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Another Corrective to the Conventional Crisis Narrative

I recently reviewed the outstanding Guaranteed to Fail, perhaps the best book written about the financial crisis. In the WSJ, James Freeman reviews Reckless Endangerment by Pulitzer Prize-winning journalist Gretchen Morgenson and analyst Joshua Rosner. It reinforces the argument I made in my review of Guaranteed to Fail that the conventional crisis narrative is a (largely successful) attempt on the part of officialdom to divert attention from their culpability for the crisis:

In Ms. Morgenson and Mr. Rosner’s book, a bipartisan parade of famous Washington movers-and-shakers appear in cameos to do some disservice (now largely forgotten) to taxpayers. There is Newt Gingrich lauding Fannie Mae at a corporate event. There is Larry Summers bullying his Treasury staff to water down a report critical of Fannie. There is current World Bank President Robert Zoellick as a Fannie executive in the 1990s lobbying on Capitol Hill.

Look at Rep. Barney Frank, responding in 2005 to the question of whether the government’s push to increase home-ownership rates might result in people buying more home than they could afford and putting themselves in dire straits. The authors report: “Frank brushed off the questioner. ‘We’ll deal with that problem if it happens,’ he barked.”

It happened all right, and perhaps the most amazing part of this tale is that so many of those responsible for the disaster remain in power.

A catastrophic failure of democratic accountability.

posted on 03 June 2011 by skirchner in Economics, Financial Markets

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Guaranteed to Fail

My review of Guaranteed to Fail is available at The Conversation. Oddly enough, the book also gets an endorsement on its jacket from our old enemy Nouriel Roubini. Since the authors are colleagues of Roubini at Stern, this may just be a collegial courtesy. Roubini’s endorsement is ironic because the book demonstrates that the crisis looked nothing like any of Nouriel’s many and varied pre-crisis narratives. Nouriel managed to forecast every crisis except the one that actually occurred.

posted on 18 May 2011 by skirchner in Economics, Financial Markets

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Conservatives and Libertarians for Dumping the Gold Stock

We have previously noted the irony of those who worry about an over-supply of fiat money taking refuge in a commodity in which governments hold stocks that dwarf annual production. We also noted that the pro-free trade social democrats at the Petersen Institute had suggested liquidating the US gold stock to reduce US government debt and interest payments.

Now conservative and libertarian US think-tanks are saying it too. It is consistent with their long-standing support for the privatisation of government assets. Of course, it is a lazy approach to debt reduction, but a lazy debt reduction is better than none.

Dumping the gold stock without tanking the gold price is easier said than done, but the RBA was able to discretely offload 167 tonnes in 1997, yielding a handsome profit on the old Bretton Woods parity price and adding income producing assets to the RBA’s portfolio (contrary to Paul Cleary’s FOI beat-up).

In Australia, sales of public trading enterprises Qantas, Telstra, CBA and the airports yielded $61 billion during the 1990s and 2000s, making a large contribution to the reduction in net debt from $96 billion in 1996-97 to a negative net debt position in 2005-06 before the terms of trade boom really took off. Peter Costello knew a lazy policy option when he saw one. One of the problems facing the current government is that it has to do debt reduction the hard way. And the gold stock’s long gone.

UPDATE: Portugal is under pressure to sell its Nazi gold back to Germany.

posted on 17 May 2011 by skirchner in Commodity Prices, Economics, Financial Markets, Fiscal Policy, Gold

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The Finite Resource Assumption: Tripling or Quadrupling Down with Jeremy Grantham

Malcolm Turnbull is not the only person to be led astray by the assumption that resources are finite. According to GMO’s Jeremy Grantham:

Scavenging refuse pits will no doubt be a feature of the next century if we are lucky enough to still be in one piece.

Here is Grantham’s strategy for trading commodities:

Given my growing confidence in the idea of resource limitation over the last four years, if commodities were to keep going up, never to fall back, and I owned none of them, then I would have to throw myself under a bus.  If prices continue to run away, then my small position will be a solace and I would then try to focus on the more reasonably priced – “left behind” – commodities.  If on the other hand, more likely, they come down a lot, perhaps a lot lot, then I will grit my teeth and triple or quadruple my stake and look to own them forever. 

Sounds like a good formula for losing ‘a lot lot’. Apparently, this is what passes for macro strategy at GMO.

posted on 06 May 2011 by skirchner in Commodity Prices, Economics, Financial Markets

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MNI-Deutsche Börse Economic Forecasting Competition

I came third in the first round of the MNI-Deutsche Börse economic forecasting competition:

NEW YORK, NY, May 5, 2011 – Market News International has announced the April winners of the MNI Forecast Competition, a free online contest in predicting US economic indicators.

April’s highest forecasters in descending order are:
•  Omair Sharif, RBS
•  Fernando Melro dos Santos, Private
•  Dr. Stephen Kirchner, UTS Business School

Until June 30, contestants are competing for the title of Best Overall Forecaster and a prize of $1,500 by forecasting ten economic data releases: Non-farm Payrolls, Retail Sales, CPI, PPI, Industrial Production, ISM Manufacturing Index, Housing Starts, Durable Goods Orders, International Trade Balance, and New Home Sales.

posted on 06 May 2011 by skirchner in Economics, Financial Markets

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20 Million Future Funds

I think it was my colleague Peter Saunders who first coined the phrase 20 million Future Funds in arguing that the Howard government should make one off contributions to individuals’ superannuation accounts rather than hoard revenue in the Future Fund.

The government has adopted the same tag line in arguing for an increase in the rate of compulsory superannuation contributions, although these contributions necessarily come at the expense of the supposed beneficiaries through lower take-home wages, fewer hours worked and reduced employment. Compulsory super promotes dissaving through other saving vehicles and only succeeds in raising net household wealth to the extent that some households are liquidity constrained and cannot dissave through other mechanisms to offset the compulsory contributions.

Bill Shorten is suggesting there is some kind of trade-off between an increase in the compulsory super contribution rate and a sovereign wealth fund. While this is absurd, it does provide Shorten with an opportunity to highlight the philosophical weakness of the federal opposition:

Turnbull’s sovereign wealth fund advocacy is inconsistent with his free market philosophy. A sovereign wealth fund would see the state play a role that Labor now sees being performed by the private sector. The importance of our superannuation savings during the GFC was evidence of how it acts as a bulwark. Since the last election, however, we have seen the Liberals move further away from their free-market credentials. It was evident in Joe Hockey’s overly regulatory approach to mortgage lending rates. And it’s evident in Tony Abbott’s Soviet style centrally controlled $10bn direct action policy on climate change. The philosophical contractions colliding within the Liberals may seem soft now, but watch it grow in the months ahead. Meanwhile, I’d rather trust thousands of trustees across thousands of super funds to invest and manage billions of dollars rather than government insiders in Canberra picking winners.

In this context, it is worth noting that the Future Fund has divested itself of two of its three biggest defence holdings, Lockheed Martin Corp. (LMT) and General Dynamics Corp. (GD) because they are supposedly engaged in mines and cluster munitions, even though Australia has yet to ratify the relevant convention and the Fund is notionally free from political direction from Canberra. Clearly the Fund is looking over its shoulder at what politicians are doing in making investment decisions.

posted on 04 May 2011 by skirchner in Economics, Financial Markets, Fiscal Policy, Politics

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Budget Needs Micro Not Macro Focus

I have an op-ed in The Australian arguing that federal budget debates need a stronger micro rather than macro focus:

A good indicator of the macroeconomic importance of the budget is the reaction of financial markets on budget night. More often than not, the market reaction is minimal, highlighting the irrelevance of the change in the budget balance to economic growth and macro variables such as interest rates.

The real economic significance of the budget is its microeconomic implications: how tax and expenditure policies influence incentives to work, save and invest. Tax and spending policies should be evaluated based on the incentives they create, for better or worse.

As if to prove my point, Shadow Treasurer Joe Hockey has an op-ed on the same page arguing that the budget should be judged solely on the basis of the surplus.

The Centre for Independent Studies has also released my Policy Monograph Why Does Government Grow?

Economic Papers has published the papers from the symposium on Monetary and Fiscal Policy Interactions: How to Improve Policy Outcomes held at the 2010 Conference of Economists. My contribution can be found here.

posted on 13 April 2011 by skirchner in Economics, Financial Markets, Fiscal Policy

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Guaranteed to Fail: Fannie Mae, Freddie Mac and the Debacle of Mortgage Finance

The financial crisis has generated hundreds of wise-after-the-fact, morality play and melodrama books on the subject, almost all of which have been completely beside the point. Until now. James Pressley reviews Guaranteed to Fail: Fannie Mae, Freddie Mac and the Debacle of Mortgage Finance:

Fannie Mae and Freddie Mac’s growth reflected astonishing advantages they had over private rivals. They paid lower taxes, could borrow at cheaper rates and were required to hold less capital. How much less? When they guaranteed the credit risk of mortgage-backed securities, or MBS, the capital requirement was 0.45 percent—just 45 cents per $100 of guarantees, the authors say; when they invested such securities, the buffer was 2.5 percent, or $2.50 per $100.

A federally insured bank, by contrast, faced a capital requirement of 4 percent for holding residential mortgages—unless it held GSE MBS. In that case, the requirement fell to 1.6 percent, creating perverse incentives for banks to originate mortgages, sell them to the GSEs for securitization and buy them back as GSE MBS. Same risk, less capital.

A race to the bottom was on—a competition to churn out increasingly dicey mortgages—only now it pitted Godzilla Fannie Mae and Freddie Mac against King Kong banks deemed to have “a too-big-to-fail government guarantee,” the authors say. Here was “a highly leveraged bet on the mortgage market by firms that were implicitly backed by the government with artificially low funding rates.” America, the bastion of free markets, became anything but when it came to mortgages.

You can read Chapter One here.

posted on 31 March 2011 by skirchner in Economics, Financial Markets

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Greenspan on Dodd-Frank

Greenspan in the FT on the Dodd-Frank Act:

the largest regulatory-induced market distortion since America’s ill-fated imposition of wage and price controls in 1971.

posted on 30 March 2011 by skirchner in Economics, Financial Markets

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RBA Drags the Chain on Transparency

Fed Chair Bernanke joins overseas counterparts in holding post-FOMC meeting press conferences:

Chairman Ben S. Bernanke will hold press briefings four times per year to present the Federal Open Market Committee’s current economic projections and to provide additional context for the FOMC’s policy decisions.

In 2011, the Chairman’s press briefings will be held at 2:15 p.m. following FOMC decisions scheduled on April 27, June 22 and November 2. The briefings will be broadcast live on the Federal Reserve’s website. For these meetings, the FOMC statement is expected to be released at around 12:30 p.m., one hour and forty-five minutes earlier than for other FOMC meetings.

The introduction of regular press briefings is intended to further enhance the clarity and timeliness of the Federal Reserve’s monetary policy communication. The Federal Reserve will continue to review its communications practices in the interest of ensuring accountability and increasing public understanding.

In this op-ed, I made the case for the RBA Governor to hold a press conference following each Board meeting and CPI release. Apart from the gains to monetary policy transparency, this would serve to reduce politicians’ media space in public debates over interest rates and inflation.

posted on 25 March 2011 by skirchner in Economics, Financial Markets, Monetary Policy

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Go Canada, Go Australia

Substitute ‘Australia’ for ‘Canada’ in this story for no loss of generality.

posted on 22 March 2011 by skirchner in Economics, Financial Markets

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Offshore Perceptions of Australia: A Failure of Leadership

The WSJ on the failure of the federal government and opposition to provide leadership on the SGX-ASX takeover:

Ms. Gillard professes to understand the general principle involved, having said that “An open economy has been in Australia’s interest.” So the failure by her and Mr. Swan to more aggressively support lifting the ownership cap to open the economy further is puzzling.

She may feel politically constrained as the head of a minority government beholden to a small band of Greens and independents. But that’s all the more reason to mount an aggressive persuasion campaign. Equally disappointing is the reaction—ranging from silence to outright hostility—from members of the ostensibly more free market opposition.

On this issue, the federal opposition is not even ostensibly free market.

Jennifer Hewett argues the government won’t risk defeat on something it doesn’t care about anyway:

It would be hard enough to muster political energy and risk defeat for something the government strongly supported, but Labor doesn’t really like this deal one bit. That is even though it knows blocking it on national interest grounds would be awkward for a government already regarded with suspicion by the international investment community. It’s why the Treasurer is sounding so cautious.

posted on 22 March 2011 by skirchner in Economics, Financial Markets, Foreign Investment, Rule of Law

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‘If the FIRB Doesn’t Kill It, We Will’

The FIRB is nothing more than a fig-leaf for political decisions that have already been made:

A senior source told the Herald that the government’s disposition was to reject the [SGX-ASX] merger, despite what the board recommended. ‘‘If [the board] doesn’t kill it, we will.’‘

posted on 19 March 2011 by skirchner in Economics, Financial Markets, Foreign Investment, Rule of Law

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A Forgotten Financial Failure

I have an article in Online Opinion questioning the dominant narrative of the recent financial crisis and its role in conditioning regulatory responses to the crisis:

Perhaps the most pernicious myth about the crisis is that it was the failure of the US government to rescue Lehman Brothers that precipitated these events. Indeed, it has become common practice to date the crisis from 15 September 2008 when Lehman Brothers was allowed to fail. Yet trouble had been brewing in credit markets for more than 12 months before.

The failure of Lehman Brothers was a trivial event compared to a much bigger but largely ignored financial failure that took place one week before when the two US mortgage giants Freddie Mac and Fannie Mae were put into conservatorship by the US government. These Congressionally-mandated, government-sponsored enterprises (GSEs) either owned or guaranteed two-thirds of the bad mortgages in the US financial system. They were far more highly leveraged than the private US or European investment banks. They will also ultimately cost US taxpayers more than all the other bail-outs of private financial institutions combined…

The failure of Lehman Brothers was merely a symptom rather than a cause of the crisis and the unwillingness of the US authorities to rescue Lehman was perhaps the one good US policy decision made through this episode. Federal Reserve Chairman Ben Bernanke conceded as much recently, when he tried to defend the decision as a necessary one, but then undercut his own argument by maintaining that the decision also had disastrous consequences. What Bernanke should have argued was that the winding up of Lehman Brothers was fairly orderly as far as these things go and not a source of major systemic problems in the financial system.

Other contributions in this series can be found here.

posted on 16 March 2011 by skirchner in Economics, Financial Markets

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Bernanke is Not a ‘Money Printer’

Frederic Mishkin is in Australia and will be presenting at the Reserve Bank on Thursday. He was interviewed by Alan Kohler for Inside Business:

ALAN KOHLER: So therefore do you join those who call Ben Bernanke a money printer?

PROFESSOR RICK MISHKIN: No, so… I don’t at all. The purpose here is not to print money and to just not worry about future inflationary consequences.

There is, however, an issue that when you have a balance sheet which is this large - and particularly in long-term assets and even more so in housing assets - the Fed is now involved in the most politicised of all financial markets in the US. The Federal Reserve and also the government has been involved in very large transactions to help the economy and bail outs.

The government’s not going to lose a penny on everything but one - the Fannie and Freddie, a couple [sic] of hundred billion dollars. So again, this is an indication of how crazy some of our policies have been.

Economists didn’t get - we missed a lot of things in this crisis, we got a lot of things wrong. Much to trusting for example of the quality of prudential supervision, which by the way in your country was done much, much better than in many other places, so you know, I don’t know whether you’re just lucky or good but…

ALAN KOHLER: Good!

posted on 14 March 2011 by skirchner in Economics, Financial Markets, Monetary Policy

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