Price of 2009 en primeur Chateau Lafite in New York, per case: $17,000
Price of shipping a case of Chateau Lafite from New York to Hong Kong: $40
Price of 2009 en primeur Chateau Lafite in Hong Kong, per case: $70,000
It’s easy to see the logic behind the Fed’s latest bout of quantitative easing. Indeed, the official Fed statement lays it out quite plainly: the economy is struggling, and needs all the help it can get; meanwhile, inflation is lower than the Fed would like to see. Since rates can’t be lowered below the zero lower bound, all that’s left is QE.
The Fed, on this view, has precious few tools at its disposal, and so its using the tools it has as best it can, in pursuit of its mandate. Right now, unemployment is way too high—and the longer it stays that way, the more structural it will become. The Fed can’t simply hire millions of people, so instead it’s buying up hundreds of billions of dollars in Treasury bonds, and hoping that the proceeds from those purchases will somehow find their way into expanded payrolls. It’s never been tried before, so no one has a clue whether it’ll work. But not trying it is simply defeatist, an admission that there’s nothing the Fed can do to boost employment.
What’s the downside? Well, for one thing, it’s extra fuel for the bond-bubble fire. Treasuries are already highly sought-after securities; this announcement increases the demand for them so much that the Fed has had to “temporarily relax” the limit of 35% of any given bond issue that it’s allowed to buy. With all that money flowing into a constrained asset class, market imbalances are all but certain to result in unintended consequences somewhere down the road.
What’s more, the Fed has historically spent relatively little time worrying about the dollar—that’s Treasury’s purview. And the first-order effects of a looser monetary policy are in fact positive: a weaker dollar means higher export revenues and therefore more money for hiring new employees.
But there are all manner of nasty second-order effects; indeed, my colleague Jennifer Ablan talks about quantitative easing as “exporting currency chaos.” It now costs essentially nothing to borrow dollars, and to then take those borrowed dollars and use them to buy other currencies, like the Brazilian real, which yield vastly more. That’s the carry trade, and it can be very destructive: it means massively overvalued currencies in places like Brazil, and when it unwinds (it always unwinds) it tends to do so in a very messy and destructive manner. (Remember Iceland?)
More generally, the Fed is spending trillions of dollars on an experiment, with no real plan for what to do if the experiment goes wrong. Indeed, it’s far from clear that the Fed has spent much time war-gaming the various different scenarios of how QE could go pear-shaped, and what it might be able to do in response.
Certainly one of those negative outcomes is a sudden bout of untamable inflation if and when the economy gets out of its current slump: after the Fed has printed all that money, the other shoe can drop fast. Too-high inflation at some point down the road isn’t probable, but it’s possible, and its likelihood is surely higher now than it was before the Fed’s balance sheet started expanding faster than the Very Hungry Caterpillar.
But there are other negative outcomes too. And in general, the further that the Fed goes down this path, the less control it has over the economy and the money supply. Which means more of that uncertainty which everybody is blaming, these days, for the very slump the Fed is trying to get us out of. You can see how QE, however logical and well-intentioned, might end up being counterproductive.
Don’t believe for a minute that the likes of Rand Paul are bringing a whole new level of nutty to upper-house politics, in contrast to staid and boring countries like the UK. Via Joseph Cotterill and Charlie Stross, here’s an astonishing speech made in the Mother of Parliaments by David James, a/k/a Baron James of Blackheath.
After opening with reminiscences of seeing “Brigadoon” in the West End, James explains that:
Lord James always struck me as a perfectly sensible person, but he does seem to have gone completely bonkers here. But hey, at least he’s provided years’ worth of grist for conspiracy theorists around the world. Who could this Foundation X be? Might they be related to the Rosicrucians? The Knights Templar? The Illuminati Elite? The Vatican? And what terrible fate might befall James, now that he has hinted at their shadowy existence?
Though not generally or publicly known, OITC is the largest International Institution of its kind. It is the largest single owner of gold and platinum bullion in the World, in addition to being a major owner of Bank Debenture Securities, International Treasuries, Cash and other forms of securities…
Original assets in the form of gold have been wisely and well utilized to create wealth that creates further wealth…
It should be noted that only a few persons in each country of the world are eligible to be able to verify, or undertake a verification, re: the position of Dr. Ray C. Dam (International Treasury Controller) and the Office of International Treasury Control. Such persons are limited to Kings, Queens, Presidents, Prime Ministers, with Ministers of Finance and Ministers of Foreign Affairs subject to security status and special conditions / dispensation.
Any sensible person would recognize OITC as a scam after spending about two seconds on its website. Which says to me that David James is, sadly, no longer a sensible person. He’s had a long and noble and storied career; someone should let him retire with dignity at this point.
Update 2: Someone should show James the OITC’s extremely comprehensive Wikipedia page, which details, among other things, how the OITC swindled $20,000 out of an Ecuadorean mayor. There’s also this:
Speaking at a press conference in Fiji, OITC representative Masi Kaumaitotoya told the local media: “Don’t you ever, ever, ever again report negatively on OITC or we’ll sue you for defamation.”
Update 3: James tells Tom Espiner that he has not been approached by the UNOITC, and that there were no links between Foundation X and UNOITC.
“The conventional wisdom likely to be repeated over the next few weeks,” writes Mohamed El-Erian today, “is that political gridlock is good for the economy”.
I’m not so sure. There are certainly some people taking that tack: Ken Fisher is saying that gridlock might be good for the stock market, but like all fund managers he’s talking his book, and his reasons are based more on investors emotions than on the fundamental benefits of gridlock. (People “freak out” when the government does something big, says Fisher, and that makes them less likely to invest in stocks.)
Meanwhile, as both El-Erian and Steve Rattner say, if you really want to help the economy, there’s a long list of things which really ought to get done and which aren’t going to happen under gridlock.
Democrats and Republicans must meet in the middle to implement policies to deal with debt overhangs and structural rigidities. The economy needs political courage that transcends expediency in favor of long-term solutions on issues including housing reform, medium-term budget rules, pro-growth tax reforms, investments in physical and technological infrastructure, job retraining, greater support for education and scientific research, and better nets to protect the most vulnerable segments of society.
And here’s Rattner’s:
The list of unfinished business is long: action on climate change, reform of entitlement spending, and a revamp of the two zombie housing agencies, Fannie Mae and Freddie Mac.
I’d love to see more specificity from El-Erian on what he means by “pro-growth tax reforms”, especially in the context of those “medium-term budget rules”. But there’s a thread running through all of these columns, which it’s important to emphasize: there’s altogether far too much debt in the economy. That goes for individuals, stuck with enormous mortgages; it goes for Fannie and Freddie; it goes for state and municipal governments; it goes for the federal government; and it goes for some, but by no means all, corporations as well.
Top of my list of Things To Do, then, would be to deal with El-Erian’s debt overhangs by abolishing the ridiculous incentives that the tax code gives for taxpayers (both individuals and companies) to borrow as much money as possible. Those incentives eradicated one of the most glistering sliver linings of the crisis: the fact that the forced deleveraging was, at least, a deleveraging. As soon as the crisis was over, everybody releveraged again.
But that kind of reform was a step way too far even when the Democrats controlled both houses of Congress and the White House; it’s unthinkable today. Similarly, we’re not going to get bipartisan action on things like climate change, entitlement reform, or strengthened social safety nets when neither of the two parties would be willing to touch such hot-button issues on their own.
Gridlock, then, only serves to make impossible what was already highly improbable under the best of circumstances. For all their exhortations, El-Erian and Rattner know full well that they’re not going to get their wish lists — and they know that they wouldn’t have gotten their wishlists even if the Democrats had kept the house. It’s all well and good to ask that “mid-course policy corrections will be identified and undertaken on a timely basis” — but what administration has ever been able to do that? The US government simply isn’t that nimble, and it never has been.
So maybe the gridlock question is germane mainly to the perennial and rather boring debate about what happens to stocks under various permutations of parties in the White House, the Senate, and the House. Grandees like El-Erian and Rattner will continue to use their op-ed bully pulpits to push for grown-up action on a long list of issues facing the country. But the reality of U.S. politics today is that Congress is listening to an angry populace, not to multi-millionaire lefty pundits. And the angry populace has no interest whatsoever in “an encompassing economic vision that acts as a magnet of conversion nationally, counters growing international frictions and facilitates much-needed global economic coordination”.
Or, to put it another way, if you give those angry Americans what they think they want, it’s unlikely to help them and quite likely to harm them. But this is a democracy, so that’s what Americans are going to get.
(Cross-posted at CJR)
My review of Matt Taibbi’s new book is up at Bookforum; I enjoyed it a lot, and even learned from it. Meanwhile, Justin’s fair take on Gretchen Morgenson received a lot of pushback in the comments, much of which was unhelpfully ad hominem. (No, Justin is not a sexist misogynist, and criticizing Morgenson doesn’t make him one.)
I actually stand by my March 2007 criticism of Morgenson, in which I said that she didn’t provide any evidence of a looming crisis in the mortgage market. Certainly, with hindsight, I was too bullish back then, but so was Morgenson, whose prognostication was far from being remotely apocalyptic:
Fewer lenders means many potential homebuyers will find it more difficult to get credit, while hundreds of thousands of homes will go up for sale as borrowers default, further swamping a stalled market…
If home prices do not appreciate or if they fall, defaults will rise, and pension funds and others that embraced the mortgage securities market will have to record losses. And they will likely retreat from the market, analysts said, affecting consumers and the overall economy.
I was covering the housing market a fair amount back then, and indeed linked to an earlier post in which I spoke at length to one of Morgenson’s favorite sources, Josh Rosner, and said that “there are lots of reasons to be worried about the future of the mortgage market”. My issue with Morgenson was simply that her arguments didn’t make any sense, and that often her facts were simply incorrect.
If you wanted good reasons to be worried about the mortgage market in early 2007, you went to Rosner, or to Calculated Risk, or to Nouriel Roubini. If you wanted bad reasons to be worried about the mortgage market, you went to Morgenson. Yet still she asks for and gets lots of credit for her columns back then, simply by dint of her prominent perch at the NYT. If she was the blogger and Tanta had the NYT column, no one would have paid any attention to Morgenson at all.
That can’t be said of Taibbi, whose fierce and excoriating journalism for Rolling Stone has performed a very important function: it helped to get people angry, and to really care about issues which can become incredibly dry and boring very quickly.
What’s more, Taibbi’s stuff is fact-checked in a way that Morgenson’s isn’t. He doesn’t make the enormous howlers that Morgenson does, partly because he cares more about the nitty-gritty of this stuff, partly because he spends much more time on each piece, and partly because the RS lead times allow him lots of editorial support.
I can highly recommend that readers of this blog read two chapters in particular in Taibbi’s book: the one on Greenspan, and the one on AIG. The former is the most comprehensive take-down of the Maestro you’ll ever see; I’d be especially interested to see Brad DeLong’s take on Taibbi’s shrillness. And the AIG chapter, which concentrates on the securities-lending operation rather than on AIG Financial Products, actually breaks news about just how incompetent and stupid AIG was, particularly its securities-lending head Win Neuger.
Justin’s point was that if you ignore the detail in Morgenson’s pieces, the big picture is often correct. Taibbi is pretty much the other way around: the detail is fact-checked and correct, but he massively over-eggs the big picture. (Goldman Sachs did not singlehandedly engineer every financial bubble in living memory; Alan Greenspan is not “The Biggest Asshole in the Universe”.)
It’s easy, however, to read Taibbi and even to enjoy the hyperbole without taking it at face value. It’s much harder to separate the useful from the contentious with Morgenson. Which is why I think she’d benefit greatly from much more active, hands-on editing. The question is: who at the NYT has the time, the desire, and the ability to do that?
Bush 41 supported Bush 43 via faxes — NYT
Datapoint from exit polls: 4 in 10 voters said they supported Tea Party — NYT
Love 20×200′s print today — 20×200
Printed Matter presents the fifth annual NY Art Book Fair, November 5–7 at MoMA PS1 — NYABF
The efficient markets hypothesis vs homeopathy — xkcd
Wells Fargo Reposesses Fully Paid Off Car — Ritholtz
“High frequency trading provides valuable incremental liquidity when high frequency traders are the governor on the steam engine. When they become the engine itself, they can’t provide stability.” — Derman
Oh dear, what have I signed up for? No sooner do I agree to start blogging more about economic journalism than I find this op-ed from Robert Rubin in the FT. It’s a pretty sorry specimen, and I do hope it’s not representative of the genre.
The op-ed, which is written in borderline-unreadable technocratese, has a simple structure: there are headwinds in the economy. What should we do about them? Spending more might be problematic. Expansionary monetary policy likewise. So what should be done? The administration should be more business-friendly. And it should put together a “serious fiscal plan”.
Rubin is long on assertion and scaremongering, and short on actual argument:
A major new stimulus could well be constructive, if it is tied to real, trusted and enacted long-term structural deficit reduction. Otherwise, a major new stimulus is likely on balance to be counterproductive, initially or over time. It could seriously increase business uncertainty about future economic conditions and policy, or change market psychology unexpectedly and dramatically, causing serious market disruptions.
It’s really hard for me to see how Rubin gets to his “likely on balance” conclusion that stimulus will be counterproductive. Does Rubin really think it probable that the announcement of extra government spending would cause some kind of crazy market crash? And “business uncertainty about future economic conditions and policy” is a pretty weak replacement for the bond vigilantes against whom Rubin so happily fought during the Clinton administration. The bond vigilantes were real, and powerful: they could and did determine the rate at which the US could borrow money.
Rubin fought those bond yields down: the 10-year bond yielded more than 7.5% when he became Treasury secretary, and less than 6% when he passed the reins on to Larry Summers. But that yield is just 2.5% today, making the specter of enormous interest payments much less scary.
You really need to be Bob Rubin to be scared by his new boogieman, “business uncertainty”. Rubin seems to be asking us to give up investment today on the grounds that it might cause business uncertainty tomorrow: it’s a tough case to make, and he doesn’t really come close to making it. Instead, he basically just says that any administration should work hard to give the business lobby anything it wants:
The administration’s response to the financial crisis, last year’s stimulus, and this year’s financial reform have, on the whole, been sound and effective. Nonetheless, there is strain between business and the administration, which could be reduced by each better understanding the other’s perspectives and difficulties. Relatedly, the administration, business, and all other interested parties, should work together more effectively on regulatory issues, to promote strong protection while also taking into account the effects on economic activity.
Most of us would agree that the Bush and Clinton administrations were, with hindsight, far too friendly to business in general and finance in particular. If the Obama administration wanted to move back to something more optimal and less business-friendly, that’s naturally going to create “strain between business and the administration”. That’s a feature, not a bug. And of course the first thing that the business lobby does when any government does something it doesn’t like is to complain about negative “effects on economic activity”. Unless and until there’s a remotely empirical basis for believing in the existence of those negative effects, this kind of rhetoric will always ring hollow.
In any event, Rubin is incredibly light on the specifics of exactly what he means by “real, trusted and enacted long-term structural deficit reduction”:
The administration and Congress should work over the next six months to enact the first phase of a serious fiscal plan, to take effect in two or three years, that must also include room for critical public investment. This first phase of deficit reduction should work towards a gradual decline in the debt/GDP ratio, not just stabilising it at a relatively high level that will inevitably ratchet up. The long-term objective, in a later phase, should be a balanced budget.
Even this “first phase” will be difficult. But it can buttress business confidence, reduce shorter-term market risks and start building the fiscal base for longer-term economic success.
This kind of thing means whatever you want it to mean. Does Rubin want the debt/GDP ratio to start declining in 2-3 years, or does he just want us to be “working towards” that decline? And how exactly is the government meant to achieve all this? Rubin wants to see “public investment and reform in economically critical areas, such as education, healthcare costs, infrastructure, immigration and others”; he gives no corresponding list of areas which might see spending cuts. And his list of tax hikes is limited to letting the Bush tax cuts on income over $250,000 a year expire. Which is all well and good, but is hardly going to move the needle on the debt/GDP ratio.
Rubin ratchets up the unintended irony in his conclusion:
Despite substantial legislative actions over the past year and a half, there is widespread and serious concern about the willingness to work across party and ideological lines and to make the tough decisions, necessary to meet our challenges.
Well yes, Bob. But how do you expect the government to make tough decisions if you, a semi-retired technocrat with no public office at all, can’t even bring yourself to name them? It’s all well and good to talk about fiscal prudence in the abstract: the difficult thing is enacting it in reality. And you’re not being remotely constructive on that front.
(Cross-posted at CJR.)
Dean Starkman has the official statement and Laura McGann has the embarrassingly verbatim Q&A: I’m the new CJR Peterson Fellow, which means that I’m going to be blogging more about macro and fiscal stuff, and especially the press coverage thereof.
If you read this blog, or its RSS feed, that’s great — everything I write as the CJR Peterson Fellow will also appear here. This just means that some of my stuff will also appear at CJR; it should also help prod me to write a bit more about the economy broadly, and the media coverage thereof — the beat I started on as a professional blogger for Nouriel Roubini in September 2006.
I need your help for this: I don’t want to just write lots of posts about how good David Leonhardt and Greg Ip are. And I’m interpreting “media” very broadly, to include everything from blog entries to CBO reports. So if there’s anything you stumble upon which falls under the general heading of fiscal/macro and which you think is particularly noteworthy, either for being good or for being bad, let me know. Send me an email, put it in a tweet with @felixsalmon in there somewhere, leave me a comment on this blog — the more stuff I get to see, the better this project will be. Feel free to shill for yourself if you’re so inclined.
And no, as I told Laura, this does not mean I share Pete Peterson’s views on the deficit and the national debt. In fact, I’m still agnostic on that question, and am looking forward to reading good pieces illuminating the debate. And slamming the lazy ones, too, of course.
There’s lots of schadenfreude at the expense of News Corp today, which finally released numbers on its UK paywalls. Mathew Ingram, for instance, reckons the numbers prove that the paywalls are a bust, while Ian Burrell surveys other media machers and finds lots of downward-pointing thumbs.
Certainly traffic has fallen off a cliff, from 21 million to 2.7 million pageviews per month. And while News International is trumpeting “more than 105,000 paid-for customer sales to date”, everybody suspects that most of those are one-off £1 purchases to get a 30-day free trial. (News has also bundled in the papers’ iPad and Kindle editions, just to make the totals even more opaque.)
With those modest numbers, there’s certainly no way that News will get any noticeable ad revenues: media buyers simply have no interest in reaching such a small audience, no matter how much information News has on exactly who they are. And certainly, as Ingram says, “the newspapers have been cut off from the news flow on the broader Internet, and the potential benefits of attracting links and commentary from other sites that could help to promote their content”.
But to get the bigger picture of what’s going on, it’s worth looking at the papers’ print circulation. The Times sold just 486,868 copies a day in September, down 15% year-on-year, while the Sunday Times is down 10% year-on-year to a circulation of 1,091,869.
Faced with that kind of circulation decline, it’s easy for newspaper people to declare that it’s not their fault, and that the problem is that readers can find all their content for free online, so why would they ever want to pay for it. The paywall then becomes a last-ditch attempt to shore up print circulation, to stop the perceived bleeding of readers from print to the web.
The NYT paywall is clearly being constructed along similar lines: as a way of preserving print circulation, rather than a means of generating extra revenue.
But the empirical evidence doesn’t support the thesis that print circulation is dropping because print subscribers are happily just reading the paper online.
I don’t know how many readers the Times and the Sunday Times have between them, but it’s certainly higher than the circulation of the Sunday Times alone, which is 1.1 million. Of those readers, fewer than 10% — just 100,000 — have bothered to activate the digital access that comes with the paper. Most of the papers’ readers are clearly not even reading the websites when they’re free.
Meanwhile, a new report from Jim Chisholm demonstrates that there is no correlation at all between print circulation declines and online readership. The Daily Mail, for instance, is booming on both the website and the print-circulation fronts.
The fact is that insofar as printed newspapers compete with the web, they compete with everything on the web, not just their own sites. No general-interest publication can prevent its print circulation from declining simply by walling itself off from the web. Which is why the NYT paywall is so silly: millions of dollars in development costs, and enormous amounts of important management time, devoted to something which will probably end up grossing no more than $20 million or so a year. That compares to $78.3 million in internet advertising revenues in the last quarter alone.
Rupert Murdoch has a philosophical aversion to free content, and that aversion is costing him dearly when it comes to the value of his UK franchises. The NYT has to be very careful that it doesn’t make the same mistake.
This blog became a locus, in my absence, for a fascinating debate about economics and economists, which wended its way from David Segal to Stephen Gandel to Barbara to Justin to Brad DeLong and back to Barbara again.
My favorite part of the discussion was Brad’s response to Justin. Justin made a simple point: the central tenet of economics is that incentives matter, and financial incentives in particular; economists get paid lots of money by financial institutions; and yet they get strangely touchy when anybody links these two facts.
Justin had John Cochrane in mind as the strangely touchy economist, as following his link would have shown, but Brad thought he was the person being referred to, and launched into a defense of Larry Summers and his response to Raghu Rajan at the 2005 Fed meetings in Jackson Hole.
Here’s Paul Krugman on the debate in question:
The 2005 Jackson Hole event was a sort of Greenspan celebration; still, it does come across as excessive — dangerously close to saying that if the Great Greenspan says something, it must be so. Second is the extreme condescension toward Rajan — a pretty serious guy — for having the temerity to suggest that maybe markets don’t always work to our advantage. Larry Summers, I’m sorry to say, comes off particularly badly.
Brad sees it differently; he says that Summers “did not ‘dismiss’ Raghu’s concerns”. But Summers did start off with this:
I speak as a repentant, brief Tobin tax advocate, and someone who has learned a great deal about the subject, like Don Kohn, from Alan Greenspan, and someone who finds the basic, slightly Luddite premise of this paper to be largely misguided.
Summers fits three things into this opening sentence. First, he renounces his previous dalliance with a Tobin tax — a tax based on the idea that a tiny amount of fettering of unlimited and virtually cost-free financial transactions might be a good thing. Second, he pays obligatory obeisance to Alan Greenspan. And third, he says that Rajan’s entire paper is based on a “slightly Luddite premise”.
All of these are things that Summers would do if he had been captured by the financial services industry: they’re entirely consistent with such capture. As were all of Summers’s deregulatory impulses when he was at Treasury, including overseeing the Commodity Futures Modernization Act.
Brad stands up for Summers’s intellectual honesty:
If you think that Larry pulled his punches in August 2005 on the importance of reforming compensation schemes because fourteen months later he was going to take a job at the hedge fund of D.E. Shaw, you attribute an extraordinarily degree of precognition–back in August 2005 I thought Larry had weathered the storms at Harvard and would be president until 2010 or so.
But this misses the point: Summers had already been captured when he was Treasury secretary, and he was hired by DE Shaw partly because he was captured.
Being captured is not some kind of intellectually dishonest overt bribe, where you truly believe A but profess to believe B because doing so makes you rich. It’s much more subtle than that, based partly in the wealth and success and sterling reputations of those (like your mentor Bob Rubin, perhaps) who believe B. And it’s a survivorship-bias thing, too: if you don’t believe B, you’ll never rise to the kind of position where your opinions matter as much as Larry’s do and did.
And as Barbara says, there’s a lot of framing going on too:
We have all, to a large extent, adopted this world view as our own—and that has altered both the way we perceive problems, as well as the way we analyze and try to solve them. But this way of understanding the world is, ultimately, only one of many. In certain circumstances it will fail.
Summers has a pretty unique way of perceiving, analyzing, and solving problems. Many policymakers, including Barack Obama, value his particular insights. But the fact is that most of the time Summers seems to end up doing and proposing exactly what Wall Street would most want him to do. Pace Brad, he might well be fully aware of the problems with Wall Street. But yes, by using words like “Luddite”, he does dismiss those concerns, or persuade himself that the costs of acting on them are greater than the benefits. And given that incentives matter, it’s silly to believe that his conclusions are wholly unrelated to his status as an extremely powerful multi-millionaire.
I’m back! And I couldn’t be happier with the fantastic set of guest blogs from Justin and Barbara — wonderful stuff. If you haven’t read it, for instance, check out Barbara’s post on rules-based vs principles-based regulation, especially as it applies to the Volcker Rule. Volcker himself advocates a principles-based approach, contra Michael Lewis, who wants some very tough rules:
Here’s a simple, straightforward way… to construe the Dodd-Frank language, and it would reform Wall Street in a single stroke: to ban any sort of position-taking at the giant publicly owned banks.
Our crisis was not drastic enough to enable legislation that ambitious, but in theory I like this idea. Basically, it forces all broker-dealers to be private rather than public companies. That was the case before Bear Stearns went public in 1985, so it’s clearly entirely possible. And Lewis points to Citadel as a good example of a private broker-dealer dealing very successfully in the much larger and faster markets of today.
Broker-dealers as a set might well get smaller if such a rule were enforced, but that’s a feature, not a bug. In fact, if broker-dealers don’t shrink at all, then the Volcker Rule has clearly achieved nothing at all.
More generally, I suspect that a lot of people who blame Gramm-Leach-Bliley (the repeal of Glass-Steagal) for the financial crisis should really be blaming the broker-dealers going public instead. After all, Bear Stearns and Lehman Brothers and Merrill Lynch were both entirely Glass-Steagal compliant, as, for that matter, were Fannie and Freddie and AIG. The problem wasn’t that they were merged with commercial banks; the problem was that they had far more leverage than any private partnership would ever be comfortable with.
The difference between the Volcker and the Lewis view of things is this: Volcker wants to stop banks making proprietary bets when they’re so big that the government will be forced to bail them out if they lose. Lewis wants to stop banks making proprietary bets with other people’s money, period, on the grounds that no one has ever treated external shareholders’ money as if it was their own.
Broker-dealers could still borrow, of course, and would still be active in the repo markets. But bond investors are by their nature much more cautious than stock investors, and so the level of risk that the banks could take would be ratcheted down a lot. And indeed if you look back at the crisis, no privately-owned broker-dealer got into trouble. That’s partly a function of the fact that very few of them exist, of course. But a system of small-enough-to-fail partnerships is in principle much more stable than having a handful of highly-regulated public megabanks.
It’s probably sad we’ll never get there.
There's been some interesting discussion in response to my earlier post about why we expect too much from economists, although a lot of the comments miss my larger point. What I was trying to say is that economics might not entirely be up to the task of explaining what we generally consider to be economic phenomena because we are overconfident about what the discipline has the ability to account for. You might call this the Freakonomics Fallacy. Whatever it is in the world we are trying to explain—crime, climate change, test scores—economics has the answer.
If this isn't in fact true, then why would we think it? Again, to underscore a part of my earlier argument that I probably didn't make forcefully enough: we think economics has all the answers because economics has become our major mode of understanding the social world around us. Charities are social businesses. Policy makers are cost-benefit analyzers. Education is a market.
This has not always been the case. In earlier eras, we were often more likely to understand human behavior and social dynamics through other prisms, such as political science, sociology, psychology, anthropology or biology. Indeed, for better or for worse, many of these fields took a turn being the dominant social science. I'm not saying that one frame gives a more accurate or useful picture of the world than another. Just that each leads to a different way of understanding why things happen the way they do because each comes with its own set of assumptions and simplifications.
Now here is the part I didn't talk about earlier. Using one frame over another may also lead to changes in perception and behavior. As economist Robert Frank once wrote, "Our beliefs about human nature help shape human nature itself." I am indebted to Joe Magee for pointing me to this fantastic paper (PDF), which explains how the economic world view might be influencing us to act more in line with its assumptions—such as the primacy of self-interest in how people make decisions. The paper includes a number of great examples, including how the Chicago Board Options Exchange wound up conforming to option-pricing theory and why companies often think layoffs are the path to maximum value. Here's a more trivial, although particularly salient, illustration that involves people playing the prisoner's dilemma:
[The] game was called, in one instance, the Wall Street Game and, in the other, the Community Game. This simple priming using different language produced differences in participants’ choice of moves, as well as differences in the moves subjects anticipated from their counterparts. When the game was called the Community Game, “mutual cooperation was the rule. . .and mutual defection was the exception. . . . whereas the opposite was the case in the Wall St. Game” (Liberman et al., 2003: 15). Both participants and those that nominated them did not anticipate the extent to which this simple labeling or naming affected responses, and subjects’ responses to the situation were much more strongly predicted by the name of the situation than by the person’s presumed likelihood and reputation for being cooperative or defecting.
This is not an indictment of the economic world view, nor a way of complaining about how it has won out out above all others for all time (it hasn't). Rather, this is simply a friendly reminder that we have all, to a large extent, adopted this world view as our own—and that has altered both the way we perceive problems, as well as the way we analyze and try to solve them. But this way of understanding the world is, ultimately, only one of many. In certain circumstances it will fail. Economics cannot explain everything that comes our way. But sometimes we're too enmeshed in economic thinking to see that.