Betting upon a second Great Depression, or are you like me and thinking that yes, we've got some tough times coming, but the only people that can create disaster are the politicians? Sadly, that last isn't quite as comforting as it could be for it was the politicians and bank regulation itself that created the first depression: as long as we don't make the same mistakes again (or newer and even more inventive ones) the disaster, although perhaps not a recession, can be avoided.
Yes, irrational exuberance in the 20s, then the Great Crash, then recession. So far, so very like our own times. But what took it from a crash to a depression, that's the part we want to know, so that we can avoid doing that.
I don't think tariffs were the real problem. No, I think the blame should be on three things. The first is that the Fed refused to cut interest rates. The second was a large tax rise so as to cut the budget deficit (alarming as it may seem, Keynes was right in part, deficit spending does mitigate recessions, it's the cutting of the spending in the good times that governments have so much problem with). The third was the then extant system of bank regulation.U.S. banking then was based on the single branch model: banks did not have widely diversified portfolios of risks, either geographically or by industry sector. Rather, all of their exposure was concentrated in the immediate hinterlands of their one deposit taking branch. This led to a certain fragility: it's worth noting that in Canada no banks went bust, while 8,000 did in the US. Canadian banks were allowed to operate countrywide, thus providing them with that diversification. It's that mass bankruptcy of banks which turned the shrinking of the credit markets into a rout.
Which brings us back to today: we see people arguing for some of the same things, but let's try not to make those same mistakes again, shall we? The first and most obvious is that we should ignore those siren calls for tax hikes, whether they're from deficit hawks or from those insistent that “the rich” should pay more. No, in an economy with contracting credit deficit spending is a rather good idea. Bernanke and his boys are most certainly not leaving interest rates too high, so that's one thing we don't need to worry about. Which leaves us, domestically, with just one thing—bank regulation.
Yes, we do have successive financial crises, that's in the nature of a market system that people will try new things and some of them will be stupid (making a loss is the market's way of telling you that you are indeed doing something stupid), but they're not all caused by the same things. Limits upon the mortgage markets and syndication are simply unneccessary: no one is going to make that mistake again, as they're not going to overinvest in telecoms companies with “interesting” accounting techniques, nor internet stocks, nor emerging nations, to give just a flavor of what has caused previous problems. Lessons learned at the cost of hundreds of billions of dollars tend to stay learned.
The second revolves around that very diversification which we would rather like banks to get themselves involved in. Christian Noyer, the governor of the French Central Bank (in reality, he's the provincial manager of the French branch of the European Central Bank) makes the point that the sub-prime crisis isn't going to topple European banks precisely because “their model of universal banking allows them to mitigate the consequences of a crisis in one segment of their activity.“ UBS may have been hit with vastly larger losses than Bear Sterns, but it didn't go bust because it has other business lines and resources to draw upon.
More good points in the article... I think trade might have been more important than he thinks because of the corresponding capital flows and investment stemming therefrom. Also, as for lessons learned, new mistakes will be made unlike the old ones but limits on leverage are appropriate for review to guard against systemic risk.
26 comments:
'no one is going to make that mistake again'
Wanna bet?
Where do you find these guys?
European banks didn't fail?
What about Credit Anstalt, which set off a cascade of failures?
Big banks don't fail?
Credit Anstalt was the biggest bank in Austria and it was a Rothschild bank.
Of the thousands of US banks that failed, many, including some very small ones, were solvent. They were just illiquid.
That wasn't their fault. It was the fault of a national financial system that was being run (largely by big banks in N.Y.) as a bucket shop.
I think you are mixing up your financial catastrophes there, Harry. Worstall's quoting a European banker on the present day, who is very confident that European banks won't fail this time. Very surprising statement, I know, but: ready, aim, then fire.
Unless of course you're counting Canada as part of Europe.
Yeah, we all know that Barings, which was ancient, big, diversified and operated around the world, couldn't fail.
Where do you find these imbeciles?
It's that mass bankruptcy of banks which turned the shrinking of the credit markets into a rout.
Mr. Worstalls' point in his own words.
Leverage is the common denominator in cases of systemic risk, hence my concluding remark. Individual banks can always find a way to fail, it's risk of the whole financial system that's of concern. Of course, we could prohibit all innovation but that comes at a cost even if we pretend otherwise.
I'm also reminded of a cute Warren Buffet comment, "why did banks have to find new ways to lose money, the old ones worked so well."
You got that backward. Solvent banks don't fail in a healthy credit market.
I know you guys are desperate to absolve the market for wrecking the economy and shift the blame to regulation, but you're rewriting history.
Worstall is, for sure. It isn't true that European banks didn't or don't fail.
It isn't true that European banks didn't or don't fail.
Well duh! Of course there are isolated failures of poorly run banks to this day. The point about diversified lines of business means that most of such banks can take substantial hits and still not fail.
What about Credit Anstalt, which set off a cascade of failures?
One of the many points in The Industrial Counterrevolution was that a turning away from the market order and the aggressive nationalism lead to WWI. In its' aftermath the economies and financial systems in England and Continental Europe were quite shaky. We know where that led to in Germany. The conditions were part of an underlying deterioration on a global level.
'and still not fail'
Bigger they are, harder they fall, more damage they do.
Continental Illinois, anyone?
I have yet to see any evidence here that you guys know economic history. You're death on theory, but, sorry, the world never operated according to that theory.
'and still not fail'
Bigger they are, harder they fall, more damage they do.
Continental Illinois, anyone?
I have yet to see any evidence here that you guys know economic history. You're death on theory, but, sorry, the world never operated according to that theory.
Regulated banks can't fail? I'm not death on theory, just curious. It seems to me that you are all on equal footing here. Howard is talking about making banks more of what he thinks will make them not fail -- larger, more diversified -- and so are you, except with you it's more regulated. But I'm willing to bet we've had some regulated banks fail, too. So, why your particular jones?
And then there's this:
Bigger they are, harder they fall, more damage they do.
That would seem to argue caution about making banks bigger. But you're full of praise for Ben Bernanke, and that's what he's busy doing, so far as I can see -- he's lashing the whole banking system together into one too-big-to-fail conglomeration. So, bigger is worse, except sometimes? Whatever the thing looks like when the Fed gets done with it, Sir William would argue that it is still a bank. I would not want to get caught multiplying entities here.
Please pay attention. I'm not full of praise for Bernanke.
What he's doing is at best CPR.
What he's not doing is pushing for the restructuring of banking (all kinds) along the lines that the New Deal worked so wonderfully.
During the reign of Glass-Steagell, banks almost never failed, yet the economy grew MUCH faster than it has since Glass-Steagell was scrapped.
The Continental Illinois failure was so shocking because it was unique. It proved -- if proof were needed -- that a politically connected, greedy, stupid Republican could beat the system and kill a bank even under New Deal safeguards.
S&L failures in late 80s and early 90s don't count? Guess the activities of The Resolution Trust Corporation was just a figment of our imaginations.
It proved -- if proof were needed -- that a politically connected, greedy, stupid Republican could beat the system and kill a bank even under New Deal safeguards.
I believed that already. But that suggests to me (it doesn't prove it) that regulating banks is a game where you have to periodically double down and bet again. This puts it in the same class of game as making banks bigger, or diversifying them: all such games are created equal in the long run. Nor do I think that Democrats are immune to greed for all time. I don't begrudge you your admiration for the New Deal, but this looks a lot like chartism.
I suppose you could just round up all the Republicans, before they get a chance to do their evil. That might work.
Does time's arrow go in two directions for you, Howard?
No, the S&L failures of the '80s were not so shocking, to me or to most business reporters, who were onto the game.
Continental Illinois was a shock though. Nobody under 50 had ever seen a big bank fail then.
We were impressed, and I am still impressed.
Maybe they are all equal in the long run, Joe, but Glass-Stegall had a very, very long run and never failed, it was just replaced.
No other approach has ever had a run even half as long.
I realize that you guys don't read economic history, but can we all agree that the most rapid periods of expansion of the US economy were also the most heavily regulated?
Can I get a witness?
Nor will, I expect. You're not living in the past, Harry. You're lving now. And, I would point out, if a regulatory regime is replaced -- if it gets beaten by its enemies -- then of course it has failed.
harry eagar asks: "...but can we all agree that the most rapid periods of expansion of the US economy were also the most heavily regulated?"
The mid to late 1930s was the most rapid expansion of the US economy? That's news to me.
By the way, I do accept your facts, which are: Glass-Steagall, and high growth. I'll add one: the end of Glass-Steagall. The simplest explanation that fits all three is that high growth makes things like Glass-Steagall not worth the risk and effort to dismantle, to the people who could. Sooner or later that's not true anymore, and when that happens you expect the regulations will get beaten. I realize you've read a lot more history than I have, but I still don't see why you credit regulation for growth when it is simpler to do it the other way around.
Depends whether you think an economy should be organized to serve people or people organized to serve an economy.
And, also, and this is the pertinent part here, whether you are satisfied if one indicator is up.
The economy is a hand with five fingers: land, labor, technique, money and geography.
The U.S. (and the world) would have grown rapidly in the 19th c. because 4 of the 5 were suddenly in plentiful supply. Guess which was the limiting factor then?
The other great expansion was 1940-82, until the first Reagan crash.
The fingers were different then: land was not expanding, but money and technique were. Labor was a limiting factor in the United States, though not everywhere else.
I won't take all these commentators seriously until they stop talking childishly about only one finger.
harry eagar wrote: "The other great expansion was 1940-82..."
Okay, now I really am confused about history. I though I remembered the 1970s (actually 1968-1982) pretty vividly and I remember several fairly severe recessions, stagflation, and rising unemployment, not mention Carter's general malaise. It didn't feel much like an expansion to me at all.
And wasn't there like a war or something happening first half of the 1940s?
So of the 1940-1982 "expansion", my recollection was only about half of it was any good. The rest pretty much sucked.
harry eagar wrote: "The economy is a hand with five fingers: land, labor, technique, money and geography."
Would you agree that the weighting of the importance of the factors is changing over time? Or no?
Agreed. For the first time, there is not only adequate but excessive capital formation. I have from time to time expressed my amazement that nobody comments on this.
From time to time, I've brought this up with real economists and so far they've all nodded, as if a lightbulb were going on, and said something like, 'Yes, of course.'
It's one of those things that everybody sort of knows without knowing that he knows it. {That's why my blog is called Restating the Obvious; it's socratic.)
America's limiting factor has always, except 1930-39, been labor. Analysts(and this would be just about all of them) who do not emphasize the strangeness and uniqueness of the labor factor in the Great Depression fail to hold my attention. What happened in that decade, unlike the 20 previous decades and the since?
Whatever it was, it cannot be ascribed to the New Deal, which operated for less than 18 months in the middle of it.
Post a Comment