FINANCIAL CRISIS | Missing Minsky

Dec. 27, 2008–Martin Wolf, at FT.com, wrote on December 24 that Keynes offers us the best way to think about the financial crisis:

We are all Keynesians now. When Barack Obama takes office he will propose a gigantic fiscal stimulus package. Such packages are being offered by many other governments. Even Germany is being dragged, kicking and screaming, into this race. The ghost of John Maynard Keynes, the father of macroeconomics, has returned [and] that of his most interesting disciple, Hyman Minsky.

Hyman Minsky

I first heard Hy Minsky talk in the 1960s. His main message was:

1. Financial systems have a built-in tendency to euphoria. The financial market does not tend toward stability. The opposite is true. Bankers and other financial actors borrow more and more heavily, making the system increasingly vulnerable to panic. Lenders start after a scare by being conservative, hedging their bets. But eventually confidence returns and speculation takes hold again. Then investors get to the Ponzi phase – manic use of credit, a euphoria or bubble.

2. The credit cycle tends to manic, but ends with panic. The Ponzi phase continues until some investors exit with their profits, or the central bank raises interest rates to reduce investor euphoria, and then a financial institution runs into difficulty. The failure causes a bankers' panic. Turning points in the five stages of the cycle are called “Minsky moments”.

3. The system tends to instability and must be regulated. Fashions in monetary theory have moved from a belief that Keynesian sophisticates could “fine-tune” the economy, to fear that the Fed had lost control of the ability to contain inflation, to a belief that markets work best with minimal interference. Hy rejected all these ideas, preaching consistently about the need for regulation and the importance of leaning against the excesses of what Keynes called the animal spirits of investors.

Born in Chicago, Hy taught at Brown, Berkeley and Washington University (St. Louis). He died 12 years ago in Rhinebeck, 77 years old, near Bard College’s Levy Institute, which has a special interest in business cycles and treated Hy as a star in his last six years. Hy didn’t live to see how closely this year’s meltdowns would follow his predicted scenario, with the Lehman failure being one of several clear Minsky moments.

Former Fed Governor Laurence Meyer, who spoke in New York City last week, has said of Minsky: “few have influenced my thinking about economics more than Hy.” If Hy had been listened to, we would have seen less permissiveness, fewer NINJA (No Income, No Job nor Assets) mortgage loans and more aggressive Federal Reserve and SEC oversight over highly leveraged instruments and institutions.

Fed Chairman Alan Greenspan and then-Governor Ben Bernanke were anxious not to “pop the bubble” because (citing the Milton Friedman-Anna Schwartz history) that’s the mistake the Fed made in 1928 - after the guy who knew what he was doing, FRBNY chief Benjamin Strong, died of TB. The Fed was concerned not to stifle financial innovation, arguing that it is ready with new weapons in the event of an asset-destroying credit freeze.

This last theory is now being tested. The stakes are high, beyond an academic debate. Whatever side one takes, any sensible person should be rooting for the outgoing and incoming Fed-Treasury teams to succeed in restoring confidence and the flow of credit.

US Financial Regulation - 2009

Valuable features of blogging are that you get feedback from comments and from Google's ranking of what you have written.

Ranking high right now is a blogspot post from March 22 titled U.S. Financial Regulation 2008. I argued for broader regulation of the financial markets. President-elect Obama has announced it is going to happen. My post begins:

In late 1999, the bulwark bank regulation of 1933, the Glass-Steagall Act - the wall between investment banks and commercial banks - was torn down. This was a great victory for creative bankers, who had found the wall irksome and restrictive.

The post can be read here.

I cited an FDIC staffer with a distinctive floppy hat warning me 40 years ago about the disastrous consequences of a drying up of bank credit. His comment is particularly poignant given what has happened since March 22.

Would I change anything if I was writing from today's perspective? Yes, I would have added references to post-1999 moves toward financial deregulation. In particular, I would reference a Texas Observer article by Patricia Kilday Hart on May 30. It describes the unseemly haste with which at the end of 2000 Sen. Phil Gramm managed to insert a rider facilitating a market in credit default swaps. The CDSs added a whole new layer of risk to the U.S. financial sector and was a large factor in the credit meltdown.

To their credit (worth noting given that Democratic legislators have recently been criticized as deregulatory co-conspirators), former SEC Chairman Arthur Levitt and Sen. Chuck Schumer both expressed deep concerns about the new law. Levitt worried about the increased leverage and risk that CDSs would create, and the splitting of regulation between the SEC and the Commodities Future Trading Commission. Sen. Schumer agreed with him and told Sen. Gramm, Chairman of the Banking Committee, that "I would rather do it right than do it quickly." See the Joint Committee Hearings on S. 2697 - The Commodities Future Modernization Act of 2000, pp. 45-46.

What's on the Bernard L. Madoff Website Now

The links are operational on the Bernard Madoff website - http://www.madoff.com. If you check and what you find differs from what follows, please email me at john@cityeconomist.com and I might do a followup.

Saturday, December 20 02:38 ET
On December 15, 2008, the Honorable Louis L. Stanton, a Federal Judge in the United States District Court for the Southern District of New York, appointed Irving Picard as Trustee for the liquidation of Bernard L. Madoff Investments Securities LLC (“BMIS”) pursuant to the Securities Investor Protection Act (“SIPA”) as set forth in the attached order. LINK

Mr. Picard supersedes Lee S. Richards, the previously appointed Receiver for BMIS and all claims by customers of BMIS will be processed by Mr. Picard as SIPA Trustee. Customers and claimants should refer to the website of the Securities Investor Protection Corporation for information about the processing of claims. SIPC.ORG

Mr. Richards continues to serve as Receiver for Madoff Securities International Ltd. pursuant to the attached order. LINK

The Trustee Irving Picard has engaged Lazard Frères & Co. LLC to assist in the sale of the trading operations of Bernard L. Madoff Investment Securities LLC.

Should you have further questions, please contact the Trustee at the following number: 888-727-8695.

Copyright ©2008 Bernard L. Madoff Investment Securities LLC. All Rights Reserved.
Member FINRA & SIPC

JOBS | Maloney–NYS Lost Big from Big 3 Shutdown

A feud of sorts has broken out between Tennessee and Michigan. A Tennessee senator led the battle against approving a proposed bailout of the Big 3 auto companies. Tennessee is the home of some automobile factories owned by foreign-based manufacturers.

Joining the argument now on the side of Michigan, Rep. Carolyn Maloney (D-NYC) has issued a report that reminds New Yorkers that 150,000 New York State jobs are dependent on the U.S. auto industry. Of this figure, 3,000 jobs are in GM and Ford plants. The rest are in auto parts and other suppliers of goods and services to auto manufacturers, dealerships, and indirect losses from suppliers of goods and services to the auto workers who lose their jobs.

The job loss would be the largest single-year loss since 1991, says Rep. Maloney, using data from an Economic Policy Institute report. The EPI report provides data to show NY State could lose 144,600 jobs if the Big 3 shut down -- out of 3.3 million jobs at stake nationally. The NY State comptroller has predicted that New York could lose as many as 225,000 jobs over the next two years. The 150,000 possible lost jobs would presumably be in addition although there may be some overlap in the projection methods.

A Bush Administration spokesperson has argued that a fallback possibility (given that the outgoing Senate refused to vote for an auto industry bailout) is for an "orderly" bankruptcy of GM and Chrysler instead of a bailout. President Bush on December 19 announced $13.4 billion emergency loans to GM and Chrysler, with $4 billion more in February, provided the companies develop reorganization plans that show they can become profitable soon.

This is what Rep. Maloney has been calling for, i.e., immediate use of some of the TARP funds to buy time for the automakers. Ford is not in such dire straits as the other two of the Big 3 and can reportedly operate for another year without government support, but joined in the request for immediate aid.

Rep. Maloney is among those who have been mentioned as possible candidates for the NY State Senate seat that is expected to be vacated by Sen. Hillary Clinton when she takes up the position of Secretary of State in the Obama Administration.

New Yorkers Suffer Collective Anxiety Disorder

Economic uncertainty has contributed to a 7 percent spike in prescriptions for sleep aids and 5 percent growth in anti-depressant and anti-anxiety drugs in New York City compared with a year earlier. The data are published by Crain’s New York and were collected by Wolters Kluwer Health, a global provider of medical information.

The spike was particularly evident in September, when an economic tsunami bankrupted Lehman Brothers Holdings Inc., forced Washington to bail out insurer American Insurance Group Inc., prompted Bank of America Corp. to rescue Merrill Lynch & Co., and led Goldman Sachs Group Inc. and Morgan Stanley to reorganize as bank holding companies.

“If we looked to diagnose the city, I would say it has an anxiety disorder,” said Mel Schwartz, a psychotherapist with practices in the city and in Westport, Conn.

The following link to a short video is not from the Crain’s article but provides advice for those who are suffering from Irritable Bailout Syndrome – see Doctor Decline.

Not My Dad's Fed

I went to work for the Fed in 1964, when William McChesney Martin, Jr. was Chairman. He would be surprised at the activism of today's Fed as it drops the equivalent of napalm on the dangerously frozen peaks of our financial landscape. Back then I was a financial economist in the Division of International Finance headed by Ralph Young, editor of the third edition of The Federal Reserve System: Purposes and Functions, 1954. (The first edition was drafted by the great Bray Hammond in 1939.)

The marble building at 21st and C Streets hasn't changed much since 1964. But three things definitely have - the link to gold, the size of Fed assets and the reach of the Fed into financial markets.

1. Link to gold broken. Back in 1964, the Treasury bought gold at a fixed price of $35 an ounce from private owners of gold, forbidden 30 years earlier from holding gold for speculative purposes. Purposes and Functions, 3rd edition says (97-99):

Gold is the ultimate basis of Federal Reserve credit and gold movements are an important factor in member bank use of Federal Reserve credit. The power of the Reserve Banks to create money is limited by the requirement of a 25 percent reserve in gold certificates against the total of deposits and issued Federal Reserve notes. All gold that enters the monetary mechanism becomes reserve money of the Federal Reserve Banks in the form of gold certificates. In practice most of their reserves are represented by a credit in a gold certificate account on the books of the Treasury.

The last connection between gold held by the Treasury and Federal Reserve Bank deposits was ended by President Nixon in 1971, under the pressure of the OPEC-led oil shortages. This also ended the gold standard and removed the cornerstone of the Bretton Woods system.

2. Increase in Federal Reserve assets. Fed assets from 1920 through 1953 are shown in Purposes and Functions, 3rd edition. They rose from $6 billion to $53 billion in 33 years.

Combined Assets, Federal Reserve Banks ($bil.), Year-End

Asset Category	1920	1930	1940	1953
Gold certificate reserves	2.06	2.94	19.69	21.34
U.S. Govt. securities	0.29	0.73	2.18	25.89
Discount loans to member banks	2.69	0.25	0.00	0.42
Subtotal	5.04	3.92	21.87	47.65
Other assets	1.21	1.28	1.28	5.18
Total	6.25	5.20	23.15	52.83

Source: CityEconomist based on data from The Federal Reserve System: Purposes and Functions, 3rd ed., 187.

Fast forward to November 2008. Fed assets were growly slowly toward the $1 trillion mark until the freeze hit and Fed assets (Reserve Bank credit) more than doubled from a year earlier, to $2.17 trillion as of December 3. The President of the Dallas Federal Reserve Bank opined in early November that Fed assets will reach $3 trillion by the end of 2008.

3. Market Operations

A "bills only" policy was abandoned in 1961, but a "bills preferably" goal still made sense because open market operations to pursue monetary policy are easiest to manage in the most liquid part of the market, the short end. In recent weeks, however, the Fed's efforts to defrost bank vaults have driven the return on Treasury bills to zero and the Fed has no choice but to operate at longer maturities.


Former Fed Governor Laurence Meyer is speaking to the New York Association for Business Economics on December 17. The title of his talk is: "Monetary Policy: Whatever It Takes." That says it all.

JOBS | Dismal News for U.S. Metro Areas

I posted this a few hours ago on Huffington Post. Unemployment tends to lower tax revenues to states and localities and raises expenditures, so it's one of the contributors to the fact that 41 states are facing budget gaps, some of them daunting.

When the Governors appealed to President-elect Obama for help today, they had support from today's Bureau of Labor Statistics release of dismal October unemployment data for metro areas.

Metro area unemployment rates (not seasonally adjusted) in October were above the October year-earlier rates in 361 metro areas and below in only eight. Unemployment rates exceeded 10 percent in 13 metro areas and were below 3 percent in 11. (The national unemployment rate in October rose to 6.1 percent from 4.4 percent a year earlier.

Unemployment exceeded 7 percent in 98 metro areas, increasing from 16 areas a year earlier. They were below 4 percent in 43 areas, a drop from 151 a year earlier. The highest unemployment was in El Centro, Calif., 27.6 percent. Next highest was in neighboring Yuma, Ariz., 19.5 percent. The lowest unemployment rate was in Bismarck, N.D., 2.2 percent. Next lowest: Logan, Utah-Idaho, at 2.4 percent.

Overall, 148 areas exceeded the U.S. average rate of 6.1 percent and 216 areas reported rates below the U.S. average. This suggests that metro areas on the whole remain better places to find jobs than rural areas.

El Centro, Calif., had the largest increase in unemployment from a year earlier, 6.8 percentage points. The next-highest increase was in Elkhart-Goshen, Ind., 6.3 points. A total of 33 areas had increases of 3 percentage points or more. Another 92 areas had increases of 2.0 to 2.9 points. Jonesboro, Ark., fell the most from a year earlier, -0.6 percentage point.

Of 49 metro areas with a 1 million or more population, Riverside-San Bernardino-Ontario, Calif. had the highest rate, 9.5 percent. Eight other large areas posted rates of 7 percent or more. The large area with the lowest rate was Washington-Arlington-Alexandria, D.C.-Va.-Md.-W.Va., 4.1 percent. Next lowest: Oklahoma City, Okla., 4.2 percent.

All 49 large areas registered higher unemployment rates than a year earlier. The area with the largest increase was Providence-Fall River-Warwick, R.I.-Mass. (+3.8 percentage points). Next largest: Riverside-San Bernardino-Ontario, Calif. (+3.2 points). Fourteen other large areas had rate increases of 2 percentage points or more, and 29 other areas had rate increases of at least 1 point.