have made their contribution, but would assign varying degrees of culpability. Certainly the past dozen years is littered with illustrations of government regulation that contributed to what eventually became a monumental financial and economic disaster.

However, it is disingenuous, perhaps hypocritical, to make these claims without acknowledging the tremendous and corrosive influence of the financial sector on government and, consequently, on regulations and how regulations were enforced. The sterling example was the repeal of the Glass-Steagall Act by the Financial Services Modernization Act of 1999, but this was accompanied by countless additional legislative changes with the cumulative effect of dismantling and weakening regulation of this sector. During the same period, the executive branch made a habit of appointing industry insiders to head Federal regulatory agencies. George W. Bush appointed over 100 lobbyists and other insiders to these positions, stacking the deck of panels and boards with oversight. Examples of this can be easily found.

John Dugan, the nation's top bank regulator from 2005 to 2010, appointed as the 29th Comptroller of the Currency by George W Bush, is the poster child for this practice. He has somehow escaped the notoriety he is due because he can fairly be called the chief architect of the great crash of 2008. He labored mightily since the late 1980s to poke holes in the Glass-Steagall framework. His 1991 Green Book, compiled while he was an assistant treasurer (appointed by GHW Bush) and packed with bankster-friendly policies, was the blueprint for deregulation of the financial industry and laid the foundation for the crash. Blame for the eventual financial disaster was bipartisan, as the implementation of the blueprint was accelerated during the Clinton administration.

Your complaint about government regulation is way too simplistic. If you want to get at causes for the crash and the ensuing financial and economic crisis, I recommend you dig into the flow of people and money between the banking and political systems.

[flintlock]

Re: The cause of the financial crisis: government policies

Perhaps, but intentionally leading someone astray through deception for personal or financial gain is a crime. It's called fraud. Why do we need reams of regulations when a few simple ones should do? And when even those simple ones aren't enforced effectively, what makes anyone think that more complex regs would be any better?

In the absence of fraud, force or coercion, people should be free to make mistakes. If I make a bad choice, I'm willing to pay the price. Why shouldn't the same be true at all levels of society? I don't want a government that tries to protect me from myself.

Oh, I agree! This is a recurring theme of mine.

[Verrocchio]

Re: The cause of the financial crisis: government policies

Oh, I agree! This is a recurring theme of mine.

That's how I live my life, as well! Now then, how do we go from the current reality to a future reality where the public can depend on the government to scrupulously enforce law and regulations? If the regulatory agencies, the judicial system, the Congress, and the rest of government are all owned by the special interest oligarchy (see post by Don of the Keiser interview of former Under Secretary of the Treasury Paul Craig Roberts), how will this future come about? If this future doesn't come about, what are the alternative futures?

[Sharky]

Re: The cause of the financial crisis: government policies

Perhaps we're getting somewhere. I would agree with you if your claim is that over-regulation is undesirable and leads to problems, but you would first need to state your argument in more specific terms.

Yes, part of my claim is that over-regulation is undesirable and leads to problems.

However, it is disingenuous, perhaps hypocritical, to make these claims without acknowledging the tremendous and corrosive influence of the financial sector on government and, consequently, on regulations and how regulations were enforced. The sterling example was the repeal of the Glass-Steagall Act by the Financial Services Modernization Act of 1999, but this was accompanied by countless additional legislative changes with the cumulative effect of dismantling and weakening regulation of this sector. During the same period, the executive branch made a habit of appointing industry insiders to head Federal regulatory agencies. George W. Bush appointed over 100 lobbyists and other insiders to these positions, stacking the deck of panels and boards with oversight. Examples of this can be easily found.

The relationship between the financial industry and government is certainly broken -- but it's a question of cause and effect.

On the one hand, government has the ability to destroy anything it touches, while avoiding prosecution. They can legally steal from one entity for the benefit of another. They can legislate businesses out of existence, either through taxation or regulation. And they can draw on the public's resources to wield their destruction. They can also offer innumerable favors to their "friends": contracts, insurance/bailouts (such as the Fed or the FDIC), destruction of competition, etc.

On the other hand, in the face of such threats, is it surprising that businesses respond by hiring lobbyists and trying to favorably influence the people who could destroy them?

I'm not trying to let the financial industry off the hook. However, unless we understand the true nature of the problem, we won't be able to solve it.

@oddlots mentioned the value of abstractions. Try this one: imagine you live on an island. There's a gang of thugs there, who run things. They tell people what to do, and demand "protection" money; if you don't obey and pay, you get beaten. As a business person, one day, you go to the thugs and offer them a deal: if they will beat up your competitor instead of you, your business will be more successful, and so you can pay them more and offer them other favors. You would even be willing to stand up and tell others on the island that the thugs really aren't so bad.

One problem both in this abstraction and in the real world is that the business people don't realize that the thugs don't really respect any deals (that's part of what makes them thugs); they could (indeed will) easily turn and destroy them as they've destroyed others -- either intentionally or through sheer incompetence (driven in part by the fact that thugs tend to ignore the law of cause and effect).

That's how I live my life, as well! Now then, how do we go from the current reality to a future reality where the public can depend on the government to scrupulously enforce law and regulations?

My claim is that there is only one solution that will be effective in the long-term, and that is to have a revolution in morality. The underlying problems are philosophical, and at the core is an moral and ethical view that has been corrupted from many angles. If you take a close look at human behavior, you will find that it is primarily morality that motivates people to correctly choose between right and wrong -- and you can't legislate morality.

If the regulatory agencies, the judicial system, the Congress, and the rest of government are all owned by the special interest oligarchy (see post by Don of the Keiser interview of former Under Secretary of the Treasury Paul Craig Roberts), how will this future come about? If this future doesn't come about, what are the alternative futures?

If we don't fix this, the alternative future is almost certainly some form of neo-fascist dictatorship. When more-and-more laws are seen as the solution, what other outcome is possible?

As for how to break the cycle, one approach is to move the focus from one of fear to one of individual rights; to advocate freedom, a just government, and principles instead of pragmatism; to prosecute criminals while not punishing those who are honest, productive and successful -- with the underlying motivation being one of adopting a correct morality.

[Verrocchio]

Re: The cause of the financial crisis: government policies

I tire of odious comparisons of the US government to thugs. You obviously haven’t lived under governments like Coceascu’s Romania, Stalin’s Soviet Union, or Mao’s China. Governments differ in kind and the US government is not synonymous with thuggery. Various departments and agencies actually function very well.

You go ahead and wait for the hoped for outbreak of morality. Maybe you can ask Santa for that. My Christmas wish would be simply for people to regain the ability to identify their economic and political self-interest and then to act in accordance with that knowledge when they mark their ballots. That would at least slow the juggernaut of domination by the oligarchy. Without that, the chances of individual rights, freedom, and just government will continue to diminish.

[Sharky]

Re: The cause of the financial crisis: government policies

I tire of odious comparisons of the US government to thugs. You obviously haven’t lived under governments like Coceascu’s Romania, Stalin’s Soviet Union, or Mao’s China. Governments differ in kind and the US government is not synonymous with thuggery. Various departments and agencies actually function very well.

I'm curious: which government departments and agencies do you think function well?

There is of course a spectrum of thuggery. The US hasn't reached the stage of Stalin or Mao-style mass murders inside the US, but they are certainly showing every sign of heading full-speed in that direction. Outside the US, we're already there or pretty close; just ask the victims of US Imperialism, including anyone in SE Asia who lived through the Vietnam War (2M+ killed), or the current residents of Iraq (1M+ killed) and Afghanistan--who did nothing to seriously threaten the US before their countries were invaded and occupied. Inside the US, we have other odious things like:

-- If you don't pay income taxes or FICA, you can go to prison
-- If you don't pay property taxes, the government can take your home
-- Regular, ongoing violations of the Constitution by the government
-- If you engage in certain acts which the government has decided are "immoral" (such as prostitution or drug use), you can be sent to prison, even if you didn't harm anyone
-- People are forced to attend government schools / indoctrination, under threat of fines or imprisonment
-- The government can step in and take your child away from you based on suspicion alone
-- People who try to stand up to the violations of their rights have been killed (for example, David Koresh & co.)
-- Basic human rights are now violated as a matter of course, as per the Patriot Act, suspension of habeus corpus, etc, etc.
-- Any emergency is seen as an excuse to further violate rights (such as the confiscation of guns in Katrina)
-- The Executive Branch has intimidated the courts to the point where search warrants and wiretaps are granted by rubber stamp, without showing cause
-- The government outright lies to the public to drag the country into war: from the Lusitania to the Gulf of Tonkin to WMDs in Iraq
-- Lies as a matter of course are made by all branches of government to the public as well as to friends and allies; the WikiLeaks cables are just one example
-- A wide-and-deep system of covert and illegal operations funded by the government, such as drug running by the CIA and using the IMF to intimidate foreign governments
-- 2M+ Americans in prison, and 5M+ on probation; the highest rate of incarceration for any "civilized" country (1 in every 18 men in the US is behind bars or being monitored)

I realize that's not "thuggery" to most Americans, but to me and much of the rest of the world, it most definitely is.

You go ahead and wait for the hoped for outbreak of morality. Maybe you can ask Santa for that. My Christmas wish would be simply for people to regain the ability to identify their economic and political self-interest and then to act in accordance with that knowledge when they mark their ballots. That would at least slow the juggernaut of domination by the oligarchy. Without that, the chances of individual rights, freedom, and just government will continue to diminish.

I'm not waiting for anything. I said what I think the cure is, which is much different from what I think will happen. I moved out of the US in 2006 in part because of the direction I saw things going -- I think the odds of the US waking up from its current moral stupor anytime soon are pretty close to zero.

Having said that, I don't see anything wrong with your proposed starting point. However, my question for you is this: How do people know what is in their economic and political self-interest? Isn't morality a big part of the answer? Isn't regaining the ability to identify what's in their self-interest the same as regaining a proper sense of morality?

[mesyn191]

Re: The cause of the financial crisis: government policies

I'm curious: which government departments and agencies do you think function well?

The DMV works pretty well believe it or not. Yes yes, you can sometimes wait in line for hours...or schedule an appointment a week or 2 ahead of time and walk right up at least in CA anyways. For private corporations and businesses of similar size to large gov. organizations you're going to run into similar inefficiency issues.

Inside the US, we have other odious things like:

There are some real issues with the gov. infringing on individual's rights (ie. "extreme rendition" to allow torture, secret courts, Patriot Act, DMCA, warrantless wire taps, PMC's, etc.) but some of the stuff you mention (ie. going to prison for not paying taxes, David Koresh LOL the cultist?, etc.) is just laughable and bizarre. Our gov. wasn't always so screwed up and it can be improved over time so long as they don't totally destroy our society and drag it down into a 3rd world shit hole. If they do it'll be because we've let the fascists and neoliberal FIRE economists run it into the ground. Not because of some vague hand wavey ideology that gov. is always bad.

How do people know what is in their economic and political self-interest? Isn't morality a big part of the answer? Isn't regaining the ability to identify what's in their self-interest the same as regaining a proper sense of morality?

The political and economic bullhorns of the media drown out all independent thought on a large scale. Most are told its about Left vs. Right. Baby Boomers vs. Gen X,Y, etc. Bush vs. Obama. So that is all they think about. The simply aren't exposed to anyone who isn't mainstream. That mental stupor you're talking about is the result of that. What is that old saying? If the only tool you have is a hammer every problem starts to look like a nail.

The general American public doesn't have the necessary mental toolbox to address the problems we're facing so they can't identify them. Instead they keep trying to make the ones they're given by the media and the gov. work and just end up confused and frustrated. This leads to the "voter apathy" you hear so much about. Which isn't really apathy, its disgust with the whole political process and media. People in general are fed up but don't know what to do about it and feel helpless.

The gov. and media are going to have to stop lying to people, but I don't see that happening anytime soon. Not because the gov. is always bad or corrupt, but because a privileged few rich want it that way.

[oddlots]

Re: The cause of the financial crisis: government policies

I seem to have got up your nose with the comments above. They seem a tad aggressive on re-reading so I apologise for creating needless heat.

So, in an effort to dispel ill feeling...

I think we will find wide-spread agreement that

- regulation can serve as a "profit centre" for those looking for advantages. Regulatory arbitrage is a common phrase in the analysis of the crisis. The complexity of, particularly, accounting rules invites scholastic, legal interpretations that can give great advantage to those first to utilise them. Particularly with regard to capital ratios and loss reserves. I've commented on the problem of regulatory arbitrage many times on this forum. I'm not blind to the problems of regulation.
- I have no doubt that regulation is often a massive, unproductive drag on the economy in may instances, Sarbanes Oxley being a prime example.

That said I think you've got to line-up your bug-bears by height and give them each their proper weight. Here's my attempt:

Bug-bear 1: the de-legitimising of the public good. To my eye there has been an on-going attack in the Anglo-American world against the notion of a common interest not represented by some commercial spokesman. Maybe it started, at least in my recollection, with Thatcher saying there is "no society, only individuals" or with Reagan's "government is not the solution, it is the problem." I think we've reaped what we've sown in this regard: you end up with the worst of both worlds: a public service that, certainly at its top echelons, is slumming until it can escape to some lucrative contract and a private sector that has been corrupted by the easy advantages offered by government contracts, favorable regulatory treatment etc. etc.

The solution you've put forward to the above is to get rid of regulation wholesale and return to a free (er, ?) market. There's some merit to that in its application to particular areas, but in general it seems a perverse reading of recent history in it's larger themes in my view.

Here's an exemplary case: why was the strategy of using the fed's balance sheet to rid private corporations of crap assets as opposed to the state re-capitalising the entity by taking an equity stake and wiping out the former equity holders, bond holders to some extent and (for god's sake) firing management. I believe this is how RBS was dealt with in the UK and certainly the Swedish crisis of the early 90s was dealt with this way. Why was this not on the table in the US? It certainly has the huge advantage of treating tax payers with the same respect accorded shareholders (cough) which I think common sense demands. So why was this unthinkable in the US?

To my mind it's because no-one can conjure the idea of a muscular government as a counter-weight to massive, striving and disparate private interests. Let me be clear: all we're looking for here is that the same set of rights and obligations be applied to private and public stakeholders alike. Yet Americans can't get there conceptually. Why?

I think this environment has been created by a kind of libertarian mindset that ironically invites the abuse of government power. In cartoon terms, government is a backwater, our friend Brown's a loser, hey let's give Brown that useless FEMA post.

Squinting hard, I just don't see any positive effect on the American economy or on American politics from this on the whole.