Friday, August 17, 2012

There must be some mistake

The New York Times publishes a column by David Stockman, via Ad Orientem.

I have previously noted that David Stockman has come in from the supply-side cold and has even gotten air time at
The greatest regulatory problem — far more urgent that the environmental marginalia Mitt Romney has fumed about — is that the giant Wall Street banks remain dangerous quasi-wards of the state and are inexorably prone to speculative abuse of taxpayer-insured deposits and the Fed’s cheap money. Forget about “too big to fail.” These banks are too big to exist — too big to manage internally and to regulate externally. They need to be broken up by regulatory decree. Instead, the Romney-Ryan ticket attacks the pointless Dodd-Frank regulatory overhaul, when what’s needed is a restoration of Glass-Steagall, the Depression-era legislation that separated commercial and investment banking...

Like his new boss, Mr. Ryan has no serious plan to create jobs. America has some of the highest labor costs in the world, and saddles workers and businesses with $1 trillion per year in job-destroying payroll taxes. We need a national sales tax — a consumption tax, like the dreaded but efficient value-added tax — but Mr. Romney and Mr. Ryan don’t have the gumption to support it.

These two points in particular resonate with me.

1. The banking system has converted its non-systemic risk to systemic risk. If the banking system wants the public to be the ultimate guarantor, then it must accept public regulation. Banks can return to their historical function as depositary institutions and payment processors and Wall Street can market speculative opportunities to high net worth investors.

2. Taxes should be simple and everybody should pay them. Forget the endless lobbying and tinkering over income, capital gains, deductions, deferrals and earned income credits. It is way past time to start debating a VAT. Herman Cain's 9-9-9 plan deserved far more intelligent consideration than it got.


Visibilium said...

Your #1 is irrelevant. Systemic risk inheres not in banks, but in the discretionary monetary policy that drives banking's cyclically bipolar existence. Banking has gotten very good at running the ball, but the Fed is quarterbacking.

Do you know anyone who has worked in banking during the last couple of decades? I know plenty, and in the back of their minds, no matter how good the economy was humming along, the worry pertained to the next round of layoffs during the next economic slowdown. Well, at least this was their thinking prior to the recent Obama perma-slowdown that has radically stunted the industry.

The point I'm making is that banking has been a tremendously cyclical industry because of its extremely leveraged operations. During the 70s heyday of Glass- Steagall, folks still complained about systemic risk in too-big-to-fail money-center banks, such as Citicorp. Glass-Steagall didn't do dork, other than to screw the consumer.

Even extreme leverage can be managed in an environment in which management is possible. The Fed, however, is running the show and has no clue how much money-printing is too much or too little. First, the stats that the Fed follows operate on a significant lag and, second, excess liquidity always manifests itself in unexpected ways.

Although the optimal monetary system is a gold coin standard without fractional reserves, it's a policy nonstarter. At the very least, we need to impose on the Fed a fixed monetary rule. Take the Fed's ham-handedness out of the system and watch the systemic risk melt away. Some risk would remain, but nothing near the acrobatics that we've experienced recently.

The Anti-Gnostic said...

Wasn't the original idea behind the Fed just to eliminate bank runs? Inevitably it appears, this means money-printing and that's the conversion to systemic risk I'm talking about. How to regulate in such an environment, one hopes there are people who know.

Visibilium said...

Eliminate bank runs? Yes, but first we have to figure out what that means. The Fed was formed to be a lender of last resort--to supply liquidity to banks during liquidity panics--and to manage an elastic currency. An elastic currency was thought to be a currency that increased and decreased according to the volume of economic activity. What an elastic currency referred to was an elastic supply of working-capital-type credit. This view of monetary elasticity stemmed from the real-bills doctrine, which thought that short-term, self-liquidating credit for working capital purposes (e.g. inventories) wasn't inflationary.

Now, back to the original point. If we mean by eliminating bank runs that we only want the Fed to be a lender of last resort, that's relatively easy to regulate. The focus would be on managing leverage and avoiding moral hazard. We have probabalistic models, such as Value At Risk (VaR), to get a handle on the risk. This stuff isn't a secret. Bankers and regulators look at the same things.

The problem is the operation of the models during exogenous extreme events, such as those events brought about by the Fed's clumsy monetary management. That leads us to the other Fed role, managing an elastic currency. Managing an elastic currency should eliminate bank runs, too, by eliminating liquidity shocks to the banking system, but we see that the Fed too often is the cause of those shocks. After the US abandoned the Bretton Woods gold-exchange standard in 1971, the Fed has had no constraints on its money creation, other than amorphous attempts at general price level measurement, such as PCE Deflator or Consumer Price Index or GDP Deflator. Not surprisingly, economic instability after 1971 had been terrible.

I was listening to an interview with an ordinary working guy who talked about being able to afford a nice split-level in the 'burbs with a two-car garage (and two cars to put in it) and a stay-at-home wife in 1970 on $300/week salary. Please try to convince me that our current monetary policy isn't rotten to the core.