It was surely a surprise when the WSJ hired Thomas Frank to write an opinion column. Anyone who has read either of his bestsellers, What’s The Matter With Kansas? or The Wrecking Crew understands that his view of American politics just doesn’t fit in with the other editorial page writers there. I, for one, am very happy he is writing there and his column today should be required reading for every citizen who cares about the future of this country.
Why Congress Won’t Investigate Wall Street
Republicans and Democrats would find themselves in the hot seat.
The famous Pecora Commission of 1933 and 1934 was one of the most successful congressional investigations of all time, an instance when oversight worked exactly as it should. The subject was the massively corrupt investment practices of the 1920s. In the course of its investigation, the Senate Banking Committee, which brought on as its counsel a former New York assistant district attorney named Ferdinand Pecora, heard testimony from the lords of finance that cemented public suspicion of Wall Street. Along the way, the investigations formed the rationale for the Glass-Steagall Act, the Securities Exchange Act, and other financial regulations of the Roosevelt era.
A new round of regulation is clearly in order these days, and a Pecora-style investigation seems like a good way to jolt the Obama administration into action. After all, the financial revelations of today bear a striking resemblance to those of 1933. In his own account of his investigation, Pecora described bond issues that were almost certainly worthless, but which 1920s bankers sold to uncomprehending investors anyway. He told of the bonuses which the bankers thereby won for themselves. He also told of the lucrative gifts banks gave to lawmakers from both political parties. And then he told of the banking industry’s indignation at being made to account for itself. It regarded the outraged public, in Pecora’s shorthand, as a “howling mob.”
The idea of a new Pecora investigation is catching on, particularly, but not exclusively, on the left.
It’s probably not going to happen, though, in the comprehensive way that it should. The reason is that understanding our problems, this time around, would require our political leaders to examine themselves.
The crisis today is not solely one of bank misbehavior. This is also about the failure of the regulators — the Wall Street policemen who dozed peacefully as the crime of the century went off beneath the window.
We have all heard the official explanation for this failure, that “the structure of our regulatory system is unnecessarily complex and fragmented,” in the soothing words of Treasury Secretary Tim Geithner. But no proper Pecora would be satisfied with such piffle. The system was not only complex, it was compromised and corrupted and thoroughly rotten even in the spots where its mandate was simple.
After all, we have for decades been on a national crusade to slash red tape and stifle regulators. Over the years, federal agencies have been defunded, their workers have grown dispirited, their managers, drawn in many cases from antiregulatory organizations, have seemed to care far more about industry than the public.
Consider in this connection the 2003 photograph, rapidly becoming an icon of the Bush years, in which James Gilleran, then the director of the Office of Thrift Supervision (it regulates savings and loan associations) can be seen in the company of several jolly bank industry lobbyists, holding a chainsaw to a pile of rule books. The picture not only tells us more about our current fix than would a thousand pages about overlapping jurisdictions; it also reminds us why we may never solve the problem of regulatory failure. To do so, we would have to examine the apparent subversion of the regulatory system by the last administration. And that topic is supposedly off limits, since going there would open the door to endless partisan feuding.
But it’s not only Republicans who would feel the sting of embarrassment. Launching Pecora II would automatically raise this question: Whatever happened to the reforms put in place after the first go-round?
Now a different picture comes to mind. It’s Bill Clinton in November of 1999, surrounded by legislators of both parties, giving a shout-out to his brilliant Treasury Secretary Larry Summers, and signing the measure that overturned Glass-Steagall’s separation of investment from commercial banking. Mr. Clinton is confident about what he is doing. He knows the lessons of history, he talks glibly about “the new information-age global economy” that was the idol of deep thinkers everywhere in those days. “[T]he Glass-Steagall law is no longer appropriate to the economy in which we live,” he says. “It worked pretty well for the industrial economy, which was highly organized, much more centralized, and much more nationalized than the one in which we operate today. But the world is very different.”
It turns out the world hadn’t changed much after all. But the Democratic Party sure had. And while today’s chastened Democrats might be ready to reregulate the banks, they are no more willing to scrutinize the bad ideas of the Clinton years than Republicans are the bad ideas of the Bush years.
“We may now need to be reminded what Wall Street was like before Uncle Sam stationed a policeman at its corner,” Pecora wrote in 1939, “lest, in time to come, some attempt be made to abolish that post.”
Well, the time did come. The attempt was made. And we could use that reminder today.
The odds are against us but if Congress won’t do the right thing here, it is incumbent on all of us in the blogoshpere to keep raising awareness of every policy inconsistency and hypocrisy we see. Sooner or later, public opinion will catch up to the truth.
“the Greenspan Doctrine”
Once upon a (not long ago) time, there was a widely established set of blueprints for regimes of monetary and exchange rate policies, one expected to fit not only the full range of economies in the global arena, but also to serve as a guide for international monetary cooperation. Confidence in the effectiveness of those blueprints has been shattered by the scale and simultaneity of asset price booms and busts that led to the current global economic crisis. A reshuffle of views on monetary and exchange rate policies may turn out to be a companion to the revision of financial regulation.
It is now increasingly accepted that, to some degree and width, mainstreaming reactions to asset price moves in monetary policy is to become a new norm. It is also becoming clear that the previous world of theoretical determinacy and optimum rules of conduct is to give place to less-obvious policy choices and more discretion.
The purpose of this note is to highlight how the special complexity and indeterminacy intrinsic to international monetary-financial relations will deepen under the new regime. In the case of financial transactions between advanced financial systems and emerging markets, there is in addition an asymmetrical impact in terms of higher foreign reserve requirements on the latter.
The determinate world of inflation targeting and exchange-rate corner solutions
“The past 10 years have been the decade of inflation targeting. (…) Narrowly defined, inflation targeting commits central banks to annual inflation goals, invariably measured by the consumer price index (CPI), and to being judged on their ability to hit those targets. Flexible inflation targeting allows central banks to aim at both output and inflation, as enshrined in the famous Taylor Rule. The orthodoxy says that central banks should essentially pay no attention to asset prices, the exchange rate, or export prices, except to the extent that they are harbingers of inflation”(Frankel. 2009).
Asset price cycles were seen as basically harmless – or non-significant as a channel of transmission of monetary policy, as in the case of developing economies without financial depth. Even when the frequent appearance of bubbles started to be acknowledged, the belief – “the Greenspan doctrine” – was that attempts to detect and prick them at an early stage would be impossible to accomplish and potentially harmful. If necessary, resorting to interest rate cuts to safeguard the economy after bubble bursts would be a safer procedure.
Low and stable inflation could then be attained through a forecast-oriented, anticipatory manipulation of basic interest rates, as the single focus for monetary authorities. Movements of floating nominal exchange rates would reinforce the effectiveness of interest rates set to target inflation. Stable inflation would also lead to low risk premiums and higher financial stability.
In the case of small countries, fixing the nominal exchange rate and abdicating of monetary policy would import stability from inflation-targeting countries. The “Great Moderation” period, with developed economies exhibiting relatively low inflation rates and output fluctuations from mid-80s onward, seemed to vindicate that confidence.
This world of presumed stable and stabilizing monetary and financial spheres was shaken by the global financial crisis. With hindsight, asset price booms and busts became acknowledged as both increasingly pervasive and harmful: real-estate and stock-market booms leading to excess US household debt and to fragile asset-liability structures; a generalized bubble burst pushing the global economy to a quasi-collapse.
Endogenous creation of liquidity and the “sea of bubbles”
Chapter 3 of the latest IMF’s “World Economic Outlook” brings evidence on the presence of real-estate and stock-market asset price busts over the past 40 years (WEO – ch.3). The recent experience with widespread busts of both house and stock prices is singular in the last 40 years (Chart 1). However, one can observe not only the frequency of previous episodes, but also that those “asset price busts are relatively evenly distributed before and after 1985 – a year that broadly marks the beginning of the ‘Great Moderation’” (p.95).
The Arrival of Asset Prices in Monetary Policy by Otaviano Canuto