Wednesday, October 15, 2008

We are governed too much.

Alan Moran - Director of Deregulation at the Neoliberal Think Tank Institute of Public Affairs puts the Neoliberal case [from Unleashed] for greater Central bank deregulation. A hasty retort is attached below and Will Hutton's analysis, on which my retort is based, linked to below, as well.

Reprising the 1930s degringolade

"You don't know what you're doing" is the soccer crowd's refrain to a failing team manager's player selections. Such an accusation applies to almost all the world's central bankers, whose carefully cultivated pretensions of deific prescience are now deflated.

Aside from attempting to address the economic mess they have created, central bankers are setting out their apologias. The authorised version is given by Charles I. Plosser, President and Chief Executive Officer, Federal Reserve Bank of Philadelphia.

Plosser tells us that monetary policy can't do everything. He says it cannot protect against buffeting caused by non-monetary disturbances, such as a sharp rise in the price of oil or a sharp drop in the housing market.

In fact, soaring oil price increases over the past couple of years were absorbed without causing economic dislocation. As for house price increases, these were caused partly by governments forcing up the price of housing land (and in the US requiring relaxed lending standards) and partly by the reckless expansion in the money supply fomented by the Fed and, indeed, by our Reserve Bank.

Plosser adds. "Encouraging the belief that any system of financial regulation and supervision can prevent all types of financial instability would be a mistake. Instead, our goal should be to lower the probability of a financial crisis and the costs imposed from any troubled financial institution." Having specified such limited goals, neither Plosser nor other central bankers and Treasury chiefs have acknowledged their abject failure to meet them.

For the central bankers, their bail-out proposals are policy-on-the-run with no sense of fitting the colossal rescue sums they want into what is needed. The US $700 billion is inadequate to liquidate the "toxic debt" variously estimated at $3-6 trillion. It will be used to reward the very people who have acted recklessly in their borrowing and lending and it is being accompanied by a re-run of the very low interest rates that were the original cause of the debacle.

The central banks have been set up with dictatorial powers over the money supply and interest rates precisely so that these levers of a stable economy can be kept away from the political process. Wisely, the machinery of monetary management has been removed from the control of politicians who therefore have to be open in borrowing and stealing to buy votes.

But, in taking such powers from politicians, we have surrendered considerable discretion in monetary management to detached experts. These reserve bankers have basked in that power. They have encouraged an army of sycophants examining every word they utter looking for hidden meaning or some hint as to where the great minds' thoughts are developing.

In fact the Masters of the Policy Levers had no clue what the money supply was doing. The recession we now face is due solely to their monetary mismanagement. When a central bank presides over year after year of money supply increasing at double digit rates, something in their training and qualifications should be asking "where is all that money going"? The increased money supply can only be reflected in inflation, transfers overseas and real economic growth.

We are pretty certain that economic growth was at levels of only 3-5 per cent, so the rest must have been boosting inflation or was being accumulated by overseas borrowers. The overseas accumulation of Australian funds is certainly one direction where the monetary expansion went. The collapse of the $A is a vivid illustration that the lenders want their money back and, in claiming it, are causing just the sort of policy surprises and wild fluctuations that the monetary policy managers were supposed to prevent.

As for the rest of the surplus money created by the Reserve Bank, if it was not being measured in the CPI it must have gone into other forms of inflation. Housing is the obvious area. House prices were inflated by mismanagement in other arms of government, which boosted prices by creating land shortages and excessive taxation of new developments. This created a casino with prices escalating and home owners complacently took out second mortgages to finance rental properties and overseas trips.

In the current debacle, there have been calls for punishment of the merchant bank Masters of the Universe. But all they were doing was responding to the policy environment set by the central bankers, and it is they who should be called to account.

Far from acknowledging their culpability, central bankers and Treasury chiefs are calling for even greater powers. It would be foolish to agree to this.

Many voices are calling for greater regulation. Regulatory controls should be constantly reviewed, though in the current world crisis it is not always the lesser regulated countries that have fared worst. In Australia, Lindsay Tanner has recognised that there remain areas where red tape is excessive and costly. Knee-jerk regulatory intensifications and government interventions have not worked in the US and UK and can store up real future problems.

*********Retort, posted to this thread, following***************************

Trust the market seems to be Moran's message, along with the old, tired Neoliberal mantra of 'free us from the shackles of being overgoverned'.

Moran doesn't appear to even believe in a democratic public sphere, otherwise he'd be down hear with the plebs defending his Neoliberal whinge. C'mon, Moran, please explain how Government ancouraged the market in credit default swaps; please explain to us ignorant people how we should be ensuring that Government gets out of the way of the various markets in financial derivatives. Please explain how the current global financial system's complex and opaque market in derivatives was based on anything but the normalization of lies and obfuscation.

The market in financial derivatives was plenty regulated. The problem is that its fundamental form of regulation was to lie about the value of the asset on which the financal instrument was supposedly based. At the heart of the current crises is the fact that there is a multi-trillion dollar global industry in financial derivatives and no one trusts the value that any other corporate body place on these products. The convulsions in the stock markets probably won't stop until true valuations can be made on the assets that these instruments are based on.

The problem then is not one of regulatin or deregulation: the market in derivates was meant to be a means of regulating risk. The problem is the degree of abstraction in this system. Failing a concrete grounding this system ran on until it hit the valuation embedded in US sub prime defaults. These aren't the cause of the mess, but the catylyst, where the currents in the credit markets came back to earth.
Reserve banks, households, corporations, states - we are all part of this system of regulation. To use an older meaning of the word government, we have all governed ourselves, our economies, our states, badly. The answer is not a return to regulation, but a different set of regulations. On a household level that means keeping your credit grounded, same as on a state level, and also for business.

Arguing like Moran does that Central Banks are solely to blame by setting the framework for financial policy gives the illusion that deregulation will not only make us freer but would have avoided the current crises. Isn't this precisely the sort of mentality that has led to the current situation?

Will Hutton

A lethal new threat is emerging at the dark heart of the financial system. We must have a unified global response or an already perilous position will become a calamity.

The problem is that the markets no longer have any faith that the world financial system they helped create has any future. The model is bust. It is encouraging that both the Americans and Germans are now moving towards what they considered ideologically unthinkable a fortnight ago - they are preparing to follow the British lead, take big public stakes in banks and offer guarantees to the interbank market.

But while this is a necessary condition for stabilisation it is not sufficient. What needs to happen on top is an assault on the dark heart of the global financial system - the $55 trillion market in credit derivatives and, in particular, credit default swaps, the mechanisms routinely used to insure banks against losses on risky investments. This is a market more than twice the size of the combined GDP of the US, Japan and the EU. Until it is cleaned up and the toxic threat it poses is removed, the pandemic will continue. Even nationalised banks, and the countries standing behind them, could be overwhelmed by the scale of the losses now emerging.

This market in credit derivatives has grown explosively over the last decade largely in response to the $10 trillion market in securitised assets - the packaging up of income from a huge variety of sources (office rents, port charges, mortgage payments, sport stadiums) and its subsequent sale as a 'security' to be traded between banks.

Plainly, these securities are risky, so the markets invented a system of insurance. A buyer of a securitised bond can purchase what is in effect an insurance contract that will protect him or her against default - a credit default swap (CDS). But unlike the comprehensive insurance contract on your car which you have with one insurance company, these credit default contracts can be freely bought and sold. Complex mathematical models are continually assessing the risk and comparing it to market prices. If the risk falls, the CDSs are cheap; if the risk rises - because, say, a credit rating agency declares the issuing company is less solid - the price rises. Hedge funds speculate in them wildly.

Their purpose was a market solution to make securitisation less risky; in fact, they make it more risky, as we are now witnessing. The collapse of Lehman Brothers - the refusal to bail it out has had cataclysmic consequences - means that it can no longer honour $110bn of bonds, nor $440bn of CDSs it had written. On Friday, the dud contracts were auctioned, with buyers paying a paltry eight cents for every dollar. Put another way, there is now a $414bn hole which somebody holding these contracts has to honour. And if your head is spinning now, add the three bust Icelandic banks. They can no longer honour more than $50bn of bonds, nor a mind-boggling $200bn of CDSs.

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