Unintended consequences of bailouts

April 30, 2009

Conflicts of interest abound

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Quote of the day

April 30, 2009

From Bloomberg:

The odds that 19 men and women (a.k.a. the Federal Open Market Committee) will be able to select the overnight interest rate that keeps the U.S. economy growing at its potential in perpetuity are next to nil.

There would be a huge outcry if the Fed set the price of oil or copper or soybeans. Yet we accept the central bank as a price setter, a monopolist, when it comes to the interbank lending rate.


Cato @ Liberty doesn’t understand Cato Unbound

April 29, 2009

Read this.  Mr Kuznicki clearly doesn't understand Mr Thiel's argument.

The broader point Mr Thiel made is that democracy and libertarianism are incompatible.  If you believe in democracy and are a libertarian, you are wasting your time.  A majority of the electorate will never vote for libertarian policies.  Further, any safeguards you put in a constitution will eventually fall to whims of the electorate.  If you're going to wish for something impossible, pick something better than an impossible libertarian-democracy.

With respect to women voters, Mr Thiel's point is simply that expanding the electorate to include women hastened the process that was already underway of making the US less libertarian (i.e. more democratic).


Review of "The Rise and Decline of Nations" by Mancur Olson

April 29, 2009

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I also got this recommendation from Patri Friedman’s article on seasteading (see previous review).   I didn’t like this work as much as the other.

For the first third of the book, Mr Olson lays out logic that leads to the following implications (all quoted):

1.       There will be no countries that attain symmetrical organization of all groups with a common interest and thereby attain optimal outcomes through comprehensive bargaining.

2.        Stable societies with unchanged boundaries tend to accumulate more collusions and organizations for collective action over time.

3.       Members of “small” groups have disproportionate organizational power for collective action, and this disproportion diminishes but does not disappear over time in stable societies.

4.       On balance, special-interest organizations and collusions reduce efficiency and aggregate income in the societies in which they operate and make political life more divisive.

5.       Encompassing organizations have some incentive to make the society in which they operate more prosperous, and an incentive to redistribute income to their members with as little excess burden as possible, and to cease such redistribution unless the amount redistributed is substantial in relation to the social cost of the redistribution.

6.       Distributional coalitions make decisions more slowly than the individuals and firms of which they are comprised, tend to have crowded agendas and bargaining tables, and more often fix prices than quantities.

7.       Distributional coalitions slow down a society’s capacity to adopt new technologies and to reallocate resources in response to changing conditions, and thereby to reduce the rate of economic growth.

8.       Distributional coalitions, once big enough to succeed, are exclusive, and seek to limit the diversity of incomes and values of their membership.

9.       The accumulation of distributional coalitions increases the complexity of regulation, the role of government, and the complexity of understandings, and changes the direction of social evolution.

He then goes on to draw some, rather ordinary, conclusions from these implications.  For example, free trade and markets are good and discrimination is bad.  Mr Olson does part with libertarian types in one important respect.  The libertarian belief that that small, weak government is best does not take into account these implications.  In the absence of government intervention, non-competitive markets will be the norm and coalitions seek to impose their will.

I understand this argument, but an example would be nice.  The only examples of these coalitions succeeding in modern life that I can think of, involve the use of the power of government.  Unions have gotten minimum wage laws passed, for example.  Lawyers all have to go to law school to take the bar, according to state law, for another.

Mr Olson gives libertarians more smackdown with respect to India under British rule.  While under British rule, India did not experience an economic boom, like many other colonies.  Under British rule, Mr Olson states, that India had a relatively free-market system.  The presence of castes and coalitions were too much to allow freedom and prosperity to triumph.  Libertarians, he says, do not adequately recognize this.

I have some quibbles with Mr Olson’s analysis and his thoughts on economic theories – he seems to believe a high-level of scientific precision is necessary for an economic theory, I think that’s crazy.  Still, I don’t think it’s helpful to get into those quibbles.  His main point is that we need to be aware of these coalitions and take them into consideration.

I agree.  But, I’m not sure purely competitive markets are the goal.  Why not allow people to live in highly grouped societies if they want to?  I think Mr Olson’s arguments suggest that we should allow free emigration of people into countries that are willing to accept them.

From this book and the previous one I mentioned above, I will take away one more, major point.  Governments and large organizations have a natural tendency to decline in quality over time.  That is a scary implication.


More on Glass-Steagall

April 29, 2009

Professor Kling, joins my argument:

I have yet to hear one coherent explanation of how the relaxation of Glass-Steagall caused this crisis. At least the proponents of the view that it was all the Community Reinvestment Act (a view which I do not endorse) have a story to tell.

Again, I'd point out that the narrative doesn't fit the evidence.  If the blame rests on Glass-Steagall, wouldn't we see the most integrated banks (integration between commercial and investment banks) being in the worst shape?  If so, how do we explain the success of JP Morgan and the failure of all the stand-alone investment banks (except Goldman and Morgan, but who knows what would have happened had they been prevented from forming bank holding companies).


The perils of quasi-non-nationalization

April 28, 2009

From Clusterstock:

If the government had just seized Citigroup six months ago, as it was supposed to, we wouldn't be in this position. The company would have been chopped up and units like Phibro would already have been sold off.  Bondholders would have absorbed some of the costs (as they should).  And we wouldn't be in the absurd position we find ourselves in now.

The Fed and libertarianism

April 28, 2009

First, let me say that I think this article is silly.  The Fed is a very un-libertarian entity, by nature.  Its essence is to eliminate the free market in interest rates by printing or destroying fiat currency.  Calling it "libertarian" is like called the Politburo libertarian.

I'd like to respond to the author's points in order:

First, it explains to a large extent why the Fed did not strongly oppose the removal of Glass-Steagall restrictions.

Ok, fine, but I still don't see why Glass-Steagall was the problem.  No such prohibitions exist in other countries and some are doing better than we are.  The extent of interconnectedness between banking and investment banking at individual institutions doesn't seem to be correlated at al with how safe the institution is.

Second, it also helps explain why the Fed failed to recognise that abandoning Glass-Steagall created more institutions that were “too big to fail”

"Too big to fail" is an unlibertarian concept.  The Fed believes in it.  Therefore, the Fed is unlibertarian.

Third, it diminished the supervisory role of the Fed, especially its direct responsibility to regulate bank holding companies. To be sure, the Fed’s supervisory responsibilities have never been very visible in the monetary policy decision-making process. But its tilt toward an economic libertarian approach pushed supervision a notch down just at a time when financial market complexity was on the rise.Fourth, as hands-on supervision slackened, quantitative risk modelling became increasingly acceptable. This approach, especially quantitative modelling to assess the safety of a financial institution, was far from adequate. But it worked hand in glove with a philosophy that markets knew best.

What diminished the Fed's supervisory was regulatory competition with the OCC and the hiring of large number of people who have PhDs in quantitative fields.  Institutionally, the Fed does not have a libertarian bias, it has a quantitative bias.

Fifth, adherence to economic libertarianism inhibited the Fed from using the bully pulpit or moral suasion to constrain market excesses. It is difficult to believe that recourse to moral suasion by a Fed chairman would be ineffective. Such public pronouncements about financial excesses are hard to ignore, reaching the broad public as well as market participants.

The Fed avoiding stopping excesses because is has an insitutional bias to be pro-inflation, like all cental banks.  Such a bias is anti-libertarian and is a necessary condition for big government.

Sixth, the Fed’s increasingly libertarian philosophy underpinned its view that it could not know how to recognise a credit bubble but knew what to do once a bubble burst. This is a philosophy plagued with fallacies. Credit bubbles can be detected in a number of ways, such as rapid growth of credit, very high price/earnings ratios and very narrow yield spreads between high- and low-quality debt.

Or they can be detected by seeing how much money has been printed – the quintessential unlibertarian activity.