Mike Konczal Talks FinReg on The Breakdown

Jul 23, 2010

Now that Obama has signed FinReg into law, Roosevelt Institute Fellow Mike Konczal appeared on The Breakdown with Chris Hayes yesterday to discuss the bill. Confused about the entire financial meltdown? Mike's got you covered. He breaks the crisis down into four interconnected sectors: an exploitative, under-regulated system of consumer finance; dark markets in derivatives; the failures of "too big to fail" banks and the ripple effects they caused; and shadow banks that were able to avoid regulations (and also lacking, as Mike suggests, the "toilet training" necessary to behave).

These four sectors will also be the basis used for grading the potency of the bill. And as Mike notes, while it offers opportunities for some much-needed general changes, it still falls short in several areas.

Listen below to get the full explanation:

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Now that Obama has signed FinReg into law, Roosevelt Institute Fellow Mike Konczal appeared on The Breakdown with Chris Hayes yesterday to discuss the bill. Confused about the entire financial meltdown? Mike's got you covered. He breaks the crisis down into four interconnected sectors: an exploitative, under-regulated system of consumer finance; dark markets in derivatives; the failures of "too big to fail" banks and the ripple effects they caused; and shadow banks that were able to avoid regulations (and also lacking, as Mike says, the "toilet training" necessary to behave).

These four sectors will also be the basis used for grading the potency of the bill. And as Mike notes, while it offers opportunities for some much-needed changes, it still falls short in several areas.

Listen below to get the full explanation:


It looks like you don't have Adobe Flash Player installed. Get it now.

And check out some of Mike's latest pieces on ND20:

How HAMP Makes Elizabeth Warren The Only Choice For Consumer Protection

Treasury versus Progressives on the Financial Reform Bill

Underwater Mortgages and the Odd Definition of the Experian Study

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How HAMP Makes Elizabeth Warren The Only Choice For Consumer Protection

Jul 22, 2010Mike Konczal

elizabeth-warren-150No one else has been a stronger advocate for public disclosure.

elizabeth-warren-150No one else has been a stronger advocate for public disclosure.

There's a debate going on about who should be nominated to run the Consumer Financial Protection Bureau at the Federal Reserve. One side says Elizabeth Warren, while another says someone from Treasury, likely Michael Barr.

At a quick glance you might not see a big difference. As Felix notes, Michael Barr is very strong on consumer finance.

But I think Warren would be a far superior choice. There are many reasons why, but I want to discuss a very specific one here that distinguishes her from anyone in Treasury. The biggest: she is a strong critic of HAMP, Treasury's largest intervention into the massive foreclosure crisis hitting millions of regular Americans, and she demands accountability on behalf of the people.

HAMP As Failure

The Home Affordability Modification Program is widely considered to be a failure. Here is Shahien Nasiripour reporting on the latest numbers from June. They haven't remotely hit the numbers they projected. Homeowners continue to suffer from a lack of modifications due to servicer problems and the overvaluation of their books. I wrote here about how the creator of the mortgage bond instrument in the early 1980s said in 2007 that a major market failure was coming. There was need for government action.

HAMP is such a failure that it is a bit of a game among the financial bloggers as to who has the best write-up of how bad it is each month and what the killer statistics are that prove it. I'm calling Stacy-Marie Ishmael over at FT Alphaville this month's winner with BarCap vs HUD on HAMP.

Evidence shows that there are principal increases for 80% of the people who go through HAMP. That is the exact opposite of what you'd like to see! It lowers interest rates, but it also increases the length of the loan. And for those who don't have principal reduction, there is a massively high redefault rate. People lose their homes anyway, even after jumping through cumbersome hoops.

Predatory lending is hard to define, but a product is predatory that sinks people deeper into debt without the expectation that they can pay it off. And that is exactly how HAMP functions. For millions of people HAMP is their main interaction with the government and embodies what the government is capable of, and this creates disillusionment and discredits the liberal state in a profound way.

And Warren Demands Accountability

The Congressional Oversight Panel, lead by Warren, has been in the lead at making information public and bringing the complaints of the people straight to those in power. (It falls under her jurisdiction because HAMP uses TARP money.) When you see the fights on youtube between Warren and Geithner, the biggest ones, the ones that make Geithner cringe the most, it is about how HAMP isn't working. Click through on that link to watch a video that gets straight to this. She demands accountability from the government and from the banking sector on the single most important issues facing Americans right now.

This is important. There's pressure to be quiet, to hope that a quick housing and economic recovery will just make this whole foreclosure crisis go away. But Warren has demanded answers. COP released a report in early 2009 about the problems with HAMP, data collection and foreclosure, a report that still stands up. She's done that at every step of TARP, but it matters here specifically for consumer protection.

And this is exactly how the CFPA should work. They fight to get good information disclosed to the public about how the banks and the Treasury department are failing the American people, reporters and wonks explain the information to the public, Treasury is held accountable. Treasury is currently working overtime to make HAMP work better; every month they are putting pressure where they can to make it better. That's how a healthy government is supposed to work, but it can only be done if the tone is set by an outsider. And Elizabeth Warren is the one qualified candidate with a proven track record of standing up to the banks and to the Treasury.

And as Steve Clemons wrote: "It's about time that at minimum, the White House got a 'team of rivals' on economic policy rather than just a 'Team of Rubins.'"

Mike Konczal is a Fellow at the Roosevelt Institute.

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Energy Deregulation - Troubled Past Portends Scary Future

Jul 22, 2010Wallace Turbeville

oil-rig-150A deregulated energy sector encourages manipulation, greed, and catastrophes.

oil-rig-150A deregulated energy sector encourages manipulation, greed, and catastrophes.

My earlier ND20 article outlined the deregulation of energy commencing in the 1990s.  Unleashed from government constraints, the industry was to serve the public's energy needs efficiently and economically. Free market forces were to supplant the waste and unwarranted burden of governmental oversight, forcing down prices and improving operations.

I must report that things did not work out very well.  Everyone is aware of the Deep Water Horizon oil spill and the Upper Big Branch Mine explosion.  The costs in human life, environmental damage, jobs and financial loss have been enormous.  It was all the direct result of the subversion of regulation by the oil and coal industries, a form of deregulation known as "regulatory capture."

Far less understood are the consequences of deregulating the other two energy sectors, natural gas and power.  After 60 years, price regulation of wholesale markets was ended by Congress and the regulators.  Vertically integrated power utilities divested many of their generating assets to unregulated Independent Power Producers to take advantage of the new free market.  Derivatives trading in these markets was then deregulated, allowing the banks and big oil firms to dominate price hedging.

Consumer prices were supposed to fall as fierce competition and unfettered trading improved efficiency.  That did not happen.  For the decade commencing in 2000, when the last phase of deregulation was completed, power prices increased 40% more than the rate of inflation. Natural gas price performance was worse. In 2009, gas prices plummeted as demand evaporated with recession. Before that year, gas prices increased 110% more than inflation for the period.

No doubt, competition drives down prices.  But if the costs of creating competition increase prices more, the net result is just a bad business deal.

Energy is a capital intensive industry.  Before deregulation, most capital investment was made by price-regulated businesses, such as gas pipeline companies and vertically integrated utilities operating within protected franchise territories. Regulated utilities and pipelines had extraordinarily low capital costs because of low risk. The new unregulated businesses were much riskier because they were exposed to market price changes.  For the consumer to benefit from deregulation, savings from competition had to overcome higher capital costs of the riskier companies.

This problem has gotten progressively worse since full deregulation.  Price risk was seen to be an unacceptable credit exposure for the unregulated companies.  Prices had to be hedged through derivatives transactions for the companies' credit standing to be acceptable.  Today, when energy companies present themselves to investors and ratings agencies, they feature their hedging strategies prominently to justify higher share value.

Most energy firms are not well-equipped to secure hedges in the conventional trading markets.  Derivatives positions require ready access to cash, and a lot of it.  Values change abruptly and the swings can be very large.  Adverse moves must be covered immediately with cash collateral posted to clearinghouses and counterparties.

Whipsawed by the need to hedge and the intolerable cash requirements of hedging, energy companies have turned to devices created by banks which can be used to avoid liquidity demands.  These devices involve risks and costs that the energy companies often do not understand (or, perhaps, care to understand). As long as they have access to hedges and the costs and risks are obscure, their businesses can survive.

Incidentally, the energy companies fought hard to secure the "end user" exemption in the financial reform legislation largely to preserve these devices.  If the cost of hedging were to become transparent under the reforms, share values would be lower.

The weakness and high capital cost of unregulated energy are illustrated by the bankruptcy of three of the largest unregulated power companies since 2003 - Calpine, Mirant and NRG. In 2008, Constellation went to the brink of bankruptcy, only to be bailed out by a cash infusion of $1 billion by Warren Buffet and the sale of a 49.9% interest in its nuclear facilities to Electricite de France for $4.5 billion.  Constellation was considered the most sophisticated unregulated producer since it was staffed largely by former Goldman Sachs personnel. Ironically, it almost failed because of a recordkeeping error related to trading.

The bankrupted companies and Constellation represent power generating capacity sufficient to serve all of the needs of New York, New Jersey, Pennsylvania and New England.

There is much, much more.  The effect of predatory bank energy trading of energy is the subject of a forthcoming article. In addition, several notorious events in the recent past were rooted in energy deregulation. Four are described below. Remedial action was taken in each case, but the stories should not end there.  Sharp minds are still hard at work seeking unfair advantages which endanger the system. We must expect similar disasters and scandals if regulatory controls are not somehow re-imposed.

California Energy Crisis. Anticipating deregulation, the state established a set of rules for the economic allocation of wholesale demand among competing power suppliers. A continuous auction process set prices during each day at levels necessary to secure supplies. In the summer of 2001, as demand peaked, suppliers implemented strategies to game the system. There were many complex strategies with ominously named, as if the traders were playing video games. (Enron's "Death Star" was most notorious.) Generally, they were designed to withhold supply, drive up prices and then sell at enormous premiums, all within short timeframes. The utilities commission refused to allow the power distributers to pass along the costs to customers. After suffering brownouts, $45 billion in losses and the bankruptcy of Pacific Gas and Electric (which serves most of northern California), the Federal Energy Regulatory Commission and the state combined to force an end to the crisis using price caps.

Round Trip Trading. Unregulated electronic trading on the Intercontinental Exchange offered a major opportunity for manipulation. Traders at two firms could collude to transact at a price and then execute a reversing transaction later so no one lost money. Energy markets are really collections of small markets based on specific delivery points.  Round trip trades artificially moved the price of gas and power at specific delivery points for the advantage of the participants. As an added incentive, ICE had a program of granting stock warrants (tremendously valuable in an IPO) based on customer volume which was inflated by the rigged trades.  When round trip trades were discovered in 2003, it became apparent that the practice was widespread.

Amaranth. This hedge fund put on a massive, highly leveraged position betting on the spread between natural gas prices for deliveries in March and April in each of the years 2007 and 2008. It was the idea of Brian Hunter, a 30 year old trader who was later dubbed by the DealBreaker blog as "the destroyer of all worlds."  In 2006, the trades lost $6.8 billion and Amaranth (a symbol of immortality in Greek mythology) collapsed. Energy markets were massively disrupted. To put this in perspective, Long Term Capital Management lost "only" $4.6 billion in 1998.  However, LTCM was integrated into Wall Street and the Fed stepped in to force a takeover by several banks to bail out investors. Does this sound familiar?

Financial Transmission Rights. The theorists behind deregulation of the power markets had a problem.  Power delivered to the grid nearer the site of demand and transmitted along uncongested paths is more valuable than the alternative. Power could not be priced efficiently in daily auctions without accounting for this value. Predictably, the experts came up with a market-based solution.  Rights to transmit from point to point would be periodically sold at auctioned by system operators to provide price signals.  But too few parties were interested in such rights to assure a valid auction.  The theorists proposed mechanisms to attract outside, financially interested bidders.  To a cynical, market-savvy observer, this was a recipe for speculation by traders in a highly volatile derivative instrument without having to post margin to cover risks.  In 2007, unsurprisingly, a few thinly capitalized shell companies which faced transmission rights losses to PJM (the system operator for the Mid-Atlantic region) simply walked away. PJM members had to kick in $100 million or so to cover the loss.  While this loss pales in comparison with Amaranth's, the episode illustrates how deregulation of complex markets can have perverse and unpredicted consequences.  If the members had refused to pick up the tab, claiming that PJM was inept and the risks were undisclosed, the largest power system in the United States might have financially failed.  In truth, this alternative appealed to many members.  We are lucky that the loss was small enough so that they paid up after a short struggle.

Some may say that the chicanery and ineptitude outlined above should not trouble us.  After all, remedies and firewalls have been put into place.  Do not believe it.  The deregulated energy sector is complicated, fast moving and large. It bristles with tempting opportunities to make a quick buck by manipulating the system. For deregulated energy, the past portends the future.

Wallace C. Turbeville is the former CEO of VMAC LLC and a former Vice President of Goldman, Sachs & Co.

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Book Notes: McKibben's EAARTH

Jul 21, 2010Bryce Covert

earth-150Our Life on Earth is Too Big To Fail.

earth-150Our Life on Earth is Too Big To Fail.

Our world -- our food, our energy, our economy -- has become Too Big Too Fail, which is to say, Too Big. What used to be local, separate systems are now all interconnected, from fossil fuels to food supplies. And these systems are all insulated from the risk we take in destroying our planet slowly -- actually, these days, quickly -- but surely. No agribusiness or electric utility is paying the full cost of the damage to the system, just as no bank feels exposed to the cost of another financial meltdown (a good bailout will make you feel invincible). But in a world in the midst of a climate disaster, we're about to experience complete system failure.

Bill McKibben makes no attempt to comfort or calm the reader of his new book, Eaarth: Making a Life on a Tough New Planet. He makes it clear that we are beyond taking measures to save our grandchildren; we need to take measures to save ourselves. Eaarth, his term for this planet that human activity has so transformed it resembles a new one entirely, will require us to completely change our lives if we want to keep living on it. And you thought passing financial reform was hard!

This is not your father's Earth. Climate change has already permanently altered our landscape. "This is the current inventory: more thunder, more lightning, less ice. Name a major feature of the earth's surface and you'll find massive change," McKibben says. "We are overwhelming the system," says Richard Zeebe, assistant professor of oceanography at the University of Hawaii. While we pump carbon into the atmosphere, plants that normally absorb it are so hot that they are absorbing less. Hotter temperatures will mean falling crop yields while populations continue to grow. In 2008, 40 million people became hungry because of climate change. A "savannizing" process is turning swaths of rain forest into desert. Animals are shrinking to adapt to the new climate. Jellyfish populations, which thrive in warmer waters, are exploding. The oceans are acidifying as they absorb more of our carbon emissions. "Forget the grandkids; it turns out this was a problem for our parents," McKibben says.

Just as with the financial sector, the system's complexity will mean its downfall. "We've connected things so tightly to each other that small failures in one place vibrate throughout the entire system," McKibben points out. A decision to turn some of our corn crop into clean-burning ethanol sent food prices skyrocketing and nearly starved us all. When Peanut Corporation found salmonella in their food, they poisoned 19,000 people through products that ranged from dulce de leche cookies to dog treats before a recall in January 2009. "It's not just the banks that have gotten too big to fail, but all the arrangements of modern life." That includes the economy, power generation, and perhaps most important of all, our food supply. After all, as McKibben says, "The only truly crucial question that human beings ask is: ‘What's for dinner?'"

The name of the game is no longer grow, but maintain. Obama's stimulus program, McKibben points out, was not meant to build more roads, but to simply repair the crumbling ones we've got. "When the wind blows harder and lightning strikes more often and more rain falls and the sea rises, repair and maintenance become full-time jobs." We have to turn to safety rather than risk and start thinking in terms of long-term consequences -- this applies not just to Goldman Sachs' business practices, but our entire economy. And we have to stop trying to grow at breakneck paces and think about just staying the size we are. In McKibben's words:

The economy that has defined our Western world is like a racehorse, fleet and showy. It's bred for speed, with narrow, tapered legs; tap it on the haunch, and it accelerates down the backstretch. But don't put it on a track where the rain has turned things muddy; know that even a small bump in its path will break its stride and quite likely snap that thin and speedy leg. The thoroughbred, like our economy, has been optimized for one thing only: pure burning swiftness. (Also, both are now mostly owned by sheiks.) What we need to do, even while we're in the saddle, is transform our racehorse into a workhorse -- into something dependable, even-tempered, long-lasting, uncomplaining.

And it also means going from the Mega Big Corporation model to the local community model -- particularly in agriculture. We need smaller, more diverse systems that are reliable and harder to tamper with. "The vast conformity of our agriculture puts us at risk -- there are no more firewalls than there were in our financial system," McKibben says. As Move Your Money urges consumers to move to community banks and get away from the bad practices that ferment in hulking corporations, McKibben urges Americans to buy food at local farmer's markets to support diversified farming. Smaller farms can implement more Eaarth-friendly practices such as intercropping, planting more crops in a year, and crop rotation. Plus it will be cheaper -- getting rid of all the middlemen involved in producing food can bring down its cost. And it doesn't have to come solely from farmers, either: a garden in your backyard or on your roof can be an excellent source of low-carbon food.

McKibben also wants to find "the equivalent of farmers' markets in electrons": localized, distributed energy generation. Electrons are conserved by transporting them over smaller distances. Electricity can be generated from renewable energy sources that are close to home. Rather than building a forest of windfarms in windy North Dakota and shipping that electricity a long way over expensive-to-build, not-yet-existent transmission, use "hydropower in the Northwest, offshore wind in the East, solar energy in the Southwest." But none of these sources are as important as plain old conservation, which McKinsey estimated in 2008 as being able to cut world energy demand 20 percent by 2020.

A lot of these changes will need to come from above. "All this change would get much easier if the federal government favored small players, not huge corporations," he says. And as for us, moving from explosive growth to steady survival will take a huge attitude shift. But what other choice have we got?

Bryce Covert is Assistant Editor at New Deal 2.0.

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The Summer(s) of Our Discontent

Jul 19, 2010Marshall Auerback

no-nonsense-150Larry Summers's misguided approach to deficits and surpluses could strangle our long-term vitality.

no-nonsense-150Larry Summers's misguided approach to deficits and surpluses could strangle our long-term vitality.

Virtually every profile on Larry Summers tells us that he is one of the most brilliant economists of his generation, celebrated for having allegedly helped to create the boom of the 1990s.  Statistical maven at age 10, the youngest tenured professor at Harvard, chief economist of the World Bank, this is a man whom the French would surely call "un homme serieux".

But after reading his latest defense of President Obama's fiscal policy in Monday's Financial Times - "America's Sensible Stance on Recovery" - one wonders.   Only Robert Rubin and Alan Greenspan played a more important role than Summers in promoting the deregulation and lax oversight that laid the foundations for the current crisis. Certainly the plethora of innocent frauds that the Director of the National Economic Council peddles in Monday's Financial Times calls his economic perspective into question.  In addition to the usual apologia of the Clinton Administration's budget policies, the latest FT defense reflects Summers's fundamental lack of understanding of modern money. Contrary to his view, the late 90s surpluses was not the reason for that period's prosperity. The surpluses are what ended the prosperity. And until the public understands this, we should expect no fundamental improvement in economic policymaking from the Obama Administration.

Let's go to the article concerned itself.  To begin with, Summers first takes issues with critics, who "have complained that the continued commitment by the administration of President Barack Obama to support recovery in the short term and also to reduce deficits in the medium and long term constitutes a 'mixed message'". In fact, he goes on to argue:  "The only sensible course in an economy facing the twin challenges of an immediate shortage of demand and a fiscal path in need of correction to become sustainable."

In this instance, Summers reflects the usual deficit dove position that budget deficits are fine as long as you wind them back over the cycle (and offset them with surpluses to average out to zero) and keep the debt ratio in line with the ratio of the real interest rate to output growth. In so doing, he violates one of Abba Lerner's key laws of functional finance:  a government's spending and borrowing should be conducted "with an eye only to the results of these actions on the economy, and not to any established traditional doctrine about what is sound and what is unsound." In other words, Lerner believed that the very idea of what good fiscal policy means boils down to what results you can get  -- not some arbitrary notion of "fiscal sustainability".

Deficit cutting, whether now or in the future, is not a legitimate goal of public policy for a sovereign nation. Deficits are (mostly) endogenously determined by the performance of the economy. They add to private sector income and to net financial wealth and, in any case, decisions by the non-government sector to increase its saving will reduce aggregate demand and the multiplier effects will reduce GDP. If nothing else happens to offset that development, then the automatic stabilizers will increase the budget deficit (or reduce the budget surplus).  This is the kind of insight that Summers should be sharing with the readers of the FT if he were to demonstrate the economic leadership we need.

Then we get this misguided statement:

"A range of other considerations - including the crowding out of investment; reliance on foreign creditors; misallocation of resources into inefficient public projects; and reduced confidence in long-run profitability of investments - all make a case in normal times for fiscal prudence and reduced budget deficits.

And there are numerous examples, notably the US in the 1990s, where reducing budget deficits contributed to enhanced economic performance."

Where to begin?  The "crowding out" thesis was discredited by Keynes over 70 years ago!  The basis of the "crowding out" claim is that such government spending causes interest rates to rise, and investment to fall.  In other words, too much government borrowing "crowds out" private investment. Because investment is important for long-run economic growth, government budget deficits reduce the economy's growth rate.

Summers's argument reflects a complete misunderstanding of government spending. Increases in the federal deficit tend to decrease, rather than increase, interest rates. In reality, fiscal policy actions are those which alter the non-government sector's holdings of net financial assets. This is because deficit spending leads to a net injection of reserves into the banking system. (And big deficits imply big injections of reserves.) When the banking system is flush with reserves, the price of those reserves -- in the U.S. the federal funds rate -- is driven to zero in the absence of countervailing measures (such as bond sales). Unless a zero-bid is consistent with Fed policy, the central bank will begin selling bonds in order to drain excess reserves. The bond sales continue until the fed funds rate falls within the Fed's target band.

It is also questionable whether budget deficits do, as Summers suggests, reduce confidence in long run profitability in all investments.   In fact, the historical record suggests that given spare capacity, public expenditures are not only productive but also foster additional activity in the private sector.  In a study of a century of UK macroeconomic statistics, Professor Vicky Chick and Ann Pettifor provide very compelling evidence illustrating that active fiscal policy promoted economic growth and helped to REDUCE the UK's public debt to GDP ratio.  By contrast, periods during which the single-minded focus on debt and deficit reduction became the main focus on policy, economic growth slowed and the UK's debt to GDP ratio rose.

This study validates one of Keynes's central conclusions: "For the proposition that supply creates its own demand, I shall substitute the proposition that expenditure creates its own income" (Collected Writings, Volume XXIX, p. 81). Summers ought to read the study before he perpetuates myths to the contrary which continue to be used by unscrupulous people, to support cuts in Social Security and Medicare that can neither be justified by economic logic, nor empirical evidence.

Nor do we rely on foreign creditors, notably China, to "fund" our spending, another horrible, but eminently predictable canard trotted out by Summers.  The folklore he is trying to etch firmly into the public debate is that when China finally sells of its US bond holdings, those yields will sky-rocket, no-one else will want the debt and it will be the end America as we know it.  But Summers has the causation all wrong: government spending comes first and debt (in the form of bond sales) only comes afterward.  Bonds are issued as an interest-maintenance strategy by the central bank.  Their issuance has no correspondence with any need to fund government spending.  The denomination of the debt, NOT the denomination of the debt holder, is the key consideration. China can only do what the Americans and everyone else it trades with allow them to do. They cannot sell a penny's worth of output in USD and therefore accumulate the USD which they then use to buy US treasury bonds if the US citizens didn't buy their stuff.

As Bill Mitchell has argued repeatedly, Americans buy imported goods made in China instead of locally-made goods because they perceive it is their best interests to do so. By the same token, America's current account deficit "finances" the desire of China to accumulate net financial claims denominated in US dollars. The standard conception is exactly the opposite - that the foreigners finance the local economy's profligate spending patterns. Unfortunately, people like Summers apparently believe the latter, and they allow Beijing to play us for fools.

Good for China. They are playing a weak hand very skillfully. We, by contrast, are being played for patsies. The Federal Reserve sets the key interest rate in the U.S., and it can always hit any nominal interest rate it chooses, regardless of the size of the budget deficit (or debt). And this isn't just true of the Fed, but of any central bank which issues its own free floating, non-convertible currency.

Of course, an article from Larry Summers wouldn't be complete if he didn't repeat the usual claims of virtually all the Clintonistas - namely, that reducing budget deficits and running 4 consecutive years of budget surpluses contributed to enhanced economic performance.

No, it didn't. The government budget surplus meant by identity that the private sector was running a deficit. Households and firms were going ever farther into debt, and they were losing their net wealth of government bonds. Growth was a product of a private debt bubble, which in turn fuelled a stock market and real estate bubble, the collapse of which has created the foundations for today's troubles. This destructive fiscal policy eventually caused a recession because the private sector became too indebted and thus cut back spending. In fact, the economy went into recession within half a year after Clinton left office.

No criticism of the government deficit is ever complete without the usual invocation of concerns for our grandchildren and the omnipresent threat of "intergenerational theft", and here again, Summers does not disappoint:  "Fiscal responsibility is not only about our children and grandchildren. Excessive budget deficits, left unattended, risk weakening our markets and sapping our economic vitality." As we have argued before, forget about future public debt service becoming a yoke around the neck of future generations.  A person plunged into long-term unemployment in the US faces a high chance of becoming poor (relatively in this sense) and losing a significant proportion of the assets they had built up while working (housing etc), largely as a consequence of the types of myths championed here by Summers. Their children also inherit the disadvantage that they grew up with and face major difficulties in later life  because the retired and retiring baby boomers want their high nominal fixed incomes plus purchasing power preservation (if not deflation) now and until the day they die.  But the youth want jobs and the prospects of a life worth living, which they won't get if we cut expenditures today on things like education and proper job training.

Fiscal hawks and deficit doves alike are strangling the baby in the crib today by denying a sensible fiscal response for the current generation's plight, while hyperventilating that fiscal deficits will do the strangulation of the next generation tomorrow. That, in a nutshell, is what is truly sapping our long term economic vitality. The only way to avoid this ongoing plight is to champion a return to full employment policies, and stop being enslaved by the economic shibboleths which people like Larry Summers and his ilk continue to champion recklessly.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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The Trouble with Tim's Treasury

Jul 19, 2010Marshall Auerback

thumbs-down-150FinReg may fall short if power is channeled into Geithner's hands.

thumbs-down-150FinReg may fall short if power is channeled into Geithner's hands.

More depressing news from the "change" President.  The Washington Post has reported that one of the major impacts of the FinReg bill passed last week by Congress is the accretion of new power to Obama's Treasury Secretary.  According to the Post, Tim Geithner stands to inherit vast power to shape bank regulations, oversee financial markets and create a consumer protection agency.

Make no mistake:  this is Timmy's bill, plain and simple, as the Post makes clear: "The bill not only hews closely to the initial draft he released last summer but also anoints him -- as long as he remains Treasury secretary -- as the chief of a new council of senior regulators."

The Geithner Treasury repeatedly pushed back against many sensible legislative proposals that would have made significant structural changes to practices that brought about the current economic crisis. And the article itself represents latest in a series of attempts to embellish the Treasury Secretary's hagiography.

Reading it, one wonders whether the Washington Post inhabits a strange parallel universe.  Have the writers actually paid attention to what is truly happening in the economy? The WaPo persists in towing the party line that Geithner's tenure has been marked with conspicuous success, supposedly by advocating a response to the financial crisis that allegedly later proved correct: "Geithner vigorously resisted calls by some lawmakers and financial experts to nationalize the nation's largest and most troubled banks during the most perilous days. Instead, he helped get the financial system back on its feet, in particular by pressing for stress tests of big banks." (my emphasis)

Oh, really?  I would argue that Washington continues to allow the big banks to operate "business as usual" and to cook the books to show profits so that they can pay out big bonuses to the geniuses who created the toxic waste that brought on the crisis. Most continue to show profits based not on fundamentally health lending activity, but one-off gains, and accounting gimmickry.  Commenting on the latest JP Morgan results, my friend and colleague Randy Wray has noted:

JP Morgan's results were horrendous: it lost deposits, it made fewer loans, and even its fees fell by 68%. So how could a bank manage to profit on such dismal results? Well in the old days it was called window dressing-banks would move one little chunk of gold among themselves to show that they were credit worthy. In Morgan's case, the profits supposedly came from 'trading"' In reality they mostly came from reducing 'loan loss reserves'. In other words, Morgan decided it had set aside too many reserves against all the bad loans it made over the past decade. After all, borrowers will almost certainly start to make payments on all their debt over the next few months and years, won't they? Sure, homeowners are massively underwater, and losing their jobs, and cutting back spending, but recovery is just around the corner.

Sure it is.  Other than the Big 5, it's hard to make a case that we have a vigorous and healthy banking sector today. The Big 5 continues to benefit from a massive financial subsidy courtesy of the Fed and an unfair playing field in which they are perceived to be "too big to fail." This, in turn, creates huge competitive disadvantages for the smaller banks seeking to attract deposits. Small banks, in particular, are being crushed by a substantially higher cost of funding than the big banks. Currently the true marginal cost of funds for small banks is probably at least 2% over the fed funds rate that large 'too big to fail' banks are paying for their funding. And remember, the small banks for the most part were not the institutions at the forefront of great financial innovations such as credit default swaps and collateralised loan obligations.

The Post, like virtually every other mainstream publication, continues to perpetuate the fiction that the stress tests performed on the banks were real.  But as Yves Smith has noted repeatedly: "Just look at the numbers. 200 examiners for 19 banks? When Citi nearly went under in the early 1990s, it took 160 examiners to go over its US commercial real estate portfolio (and even then then the bodies were deployed against dodgy deals in Texas and the Southwest). This is a garbage in, garbage out exercise. The banks used their own risk models to make the assessment, for instance, the very same risk models that caused this mess. And there was no examination of the underlying loan files."

Given his hapless performance at Treasury, one can begin to understand why Timmy was so loath to have government take over the banks via an FDIC style restructuring.   It's a projection of his own incompetence and timidity.  Rather than ask what needed to be done to be sure of a solution, Geithner asked instead, what was the best Treasury could do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress?

Why did a new administration, confronting a huge crisis, not try to change the terms of debate?  Contrast the behavior of the Geithner today with the actions undertaken by the Roosevelt Administration. During the period in which the banking system was being restructured under Jesse Jones, Chairman of the Reconstruction Finance Corporation, the RFC required letters of resignation from the top three bankers of any institution receiving aid. These were not always accepted, but their mere existence was a potent deterrent to repeat behavior.

How many managers have been replaced during the current crisis? How many are being charged for fraudulent behavior?  Elizabeth Warren has at least made attempts at some sort of public accounting. As a result, her future job security is being compromised, despite the fact that Warren is the obvious choice to take over the newly formed Consumer Protection Agency.

By contrast, the Geithner Treasury has persistently frustrated every attempt to gain better understanding of the causes of the financial crisis via endless court challenges, obfuscation, lies and delaying tactics.  Additionally, Treasury has consistently opposed any serious attempts to engender structural changes in the banking system as the Financial Regulation bill worked its way through Congress.  Because Elizabeth Warren has refused to play ball with this insidious bankers' club, she's deemed not to be a "team player" by Geithner.

They extol his calls for great capital, but don't seem to have noticed the blatant failure of the Geithner strategy to "just raise capital requirements" as the way to deal with distorted incentives and the tendency of banks to take irresponsible risks has been comprehensively blown off by the financial sector.   Treasury insisted on "capital first and foremost" throughout the Senate debate this year - combined with their argument that these requirements must be set by regulators through international negotiation, i.e., not by legislation.  But the big banks are chipping away at this entire philosophy daily through their effective lobbying within the opaque Basel process - as one would expect.  Take a look at the article below from the Wall Street Journal:

Banks Gain in Rules Debate

Regulators Seen Diluting Strictest New 'Basel' Curbs; Fear of a Credit Crunch

By DAMIAN PALETTA and DAVID ENRICH

The world's banks appear to be winning a reprieve from tough new capital requirements and curbs on risk-taking, as regulators and central bankers are moving toward less stringent rules than initially proposed.

Bowing in part to fears that tougher requirements would diminish the credit needed to revive a sluggish global economy, officials gathered in Basel, Switzerland, are trying to strike a compromise over a set of new international banking standards initially proposed in December. The final accord will have a more global reach, and thus in some respects a more potent impact, on banks and borrowers than the financial regulatory bill likely to pass the U.S. Congress Thursday.

The new Basel rules, as they are called, would still be stiffer than existing standards. Industry officials fear the changes could shrink bank profit margins and make credit tighter and more costly for consumers and businesses. Alterations under discussion this week would ease key requirements that have been under discussion for months. Advocates for a tougher line have argued that excessive concessions could leave the financial system vulnerable to problems the entire process is intended to address.

Check out the rest of the article here.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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Fed Up with FinReg: Rooseveltians React

Jul 15, 2010

With financial reform on its way to the President's desk, the Roosevelt Institute's fellows and colleagues weigh in on the bill's weaknesses and the way forward.

Robert Johnson, Roosevelt Institute Senior Fellow and Director of the Project on Global Finance; Executive Director, INET:

With financial reform on its way to the President's desk, the Roosevelt Institute's fellows and colleagues weigh in on the bill's weaknesses and the way forward.

Robert Johnson, Roosevelt Institute Senior Fellow and Director of the Project on Global Finance; Executive Director, INET:

Scott Brown made them go back to the woodshed, and that made them look worse once again, but other than that, the bill is the same industry-crafted/not-up-to-the-task/so-called "accomplishment" that leaves 4 out of 5 Americans in the Bloomberg survey yesterday suggesting that they wouldn’t feel protected from a future financial crash.  They missed on Too Big to Fail, on Derivatives they got about 20 percent of the way there. Gary Gensler was a positive dimension of this process at the CFTC.  His work and the introduction of Elizabeth Warren's consumer financial protection agenda merit applause,  and that for Elizabeth herself, and not so much for the political process locating the Consumer Financial Protection Bureau in the Central Bank which, by tradition, will subordinate those concerns.  On to mortgage modification, GSE reform, reform of high frequency trading and usury limits.   This bill is forbearance.  Pressure for real reform must be sustained.  That may be the only way to deter Too Big to Fail management from being reckless again soon.  They cannot afford to unmask how weak this legislation is with another crash in the short term.

Elizabeth Warren, Harvard Law School Professor and current chair of the Congressional Oversight Panel to oversee banking bailouts:

President Obama's leadership on Wall Street reform over the past year has paid off, and soon he will have the opportunity to sign the toughest set of financial reforms in three generations.  For the first time, families will have a tough, independent cop in Washington to help clear out the tricks and traps hidden in consumer credit agreements.

Michael Greenberger, Founder and Director of the Center for Health and Homeland Security and professor at the University of Maryland School of Law, who participated in the Roosevelt Institute's Make Markets Be Markets conference:

In last Sunday's New York Times, Paul Volcker, with a tinge of unhappiness and regret, graded the Dodd-Frank financial reform bill as a B-. With an equal amount of regret, I agree. But, I am not unhappy. I consider the B- a mid term grade. I say this, because the bill places so much emphasis on effective implementation. To be sure, legislative directives are now in place to guide the regulators to a path of effective enforcement. For example, for purposes of regulating the completely opaque and highly risky derivatives market -- whose synthetic collateralized debt obligations and naked credit default swaps turned our economy into a unpoliced and poorly capitalized multi-trillion dollar casino-- Dodd-Frank sets the contours that have the potential of converting that entire market into a fully transparent and fully capitalized environment. But, dozens of rulemakings, studies and reports stand in the way.

If properly regulated, the very kind of risky trillion dollar bets that brought down the economy can be collared, reduced and, if necessary banned. If that happens, the derivatives title would get a final grade of A. If, however, in the subterranean agency processes through which implementation will be birthed, well funded Wall Street advocacy predominates, and the progressive institutions -- the unions, consumer and environmental groups, and small businesses -- are checked by a lack of resources, the B- could turn into an F. In short, the fight to stabilize the economy through banning the poorly capitalized casino trillion dollar bets depends completely on regulatory follow-through. Dodd-Frank gives reformers the weapons. The question is do progressives have the staying power and resources to make a success of this legislative effort.

Thomas Ferguson, Roosevelt Institute Senior Fellow and professor at the University of Massachusetts, Boston:

The bill makes some marginal changes, but it does not attack the fundamental problems that got us into the disaster of 2008. It just ducks the too-big-to-fail problem. The large banks will continue to dominate the derivatives business, as only portions of that move to clearinghouses or exchanges. In fact, the legislation is going to lock in the positions of the largest banks. At the start of the crisis, the four largest had about 40 percent of all deposits; now they hold something like 56 percent. That will probably only increase, with all that implies for consumer choice. The legislation creates a new council of the regulators, who are precisely the people who failed in the years before 2008. There is a consumer product safety agency that's to be established, but it's in the Federal Reserve, which simply hates consumer product safety. And the auto dealers got exempted from regulation.

It's easy to understand why Sen. Russ Feingold said he just could not vote for this bill -- but you may get a worse bill under another Congress. The very same Congress that's pushed this bill through at a snail's pace also created the Angelides Commission, which is supposed to inquire into what happened and why. This, of course, is not going to report until after the November elections. And so right from the beginning you knew the folks who were pushing this bill were not serious. I mean, that is to say, if they learned anything from the Commission, they weren't planning to use it in the bill. But they were planning to take in record amounts of campaign contributions and allow lobbyists to go wild offering them the sun, the moon, and the stars.

Mike Konczal, Roosevelt Institute Fellow:

The plan of counting on moderate Republicans instead of progressive Democrats like Cantwell and Feingold gave people like Scott Brown the chance to make crony-style changes to the bill that cheat the general public and help the biggest players. People with generic checking accounts will pay more to protect the largest hedge funds and investment banks. Is that what we want?

Wallace Turbeville, ND20 contributor and former Goldman Sachs VP:

Passing financial regulation is good politics and consumers will benefit from some protection. But the twin evils of incentivized risk taking and "too big to fail" survived. Congress did not swing and miss, but it managed only two foul balls. Perhaps we should have waited until Treasury and the Fed were past being petrified of the weakened financial system.

On bank abuse of market power, Congress did not swing and miss; the bat never left its shoulder.

During implementation, vigilance must be maintained. The banks will work overtime. They don't see the justification for change.

Henry Liu, ND20 contributor:

Much focus has been placed on financial regulation as a way to prevent future financial market failures. It is true that the financial market meltdown that began in the summer of 2007 was the result of excessive debt, opaque debt securitization, over-leverage, underpricing of risk, banks acting as proprietary traders, credit default swaps insurance not backed by sufficient capital, etc. But the root cause is insufficient worker income to absorb rising worker productivity to generate a global overcapacity. The FinReg bill missed the target by not addressing the problem of cross-border wage arbitrage by U.S. transnational corporations.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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Heather McGhee on FinReg Passage

Jul 15, 2010

Our colleague Heather McGhee at Demos sees FinReg's passage as the first step in rebuilding the American middle class and refashioning the rules of Wall Street, even if it still falls short of Glass-Steagall:

Our colleague Heather McGhee at Demos sees FinReg's passage as the first step in rebuilding the American middle class and refashioning the rules of Wall Street, even if it still falls short of Glass-Steagall:

"The meltdown of 2008 was a costly example of what happens when we dismantle the public structures that are the foundation of America's prosperity. Today we begin to rebuild those structures, and in so doing, start rebuilding the American middle class. With this vote, the Congress has begun writing financial rules of the road that will once again benefit Main Street, not just Wall Street. After the new consumer regulator opens its doors, Americans will open a checking account or apply for a loan with greater security because their lender will be accountable to basic standards of fairness and transparency. Investors will know that their broker-dealers are acting in their interest. Businesses hedging risk will know the real price of the derivatives contracts they buy. And if we have truly independent regulators with the will to stop reckless speculation, those regulators will have the power and tools to do so.

The Wall Street Reform and Consumer Protection Act's consumer reforms, investor protections and new Wall Street rules are necessary for a strong economic recovery. Although the Act falls short of transforming the financial sector in the way that the Glass-Steagall Act did after the last great banking crisis, it represents a victory of the public interest over the status quo in virtually every provision and rule. Demos applauds the tireless efforts of experts and advocates in Washington and across the country who have worked together to create this historic set of reforms."

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FinReg Achilles' Heel: Not Too-Big-To-Fail, But Too-Connected-To-Fail

Jul 14, 2010Henry Liu

money-globe-150Henry Liu demonstrates why FinReg, however well designed, cannot be counted upon to prevent future market failures.

A rule of finance: All trading models buy safety by externalizing risk to the trading system.

money-globe-150Henry Liu demonstrates why FinReg, however well designed, cannot be counted upon to prevent future market failures.

A rule of finance: All trading models buy safety by externalizing risk to the trading system.

There is an invisible, but solidly anchored assumption in all structured finance and derivative trading models -- namely, that a systemic collapse would trigger a government bailout. Since each and every derivative trading model derives protection by externalizing risk to the trading system, systemic risk expands automatically (making systemic meltdown inevitable). Institutions, then, have an incentive to be considered of "systemic significance" in order to secure a fail-safe advantage in interconnected transactions, even though by themselves they are not "too-big-to-fail". These trading models are operative when they are marked-to-model, but inoperative when they are marked-to-market in a downturn. This is the point when these models' fail-safe strategy by government bailout is activated.

Even a government like Hong Kong, which assumes a radical laissez faire posture, has had to intervene directly in the equity market because of the connections between a fixed exchange rate and unregulated financial markets that allow manipulators to attack its equity markets by rigging the automatic effect of exchange rates on interest rates to create deflationary pressure on stock prices.

As you will see, focusing on "too-big-to-fail" alone leave windows of vulnerability for "too-connected-to-fail" hazards.

Hong Kong Monetary Authority Fought Off Hedge Fund Attacks in 1997

In October 1997, three months after China recovered Hong Kong following a century and a half as a British colony, the HK$, which had been pegged to the US$, came under powerful, repeated, speculative and manipulative attacks due to the contagion effects of the Asian financial crisis. The automatic monetary adjustment forced interbank interest rates in Hong Kong to shoot up to unprecedented levels (up to an astronomical 300% at one point), reflecting substantial risk premiums on the HK dollar. This generated severe deflationary consequences for the financial and property markets, as well as the entire economy.

The interventionist role the Hong Kong Monetary Authority (HKMA) played in handling violent market turbulence was controversial by the standard of its own free market ideology. HKMA later admitted that as Hong Kong's link mechanism was on "autopilot" during the attacks, the interest rate adjustments were part and parcel of the working of a currency board regime, and therefore generating an inevitable and painful financial crisis. The fact that such financial and economic pain was avoidable by de-pegging was not officially acknowledged as an option.

Hong Kong was the target of speculative and manipulative attacks four separate and sequential times during the Asian financial crisis of 1997. The first three attacks took the form of garden variety currency dumping, whereas the fourth attack targeted the structural vulnerability of the Hong Kong's currency board regime after speculators were convinced that HKMA would defend the peg at all cost. And speculators were waiting to be the happy recipients of guaranteed profit from HKMA's fixation on the peg.

The first attack took place in October 1997, as a result of contagion from the regional financial turbulence that began in Thailand in July 1997. Currency speculators took large naked short positions against the HK dollar, with the expectation of profiting from the breakdown of the Hong Kong linked exchange rate regime. However, interbank interest rates soared in response, forcing speculators to unwind their naked short position as the high cost of borrowing made leveraged naked short trades unprofitable.

Although the automatic defense mechanism inherent in the currency board regime prevented the breakdown of the currency peg, the penalty took the form of unsustainably high interest rates. For example, the overnight interbank interest rate on October 23, 1997 reached as high as 500%. This local interest rate volatility echoed the external market volatility, created psychological shocks to market participants that forced the market to put a risk premium on Hong Kong dollars. Consequently, local banks increased their precautionary demand for liquidity, resulting in continuing high level of interest rates for the HK market. A liquidity crisis developed, further exacerbating already abnormally high interest rates.

This high interest rate anomaly incurred huge adjustment costs in the Hong Kong economy, particularly in the finance, business and property sectors. Labor costs, even though they accounted for only about one-third of the operating expenses of an average corporation in Hong Kong, as compared to the US average of two-thirds, had to be reduced by management through lay-offs and cuts in real wages and benefits in the early 1998. Asset prices such as land, real property and company shares, together with rental and dividend income, also plummeted sharply and swiftly.

The high cost of defending the currency peg system manifested itself in severe price deflation. It triggered further speculative and manipulative attacks in January and June, 1998, each time draining substantial wealth from Hong Kong companies and residents into offshore hedge fund accounts. The monetary defense mechanism successfully maintained the currency peg in the market at the cost of generating sharp, across-the-board price deflation in the economy.

The Hong Kong dollar continued to trade at the pegged exchange rate to the US dollar, but the same US dollar was buying more assets in Hong Kong than before the crisis. The currency board regime merely deflected currency devaluation toward asset deflation. The exchange value of the HK dollar remained fixed to the US dollar, but Hong Kong asset prices and wages fell. It would be less painful to the local economy if asset prices and wages remained unchanged while the HK dollar was devalued against the US dollar.

The HKMA was able to defend the fixed exchange rate of its currency because it had large foreign reserves, but it did so by allowing wealth to be drained from the Hong Kong economy through asset deflation, weakening its market fundamentals. The net economic outcome was negative on balance. The monetary operation was successful, but the economic patient was left near dead.

In August 1998, the fourth and near-fatal attack took place, targeting at the automatic adjustment mechanism of the Hong Kong currency board regime. This took the form of simultaneous attacks on money and equity markets, known in hedge fund tactics as a "double play".

In a double play, before launching attacks, manipulative traders would pre-fund their attacks with highly leveraged positions with HK dollars in the debt market, engaging in big swaps to access large sums in HK dollars that multilateral entities had raised through their bond issuance. Speculative and manipulative traders then spread rumors about imminent Chinese yuan devaluation and a pending collapse of the Hong Kong equity and property markets. At the same time, they made large naked short positions in the stock futures index market. Then, they induced an interest rate hike by dumping their pre-funded HK dollars in the spot and forward market to force the HKMA to buy HK dollar with US dollars from its reserves. All these actions induced the Hang Seng index to plummet sharply and abruptly, from 16802 in June 1997 to 6708 in August 1998. Within three days beginning October 20, 1997, the Hang Seng index dropped 23%.

As the Hong Kong stock market started to plunge, other speculators saw opportunities for profit through massive naked shorting. The Hong Kong financial markets fell into chaos, as further naked short selling created panic selling of shares in free fall.

The Damage by Naked-Short Attacks

The current ban against naked short selling by Germany during the 2010 EU sovereign debt crisis is driven by more than mere phantom fears. The German defensive measure has the 1992 experience of the British pound and the 1998 experience of Hong Kong dollar with naked short selling as cautionary guides.

During the Asian financial crisis of 1997, speculators and manipulators exploited the automatic interest rate adjustment mechanism of the currency board regime, turning speculation into manipulation for certain profit. Hedge funds took naked short positions simultaneously in the Hong Kong stock and futures markets. Simultaneously, they sold yet-to-be-borrowed Hong Kong dollars against the US dollar. Under the currency board regime, the HKMA must stand ready to buy back HK dollars released into the market to maintain the peg.

This was the structural dilemma inherent with the currency board regime. On the one hand, continuing buybacks of HK dollars by the HKMA automatically shrank the Hong Kong monetary base and drove HK dollar short-term interest rate up sharply. On the other hand, the overnight interest rate having risen sharply to 500% at one point in October 1997, triggered precipitous drops in stock and stock futures prices and produced hefty profits for short-sellers. After every attack, market confidence plummeted further by the hour, creating an imbalance of sellers over buyers to push share prices further down.

The HKMA feared Hong Kong's economy could very well bleed to death if the downward vicious cycle was permitted to continue. If the economy should die from hemorrhage of wealth, no further purpose would be served by preserving the currency board. And if the downward asset price spiral was allowed to continue, the currency board would eventually also collapse after the large foreign reserves was exhausted, because wealth was draining from Hong Kong with no stop loss limits.

It soon became clear that the option was not even to choose between letting the economy collapse and letting the currency board regime collapse. The two are linked so that as one sinks, the other would be dragged down with it. The economy must be saved along with the fixed exchange rate. Yet few acceptable options were available to reverse the trend of depleting foreign currency reserves while bleeding the equity market dry. Among all the unpalatable options available, only two stood out with some uncertain promise: 1) outright capital control and 2) direct market intervention. Both were not cost-free silver bullets.

Malaysia's Capital Control Not Operative for Hong Kong

While earlier in the 1997 Asian financial crisis, Malaysia had adopted capital control with positive results, Hong Kong would not benefit from similar measures because, unlike Malaysia, the Hong Kong economy was primarily an outward-oriented trading economy with no sizable domestic market of its own. Hong Kong therefore chose direct market intervention with its huge foreign reserves. When manipulative and speculative attacks intensified again in August 1998, the HKMA intervened with its reserves of US dollars simultaneously in the money, stock and futures markets, in addition to buying back Hong Kong dollars in the foreign exchange market.

During the last two weeks of August, 1998, the HKMA imposed temporary penalty charges on targeted lenders that served as settlement banks for the manipulators and speculators to make speculative funds more expensive while HKMA itself bought US$15 billion worth of Hang Seng Index constituent stocks (8% of the index's capitalization). In addition, it took naked long positions that pushed the stock futures 20% higher to squeeze the naked short sellers. After the massive market intervention by the HKMA, the exchange rate of the HK dollar quickly stabilized, and currency futures and short-term interest rates returned to sustainable levels. Manipulator and speculators were left licking their wounds but not until substantial damage had been done to the Hong Kong economy. To soften anticipated neo-liberal criticism, the HKMA labeled its market intervention as "market incursion".

Still, for this unprecedented "market incursion", the HKMA received harsh criticism for deviating from its long-standing "positive nonintervention" policy. In defense, the HKMA argued that the "incursion" was justified by Hong Kong's strong economic fundamentals as well as the severity of the regional financial turmoil. The HKMA contended that without forceful incursion to foil market manipulation, not only would the currency board have collapsed but there would also have been serious regional and global ripple effects. It was a "too-big-to-fail" argument that was summarily dismissed by US neo-liberals who quietly did the same on a much larger scale in 2008.

The 1998 market incursion was a deviation from Hong Kong's economic policy of "Positive Non-Interventionism" adopted under British imperialism after WWII to appease US free market ideology. The policy was first officially implemented in 1971 by John James Cowperthwaite, a Scottish civil servant in the British Colonial Office who worked to remove all colonial government interventionist preference toward trade with Britain in order to facilitate more trade with the US, the world's biggest market with seemingly inexhaustible purchasing power.

Friedman Condemned Hong Kong for Market Intervention

Milton Friedman's opinion in the October 6, 2006 Wall Street Journal, less than a year before the global credit crisis that imploded in New York in July 2007, criticizing Hong Kong for abandoning Positive Non-Interventionism, praising instead Cowpertheaits as having been "so famously "laissez-faire" [in ideology] that he refused to collect economic statistics for fear this would only give government officials an excuse for more meddling." This is an amazing praise from Friedman who was known for his 1953 propositions for a "positivist" methodology in economics which stresses the important of economic data.

Hong Kong's Sin Repeated by the US

Notwithstanding their stern criticism of the HKMA in 1998, the Federal Reserve and the US Treasury also engaged in direct market intervention in US markets a decade later in 2008. This was done under the rationalization of saving "systemically significant" private institutions that were deemed "too big to fail". At least the HKMA bought all the listed shares in the Hang Seng index, rather than toxic assets from only selected distressed firms as the Fed and Treasury did, which was decidedly less evenhanded or market neutral.

Click here to read the full article.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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Tom Ferguson on FinReg Bill: "Not Worth the Hype"

Jul 13, 2010

In a recent interview with the Real News Network, Roosevelt Institute Senior Fellow Tom Ferguson told host Paul Jay that the finreg bill is a disappointment when compared to major reforms like Glass-Steagall. "This thing is not worth the hype. It makes some marginal changes, but it does not attack any of the fundamental problems that got us into this sort of disastrous financial crisis back in 2008."

In a recent interview with the Real News Network, Roosevelt Institute Senior Fellow Tom Ferguson told host Paul Jay that the finreg bill is a disappointment when compared to major reforms like Glass-Steagall. "This thing is not worth the hype. It makes some marginal changes, but it does not attack any of the fundamental problems that got us into this sort of disastrous financial crisis back in 2008."


Tom says that the bill does almost nothing to address the problem of too-big-to-fail and invests more power in the same regulators who failed to prevent the last crisis. Despite some changes to derivatives, "in the end they let the big banks keep about, probably, 80 percent of the derivatives business they've got." Because of this, Tom predicts that "you are very likely sometime—maybe in the not too distant future if things don't go well in Europe—to see yet another big bank brought down by some stupid business deal."

Tom counts the one-time audit of the Federal Reserve and the creation of the Consumer Financial Protection Bureau as two of the bill's modest victories. However, he believes it is a mistake to house the consumer agency in the Federal Reserve, which already has the power to create and enforce consumer regulations and has instead "sat back for years and let banks rip everybody off."

As for whether the bill is worth passing in its current form, Tom says that "you'd probably better take this one, because you'll probably get a worse bill next time," but he's sympathetic to those who want to start over. Ultimately, he views the bill as a victory for Wall Street lobbyists and a prime example of how corporate money can undermine and corrupt the legislative process. He says the banks "know they just dodged a silver bullet" and will wind up paying and changing far less than they should have. "In the end, we have a tale full of sound and fury, signifying nothing."

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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