Redstate

If for no other reason than that it's politically impossible.

My point here is really to point out the limits of the much more heavily regulated world that is coming.

I want to point you to this article by Steve Forbes...

http://www.forbes.com/columnists/forbes/2008/0505/019.html

There is some irony in your analysis. You say the crux of the problem is that the dollar is terribly weak. Well, if you look at Forbes' analysis, the weak dollar can be traced right back to Fed policy. Thus, I would have to argue with your lack of guilt placed on the Fed. It appears, if you agree with Forbes, that they created this monster.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

...the weak dollar. I said that lack of confidence in the dollar is causing the commodity price bubble. The bubble will deflate rapidly, as soon as the dollar turns around, which it has already started to do. The systemic moral hazard problem remains.

Steve is obviously a very bright guy, but he has his point of view regarding policy that he's been articulating for years, and he's also a gold bug from way back.

I'm saying that massive re-regulation is inevitable, and the argument should be over how to do the least amount of damage.

Fine, the crux of the problem isn't the weak dollar, however the weak dollar is a significant portion of the problem. Is that better?

The point I was making is that the weak dollar is a serious problem that is perpetuating and even causing many of the other problems, and the Fed's own policies have perpetuated that problem.

My point is that the Fed shouldn't escape serious responsibility for what is happening.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

There is secular weakness, which has been in place for some time, as trendline growth in the US falls farther and farther behind the rest of the world.

And then there is the recent spike caused by monetary interventions.

Although they try to rhetorically finesse the issue, everyone at the Fed knows they're walking the edge of a knife. They overused the interest rate lever in responding to the crisis, and I have a feeling they wish they could have some of that back.

They're also engaged now in some heavy policy engineering intended to improve their tools. In particular, they want the ability to separate monetary policy from liquidity enhancement. Their current tools are too crude to distinguish the two different classes of problem, and that's why they overshot so far on the dollar.

One of the things that will help to make this split is accelerating a rule change that will allow the Fed to pay interest on Fed funds, which was slated for 2011.

If you want a much stronger dollar, there are only two ways to do it: either make the US economy a high-growth economy again (not gonna happen), or raise interest rates sharply.

And do you really want the latter to happen at this point in time?

Re words: don't play games with me, Mike. I'm not going to let you get away with distorting what I say, even if you think you're harmlessly stretching my words to make your point.

I was pointing out that the Fed policy has weakened the dollar significantly, and as you pointed out, the weak dollar is part of the problem. Thus, it is unfair to totally give a pass to the Fed. That was the point. Whether or not the dollar was the crux of the problem or not was not the issue. The issue is that Fed policy caused a perpetuation of the weakening dollar which was the source of many of our problems. Thus, the Fed must take responsibility for that.

If you remember most of my arguements on this matter you will remember that I said for a long time that they were dropping rates too precipitously. Though, if you agree with Forbes, you would say they should have increased rates.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

...on this general subject.

If I understand you correctly, your point is that the Fed is not blameless in the current situation.

I can completely agree with that, as far as it goes.

The Fed's low-rate policy in late 2003 and early 2004 (also a time of bizarre and worrisome distortions in the credit and money markets) is blamed by some people as the most important cause of the housing bubble. I think that's a vast oversimplification and I completely disagree, but I don't think that's what you're going for here.

The Fed's actions since mid-September have most definitely caused the exacerbation of dollar weakness we've seen since then. Fair enough, I agree with that. I also agree that dollar weakness (and the commodity-price spike that it caused) are important problems.

I don't agree that dollar weakness is part of "the problem" of general market instability that the Fed has been primarily concerned with. That problem has a lot more to do with extreme dysfunction in the mortgage-finance markets, and its result, the unstable overnight repo markets. (The latter is the "credit crunch" that MSM types keep yammering about.)

The Fed correctly saw the need to address the credit and money market problems, and it so happens that the tools they brought to bear on the job have resulted in dollar weakness and inflation.

It's like the side effects of chemotherapy. The cancer shrinks (the overnight money markets are more stable now than they've been for months), but all your hair falls out (the dollar weakened).

The Fed has known for months that they would need to come back and sop up the monetary disturbances they have created once the credit crisis had resolved.

The big problem is that (as even Bernanke admits) we can't really declare the credit crisis resolved until housing prices find a floor.

And the smartest people in the business are scared ****-less by the fact that we still have no clue where or when the floor will be reached.

so closely tied. It seems to me you can have a strong currency by having a sound financial base and not much debt, even if growth is anemic. Likewise you can have rapid growth along with inflation and a weakening currency.

"Nothing works like freedom, Nothing succeeds like liberty"
Kyle

Forbes, and others like him, are not advocating a "strong" dollar, but rather a stable dollar. Forbes will tell you that a strong dollar is no less dangerous than a weak dollar.

If you don't read the article, the basic premise is that Forbes believes that fed policy should be rooted in a STABLE dollar. That is rather than trying to manage the cycles of the economy.

You are right. A strong dollar is no better than a weak one. That is why Forbes advocates a policy that keeps the dollar stable.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

"Nothing works like freedom, Nothing succeeds like liberty"
Kyle

the prevailing wisdom is that monetary policy should be based on managing the economy. In other words, when the economy overheats raise rates, and vice versa. Forbes believes the economy is far too sophisticated to manage and the fed should thus focus on managing the dollar.

It is a very fascinating piece if anyone gets a chance to read it.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

Interesting question.

It would have opened up a whole lotta pain for a whole lotta people, but the alternative now is going to be more regulation not less.

The question at the time wasn't whether Bear should collapse. They were dead meat as soon as the rest of the Street stopped trading with them, which had already happened by late in the day on the Thursday of that week.

The real question for the Fed at that time was whether to allow the Bear collapse to cause a few dozen (or hundred) other firms to collapse along with them and totally freeze the global economy.

I would have done exactly what they did, and I say that with almost two months of hindsight.

why would other firms collaps,

and are you still not at all concerned by the power grab the fed took in procuring this deal.

Last time we discussed this you said the market makes sure the fed doesn't grab too much power, however it appears as though the market is asking the fed to grab more power.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

Socialism doesn't work. It looks nice on paper, but it's been tried and it's failed miserably every time (usually accompanied by widespread death and suffering).
Proud member of the V.R.W.C.

enough to come up with that solution on my own. AFTER it was announced I thought it was the right thing to do and I do agree that after 2 months of hindsight there was really no better solution.

Socialism doesn't work. It looks nice on paper, but it's been tried and it's failed miserably every time (usually accompanied by widespread death and suffering).
Proud member of the V.R.W.C.

moral hazard in the history of moral hazards. If you are a big enough financial firm the fed will protect your assets no matter what. Let's say other firms did collapse. Isn't that the ultimate outcome of too much risk taking. The Fed wasn't jumping in when New Century, First Magnus, Greenpoint, etc. were dropping as a result of too many bad loans. The amount of smaller mortgage companies that failed were together much more significant than Bear Stearns, and yet the Fed didn't step in then.

Now the Fed has set the precedent that if you are big enough, your assets will be protected. That is a massive moral hazard.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

If you are big enough, nanna Fed will step in and stop you from falling and skinning a knee...

And because of this more regulation is coming.

It's like my parent told me when I was 18, if you live under my roof, you live with my rules.

Sucks.

In the last thirty years we have seen a constant erosion of the old consensus against anti-trust. The result is that we have seen in most industries, and certainly in the financial industry a stratification with just a few mega-firms doing most of the business.

This sets up the "too big to fail" scenario, not to mention the problems with competition/collusion. I feel this was a huge mistake.

"Nothing works like freedom, Nothing succeeds like liberty"
Kyle

however the thinking was that these firms began to take on more and more roles and thus there was no monopoly.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

1. You can let the air out slowly in which case the integrity of the balloon is maintained. It's not damaged, just shrunken.

2. You can pop the ballon in which case pieces fly everywhere and there's no putting the thing back together again.

The Fed chose option 1.

I think Blackhedd has written other diaries on why this was much preferred to the alternative. But...
One of Milton Friedman's "Free to Choose" shows explained how the banking system failed in the 30s. The short version is 1 bank failed due to a temporary liquidity issue and triggered a run on other banks which fell like dominos. These other banks weren't involve in the problems of the Bank of the US, but they failed as a result of the first bank's problems. The New York Fed could have stepped in and saved that bank, but chose to let it fail. That decision was one of the several causes of the Great Depression.

In the same way, the Fed let Bear fail, but chose to prevent the problem from spreading and it WOULD have spread quickly. By stopping the panic, the Fed has saved our economy from a massive hit.

Yes they've created some new moral hazards in the process. They'll have a difficult time unwinding that... but it was still the only thing they could reasonably do.

Socialism doesn't work. It looks nice on paper, but it's been tried and it's failed miserably every time (usually accompanied by widespread death and suffering).
Proud member of the V.R.W.C.

what would have happened if the Fed hadn't stepped in. I will point out that the major reason that we had a depression rather than a recession was the Smoot Hawley Act, which set up new tariffs, and rolling back of many of Calvin Coolidge's tax cuts. Now, that should scare everyone.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

there were other mistakes made. The Fed made just about the worst move to handle every twist of the monetary crisis that resulted. Many of the command economy decisions made by the Roosevelt administration made things worse. All of it lead to a deep depression that lasted far longer than it needed to.

Socialism doesn't work. It looks nice on paper, but it's been tried and it's failed miserably every time (usually accompanied by widespread death and suffering).
Proud member of the V.R.W.C.

my point is that we may see history repeat itself with the Dems also now employing protectionism and raising taxes during a recession. That was why I pointed out those two things because the Dems want to make those exact same mistakes again.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

Socialism doesn't work. It looks nice on paper, but it's been tried and it's failed miserably every time (usually accompanied by widespread death and suffering).
Proud member of the V.R.W.C.

In fact, the Republicans, then, rolled back many of Coolidge's tax cuts. The two scenarios have a lot of similarities.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

all at exactly the wrong time, caused the great depression. And then leftwingers called it a "failure of the market" HAHA!

"Nothing works like freedom, Nothing succeeds like liberty"
Kyle

I think most people agree that recessions are almost inevitable at some point during an economic cycle. When the internet bubble burst we were inevitably heading toward a recession and we finally wound up in one. That said, depressions are entirely the fault of poor government policy in response to stimuli that would naturally cause recessions.

Once black monday hit in 1929, we were going to go into a recession. That was inevitable. The depression that followed was entirely due to bad policy.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

maybe yes.

Let's see what the long term impact (more regulation, more risk taking etc) will be before we declare it genius.

received much publicity however the pols are inching toward extending the Fed's regulatory power over "financial services" companies rather than merely banks. That means if you deal with money the fed can by fiat regulate you. This is what I mean. The fed has just expanded its powers exponentially and no one is a bit concerned.

Was it over when the Germans bombed Pearl Harbor

The Provocateur

Assuming you're talking about the New York Fed's response to the Bear Stearns collapse.

They had spent months war-gaming scenarios very much like it. And Bear Stearns was the smallest and most exposed of Wall Street's Big Five, and the rumors were swirling around them for months.

So genius? Probably not.

But you know what it definitely was? BALLSY.

And the reason it was so ballsy was because they knew with absolute clarity that they were creating the mother of all moral hazards, and that the world would never be the same afterward.

They really had no choice in the matter, but history would have judged them very harshly for allowing a systemic collapse. From Bernanke on down, Fed officials have studied the lessons of the Depression, and were determined above all to prevent a replay. The proximate triggers of both the 1929 and 1907 market meltdowns were much smaller and less significant than the collapse of Bear Stearns was.

But as a result, we now have this evil new world of massive regulations coming.

As someone succinctly said upthread:

Sucks.

I want to succeed fully or fail fully by my own choices, not an unelected official's.

What happens after your IRA and 401(k) nest eggs get wiped out in the next major stock market crash?

Because in the 19th century, before the Federal Reserve and the Securities and Exchange Commission, those kinds of stock market panics happened every 15 years or so on the average.

Middle-class people didn't count on the stock market for their personal retirement nest eggs back then, as they do now.

If you want to make the stock market a viable investment vehicle for the average American who doesn't have the financial resources to absorb a major crash, you have to provide stability to the market. You also have to provide enough regulation to prevent fraud. In the 19th century, there was so much outright fraud and conspiracy in the stock market that only the wealthiest tycoons could deal with it. (Remember the story of the "Big Four" and how they attempted to defraud railroad investors by printing counterfeit stock?)

For anyone else, "playing the stock market" was little more than a crap shoot.

There's a fairly significant literature out there on this subject, and it appears that free capital markets go through cycles of maturation on their own.

The nascent American stock markets were certainly not a place for ordinary individuals to be investing in the 19th century. But the core regulations governing the issuance and secondary trading of stock to the public (the Securities and Exchange Acts of 1933 and 1934, and the Investment Company Act of 1940) are only part of the reason why.

As stock markets grew larger, and as business organizations generally grew larger in the 20th century, a certain maturation came into the stock markets and they became better behaved on their own.

And this is entirely natural, because risk always finds its price in a free market. If there's any kind of question about the probity of a stock issuer, the price of their shares will reflect it, in the form of a huge discount.

But your point is actually rather a strange one, since it seems to reflect a point of view that the stock markets should have the characteristics of an investment suitable for ordinary individuals. This is the traditional function of bond markets, not stock markets, which at most times in history have been viewed as vehicles for speculation.

In fact, what you are describing is really a result of the development of the mutual fund industry in the middle of the last century.

Large public companies now make up the lion's share of American industry by revenue, and they employ about half of our workforce. The ownership of these companies is very widely diffused, across millions of pension and 401(k) accounts, but the control of these companies is highly concentrated in the hands of the individuals who run those pension funds and tax-free endowments.

This all by itself has totally changed the character of American management, and not necessarily for the better. I often say that "stocks are the new bonds."

I could write a whole book on that subject.

the real world does not conform to economic theories. Like anything it has it's problems, but it has proven it's value over the years even though it is a blatant example of government meddling.

"Nothing works like freedom, Nothing succeeds like liberty"
Kyle

...with this piece. More than one reader has interpreted it as advocacy for a return to naked markets. In fact my conclusions clearly were that A) we're not going back there because current politics won't allow it, and B) it wouldn't work in the first place.

What I'm really trying to show is this:

Government bailouts create moral hazard, which necessitates regulation (since the moral hazard knocks out the natural controls that exist in naked markets). But this necessarily becomes a vicious cycle.

That's because the increase in moral hazard due to government activity increases rather than decreases the natural tendency of markets to experience periodic disorders. It only seems to be otherwise because the government socializes the losses.

Your list of shame stops at 1893, but you could have followed up with 1897, the evil and crushing panic in 1907, a whole chain of banking crises throughout the 1920s, the 1929 crash, the gold-market disorders throughout the 1960s, the 1972-73 bear market, the Drysdale default in 1982, the stock market crashes of 1987, 1989 and 1991, the S&L debacle, the Asian flu and the Long-Term crises, the Internet bubble, the bond market disorder in 2003, and now the Subprime Crisis of 2007-20??.

You can't argue that the heightened regulation initiated during the New Deal prevented any of these more recent disorders.

The combination of government bailouts and increased regulations necessarily lead to pressure for more regulation, because they create moral hazard.

The reason the subject matters is because, in classic fashion, we're about to respond to market disorder with still more regulation. And what I wanted to do is really to explore the potential to move at least somewhat in the other direction for a change.

We're going to get more regulation, but we probably need less, on the whole. (We certainly need different regulation.) Too much regulation of capital markets ultimately has a negative impact on the real economy of goods and services, and that's the world we're moving toward.