Posts Tagged ‘banks’


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René Magritte,

René Magritte, “Song of the Storm” (1937)

Are we seeing the signs of a global economic meltdown?

Marxist and other radical economists often remind people of the inherent instability of capitalism—unlike their mainstream counterparts, who tend to focus on equilibrium and the invisible hand of free markets.

But, right now, the warnings about new sources of instability are coming from quarters that are anything but radical. And they’re all saying pretty much the same thing: National monetary policy is increasingly ineffective. Central banks are largely impotent. The IMF points to increased global economic risk because of impossible amounts of debt that will never be repaid. Creditors are way too overextended. Finance capital is out of control. Growth everywhere is threatened. China and emerging-market nations are mostly to “blame.” And so on and so forth.

Here’s a recent sample of three recent articles [ht: ja]: from the BBC, Reuters, and the Guardian.

Andrew Walker (for the BBC) cites the latest IMF World Economic Outlook, according to which emerging and developing economies will register slowing growth in 2015 for the fifth consecutive year, to argue that (a) economic growth in China is slowing down (and helping to pull down the rest of the world, both directly and indirectly) and (b) lackluster growth in rich countries is failing to pull the rest of the world along. In addition, according to the latest IMF’s Global Financial Stability Report, the explosion of dollar-denominated credit in recent years, along with the rise in the value of the dollar, is going to make it difficult to repay those debts, a growing problem which is in turn exacerbated by the reverse “flight to safety” of financial capital. And then, of course, there are the negative effects—in Russia, Brazil, Venezuela, and elsewhere—of falling oil prices.

David Chance (for Reuters) cites the recent report by the Group of Thirty according to which low interest-rate rates and money creation not only were not sufficient to revive economic growth, but risked becoming problems in their own right.

The flow of easy money has inflated asset prices like stocks and housing in many countries even as they failed to stimulate economic growth. With growth estimates trending lower and easy money increasing company leverage, the specter of a debt trap is now haunting advanced economies.

At the same time, we’re listening to a growing chorus, at least in the United States (first from Federal Reserve Governor Lael Brainard and then Fed governor Daniel Tarullo) against the prospect of changing central bank policy and raising interest-rates anytime soon.

Finally, Will Hutton (for the Guardian) warns that capital flight and bank fragility threaten to create new asset bubbles and the eventual bursting of such bubbles—and there’s no prospect of global coordination to prevent the resulting economic dislocations.*

The emergence of a global banking system means central banks are much less able to monitor and control what is going on. And because few countries now limit capital flows, in part because they want access to potential credit, cash generated out of nothing can be lent in countries where the economic prospects look superficially good. This provokes floods of credit, rather like the movements of refugees.

The upshot? My view is these three commentators are on to something, backed up by the research taking place within the IMF and other international entities. Clearly, they are concerned that the anarchy of production—the anarchy of both “real” production and of finance, within and across countries—and the absence of any new ways for central bankers to regulate that anarchy are creating new fissures and cracks within the global economy.

The problem of course is, the same search for profits mainstream economists and policymakers hoped would lead the recovery from the crash of 2007-08, along with the initially hesitant and then increasingly desperate measures central bankers have adopted to enhance the prospect of that search, now seems to be undermining that fragile recovery.

That’s the gathering storm they—and we—should be worried about.

*I do have one bone to pick with Hutton, who argues that excessive credit is created by banks lending out money based on existing deposits, which in turn is based on “the truth that not all depositors will want their money back simultaneously.” The latter may be the case but Hutton gets the order wrong: it’s bank credit that creates deposits (like fairy dust), not the collection of deposits that serves as the basis for the expansion of credit.


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Here’s Fred Mishkin [ht: ra], an economist at the Columbia Business School and star of Charles Ferguson’s Inside Job, on the possibility of preventing a rerun of the 2008 financial crisis:

Frederic S. Mishkin, a former Fed governor, noted that financial firms tend to resist increased regulation, often with considerable success. “They’re going to hire a lot of lawyers to figure out how to get around these regulations and undermine them,” Mr. Mishkin, a Columbia University economist, said.

This is the same Mishkin who argued, in late 2011, it was necessary to regulate Too Big to Fail banks:

Too-big-to-fail is now a larger problem than before, in part because banks have merged in a way that creates even larger banking institutions and because, with the Fed bailout of Bear Stearns in March 2008 and then the financial assistance to AIG by the Fed and the U.S. Treasury in September of 2008, it has become clear that a much wider range of financial firms are likely to be considered “too big to fail” in the future. Indeed, the most prominent case of a firm that was not bailed out—Lehman Brothers in September 2008—was followed by such a severe crisis that it is unlikely that governments would let this happen again. In the wake of the Lehman failure, governments throughout the world bailed out or guaranteed all their major financial institutions.

One way to address the too-big-to-fail problem is to limit the size of fifinancial institutions, which might involve either the breakup of large fifinancial institutions and/or limits on what activities banking institutions can engage in. However, arbitrary limits on their size or activities might well decrease the effificiency or raise other risks in the fifinancial system. An alternative approach is to subject systemically important institutions to greater regulatory oversight, say by a systemic regulator. . ., or by imposing larger capital requirements for systemically important financial firms.

The Dodd–Frank financial reform bill passed in summer 2010 gives the federal government one more tool for dealing with systemically important financial companies. Before Dodd–Frank, the U.S. government only could take over individual banking institutions, but not fifinancial holding companies that own banks and other fifinancial institutions. (In other words, it could take over Citibank, but not Citigroup or a free-standing investment bank like Lehman Brothers.) It used to be that the government had only two alternatives with such fifirms: send them into bankruptcy or bail them out. Now, the federal government has “resolution authority” over such fifirms, which means that they can treat them as they would an insolvent bank. Critics have expressed concerns that this federal resolution authority will further entrench too-big-to-fail and so make the moral hazard problem worse. . . As with all regulatory authority, the devil will be in the details. But the new resolution authority is likely to help limit moral hazard because it gives the government a big stick to force systemically important financial institutions to desist from risk taking or to raise more capital—or else face a government takeover that imposes costs on managers and shareholders.

On one hand, according to Mishkin, we have Too Big to Fail banks, which are “now a larger problem than before,” that need to be regulated. On the other hand, also according to Mishkin, the banks will resist regulation by hiring a lot of lawyers “to get around these regulations and undermine them.”

So, why are we repeating the mistakes of the past, after the last great depression, when the banks were left with both the incentive and the means to evade and ultimately overturn the regulations?

Economists like Mishkin might even write that up in a working paper if only we paid them enough money.


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Harmen de Hoop and Jan Ubøe, “Permanent Education (a mural about the beauty of knowledge)” (Nuart 2015, Stavanger, Norway)

Ubøe, Professor of Mathematics and Statistics at the Norwegian School Of Economics, gives a 30-minute lecture on the streets of Stavanger on the subject of option pricing.

Drawing on Black and Scholes explanation of how to price options, Ubøe will explain how banks can eliminate risk when they issue options. Black and Scholes explained how banks (by trading continuously in the market) can meet their obligations no matter what happens. The option price is the minimum amount of money that a bank needs to carry out such a strategy.

While the core argument is perfectly sound, it has an interesting flaw. If the market suddenly makes a jump, i.e. reacts so fast that the bank does not have sufficient time to reposition their assets, the bank will be exposed to risk. This flaw goes a long way to explain the devastating financial crisis.

This theory, and similar other theories, led banks to believe that risk no longer existed, so why not lend money to whoever is in need of money? In the end the losses peaked at 13,000 billion dollars – more than the total profits from banking since the dawn of time.

My guess is, most of the members of the audience did not understand the mathematics. However, Ubøe assures them it works—both as a form of knowledge (the manipulation of the mathematics) and as a strategy for banks (to eliminate risk)—and they can’t but believe him. It has a kind of beauty.

And then he explains that other effect of the math: it led banks to believe they had found a way of eliminating risk (because, like the audience, they believed the mathematicians), which fell apart when markets made sudden jumps and the traders weren’t able to reposition their assets quickly enough.

In that case, the beauty of the knowledge is undermined by the ugliness of the results.