Relevant and even prescient commentary on news, politics and the economy.

Banks review themselves in England

Here is a video of an interview done by International Business Times UK. The video addresses the issue of “Mis-selling of derivatives” before the crisis. The banks are stalling on judgements so that the time limit passes and people cannot bring claims against them. They are also doing some other unethical things. Yet, the government has given the banks the authority to review their own wrong-doing. Amazing…

 

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More supply of money to Capital thanks to Fed

But weak job growth in the face of big corporate profits. As I explained in the video of a previous post, the supply of money to capital income has increased, and they are enjoying the cost savings from low interest rates. They give many thanks to the Fed’s monetary policy.

Meanwhile, lower interest rates are not helping labor income. The supply of money to labor has decreased which is a drag on real GDP.

Here is a video by Fora TV that explains further. They present a graph for nominal consumer spending showing its decline. The idea is that the supply of money in the money market for labor income has decreased, while it has increased in the capital income market.

 

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Financial Arson: News not Paranoid Fantasy

I have long been interested in the possible use of naked credit default swaps to profit from deliberately driving a firm bankrupt (see here, here, and here). My idea was that this was like arson of a building insured for more than it is worth.

I was not the only one who had this idea. It is no longer a proposed fraud. It is actually committed and caught doing it fraud.

at The Atlantic, Matthew O’Brien discusses reporting by Stephanie Ruhle, Mary Childs & and Julie Miecamp at Bloomberg

1. Buy CDS on a bond, and then bribe the borrower to temporarily default. This is like taking out insurance on your neighbor’s car and bribing him to get in an accident. You get the insurance, and then you kick some money back to him to upgrade his car.

Sound far-fetched? It’s not. It’s essentially what a unit of the Blackstone Group did with the Spanish gaming operator, Codere SA. First, Blackstone bought insurance on Codere’s bonds, so it stood to make a nice bit of money if Codere missed an interest payment. But how do you make a company miss an interest payment? Well, Blackstone took over one of Codere’s revolving loans, as a hostage, and told the gaming company: “We’ll force you to pay back this entire revolving loan unless you kindly miss the next interest payment on your bonds.” It was a clever ransom. And guess what? The clever ransom worked. The interest payment came late. Blackstone made $15.6 million from its CDS. And as for Codere, they turned out fine, too. Blackstone agreed to restructure its bonds, and reward the company for good behavior with another $48 million loan.

OK I admit I didn’t figure out the part about losing nothing from the default because it is just a late payment. That’s why they make the big bucks. Also I didn’t do it, so I don’t risk jail time. But somehow I don’t think anyone will go to jail over this one either.

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Sell out alert

Via Alternet:

The list of Democrats who are entering these negotiations embracing the GOP’s terms continues. There are at least nine in the Senate. California’s Dianne Feinstein, Montana’s Max Baucus, West Virginia’s Joe Manchin, Delaware’s Chris Coons and Tom Carper, and Colorado’s Michael Bennett have all said they support cuts to entitlements in letters to constituents, proposed bills or statements made after the President’s fiscal reform commission led by Eskine Bowles and Alan Simpson issued its 2010 report proposing capping or cutting entitlements while lowering or eliminating corporate taxes.The list of Democrats who are entering these negotiations enbracing the GOP’s terms continues. There are at least nine in the Senate. California’s Dianne Feinstein, Montana’s Max Baucus, West Virginia’s Joe Manchin, Delaware’s Chris Coons and Tom Carper, and Colorado’s Michael Bennett have all said they support cuts to entitlements in letters to constituents, proposed bills or statements made after the President’s fiscal reform commission led by Eskine Bowles and Alan Simpson issued its 2010 report proposing capping or cutting entitlements while lowering or eliminating corporate taxes.

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Alan Greenspan’s new book

Brad DeLong reviews Alan Greenspan’s new book:

Alan Greenspan: The Map and the Territory: Risk, Human Nature, and the Future of Forecasting:

The true size of the American subprime problem was hidden for years by the defective bookkeeping of the GSEs…. Not until the summer of 2007 did the full magnitude of the subprime problem begin to become apparent…. Had Fannie and Freddie not existed, a housing bubble could still have taken hold. But had such a bubble developed, it is likely that in and of itself, it would not have wreaked such devastation in late 2008…. Even given the excess[ive MBS holdings] of the GSEs, had the share of financial assets funded by equity been significantly higher in September 2008, arguably the deflation of asset prices would not have fostered a default contagion, if at all, much beyond that of the dot-com boom…”

Lifted from comments on Delong’s post from reader Bloix:

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A “weird” case for a higher interest rate

Is there a case for raising interest rates by the Fed? Even a weird one?

In the previous post, I explained the reasoning behind the current lower level of real GDP. The explanation is that real GDP declines to an equilibrium with the low interest rate in the money market for labor income.

So if a lower interest rate lowers equilibrium real GDP, then would a rise in the interest rate raise real GDP?

First I want to show a graph posted by Nick Rowe back in August of 2011. In his post, he explains

Nick rowe islm
In his post, Mr. Rowe explains the “weird” up-sloping IS curve as he puts it. Yet, even though it is weird, I agree with the graph. The graph basically points to “where we are” and “where we want to be”, and then draws a line between those points.

“Where we want to be” is a natural rate of interest that is positive. I have written before that the natural rate of interest is positive, but many economists say that the natural rate of interest is negative.

Mr. Rowe gives 2 definitions of the natural rate of interesting the comments section of the post where the graph comes from.

“1. What would equilibrate desired saving and investment given the actual level of income and actual expectations for future income.

2. What would equilibrate desired saving and investment if income were at the natural rate (LRAS) and were expected to remain so.

You are using it in sense 1; I am using it in sense 2.”

I agree with Mr. Rowe that #2 is the better definition to use. When real income (real GDP) reaches its natural rate at the LRAS curve (effective demand limit), there is a natural rate of interest that will keep real GDP stable.

So how does he explain the up-sloping IS curve?

“3. Why does my IS curve slope up? It is not because I think that a higher interest rate would increase demand for newly-produced goods. Rather, it is because I think that a sustained increase in demand for goods would have such a strong self-reinforcing effect on desired investment and consumption that interest rates would need to rise to keep output demanded equal to output. The marginal propensity to invest plus the marginal propensity to consume exceeds one, in other words. Take a normal Old Keynesian IS curve, and assume mpc+mpi>1, and it will slope up.  I explain this more in an earlier post.”

He is describing a mechanism by which a sustained increase in demand for goods would be accompanied by not only a rise in desired investment, but also a rise in interest rates. The result would be that output demanded would equal output.

I don’t want to get into the LM curve in this post, but my view is that the LM curve is flat now. But when the natural rate of real income is reached, it may continue horizontal or go vertical or anywhere in between depending on what the central bank decides. Mr. Rowe says as much for the vertical LM curve.

As Mr. Rowe says…

“The LM curve does not have a fixed slope. The slope of the LM curve is whatever the central bank wants to make it.”

The LM curve comes from the equilibrium states in the model for the money market. Yet, I want to show now that the what Mr. Rowe sees in the goods market of the IS curve, I see in the money market of the LM curve.

In the previous post, I divided the money market into two markets, one for labor income and one for capital income. These two markets behave differently, so we need to understand the money market for labor income because it is a powerful force to determine the purchasing power for goods.

Here is a video using this model of the money market for labor income to show how an increase in interest rates would coax a rise in real GDP a la Nick Rowe’s “weird” IS curve. (previous video that set up this model.)

 

Just as Mr. Rowe’s up-sloping IS curve was weird, the idea that business will invest more at a higher interest rate is weird. Yet the money market shows that possibility. The idea is that the money market searches for its equilibrium. And if money supply and the interest rate are held constant, the only way to find that equilibrium is by a shifting demand curve.

Also, Mr. Rowe saw in the IS curve that a higher demand for goods would result in a higher demand for investment. He also saw that the interest rate would respond by rising. And I show that in the money market for labor income, a higher interest rate would coax demand for goods to a higher equilibrium, which would create a self-enforcing effect on desired investment.

The demand curve in the money market can shift from a rise in prices or a rise in real GDP. The bet is that with a carefully increasing interest rate, real GDP would rise more than prices.

So according to these weird points of view, a higher interest rate would correspond to a higher real GDP and higher investment… bringing an end to the depressed economy.

I would like to include a video that was on a related post by Nick Rowe. The video shows that to create an equilibrium in an inverted pendulum, the first reaction is to move in the opposite direction that the disturbance is going. The purpose of the video I think is to get us to think in wild and weird ways to bring the economy back into a healthy equilibrium.

 

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The Efficient Racing Hypothesis

by Mike Kimel
The Efficient Racing Hypothesis
Professor Sporkweather Mo of Fridgewater University has famously postulated that a driver cannot consistently achieve better than average finishes on a recklessness-adjusted basis, provided that all drivers have the same information on track and weather conditions at the start of a race.
Using decades of data on drivers who made their living racing vehicles, Professor Mo has shown that even professional drivers are unlikely to finish with a time that beats the race average during any given race.  Once survivorship bias is accounted for by including those drivers unlucky enough to only have raced only a few times (due to being cut from their respective teams, injury or death) results look even worse.  The belief that many racing aficionados have that any skill is involved is false, and the fact that a few drivers seem to perennially come in at the top of the ranking tables is merely a function of randomness.
 

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Bill Black on JP Morgan settlement

Via the Real News is Bill Black on the JP Morgan setttlement:

DESVARIEUX: Okay. And because of these massive losses, now JPMorgan has to pay this $13 billion settlement. But it’s really being reported as this big step toward bringing the banks to justice for their role in the financial crisis. Do you actually agree with that point of view?

BLACK: No. Indeed, in the introduction, which was an accurate statement of how the Justice Department is presenting this, it’s actually inaccurate in many different ways.

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