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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.

79 Comments

  • Posted by August

    1. do you think that the american people will bravely buy the 10 year and 30 year treasuries that nobody from the other countries want? Fom I what I can tell, they are instead buying TBT (not TLT).
    2. didn’t you repeatedly belittle the roles of countries like China in the market of long-term treasuries, claiming that everything will be fine with or without China?

  • Posted by Ben, the drama Queen

    When one finds out that ones currency was faked and literary counterfeited by the ones under one’s supervision but one’s owners at the same time, on a scale as big as the wide world, one would expect some constitutional obedience at most but at least one little bit of a small green shoot of reason, coming from someone or somewhere; not lying, wash-trading, garbage laundering, pumping & dumping, German bashing, fiscally stimulating, orchestrating a crunch, underlining epic flight to this quality and out of reality and then running the printing press hard to replace the suddenly-vanishing counterfeited currency at a pace, lagging tremendously (!) the disappearance of it and then stress testing what’s left of reality on top of the green shoots rally. But then again it is what it is and I must confess it all looks fine and dandy on the above and all other charts. Make no mistake though – all those lines you see were always meant for you – to remain blind and all the statements you’ve heard – for you to stay deaf. And go long or go short at exactly the wrong time. Silent you are. In my book this was and still is not as smart and not as bright as all those awards, shining in front of this recipe source.

    This however is not an accusation. Merely an observation as to the “brightest and smartest” or – if you like – “the dumb & the dumber” – theme …

  • Posted by bsetser

    August –

    a)yes, i do think that at the right price Americans will buy Treasuries. The large role foreign investors play in this market is a recent development. In many countries, domestic investors are the main players in the local currency denominated government debt market. the question is the right price. If treasury yields keep moving up, the rally in credit (riskier debt) will start to look overdone and money will move back into treasuries. also note that low short-term rates eventually make holding longer term treasuries attractive if you have access to short-term financing.

    b)I don’t think I ever belittled the role china plays in any market. I generally have tended to argue that china’s actions to have an impact, while say the fed tends to argue that “flows” don’t matter since they don’t change the fundamentals. I have argued that issuance has grown relative to Chinese demand, so China is no longer as critical a player as it once was. My argument above is consistent with that observation; when treasury yields (ten year yields fell to close to 2%, it wasn’t central bank buying — as the data now makes clear — and now that the mood in the private market has changed, central banks have stepped in … )

    c) I did a bit of additional work and disaggregated issuance into bills and notes, and that changed by view slightly. I hadn’t realized until i did this work that almost all the increase in supply last year was at the short-end of the curve, i.e. mostly bills. long-term supply only started to increase dramatically in the past 4-5 months. that made me a bit less sanguine, as I was inferring something about demand for longer-term notes from the surge in demand for bills.

    incidentally, there is a big debate in the academic literature on whether supply matters for the treasury market or not — with some arguing that it doesn’t (note that over the last year supply has increased dramatically and yields are still down) and others arguing that it does. Non-economic bidders like central banks can be viewed as reducing supply, so this is relevant for the debate on the impact of c. banks on the market as well. this is all one big test of a lot of these theories.

  • Posted by K T Cat

    Another great post.

    I would suggest we’re at the start of a Treasuries rout. As John Jansen says on his marvellous blog, since there is an endless supply of the stuff, why rush in to buy right now? I’m a domestic investor and I made money in TBT. Had I not bought a house, I’d be making still more money shorting long-term Treasuries.

    The economic strategy of this administration and congress are completely incomprehensible to me unless I make the comparison to Juan Peron. Until I see some strong counterexample, that’s the model I’m using for investing. It’s worked well so far.

    The government is just about to buy a big chunk of GM. It bought part of Chrysler. There is no exit strategy as far as I can tell. Both are financial toads. Massive production costs (cap and trade) are about to be levied on private industry to cater to a political group (the greens).

    That’s a whole lot of Peronism right there and that’s just what you can see quickly and easily. What’s below the surface must be far, far worse.

    Buy Treasuries? And invest in that kind of stupidity? I don’t think so.

  • Posted by Ismail

    Brad,

    how come central banks make it so complicated and simply do not buy government bonds either from the government directly (or in the case of the ECB on the secondary market) and not delete these bonds immediately? That way the total level of debt to GDP would not rise. What is the problem here? Yes of course, printing money causes inflation. But not if you have deflation. Just recently the latest inflation figures for Germany showed a rate of 0.0%, in a country where you did not have any property boom. Presumably in the US and the UK there should be a large scope for printing money to buy government debt without stoking inflation.

  • Posted by Cedric Regula

    More big action today. The early morning started with the long end re-tracing half the losses of yesterday. Then it reversed again and we are presently at a 20% retracement. If we end the day at yesterday’s level, that would be a strong technical sign that weaker prices are what is in store for us. So I misplaced a handbag on my TBT this morning, but it seems I may retrieve it by the end of the day.

    Also it doesn’t surprise me that some academics argue that supply doesn’t matter because there are huge governmental institutions in the market that don’t need to make money because they get government paychecks, healthcare and juicy pensions. The fact that the academics are partially right about that is very annoying to me.

  • Posted by FollowTheMoney

    Maybe T-bills would be attractive at 6-8% rate, but i have a feeling private investors are waiting for higher rates because of dollar uncertainty.

    In any case, why in the world would anyone buy a 30 year at 4%???

    Don’t you think Oil will return more than 4% in the next 5 years alone? Or at an investment in agriculture may yield 5%? How about Brazilian Government Bonds or just buying an Asian Equity fund with a 6% annual yield?
    China has to be flying high after buying oil in the 40-50 range. They have to be looking at the return and say well 3% on Tbills and 20% return on oil. hmmmmmmmm

    Now let’s talk inflation.
    Prices at the local grocery store are going through the roof! I’m almost back to paying $3/gallon for premium. Prices are skyrocketing for basic commodities.

    Consumer is going to get squeezed! Green shoots are crazy to think that consumers can hold up the retail sector at ~$3 gallon gas, and food prices that are going going gone out of the park.

    No no no, Mr.Bernanke and Co. need focus on Mary and John, instead of Mr. Von Bueren and Mrs. De ….Interest rates NEED TO RISE. Inflation is certainly evident in my neck of the woods.

  • Posted by jonathan

    FTM makes a point: that 4% isn’t necessarily attractive if you foresee dollar weakness, higher future rates, etc. I’ve thought that was part of the equation over the last several months; buying short was a way of minimizing future risk while gaining short run security.

    Isn’t longer buying driven to a very large extent by the crushingly low present yields and the need to show some return? If so, this money will be pretty nervous, hoping on the one hand for more QE and praying on the other that long rates don’t spike.

  • Posted by FollowTheMoney

    @ jonathan-

    investors are also betting the u.s.a maintains AAA status by the purchase of Tbills at current rates.

    Both UK and USA have questionable AAA ratings in my opinion. But unfortunately what is AAA when you have Moodys and Standard/Poors giving the ratings???
    Absolutely worthless, Moodys lost all credibility when they had AAA on financials and insurance companies 2 years back.

    we need a global credit rating agency, not Moodys which will tilt to favor Buffet.

  • Posted by Cedric Regula

    Jonathon

    I think at some point we may see the leveraged carry trade get popular again. This is where the banks leverage their near zero cost of funds and buy the long end.

    Japan was notorious for doing this thruout the decade as well.

    The fact that players don’t seem to be doing this now indicates they are worried about something at current levels, even tho the yield curve spread is at record levels.

  • Posted by Cedric Regula

    I’m pretty sure the market will do a de-facto re-rating of USG debt before the rating agencies do. The agencies will come along after the fact same as they did with most of the financials.

  • Posted by bsetser

    On the other hand if you peg to the dollar, you are often stuck buying dollars even if you believe the dollar will depreciate over time. the decision to accumulate dollars is often made for exchange rate management reasons independent of expected local currency returns. the reserve manager then just has to choose among dollar assets, subject to the country’s reserve management guidelines …

    re: the rating agencies. they rate the risk of default, i.e. not paying your contractual commitment. nothing else. inflation that reduces the real return isn’t a risk that they directly focus on (tho if expectations about inflation push up rates creating a debt trap, that is a risk that can lead to default). the risks for the us are minimal so long as debt to GDP doesn’t rise above 80% (remember many European countries have long been a bit above the maastricht 60% criteria) and so long as the united states debt stock is denominated in dollars.

    Argentina got into truoble with a debt to GDP ratio of around 60% but that was will debt denominated in dollars not peso and an overvalued currency. adjust for the overvalaution and the debt to GDP ratio was more like 80% of GDP — and more importantly argentina was paying 11-12% or more nominal in USD to raise money, and with domestic deflation, real rates were above that. 3.75% nominal for ten year money isn’t a rate that implies a real risk of destablizing debt dynamics and a default. read bailouts and bailins (my book with roubini) to get a sense of what puts a country at risk of default. 60% debt to GDP and low nominal yields do not create a real risk so long as you are borrowing in yuor own currency. 80% puts you in a world where you have to start to worry, as any major shock could push you into a danger zone — i.e. it is a level where you would want to aim to reduce the debt to GDP ratio over time.

    that said, I am curious what those who believe the us is heading toward default/ etc recommend the uS do now? cut current spending/ raise current taxes to reduce the current borrowing need, but risking the recovery? more aggressive fiscal consolidation than implied by the obama baseline? raise future taxes? drop health care reform (and maintain the current system which generates some of the highest costs and worst outcome among the oecd countries?) have the fed raise s-term rates? signal it won’t buy any more treasury bonds/ let its balance sheet shrink if various crisis facilities are unwound? commit not to expand its balance sheet further? etc

    concretely, what you are for? reversing the counter-cyclical policies put in place? higher future taxes? spending cuts (but on what?) the current plan is to have the us gov borrow more to sustain demand to avoid a bigger fall in output — while the private sector rebuilds its balance sheet. the combined result is actually less us borrowing from the world than was the case on the pre-crisis baseline (trade deficit is smaller). but it is still too much borrowing from the world? should the US reduce the fiscal stimulus to try to bring the trade deficit down to zero?

  • Posted by Cedric Regula

    jeezus Brad…I do this for free…what am I supposed top do. Figure out how to save the world while Wall Street worries about their bonuses and Congress worries about getting re-elected?

    But I guess I do have some opinions that popped into my head over the last year or so. I’ll try and organize some cohesive thoughts and post agsin as soon as I can make whole sentences out of it.

    Also, I hate to keep repeating this, but we do have 80% debt to GDP when we add in what the USG owes the Social Security fund after borrowing all the surplus since 1983. The CBO adds that in too, so it’s not only me. If you doubt it, get your hands on some of the non-marketable treasuries held in the fund and try and cash them at your bank. Or give them to your broker. Maybe 2fish gives cash for them. But I’m pretty sure what they will say.

  • Posted by K T Cat

    Brad,

    I am curious what those who believe the us is heading toward default/ etc recommend the uS do now? cut current spending/ raise current taxes to reduce the current borrowing need, but risking the recovery?

    First, get over the notion that there is a recovery at all. Whether it’s John Q. Public, Diamond Offshore or the US Government, borrowing is living beyond your means. It makes sense if you’re buying a house, acquiring new giant welders to construct offshore oil rigs or paving roads to places yet unserved, but that’s not what we’re doing with the borrowing. Instead, we’re partying.

    If you listen to an hour of Dave Ramsey, you’ll hear stories from people who have done just that and find themselves buried in debt. For those years while they were borrowing on their credit cards, it looked like a “recovery” or “growth” but it was nothing of the sort. It was spending money they hadn’t earned.

    In reality, our naitonal standard of living is probably a good $5000 per capita lower than we think it is. Eventually the problem will correct itself, just like it does for Dave’s callers when their credit card companies won’t extend any more credit. Either they can control the situation and they start living below their means and paying off their debts or they declare bankruptcy.

    During the time they were borrowing, they lived a fantasy life. That’s what this “recovery” is. What should the US do? Start living below its means. The sooner we start, the less painful it will be. That means a lower standard of living for all of us and reductions in entitlements.

    And you can forget about that universal health coverage. We couldn’t afford it last year and we can’t afford it this year.

  • Posted by guest

    Not all countries are equal to deflationary prospect. Any forex intervention to prop up the usd from Russia MOF has to be read as a correlary additional imported inflation unless price elasticity to the imported goods.

    MOSCOW, May 20 (RIA Novosti) – Russia’s consumer prices increased 6.6% from January 1 to May 18, the country’s top statistics service Rosstat said on Wednesday.

    Russia’s inflation stood at 7.2% in the same period of last year, Rosstat said.

    Consumer price growth in Russia started to slow down in April with prices growing by only 0.7%, compared with 1.3% in March.

    Experts from the Economic Development Ministry attribute slower inflation to the decline in consumer demand, a result of the ongoing economic crisis.

    Russia’s Central Bank cut from May 14 its key lending rate by 0.5 percentage points to 12% per annum, following a slowdown in consumer price growth. Interest rates on other Bank of Russia operations were also cut by 0.5 points from May 14.

    The government expects inflation to stay below 13% in 2009, compared to last year’s figure of 13.3

  • Posted by FollowTheMoney

    Currently, there’s what i call a conspiracy of optimism about all the borrowing and spending by Mr. Obama but in the long run it’s doing more HARM than good. Some people want the immediate 6 months of sunshine, and then after the 6 months they haven’t really planned for 5 years of ice cold winter. When winter comes the closet has only shorts and tee shirts. Worse will be the roads will be covered in such deep snow making it impossible to find the warm rescue jacket.

    What we need to do?

    We need to cut spending, we need to stop playing world police man, and we need to eventually raise taxes. We also need to restructure consumer behavior, and implement some structural change in our employment sector. It’s not going to be easy, and it’s going to take a lot longer than most posters on this board assume.

    HealthCare & Alt. Energy

    We do however need to invest in restructuring Health Care (to an EU/Canadian platform) and continue to invest in Technology and Alternative Energy. Everyone needs a right to basic treatment, and a right to attend university. Education and Science are my AAA for prescription for the United States.

    However:

    The current plan of trying to keep interest rates low, by inflating the money supply is dangerous. Not only could we upset foreign creditors, but in the long run we will surely have a devalued currency (hurting those that save). We also risk the potential for very severe inflation which may already be evident. As dollar continues being devalued=oil continues to move up, thus hurting the spending power of the Green Shoots movement.

    United States of Europe?

    In the last 12 months the United States looks more like Europe than Europe looks like the 2009 United States. The United States Government now owns the majority of numerous financial firms, auto makers, insurance giants and mortgage companies. We have added long term liabilities which will be very difficult to re-pay.

    Obama Comment

    Sometimes we just need to bite the sour apple and at this point risk the recovery. Continuing the current economic prescriptions are bad for nation which as Obama himself puts it is “basically broke”.

    Continuing the Current “spend prescription”

    Deflation or inflation both of those are going to end badly. The Fed is throwing the world at trying to end deflation but if this continues it will end much worse than had we just left the market alone. In my opinion, it will end in inflation, a take away of AAA and or a collapse of the dollar as foreigners pull dollar denominated assets from the market.

    Only Time will Tell.

  • Posted by Cedric Regula

    A lot of this is going completely against my Young Republican training, but I’ve slowly morphed into a disenfranchised independent over the years anyway.

    The crux of the problem is we have a short term problem of poor economy and unemployment, and its difficult to do anything worthwhile and intelligent quickly. So for that reason, I think we are stuck funding the safety nets.

    There are longer term structural issues that also need government planning, direction, legal streamlining, and probably loans or funding.

    So here’s a mishmash of ideas and wishlist.

    1) Make current taxes very progressive now. Rich people will scream and find out there is nothing they can do about it.

    2) The financial industry needs downsizing. Right now we are having the taxpayer pay for all the bad paper out there, plus support stock and bond values. This is unaffordable. I don’t have the detailed knowledge to propose credible alternatives, but other ways have been proposed.

    3) The idea of reducing mortgage principal rather than interest rates makes some sense because it would reduce the incentive for people to walk on their mortgages.

    4)If we need some FDR style makework programs, there is 2000 miles of border fence that needs building.

    5) Nuclear power is the only large scale way we can economically cut global warming way down(replacing coal plants) and longer term provide enough power for plug-in hybrids and reduce our foreign oil bill.

    6) Forget cap and trade. It’s a regressive tax and it not a solution for global warming. Unless of course it completely kills the economy and we all eat each other.
    I also have some doubts about whether the science behind global warming is complete or valid. The Greens say there is no discussion on the point. The government agrees because the Greens sold the “solution” as a tax increase. I think we need to re-visit that process.

    7) Make old people retire and give the jobs to young people. I just read things are working the other away around lately because of fear of age discrimination suits.

    8) Warren Buffet’s trade voucher idea still sounds good to me.

    9) Follow thru with G-7 plans on global financial regulation

    10) Health care needs reform, but heavy on the cost reduction side. With the state of private and government finances it’s not realistic to think we are going to expand coverage and costs.

    Here’s a controversial one. Medicare is identified as the biggest threat to bankrupt the government. I read that 30% of the costs are spent on patients in their last month of life. Reduce the cost of dying!

    11) Stop trying to fix everything by doing helicopter drops of money on top of banks.

    There’s more but I’m tired or typing.

  • Posted by bsetser

    cedric — i should have been more precise and said marketable treasury or marketable debt to GDP ratios. there isn’t much evidence the market is moved by changes in future implicit liabilities (see the market impact of W’s prescription drug benefit)

    kt cat — no recovery presumably implies deflation, i.e. shrinking nominal GDP. and shrinking nominal GDP + an existing fiscal deficit equals a rising debt to GDP ratio over time. to assure a stable debt to GDP ratio would you cut spending/ raise taxes now to avoid that, risking a pre-cyclical fiscal policy reaction?

    incidentally, I don’t see much evidence that the US is currently borrowing to throw itself a party, unlike in say 06 or 07 when that was very much the case — higher oil? No problem, lets borrow more to keep buying more of everything else. consumer spending last i checked was down substanially y/y. industrial prod is down substantially y/y too. not exactly a party.

    re: entitlements, fully funding social security benefits at current levels takes about 1% of US GDP over the life of the program if memory serves. us could certainly afford that and still have tax levels below european levels. soc security isn’t ruinously expensive; it just requires a somewhat higher level of taxes over time. medicare on current cost growth trajectories is a different story.

  • Posted by Twofish

    Cedric: If you doubt it, get your hands on some of the non-marketable treasuries held in the fund and try and cash them at your bank.

    The US government doesn’t sell SSN treasuries, but the point is that it could, and if it did swap those Treasuries for something of value, it wouldn’t have any problem selling them.

    KT Cat: First, get over the notion that there is a recovery at all. Whether it’s John Q. Public, Diamond Offshore or the US Government, borrowing is living beyond your means.

    That makes no sense at all. When you put money into a bank, that’s the bank borrowing your money and investing it in something that presumably will allow them to return the money to you with interest. Borrowing money is not a bad thing, if you borrow it for something productive.

    KT Cat: During the time they were borrowing, they lived a fantasy life. That’s what this “recovery” is. What should the US do? Start living below its means.

    This is the mistake that people made that caused the depression to be much worse than it had to be. A nation is not a household, what makes sense for an individual makes no sense for a nation. If an individual cuts back, this is a good thing because it leaves more resources for investment. If everyone ends up cutting back, then you are using the investment for anything, and you end up suffering for nothing.

    KT Cat: That means a lower standard of living for all of us and reductions in entitlements.

    This is disastrous since it means zero investment in technology or wealth generating activities. The problem is that people think that for there to be gain, there must be pain, not recognizing that you can have lots of pain, but no gain.

    Part of the reason I don’t buy this is Mao. Mao came into power with the notion that if everyone sacrificed for the common good, that there would be massive wealth. Everyone sacrificed and you have thirty years of economic misery. Now Deng comes along and says that it’s a great thing to be rich, and things start working.

    You have massive amounts of borrowing and debt in China. Banks borrow from consumers to build factories that allow them to repay the loans to consumers. It’s not borrowing that is bad, but the direction of the borrowing.

  • Posted by Twofish

    FollowTheMoney says: Continuing the current economic prescriptions are bad for nation which as Obama himself puts it is “basically broke”

    First of all, the US is nowhere near broke. It’s got economic problems, like every other nation that has existed or will exist, but most countries would gladly exchange their problems for the one’s the US has.

    Second, there are no perfect policies. All policies are bad, and you just need to find the ones that are less bad. There is a danger of inflation with massive government spending, but it is much, much less risky than the alternative. We tried that in 1930, it was a disaster. Maybe this policy will also be a disaster, but it’s not crazy to look at something that didn’t work, and to do the opposite.

    If all you offer is unavoidable doom and gloom, then we lose absolutely nothing by trying something else first on the off-hand chance that it may make things better. If we are doomed whatever we do, then I say go down fighting.

    FollowTheMoney says: Deflation or inflation both of those are going to end badly.

    It’s called the business cycle.

    Since one day people think that we are going to die from inflation and the next day people think that we are going to die from deflation, has anyone considered the weird possibility that everything will end up balancing and we are going to end up fine?

  • Posted by Cedric Regula

    Brad:”there isn’t much evidence the market is moved by changes in future implicit liabilities ”

    Congress borrowed against the fund, i.e. the SURPLUS was spent in the year received. That is NOT implicit, nor is it future liability. It was the piggy bank for the aging demographic (re-designed by Greenspan in 1983), but Congress got their hands on it. They also pay 2% on the loan.

    So from that standpoint, that part of the debt is at a very low fixed cost, and therefore would not contribute to a “debt trap” scenario like we may get with the marketable portion of debt rolling over at much higher rates.

    But when the surplus stops coming in due to a retiring demographic, the Treasury will need to sell real Treasuries in the open market (the Fed will be out of business by then) and put cash in the fund so they can write SS checks that will clear when us old foggies present the check at a commercial bank.

  • Posted by Twofish

    FollowTheMoney: Some people want the immediate 6 months of sunshine, and then after the 6 months they haven’t really planned for 5 years of ice cold winter.

    It’s because past a certain point, there is really nothing you can do, and if you have a situation where you are doomed, then there is no point in planning or thinking about it. The only thing that are worth planning for are things in which planning makes any real difference.

    Once you reach a certain point, it doesn’t matter. If I end up with personal debts of $10 million then it doesn’t make a difference if I’m $10 million in debt or $10 billion in debt. It’s all the same to me.

    FollowTheMoney: It’s not going to be easy, and it’s going to take a lot longer than most posters on this board assume.

    And politically it’s going to be impossible to do anything long term if you are in the middle of a crisis. In order to restructure any sort of system, it takes *decades*, and that becomes impossible if you have 15% unemployment. In any sort of quasi-democratic system, you have about two to three years to show that you can make things better before you get thrown out.

    And after you’ve restructured things, you’ve invariably created new problems.

  • Posted by --Andrew

    I’m in no way a professional and I apologize for the unorganized nature of what follows. However, in my uneducated view the US needs to deal with the crisis in front of it before worrying about the later problems, if the current rock sinks us the ones on the horizon won’t matter. That means the US needs to simulate the economy first and, be mindful of, but worry about, public debt load and inflation later. I have often read that in bankrupt companies (and economic downturns) it is easier and more economically effective to stabilize and bail out than it is to rebuild from absolute rock bottom. In other words, it is hard to fix things once the eggs have been broken and scrambled together. However, this by no means we should coddle, risk holders – shareholders, bondholders, management get haircutted/booted — failure means everyone sacred cows are at risk to getting slaughtered at the public trough.

    On the question of domestic versus external economic focus, I think the US has the need, not to mention luxury of being able, to concentrate on the domestic. It is not facing a currency collapse and is self-funding currently with domestic dollar denominated treasury purchases, as you have mentioned. As important as the external is, it is secondary to having a healthy domestic economy. You can’t pay back external debts if you do not have an economy (or a trade surplus for that matter — I’m ruling out asset transfers from the US here, gold, natural resources, etc. as I assume most folks would) In this context I think that it is going to be interesting to see what the Federal Reserve will do purchasing long term treasuries to keep interest rates low or will they let the dollar drop (a devalued dollar as you have often pointed out will help restore trade balance). This will also probably help shake off the central banks who are pegging to the dollar. That being said I think that the emerging economies that maintain a peg through any dollar downturn will be facing huge international protests and pressure to revalue (not to mention howls of protest internally due to the falling value of their reserve portfolio, which I am not unsympathetic to, but this needs to be rebalanced in some form and will happen in some way regardless of their protests — I seem to recall you commenting on the burgeoning inflation that was happening in China due to their peg back in, I think, 2007. Squeeze the financial balloon and it’ll simply pop out in a different area.). They are going to have to deal with it anyways regardless with what the US government/Fed does due to the increasing saving rate/decreasing consumption of the US consumer — The demand that they have counted on is going away. In particular, this will probably come back to haunt China, again as you have pointed out, the largest international exporter/surplus producer.

    The US also needs to restore faith in the markets by doing a FDIC-like nationalizing clean-up of the still insolvent entities in the now relatively stabilized financial system while sensibly re-regulating. As the SEC motto says “Sunshine is the best disinfectant.”

    This all being said the US should at least try to keep a wary eye out for the next boulder likely to hit us in the current financial rock slide, it is simply prudent. The US Fed and Treasury will have to back off on the throttle when the economy is no-longer on life support, but they will have to do so extremely carefully to avoid tanking the economy while at the same time reining in liquidity and potential inflation. I think the US Federal Government also needs to realistically commit to the long term paying down of the debt taken on during this crisis.

  • Posted by FollowTheMoney

    TwoFish-

    Ever think that your risking not only economic recovery but also an economic currency crisis?

    History shows the Weimer Republic had some Calm before the Storm when she initially started printing away as well.

    I think there’s more troubles ahead, and just to add to the outright fundamental deterioration, i’ll add a good ole fashioned conspiracy w/ humor:). Let’s play with the numbers. wasn’t the 52 wk low on the S&P500, 666? Isn’t this a warning from the beast? Could the beast be slowly be preparing to attack?

    Dear Twofish,

    “Woe to you, Oh Earth and Sea, for the DEVIL sends the BEAST with wrath, because he knows the time is SHORT…
    Let him who hath understanding reckon the number of the beast for it is a human number, its number is Six hundred and
    sixty six….”

  • Posted by bsetser

    cedric — i agree. repaying the soc sec trust fund implies issuing more treasuries as their existing treasuries mature. it is a predictable, real obligation of the us gov. the question is whether this obligation really impacts the market in the same way as an increase in current supply. say you cut soc sec benefits so the trust fund last longers/ there is less ongoing pressure to borrow (or raise taxes/ cut spending) to repay the trust fund after say 2025. would that change current yields?

    Andrew — glad you remember how much trouble a truly weak dollar posed for all the dollar peggers back in 07/ early part of 08! how would you handle the banks exactly? rip up the stress tests and declare some of the banks that passed insolvent? and then do you pass losses onto bond holders/ holders of s-term paper to limit the “clean-up” costs to taxpayers? or do you protect bondholders to avoid the risk of renewed panic?

  • Posted by Cedric Regula

    Brad:

    I don’t think the bond market could figure out the impact on rates due to adjustments in payout. It’s kind of a horseshoe and handgrenades thing. But the CBO quotes the entire number…$11T at present. And I don’t think other countries split things out separate either so they can print lower numbers in OECD reports. Besides, Cheney drops the SS part whenever he speaks of the national debt, so we know that can’t be good.

    Besides, I think the most likely way things turn out is they will increase the medicare deduction that is charged against the social security payment. Right now I think they charge about $250 against a check of around $2000. Since I won’t see one for quite some time yet, I’m budgeting for 100% of my SS check being deducted for medicare. Not sure everyone is doing it that way tho.

  • Posted by don

    Don’t TIPs returns tend to overstate expected inflation when deflation is a possibility, owing to the asymmetric result that TIPs yield the same return as nominal bonds in case of actual deflation? This makes them more attractive than true real return bonds.

  • Posted by ReformerRay

    Brad Setser says: “should the US reduce the fiscal stimulus to try to bring the trade deficit down to zero?”

    No because that is only a temporary solution. A permanent solution is needed. The U.S. must first change its policy. Equal trade must become the goal of U.S. trade policy before the trade deficit is reduced.

    A permanent solution is to set up a system which imposes tariffs of manufactured imports from those countries that insist on a trade surplus with the U.S. The U.S. must say, “We do not wish to trade with any nation on the basis that they sell more to us than we sell to them”. Incedentally, that policy would be advisable for all nations to adopt. With equal trade, all nations could be assured that an increase in trade will benefit their economy.

  • Posted by ReformerRay

    Bester sez: “Andrew — glad you remember how much trouble a truly weak dollar posed for all the dollar peggers back in 07/ early part of 08! how would you handle the banks exactly?”

    By distinguishing between those debts the federal government should assume responsibility for and those they should not.

    The Futures Modernization Act of 2000 required that derivatives and some other fancy “instruments” be exempt from regulation. That act was passed to satisfy those who wanted to escape regulation.

    If an activity deserves to not be regulated by the Federal government, it deserves not to be assumed or paid for by the Federal government.

    So, just go through the 2000 Act – list all the activities excluded from regulation – and declare that no more Federal money can be passed through to be used to pay any of the debts related to unregualated activities on this list.

    Then just enforce that decree. And allow chips to fall as they may. No need for the government to say which Bank is insolvent. Let the market decide.

  • Posted by Biofuel

    The principle must be whoever benefited the most from the boom must help out the most during the bust. Where there is will, there is way. If it’s bondholders, so be it.

    I would like to also see the following:

    - Forgive all federal student loans. Plentiful and generous grants for tuition and living expenses to students studying engineering and natural sciences.

    - Directs grants to medium to small businesses/universities/etc for innovation (any sort of innovation), through competition with a review process of course – the review being done by other small businesses. Use NIH/NSF review process as a model.

    - Business start up money plentiful through a competition as above

    - 10 billion $/year to NASA to do whatever they wish to do; 20% of that for salaries (50bil $ over 5 years – a drop in a bucket in comparison of what is being spent right now)

    - Ditto for NSF…

    - Bust monopolies: Miscrosoft has outlived its usefulness; bust Walmart

  • Posted by Glen M

    I would replace Obama’s financial advisers with Peter Morici and let him figure it out.

  • Posted by FollowTheMoney

    I like BIOFUEL! Great commentary. Great addition to the community.

    BIOFUEL. I agree education, technology and start up capital to “young go-getters”.

  • Posted by RebelEconomist

    don,

    I think the issue you raise only applies if there is net deflation over the previous life of any particular TIPS. I dare say that most of the outstanding TIPS already have a cushion of inflation uplift from previous years, so I doubt whether it is a major issue.

  • Posted by Howard Richman

    I second Cedric’s 8th point: ” :-) Warren Buffet’s trade voucher idea still sounds good to me.”

    In our book “Trading Away Our Future” we propse a Program for a Strong America. It basically consists of two parts:

    1. An Import Certificates plan (like Buffett’s trade voucher plan) to balance trade.

    2. Moving the tax system to a consumption tax to encourage savings.

  • Posted by K T Cat

    Man, go away for a while and look at what happens!

    Here’s my short response to all the kind people who took the time to respond to me.

    Borrowing makes sense if it increases your future wealth. That is, it makes sense to borrow to pave roads that open access to natural resources. It does not make sense to borrow to extend entitlements in the US in 2009. Your entitlement spending isn’t going to generate the future revenues to pay back those debts. You’re simply living beyond your means and that never works for long.

    Whether you want it to or not, this borrowing will stop.

  • Posted by Al Havermann

    Bsetser said:

    concretely, what you are for?

    Actually, that would intense prosecution of those at the major banks, the Treasury and the Fed including former Secretaries. And then of course, a return to the rule of law and maybe even the Constitution.

  • Posted by Howard Richman

    Brad,

    I am glad that you are open to suggestions right now. But you don’t need to look any further than John Maynard Keynes for a solution.

    He predicted the disaster that eventually occurs in a trade-deficit country that ignores its trade deficits, as the United States has been doing. In his General Theory of Employment Interest and Money he wrote:

    “(A) favorable balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression” (p. 338).

    One of Keynes solutions for a trade deficit country was to subsidize exports and restrict imports in order to balance trade, just as in Buffett’s Import Certificates plan.

  • Posted by Howard Richman

    Glen wrote:

    “I would replace Obama’s financial advisers with Peter Morici and let him figure it out.”

    I agree with Glen about Morici. I would add Warren Buffett and Ralph Gomory to his list.

  • Posted by Glen M

    Throw in a couple of Richman’s for good measure. 8)

  • Posted by Twofish

    ReformerRay: By distinguishing between those debts the federal government should assume responsibility for and those they should not.

    The trouble is that the economy is interconnected enough so this is basically impossible. If someone takes “responsible money” and turns it into “irresponsible money” and you disclaim “irresponsible money” then you still haven’t solved the problem, since you have this nasty domino effect.

    ReformerRay: The Futures Modernization Act of 2000 required that derivatives and some other fancy “instruments” be exempt from regulation.

    No it didn’t. The name of the bill was the Commodities Futures Modernization Act, and the act basically said that things like mortgages and interest rate swaps were not commodity futures and hence were regulated by the SEC and not the CFTC. By contrast, in the US, currency and stock index futures *are* commodity futures and hence regulated by the CFTC and SEC.

    The SEC did a horrible job regulated derivatives, but I don’t see that the CFTC would have done any better. Traditionally, the CFTC has been more lax at things like capital requirements than the SEC.

    Also, there isn’t a clear distinction between “regulated” and “unregulated”. For example, you or I couldn’t go to a bank and by a CDS, and a bank in the US couldn’t sell most individuals any sort of derivative. Remember that the cause of this mess was an AIG group in London, and they were in London because what they were doing there would have been flatly illegal in the US.

    So let’s make it illegal in England? Well driving on the left side of the road is flatly illegal in the US, that doesn’t mean it should be banned in England. The derivatives market in England is far, far bigger than the United States because derivatives are used for things in Europe that would be used for mutual funds in the US.

    In England, you can go to a bank and buy a contract that pays the value of a stock index. In the US, you can’t. You can’t go to your Citigroup branch and buy an index fund, you have to go to Fidelity or Vanguard to do that, and they’d like to keep it that way.

    Part of what makes regulation so messy, is that you just can’t think nationally. AIG-FP existed as this mutant frankenstein monster that used a gap in US Federa/New York State/English/German law, and if you have such huge problems coordinating US and English governmental and economic policy (with several hundred years of shared history and culture), just wait until you bring the Chinese and the Saudis into the picture.

    Also decisions in other countries affect US decisions, and vice versa. The US Treasuries and FDIC had to give guarantees on US bank deposits because once Europe did it, people were pulling money out of US banks and putting it into European banks.

    ReformerRay: That act was passed to satisfy those who wanted to escape regulation.

    No it wasn’t. It as a “custody agreement” between the SEC and the CFTC. The only reason it gets mentioned was that it was part of a political effort by Republicans to blame the mess on Clinton.

    ReformerRau: So, just go through the 2000 Act – list all the activities excluded from regulation – and declare that no more Federal money can be passed through to be used to pay any of the debts related to unregualated activities on this list.

    Who declares this? This reason I mention this is that a lot of the solutions that people mention require that the US have a Stalin or Mao figure that could make a declaration and have it stick.

    No one in the US except for maybe for Congress could make that sort of declaration, and that involves getting several hundred people to agree to it.

    And even if you made that declaration, no one is going to believe it. The thing about “moral hazard” is that you can swear up and down that you won’t do a bailout, but everyone figures that in a crisis, you will do it anyway, because if you don’t, you will get fired and be replaced by someone that will.

    ReformerRay: Then just enforce that decree. And allow chips to fall as they may. No need for the government to say which Bank is insolvent. Let the market decide.

    What market?

    Once the banks start collapse, there is no more market. The financial markets consist of banks and similar institutions making trades with each other. Once banks fail, the market stops existing. This is why I was seriously alarmed Q4-2008. Now the danger of market destruction has passed.

    One has to distinguish between a drop in the market and a market failure. If the SP500 drops to 500, this may not be a bad thing as long as people are still buying and selling stocks. If you run into a situation, in which the markets are basically closed for business, then this does become alarming.

  • Posted by Twofish

    ReformerRay: No because that is only a temporary solution. A permanent solution is needed.

    I don’t think that there is such a thing as a permanent solution in economics. Today’s solutions become tomorrow’s problems. All the stuff that Obama is doing right now is going to cause huge, huge problems down the road.

    This may be because I’ve very heavily influenced by classicial Chinese thinking about history. Western historical thinking since the 19th century has always assumed that things move toward some goal, whereas traditional Chinese thinking sees history in terms of cycles.

    There is an Western assumption that cycles such as those between credit boom/credit bust and those between regulation/deregulation are bad, whereas one reason I tend to want to live with them and manage cycles rather than eliminate them is because the cure ends up being worse than the disease.

  • Posted by DJC

    “Geithner to Beijing: Keep buying our debt”

    “”We have lent a massive amount of capital to the United States, and of course we are concerned about the security of our assets,” (Chinese Premier)Wen said. “I do indeed have some worries.”"

    You better have some worries! I pity the fool holding 30 year Treasuries for 30 years…that’s nuts…

    Chinese are moving out of long and into short T’s, smart move until they can get out completely.

    The great sell off is coming; if not already here.

    http://www.reuters.com/article/topNews/idUSTRE54Q5SX20090527

  • Posted by Rien Huizer

    Brad,

    The peggers do not have to buy bonds, they can achieve their objectives in the short end of the market. Bonds are for very specific audiences, like pension funds, other legitimate hedgers of long term liabilities, and speculators. CBs are not supposed to speculate and they have no (forseeable) long term USD liabilities. Currently the market is looking for the level that expresses the normal audience’s risk/return appetite and that appears to be that long term treasuries are too expensive. Maybe next week the think they are too cheap. I think we are reading too much into these short term movements. But, but, finally the foreigners are no longer underpinning (artificially low) long term interest rates. Pity this did not happen some five years ago, that would have saved the world (US inlcuded) a lot of trouble.

  • Posted by a

    2Fish: “If all you offer is unavoidable doom and gloom, then we lose absolutely nothing by trying something else first on the off-hand chance that it may make things better. If we are doomed whatever we do, then I say go down fighting.”

    Once again you make “doom” unique. According to you, there is “doom” – one kind and that’s all. Sorry, there are gradations in all things, including doom. There is:

    1/ 1907 Depression
    2/ 1930s Depression
    3/ 1840s Ireland
    4/ French Revolution
    5/ Russian Revolution
    6/ Sacking of Rome

    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.)

    Again and again you argue that acting irresponsibly doesn’t matter, because no matter what, the alternative is doom. This is a strategic error of the first order, and it’s exactly the kind of reasoning which makes things worse rather than better.

  • Posted by K T Cat

    Another short answer to the original question. State and corporate debts are separate from me. That is, California is going through fiscal spasms*, but it won’t have a direct effect on me. If the US does the same, I’m in real trouble because they control the currency.

    With a $1.8T deficit and the size of my family, Obama took out a $36,000 loan in my name this year. And just what did I buy with that? Did I buy anything that will help me pay down that debt in the future? No, we bought GM. And windmills. And high speed rail from LA to Las Vegas. And health care for people who haven’t earned it. I wouldn’t have bought that garbage if it was free.

    Like it or not, though, I’ll have to find a way to service and pay down that $36,000. Next year Obama will make me borrow another $24,000 to buy similar trash. Having personally crawled out of debt before, I know what it’s going to take and it won’t be pretty.

    Get ready for a much lower standard of living.

    * – California is the ultimate rebuttal to those who blame our fiscal woes on military spending and low taxes.

  • Posted by bsetser

    Rien — well, central banks don’t have to buy bonds, but some do need a bit of income if they want to be (financially) independent …

    China and other over reserved CBs do effectively have long-term $ exposure though. They have some s-term liquidity needs, but given that they opted to put a lot of their portfolio in things like agency MBS and equites before the crisis, they clearly believe that they have all the actual liquid assets they really need …

    agree that central banks might have done the world a service by buying fewer long-term bonds five years ago.

  • 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 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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