- Volcker: How to Reform the Financial System
- links for 2010-01-30
- "Hearts and Minds"
- Did Obama Change the Conversation?
Posted: 31 Jan 2010 12:33 AM PST
Paul Volcker summarizes his ideas for reforming the financial system:
How to Reform Our Financial System, by Paul Volcker, Commentary, NY Times: President Obama 10 days ago set out one important element in the needed structural reform of the financial system. No one can reasonably contest the need for such reform...
A large concern is the residue of moral hazard from the extensive and successful efforts ... to rescue large failing ... financial institutions. ... The phrase "too big to fail" has entered into our everyday vocabulary. It carries the implication that really large, complex and highly interconnected financial institutions can count on public support at critical times. The sense of public outrage over seemingly unfair treatment is palpable. Beyond the emotion, the result is to provide those institutions with a competitive advantage in their financing, in their size and in their ability to take and absorb risks.
As things stand, the consequence will be to enhance incentives to risk-taking and leverage, with the implication of an even more fragile financial system. ... That is why Adam Smith ... advocated keeping banks small. Then an individual failure would not be so destructive for the economy. That approach does not really seem feasible in today's world, not given the size of businesses, the substantial investment required in technology and the national and international reach required.
Instead,... the ... implied moral hazard has been balanced by close regulation and supervision. Improved capital requirements and leverage restrictions are now also under consideration ... as a key element of reform.
The further proposal ... to limit the proprietary activities of banks approaches the problem from a complementary direction. ... The specific points at issue are ownership or sponsorship of hedge funds and private equity funds, and proprietary trading... Those activities are actively engaged in by only a handful of American mega-commercial banks, perhaps four or five. ...
Apart from the risks inherent in these activities, they also present virtually insolvable conflicts of interest with customer relationships, conflicts that simply cannot be escaped by ... walls between different divisions of an institution. The further point is that the three activities at issue ... are in no way dependent on commercial banks' ownership. ...
There are a limited number of investment banks (or perhaps insurance companies or other firms) the failure of which would be so disturbing as to raise concern about a broader market disruption. In such cases, authority ... to limit their capital and leverage would be important... To meet the possibility that failure of such institutions may nonetheless threaten the system, the reform proposals ... point to the need for a new "resolution authority." ... To put it simply, in no sense would these capital market institutions be deemed "too big to fail." ...
I am well aware that there are interested parties that long to return to "business as usual," even while retaining the comfort of remaining within the confines of the official safety net. ...
I've been there — as regulator, as central banker, as commercial bank official and director — for almost 60 years. I have observed how memories dim. Individuals change. Institutional and political pressures to "lay off" tough regulation will remain — most notably in the fair weather that inevitably precedes the storm.
The implication is clear. We need to face up to needed structural changes, and place them into law. ...
Posted: 30 Jan 2010 11:01 PM PST
Posted: 30 Jan 2010 01:36 PM PST
Robert Shiller says pessimism is leading to a pessimistic outlook for economic recovery:
Stuck in Neutral? Reset the Mood, by Robert Shiller, Commentary, NY Times: The United States and other advanced economies may be facing a long, slow period of disappointing growth.
That is a widespread concern, as recent polls demonstrate. A USA Today/Gallup poll ... found ... that about two-thirds of Americans say they think that economic recovery won't start for two more years, while 28 percent say it won't begin for at least five years.
Among students of history, there are fears that we will suffer the type of chronic economic malaise that afflicted the world after the 1929 stock market crash, or that weakened Japan after the puncturing of twin stock and housing market bubbles around 1990. ...
The fears themselves are an integral part of the problem. Economists have a tendency to assume that everyone's behavior is rational. But post-boom pessimism is a factor driving the economy, and it is likely to be associated with attitudes that may be enduring. ...
The present mood ... needs to be put into a longer historical context. After World War II, there was rapid growth in labor productivity until sometime around the early 1970s. But then there was a major break, roughly coinciding with three events of 1973-74: the oil crisis, a huge stock market tumble and the first significant depression scare since the Great Depression itself.
According to the Bureau of Labor Statistics, annual growth of business output per labor hour averaged 3.2 percent from 1948 to 1973, but only 1.9 percent from 1973 to 2008.
Ever since the long-term productivity slowdown became visible, the economist Samuel Bowles, now at the Santa Fe Institute, has said that its causes are to be found as much in the loss of "hearts and minds" of workers and investors as in technology.
This month at Yale, in lectures titled "Machiavelli's Mistake," he spoke of the error of thinking that a high-performance economy could be based on self-interest alone. And he warned of the overuse of incentives that appeal to individual gain.
The speculative boom periods that ended a few years ago carried us into such overuse, and today's malaise is partly a result of our disorientation from that period.
In their coming book,... George Akerlof ... and Rachel Kranton ... argue that an economy works well when people personally identify with it, so that their self-esteem is tied up with its activities. ... [A] relatively uninterested, insecure work force is unlikely to bring about a vigorous recovery.
Solutions for the economy must address not only the structural instability of our financial institutions, but also these problems in the hearts and minds of workers and investors — problems that may otherwise persist for many years.
I don't know if "problems in the hearts and minds of workers and investors" -- workers in particular -- is the "heart" of the slow recovery problem. I always find Shiller's psychology-based explanations less than fully convincing, but listen anyway because he has a pretty good track record at predicting emerging bubbles. But I will say this. Aggressive, effective job creation policy by the government -- putting people to work -- would go a long way toward repairing any problems in the hearts and minds of workers.
As for investors, their hearts and minds would be best repaired through strong regulatory measures that prevent the type of behavior that got us into this mess, or that substantially reduce the consequences when hearts and minds work together to cause this to happen again despite our efforts to prevent it.
Posted: 30 Jan 2010 10:35 AM PST
I think it's too soon to be talking about deficit reduction given the state of the economy, and particularly the state of labor markets, but there's no reason to let the people who do want to talk about it dominate the conversation.
We do need a plan to bring the deficit down in the long-run, but right now we need more, not less deficit spending, and there are job creation proposals currently under consideration by Congress that rely upon the ability to increase the deficit in the short-run (e.g. see here for Dean Baker's negative reaction to one recent proposal from the administration).
If we could talk about the long-run deficit problem without making it less likely that we will enact further job creation measures now, there would be no problem with the deficit discussions. But that's not the case. Even though the long-run problem -- health care costs -- is largely independent of short-run stimulus measures, i.e. the short-run stimulus measures contribute very little to the long-run problem, all of the discussion about the long-run problem make it much less likely that Congress will use deficit spending in an attempt to create jobs. People are confused about the nature of the problem, and Republicans opposed to more stimulus (or just saying no for political reasons) have no incentive at all to clear up the confusion.
So we really ought to be talking about short-run measures to increase deficit spending and create jobs, but Republicans have been successful at turning the conversation to the long-run, and the administration has played right into this strategy.
Stan Collender takes a look at recent Republican strategy on the long-run deficit issue:
GOP Doesn't Do Fiscal Responsibility, by Stan Collender: The following all happened just this week:
Item 1. The Conrad-Gregg commission, which needed 60 votes in the Senate, was defeated 53-46. The amendment creating the commission would have been adopted 60-39 if all of the GOP senators who co-sponsored the amendment voted for it. Instead, seven of the Republican co-sponsors withdrew their co-sponsorship the week before the vote and then voted against it.
Item 2. All Senate Republicans voted against re-establishing the pay-as-you go rules, which would have required that, with certain exceptions, any new mandatory spending or revenue legislation not increase the deficit. The rules were adopted with only Democratic support.
Item 3. With the Conrad-Gregg commission killed, congressional Republicans have been heavily critical of the commission the Obama administration may create by presidential order to consider ways to reduce the deficit. There are growing indications that the GOP House and Senate leadership, each of which would get to appoint three of their own members to the commission, may refuse to name any in the hope that the panel's deliberations will be stopped dead in its tracks without them or that the Democrats will proceed on their own. The stated reason for the GOP opposition is that there's no guarantee that a presidential commission's recommendations will be taken up by Congress even though there's even less of a chance if it's not created.
Item 4. Republican Chairman Michael Steele is saying so often that Republicans are against cuts in Medicare that it's starting to sound like a mantra. Add to that their stated opposition to revenue increases (see #1 above), military spending reductions, homeland security reductions, and the extremely low possibility that, if Medicare is too hot to handle, they'll go anywhere near Social Security, and the deficit reduction math becomes totally impossible.
What's most infuriating about this is that the GOP is even blocking what used to be the easiest thing for everyone to agree to do -- budget process changes. In fact, the saying among budget aficionados in Washington used to be that when Congress couldn't or wouldn't do anything about the budget, it did something about the budget process. Now, however, because of GOP opposition, even budget process changes that wouldn't impose any immediate changes in spending or revenues, are becoming, or have already become, impossible to adopt.
You can't get people all worked up about the deficit, and then block every attempt to deal with it, especially when your party has been behind some of those proposals in the past. Or so you would think. However, up until Obama met with Republicans yesterday, I would have expected the strategy behind the Republican opposition that Stan Collender describes to work no matter how transparent it is. It always worked before. But in listening to people talk about Obama's meeting with the Republicans, I am beginning to think that his appearance, and particularly his rebuttal, was more notable than people realize -- that Obama began to change the conversation in a way that identifies and portrays Republicans as the obstructionists they are. Am I nuts to think that?
Update: Brad DeLong:
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