IMF

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Weekend October 12, 2012

What a strange week.

The paucity of hard economic news was punctuated by a quite remarkable mea culpa issued by the International Monetary Fund. Or rather the punctuation was provided by the chatter within the commentariat about the apparent regret the IMF has in arguing for austerity prior to the full recovery of sundry economies that it monitors.

You see, the IMF has suddenly come to the realization that cutting government spending is not an expansionary policy. Nope. The numbers don’t add up that way. Austerity is, as has long been advocated here, a one way ticket to contraction. Now the IMF doesn’t quite come out and say whoops. Instead it uses the usual jargon laden obfuscation of economics. It even consigns its volte face to a marginal column where only the commentariat will notice. I imagine this is so the general public of those nations deeply down the road in failed austerity driven attempts to expand will not notice and express their rightful anger at having been sold snake oil and not efficacious policy.

Austerity led expansion is snake oil no matter how you bottle it. That millions of unsuspecting people had to suffer ruin in order for the dolts at the IMF to re-read their history books and re-learn the lessons of the 1930’s is a tragedy. It ought to be a criminal offense – the harm justifies severe punishment. Somehow I doubt we will see hordes of IMF economists being carted off to jail. But its nice to dream about.

The way the IMF packages its mea culpa is sweet: it has discovered, gasp, that the multiplier on spending cuts is more than one.This means that for every dollar of expense reduced the economy loses more than one dollar of GDP. Duh. This seems to me to be a basic lesson of history. Of course it’s a lot more complicated than that, but there’s nothing in the complication not already well documented in Keynes. His entire masterwork is dedicated to learning, explaining, and generalizing from the lessons of the disastrous policies of the 1920’s and 1930’s. It’s all there sitting in the library. The IMF only had to read it. But it didn’t. Not until it had wrought unbelievable damage.

Not that the IMF is alone in its folly. Most central banks, economics ministers, and policy officials seem all in the thrall of the voodoo that superseded Keynes. The absurd belief in market magic and supply side boosterism would be laughable were it not so persistent and damaging. Worse: when the damage started to accumulate and the evidence pointed irrevocably to the failure of supply side magic it took far too long for folks like the IMF to climb down and admit to error. The arrogance of orthodox economists was toxic to social welfare. They put their own reputations and wellbeing ahead of those whose lives they destroyed through the imposition of their ill-founded theories. That their ideas had been debunked decisively seventy years ago apparently was no barrier to their determination to force us all to accept their righteous opinions.

And here’s the real kicker: the biggest culprits are still at it. There are nations who have less wiggle room than others. Some element of austerity may be unavoidable there. But in others, notably the UK and the US, there is no excuse whatever. Taking fright at debt to GDOP ratios well below historic highs bespeaks to weakness not strength. An unwillingness to borrow at zero interest rates is a folly future generations ought to deride in no uncertain terms. Specious argument upon specious argument has been piled up to defend the unnecessary decimation of economies. Why? Ideological lunacy. And unfounded moral sensibility.

Well at least the entire episode has exploded once and for all any pretension economics had to being scientific. Science progresses by correcting its errors. It keeps refining its explanations and laying bare what it fails to explain. Economics, in contrast, magnifies its error by embedding them in its axiomatic foundation, thus avoiding having to discuss them, and so refuses to learn. It is regressive rather than progressive. Right now it is sitting somewhere in the year 1870 waiting for a reason to go further back. We can expect a Marxist critique of capitalism any day now. How new and refreshing that will be. Or has that already been done?

Anyway, at least we learned this week that IMF was wrong and that it knows it was wrong.

I suppose that’s progress.

Maybe.

 

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Buddy Can You Spare … $6,000?

Wow. The IMF really knows how to annoy me. I know they’re well meaning, by and large, and are trying to provide super analysis of our current crisis so that politicians everywhere have ample background against which to develop their plans.

But.

Do they have to let me know just how much this will all cost? They do. And it isn’t a pretty picture.

Their latest effort suggests that when the dust finally settles on the Great Recession and we have stabilized the banks the taxpayers will have spent approximately $1.9 trillion on the banks alone.

Naturally I wanted to figure how much I should contribute, so I did the math. Assuming there are about 320 million Americans, $1.9 trillion comes out to about $6,000 each. Give or take.

Ugh.

Now this is a projection and assumes all sorts of arcane stuff like the rate of loan losses given various factors such as unemployment and so on. But it isn’t a wild guess. It has all the hallmark of a very clever calculation.

Which makes it even more annoying.

They figure that the current $700 billion TARP will be nowhere near enough. Right now the administration has TARP in its budget as a loss of $250 billion. The difference between the $700 billion and the budget amount is their expectation of the toxic assets that will eventually turn out to be not so toxic after all. The IMF is a tad more skeptical. They obviously have a dimmer view of the chances of recovery for those toxic assets so they set aside $450 billion for this ‘direct’ intervention part of the overall bailout.

Next they calculate the cost of all the indirect stuff that the government is doing. Like the cost of coming through on the FDIC guarantees of various institutions and programs. That is projected to cost us about $800 billion.

Finally there’s all those programs the Federal Reserve Boards has been running to pump liquidity into the economy and to provide ‘non standard’ assistance for the banks and other financial companies who come knocking at its door. That’s costing us about $600 billion.

Add in some loose change and you arrive at the $1.9 trillion.

That is approximately 13% of our annual GDP. It’s a ton of money.

Needless to say the administration doesn’t agree with the IMF. Apparently the Obama team thinks the IMF is being far too conservative in its loss estimates so it’s sticking with its budget numbers for TARP.

Even so this is not a cheap exercise.

Which is why stuffing the financial genie back in the bottle is so important. And why keeping the costs to a minimum is crucial. When the range of estimates from best case to worst case has a spread of about $400 billion [best case cost $240 billion; worst case cost $640 billion] then everything you can do to limit the damage is crucial.

That’s a lot of schools. A lot of health care. A lot of anything.

$6,000 for every single one of us. That’s just to keep places like Citibank, Goldman Sachs, Bank of America, and JP Morgan Chase afloat.

Frankly I have better things to do with my $6,000 than to support the evidently needy folks on Wall Street. Somehow, when I meet them, they don’t look too needy. They seem to be living quite well, even though they just destroyed trillions of shareholder wealth. I know they’re going through the pain of giving up one or two of their houses. And the kids may now have to go to a lesser elite school. And that Upper East Side apartment may have to be downsized to something less ostentatious. And a couple of the annual trips may have to be curtailed. And … rats! Now I’ve let my anger leak through.

I know. I know. We need to save the banking system. I am the first to argue that. In fact I am all for saving the banks.

Its the bankers I don’t want to save.

I really don’t.

Maybe we can have a new plan?

We could each throw in $3,000 to save the banks. And then set up a voluntary pool to save the bankers. We could all contribute to this second pool according to our sympathy for them, up to a limit of an additional $3,000. Or maybe we should just be alowed to apportion our own $6,000 between the bankers and the banks.

I know how much I’d give to save the bankers.

What about you?

$6,000. That just bugs me. Thanks a lot IMF for pointing that out.

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Sometimes the Truth Really Hurts

I have just managed to spend some time reading through the IMF’s recent Global Financial Stability Report. And yes it’s tedious at over 200 pages in length. Suffice to say that this is not the stuff young children should be allowed to read: the numbers are staggering.

Martin Wolf at the Financial Times offers a great summary of the report so I won’t repeat it. You all should add him to your regular list of reading: I think he is one of the best analysts on world affairs out there.

But, for those of you who want a sample here are some numbers to get your arms around:

  • $4.4 trillion. That’s the total of all global banking write-offs expected at the moment.
  • $2.7 trillion. That’s the write-offs in the US alone. Just to show how fluid the situation is: this level of write-offs compares with the last IMF estimate back in October of only $1.4 trillion.
  • 37 years. These write-offs represent 37 years worth of foreign development aid at 2008 levels.
  • 13%. The write-offs represent about 13% of the GDP of the countries involved.
  • $8.9 trillion. This is how much governments worldwide have spent so far in providing aid to the financial system. And that looks like just a beginning.
  • $500 billion. The amount of new capital US banks need to get back to a 17 to 1 capital ratio, which is barely adequate.
  • $25.6 trillion. The amount of bank assets that will mature and need to be replaced between now and 2011. Yes that’s $25.6 trillion!

As you can see these numbers are simply breathtaking. They tell a story of an industry not just run amok, but totally beyond control. Insane and totally self regarding the banking industry has brought the world to its knees.

Banking became a world unto itself. It created products and services that had no bearing to the ‘real’ economy, but represented fluff that trading desks could churn at lightening speed to earn fees that supported short term bonus structures. The actual contribution of banking to economic activity was hidden behind a veil of self gratification and greed that ended up destroying the world economy. The numbers do not lie: the business models providing the basis for banking over the past thirty years are a disaster.

The truth is that banking became a cancer. It is an illusion based upon a series of false premises and demonstratively incorrect economic theories. It is no accident that the derivatives business exploded right after the publication of the Black-Scholes-Merton financial economic theory. That theory is wrong at its core, but it gave legitimacy to what had previously been viewed as gambling. It took a phone call from Milton Friedman to the SEC to force them to allow the Chicago Exchange to trade derivatives. The rest is history. Finance became totally separate from all other economic activity. A world unto itself it has now ruined lives right across the globe.

There was no underlying purpose to most of what the big banks trading floors did other than to generate fees. It was perhaps the world’s most utterly pointless and useless utilization of resources ever.

And the IMF’s data highlight the incredible damage.

What the IMF also points out is that recessions following financial crises are particularly severe. So are recessions that spread out across the entire globe.

Presumably recessions like this one that are both global and originating within the financial sector are the worst possible kind.

Sorry folks, but this recovery may have to be long and slow in order to eliminate the excesses that the banks wrought.

In fact that’s a very good bet.

Which is why I beat the drum of banking reform. Never again must they do this to us.

Addendum:

For those of you who have no clue what the ‘Black-Scholes-Merton’ theory is: have no fear! It is one of the most significant economic theories of the last fifty years. It won the authors Nobel prizes and huge acclaim. It is taught at the most elite economics departments around the world – MIT seems to be at the fore. It anchored the whole explosion in derivatives trading. It gave intellectual plausibility to options trading.

And it is wrong. Totally.

It relies on core assumptions that collapse in the face of empirical analysis and, frankly, should be tossed aside along with stuff like the ‘efficient markets hypothesis’ and all the other equipment of the extreme neo-classical school of economics. Hiding behind all those Nobel prizes doesn’t make up for the damage their ideas have wrought.

One of my beefs with the economics profession is that it simply doesn’t want to admit its role in the current debacle. I suppose $4.4 trillion in write-offs isn’t enough to get their attention. This was their model. Their theory. They are just as culpable as the idiots on the trading desks, and the politicians of all political stripes who pressed for deregulation.

When I hear academic economists decrying their colleagues for teaching this rubbish I will start to listen to what else they have to say. Meanwhile I consider them more than a little ethically challenged.

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The IMF Weighs In

The IMF has just published its research on the current financial crisis. They estimate that losses so far on ‘US originated assets’ have now surpassed a whopping $2 trillion worldwide, and a headed for an almost numbing total of $4 trillion before the crisis abates.

Besides being extraordinarily sobering, that’s an eye-popping amount of carnage inflicted on the world’s banking system courtesy of our obsession with real estate and the terrible things we did to spread homeownership.

It will take years for this mess to be cleansed fully, and I doubt that banking will ever be the same again – notwithstanding Goldman Sachs agitated opposition to changing regulation.

Buried in the IMF analysis, their report is almost 250 pages long, are a few policy recommendations I think are worth keeping in mind as we watch as new regulations are crafted here. I will simply repeat them verbatim:

‰Û¢ A more active role of supervisors in determining the viability of institutions and
appropriate corrective actions, including identifying capital needs based on
writedowns expected during the next two years.

‰Û¢ Full and transparent disclosure of the impairment of banks‰Ûª balance sheets, vetted by supervisors based on a consistent set of criteria.

‰Û¢ Clarity by supervisors regarding the type of capital required‰ÛÓeither in terms of the tangible common equity or Tier 1‰ÛÓand the time periods allotted to reach new
required capital ratios.

These three ‘immediate actions items’ get straight to the heart of the crisis.

We need much more urgency in policy action. Here in the US we have been undertaking a slow motion series of steps: the crisis has now been in full bloom for nearly three consecutive quarters and we still don’t have adequately re-capitalized banks. It seems as if the administration has been hoping that time alone will ameliorate the situation so that cleaning everything up becomes less painful. That won’t work at all. More likely: it will exacerbate things. Banks suffering through a long a lingering near death are of no use either to their shareholders, whose shares are worth practically nothing now anyway, or to the economy at large because what we need is new lending not slow and careful capital rebuilding.

The IMF appears to support the kind of swift and dramatic intervention I have been advocating since the start. Call it what you will, but forcing a failed bank through state sponsored bankruptcy, and returning to private ownership quickly is still the most viable and sensible policy option we have.

The second policy the IMF urges is also tough for the administration: transparent demonstration of the actual damage each bank has. This is controversial simply because by going public with such information exposes the weak banks to potential investor and depositor flight. People will naturally want to get their money out from a bank that is declared ‘impaired’. Even if such a ‘run on the bank’ is avoided the cost of borrowing for an ‘impaired’ bank will inevitably rise as the credit markets impose a risk premium on it. This will create a double jeopardy: not only will the public know that a particular bank is impaired, but its competitive position will be eroded simultaneously. So a weak bank’s ability to recover will be diminished. Hence the need to force them quickly through bankruptcy or nationalization.

The final policy imperative is far less controversial. It simply asks that bank regulators impose a clear and even handed standard for measuring capital adequacy. Having such clarity will enable investors and depositors to make informed decisions about the soundness of the banks they do business with.

There is no real news in this third policy recommendation.

But I look forward to progress on the other two.