Matthew Goldstein and Jennifer Ablan report on the latest US investment craze:  buying up large bundles of foreclosed homes from Fannie Mae and renting them out to take advantage of the hot rental market.  Randall Wray is among the critics quoted in the article who contend that, as Goldstein and Ablan put it, “the federal government is fostering a transfer of wealth of sorts by selling big pools of foreclosed homes to big fund investors and high-net-worth individuals. There’s also concern that some of the players who helped create the housing crisis will now benefit by buying foreclosed homes at a steep discount.”

Wall Street benefited from the ballooning indebtedness of American households on the way up, and now on the way down they’re taking advantage of the flipside of that indebtedness, as families’ assets are seized, transferred, and rented out … likely to some of the same people who just lost their homes.  That feedback loop is galling enough.  But as Wray has pointed out, it’s also a cycle that’s been greased by foreclosure fraud.

Felix Salmon is surprised at the continued success of the financial industry in pushing legislation (in this case, he’s talking about the proposed “JOBS Act,” a key provision of which involves a nice dose of financial deregulation):  “a bill which was essentially drafted by a small group of bankers and financiers has managed to get itself widespread bipartisan support, even as it rolls back decades of investor protections.”

At this point, it’s very difficult to imagine what could possibly change these dynamics.  Clearly, triggering a global economic collapse hasn’t made a dent in the sway the industry holds.  There was a lot of enthusiasm surrounding the Occupy movements, but it’s hard to see it amounting to a countervailing political force (even if it intended to be one, which isn’t clear).  Dodd-Frank, for all its faults (and they are legion:  see this new Levy Institute working paper by Bernard Shull, and Chapter 1 of this analysis) appears to be the only game in town.  If it’s able to shrink the sector a little that may change the political economy—but only at the margins.  And that’s likely the best case scenario.

The title of C. J. Polychroniou’s latest policy note, “Neo-Hooverian Policies Threaten to Turn Europe into an Economic Wasteland,” gives you a pretty good idea of where he’s coming from:

There can be no denying that, despite the experiences provided by the Great Depression and the numerous financial crises that have taken place since 1973, policymakers have been dismally wrong in their assessment of the 2007–08 global crisis and governments dreadfully incompetent in developing a clear strategy for addressing it appropriately. The reason for this lies with an economic ideology, a conceptual framework with which government officials and bankers deal with economic reality, that is fundamentally flawed.

As a way of addressing some of the flaws of the eurozone policy architecture, and of counteracting the ideology of austerity that is embedded in that architecture (the “fiscal compact” currently being debated, which would place more automatic penalties on governments that deviate from severe limits on budget deficits, goes even further in embedding this ideology in the setup of the European Monetary Union), Polychroniou is looking to a “United States of Europe” model, with an expansion of EU-level fiscal policy powers.

As he observes, however, the European project is moving in the opposite direction:

Indeed, in an indication of where Europe may be headed politically, the EU’s budget was slashed by four billion euros in 2010, with some governments arguing that the EU budget, in the words of British Prime Minister David Cameron, should be progressively “reduced rather than increased”—and this appears to be the definite trend in Euroland.

What manner of union is this?

Read the policy note here.

Your Minsky quotation of the day:

The rise in bank share prices that follows a growth in profitability is particularly important in a world of professionally managed institutionalized banks.  The typical professional bank president is not a rich man when he starts his career.  As a bank president he is a hired hand trying to achieve a personal fortune.  But given the tax structure, it is difficult to accumulate a fortune by saving out of income; the most efficient route for a business executive is by way of stock options and the capital gains that accrue as the stock market price per share rises.  As holders of stock options, bank management is interested in the price, on the exchanges, of their bank’s shares.

The price of any stock is related to the earnings per share, the capitalization rate on earnings of the bank’s perceived risk class, and the expected rate of growth of such earnings.  If bank management can accelerate the growth rate of earnings by increasing leverage without a decrease in the perceived security and safety of the bank’s earnings, then the price of shares will rise because both earnings and the capitalization rate on earnings that reflects growth expectations rise.  In a capitalist society with institutionalized organizations and tax laws such as ours, fortune-seeking by the mangers of institutionalized enterprises leads to an emphasis upon growth, which in turn leads to efforts to increase leverage.  But increased leverage by banks and ordinary firms decreases the margins of safety and thus increases the potential for instability of the economy.

From Minsky’s “Stabilizing an Unstable Economy,” p. 266 (first published in 1986, though I’m told largely finished by 1982).

Perhaps we’re back to our old ways. For many moons, the household savings rate has again been falling, though it is still above the levels reached in the years leading up to the home loan crisis of 2007–2009. There are even some signs of a resurgence of the mortgage-backed securities industry. Could the economy be riding a merry-go-round familiar to students of economic history, as concerns about financial fragility, risky borrowing, and small nest eggs ebb and flow with the headlines of the day?

There is an economic term for this type of historical pattern that has not been prominent in recent debates. In loose terms, an epistemic cycle is an economic cycle of learning, knowing about, or understanding certain issues or facts; for example, the dangers of reckless consumer borrowing. The late Hyman Minsky of our Institute wrote authoritatively about the tendency of financial risk-taking to build up over time in the years following a crisis, as people gradually let their guard down after a fight to save the financial system. Eventually such trends would bring on a crisis and a subsequent return to more cautious behavior, especially on the part of banks and regulators.

This leads to the question of whether policymakers can reduce the danger that risky levels and types of borrowing will return over the coming years, as people begin to put the financial turmoil of the past few years into perspective. Economists of all stripes tend to be pessimistic about such issues, ironically in many cases because of a belief that human behavior is generally rational in one way or another.

One concept that often comes up in discussions of policies for dealing with the aftermath of the crisis is moral hazard, which was the subject of an interesting essay in yesterday’s New York Times. continue reading…

(cross posted at EconoMonitor)

Guess which US bank holds assets equal to a fifth of US GDP.

Now guess what percent of its assets have extremely long maturities, greater than ten years: a) 10%; b) 20%; c) 30%; d) 40%; e) 50%.

Answer: The Fed, and e) 50% of its assets have ten years or more to maturity.

Recap. The global financial crisis (GFC) began about four years ago. The Fed pulled out all the stops to save the biggest banks. As I discussed previously the Fed engaged in “deal-making” designed to protect creditors of failing banks, and used Section 13(3) to create Special Purpose Vehicles that engaged in legally questionable lending and asset purchases to save banks and shadow banks. Four years later, the Fed’s balance sheet is still humongous and it is even increasing its interventions in recent weeks through loans to foreign central banks.

A recent speech by Herve Hannoun at the Bank for International Settlements, “Monetary policy in the crisis: testing the limits of monetary policy” (link below) shows that ramping up the role for central banks has taken place all over the world. Indeed, in emerging market economies, the central banks have assets equal to 40% of GDP. In large part that is due to accumulation of foreign currency reserves among countries like China and Brazil–a topic beyond the scope of this blog. But the intervention by central banks during this GFC is entirely unprecedented–and is starting to worry most observers, who are asking when, or if, this will ever end.

Graph 1: Central bank assets, and as share of GDP

Graph 2: Maturity of assets

You can find the BIS report here.

To be sure, I do not share the worry of the BIS and many other commentators that the central bank expansions will cause inflation. My worry is this: the “too big to fail” (or as my colleague Bill Black calls them “systemically dangerous”) institutions have learned that no matter what they do, they will be saved and their top management will never be punished. continue reading…

Matías Vernengo does a quick review of “Getting Up to Speed on the Financial Crisis,” which is a survey of work on the global financial crisis that will be published in the Journal of Economic Literature.  “Getting Up to Speed” is intended as a “one-weekend-reader’s guide” to the crisis.  It offers, says Vernengo, a fine selection of the relevant orthodox literature on the financial crisis.  The problem is that that such a selection only gets you so far in understanding the crisis and its roots:

The biggest problem with their paper is not the limited number of documents reviewed, which seem to be fairly representative of conventional views on the financial crisis, but the limitations of what the mainstream of the profession knows about the crisis, and worse, what the profession clearly does not know it does not know, the unknown unknowns, so to speak. And that is why ignoring heterodox and progressive contributions has been very harmful for the profession.

Vernengo points to a number of heterodox contributions that provide more comprehensive accounts of the dynamics underlying the crisis, including Wynne Godley’s (1999) “Seven Unsustainable Processes” (if you haven’t read this Godley piece, it’s worth your time).  Read Vernengo here at Triple Crisis.

Also take a look at Gerald Epstein’s follow-up, in which he quotes the rather revelatory first sentence of “Getting Up to Speed” (emphasis is Epstein’s):

“Many professional economists now find themselves answering questions from their students, friends, and relatives on topics that did not seem at all central until a few years ago, and we are collectively scrambling to catch up.” …

Note how damning of mainstream macroeconomics this statement is: the key dynamics of the crisis – massive leverage and credit expansion, fed by the shadow banking system, that contributed to a housing bubble and crash – all elements of a macroeconomic dynamics well known to more than one generation of economists trained in the economics of Keynes and Minsky.

The Financial Times got its hands on a confidential “debt sustainability analysis” that was circulated among eurozone finance ministers.  The gist of the analysis is that the austerity measures being imposed on the Greek population will depress growth so brutally that the government will almost certainly not meet its debt reduction targets:

…even under the most optimistic scenario, the austerity measures being imposed on Athens risk a recession so deep that Greece will not be able to climb out of the debt hole over the course of a new three-year, €170bn bail-out.

It warned that two of the new bail-out’s main principles might be self-defeating. Forcing austerity on Greece could cause debt levels to rise by severely weakening the economy while its €200bn debt restructuring could prevent Greece from ever returning to the financial markets by scaring off future private investors.

In other words, the latest rescue plan for Greece could be classified (if one were feeling deeply generous) under the category of “buying time.”  But buying time for what exactly?

In this policy brief, Dimitri Papadimitriou and Randall Wray tell us that the eurozone must ultimately move in one of two directions:  either toward a coordinated breakup or toward the development of some real fiscal and monetary policy capacities, which means having the European Central Bank step up as a buyer of last resort for member-state debt and increasing the fiscal space of the European Parliament so that it is able to stimulate growth.  The Union, in other words, must be severed or completed. continue reading…

It has been recognized for well over a century that the central bank must intervene as “lender of last resort” in a crisis. In the 1870s Walter Bagehot explained this as a policy of stopping a run on banks by lending without limit, against good collateral, at a penalty interest rate. This would allow the banks to cover withdrawals so the run would stop.

Once deposit insurance was added to the assurance of emergency lending, runs on demand deposits virtually disappeared. However, banks have increasingly financed their positions in assets by issuing a combination of uninsured deposits plus very short-term nondeposit liabilities (such as commercial paper). Hence, the GFC actually began as a run on these nondeposit liabilities, which were largely held by other financial institutions.

And here is where the issue gets complicated. As I argued in a previous blog post, banks and other institutions relied largely on “rolling over” short-term liabilities (often, overnight). But when reports about the quality of bank assets began to surface as subprime mortgage delinquencies rose, financial institutions began to worry about the solvency of the issuers of the liabilities. As markets came to recognize what had been going on in the securitization market for the past half-decade, “liquidity” dried up—no one wanted to hold uninsured liabilities of financial institutions.

In truth, it was not simply a liquidity crisis but rather a solvency crisis brought on by all the risky and fraudulent practices.

Not only did all “finance” disappear, but there was also no market for the trashy assets—so there was no way that banks could sell assets to cover “withdrawals” (again, these were not normal withdrawals by depositors but rather a demand by creditors to be paid). As markets turned against one institution after another, financial institution stock prices collapsed, margin calls were made, and credit ratings agencies downgraded securities and other assets. The big banks began to fail.

Government response to a failing, insolvent, bank is supposed to be much different than its response to a liquidity crisis. It has always been the standard view—dating all the way back to Bagehot—that lender of last resort does not apply to an insolvent institution. Indeed, since 1991 the Fed has been prohibited from lending to “critically undercapitalized” institutions without first obtaining explicit prior approval of the Secretary of the Treasury. And no matter what the Fed officials or the banksters claim, the big banks were “critically undercapitalized”, and the Fed did lend to insolvent banks—against the 1991 statute that was enacted precisely to prevent the Fed from avoiding the fiscal discipline of congressional appropriations. (Walker Todd 1997) I’ll have more to say about that in a later blog. But let’s turn to other problems with the bailout. continue reading…

C. J. Polychroniou has a new one-pager that starts off by noting the asymmetries in the approaches taken by governments in the US and Europe to the 2007-08 crash and its aftermath:  featuring bold public interventions to save the banking and financial systems but relatively limited measures for the millions of unemployed.  He then turns his sights to the latest 130 billion euro Greek “rescue” package and, in the context of a series of such packages and their accompanying austerity demands, Polychroniou suggests that Greece is being pushed too far:

It is high time for Greece to put an end to the EU farce that has now turned into a real tragedy. The nation should refuse to accept another lethal injection and threaten immediate default. At this juncture, there is no other way out.

Read it here.

(cross posted at EconoMonitor)

Yves Smith at Naked Capitalism has long been skeptical of the negotiations by the State Attorneys General and the banksters over the foreclosure frauds (see here). And while I had held out some hope that California and New York would either refuse to join, or would insist on good terms, today’s announcement of the settlement makes it clear that the banksters had their way. I expect that the US Attorney General, Eric Holder and HUD Secretary Shaun Donovan played important roles in making sure the bank frauds would only get little slaps on the wrist.

Some of the details are not clear, but apparently the 750,000 people who had their homes stolen from them will get a mere $2000 a piece in compensation. That is how this Administration values homeownership. Yep, a bankster can take your home and you might get two thousand bucks–and with that you can pay first and last month’s rent on a cheap, run-down apartment if you are willing to live in a low rent city.

It also gives you some idea of the cost of buying out 49 states: $2.75 billion. Yep, that is all that the states get out of this settlement. They’ll look the other way and let you move in, completely destroy property records and proceed to steal the homes of your citizens while destroying your economy and tax revenues–and for under 3 billion measly dollars you can buy off their chief prosecutors.

What about underwater borrowers? Well after crashing the real estate markets, the worst of the banksters have agreed to provide $3 billion for relief. How far underwater are homeowners? $700 billion. So far. continue reading…