Mystery Economic Theater 2010

[ewmayer]

Moron of the Week:

...None other than our old pal Paul Krugman, who in musing about the apparent insufficiency of the 2009 economic stimulus of nearly $1 trillion in new-borrowed money, reveals that he truly believes that government make-work jobs can substitute for real sustainable private-sector job creation:

But the stimulus wasn’t nearly big enough to restore full employment.

My Comment: Right ... we have debt-and-unsound-lending-explosion-driven housing bubbles for that.


Neologism Des Tages: "Realwirtschaftler"

In the field of politics there is a popular term taken from the German, Realpolitik, literally "real politics". A popular definition of this is "a ruthlessly realistic and opportunist approach to statesmanship, rather than a moralistic one, esp as exemplified by Bismarck", but here I`d like to use the less-nationalist version of the term, i.e. as used to distinguish politics grounded in the messy complexities and often-unsatisfactory compromises of the real world from ivory-tower political science as often taught at university.

In that spirit I`d like to introduce the term Realwirtschaft, literally "real economics". Note that German already has a common usage for the same term:

"Unter dem Begriff Realwirtschaft (realer Sektor) wird in der Volkswirtschaftslehre der Teil der Gesamtwirtschaft bezeichnet, der nicht zum monetären Sektor zählt."

Translation:

"The term Realwirtschaft (real sector) is used in the field of applied economics to describe the part of the overall economy which does not belong to the financial sector."

That is different than my usage here, but fits nicely into the same framework because it deals with the "real" productive sector of the economy so often neglected by neoclassical and Keynesian/monetarist (briefly, "Ponzi") economic theory.

Practitioners of (my form of) Realwirtschaft are still "economists", but because I so often use "economist" as a pejorative - because the overwhelming majority of its practitioners deserve such - I find myself looking for a term to distinguish practitioners of "real economics" from their odium-deserving economics-as-a-quasi-religion-practicing "colleagues". I find the German facility for stringing together nouns and modifiers handy in this respect, hence the term Realwirtschaftler, meaning "practitioners of real economics". Anyway, well-known Aussie Realwirtschaftler Steve Keen has another gem about the distressing tendency of most of the economics profession to ignore something as crucial as private-sector debt in the theories and models, and the high price everyone pays when top governmental-position economists and central bankers succumb to such lunacy:

What Bernanke Doesn't Understand About Deflation:

That sucking sound will continue for many years, because the level of debt that was racked up under Bernanke’s watch, and that of his predecessor Alan Greenspan, was truly enormous. In the years from 1987, when Greenspan first rescued the financial system from its own follies, till 2009 when the US hit Peak Debt, the US private sector added $34 trillion in debt. Over the same period, the USA’s nominal GDP grew by a mere $9 trillion.

Ignoring this growth in debt – championing it even in the belief that the financial sector was being clever when in fact it was running a disguised Ponzi Scheme – was the greatest failing of the Federal Reserve and its many counterparts around the world.

Though this might beggar belief, there is nothing sinister in Bernanke’s failure to realise this: it’s a failing that he shares in common with the vast majority of economists. His problem is the theory he learnt in high school and university that he thought was simply 'economics' – as if it was the only way one could think about how the economy operated. In reality, it was 'neoclassical economics', which is just one of the many schools of thought within economics.

Let’s call a spade a spade: two of the key beliefs of the neoclassical school of thought are now coming to haunt Bernanke – because they are false. These are that the economy is (almost) always in equilibrium, and that private debt doesn’t matter.

One of Bernanke’s predecessors who also once believed these two things was Irving Fisher, and just like Bernanke, he was originally utterly flummoxed when the US economy collapsed from prosperity to Depression back in 1930. But ultimately he came around to a different way of thinking that in 1933 he christened 'The Debt Deflation Theory of Great Depressions'.

You would think Bernanke, as the alleged expert on the Great Depression had read Fisher’s papers. And you’d be right. But the problem is that he didn’t understand them – and here we come back to the belief problem. The Great Depression forced Fisher – who was also a Neoclassical economist – to realise that the belief that the economy was always in equilibrium was false. [EWM: Keen`s detailed quotes by Bernanke and Fisher to support his "didn't understand" claim have been snipped here for brevity].

We might not be in such a pickle now if economics had started to become more of a science and less of a religion by following Fisher’s lead, and abandoning key beliefs when reality made a mockery of them. But instead neoclassical economics completely rebuilt its belief system after the Great Depression, and here we are again, once more experiencing the disconnect between neoclassical beliefs and economic reality.

My Comment: And lastly, this next blurb should have appeared yesterday (I'm updating every 100 days) but I forgot to post before leaving work - See the bottom of post #165 in this thread if you need an explanation of the timeline here:

----------------------------

[30 August 2010] Today is Day 1300 since the start of the global financial crisis, and there have been 0 related criminal convictions.

[garo]

So what do you think should have happened? No stimulus at all in 2009? http://www.economy.com/mark-zandi/do...-Recession.pdf talks about what would have happened then. Ernst, your and Mish's attacks on Krugman are sounding increasingly deranged and lacking in basic courtesy and respect.

[ewmayer]

Originally Posted by garo

So what do you think should have happened? No stimulus at all in 2009? http://www.economy.com/mark-zandi/do...-Recession.pdf talks about what would have happened then. Ernst, your and Mish's attacks on Krugman are sounding increasingly deranged and lacking in basic courtesy and respect.

Garo, for you to claim I have not put forth (or linked to) numerous alternative suggestions for what-to-do in this thread is just silly, and I have no intention of wasting my time by doing your homework for you and digging out post-by-post the numerous proposed alternatives for the bank bailouts, the stimulus package, etc. It all comes down to whether you want to admit that the only real cure for too much bad debt is to force the bad debt out into the open, take the needed painful medicine now, and start tackling the structural issues that afflict the economy and government and personal finances at all levels, or continue to waste huge sums of money (necessarily borrowed at the expense of future prosperity and growth) maintaining the pretense that there is a magic elixir which will allow us to "grow and stimulate" out way out from under that colossal mountain of debt and unsustainable financial commitments.

I have no problem calling Ponzi master Greenspan a moron for believing (or at least pretending) that there is no such thing as "to much debt" and that perpetually living beyond one's means is a viable basis for an economy. I similarly have no problem calling Krugman a moron for advocating the same lunacy at the sovereign-debt level, and for claiming -as in the post I linked yesterday - that government make-work jobs can substitute for genuine productive private-sector employment. I save my respect for those who deserve it, and in this case, we are way beyond mere subjective "honorable people can disagree" differences - Krugman and his ilk are advocating the mathematically impossible. If my resulting derision makes me "deranged" in your eyes, then 'tis a form of 'madness' I gladly embrace.

--------------------------

Troubles at Afghan Bank Jolt Financial System. The Afghan government intervened to shore up a deeply troubled bank on Tuesday, sending shock waves through the capital and prompting fears that Afghanistan’s pervasive corruption had now put the country’s entire financial system at risk.

Sherkhan Farnood and Khalilullah Frozi, the top executives of Kabul Bank, abruptly left their jobs this week at the demand of officials at the Central Bank of Afghanistan, after the discovery that Kabul Bank’s losses might exceed $300 million. That number far exceeds the bank’s assets.

The Central Bank installed its own chief financial officer, Masood Khan Musa Ghazi, as the chief executive of the bank.

Afghan and American officials expressed alarm not only at Kabul Bank’s financial condition but also at the prospect of a collapse of confidence in Afghanistan’s fragile financial system, which was built from scratch after the ouster of the Taliban in 2001.

The immediate concern was that news of the bank’s financial irregularities, already spreading through the capital, would prompt a run on the bank itself and that the panic would spread to other financial institutions. Bank deposits in Afghanistan are not guaranteed by the central government, officials here said.

“This could be catastrophic for the country,” a senior Afghan banking official said. “The next few days are critical. I am worried.”

Kabul Bank and its chairman, Mr. Farnood, lie at the heart of the political and economic nexus that sustains — and is sustained by — the government of President Hamid Karzai. Mr. Frozi was an adviser to Mr. Karzai’s presidential re-election campaign last year, and Kabul Bank provided millions to Mr. Karzai’s campaign.

American investigators say that Mr. Farnood’s unorthodox financial dealings, which included lending tens of millions of dollars to himself and other politically connected Afghans, have long been shielded from scrutiny by his close ties to Mr. Karzai.

American officials said the intervention by the Central Bank was personally approved by President Karzai himself, after he was briefed about the details of Kabul Bank’s financial condition and its irregularities.

Investigators and bank regulators say Kabul Bank is also tied to the inquiry into New Ansari, the money-transfer firm, or hawala, that is suspected of moving billions of dollars out of the country for Afghan politicians, drug traffickers and insurgents. Kabul Bank used the firm, whose dealings are nearly impossible to track, to transfer at least $60 million out of the country, a bank shareholder said.

For a bank to use a hawala to move money is inherently suspect, investigators say, because a financial institution like Kabul Bank already has the means to transfer the money electronically. Electronic transfers are easier for regulators to follow.
...
In interviews, Afghan officials and businessmen described Kabul Bank as Mr. Farnood’s personal fief, which he used to reward himself, shareholders and political allies who could advance his financial interests.

First among the beneficiaries was Mr. Farnood himself, the officials said. He invested about $140 million of the bank’s money in the real estate market in Dubai in the United Arab Emirates, said Mahmoud Karzai, the president’s brother and a Kabul Bank shareholder. Among those properties were more than a dozen multimillion-dollar villas in Mr. Farnood’s name, some of them on Palm Jumeria, an island off Dubai’s coast, Mr. Karzai said.

The Dubai real estate market collapsed in 2008, wiping out much of Mr. Farnood’s investment and leaving Kabul Bank with the losses. A senior Afghan banking official said that the bank’s estimated losses were believed to be about $300 million, with assets of about $120 million.

It is not clear what Mr. Farnood did with all the properties he purchased, but he made at least some of them available to his friends and allies. One of them was Mahmoud Karzai, who owns about 7 percent of the bank. Speaking in an interview from Dubai, Mr. Karzai said he had rented one of Mr. Farnood’s villas for the past year and a half.

Mr. Karzai said the bank’s troubles — and Mr. Farnood’s opaque dealings — had made him decide to vacate soon.

“I want to move to a different house,” Mr. Karzai said. “I want to cut this out.”

My Comment: "I want to cut this out"...translation; "My free oceanside villa, hookers and blow are under threat ... time to lie low for a little while until this blows over." Seriously, these mega-corrupt scumbags are the ones the U.S. (which abetted Karzai`s massive election fraud last year) is entrusting the future of Afghanistan to? Good luck with that ... but given that the U.S. - by supporting such loathsome, nation-looting crooks - has no chance of winning the "hearts and minds" battle necessary to prevail, why not save a lot of time, expense and many more lost lives, and simply hand back the country to the Taliban now?

[Prime95]

Originally Posted by garo

http://www.economy.com/mark-zandi/do...-Recession.pdf talks about what would have happened then.

This analysis from the article caught my eye:

TARP has been a substantial success, helping to restore stability to the financial system and to end the freefall in housing and auto markets. Its ultimate cost to taxpayers will be a small fraction of the head- line $700 billion figure: A number below $100 billion seems more likely to us, with the bank bailout component probably turning a profit.

It is beyond me how anyone can claim the government will turn a profit on all the crap mortgage backed securities it overpaid for.

[Fusion_power]

George, Don't let the left hand know what the right hand is doing.

Look carefully at Fannie and Freddie and you will see part of the picture how the MBS are being hidden.

DarJones

[ewmayer]

Originally Posted by Prime95

It is beyond me how anyone can claim the government will turn a profit on all the crap mortgage backed securities it overpaid for.

Well, we need to be careful here to spot the shell under which the crap-MBS really is being hidden. IIRC there were actually relatively few MBS purchases under TARP - as originally proposed by Paulson, Bernanke et al TARP was indeed intended to purchase "troubled, illiquid assets" and thus "magically help restore banks` balance sheets to a semblance of solvency" - but in the end opted to mostly preferred stock and warrants in the banks, which avoided the whole messy "how to value this toxic crap" issue. Here`s what Wikipedia says about the breakdown of TARP spending as of early 2009:

As of February 9, 2009, $388 billion had been allotted, and $296 billion spent, according to the Committee for a Responsible Federal Budget. Among the money committed, includes:[35]

* $250 billion to purchase bank equity shares through the Capital Purchase Program ($195 billion spent);
* $40 billion to purchase preferred shares of American International Group (AIG), then among the top 10 US companies, through the program for Systemically Significant Failing Institutions ($40 billion spent);
* $20 billion to back any losses that the Federal Reserve Bank of New York might incur under the Term Asset-Backed Securities Loan Facility (none spent);
* $40 billion in stock purchases of Citigroup and Bank of America ($20 billion each) through the Targeted Investment Program ($40 billion spent)
* $12.5 billion in loan guarantees for Citigroup ($5 billion) and Bank of America ($7.5 billion) through the Asset Guarantee Program (none spent);
* $25 billion in loans to automakers and their financing arms through the Automotive Industry Financing Program ($21 billion spent)

The Congressional Budget Office released a report in January 2009 reviewing the transactions enacted through the TARP. The CBO found that through December 31, 2008, transactions under the TARP totaled $247 billion. According to the CBO's report, the Treasury had purchased $178 billion in shares of preferred stock and warrants from 214 U.S. financial institutions through its Capital Purchase Program (CPP). This included the purchase of $40 billion of preferred stock in AIG, $25 billion of preferred stock in Citigroup, and $15 billion of preferred stock in Bank of America. The Treasury also agreed to lend $18.4 billion to General Motors and Chrysler. The Treasury, along with the FDIC and the Federal Reserve, has also agreed to guarantee a $306 billion portfolio of assets owned by Citigroup.[7]

The CBO also estimated the subsidy cost for transactions under TARP. The subsidy cost is defined as, broadly speaking, the difference between what the Treasury paid for the investments or lent to the firms and the market value of those transactions, where the assets in question were valued using procedures similar to those specified in the Federal Credit Reform Act (FCRA), but adjusting for market risk as specified in the EESA.[7] The CBO estimated that the subsidy cost of the $247 billion in transactions before December 31, 2008 amounts to $64 billion. An updated analysis from the Committee for a Responsible Federal Budget estimates a budgetary impact of $80 billion for all TARP spending as of 02/3/09.[35]

Or perhaps George was referring to the non-TARP (but roughly contemporaneous) "The Treasury, along with the FDIC and the Federal Reserve, has also agreed to guarantee a $306 billion portfolio of assets owned by Citigroup", which is similar in spirit (i.e. spread the total losses out over years) to the Fannie/Freddie backstopping.
My take is that because TARP sensibly included terms (e.g. no executive bonuses) most firms find overly restrictive, all those - mainly the too-big-too-fails - which have other ways to get the government to give them free money have made a big show of repaying their TARP monies, and are back to paying huge bonuses, many while still having huge amounts of toxic assets they are currently artificially valuing (thanks to the govt-sponsored suspension of the longstanding FASB mark-to-market accounting rules) and/or holding off-balance-sheet (much as the government is keeping its Fannie/Freddie commitments and Social-Security borrowings off balance sheet). all while continuing to get getting bailed out by other means.

"Other means" includes the myriad of discount lending facilities the Fed opened in 2007 and 2008 (borrow at effectively 0%, invest in Treasuries yielding 2-3% for a risk-free return), the FDIC Temporary Liquidity Guarantee Program, and most especially the Fed's $Trillion-plus MBS-purchasing spree which ended this past spring. The beauty of running most of the real bailouts through the Fed and the Treasury's backstopping of Fan and Fred is the sheer lack of transparency - The Fed has only said how much it *spent* on MBS, not how it decided to set the purchase price. IMO that is where most of the real bailouts are occurring - safely out of sight on the Fed's "balance sheet", whose size, management and expansion rate are beyond the control of congress and the executive branch. There it sits, with the as-yet-unbooked losses on the crap-MBS waiting to be converted into currency devaluation by way of the Fed's usual "slow bleed to zero" stealth-taxation mechanism.

[cheesehead]

Originally Posted by garo

So what do you think should have happened?

Let me point out that Ernst is the only person so far to have contributed a detailed entry for my "Alternate scenarios for post-Sept. 15 2008" thread at http://mersenneforum.org/showthread.php?t=12816

I've been hoping to have entries there from conservatives -- who, collectively, nationally, seem to be just saying "NO" to everything that has been tried, but somehow managing not to have the fortitude to set forth a noticeable plan of what they would have had the government do instead.

Apparently, today's conservatives would prefer that the country had just gone into the dump a la Hoover and that we have a second Great Depression, gambling that their well-honed ability to blame everything on liberals would result in dazzling enough fiscally-illiterate voters to persuade them to restore political power to the folks who caused this crisis.

I'll bet Barry Goldwater would've set forth some coherent plan that had more words than "NO". (Of course, today's GOP leaders would've been horrified by such a rational appeal, because it ignores think-tank findings that the best way to sway voters is to use framing and a carefully-selected set of phrases to reach them on subconscious emotional levels.)

[garo]

Usually when govt. mouth-pieces claim that "TARP" will not lose too much money or will make money they may be technically correct but as Ernst rightly points out there are so many other forms of bank bailouts - and the neverending sinkholes of Fannie and Freddie that provide a backdoor bailout to the banks - that that sort of a statement is misleading at best.

Ernst, I'm in full agreement with you on bank bailouts, the lack of regulation and all that. But bailouts and stimulus are two separate issues. It is possible to be in support of one but not the other. And not be called a moron for doing so, thank you very much!

@George: Zandi and Blinder are not exactly my favourite economists</understatement>. But their analysis of what might have happened deserves some attention.

@cheesehead: Ernst's solution is great and I mostly agree with it but it only deals with the financial crisis. He does not present any solutions for the "economic" crisis so I think I am well within my rights to ask him how he would deal with that. Also, what will be the effect on unemployment of the steps he proposes. And taxes? Debt-deleveraging is necessary. But done the wrong way or done too fast, it can make the economy much much worse.

@All: I would again urge everyone to read Jeremy Grantham's latest from July http://www.gmo.com/websitecontent/JG...ssays_2Q10.pdf
My position is to simply ape his position on everything

[ewmayer]

Thanks for the kind words, cheesehead ... garo, with respect to alternatives to last year's stimulus package and how to deal with the unemployment crisis, my main 2 themes are thus:

[1] For stimulus to have any chance of being effective, it needs to produce (either directly or indirectly) more GDP growth than it costs - this is why the "priming the pump" metaphor is commonly used by its advocates. Simply overpaying folks to refill potholes and work on overpriced local-pork-barrel projects provides paychecks but does zilch (or close to zilch) in terms of supporting sustainable economic growth. Looking at the great Depression, you see the FDR administration tried many things, and failed at many (perhaps most) of them, but the point is, they had their priorities right (help out main street, provide jobs but also gain some real broader societal benefit from doing so), and some of those projects (Hoover Dam and the interstate highway system come to mind) proved huge wins down the road. For me, that nearly-$trillion spending package could have instead been targeted at ending America's overreliance on fossil fuels (especially oil) and initiating the largest clean-tech R&D effort in history, a sort of "Green Energy Manhattan Project". That would have long-term economic, environmental and national-security benefits.

[2] I have no problem with extending unemployment benefits in a genuine jobs crisis like we have at present, but firmly believe in getting something back in return for those checks - e.g. some kind of national community-service initiative. See my previous posts (and the ensuing discussion) in this thread about that.

And of course this needs to be in the context of forcing the bad debt hobbling the economy into the open - there can be no real recovery before many of the debt-excesses of the past several decades are wrung out. And the "learning to live within our means" theme needs to apply not just to overleveraged households but to the government as well.

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Quick roundup of the major stories of the past few days: Lehman`s Dick Fuld lied his ass off to the FCIC yesterday and appears to have gotten away with it ... NYT editorial about corporate execs crying about a provision in the new financial reform law that requires companies to disclose the ratio between a chief executive’s pay package and that of a typical employee...and the SEC is very belatedly (but hopefully better-belatedly-than-neverly) looking into several of the most-popular HFT market-scamming practices, specifically those of "Quote Stuffing" and "Sub-Pennying". Since the aforementioned ZeroHedge article summary is based on a WSJ piece, we of course must temper all the evidence of flagrant market-manipulation by the HFTs with a nice-sounding blurb about the wonderful benefits to "the average investor" of such "financial innovations":

The transformation of the stock market [into a rigged computer-algo-manipulated casino] has some benefits for investors, of course, including some lower costs. And some [of the leading HFT scamhouses] say greater volume of canceled orders is a natural consequence of high-speed markets, where traders constantly troll across the exchanges for the best price.

The last "best price" bit is soon after negated by an example of clear scammery-via-quote-stuffing-induced latency arbitrage ... and as to the sheer numbers involved:

An eye-popping number of the stock quotes entered in the U.S. market's exchange system are canceled.

For example, on Feb. 18, trading volume on the Nasdaq exchange totaled about 1.247 billion shares, according to data compiled by T3 Capital Management, a New York hedge fund. However, over the course of the same day traders submitted offers to buy or sell stock for roughly 89.704 billion shares. In other words, only 1% of the orders posted on Nasdaq actually traded.

Yesterday`s ISM Numbers and the "Sniff Test"

Noted Realwirtschaftler David Rosenberg comments on yesterday`s market-buoying "much better than expected" ISM numbers (which he says don`t pass the sniff test, since the headline number seems much better than the sum of its regional parts), and concludes with a commentary on the ongoing debate as to whether we are merely in a very deep recession, or

What is a depression anyway, and why do we continue to be in one?:

I can understand how emotional the debate can get over whether or not we have actually just stumbled along some post-recession recovery path or whether or not this is actually a depression in the sense of a downward trend in economic activity merely punctuated with noise that is influenced by recurring rounds of government intervention. The reality is that the Fed cut the funds rate to zero, as was the case in Japan, to little avail. Then the Fed tripled the size of its balance sheet - again with little sustained impetus to a broken financial system. Government deficits of nearly 10% relative to GDP, or double what FDR ever ran during the 1930s, have obviously fallen flat in terms of providing and lasting impact to the economy.

This is going to sound like a broken record but it took a decade of parabolic credit growth to get the U.S. economy into this deleveraging mess and there is clearly no painless “quick fix” towards bringing household debt into historical realignment with the level of assets and income to support the prevailing level of liabilities. We are talking about $6 trillion of excess debt that has to be extinguished either by paying it down or by walking away from it (or having it socialized). Look, we can understand the need to be optimistic, but it is essential that we recognize the type of market and economic backdrop we are in.

Robert Reich | The Stock Market Rally Versus the World's Economic Fundamentals:

Robert Reich’s latest epistle – I agree with everything he says except for the ‘we need more stimulus’ advocacy. OTOH I am not as hard on RR as on ‘stimulus to the moon in ever-huger amounts’ folks like Krugman, because Reich always makes clear that his number one concern is the labor market, and he advocates not pork-barrel-megastimulus but rather more-targeted lots-of-jobs-for-the-money and “economic sectors which should be drivers of future sustainable growth” (e.g. cleantech) stimulus. I know Mish will likely disagree even on that, but hopefully despite such policy debates our readers will find the “Can China Inc really pull the whole world out of recession?” theme illuminating:

The Stock Market Rally Versus the World's Economic Fundamentals

[Prime95]

Originally Posted by ewmayer

...we of course must temper all the evidence of flagrant market-manipulation by the HFTs with a nice-sounding blurb about the wonderful benefits to "the average investor" of such "financial innovations"...

I'm a simple man (a simpleton?). To me the stock market is a zero sum game. In every transaction you have a buyer, a seller, and a middleman/broker. Every dollar the middleman/broker makes must come from either the buyer, the seller, or both.

With this background, I cannot comprehend any argument as to how HFT, which generates billions for the middlemen/brokers, is of any value to the average investor - the buyers and sellers.

[Fusion_power]

HFT quote stuffing allows a computer to shove so many orders into a system that all orders on that system become delayed. If the delay is long enough, the computer can then go to an alternate computer market and find tiny differences in price between the two that can be exploited. There is ZERO benefit of any sort for the average investor, it is all about benefit for the HFT.

There are other manipulations that you can speculate about. I came up with 3 other methods that could be used to exploit the market including 'tweening' (getting between the bid/ask price to skim off slices), 'leading' (detect a competitors market action and get ahead of it), 'shoving' (use a barrage of buy/sell orders to manipulate the price of a given stock either up or down with a final liquidation of position at a profit). If I can think of ways to do this you can bet the smart cookies writing the programs can think of better ways. The thing is that as more HFT's get in the fray, they tend to cancel each other out. This postulates that an arms race of sorts is going on as they search for new ways to skim before others can balance it.

DarJones