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October 02, 2008

Comments

a reader

It is unclear to me how the US can retain its economic strength without a premier financial system.

Rogue

The focus can now be more on tangible products innovation as a source of growth rather than financial innovation. You can only grow so much by constantly shifting assets around.

Poujade

I am afraid I do not understand. New firms need money to grow, old firms need money to finance new projects, individuals need money for all kinds of purposes: banks were created to deal with all these needs.What exactly do you mean by shrinkage of the financial sector?
Preventing traders from trading? How does that enhance efficiency and growth?

Poujade

(well I guess that if you outlaw quant finance and exotic trading, mathematically gifted individuals will go back to designing nuclear fusion power power plants and leave Brownian motions out of the financial world)

While we are at it, I think we should outlaw business and money-making activities to make sure the best brains focus on the really important stuff (feed everyone, live forever, develop economics research)

alex

Poujade,

From the linked article: "the US financial sector, in greasing the wheels of the real economy, has been soaking up an astounding 30% of corporate profits and 10% of wages".

Sounds to me like we've been paying too much for financial services. And what do we get in return? Supposed risk reduction that leads to a banking crisis.

Financial services, like garbage collection, are essential to a modern economy. Without garbage collection the disease spread by rats and fleas would seriously hamper productivity. But suppose that "30% of corporate profits and 10% of wages"" went to garbage collection, and all we got in return was a service threatening to break down and leave trash in the streets. I'm sure that everyone would be calling for a more reliable and less expensive garbage collection system. The NYT and WaPo would be telling us how bad garbage collection services were hamstringing the economy. Why treat bankers and other financial wizards differently, because they dress fancier?

Poujade

I guess my point was: what do you have in mind with this "significant shrinkage"?

- First of all, what is this 30%? I read the article too, but I don't know what Rogoff refers to: overall banking fees? banking profits as a share of all profits?... Banks do many different things: financing (do you want to curb financing? will that help growth?), advisory (which is pretty much an outsourced strategy department and creates as much value -if not more- as if it was part of the company), asset management, trading... What is it that you want to shrink? I have some ideas of my own, but I'd rather read first the clever ideas from the clever readers from this blog.

-As for my second post, I provided one oddball solution in which I truly believe: our society should make a better use of all the "clever people" by providing the right system of incentives (and I do mean it, although I also tried to show that things are, as usual, more complicated than they look)

alex

Poujade: What is it that you want to shrink?

The cost of providing financial services. Example: CDO's were supposed to be a risk reduction tool. In practice, they were anything but. Folks got paid a pretty penny for pushing this scam. Yet the actual contribution to the economy was negative (and I, as a taxpayer, will probably get stuck with part of a $700B tab for fixing it up).

Should we continue to pay financial geniuses to concoct these ever more elaborate Ponzi schemes? And then get stuck with the tab for cleaning it up? I'd rather put my money into better garbage collection (which is also an essential service).

As to your snark about how "we should outlaw business and money-making activities", I'd oppose that. I'm all for "business and money-making activities" as long as they're not fraudulent.

And please don't trot out the "free market" canard. If there was anything resembling a free market in banking, there wouldn't be a Federal Reserve and Congress wouldn't be reaching for my wallet to clean up this mess.

Poujade

Talk about loving your country: debating financial reform in the middle of the night (I currently am in France) as I am waiting for the VP debate... I'll probably regret that tomorrow (sic).

Back to the topic. I see two different points in your criticism:
- CDOs are expensive. Well, yes they are. People were willing to pay a lot for them. After this mess, I am pretty sure that they will not be willing to do so anymore...

-Did the bankers scam the good folks by downplaying how risky these investments were? Were they involved in anything "fraudulent"? Well, I do not know if you ever read a broker report, but its already full of regulatory "BS" explaining how risky these products really are. Should the bankers be blamed for the clients'lack of due diligence?

Don't get me wrong, some of these guys were frauds (especially in the rating agencies) but main street has been just as irresponsible and greedy as Wall Street...

So what is it again that you want to shrink? The cost of CDOs ? I am pretty sure it will shrink by itself...

Justin Rietz

Fractional reserve banking is inherently fraudulent. When was the last time you opened a checking account and the bank manager told you "oh, by the way, for every $100 you deposit with us, we keep about $3 in the bank. So if 3% of our customers withdraw their money in a short period of time, we will be insolvent"?

There should be 100% reserve requirements for all demand deposits, and stricter reserve requirements in general. The Fed should be abolished (we don't let the government control the price of any other goods, why do we let them control the price of our most valuable commodity, money?), and we should move to an asset-backed currency.

As far as the current bailout plan, I would drop the $700 billion, grant 100% FDIC coverage on all demand deposits for a limited period of time, cut taxes across the board and decrease government by the same amount.

As for me, I'm loading up on gold bullion, cigarettes, canned food, and ammunition. ;-)

Luis Enrique

sure it's possible - a smaller financial that extracts fewer rents for what it does would be great - the problem of course lies with chucking millions of people out of work in the process, and how long it takes to recover from that.

Per Kurowski

The plan is that “the US government will serve as buyer of last resort for the junk debt that the private sector has not been able to price”.

And so… who can guarantee us this is a bail-out and not a take-down?

Is not the bliss of ignorance being dangerously ignored… in these mark to the market days?

alex

Poujade: "Did the bankers scam the good folks by downplaying how risky these investments were? Were they involved in anything "fraudulent"? ... Should the bankers be blamed for the clients'lack of due diligence?

Generally the clients were bankers or other supposed financial experts too - CDO's weren't your typical do-it-yourself investment.

As to whether the purchase of various exotic instruments was fraudulent or merely incompetent, like you I suspect that it was a mix. Ultimately it doesn't matter much though, as the effect is the same.

And there were bankers smart enough to avoid the worst of this garbage. For example, I was reading that Wells Fargo is in pretty good shape. So it was hardly unforeseeable.

So what is it again that you want to shrink? The cost of CDOs ? I am pretty sure it will shrink by itself...

And without proper regulation and oversight they'll just be replaced by another TLA (three letter acronym).

Of course any effective regulation and oversight will be met with screams of it stifling business "innovation".

If you want to be an exciting, creative capitalist become a VC or something. Not that that's without its problems, but given that it doesn't threaten to bring the country to a halt we can just let the usual mechanisms of free market capitalism deal with any problems that aren't outright fraud.

Bankers? More than ever I appreciate and long for the stodgy old stereotype.

alex

Luis Enrique: "a smaller financial that extracts fewer rents for what it does would be great - the problem of course lies with chucking millions of people out of work in the process"

What efficiency improvement isn't that true of?

Also, I didn't hear many cries of anguish from the financial sector as millions of manufacturing, engineering and programing jobs were shipped offshore. In fact, that's right, they promoted it by giving a thumbs down to any company that wasn't happily offshoring.

Not that that was an efficiency improvement of course. Instead of comparative advantage we got a giant current account deficit (which helped with the banking mess).

Lastly, most financial services jobs are relatively low level, and we'll still need most of the people in those positions. Far worse for job loss will be the end of the unsustainable construction boom, not to mention the general unemployment due to a severe recession.

hari

Rogoff is surely on right track. Dani is assured, so it seems, from this ex-IMF finance expert. He's presently the foremost sane mind commenting on the need to shrink/contract the hi fi sector with a view, I think, to discard all the weeds germinated during deregulated fraudulent gambling by banking sector - ie. investment banks and hedge funds.

I've discarded the latter two institutions,a nd I expect them to face serious policy constraints in EU markets, including the laissez faire gung-ho City (Lon) market.

The City will be white washed...because of the crimes committed by deregulation....under Gordon Brown.

Tonights meeting in Elysee Palace under Sarkosy will defintely calim the upperhand in undermining investment banks and hedge funds operations inside EU.
Either they are supervised or they become an extinct race of US/UK capitalisms scavengers! Basta.

me

http://www.npr.org/templates/story/story.php?storyId=95395712


----excerpt -----
...

After reporting on this crisis for several weeks, NPR's international economics correspondent Adam Davidson says that this is indeed a severe and scary crisis.

"And the more I report it, the more scared I have been," Davidson tells This American Life host Ira Glass as part of a one-hour special report on the last week of financial turmoil.

What is clear, Davidson says, is that spending $700 billion will help. "But it's also very clear that the plan we've been hearing all about, the Paulson plan, has a lot of problems. There are a lot of things that a lot of people do not like about it."

What's Not To Like About The Bill?
...

With the Paulson plan, the taxpayer ends up owning toxic assets of questionable value. If the mortgages bundled into these securities default, then the taxpayer is on the hook.

"In the stock-injection plan, we would not only own stock, we would own something called 'preferred stock,'" Davidson says. That means the taxpayer would be the last one to lose money, because the non-preferred shareholders would take the first losses. Taxpayers would be more protected and less likely to lose money, he says.

Why Not A Stock-Injection Plan?

If a stock-injection plan is better for the taxpayers, why wouldn't the government choose it over the Paulson plan? It turns out that many groups oppose the idea, Davidson says.

One group is conservative Republicans. "They just don't fundamentally, in their guts, don't like the idea of the U.S. government owning shares of private companies," he says. "It just smells like socialism to them and they can't support it."

Perhaps more importantly, banks really hate the idea. When the government took over insurance giant AIG, it essentially bought a huge share of the bank's shares and zeroed them out. All the shareholders lost billions of dollars and the chief executive of AIG was fired to boot.

So it was surprising to learn on Friday that, despite intense opposition from the powerful banking lobby, language authorizing the government to use a stock-injection plan did make it into the final version of the bailout bill. The law does not make a stock-injection plan mandatory, but it does leave it as one option that the Treasury secretary can use when bailing out a distressed bank.

me

http://www.thisamericanlife.org/Radio_Episode.aspx?episode=365

Luis Enrique

Alex - I could niggle and point out that it is possible to raise efficiency in a given sector and employment at the same time - but that's by the by ... when I wrote about millions of jobs lost, I wasn't talking about the bankers themselves, I was talking about non-bankers losing jobs in the (possible) mega-recession.

vigdor

the stock injection plan is definitely the right way to go. You have to ask yourself what the hell were all these government guys doing wailing around and why did Paulson want to buy toxic assets instead of preferred stock?

There's a tremendous site about the stock injection - it has 4 parts that are must viewing! Check it out http://www.StockInjectionPlan.org - go there it's your duty!

adrian hicks

what we need now and will always need is to create true value. China would be glad to tell you that we live in a service economy.The bottom has to drop at some point. I think the only thing that has staved it this long is that our government in the last 8 years has debted more the six trillion dollars. That has done a lot for our economy without notice, if you know what I mean.

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