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Robert Samuelson and Nicole Gelinas
Debating the Wreckage « Back to Story
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Your second to last paragraph talks about keeping inflation low for so long. The only reason that inflation can be considered low is because of the profound error in accounting for inflation.

In order to measure the real inflation rate for money prices, it would be necessary to include everything which money can buy. When you consider that money is used to by factories, stock certificates, debt, and so on, it is absurd for our economists to say that inflation has been low for the last year and a half. Trillion dollars of growth in the financial markets since the meltdown is inflation, even though consumer prices have not increased much, or as some argue, have actually deflated.

That confusion is a large part of the disruptive monetary and fiscal policy in this country. When inflation is focused in a type of financial instrument or in real estate or non-consumer commodities, it is pretended that inflation is low and the green light is given for pumping the money supply.

Inflation has not been low. There was tremendous inflation in the 1990s, tremendous deflation in the early 2000s, tremendous inflation in the mid 2000's and another tremendous deflation in the later 2000s.

Until people see through the low inflation ruse, the Fed will continue to wreak havoc in our economy.
Isn't it odd theat neither Gelinas or Samuelson speak to the people who didn't pay the mortgages they took out? If they had paid them, all the rest would be just background corruption.
Bank consolidation in the 80's was sold, in part, on the notion that larger institutions would be too big to be able to fail. As we moved through the succeeding two decades, this slowly morphed into too big to be "allowed" to fail."

It seems to me that the idea that the government would bail out huge institutions, whose collapse threatened to be catastrophic, was, towards the end of this period, considered to be inevitable.
People seem to ignore the role that the collapse of the dollar in 2008 had on the markets. That's what pushed people ove rthe edge. I believe that Congress' unwillingness to reform Fannie MAE and Freddie MAC along with the completely ignorant response of Henry Paulson's $165 billion "stimulus" led investors to believe that no one had a clue. This led to the dollar sell off and the tanking of all those assets denominated in dollars. Soros made $10 billion. Was he involved in some way?
There are only two federal regulations that are required to forever fix this mess and prevent it from happening again:

1) All trades are final, with full payment due at the end of each business day.

2) All losses are final, to be asborbed by the owner.

Those two things would forever get rid us of the obscene credit-driven business environment that's been erected over the past 40 years across the globe.

If you want something, pay for it...if you can't pay for it, save until you can or borrow at exorbitant rates. Either way, we return to a world where goods, services, and economic activity are funded by actual money, rather than complicated paper shuffling schemes.
As long a Capitolism remains the enemy of Marxists, there will be attacks from every direction and by every tool available. New methods will be devised to blind-side investors and government regulators. As Constitutional freedoms wither or mutate, limits of government intervention will expand.We are entering the age of reduction of the governed. Votes no longer carry enough power to resist judicial reversal or the deadly Executive Order. I am afraid my 84 years are not enough to push me off the stage in time to not see my country brought to its knees.WWII SubVet
I am surprised that both writers ignore the role of the Federal Reserve System in creating the financial bubble. The Fed, the rating agencies, Fannie and Freddie all played a significant role in this catatrophe. There is a lot of blame to go around, but the Fed takes first prize by expanding the money supply and keeping interest rates at ridiculous levels.
Wow! I'm not used to civil discourse these days. No ad hominem attacks; just reasoned analysis. I happen to respect both writers very much and look forward to reading more of their analyses.
Human nature is indeed why we need consistent and uncomplicated government rules, and one rule that stands out is that those who stand to gain if an enterprise succeeds should be the only ones to lose if it should fail. If investors were assured that such a policy would be enforced consistently, they would be free to assess risk accordingly.
Great, stimulating discussion. And so civilised! You guys must not be from around here.
Don't you recognize that this is the best time to get the loans, which will realize your dreams.
Charles R. Williams September 20, 2010 at 9:46 AM
Both Gelinas and Samuelson overestimate the role played by Wall Street in the Great Recession. $10T in private net worth was wiped out since 2006. Lehman, Hank Paulson on his knees and TARP is all a spectacular side show. Consumption will not recover until consumer balance sheets recover. Savings have to be channeled into productive investment. The political climate is hostile to investment. Recovery will take a long time.

All this would have happened if the banks were not overlevered. And the Dodd/Frank bill does nothing but institutionalize TARP. Geithner will not have to get down on his knees the next time.

Interest rates were too low and the politicians engineered a reduction in mortgage lending standards. A housing bubble ensued where a decade of savings were squandered. The bubble broke. All of this could not happen without exciting times on Wall Street but unless you live and work there it was nothing but a sideshow.
Two observations, one specific the other general: As to the specific, you only take particular issue with Samuelson as to his assertions that: “. . . government’s willingness in this respect could not be known with absolute certainty in advance.”, to which you respond by the no doubt correct observation that: “But almost nothing can be known with such certainty. Investors, like anyone else, must imperfectly predict the future, based partly on past behavior.”

But rather than having used the phrase “absolute certainty” if Samuelsson had used the phrase “significantly operable certainty”, wouldn’t you agree his essential point would be correct?

And generally, virtually all of the discussions on the issue of “moral hazard” --- including here Samuelsson and you ---- treat it as a financial issue. But by and large, it is not. The phenomena of “moral hazard” involves what is essentially and basically in the realm of human psychology. In most general terms the issue involves: If a certain objective condition exists, will people tend to perceive it as having certain objective ramifications, and if they do will they then tend to behave in a certain way? Specifically, if the government has sometimes bailed out a few failing financial firms, will key investors then conclude that therefore there is a significant probability that it will do so in the future as to the financial firm they are concerned with, and if they do will that tend to make them inclined to take significantly greater risks than they would otherwise?

Query: Has a reasonably scientific poll ever been conducted amongst those key players who would make the relevant decisions regarding potential “moral hazard” risk along the following lines:

(1) Based on previous government bailouts of financial firms do you view the probability to be significant that the government would bail out your firm if it had similar financial problems?

(2) If yes, what do you assess the probability to be: Less than 10%? At least 25%? At least 50%? Grater than 50%?

(3) If the answer to #1 is YES, has that made any significant difference in your evaluation of the acceptable level of risk to which you would be willing to subject your firm? And if so, how and in what way?

If such a poll has been taken, what were its results? And if none has been taken, wouldn’t one be useful in shedding some clarifying and essential light on the issue, which at this time seems to involve pretty much pure speculation?
Henrik Ræder Clausen September 20, 2010 at 12:15 AM
With all due respect, I disagree with both explanations. As was pointed out by Gretschen Morgenson in New York Times two years ago, the real source for the financial madness was the opportunities afforded by the central banks and their continuous 'quantitative easing', as expressed through artificially low interest rates.

The problem is that we have inflation at all. In a genuinely capitalist economy, falling prices is the natural state of affairs, as improved manufacturing processes makes consumer goods easier and cheaper to produce.

Inflation surely stimulates the economy, but in a destructive way. Germany was happy for its inflation in 1921-1922, before it went horribly wrong.

Inflation was also the policy of post-WWI US, leading to the 1929 crash and the ensuing Great Depression. It was the policy of the 1950's, leading to a mild recession late in the decade. It was the policy of the 1960's, leading to the 'Stagflation' of the 1970's. It was the policy of the 1990's, leading to the .com crash. And it was an intense policy of the 2000's, leading straight to the 2008 crisis.

Inflation is still the deliberate goal of the Federal Reserve, the ECB and other central banks. And it WILL lead to more crises.
Because all financial companies did not suffer the same implosions in the recent financial crisis, it becomes less likely that a combination of purely exogenous forces such as easy money, greed, deregulation, etc. was the cause.

After all, both greed and easy money were universal and we know that many completely unregulated financial companies were unscathed. It seems far more likely that both moral hazard and the agency problem are to blame and so long as we continue the same management compensation practices that brought us here, we will most certainly suffer other financial crises.

The most common characteristic of financial companies which suffered catastrophic losses was compensation arrangements which paid decision makers for current period accounting profits while assigning the long term accumulation of balance sheet risk to shareholders (and in the case of insured depositories, to taxpayers). These were the compensation schemes that had paid senior managers of failed institutions many millions and left shareholders with nothing.

In the last banking crisis, I assembled the New Dartmouth Bank investment group that purchased and then combined the assets of three failed banks in New Hampshire. The investors were led by Jack Byrne, a former actuary and a very successful manager of insurance companies (GEICO; Fireman’s; White Mountains Insurance).

Jack was easily the wisest client any investment banker ever had and I accepted his offer to design management compensation arrangements which paid our very capable management team adequate salaries and awarded them five year options, the value of which were based on the long term accretion to tangible book value. His ideas about management compensation should be watchwords for investors, corporate directors and deposit insurers. Jack said, “We want to align the interests of the managers with those of the owners. If I can design the compensation, I will predict the outcome”.