Someone Is Saying Something Wrong on the Internet in the Pages of the Wall Street Journal!
8/5/09 10:31 PM
Grasping Reality with Both Hands The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, Reality-Based, and More than Two-Handed Look at the World J. Bradford DeLong, Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.
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Someone Is Saying Something Wrong on the Internet in the Pages of the Wall Street Journal! Someone Is Saying Something Wrong on the Internet in the Pages of the Wall Street Journal! My friend Mark Thoma is trying to diminish my quality of life by emailing me links to Donald Luskin writing in the Wall Street Journal: http://delong.typepad.com/sdj/2009/07/someone-is-saying-something-wrong-on-the-internet-in-the-pages-of-the-wall-street-journal.html
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Someone Is Saying Something Wrong on the Internet in the Pages of the Wall Street Journal!
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Street Journal: Luskin: President Barack Obama proposed last month that the Fed act as an overall “systemic risk” regulator, with consolidated supervisory responsibility over “large, interconnected firms whose failure could threaten the stability of the system.” Now William C. Dudley, the ex-Goldman Sachs economist just appointed president of the New York Federal Reserve, has upped the ante.... Mr. Dudley is effectively asking for the power to control asset prices... Sigh. Sigh. Sigh. The Federal Reserve is not "asking for the power to control asset prices." It already has the power to control--or, rather, profoundly influence--asset prices already. When the Federal Reserve carries out an expansionary open-market operation, the whole point of the exercise is that it boosts bond and stock prices. The Federal Reserve buys bonds for cash. There are then fewer bonds out there for the private sector to hold. By supply and demand, the prices of those bonds goes up, and their yields--the interest rates quoted in the financial press--go down. Also by supply and demand, when bonds are yielding less investors are willing to pay more for substitute assets like equities and real estate, and their prices go up as well. When the Federal Reserve carries out a contractionary open market operation, the same process works in reverse: the whole point of the exercise is that it lowers bond and stock prices. The Federal Reserve sells bonds for cash. There are then more bonds out there for the private sector to hold. By supply and demand, the prices of those bonds goes down, and their yields-the interest rates quoted in the financial press--go up. Also by supply and demand, when bonds are yielding more investors are willing to pay less for substitute assets like equities and real estate, and their prices go down as well. For Luskin to claim that Dudley is asking for something new--that there is an extraordinary increase in the big, bad government's power to regulate financial markets contained in Dudley's "effectively asking for the power to control asset prices" is to demonstrate a degree of cluelessness that takes my breath away. The Federal Reserve already has the power to control asset prices. It has had this power since its founding in 1913. That's the point. That's what a central bank does. That's what it's for: it's an island of central planning power seated in the middle of the market economy. If you don't like it, call for its abolition. But don't pretend that it isn't there--don't pretend that "Mr. Dudley... asking for the power to control asset prices" is some wild change in our current system. Jeebus save us... So what did Federal Reserve Bank of New York President William Dudley say at the 8th Annual BIS Conference in Basel last June 26? He said: 1. We had not understood that interconnection had breached the firewalls of the banking system--that it was no longer enough to guarantee the stability of the financial system that the FDIC guaranteed deposits and the Federal Reserve supervised commercial banks, as we saw when the disruption of the securitization marktes of the shadow banking system quickly transmitted itself to the entire financial sector and caused the biggest globl economic decline since the Great Depression. Thus "the U.S. Treasury is right in proposing a systemic risk regulator as part of their regulatory reform plan... we shouldn’t kid ourselves about how difficult this will be to execute.... It will take the right people, with the right skill sets, operating in a system with the right culture and legal framework. I don’t believe creating this oversight process will be an easy task"... 2. We need to try to "engineer out of the financial system" destabilizing positive-feedback mechanisms like: (a) collateral tied to credit ratings; (b); collateral and haircuts; (c) compensation "tied to short-term revenue generation, rather than long-term profitability over the cycle"; (d) incentives for banks to fail to "raise sufficient capital to be able to withstand bad states of nature... many banks did not hold sufficient capital and market participants knew this"... http://delong.typepad.com/sdj/2009/07/someone-is-saying-something-wrong-on-the-internet-in-the-pages-of-the-wall-street-journal.html
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Someone Is Saying Something Wrong on the Internet in the Pages of the Wall Street Journal!
8/5/09 10:31 PM
bad states of nature... many banks did not hold sufficient capital and market participants knew this"... 3. Specifically, we need to add debt that automatically converts to equity on the downside 4. And, specifically, we need CDOs and other securitized obligations that are easier to value, and we need more public reporting of exposures. It's only after this that Dudley gets to monetary policy and asset bubbles, and his belief that we need "a critical reevaluation of the [Greenspanist] view that central banks cannot identify or prevent asset bubbles, they can only clean up after asset bubbles burst." There is an opportunity for the government to "lean against the wind" in real time, Dudley believes, and cites as an example that "the compressed nature of risk spreads and the increased leverage in the financial system was very well known going into 2007." The problem with "leaning against the wind" to some degree to try to curb the growth of asset bubbles, Dudley says, is that the standard tool that the Federal Reserve uses to affect asset prices are open-market operations directed at the short end of the yield curve, and "the instrument of short-term interest rates... is not well-suited to deal with asset bubbles." The problem is that using short-term interest rates to manipulate asset prices raises or lowers all asset prices together, which means that one risks curbing the bubble by attacking the economy and causing the recession one wants to avoid. In a bubble the Federal Reserve does not want to lower all asset prices but, rather, just the prices of those risky assets that are affected by the bubble. One way to think about it is that standard Fed tools allow it to affect the market rate of time preference and thus the level of asset prices, but that the configuration of asset prices is actually a two-dimensional animal in which both the rate of time preference and the premium on risk are important. The Fed then needs two different policy instruments to do its job. Openmarket operations that affect the rate of time preference are one. And Dudley thinks that banking collateral regulatory policy--"we might give a systemic risk regulator the authority to establish overall leverage limits or collateral and collateral haircut requirements... limit leverage and more directly influence risk premia..." But nobody should believe the Wall Street Journal when it tells us that Dudley wants to move us into a world in which for the first time the Federal Reserve "is effectively asking for the power to control asset prices." That's not what is going on at all. Why oh why can't we have a better press corps? rated 4.24 by you and 17 others [? ] You loved this post (
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Someone Is Saying Something Wrong on the Internet in the Pages of the Wall Street Journal!
8/5/09 10:31 PM
You can follow this conversation by subscribing to the comment feed for this post. You have to wonder exactly what the editorial page of The Journal is hoping to accomplish. Anyone who has a deep understanding of the role of the Fed--Brad Delong and others, as opposed to an amateur like me who understands some things but not everything-wouldn't skip over that article. Instead, they'd read it and, if it's as bad as Brad suggests--considering it's from Luskin, it wouldn't be a surprise--either laugh or spit something up in disgust. Anyone who has a reason to follow the news concerning the Federal Reserve closely isn't going to be swayed by such nonsense, and anyone who isn't already a true believer of the editorial page's thoughts isn't going to be paying attention. Either the people in the editorial division are supportive of the political nonsense masquerading as economic commentary, or they are too ignorant to know the difference. I'm not sure which one is worse. Posted by: Brian J | July 30, 2009 at 12:34 PM If you try to reconstruct Luskin's argument, it's actually similar to Bernanke's: monetary policy is too blunt a tool to prick specific asset bubbles. But then for some reason Luskin throughout his argument conflates specific asset bubbles and assets as a whole. Posted by: Joseph Lawler | July 30, 2009 at 01:16 PM OT -- It looks as though Prof. DeLong may have to reset the Bulletin of Economic Scientists WaPo demise clock back a few seconds: http://www.washingtonpost.com/wp-dyn/content/article/2009/07/30/AR2009073002023.html The staff writer, Carrie Johnson seems to be risking her stenography certification. Will this stand? Posted by: MaryCh | July 30, 2009 at 01:31 PM Yeah, we need better. Another reason the financial scheme sucks so much, is bad playahs like Goldman Sachs. See http://www.rollingstone.com/politics/story/29127316/the_great_american_bubble_machine . Matt Taibi should get more attention and respect, dolts like Samuelson, Will, Cohen, and the execrable Martin Feldstein (as explained at WaMo) should get less to none. Posted by: Neil B ♪ | July 30, 2009 at 02:00 PM Makes me wonder if there is a way to push interest rates for different kinds of borrowing in different directions, but then I guess they'd need to know a lot about the purposes for which money was being borrowed, information that isn't always available. (Plus, for a bank that runs 20 different kinds of business, who can say which one of them they are borrowing money for? But maybe we could require them to say.) Not that I know anything about this. But it sure would've been nice to be able to keep borrowing costs for non-bubble purposes down while hiking the costs of mortgages to tamp down housing speculation... though one also wonders whether that would have just stoked the frenzy more, as people would be frantic to Get! In! Now! Before Interest Rates Go Up! I mean, it's not like they didn't rationalize everything else away. So perhaps a simpler approach would have been saying to banks "You can no longer lend money to every deadbeat who asks for it using appraisals that bear no resemblance to reality and taking no account of the downside risk". Not everything has to be controlled through interest rates. Isn't that kind of regulation the purview of the Fed too? Posted by: Jacob Davies | July 30, 2009 at 03:36 PM The Fed influences but doesn't control asset prices. It can't even control the Fed funds rate, if by control one means keep it a preordained level ad infinitum. Posted by: Bill Stepp | July 30, 2009 at 07:01 PM Weird. Wasn't Greenspan the guy who went on about "irrational exuberance" and raised interest rates in an attempt to prick the late 90s internet bubble? In the 00s, I gathered he was in favor of Republican bubbles, but opposed to Democratic bubbles. I think the former are red, the latter blue. Posted by: Kaleberg | July 30, 2009 at 07:05 PM In my Tract The Age of Turbulence: Plea for a New World Economic Order, I explain the nature and causes of economic depressions.
http://delong.typepad.com/sdj/2009/07/someone-is-saying-something-wrong-on-the-internet-in-the-pages-of-the-wall-street-journal.html
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Someone Is Saying Something Wrong on the Internet in the Pages of the Wall Street Journal!
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A new, bigger Crash will come causing a real depression. Preparing for the Crash, The Age of Turbulence. Proposes a way to profit from The Crash. That strategy covers Treasuries, Corporate Bonds, Minerals (Oil, Precious Metals and Base Metals.) and Stocks. Its aim is to profit from both the Asset Price Bubble and Irrational Exuberance and The Crash and Economic Depression that will ensue. A turbulence in fluid dynamic is a chaotic state of a liquid or a gas. It Owns Most of the Proprieties of The Liquidity Trap, Origin of The Crash. It tries to accomplish Alan Greenspan Mission Impossible: "That is mission impossible. Indeed, the international financial community has made numerous efforts in recent years to establish such oversight, but none prevented or ameliorated the crisis that began last summer. Much as we might wish otherwise, policy makers cannot reliably anticipate financial or economic shocks or the consequences of economic imbalances. Financial crises are characterised by discontinuous breaks in market pricing the timing of which by definition must be unanticipated if people see them coming, then the markets arbitrage them away." .... The clear evidence of underpricing of risk did not prod private sector risk management to tighten the reins. In retrospect, it appears that the most market-savvy managers, although conscious that they were taking extraordinary risks, succumbed to the concern that unless they continued to "get up and dance", as ex-Citigroup CEO Chuck Prince memorably put it, they would irretrievably lose market share. Instead, they gambled that they could keep adding to their risky positions and still sell them out before the deluge. Most were wrong." Alan Greenspan The Age of Turbulence: Adventures in a New World [Economic Order?]. I propose a plausible alternative solution to the depression: Enter Your €5 in The Cra$h R€gi$t€r. Buy Now The Tract That Will Be Published September 17th, 2009. Posted by: Shalom P. Hamou | August 01, 2009 at 11:04 PM
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