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Volcker and Banks

We have reached a crucial point in our attempt to bottle up the banks. It looks as if they will win. That means the economy will lose, and the likelihood of a new crisis immediately jumps. Read your Minsky. And weep.

There is a looming deadline in the Dodd-Frank regulations that requires rules to go into effect to govern proprietary trading. As you all know by now I am ardently opposed to banks being allowed to speculate. I refuse to call speculation ‘banking’, which is a term I like to reserve for the very dull and prosaic process of credit extension based upon sober analysis. It was yahoo trading that launched us into this crisis as banks sought short term profit at the expense of any semblance of banking rectitude – the creation of all those unnecessary derivatives in order to meet insatiable trading desk demand for commodities to move about was the ultimate reason the mortgage market mutated into a cancerous mess. Bankers still have not paid the price – personal price – for their role in casting us all over the cliff. Yes, we aided and abetted with our debt splurge, but sound credit analysis would have mitigated against our ways. We rely on banks to be measured, and not to be at the forefront of folly.

So, in my mind, it is essential to eradicate – totally – any temptation to indulge in such self destructive trading. This will not overcome the ever present dangers of credit extension. Banking will always be fraught with uncertainty, and so will never be cleansed of cyclical losses. But there is no need at all to accelerate the conflagration by adding speculation to an already combustible mix.

Banking is too important to the proper and socially beneficial workings of an economy to be left to bankers. They have amply demonstrated that they cannot, and should not, be left to regulate themselves. I say this as someone who spent more than a little time in the mid to late 1980’s writing position papers for bank lobbyists dedicated to the abolition of the twin regulations of the Glass-Steagall and the MacFadden Acts. How naive I was.

The problem bankers face is that traditional banking is pedestrian. It moves slowly. It is riven through with bureaucracy. It resembles a tedious department of the government in its red tape, rules, and other restrictions. It produces a clodden return for its shareholders. And it is hardly a stage on which a go-getter post grad business school ace wants to act.

Trading is a lot more fun. So is playing with fireworks. It is exhilarating. Dangerous. Filled will thrills and spills. And very profitable. Sometimes. The rest of the time the losses will wipe out all those gains. Over any decent span of time speculation ends up being a lot less attractive. The losses and profits tend to offset each other. The problem is that when trading gets jumbled in with banking – where margins are wafer thin most of the time – a single error can destroy years of steady progress. Capital can get swallowed up quickly. Liquidity evaporates. And bankruptcy beckons even though large swathes of the bank’s assets are sound. More importantly, such a disaster freezes the banking system, produces a credit crunch, precipitates a recession and thus swallows regular people, jobs, households and a lot else besides. We just lived through such an event. It is hardly a fictional creation.

As I said – banking matters. We need sound banks. Which means we need to reform our current banks because they are not sound. Or, at least, sound enough.

This is why trading should never, ever, co-mingle with banking.

Which is why a hard and fast ban on proprietary harding is essential as we re-build our banking system.

At the moment the bankers are pressing back against the implementation of the so-called ‘Volcker Rule’, named after Paul Volcker the former Fed chief. His rule would carve out trading from banking in a manner similar to the old Glass-Steagall Act. The banks are throwing up all sorts of dust in order to distract politicians, and are getting serious help from big business and foreign governments all of whom seem to fear a loss of market access.

Those fears are palpably nonsense.

I don’t recall big business and foreign governments having a hard time getting access to US money markets back in the Glass-Steagall era. Indeed I recall all too vividly some banks regretting being involved in sovereign lending. Nor do I recall big business being hamstrung by a lack of credit. On the contrary big business was a center of financial innovation as it developed all sorts of new funding devices to expand its way into direct market access. It was the banks fearing losing market share, not big business fearing tight credit, that drove, in part, the fight against Glass-Steagall.

This debate over the Volcker Rule is emblematic of the power struggle that sits at the heart of our economic recovery. This is a fight that we cannot lose. To do so condemns us to continued subsidy of the banking system, and to heightened risk of economic collapse in the near future. The big banks are preposterously sized with respect to even the US economy. They are grotesque giants capable of sinking us with one incorrect derivative decision. Their power has not been eroded sufficiently to rein them in. Only breaking them up will accomplish that task. Even with a full implementation of the Volcker Rule, behemoths like JP Morgan Chase, Bank of America, and Citibank will continue to lurch about the economic landscape supported by our subsidy which enables them top raise money much more cheaply and in much larger quantities than they could were they truly private organizations. Their quasi-public status allows them to make poor decisions – which they do with alarming frequency – and offload the consequences onto us. All while their managers benefit from rotten bonus incentives and lead the continued march towards greater income inequality.

This anti-social behavior has to stop. It is undermining democracy. It is ruining our economy.

Full application of the Volcker rule is urgently needed. But it is only a first step. Our bureaucrats may think they can devise subtle plans to deal with future bank failures. They cannot. All their clever plans will dissolve at first contact with a ‘too-big-to-fail’ event. The panic will force accommodation. The bankers will re-surface to pillage us again. Only breaking the banks into smaller chunks will prevent them from being the danger they became after deregulation.

The Volcker Rule is a beginning. It is not an end.

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Sales Point the Way

The stock market sagged at the sight of today’s retail sales report. The news was note as good as Wall Street had forecast, so stock prices had presumably anticipated something that didn’t exist. What a shock.

Coming out of the end of last year some forecasters had begun to hyper ventilate about 2012 being a breakout year. Sales, employment, production, and confidence were all moving in the right direction, and even the Fed was beginning to see healthier GDP prospects. This led to some folks getting a tad carried away and forecasting retail sales growth of about 1.0% in January. So the report of a mere 0.4% rise was something of a shock.

It ought not to have been.

Much of the rise at the end of last year was a typical late recession, early recovery, burst of ‘pent up demand’ for big ticket items such as cars. Look through the data and you see automobile sales being critical to the increase from fall onwards. In order to make those purchases households reversed their steady de-leveraging and ran up some extra debt. This was unlikely to be a sustainable trend, so sales were bound to level off. Which the January report shows they did.

It was only if you accept that the recovery was truly solid and that households had reached a comfortable debt to income level that you could then look to a period of robust sales. Even then incomes don’t provide any real help. Indeed stagnant wages will be a primary source of weakness for a long time to come. What aggregate income growth we saw – and what also fed into sales growth – was not a rise in wages, but a rise in total incomes driven by rising employment. This is a real trend and will help us throughout 2012, but eventually we will arrive at a point where the absence of wage increases will act as a brake on growth.

So, in my view, we are riding a small wave at the moment, we are not seeing the emergence of anything more than the consequences of having more workers earning wages, coupled with a more general feeling of well-being as the crisis continues to recede. Those two are the factors driving sales. Nothing more.

So looking for the kinds of growth rates Wall Street was forecasting was based on a misunderstanding of what’s going on at ground level.

Having said that, we should not under-estimate growth either.

Sales grew across the board. The big box stores saw growth of around 2.0%; and sales at bars, restaurants, bookstores, and music stores all grew by between 1.0% and 1.5%. Things are generally much better than they were a year ago. The only sales that declined were at online outlets where both internet and mail-order sales dropped by about 1.1%. This may simply be a seasonal oddity, but it is worth watching over the next month or two.

So. What to make of this?

Not a great deal. Ignore the stock market reaction – safe advice under normal times and especially at the moment – and watch wages, employment, confidence, and debt ratios. They are all moving in the right direction, but slowly. Sales won’t move much differently. Nor will GDP. The outlook for modest growth stays in effect. Especially during a year infested with political hyperbole and grandstanding.

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Getting Trendy

The economy is all about trends and tendencies. We have to watch data over longer periods in order to identify where it is headed because short term or one-off bumps and leaps can mislead us easily.

In that context we should pay attention to today’s news that new claims for unemployment assistance dripped 15,000 to 358,000. Not only is that a good week-to-week improvement it helps bring the four week moving average down to 366,250, which is the lowest it has been since 2008.

Couple this news with last week’s employment report and all the anecdotal information we are receiving about hiring, and there is no doubting that the economy has entered a new and more optimistic phase.

Thing are looking up.

But.

Given the depth of the crisis we need to pause a moment and dwell on another trend: continuing claims rose 64,200. There is a dramatic bifurcation taking place in the unemployment roles. The short term unemployed are getting back to work much more easily, and fewer are being added to the rolls. Yet the longer term unemployed are having greater difficulty finding work, and many are simply leaving the workforce. It is easy to overplay the drop in workforce participation which has shrunk markedly through the crisis, but it is something we need to watch carefully. We need to make more effort to ameliorate the effects of long term unemployment via re-training and other measures. This will stop the erosion of skills that prevents the long term unemployed from returning to work.

That and we need to stop vilifying them as being lazy, unskilled, and living off our largesse. Only right wing economists and way out right wing politicians believe that the unemployed are naturally indolent who need to accept their fate and take low wages in order to get the job market back humming again.

Speaking of which Charles Murray’s new book ‘Coming Apart, and the Culture Myth’, has received far too much attention. Its central premise is that our long term problems are due to a drop in social values. Were our workers only to become good church goers, to stay happily married, and to keep away from temptation, our economy would hum once more, just like it did – in Murray’s mind anyway – way back when.

This repulsive and shallow analysis is simply a regurgitation of late Victorian and early Edwardian upper class twaddle. It recalls the dusty years of a fading empire when the elite realizes that its formula is no longer working. Since elites have a hard time coming to terms with the illusions upon which they imagine their success to be built – they routinely mistake the causes of success, and imagine their superiority is based upon exceptional values or work ethic rather than good luck – they then begin to preach to the unwashed. Murray has fallen down the same hole. It is naive and counter productive to think that social values will magically transform our economy, allow us to compete with global competitors, and re-balance our debts all with one deft sweep of the arms. It will be harder work than that. Work that begins with getting working wages to grow and not languish in the gutter.

That and eliminating an economic theory that argues all unemployed workers must value leisure more than work, and thus all the unemployed must be voluntarily so. There are a few economists I can think of who I wish, for a while, could test that stupid theory empirically. Now that would be a trend in the right direction too.

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The Art of Bankers and Economists

The big question, and one I have been asked several times this morning already, is this: does the good jobs report last week signal a major shift in the economy?

No.

Clearly the tone of things has changed, but there are still large reservoirs of under-used resources to be brought back on line before we can talk about a healthy economy. This entire recovery has been one characterized by baby steps. Our economy seems nowadays to be akin to a supertanker, lumbering, slow, making very long turgid moves, unable to make quick transitions. The days of fast recovery are a distant memory.

This, of course, is partly due to the nature of our recent crisis. The financial sector and the run up in household debt combined to undermine everything. Digging out from the catastrophe that our banks wrought is necessarily difficult. Particularly since they remain unchastened, under-capitalized, and way too large for our own good. Beware: the banks will be the cause of our next downturn.

Which leads me to a beef of mine, something that has dogged me throughout the crisis. I wish we could stop calling the yahoos who destroyed our economy ‘bankers’. In my day we referred to them as ‘traders’. Its a better description of what they do. They sit at desks and move mountains of money about. They do not do banking. They trade. Their incentives are built around rapid movement of bulk capital and cash in order to turn wafer thin spreads into huge profits. It is a volume business. It is largely self-contained. It has very little to do with banking.

Bankers take positions. They own the assets they create when they lend. They husband those assets when necessary. They are in contact with customers. They assist when credit weakens. They build reserves to offset losses. They stay very far away from speculative capital flows. They are the epitome of dull and boring.

We need bankers. We don’t need traders.

Our problem, which was emerging during my tenure in banking, is that our major banks are all run by traders. They have extremely short term decision horizons, and they believe they can fudge risk away by offloading it on other banks or by insuring against it. Every single bank seems to think it can accomplish this risk immunization. Hedging is everywhere. Structured finance sits precariously on top of a narrow foundation of basic assets that are not at all altered by the fun and games erected up above. The risk still exists, only it is masked behind accounting conventions and tricky book entries designed to fool regulators and shareholders into believing a 30:1 leverage ratio is not just sensible but is sound to boot.

I would laugh at this were it not so damn dangerous to you and I. These indescribably ignorant fools have the ability to ruin our economy. They will do so again. Soon.

Why?

Because we didn’t punish them. Nor did we have the courage to rid our politics of their influence. Their money still flows. So their games still continue. Until JP Morgan Chase, Citicorp, Wells Fargo, Bank of America, and the others are broken into little pieces, and until we have re-established a separation between banking and trading, our economy is not safe. It is as simple as that.

And we are not there yet.

So, while the economy may be turning around in its pondering way, we cannot be assured this recovery will last.

Further: we are now being treated to an object lesson in the irrelevancy of economics.

The good jobs news has brought to the fore the great divisions within economics. Those of you who are new to the subject might be forgiven if you imagine it to be a scientific pursuit laden with sage insights and bursting with solid advice. Not at all. It is an art. It is an adjunct to politics. It is full of ideological axiomatically driven bias. Its object is to discuss its own artifacts not those of a real economy. Thus it expends derisory amounts of time on a general equilibrium that no one, not once, has actually witnessed. It stylizes consumers as being automatons with inhuman cognitive capacities. And it flattens business firms into a ludicrous other wordily construct that no business person I know would recognize, let alone dignify as a grown up interpretation of what goes on. This is all done in order to pursue the holy grail of determining, definitively, that markets are more efficient than any other form of allocating mechanism – like the government for instance. At the end of all this its more honest adherents will admit the entire enterprise is disconnected from the real economy, while its more ardent defenders will argue this paraphernalia actually helps interpret the real world.

Quite how, I am at a loss to say. But there we are.

Meanwhile the more politically connected representatives of this melange of arts get involved in the debate about the jobs news.

One side, represented by the infamous Glenn Hubbard – of ‘Inside Job’ notoriety – says that the pick up in employment is despite Obama’s policies. The other side, represented ably by Larry Summers – the leader of bank deregulation amongst other oddities – says that the gain is entirely due to those self same policies.

Nothing could articulate for you the irrelevancy of economics more clearly. Which is it? Did those policies help or hinder? A scientist could answer that question. An artist can always paint a picture or tell a tale to defend whatever side needs a good story. Some people like abstract art. Some people find orthodox economic theory appealing. Whatever pleases your eye. And whatever plays into your preconceived views. Capitalism is great. Or it is an abomination. Economists have no idea which. But they can sure as heck talk about it. As artists they are unsurpassed. The stories they tell are riveting. The pictures are full of color and texture. Our walls and libraries are copiously equipped with the product of economic artistry.

The connection between bankers and economists, beyond their artistry, is that they have the power to be really dangerous. They both believe themselves in possession of magic that allows them to defy uncertainty. They have concocted recipes for brews and potions that addle the rest of us into thinking that we, too, are free from the ravages of uncertainty. Since that is so alluring, we were in their thrall.

Then they trashed the place.

Only to emerge as the people we turn to fix things. Now the bankers are called creditors. They’re the ones calling for wisdom and sacrifice on the part of the devastated economies. And the economists are the ones we turn for the wisdom and to organize the sacrifice in order that we all may return to our happy ways. So the economists negotiate with the bankers on our behalf in order to right the wrongs they wrote.

How did that happen?

I don’t know.

But it goes to show how relevant irrelevancy can be.

Alice in Wonderland?

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Buyer’s Remorse?

Some of you are no doubt aware that Sir Fred Goodwin is no longer Sir Fred, but simply Fred. The UK government has an obscure department tucked away deep within its wood paneled bureaucracy that has the power to reverse awards like knighthoods. So whereas once Fred was a poster child for aggressive capitalism, and thus was invested as Sir Fred, he, having fallen calamitously from grace and having taken the Royal Bank of Scotland with him, is now relieved of his title and has reverted to being one of us – a mere commoner. He is Fred once more.

This is a tad perverse. I think it’s silly to give out titles anyway, especially knighthoods – where exactly was Fred’s horse and armor? – but this idea of taking it back just makes the first error more noticeable.

I recall being given Tom Peter’s run away business best seller back in the 1980’s. In it he described the business practices of a series of supposedly excellent firms, the kind we all ought to emulate. The CEO of our bank wanted us to absorb the lessons carefully, copy them, and propel our little enterprise to the top of the performance list. As it turns out it was a good job we failed, lamentably, to replicate their success. Most were dismal failures a few years later. The lesson is obvious: business success is short lived and almost entirely due to good luck. This is as it should be in an uncertain world. Indeed it is exactly what we would predict.

But, no matter, the UK government’s u-turn prompts me to wonder what other titles need to be rescinded now that history has had its way with lofty reputations. I have few winners of the economics pseudo-Nobel prize in mind.

What about you?

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