demandside

Plus Wm. Poole, Idiot of the Week, news and notes on regulation

05.07.09

Today, the Forecast Bulb is Dimming as a result of the inability to turn the financial ship fast enough.  We engage in a lengthy, well, rant about the seeming imperviousness of institutional bias to evidence, experience, fact and fate.  Then some notes on regulation.  In between it is Idiot of the Week with Bill Poole, formerly of the St. Louis Fed, now of the Cato Institute.

First the News:

Abbreviating the news today:

Unemployment:

Initial claims, the four-week moving average, has taken a step downward, back to 623,500, off over 32,000 from the peak.  The continued claims continues to go straight upward, but it is possible that a glimmer of light is appearing.  Say it with me, infrastructure spending, aid to states, stimulus package.  This does not, repeat not, mean that the unemployment rate will back off any time soon.  And the run-up in both initial claims nad continued claims, even just to this point, is the worst it has been in modern history.

Stress Tests

It is not news that the banks made big blunders in lending and securitizing and took big losses and are now insolvent.  What is now generating news is that the Treasury Department’s stress tests will show this.  This is generating lots of criticism of the tests.  Kind of like blaming the breathalizer for being drunk.  Maybe if the police didn’t let on you are drunk you could drive home safely.

Housing

Mid to high range residential property is defaulting now like subprimes.

Manufacturing

The ISM number rose to 43.7 in April from 40.8 in March, indicating gutting of the manufacturing sector is almost complete.  No.  Indicating a slower contraction, but still contraction.  The gutting comment is my editorial.

From Last Week

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — decreased at an annual rate of 6.1 percent in the first quarter of 2009 …

Real personal consumption expenditures increased 2.2 percent in the first quarter, in contrast to a decrease of 4.3 percent in the fourth. …

Real nonresidential fixed investment decreased 37.9 percent in the first quarter …

Nonresidential structures decreased 44.2 percent …

Equipment and software decreased 33.8 percent …

Real residential fixed investment decreased 38.0 percent …

So PCE increased (as expected), but investment slumped sharply in all categories.

And just a last note from the real world:

Cities are the world’s primary contributors to greenhouse gas emissions – and yet they will be the first to suffer from the consequences of climate change, such as storms and rising sea levels.

Enough news Forecast Bulb Dimming

The long-term bulb is dimming on the Demand Side forecast.

One might call it the return of realism or inversely the disappointment of the naive.  And many of you may have already arrived at this point.

It has been with some dismay that Demand Side has watched the economy foundering, the tools and theories of the establishment being crushed by events, and yet no realization that anything has to change.  The consumer society has died.  A  new economy based on strategic goals like the survival of the planet and its inhabitants, the avoidance of chaos and suchlike is demanded.

Unfortunately most folks live in a soup of experience out of which they cannot see.  They feel secure in or dependent on the current trajectory, or see no alternative.  Those who are supposed to be watching and weighing the broader movement of things are, we have come to accept, captured by narrow self-interest.

It is not that the blind alley into which we running our society is invisible or that our economic technocrats are being defeated by the seduction of an army of Mata Hari’s.  It is that the establishment is established in immovable institutions whose continued existence depends on a return to the lost land of consumer finance.  Irrespective of the fact that the lost IS lost and cannot be recovered, all the forces of Wall Street are at the disposal of those who promise its return.  The leviathans of the earlier day, the Citibanks and Bank of Americas and so forth, are sprawled across the road to recovery with no capability, even if they had the intention, to reform.  The houses of Finance and also of Academia are run by individuals whose entire investment is in a failed economic scheme.  While their hope of gain is miniscule, it is greater than if they were to admit that the fallen house of cards was a house of cards to begin with.  Were they to do that, they would lose their place as dealers.

Simply put, since they depend on a consumer society and a complex scheme of rational markets and corporate oligarchy, they will spare no effort in assuming or projecting one.  Of course, nothing will materialize to support them.  Only zombie forms dependent on indulgences from the taxpayer and regulator are possible.

These are not passive supplicants at the public trough.  By no means.  Those on Wall Street are in Simon Johnson’s terms, oligarchs.  Demand Side the book used the term corporate oligarchy.  Those in Academia are shielded by tenure, obscure mathematics, or a culture of debate.  Nonetheless they are wrong and dangerously wrong.

The fact that they are wrong was not the problem with the Demand Side forecast.  Our problem was the delusion that once the supply side charade was vaporized and the intellectual foundations of the system disintegrated, as an obstacle it would fall of its own weight.

Indeed, the first part has occurred, the vaporization and disintegration, but the established system posses not dead weight, but momentum, the momentum of self-interest.  Rather than capitulation, each new crumbling has witnessed the invention of new rationalizations and excuses.

The most pernicious variation of this is the inneffectiveness of monetary remedies under the Fed and Treasury.  More than eighteen months ago the Fed began its expansionary monetary policy and its special facilities for the financial sector.  All this time it was not enough medicine, according to the Fed, not that the medicine was ineffective.  Now, barely a month after the beginning of the fiscal stimulus, we are seeing signs of some stability in the real economy.  Outlandishly, Fed apologists ascribe it to monetary policy.

In today’s Idiot, we feature …. Poole, former Fed official and unrepetent Libertarian trying to concoct out of the disgusting and decadent a potion palatable enough to force down the throats of the unwitting.  That is, a way of explaining how stupidity in monetary policy and incompetence in regulation did NOT lead to the current crisis, and is instead, the way out.  In Mr. Poole you see the perfect example of a nabob of orthodoxy who is willing to let the ship go down rather than give up his captaincy.

In any event, it is not dead weight we are left with, but momentum.  This momentum is sending the old order careening through an out-of-control institutional system — the financial sector — into the real economy and through the body politic.  The damage is justified by either, “It was an act of nature, “Nobody saw it coming,” “We couldn’t do anything,” or “We’re doing everything we can.”  That the collapse continued so long and continues to continue gives lie to this whole line of defense.  If we didn’t see it coming eighteen or twenty months ago, perhaps we can see it now.

The fact remains that the economy is crumbling, has crumbled, and those who are in charge have not altered that fact, nor even altered the trajectory appreciably.  Citibank and Bank of America are no less problems for the economy today than they were when the whole “float them on a sea of taxpayer loans” scheme began.  The great earnings triumphs of the past few weeks which to some have meant new hope for this sector, to others have meant the big squeeze on the credit card and Scroogian credit conditions.  They’d better make money when they’re getting it at zero.

You have seen here at Demand Side that we correctly predicted the crash.  We increased our gauge of its severity as it approached with no effective policy preparation.  Our projections have held up well.  AND we haven’t tweaked them semi-weekly.

Even today’s change is to the long-run, outside-the-charts forecast.  Those charts on the web site, which we occasionally or semi-occasionally revise are still intact.

The point is not that we have been so right, but that the Fed and others who sip the Monetarist kool-aid have been so wrong.  And not so much that they have been wrong, but that they have not changed course nor revised their analysis.  They have never questioned the Monetarist remedies.  Each passing month of ineffectiveness only raises their alarm about the severity of the problem.  It cannot be that their medicine doesn’t work.  It can only be that this is a new and more virulent strain of the disease.  Phooey.  The disease has become more dangerous because it has gone so long without effective treatment.  The entrenched financial interests have suborned non-answers as the first line of defense.

The mechanics of the economy are not so difficult, and are in fact well understood by some.  I was glad to see that Joe Stiglitz went to dinner at the White House, along with Paul Krugman, last week.  You hear people like Dick Durban, Senator of Illionois, admit that Wall Street controls Washington.

I personally think you need to be a pretty good politician to become president and that Obama may be picking his fights at this point.  Getting health care through and getting the stimulus in place will be fully enough.  The consequences of ineffecitve policy will soon enough generate political will.  Whether it will be enough to overcome the entrenched financial czars remains to be seen.

The difference between mechanics and institutional interest can be seen pretty clearly in money.  As we’ve said many times, money is simply a means of exchange, from one worker to another, from then to now, from this nation to that nation.  We’ve also said, however, that money flows to power.  So the mechanics of money are corrupted when institutions are allowed inordinant or unbalanced power.  Even in the flows of money.

As an aside that really has little to do with the subject.  My wife is Russian.  She grew up in the Soviet era and she sometimes says proudly, “People always had enough money.”  A lot of the reason for that was there was nothing to buy.  Apartments were free.  Likewise health care, education.  But the stores were empty.  Money had a different use there, I guess, than as a medium of exchange.  Or at least it was a long-handled exchange.

But even the mechanics are corrupted when the manuals are so full of bull.  William Poole later, but here is David Malpass on Bloomberg.  Malpass is a Wall Street analyst.

MALPASS

This is straight out of the Chicago School.  There cannot be any stimulus because it is — what is the word? — ah yes, “crowding out” private activity.

Somehow we could have tens of trillions of dollars of private stimulus borrowing in the Greenspan years without this effect crowding out needed public investment, but the moment the public sector borrows to build a road or energy efficient future, it becomes ineffective.  The only economic growth can come from the private sector.  No wonder we have tens of thousands of acres of empty houses and at the same time crumbling infrastructure and dilapidated health and education systems.

How can effective action on the economy be undertaken when the debate is stuck in the flat Earth - round Earth era?

The entire effectiveness of Monetarist pap is of the same nature.  Never has a theory survived so much evidence and experience contradicting it.  The Fed has reduced interest rates to zero and created more money than ever before by a factor of four or five.  Now maybe there are some green shoots.  Never mind the fiscal stimulus.

And you can bet when the economy does stabilize, it will be because the Fed’s measures finally kicked in.  Bernanke went from a scholar of the Great Depression whose theory was that the failure to save the banks was the critical error.  He has proven that even compromising the balance sheet of the central bank and getting hundreds of billions out of the taxpayer does not save the banks.  As we’ve said, it is the banking function that must be maintained and rehabilitated.  The banking institutions need to suffer the same fate as any real economy firm who sold toxic products to the public.

Instead it is becoming clear that Bernanke will go from eighteen months ago being “the man who would save the system with his aggressive policy response” to today “the man who has done all he can be expected to do and now it’s time for somebody else to step up” to in the future “the man whose clear vision led us out of the mess.”

In fact, Bernanke has had little more effect than a man waving a rag at the sun to get it to go down.  Timothy Geithner has become his assistant.  They cannot do the things that will work because that way lies over the bodies of the financial institutions who are their chief sponsors.

Anyway, I was glad to see Joe Stiglitz and Paul Krugman up at the White House talking off the record.  That probably means a lot was said by all parties.  I hope they heard from the President that as soon as the political dynamics allow there will be real change in treatment of these oligarchs.

Although efficient and productive outcomes will not happen absent the correct policy choices, there is no guarantee that these choices will either sooner or later be chosen.  It is entirely possible for the entrenched financial interests to produce a future in which they are profitable and everybody else is not.  We are told that a healthy economy cannot come back without a healthy banking sector.  That is true.  But a healthy banking sector will not be comprised of zombie leviathans kept alive by regular taxpayer and central bank transfusions.

The

Now to IDIOT OF THE WEEK

William Poole,

Poole was for ten years President and CEO of the Federal Reserve Bank of St. Louis and is now a senior fellow at the notorious Cato Institute

POOLE

Bill Poole is not David Malpass.  He is marginally more independent.  Poole is better identified as a technocratic regulator.  And his comments here were excerpted from some on Bloomberg that were somewhat more cogent.

Neither is Poole Dennis Gartman or another of those whose need for sales determines both his politics and his economics, and for whom even the closing of Cayman Island tax shelters is anti-American.

That said, Poole was selected as Fed honcho precisely because of his ideological biases.  The Fed is full of Monetarist zealots who gather like Trekkies and reinforce to each other the importance of their vacuous line of attack and conduct impotence support sessions.

Here Poole serves our purposes first by counting backward from results — if the slackening of the pace of deterioration can be called results — to the cause, here noted as last September.  Then we are assured that the nine or twelve, or maybe six months, more or less would APPEAR to put recovery — if it happens — PRECISELY in line with the Monetarist predictions.  Unfortunately, the Fed’s easing began about a year prior to the September date Poole selects, even if Bernanke’s unprecedented aggressiveness is to Poole in hindsight too timid.

The second segment here is Poole’s at-sea-ness with regard to regulation.  Well, I guess I missed it.  The causes of the crisis passed in the night.  We have got to get these people out of here.  Regulation?  Why bother?

William Poole, IDIOT OF THE WEEK

But let’s stay on the subject of regulation.

Here’s a post from Calculated Risk which includes comments by Ben Bernanke on this subject.

From May 7

REGULATION

There is no question that the Fed failed to adequately perform their regulatory responsibilities during the housing and credit bubble. … Part of the problem was supervisory responsibility were split between various state and Federal regulators. As Fed Chairman Ben Bernanke notes in this speech, under the Gramm-Leach-Bliley Act of 1999, the Fed “serves as consolidated supervisor of all bank holding companies, including financial holding companies.” Although the Fed missed significant problems at these holding companies, many of the problems were at mortgage brokers, and commercial banks that were not regulated by the Fed.

The regulators that I spoke with in 2005, at various agencies, were all concerned about the impact of the housing bubble and lax lending standards. But it was difficult to get the various regulators to coordinate. And several people told me confidentially that the Fed and the OTS were blocking efforts to tighten lending standards. So more consolidated supervision is required - but part of the problem during the bubble was that a few key individuals were able to block the efforts of other regulators.

So I think a framework to identify systemic problems would be an important addition.

Fed Chairman Ben Bernanke offers some suggestions:

(Now quoting from Bernanke.  Be patient.)

monitoring large or rapidly increasing exposures–such as to subprime mortgages–across firms and markets, rather than only at the level of individual firms or sectors;

assessing the potential systemic risks implied by evolving risk-management practices, broad-based increases in financial leverage, or changes in financial markets or products;

analyzing possible spillovers between financial firms or between firms and markets, such as the mutual exposures of highly interconnected firms;

ensuring that each systemically important firm receives oversight commensurate with the risks that its failure would pose to the financial system;

providing a resolution mechanism to safely wind down failing, systemically important institutions;

ensuring that the critical financial infrastructure, including the institutions that support trading, payments, clearing, and settlement, is robust;

working to mitigate procyclical features of capital regulation and other rules and standards; and

identifying possible regulatory gaps, including gaps in the protection of consumers and investors, that pose risks for the system as a whole.

Precisely how best to implement a macroprudential agenda remains open to debate. Some of these critical functions could be incorporated into the practices of existing regulators, or a subset of them might be assigned to a macroprudential supervisory authority. However we proceed, a principal lesson of the crisis is that an approach to supervision that focuses narrowly on individual institutions can miss broader problems that are building up in the system.

Aside from replicating the stilted language of a college sophomore, Bernanke and others miss the boat completely with regard to regulation.

It is the market that needs to be regulated.

The products need to be of standard size and their specifications thoroughly examined.  Mortgages, for example, need to be financing instruments that can be counted on for no hidden surprises so the buyer and seller can deal on the property in question without worry.  Credit cards do not need nine pages of three point type.  One agency can examine and pass on all terms and credit card issuers can compete on rates, rather than try to make money on hidden fees.  The financial innovation, so called, is not a better mousetrap, it is a more obscure and opaque financial arrangement.  There is no need for 57 varieties.  These are financing instruments to support real products and services.

Some, including Stiglitz, have advocated a Financial Products Safety Commission that would investigate new financial products for their toxicity.  What a good idea.

And the size of the market participants needs to be regulated.  For some reason it is still accepted wisdom that bigger is better with regard to banks.  There is no support for this.  By having banks that are small enough to fail, we reinstitute market discipline. Big is good for the banks because it comes with the free too big to fail insurance from the taxpayer so they can run out to the end of the risk spectrum.  But it is not good for the economy nor the taxpayer.  There are no economies of scale with banking.  It is the personal one-on-one relationship between borrower and lender that was lost by bigness that contributed the most to the cascade of bad loans that is sinking these institutions now.

Fully two-thirds of Bernanke’s suggestions involve mitigating the problems associated with institutions that are too big.  The fact that Europe has big banks only means that Europe has the same problems.  Glass-Steagall got it right.  We can see that now.

The pretense that there have been efficiencies or access to new money that somehow created value above what has been lost in this debacle is not even raised in serious conversation, at least not explicitly.  The private banking system has crashed the economy by its own hand.  Let there be no question.  It was not the government.  Unless by that you mean the government didn’t stop them.  And now we need regulation.

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