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May 3, 2009

Economist's View - 4 new articles

"Troubled Banks Must be Allowed a Way to Fail"

Kansas City Fed president Thomas Hoenig has a plan for allowing large and systemically important banks to fail. If we prevent financial institutions from becoming so large and systemically important in the first place, the plans below wouldn't be needed. But if we going to allow such institutions to exist - not my first choice but for now we have what we have - then this is a reasonable approach to take. One difference I have, though, is that I think that stronger form of guarantee for depositors, a key component of the Swedish plan, is needed. That changes the equity calculations when you look solely at the flow of money to depositors, and the politics of that aren't great, but the improved overall outcome can more than compensate for the cost of the government guarantees:

Troubled banks must be allowed a way to fail, by Thomas Hoenig, Commentary, Financial Times: When the financial crisis began ... in 2007, US policymakers reacted quickly out of fear that ... events would lead to a global economic collapse. In my view, the policy response ... has been ad hoc, resulting in inequitable outcomes among firms, creditors, and investors. Despite taking a number of actions..., uncertainty continues and markets remain stressed.

I believe there is an alternative method for addressing this crisis...: the implementation of a systematic plan to resolve large, problem financial institutions. ... Boiled down..., the plan would require those firms seeking government assistance to make the taxpayer senior to all shareholders, with the government determining the circumstances for managers and directors. ...

Non-viable institutions would be allowed to fail and be placed into a negotiated conservatorship or a bridge institution, with the bad assets liquidated while the remainder of the firm is ... re-privatised as soon as is feasible. ...

This plan has ... management and shareholders bear the costs for their actions before taxpayer funds are committed. This process also is equitable across all firms; is similar to what is currently done with smaller banks; and provides a definitive process that should reduce market uncertainty. ...

In contrast..., the current policy raises a host of issues:

● Certain companies have not been allowed to fail and, as a result, the moral hazard problem has substantially worsened. ...

● So-called "too big to fail" firms have been given a competitive advantage and, rather than being held accountable..., they have actually been subsidised in becoming more economically and politically powerful. The US government has poured billions of dollars into these firms without a defined resolution process... The longer resolution is postponed, the greater the losses and the larger the debt burden.

● ...[T]he Federal Reserve is making loans directly to specific sectors of the economy, causing the Fed to allocate credit and take on a fiscal as well as a monetary policy role. This ... may compromise ... independence ... and make it more difficult to contain inflation in the years to come.

● ...We have entrenched these even larger, systemically important, "too big to fail" institutions into the economic system, assuring that past mistakes will be repeated.

Certainly, the approach I suggest for resolving these large firms also is not without substantial cost, but it looks to both the short and long run. ... While I agree that central banks must sometimes take actions affecting the short run, they must keep the long run in focus or risk failing their mission.

The fact that Citibank can negotiate the outcome of the stress tests is, I think, pretty good evidence that banks have become too big and too politically powerful for our collective good. (See here too.)


A "Quite Sophisticated Mixing of Public and Private"

A convert to the European social insurance system:

Going Dutch, by Russel Shorto, NY Times Magazine: ... For 18 months now I've been playing the part of the American in Holland, alternately settling into or bristling against the European way of life. ... For the first few months I was haunted by a number: 52... For it represents the rate at which the income I earn ... is to be taxed. To be plain: more than half of my modest haul ... was to be swallowed by the Dutch welfare state. ... I am politically left of center in most ways, but from the time 52 entered my brain, I felt a chorus of voices rise up within my soul, none of which I knew I had internalized, each a ghostly simulacrum of a right-wing, supply-side icon: Ronald Reagan, Jack Kemp...

And yet as the months rolled along, I found the defiant anger softening... I have found myself not only giving the Dutch system a personal test drive but also wondering whether some form of it could be adopted by my country. ...

I spent my initial months in Amsterdam under the impression that I was living in a quasi-socialistic system, built upon ideas that originated in the brains of Marx and Engels. This was one of the puzzling features of the Netherlands. It is and has long been a highly capitalistic country ... and yet it has what I had been led to believe was a vast, socialistic welfare state. How can these polar-opposite value systems coexist? ...

The Dam is ... a reminder ... of its ceaseless battle with water. And that battle turns out to be the key to understanding the Netherlands' blend of free market and social welfare. The Low Countries never developed a fully feudal system of aristocratic landowners and serfs. Rather, sailors, merchants and farmers bought shares in trading ships and in cooperatives to protect the land from the sea, a development that led to the creation of one of the world's first stock markets and helped fuel the Dutch golden age. Today the country remains among the most free-market-oriented in Europe.

At the same time, water also played a part in the development of the welfare system. ... Everyone had to deal with water. ... But in most cases your land lies in the middle of the country, so where are you going to pump it? To someone else's land. And then they have to do the same thing, and their neighbor does, too. So what you see in the records are these extraordinarily complicated deals. All of this had to be done together." ...

There is another historical base to the Dutch social-welfare system, which curiously has been overlooked by American conservatives... It is rooted in religion. "These were deeply religious people, who had a real commitment to looking after the poor," Mak said... "They built orphanages and hospitals. The churches had a system of relief, which eventually was taken over by the state. So Americans should get over 'socialism.' This system developed not after Karl Marx, but after Martin Luther and Francis of Assisi." ...

The Dutch are free-marketers, but they also have a keen sense of fairness. As Hoogervorst noted, "The average Dutch person finds it completely unacceptable that people with more money would get better health care." ...

Decent housing is another area where the Dutch are in broad agreement. ... Social housing differs from much of the public housing in the United States in that the government does not own or manage the properties. Rather, each is owned by an independent real estate cooperative. The system is not-for-profit, but it pays for itself. ...

This points up something that seems to be overlooked when Americans dismiss European-style social-welfare systems: they are not necessarily state-run or state-financed. Rather, these societies have chosen to combine the various entities that play a role in social well-being — individuals, corporations, government, nongovernmental entities like unions and churches — in different ways, in an effort to balance individual freedom and overall social security.

So here is a little epiphany I had... Maybe we Americans have set up a false dichotomy...: the old left-wing idea of vast and direct government control of social welfare, and the right-wing determination to dismantle any advances toward it, privatize the system and leave people to their own devices. In Europe, meanwhile, the postwar cradle-to-grave idea of a welfare state gave way in the past few decades to some quite sophisticated mixing of public and private. ...

So where does this get us? ...[W]hile I certainly wouldn't wish the whole Dutch system on the United States, I think it's worth pondering how the best bits might fit. ... [full article]


Who's Afraid of Depression?

Why aren't people as worried about the economy falling into "periods of widespread unemployment or depression" as they have been during other recent downturns?:

Depression Scares Are Hardly New, by Robert Shiller, Commentary, NY Times: What is the chance that the current downturn will morph into another Great Depression? That question has been preoccupying people for months.

The popular mood has a huge impact on the economy, so it's worth noting what many people seem to forget: Depression scares come and go. And by one authoritative measure, the current outbreak of concern has been surprisingly mild.

The University of Michigan Surveys of Consumers have included in their regular measurements this specific question about fear of a prolonged depression:

Looking ahead, which would you say is more likely — that in the country as a whole we'll have continuous good times during the next five years or so, or that we will have periods of widespread unemployment or depression, or what?

The Michigan surveyors produce a confidence score from the answer to this question. ... If we define a depression scare as any time the score is below 65, there have been four such scares since 1951. ... Note that so far, at least, the worst reading in the current scare has not been as bad as those of the previous episodes. ...

The good news is that from March to April this year, the score on this question jumped ... But that upward trend cannot be trusted to continue. Historically, big jumps in the score have tended to reverse themselves in later months. When people's fear reaches depression level, the underlying emotion seems to persist for years, despite occasional oscillations. ...

Like its predecessors, the current depression scare is characterized by serious problems that won't easily go away. After the bursting of bubbles in the stock market and housing market, balance sheets everywhere are out of whack, and millions of people are insolvent. So it's hard to expect that there will be a sudden and impressive recovery of confidence.

But why is this new depression scare apparently weaker than the others...? ... One can only speculate. Now that oil prices have moderated, it's possible that most people have less vivid worries than they did in 1974-75 or 1979-82 because their economic problems are not evident every time they shop or drive their cars.

During those earlier two scares, out-of-control inflation was widely visible, but today many people haven't personally experienced rising unemployment and foreclosures. And it's possible that the optimistic tone of the president and the Fed has assuaged some fears, and that people might believe that the government is fixing their problems.

This time, the reasons to fret about a possible depression may seem less concrete. For most people, the worries ... about things like bank stress-test results or the "OIS-Libor spread," are rather hard to comprehend.

As Franklin D. Roosevelt famously said during the Great Depression, "the only thing we have to fear is fear itself." Let's hope that is true, and that the relative complacency in the general population is good news for the economy. ...


links for 2009-05-03

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