2016 Economic Crisis Thread - Duck and Cover?

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Will the global economy implode in 2016?
	We're hosed - I have stocked up on canned goods
	My private security guards will shoot the paupers
	We'll be good or at least coast along
	I have no earthly clue

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Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

Cohan wrote this piece back in 2012 on why the Dodd Frank and the Volcker Rule couldn't theoretically protect us from another banking crisis:

How We Got the Crash Wrong posted:

ONE OF THE most seductive narratives about the recent financial crisis is that it was caused by dizzying increases in the amount of leverage on the balance sheets of Wall Street firms, leaving the financial system virtually no margin for error. Leverage, we�ve been told repeatedly, went from about 12-to-1 in 2004 to 33-to-1 in 2008. (Leverage is the ratio of debt or assets to equity; at 33-to-1 leverage, a mere 3 percent drop in the value of a firm�s assets can wipe out its equity.) The reason for the increase, so the story goes, was an underappreciated change, in April 2004, to an obscure Securities and Exchange Commission rule, which let Wall Street off its short leash and allowed unprecedented risk-taking. If not for that, according to the popular press and many accomplished scholars, the crisis might not have happened. The acceptance of this thesis has colored not only how we think about what happened but also the new laws that were designed to prevent the next crisis. The problem is, it�s flat wrong. And because we have misunderstood the facts, we may now be trying to cure the wrong disease.

The spread and evolution of the idea that the financial crisis was caused by a giant increase in leverage, enabled by the SEC, bears a passing resemblance to the old-fashioned, elementary-school game of telephone. While the change to the SEC�s so-called net-capital rule in 2004 was plenty esoteric, in the main, it did not allow big securities firms to take on more leverage. The SEC did two things in 2004: First, it assumed the added responsibility of regulating Wall Street�s larger holding companies�as opposed to just the broker-dealer subsidiaries within them. That�s where more and more funky and risky assets, such as derivatives and mortgages, had been housed over the years. Second, the SEC required the holding companies to report their capital adequacy in a way that was consistent with international standards, and to discount their assets for market, credit, and operational risks. Clearly, the SEC did a poor job of monitoring Wall Street once it obtained this increased regulatory authority. But the rule change increased rather than decreased the SEC�s oversight of the financial sector, and did not suddenly permit a dramatic increase in leverage.

Yet that�s not how the rule change got interpreted. In the aftermath of the collapse of Bear Stearns, in March 2008, people were eager to know how a company that had thrived for 85 years, and that had $18 billion in cash on its balance sheet, could evaporate in a week�s time. Enter Lee Pickard, a former director of the SEC�s trading-and-markets division and one of the architects of the net-capital rule in 1975. In an August 2008 essay in American Banker, Pickard lambasted the 2004 change, which he believed had allowed Bear Stearns to incur �high debt leverage� without �substantially increasing [its] capital base.� He argued that the original net-capital rule required securities firms to discount, or �haircut,� the value of their assets depending on the assets� perceived risk, and that it limited the amount of debt they could incur �to about 12 times [their] net capital.� After the SEC�s 2004 rule change, he wrote, the large securities firms were permitted to avoid the haircuts and the limitations on indebtedness. According to Pickard, �The losses incurred by Bear Stearns and other large broker-dealers� were caused �by inadequate net capital and the lack of constraints on the incurring of debt.�

Pickard�s criticism appealed to journalists eager to understand the causes of the crisis. On September 18, 2008, The New York Sun ran an article summarizing Pickard�s assertions and quoted him as saying �The SEC modification in 2004 is the primary reason for all of the losses that have occurred.� The SEC�s trading-and-markets division tried to refute Pickard�s critique in a little-read appendix to a report issued on September 25 on the collapse of Bear Stearns. �[Pickard] says that broker-dealers were formerly subject to a leverage ratio limit of 12x net capital,� the commission wrote, but they �were not.�

Nonetheless, the idea kept picking up steam. At the end of September, TheNew York Times began a series about the causes of the financial crisis. One headline blared: �Agency�s �04 Rule Let Banks Pile Up New Debt.� On December 5, the Columbia Law professor John Coffee added his imprimatur. In the New York Law Journal, Coffee wrote of the 2004 rule change, �The result was predictable: all five of these major investment banks increased their debt-to-equity leverage ratios significantly in the period following� the change. Around the same time, Coffee�s esteemed colleague, Joseph Stiglitz, writing in Vanity Fair, described five key �mistakes� that had helped cause the financial crisis. Sure enough, the 2004 rule change got prominent play. And for the first time, Stiglitz explicitly mentioned the extent to which the leverage ratios had increased��from 12:1 to 30:1, or higher,� he wrote, allowing the banks to �buy more mortgage-backed securities, inflating the housing bubble in the process.� The idea that the SEC�s rule change had allowed leverage to balloon now had the backing of a Nobel Prize winner.

On January 3, 2009, Susan Woodward, who was the SEC�s chief economist from 1992 to 1995, spoke at the American Economic Association. Her slides repeated Pickard�s thesis and used the same numerical ratios that Stiglitz had used. One of her fellow panelists that day was Alan Blinder, a former vice chairman of the Board of Governors of the Federal Reserve System and an economics professor at Princeton.

Three weeks later, Blinder wrote an opinion column for TheNew York Times about the �six errors on the path to the financial crisis.� Error No. 2, Blinder wrote, was �sky high leverage� enabled by the 2004 rule change. He, too, noted how securities firms� leverage had grown, this time to 33-to-1, from 12-to-1. �What were the S.E.C. and the heads of the firms thinking?� he wondered. Blinder�s column firmly established the conventional wisdom, which proved increasingly difficult to dislodge.

BOTH STIGLITZ AND Blinder were right to point out that Wall Street was highly leveraged before the crash, on the order of 33-to-1 or more. But the truth is that in recent decades, Wall Street firms have almost always been highly leveraged. For instance, according to a 1992 study by the U.S. General Accounting Office (now the Government Accountability Office), the average leverage ratio for the top 13 investment banks was 27-to-1 midway through 1991 (up from 18-to-1 in 1990). A subsequent GAO report, in 2009, noted that the big Wall Street investment banks had higher leverage in 1998 than in 2006. According to SEC filings, in 1998, the year before it went public, Goldman Sachs was leveraged at nearly 32-to-1, while in 2006 it was leveraged at 22-to-1. In 1998, Bear Stearns�s leverage was 35-to-1; in 2006, its leverage was 28-to-1. Similar patterns applied at Merrill Lynch and Lehman Brothers. To be sure, leverage has fluctuated over time: In the early 1970s, for instance, it was generally below 8-to-1. But in the 1950s, it sometimes exceeded 35-to-1.

Of course, even a dollar of debt is too much if you are clueless about how to manage risk. And with one or two notable exceptions (Goldman Sachs and JPMorgan Chase among them), by the time 2008 rolled around, risk management on Wall Street had become a farce, with risk managers being steamrolled by bankers, traders, and executives focused nearly exclusively on maximizing annual profits�and the size of their annual bonuses. Yet there was a long era�roughly between 1935 and the late 1980s�when Wall Street�s ability to manage risk was one of its singular successes, bringing its partners and executives great wealth, making its firms the envy of the world, and helping to raise the standard of living for most Americans by making capital available to businesses large and small alike. What changed was not so much the leverage, but the attitude toward risk.

After Pickard�s article appeared, SEC officials contacted Pickard and urged him to correct his essay. But he wouldn�t budge. Finally, on April 9, 2009, Erik Sirri, who then held the same SEC job that Pickard once had, gave a speech before the National Economists Club in Washington to try to set the record straight. Sirri said that the effort to paint the 2004 rule change as the cause of the crisis �lacks foundation in fact.� Instead, Sirri reminded his audience, the change expanded regulatory oversight. And while the changes allowed Wall Street firms to marginally adjust the way they calculated their net capital, these adjustments did not meaningfully allow them to increase their leverage or reduce their equity capital.

Shortly after reading Sirri�s speech, which the media did not cover, Jacob Goldfield, a former partner and trader at Goldman Sachs, corresponded with Blinder and his editor at The New York Times, and urged the paper to run a correction. According to Goldfield and Blinder, TheTimes agreed to make the change. �Anyway, it remains unfixed,� Goldfield told me recently.

In December 2010, at the Federal Reserve Bank of Chicago, Goldfield gave a presentation about the misperception. As anyone could have, Goldfield had dug out the historical financial statements of the Wall Street firms�on file with the SEC�and made the calculations himself. He found that Wall Street�s leverage ratio was never remotely close to 12-to-1 in 2004. On slide after slide, Goldfield wrote of the alleged increase in financial leverage brought on by the rule change: �It didn�t happen.�

A breakthrough, of sorts, in the debate came last October, when Andrew Lo, an economics professor at the MIT Sloan School of Management, wrote a paper that was later published in the Journal of Economic Literature, in which he reviewed 21 books about the financial crisis written by an array of scholars and journalists (and including House of Cards, my book about the collapse of Bear Stearns). Many of the books described the rule change and its impact. After parsing them, Lo observed that the authors could not even agree on what caused the crisis�like the role the SEC�s 2004 rule change played in financial leverage, for instance.

�If such sophisticated and informed individuals can be misled on a relatively simple and empirically verifiable issue, what does that imply about less-informed stakeholders in the financial system?� he wondered. Lo suggested that the misguided narrative fit neatly into people�s preconceived notions about the causes of the financial crisis and the need to apportion blame. �This example should serve as a cautionary tale for all of us,� he wrote, �and underscores the critical need to collect, check, and accumulate data from which more accurate inferences can then be drawn.� (Goldfield had alerted Lo to his cause; they were once classmates at the Bronx High School of Science.)

Blinder, for one, now admits he made a mistake. �The way I should have put it is that leverage is much too high,� he told me in March. �Period.� He said he would again urge TheTimes to correct the record. Susan Woodward also concedes the point that the 2004 rule change was not the problem. But, she told Reuters, �Everyone agrees that too much leverage was a key cause.� Pickard, meanwhile, is sticking to his guns. He told me recently that he is still �100 percent behind what [he] wrote.�

JUST AS THE idea of too much leverage has occupied a large place in the popular understanding of the financial crisis, it has also preoccupied our legislators and regulators, who�ve fixated on reducing leverage. The Dodd-Frank Act, signed into law in July 2010, limits leverage to 15-to-1, while the still-being-written Volcker Rule contemplates vastly limiting the amount and kind of proprietary risk that Wall Street firms can take.

While most people welcome leverage limits as the just consequence of Wall Street�s greed, and conclude that we will be safer if these businesses are run more prosaically, there is a real danger that we have focused on the wrong problem, and will condemn our once enviable capital markets to a period of bland ineffectiveness. While lower leverage would certainly provide more of a margin against the inevitable future errors of Wall Street executives, hard limits on risk-taking might also lead to stifled innovation and slow economic growth. Would Michael Milken, at Drexel Burnham, still have created the junk-bond market�or Lewis Ranieri, at Salomon Brothers, the securitization market�if the Dodd-Frank law or the Volcker Rule had been around to curb their firms� ability to take risk?

The problem on Wall Street has never been about the absolute amount of leverage, but rather about whether financiers have the right incentives to properly manage the risks they are taking. During Wall Street�s heyday, when these firms were private partnerships and each partner�s entire net worth was on the line every day, shared risk ensured a modicum of prudence even though leverage was often higher than 30-to-1. Not surprisingly, that prudence gave way to pure greed when, starting in 1970 and continuing through 2006, one Wall Street partnership after another became a public corporation�and the partnership culture gave way to a bonus culture, in which employees felt free to take huge risks with other people�s money in order to generate revenue and big bonuses.

People are pretty simple: they do what they are rewarded for doing. If they get multimillion-dollar bonuses by taking huge risks with other people�s money�as they still do�then they will continue to take those huge risks, and not give it another thought. To prevent another crisis, Wall Street�s top executives, bankers, and traders should once again have something close to their full net worth on the line every day�not just the portion represented by company stock or options�so that they will collectively take risk management more seriously. That�s a solution that has nothing to do with the amount of leverage on Wall Street�s balance sheets.

# ¿ Jan 21, 2016 17:07

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# ¿ Apr 27, 2024 19:27

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

That lecture is fantastic. Thanks for linking it.

# ¿ Jan 22, 2016 01:20

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

My Imaginary GF posted:

Hundred years ago, what was the currency they used in Luxembourg?

Plenty of countries in Europe are older than the United States (most of them are even!). A nation isn't just a party and its government.

# ¿ Jan 31, 2016 08:42

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

Bip Roberts posted:

Besides the UK which ones had remotely continuous governance?

I'm arguing that most identify as being French, not citizens of the Third Republic or some poo poo. People don't view their nationalities by whatever their current government is. That's a uniquely American thing going.

# ¿ Jan 31, 2016 21:45

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

ToxicSlurpee posted:

One of the big issues with the housing market is that developers always think "what will make me the most money?" and luxury *thing* is what they tend to go to. This is why you have so drat many empty McMansions in America right now. The target market is always suburban white people with money. It also doesn't help that people living in areas where stuff that gets developed absolutely do not want low-income or affordable housing to go up because those people come with it.

Not to mention that banks actively withhold houses from the market to cut off supply and jack up prices even further.

# ¿ Feb 12, 2016 22:32

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

Why are Sweden, Switzerland, and Denmark running higher negative interest rates than the Eurozone?

# ¿ Aug 18, 2016 17:05

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

icantfindaname posted:

Well, I will say that after witnessing liberals and Democrats play down and ignore the inequality issue, seeing a purestrain Republican "poor people have refrigerators! refrigerators didn't even exist 200 years ago!" is refreshing in a weird way

Did anyone really think liberals were anything but capitalists? Forget even the neoliberal label. They are pro free market through and through.

# ¿ Aug 18, 2016 17:57

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

override367 posted:

An economic crisis will give Trump the excuse to just eliminate the income tax, medicare, medicaid, social security, and the VA

He is going to do this regardless

# ¿ Dec 3, 2016 02:48

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

DeathSandwich posted:

I'm not real super familiar on the Italian situation: Is the bank just extremely over-leveraged or is there some sort of cash flow problem for the country?

Almost all of the major European banks are hilariously over leveraged and are doing their best to sweep it under the rug and hope the public doesn't notice

# ¿ Dec 5, 2016 14:48

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

If anything, the healthcare industry in the US is grossly oversized. Last time I was in the ER overnight in this massive hospital I was its only there and all the other patient rooms were empty.

# ¿ Jan 2, 2017 14:10

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

They will cure the Chinese market with TCM

# ¿ Jan 4, 2017 01:01

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

Orange Devil posted:

Capitalism is a woefully inefficient economic system for improving human lives. Though I will concede it is better than slavery and feudalism.

Dude your typical farmer peasant in England during the middle ages had more free time to the point England started drafting specific laws later on to keep them working

Also lol save the healthcare talk until after the GOP kills off its own fanbase after repealing Obamacare

# ¿ Jan 8, 2017 16:37

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

Before capitalism came along the poor weren't so wholly subservient to a the higher economic classes since subsistence was still a thing.

Look at Alexander II's land reforms in Ukraine.

# ¿ Jan 8, 2017 17:12

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

Trump's supporters don't get to bitch about global free trade because they consecutively voted in the last 4-5 pro-NAFTA presidents and all the necessary congressmen/senators who legislated it.

# ¿ Jan 12, 2017 16:29

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

Helsing posted:

That's what is so frustrating about Obama. The Bush administration fully revealed just how empty the ideals of "pragmatic" centrism had become. The Iraq War and the financial crisis were the symptoms of an extremely damaged and unstable political system that was in desperate need of repair. We desperately needed some kind of new vision from the left or at least the liberal side of the spectrum eight years ago when it could have done some good. But Obama doubled down on a failed ideology at exactly the moment that it's failures had been plainly revealed and we're all going to pay the price for that now.

I don�t think he or anyone else realized the GOP was radicalized right under their noses. Both Clinton and Jeb! campaigned on courting Bush and HW Bush Republicans. Too bad that wasn�t the makeup of the party. They saw their repeated failures on the national level (with McCain and Romney) as an excuse to slide further right. The Koch brothers came in and astroturfed the poo poo out of the movement, Fox News was there with completely unhinged hosts who had no idea what kind of damage they were doing (Glenn Beck running around calling for some kind of national unity), and the senators/congressmen in Washington were selling their voters a kind of fiction where shutting down the government and repealing Obamacare were feasible without burning bridges.

In truth part of this was how our government was designed. The President and congress fighting over authority is as old as time itself.

But that said, of course all of this was extremely divisive in the long run, which is why Trump voters now get the idea that they�re going to be able to bring about healing going forward instead of the country being effectively split into two. The level of escapism is dangerous here. Trump and his supporters cannot say the truth because that reality is a dangerous one for them and pretty much everyone else. A civil war is upon us if the economy crashes.

Dead Cosmonaut fucked around with this message at 00:45 on Jan 29, 2017

# ¿ Jan 29, 2017 00:42

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

Had any of the optimization theory the Soviets painstakingly developed been applied through computing, the Soviet Union would have fixed a good deal of its problems.

# ¿ Feb 27, 2017 11:11

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

caps on caps on caps posted:

It's entirely feasible to think about the optimization problem a planned economy has to solve. It's well known that, with stable preferences, solving the problem for just one market alone is hard enough that we can not realistically do it with computers. But an economy is not a static problem in a single market.

The funny thing is that a good deal of trading that goes on at Wall St. is now automated, using the same theory the Soviets developed.

# ¿ Feb 27, 2017 18:10

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# ¿ Apr 27, 2024 19:27

Dead Cosmonaut: Nov 14, 2015; by FactsAreUseless

OhFunny posted:

https://www.bloomberg.com/politics/articles/2017-02-28/ryan-said-to-forge-unexpected-alliance-with-bannon-on-border-tax

Can't wait to read about this next to Smoot-Hawley Tariff Act.

God the trade and currency war this would cause.

edit: Just saw this too:

https://twitter.com/ReutersPolitics/status/837144192631570432

Christ. He's going to tear apart the whole international trade system down.

The only way Trump gets his way is if the use withdraws from the WTO.

Global trade isn�t going to end if he does that. It just means that all of our influence on the global economy goes to either Europe or China.

# ¿ Mar 3, 2017 12:53

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