Apologies to everybody here who would normally warrant a whole blog post of their own, but I’m way behind when it comes to catching up on the Felix Salmon smackdowns and so I’m going to clear them all out in one fell swoop, starting with:
Yves Smith, who hates my post on triple-A debt so much that she accuses me of “spending too much time with lobbyists from ISDA and SIFMA”. Her main beef is with my contention that an excess of overcaution was responsible for the enormous demand for triple-A debt. That can’t be true, she says:
If there was “overcaution” you would have seen a wide spread between AAA bonds and lesser-rated bonds.
The first thing to remember here is that there were so many triple-A bonds at the height of the bubble that all the other bonds in the world combined were in the minority. The supply of triple-A debt expanded to meet the demand for it; lesser-rated debt had its own supply-and-demand dynamics and spreads became tight as the Great Moderation thesis took hold.
On top of that, the bond bubble generally was indicative of overcaution: if cautious people buy triple-A-rated debt rather than other debt, they also buy bonds rather than stocks. An overcautious world has too many bonds relative to stocks and too many triple-A bonds relative to other bonds. That’s exactly what we saw.
Yves has her own explanations of the rise in triple-A-rated debt. One is the rise in the derivatives market, which meant a similar rise in the demand for triple-A-rated collateral; the other is regulatory arbitrage, in that under Basel II, banks could hold triple-A debt on their books with zero capital requirements.
Both of these explanations are entirely true, but they’re not really dispositive of my thesis; in fact, both are symptoms of the very overcaution I’m talking about. Collateral is designed to protect you in the event that your counterparty makes bad bets and can’t pay; by asking for triple-A-rated collateral, Wall Street essentially outsourced its diligence to the ratings agencies while being able to say that it had extremely high standards. And the Basel II rules, too, gave triple-A-rated debt a zero risk weighting because they wanted to encourage banks to stay cautious when it came to the quality of their assets.
Next up comes Richard Smith, also at Naked Capitalism, with a very long post taking issue with my very short dismissal of the idea of coin seignorage as a tool to get around the debt-ceiling problem. I should probably explain my position in slightly more detail: yes, there is an argument to be made that coin seignorage is legal and that it could be done without Congressional approval if the coins were made of platinum or maybe palladium. But just because something can be done doesn’t mean it should be done. We shouldn’t rule via loophole, and more importantly, we shouldn’t take monetary policy out of the hands of the Fed and put it into the hands of Treasury. Sometimes, in a crisis, loopholes are the only way to get things done. But we’re not in a real crisis right now — insofar as we’re in a crisis at all, we’re in an utterly fake one. So let’s deal with the root of the problem, which is Congress, rather than trying to ignore it with the use of dangerous loopholes.
Let us parse this:
- Summers says that peripheral countries that cannot access the private market cannot repay their debts if the strong countries of Europe charge them high premium interest rates.
- Summers says that peripheral countries that cannot access the private market can repay their debts if the strong countries of Europe charge them the interest rates at which the strong countries can borrow.
Both of these statements by Summers seem to me to be true. It is often the case that debt loads that are unsustainable at high interest rates are very sustainable indeed at low interest rates.
But to take a very salient and obvious example, the debt load of Greece is clearly not sustainable, even if it were brought down to German-government interest rates.
Brad also has a clever way in which the ECB can take $10 billion of French and German money and turn it magically into $471 billion of liquidity which could be provided to Italy. But bringing the ECB into this doesn’t help matters: yes, of course the ECB can lend $471 billion to Italy and it could probably do so even without a French and German guarantee. But it won’t, because (a) doing so would be politically impossible and (b) doing so would violate Article 123 of the Lisbon Treaty, which bans monetary financing.
Finally, there’s John Hempton, with his novel thesis that “the last ethical newspaper company is News Corp”, on the grounds that it’s the one company where the proprietor doesn’t ask for journalists’ sources. I’ll leave the rebuttal of this one as an exercise for the reader, I think; I’ll simply note that Rupert Murdoch is perfectly happy dictating his newspaper’s front pages, sometimes with highly embarrassing consequences. Does that sound like a company where the proprietor is assiduously disinterested in his newspapers’ content to you?
Do keep the smackdowns coming. They’re the true essence of blogging.