Wednesday, December 14, 2016

Book Review: “The Man Who Knew: The Life and Times of Alan Greenspan” by Sebastian Mallaby

I read this excellent biography with a great deal of interest since I worked with (and debated) Federal Reserve officials on a variety of issues when I worked at the Treasury Department and Alan Greenspan was Chairman of the Federal Reserve Board. While long, the book is well written and exhaustively researched. It does deal with some contentious economic issues, but does so in an accessible way. It also discusses the political situation and Greenspan’s political maneuverings during key points in his career, and goes into some detail about his personal life. It is a well-rounded portrait of a very strange man who became one of the most powerful economic players in the world.

There are two issues I was particularly interested in because of my involvement with them during my Treasury career. The first is Greenspan’s public advocacy that Treasury issue five-year gold-backed notes in a September 1981 Wall Street Journal article, and, as I recall, in a submission before the Reagan Administration’s Gold Commission. I was early in my Treasury career working on Treasury debt management issues among other domestic finance policy issues, and I was tasked to write internal memos rebutting Greenspan’s arguments for gold-backed notes. I did not find Greenspan’s argument that the Treasury would save money convincing as an analytical matter, and, as a practical matter, I pointed to the disastrous French experience with gold-backed bonds under President Giscard d’Estaing. 

What I did not know and learned from this book is that one of the reasons that Greenspan proposed this was as a ruse to stop the Gold Commission from advocating a return to the gold standard. At Treasury, we did not think this was a real possibility because of the presence of Administration officials on the Commission who would follow Treasury’s lead on this, even if the new President was intrigued with the idea. Any decision to return to the gold standard would involve Treasury as well as the Fed. Treasury owns the U.S Government’s gold, not the Fed, and an issue this important would have to be an Administration initiative.

While Mallaby does not conclude how wedded Greenspan was to the idea of Treasury issuing gold-backed notes, I was and am under the impression that he thought it was a good idea. He would later propose a more realistic alternative, inflation-indexed notes and bonds, which Treasury resisted for years but finally decided to start issuing in 1997 during the Clinton Administration. (I was involved in these discussions over the years and was delegated to formulate and write the key terms and conditions of these securities once the decision was made to issue them.)

The other issue that I was particularly interested in was Mallaby’s description of the dispute over the regulation of over-the-counter (OTC) derivatives in the President’s Working Group on Financial Markets in 1998. Brooksley Born, the Chair of the Commodity Futures Trading Commission (CFTC) wanted to claw back some of the exemptions that the CFTC had made pursuant to legislation from CFTC regulation for many OTC derivatives (without making a determination whether the instruments in question were subject to the Commodity Exchange Act, the statute the CFTC administers and enforces). Because of the 2008 financial crisis in which credit default swaps played a role, Born has been lionized for advocating for regulation of OTC derivatives.

I have argued on this blog that what happened at the PWG meeting has been misrepresented by a PBS Frontline documentary and elsewhere. (See here, here, here, and here.) Mallaby’s account of what happened at the key PWG meeting generally agrees with what I have written. He talked to Pat Parkinson, who worked at the Federal Reserve Board at the time and was present at the PWG meeting, as was I. In an endnote, Mallaby quotes Parkinson remarking that Born “snatched defeat from the jaws of victory.” Here is what I wrote about this:

“…One of the reasons for her [Born’s] failure is that she stubbornly maintained that OTC derivatives were subject to the Commodity Exchange Act (“CEA”), an argument, which, for technical reasons, put into question the legality of certain outstanding derivatives, such as total return swaps based on equity securities. It also seemed by her insensitivity to this issue that she was motivated too much by turf considerations. That guaranteed that others, especially the bank regulators, would oppose the CFTC on this.

“Secretary Rubin was, in fact, concerned about OTC derivatives because he felt that they might be increasing systemic risk. (It should be kept in mind that the Treasury had little turf to be concerned about with regard to this issue, except that of the Office of the Comptroller of the Currency, which is fairly independent from the Departmental Offices and, consequently, is often left to fend for itself.) Because Rubin had sympathy with Born’s policy concerns, though not her legal arguments or apparent turf grabbing, he proposed that the President’s Working Group on Financial Markets ask a series of questions to the public about OTC derivatives, similar to the questions the CFTC had prepared for a concept release on the subject. Born refused, and despite pleas from the other members of the PWG, went ahead with the concept release in May 1998.

“Her intransigence on this subject drove Rubin into Chairman Greenspan’s corner, much to the relief of the major OTC derivatives dealers who were not unaware that the Secretary was not entirely comfortable with their business. There is a chance that, if Born had approached Rubin and SEC chairman Arthur Levitt with her policy concerns rather than with her legal arguments, she might have been able to get their support for some greater oversight of the derivatives industry. It is possible that some of the discussion would have focused on how to do it and who should do it, though Greenspan and others would have continued to argue that any government interference in the form of regulation of this market would be harmful. In any case, that would have been a healthier and more productive debate than the endless, and ultimately boring, legal debate over whether swaps are futures.”
I was happy to see that this major book provides an account of what happened at the PWG meeting on derivatives that is more accurate than that which is generally believed. Mallaby, though, does not mention that Rubin proposed that the CFTC’s proposed Concept Release be issued by the PWG as a way of reducing the legal uncertainty for certain OTC derivatives and that Born flatly refused to consider this. Her intransigence, which I ascribe to political incompetence, was key to her failure to achieve greater regulation of OTC derivatives.

Also, Mallaby does not discuss that regulating the OTC derivatives market could be accomplished in a different way than that proposed by the CFTC. Financial regulation can hinge on the regulation of certain types of instruments or on certain types of financial entities. While many OTC derivatives could be viewed as not subject to regulation as instruments at the time of the PWG meeting, many of the market makers and key market participants for these instruments were subject to regulation by the various bank regulators, the SEC, and, in some cases, the CFTC. The big players were the commercial and investment banks, and Treasury staff, including me, thought that the bank regulators and the SEC would do an adequate job in this area. We were mistaken, but that was not the only area where there was a failure of the regulators to use their existing authority to head off, or at least mitigate, the 2008 financial crisis. It is also not clear, though, what the relatively small CFTC would have been able to do if they clearly had the authority to regulate this market, which they did not.

There are other areas where Mallaby debunks the accepted story, such as in his discussion of Fed Governor Edward Gramlich, Greenspan, and what the Fed did or did not do with respect to subprime mortgages. Mallaby’s account is more favorable to Greenspan than what is commonly believed. It would be interesting if people with direct knowledge of this were to weigh in with their account of what happened and whether they support Mallaby’s account. (I have no reason to doubt Mallaby’s account, but this is a contentious issue.)

At the conclusion of the book, I think Mallaby is perhaps a bit too generous in his assessment of Greenspan. He writes: “Greenspan’s passivity as a political actor exacerbated his single error as an analyst—his underestimation of the potential costs from financial fragility.” However, one could argue that another failure was that monetary policy was too loose at the end of Greenspan’s tenure, leading to stock market and real estate bubbles, though not consumer price inflation, and that this was an error. To be fair, Mallaby does discuss these issues elsewhere. (In an amusing 2008 article, the satirical website The Onion wrote: “A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest.” See “Recession-Plagued Nation Demands New Bubble To Invest In.”)

While one I could go through the book and mention other points of disagreement, mostly minor, and some not terribly significant errors and omissions, which the author may correct in subsequent editions, this book is a very impressive biography and highly readable. If you are interested in Alan Greenspan or generally interested in U.S. economic developments from the 1970s on, this book is well worth reading. Because Mallaby did an incredible amount of research, including numerous interviews with many people, even those who were directly involved in some aspects of the story can likely learn things they did not know. Mallaby set out a very ambitious goal when he started this project, and he succeeded.   

Saturday, October 15, 2016

Tim Geithner’s Per Jacobsson Lecture

One of the events at the IMF annual meetings is a Per Jacobsson Lecture on issues involving finance, usually delivered by a prominent or current policymaker. The quality of these lectures varies; I have attended three, and one was particularly boring. (Information about the Per Jacobsson foundation can be found here, and a list of the lectures is here.)
This year former Treasury Secretary Tim Geithner gave the lecture. (Links: prepared text, slides, and video.) Previously, I had not been overly impressed with Geithner as a public speaker, but I was pleasantly surprised about how good this speech was, both substantively and as a performance.
The title was “Are We Safer? The Case for Updating Bagehot.” Geithner’s main point is that improved regulation has made a financial crisis less likely than before the crisis beginning in 2007, but that the emergency authorities for government officials in the U.S. to use if there is a crisis are more restricted than in the last crisis. If there is a major, financial crisis, officials would have to go to Congress to ask for more emergency authority.
One of the reasons for the restrictions on emergency authorities is to deal with the moral hazard problem. The thinking is that, if the government does not have the legal authority to bail out financial institutions, they will be more careful. Geithner recognizes that argument, but he argues that you have to rely on both regulation and a commitment to use the emergency authorities in the event of a systemic crisis. He argues that, just as you do not convene a meeting of the town council to decide whether to send fire trucks to a burning house, you should not have to go to the legislature to deal with a massive, fast moving financial crisis.
Geithner is correct, but he did not address some other issues.  For example, he did not address the too big to fail issue or whether resolution of a failing institution would work for a large, complex financial company with a global business. There is some question of how this would work with multiple regulators from different countries trying to protect their citizens and companies with business with the failing entity. Also, the insolvency regimes and commercial codes of different countries vary, which would pose challenges that might be difficult to resolve quickly.
As a last criticism, Geithner did not mention the problem of regulatory capture or regulatory structure. As readers of this blog know, I have been concerned about the issue of regulatory capture in the U.S., which is made worse by having too many regulators. This has caused each regulator to advocate for its regulatees. After all, the primary regulator’s significance and budget shrinks (with the exception of the Fed, which controls its own budget), if the business it regulates contracts. Also, the many contacts between the staff of a regulatory agency and the staff of the entities it regulates provides many opportunities for the regulated entities to convince regulatory staff of the correctness of their views. This does not imply that anything illegal or unethical is taking place; regulatory capture does not need that and regulatory capture is never total. Regulatory agencies and their staffs do try to do their assigned jobs, but partial capture did contribute to the last financial crisis. Regulatory agencies did have authorities that they did not use to curtail the recklessness that was taking place. They apparently did not see the magnitude of the risks that were piling up, and the regulated institutions, which to some extent may have been fooling themselves, probably played a role in convincing the regulators that everything was fine.
Nevertheless, Geithner’s speech is worth reading or viewing. I have not summarized everything he said. Clearly, he has given a lot of thought to the subject of financial crises, and what he has to say is worth paying attention to.
Unfortunately, while in his spoken lecture, he ends by saying “we can do better,” it is unlikely that any legislation will be enacted in the U.S. to deal with his legitimate concerns. This is not a top legislative priority, and legislation in this area is difficult to pass, given the diverse interest of various interest groups. It may take another crisis to make changes, and that is something none of us wants.

Friday, October 14, 2016

IMF Annual Meeting Seminars – Observations

Last week I attended seminars and other events sponsored by the IMF in conjunction with its annual meeting in Washington, DC. Here are some observations.

The IMF had fewer “open” events than in the past, and fewer big-name economists were present on panels, though they may have spoken at the conferences and events sponsored by banks and other private organizations that are put on in conjunction with the World Bank/IMF annual meetings. Nevertheless, it appears that the IMF organizers, probably including IMF managing director Christine Lagarde, had issues they wanted to highlight. Three main themes were preponderant: globalization, technology, and income inequality.

The IMF and its sister organizations, the World Bank and the World Trade Organization, are staunchly in favor of free trade. There is hand-wringing concerning that the case for free trade – that the benefits for countries outweigh the costs – is difficult to make on the public square in an economic environment of slow economic growth, growing economic inequality, visible job losses due to trade, and fear of change. While the great majority of economists across the political spectrum believe in free trade, the institutions implicitly recognized that this is not enough to convince the public. I do not remember hearing, though, any solutions except to be more forceful in presenting the economic arguments.

Regarding trade agreements, there was some, but not enough, discussion that some of the opposition to certain free trade agreements center on factors such as dispute resolution procedures, labor practices, and environmental concerns, rather than lowering of tariffs. Interestingly, one speaker (this may have been at a J.P. Morgan event) did say that the chances of U.S. ratification of the Transatlantic Trade and Investment Partnership (“TTIP”) are greater than ratification of the Trans-Pacific Partnership (“TTP”). The countries of the TTIP are more similar with respect to labor practices and environmental issues than the countries of the TPP, and U.S. workers are less fearful of job losses to many of the countries of the EU than they are to losses to Asian countries.

As to technology, the message was that the pace of change has been remarkable with profound effect on jobs. Technology facilitates globalization, making it easier to outsource jobs to other countries. It also eliminates existing jobs. This causes unease among certain sectors of developed nations’ populations about their economic prospects.

I am suspicious of arguments that technology make the goal of full employment unattainable. I remember that, when I was in grade school in the late 50s and early 60s, there was much concern about how automation would have these economic deleterious effects. It did not happen. I do recognize, though, that the changing nature of available work will create winners and losers, and that, if not handled right, can create political movements that are at core undemocratic.

I think the IMF is right to highlight this issue, though I was disappointed by many of the speakers on this subject. There was a tendency to make bold assertions, such as that more than half of the largest U.S. companies are going to disappear in the coming decade or that the U.S. educational system needs fixing. Absent was any analysis to convince one of the inevitable failure of companies or any analysis of what is wrong with U.S. education and how it should be fixed. That does not mean the speakers are wrong, but bold assertions without analysis is not that useful.

As for growing economic inequality, which to some extent may be exacerbated by technological change, and slow economic growth, this is indeed a problem that needs to be highlighted and is a major factor of populist movements in developed countries. Besides making some changes to tax codes and to government spending, I do not recall hearing any proposals on how to address this problem nor any analysis of why it is occurring. To be fair, though, it is a difficult issue to analyze and there does not appear to be any consensus about the cuases of economic inequality. The IMF’s highlighting of this issue is appropriate and it will hopefully spur more thinking and research on this topic by economists and others.

In short, while not conveying to attendees fear of a coming economic cataclysm, the overall message was decidedly not one of optimism. To be more positive, the IMF was warning that there are currently developments that could lead to creeping disasters if problems are not addressed. There is the hope that they will be.   

Thursday, September 1, 2016

Kevin Warsh’s Muddled WSJ Op-Ed Criticizing the Fed

Kevin Warsh, a former Federal Reserve Board governor, recently wrote an op-ed for The Wall Street Journal, “The Federal Reserve Needs New Thinking.” The article could have benefitted from an editor making helpful suggestions, because, as it reads, it expresses more the author’s anger at the Fed and what he views as academic economic thinking than a coherent argument. This is not the way to write a persuasive essay.
This is not to say that Mr. Warsh does not make some valid points. For example, it is true that the Fed and other major central banks have not been able to push inflation up to their target rate of 2 percent. That does not mean it is “puzzling” why some economists want a higher target inflation rate. You do not have to agree with the argument that, in a period of “secular stagnation,” higher inflation rates are necessary so that central banks have more latitude to push real interest rates lower into negative territory to be puzzled by the reasoning. In fact, I am suspicious of the merits of a 4 percent inflation target, not because of any serious empirical study, but because I fear, given the experience of inflation during the 1970s, once inflation gets that high, the risks are that it will go higher and bringing it down will be painful. The arguments of the proponents, though, are not puzzling.
What Warsh does not quite say is that the inability of achieving inflation of 2% demonstrates the limits of monetary policy in the current economic conjuncture. The argument that the Fed has been too aggressive in monetary policy seems to be based on disquiet at the growth of its balance sheet, rather than the effect the expansion of the monetary base has had. In this connection, it is instructive to look at the collapse of M2 velocity (nominal GDP divided by a measure of the money supply, M2).

The Fed has been aggressive in expanding its balance sheet because the economy is not getting much of a boost from fiscal policy. While the graph indicates that there are limits to what the Fed can achieve, the Federal Open Market Committee decided that doing something during a time when Congress was unwilling to increase spending was prudent. It is hard to argue with that, but Warsh seems to.

Warsh also speaks of “monetary, regulatory and fiscal errors” without specifying what these errors are. I suspect that Warsh does not mean that fiscal policy should be more expansionary in terms of increased spending, though, of course, he might be in favor of tax cuts. He also might mean that the budget deficit should be brought down faster; there is no way to tell from his article. Also, the limits to the efficacy of monetary policy does not help Warsh’s argument that the Fed is too powerful, though one can make a different argument than Warsh does that this is the case.
Warsh’s attack on an “economic guild” and groupthink is also muddled. One only has to read articles by various economists to know that there is little consensus, academic or otherwise, about macroeconomic policy. Given that Warsh is currently at the Hoover Institution, he must be familiar with John Taylor, who rarely agrees with Paul Krugman. What I suspect Warsh is incensed about are the views of the powerful Federal Reserve Board staff. From what I have observed when I worked at Treasury, I suspect that the Board staff can make life less than pleasant for a governor who habitually disagrees with them. I do not know whether that was the case when Warsh was at the Fed, but, if it was, that could explain Warsh’s anger at groupthink. There may be some groupthink at the Board, but there is little evidence of groupthink among economists generally. In fact, there is robust argument.
Warsh contends that “citizens are rightly concerned about the concentration of economic power at the central bank.” That may be true of the people whom Warsh knows and talks to, but I doubt that is generally true. Most people only have a vague idea about what the Federal Reserve does or what its powers are. Attacking the Fed, as Ron Paul has often done from a libertarian perspective, only works marginally as a political argument. Leftists who argue that the Fed is dominated by bankers do not do any better.
The implication of Warsh’s argument that the Fed should do less is one with which I doubt he agrees. In a time of low nominal interest rates, it would make sense to help the economy for the government to spend more to put idle resources to work. A good place to start is infrastructure spending. Infrastructure improvement is needed in this country and there should be increased spending to make sure our bridges, highways, airports, public transportation systems, rail lines, water and sewer lines, natural gas mains, etc. will serve us well going forward. In some instances – the DC Metro comes to mind – they are currently failing. What better time to do this than when the economy is sluggish and it costs next to nothing for the Federal government to borrow. But, of course, the deficit hawks will squawk at this and insist on spending reductions elsewhere in the budget. The case remains, though, that fiscal policy could relieve pressure on the Fed to continue an aggressive monetary policy, but I doubt Warsh would agree with this.
Warsh’s article is a muddle. During the George W. Bush Administration, I met him when I was working at Treasury and he was at the White House at a meeting on a regulatory issue, though I would be surprised if he remembered me. He seemed quite smart, though perhaps a bit ideological for my taste. My impression is that he could write a much better article.

Thursday, July 28, 2016

The Siberian Candidate?

The WikiLeaks release of emails stolen from the computers of the Democratic National Committee was well-timed to cause maximum embarrassment to the Hillary Clinton campaign; however, as of this writing, it does not seem to have seriously hurt Clinton. From the press reporting on the emails, they show that the DNC favored Clinton over Bernie Sanders. To anyone paying attention to the primaries, that is not news, and, the email release causing Deborah Wasserman Schultz to resign as DNC chair probably is good for the Democrats. Many had been calling for her resignation for some time; she has not been an effective leader of the DNC and should have left some time ago. The most damaging email was that someone considered using religion to attack Bernie Sanders, though I have not seen anything to suggest that the DNC actually followed up on that tactic. For a rundown of the most embarrassing revelations, here is a Washington Post article.
The more interesting aspect of this story to date is the Russian connection. Computer security experts in and out of the government believe that it was Russian intelligence agencies that hacked into the DNC computers. What is less clear is how the stolen emails reached WikiLeaks, but it is not a huge leap to conclude that there is a high likelihood that the Russian government (or, at least, parts of it) had something to do with it. The initial motive to hack into the DNC computers was likely not to help Trump, since the hacking started before it became clear that he had a good chance to win the Republican nomination. But later the Russians likely realized that what they had could be used to disrupt U.S. politics. (For one theory about possible Russian motives that is independent of helping Trump, see the end of this post.)

As for WikiLeaks, Julian Assange wants to hurt Clinton politically and timed the email release to do the most damage to her campaign. He also claims to have more emails, which presumably will be released at a politically opportune time. Whether these are damaging enough to throw the presidential election to Donald Trump is not something that is predictable, but contemplating the possibility is disturbing.
Here are some articles on Trump and Russia that I found interesting:

“How a Trump presidency could destabilize Europe” by Anne Applebaum, Washington Post (July 21, 2016, dates are those appearing online, not when an article appeared in a print edition.) This article appeared before WikiLeaks put the emails on its website (July 22). Anne Appelbaum writes: “Russia is clearly participating in the Trump campaign. The theft of material from the Democratic National Committee a few weeks ago was the work of Russian hackers. Russian state media and social media, together with a host of fake websites and Twitter accounts with Russian origins, actively support Trump and are contributing to some of the hysteria on the Internet. I’m not arguing that any of this has been decisive. But whatever resources Putin wagered on Trump, they are paying off.”
I should note, though the Washington Post does not, that Anne Applebaum is married to Radosław Sikorski, a Polish politician who was Poland's foreign minister until September 2014. Applebaum is both an American and a Polish citizen. Obviously, Poland has a lot to worry about Russia, as do Estonia, Latvia, and Lithuania, and Trump's recent statements about NATO are not reassuring to these countries. Obviously, Applebaum is not an objective observer, but she makes good points in this article.

“Mook suggests Russians leaked DNC emails to help Trump” by Jeremy Herb, Politico (July 24, 2016).
“Why Some Leftists Are Defending Donald Trump’s Ties to Russia” by Jonathan Chait, New York (July 25, 2016). This is an interesting article about divisions between American liberals and leftists as exposed by the Russian transparent attempts to help Trump. However, I think Chait paints the American left with too broad a brush.

“Cybersecurity Experts Say Russia Hacked the Democrats” by Eli Lake, BloombergView (July 25, 2016).
“FBI Investigating DNC Hack Some Democrats Blame on Russia,” Bloomberg Politics (July 25, 2016).

“All Signs Point to Russia Being Behind the DNC Hack” by Thomas Rid, Vice Motherboard (July 25, 2016).
“Why Russia is rejoicing over Trump” by Anna Nemtsova, Politico (Europe edition, July 21, 2016).

“The Muscovite Candidate?” by David A. Graham, The Atlantic (July 25, 2016).

“It's Official: Hillary Clinton Is Running Against Vladimir Putin” by Jeffrey Goldberg, The Atlantic (July 21, 2016).
“Exploring Russian ties to the men lurking behind Trump” by Jamie Dettmer, The Hill (July 25, 2016). The first sentence of this article: “Imagine the uproar talk-radio show hosts Laura Ingraham, Alex Jones and Rush Limbaugh would be whipping up now, if Hillary Clinton’s chief campaign manager had been for years a trusted adviser to Ukraine’s Viktor Yanukovych, as Donald Trump's Paul Manafort was.”

“The DNC Hack Is Watergate, but Worse” by Franklin Foer, Slate (July 26, 2016).

“Donald Trump Calls on Russia to Find Hillary Clinton’s Missing Emails” by Ashley Parker and David E. Sanger, The New York Times (July 27, 2016).

“Did Putin Try to Steal an American Election?” by Nicholas Kristof, The New York Times (July 28, 2016).
“Is D.N.C. Email Hacker a Person or a Russian Front? Experts Aren’t Sure” by Charlie Savage and Nicole Perlroth, The New York Times (July 27, 2016). This article discusses the identity of “Guccifer 2.0.”

“Donald Trump Again Praises Putin’s Leadership, Saying It’s Better Than Obama’s” by Ashley Parker, The New York Times (July 28, 2016).

“Donald Trump’s incredible new defense of his Russia-spying-on-Hillary comments: Just kidding!” by Aaron Blake, The Washington Post (July 28, 2016). This is a convincing rebuttal of Trump’s attempt to say he was joking.
“How Putin Weaponized Wikileaks to Influence the Election of an American President” by Patrick Tucker, Defense One (July 24, 2016).

“Why Security Experts Think Russia Was Behind the D.N.C. Breach” by Max Fisher, The New York Times (July 26, 2016).
“As Democrats Gather, a Russian Subplot Raises Intrigue” by David E. Sanger and Nicole Perlroth, The New York Times (July 24, 2016).

“Spy Agency Consensus Grows That Russia Hacked D.N.C.” by David E. Sanger and Eric Schmitt, The New York Times (July 26, 2016).
“In D.N.C. Hack, Echoes of Russia’s New Approach to Power” by Max Fisher, The New York Times (July 25, 2016). This article has a different interpretation about what the Russians may be up to. Max Fisher writes: “To paraphrase Mark Galeotti, a New York University professor who studies Russia’s military, this is a country whose economy is smaller than Canada’s or South Korea’s, yet is seeking a great power role akin to China or the United States. Traditional methods won’t cut it.” Later on in the article:

“That sheds light on why Russia might want to release Democratic National Committee emails, whose greatest effect is creating a kerfuffle within Democratic politics. It’s not as if the resignation of the party chairwoman, Debbie Wasserman Schultz, was some strategic Russian ambition.
“While some observers say Moscow sees a potential friend in Donald J. Trump, it would also be well within Russian strategy to stir up trouble just to stir up trouble. This is what Mr. Adamsky calls “managed stability-instability” — low-level confusion and disunity that Russia could perhaps one day exploit.”

I would be interested to know if this theory is widely shared among Russian experts.

Thursday, July 7, 2016

Book Review: “Chain of Title: How Three Ordinary Americans Uncovered Wall Street’s Great Foreclosure Fraud” by David Dayen

David Dayen’s book, Chain of Title, looks at the financial crisis of 2008 and its aftermath from a different perspective than most of the existing literature, which has focused on the financial difficulties of major financial participants and how the government did or did not come to their rescue. Dayen focuses instead on the plight of the people whose homes were foreclosed on and the fraud committed to accomplish these foreclosures. The financial difficulties of many of the homeowners were due to their losing their jobs as a result of the economic downturn in the aftermath of the financial crisis.

As for the financial institutions, the book describes in great detail how they and their lawyers commit fraud in having documents manufactured after the fact in order to cover up that the mortgages and the associated notes were not properly transferred after the original secured loan was made. The financial institutions had taken shortcuts in order to securitize home mortgage loans quickly and to evade local real property recording fees. When many of the home mortgages were in default, the financial institutions bringing the foreclosure cases to court in those states, such as Florida, which require this, they manufactured documents, sometimes sloppily to a comical extent. Judges, in many instances looked the other way, and some in Florida had a financial incentive to process as many cases as possible, because they were paid by the case.

In many, though not all cases, the homeowners had in fact missed payments on their mortgage loans, sometimes with the encouragement of representatives of the lenders. Some might say that, therefore, they do not deserve much sympathy because the original deal was that the mortgage loan was secured by the home. Defenders of financial institutions might dismiss this book as leftist propaganda in the “Occupy Wall Street” genre. The author, in fact, writes for left of center publications and websites. But, this is too easy a dismissal. As Zach Carter in an article about this book for the Huffington Post remarks:

“Because Chain of Title shows both the Bush and Obama administration policies siding with elites against consumers, it’s tempting to see the book as a narrative of the American political left. But the lessons Dayen draws from his tale could come straight from a conservative think-tank. Property rights are important, he argues, and the rule of law matters. But neither mean very much when the government refuses to enforce them for everyone.”

In fact, not only were homeowners being foreclosed on by institutions that did not have proper documentation that the mortgages and the notes had been properly transferred to them, institutional investors in mortgage-backed securities were put at risk by the practices of the financial institutions. In many cases, it appears that the mortgages and notes were not properly transferred to the trusts associated with the securities, which means that there were potentially adverse consequences to investors if something went wrong. If a trust did not hold the mortgages and the notes, the arrangements to issue the securities ran afoul of the tax regulations that permit such a structure. Investors, therefore, might not have the type of security they thought they had. In the event, the book documents that the both the IRS and the Justice Department knew about this but decided to do nothing about it, not even to use this and other possibly illegal practices of financial institutions to bring pressure on them to offer some relief to homeowners.

Most readers will be outraged by the practices described in this book. The author begins by telling the story of a Florida nurse who runs into problems with a financial institution and her developing obsession with foreclosure practices. Two other main characters are subsequently introduced who share the same obsession, a car salesman and a lawyer. The early part of the book reads like a novel, especially when telling the story of the nurse.

Scores of other characters are introduced, and it is hard to keep them all straight, as they disappear and then reappear much later. The book would have been helped by a listing of all these people with a brief description of who they are. Also, it is somewhat disappointing that many of these people have interesting stories, but they are not fully developed, leaving the reader to ask what happened to them.

Another problem with the book is that it makes no attempt to analyze why the government acted as it did. For example, it seems that the author made no attempt to interview Treasury Secretary Tim Geithner or Attorney General Eric Holder about their reasons for not getting tough on these bad and, most likely, illegal practices. Perhaps, they would have refused to be interviewed, but that would have told us something. Someone else in the government might have been willing to talk if they were not.

Still, while I have these criticisms, this is an important book, and probably will not get the attention it deserves. As far as I can tell, the only major (“mainstream”) publication to review the book is the New York Times Book Review. The review is by Frank Partnoy, a professor at the University of San Diego School of Law. Those familiar with Professor Partnoy’s writings will not be surprised to learn that he likes the book
The book should be read because it has an important story to tell about one of the causes of the financial crisis and about how the federal and state governments operate when powerful constituencies are affected. Arguably, if financial institutions had correctly transferred mortgages and notes and paid the recording fees, this would have slowed down the mortgage securitization process, which reached such a frenzy that “synthetic” securities based on mortgages were created, the banks not being able to make enough, mostly bad, loans quickly enough. This could have lessened the severity of the financial crisis, which after all stemmed from a real estate bubble fueled by excessive lending.  

It is also disturbing to realize that the problems with foreclosure practices and improper transfers have apparently not been cleaned up. What is holding back another excessive frenzy in private label mortgage related securities is not the financial institutions but limited investor demand. Meanwhile, the government remains undecided about what to do about Fannie Mae and Freddie and Freddie Mac. The book does not go into this, but one might wonder how properly documented the trusts underlying their securities are. (I don’t know.)

The Obama Administration can be justifiably criticized in not facing these problems head on. As far as the prospects for the next Administration in dealing with this, Hillary Clinton is viewed as too close to Wall Street, and therefore it is unclear whether a Clinton Administration would have any appetite to deal with this. A Clinton Administration would have people who understand the issue. As far as Donald Trump is concerned, while he is running a populist campaign, he was involved in the mortgage industry in Florida (see article by Dayen and another article by Lynn Szymoniak, one of the main characters in Dayen’s book). Also, the finance chair of Trump’s campaign is Steve Mnuchin, who once headed OneWest Bank, which Dayen contends was “one of the worst foreclosure operators” (see the end of this Salon article). This is, of course, not dispositive of what a Trump Administration would do, but the signs are not positive.

One can hope that federal and state governments do not continue to view this issue as a can to be kicked down the road until the next crisis happens. Absent a crisis, though, the next Administration will likely view many other issues as more pressing, though some of the regulators may do something.

Thursday, June 9, 2016

Review of The End of Alchemy by Mervyn King

Mervyn King, the Governor of the Bank of England from 2003 to 2013, has written an interesting book, The End of Alchemy: Money, Banking, and the Future of the Global Economy. As he states at the outset, this book is not a memoir of the financial crisis and its aftermath. Rather it is his reflections on the problems he sees in the world economy and its financial sector informed by his long career in public service.

These reflections are always interesting, and the book, written for a general audience and consequently not burdened by graphs and math, is well written. This does not mean that the book is unsophisticated; a discussion of Keynesian economics is perhaps the clearest presentation of a difficult subject that I have run across, though King has criticisms of modern economic theory, including those derived from Keynes’ significant contributions.

King is particularly critical of the euro. His argument about the folly of creating the euro is essentially the same as the one Yanis Varoufakis makes in his book, And the Weak Suffer What They Must? (reviewed in my previous post). King believes the lack of a political union, a common fiscal policy, and democratic political legitimacy of Eurozone decision makers dooms the monetary union to failure. While he does not propose a path forward, he does write:

“The tragedy of monetary union in Europe is not that it might collapse but that, given the degree of political commitment among the leaders of Europe, it might continue, bringing economic stagnation to the largest currency bloc in the world and holding back recovery of the wider world economy. It is at the heart of the disequilibrium in the world today.”
While the reflections are interesting, the book is not always clear about how the various discussions fit together or, as one proceeds through the book, what the central thesis is. The main proposal in the book, which concerns banking and is aimed at removing the “alchemy’ referred to in the title is made two-thirds of the way through the book, with interesting discussions preceding that, not all of which relate all that much to his proposal.

By “alchemy,” King is referring to our fractional reserve banking system, in which demand deposits are for the most part invested in longer-term and riskier assets, while the owners of the deposits believe that they can withdraw their deposits either to spend the proceeds or transfer them to another financial institution whenever they want. Of course, if all, or many, of the depositors of a bank want to do this at the same time, the bank cannot pay and will have to go to the central bank for a loan backed by the bank’s assets. As banks have gotten into riskier activities, King believes that this is not a satisfactory situation. He wants to transform the central bank from a lender of last resort to a “pawnbroker for all seasons.”

Unlike others who have proposed breaking up banks and limiting what deposit-taking institutions can do and letting other financial intermediaries without access to the central bank take on the riskier activities, King proposes that banks that take deposits pledge up front assets to the central bank in sufficient amount, after haircuts, to back the deposits. He would also impose an overall leverage ratio on the bank, but would eliminate complex regulations after a transition period to this new regime. Within these restraints, the bank could do what it wants with the rest of its balance sheet. If the bank got into trouble, depositors would know that the banks could borrow from the central bank up to the amount of the collateral minus haircuts which it has pledged to the central bank.

This idea is not totally fleshed out. While the haircuts on the pledged assets, which are presumably higher the riskier assets are in terms of market and credit risk, are determined at the outset, King does not explain what would happen during a financial crisis during which the market valuation of some assets may plummet and may not be sufficient after haircuts to back the deposits. This is not an insurmountable issue, perhaps there could be a daily mark-to-market regime, but it would have been better if he had addressed it.

The proposal is quite radical, but worthy of consideration and debate. Banks will of course strenuously oppose this, and it may not be politically possible. King is though correct that financial crises are inevitable and that current arrangements probably make them more likely and lead to ad hoc approaches to dealing with them. For example, while current government officials express confidence that the resolution procedures established by Dodd-Frank will work, many outside observers have doubts that they will work in the case of a failure of a large, international bank. Differences in legal requirements, procedures, and concepts in different countries exacerbated by government officials primarily concerned about protecting their own citizens and companies which are creditors of the failing bank would make international coordination difficult. The untangling of a web of transactions among financial institutions and the necessity for government officials of various countries to understand these transactions and what unwinding them may imply compounds the difficulty. Whatever current laws and expectations are in calm times, one can easily see that officials will conclude in a crisis that creative, ad hoc measures are necessary.

Among other issues, King stresses the importance of political developments affecting economic conditions and economic conditions affecting political developments. He is of course correct in this, and we can see it in the increased popularity of fringe parties and unconventional politicians in the West. Taking this further, King makes a distinction between what he calls the “economy of stuff” and the “economy of stuff happens.” What stuff happens is unpredictable, and consumers deal with “radical uncertainty” by effectively using short-cut rules which may change given experience over time. This criticism of economic theory is well-taken, but King is less clear about how government official should shape policy in a situation of radical uncertainty. At points he seems modest about what an institution such as the Bank of England can realistically know, and at other points, he seems to want the Bank of England to take actions, which may be painful in the short run, in order to change the expectations and heuristic rules of consumers. He thinks this is necessary in order to change the economy from an unsustainable course. Unfortunately, King is not clear about how policymakers determine that an economy is on an unsustainable course, or what he means by that.

As for King’s general prescriptions of the world economy, he outlines them in a chapter entitled “The Audacity of Pessimism: The Prisoner’s Dilemma and the Coming Crisis.” It is hard to take much comfort from this chapter. King’s recommendations are either thin or not politically realistic.

First, he thinks that countries should “boost productivity,” by changing their tax systems and regulations. He writes that “the specific microeconomic policies required will differ from country to country,” but he does not acknowledge that this could make for a robust debate among economists and others. For example, consider the debate in the U.S. about raising the minimum wage, which each side proffering its own economists and studies about whether this decreases employment or reduces income inequality.

Second, King argues for the promotion of trade. Among most economists, though not among the general public, there is general agreement that freer trade (reduced tariffs and many, though not all, other non-tariff barriers to trade) benefit all the countries involved. However, the devil is in the details. Criticisms of trade deals, such as the Trans-Pacific Partnership, include more meritorious arguments than those about employment. The dispute resolution procedures and other issues, such as those involving patent protection for drugs, have been raised, and economic theory has less to say about these political issues. Increased trade is usually good, but King should realize the complexity of some of the issues involved. Trade deals need to be examined, not just supported automatically because of tariff reductions.

His third proposal is that the world move back to a floating exchange rate regime. He does not say it explicitly, but King seems to be recommending here that the euro in its current form needs to be ended. Rather, than kicking many of the weaker countries out, King floats the proposal that Germany should exit. Of course, that is not going to happen, because, as King argues elsewhere in the book, the euro is a political project. The key relationship in Europe is between Germany and France. This is true, even though France has become less powerful than it once was both politically and economically. The political reason for the euro would disappear with a German exit, but at the same time, Germany’s use of the euro causes both economic and political problems, which have been compounded by the current German government’s economic and diplomatic policies in the Eurozone, which are personified by German Finance Minister Wolfgang Schäuble.

In spite of these criticisms, I recommend the book to those interested in the subject matter. While some ideas need more development, King is an original and provocative thinker and he writes well and in an engaging manner. Because the book does not develop clearly one central argument but covers quite a bit of the waterfront, the book is best approached as a series of interesting articles. Though written for a general audience, the book’s arguments are sophisticated, and one hopes that what he has to say will be considered and debated by academics and economic policymakers.