[Dear Reader: What follows is a transcript of the conference held today at the University of Chicago on the origins and implications of the current financial crisis. It was enormously stimulating. The panelists were twelve professors of economics, history, sociology and anthropology from the University of Chicago, Rutgers, the New School for Social Research, the University of Michigan, and the University of Missouri at Kansas City. NB This is the raw transcript; I will correct it for spelling and turn it into full Thucydidean prose in the next week or so.]
Panel 1: Sources of the Crisis
(see separate posting, where I have typed these up complete)
[What follow are the rough notes to Panels 2 and 3. I will turn them into prose soon.]
Panel 2: Crisis in Perspective: Historical and International Comparisons
Michael Bordo
Dept. Econ., Rutgers
ecoinonmic history in long term
def. financil acrisis episode of financial turbulence leading to distress
insolvency among participatns
official intervention to containt hese consqeuences
curency and banking crises
twinning of crieses also soometimes
four periods
first era of glibalization
1880-1914
intrewar period
GDepr
Breton WOods period
WW2 to early 70's
second era of globalizations
70s to 90s
divide number of crises by number of country year observations
there are a lot mre crises today than in thte first period
had to do with frequ of currency crises--more today because more countries andmore capital mobility
so crisis problem is not something that just happened
severity of recessions is linked to asset price busts (def. as asset and equity prices)
IMF event study:
house price busts tend to rally make reessions a lot deeper
credit crunches do not do quite as much damage
stock market crashes are not quite as serious
with a housing price colapse, a crisis lasts about 6 years. we're now in year 3; housing prices are down 30%
decline in GDP last about 2 years
in the past, a lot of financial crises began in US--1857, 1893, 1907, 1929-1933, today
This crisis began with collapse of US suprime mortgage market.
Multiple causes, as discssed in Panel 1. plus savings glut in Asia.
...through network of derivatives
then spread US to rest of world
Fed responded by flooding financial markets with liquidity.
There has not yet been a big bailout (!) as in RFC in 1930's or Swedish banking more recently.
(REALLY? HUH?)
shows graphs os spreads, discount rate, recessions ,and political events (too much to write down)
financial innovations
Fisher and Minsky story--investment boom and new credit instruments, state of euphoria, bust, overindebtedness, crisis
assymetric information--borrower has better information on loan than has the lender (see graphs just mentioned)
Tradition view sees crisis from iability side.
Depsitors run to bank to gtry to get their money out.
Panic occurs when a bank fails, and a contagion of fear and panic spreads.
But most of these panics started on asset side, until after GD the govt set up depsot insureace
So now crises come from tha asset side.
1970 collapse of Penn Central
Fed headed off incipient crisis as lender of last resort.
LTCM was also headed off.
1763 one too
What drives these is financial innovation, today the securitization of subprime mortgages.
Crises are transmitted across countries. This crisis today too. Start in advances countries. Happends through sudden stop -- with crisis, we suddenyly stop lending. In 1890, the Baring crisis.
Policy: initially you provide liquidity becuase of run on banks. THat's what the Fed did; good. But if crisis spreads to insolvency, then story become how Treasury can deal with bansk--remove toxic assets from banks, creating a bad bank. And close down insolvent banks. US is making moves in this direction, but not much yet. Bordo predicts that US will have to take over insolvent banks, remove management, wipe out shareholders, put bad assets in bad bank, then recapitlize an sell it off to new shareholders. Bordo thinks that the easing right now will attenuate the crisis.
Bordo thinks that fiscal policy will not get us out of this recession. That is his reading of the GD.
L. Randall Wray
Economics UMKC
The Rise and fall of money manager capitalism: A Minskian analysis
Boom and Bust
virtually no (??) crises before 1970's
The problem is not irrational exuberance.
The seeds of this crises date back to 1951, sewn by Fed's incrlt aggressive use of interest rates.
financial instn innovations
Stablity is destabilizing
Huh?
Big Bank and Big Govt constrained the instability
this allowed managed money to grow
shifted the wirgh to fht financial system away from banks toward pension funds etc.
virtuous cycle, in which stablity and competition fuel a cycle of rising asset prices
3 innovations: securtization, futures, swaps
originate to distribute model
convention wisdom is that lowering spreads, spreading ownership sna dn drmocratiaiton of criedit was evidence of risiing efficiency
so not originally a suprime problem
CDS "Insurance"
$60-70 TRILLIOIN
held and sold by banks abd hedge funds
used to make bets on death of assets, firms and countries!
CDS: I sell 1 million life insurance policies to you on a 90 year old nursing home patient for $1M each at $50 and book revenue $50M
Patient worsens so premium rises to $100
You sell 1 million policies at $100, book profit of $50 M
YOu are fully hedged: If patient dies, I pay...
[...]
So CDS purpose was to perpetrate fraud.
...
Role of Managed Money
Commodities wer epreviously not managed - pure gamble.
Studies showed commodities not corrleated with equities. So they were diversification tools.
Thorugh 2004, managed money bought physicals; holding is costly, so they moved to futures market.
Rolled on delivery date.
Obama's Recovery Plan
infrastructur project up to 3 million jobs
creat 5M green jobs
address widening income innequality gap, strengthen usions, raise minimum wage, reduce taxes on middle class
subsidizie states; share of medicated and child helath
TARPS and PPIPS Fed purchase of toxic waste... Money manager version of trickle down theory.
successful crisis resolutions require four things:
transparency
assertiveness
accountablity
clarity
Rather, we need:
liquidity: we need to lend without limit, on no collateral at all. Exapnd FDiC insurance.
But Paulsona and Geithner plans: Who needs socialism when Goldmann Sachs runs the Treasury?
Their plans wil not work of it is a solvnecy crisis.
insolvency: no urgency
Need a payroll tax holiday--$4000 per workers and same for firm.
fiscal stimulus: we need both tax relief and government spending, unemployment compensation, infrastructure, $400 B block grants to grants
Mortage relief: refinance on favorable terms
rent to own
comination of private and sociazlized losses
Sustainable growth package I
We need to change the form of capitalism: from the ideas of Hyman MInski
need payroll tax reform--it's inflationary, regressive, discourages employment
Abolish the trust fund.
Need Payygo and tax income to share real income
State and local govt: reverse devolution
Need public pension fund system for all, and health care!
This guy is talking about massive govt management of the economy.
see www.levy.com
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The Perils of Shifting form Personsal to Impersonal Finance, 1637-2007
Larry Neal
Economic HIistory, LSE
a lot of parallels to South Sea and Mississippi bubbles
See his book The Origin and Development of Financial Markets and Institutions
2007-2009 is unique in historym but there are precedents.
Financial innovations help economic growth in the long run.
Cordinate innovations between banks, markets and govts.
Crises often occur i the short run.
Banks really should operate on personal connections (so long as it's confidential).
But for large scale growth you need to go to capital markes. (Require transparency.)
In bakground, govts have to try to coordinate this.
list of several historical crises
(Ann Goldgard, The Tulip Mania - new book)
The Dutch govt solved the mania by allowing people to back out of the tulip forward contracts by paying a pennies on the dollar backout unwind possiblity. Most of what people lost was just the paper gains that they had made.
With South Sea Bubble, Walpole solved in 1723 by separating out shares into a trading company and the other half into long term annuities perpetual to shareholders. He thus detoxified the bulk of the assets. (Neal shows this in unpublished paper.) resumption of trading in South Sea annuities. France takes the Randall Raich approach (the Dutch solution).
Obstfield & ___ trilemma graph for international gold stadnard, Breton Woods and post-Breton Woods
Steven (Larry) Epstein - _Freedom and Growth_ - on Italian city states. They figure out how to expand stability across northern Italy.
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Q&A
Bordo and Neal emphasize that evolution of capitalism occurs through financial innovation.
Crises are hiccups or blocks along the way. But then growth always resumes afterward, always.
Sewell: Getting it right is different at different times.
Neal: The French mistake after the Miss bubble in the 18th centiry was a big misstep.
...
Bordo: Minski usee irrationality ; cannot be modelled. wasn't taken seriously in 60s through80s
Bordo to Randall: yours is a recipe for inflation
Randall thinks that his model is not inflationary, but recongizes that this is a potential problem What we need is JOBS.
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LUNCH
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Karen Ellis babbles, thanking
Chris M., head of Economica the undergraduate student organization. They publish a journal too.
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Panel 3: Ramifications, Philosophical and Political
2 PM - 4 PM
Moderator: John Kelly, Department of Anthropology, University of Chicago
Richard Epstein
Law School
University of Chicago
has taught here since 1972
Senior Fellow, Hoover Institution
When you are faced with cries, should you staythe course with sound first principles, or do you have to do emergency mode,newer dift and more daring than what you have done before? Hard question to answer in abstract since need baseline. Most Americans are comforatble with mixed economy, partnership between govt and private sector. Not Epstein.
Ram Emmanuel: "A crisis is too good a thing to waste." (//Naomi Klein)
in short run, deregulation will not be enough to get us out of this recession. some kind of stimulus prudent, if you can believe that, "if you can keep the regulatory impulses out." "...not as easy as you think."
Think of Autumn 2008 bailouts of banks. In secretary's bill in fall, there was ridicoulous bundling, so that a bailout bill incldd weird stuff about helath care.
Classical liberal theme: first you wish to attack this system of the creation of state monopolies and cartels. IN New Deal era, while there was modest public good projects, there was also huge cartelization. agricultural industry, labor markets, etc. Each cartel at micro level each increased prices and reduced output but no one thought that in aggregate this would be a problem. If you take into account the losses to the losers, this is huge! But after the stimulus packages passes, the regulatiory package remains. Smot Haely, strong union packagges, state laws for protections of dealers and franchises. These things start to matter! IN times of general prosperity, these price minimums have less effect. But these rigidities astart to hurt people in tough times.
Think of bailout of auto industries. Why do big 3 do so badly compared to Japanese companies in the US?
"legacy costs," everyone says. Where do legacy costs derive from? IN a competitive market, a firm will not take huge debts in furuter against prosperity today. INtrodude a monoly and everything changes. "If you put together a program which wil forge you a winning political coaltion, you have sold out."
bankruptcy reorganization is what we need for these big companies
Not that we believe in freedom of contract come hell or high water; rather, need an easy way out in case things get too bad.
IN bankruptcy, all executoary contracts may be disavowed by beneficiaries in bankrupty court. THat means you can disavow the conracts, so that things can get going from the start again.
(Given that this is unrealistic, what is a distastegul but moderately principled approach to the Big 3 and their legacy costs?)
Everyone must be subject to the ravages of bankruptcy.
All of the micro stuff that Epstein worries about go straight to the bottom line.
Now, is what is true about these very business sectors also true of "the financial sector"? It is difficult to disentangle everything. The classical liberal model does not call for total dergeulation. Rather, sensitive regulation. YOru regulatory schemes need to be able to keep up with the flow.
Take a first example: the velocity of transactions. Mortgages in the GD. Even in the GD this was not a trivial problem. "Roosevelt in one of his good moves introduced the bank holiday." underlying causes took more time. Bottom line is that there was low velocity, fewer transactions, etc. Esp because banks tended to hold their own mortgages. Now holding own mortgage may not be a good financial strategy, eg if there is a regional catastrophe. So modern computer techniques an ficnnance allowed repackaging, the story we have been hearing today. Even simple recording of who owns these things becomes very difficult.
...
Banker regulators are there to protect us by making sure that asset values on book reflect curent position: "mark to marekt" , "fair valuation". The problem with financial derieves porobelm was that you couldnt do this evaluation.
Huge global problem of competing regulatory frameworks. That's one reason why this crisis is an international problem.
We may have to slow down the transactions in order to get the rules right.
-------------------------------------------------------
David Ruder
Law School
Northwestern University, since 1961!
chairman of SEC 1986-1989!
founder of Mutual Fund Directors' Forum
Some of the panelists suggest that there is no solution; Ruder will offer us a solution. Global problem.
complex instruments
oversight failures
lack of adequate national and international attention to systemic risks
administration and congress signal interest in reforming the whole system
Is an international financial regulatory system necessary?
unikely that US will cede power to an internatinoal regulatory body. but we should obviously take other pwoers' opinons into account.
A sound system will:
restrain greed and fraudulent activities
encourage innovation
protect the public and the economy.
What should the components of such a system be?
here's the POV of a financial regulator, chairman of the SEC:
Listening to Richard Epstein, you wonder how an ideal solution can also be made to fly with Congress.
Any revisions should seek to improve on the current system, not to creata a single financial regulator, which would be likely to fail and to introduce an unnecssay level of bureaucracy. bodies like the SEC can make independent decisions, able to reissit siren call of Congress and White HOuse. Also, eidence from countries like BRitain with single regulator do not offer hope. Britain's "Big Bang" regulation of a few years ago did not find the right solution.
should have task of protecting against huge dislocations such as we have had
he has testified bfore congress that first we need disclosure of risk positions.
look at the positions of entities like hedge funds which have the ability to affect the financial circumstances of the US and the world.
Then, that regulator needs the power to do something, to impose leverage ratios and risk prohibitions and the possibility of taking over an outfit which has access to Fed funds.
the regulator could be the Fed, but needs to be something.
do need to preserve the Fed's function
Regulation should continue to be based on fucntion.
So banks should be supervised by banking authorities concerned with... should be more centralized and coherent.
Reg of insurance companies is inadequate in US. Should be an alternative federal regulator.
The SEC should regulate other financial instns. should also have expanded power to reg hedge funds, ratings agencies and other players in the game.
"Participants need protection against misrepresentations and stealing by others." protection against fraud in particular.
Bernie Madoff problem--what went wrong? Ruder says SEC has best enforcement system in the world. What is needed is enhanced funding so that the SEC can cope with innovations. Wall Street has used the young best and brightest to create new financial products. Monetary incentive will remain the way to get the minds. So the SEC needs a bigger budget to pay good people to cope with these products. People who know about modeling anf tails. NEed people who know about catastrophes.
Philosophical propositions: capialistm is not enough. Unregulated markets do not provide sufficient protection. need regualtrion of capital markets for securites, as in other things.
shoudl be different regulation for banking soundness and for other market areas where there is a presumptio tht those who are unsound will fail. that is good.
remember also global interconnections between financial markets around the world.but US will never relinquish control over regulatory systems to a world body.
John Cochrane: "The Good, the Bad and the Ugly: Politics in the CUrrent Situation"
GSB, University of Chicago
not repeating the three main mistakes of the GD:
1. money: in financial crisis, people want to hold more money. the Fed can let them do that. That is what the Fed failed to do in the GD< leading to 25% [de]flation. The FEd learned that lesson. has put about a trillion into the economy. we also now want treasurey bills too, and the Fed has figured out a way to do that. evena danger of inflation.
2. runs: there were chaotic runs on banks.
banks: There was a wave of bank fialures, so there was no on e there to make loans. Nowadays, the market is open, ans new banks can start up. Decades ago, if the bank failed, then there was none to replace it.
When WaMu failed, it wasbought up and infused with cash within a week.
3. FDR fuoght dfeflation with price supports and cartelizaiton. We have still the legacies of the GD, but have not make matters worse.
Bad:
We are turning into the bailout nation, refusing to let anything big go under. Bernanke said as much recenty. AIG just came around for its second round of baoiulaiotts.
TARP like a horror movie refuses to die and is even standin in the way.
Say you have bank with troubled assets at $.40 on dollar. If it sells, then the bak has to mark all its assets down to that.
There is this dream of liquidity, s though the govt can just stir a little. Doesn't work that way.
Assets are always illiquid; that's how bank assets always are.
peasant with putchforks get angry about GM, but think that it's dift with AIG
Myth: illiquid assets, hard to value, people don't want to buy them. Banks need capital. Story is that banks cannot raise capital, so they are dumping assets =on the market, so lendin ghas stopped. At leat this focuse on a reasonable policy answer. ANd it is true, something has stopped banks from lending. But this story is not proven. It rings false. First because assets are always hard to value. 10 MBA's won't get close to figuring the market alue out of an aeset. THis is not liek engineering. 2. It is not true that banks cannot raise money. ...What we should care about is new lending. For that, all yo uneed is one healthy bank. And banks as a whole have not deleveraged. Teh Fed AH report show sthat banks are alctually lending more than they did just before.
accounting rules for money marketk mutual funds
repo rules and chapter 11
this is the engineering level
The danger: That we wil hva e febderally run banking system for years
Remember how hard it was to hget rid of the rural electrification program.
There is no defintion of "systemic." You cannot put a stop to the bailout, since everyone wabnts one. Now adays life insurance industry wants a bailout. The Hartford bought a bank and now wants balout money.
Why baoil out people who invested in guaranteed rate of return contracts? ike Bernie Madoff's victims or people in Florida.
Bakruptcy court is where you go to get $.50 on the dollar for your investments.
Itcannot be the job of the federal govt to stop anyone from losing money. And it is not able to do that thing.
Fiscal stimulus, bad #2: this fails basic accounting. it will not raise the level of the whole economy. If you take from A to give to B, then A cannot spend his money. It prevents A's oney from being leant out by A's bank on a loan. Were in a credit crisis, so this is counterproductive!
If you like fiscal stimulus, then you should like Bernie Madoff, big bonues, TARP money. In all cases, they took money and gave it to people who are likely to spend it. It is just not important for the short run behavior of the ecnomy.
(how distinguish this from multiplier effect in ordinarytimes?)
The Danger: Inflation:
Will the Fed raise interest rates [to slow things down to prevent inflation]? It will be politically difficult. And the Fed may not be able to 'take th emoney back' sp to speak. (This directly addresses Randall's utopianism of earlier.)
Regulation: big decision is to leave monoliths in place or brak them up? Fed govt cannot watch over everyone to make sure that they do not do anything stupid.
Look at IRS forms.
Most of our current problems come from bad regulatios of the past.
clever device for getting around capital requirements ex.
...
A little hope:
Hope #1:
Investors bear most of the blame.
We should write catastrophe insurance?
There is no magic in investment; there is only risk. When investors reaize this, they will understand that money has to be for the long term.
Hope #2: signs of recovery
The economy needs to recover quickly before the quack medicine can take its effects and then people learn the wrong lessons from this.
-------------------
Q&A and discussion:
Kelly's questions
"imperative cooperation" as a euphamism for domination
recent G20 meetings: Obama press conference. Have we reached a new post-Washington Consensus model?
national capitalist regimes vs global capitalism
Epstein: China is not innocent of any of this. Big run up from cheap money in China. similar effects as subprime crisis...
Cochrane: some financial innovation is to get around regulations. But another kind has a genuine economic function--make sense--e.g. mortgage-backed securities.
fix the bugs in accounting rules. CDSs are also great innovations.
David: structured products are 50% of the financial system. In 90s Greenspan argued that derivateves should not be regulated. And they were. Unregulated system resulted. So now what we need to do is reregulate.
Cochrane: instns should be able to innovate, but only if they are not guaranteed by the Fed. The porblem is unregulated traded with someone else's money. In 80's, everyone took high risks.
Epstein: the problem with disclosure is that it means disclosig your trading strategies.
Cochrane: global savings glut is BS story
distinction between savings and bearing of risk
There is no liquidity trap out there; rather, people want to put there money in the bank/bonds and not in securities or something high-risk.
Cochrane: the crisis is...
Epstein: this is not an innocent discussion. it wil drive the prices further down. [?] threat of renegotiation and late payments: uncertainty. The legal priority rule is a great thing.
A question from crowd: Should we nationalie banks temporarily?
David: yes
Epstein: govt ownership will last on and on
Epstein: priority rules must be held to. The only element of discretion is to figure out how a trustee maximizes aggregate value. What % of system can you solve by ex ante rules which are reasonably rigid? Optimallity is you go as far as you can with rules first. "You have to toss old peope off the end of the ship in order to make room for people at the other end."
Cochrane: one good thing about xecutive compensation rules is that it makes it unattaractive to be a govt-owned bank, so it may speed the return to private banks
practical rules;
sec
accounting rules rule 157 - how banks evaluate assets
should SEC impose short-selling rules on the market? (Cochrane & Epstein: no. short-sellers make prce discovery)
Epst: another reform: reuirement of publicisizng reseaerch destroyed rsearch. SEC non-discrimination rules kill some of the research discipline.
David: given notion that you have to give all info to the regulator, a tough qursytion is what the regulator should DO with that information. Will he stifle information?
Espt: But you really want to create a partition.
Cochrane: speculators and short-setlleres are good because they are willing to buy stuff up quickly.
David: CDSs need a clearing system. That is the solution to that problem.
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PANEL 4: AFTER THE CRISIS: RE-IMAGINING THE ECONOMY
4:30ish-6:15
Eugene Fama
Booth School of Business
University of Chicago
Keith Hart
Department of Anthropology
University of London
James Galbraith
Public Policy
University of Texas, Austin
Moderator: Moishe Postone, History Department, University of Chicago
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