Whether exuberant or pessimistic, market expectations tend to gather momentum:
“It is a chicken-and-egg issue,” said Tanya Azarchs, an analyst at S&P. “When Lehman looks as if it’s having trouble raising capital, shares fall. When shares fall, raising capital by selling shares gets harder. Regardless of whether the rumour is true or not, in a way it becomes self-fulfilling.”
Dodging Moral Hazard flagellation left, right and centre, The Fed has attempted to plug the whole. However, the move
… opens a door to a vicious circle. The markets where the stocks used as collateral are traded are the same markets that are now recording sharp drops… So, the collateral that will now be offered to the Fed for the loans will possibly be worth less, indeed, a lot less, than the loans against which it offered. In fact, if the securities firms use the loans to restore liquidity in the markets (and this is a big ‘if’) then prices will be established at lower level. Hence, even in such a situation, the Fed will be left with under-collateralised debts on its balance sheet.
Peter Levin sees worse to come:
This is an institutional collapse, in that we should expect to see a number of institutions falter and then either get bailed out by the federal government, “bailed in” by a consortium of other firms (who would guarantee credit, take on some assets, or both), or bought out. Some of these firms seem like they cannot fail. But they will. We’re talking about JP Morgan, Goldman Sachs, Morgan Stanley. Effectively, all the independent broker-dealers are potentially on the block. More traditional banks with commercial deposits, less leverage, and less exposure to the financial markets as such are in better shape.
(cf. FT.com) He has some excellent suggestions about who to blame, including Robert C. Merton and his disciples.
Similarly, Ben Eltham points his finger, via Quiggin’s proclamations after the Frannie bailout, at teh neoliberalism. There’s certainly some governance reform on the table, not least because Lehman Bros was operating within the relevant guidelines and legislation. As John Carney plaintively queries:
maybe we should start paying attention to the kind of corporate governance reform that works rather than the kind the experts favor
As I’ve noted here before, what ‘works’ - what is considered to be economic - is a thoroughly contingent but not arbitrary process that begins with each actor’s interpretations of a situation. So questions like ‘when will it [the bailouts] end?’ beg questions like, ‘when will publics reestablish matters of fact?’ I don’t think recourse to metaphors like ‘external concrete objects’ is particularly useful in this situation, because in the context of markets, these are always the outcome of agreements on what should count.
Elsewhere: Tyler Cowen engages in some public circumspection about Glass-Stegall.
Joe Stiglitz on comparisons with 1929
Earlier: Kim on the Subprime crisis. nb. If you found Blackburn’s piece enlightening, I suggest you have a go at Martha Poon’s prize winning work on consumer credit score cards
Tigtog has intiated a discussion post here
Update: AIG bailout announced. Quiggin: This is, purely and simply, a case of a speculative financial enterprise that’s too big to fail.. Yuval Millo points out the ‘leakage’ connections.
Apologies - I had some issues with html tags. Hopefully the post makes more sense now.
new mat link still busted
fixed.
Update: Stiglitz weighs in
DK.au,
It’s not just neoliberalism, it’s the inherently unstable nature of the contemporary global financial system. Essentially the events of the past 13 months have shown that the doom-sayers like Nouriel Roubini, Steve Keen and George Soros were right: the vast tides of unregulated financial derivatives sloshing about the globe were a ticking time bomb, and they have now exploded. Neoliberalism - the irrational belief in the eternal good of markets - is certainly looking pretty silly right now.
I got a call from a friend of mine last night who was panicking about his share portfolio. He’s $200,000 down on his $1m portfolio and can’t understand why profitable Aussie companies like NAB and Macquarie are getting hammered. I tried to explain that so-called “bottom-up” analysis won’t work anymore: the macro-economics mean that the notional earnings of financial companies are essentially worthless.
The problem is that the average US and Australian consumer is in such heavy debt. And debt must eventually be repaid, if not by the consumer than by the shareholders and insurers of the entities holding that debt. This is a point that still seems to elude many market “analysts,” who have been too tied up in the boom narratives of the developing world to realise that western economies are borrowing more than they can repay.
As Steve Keen points out in Crikey: “US government debt is already 53% of US GDP, but that’s trivial beside business debt at 72%, household debt at 98%, and — most toxic of all — financial sector at 112%. Not all of that private sector debt is toxic, but even if half of it were, a government attempt to paper over the crisis would triple its accumulated debt.”
It’s all very simple really. Take some stuff at a certain price. Make a bit o’ cash, make a bit more, a bit more abitmoremoremoremoremoremoremoremoremoremoremoremoremoremoremoremoremoremoremoremore
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FEEDING FRENZY!!!
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Hang on a cup of coffee isn;t worth$3.50. That’s crazy. I ain’t spending my money no more.
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Crash!
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Happens again and again and again and again.
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It’s okay. It’ll come ’round again. Just make a bit o’ cash, a bit more a bit more etc.
That’s a pretty broad and broken brush; but then, ‘neoliberalism’ is an invented bogeyman term.
The problem here is that the monetarists were wrong and the Austrians, apparently, were right. Constantly inflating the money supply causes the economic centre of gravity to shift towards impossibly large and complex financial instruments and drives inflation and unsustainable booms. Stepping in to “guarantee liquidity” only prolongs the problem by expanding the money supply further and creating moral hazard.
Of course the Austrians might be wrong too. The Keynesians were pretty confident they had it licked and after they were wrong, so too did the Chicagoan monetarists.
Jacques Chester, it seems we agree on the dim prospects of the dismal science.
By the way, I’m astonished at the moral hazard arguments being proposed in this debate. The root cause of the current crisis is not moral hazard, it is lax regulation. We would reached this situation sooner and perhaps with even more damage if Paulson and Bernanke hadn’t acted when they did. Not that I agree with systemic bail-outs forever - of course, it isn’t possible - but the lesson here is not that government support encouraged big financial institutions to take stupid risks. The lesson her is that government neglect allowed those risks to become system-threatening.
‘neoliberalism’ is an invented bogeyman term.
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True but that doesn’t mean it’s apt. It describes an actual phenomena of political agency. That it was coined by its opponents only means that it’s typical of most such labels.
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Of course the Austrians might be wrong too. The Keynesians were pretty confident they had it licked and after they were wrong, so too did the Chicagoan monetarists.
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They’re all wrong. At least about something. Human economy is a simple phrase for a lot of stuff that’s basically pretty chaotic. You simply can’t wrap it up in a nice little box of understanding and everything’s hunky dory.
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Shit happens. And a good thing to. We deserve it.
Can I suggest that if people want to discuss the existence or otherwise of neoliberalism per se they do it on the post Mark wrote about just that question?
http://larvatusprodeo.net/2008/08/29/on-the-futility-of-arguing-about-hayek-or-whats-in-a-name/
Maybe we could accept it as a term of trade (heh!) as it were for the purpose of dk.au’s argument? Since it was actually (as I read it) just a reference to Ben’s point not key to what dk.au is actually saying…
Maybe we could accept it as a term of trade
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Yeah that’s pretty much what I’d say it is. They almost all are.
I don’t want to sound rude, but you obviously aren’t conversant with the Austrian branch of economics. They take human unpredictability very seriously; in fact they have a pretty sharp difference of opinion on the use of mathematical formalism in economic thinking.
I think Rothbard said it best. He was chatting about some government-provided thing or another, and remarked how he is frequently asked what the free market in that thing if the government left the field. He said he didn’t know. In fact, he couldn’t know, which was the whole point of having a free market in the first place. If it was possible to know how every market “ought” to be structured, central planning would be possible and free-market economics a pointless sideshow. An example of reductio ad absurdum, I believe.
By way of analogy, consider meteorology. It too is chaotic, but that doesn’t render it useless. Given the broad principles of how gases behave, the rotation of the earth, evaporation and a handful of other well-settled physics geegaws, a meteorologist can explain with great and exact detail why yesterday’s storm happened the way it did. He or she can also give you a good idea of why and how seasonal weather patterns occur. They might even venture a reasonable prediction of future weather over the next few days.
But not with any certainty or precision, and always with caveats. Economics and meteorology are imprecise and often inaccurate, but that doesn’t make them worthless in the large.
Jacques -
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I’ve been subjected to various servings of Austrian economics over the last two years or so. Having attempted to become familiar with economics I’ve learnt why it is that economics is the science where two people can win a novel prize for saying the exact opposite thing.
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I didn’t make any assertions viz the Austrians’ errors specifically. I simply think it wiser to assume that every school will get things right (maybe) but will get things wrong (definitely).
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The only one who sees all is God and he doesn’t exist.
And no you aren’t rude. That’s not rude. If you want rude come on over to Catallaxy. I’ll show you rude.
CRIKEY.com.au 16/09/08
Steve Keen: Welcome aboard the FF Titanic
By Associate Professor Steve Keen, School of Economics & Finance,
University of Western Sydney:
Another day, another financial collapse. The effective nationalisation
of Fannie Mae and Freddie Mac last week was initially greeted by the
market, yet again, as The End Of The Crisis. Then Lehman Brothers
teetered and finally fell into bankruptcy. The crisis was, once again,
alive and well.
There is a pattern here: a rescue of one once venerable institution
with what appear to be oodles of money, a brief euphoria, and then yet
another failure at often an even bigger institution.
The key collapse here, and the one that makes it obvious that no
rescue is going to stop this crisis, was the failure of Fannie and
Freddie. The terms of the rescue require them to sell 10% of their
portfolio of loans every year — which would start at a cool $500
billion in 2010.
But Fannie and Freddie have been the key buyers of (above subprime)
mortgage debt for decades. What happens to the economy if, instead of
them buying debt, they start trying to sell it? Who on earth is going
to buy it?
This is a rescue plan that can’t possibly work, because it attempts to
keep the US economy moving at full speed ahead, while simultaneously
throwing the engine into full reverse. The US expansion of the past
three decades has been debt-fuelled. Now America is going to try to
grow just as quickly, while reducing debt.
Good luck. Last year, the growth in private debt added US$4.5 trillion
in spending power to the USA’s $14 trillion GDP — a whopping 27
percent of America’s aggregate demand. Now the private sector
(including the “conservatored” Fannie and Freddie) is going to try to
reduce debt? Then aggregate demand will fall by more than 30 percent.
That is the recipe for a Depression, not a rescue.
There is little that the US government can do to counteract this
process, especially since it is already deeply in debt itself.
Ideally, the government should be increasing its debt and giving the
private sector the money it needs to honour its financial
commitments-at the cost of a serious haircut (otherwise known as
nationalisation). But in this crisis, the government is starting off
with its hands tied, and looking puny to boot.
Government debt is already 53% of US GDP, but that’s trivial beside
business debt at 72%, household debt at 98%, and — most toxic of all
– financial sector at 112%. Not all of that private sector debt is
toxic, but even if half of it were, a government attempt to paper over
the crisis would triple its accumulated debt.
So the Feds can’t afford to rescue America’s private sector from
itself, and every rescue will be far too little, far too late.
Stepping in to “guarantee liquidity” only prolongs the problem by expanding the money supply further and creating moral hazard.”"
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So as the US government cranks up the money supply do they risk a collapse of the US dollar and aggressive inflation?
Or does the deflationary nature of collapsing asset prices act as a counter to the need for more dollars?
murph — as I recall it, the Austrians say that catastrophic failure is not just inevitable, but necessary. A lot of busting up has to happen before resources start to wind up where they can be put to best use.
So if the money supply is cranked up, all that happens is you get a bigger crash later on instead of a smaller crash now.
But didn’t the japanese just stick their heads in the sand and ignore trying to resolve their debt problems in the 90’s?
Good large banks were forced under the guidance of the Min. of Finance to absorb smaller heavily indebted banks and at least their staff kept a job.
They then held interest rates at nearly zero and the economy contracted for 10 yearsand probably still has this problem now .
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And when it comes to trying to diagnose the cause of the current problems it isn’t as simple as stating ‘”Öh the republicans caused it - they are neoliberals and what did you expect !”
That reads like fitting your prejudices to any current circumstance .
Markets are functional for pricing assets but in any endeavour sleaze bags and unfortunately lots of very educated and intelligent people put themselves above others and appear to feel that profiting by parting fools from their money is all acceptable behaviour.
No amount of beaurocratic tinkering is ever going to change that dynamic . Regulations must exist as they apparently do with the regulations governing banking in Australia which allow the prosecution of those who bend the rules and act in a corrupt or criminal way.
Of greater merit would be trying to attract all those educated and intelligent financial market workers to do things more in tune with assisting others , building useful institutions for us all and helping tackle all the numerous challenges being thrown up at the moment.
murph — that just supports to Austrian argument that you have to allow failures; and that they should come sooner rather than later.
Confirmation bias is universal. I have it too.
If I could put this current market kerfups down to anything, it would be hubris. The traders thought they had outsmarted each other and mundane financial realities. The gods, so to speak, didn’t agree.
Free markets are pretty damn efficient mechanisms for distributing resources for maximum utility - provided everyone has confidence in the mutually shared information base that always underpins arbitrage opportunities. And there’s not much confidence around at the moment.
Perhaps it’s time to make like a bear, crawl into a cave and stick a tampion up yer.
I’d really encourage everyone on this thread to read the Martha Poon article that DK.au links to. It gives a dramatically rich and detailed description of the sociology of mortgage markets and explains in gripping detail how the subprime markets developed through the FICO credit rating. Thanks DK.au for that link.
Isn’t there an element of reification here, though? The traders’ hubris surely had to do with forgetting any link between what they did in outsmarting each other and any connection between the value they created and whatever was at the end of the very long chain to which it was “secured”? Although that’s hubris, too, I spose. But the abstractions piled on abstractions have to be a factor.
Good comments, and thanks for looking over the thread Kim while I’ve been playing netball.
The layers of abstraction surely are an important factor. From an outsiders point of view, a big part of this problem appears to be a kind of representationalist pissing contest amongst ‘quant’ modellers. What does it mean to say their models are accurate at all? The answer sociologists of science like Don Mackenzie have come up with is performativity: you have to enrol actors into the accuracy of your modelling for it to work - ie. its success is not based on any ‘external’ measures, but its capacity to construct a world around it. This is where the metaphorical exchange between evolution and the neoliberal doctrine becomes interesting, at least in the sense of entitlement of representing markets as humanity’s closest articulation of efficient, natural systems.
But I don’t think the ‘end of neoliberalism’ thesis of Quiggin and Stiglitz can take us very far. We’ll be so thoroughly haunted by the precursors (various articulations of biopolitics, rendering of calculable, self governing subjects) and legacies (institutions like the Productivity Commission, a fair whack of contemporary Parliamentary discourse etc.) regardless of the outcome of this bailout or the next one. At the risk of starting an argument that belongs on Mark’s thread, if neoliberalism is an ‘invented bogeyman’, then we can blame the Russian Dolls of the Mont Pelerin Society, Chicago and Freiburg Econ, Foundations like Volker, thinktanks like CIS and AEI and the outer layer of PR Hacks for animating it and keeping it on life support for so long.
No worries, dk, and I think this puts it well:
And the conditions of possibility of that world’s construction include the logics of competition themselves and the fictiveness of value (which is why I think “derivative” is such a great name in an ironic sense…)
Both those two things are among the building blocks from which all neoliberal practices (and subjects) are assembled.
Lol so can we, like, use fiscal policy now? Or is that still taboo?
“The traders’ hubris surely had to do with forgetting any link between what they did in outsmarting each other and any connection between the value they created and whatever was at the end of the very long chain to which it was “secured”? “.
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Adrien left an interesting chronology of the events he thinks led to this current situation in the markets on the Hayek thread . His conclusion though reflects that despite all the regulatory changes our behaviour as market participants hasn’t evolved at all.
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Kim’s quote above reminds me of the BT traders getting busted in New York in the late 80’s. This was one of the first times a client bit back . I think it was Colgate Palmolive . They had been sold into a deal where the only people who would be making money were the investment bankers who conned them into it. These traders made the stupid mistake ( I think a lot of readers will see it as a perfect example of hubris) of talking about the deal and how they were going to “rip the faces off” their clients on the company telephones - the telephones which record all conversations so a client has some degree of protection if a dispute about details develops later.
Many deals don’t pretend to create value or need to retain any conceptual link to
real assest - they are just excuses to rip people off.
All for the good of the economy mind you but a criminal act none the less.
Not necessarily.
Certainly the doomsayers can point to some facts that support their doomsaying. However, “predicting what” is not necessarily identical to “explaining why”.
Some of those derivatives were designed to mislead. Most of them were too complex for easy understanding. A golden rule can be stated here; “if you don’t understand it, don’t buy it.”
Imbalances in the market grow to dangerous levels only if a critical weight of money fails to observe that golden rule. Plainly, this has happened this time.
The sociology of institutions intrudes here. Many of these decisions to buy are made by functionaries who are not personally liable for the financial consequences of poor decision making. If it were their money, they may have thought twice.
In these institutions the Boards, who represent the owners are often too remote from the field of action and are too inexpert to make intelligent decisions. Boards often rely on their functionary employees who have their own reasons (yearly bonuses, promotions, etc.) for being less prudent with other people’s money than they might be with their own.
These inefficiencies, occasionally, are large enough to allow imbalances to grow to the extent that they threaten major systemic failure.
I believe that this is what has happened this time.
A good point Katz - nothing worries market players less than losing other people’s money.
Quiggin:
http://johnquiggin.com/index.php/archives/2008/09/17/that-didnt-last-long/
Murph - His conclusion though reflects that despite all the regulatory changes our behaviour as market participants hasn’t evolved at all.
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Exactly. It hasn’t.
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We’re all still doing the same thing we were way back when. Partially this is because most people have no real general overview. Witness the herd behaviour in economic crisis. Everyone goes to the bank to withdraw their money. Result: the crash they all fear will happen happens because they did exactly what they shouldn’ve done.
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Those who have the overview reap the rewards of the fallout. And we all know who they are… a dark smokey room full of Donald Trump Clones.
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DONALD TRUMP #1: You’re fired.
DONALD TRUMP #2: No, you’re fired.
DONALD TRUMP #4: You’re both fired.
DONALD TRUMP #3: I met this girl today and she told me that our hair proves money can’t buy good taste. What did she mean? (Sob)
dk.au and Everyone:
It’s a Depression. [I’ve been saying that for nearly two years - can’t help being perceptive.
L-O-L].
Get used to it …. and then start doing something to help survive until things improve; maybe even turn the depression to your own advantage too.
Sticking one’s head up one’s fundamental orifice and deluding oneself that it is all merely a market downturn with a bumpy correction is a good solid recipe for extinction.
It’s not just a market downturn, obviously, because it’s a crisis of confidence in the integrity and function of the key nodes of the globalised finance system. “Depression”, though, is just another word, and I don’t think adds all that much to understanding, because the structures are so much different from in 1929. It’s more useful, I think, to look at different commonalities in behaviour and mindset, as dk.au is doing, and what responses they will provoke from different actors (including publics).
Anyways, here’s a related post:
http://larvatusprodeo.net/2008/09/18/the-end-of-financialisation/
More interestingly, its a US depression from which much of the west - including the AU economy - is substantially shielded.
Which goes to the decline of TEH LAST superpower.
Graham, to explain the post title a little more fully, please allow me to quote a little more of the Peter Levin post:
I wouldn’t bet your house on insulation, Lefty E. But to the degree that there will be some, it will be because Australia is not just tied into markets in Asia, but also regarded with confidence by Asian sovereign wealth funds and Asian capital.
True Kimski - and unless the US voting public is now entirely pomo and exclusively symbol -oriented (and I guess I dont rule that out), things are pretty tough for McCain from here on in. An army of Palins wont save him from this particular mess.
Unless, as I say, the American voter these days just stares at flashing neon saying “that’s purdy”.
I tend to doubt it can be that bad. I think he might starting running the line that we just had 8 years of mavericks, and smell the deep shit you’re in.
I have no background in economics (to me Rothbard is the villain in Swan Lake), so when my beloved Geek tried to explain what the Yank banks had been up to, my reaction was: “They’ve been doing WHAAAAT?!” I’m still horrorstruck by the immorality of giving loans to people who you know will default. Aside from that, isn’t universal market information a fundamental assumption of capitalism? Because that seems to me what has fallen down here (not that market information has ever truly approached universality or transparency, but that’s another story). It’s one thing to take a financial risk and quite another not to know what size risk you are taking. Or is this just a librarian’s perspective?
Chookie - while (as far as I know) librarians aren’t famous for their love of risk-taking, I don’t think your reaction is atypical.
Ze Austrian sgkool is nat wrong it is ze sgkool zat iz innerested in ze Verstern philazaphee off cankerink. I ham fram Austria but I dezided to kam to Amerika to be a zomebody mit der body.
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Unt now I ham ze Guvunator unt ze vomanizink, pot smoking, steroid abusink zon off an ex-Nazi.
Kim [31] and dk.au [33]:
Thanks.
I used that term “Depression” as widely as the broad term “War”; not in the narrow technical sense. Of couse the specific circumstances of each disaster are quite different.
“Depression” is understood by ordinary people as a situation where markets are in turmoil, where supposedly rock-solid banks and other financial firms are going down the gurgler, where the jobs of efficient workers in productive workers are being wiped out for no reason, where people within your own circle are losing their savings and their homes [and yes, I am quite clear about the distinction between “home” and “house”]; where there is government intervention to little or no effect ….
Continuing to use arcane technical terms for the current situation only arouses suspicion that “they” are covering-up the “real” situation …. and it can’t help but aid recruiters for extremist organizations.
Call a spade a spade and you’ll save a lot of distress [even if the spade is actually a shovel]. So far as a lot of people are concerned …. it’ a Depression.