April 12, 2010
The long-overdue need for financial reform is finally getting some serious attention in Washington. As banking lobbyists continue to grease palms in the Senate, we are beginning to hear a number of novel ideas from some clever commentators, focused on preventing another financial crisis.
On April 9, John Mauldin published a thought-provoking essay entitled, “Reform We Can Believe In”. At one point in the piece, Mauldin considered the question that has been hanging over our heads for the past eighteen months:
What happens if we do nothing?
What happens when we have the next credit crisis, when a major sovereign government defaults, as I think will happen? It will be a body blow to many banks, especially in Europe. Once again, we could have banks worried about lending to each other or taking letters of credit, which would be a disaster for world trade and the recovery we are now in.
That we (and Europe and Britain) have taken so long to enact real reform has the potential to really put the world at risk. In the next crisis, we will not have the tools available to stem the tide that we did the last time. Rates are already low. Do you think we could pass another TARP? The Fed’s balance sheet is already bloated. It could get much worse unless we get financial reforms that have some bite.
All this debating about a consumer protection agency and where it should be and all the other trivia is wasting time. Fix the big things. Credit default swaps. Too big to fail. Leverage. Then worry about the details.
Although I left out Mauldin’s suggestion to “leave the Fed alone” from that last paragraph, his essay contains a fantastic explanation of how the Federal Reserve System is organized. Best of all, Mauldin spent plenty of time reflecting on Milton Friedman’s suggestion that we program a computer to set monetary policy, instead of leaving that authority with the Fed:
Let me be clear. There are a lot of things not to like about the Federal Reserve System. I think it was Milton Friedman who said we would be better off with a computer determining monetary policy. A quote from an interview with him is instructive. When asked “Do you still think it would be a good idea to have a computer run monetary policy?” he answered:
“Yes. Of course it depends very much on how the computer is programmed. I am not saying that any computer program would do. In speaking of that, I have had in mind the idea that a computer would produce, for example, a constant rate of growth in the quantity of money as defined, let us say, by M2, something like 3% to 5% per year. There are certainly occasions in which discretionary changes in policy guided by a wise and talented manager of monetary policy would do better than the fixed rate, but they would be rare.
“In any event, the computer program would certainly prevent any major disasters either way, any major inflation or any major depressions. One of the great defects of our kind of monetary system is that its performance depends so much on the quality of the people who are put in charge. We have seen that in the history of our own Federal Reserve System.
Another perspective on financial reform came from Jim McTague in the April 12 edition of Barron’s. He began with the remark that both the House and Senate reform bills lack adequate measures for “efficient and intelligent policing”. Nevertheless, the solution he embraced was simple:
The aptly named Richard Vigilante, who recently co-wrote a book called Panic with Minneapolis-based hedge-fund legend Andrew Redleaf, suggests this approach: Force all firms managing other people’s money to publish their investment positions in detail before the market opens; this would include hedge funds. Then, the short sellers could punish ineptness before it spreads by betting heavily against a particular institution’s stupid decisions.
“Bankers would hate it. It’s their worst nightmare,” says Vigilante, whom I met with at Firehook bakery on Washington’s Farragut Square. If the system had been in place in 2006, short sellers would have stamped out the smoldering subprime mania before it had a chance to spread, he asserts.
His suggestion is both brilliant and a model of simplicity — it could protect consumers against all kinds of risky financial products — but it will never become reality.
Bankers would scream about the need to protect their proprietary-trading information. And, as was the case with health-insurance “reform,” Congress is bent on ramming a bill, no matter how flawed, through the legislative sausage works in order to mollify an uncommonly angry electorate before Nov. 2. To entertain new ideas at this juncture, even good ones, would upset the ambitious timetable.
Like health care, the new financial regulatory regime is built atop the cracked masonry of the old one. The same flatfoots who were on patrol when the subprime caper went down will be given larger beats to walk. They will be overseen by a brain trust, a Council of Regulators, culled from their ranks, who, like chemical sniffers, would seek to uncover systemic threats to the volatile financial system. In fact, COR is the core of the whole scheme.
The proposal for a Council of Regulators has drawn a good deal of criticism, primarily because it would be chaired by the Treasury Secretary. Matthew Bishop and Michael Green, authors of The Road From Ruin, had this to say about a Council of Regulators in a recent Huffington Post piece:
Indeed, with the Treasury Secretary in the chair, would this council really face down the political leaders and try to stop an emerging bubble spreading a feelgood factor across the nation (as bubbles do, before they burst)? Even in his pomp Alan Greenspan knew that a Fed chairman couldn’t risk being too gloomy about the economy and keep his job. What chance then of a Treasury Secretary, a cabinet member, being so bold?
Rather than another layer on top of the dysfunctional existing regulatory system, America needs to sweep away its absurd proliferation of regulators and replace them with a powerful super regulator, independent of day-to-day politics and empowered to do the job properly.
Regardless of what the final product will include – one thing is becoming increasingly likely: Some semblance of financial reform legislation will eventually become enacted. It won’t be perfect but anything will be better than what we have now. (Well, almost anything . . .)
More Good Stuff From David Stockman
August 2, 2010
The people described by Barry Ritholtz as “deficit chicken hawks” have their hands full. Just as some Democrats, concerned about getting campaign contributions from rich people, were joining the ranks of the deficit chicken hawks to support extension of the Bush tax cuts, people from across the political spectrum spoke out against the idea. As I pointed out on July 19, President Reagan’s former director of the Office of Management and Budget (OMB) – David Stockman – spoke out against extending the Bush tax cuts for the wealthy, during an interview with Lloyd Grove of The Daily Beast:
The infamous former Federal Reserve chairman, Alan Greenspan, had already spoken out against the Bush tax cuts on July 16, during an interview with Judy Woodruff on Bloomberg Television. In response to Ms. Woodruff’s question as to whether the Bush tax cuts should be extended, Greenspan replied: “I should say they should follow the law and let them lapse.”
When Alan Greenspan appeared on the August 1 broadcast of NBC’s Meet The Press, David Gregory directed Greenspan’s attention back to the interview with Judy Woodruff, and asked Mr. Greenspan if he felt that all of the Bush tax cuts should be allowed to lapse. Here is Greenspan’s reply and the follow-up:
The drumbeat to extend the Bush tax cuts has been ongoing. Federal Reserve chairman, Ben Bernanke, claimed on July 23, that those tax cuts would be one way of providing stimulus for the economy – provided that such a move were to be offset “with increased revenue or lower spending.” Increased revenue? Does that mean that people – other than those earning in excess of $250,000 per year – should make up the difference by paying higher taxes?
On July 31, David Stockman came back with a huge dose of common sense, in the form of an op-ed piece for The New York Times entitled, “Four Deformations of the Apocalypse”. It began with this statement:
The article included a boxcar full of great thoughts – among them was Stockman’s criticism of the latest incarnation of voodoo economics:
Mr. Stockman took care to lay blame at the foot of the man he described in the Lloyd Grove interview as an “evil genius” – Milton Friedman – who convinced President Nixon in 1971 to “to unleash on the world paper dollars no longer redeemable in gold or other fixed monetary reserves.”
Despite the fact that tax cuts are considered by many as the ultimate panacea for all of America’s economic problems, David Stockman set the record straight about how the religion of taxcut-ology began:
Stockman’s discussion of “the vast, unproductive expansion of our financial culture” is probably just a teaser for his upcoming book on the financial crisis:
On the day following the publication of Stockman’s essay, Sarah Palin appeared on Fox News Sunday – prepared with notes again written on the palm of her hand – to argue in support of extending the Bush tax cuts. Although her argument was directed against the Obama administration, I was fixated on the idea of a debate on the subject between Palin and her fellow Republican, David Stockman. Some of those Republicans vying for their party’s 2012 Presidential nomination were probably thinking about the same thing.
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