Speaking of too big to fail, a petition organized by Public Citizen has been sent to the Federal Reserve and Financial Stability Oversight Council (FSOC) calling for the break up of Bank of America. The petition identifies BofA, given its size and fragility, as a threat to the US financial system. It cites a recent NYU study that ranks the financial institution as posing the greatest systemic risk among US firms, based on capital shortfall. Public Citizen also argues that Bank of America is simply too large and too interconnected to be regulated effectively.
Micah Hauptman explains that the break up and reorganization could be carried out under the authority given to the Fed and FSOC under section 121 of the Dodd-Frank Act (if a financial institution is determined to pose a “grave threat”). The petition argues that taking action now under section 121 is preferable to attempting an orderly liquidation in the midst of a crisis:
If the Agencies do not use section 121 in advance of financial distress at a firm that poses a grave threat to U.S. financial stability, they risk undermining other critical Dodd-Frank Act provisions. Many Dodd-Frank Act provisions related to systemic risk would be far easier to implement if systemically important institutions were smaller and less complex. One of the most critical is the orderly liquidation authority in Title II.
If a large, systemically dangerous institution such as Bank of America were to fail, regulators would have only one course of action—to attempt orderly liquidation. To permit the institution to fail without intervening would result in financial disaster; to bail it out would sharply contradict the Dodd-Frank Act’s express policy of “protect[ing] the American taxpayer by ending bailouts.” But the Dodd-Frank Act’s orderly liquidation procedures are untested and could prove difficult to implement in practice, particularly with respect to the largest and most complex institutions such as Bank of America.
One potential problem with the orderly liquidation authority is that U.S. officials lack jurisdiction over extraterritorial entities and therefore may be unable to put globally significant institutions through resolution. Currently, there are no existing international agreements regarding the resolution of a domestic institution’s entities that operate in foreign countries. Without such agreements in advance, regulators would need to try to reach agreements, potentially requiring changes in the laws of multiple countries, in the midst of a crisis.
You can read the petition here and a related letter, signed by economists, legal scholars, and various public interest groups, here.
The Financial Times has been running a series for some time on “Capitalism in Crisis.” In yesterday’s paper Martin Wolf provided a summary of the discussion and proposed “Seven ways to fix the system’s flaws.” The first and most important task, he notes, is to manage macro instability. In this regard, he pays homage to the late Hyman Minsky and notes that
… his masterpiece, Stabilizing an Unstable Economy, provided incomparably the best account of why this theory (of a stable capitalist economy) is wrong. Periods of stability and prosperity sow the seeds of their downfall. The leveraging of returns, principally by borrowing, is then viewed as a certain route to wealth. Those engaged in the financial system create – and profit greatly from – such leverage. When people underestimate perils, as they do in good times, leverage explodes.
What is the answer to macro instability? According to Martin Wolf, the first answer is to recognize that crisis is inherent in free-market capitalism. Second, macroprudential policies matter, including restrictions on leverage and better capital buffers in banks. And finally, governments, including central banks, have a role to play in stabilizing the economy after a crisis.
As for the financial system, Wolf wants “to protect finance from the economy and the economy from finance” by building bigger shock absorbers in the form of better capital buffers and less leverage. There should be no more “too big to fail.”
Wolf notes at the end of his article the close links between wealth and politics, but his suggestion to partially fund political parties and elections will not solve this problem, even though it may represent a good start. The crisis has shown that the links between finance and politics are deeply entrenched both in the US and Europe, and unless deep structural reforms are enforced, the problem of TBTF is not likely to go away.
The increased recognition of Minsky’s outstanding theories is indeed welcome, especially by Martin Wolf (who also has become somewhat of a Godley follower in his analysis of the current global crisis). But whereas his diagnosis of the global financial crisis is largely in line with Minsky’s financial instability hypothesis, his policy advice falls short of what Minsky would have prescribed. continue reading…
Paul Krugman—orthodox economist? Heterodox economist? Pragmatic economist? New Keynesian economist? Michael Stephens recently commented on an article in the Economist that discussed MMT, as well as two other non-mainstream schools of macroeconomic thought. The article contrasted the three relatively unfamiliar and unorthodox approaches with “[m]ainstream figures such as Paul Krugman and Greg Mankiw[, who] have commanded large online audiences for years.”
As Michael points out,
If you step back, what’s slightly unsatisfactory about [describing Krugman simply as a mainstream economist] is that Krugman is, right now, more in tune with the policy preferences of two-thirds of these “doctrines on the edge of economics” than he is with the reigning fiscal or monetary policy stance of the US government.
But as Michael well knows, Krugman is hardly alone among neoclassical scholars in most of his policy views. Micheal’s point is true of quite a few mainstream economists right now—they are far more flexible on the policy issues that dominate the agenda today than they are on many other economic issues. This excerpt from a recent essay written by Marc Lavoie may help to illuminate the very significant differences of opinion that distinguish such forward-thinking neoclassicals from numerous heterodox economists around the world:
Robert Skidelsky runs through and corrects five fallacies about debt that one often hears lazily deployed in the public arena. His third correction:
…the national debt is not a net burden on future generations. Even if it gives rise to future tax liabilities (and some of it will), these will be transfers from taxpayers to bond holders. This may have disagreeable distributional consequences. But trying to reduce it now will be a net burden on future generations: income will be lowered immediately, profits will fall, pension funds will be diminished, investment projects will be canceled or postponed, and houses, hospitals, and schools will not be built. Future generations will be worse off, having been deprived of assets that they might otherwise have had.
Nick Rowe had a post a couple weeks back on this same topic that might be of interest to some MMTers and Abba Lernerites. Rowe lays out four different positions on the question of whether or in what sense the national debt imposes a burden on future generations, the first of which (it’s labeled “Abba Lerner”) sounds like it’s supposed to represent functional finance. Rowe is ultimately dismissive of the functional finance approach, but you’ll find quite a bit of lively discussion in comments and a number of links to the ongoing debate.
For some background reading on functional finance, Thorvald Grung Moe recommends this short piece from 1943 by Abba Lerner himself: “Functional Finance and the Federal Debt.” It’s tightly argued and written in a reasonably jargon-free style that’s so rare in economics or public policy writing.
For those who want more of the basics and central contrasts, Mathew Forstater’s primer on deficit “doves,” “hawks,” and “owls” (beginning on p. 6 of this working paper) is a helpful place to start.
Update: Nick Rowe graciously engages in the comments section below.
Phil Izzo of the Wall Street Journal points us to the invaluable work of the people at The Daily Stag Hunt, who tallied the number of times that laughter appears in the transcripts of the Fed’s FOMC meetings. Peak laughter, as The Daily Stag points out, corresponds nicely with the height of the housing bubble:
If there weren’t a six-year delay on the release of these transcripts, this could be a useful tool for measuring systemic risk.
You may not agree with Alan Blinder when he writes in the Wall Street Journal that the budget deficit should be an issue in the 2012 campaign. But it certainly will be. And Blinder deserves kudos for pointing out that there are no immediate or near-term economic problems stemming from US deficit and debt levels:
“Myth No. 2 is that America’s deficit problem is so acute that government spending must be cut right now, despite the struggling economy. And any fiscal stimulus, even the payroll-tax extension, must be “paid for” immediately.
Wrong. Strange as it may seem with trillion-dollar-plus deficits, the U.S. government doesn’t have a short-run borrowing problem at all. On the contrary, investors all over the world are clamoring to lend us money at negative real interest rates. In purchasing-power terms, they are paying the U.S. government to borrow their money!”
Blinder also points out that if you accept the CBO’s long-term budget forecasts (James Galbraith notes some problems with the projections here), then the issue is entirely one of healthcare costs. Deficit doves and deficit owls (proponents of “functional finance”) will dispute the optimal or sustainable level of long-term deficits, but if you care about the long-term deficit, then you care about government healthcare costs. And growth of government healthcare costs is largely a function of cost inflation in the private market. So if you have any interest in the long-term deficit, then you have to have a plan for controlling long-term healthcare costs system-wide. If you don’t have such a plan, you’re engaged in some other type of project.
If you haven’t seen it already, this is a great utility that’s been linked to over the years, allowing you to see what the US budget deficit would look like if we spent the same amount per capita as other nations. For the owls, this won’t be a matter of long-term debt and deficits, but of efficiency: what exactly are we getting by spending more than twice as much, per capita, as other wealthy nations?
Randall Wray and Marshall Auerback put out a Levy Institute policy brief in 2010 on their vision for healthcare reform that featured giving people under 65 the option to “buy in” to Medicare (you will recall that at one point during the health reform battle this provision looked like it might be included in the final bill. It was ultimately dumped by Joe Lieberman). Read the policy brief here.
As a counterpoint to the last post on the curious dominance of conservative macro policy ideas in Europe, here is Matías Vernengo getting into the political economy of who benefits from these failed policies and why there seems to be no sense of urgency around the fact that the real economy is broken:
(This is from a Real News Network interview from December, originally highlighted at TripleCrisis)
Also check out Vernengo’s recently released working paper. Vernengo and his coauthor, Pérez-Caldentey, give a post-Keynesian interpretation of the eurozone crisis that places financial deregulation and the core-periphery imbalances that are inherent in the euro model at center stage.
Marshall Auerback compares the job numbers in the US to those in Europe and asks why the US is doing so much better (or failing less miserably). One of the differences he highlights is the zealous dedication to fiscal austerity in Europe, compared to the relatively half-hearted, passive observance of doctrine in the US.
For people operating on the basis of loose stereotypes about the differences between the US and Europe, this has perhaps turned out to be surprising. You might have assumed that Europe’s more expansive social welfare systems would be accompanied by more progressive approaches to fiscal or monetary policy. But as Matt Yglesias observes, Europe is awash in some pretty conservative ideas about macroeconomic policy:
… the American right has lately fallen out of love with both J.M. Keynes’ fiscal stimulus ideas and Milton Friedman’s monetary stimulus ideas. Tussle between these two has dominated practical policymaking for decades in the United States, but if conservatives were to cast their eyes toward Europe they’ll find a continent where these ideas about demand-side management get short shrift.
(To muddy the waters a bit, due in part to the strength of the aforementioned social welfare supports the default fiscal policy stance in Europe is actually more expansionary than in the US. More robust automatic stabilizers in Europe make a “do nothing” policy more fiscally expansionary, even while official or discretionary European policy is dedicated to deficit reduction and tight money. In the US you have almost the reverse: automatic stabilizers play less of a role in counteracting recessions, while official policy—in the White House, if not Congress—continues to feature calls for more discretionary stimulus.)
To add a cute little twist to this tale, the dismal failure of these contractionary policies in Europe could, perversely, help entrench the American right and its ideas for some time. If Europe collapses outright or even continues to limp along, the US recovery is likely to get bogged down, which in turn makes the election of a Republican President in 2012 more likely. And as Ezra Klein points out, if more robust catch-up growth emerges in the US some time in the next five years, the person sitting in the Oval Office, and his policy message, will get most of the credit. So the abysmal practical failure of a set of policy ideas in Europe could actually end up entrenching those same ideas on this side of the pond.
Randall Wray passes on this piece by Chris Hayes (of TheNation and MSNBC) on the challenge mounted by heterodox economists to the neoclassical consensus. Reporting from the ASSA, Hayes gets into the ways in which the boundaries of the “mainstream” are policed in economics. It’s really worth reading the whole thing. I particularly liked this bit:
Despite the fact that as many as one in five professional economists belongs to a professional association that might be described as heterodox, the phrase “heterodox economics” has appeared exactly once in the New York Times since 1981. During that same period “intelligent design,” a theory endorsed by not a single published, peer-reviewed piece of scholarship, has appeared 367 times.
I previously summarized research that two of my graduate students, James Felkerson and Nicola Matthews, are conducting on the Fed’s bailout. Using data that the Fed was forced to release, they demonstrated that the cumulative total lent and spent on assets by the Fed was over $29 trillion. (See the first paper here: http://www.levyinstitute.org/publications/?docid=1462) Their estimate was larger than previously reported because others have focused on loans, and in some cases, guarantees, outstanding at a point in time. The Fed’s own estimate is $1.5 trillion (loans outstanding), while Bloomberg’s number was $7.7 trillion (including commitments that were promised but never used).
To be sure, using methodology similar to that of Felkerson and Matthews, the GAO had obtained an estimate of $26 trillion for the cumulative total. The value added of our research is the detail provided—how much lending was provided in each facility, how many assets did the Fed buy through each facility, and who were the major users of each facility—and how much did they get. In coming weeks and months we will release a lot more analysis of this data.
Our figure of $29 trillion made headlines, and attracted a fair amount of commentary. Although we were very clear in our presentation, casual readers as well as many reporters from the media wrongly interpreted our results as a measure of the Fed’s exposure to risk. Chairman Bernanke’s memo emphasized that the Fed’s total exposure never exceeded more than $1.5 trillion—and since there is no way that it ever would have realized anything close to 100% loss on its loans, the real risk of loss was only a tiny fraction of that. Further, he (rightly) asserted that most of the loans were repaid, indeed, most of the special lending facilities have been closed.
To be sure, the total amount of loans still outstanding as of November 2011 was just under $1 trillion. In recent weeks the Fed has renewed its lending to foreign central banks (in “swaps”), so outstanding loans have climbed a bit. But the Fed and its defenders are correct: Fed maximum exposure to losses would likely be measured in tens of billions of dollars—maybe hundreds of billions, but most certainly not trillions.
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