The Moorish Wanderer

How to think about the crisis (seriously)

Posted in Uncategorized by Zouhair ABH on May 30, 2009

There follows a summary of a great meeting of minds. Thnaks to Bernard Guerrien, PhD (prof at Paris I Sorbonne) :

Krugman : « Between the housing bust and the sudden decision of consumers to save, after all, we have a world with lots of excess capacity. The GDP report that just came out says that business-fixed investment, non-residential fixed investment, essentially business investment, is falling at a 40 percent annual rate. This causes a problem. There are lots of people who want to save, creating a vast increase in savings, not only in the US but around the world, combined with a sharp decline in the amount that the private sector is willing to invest, even at a zero interest rate, or rather even at a zero interest rate for US government debt, which is what the Federal Reserve has the most direct impact on. One way to think about the global crisis is a vast excess of desired savings over willing investment. We have a global savings glut. Another way to say it is we have a global shortage of demand. Those are equivalent ways of saying the same thing. So we have this global savings glut, which is why there is, in fact, no upward pressure on interest rates. There are more savings than we know what to do with. If we ask the question “Where will the savings come from to finance the large US government deficits?,” the answer is “From ourselves.” The Chinese are not contributing at all. That is the way Keynesian policy works in the short run. It takes excess desired savings and translates them into some kind of spending. If the private sector won’t do it, the government will ». Ferguson : « The Fed has committed itself to buying $300 billion worth of treasuries this year, but clearly it will have to buy a great many more than that. Remember, $1.7 trillion or so are coming onto the market. And you assume that the credibility of the United States in the eyes of Americans, as well as foreign investors, is going to withstand this? At some point the United States does start to look like a Latin American economy, not only to people abroad but maybe to people at home. If the Fed’s balance sheet explodes to up to $3 or $4 trillion, who knows how big it could get. At what point do people stop believing in the US dollar as a reserve currency, or even as a store of value for their own savings? » Soros « When the flow of credit restarts, suddenly there will be a flip-flop where the fear of deflation will be replaced by the fear of inflation. The pressure for interest rates to rise will be very, very strong, and the rise in interest rates could choke off the recovery. And so we are facing a period of stop-go, or stagflation similar to but more severe than what we faced in the Seventies. But that is a favorable outcome compared to what would have happened if we hadn’t done what we are doing…..You have to regulate credit. And that means using tools that have largely fallen into disuse. Of course you have margin requirements, minimum capital requirements; but you actually have to vary them to counteract the prevailing mood of the market, because markets do have moods. It should be recognized that exuberance actually is quite rational. When I see a bubble beginning, forming, I jump on it because that’s how I make money. So it’s perfectly rational. Roubini : « We have to go to a world where there is greater prudential regulation and supervision of the financial system. I think the challenge for the US economy is, can we grow without excessive credit and leverage? Can we grow in a more sustainable way? And what are going to be the sectors of the economy that give us sustainable, long-term growth? I think that’s an open question » Krugman : « We went from an economy in which about 4 percent of GDP came from the financial sector to an economy in which 8 percent of GDP come from the financial sector, and in which at its peak 41 percent of profits were being earned by the financial sector. And there is no reason to believe that anything productive happened as a result of all of that. These extremely highly compensated bankers were essentially just finding new ways to offload risks on to other people » Bradley : « The second mistake was in 1999, the explicit decision by the Clinton administration and Congress not to regulate derivatives, in particular credit default swaps. In 2002 they were worth $1 trillion and today they’re worth $33 trillion, and that decision not to regulate derivatives created the following sequence: you have mortgages; then a thousand mortgages are packaged and sold as a mortgage-backed security; a thousand mortgage-backed securities are packaged and sold as a collateral debt obligation [CDOs]; then a thousand collateral debt obligations are packaged and sold as a CDO squared; and insuring each one of those bundles are credit default swaps, which are a part of that $33 trillion. And our government deliberately decided not to regulate this chain of investments. One result was that the 374 people in the London office of AIG who were responsible for AIG derivatives destroyed a company that had 116,000 employees in 120 countries. Why? Because there was no regulation at all » ……… « The third decision was in 2004. The SEC allowed banks to go from 10 to 1 leverage to 30 to 1 leverage. And guess what? Once they were allowed to do it, they did it »

The whole discussion could be found in the following weblink : http://www.nybooks.com/articles/22756

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