What's the problem?

January 14, 2011 5:43 AM

Interview with Gary Gorton (pdf) - Fascinating look at private institutional bank money creation (really) and subsequent run on the shadow banking system that hearkens back to the late-19th century banking crises with securitization playing the role of checking before the advent of deposit insurance. "Gorton is a lucid narrator of a complex tale." (via via)
posted by kliuless (10 comments total)

um, i guess i should add that altho gorton's analysis is essential to understanding the global financial crisis (imo) and what's still wrong with the banking system -- a dearth of panic-defying 'safe' assets/collateral -- i think his proposal for "narrow-funding banks" to securitize lending (cf. covered bonds) is lacking because i don't see how they would function without a guarantee, either explicit or implicit, and an 'AAA' imprimatur from a ratings agency hardly seems appropriate at this juncture. like in some sense, to regulate is to insure.
posted by kliuless at 5:55 AM on January 14, 2011

also while gorton takes a crack at modern economics -- "if you take a standard macro model, a dynamic stochastic general equilibrium model, this is a neoclassical growth model that has no technology for transactions" -- and makes a good point about (a lack of) measurement:

Macroeconomics as a paradigm in large part is determined by what is measured... The way models are built, and the way people think, is determined in large part by what we measure... So it's hard to even imagine how you're going to build models if we don't measure things that are more directly associated with what we would like to know.

a cynic would note of course that that's why shadow banking came into existence in the first place; 'they' didn't want you to know.
posted by kliuless at 6:00 AM on January 14, 2011

You mean everyday life in Northern Ireland? http://en.wikipedia.org/wiki/Banknotes_of_Northern_Ireland
posted by parmanparman at 6:15 AM on January 14, 2011

The situation that we’re in now, seriously, is one where we are back in about 1860: We’ve just had a big crisis, and we’re trying to figure out what to do. We can only hope that it doesn’t take 77 years to figure it out this time.

It's going to take even longer because there is nowhere else to go. After the 1873, 1884, 1893 and finally the 1907 crises (due to further and further devaluing of commodity based currencies), the USG decided to go with the nuclear option and enact a strong central bank to make money which is based solely on the value of what the USG says it is.

After the Fed was created, which by the way was at that time using a quasi-commodity backed debt repayment system based on gold and commercial paper, and they still couldn't sustain the economic growth we wanted with the commodity growth rate (tangible backing of assets), they had to devise a new devaluation method post WWII known as the bretton-woods system. Later when that was still not creating enough capital growth, we completely separated our currency from commodities with the Nixon shock and created the currency and growth "boom" we have followed ever since by fooling the world into thinking our monopoly money had value (Good luck defining value in such a context).

With the latest round of quantitative easing, there is literally nowhere else to go with devaluation of the trust backing the US Dollar except for a complete reevaluation of the true tangible value that the US Dollar has in real terms. How to value that would be an interesting next step. For example what commodity or other measure do you use as a reference. Gold is obviously for old prospectors as it has no "inherent value."

Those non-heterodox Econ PhD's better get crackin.
posted by AndrewKemendo at 6:40 AM on January 14, 2011 [1 favorite]

That interview was very informative - thanks for posting it.
posted by exogenous at 8:06 AM on January 14, 2011

A very lucid discussion of the topic. One of the best i've read. Thx for this kliuless.
posted by storybored at 10:55 AM on January 14, 2011

Yeah, I am most certainly in the category of people who really shouldn't need to know anything about "repo haircuts" and so on, and indeed I don't know much. Happy to stay that way, mostly. But I am suspicious of the way he seems to blame continued high unemployment on "banks not lending". Whatever set off the banking crisis that contributed to it, I think more traditional macroeconomic approaches are better suited to explaining the situation now. Getting the securitization market back up to its former heights, money-izing credit as fast as can be done, re-inflating the credit bubble if you like, only doing it more safely this time -- yeah, it does seem like just the sort of project that could easily be tried and failed repeatedly over 77 years.
posted by sfenders at 4:05 AM on January 15, 2011

With the latest round of quantitative easing, there is literally nowhere else to go with devaluation of the trust backing the US Dollar except for a complete reevaluation of the true tangible value that the US Dollar has in real terms. How to value that would be an interesting next step. For example what commodity or other measure do you use as a reference.

careful, you might start sounding a bit crazy...

Andrew Sprung explores in detail Loughner's obsession with [currency]: "Firstly, the current governmental officials are in power for their currency, but I'm informing you for your new currency! If you're treasurer of a new money system, then you're responsible for the distributing of a new currency. We now know - the treasurer for a new money system, is the distributor of the new currency. As a result, the people approve a new monetary system which is promising new information that's accurate, and we truly believe in a new currency. Above all, have you your new currency, listener?"

but you mightn't be alone:

It is relatively simple and intuitive to make the connection between Fed policy and wealth inequality. Whether through open market operations or direct lending through the discount window the first recipients of newly created money are the banks in the Fed system... this newly created money is first lent to their most creditworthy customers. In addition, the amount one can borrow is obviously a direct function of one's already existing net worth so it is the "wealthy" who are able to borrow these newly created funds first and at the lowest rate of interest... Those with access to better economic information, such as bankers with access to the Federal Reserve, are able to better navigate this world of floating monetary standards and gain outsize economic rewards.

cf. publicly-owned banks; the real tea party begins here :P
posted by kliuless at 11:34 AM on January 15, 2011

btw, if you do want to know more...
-The systemic risk of the repo system
-The Sizable Role of Rehypothecation in the Shadow Banking System
-Follow the money
-Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007
-Heading Off the Next Financial Crisis
-So What Exactly Caused the Financial Crisis? [cf. viz.]
-One damn panic after another
-Why do we need maturity transformation? [cf. viz.]
posted by kliuless at 11:49 AM on January 15, 2011

oh and fwiw, GFC Finance as War Finance - "populist targeting of the Fed, both from the right and from the left, is nothing new. Big Finance and Big Government are perennial bogeymen in American political discourse..."

also see tyler cowen on perry mehrling's new book, The New Lombard Street:

Mehrling tells us that the Fed is now committed to supplying liquidity in money markets through its role as a dealer, on both sides of its balance sheet, and that is a critical shift in the nature of central banking. He discusses (pp.126-127) how the collateral behind the shadow banking system relied on CDS markets for its pricing. In Mehrling's account, insurance companies (including AIG) were indirectly serving as dealers of last resort, believing that they held invulnerable positions but nonetheless exposed. Investment banks, on their side, thought they held matched books but the higher and lower CDO tranches turned out to be less similar than they had been expecting, based on historical price risk. None of these expectations survived contact with the reality of the crash.

Now it's the central bank which sells AAA protection because eventually, in Mehrling's view, this activity cannot forever remain a private function (for a start, which insurer is itself safer than AAA?). A good and indeed central question to ask anyone who is proposing a financial system is to ask who will sell AAA insurance.

To quote Perry, the new Fed principle seems to be: "insure freely but at a high premium."

Mehrling also suggests that looking at the Fed's balance sheet, or its transactions, is misleading. The key question is what kind of liquidity dealing option the Fed is promising to the market.

I continue to ponder Mehrling's main claims, but in any case this is an important book about the new Fed.

iow, "credit, being inherently instable, needs plumbers -- central bankers to supply liquidity or impose discipline as required..."

meanwhile, "Chinese President Hu Jintao emphasized the need for cooperation with the U.S. in areas from new energy to space ahead of his visit to Washington this week, but he called the present U.S. dollar-dominated currency system a 'product of the past' and highlighted moves to turn the yuan into a global currency."
posted by kliuless at 8:53 AM on January 17, 2011