Discussion with Paul Volcker; video
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Paul Volcker
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Paul Adolph Volcker (born September 5, 1927 in Cape May, New Jersey), is an American economist. He is best known as Chairman of the Federal Reserve ("The Fed") under United States Presidents Jimmy Carter and Ronald Reagan (from August 1979 to August 1987). He is today an economic advisor to Democratic presidential candidate Barack Obama.
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From Calculated Risk -
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Charlie Rose: A Discussion with Paul Volcker
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My favorite quote from the interview -
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"....We need fewer financial engineers and more electrical engineers, chemical engineers, and civil engineers to take care of our infrastructure. We put too much talent into false castles in the financial world...."
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Paul Volcker
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Paul Adolph Volcker (born September 5, 1927 in Cape May, New Jersey), is an American economist. He is best known as Chairman of the Federal Reserve ("The Fed") under United States Presidents Jimmy Carter and Ronald Reagan (from August 1979 to August 1987). He is today an economic advisor to Democratic presidential candidate Barack Obama.
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From Calculated Risk -
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Charlie Rose: A Discussion with Paul Volcker
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My favorite quote from the interview -
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"....We need fewer financial engineers and more electrical engineers, chemical engineers, and civil engineers to take care of our infrastructure. We put too much talent into false castles in the financial world...."
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Comments
How do you do that when the financial people earn so much more money?
That, and once we finish nationalizing banking.
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Maybe it's just me, but I have always been bothered by the fact that a lot of American talent and brainpower seems to have been misdirected into the financial industry. The ranks of hedge fund managers, quantitative analysis people, investment bankers, etc. are filled with brilliant people, but what is it that they actually do? Maybe I am being over-simplistic, but it appears to me that these people specialize in the transfer of wealth (a lot of it to themselves, I might add) without actually producing anything. Aren't these people parasitic to the overall economy? Aren't these people a lot like the gambler who is always attempting to develop a "system" to beat the odds?
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No.
The heart of any economic system is efficient allocation of resources.
When I say "efficient" I am using a specific technical meaning: "resources go to those that value them the most."
If I allocate banannas from someone who does not like banannas to someone who does then I have created value and increased the amount of wealth in the world.
A "market mechanism" is a process or system that performs resource allocation. Money and the free market has been shown to be a pretty effective market mechanism.
These quants and traders are doing resource allocation at a larger scale. They are creating value and are taking a share of that value for themselves in reward.
The answer......YES THEY ARE PARASITES!!!
From Yahoo News...."The pledges by six countries that use the euro and Britain helped soothe stock markets, along with a promise by top central banks to provide unlimited short term dollar credits."
Wow, both the EU and American parasites are trying just about everything to try and keep their large tower of rotting corruption and greed from toppling over. Latest announcements include promises of "unlimited amounts" to try and keep the crash at bay.
It won't work. The parasites let their own greed turn them from simply parasites into predators, and they now are having to deal with the consequences of their own excesses.
Your resource allocation explanation would be believable, except it falls apart upon examination of creations like CDO's, or CDS's. The function of these financial instruments is nothing more than to spread / direct known risks away from the originators thru layers of complexity that apparently even the originators do not fully understand. That's not efficient allocation, that's greed attempting to escape the unpleasant reality of risk.
In theory yes, but they seem to be doing more damage than good. The problem is they are part of a system that is susceptible to bank runs that put people out of work. So they are working the system for their own benefit with the result of disrupting the larger economy. That is a case where there needs to be regulation to keep the side effects of their actions to within limits that do not disrupt others.
They do perform a function though, which is to allow specific risks to be passed on to other parties than can cancel out that risk with something else, and thus reduce the total risk present. The problem is the mechanisms they currently use to do that consume vast amounts of cash, such as we saw on Friday with the Lehman unwinding, which caused world markets to drop by almost 20% and then pop back up again the next day. If there was another system to handle that set up via regulations, that would be fine too.
Using an ecology as a metaphor for the economy, the financial guys are outcompeting the rest of us. We (as a collective society) need to get smarter with our money.
Using an organism as a metaphor for the economy, the financial guys are outcompeting all of the normally functioning cells. They are a cancer and we need medicine (i.e. government regulation) to control their growth.
I disagree. We haven't examined creations like CDO's and CDS's enough to make my argument fall apart. I claim that those are advanced resource allocation techniques that we, at this site (or at the very least "I"), do not understand the benefit of. If they did not benefit someone, then they would not exist.
Market regulation to promote stability would be a good and useful thing. I don't think we, as a society, know enough to do that. The financial system is incredibly complex and stability in complex systems is difficult. One might argue that the derivative products exploit flaws in current regulation. Any new regulation might have similar flaws. How does one know? I don't think system analysis science is advanced enough to build a failsafe regulation structure.
I dunno. Wasn't it the Depression-era Glass-Stengal act that kept a lid on this kind of stuff, until it was repealed in the late 90's. Then it was only a few short years before all hell broke loose.
The credit bubble that the CDO's and SIV's took a symbiotic relationship with, tells me those smart people KNEW this would happen eventually, but the trick was to get it while it lasted, because NONE of them would be required to pay anything back into the system they corrupted.
You don't need to be that smart, just observant of the street economics and recognize what you are seeing is reality, not what you are being told is reality.
Maybe. I don't know. Why was GS repealed? I can't find anything. It is all swamped in people blaming the repealing of GS for the current mess. I've blamed it on that myself.
Presumably, GS had some negative side effects. I don't know what they are. My most cynical side says they repealed it under lobbyist pressure so that specific people who study history could make a mint.
GS, presumably, made it impossible for US financials to take on the kinds of risk that European financials could. That sounds like a good thing in times like these, but it sounded bad when the act was repealed and the London financials market was able to out compete the NY one. At least, that's my understanding of why it went away.
Of course, you're right that it was lobbyist making the case that NY could no longer compete due to onerous regulation.
Bill Clinton signed into law the bill that repealed the Glass-Steagull Act. This is what he said about why he signed the bill. It supports what RCC is saying --
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Bill Clinton on the Banking Crisis, McCain, and Hillary
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......I thought at the time that it might lead to more stable investments and a reduced pressure on Wall Street to produce quarterly profits that were always bigger than the previous quarter.....
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.....Phil Gramm and I disagreed on a lot of things, but he can't possibly be wrong about everything. On the Glass-Steagall thing, like I said, if you could demonstrate to me that it was a mistake, I'd be glad to look at the evidence. But I can't blame [the Republicans]. This wasn't something they forced me into. I really believed that given the level of oversight of banks and their ability to have more patient capital, if you made it possible for [commercial banks] to go into the investment banking business as Continental European investment banks could always do, that it might give us a more stable source of long-term investment.....
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It is looking like maybe Mr. Buffet was right?
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Warren Buffet on Derivatives
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....I view derivatives as time bombs, both for the parties that deal in them and the economic system....
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Credit fundamentals, ratings and value-at-risk:CDOs versus corporate exposures
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..... A sensitivity analysis incorporating market information and rating migrations data reveals that the behaviour of CDO tranche ratings can differ markedly from that of corporate ratings. In addition, tranching is found to have an important impact on the probability of large losses. This highlights how investors who narrowly focus on ratings and draw direct parallels with corporate exposures can seriously misjudge the value-at-risk of CDOs.....
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Translation – The risk associated with CDO's was misrepresented. "Financial engineering" work in progress and on full display.....
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The GSEs have been subsidizing mortgages, encouraging greater spending on homes. The government even encouraged the GSEs to lend to a greater number of people with poor credit in order to broaden the ranks of home-ownership. The mortgage tax deduction is perhaps the BIGGEST evil, which heavily encourages mal-investment on housing.
Deposit insurance is another of the pillars upon which the bubble rests, by encouraging savers to be irresponsible, only choosing their banks based on service and interest rates rather than prudent risk management.The super-low interest rates maintained by the central banks were just icing on the cake.
The government encouraged mal-investments in real-estate and lulled everyone into thinking that everything was "safe", since the government would bail them out if anything bad happened. I fail to see how even MORE government involvement is going to make things better.
Sorry, this buys into the current meme that somehow CRA led to the GSEs going crazy lending all sorts of money. The facts are, that the GSEs lost share throughout the boom, because they were hampered by significantly stricter lending requirements than their non-GS equivalents.
The lending to people with poor credit was driven in FAR greater part by non regulated entities, and the debt was securitzed. CFC. New Century. Merit. Remember those guys? They weren't selling to Fannie and Freddie.
check out this article.
http://www.mcclatchydc.com/251/story/53802.html
Good article, DJO.
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I too have read that the Community Reinvestment Act (CRA) "...legalized the idea that lending institutions could not make loan decisions based solely on criteria such as income and ability to pay the loan back....". I would guess the anti-regulation folks are pushing that falsehood.
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Sniglet –
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Did you know that the CRA only applied to commercial banks and thrifts? Investment banks didn't have to play by those rules, yet Bear Stearns was one of the first to go down.
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And no one is saying it was only the CRA. The FMs where pressured into taking lots of subprime mortgages, which they each did in many tens of billions of dollars.
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Given that the CRA was enacted in 1977 and the current bubble occurred much later, I would guess it had little or no effect on prices.
From http://findarticles.com/p/articles/mi_m ... tBody;col1
"CRA business" <> subprime. Fannie and Freddie were both restricted to "conforming" loans, and had less than 5% of their overall portfolio in ARMs, as recently as 2005. see pg 28 of this http://billcara.com/CS%20Mar%2012%20200 ... ousing.pdf
To the extent they started buying subprime crap it was in 2004. It was bad business but it had nothing to do with CRA
http://seekingalpha.com/article/98270-h ... e-to-blame
$10B in loans in 1997-2001 is pittance compared to their portfolios. Find real evidence of large subprime holdings by either agency prior to 2004 and get back to me...
http://www.villagevoice.com/content/printVersion/541234
To put this in perspective - non-GSE subprime lending in 2005 was $824B (and Alt-A was $722B) while Fannie and Freddie backed $434B over 3 years.
Sounds to me like there was 6x as much sub-prime being pumped out by the non GSE entities (824 x 3/434)
How is this a fannie/freddie/cra problem?
Actually, I wasn't even thinking of the CRA. The GSEs (and FHA) have been subsidizing mortgages and propping up home values for DECADES. This housing bubble got it's start long ago, not just the recent blow-off. Housing prices rose far above traditional measures following WWII, which wasn't a coincidence seeing as how all these new institutions were in place. The GSEs have ridiculously low lending criterion. No private lender would offer such attractive mortgages under the same terms.
By the way, how is it that the GSEs wound up with so much Alt-A and sub-prime paper (which was the chief cause of their balance sheet implosion) if they were strictly adhering to their own lending criterion? They were clearly buying mortgage securities that didn't comply with their own standards.
Further, the GSE balance sheets were ballooning at an enormous rate in the last decade. They may have been losing market share, but they were still the biggest players in the game.
Mortgage tax deductions have been hugely significant in inflating real-estate too, so I don't lay all the blame on the GSEs.
The fact that it took decades for the end-game of the government subsidized real-estate industrial complex to come falling down doesn't negate the theory that it was all this interference that were the root cause of the disaster.
As I point out above, this is just not true. They had far less subprime than the non-GSE lenders, and imploded primarily due to leverage, not bad paper.
Relative to non-GSEs, they have
1) smaller loan amounts (since their loan amounts were constrained by OFHEO limits)
2) relatively few >90LTV loans http://2.bp.blogspot.com/_pMscxxELHEg/S ... reddie.jpg
So given this, how did they drive home prices up?
I am not a huge fan, but there is so much misinformation flying about that it just drives me crazy.
I don't understand your focus on prior to 2004. The composite CSI is now back to 2004 levels, which is when things started to get crazy at the FMs. At that time the private sector had provided an alternative to the mission of the FMs, without the interest rate subsidy resulting from the government backing their loans. Had the FMs simply gone into the sunset, the bubble would not have reached the proportions that it subsequently did. The subprimes as we have seen are highly unstable, but if the market had not been so distorted by quasi-governmental entities competing with the private sector, the subsequent adjustment might not have been as bad, because they would not have brought into the market the type of investors who recently demanded that the government make good on the backing of the FMs.
Just ask yourself this: what would have happened to US house prices had the GSEs not existed in the first place?
I think the answer is pretty simple: house prices would have been considerably lower without the GSEs. The GSEs were fundamental in keep housing prices high ever since they were created. I would even go so far as to say there has been a housing bubble ever since the 1950s. Looking at the size of the GSE portfolios (in the trillions of dollars) it is quite obvious that the private sector would have had to do a LOT of heavy lifting to compensate had they not existed. Almost certainly private lending would have required dearer terms for it's loans, which would have made home-ownership more costly, and kept housing prices down (i.e. because fewer people could have afforded mortgages).
I tend to agree with you, but you are dead wrong about deposit insurance. It's been around since the 30s, and it's one of the only bright spots of the current crisis. The banks themselves pay the insurance, which means depositors pay it, and it is proven to prevent bank runs which can be quite damaging. In fact, I can't even imagine how ugly this thing would have gotten without FDIC and NCIS insurance.
My focus on 2004 is because if the meme that the CRA caused the GSEs to go crazy with subprime. Legislation passed in 1999 but the impact not seen until 2004? Whahuh? My point is that something else was at work
And your reponse completely ignores that fact that there was at least 6 times as much subprime coming out of the private sector as there was out of the GSEs. So if the GSEs had not been the picture, the rest of the market would have picked up the slack and fueled the run up in the market just fine. Remember, until post Bear Stearns the GSE's were capped in amount of loan by OFHEO. They were non-factors in markets like california
So you are arguing that homes have been overpriced since post WWII? What is your basis for this? Income multiples? Excessive appreciation? WAGNER?
First time I've heard that argument, but seems baseless given that through 1997, home prices were up 10% in real terms over the last 100 years.