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“Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Expensive”

Real Reasons Bankers Don’t Like Basel’s Rules: Clive Crook – Bloomberg. Why bankers’ whining about higher equity requirements is just that:

A much-cited paper by Stanford’s Anat Admati and colleagues — “Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Expensive” — should have ended this debate once and for all. It dismantles the banks’ position step by painstaking step.

The study makes the crucial distinction between the interests of bank managers, bank shareholders and the public at large. Managers are being disingenuous. They do have reasons, valid after a fashion, for opposing higher capital requirements, just not reasons they can admit. The one they emphasize — cost of funding and its effect on future lending — is fit for public use, but bogus.

What might their real reasons be? If banks sell more shares, it’s true that the return on equity will fall. If managers’ pay is tied to return on equity (as it often is), they will be worse off. Shareholders, on the other hand, shouldn’t mind, because the risk of their investment is reduced in proportion. Taxpayers, of course, would be better off — less likely to be stuck at some point with the cost of bailing out the bank. 

The paper is here.

Cross-posted at Asymptosis.

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It’s the Private Debt, Stupid

I’ve gone on about this elsewhere, but thought I should bring it up front and center here.

While everyone hyperventilates about government debt, they don’t seem to be aware of the massively greater load of private debt, and its spectacular runup compared to government debt:

This from Steve Keen’s latest. (It’s not very long. There are lots of pictures. It makes every kind of sense. Read the whole thing.) The blue line is publicly held debt — not including money the government owes itself (on the consolidated budget) for Social Security and Medicare.*† The red line is debt of 1. households and nonprofits, 2. nonfinancial businesses, and 3. financial businesses.

Here’s how those sectors break out:

Again, you hear all sorts of hyperventilating from the morality-based school of economics about households/consumers going on a debt-financed spending binge, especially in the 00s. And that definitely happened. With the financial industry begging them to borrow — almost literally throwing money at them — and telling them authoritatively that it’s free because house prices always go up, it’s not surprising. Humans will be humans; who’s gonna turn down money when the powers that be — who presumably know a lot more about finance than a high-school-educated homeowner working at a lumber mill — say it’s free?

But that ignores the really massive runup: financial corporations’ debts. Starting at a little over 10% of GDP in 1970, they hit almost 80% by 2000, and when the crash hit they were over 120% of GDP — a 10x, order-of-magnitude increase over 40 years.

The story explaining these pictures was told long ago — notably by Irving Fisher in 1933 (only after he had driven his Wall Street firm to ruin and lost everything, including his house, by clinging, Polyanna-like, to the kindergarten-ish Price-Is-Right! nostrums of classical economics). Minsky told it in cogent and convincing detail.

The basic story is very simple. It goes like this (in my words):

• Banks (and shadow banks) make money by lending. Bankers have every incentive to increase their loan books, even by extending questionable loans, because bankers don’t personally bear the eventual, down-the-road losses from loan defaults — they’ve gotten their money already.
• When banks run out of real, productive enterprises to lend to — enterprises that can pay back loans and interest from the production and sale of real goods that humans can consume — they start lending to speculators (gamblers) who are buying financial assets in hopes that their prices will rise.
• That lending — extra money being pumped into the system — does indeed drive up the price of financial assets, far beyond the value of the real assets that (according to most economists you listen to) supposedly underpin those financial assets’ value.
• Eventually people realize that the value of financial assets far exceeds the value of real assets — and far exceeds the capacity of the real economy to service the loans that drove up those financial asset prices. Prices of financial assets plummet, borrowers default because there just ain’t enough real income to service the loans, financial-asset prices plummet some more, all in a downward spiral — with all sorts of collateral damage to the real economy.

There’s your (economy-wide) Ponzi scheme. Households and nonfinancial businesses definitely participate (the financial industry makes it almost irresistible not to), but it’s driven by the financial industry, and a huge proportion of the takings go to players in the financial industry.

But as Keen points out, the powers that be almost completely ignore that simple story. He quotes one of Bernanke’s extraordinarily rare mentions of either Fisher or Minsky:

Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macro-economic effects… (Bernanke 2000, p. 24; emphasis added)

The rarity — inexplicable to me, at least — speaks even more loudly and eloquently than this blithely dismissive quotation does.

When really smart people like Ben Bernanke constantly ignore an elegant, simple, even obvious explanation that’s been lying on the ground, ready to pick up, for at least 75 years, you gotta figure they’ve got some incentive — whether they’re conscious of it or not. That’s what I talked about the other day.

Again, read Steve’s whole piece. And if you have any interest in economics and haven’t bought the new edition of his book yet, do.

* Please don’t try to dismiss this by pointing to the net present value of SS/Medicare liabilities extending into the infinite future. 1. Including those intra-government debts doesn’t change this picture much at all. 2. It’s a completely separate discussion, about whether we choose to provide those services out of current GDP over future years and decades. 3. If charges by health-care providers were rising at the same rate as inflation, even that future cost would not be a terrible burden. 4. Social Security is actuarily solid on a cash-flow basis for decades, and beyond the foreseeable future (75 years+) if we simply Scrap The Cap on the payroll tax, requiring high earners to pay their full share.

† I’m not clear whether he includes bonds held by the Fed — again, money the government owes itself, if you view Treasury and Fed as both being part of the government — which total a whopping $1.6 trillion or so, more than 10% of GDP, last I checked. I don’t actually know if Fed holdings are included in “debt held by the  public.” (You gotta wonder whether the Fed counts as “the public.”) Little help, so I don’t have to go Google it up myself?

Cross-posted at Asymptosis.

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A Modest Forecast: The Average Real Growth in Ireland will Exceed 10% a Year From 2012 to 2014

by Mike Kimel

A Modest Forecast: The Average Real Growth in Ireland will Exceed 10% a Year From 2012 to 2014

 You read the title correctly: the Irish economy will grow by more than 10% next year. Now, hearing that, you might be asking yourself: “Is this guy for real? He must be nuts.”

 Because I’ve looked around and nobody is predicting that sort of growth for Ireland for the next few years. So let me lay out ten facts that should make it obvious to just about everyone:

1. According to the Central Statistics Office of Ireland, real GDP (measured in 2009 Euros) peaked at 45,583 million Euros in the fourth quarter of 2007. It bottomed out in the fourth quarter of 2010 at 39,403 million Euros. That is, real GDP fell by 13.5%. Since then, GDP has barely budged. So its safe to call 2011, four years after the peak, as a year when the bottom out process was ongoing.

2. According to the OECD, Ireland’s all in top marginal tax rates are about 52.1%.

3. According to the BEA, real GDP (measured in 2005 dollars) was 976.1 billion in 1929. It reached a nadir of 715.8 billion in 1933, amounting to a drop of 26.6%. Note that while growth was negative in 1933 (four years after the peak), it was just a small drop. The bulk of the decrease occurred from 1929 to 1932. 

4. According to the IRS, the top Federal marginal tax rate was 63% in 1934, and it rose to 79% in 1936. Note that this wasn’t an “all in” rate.

5. According to the BEA, real economic growth in the US in 1934, 1935 and 1936 was 10.9%, 8.9% and 13.1%. The annualized rate of growth from 1933 to 1938, years which I’m cherry-picking to show some relatively poor growth, was 6.7% a year.
6. FDR instituted a number of large scale programs. For instance, [b]y March, 1936, the WPA rolls had reached a total of more than 3,400,000 persons. For comparison, according to the BEA’s NIPA Table 7.1, the entire population of the US in 1936 was 128.181 million. Thus, 2.7% of the US population was employed in the WPA alone. Throw in the CCC, the Rural Electrification Administration, the TVA, and I think we can all agree that the Federal government was playing a big role in the economy.

7. Many eminent worthies, too many to name, in fact tell us that the rapid growth in the economy from 1933 to 1940 was due to the bounce-back in the economy. They also tell us that the economy would have recovered much more quickly if FDR had not followed socialist policies.

8. Ireland doesn’t have as far to bounce back from as the US did in 1934, implying slower growth in Ireland today than in the US in 1934.

 9. On the other hand, taxes are much lower in Ireland today than in the US in 1934, and nobody is accusing the Irish today of following socialist policies, implying faster economic growth in Ireland today than in the US in 1934.

10. Facts 8 and 9 probably cancel each other out, leaving us to expect, on average, about the same growth rate in Ireland over the next few years as we saw in the US during the New Deal years when FDR ruined the economy.

As the eggheads say, QED. 

What’s nice about this is that we will see rapid growth in other countries too. Taxes are much lower in the US now then they were during the New Deal years, and for all the cries of socialism and whatnot, there is WPA or CCC or Rural Electrification Program. Heck, even the Fed doesn’t seem to want to do anything about jobs and that’s part of its mandate. Back to the eggheads for a moment.

There’s a bunch of them who think the New Deal helped the economy, that lower taxes don’t generate faster economic growth or that its a good idea for the government go out and buy stuff to boost demand at times of economic weakness. Boy are those folks about to be surprised by the magic of the free market and low taxes. — Disclosure:

I profess, in the sincerity of my heart, that I have not the least personal interest in endeavoring to promote this necessary work, having no other motive than the public good of my country, by advancing our trade, providing for infants, relieving the poor, and giving some pleasure to the rich.

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The Meme that Refuses to Die: Government Debt Must Be Paid Back

I’m stealing this headline directly from Sandwichman. He sez:

No it doesn’t. It almost never is. To pay back government debt, you have to run a budget surplus, and while there may be modest surpluses from time to time, they don’t add up to more than a minuscule fraction of all the accumulated debt. But don’t take it from me, look at the record.

Here’s a longer-term view of nominal debt, zoomed in on successive times slices so you can see the changes:

Do you notice our progenitors’ great-great-grandchildren (us) paying off our forebears’ debts? Yeah, neither did I. (It did happen once, and the result was economic catastrophe. Every depression in our nation’s history was preceded by a big decline in nominal Federal debt.)

Here’s the U.K.:

David Graeber, from Debt: The First 5,000 Years:

The reader will recall that the Bank of England was created when a consortium of forty London and Edinburgh merchants — mostly already creditors to the crown — offered King William III a £1.2 million loan to help finance his war against France.

To this day, this loan has never been paid back. It cannot be. If it ever were, the entire monetary system of Great Britain would cease to exist.

That loan was issued 317 years ago — in 1694.

Governments that issue their own money don’t have to pay off their debts. They actually can’t. In fact, they issue money — the money that’s necessary for a growing economy to operate — by deficit spending.

Private borrowers (and non-sovereign-currency states like Greece and Alabama) do have to pay off their debts (or default). That’s why the level of private debt, not sovereign debt, is the big management problem — a problem that neoclassical economics has not tackled, does not even have the theoretical apparatus to tackle.

Yes, of course: government debt and interest payments as a percentage of GDP are important issues. I’ll hand it back to Sandwichman:

The debt burden depends on the ratio of debt to GDP as well as the interest cost in servicing it. The way to reduce this burden is to have a combination of real economic growth, inflation and modest interest rates. If you want to show your solicitude for the well-being of future generations, demand macroeconomic policies that will boost demand and raise inflation a bit, consistent with continued low interest rates.

Today’s creditors will hate you. But your grandchildren will love you.

Update (thanks to Buffpilot for finding holes): A more precise explanation of why a sovereign-currency issuer might “have” to pay back their debt: if they have committed to redeem their money for something else. For instance Argentina (dollar-denominated debt) and whole host of others who were on a gold standard, had promised to give gold in return for their money. If they can’t or won’t do so, that’s a default on their promise. The U.S. and the U.K. (among others) do not face that situation.

Cross-posted at Asymptosis

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Cleveland = The New India?

My Economics Professor in MBA School, Peter Klein, lectured fondly of the Indian (as in subcontinent, not AmerInd) “entrepreneurs” who risked life and limb going through rubbish heaps looking for scrap metal and other items that could be sold. Despite the risk—I’m not writing metaphorically when I say “risked life and limb”—it was the best opportunity they had of making a better life for themselves.

Apparently, that Indian entrepreneurial spirit (or, as Newt Gingrich might call it, “work ethic”) is being mirrored these days in Cleveland. But now a former county treasurer wants to put a stop to it:

[Former Cuyahoga County Treasurer] Jim Rokakis: We’re looking at a neighborhood that has almost as many vacant houses awaiting demolition as there are houses with people living in them. We have one here. One here. One here. One there.

[Narration?] Rokakis is leading the effort to tear down thousands of abandoned homes because they’re rotting their neighborhoods from the inside out. It often starts, he told us, when a vacant house becomes an open house to thieves.

[TV Correspondent] Scott Pelley: It’s a nice house from the roof to about here. And then down here it’s been ripped to pieces. What’s goin’ on?

Rokakis: Well this is typical because this is as high as they could reach without using ladders. They ripped off the aluminum siding, which you’ll see on most of these houses. The aluminum and the vinyl siding comes off. It’s getting’ about a buck a pound.

Pelley: Essentially foreclosure scavengers have been through here?

Rokakis: The thieves have gone high tech. They know when evictions are occurring ’cause they’re posted online. And they will follow the sheriff. They’re usually there that afternoon or that evening.

Rokakis: So, in here, what you’re gonna see, well. I guess they took everything including the proverbial kitchen sink, right? The sink is gone. The plumbing is gone in this house. All the copper. Anything metal that had value is gone. The furnace is gone.

Pelley: The light fixture–

Rokakis: Light fixture came out–

Pelley: Is gone. How often is this happening in Cleveland?

Rokakis: This happens every day. And the foreclosure crisis creates this spiral, because as a result of this people are now more likely to leave neighborhoods like this. And as they leave, the scavengers come in and do the same thing to the house next door or across the street.

Apparently, Mr. Rokakis objects that houses are starting to look like Bruce Willis’s after the opening scenes of RED. Maybe someone will set the former treasurer straight that the employment of “reuse, reduce, and recycle” techniques in the service of entrepreneurial activities is an Economic Virtue.

(Though, speaking strictly for me, I’m glad that my wife and eldest daughter are willing to delay their hoped-for move to Cleveland for at least the next few years.)

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Bob Lefsetz Explains It All To You

In the midst of an essay on Louis C.K., Bob Lefsetz (chez Ritholtz) explains what the Lemieuxes and (now, sadly) Mannions of the world keep ignoring:

One of the reasons artists have lost power is they no longer lead.
It’s kind of like our President. He’s so busy appeasing people that
even his natural constituency is turned off.

There are other things that, at best, don’t help. But President Clinton survived “welfare reform“—even though the inevitable consequences were well-noted at the time—because he vetoed bills that were worse than doing nothing.

Clinton’s immediate successor threatened to veto bills that were not to his liking, and went five and one-half years before having to veto one.

Barack Obama often threatens to veto legislation, but no one takes that claim seriously. Indeed, he has done it twice so far, one a procedural play, the other (much to his credit) the Bottom-Fishing and Robo-Signing Retroactive Legality Act of 2010.

A record like makes it rather difficult to run on a “they’re keeping me from doing good things” platform.

UPDATE: Mark Thoma sums up the effect of the Obama negotiation/”leadership” strategy on voters:

I really don’t like that my choices in the upcoming election will be between one candidate who will betray the things I believe in, civil liberties, progressive taxation, etc., etc., etc., and a crazy person from the other side (take your pick) who will be even worse.

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The Fed Always Thinks That Unemployment’s Not a Problem

A couple of our gentle Bears have suggested that I repost this over here. Ask and ye shall receive. It’s a good complement to and demonstration of the point I tried to make in my last post.

From Mike Konczal:

Their model is obviously telling them that whatever (non-)actions they’re taking at the moment will solve the problem.

And their model is obviously, consistently, and wildly wrong — and always wrong in the same direction.

Altering that model to accurately predict unemployment, of course, would require that they allow more inflation in order to address both of their mandates.

And higher inflation utterly slams the real wealth of creditors.

And the Fed is run by creditors.

Comparing the Federal Reserve’s Reaction to the Financial Crisis Versus the Unemployment Crisis | Rortybomb.

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250 Billion Reasons Why the Fed Hates Inflation (and Doesn’t Care About Employment)

Let’s start with the basics:

Increased inflation results in (in a sense, is) a wealth transfer from creditors to debtors.

Debtors get to pay off their loans in less-valuable dollars — dollars that can’t buy as much real-world stuff, stuff that humans can consume, that they value.

If you’re holding a hundred million dollars in bonds — you’ve lent out hundred million dollars — and bananas are going for a dollar apiece, an extra percent of inflation means that a year from now, you can only buy 99 million bananas. The people who borrowed the money from you get the other million bananas. If inflation stays up and the loan remains outstanding, they get another million bananas next year. You don’t.

You can start to see why creditors might be inflation-averse.

How big is this wealth-transfer effect? Here’s a quite conservative back-of-the-envelope calc.

Figure that there are somewhere north of $50 trillion dollars in private “credit market instruments” out there in the U.S. as of Q3 2011 ($120 trillion in total liabilities).

Do the math: 1% of $50 trillion is 500 billion dollars. One extra point of inflation transfers that much wealth — buying power — from creditors to debtors. Every year.

This is probably an overstatement — many people/businesses are both creditors and debtors, so part of the transfer is from them to themselves. But still: let’s cut the number in half. An extra point of inflation transfers a quarter of a trillion dollars per year in buying power — real wealth — from creditors to debtors.

Because this effect impacts the huge existing stock of financial assets, 1. it is a permanent , and 2. its scale utterly dwarfs the relatively measly (and multidirectional) effects on flows — often second- or third-order effects — that (neoclassical) economists tend to go on about when discussing inflation. (“Money illusion,” “neutrality of money,” etc.)

And there are far fewer creditors than there are debtors. The effects of the transfer are concentrated on one side, diffused on the other. (See: Mancur Olson).

I’ll have a lot more to say about this in future posts, but keeping this short, I’ll bring it back to the the title of this post:

The Fed is run by creditors. And I’ve heard it said that financial incentives matter. The Fed governors have a huge incentive to keep inflation low, and ignore the other side of their dual mandate: employment.

We tend to talk in very big numbers these days, but a quarter of a trillion dollars a year seems like it’s still enough to get people’s attention.

Cross-posted at Asymptosis.

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Dylan Ratigan interviews Yves Smith on  where the money goes (h/t rjs):

Smith: Investors Are Afraid of Suing the Big Banks for Fear the Government Will Retaliate

On this episode of Greedy Bastards Antidote, we’re covering a new term from our upcoming book. This week, we’re focusing on extractionism. Joining us to discuss it is Yves Smith of She is author of ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.

This week, I talk with Yves Smith, and she opened my eyes to some radical stuff going on in the capital markets. Big Banks are extracting capital for themselves with such power that investors are actually afraid to go to the courts for redress.

Yves said that one prominent securities lawyer told her “he knows investors who he said if Jamie Dimon came into somebody’s house and killed the children of these people, he said they would be afraid to call the police.” That’s how bad the extraction has gotten. And that’s not capitalism.

But first, what is extraction, and how is it the opposite of capitalism? How can extractionist systems have all the characteristics of capitalism, while hiding the elimination of productive resources over time?

Greedy Bastards like to call themselves capitalists, but what they’re actually doing is the exact opposite: it’s extractionism: taking money from others without creating anything of value; anything that produces economic growth or improves our lives.

Under an extractionist system, we find lose value at a faster rate over time, while we need to be creating it. Instead of giving people incentives to make good deals where both sides can benefit, extractionist systems rewards those who take and take some more, and give nothing in return. Sadly, extractionism has crept its way into every aspect of our economy — it’s everywhere, from trade to taxes to banking…

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Occupied Media: Interview With Professor William K. Black

Often  participating in econoblogging is done by an older crowd.  I  receive requests by younger potential econobloggers to read some of their posts, but often such posts are lacking in enough documentation and thoroughness of understanding for publication here.  My hope is that this young woman becomes the exception.  Re-posted with authors permission   Dan

by Taryn Hart at Plutocracy files

Guest post:  Occupied Media: Interview With Professor William K. Black

So, this video took far too long to post due to technical difficulties (and we ultimately ended up posting without video). However, the content is amazing. The interview is with esteemed law professor Bill Black who has been a tireless advocate for reform of the financial system and prosecution of the fraudsters that brought our economy to its knees. The title of his book really says it all: The Best Way to Rob a Bank is to Own One.
Professor Black is an Associate Professor of Economics and Law at the University of Missouri, Kansas City, a white-collar criminologist and a former financial regulator. He blogs at New Economic Perspectives and tweets at @WilliamKBlack. Professor Black has been an advocate of the Occupy Wall Street Movement and he has been remarkably generous with his time.

A huge thanks to video editor Paul Shockey for getting this interview out despite the numerous technical problems.

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