“Should Greece Default” by Ted Temzelides link to Blog below:

 http://blog.chron.com/bakerblog/2012/02/should-greece-default/

Comment:

This Blog entry articulates the case for the ECB bailout plan pertaining to Greece and admonishes aginst a default and exit from the EU.

However:

“Question is: would anyone join the European Union today–knowing what they know? Why? The construction of the EU was ill-conceived in the first place-common currency but no common political structure–each anomaly has to be negotiated in real time. It’s not a great solution, but perhaps Greece going it alone would be more to their advantage.  Not to be esoteric, but is this the same insanity as the unwinding of a derivative or a securitization product—easy to get in, very difficult to get out.”

http://beta.project-syndicate.org/commentary/capturing-the-ecb

The Bank for International Settlements has been warning on this topic of hyper-leverage in these “efficient markets” for years.  The truth is that at the heart of this crisis, has always and forever been the OTC Swaps markets.  It’s why we can’t clear the various asset classes.  The basic “gap” is and has been quantifiable—but the leak could not be staunched as in earlier times—no matter how much stimuli.  The variability of appended derivatives adds onerous pressures.  Probably the correct action in mid 2008 would have been to suspend trading of all OTC swaps, confirm the trades, assess the “naked” transactions, and establish houses or exchanges for clearing post haste. 

Once quantified and done, calculate the real default severity and execute a modern Biblical Jubilee (or principal adjustment, we were due for one anyway and would have cost less than TARP and the Stimulus combined)—then markets could have cleared and GDP could have had a real chance at recovery. 

It’s as if Moses came down from the mountain with modern synthetic stone tablets; and the “Words” carved into these tablets courtesy of computer aided graphics of course, was: “Let the small businesses Plow Under, let the homeowners be foreclosed on wings of Hellfire, let the unemployed be stultified with rough-edged Brimstone: but at all costs and no matter what, save the “swaps” markets.  This sadly, has given us not too big to fail, but its new evolutionary progeny “TOO Big to Bailout”.

http://beta.project-syndicate.org/commentary/clearinghouse-over-confidence

Professor  Roe,

A couple of anecdotes on opacity:

1. In late 2008, Congressman Peterson of MN was Chairman of the Agriculture Committee in the House and introduced legislation to put an end to the majority of “naked swaps”—this brought an onslaught of criticism by the banking and insurance lobbies;
2. In 2009, I was hosting a panel for the Research and Statistics Division at the Board of Governors of the Federal Reserve regarding commercial real estate and capital markets and wanted to find out what amounts were referenced and appended to commercial real estate and CMBS financing. I contacted ISDA and the Pension Real Estate Association research departments —they no data;
3. I had lunch with officials from OCC and inquired if I could see the back-up data to their call reports delineating a breakdown of OTC derivatives by type of securitized products or asset classes, i.e. how they broke out by the various groups (residential loans, commercial loans, credit card debt, student loans, etc.). The reply was that their data was “not that granular”.
4. I won’t mention here the “steam rolling” of Brooksly Born by Larry Summers, Phil Graham and Alan Greenspan—but it was pivotal in setting up the debt crisis.

From a paper of mine Speculative Economics which enumerates factors to review:

“A review of derivatives, especially the unregulated swaps or OTC markets, and how their existence and use has acted to magnify the bursting of an otherwise severe but manageable series of “asset bubbles” into a complexity at a higher “order of magnitude” than has been contemplated in modern times—which has virtually frozen the capital markets. As a note, these instruments are termed by some as “welfare enhancing” credit risk transfer instruments — which create diversification and liquidity. However, the speculative nature and volume of these unregulated instruments have been daunting to the international financial system and hard on real economies.”

The opacity of these markets is the primary driver in holding the U.S. and global economies in suspended animation—markets can’t clear—simply because derivatives still remain uncontrolled and unaccounted. At least a clearing house would be start.

Please click on link above.

Behaviour will never be regulated; the ability to monitor the holistic system or “connect the dots” is again being discussed by various parties–most recently in the report–Enhancing Financial Stability and Resilience: Macroprudential Tools and Systems for the Future. It was a faillure of the system as a whole. Non-existent regulation, abysmal legislation with no forethought of unintended consequences, a former “sophist” Fed Chairman, who didn’t see the whole picture and CEO’s who didn’t fully understand their businesses (isn’t that what a CEO is supposed to do?).

From a writing of mine:

“There is inherent value in being a student of history applying heuristic and analytic methods to the research of core phenomena in pursuit of solutions that have the highest probability of success. Below is a program that, importantly, contemplates reviewing a hierarchy of causes of the current financial turmoil to determine which were most contributive. This would be inclusive of recommendations developed from an understanding of the historical events of the past 25 years coupled with a pragmatic understanding of what occurs in the daily world of this strata of various financial transactions. The financial upheaval that is with us today and will continue for an indeterminate amount of time—needs to truly be understood. However, re-tracing specific events leading up to a complex series of problems is especially important to fully grasping the situation before devising a strategy.

Restoring confidence would mean embracing very
determined and decisive action. Moving to the beginning of these evolutionary processes one might consider,‘‘What policy actions could have been instituted that might have created systemic regulatory and prudential (supervisory) framework control?’’ These regulatory frameworks are still capable of acting positively today. The categories contained in the frameworks could be carefully defined and enumerated. Embracing these concepts, the program would contain the following attributes and components:

a. A concise historical timeline of causal events that led up to this severe economic crisis inclusive of the dismantling of earlier safeguards that had been put into place.
b. An analysis of capitalism by breaking it down to its component parts viz., a) free market theory and b)‘‘financial capitalism’’ (banking and financial services).
These two concepts, although complementary, in the main have some mutual exclusivity and need not necessarily be synthesized as one theory. Too often, ‘‘capitalism’’and ‘‘free enterprise’’ are used interchangeably although
they refer to different concepts. One element to
be reviewed could be the growth of the financial services sector from 15 percent to 25 percent of GDP and the its effect on employment.
Regulatory anomalies that have occurred over the past 25 years or so which portray a confusing system of financial regulatory frameworks and legislation that have generated an array of unintended consequences through poor coordination. Included would be legislation
of the late 1990’s.
c. A review of derivatives, especially the unregulated swaps or OTC markets, and how their existence and use has acted to magnify the bursting of an otherwise severe but manageable series of ‘‘asset bubbles’’ into a complexity at a higher ‘‘order of magnitude’’ than has
been contemplated in modern times—which has virtually frozen or stalled the capital markets. As a note, these instruments are termed by some as ‘‘welfare enhancing’’
credit risk transfer instruments—which create
diversification and liquidity. However, the speculative nature and sheer volume of these unregulated instruments have been daunting to the international financial system and hard on real economies.
d. The adverse effects of unplanned international support systems in terms of credit, interest rate, and foreign currency derivatives and the roles played by various dealers and other participants.
e. A view of the inherent flaws of the credit rating agency system.
f. The concept of ‘‘super anti-efficient’’ or shadow markets and the evolution of special purpose entities (SPEs) as they relate to the current dilemma’s offbalance-sheet transactions and their effects.
g. Overview of the existing inventory and potential default severity of credit instruments (by asset class)still held by financial institutions (especially housing)
along with relevant Financial Accounting Standards Board (FASB) accounting procedures.
s Recommendations for applied remedial actions in an effort to address the current turmoil at its core, and to restore a sense of normalcy to the United States economy, and to the global markets.

Obviously, other elements would need to be analyzed and solved for, such as residential and commercial real estate valuation and their financings. But the key to any program would be to have one overarching purpose: to allow the markets to clear, reset and move forward. Reinstatement or the creation of new frameworks would provide of new frameworks would provide boundaries to keep the economy on a smooth road.”

Comment by Stephen R. Ganns — March 7, 2011 @ 1:07 pm

 According to Euro News, one of the stated intentions was expressed as: 

 “… to avoid a repeat of the global financial crisis the G20 nations have decided to put the policies of seven of its members, the US, China, Britain, Germany, France, India and Japan under the microscope. The IMF will seek out imbalances in debt, trade, and budget deficits, although its conclusions will not be binding on members.”

 “The guidelines operate a little bit like a net which actually holds those of the countries that violate or do not respect the guidelines and the net is a little bit tighter for those countries that are considered of systemic importance because they represent more than five percent of the GDP of the G20”, said French Finance Minister Christine Lagarde.

 This regime or set-up raises questions here in the U.S.   Question one: Why are these particular entities, the BIS and FSB (which are made up of central bank representatives) being vested with so much latitude and altitude (respect of position) —when the central banks themselves exist to be of service to their States of origin?   Additionally, the central banks in many cases are owned by their private commercial banking members.    Question two: Although the IMF is performing better work than it did in the past (even though that past is quite checkered), is it really an organization in which we want to abdicate our faith to in terms of monitoring our own economy or in their parlance, “put… under the microscope”–so as  to be judged?

 We see that the conclusions won’t be binding.    However, look at Minister Lagarde’s language above, “…the net is a little bit tighter…”   Is that the non-binding net for “violators” and “disrespectful” miscreants?    Would there be embarrassment or moral suasion (persuasion and pressure) for non-compliance?  What influence will this have on buyers of sovereign debt or sovereign trade agreements?    How does this affect the dollar as a reserve currency?  How will the Rating Agencies react to these analyses since they have had very little a priori vision (ability to analyze beforehand) in the past?   There are other potentially serious unintended consequences.

 Why is this happening?   It appears that we did not fill the void proactively when the crisis occurred—to correct earlier legislation, propose effective regulation and internal surveillance..   And so in the final analysis, Westphalian principles (of sovereignty) are being bypassed by international entities and coalitions without the approval of the United States Congress.  It’s an interesting system being put into place which has the force of a treaty, and yet is arranged to not necessarily need ratification.    I guess we could throw in the towel and declare our ascendancy (primary influence) as a country officially ended.    As Shakespeare would have said, “We did to our own selves.”

 What possible perspective should or could we take?

 Let’s review the actual position of the U.S. in relation to the rest of the world; and fashion a Prognosis for U.S. Full Faith and Credit.

 The United States is very well established, with its Constitution, its freedoms, its magnitude and its capacity for production. It acts as a beacon to individuals throughout the world.  It houses approximately 4.5 percent of the world’s population and yet is responsible for 25 percent of the world’s output or production.  GDP per capita is another U.S. statistic that resides in a high range relative to the rest of the world.

 To add some perspective, let’s take a look at the listing of global GDP and population for 2009:

• United States— $14.25 trillion; 313 million
• Japan— $5.1 trillion; 127 million
• PR China— $4.9; trillion 1.4 billion
• Germany— $3.3 trillion; 81 million
• France— $2.7 trillion; 65 million
• UK— $2.2 trillion; 62 million
• Italy— $2.1 trillion; 60 million
• Brazil— $1.6 trillion; 193 million
• Spain— $1.5 trillion; 47 million
• Canada— $1.3 trillion; 34 million
• India— $1.2 trillion; 1.2 billion
• Russia— $1.2 trillion; 142 million
• Saudi Arabia— $360 billion; 26 million
• Iran— $330 billion; 79 million

 These numbers indicate that the United States and its citizenry have a very high capacity to monetize resources, both as hard assets and as human innovation, production, and technology.  Truth is that we maintain our position even with weaknesses in our employment and banking sectors.  So the question becomes, what is the prognosis?

 The balance sheet of the United States is not in the news very often. However, in a fiat monetary system, which we have, wouldn’t this be the central part of the ‘‘full faith and credit’’ that backs our currency? The value of our public and private assets is truly a staggering amount.  The public assets alone have an estimated value of some $500 trillion, including land holdings, mineral rights, real estate, equipment assets, etc.  Quite simply stated, we are not bankrupt by any stretch of the imagination.

 So from one perspective, what we have as a country is a cash flow problem. Assets could be monetized. Treasury and the Fed could get creative with the inter-play between assets and the national debt. The structural deficits (primarily entitlements) need re-thinking accompanied by good planning. GDP and employment need attribution analyses to provide for immediate growth and employment. ** Regulation needs to be pursued in a logical and coordinated manner.   The timeline leading up to the crisis marks a clear and lucid set of events which can be defined and remedied here at home.

  It would certainly be auspicious for the stewards of our economy to create a point of control to analyze and coordinate workable solutions.   If this can be done in a timely manner, with creativity and certainty, the prognosis can still be good.

 Caution: The United State needs to know thyself again.   We need to develop the political will to recognize what ends our mission serves.  Until this happens, we continue to risk floundering adrift in a sea of uncertainty.   

 *Communiqué: Meeting of Finance Ministers and Central Bank Governors, Washington DC, 14-15 April 2011 http://www.g20.org/Documents2011/04/G20%20Washington%2014-15%20April%202011%20-%20final%20communique.pdf

**Attribution Analysis—analyzing the attributes of a particular endeavor to determine what actions or properties contribute to or detract from stated objectives.

Editor’s Note: The post comes to us from Guido Ferrarini, Professor of Business Law and Director of the Centre for Law and Finance at the University of Genoa, and Maria Cristina Ungureanu, Research Fellow at the Centre for Law and Finance.

On 2 April 2009, the G-20 issued the: Declaration on Strengthening the Financial System. The Declaration vested “enhanced capacity” to the former Financial Stability Forum–now re-named the Financial Stability Board. It also seems to have appointed the IMF with an enhanced role in the arena of financial regulatory reform. Several reports and articles have since been produced, many of which are quite comprehensive.

The G-20 document references many component parts; one of which deals broadly, with compensation. This is the subject of the post by Professor Ferrarini and Ms. Ungureanu.

However, before I turn attention to my comment, I would like to make an observation. We still live in a world which subscribes to a Westphalian system (well discussed by Padoa-Schioppa in his intellectually breathtaking Per Jacobsson Lecture). Much of the declaration reads as if it were some form of treaty by sovereign governments. As these types of issues do not garner much press or interest for that matter, and are not very well understood by legislators (empirically evident in the U.S.), the liability extant is that it will meet with opposition when finally understood by those with responsibility. Surveying several legislators, economics and business professors, bankers and business chieftains in the U.S, it is interesting to note that 99 out of 100 have never heard of the BIS–much less one of its secretariats the FSB.

The idea of mis-alignment of compensation being a central cause (of the Turmoil of 2007) is a “red herring” of immense proportion. It’s tantatmount to a medical doctor chasing the symptoms of a patient rather than dealing with the source of the illness.

The turmoil and consequent damage caused globally was primarily a failure of sovereign governments and central banks to monitor and understand what was occurring under their charge. This primarily was a U.S. problem of faulty legislation and poor use of regulation; but most importantly, monitoring in an holistic fashion. Putting forth the idea that “greed” (let’s call it what it is) can be regulated is unrealistic and counter-productive–as well as counter-intuitive.

It is a fact that Wesphalian systems are dirigistic and need to set rules and guidelines–especially in the insured banking sector. Yes leverage requirements, yes de-construction of too big to fail institutions offering too many diverse products and services, yes prudential supervision, yes reform of CRA’s, etc. But the attempt at moderating compensation from outside of the internal entity or organization by an authority that is not part of the actual Sovereign is a non-starter and will not gain traction.

The turmoil developed over a 25 year period; very specific events occurred in the timeline which led up the collapse. It’s time to revisit those events.

Comment by Stephen R. Ganns — April 13, 2011 @ 7:04 pm

Good article!

Seems we need a distinction to be able to differentiate the parts of capitalism–which have somehow become fused. Digressing for a second, the societal considerations seem to be inherent in the Westphalian system of which we are a participant. That system is dirigistic–setting up the rules or guidelines–which are needed to make sure the impact to the society operates toward the greater good. Once the rules are in place, the system can operate freely.

It seems that the problem is one of definition and non-differentiation between Free Enterprise and pure Finance, or as it has been coined, Financial Capitalism.

The reason the distinction between Free Enterprise and Finance is so important today, lies in the fact that free enterprise or free markets have always generally been able to achieve a natural equilibrium based on supply and demand. However, speculative “financial” practices tend to force real production economies to become unbalanced. This generally creates the “boom and bust” phenomenon. Unfortunately, the two concepts still remain fused today and synthesized in the public’s mind within the definition of capitalism-just as Karl Marx intended it in the mid 1800′s when he coined the term as a pejorative or strictly negative term.

Free enterprise is an economic system in which markets are created by private businesses to sell their goods and services to the general public.

The basic components of capitalism’s current properties would include:

1. Real assets, property, facilities and equipment are privately held.

2. The economy creates equilibrium through the concept of supply and demand– essentially driven primarily by demand, those who need goods and those who have supply.

3. The concept of best use of natural and human resources and the marketing of those resources successfully to consumers to gain maximum exchange.

4. Limited government regulation exists as a dirigisme to ensure fair play and to prevent market manipulation.

5. However, it is worthy of note that this does not imply in any way an anarchy. Government would lay out the ground rules to keep the markets from being undermined or manipulated. This is completely consistent with Adam Smith’s “invisible hand” as taught in “…The Wealth of Nations”. Why? Simply because in his earlier work (which was continually revised), “The Theory of Moral Sentiments” which speaks of social responsibility, could be referred to as a “visible hand”, thus creating a binary and balanced system going hand in hand.

By finance or financial capitalism, we mean the use of capital or wealth to create more wealth including the charging of interest and speculations in different types of financial products such as various types of investments, equities, options or other derivatives. In defining finance by these particular uses, functions and habits, it can be seen that the nature of finance is not centrally (directly) involved in the actual production process. It is generally a facilitator, aiding production, as in providing capital for daily operations or expansion or consumption. This is finance’s true value.

Viewing the current turmoil of 2007, it can be seen that the “capital markets” have frozen dramatically, seriously hindering production, consumption and free enterprise. Question becomes: what would cause this imbalance to occur between these two forces?

We can solve for that.

Stephen R. Ganns

http://yaleherald.com/opinion/remaking-capitalism-for-the-greater-good/