Not long ago I wrote a column about a National Bureau of Economic Research study that blamed the Great Recession on a bank panic rather than that usual suspect -- the subprime mortgage crisis. There was a subprime crisis, sure, but it was just the catalyst for the much more damaging bank panic. All this relates back to a little-noticed structural change in the U. S. banking system where Reagan-era deregulation led to the growth of money market funds that killed the savings deposits that had traditionally backed most bank lending. Rising to replace savings (and make a lot more profit) was loan securitization and REPO collateralized inter-bank lending. The Great Recession was caused by the banks all losing faith in each other, with commercial lending grinding to a halt as it continues to be in many places even today. Heck of a story, eh? Now that I had a better understanding of the actual crisis, I immediately came up with two questions: 1) Why didn’t we see this coming? and; 2) How do we avoid it happening again?Notice how this traces back to the rise of the Right under Ronald Reagan. And notice how it points to the sleazy "hide the problem" approach of George Bush in 2006. And notice how the current Chairman of the Federal Reserve was willing to "play along" with the deception in order to get the top job. This is terrible. This needs to be fixed. Bank Regulation needs to go back to the fixes under FDR. The buying of politicians and lobbying by Wall Street has to stop.
Lets take the answers to these two questions in reverse order:
How do we avoid it happening again? We don’t. Government doesn’t have the tools to do so, which it hates to admit. At best, the efforts of Paulson, Bernanke, and Geithner reduced the severity of the crisis and helped the economy get back to something closer to equilibrium. In practice, not even the Fed has enough financial clout to fix a $20 trillion problem. They pretended they did, and continue to pretend so, but the truth is that all the balance sheet expansion and stimulus spending was a bandage just intended to reduce panic in the markets until they could regain natural equilibrium. And none of the reform proposals being floated in Congress do much to change this in the future. So if Geithner and Bernanke look like dopes because their efforts haven’t handily solved the problem, returning us to positive economic growth, it isn’t really their fault. Nobody else could do it, either, with the tools they have available. And that’s the rub, because to admit so is to embrace anarchy, which is not part of the platform of either party.
Why didn’t we see it coming? We did, but then we deliberately shut our eyes. The REPO market had been growing strongly since 1990 -- growing at a rate high enough to cause concern for both markets and governments. We could see it growing in a number called M3, which was one of three measures of the total money supply, along with M1 and M2, which were released by the Fed in a report every quarter.
Notice I said WERE released -- past tense. M1 and M2 still are released every quarter, but M3 -- the only public measure of the REPO market available anywhere, stopped being published by the Fed on March 23, 2006, ostensibly to save money.
M3 was one of the oldest statistics released by the Federal Reserve, dating almost all the way back to the bank’s founding. It was the only financial index ever retired by the Fed. Yet killing M3 seems to have been important to the George W. Bush Administration -- so important it was used as a litmus test of the loyalty of Fed chairman nominee Ben Bernanke during his confirmation hearings in the Senate.
Bernanke supported the idea of dropping M3, saying it wasn’t very useful and getting rid of the index would save $1.5 million per year.
Aren’t we glad we saved all that money?
But M3 also would have shown us the asset bubble growth in 2007 and 2008 and could have predicted when that bubble would pop.
By dropping M3 the Bush Administration was deliberately blinding both itself and the markets -- poking out eyes apparently to keep the good times rolling for a few months longer. Only research will reveal the nuances of this decision, but it is research that should be done.
I can’t find an economist today who supported the death of M3, yet die it did as an apparent act of loyalty to Ronald Reagan, who set the REPO monster growing back in 1980 with bank deregulation.
Saturday, April 17, 2010
Here is Robert X. Cringely pointing his finger at the cause of the financial collapse. This is a bit from Cringely's post on the Adam Smith's Money World web site: