Free-market responses to the crisis?

I’m working on questions of a new financial architecture in the wake of the financial crisis and the various bailouts, and I’m interested in whether there is a well-worked out free market alternative to the policies we’ve seen so far.

To be clear, I’m not interested, at this point, in arguments about whether free markets are to blame for the crisis. I’m also not interested in criticism of the bailout unless it’s presented as part of a reasonably detailed argument that doing nothing, or doing something different, would produce a better outcome. Finally, I’m not interested in responses based on fringe economic theories, for example, anything based on gold or the ideas of Ron Paul[1]. That is, I’m interested in work by mainstream economists putting forward a more free-market alternative to the policy of partial nationalisation adopted so far.

fn1. I’ll post on this later, but in this thread, I will terminate with prejudice anything of this kind, and similarly for meta-comments that Paul is not really a fringe figure or that someones right to free speech is being censored here.

43 thoughts on “Free-market responses to the crisis?

  1. Hanke is a mainstream economist, though his track record as an advocate for the disastrous Argentine currency board doesn’t inspire confidence. But he doesn’t offer an alternative, just bags out his usual target.

    Hanke endorses a book I just finished reading called “Gold – The Once and Future Money” by Nathan Lewis. Not very mainstream I suppose but if you say he is mainstream I suppose I can continue to put such arguments around these parts. In any case if you genuinly want new ideas you should be prepared to look outside the mainstream.

    Hanke suggested that Argentina not pull the pin on their currency board. The currency board wasn’t perfect but it had elliminated the massive rate of inflation that Argentina had endured during the 1980s. They then pulled the pin and surprise, surprise, the peso plummeted in value, massive inflation returned and the economy tanked. Pulling the pin did not solve any problems but created a heap of new ones. To conclude from this that Hanke was wrong when he said don’t pull the pin is really quite twisted. If you merely think the currency board was imperfect then you’re not really disagreeing with Hanke.

    During the current financial “crisis” the US government and it’s agencies panicked and in their panick they spooked the markets# (I’d be spooked to if I was in a room with a panicked elephant).

    Hanke has argued (although not so well in the article I linked you to) in interviews that the bailouts were not necessary and that the market would have cleared up the mess itself. Given that the core problem was an issue of solvency, not liquidity, there is every reason to believe that he is correct. My own view is that the government takeovers are more forgivable than the government bailouts so long as the government operates as little more than a company receiver. Although why the normal course of bankruptcy and payout on deposit insurance wasn’t followed is somewhat lost on me. Why even have deposit guarantees if the government is going to take over insolvent banks in any case.

    In terms of bank guarantees in Australia I personally think a better response would have been an unlimited guarantee on 90% of all bank deposits with a later pull back to 75%. That would still leave 10% at risk (25% later on) which would ensure that risk takers in the banking sector were not rewarded with an equally low cost of funds. The current setup sows the seeds for future problems. A 90% guarantee would take most of the political heat out of a bank insolvency whilst not entirely displacing lenders responsibility for considering the risk associated with their chosen investment.

    # Yes Ernestine I know that markets are not people. It is just a turn of phrase.

  2. Prior post says

    “The problem with that idea was, and is, how to price “toxic� assets that nobody wants. And lurking beneath that problem is another, stickier problem: If they are priced at current market levels, selling them would be a recipe for instant insolvency at many institutions. The fears that are locking up the credit markets would be realized, and a number of banks would probably fail.

    Let them fail is a market solution. The numbers of financial institutions and the complexity of financial instruments they produce clearly needs rationalising and the market is attempting to clear. Toxic assets should be brought to account at toxic values to owners until they are cleared – that is the sad reality here. What point government purchasing toxic assets without any stake in the improved institution? That is asking the taxpayers to bear the burden of risk arising from risky behaviour by the few who often remain insulated from the downturn by their own wealth holdings (and it was ever thus).

    Taxpayers funds should be directed not at staving off an inevitable correction in the overblown financial sector, but in assisting the economy recover (main street). Its main street that runs Wall street in the end.

    Additionally let superannuation savings be determined by individuals, not funds. How many ordinary people might have been better off paying off their mortgage before having their super directed to superannuation funds.

    More power also needs to be given to shareholders to limit executive excess remuneration. Surpluses of this size cannot continue to be withdrawn from company funds without peril to the company itself (and this is not helped by short term fly in fly out executives). It is collusion between short term managers acting in their own interests, rather than the interests of the shareholders, if the majority of shareholders do not approve a remuneration deal. This is not a free market solution but I cant see one possible when the bargaining power of management to approve excess is not matched by the bargaining power of shareholders to restrict misuse of their equity.

  3. Personally I think Alanna, et al are right in that the market is trying to clear but there is counterproductive and institutionalised resistance to that. How long politicians can make good guys of themselves with future taxation is anyone’s guess but the simple answer to that may lie in the scope of the problem now and the length and nature of its buildup. It doesn’t look good with the benifit of hindsight.

    It might be useful to reflect on the really big picture here. In the absence of some Divine, all knowing, global central banker with Goldilock’s ‘just right’ amount of money that we could all use prudently and wisely, not least to represent real forgone consumption and hence real investment, we had to rely on a raft of weaker beings, their offerings and rates of exchange. In that sense these mortal imitators were all intent on creating their ideal slice of mannah to facilitate their own particulat version of Heaven on earth. Calls for another Bretton Woods seem to indicate they failed and Gawdelpus now or where are the real priests?

    In the absence of a hotline to the Divine our mortals only had MV=PQ and an eye on goods and services inflation as their Bibles, although many were comfortable like ours to deliberately target 2-3% annual reductions in the value of their particular mannah. They couldn’t know what God knew about that MV=PQ and that in reality it consisted of a balance of two velocitys of circulation, one for the day to day exchange of goods and services and one for assets. To rely on day to day prices alone was to ignore any structural disharmony occurring, should they perhaps fail to heed his words and go forth and multiply. And God smiled knowingly and thought to himself perhaps they will see the error ways with the odd asset crash or two and work it out. Instead he watched aghast at the Devil’s work and Sodom and Gomorrah unfolding. So that’s why God gave them free markets to wash it all away?

    Yeah well, perhaps not, but perhaps the length and depth of central bankers trying to play God, coupled with a fair bit of human frailty has got us right up manure creek without any means of propulsion now. Normally money creation and a worsening balance of trade would see inflation rise and currency devalue, which should have occurred in most developed countries. Creating money does that but this time round an aging demographic tried to save for their retirement and started bidding up assets. That shouldn’t have lasted except for Asian savers jumping on board due to a lack of security in lending and institutional structures in their own backyard (God likes irony). Basically a lot of broke baby boomers with a lot of their productive capacity in China and India now, hoping their offspring will be able to work hard and unwind it all gently and quickly for them. Now that will be some bloody geat miracle for mine and Gen X,Y and Zee should beware false Gods here I reckon.

  4. Nothing summed up the problem better for me than the front page picture in the Weekend Oz of boomer Sallyanne Atkinson(former ABC Chairwoman) leaning wistfully on the front fence of her leafy burb house under the article caption ‘Gillard throws ABC $22m lifeline’.

    “I never thought it would come to this” says our Sally but the mini cartoon below is the absolute corker. It shows a somewhat stunned looking mum with babe in arms looking at a mini shop front with the ABC blocks and ATM on the hoarding above while below it are the buttons and screen showing ‘Insert baby here’ and alongside it a woman behind a counter with outsretched arms saying- ‘The government made us upgrade to a bank’

  5. John, if we are to remain a step ahead of the world then the government should have an industry policy whereby businesses are encourage to invest in real economic activity and hire employees on a full-time basis in return for tax breakes. Maybe that will generate new wealth.

  6. With those balnket deposit guarantees and no apparent lack of liquidity in the marketplace, it looks like the Rudd Govt have an ‘Industry Policy’ right now Michael, by all reports-

    “NAB will place shares with institutions at $20 each, after its offer was oversubscribed following “overwhelming” demand, the head of the bank’s Australian operations Ahmed Fahour said.
    NAB announced the $2 billion share placement to institutions and sophisticated investors earlier today.
    It took just one hour to build the book from the fixed price offer of $20 per share, said Mr Fahour.
    The pricing is equivalent to a 9.7 per cent discount to NAB’s closing share price on Friday of $22.15.
    The books closed at 12.30pm (AEDT) after NAB received a very strong response to the placement, which would allow the bank to pursue organic growth opportunities, Mr Fahour said.”

  7. John, if I may reply to Observa by saying if we can agree that no nation has ever printed its way to prosperity then governments need to introduce innovative solutions to stimulate economic growth and create new wealth for the herd-like mentality that continues to plague markets is not a good sign.

  8. From that Reason article:
    “…cutting capital gains taxes would allow for firms not under pressure from subprime-related losses to grow larger, creating a more competitive market”.
    A smaller number of larger firms is a more competitive market, according to Reason.
    Are these people blithering, idiots, or blithering idiots?

  9. This may be a little OT, but it responds to some of the comments above. The Chinese have announced a 586 billion dollar stimulus package of investment in projects to create jobs in production of goods. This will probably do more good for the global economy in the longer term than the US bailout.

  10. Perhaps melanie, the world’s biggest predatory lenders are getting a bit nervous about all those IOUs they have on their books and want to call them in for some real returns now. Whaddya reckon we all cry foul and take them to the Hague for some welcome relief from unfair lending practices? Poetic justice if we stack the Court with lefty judges I reckon.

  11. Just thinking of some of Michael’s ‘innovative solutions to stimulate economic growth and create new wealth’. Bit of a nuanced approach. Some surreptitious diplomacy with Obama and NATO to stack the Court, whilst taking the public high moral ground with China and our burnable dirt naturally. Don’t want them sending the kneecappers round here.

  12. John says

    “John, if we are to remain a step ahead of the world then the government should have an industry policy whereby businesses are encourage to invest in real economic activity and hire employees on a full-time basis in return for tax breaks. Maybe that will generate new wealth.”

    Well actually I suspect all the tax breaks for superannuation and financial investments may have created all hell in terms of speculation in financial assets like shares and investment properties – thats the trouble. What sounds like a good worthwhile idea for government investment in the private sector rapidly becomes a market to see which group can clamour loudly for the most breaks (like ten kids at dinner time) and the ratchet effect dictates that once absorbed into government processes and administrative protocols – government policy rarely recognises when its time to switch the drip off which has tissued in the vein, created a nasty bruise and led to congestive cardiac failure.

    Personally Im a bit inclined to think that government should forget trying to chase and cajole or manipulate private markets towards what used to be a government responsibility – the construction of useful social capital and essential services.

    However I do agree re the this suggestion of Johns – underemployment trend worrying – it can only ultimately drain demand.

  13. From that Reason article:
    “…cutting capital gains taxes would allow for firms not under pressure from subprime-related losses to grow larger, creating a more competitive market�.
    A smaller number of larger firms is a more competitive market, according to Reason.
    Are these people blithering, idiots, or blithering idiots?

    They are definitely blithering idiots.

    And this
    “NAB will place shares with institutions at $20 each, after its offer was oversubscribed following “overwhelming� demand, the head of the bank’s Australian operations Ahmed Fahour said.
    NAB announced the $2 billion share placement to institutions and sophisticated investors earlier today.
    It took just one hour to build the book from the fixed price offer of $20 per share, said Mr Fahour.

    Great so the large banks do business with the large funds and the small shareholders dont even get offers. I met one of those today and he was mightly ticked off as he could have had chance ti redeem some of his losses.

    Tighten seatbelts while these groups have a private party to gamble again (with other people’s money) and then hype us up to the next crash. How could so many have thought pe ratios in the clouds were real? When we have no taxes left to bail any firm out and the government is stripped and we are all too broke to save maybe the humility will arrive.

    Something seriously needs changing in the corporations legislation and there is no free market solution to that except for ordinary shareholders being fleeced.

  14. No Alanna the truth that- it is monetary expansion that causes the business cycle but real factors that constitute it, is staring us all in the face now. It’s an eery feeling watching the real economy crash around our ears now, knowing that all the kings horses and all the kings men can’t put Humpty together again, no matter how much they run about looking important and concerned.

    The die was cast a long time ago with slow inflation of money and that first pleasurable fix. It’s a beguiling drug that will inevitably result in increasing dependency and with it the need for ever more doses to placate the victims. More drug and more dependency with the odd bender and comedown along the way but heading for the ultimate breakdown as it warps all sense and reason but the hunt for the next quick fix. We can see it all around us with our Govts of dependence on taxation by stealth reduced to printing money and flinging it from the Treasury balconies and the great names of industry like GM and GE reduced to selling their bodies on the streets with their GMAC and GE genie money. The horrors of going cold turkey are upon us now.

    Naturally there are those that want to trot out the methadone now but it’s time to be cruel to be kind. Enough is enough of pandering to the sensitivities and depradations of these drug addicts and it’s time for some tough love from those of us who know better. If the drug addicts among us have nicked the silver and flogged it along with anything else lying around then it’s tough tits, kick them out and time to move on. We need to concentrate on the functional members of the family, rather than continue the hand wringing.

    In that sense more neo-Keynesian procrastination and obfuscation is nonsense. It’s what unleashed these Louis Leeches and Gordon Geckos on us in the first place by believing that well administered Govt consumption will fix all things. It’s true that much consumption is what drives producers to produce each day, providing it’s real and not legalised theft, but these NKs have a fundamental flaw in their makeup. They want you to believe that Photography Phil can walk into the Kodak shop in their Kodak world and ask the salesman for all the benefits of a digital camera because, ‘well wouldn’t it be nice?’ Yes you and I both wish, thinks the salesman to himself and why do I always get these tossers around closing time. Therein lies the flaw in NK thinking, because we know what it really takes to solve Photography Phil’s problem so to speak. It has nothing to do with the value of Phil’s house, share portfolio or the inflated fiat money in his pocket right then and there.

    $2bill raised by the NAB within an hour shows there’s no shortage of idle balances looking for a home now. Not until those idle balances and the grossly distorted asset prices that support them fall to a level where what’s left can find a safe home in real savings and investment, reward for true entrepreneurship, risk and innovation, will things start moving again. That should be obvious to us all watching NK headless chooks run about in ever diminishing circles as the lineup for bailouts grows ever longer by the hour. Methadone from helicopters for the baby boomer addicts, with their offspring to pick up the tab presumably or therapy sessions where they bury money and hand out shovels to dig up the wealth. Good old fiscal stimulus to calm the convulsive tremors.

    Powerless to unwind history now and cognisant of the fact that the car factories, equipment, houses etc, won’t suddenly evaporate like funny money is fast doing, we need to turn to the aftermath and preventing it from happening again. That means anchoring the banking money supply in something of real value and I’ve mentioned historical RE as an option for collateral. Clearly revolving consumer credit is most at risk here in the banking system and it should be removed longer term. As my grandparents knew, consumer credit is a one fix hit before interest kicks in, so it has no place in sensible money supply. In fact bank money should only be lent on realisable collateral, should our children be asked to guarantee a short term run on deposits. That way they can relatively safely back the money supply, whilst leaving the more adventurous to risk their real savings with the GE money genies if they so desire. As I pointed out previously we have the valuer general and every property owner to keep RE values constantly honest and then the computing can do the sums on just how much collateral backing the banks’ loan books have. It’s not that hard, once market forces have sorted out the malinvestments.

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