Meanness, Mediocrity, and Bank Reform

It takes a particularly virulent form of mean spiritedness for a nation to walk away from its most vulnerable citizens at a time of their greatest need. Yet that is what the US, and by implication you and I, has just done. The Senate was unable to muster enough votes to continue the extension of long term unemployment benefits. So they lapsed. The cost would have ben small in the context of our overall deficit. The impact would have been enormous for the thousands of families whose lives have been turned upside down by the corrosive effects of long term unemployment.

Do we care?

No.

We have become a nation so narcissistic and incapable of community action that we simply don’t care.

I fear for the children of those families.

And I fear for the future of any country so implacably opposed to generosity during difficult times.

This was a supremely mean action. It will have practically no impact on the trajectory of our debt. It panders to the puritanism of the right wing who are relentless in their Victorian era desire to impose punishment on the poor, as if being poor or unemployed was driven only by moral incapacity. That horrible and nonsensical attitude still rears its ugly head in Anglo Saxon economies, and is embedded in the roots of modern economics as well. Orthodox economists believe – or at least they teach – that being unemployed is a choice. To them anyone without a job has chosen not to work. So providing benefits to the unemployed to mitigate the effects of unemployment is a distortion of the workings of the ‘free market’. Naturally the puritans love this nonsense and have latched onto it in order to provide themselves with an intellectual legitimacy for their mean spiritedness.

This nasty attitude reminds me of St Augustine who, as ever the fatalist, told the slaves of his era that they must have sinned badly in the eyes of god for him to have made them slaves. His advice was to grin and bear it. And to try to pray a lot.

When historically significant preachers set this kind of example for the elite to trample on the poor, it comes as no surprise to read of the Senate’s nasty attitude.

Moving on:

Today’s report that GDP grew only 2.7% in the first quarter has been treated both as a surprise and a disappointment by the financial markets who imagined things were going better than that. I say ‘imagined’ because the evidence has been accumulating for weeks now that we are experiencing an entirely mediocre upturn. One that continues to be very vulnerable to weakness. Much of the disappointment seems to stem form the fact that every time the government has issued a first quarter GDP report the numbers have been worse. Today’s release is the third and final estimate. The first estimate was for 3.2% growth. That was trimmed in the second estimate to 3.0%. We finally settled at the 2.7% announced today.

That is not a very good growth rate for only the second quarter of recovery. Typically the US economy goes through two or three quarters of rapid growth – well over 4.0% – before settling back down at its historic 3.0% level. That we haven’t had such an experience this time merely reinforces my opinion that the economy was much more damaged by the banking follies of earlier this decade than many others give it credit for. Allow me to repeat: recoveries following financially rooted crises are always – always – more difficult and prone to setbacks. This is an empirically supported observation. Unfortunately it is not well known in academic economic circles because it is the outcome of research by non-traditional economists. Since my more orthodox brethren don’t read heretical works, like those of Keynes or Minsky, they are blissfully unaware of the dangers we still are facing.

Having said that, even the orthodox folks at the Fed are now beginning to become concerned that growth is not what they imagined it would be. That’s a relief since it removes the prospect of a Fed tightening from the immediate agenda. Any rise in interest rates now would send us downward quite quickly. We are lucky that the gloom in today’s report is sufficient to knock some sense into even the thickest of fiscal hawks heads. Or at least I hope so.

Just to complete the survey of mediocrity I should give you the actual numbers from the GDP report:

Consumption was positive, adding 2.1% to GDP

Private investment was also positive, adding 1.8%.

Net exports [exports less imports] was negative, deducting 0.8% from the total.

Government spending was also negative, deducting 0.4% .

These numbers hide a few important points.

First: the consumption figure is decent, but not great. Usually as the economy bounces back consumption is a major driver as consumers spend more than normal in order to make up for the spending they didn’t do during the downturn.

Second: the private investment figure is misleading. All of the growth came form inventory changes and not from actual investment in things like construction or machinery. Those two sectors were flat, and construction looks to be mired in a long term slump.

Third, and final: the government spending number is very worrying. I have warned of this before. The positive impact of the Federal level deficit is being more than offset by the draconian austerity plans that the States are implementing. While these local actions may appear to make sense to local politicians and voters, they are making the economy much weaker. They are draining spending power from the national economy. In effect the States are hoping that someone else will get the economy moving. The irony is that many of those same politicians and voters then express opposition to Federal deficit spending which remains our best hope for stimulating recovery and allowing those local budgets to recover.

Overall I have to admit that the economy is moving along a track that I see as both very predictable and susceptible to risk. We should expect more mediocrity for the rest of this year.

Let me add my voice to those calling for more support to the economy. I have railed against austerity enough. I believe it to be blindly stupid. Those who want to shift the focus to the long term issues, and in particular our budget problems, are missing the point entirely. Without fixing the short term the long term is irrelevant. This was the driver behind Keynes famous dictum that ‘in the long term we are all dead’. His main point being that dealing with long term, far away, issues is always easier than dealing with immediate and more intractable issues. In his view this ease draws the attention of policy makers and economists away from the difficult and often messy problems of today, while allowing them to present a virtuous facade to the public.

In this case the mediocrity is of leadership and intellect. We suffer from a bureaucratic mindset that frames everything in terms of checklists and rules. So all the solutions on offer are tweaks to existing rules or the addition of new rules. As someone once said: if the only tool at hand is a hammer, all problems look like nails.

Maybe we need new tools.

Finally today, and to add to the mediocrity, we must mention bank reform.

After all the fuss and hand wringing Congress has managed to cobble together a reconciled financial reform bill. Presumably it will get to Obama’s desk before long. The timing of agreement was driven more by political considerations than by the need for reform: Obama is off to attend the latest G20 meeting and wanted to have legislation in hand so the US can dictate the nature of worldwide reform.

The simplest question to ask about the reform is: does it prevent future crises?

No.

What is does is to paper over a lot of the medium sized holes in the system and close down some of the more egregious consumer oriented activities of the banks. It doesn’t have enough strength to stop future melt downs. And it doesn’t prevent the need for future bail outs.

The better parts of the reform focus on the consumer. A new consumer protection agency is created but buried at the Fed. This is a typically lame response to the exploitation of consumers that has characterized banking for years. Remember though that the Fed had oversight for mortgage pricing regulation before the bubble. It did nothing to stop the activities of the worst offenders. Since the Fed remains staffed to the rafters with mathematically inclined economists rather than socially minded attorneys, I doubt this new agency will have the bite that some think it may.

Meanwhile the reform does tighten up the derivatives market somewhat although I suspect that the banks and their armies of overpriced lawyers will gut the intent of the new law within weeks. The ‘Volcker’ rule survived in muted form to reduce bank speculation, and the ‘Lincoln’ initiative also made it through to force banks to offload their speculative book of derivatives into non-Federally insured subsidiaries. Quite what this achieves I am not sure. The simple question we need to ask is: will the regulators allow Citibank to go belly up because its non-insured book of derivatives goes bust and threatens the mother ship? No I don’t think so. Thus the Lincoln plan is window dressing. The Volcker rule has more merit because it simply bans certain activities, specifically the use of low cost Federally insured deposits as a funding source for non-client based speculation. The problem is that the ban is not tight or comprehensive enough. The boys still have plenty of matches to play with.

Other aspects of reform are also humdrum. The big banks will have to cough up some cash to create a bail out fund, so that future bail outs will not come from the taxpayers. This raises the interesting question: why do we need this provision if the reform ‘stabilizes’ the financial system, which is Geithner’s claim? The obvious answer is that no one really thinks we will avoid future bail outs. Nor is the amount anywhere near enough in the context of the behemoth banks that now populate our system.

Finally the much ballyhooed liquidation process for big banks, while it sounds great, will immediately run afoul of international complications. Unless there is a uniform world wide and coordinated approach to bank bankruptcy procedure no amount of huffing and puffing here in the US means much. It certainly does nothing to end too big to fail.

And that is, in my mind, the really big issue. This reform does not eliminate banks that are too big to fail. All it does is to provide some nice rules for future bankruptcy procedures and to mitigate some, but not all, the causes of the past crisis. Our legislators are intent on, and content with, planning to fight the last war. That makes them feel good, but does not solve our central financial problem. While the dinosaurs still roam and dominate finance we are destined to endure more crises and suffer through an oligopolistic market where competition is stifled by the lumbering bureaucracies we call the big banks.

Oh well. I suppose some other president can solve that problem. The current incumbent wants to punt.

Mediocrity indeed.