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The Treasury market, in a world no longer dominated by central bank reserve managers

by Brad Setser
May 27, 2009

In case you haven’t heard, the Treasury market – and the mortgage market — had a bad day. Ten-year Treasury yields are back at their November 2008 levels (long-term Treasury yields didn’t fall immediately after Lehman). 3.7% for ten year money isn’t all that high a rate. Especially for a country with a substantial fiscal deficit. But it isn’t 2% either.

What happened?

In very broad terms, rising supply met falling demand from one important subset of the market. Bringing in new (private) money has required higher yields.

The supply of longer-term Treasuries is increasingly rapidly. Until I looked closely at the data – from the monthly statement of the public debt — I hadn’t realized that the big increase in outstanding supply of longer-dates Treasuries only really came in 2009. The surge in Treasury issuance in 2008 was almost entirely short-term bills.

treasury-issuance-thru-april-09-1

Over the last 12 months of data (data through the end of April, May data will be out soon), the US issued $735 billion of notes, bonds and TIPs.* In calendar 2008, the increase in supply of longer-term Treasuries was about $400b – a large sum, but easily within the realm of historical experience.

Yet even as the supply of notes has increased, central bank for longer-term Treasuries for their reserves has fallen. Central bank demand for longer-term Treasuries – on a rolling 12m basis – has been trending down since August 2008.

treasury-issuance-thru-april-09-2

That has meant that private investors have had to absorb almost all of the growth in supply. That is a noticeable change. Central bank reserve demand more or less matched the increase in note supply in 2006; it exceeded the increase in supply in 2007.

Looking at the 12m change actually understates the swing in central bank demand. In the first quarter of 09, the outstanding stock of longer-term Treasuries rose by $278 billion. Central banks – according to the Treasury data – only bought $25 billion of longer-term Treasuries (all in March, and likely mostly short-term notes). China only bought $15 billion (all in March). Over that time period, central banks bought $85 billion in short-term Treasury bills, including $32 billion from China.

Since the first quarter, the scale of long-term issuance has only increased. Central banks aren’t just buying bills anymore, but they still prefer the shorter-maturities. Treasury market blogger Jansen:

Foreign central banks continue to intervene, buying dollars and selling their local currencies. The names most mentioned in that endeavor are Russia and Brazil. Sources tell me that the fruits of the intervention are parked in 2 year notes and 3 year notes. There is a dearth of central bank interest in the longer maturities.

Foreign central banks continue to intervene, buying dollars and selling their local currencies. The names most mentioned in that endeavor are Russia and Brazil. Sources tell me that the fruits of the intervention are parked in 2 year notes and 3 year notes. There is a dearth of central bank interest in the longer maturities.

Other things have changed too. The expected level of public debt in 2015 is higher now than a year ago. American households stopped buying cars and started saving. The global economy slowed dramatically. Industrial production is down, and spare capacity is up. Inflation is down. As is expected inflation (from TIPs yields), though not as much as in the fall. The Fed’s balance sheet is larger, and expected to get still larger.

My guess though is that central banks’ shift toward shorter maturities has had an impact on the market.

Relative to a lot of models – including say Goldman’s model – ten-year yields were lower than they would have been expected to be back when central bank demand topped issuance.

Now, not so much …

Domestic US holdings of Treasuries are actually quite low relative to US GDP. Even now. Relative to the early 1990s – when debt to GDP levels were comparable to current levels – more Treasuries are held abroad. But after a long period when Treasury issuance lagged central bank demand (to such an extent that central banks were pushed into Agencies), the US is entering an era where domestic holdings of Treasuries will have to rise, absolutely and relative to GDP.

One aside: total Treasury issuance over the last 12 months of data was over $1.6 trillion. The market has already demonstrated that it can absorb a very large increase in supply. This was – obviously – a period of financial stress, which helped increase Treasury demand. It was also a period when the Fed was a net seller of Treasuries, not a net buyer. For most of 2008 the Fed was selling its Treasury stockpile to finance its lending to troubled financial institutions. It only started buying recently. That is one reason why it isn’t obvious to me that the total amount of Treasuries the private market will need to absorb over the next 12 months will be substantially higher than the amount it has absorbed over the last 12 months. However, the composition of new Treasury issuance is likely to continue to shift, so the amount of longer-term Treasuries the market will need to absorb will continue to rise. And of course a sustained deficits do produce a large rise in the outstanding stock …

Note: Paul Swartz and Arpana Pandey of the Council on Foreign Relations Center for Geoeconomic Studies helped gather the underlying data used in this analysis. The Center for Geoeconomic Studies is also now putting out a chartbook showing how the the BRIC countries foreign exchange reserves compare with their US holdings . This publication draws on the work Arpana Pandey and I have done tracking global capital flows. Check it out.

*Treasury bills generally do not pay a coupon and have a maturity of a year or less. Treasury notes have a coupon and generally have an initial maturity of between one and ten years. Bonds have a maturity of over ten years. TIPs are Treasury Inflation Protected Securities; their principal adjusts along with inflation.

80 Comments

  • Posted by ReformerRay

    1. Twofish and I are in a disagreement about which parts of the Commodities Future Modernization Act of 2000 are important. I got my info from this source (on the web) “MEMORANDUM FOR ISDA MEMBERS COMMODITY FUTURES MODERNIZATION ACT OF …
    This is a description of all the goodies in the act that can be used by the members of the International Swaps and Derivatives Association to make money.

    “Under the Act, no contract
    shall be unenforceable under the CEA or any other provision
    of Federal or State law based on a failure to comply with
    any exemption or exclusion from any provision of the CEA.
    2. OTC Derivatives.
    The Act excludes from the coverage of the CEA and
    regulation by the CFTC a broad range of swap agreements and
    other OTC derivatives that are not executed on a trading
    facility.
    • Transactions involving any commodity (other than an
    agricultural commodity) that are not executed on a
    trading facility are excluded from the CEA if they are
    entered into solely by eligible contract participants2
    and are subject to individual negotiation.
    • Also excluded from the CEA are transactions involving
    “excluded commodities” (a broad range of interest rate currency, credit, equity, weather and other
    derivatives”.

    There are many provisions in this act. The provisions that the lawyers thought the members of ISDA would find of most interests is the legal authority of members of ISDA to enter into individual contracts that would be enforced in U.S. courts but not regulated by any federal agency if they meet certain requirements specified in the memorandum.

    I think this memorandum fully justifies my contention that the 2000 Act specifically exempts certain activities from Federal regulation (the above quotes are from the beginning of the Executive Summary).

    So, we currently have in U.S. law a way to distinguish regulated from unregulated acts permitted of the Financial community.

    Twofish also says that financial activities are so interconnected all over the world that the problem cannot be solved by reforming U.S. practice.

    I am not interested in solving all financial problems all over the world. I am interested in restricting what banks and other financial institutions, such as insurance firms, can do legally in the U.S. That can be done by U.S. law. Those firms that want to participate in a regulated system will receive guarantees from the Federal government. Those firms that want to engage in activities prohibited to firms in the regulated system can set up new firms outside the regulated system to exploit all the opportunities all over the world. But they will not be able to rely on the wealth of the firms in the regulated system to back their bets nor will they be able to rely on the U.S. government to back their bets.

    Twofish says this can’t be done. Congress will not pass such a law. Says who? Congress is learning. The public doesn’t understand what is going on but they are no longer naïve believers in everything Secretary Geithner says.

    Twofish says that once banks start collapsing there is no market. That assumes that all banks will fail if the U.S. stops paying for contracts executed outside the regulated system. Of course, that is non-sense. Many banks did not participate in the feeding frenzy that brought down the world economy.

    He has many more comments that should be refuted but I am too lazy to do so.

    Re-read my proposal and discount Twofish’s comments.

  • Posted by ReformerRay

    Twofish says there are no permanent solutions. I agree. Permanent is to strong a word. I should have said “solutions dependent upon the U.S. economy remaining in a funk” versus “solutions that are incorporated into law and are intended to operate after the U.S. economy recovers”.

    There is a difference between the two kinds of solutions. The first is clearly temporary. The second is not permanent, in an absolute sense, but it has a longer reach that the first solution.

  • Posted by Twofish

    ReformerRay: he provisions that the lawyers thought the members of ISDA would find of most interests is the legal authority of members of ISDA to enter into individual contracts that would be enforced in U.S. courts but not regulated by any federal agency if they meet certain requirements specified in the memorandum.

    Wrong. Reread the law.

    The CMEA excludes interest rate swaps and OTC derivatives from the Commodities Exchange Act of 1936 and the regulation by the Commodities Futures Trading Commission. They are still subject to regulation under the Securities Act of 1933, the Securities Exchange Act of 1934, and oversight by the SEC.

    Foreign exchange and stock index contracts are regulated under the CEA and by the CFTC. The CMEA ended a regulatory feud that had been going on for over a decade, and put most OTC derivatives under the jurisdiction of the SEC rather than the CFTC. THAT’S ALL.

    One thing about the SEC is that the SEC puts much stricter margin requirements than the CFTC does.

    ReformerRay: Twofish says this can’t be done. Congress will not pass such a law. Says who?

    Says me. We can go district by district, and you won’t get the votes. In any case, you can’t get a bill passed quickly, and you certainly won’t get any bill passed without any loopholes and compromises.

    If you think otherwise, care to explain why the US has two agencies regulating derivatives?

    ReformerRay: Twofish says that once banks start collapsing there is no market. That assumes that all banks will fail if the U.S. stops paying for contracts executed outside the regulated system.

    No. There are about a dozen major banks that form the hub of securities trading system. If you have three of them fail, then the system collapses and you can’t create any sort of market, which is likely to cause a chain reaction.

    ReformerRay: Of course, that is non-sense. Many banks did not participate in the feeding frenzy that brought down the world economy.

    But once you get a chain reaction of failures going, then the banks that did will kill the banks that didn’t.

  • Posted by Twofish

    a: Which would you prefer: the standard of living in Portugal, Argentina or Zimbabwe? (All three of these I imagine you would conflate as “doom” for the U.S.)

    I think you are missing my point. There is some real argument over what exactly the US should do. If it were the situation that doing something now would cause the US to be like Portugal, and waiting would turn the US into Zimbabwe, then of course we should do something now.

    But you need to argue that that is going to happen. If doing something now and waiting are both going to turn the US into Portugal and Zimbabwe, then you lose nothing by waiting and trying something else.

    And if the “gloom and doomers” are right, I don’t see how spending 10% GDP and waiting a year is going to make that much difference.

    The worst case scenario I can see from the current policies is either Japanese stagnation or late-1970’s inflation, neither of which are nearly as bad as the Great Depression.

    KT Cat: With a $1.8T deficit and the size of my family, Obama took out a $36,000 loan in my name this year

    No he didn’t. He took out a $1.8T loan on behalf of the US Federal Government. Be careful about talking through inaccurate analogies. If you are in a low tax bracket, it’s unlikely that you will be paying much of that back. If you have savings that you used to buy treasuries, then you are a lender and not a borrower.

    KT Cat: And just what did I buy with that? Did I buy anything that will help me pay down that debt in the future?

    Among other things, the debt bought 12 aircraft carriers that keep the flow of oil coming from Saudi Arabia. Highways, bridges, scholarships to future physicists and engineers, the type of research that led to the internet. And you’ll get back a lot of that money when you go to the bank and then you get money rather than a sign that says SORRY.

    KT Cat: Like it or not, though, I’ll have to find a way to service and pay down that $36,000.

    No you don’t, if your tax bracket is low enough, you aren’t going to be responsible for much of it. We’ll take that money from some Wall Street banker that caused the financial mess. Also, the Saudis and Chinese would be willing to pitch in.

    KT Cat: Having personally crawled out of debt before, I know what it’s going to take and it won’t be pretty.

    Wrong analogy. Rich people find it much much easier to get out of debt than poor or middle class people. Look at Donald Trump. He was in debt to the tune of almost $1 billion, and he didn’t have that much trouble paying it. Part of it is that if you owe $1 billion, you can play hard ball with your lenders in ways that someone that owes $50,000 can’t.

    Rich and poor unfortunately have very little to do with personal wealth or debt. If you are poor and owe $50,000, you are in a lot of trouble. If you are rich like Donald Trump and owe $1 billion, you aren’t going to have problems maintaining a very comfortable life.

    How someone that owes $1 billion can lead a much better life than someone that owes $50,000 is one of the interesting and mysterious things about the world, but there it is….

  • Posted by a

    2Fish: “But you need to argue that that is going to happen. If doing something now and waiting are both going to turn the US into Portugal and Zimbabwe, then you lose nothing by waiting and trying something else.”

    There you go again, as if Portugal and Zimbabwe are the same. They’re not the same outcome. Dropping to the standard of living seen in Portugal may be “doom,” but it’s a better “doom” than Zimbabwe. So, I’m sorry, but I think I do understand the point you are arguing, and I’m afraid it’s just a bad argument, because it makes it seem that all bad outcomes are the same. (By the way, the point in quotes seems to be diametrically the opposite of your usual point, which is that you lose nothing by doing something now rather than waiting.)

    2Fish: “And if the “gloom and doomers” are right, I don’t see how spending 10% GDP and waiting a year is going to make that much difference.”

    Anyway, it’s 10% this and 10% next, no? And then all the guarantees (Agencies and money markets), no exit strategy and maybe more the year after, to prevent a double dip. So I think we’re talking much more than 10%.

  • Posted by ReformerRay

    Twofish is arguing with lawyers the ISDA thinks are experts in this field.

    These lawyers say that “fraud, manipulation and insider trading provisions apply” but that is the only federally inforced limitions. Twofish – tell me how a contract executed according to the conditions set forth by the memoradum can run afowl of Federal regulations, other than by fraud, etc. as noted above?

    Twofish sees a chain reaction – among the banks that deal in these kind of toxic assets. To which I say, “very good”. These kind of bad actors need to be punished.

    This fear of consequences has been overdone from the very beginning. Paulson said the sky was falling because money markets were clogged up, overnight trading had haulted. Turned out Ben Bernanke took care of that problem long before Paulson could intervene with his windfall granted by the Congress.

    What the Congress will not do today, they will do tomorrow.

  • Posted by ReformerRay

    The banks and insurance companies that participated in the swindling of America are in much better shape to survive now compared with 7 months ago because of all of the Federal monies provided and promised.

    I simply want to bring an end to it. The Federal government needs to say: “No more federal money to be used to fulfill contracts established according to the conditions established in the Commodities Futures Modernization Act of 2000”.

    If the Federal government can guide Chrysler and GM though bankrupcy procedures they can surely handle smaller companies, such as the major banks.

    I do not necessarily want any bank to fail. But I do not fear bank failure. If they cannot survive without Federal money going to pay for contracts established outside the regulated system, then they should die.

    Take all this money that Geithner wants to give to the banks and give it to FDIC – to be used to deal with bank failures without getting the money from sound banks.

    Scrambling to keep the old system going (where other banks paid for bank failures) should be replaced by a set of principles which supports the regulated banking system of tomorrow, not the one of recent past.

  • Posted by ReformerRay

    Here is an example of Sec authority over these matters (from the memorandum above).

    “The SEC nevertheless may neither require the
    registration of securities-based swap agreements nor
    promulgate or enforce rules or orders that impose
    reporting or recordkeeping requirements or other
    procedures or standards as prophylactic measures
    against fraud, manipulation or insider trading with
    respect to securities-based swap agreements”.

    Now that is what I call “speculator friendly” regulation.

  • Posted by ReformerRay

    Twofish wants me to explain why there are two agencies “regulating” derivatives.

    The answer: Because the Congress is not as simple minded as I am.

  • Posted by Twofish

    ReformerRay: Twofish is arguing with lawyers the ISDA thinks are experts in this field.

    No. I’m arguing with you, as you are misreading and misrepresenting what the lawyers are saying.

    ReformerRay: These lawyers say that “fraud, manipulation and insider trading provisions apply” but that is the only federally inforced limitions.

    No they aren’t. What that section does is remove security-based swaps (and only security-based swaps) from the SEC reporting and registration requirements. The purpose of this rule is that there are some securities (like stocks and bonds) that require a new set of registrations. There are things like options that don’t. If I want to write a put option to you, that is not a new security under US law (it is under Chinese law). That law puts security based swaps in the same group as put/call options rather than registered stock.

    ReformerRay: Twofish sees a chain reaction – among the banks that deal in these kind of toxic assets. To which I say, “very good”. These kind of bad actors need to be punished.

    Except that there isn’t any investment bank that doesn’t deal with these assets, and if you kill all the investment banks, then you have no market because no one is trading with anyone else.

    ReformerRay: If the Federal government can guide Chrysler and GM though bankrupcy procedures they can surely handle smaller companies, such as the major banks.

    The major banks are all considerably larger than Chrysler and GM. Citigroup employs about 300,000 people. General Motors employs about 93,000. Goldman-Sachs employs about 20,000. The big banks are huge because it takes a lot of people to get a market going.

    Also, you need huge pools of capital in order to handle an industrial bankruptcy. GM needs the big banks for overnight financing.

    ReformerRay: Take all this money that Geithner wants to give to the banks and give it to FDIC – to be used to deal with bank failures without getting the money from sound banks.

    If you give money to give to FDIC to give to banks, why not give the money straight to banks in the first place?

    Anyhow, FDIC deals with bank failures by merging a bad bank with a good bank, and having the good bank take over the bad banks capital. The problem comes in that you have a big bank eat up a small bank, but what do you do when the biggest banks have problems.

    ReformerRay: Scrambling to keep the old system going (where other banks paid for bank failures) should be replaced by a set of principles which supports the regulated banking system of tomorrow, not the one of recent past.

    I don’t think you can create an economic system based on “principles” because what you end up is something that just doesn’t work.

    When every anyone has tried it’s tended to be a disaster. You create an economic system by trial and error.

    ReformerRay: The answer: Because the Congress is not as simple minded as I am.

    And if you want to get anything political done, you can’t be very simple.

  • Posted by ReformerRay

    I want to begin with the recognition that it is possible that I have misrepresented, for one reason or another, what the CMFT Act of 2000 says. I’ll admit, I focused on what the lawyers said. As a read more of their report, they give example after example of things that are excluded from regulation. That is what the International Swaps and Derivatives Association is interested in learning about. Some things are still regulated, for example, designated contract markets.

    My proposal is to exclude from Federal support only those contracts that are specifically identified in this act as excluded from regulation. The lawyers provide enough detail to convince me that many fish will be caught in this net. What else the 2000 law says is irrelevant for my purpose.

    Twofish says that all investment banks deal with these toxic assets. I suppose he is right. But not all of them have enough of these assets left on their banks that refusal to provide Federal money to pay for contracts explicitly removed from regulation by the 2000 Act will kill all investment banks. Tell me this Twofish – how do you know what proportion of all assets in each of the investment banks consist of contracts that would be caught in my proposed net? AIG and other banks have disposed of some of their “mistakes”. How many I do not know. But I am certain that each bank has a different level of exposure. And I do not believe that the collapse of those that are in the worst shape will bring down all investment banks. What evidence has you or Paulson or anyone else provided showing that “contagion” is really a great danger? We have acted on fear not backed up by information.

    Banks are different from manufacturing firms in that manufacturing firms have suppliers and many other jobs depending upon them. Dealing with all the stake holders or interests that should be considered in a Chrysler or GM bankruptcy is much more difficult than dealing with a bank.

    I agree that the major banks provide a quite different problem from smaller banks. Standard FDIC practice for dealing with failed small banks should not be applied to AIG or a large investment bank. But if necessary, a procedure can be worked out, as the GM deal is showing.

    Twofish says: “If you give money to give to FDIC to give to banks, why not give the money straight to banks in the first place?” The FDIC money will be used to pay off legitimate debts of failed banks. That is a lot less money than what is now going indiscriminately to a large number of banks without any progress in getting rid of toxic assets. I want to move toward a “clean” banking system. Twofish and Secretary Geithner seem to want to maintain existing banks rather than purge them.

    Twofish says he doesn’t think principles are a good basis for establishing an improved version of the banking system that failed. So, what would he use? Continue the practices that failed? Systems fail only because operators cease improving them. We must begin somewhere. I say begin with a resolution to separate the regulated from the unregulated financial system and let the unregulated system do what it wants so long as fraud, etc. is searched for, detected and prevented.

  • Posted by ReformerRay

    I wrote “banks” when I intended to write “books”, above

  • Posted by ReformerRay

    I want to build a strong fence between civilized bankers who focus on protecting depositorers money and financing companies and the hard charging profit seekers who are taking risks in the jungle. Both types are needed, in my opinion. And the guys in the jungle should be given freedom.

    There should be a gate that opens under specified conditions. Regulated banks should be able to invest in the firms on the other side of the fence, to receive profits from their investments, but not to insure any of their contracts nor to expose an “excess” amount of their capital to the dangers of the jungle.

  • Posted by don

    rebel – The tendency I was thinking of (which I think comes from something Mankiw wrote) comes from expectations about the future and is strongest in newly-issued TIPs.

  • Posted by Rien Huizer

    Twofish e al re living standards:

    Have any of you ever been to these countries? LIving standards are quite hard to measure. There are parts of Portugal with higher living standards (for the middle class) than the US (think of college fees, healthcare, housing) than some parts of the US. There is also a lot of hardship as well as wealth in both countries that simply cannot be picked up by statistics. But both countries provide a decent basic package of public goods to their citizens and have open economies that allow for a degree of interregional (or international in the case of Portugal) euqalization of income and wealth levels.

    Zimbabwe is a different case. Very poor institutions, euphemistically speaking, combined with poverty. A country where the concept of (average) standards of living is meaningless.

    There may be an equivalent of Portugal among the US states (a mix of Alabama and Rhode Island perhaps), but there is no Zimbabwe and is highly unlikely purely economic policies or economic developments would generate Zimbabwean conditions there. You have to be a bit of a Marxist to attribute so much to economics…

  • Posted by Rien Huizer

    Reformer Ray,

    @I want to build a strong fence..@

    Strangely enough the US financial sector as a whole was probably the heaviest regulated one in the OECD. Yet all these troubles could occur there, and not for the first time (remember Penn Square, the repo crisis, Drexel Burnham, the S&Ls, etc Though none of those was allowed to get so close to a system meltdown.

    There is a balance between financial system safety and -efficiency and in the past 25 years we have seen financial technology (efficiency enhancing, but also facilitating socially unacceptable behaviours (what is that?) outstrip regulation repeatedly). The regulation that had become obsolete was sometimes kept in place (because every bit of regulation has an impact on the competitive landscape, hence every change crates winners and losers) and sometimes abandoned without a functional replacement. Add to that a world with rapidly increasing openness and quasi financial markets (commodities, real estate via derivatives and securitization) and the role of financial regulators meets the challenge of politics (where the losers seek compensation), recruitment of talent in competition with an explosion of opportunities in the market, and a rapid expansion of quasi-financial asset classes with their own inherent liquidity and breakdown characteristics. Welcome to the new world.

    Building a wall to keep reality out has never worked and will not this time. A small example: suppose banks are required to maintain capital ratios at 1950s (actual levels), far in excess of 15% of a very limited set of permissible assets. Where will people put their money? If all bank-like service providers (funds, credit unions, finance companies etc) would be made subject to the same rules what would happen? You would have to close the borders for international financial service providers from more competitive regulatory jurisdiction first. That would not be easy. Second you would make the recovery almost impossible because the recovery mechanism (in the past) relied on slack in the financial system to lower the risk/return threshold facing initiators of new projects) relies on a restart of the investment cycle. Without that, no wall will protect a banking system that relies on at least modest growth to repay current outstandings. An that applies a fortiori for what is left of the shadow banking system.

    There is a strong case for financial reform acoording to explicit design pinciples with wide discretion for the regulators, similar to the tax authorities (not a task for the fed, but for the good old Treasury Department). Some of these principles should be that any form of deposit taking from US residents by US residents contitutes the business of banking and is subject to bank regulation (the bank regulation as such is actually not that bad). Any form of securities, commodity or derivatives activity would be broadly defined as well and overseen by the banking regulator, but with different expertise, not guaranteed by the gvt and subject to industrry-specific financial benchmarks. Banks/Bank holding companies should not be able to engage in any unregulated business. The US gvt might as well explicitly guarantee their liabilities in return for a royalty. Securities companies would be explicity unguaranteed and the owners and creditors of securities businesses, should these fail regulatory tests, would be forced to take haircuts. Any other provider of financial services (international or domestic) offering services in the US would (a) be required to pay for advertising highlighting the dangers of using his products (like tobacco) and (b) risk criminal prosecution if activity would be deemed to intrude upon regulated activities.

    This is just a rough sketch of what a draconian, but not unfasible system might look like. Look at the hurdles:
    – preserving an activity entirely to a single industry with the regulator having the discretion to declare substitutes regulated. That would kill a lot of innovation and put the bulk of short term non-equity financial investment into banks without any incentive but to preserve principal. More or less the situation in many European countries before the middle 1980s.
    – having a single regulator wide powers would run into fierce opposition in Congress.
    – at least a 100000 financial ervices sales people wuld be out of work (my system needs no marketing)
    – the system would generate as many opportunities for corruption as the present one, only it would be further underground and closer to crime. Look at the history of alcohol and drugs regulation.

    More?

  • Posted by Twofish

    ReformerRay: Tell me this Twofish – how do you know what proportion of all assets in each of the investment banks consist of contracts that would be caught in my proposed net?

    Because I read balance sheets. All this stuff is listed if you know where to look.

    In any event, it wasn’t the investment banks that had problems with CDS’s, it was an insurance company.

    ReformerRay: Banks are different from manufacturing firms in that manufacturing firms have suppliers and many other jobs depending upon them.

    And banks have everyone in the world depending on the, What happens when your ATM card stops working? What happens when GM’s ATM card stops working?

    ReformerRay: Dealing with all the stake holders or interests that should be considered in a Chrysler or GM bankruptcy is much more difficult than dealing with a bank.

    No it’s not, because you have time. Working through the GM bankruptcy has taken about six months. In a full banking crisis, six hours is an eternity. When both Lehman and Bear-Stearns went under, everyone had to move heaven and earth to get to the weekend, and that had to have a deal in place by the time markets reopened.

    ReformerRay: But I am certain that each bank has a different level of exposure. And I do not believe that the collapse of those that are in the worst shape will bring down all investment banks.

    It did. There are no more investment banks in the United States.

    The trouble is that when one bank falls, fear takes over and people start pulling money out of every other bank. If you pull enough money out of a bank, and you don’t have an emergency lifeline, then the bank will fold, which just adds the the fear.

    It’s pretty obvious that had GS and Morgan-Stanley not become bank holding companies and eligible for a federal life line, that they would have been gone within a week. You also saw the money markets and commercial paper markets failing. Since everyone was afraid everyone else would be dead in a week, no one was willing to lend money to anyone, and when that happens everyone dies.

    This isn’t a hypothetical. People were watching as the banks were all heading for a massive crash.

    ReformerRay: What evidence has you or Paulson or anyone else provided showing that “contagion” is really a great danger?

    Because I was watching it happen. The funny thing about watching the world fall apart is how calm everyone was. People were just too damn busy to be depressed.

    Anyway, look at AIG’s balance sheet in Q4 2008 and then see who gets clobbered if it defaults. You see a lot of European banks. Once German banks default by the truckloads, American banks were going to die.

    ReformerRay: But if necessary, a procedure can be worked out, as the GM deal is showing.

    A procedure has been worked out.

    ReformerRay: That is a lot less money than what is now going indiscriminately to a large number of banks without any progress in getting rid of toxic assets.

    1) Most of the money that has been pumped into the banking system has come out the other end in the form of mortgages and credit.

    2) There has been some huge progress in getting rid of toxic assets. AIG has been spinning off subsidaries, and Citi is preparing to do something similar. We are about to have another major corporate bankruptcy, and no one is panicking becomes we think we know where all of the timebombs are.

    The trouble is that when something works you don’t hear about it.

    ReformerRay: I want to move toward a “clean” banking system. Twofish and Secretary Geithner seem to want to maintain existing banks rather than purge them.

    They are being purged. I don’t see anything you are suggesting as being faster or more efficient than what has been done.

    ReformerRay: So, what would he use? Continue the practices that failed?

    Trial and error. Figure out what broke. Figure out what worked. Fix what broke.

    ReformerRay: I say begin with a resolution to separate the regulated from the unregulated financial system and let the unregulated system do what it wants so long as fraud, etc. is searched for, detected and prevented.

    That doesn’t work. We tried that and it failed miserably. The reason it failed are:

    1) you make huge amounts of money borrowing money from regulated sources and lending to unregulated ones. This links the regulated and unregulated systems so that when the unregulated system fails, it kills the regulated one.

    2) because the unregulated system pays more return, people move money from the regulated system to the unregulated. This has two bad effects. The first is that it makes the unregulated system too big to fail. The second is that it puts a lot of pressure to deregulate the regulated system.

    3) Finally, once the deregulated system becomes big enough, people believe that it is too big to fail, and they are right. At that point everyone takes money out of the regulated system and puts it into the deregulated one to the point that you become so dependent on the deregulated system that you have to do a bailout when it fails.

    What happened (and you can see this with mortgages) is that you end up with a system that has the worst of both worlds.

  • Posted by Twofish

    Rien Huizer: Strangely enough the US financial sector as a whole was probably the heaviest regulated one in the OECD.

    Which is why AIG-FP was in London. It couldn’t do what it did in NYC. This is one big problem with trying to separate things into “regulated” and “unregulated.” For it to work, you have to get every other major country in the world to agree.

    ReformerRay: Regulated banks should be able to invest in the firms on the other side of the fence, to receive profits from their investment.

    This is a bad idea. Japan had this sort of structure in which a bank could own an associated securities company. The trouble is that when the securities company goes bust, then it takes the bank with it.

    The writers of GLBA knew that this would be a problem (they saw Japan), so US banks have a structure in which a holding company owns both the commercial bank and the investment bank. So if the investment bank goes bust, the commercial bank is safe. However this creates another problem. FDIC has legal authority to seize a bad FDIC insured bank. However if the FDIC insured bank is in good shape, but the non-FDIC investment bank is not, then FDIC can’t act. Congress is working on this problem.

    ReformerRay: Not to insure any of their contracts nor to expose an “excess” amount of their capital to the dangers of the jungle.

    US commercial banks can’t insure contracts. Insurance companies however…….

    Also, banks are required to maintain lots of required capital. The US is rather strict about what banks can hold as required capital.

    In the case of Germany, they can make their capital more safe by buying insurance on their capital holdings…. From AIG…. And to prove that their capital holdings are perfectly safe, they got AAA bond ratings.

    The problem here was that if you are a German bank and you need insurance, who do you get it from? Good Wholesome Honest Insurance that will charge you an arm and a leg, or those folks at AIG-FP who will gladly sell you the insurance that you need at prices that are totally unbelievable……

    You can also for your required capital buy these low-interest bonds or else these wonderful CDO’s that pay incredibly high interest, and which everyone says has these AAA ratings.

  • Posted by Twofish

    A *really* good summary of the problems with deriviatives….

    http://www.npr.org/templates/story/story.php?storyId=104130944

  • Posted by Twofish

    Something that Gillian Tett makes more clear is that most people outside of banking think that the “shadow banking system” is some secretive thing that is a small part of the system, whereas in fact that “shadow banking system” is bigger than the “non-shadow banking system.” If you get a mortgage, a credit card, auto loan, commercial business loan, or any credit at all, the money that you got came from the “shadow banking system” rather than the “non-shadow banking system.”

    The “shadow banking system” needs to be regulated because it *is* the banking system, and it really can’t be shut down, because there really is no “non-shadow banking system” any more. People in banking don’t talk much about the non-shadow system not because it is some deep dark secret, but rather because it’s like the air or the clouds. You see it every day that you don’t think about it.

    Part of the reason the shadow system is rather poorly regulated is that throughout the 2000’s, there was this idea that government was the problem rather than the solution, and any sort of government intervention with business was bad, so routing everything through this other banking system was a good thing. Over time, the shadow banking system would prove to be so much better than the traditional one, that the traditional system would fade away.

    The fact that this just didn’t work probably became obvious the day after Lehman died. I’m willing to bet that no one at the US Treasury had the slightest idea that if Lehman died, that AIG would go under, because there was just no one keeping track of who had what risk.

  • Posted by ReformerRay

    Twofish says: “I’m willing to bet that no one at the US Treasury had the slightest idea that if Lehman died, that AIG would go under, because there was just no one keeping track of who had what risk”.

    No one was keeping track because they were forbidden to do so.Twofish says that “regulation” of the shadow banking system was shifted to the SEC. But the Sec was limited to ability to prosecute for fraud. To make sure SEC could not do that effectively, the 2000 Act prohibited the SEC from forcing companies to provide information to SEC that could be used to discover fraud (see the language in a post of mine above – quite a bit above)

  • Posted by ReformerRay

    Twofish says a lot of things, some which support my position, some oppose it.

    He claims that separation of the regulated from the unregulated system has been tried before and it did not work.

    When and where was it seriously tried? What law did the AIG employees in London violate when they sold insurance for derivative contracts in such numbers as to destroy AIG?

    My proposal is to outlaw ANY firms in the regulated system (and all insurance firms must be in the regulated system to sell insurance in the U.S.) from selling insurance contracts to pay in the case of default on contracts created in the unregulated system (derivatives would be in the unregulated system, as per the legislation in the Commodities Futures Modernization Act of 2000). I do not believe that such a law has ever existed in the U.S.

    Some efforts were made after 1929 to keep the regulated system protected from high flying speculation, but those efforts were undermined by successive decisions by the U.S. Congress.

    Twofish points out how money accumulated in the regulated system naturally flows to the unregulated system because that is where higher profits are available. It is precisely this flow which should be permitted but limited by regulation. He does not agree with my proposal to open the gate between the two systems, under controlled conditions. Again, he says that has been tried but did not work. OK, why didn’t it work? What should be done to make it work?

    I am a naïve outsider to the financial system. I learn some things from Twofish’s comments. But nothing he has said has modified my opinion that stringent controls must be applied to profit making activities of the regulated sector, that an unregulated sector must be permitted and encouraged to exist, that the regulated sector must be permitted to make a profits (which I think means allowing the regulated sector to profit, in some fashion, from the gains to be made in the unregulated sector),

    The U.S. public is in a different position today from the one that existed from 1980 – 1997, when deregulation was popular. Today, we want some restraints on the behavior of financial firms. My fear is that this impulse will translate into a draconian law that will make too much illegal and will combine excessive reach with insufficient funding for people to do the regulation. The impulse to regulation will give regulation a black eye if done poorly.

    We should have regulation held to a minimum but enforcement expanded to a maximium.

    One more comment. The ability of hedge funds to leverage their bets by borrowing unlimited sums from the regulated banks was THE source of the funding that allowed the hedge funds to grow so big and profitable. My proposal will limit their growth to funds they can raise outside the regulated banking system. Cutting them off from funds from the regulated system (except under controlled conditions) will reduce their ability to make outlandish profits and it will serve notice to investors that hedge funds are no longer too big to fail (they will not drag down the regulated banking system when they fail), thus the money invested in hedge funds can disappear, if the hedge fund makes bad bets.

  • Posted by Hugh Bastard

    To Mister Richard Branson,
    I am communicating to you on behalf of a group of people who for the past amount of years have been involved in the crimes that are tantamount to treason in a majority of nations worldwide, that have at times been know as terrorist and in other times liberating. This group has had the willing support of many others in its existance and now finds itself in the most dire need. They need one million dollars for the continuation of their cause, they know that in the past you have shown sympathy to groups with a similar belief and fundamental core structure. They believe that you are the man to help continue this cause. This group is known in various circles as FBI, they have promoted me on the basis that I will receive five percent of the total amount that you will willing donate to their cause, for the continuation of this mission. They are currently in the process of promoting a month long exercise at the expense of the public and other private groups to help achieve this cause; with your help the casualties of this, may be minimised.

    Sincerely H.B.

    对理查・ Branson先生,我沟通给您代表为过去相当数量几年在罪行介入了是同等的对在大多数的谋反国家全世界的一群人,那时常是知道作为恐怖分子和在解放其他的次内。 这个小组在它的存在有许多其他的愿意的支持和现在发现自己在迫切需要。 他们需要他们的起因的继续的一百万美元,他们知道从前您显示了同情对与一个相似的信仰和根本核心结构的小组。 他们相信您是帮助的人继续这起因。 这个小组被认识以各种各样的圈子作为FBI,他们提升了我,根据我将接受您将愿捐赠到他们的起因总额的百分之五,这个使命的继续的。 他们当前是在促进月久的锻炼过程中牺牲公众和其他私人组帮助达到这起因; 在您的帮助下此的伤亡,也许减到最小。 恳切H.B。

    對理查・ Branson先生,我溝通給您代表為過去相當数量几年在罪行介入了是同等的對在大多数的謀反國家全世界的一群人,那時常是知道作為恐怖分子和在解放其他的次内。 這個小組在它的存在有許多其他的願意的支持和現在發現自己在迫切需要。 他們需要他們的起因的繼續的一百萬美元,他們知道從前您顯示了同情對與一個相似的信仰和根本核心結構的小組。 他們相信您是幫助的人繼續這起因。 這個小組被认识以各種各樣的圈子作為FBI,他們提升了我,根據我將接受您將願捐贈到他們的起因总额的百分之五,這個使命的繼續的。 他們當前是在促進月久的鍛煉過程中犧牲公眾和其他私人组幫助達到這起因; 在您的幫助下此的傷亡,也許減到最小。 懇切H.B。

    Aan Mijnheer Richard Branson, Ik communiceer aan u namens een groep mensen die voor de afgelopen hoeveelheid jaren in de misdaden zijn geïmpliceerdr die wereldwijd aan verraad in een meerderheid van naties gelijkwaardig zijn, die af en toe kennen als terrorist en in andere tijden het bevrijden zijn geweest. Deze groep heeft de gewillige steun van vele anderen zijn bestaand gehad en zich nu in het meeste nijpend tekort gevonden. Zij hebben één miljoen dollars voor de voortzetting van hun oorzaak nodig, weten zij dat in het verleden u sympathie aan groepen met een gelijkaardig geloof en een fundamentele kernstructuur hebt getoond. Zij geloven dat u de man bent helpen deze oorzaak voortzetten. Deze groep is gekend in diverse cirkels aangezien FBI, zij me op de basis hebben bevorderd dat ik vijf percent van het totale bedrag dat u bereid om aan hun oorzaak te schenken zal, voor de voortzetting van deze opdracht zal ontvangen. Zij zijn momenteel tijdens het bevorderen van een maand lange oefening ten koste van het publiek en andere privé groepen helpen deze oorzaak bereiken; met uw hulp kunnen de slachtoffers van dit, worden geminimaliseerd. Oprecht H.B.

    À Monsieur Richard Branson, Je communique à vous au nom d’un groupe de personnes qui pour la quantité passée d’années ont été impliqués dans les crimes qui sont équivalents à la trahison dans une majorité de nations dans le monde entier, cela ont parfois été savent comme terroriste et en d’autres fois libérant. Ce groupe a eu l’appui disposé de beaucoup d’autres dans son existence et se trouve maintenant dans la plupart de besoins extrêmes. Ils ont besoin d’un million de dollars pour la suite de leur cause, ils savent que dans vous avez montré au delà la sympathie aux groupes avec une croyance semblable et une structure fondamentale de noyau. Ils croient que vous êtes l’homme à aider à continuer cette cause. Ce groupe est connu dans divers cercles comme FBI, ils m’ont promu sur la base que je recevrai cinq pour cent du montant total que vous voulant donner à leur cause, pour la suite de cette mission. Ils sont actuellement en cours de favoriser un exercice long de mois aux dépens du public et d’autres groupes privés pour aider à réaliser cette cause ; avec votre aide les accidents de ceci, peuvent être réduits au minimum. Sincèrement H.B.

    Zum Herrn Richard Branson, Ich stehe zu Ihnen im Namen einer Gruppe von Personen in Verbindung, die für die letzte Menge von Jahren in die Verbrechen, die mit Verrat in einer Majorität Nationen weltweit gleichwertig sind, das sind gewesen manchmal wissen als Terrorist und in anderer Zeitbefreiung miteinbezogen worden sind. Diese Gruppe hat die bereite Unterstützung von vielen anderen in seinem Bestehen gehabt und jetzt im meisten dringenden Bedarf findet. Sie benötigen eine Million Dollar für die Fortsetzung ihrer Ursache, wissen sie, dass in der Vergangenheit Sie den Gruppen mit einem ähnlichen Glauben und grundlegenden einer Kernstruktur Sympathie gezeigt haben. Sie glauben, dass Sie der Mann sind, zum zu helfen, diese Ursache fortzusetzen. Diese Gruppe bekannt in den verschiedenen Kreisen als FBI, sie haben gefördert mich auf der Basis, der ich fünf Prozent der Gesamtmenge, die Sie willend zu ihrer, Ursache zu spenden werden, für die Fortsetzung dieses Auftrags empfange. Sie sind z.Z. bei der Förderung einer einmonatigen Übung auf Kosten von der Öffentlichkeit und anderen privaten Gruppen, um zu helfen, diese Ursache zu erzielen; mit Ihrer Hilfe können die Unfall von diesem, herabgesetzt werden. Herzlichst H.B.

    Στον κύριο Richard Branson, Επικοινωνώ με σας εξ ονόματος μιας ομάδας ανθρώπων που για το προηγούμενο ποσό ετών έχουν συμμετάσχει στα εγκλήματα που είναι ισοδύναμα προς την προδοσία σε μια πλειοψηφία των εθνών παγκοσμίως, τα οποία ήταν κατά περιόδους ξέρουν ως τρομοκράτης και σε άλλη χρονική απελευθέρωση. Αυτή η ομάδα είχε την πρόθυμη υποστήριξη πολλές άλλες στην ύπαρξή της και βρίσκεται τώρα στην περισσότερη τρομερή ανάγκη. Χρειάζονται ένα εκατομμύριο δολάρια για τη συνέχεια της αιτίας τους, ξέρουν ότι στο παρελθόν έχετε παρουσιάσει συμπόνοια στις ομάδες με μια παρόμοια πεποίθηση και μια θεμελιώδη δομή πυρήνων. Θεωρούν ότι είστε το άτομο για να βοηθήσετε να συνεχίσετε αυτήν την αιτία. Αυτή η ομάδα είναι γνωστή στους διάφορους κύκλους δεδομένου ότι FBI, με έχουν προαγάγει στη βάση ότι θα λάβω πέντε τοις εκατό του συνολικού ποσού που πρόθυμος να δώσετε στην αιτία τους, για τη συνέχεια αυτής της αποστολής. Είναι αυτήν την περίοδο στο στάδιο της προώθησης μιας μακροχρόνιας άσκησης μήνα εις βάρος του κοινού και άλλων ιδιωτικών ομάδων για να βοηθήσουν να επιτύχουν αυτήν την αιτία με τη βοήθειά σας τα θύματα αυτού, μπορούν να ελαχιστοποιηθούν. Ειλικρινά H.B.

    Al l$signor Richard Branson, Sto comunicando a voi a nome di un gruppo di persone che per la quantità passata di anni sono stati coinvolgere nei crimini che sono equivalenti al tradimento in una maggioranza delle nazioni universalmente, quello occasionalmente sono stati sanno come terrorista ed in altre volte che liberano. Questo gruppo ha avuto il supporto disposto di molti altri nella relativa esistenza ed ora si trova nella maggior parte della necessità estrema. Hanno bisogno di un milione di dollari per la continuazione della loro causa, sanno che nel passato avete indicato la compassione ai gruppi con una simile credenza e una struttura fondamentale del centro. Credono che siate l’uomo da contribuire a continuare questa causa. Questo gruppo è conosciuto in vari cerchi come FBI, lo ha promosso sulla base che riceverò cinque per cento della somma totale che volendo donare alla loro causa, per la continuazione di questa missione. Sono attualmente nel corso della promozione dell’esercitazione di lunghezza di mese a scapito del pubblico e di altri gruppi riservati per contribuire a realizzare questa causa; con il vostro aiuto gli incidenti di questo, possono essere minimizzati. Francamente H.B.

    氏にリチャードBranson、私は国家の大半の反逆に世界的にほとんど等しい罪にテロリストとしてそして解放する他の時間で年の過去量のために、それ時々あったあることが知っているかかわった集団に代わってあなたと伝達し合っている。 このグループに存在で多くの他の喜んでサポートがあり、今緊急に必要とする状態の見つける。 それらは原因の継続のための百万ドルを必要とする、以前同じような確信および基本的な中心の構造を持つグループに共鳴を示したことを知っている。 彼らはこの原因を続けるのを助けるべき人であることを信じる。 このグループはFBIとしてさまざまな円で私があなたがこの代表団の継続のための総計の5%原因に寄付することを決定する受け取るという事実に基づいて、彼ら促進し私を知られていて。 それらは公衆および他のプライベートグループを犠牲にして月の長い練習の促進の過程においてこの原因の達成を助けるように現在ある; あなたの助けによってこれの死傷者は、最小になるかもしれない。 誠意をこめてH.B。

    미스터에 리처드 Branson, 나는 국가의 대다수에 있는 반역과 세계전반 동등한 범죄에서 테러리스트로 그리고 해방하는 다른 시간에서 년 과거 양을 위해, 그것 때때로 이다 것이 알고 있다 포함된 집단의 대신으로 당신에게 교통하고 있다. 이 그룹은 그것의 실존에서 많은 다른 사람의 기꺼이 하는 지원이 있고 지금 절박한 필요에서 찾아낸다. 그들은 그들 원인의 계속을 위한 일백만 달러를 필요로 한다, 과거에는 당신이 유사한 신념 및 기본적인 중핵 구조를 가진 그룹에 교감을 보여주었다는 것을 알고 있다. 그들은 당신이 이 원인을 계속한다고 것을 도울 남자 다고 믿는다. 이 그룹은 FBI로 각종 원형에서 나가 당신이 이 임무의 계속을 위한 총계의 5% 그들 원인에 기증하는 것을 의도한 받을 것이다 기초로 하여, 그들 증진해 저를 알려져. 그들은 공중 및 다른 개인 그룹을 희생해서 달 긴 운동을 승진시키기의 과정에서 이 원인을 달성하는 것을 돕도록 지금 이다; 당신의 도움으로 이것의 사고는, 극소화될지도 모른다. 근실하게 H.B.

    Ao senhor Richard Branson, Eu estou comunicando-me lhe em nome de um grupo de pessoas que para a quantidade passada de anos foram envolvidas nos crimes que são equivalentes à traição em uma maioria das nações no mundo inteiro, isso foram às vezes sabem como o terrorista e em outras vezes que liberam. Este grupo teve a sustentação disposta de muita outro em sua existência e encontra-se agora em a maioria de extrema necessidade. Precisam um milhão de dólares para a continuação de sua causa, sabem que no perto você mostrou a simpatia aos grupos com uma opinião similar e uma estrutura fundamental do núcleo. Acreditam que você é o homem a ajudar a continuar esta causa. Este grupo é conhecido em vários círculos como o FBI, eles promoveu-me na base que eu receberei cinco por cento da quantidade total que você querendo doar a sua causa, para a continuação desta missão. Estão atualmente no processo de promover um exercício de um mês. às expensas do público e de outros grupos confidenciais para ajudar a conseguir esta causa; com sua ajuda as víctimas desta, podem ser minimizadas. Sincera H.B.

    К господину Ричард Branson, Я связываю к вам именем группы людей которые для прошлого количества лет включались в злодеяния которые равный к предательству в большинстве наций всемирно, то временами знают как террорист и в других временах освобождая. Эта группа имела охотно готовую поддержку много других в своем существовании и теперь находит в большинств крайней нужде. Им нужны миллион долларов для продолжения их причины, они знают что в в прошлом вы показывали сочувствие к группам с подобным верованием и основной структурой сердечника. Они верят что вы человек, котор нужно помочь продолжать эту причину. Знают эту группу в различных кругах как ФБР, они повышала меня на основание которому я получу 5 процентов полной суммы которая вы будете завещающ для того чтобы подарить к их причине, для продолжения этого полета. Они в настоящее время в процессе повышать месячную тренировку за счет публики и других приватных групп для того чтобы помочь достигнуть этой причины; с вашей помощью потери этого, могут быть уменьшены. Задушевно H.B.

    A señor Richard Branson, Estoy comunicando a usted a nombre de un grupo de personas que para la última cantidad de años han estado implicadas en los crímenes que son equivalentes a la traición en una mayoría de las naciones por todo el mundo, eso han estado ocasionalmente saben como terrorista y en otras veces que liberaban. Este grupo ha tenido la ayuda dispuesta de muchos otras en su existencia y ahora se encuentra en la mayoría de la extrema necesidad. Necesitan un millón dólares para la continuación de su causa, saben que en el pasado usted ha demostrado condolencia a los grupos con una creencia similar y una estructura fundamental de la base. Creen que usted es el hombre a ayudar a continuar esta causa. Conocen a este grupo en varios círculos como FBI, ellos me ha promovido sobre la base que recibiré el cinco por ciento de la cantidad total que usted queriendo donar a su causa, para la continuación de esta misión. Él está actualmente en curso de promover un ejercicio de un mes a expensas del público y de otros grupos privados para ayudar a alcanzar esta causa; con su ayuda las muertes de esto, pueden ser reducidas al mínimo. Sinceramente H.B.

  • Posted by Rien Huizer

    Reformer Ray,

    There are three ways for dealing with the negative externalities of the financial system (1) nationalization destroying many positive externalities and crating new nagative ones in the process) (2) total liberalization (not even consumer protection -hard to do I guess: politically unacceptable but perhaps economically not too bad. Only the truly strong or very devious could then survive and the survivors would have an interest in making the system default proof -as well as even more expensive than nationalization. (3) some form of regulation. No regulation (as twofish explains above) will be foolproof (even assuming technology and innovation are frozen) because of the difficulty of reaching interntional agrement. The British would not have gone along in the post reform post Bank of England days, when all the merchant banks had moved into foreign ownership. The family estate had become a hotel for roving bandits. Naturally the British wanted lax supervision (they forgot about their domestic market though).

    “Good” regulation (if there is such a thing) must have a very wide scope (but then it infringes very quickly upon other public interests. Regulators must have wide discretion (ditto) and the regulated must be rewarded for good behaviour (that was your old financial services cartel, blown up by competition-engendering deregulation).

    What we do not need is a combination the worst consequences of all three (like we had during the past en years: (1) implicit nationalization of deficits caused by private firm failures (2) a free for all plus discreet cartels (like bands of friends working in exotic derivatives for various firms and being paid like independent contractors) in areas with weak or ambiguous regulation (3) unchecked cartellization in the well regulated parts of finance (branch banking in rural America).

    Hedge funds are by definition unregulated and often beyond the scope of national regulation, since they reside where local regulators do not mind them fooling around in other people’ markets (and with other peoples’ money).

    The obvious way to protect US institutional savers would have been to allow pension fund and life insurance investment to be only in instruments and issuers/risks and with managers appearing on an approved list vetted by some national regulator. Good, transparant and adequately governed fund managers (including hedge funds nd private equity) should have no problem.

    That would solve the problem of rating agencies as well. They could survive as providers of analytical services to the regulator. The regulator should be liable for poor recommendations, but of course not for adverse (according to whom) market movements and individual default risk. No decent regulator would have had the stupidity of the rating agencies with subprime based structures (see a recent article in the Journal of Econ. Perspectives) and if it had, the gvt’s deep pockets should have been available rather than those of the rating agencies.

  • Posted by Rien Huizer

    Hugh Bastard,

    You are a terrible translator (at least the Dutch, French, German, Spanish and Russion suck, and you could have taken the trouble to transliterate the Chinese, Japanese and Korea like you did with the Greek and Russian. but great and topical content. Will see more of you?

  • Posted by ReformerRay

    What have I learned about regulation of the finance industry from Twofish, Rien Huizer, The Economist magazine and Gary Gorton (paper cited and discussed in James Hamilton blog)? A lot. To be summarized below.

  • Posted by ReformerRay

    “Gorton and Pennacchi (1990a) argue that the essential function of banking is to create a special kind of debt, debt that is immune to adverse selection by privately informed traders”. Preservation of wealth is made possible by this kind of banking. That is why we need a regualated banking system.

    The Economist magazine has described, over the years, the competition between London and New York for the location of the huge profits created by the shadown banking system. Other nations want a piece of that pie.

    So, two not necessarily compatiable objectives. Preserve wealth in the U.S. by a healthy regulated banking system that has debt immune to adverse selection. Second, maintain welcome for the shadow banking system in the U.S.

    Both systems must be allowed to gain profits. Gorton points to the survival problems of the regulated banking system when they no longer have a monopoly on lending. We saw, on September, 2008, the destructive consequences of allowing the shadow banking system to do whatever it wants.

    I will join the ranks of those who do not know the best way to keep both banking systems alive and well in the U.S. One set of laws should be developed in the U.S. which focuses on preservation of the regulated banking system first and then allows as much freedom as possible to the shadow banking system, while making sure that the regualted system is not swallowed up by the shadow system.

  • Posted by ReformerRay

    One other point. Reporting requirements for firms in the shadow banking system is an issue of great importance. Assigning SEC the responsibility of conrolling fraud without the authority to require regular reports is saying that we do not want fraud controlled.

    Again, I do not know the answer to this issue.

  • Posted by Rien Huizer

    Reformer Ray,

    “I will join the ranks of those who do not know the best way to keep both banking systems alive and well in the U.S. One set of laws should be developed in the U.S. which focuses on preservation of the regulated banking system first and then allows as much freedom as possible to the shadow banking system, while making sure that the regualted system is not swallowed up by the shadow system.”

    How?

  • Posted by ReformerRay

    To Rein Huizer:
    In the above posts, I have stumbled around, trying to put down some markers for success without the details, which I don’t know.

    Perhaps the electronic exchange system provides a means, along with laws. The U.S. must allow money to flow out of the U.S. But, can we establish laws which mandate recording each transaction? How about laws which limit the receipent of said transactions to firms or individuals who register their firm with the SEC (or some other agency) and who agree to provide information on the dollars received from regulated U.S. banks and insurance firms. Dollars received from private corporations not in the regulated system would escape this requirement, thus firm to firm payments for imports would not be affected.

    Information about what is going on as it affects the regulated banking and insurance industry in the U.S. is essential. Hedge funds, no matter where located in the world, would be asked to report funds received transactions from U.S. banks and insurance firms in the regulated system. They can keep money spent secret (which they claim is their primary objective).

    Mr. Huizer: In your post above, you also lay down some markers. But you seem, like me, reluctant to become too specific for fear of your reach exceeding your understanding. That is certainly my situation.

  • Posted by ReformerRay

    Mr. Heizer: Rereading your post above – I see a difference between us, in that you want to find good men to put in sensitive positions while I look for good laws and good reporting requirements.

    Is that a fair statement? How would you characterize our differences? How would you summarize Twofish’s position?

    (He says he is for regulating everything financial – in one place – but he is also skeptical of the efficacy of regulation – because he is looking at past regulation rather than trying to visual a better system)

  • Posted by Rien Huizer

    Reformer Ray,

    This is becoming quite a long conversation but you are right that I have more confidence in judges (= good people, concept requiring clarification!) than in formal rules. Most lawyers are too. Of course, the ideal combination is good rules (predictability) and good men (making sure inevitable defects in the rules get fixed fairly). If these “judges”/regulators are embedded in a good governance structure (transparency, professional qualifications, sufficiently long tenure but also oversight by an elected bosy) I am confident that it would be far easier to write rules that help to achieve desired outcomes.

    As to 2fish, I often agree with his pragmatic and professional views, especially as to the futility of even trying to fix the system in a “grand” way, like you want to do. Whenever I write about my regulatory wish list (which tends to change occasionally, despite the fact that I have relevant qualifications and am reasonably familiar with the status of the subject (as does 2fish, apparently) I am always aware that the nature of regulation, especially in a democracy, is that it tends to produce many unintended consequences and is likely to be captured by interest groups. I think 2 fish is more pro-industry and for me it does not matter if the finance industry survives in tis present shape (much of it is parasitic, from an efficiency perspective, I believe), while 2fish may have more of a vested interest, no offense intended of course.

  • Posted by Alex at lllzzz

    “Good” regulation (if there is such a thing) must have a very wide scope (but then it infringes very quickly upon other public interests. Regulators must have wide discretion (ditto) and the regulated must be rewarded for good behaviour (that was your old financial services cartel, blown up by competition-engendering deregulation).

  • Posted by London Mortgage Rates

    It all sounds like a good excuse to keep economies complicated, allowing money to be siphoned off by those who know what they are doing. After issues over sub-prime mortgages and how financial experts played the system is a classic example. All economies need transparency.

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