Inflation and the Fed

Published in Barron’s.

Forsyth suggests that a “‘complete financial externality’…would aptly describe the Great Financial Crisis of 2007-09.” I don’t think so. That crisis, like many others, was “endogenous,” as my old friend, Hy Minsky, used to say—reflecting the internal dynamics of interacting leverage, inflated asset prices, moral hazard, and risk in the financial system. Central banks are part of the system, and its internal interactions are not above the system in some celestial role. If you are prone to believe in “the control asserted by central banks over economies,” recall the hapless announcement by central banks that they had created the “Great Moderation,” which proved instead to be the Great Bubble. Widespread belief that central banks are in control may be another endogenous risk factor.

Asset Managers Should Not Vote Shares They Don’t Own

Published in The Wall Street Journal.

“Maybe it is time for the SEC to require index funds to poll their investors and vote their shares only as specifically directed,” say Phil Gramm and Michael Solon (“Enemies of the Economic Enlightenment,” op-ed, April 16). They are so right, except it is not “maybe,” it’s time, period.

Asset managers should not be able to vote the shares they do not own to pursue their political notions or business purposes. Instead, they should be able to vote only when instructed by the real owners. That means voting by the principals, not by the agents. In this way, the asset managers would be treated exactly like the broker-dealers who control huge numbers of shares registered in street name, but must ask the real owners how to vote. It is indeed high time for the SEC to fix this very troubling anomaly in corporate governance.

We can’t help feeling that we today are smarter

Published in the Financial Times.

Martin Wolf is certainly correct that “further financial crises are inevitable” (March 20). Let me add one more reason why this is so — another procyclical factor rooted in human nature. This is the intellectual egotism of the present time: the conviction we can’t help feeling that we are smarter than people in the past were, smarter than those old bankers, regulators, economists and politicians of past cycles, and that therefore we will make fewer mistakes. We aren’t and we won’t. The intellectual egotists of the future will condescendingly look back on us in their turn.

Zimbabwe Monetary Theory

Published in Barron’s.

A more instructive name for so-called Modern Monetary Theory is Zimbabwe Monetary Theory, or ZMT (“Do Budget Deficits Matter? Not to Today’s Left or Right,” Up & Down Wall Street, March 1).

It is hardly a new idea, The core issue, however, is not whether a currency is issued by fiat or instead is said to be tied to some other value. The real issue is the nature of governments and their eternal monetary temptation.

In the wake of the destruction of its old fiat currency under ZMT, Zimbabwe has not saved itself from renewed monetary debasement and confusion by trying to link to the U.S. dollar. Likewise, promising that the dollar was tied to gold under the Bretton Woods Agreement did not prevent the U.S. government from defaulting on its Bretton Woods commitments and feeding the great inflation of the 1970s.

The paradigm for government monetary behavior was perfectly explained by Max Winkler in his lively study of government defaults, Foreign Bonds: An Autopsy. In 1933, Winkler looked back a couple of millennia to a great story of Dionysius, the tyrant of Syracuse. Having gotten himself excessively in debt and being unable to pay, Dionysius ordered his subjects to turn in all their silver coins on pain of death. After collecting them, he had each one drachma coin restamped “two drachmas,” and then had no trouble paying off the debt. Dionysius, Winkler said, thereby became the father of currency devaluation. He also became the father of Zimbabwe Monetary Theory.

The end of ‘too big to fail’ remains difficult to picture

Published in the Financial Times.

If you buy shares of stock for $100 and they fall to $30, we say, “Oh well, that’s the stock market.” If you buy a bond for $100 and it ends up paying 20 cents on the dollar, we say, “Oh well, that’s the bond market.”

But if your deposits in big banks are going to pay 97 cents instead of par, that is a financial crisis, and the government must intervene to protect you.

That is why Simon Samuels is so right that “we are a long way from ending ‘too big to fail’” (“The ECB should resist the lure of bigger banks,” Jan. 31). As long as we insist that no one can lose money on bank deposits, too big to fail can never end and never will.

Golden Years

Published in Barron’s.

After considering the many problems of retirement finance in a lower-return world, the article (“The New Retirement Strategy,” Jan. 5), gets to David Blanchett’s suggestion: “It might be better to simply work longer.”

Yup. The best way to finance retirement is not to retire, at least not too soon. Shorten the time to be financed. Lengthen the time when savings can be generated. The math is simple and inescapable.

Saving for Retirement

Published in Barron’s.

A house with no mortgage left on it is a classic retirement asset and a good way to save for one’s older years (“Remaking Retirement,” Cover Story, Nov. 19). A big issue not mentioned in your otherwise informative articles on 401(k) and other retirement savings accounts is how to utilize these accounts, now completely focused on stocks and bonds, to address the hardest financial problem of many young families. This is how to finance the down payment on their first house, which is also an excellent retirement asset.

In my view, Congress should amend the governing acts for retirement accounts to provide for a simple and penalty-free withdrawal from 401(k) and individual retirement accounts for the down payment on a first house, with the tax deferred on the income withdrawn (perhaps starting amortization at age 70½). We should give investing in a house of your own the same retirement-account tax treatment as investing in stocks and bonds.

Congress did have bills introduced in this direction in the 1990s—it would be a good bipartisan project to actually do it now.

2 percent inflation is just a central bank fad

Published in the Financial Times.

Your interview with Shinzo Abe (“Japanese PM targets big reforms to cement legacy,” Oct. 8) may indicate some momentum in a fundamental shift in ideas — a shift away from the in-retrospect foolish “golden age” theory of retirement, which was invented in the 1950s. This led to the notion that, starting in their 60s, people should be paid while spending a couple of decades or more in idleness and entertaining themselves, rather than remaining productive. Mr Abe instead wants “a society where people never retire and pursue lifelong careers.” If not lifelong, perhaps, at least significantly longer.

Your article proceeds to assert dogmatically that this “will count for little if deflation is not banished” because “the Bank of Japan’s 2 percent inflation objective is still far off.” This treats the necessity of 2 percent inflation as a fact instead of a pretty dubious theory. In reality, perpetual inflation at 2 percent is merely the latest fashion in central banking ideas. It follows many other central bank fashions, which have succeeded each other over a century, going back to the gold standard. Like the “golden age” theory of retirement, I believe the “2 percent inflation forever” theory will be found wanting and replaced.

Efforts to close the ‘doom loop’ are destined to fail

Published in the Financial Times.

Thomas Huertas (“Bank holdings of sovereign debt need scrutiny,” September 7) makes very reasonable proposals of how to control the “doom loop” of government debt making the banking system more risky, while the banks make the government’s finances more risky. But the sensible reforms he recommends won’t happen and can’t happen. This is for a simple and powerful reason: the financial regulators who would have to take the actions are employees of the government which wants to expand its debt. A top priority of all governments is to be able to increase their debt as needed. The regulators will not act against this fundamental interest of their employer.

An egregious example of this problem in the U.S. context is that as the bubble inflated the banking regulators did, and still do, allow the banks to hold unlimited amounts of the debt of Fannie Mae and Freddie Mac, the government-backed mortgage firms, long since failed and in conservatorship. Moreover, the regulators allowed (and indeed promoted, through low risk-based capital requirements) banks to own and finance with deposits the preferred equity of Fannie and Freddie. These were distinctly bad ideas. But what were the poor regulators to do? Their employer, the US government, wanted to expand housing debt and leverage through Fannie and Freddie, and they went along.

Letters to Barron’s: Rediscovering Minsky

Published in Barron’s.

Hyman Minsky is featured in Randall W. Forsyth’s “Musk’s Buyout Plan May Signal Market Woes Ahead,”(Up & Down Wall Street, Aug. 11). About Hy, who was a good friend of mine and from whom I learned a lot, Forsyth says that his “insights were rediscovered after the financial crisis,” meaning the crisis of 2007-09. That is true, but Hy was previously rediscovered in the financial crises of the 1990s, and before that was discovered during the financial crises of the 1980s. The popularity of his ideas is a coincident indicator of financial stress.

Hy’s most important insight, in my opinion, is that the buildup of financial fragility is endogenous, arising from the intrinsic development of the financial system, not from some “shock” that comes from outside. I believe this key contribution to understanding credit cycles can be improved by adding that “the financial system” includes within itself all of the financial regulators, central banks, and governments. All are within the system; no one is outside it, looking down. They all are part of the endogenous process that generates the crises, which periodically cause Hy Minsky to be rediscovered again.
Alex J. Pollock
R Street Institute
Washington

Fixing capitalism

Published in Barron’s.

In “A Radical Proposal for Improving Capitalism” (Other Voices, June 16), Eric A. Posner and E. Glen Weyl repeat the venerable observation of Adolph Berle and Gardiner Means (in The Modern Corporation and Private Property, published in 1932) that in corporations, “ownership was separated from control,” where the shareholders are seen as principals and the management as hired agents. But this is old news.

The fundamental structure of corporations has changed little since 1932, but the structure of capital markets has changed a lot. In addition to the concentration of voting power that Posner and Weyl reasonably worry about, a more fundamental problem is that we now have an additional, dominating layer of agents: the investment managers. The result is a further separation: that of ownership from voting. The hired employees of the investment-management firms control the votes, and claim to be stockholders, but in fact they are merely agents with other people’s money.

What do those other people, the real owners, have to say in contrast to whatever their hired agents may think? Those may not be at all the same. If you don’t like agents being in control in the one case of separation, why would you like them being in control in the other?

Letter to Editor Barron’s: Listen up, Uncle Sam

Published in Barron’s.

Governments “should take particular care to prevent real estate bubbles,” writes Michael Heise (“Global Debt Is Heading Toward Dangerous Levels, Again,” Other Voices, May 19).

He’s right, of course. But the U.S. government does the opposite. As it has for decades, it promotes real estate debt and inflates real estate prices through government credit, subsidies, guarantees, and regulation—not to mention the massive monetization of mortgages by the Federal Reserve. When will they ever learn? The best bet is never.

Governments could take bitcoin out of circulation

Published in the Financial Times.

Nima Tabatabai asks about bitcoin, “can financial regulators control this emerging digital monetary asset?” ( Letters, May 18). The answer is they can. If a government sets its mind on it, it can tax, punish and regulate any monetary asset out of circulation. In the 1860s, Congress put a 10 percent tax on state bank notes to prevent their competing with the new U.S. national bank notes. State banks survived by expanding deposits, but state bank notes as a currency were gone. In the 1930s, the U.S. government, formerly on the gold standard itself, made it illegal for its citizens to own gold or denominate payments in it. Violating the prohibition was made a crime punishable by a fine of $10,000 or 10 years in prison. In the 1960s, the U.S. government simply refused to honor its explicit promise to redeem paper silver certificates with the silver dollars which were certified as “payable to the bearer on demand.” Thus U.S. dollar bills convertible to silver ceased to exist as a currency.

What might governments do to bitcoin or its holders or users? That depends on how threatened by it they feel.

EU could follow Lincoln’s model on dual banking

Published in the Financial Times.

Sir,

When looking at the difficulties of European banking union (“Eurozone banking union heads towards ‘critical phase’”, April 11), perhaps a model to explore is that created by the US during the administration of Abraham Lincoln.

The National Currency Act of 1863, now known as the National Banking Act, created banks chartered by the federal government. These new “national banks”, regulated by the national comptroller of the currency, existed and still exist alongside the “state banks” chartered by the individual US states. Thus we got the dual banking system.

Might the EU similarly think of a dual banking structure, with some banks chartered and regulated by the EU, and others remaining chartered by the individual member states?

Macroeconomics and the unknowable future

Published in the Financial Times.

Martin Wolf is so right that “a macroeconomics that does not include the possibility of crises misses the essential” (“Economics failed us before the global crisis,” March 21). Indeed, institutions, debt and the temptations of leverage are essential to the theory, especially leverage, which is the snake in the financial Garden of Eden. The expectations of the most rational, intelligent and well-informed people are often enough surprised and shocked by events. That the financial and economic future is not only unknown, but unknowable, is what an adequate macroeconomic theory must incorporate.

Skin in the student loan game

Published in Barron’s.

Sheila Bair (“Sheila Bair Sees the Seeds of Another Financial Crisis,” Interview, March 3) is so right about colleges having no skin in the troubled student loan game, which creates a fundamental misalignment of incentives. Colleges play a role like mortgage brokers did in the housing bubble: promoting the loans, getting the borrower to run up debt, and immediately benefiting financially from the loan but having zero economic interest in whether the loan defaults or not. Therefore, it has been too easy for colleges to inflate their costs into a bubble that floats on the government-sponsored debt, just as the bubble in house prices did. The solution is straightforward: Colleges should be fully on the hook for the first 20% of the student loan losses from each cohort of their students. This would make colleges care about their students’ future financial success, care about their defaults and losses, better control their costs, and in general create better outcomes for all concerned.

Housing bubbles always make mortgage books look good

Published in the Financial Times.

Thanks for Ben McLannahan’s very good Big Read survey of the house price and mortgage debt inflation in Canada (“Canada’s home loans crisis”, February 9). One point needs clarification, however.

Mr. McLannahan writes: “Many also note that mortgage books at the big banks look rock solid.” But this means little, for housing bubbles always make the credit performance of mortgage loans look good. As long as the borrowers can sell the houses for more than they paid, credit losses are minimal. As long as house prices keep rising, the lenders, like the borrowers, are happy. When the house prices ultimately fall, the defaults and losses appear and accelerate rapidly. The resulting contraction of credit makes them fall more.

It is the price of the house that is leveraged. The risk question is always: how much can prices fall? The answer is, more than you think.

The word ‘fintech’ is a contrast of two halves

Published in the Financial Times.

Sir, Your instructive report “Online lenders count cost of push for growth” (Dec. 15) recounts their rising defaults and credit losses. This points out the contrast between the two halves of “fintech” when it comes to innovation. The “tech” part can indeed create something technologically new. Alas, the “fin” part — lending people money in the hope that they will pay it back — is an old art, and one subject to smart people making mistakes. In finance, “innovation” can be just an optimistic name for lowering credit standards and increasing risk, with inevitable defaults and losses following in its train.

Central banks are useful but not that impressive

Published in the Financial Times.

Martin Wolf’s apologia for central banks (“Unusual times call for unusual strategies from central banks,” Nov. 13) asserts that critics of central bank financial manipulation assume that “in the absence of central bank policies, the economy would achieve an equilibrium.” As one such critic, I do not share the assumption claimed, since “equilibrium” in an innovative and enterprising economy never exists. As the great Joseph Schumpeter said: “Capitalism not only never is, but never can be, stationary.” It is always in disequilibrium, heading someplace else into an unknowable future.

Without doubt, central banks are very useful to finance panics and busts. They are also good at monetizing budget deficits to finance the government of which they are a part. Other than that, pace Mr. Wolf, their capabilities are not that impressive.

Economics and politics are always mixed together

Published in the Financial Times.

Sir, Mark Hudson (Letters, Oct. 3) is certainly correct that “economics is not a science.” Nothing could be clearer than that! But he exaggerates in asserting that economics is “a subsidiary branch of politics.” Rather, economics and politics are in actual experience always mixed together. The old term “political economy” captures the reality nicely.

Mr. Hudson is also right that the tenets of political economy are inevitably based on some psychological generalisation — going back to Chapter 2 of The Wealth of Nations and “a certain propensity in human nature . . . to truck, barter, and exchange.” For this propensity, we should be ever grateful.