Topic: Finance, Banking & Monetary Policy

“A Real Regulator”

Sunday’s Meet the Press had a fascinating colloquy on securities regulation, revealing Washington’s immense capacity for self-deception.

David Gregory set up the story, on which CNBC’s Erin Burnett commented:

MR. GREGORY: … I want to stay in New York and something else that has rocked Wall Street beyond the economy, and that is Bernard Madoff. Big money man, investment man who was the darling of Wall Street for many, many years. Now it turns out he ran a giant Ponzi scheme and billions have been lost, from the small investor to, to Jewish organizations and, and philanthropies across the country. Steve Pearlstein, who writes about the economy for The Washington Post, wrote this: “With the Madoff story, it is now revealed that the masters of the universe aren’t just too clever by half—they’re not that clever at all. For years, they not only allowed themselves to be bamboozled by a con artist but also willingly and enthusiastically served as his market agent, offering friends, relatives and favorite charities the opportunity to invest with their good pal, Bernie Madoff. (So much for the idea that wealthy individuals and ‘sophisticated’ institutional investors don’t need the protection of government regulators.)” Was anybody watching?

MS. BURNETT: It, it is incredible, because there had been credible complaints brought to the SEC that said along the lines of, “This is too good to be true. You don’t get these sorts of consistent returns.”

MR. GREGORY: Mm-hmm.

MS. BURNETT: And they didn’t do anything about it. But they’re—you know, I was talking to Mort Zuckerman, the New York real estate man, earlier this week, and he had lost $30 million in one of his charities that was invested with Bernie Madoff. And he said, “I didn’t even know who the guy was. I had given my money to somebody else who actually”…

MR. GREGORY: Right.

MS. BURNETT: …”entrusted the entire $30 million to one guy, a guy I’d never heard of, and then I get a letter finding out that it’s completely gone.” So you’re talking about some very sophisticated people who were completely duped, and maybe some of them should have been doing more due diligence. Some of them were trusting that role to others…

MR. GREGORY: Right.

MS. BURNETT: …who had a fiduciary responsibility to do it. But there’s no question we need a real regulator.

“[W]e need a real regulator.”

Ms. Burnett, the SEC that failed to prevent this is a real regulator.

When regulators fail to address a problem ahead of time, when they regulate inefficiently, when they hand their rulemaking organs to the industries they are supposed to oversee, those are all the actions of real regulators. That’s what you get with real regulation.

What Burnett meant when she called for a “real” regulator, of course, was “the regulator I can imagine.” The regulators people imagine are foresighted, interested only in the public good, they’re resistant to lobbying, and they run efficient organizations. But these characteristics are simply imaginary.

Watching discussions like these, you come to realize how legislation and regulation thrive on self-deception and the appeal to ego.

Thousands of people come to Washington and stay because they believe that they can design the ideal regulatory system. They think they know how to write a law or a regulation that works for everyone, that protects consumers, that doesn’t pick winners and losers in the marketplace, that doesn’t make the glaring errors that we see month in and month out on Sunday morning political shows.

(If only voters didn’t elect the wrong guy. If only lobbyists didn’t ‘corrupt’ the system. If only, if only, if only … .)

Alas, we’re stuck with real regulators. They fail, and when people rely on them, the failures of regulation are magnified. (Not that Mort Zuckerman should get his money back from anyone other than Bernard Madoff. No bailout.)

Libertarians and pro-Washington people (for lack of a better term) have the same goals: honest, transparent marketplaces, productive economies, healthy and happy people. The difference is that Washingtonians strive to defeat human nature rather than harnessing it, and they build a bigger and bigger machine for doing that, sometimes calling it “real regulation.”

Blagojevich’s Real Outrage

I’ve often said, as for instance here, that P. J. O’Rourke is so funny that people forget what an insightful reporter and analyst he is. (In the article linked, I suggested giving young people his books Parliament of Whores and Eat the Rich as “a post-graduate course in political science and economics .”)

Now it looks like I may have to say the same about Joe Queenan, the humor columnist and author of such books as Red Lobster, White Trash, and the Blue Lagoon. In the Washington Post Queenan says that Rod Blagojevich’s attempt to sell the president-elect’s U.S. Senate seat is actually not his most corrupt deal. He makes a strong point:

What’s far more worrisome is Blagojevich’s bizarre confrontation with the Bank of America. The day before he was arrested on charges of massive corruption, Blagojevich visited a group of striking workers at a North Chicago firm called Republic Windows & Doors. After being laid off the week before, the employees had begun a sit-in, demanding benefits they were still owed by their employer, which said it could not meet their demands because the Bank of America had cut off its financing. At this point, Blagojevich informed bank officials that unless they restored the shuttered window-and-door company’s line of credit, the state of Illinois would suspend all further business with Bank of America. A few days later, the bank caved in and ponied up a $1.35 million loan.

The idea that the governor of a state as prosperous and important and sophisticated and upscale as Illinois would make this kind of threat is terrifying. Even more terrifying is that Bank of America saw no alternative but to give in. Yet even more terrifying is that nobody outside Chicago seems to have gotten terribly worked up about the situation, riveted as they are on the governor’s more theatrical transgressions. But peddling a Senate seat or using scare tactics to shake down a newspaper are nowhere near so serious a menace to society as letting the government arbitrarily intervene in financial transactions between banks and creditors. A crooked governor we can all handle. But a governor who capriciously decides which commercial enterprises a bank must finance and which it can ignore is a scary proposition indeed.

Rome wasn’t built in a day. But get the wrong politician in office, and you can burn it in a day.

What the grandstanding Blagojevich reportedly attempted to do in the Republic Windows vs. Bank of America set-to is precisely the sort of thing that happens in China, where the government routinely orders up bank loans to politically connected firms. Whether a failing company actually deserves financing becomes irrelevant to the conversation; the government doesn’t want a company to fail, so it decides that it must not go under, even if it’s run by clowns, stooges, gangsters or in-laws.

Taxpayers Picking Up the Tab for a Bigger Bailout Thanks to Republican Lobbyists

The Associated Press reports on the various former Republican politicians who got fat contracts and enriched themselves in exchange for lobbying on behalf of Freddie Mac. Unfortunately for taxpayers, these amoral lobbyists were successful and the government-created entity was able to dig itself even deeper into a hole - which taxpayers are now responsible for filling.

When the Washington Nationals played their first-ever baseball game in the nation’s capital in April 2005, two congressmen who oversaw mortgage giant Freddie Mac had choice seats — courtesy of the very company they were supposed to be keeping an eye on. …The Nationals tickets were bargains for Freddie Mac, part of a well-orchestrated, multimillion-dollar campaign to preserve its largely regulatory-free environment, with particular pressure exerted on Republicans who controlled Congress at the time. Internal Freddie Mac budget records show $11.7 million was paid to 52 outside lobbyists and consultants in 2006. Power brokers such as former House Speaker Newt Gingrich were recruited with six-figure contracts. Freddie Mac paid the following amounts to the firms of former Republican lawmakers or ex-GOP staffers in 2006: Sen. Alfonse D’Amato of New York, at Park Strategies, $240,000. Rep. Vin Weber of Minnesota, at Clark & Weinstock, $360,297. Rep. Susan Molinari of New York, at Washington Group, $300,062. Susan Hirschmann at Williams & Jensen, former chief of staff to House Majority Leader Tom DeLay, R-Texas, $240,790. …The tactics worked — for a time. Freddie Mac was able to operate with a relatively free hand until the housing bubble ultimately burst in 2007.

Interestingly, at least one of these former politicians is contemplating a return to the political arena. He even portrays himself as a friend of the taxpayer. It is unclear, though, how much of a friend he really is considering that the story reveals that, “Freddie Mac enlisted prominent conservatives, including Gingrich…, paying [him] $300,000 in 2006, according to internal records.”

Hyperinflation?

Half a century ago, Illinois Senator Everett Dirksen is supposed to have summed up the Federal government’s profligate ways with the comment that “a billion here, a billion there, and pretty soon you’re talking real money.” These days it’s “a trillion here, trillion there.” Unfortunately, many don’t believe it’s real money any more. And they may be right, which might explain the eagerness in Congress to shovel some of it to failing enterprises such as the Big 3. How long before it’s “a quadrillion here, a quadrillion there?” At the rate we are going, it will be a lot sooner than another half century.

This Month at Cato Unbound: What Happened?

Writing the history of a financial crisis can’t be easy, and it’s even harder when that crisis is still unfolding.  That’s why this month we’ve invited a team of economic experts for a very special issue of Cato Unbound.  Each brings a different perspective on our financial troubles, and, partly because the matter is so far from settled, we’ve decided to give them all equal billing:  Lawrence H. White, William K. Black, Casey Mulligan, and J. Bradford DeLong will each write a full-length essay in a first of its kind roundtable format.  The question at hand:  What happened?

Prof. White’s essay is available here, and I found the following particularly interesting:

One can’t explain an unusual cluster of errors by citing greed, which is always around, just as one can’t explain a cluster of airplane crashes by citing gravity. Anyway, the greedy aim at profits, not losses.

I’m just old enough to remember how everyone called the 1980s a decade of greed. Then there were the 1990s, also a decade of greed. The 2000s? Greed yet again. (I wish I could invest in this “greed” thing. It never seems to go out of style.)

I also liked the following, which makes one of its most substantive points in the final parenthesis:

As calculated by the Federal Reserve Bank of St. Louis, the Fed from early 2001 until late 2006 pushed the actual federal funds rate well below the estimated rate that would have been consistent with targeting a 2 percent inflation rate for the PCE [Personal Consumption Expenditure] deflator. The gap was especially large—200 basis point or more—from mid-2003 to mid-2005. [4]

The excess credit thus created went heavily into real estate. From mid-2003 to mid-2007, while the dollar volume of final sales of goods and services was growing at a compounded rate of 5.9 percent per annum, real-estate loans at commercial banks were (as already noted) growing at 12.26 percent. [5] Credit-fueled demand both pushed up the sale prices of existing houses and encouraged the construction of new housing on undeveloped land. Because real estate is an especially long-lived asset, its market value is especially boosted by low interest rates. The housing sector thus exhibited a disproportionate share of the price inflation predicted by the Taylor Rule. (House prices are not, however, included in standard measures of price inflation.)

I understand that it isn’t easy to incorporate housing prices into measures of inflation, and that there is no generally accepted method of doing it. It seems more important than ever, though, to include these prices in some way, if only to let the public know the sort of trouble housing inflation has very likely been causing.

Greenspan: The Debate Continues

Jeffrey Rogers Hummel and David Henderson have responded to critics of their defense of Alan Greenspan’s monetary policy. Answering particularly the criticisms of Cato adjunct scholar George Selgin, they provide further evidence for their contention that Greenspan was not pursuing an unduly loose monetary policy in the early years of this decade.

As I noted before, in early November Cato published a paper by Henderson and Hummel with the now-controversial and counterintuitive thesis that “although Greenspan’s policies weren’t perfect, his monetary policy was in fact tight, and his legacy is one of having overseen low and stable inflation and a striking dampening of the business cycle.” A couple of weeks later we published a paper by Lawrence H. White with a very different perspective. White argued that after the dot-com bust, the Greenspan Fed held interest rates extremely low for several years, setting off what Cato senior fellow Steve Hanke called “the mother of all liquidity cycles and yet another massive demand bubble.”

Back in May, Gerald P. O’Driscoll Jr. had also sharply criticized the Greenspan Fed in a Cato Briefing Paper. He wrote that the Fed had been creating asset bubbles and moral hazard by its implicit policy of intervening to keep asset prices high.