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Archive for June 18th, 2010

11 Notes

Friday, June 18th, 2010

Internet issues are resolved, so here’s a post of things that built up while things were down.

1) You know that I have mixed feelings about the Fed.  They have done a poor job with bank regulation, monetary policy, and managing systemic risk.  The trouble is, if you’re going to have a fiat currency, monetary policy is credit policy, and so your central bank should broadly control credit if you are going to do that at all.  (If not, then set up a currency board, or back your currency with silver/gold.)

So when I hear that the Fed is winning in reconciliation of the finance bill, I think it is good in some ways – yes, they should oversee small banks, but bad because the Fed should not have bailout authority, or at least they should not be able to hide what they do when monetary policy is unorthodox.  It is one thing to delay oversight of ordinary dealings, but rotten to hide debasement of the currency through special dealings with favored entities.

But I see little value in the size of the Fed.  They have too many people doing too little.  Monetary policy and bank supervision?  Fine if they do it well.  But the institution as a whole could be radically slimmed.  Congress should take closer control of the Fed, slim it down, and focus it on the missions that it should attend to.

2) I am not impressed with Donald Kohn.  He has a farewell interview with the Wall Street Journal, and not once does he mention the buildup of debt in our economy, partially fostered by easy monetary policy from the Fed, as a problem.  Blind guy, and even worse, he still doesn’t get that bubbles are typically able to be seen in advance, or, that the Eurozone isn’t structurally flawed.

Thought experiment time.  What if we tossed out all the Fed governors, and replaced them with a bunch of notable value investors?  Value investors suffer from the problem that we see problems early, and adjust portfolios too soon.  That could be of benefit to monetary policy, because value investors often see when things are becoming overdone, well in advance of it becoming too big to handle.  This would be a big improvement on the current system.

3) I get email from congressional staffs asking for advice on issues, or asking me to write about them.  Recently I was asked what I would ask the nominees for the Federal Reserve Board.  This is what I said:

  • We find ourselves in this crisis because the Fed ran an asymmetric monetary policy for years: loosen aggressively when the least crisis comes up, and tighten slowly until there are small squeaks of pain.  This led short interest rates progressively lower, until we found ourselves in the liquidity trap that we are now experiencing.  How are you going to get us out of this liquidity trap?
  • How are you going to provide decent opportunities to savers so that capital formation can begin again?
  • What have you done in your life that qualifies you for this level of responsibility?
  • To the economists: neoclassical economics did us no favors with respect to this crisis.  Only a few Austrian economists predicted it, along with a few practical economists in the business world.  We need a new paradigm for monetary policy.  Are you capable of providing it?
  • To the non-economist: You will be working primarily with neoclassical economists, with their theories uncontaminated by data.  How will you avoid being sucked in by their groupthink?

4) When I went to hear Raghuram Rajan and Carmen Reinhart at the Cato Institute, I was very impressed with what both of them had to say.  Rajan was the skunk at the farewell party for Alan Greenspan back in 2005 at Jackson Hole, when he was the only one to fully suggest that imbalances were building up due to debts being incurred in the financial sector.  Few aside from The Economist noted what he said.  More noted Donald Kohn’s dismissive response, which was not erudite, in my opinion.

Both noted that the current financial reform bill would do little to fix the real underlying problems, with which I agree.  It constrains in many areas that don’t need it, and does not constrain areas that were significant to the crisis – e.g., the GSEs and the Fed.  Imagine a simple proposal that would immediately force flexibility onto the economy: dividends are deductible, but interest payments (and preferred dividends) are not.  An easy way to lower leverage, and encourage flexible finance.

Also, they noted the possibility that the US Government would engage in financial repression, which would force people to invest in government securities on unfavorable terms.  Ugly stuff.

And as an aside, we met in the F. A. Hayek Auditorium.

5) Can Hayek be cool?  Perhaps, give the recent rap video.  I am not surprised that few neoclassical economists give Hayek any credit; he cuts against most of what they stand for, so why should they commit treason?

As for Glenn Beck, I get tired very quickly of the facile answers that appeal to the anger of the masses.  There are real problems, and we need to deal with them, but oversimplifying the problems will not get us to the solutions; it will only create a new set of problems.  I have no favor toward the Tea Party; they don’t stand for anything coherent.  I am not an Austrian economist, much as I like some of their ideas.  My ideas have been derived from my observation of how financial systems work over the last 25 years.

6) Following Austrian economics would be a huge improvement over what we usually do, though there is a problem.  Once you hit the bust, nothing works.  The Austrian view will be a “big bang” and clean it up fast, but it will be a lot of sharp pain.  The virtue of Austrian Economics is that it would restrain the boom, and thus make it less likely that one faces the pains of the bust.  But there are no easy solutions in the bust.

Focus on the boom, not the bust.  Solve the boom, and the bust does not come.

7) It is common that many debt classes that have few defaults get an aura about the qualitative factors that forestall default.  Well, what of municipal finance?  Under stress, is it possible that the cultural factors that made default less likely might wither, and defaults cascade in likelihood?  Yes, I think that is possible, and I think that is why Buffett is lightening the boat on munis.

8 ) Solve the revolving door problem for the SEC?  Pay them more.  I get it, but are we really willing to pay market-based salaries for expertise?  I doubt it.  The government tends to be chintzy; penny wise and pound foolish.

But if you hired real experts, would the government be willing to set them free and let them corner real frauds?  That is the question.

9) Fannie and Freddie common stocks are on their way to zero.  Their NYSE delisting is just one more step in the road to total dissolution.  The simplest solution is to fold them into GNMA, and slim down the massive operations that don’t do much for the mortgage market.

10) The unequal signal problem exists with the banks that took TARP money.  We hear a lot about those that repay, but little about those that do not pay.  Well, here is an article about those who did not pay.

11) Evan Newmark is occasionally annoying, but often perceptive.  Should President Obama do what he does not want to do?  It couldn’t hurt; his allies on the far left are already disaffected. The question is whether he can be as dispassionate as Bill Clinton, and pursue a centrist course.  I don’t think he is capable of that, because he is too smart, and smart people, unless they moderate their idealism, don’t compromise well.

That’s all for now.


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

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