The task of a bad bank should be to sell their good assets to the good banks and to other potential buyers as to the “vulture” funds. When Chairman Bernanke’s approach is followed: “to set up and capitalize so-called bad banks, which would purchase assets from financial institutions in exchange for cash and equity in the bad bank”, we get exactly the incentive problem that caused yesterday’s jitter in the markets: how to value the toxic assets. The pricing of such asset categories too low would make many big banks insolvent while purchasing at an inflated price above market values means the taxpayers handing a subsidy to the banks.
In the banking crisis of Finland in the beginning of the 1990s, the “bad banks” were fallen angels, banks fallen to the control of the government, which sold their good assets to the remaining healthier banks and to foreign financiers. Thereafter the bad banks managed their portfolio of sour loans and real estate holdings as every bank is accustomed to do.
Pretty soon after the first fallen angel emerged, all banks were offered a capital loan on equal terms in proportion to their risk-weighted assets and off-balance commitments. Such funding was junior enough to count as tier I capital: interest could only be paid after the receiving banks had fulfilled their other commitments, but dividends on preference shares and common stock could be distributed after the banks had paid interest on the capital loans.
In practice, the government’s capital loan offer funded “mating”. During the consolidation process the banks were able to raise private co-finance, both equity and long-term debt, in the financial markets. Those banks that did not find a stronger partner ended up as bad banks.
Besides the customary political process, the delay in solving the Finnish banking crisis was caused by the lack of a government agency that received fallen angels. But, the USA has an experienced government agency for that purpose, the FDIC.
US Treasury Secretary Geithner need allocate the remaining TARP funds to the FDIC. What the USA is lacking is a government offer for funding that would facilitate the amicable mating ritual on equal terms for every partner.
It is not the purpose of a government agency to profit from solving the banking crisis. It was astounding to read in today’s press Chairman Bernanke to have announced yesterday that the Fed expects to make big profits from its increased role in the credit markets.
The task of the Fed and other federal agencies is to breathe new life to the speculative confidence of private actors as well as strengthening credit creation. This follows from Keynes’s analysis in Chapter 12 “The state of long-term expectation of his General Theory (p. 158): “the recovery requires the revival of both”. The whole chapter eloquently covers the difficulty of valuing long-term investments in the stock market.
Showing posts with label Keynes. Show all posts
Showing posts with label Keynes. Show all posts
Wednesday, February 11, 2009
Tuesday, January 20, 2009
Preventing the world from central bankers’ ego
Instead of Keynes, would the old Friedman rule be worth studying again? Milton Friedman invented his rigid rule for monetary growth to save the citizens of a free society from the central bankers’ ego unlike Lenin’s instruction to most effectively destroy a society by destroying its money.
Friedman was fearful of “the assignment of wide discretionary powers to a group of technicians, gathered together in an ‘independent’ central bank” and wanted “to establish institutional arrangements that will enable government to exercise responsibility for money, yet at the same time limit the power thereby given to government and prevent this power from being used in ways that will tend to weaken rather than strengthen a free society”; Capitalism and Freedom (1962, p. 39). Friedman introduced the idea of a constant annual rate of growth of money stock, regardless of changing economic conditions, to curtail the discretionary power of the monetary authorities in A Program for Monetary Stability (1959).
“The fact is that the Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than any inherent instability of the private economy”; the Federal Reserve System exercised its power to conduct monetary policy “so ineptly as to convert what otherwise would have been a moderate contraction into a major catastrophe” (C&F, p. 38).
By Friedman’s hindsight, the error list of the Fed included the unusually tight monetary conditions since mid-1928 culminating in an attempt to curb “speculation”, but leading to the 1929 stock market crash - that is, the Fed pricked the bubble which Greenspan’s Fed declined to carry out; the money stock declined by nearly 3 per cent from August 1929 to October 1930 – “a larger decline than during the whole of all but the most severe prior contractions”; prior to October 1930, there had been no sign of a liquidity crisis, or any loss of confidence in banks, but thereafter the economy was plagued by recurrent liquidity crises, runs on banks and waves of bank failures, but the Fed “stood idly by” because of “will, not of power”; Britain went off the gold standard in September 1931 inducing gold withdrawals from the USA, but two years of severe economic contraction did not prevent the Fed from defending the dollar and ending the gold drain by raising the discount rate – the rate at which it lent to member banks; the US money stock fell by one third from July 1929 to March 1933 with over two-thirds of the decline after Britain’s departure from the gold standard.
No wonder, Friedman wanted to avoid important policy actions being “highly dependent on accidents of personality” by introducing his rule of money growth that would also prevent monetary policy from being subject to the day-to-day whim of the politicians.
Was Alan Greenspan’s ego too big because of Friedman’s infamous research on and critique of the US monetary policy of the 1930s in A Monetary History of the United States 1967-1960 with Anna Swartz (1963)? Did Alan want to show how the Fed’s errors of the 1930s can be avoided? Alan fought preventively against “deflation”, a continuous downward spiral of prices and wages, in 2003-2005 during the most rapid global economic growth ever experienced! Greenspan’s Fed ridiculed active monetary policy by inventing to raise the steering rate of interest at a “measured” pace – the flip side of Friedman’s rule of a constant rate of growth of money supply?
What went wrong? The world is a global village was already taught in the mid-1960s. With a number of emerging market currencies pegged to the US dollar and the pound sterling and the euro shadowing the US policy rate changes, the USA is no longer a small open economy. The Fed ought to have a surveillance of monetary and fiscal conditions in the whole dollar block, not only the US economy, before taking decisions.
Also, the new rule of raising the steering rate at a “measured” pace softened the signal of monetary policy to the market participants in contrast to the previous policy actions and greatly increased long-term uncertainty about inflation and interest rates though making the next policy step more predictable - and lulled all financial journalists as well.
Is Ben Bernanke’s ego also too big? He earned his academic credentials by research on the Great Depression, lectured as a Governor of the Fed on quantitative easing, Deflation: Making Sure "It" Doesn't Happen Here, by using the balance sheet of the Fed. He is regarded as THE expert on financial crises, on exactly those sequences of events the world has experienced during the past two years.
This crisis has shown that Keynes's green cheese, money created by the banks and other financial intermediaries, is no substitute for the US treasuries in case of real excess demand for the “moon”, currency and highly liquid government bonds. So, global imbalances and their financing patterns matter for monetary policy.
Friedman confessed in the 1986 Economic Inquiry that his “rule” did not satisfy the most basic incentive scheme because it was not in the self-interest of the Fed hierarchy to follow the hypothetical policy of such a rule. But in the end, Friedman was after getting rid of the whole Fed: private markets would deliver financial and price stability at equal or less resource cost.
Friedman was fearful of “the assignment of wide discretionary powers to a group of technicians, gathered together in an ‘independent’ central bank” and wanted “to establish institutional arrangements that will enable government to exercise responsibility for money, yet at the same time limit the power thereby given to government and prevent this power from being used in ways that will tend to weaken rather than strengthen a free society”; Capitalism and Freedom (1962, p. 39). Friedman introduced the idea of a constant annual rate of growth of money stock, regardless of changing economic conditions, to curtail the discretionary power of the monetary authorities in A Program for Monetary Stability (1959).
“The fact is that the Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than any inherent instability of the private economy”; the Federal Reserve System exercised its power to conduct monetary policy “so ineptly as to convert what otherwise would have been a moderate contraction into a major catastrophe” (C&F, p. 38).
By Friedman’s hindsight, the error list of the Fed included the unusually tight monetary conditions since mid-1928 culminating in an attempt to curb “speculation”, but leading to the 1929 stock market crash - that is, the Fed pricked the bubble which Greenspan’s Fed declined to carry out; the money stock declined by nearly 3 per cent from August 1929 to October 1930 – “a larger decline than during the whole of all but the most severe prior contractions”; prior to October 1930, there had been no sign of a liquidity crisis, or any loss of confidence in banks, but thereafter the economy was plagued by recurrent liquidity crises, runs on banks and waves of bank failures, but the Fed “stood idly by” because of “will, not of power”; Britain went off the gold standard in September 1931 inducing gold withdrawals from the USA, but two years of severe economic contraction did not prevent the Fed from defending the dollar and ending the gold drain by raising the discount rate – the rate at which it lent to member banks; the US money stock fell by one third from July 1929 to March 1933 with over two-thirds of the decline after Britain’s departure from the gold standard.
No wonder, Friedman wanted to avoid important policy actions being “highly dependent on accidents of personality” by introducing his rule of money growth that would also prevent monetary policy from being subject to the day-to-day whim of the politicians.
Was Alan Greenspan’s ego too big because of Friedman’s infamous research on and critique of the US monetary policy of the 1930s in A Monetary History of the United States 1967-1960 with Anna Swartz (1963)? Did Alan want to show how the Fed’s errors of the 1930s can be avoided? Alan fought preventively against “deflation”, a continuous downward spiral of prices and wages, in 2003-2005 during the most rapid global economic growth ever experienced! Greenspan’s Fed ridiculed active monetary policy by inventing to raise the steering rate of interest at a “measured” pace – the flip side of Friedman’s rule of a constant rate of growth of money supply?
What went wrong? The world is a global village was already taught in the mid-1960s. With a number of emerging market currencies pegged to the US dollar and the pound sterling and the euro shadowing the US policy rate changes, the USA is no longer a small open economy. The Fed ought to have a surveillance of monetary and fiscal conditions in the whole dollar block, not only the US economy, before taking decisions.
Also, the new rule of raising the steering rate at a “measured” pace softened the signal of monetary policy to the market participants in contrast to the previous policy actions and greatly increased long-term uncertainty about inflation and interest rates though making the next policy step more predictable - and lulled all financial journalists as well.
Is Ben Bernanke’s ego also too big? He earned his academic credentials by research on the Great Depression, lectured as a Governor of the Fed on quantitative easing, Deflation: Making Sure "It" Doesn't Happen Here, by using the balance sheet of the Fed. He is regarded as THE expert on financial crises, on exactly those sequences of events the world has experienced during the past two years.
This crisis has shown that Keynes's green cheese, money created by the banks and other financial intermediaries, is no substitute for the US treasuries in case of real excess demand for the “moon”, currency and highly liquid government bonds. So, global imbalances and their financing patterns matter for monetary policy.
Friedman confessed in the 1986 Economic Inquiry that his “rule” did not satisfy the most basic incentive scheme because it was not in the self-interest of the Fed hierarchy to follow the hypothetical policy of such a rule. But in the end, Friedman was after getting rid of the whole Fed: private markets would deliver financial and price stability at equal or less resource cost.
Tuesday, May 13, 2008
Defunct economist and price stability
The defunct economist whose slaves today’s practitioners of price stability are is Keynes himself!
The infamous, eloquent ending passage (p. 383) of J. M. Keynes’s The General Theory describes: “…the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men … are usually the slaves of some defunct economist.”
Keynes’s A Tract on Monetary Reform – dedicated to the Governors and Court of the Bank of England in 1923 – argues for why the Treasury and the Bank of England “should adopt the stability of sterling prices as their primary objective” (p. 147).
Of course, the book simultaneously advocates the policy of flexible exchange rates: stability of sterling prices “would not prevent them aiming at exchange stability as a secondary objective.” The Fed “failing to keep dollar prices steady, sterling prices should not…plunge with them merely for the sake of maintaining a fixed parity of exchange” (p. 147).
Keynes clearly gives credit to Irving Fisher as “the pioneer of price stability as against exchange stability,” but he doubts Fisher’s policy approach based on automatic index adjustments: “If we wait until a price movement is actually afoot before applying remedial measures, we may be too late.”
Keynes quotes Hawtrey’s Monetary Reconstruction (1922) “It is not the past rise in prices but the future rise that has to be counteracted”, points to “the, often more injurious, short-period oscillations”, warns not “advisable to postpone action until it was called for by an actual movement of prices” and adapts Fisher’s approach by presenting the idea of price stability in terms of an official index number, the price of a standard composite commodity:
“It would promote confidence … (if) the authorities were to adopt this composite commodity of a standard of value in the sense that they would employ all their resources to prevent a movement of its price by more than a certain percentage in either direction away from the normal”.
Keynes favored “a general judgment of the situation based on all the available data” in the regulation of the bank steering rate over a cut-and-dry formula and in detail described what in essence comprises the economic and monetary analysis that the European Central Bank (ECB), or the Fed or the Bank of England for that matter, bases it decisions on.
“The main point is that the objective of the authorities, pursued with such means as are at their command, should be the stability of prices.” (p. 149)
Keynes was too optimistic of the power of economic ideas over vested interests: “Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas”.
Nothing explains better than vested interests the 70 year chain of monetary policy disasters all over the world, up to Black Wednesday or the 13 percent drop of the GDP from 1990 to 1993 in Finland’s banking crisis.
Keynes was right in the long run. The ideas which civil servants and politicians applied to monetary management during the 1990’s were definitely not the newest in the perspective of his A Tract on Monetary Reform. But the ideas were new to many economic scribblers and still are not accepted by agitators.
Unlike Keynes’s “practical men, who believe themselves to be quite exempt from any intellectual influences”, today’s central bankers know Keynes, Irving Fisher and results of academic research. Apart from charlatans, they are nobody’s intellectual slaves, but independent thinkers and professionals of the highest caliber.
(All italics here are as in the original text!)
The infamous, eloquent ending passage (p. 383) of J. M. Keynes’s The General Theory describes: “…the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men … are usually the slaves of some defunct economist.”
Keynes’s A Tract on Monetary Reform – dedicated to the Governors and Court of the Bank of England in 1923 – argues for why the Treasury and the Bank of England “should adopt the stability of sterling prices as their primary objective” (p. 147).
Of course, the book simultaneously advocates the policy of flexible exchange rates: stability of sterling prices “would not prevent them aiming at exchange stability as a secondary objective.” The Fed “failing to keep dollar prices steady, sterling prices should not…plunge with them merely for the sake of maintaining a fixed parity of exchange” (p. 147).
Keynes clearly gives credit to Irving Fisher as “the pioneer of price stability as against exchange stability,” but he doubts Fisher’s policy approach based on automatic index adjustments: “If we wait until a price movement is actually afoot before applying remedial measures, we may be too late.”
Keynes quotes Hawtrey’s Monetary Reconstruction (1922) “It is not the past rise in prices but the future rise that has to be counteracted”, points to “the, often more injurious, short-period oscillations”, warns not “advisable to postpone action until it was called for by an actual movement of prices” and adapts Fisher’s approach by presenting the idea of price stability in terms of an official index number, the price of a standard composite commodity:
“It would promote confidence … (if) the authorities were to adopt this composite commodity of a standard of value in the sense that they would employ all their resources to prevent a movement of its price by more than a certain percentage in either direction away from the normal”.
Keynes favored “a general judgment of the situation based on all the available data” in the regulation of the bank steering rate over a cut-and-dry formula and in detail described what in essence comprises the economic and monetary analysis that the European Central Bank (ECB), or the Fed or the Bank of England for that matter, bases it decisions on.
“The main point is that the objective of the authorities, pursued with such means as are at their command, should be the stability of prices.” (p. 149)
Keynes was too optimistic of the power of economic ideas over vested interests: “Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas”.
Nothing explains better than vested interests the 70 year chain of monetary policy disasters all over the world, up to Black Wednesday or the 13 percent drop of the GDP from 1990 to 1993 in Finland’s banking crisis.
Keynes was right in the long run. The ideas which civil servants and politicians applied to monetary management during the 1990’s were definitely not the newest in the perspective of his A Tract on Monetary Reform. But the ideas were new to many economic scribblers and still are not accepted by agitators.
Unlike Keynes’s “practical men, who believe themselves to be quite exempt from any intellectual influences”, today’s central bankers know Keynes, Irving Fisher and results of academic research. Apart from charlatans, they are nobody’s intellectual slaves, but independent thinkers and professionals of the highest caliber.
(All italics here are as in the original text!)
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