Back in the old days (pre-1980s), the term systemic risk did not refer to contagion of illiquidity within the financial sector alone. Back then, when the real economy was much more important than low margin, unglamorous banking, it was understood that the really scary systemic risk was the risk of contagion of illiquidity from the financial sector to the real economy of trade in real goods and real services.
If you think of it, every single non-cash commercial transaction requires the intermediation of banks on behalf of – at the very least – the buyer and the seller. If you lengthen the supply chain to producers, exporters and importers and allow for agents along the way, the chain of banks involved becomes quite long and complex.
When central bankers back in the old days argued that banks were “special” – and therefore demanded higher capital, strict limits on leverage, tight constraints on business activity, and superior integrity of management – it was because they appreciated the harm that a bank failure would have in undermining the supply chain for business in the real economy for real people causing real joblessness and real hunger if any bank along the chain should be unable to perform.
As the “specialness” of banks eroded with the decline of the real economy (and the migration globally of many of those real jobs making real goods and providing real added-value services to real people), the nature of systemic risk was adjusted to become self-referencing to the financial elite. Central bankers of the current generation only understand systemic risk as referring to contagion of illiquidity among financial institutions.
They and we all are about to learn the lessons of the past anew.
We are now starting to see the contagion effects of the current liquidity crisis feed through to the real economy. We are about to go back to the bad old days. Whether the zombie banks are kept on life support by the central banks and taxpayers of the world is highly relevant to whether the zombie bank executives pay themselves outsize bonuses and their zombie shareholders outsize dividends with taxpayer money. It appears sadly irrelevant to whether the banks perform their function of intermediating credit and commercial transactions in the real economy along the supply chain. The bailout cash and executive and shareholder priorities do not seem to reach so far.
The recent 93 percent collapse of the obscure Baltic Dry Index – an index of the cost of chartering bulk cargo vessels for goods like ore, cotton, grain or similar dry tonnage – has caused a bit of a stir among the financial cognoscenti. What is less discussed amidst the alarm is the reason for the collapse of the index – the collapse of trade credit based on the venerable letter of credit.
Letters of credit have financed trade for over 400 years. They are considered one of the more stable and secure means of finance as the cargo is secures the credit extended to import it. The letter of credit irrevocably advises an exporter and his bank that payment will be made by the importer's issuing bank if the proper documentation confirming a shipment is presented. This was seen as low risk as the issuing bank could seize and sell the cargo if its client defaulted after payment was made. Like so much else in this topsy turvy financial crisis, however, the verities of the ages have been discarded in favour of new and unpleasant realities.
The combination of the global interbank lending freeze with the collapse of the speculative, leveraged commodity price bubble have undermined both the confidence of banks in the ability of a far-flung peer bank to pay an obligation when due and confidence in the value of the dry cargo as security for the credit if liquidated on default. The result is that those with goods to export and those with goods to import, no matter how worthy and well capitalised, are left standing quayside without bank finance for trade.
Adding to the difficulties, letters of credit are so short term that they become an easy target for scaling back credit as liquidity tightens around bank operations globally. Longer term “assets” – like mortgage-back securities, CDOs and CDSs – can’t be easily renegotiated, and banks are loathe to default to one another on them because of cross-default provisions. Short term credit like trade finance can be cut with the flick of an executive wrist.
Further adding to the difficulties, many bulk cargoes are financed in dollars. Non-US banks have been progressively starved of dollar credit because US banks hoarded it as the funding crisis intensified. Recent currency swaps between central banks should be seen in this light, noting the allocation of Federal Reserve dollar liquidity to key trading partners Brazil, Mexico, South Korea and Singapore in particular.
Fixing this problem shouldn't be left to the Fed. They aren't going to make it a priority. Indeed, their determination to accelerate the payment of interest on reserves and then to raise that rate to match the Fed Funds target rate indicates that the Fed are more likely to constrain trade finance liquidity rather than improve it. Furthermore, the Fed may be highly selective in its allocation of dollar liquidity abroad, prejudicing the economic prospects of a large part of the world that is either indifferent or hostile to the continuation of American dollar hegemony.
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If cargo trade stops, a whole lot of supply chain disruption starts. If the ore doesn’t go to the refinery, there is no plate steel. If the plate steel doesn’t get shipped, there is nothing to fabricate into components. If there are no components, there is nothing to assemble in the factory. If the factory closes the assembly line, there are no finished goods. If there are no finished goods, there is nothing to restock the shelves of the shops. If there is nothing in the shops, the consumers don’t buy. If the consumers don’t buy, there is no Christmas.
Everyone along the supply chain should worry about their jobs. Many will lose their jobs sooner rather than later.
If cargo trade stops, the wheat doesn’t get exported. If the wheat doesn’t get exported, the mill has nothing to grind into flour. If there is no flour, the bakeries and food processors can’t produce bread and pasta and other foods. If there are no foods shipped from the bakeries and factories, there are no foods in the shops. If there are no foods in the shops, people go hungry. If people go hungry their children go hungry. When children go hungry, people riot and governments fall.
Everyone along the supply chain should worry about their children going hungry.
When that happens, everyone in governments should worry about the riots.
Controlling access to trade finance determines who loses their jobs, whose children go hungry, who riots, which governments fall. Without dedicated focus on the issue of trade finance and liquidity from those in the emerging world most interested in sustaining the growth of recent years, little progress can be expected.Trade finance is rapidly communicating the stress on bank liquidity to the real economy. It presents a systemic risk much more frightening than the collapsing value of bits of paper traded electronically in London and New York. It could collapse the employment, the well being and the political stability of most of the world’s population.
The World Trade Organisation hosted a meeting on trade credit in Washington Wednesday to highlight the rapid and accelerating deterioration in trade finance as an urgent priority for public policy.
I look at the precipitous collapse of the Baltic Dry Index and I wish them Godspeed.
Further reading:
WTP warns of trade finance ‘deteriorating’ amid financial crisis
Cost of some trade finance deals up sixfold – WTO
Shipping holed beneath the water line
Shipowners idle 20 percent of bulk vessels as rates collapse
Friday, 14 November 2008
Friday, 7 November 2008
The Fed doubles its balance sheet - above $2 trillion in just 5 weeks
Think about that. If any commercial or investment bank had been seen to do that, it would become an instant leper in the credit markets. It is a truism that banks go bust by writing business that wiser banks rejected, and so grow their balance sheets faster. As a young bank supervisor I was told that the surest way to spot a potential bank failure was to look for outliers in asset growth.
Had anyone at the Fed or FSA been brought up in the old school, they would have seen Countrywide and Northern Rock coming a mile off. Perhaps they did, but in the new Friedmanite culture of forbearance and free markets, and Basle II risk models, they decided to let capitalism run its disastrous course rather than take unpopular decisions about constraining the prerogatives of over-compensated executives and shareholders.
And now we have the Fed doubling its balance sheet in just five weeks. It is exactly by taking on the assets of the banking sector that are otherwise unmarketable that the Fed has grown its balance sheet. And it is by doing this while indulging the banks in continued oversized dividends and executive bonuses that leads me to believe the policy must ultimately fail to either correct the problems in the US banking sector or sustain the credibility of the Federal Reseve as a prudential supervisor and lender of last resort.
Dallas Fed President Richard W. Fisher has speculated that the balance sheet could expand to $3 trillion by January:
At the same time the Fed has equalised the interest it pays on reserves deposited in the Fed and the Fed Funds target rate. That undermines any incentive to interbank lending, virtually ensuring that banks will prefer to hold their cash as reserves at the Fed rather than as lending exposures to one another. On the other hand, according to a Fed research note from August, it allows the Fed to supply greater liquidity for market needs without the risk of pushing lending rates below target rates.
In contemplating the anomalies of this policy, it occurred to me that it might be aimed at reinforcing the dollar by drawing reserve balances to the Fed in preference to other central banks as they follow the Fed by cutting rates this week. Perhaps the Fed is pre-emptively combating dollar capital flight, or perhaps it is a further extension of the "ring fence" tactic of drawing assets to the US in contemplation of future insolvencies to secure advantage for US creditors over global peers.
As Sam Jones at FTAlphaVille commented yesterday:
This is uncharted territory for a central bank of a reserve currency. I suspect, however, that these moves play into the strategy of the Paulson Plan survivor bias. As someone reminded me recently, Mr Paulson's primary objective at Goldman Sachs was to outperform peers in both good times and bad times. If profits were to be made, he wanted Goldman to have more of them. If losses must be booked, he wanted Goldman to have less of them. He seems to have taken the peer outperformance strategy global with the Paulson Plan.
.
Hat tip to FTAlphaVille for posting relevant Fed insights yesterday and today:
The mother of all balance sheets
Fed capitulates: the central bank is broken
Had anyone at the Fed or FSA been brought up in the old school, they would have seen Countrywide and Northern Rock coming a mile off. Perhaps they did, but in the new Friedmanite culture of forbearance and free markets, and Basle II risk models, they decided to let capitalism run its disastrous course rather than take unpopular decisions about constraining the prerogatives of over-compensated executives and shareholders.
And now we have the Fed doubling its balance sheet in just five weeks. It is exactly by taking on the assets of the banking sector that are otherwise unmarketable that the Fed has grown its balance sheet. And it is by doing this while indulging the banks in continued oversized dividends and executive bonuses that leads me to believe the policy must ultimately fail to either correct the problems in the US banking sector or sustain the credibility of the Federal Reseve as a prudential supervisor and lender of last resort.
Dallas Fed President Richard W. Fisher has speculated that the balance sheet could expand to $3 trillion by January:
“You can see the size and breadth of the Fed’s efforts to counter the collapse of the credit mechanism in our balance sheet. At the beginning of this year, the assets on the books of the Fed totaled $960 billion. Today, our assets exceed $1.9 trillion. I would not be surprised to see them aggregate to $3 trillion—roughly 20 percent of GDP—by the time we ring in the New Year.”
At the same time the Fed has equalised the interest it pays on reserves deposited in the Fed and the Fed Funds target rate. That undermines any incentive to interbank lending, virtually ensuring that banks will prefer to hold their cash as reserves at the Fed rather than as lending exposures to one another. On the other hand, according to a Fed research note from August, it allows the Fed to supply greater liquidity for market needs without the risk of pushing lending rates below target rates.
In contemplating the anomalies of this policy, it occurred to me that it might be aimed at reinforcing the dollar by drawing reserve balances to the Fed in preference to other central banks as they follow the Fed by cutting rates this week. Perhaps the Fed is pre-emptively combating dollar capital flight, or perhaps it is a further extension of the "ring fence" tactic of drawing assets to the US in contemplation of future insolvencies to secure advantage for US creditors over global peers.
As Sam Jones at FTAlphaVille commented yesterday:
There’s a big danger here for the Fed: that it is trying to catch a falling knife. The Fed is risking things it’s never risked before. That’s not to say we’re in apocalyptic territory at all; consider the firepower the Fed has behind it. It is though, to use a hackneyed, but apt phrase, paradigm shifting.
In Japan, where quantitative easing failed, the central bank’s balance sheet swelled to a size equivalent to 30 per cent of GDP. The Fed’s balance sheet is currently equivalent to 12 per cent of GDP.
This is uncharted territory for a central bank of a reserve currency. I suspect, however, that these moves play into the strategy of the Paulson Plan survivor bias. As someone reminded me recently, Mr Paulson's primary objective at Goldman Sachs was to outperform peers in both good times and bad times. If profits were to be made, he wanted Goldman to have more of them. If losses must be booked, he wanted Goldman to have less of them. He seems to have taken the peer outperformance strategy global with the Paulson Plan.
.
Hat tip to FTAlphaVille for posting relevant Fed insights yesterday and today:
The mother of all balance sheets
Fed capitulates: the central bank is broken
Change I can't quite believe in
I wanted Obama to win. I really, really, really wanted Obama to win. McCain/Palin gave me nightmares. Just about the whole world held it’s collective breath willing Obama to win on Tuesday.
Obama’s election is powerful confirmation that America remains a land of opportunity, a democracy where power is allocated at the ballot box. It reassured the world that despite the lawlessness and arrogance of the past eight years, Americans are capable of enlightened, rational self-determination. It restores hope in much of the world that America can reorient itself toward tolerance and dialogue.
For all of that, I haven’t been happy since watching Obama’s acceptance speech live Wednesday morning on the BBC.
I have a bad feeling that America has just elected its Tony Blair. The package of Change the voters ordered isn’t what is being delivered to the White House.
The appointment of Rahm Emanuel as White House chief of staff didn’t ease my mind. Like Mr Blair’s close advisors Lord Goldsmith and Baron Levy, Mr Emanuel may inflame the suspicions in the Middle East that the agenda for the region under Obama will be no different than under Bush. The credibility of the United States as an honest broker and agent for peace will be further eroded if Obama’s gatekeeper is viewed as pre-disposed to more of the same policies which have fuelled hostilities. I hope it is not anti-Semitic to make the point that objectivity and fair dealing will be suspect with a chief of staff who is the son of an militant Israeli, who served as a civilian volunteer for the Israeli Army, and who has used his public positions in American politics – except for a brief stint at Dresdner Kleinwort Wasserstein – to promote Israel’s interests.
Those who know Mr Emanuel suggest that because his devotion to Israel is unquestionable, he will be able to push Israelis toward moderation. Perhaps the combination of a Kenyan goat herder's son with an Irgun terrorist's son will be a winning combination for crafting a durable peace. But many in Israel, the Middle East and Washington will expect that future acts of aggression by Israel against Iran or other neighbours will be defended – if not promoted – by the man at Obama’s elbow.
It is now emerging that Mr Emanuel was also a director of Freddie Mac when it stands accused of misreporting profits and ignoring red flags.
The rumours that either Larry Summers or Tim Geithner will be made Treasury Secretary made me even queasier. The appointment of either of these architects of the current global financial disaster, these arch-deregulators and serial-forbearance artists, would be a great middle-finger to America’s foreign creditors and the global investors suffering asset deflation. Both men have been instrumental in, first, the Fed’s exported inflation via massive monetary bubble-blowing and, now, the Fed/FDIC/SIPC exported deflation through Chapter 11 and margin call orchestrations ensuring more pain abroad than at home.
Summers would be particularly egregious. Not only did Summers promote the Friedmanite export of toxic debt to the rest of the world at the Clinton Treasury, at the World Bank he promoted the export of toxic pollution to underdeveloped nations to add poison to poverty. To quote from his 1991 memo, "I think the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that."
The much bandied idea that Robert Gates, former deputy director of the CIA under President G.H.W. Bush, architect and financier of Saddam’s military machine and Bin Laden’s Al Qaida, might be kept as Secretary of Defense under Obama “for continuity’s sake” after six years of failed and callous military adventurism in Iraq and Afghanistan, with occasional illegal forays into Pakistan, Georgia, Syria and Iran, makes me frankly nauseous. If America is ever to restore its fiscal balance, cuts in the bloated military/security/intelligence apparatus will have to be implemented. A career insider central to the creation and export of the bloat is the wrong man for the job.
.
Maybe the problem in America is not a struggle between rich and poor. Overtaxed and undertaxed. Empowered and disenfranchised. Educated and illiterate. Insured and uninsured. Law abiding and lawless. Godless and God-fearing. Republican and Democrat. Red and Blue.
Maybe the problem in America is there is no struggle about the fundamental mechanisms of American oppression and aggression: debt and threat.
American policies promote debt and force as the hammer and anvil for shaping the economy and the political dialogue. What cannot be financed into penury must be crushed into submission. The bulk of the economy is designed to prosper either the bankers or the police/prison/military/intelligence industries at everyone else’s expense. Propped up on these twin pillars of debt and threat, America remains staunchly and irrevocably American whoever wins the elections.
The restoration of fiscal prudence has been swiftly repudiated post-election in favour of more debt-financed “stimulus” and “stabilisation”.
The restoration of the rule of law and holding those who committed crimes accountable – both within America and internationally – has received no post-election endorsement from Obama.
I asked the asylum Iraqis at the local kebab shop last night what they made of the American election. They follow the news, and I’ve always found them knowledgeable and articulate. The kebab chef (a former civil engineer from northern Iraq) looked glum. “It makes no difference. They are all the same.” I fear his well-informed cynicism is sound.
Our unglamorous and unelected British prime minister, Gordon Brown, called for more international cooperation “with American leadership central to its success” – as he toured the Arab Gulf with his begging bowl. He was physically following American “leadership” as he trailed Deputy Secretary of the Treasury Robert Kimmet’s pilgrimage to the Gulf last week. American leadership got us successfully into this debt crisis, and Brown appears determined to follow it even deeper.
The central banks in the UK, EU and Switzerland obliged yesterday by following the Fed toward negative real interest rates, discouraging savers and lenders alike by cutting 150bps, 50bps and 50bps respectively. Jean-Claude Trichet spoke of the cooperation of the central banks as a “brotherhood”. He made me think of the mafia or the Freemasons. Perhaps he meant to.
Obama’s election still inspires me. I still hope for change.
Obama demonstrated good judgement throughout the campaign, and good management of the people working for him. That in itself will bring major change to the White House.
Better managed American debt and threat policies under Obama will be an improvement over the horribly managed debt and threat policies under Bush. Some hope.
Obama’s election is powerful confirmation that America remains a land of opportunity, a democracy where power is allocated at the ballot box. It reassured the world that despite the lawlessness and arrogance of the past eight years, Americans are capable of enlightened, rational self-determination. It restores hope in much of the world that America can reorient itself toward tolerance and dialogue.
For all of that, I haven’t been happy since watching Obama’s acceptance speech live Wednesday morning on the BBC.
I have a bad feeling that America has just elected its Tony Blair. The package of Change the voters ordered isn’t what is being delivered to the White House.
The appointment of Rahm Emanuel as White House chief of staff didn’t ease my mind. Like Mr Blair’s close advisors Lord Goldsmith and Baron Levy, Mr Emanuel may inflame the suspicions in the Middle East that the agenda for the region under Obama will be no different than under Bush. The credibility of the United States as an honest broker and agent for peace will be further eroded if Obama’s gatekeeper is viewed as pre-disposed to more of the same policies which have fuelled hostilities. I hope it is not anti-Semitic to make the point that objectivity and fair dealing will be suspect with a chief of staff who is the son of an militant Israeli, who served as a civilian volunteer for the Israeli Army, and who has used his public positions in American politics – except for a brief stint at Dresdner Kleinwort Wasserstein – to promote Israel’s interests.
Those who know Mr Emanuel suggest that because his devotion to Israel is unquestionable, he will be able to push Israelis toward moderation. Perhaps the combination of a Kenyan goat herder's son with an Irgun terrorist's son will be a winning combination for crafting a durable peace. But many in Israel, the Middle East and Washington will expect that future acts of aggression by Israel against Iran or other neighbours will be defended – if not promoted – by the man at Obama’s elbow.
It is now emerging that Mr Emanuel was also a director of Freddie Mac when it stands accused of misreporting profits and ignoring red flags.
The rumours that either Larry Summers or Tim Geithner will be made Treasury Secretary made me even queasier. The appointment of either of these architects of the current global financial disaster, these arch-deregulators and serial-forbearance artists, would be a great middle-finger to America’s foreign creditors and the global investors suffering asset deflation. Both men have been instrumental in, first, the Fed’s exported inflation via massive monetary bubble-blowing and, now, the Fed/FDIC/SIPC exported deflation through Chapter 11 and margin call orchestrations ensuring more pain abroad than at home.
Summers would be particularly egregious. Not only did Summers promote the Friedmanite export of toxic debt to the rest of the world at the Clinton Treasury, at the World Bank he promoted the export of toxic pollution to underdeveloped nations to add poison to poverty. To quote from his 1991 memo, "I think the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that."
The much bandied idea that Robert Gates, former deputy director of the CIA under President G.H.W. Bush, architect and financier of Saddam’s military machine and Bin Laden’s Al Qaida, might be kept as Secretary of Defense under Obama “for continuity’s sake” after six years of failed and callous military adventurism in Iraq and Afghanistan, with occasional illegal forays into Pakistan, Georgia, Syria and Iran, makes me frankly nauseous. If America is ever to restore its fiscal balance, cuts in the bloated military/security/intelligence apparatus will have to be implemented. A career insider central to the creation and export of the bloat is the wrong man for the job.
.
Maybe the problem in America is not a struggle between rich and poor. Overtaxed and undertaxed. Empowered and disenfranchised. Educated and illiterate. Insured and uninsured. Law abiding and lawless. Godless and God-fearing. Republican and Democrat. Red and Blue.
Maybe the problem in America is there is no struggle about the fundamental mechanisms of American oppression and aggression: debt and threat.
American policies promote debt and force as the hammer and anvil for shaping the economy and the political dialogue. What cannot be financed into penury must be crushed into submission. The bulk of the economy is designed to prosper either the bankers or the police/prison/military/intelligence industries at everyone else’s expense. Propped up on these twin pillars of debt and threat, America remains staunchly and irrevocably American whoever wins the elections.
The restoration of fiscal prudence has been swiftly repudiated post-election in favour of more debt-financed “stimulus” and “stabilisation”.
The restoration of the rule of law and holding those who committed crimes accountable – both within America and internationally – has received no post-election endorsement from Obama.
I asked the asylum Iraqis at the local kebab shop last night what they made of the American election. They follow the news, and I’ve always found them knowledgeable and articulate. The kebab chef (a former civil engineer from northern Iraq) looked glum. “It makes no difference. They are all the same.” I fear his well-informed cynicism is sound.
Our unglamorous and unelected British prime minister, Gordon Brown, called for more international cooperation “with American leadership central to its success” – as he toured the Arab Gulf with his begging bowl. He was physically following American “leadership” as he trailed Deputy Secretary of the Treasury Robert Kimmet’s pilgrimage to the Gulf last week. American leadership got us successfully into this debt crisis, and Brown appears determined to follow it even deeper.
The central banks in the UK, EU and Switzerland obliged yesterday by following the Fed toward negative real interest rates, discouraging savers and lenders alike by cutting 150bps, 50bps and 50bps respectively. Jean-Claude Trichet spoke of the cooperation of the central banks as a “brotherhood”. He made me think of the mafia or the Freemasons. Perhaps he meant to.
Obama’s election still inspires me. I still hope for change.
Obama demonstrated good judgement throughout the campaign, and good management of the people working for him. That in itself will bring major change to the White House.
Better managed American debt and threat policies under Obama will be an improvement over the horribly managed debt and threat policies under Bush. Some hope.
Friday, 31 October 2008
Byways and Tribal Capitalism
I have been indulging in leisure again. For nine days I backpacked along the ancient Ridgeway, the superhighway of Neolithic Britain and a trade route into the modern era. Starting about 6,000 years ago, (roughly the time Sarah Palin imagines Adam and Eve holding hands in a newly wrought Eden) the Britons occupying the plains either side of the Ridgeway were settling the river valleys to raise crops and herd animals. As the crops and herds increased, and the Iron Age and Bronze Age opened trading opportunities in new technologies, these Britons took strides that set them and their heirs on the road to market capitalism.
The road they followed is the road I walked – the Ridgeway Trail.
The Ridgeway is a geographic feature of Jurassic and Corallian limestone, an 87 mile long spine of rocky downs running through Southern England from Ivinghoe Beacon in Buckinghamshire to Overton Hill, near Avebury in Wiltshire. It was linked by other routes to ports in the South and on the Channel. The Ridgeway was admirably suited as a commercial highway in early times because the limestone was porous, draining rain away from the high pathway to the plains below. When the tracks below were impassable mires of mud for man and beast, the Ridgeway remained a quick and easy road from one region to another. Being high, with excellent views down the slopes and over the plains, it was also possible to detect and defend against brigands who might beset unwary travellers, with ring forts provided to secure travellers and goods along the route.
Neolithic Britons were secure enough to form large agrarian tribes, planting and harvesting grains and herding sheep. They were prosperous enough to have excess grain and sheep to trade for iron and bronze tools and gold jewellery and other valuable trade goods. They were economically advanced enough to have specialisation, with certain tribes and regions known for their skill in producing iron or bronze or pottery. They were politically advanced enough to have organised militias, with a ‘warrior aristocracy’. They were wise enough to promote collective security and agree byways for safe passage with neighbouring tribes to enable commerce along the Ridgeway.
The Ridgeway reminded me every day we walked along that it is infrastructure, transparency and mutually-enforced rules which secure and grow markets for productive capitalism. Infrastructure provides a common framework for trade to take place. Transparency allows those trading in markets to evaluate each other’s wares and defend against brigands who might wish to ambush the unwary. Rules of safe conduct and fair dealing promote the confidence which encourages those with excess production to bring it to market to trade for their present and future needs. Mutual enforcement ensures that the temptation of any tribe to loot its neighbours is curbed by the risk of finding itself precluded from the trade routes and from access to markets.
I imagine that like many small, agrarian, tribal states, England of the pre-Roman period was organised into settlements relying on militias with only small dedicated military elites. This arrangement, as exists in modern Switzerland, allows the civilian militia to contribute most of its energies under secure conditions to increasing production, growing the surplus which sustains collective prosperity. Although a professional military or ‘warrior aristocracy’ can be useful in providing skilled leadership, if that military gets too large, or the aristocrats too greedy, the incentive to produce a surplus is removed and tribes tend to weaken, grow poor and fail. Prosperity and security require a delicate balance in the social contract.
The Ridgeway also reminded me that prosperity invites looting by aggressors. By the Roman era, England was producing a large enough surplus to be exporting across the Channel, with trade goods from as far afield as the Mediterranean. This has been substantiated by findings of pottery, jewellery, coins and other goods in early Celtic settlements.
It was the prosperity of England as a grain exporter that led Julius Ceasar to covet it for the Roman Empire.
A professional military demands a large production surplus from the civilian population to sustain it. The state expropriates the surplus production and provides it to the military. If the military can secure more resources and more production to the state, the expropriation can increase prosperity of its tribe – or at least the elite that commands it. But if the military fails to secure more resources, then the expropriation from those producing a surplus will gradually erode the incentive to produce a surplus – leading to decline and increasing poverty and political strife.
Ceasar understood that securing the large agricultural surplus of England to finance and feed his armies would help underpin the military strength of the Roman Empire. Naturally, the Romans secured and settled the most prosperous agricultural regions. As a result, there are Roman traces along the Ridgeway – improvements to the roads, the forts, and the commercial links to market towns and ports on the coasts. We walked Roman roads last week too - straight, raised and solid even 2,000 years later.
Following the Romans, the Danes, the Angles, the Saxons and the Normans invaded and occupied the same lands. Throughout the changing political and ethnic mix of tribes and elites, the Ridgeway continued to function as a trade route through prosperous middle England.
Modern markets could usefully reflect on the durable Ridgeway model of market infrastructure. Transparency of assets – whether sheep or shares or CDOs – is critical to the effective function of markets for price discovery and investment. Those who have secured a surplus are unlikely to risk taking their wealth to a market where assets are not open to inspection and proper valuation. Security of trade routes and market towns for merchants and traders is essential to encourage those with a surplus to bring it forward, promoting effective allocation of assets and underpinning growth in production. Mutually-enforced rules of conduct, fair dealing and safe passage are key to building a reputation that attracts both buyers and sellers and ensures a sustained market prosperity.
The modern ‘warrior aristocracy’ could usefully reflect on the fate of societies that deplete the incentives to surplus production and fail to secure commensurate returns from a costly military. Whether a Neolithic tribe, a Celtic settlement, the mighty Roman Empire or the Soviet Union, history proves that a tendency to excess expropriation by the state undermines any incentive to investment and surplus production. Excess expropriation will ultimately weaken the economy supporting the elites and the professional military that secures their privileges and interests.
As the global elites meet in the coming weeks to address the current economic crisis, they could do worse than contemplate the lessons I gleaned from the Ridgeway. Those who provided poor transparency, promoted dishonest market practices, looked the other way or collaborated in the robbing of passing merchants and investors, and otherwise violated the precepts embodied in the Ridgeway model should be held accountable for their failings. The global model going forward must return to the principles embodied in the ancient stone backbone of English commerce.
Links:
The Ridgeway (Wikipedia)
The Ridgeway National Trail
Neolithic, Iron Age and Bronze Age Britain (BBC)
_______________
Congratulations to Rich H (Miss America) who was to cover for me last Friday and instead secured his own position in the RGE blogroll.
The road they followed is the road I walked – the Ridgeway Trail.
The Ridgeway is a geographic feature of Jurassic and Corallian limestone, an 87 mile long spine of rocky downs running through Southern England from Ivinghoe Beacon in Buckinghamshire to Overton Hill, near Avebury in Wiltshire. It was linked by other routes to ports in the South and on the Channel. The Ridgeway was admirably suited as a commercial highway in early times because the limestone was porous, draining rain away from the high pathway to the plains below. When the tracks below were impassable mires of mud for man and beast, the Ridgeway remained a quick and easy road from one region to another. Being high, with excellent views down the slopes and over the plains, it was also possible to detect and defend against brigands who might beset unwary travellers, with ring forts provided to secure travellers and goods along the route.
Neolithic Britons were secure enough to form large agrarian tribes, planting and harvesting grains and herding sheep. They were prosperous enough to have excess grain and sheep to trade for iron and bronze tools and gold jewellery and other valuable trade goods. They were economically advanced enough to have specialisation, with certain tribes and regions known for their skill in producing iron or bronze or pottery. They were politically advanced enough to have organised militias, with a ‘warrior aristocracy’. They were wise enough to promote collective security and agree byways for safe passage with neighbouring tribes to enable commerce along the Ridgeway.
The Ridgeway reminded me every day we walked along that it is infrastructure, transparency and mutually-enforced rules which secure and grow markets for productive capitalism. Infrastructure provides a common framework for trade to take place. Transparency allows those trading in markets to evaluate each other’s wares and defend against brigands who might wish to ambush the unwary. Rules of safe conduct and fair dealing promote the confidence which encourages those with excess production to bring it to market to trade for their present and future needs. Mutual enforcement ensures that the temptation of any tribe to loot its neighbours is curbed by the risk of finding itself precluded from the trade routes and from access to markets.
I imagine that like many small, agrarian, tribal states, England of the pre-Roman period was organised into settlements relying on militias with only small dedicated military elites. This arrangement, as exists in modern Switzerland, allows the civilian militia to contribute most of its energies under secure conditions to increasing production, growing the surplus which sustains collective prosperity. Although a professional military or ‘warrior aristocracy’ can be useful in providing skilled leadership, if that military gets too large, or the aristocrats too greedy, the incentive to produce a surplus is removed and tribes tend to weaken, grow poor and fail. Prosperity and security require a delicate balance in the social contract.
The Ridgeway also reminded me that prosperity invites looting by aggressors. By the Roman era, England was producing a large enough surplus to be exporting across the Channel, with trade goods from as far afield as the Mediterranean. This has been substantiated by findings of pottery, jewellery, coins and other goods in early Celtic settlements.
It was the prosperity of England as a grain exporter that led Julius Ceasar to covet it for the Roman Empire.
A professional military demands a large production surplus from the civilian population to sustain it. The state expropriates the surplus production and provides it to the military. If the military can secure more resources and more production to the state, the expropriation can increase prosperity of its tribe – or at least the elite that commands it. But if the military fails to secure more resources, then the expropriation from those producing a surplus will gradually erode the incentive to produce a surplus – leading to decline and increasing poverty and political strife.
Ceasar understood that securing the large agricultural surplus of England to finance and feed his armies would help underpin the military strength of the Roman Empire. Naturally, the Romans secured and settled the most prosperous agricultural regions. As a result, there are Roman traces along the Ridgeway – improvements to the roads, the forts, and the commercial links to market towns and ports on the coasts. We walked Roman roads last week too - straight, raised and solid even 2,000 years later.
Following the Romans, the Danes, the Angles, the Saxons and the Normans invaded and occupied the same lands. Throughout the changing political and ethnic mix of tribes and elites, the Ridgeway continued to function as a trade route through prosperous middle England.
Modern markets could usefully reflect on the durable Ridgeway model of market infrastructure. Transparency of assets – whether sheep or shares or CDOs – is critical to the effective function of markets for price discovery and investment. Those who have secured a surplus are unlikely to risk taking their wealth to a market where assets are not open to inspection and proper valuation. Security of trade routes and market towns for merchants and traders is essential to encourage those with a surplus to bring it forward, promoting effective allocation of assets and underpinning growth in production. Mutually-enforced rules of conduct, fair dealing and safe passage are key to building a reputation that attracts both buyers and sellers and ensures a sustained market prosperity.
The modern ‘warrior aristocracy’ could usefully reflect on the fate of societies that deplete the incentives to surplus production and fail to secure commensurate returns from a costly military. Whether a Neolithic tribe, a Celtic settlement, the mighty Roman Empire or the Soviet Union, history proves that a tendency to excess expropriation by the state undermines any incentive to investment and surplus production. Excess expropriation will ultimately weaken the economy supporting the elites and the professional military that secures their privileges and interests.
As the global elites meet in the coming weeks to address the current economic crisis, they could do worse than contemplate the lessons I gleaned from the Ridgeway. Those who provided poor transparency, promoted dishonest market practices, looked the other way or collaborated in the robbing of passing merchants and investors, and otherwise violated the precepts embodied in the Ridgeway model should be held accountable for their failings. The global model going forward must return to the principles embodied in the ancient stone backbone of English commerce.
Links:
The Ridgeway (Wikipedia)
The Ridgeway National Trail
Neolithic, Iron Age and Bronze Age Britain (BBC)
_______________
Congratulations to Rich H (Miss America) who was to cover for me last Friday and instead secured his own position in the RGE blogroll.
Friday, 17 October 2008
We had to burn the village to save it
The title of this diary is a quote from the Vietnam era that sums up for many the arrogance and pointlessness of American aggression in Asia two generations ago. It keeps coming to mind each time I read President Bush’s (paraphrased) statement this week: We had to nationalise the banks “to preserve the free market.”
There is no free market when the government owns the actors and sets the terms of transactions. There is no village once it has been burned to the ground.
The collapse of the financial sector is unacceptable. It is unacceptable to bankers who have vested careers, status and equity wealth in the disproportionate expansion of the financial sector. It is unacceptable to politicians who have risen to high office doing the bidding of the financial sector in ceding progressively more generous taxpayer subsidy and regulatory forbearance to its chieftains.
And so in the US, UK and EU we have politicians appropriating more petrol to hand to the arsonists who started the conflagration which is consuming our economic and political fabric. The regulators whose forbearance is a root cause of the current conflagration are handing the arsonists fresh zippo lighters. The policies adopted in these debtor nations will fail, must fail, because they destroy what remained of market economies. In the meanwhile, however, the bankers and the politicians and the regulators cannot conceive of failure and so insist on more of the same – ordering hundreds of billions in more incendiaries to fuel the blaze. The same tax breaks. The same housing subsidies. The same regulatory forbearance. The same ill-transparent, off balance sheet, accounting sleight of hand. The same eradication of market incentives to productive, disciplined saving, investment and labour.
Those who would prudently save will be punished with negative real interest rates and asset deflation. Those who would prudently invest in productive industry will be starved of scarce capital and forced into liquidation. Those who would prudently labour for a decent wage will be slowly robbed by inflation and kept docile by the threat of unemployment.
There can be no more iniquitous alliance than to have the politicians at the service of the bankers, unless perhaps it is to have the military at the service of the bankers too. The US seems to have committed itself to this worst of all possible combinations, with Congressmen threatened by the imposition of martial law if they failed to acquiesce to the Paulson Plan. Thankfully the British and EU militaries are too small and ineffective to be leveraged into a similar threat to global or domestic peace and security.
Subsidised banking seems a faster method of going bust than military adventurism, but the two together will see the US bust even more certainly. The $700 billion appropriated for the Paulson Plan and the $840 billion extended in parallel by the Federal Reserve last month are together more than three times the expenditure on US wars for the past five years. The federal borrowing requirement for 2008 is now in excess of $1.02 trillion, and for 2009 is now estimated between $1.5 and $2 trillion.
Such hyperbolic growth in the fiscal deficit and debt is unsustainable, even with such very tolerant creditors as the Japanese, Gulf Arabs, Russians and Chinese. They can see that each dollar added to the Fed’s balance sheet is tinder for burning those already held or denominated in their reserves. They can project the curve forward. At some point, they must react and restrain further debasement of their reserves and investments, either by collectively raising the prices charged for the resources and products they export, the interest charged on existing and future debt, or the forced exchange of debt for equity ownership of real economic assets.
Or all three.
The cycle of debt deflation is just getting rolling. The banks were only the first bailout and already the federal deficits are ballooning unsustainably. What will be the recourse when municipalities and states face default through catastrophic tax and revenue shortfalls? What will be the recourse when large commercial employers, industries and infrastructure confront failure from collapsing consumption expenditure? What will be the consequence when unemployment, homelessness, political disaffection and crime are resurgent and threaten the political fabric?
We are at the end of the beginning. Hank Paulson has played a clever game for the past decade of exporting dodgy paper to the US creditors abroad while forcing a middle class subsidy of the tax exempt corporatists at home. Now he plays a clever game of devaluing all currency and paper assets, exporting the pain to foreign taxpayers and investors. But this is not a game that America can win without the debasement of everything America once represented as holding value in its formerly prosperous market economy.
In my experience, there is nothing so permanent as a temporary expedient. It is hard to see how partially nationlised banks will ever be more than the means of political redistribution of wealth and power, and so corrupt both the economy and political system.
We had to burn the village to save it.
Perhaps someday we will hear a remorseful Mr Paulson or Mr Brown echo Robert McNamara, early architect and aggressive propagator of the Vietnam War: “We were wrong, terribly wrong.”
________________________
I will be out of touch for most of the next nine days, but will check in as and when I can. There may be a guest blogger here next Friday who I'm confident will be enthusiastically received, if he accepts.
There is no free market when the government owns the actors and sets the terms of transactions. There is no village once it has been burned to the ground.
The collapse of the financial sector is unacceptable. It is unacceptable to bankers who have vested careers, status and equity wealth in the disproportionate expansion of the financial sector. It is unacceptable to politicians who have risen to high office doing the bidding of the financial sector in ceding progressively more generous taxpayer subsidy and regulatory forbearance to its chieftains.
And so in the US, UK and EU we have politicians appropriating more petrol to hand to the arsonists who started the conflagration which is consuming our economic and political fabric. The regulators whose forbearance is a root cause of the current conflagration are handing the arsonists fresh zippo lighters. The policies adopted in these debtor nations will fail, must fail, because they destroy what remained of market economies. In the meanwhile, however, the bankers and the politicians and the regulators cannot conceive of failure and so insist on more of the same – ordering hundreds of billions in more incendiaries to fuel the blaze. The same tax breaks. The same housing subsidies. The same regulatory forbearance. The same ill-transparent, off balance sheet, accounting sleight of hand. The same eradication of market incentives to productive, disciplined saving, investment and labour.
Those who would prudently save will be punished with negative real interest rates and asset deflation. Those who would prudently invest in productive industry will be starved of scarce capital and forced into liquidation. Those who would prudently labour for a decent wage will be slowly robbed by inflation and kept docile by the threat of unemployment.
There can be no more iniquitous alliance than to have the politicians at the service of the bankers, unless perhaps it is to have the military at the service of the bankers too. The US seems to have committed itself to this worst of all possible combinations, with Congressmen threatened by the imposition of martial law if they failed to acquiesce to the Paulson Plan. Thankfully the British and EU militaries are too small and ineffective to be leveraged into a similar threat to global or domestic peace and security.
Subsidised banking seems a faster method of going bust than military adventurism, but the two together will see the US bust even more certainly. The $700 billion appropriated for the Paulson Plan and the $840 billion extended in parallel by the Federal Reserve last month are together more than three times the expenditure on US wars for the past five years. The federal borrowing requirement for 2008 is now in excess of $1.02 trillion, and for 2009 is now estimated between $1.5 and $2 trillion.
Such hyperbolic growth in the fiscal deficit and debt is unsustainable, even with such very tolerant creditors as the Japanese, Gulf Arabs, Russians and Chinese. They can see that each dollar added to the Fed’s balance sheet is tinder for burning those already held or denominated in their reserves. They can project the curve forward. At some point, they must react and restrain further debasement of their reserves and investments, either by collectively raising the prices charged for the resources and products they export, the interest charged on existing and future debt, or the forced exchange of debt for equity ownership of real economic assets.
Or all three.
The cycle of debt deflation is just getting rolling. The banks were only the first bailout and already the federal deficits are ballooning unsustainably. What will be the recourse when municipalities and states face default through catastrophic tax and revenue shortfalls? What will be the recourse when large commercial employers, industries and infrastructure confront failure from collapsing consumption expenditure? What will be the consequence when unemployment, homelessness, political disaffection and crime are resurgent and threaten the political fabric?
We are at the end of the beginning. Hank Paulson has played a clever game for the past decade of exporting dodgy paper to the US creditors abroad while forcing a middle class subsidy of the tax exempt corporatists at home. Now he plays a clever game of devaluing all currency and paper assets, exporting the pain to foreign taxpayers and investors. But this is not a game that America can win without the debasement of everything America once represented as holding value in its formerly prosperous market economy.
In my experience, there is nothing so permanent as a temporary expedient. It is hard to see how partially nationlised banks will ever be more than the means of political redistribution of wealth and power, and so corrupt both the economy and political system.
We had to burn the village to save it.
Perhaps someday we will hear a remorseful Mr Paulson or Mr Brown echo Robert McNamara, early architect and aggressive propagator of the Vietnam War: “We were wrong, terribly wrong.”
________________________
I will be out of touch for most of the next nine days, but will check in as and when I can. There may be a guest blogger here next Friday who I'm confident will be enthusiastically received, if he accepts.
Friday, 10 October 2008
Turbulence and Trends
A trend is a trend is a trend.
But the question is, will it bend?
Will it alter its course
through some unforeseen force
and come to a premature end?
-- Sir Alec Cairncross
I’ve had a lot of meetings this week, and very little time to reflect on fast moving events. This entry may be light on cites and hyperlinks as I’m in a bit of a rush today. It will also lack much in the way of perspective or insight as I find it impossible to distance myself just now from the swirling turbulence around me.
Here in Britain, several banks were offered partial nationalisation as an alternative to private recapitalisation. Strangely, this seems to have encouraged them to more strenuous efforts to recapitalise. The plan is now being held up as a model as it seems to force managements to confront their undercapitalisation as a problem that they can solve to their advantage or that will be solved for them to their heavy personal cost.
Iceland collapsed. It was more of a hedge fund than a country, with it’s 200,000 population supporting a massive leveraged position in financial markets via risk loving bankers and financiers. There were approximately 200,000 British depositors in accounts offered by Icelandic banks. Local authorities (municipalities) and charities were also big investors, exposed for more than £700 million. As a result, the government has frozen Icelandic-owned assets in the United Kingdom – using terrorism legislation, naturally – to provide the basis for a partial recovery of the losses likely to be incurred. This is causing more stress between the two island nations than they have known since the Cod Wars of the 1980s. Also causing tension is a rumour that Russia might bailout Iceland with $4.5 billion of credit, leading to speculation that the Russians may be eying the vacant airbase formerly used by Americans. This is problematic as Iceland is a member of NATO, and so has spurred efforts toward finding European alternatives.
Europe continues to call for collaboration while each country unilaterally defines and acts on its self-interest. That is the way it should be, and I approve heartily. I would rather not have the European Union making hasty decisions or holding such concentrated powers that it can force a uniform resolution across all member states. Either the EU builds consensus for action in the common interest, or it remains impotent. Either is preferable to too much concentration of power in Brussels.
In an attempt to shut just one stable door in a barn full of bolting horses, the Treasury has laid legislation before Parliament to reform the treatment of UK bank insolvencies and deposit insurance arrangements. Roughly described, the Financial Services Authority will decide if a bank is bust, the Bank of England will be responsible for overseeing its resolution and ensuring financial stability of the system, and the Treasury will oversee a new deposit insurance scheme that no one can currently describe but will make permanent the rise in protection to £50,000 per depositor. Despite the massive failure of Lehman, and the huge losses incurred by investors and hedge fund prime brokerage clients in London, the legislation is completely silent on the insolvencies of investment banks and broker-dealers and other institutions of systemic importance to financial markets. My fear is that the failure to address the systemic issues as a whole will be a vulnerability exploited by US banks and authorities as they try to undermine London as a financial centre, gaming the fragile global markets.
There is still a touching confidence among many in the City that the US authorities will provide the “leadership” to reinforce collapsing markets. As John Plender of the Financial Times quipped, “Gaul votes for Rome to take the strain.” This seems to me to display a total incomprehension of the way US authorities operate to externalise pain and loss to the greatest extent possible in times of crisis. Gaul, after all, was an occupied state that was militarily and economically exploited to Rome’s advantage for centuries before Rome’s collapse. Saving Gaul was never a high priority once Rome was threatened.
Elsewhere in the world, bureaucrats continue to show up at the office in the morning and check to make sure all boxes are ticked, all forms are correctly ordered, and all initiatives in progress continue their stately way forward unimpeded by global chaos. I find this comforting, although much of their efforts will ultimately prove futile and failed.
Finally, an optimistic note. I was reminded yesterday that the vast bulk of “wealth” created during the Greenspan/Bernanke bubble years accrued to the very top percentiles of population – with many in the OECD middle class and lower class either stagnating or getting poorer as they mired themselves in unsustainable debt. While opportunity and employment grew strongly in emerging countries, there too the elites gained disproportionately as income inequalities surged. The crash of global financial markets therefore will have disproportionate effect on the elites, impoverishing them to a far greater extent, although it will be felt throughout society as employment, pensions, investments and public services contract.
Once we hit bottom of this downturn, some years hence in all probability, we may experience a democratisation of wealth and opportunity like none seen since the end of World War II when education reforms and unionisation laid the groundwork for the rise of the American and OECD middle classes. Those who have lost economic and political power during the boom years, are likely to organise and retake authority within economic and political systems during the bust years. The collapse of concentrated wealth in Wall Street will spur more collaborative capital formation and investment throughout the economy. This could provide reorientation of economic progress toward more equitable, sustainable and democratic outcomes in coming generations. I hope so, it’s the only bright spot of the week.
But the question is, will it bend?
Will it alter its course
through some unforeseen force
and come to a premature end?
-- Sir Alec Cairncross
I’ve had a lot of meetings this week, and very little time to reflect on fast moving events. This entry may be light on cites and hyperlinks as I’m in a bit of a rush today. It will also lack much in the way of perspective or insight as I find it impossible to distance myself just now from the swirling turbulence around me.
Here in Britain, several banks were offered partial nationalisation as an alternative to private recapitalisation. Strangely, this seems to have encouraged them to more strenuous efforts to recapitalise. The plan is now being held up as a model as it seems to force managements to confront their undercapitalisation as a problem that they can solve to their advantage or that will be solved for them to their heavy personal cost.
Iceland collapsed. It was more of a hedge fund than a country, with it’s 200,000 population supporting a massive leveraged position in financial markets via risk loving bankers and financiers. There were approximately 200,000 British depositors in accounts offered by Icelandic banks. Local authorities (municipalities) and charities were also big investors, exposed for more than £700 million. As a result, the government has frozen Icelandic-owned assets in the United Kingdom – using terrorism legislation, naturally – to provide the basis for a partial recovery of the losses likely to be incurred. This is causing more stress between the two island nations than they have known since the Cod Wars of the 1980s. Also causing tension is a rumour that Russia might bailout Iceland with $4.5 billion of credit, leading to speculation that the Russians may be eying the vacant airbase formerly used by Americans. This is problematic as Iceland is a member of NATO, and so has spurred efforts toward finding European alternatives.
Europe continues to call for collaboration while each country unilaterally defines and acts on its self-interest. That is the way it should be, and I approve heartily. I would rather not have the European Union making hasty decisions or holding such concentrated powers that it can force a uniform resolution across all member states. Either the EU builds consensus for action in the common interest, or it remains impotent. Either is preferable to too much concentration of power in Brussels.
In an attempt to shut just one stable door in a barn full of bolting horses, the Treasury has laid legislation before Parliament to reform the treatment of UK bank insolvencies and deposit insurance arrangements. Roughly described, the Financial Services Authority will decide if a bank is bust, the Bank of England will be responsible for overseeing its resolution and ensuring financial stability of the system, and the Treasury will oversee a new deposit insurance scheme that no one can currently describe but will make permanent the rise in protection to £50,000 per depositor. Despite the massive failure of Lehman, and the huge losses incurred by investors and hedge fund prime brokerage clients in London, the legislation is completely silent on the insolvencies of investment banks and broker-dealers and other institutions of systemic importance to financial markets. My fear is that the failure to address the systemic issues as a whole will be a vulnerability exploited by US banks and authorities as they try to undermine London as a financial centre, gaming the fragile global markets.
There is still a touching confidence among many in the City that the US authorities will provide the “leadership” to reinforce collapsing markets. As John Plender of the Financial Times quipped, “Gaul votes for Rome to take the strain.” This seems to me to display a total incomprehension of the way US authorities operate to externalise pain and loss to the greatest extent possible in times of crisis. Gaul, after all, was an occupied state that was militarily and economically exploited to Rome’s advantage for centuries before Rome’s collapse. Saving Gaul was never a high priority once Rome was threatened.
Elsewhere in the world, bureaucrats continue to show up at the office in the morning and check to make sure all boxes are ticked, all forms are correctly ordered, and all initiatives in progress continue their stately way forward unimpeded by global chaos. I find this comforting, although much of their efforts will ultimately prove futile and failed.
Finally, an optimistic note. I was reminded yesterday that the vast bulk of “wealth” created during the Greenspan/Bernanke bubble years accrued to the very top percentiles of population – with many in the OECD middle class and lower class either stagnating or getting poorer as they mired themselves in unsustainable debt. While opportunity and employment grew strongly in emerging countries, there too the elites gained disproportionately as income inequalities surged. The crash of global financial markets therefore will have disproportionate effect on the elites, impoverishing them to a far greater extent, although it will be felt throughout society as employment, pensions, investments and public services contract.
Once we hit bottom of this downturn, some years hence in all probability, we may experience a democratisation of wealth and opportunity like none seen since the end of World War II when education reforms and unionisation laid the groundwork for the rise of the American and OECD middle classes. Those who have lost economic and political power during the boom years, are likely to organise and retake authority within economic and political systems during the bust years. The collapse of concentrated wealth in Wall Street will spur more collaborative capital formation and investment throughout the economy. This could provide reorientation of economic progress toward more equitable, sustainable and democratic outcomes in coming generations. I hope so, it’s the only bright spot of the week.
Friday, 3 October 2008
Financial Eugenics: The Paulson Plan for Survivor Bias
As I write this I don’t know the outcome of the attempt to ram through legislation for looting the US Treasury of $700 billion before the end of the Bush administration. I suspect that Congress will force the passage of the bill in some form because the media and political narrative on the necessity of the measure is unremitting and so horribly biased.
No alternatives will be considered.
No constraints on the unilateral executive authority of Hank Paulson will be considered.
No assurances that funds will be used to unlock credit markets or promote lending to the real economy (as opposed to the financial robber barons) will be considered.
Instead, the bill will get laden with an additional 300 pages of pork to sway the dissenters, adding to the tab imposed on the American taxpayer.
Having listened to all 42 minutes of the late night Treasury briefing of investment banks on Sunday, there is no doubt in my mind that this legislation represents the sort of federal largesse for Goldman Sachs, Morgan Stanley, Citibank and JPMorgan Chase that the Iraq war provided for Halliburton and Blackwater.
The most cynical moment in the call is when the Treasury official confirms, ”our preference would be to help the healthy banks become even healthier” rather than helping troubled banks or illiquid banks.
America is now a centrally planned economy where the Treasury will determine which firms survive and prosper through allocation of scarce capital to an undercapitalised financial sector.
Clearly what is going on here has nothing to do with kick starting the credit markets or stabilising the equity markets or restoring depositor confidence in banks. (Treasury official: “No provision in the legislation that mandates re-lending.”) What is going on here is a blatant attempt to provide government funds to a select cadre of firms (not all banks) which are chosen to be the survivors feasting off the carcasses of their less fortunate and less well-connected brethren as the downturn intensifies in the years to come.
The crash in equities will still happen. The debt deflation of the economy leading to mass commercial and consumer credit defaults will still happen. The collapse of many national, regional and local financial institutions will still happen. The bankruptcy of many municipalities and shortfalls in state budgets will still happen.
This bill is about engineering survivor bias to friends of the Bush administration so that they profit disproportionately from the collapse of these markets using the funds provided by the taxpayer via the unreviewable and unconditional authority of the Secretary of the Treasury.
The basic plan is to set up a federal money laundering operation. Bad assets come in, get laundered by the Treasury and put in a new AAA “wrapper” (as it’s termed on the call), and good assets go out, issued as Treasury guaranteed securities. Whether the final value of the legislation this week is $700 billion or $150 billion is irrelevant as long as the laundering operation can accommodate the throughput, as that number is only a cap on total extensions at any one time.
The SEC will support the plan and survivor bias by relaxing FASB 157 on mark to market accounting. If there is no agreement on what an asset is worth, it is worth whatever the firm holding it says in its Level 3 accounts or the Treasury Secretary accepts in buying it.
The Federal Reserve will support the plan by relaxing the definition of “control stake” in US banks and bank holding companies to allow secretive cabals to hold through private equity and offshore hedge funds. No one knows the beneficial owners of these ill-transparent private equity investors, and so it is the ideal way to reward loyal and helpful insiders, legislators and officials – as well as cede further ownership of American assets to foreign stakeholders who would be politically unacceptable if publicly acknowledged. Many foreign creditors are irate at the losses their funds, banks and pensioners have sustained from investments in the United States, and this plan provides a secret way to buy them off and keep them lending and investing as their own economies are roiled by the deflation to come.
For the past year the survivor bias has been orchestrated from the Federal Reserve, with its extension of innovative credit facilities and selectively engineered rescues or forced mergers. That has been very useful, but that well is now dry. The Fed has no more good assets to trade for the bad assets the banks can offer. And the supply of bad assets just keeps growing as market illiquidity spreads further from the core of the mortgage backed securities market. Instability is now leading to a realistic threat that the Fed and Treasury could lose control of the deflationary process.
Part of the reason the Paulson Plan is so attractive is that it recapitalises the Fed by promoting the unwinding of repos and lending facilities which left the Fed holding toxic assets. As the repos and credit facilities gradually unwind, these toxic assets can now be taken back by the banks and exchanged for good cash. The Fed gets its balance sheet Treasuries and cash back to restore its flexibility to intervene anew.
Favoured private equity and insiders who swap US dollars for equity in the banking system will presumably be aware of the survivor bias being engineered on their behalf. Sovereign wealth funds, investment funds and private equity investors ripped off in the first round of recapitalisation may be willing to come back in once it is clear to them that the next round will benefit from official favouritism. Warren Buffett’s timely stake in Goldman Sachs is clearly linked to his confidence the Paulson Plan will benefit them disproportionately.
A factor which is probably critical but has received little discussion is that literally thousands of Bush administration apparatchiks will need jobs come January, and a fair selection of GOP House and Senate legislators and their aides too. What better way to enahance their CVs in their final months in power than to distribute $700 billion or so in pre-Christmas largesse to the most remunerative employers in the world? And what better way to ensure the corporate largesse is returned to the GOP to win back the White House and Congress in 2012 as the recession fuels public anger?
And then there is a huge arbitrage opportunity as well so that everyone makes money for years to come. According to the conference call, the pricing on offer from the Treasury will be a bit below Level 3 pricing. The toxic assets will be repackaged and resold with a new AAA wrapper, possibly priced well below what the Treasury paid, assuring a huge profit on both immediate liquidation by the banks and ultimate maturity by investors. The Fed gets its cash and Treasuries back; the banks make huge profits; the foreigners and off-shore tax avoiders get disguised ownership of the American financial system; the taxpayer gets ripped off. What’s not to love?
Think back to Fisher’s Theory of Debt Deflation in Great Depressions. Dollars become “bigger” as deflation takes hold because each dollar can buy more assets as assets deflate. That means that as these clowns crash the markets, their $700 billion of liquid cash funnelled to their friends and recycled through the Treasury laundrymat can progressively buy up the rest of the pieces on the gameboard at low discount prices. Game over with those who caused the crash and robbed the bank winning.
Deflation is going to happen – globally. Either we can use the course of deflation to shape healthy economies that will provide growth and employment and productive returns on investment in future, or we can allow deflation to further enrich those miscreants whose irresponsible policies led to the violent financial collapse we are about to experience.
There is a fundamentally healthy economy in America – somewhere underneath all the financial excess and chicanery and all the financial/oil/military/healthcare/developer corruption of local, state and federal politics. It will be a painful and slow process to kill off the metastasising cancerous growths on the economy, but if Americans achieved that, they could embrace a healthier and more productive and more prosperous future.
I would like to believe Americans expressed the courage to change over last weekend when they 25 to 1 rejected an unconstrained and unconditional bailout of Wall Street in favour of cold turkey deleveraging of the economy. I wish I could believe that it mattered in the political calculus, but the result of the House vote on the bill will tell us that.
Fight the survivor bias. It’s not your survival they’re engineering.
No alternatives will be considered.
No constraints on the unilateral executive authority of Hank Paulson will be considered.
No assurances that funds will be used to unlock credit markets or promote lending to the real economy (as opposed to the financial robber barons) will be considered.
Instead, the bill will get laden with an additional 300 pages of pork to sway the dissenters, adding to the tab imposed on the American taxpayer.
Having listened to all 42 minutes of the late night Treasury briefing of investment banks on Sunday, there is no doubt in my mind that this legislation represents the sort of federal largesse for Goldman Sachs, Morgan Stanley, Citibank and JPMorgan Chase that the Iraq war provided for Halliburton and Blackwater.
The most cynical moment in the call is when the Treasury official confirms, ”our preference would be to help the healthy banks become even healthier” rather than helping troubled banks or illiquid banks.
America is now a centrally planned economy where the Treasury will determine which firms survive and prosper through allocation of scarce capital to an undercapitalised financial sector.
Clearly what is going on here has nothing to do with kick starting the credit markets or stabilising the equity markets or restoring depositor confidence in banks. (Treasury official: “No provision in the legislation that mandates re-lending.”) What is going on here is a blatant attempt to provide government funds to a select cadre of firms (not all banks) which are chosen to be the survivors feasting off the carcasses of their less fortunate and less well-connected brethren as the downturn intensifies in the years to come.
The crash in equities will still happen. The debt deflation of the economy leading to mass commercial and consumer credit defaults will still happen. The collapse of many national, regional and local financial institutions will still happen. The bankruptcy of many municipalities and shortfalls in state budgets will still happen.
This bill is about engineering survivor bias to friends of the Bush administration so that they profit disproportionately from the collapse of these markets using the funds provided by the taxpayer via the unreviewable and unconditional authority of the Secretary of the Treasury.
The basic plan is to set up a federal money laundering operation. Bad assets come in, get laundered by the Treasury and put in a new AAA “wrapper” (as it’s termed on the call), and good assets go out, issued as Treasury guaranteed securities. Whether the final value of the legislation this week is $700 billion or $150 billion is irrelevant as long as the laundering operation can accommodate the throughput, as that number is only a cap on total extensions at any one time.
The SEC will support the plan and survivor bias by relaxing FASB 157 on mark to market accounting. If there is no agreement on what an asset is worth, it is worth whatever the firm holding it says in its Level 3 accounts or the Treasury Secretary accepts in buying it.
The Federal Reserve will support the plan by relaxing the definition of “control stake” in US banks and bank holding companies to allow secretive cabals to hold through private equity and offshore hedge funds. No one knows the beneficial owners of these ill-transparent private equity investors, and so it is the ideal way to reward loyal and helpful insiders, legislators and officials – as well as cede further ownership of American assets to foreign stakeholders who would be politically unacceptable if publicly acknowledged. Many foreign creditors are irate at the losses their funds, banks and pensioners have sustained from investments in the United States, and this plan provides a secret way to buy them off and keep them lending and investing as their own economies are roiled by the deflation to come.
For the past year the survivor bias has been orchestrated from the Federal Reserve, with its extension of innovative credit facilities and selectively engineered rescues or forced mergers. That has been very useful, but that well is now dry. The Fed has no more good assets to trade for the bad assets the banks can offer. And the supply of bad assets just keeps growing as market illiquidity spreads further from the core of the mortgage backed securities market. Instability is now leading to a realistic threat that the Fed and Treasury could lose control of the deflationary process.
Part of the reason the Paulson Plan is so attractive is that it recapitalises the Fed by promoting the unwinding of repos and lending facilities which left the Fed holding toxic assets. As the repos and credit facilities gradually unwind, these toxic assets can now be taken back by the banks and exchanged for good cash. The Fed gets its balance sheet Treasuries and cash back to restore its flexibility to intervene anew.
Favoured private equity and insiders who swap US dollars for equity in the banking system will presumably be aware of the survivor bias being engineered on their behalf. Sovereign wealth funds, investment funds and private equity investors ripped off in the first round of recapitalisation may be willing to come back in once it is clear to them that the next round will benefit from official favouritism. Warren Buffett’s timely stake in Goldman Sachs is clearly linked to his confidence the Paulson Plan will benefit them disproportionately.
A factor which is probably critical but has received little discussion is that literally thousands of Bush administration apparatchiks will need jobs come January, and a fair selection of GOP House and Senate legislators and their aides too. What better way to enahance their CVs in their final months in power than to distribute $700 billion or so in pre-Christmas largesse to the most remunerative employers in the world? And what better way to ensure the corporate largesse is returned to the GOP to win back the White House and Congress in 2012 as the recession fuels public anger?
And then there is a huge arbitrage opportunity as well so that everyone makes money for years to come. According to the conference call, the pricing on offer from the Treasury will be a bit below Level 3 pricing. The toxic assets will be repackaged and resold with a new AAA wrapper, possibly priced well below what the Treasury paid, assuring a huge profit on both immediate liquidation by the banks and ultimate maturity by investors. The Fed gets its cash and Treasuries back; the banks make huge profits; the foreigners and off-shore tax avoiders get disguised ownership of the American financial system; the taxpayer gets ripped off. What’s not to love?
Think back to Fisher’s Theory of Debt Deflation in Great Depressions. Dollars become “bigger” as deflation takes hold because each dollar can buy more assets as assets deflate. That means that as these clowns crash the markets, their $700 billion of liquid cash funnelled to their friends and recycled through the Treasury laundrymat can progressively buy up the rest of the pieces on the gameboard at low discount prices. Game over with those who caused the crash and robbed the bank winning.
Deflation is going to happen – globally. Either we can use the course of deflation to shape healthy economies that will provide growth and employment and productive returns on investment in future, or we can allow deflation to further enrich those miscreants whose irresponsible policies led to the violent financial collapse we are about to experience.
There is a fundamentally healthy economy in America – somewhere underneath all the financial excess and chicanery and all the financial/oil/military/healthcare/developer corruption of local, state and federal politics. It will be a painful and slow process to kill off the metastasising cancerous growths on the economy, but if Americans achieved that, they could embrace a healthier and more productive and more prosperous future.
I would like to believe Americans expressed the courage to change over last weekend when they 25 to 1 rejected an unconstrained and unconditional bailout of Wall Street in favour of cold turkey deleveraging of the economy. I wish I could believe that it mattered in the political calculus, but the result of the House vote on the bill will tell us that.
Fight the survivor bias. It’s not your survival they’re engineering.
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