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Fed Chair Ben Bernanke
In the wake of the Great Crash, we were treated to raucous discussions among economists offering explanations for how such a thing could have happened and who was to blame. Let’s ignore the wingnut explanation that the Government caused the disaster by forcing defenseless banks to lend money to poor people to buy houses. A common view among less insane conservative economists is the Savings Glut theory, that all that money from trade surpluses from China and OPEC nations drove down interest rates and encouraged too much risk-taking. Fed Chari Ben Bernanke strongly supports this view.*
But Bernanke isn’t the only one. The decidedly not conservative Paul Krugman and Robin Wells wrote an article for the New York Review of Books, arguing that Great Crash was primarily the result of the housing bubble, which in turn they attribute to the savings glut, along with out of control financial innovation and the utterly disastrous failure of US and other financial sector regulators.
That view is challenged by economists at the Bank for International Settlements. I described one paper by Claudio Borio here. The essential point of this paper, available here, is that financial models used by macroeconomists ignore the impact of finance on the real economy.
Borio and Piti Disyatat wrote another paper in 2011 directly addressing the savings glut. Yves Smith gives space to Andrew Dittmer to translate it from economese to English here, and I won’t try to compete with Dittmer’ explanation. Here’s the short version from Borio and Disyatat’s 2012 paper:
The core objection to this view is that it arguably conflates “financing” with “saving” –two notions that coincide only in non-monetary economies. Financing is a gross cash-flow concept, and denotes access to purchasing power in the form of an accepted settlement medium (money), including through borrowing. Saving, as defined in the national accounts, is simply income (output) not consumed. Expenditures require financing, not saving. The expression “wall of saving” is, in fact, misleading: saving is more like a “hole” in aggregate expenditures – the hole that makes room for investment to take place. … In fact, the link between saving and credit is very loose. For instance, we saw earlier that during financial booms the credit-to-GDP gap tends to rise substantially. This means that the net change in the credit stock exceeds income by a considerable margin, and hence saving by an even larger one, as saving is only a small portion of that income.
The paper argues that unrestrained extensions of credit and the related creation of money caused the problem. This emphasis on the financing side of the economy edges the 2011 Borio Disyatat paper towards the Modern Money Theory side, but they don’t take that step. They claim that the problem was policy elasticity, by which they mean that bank regulators did nothing to control the credit booms in the financial sector, which they could have done.
The Fed responded to Borio and Disyatat and others who agree in a paper entitled ABS Inflows to the United States and the Global Financial Crisis. The paper explains that global current account surpluses (the savings glut) “increased the supply of capital”**. It turns out they also include a huge pile of other financial assets under at least nominal control of bankers: “currency, deposits, and debt securities held by all domestic sectors”. This money was looking for a safe return. Its managers decided that investing in the US housing boom through real estate mortgage-backed securities was just the thing. The Fed helpfully provides a lovely chart:
That’s $99.7 trillion in accumulated financial wealth in the third quarter of 2007, just before the Great Crash. This isn’t capital, invested in productive activity to hire people to produce goods and services, and earning its return by risking loss of capital. It is a giant pile of debt. It’s sucking our future productivity out of us.
I think that there is too much capital in the form of financial assets, piled up in corporations, hedge funds, foundations, Sovereign Wealth Funds and the entire gamut of money-hiding banks, put there by dictators, drug lords, and other species of hyper-rich people. Some of it may benefit the average person, because it is in pension plans, but it’s a drop in the bucket compared to the financial assets owned by the hyper-rich.
Why does this matter? The simple savings glut explanation, current account surpluses of China and OPEC nations, makes it look like external forces were behind the Great Crash. It supports the false Obama administration line that Wall Street was greedy, not criminal. It enables the regulators to claim that it wasn’t their fault that Wall Street was stealing money from the real economy before and after the Great Crash. It tells us that we stupid borrowers are at fault, not the banksters who shoved money at anyone who could breathe. It pushes the blame to the Chinese and to OPEC nations, convenient scapegoats for neoconservatives. It enables the Administration to complain about the trade policies of the Chinese and thus to push for some trade deal worse than NAFTA for the workers of this country but great for the hyper-rich. It points to a set of fixes for the economy that work out great for the hyper-rich but suck for everyone else. It points to a set of regulatory changes that don’t fix anything, but make banksters richer and more dangerous. In other words, it is just about the worst possible explanation.
An alternative explanation, perhaps supported by the Fed paper, that adds to the Simple Savings Glut theory the massive accumulation of financial assets by a tiny minority of hyper-wealthy people, suggests a completely different set of solutions.
No wonder the Simple Savings Glut theory has so many supporters.
—
*See bibliography in this paper.
**Here is the relevant paragraph:
Our research builds on a number of papers linking the emergence of the global financial crisis to international imbalances. This research has followed two distinct strands. The first of these is the story sketched out above, in which current account surpluses in the emerging market economies increased the global supply of capital, reduced interest rates in the United States and other advanced economies, and thus encouraged the emergence of the bubble in subprime housing mortgages. Caballero, Farhi, and Gourinchas (2009), Jagannathan, Kapoor, and Schaumburg (2009), Obstfeld and Rogoff (2009), and Rajan (2010), among others, all discuss variants of this argument. Members of the official sector, such as Bernanke (2009) and Bini Smaghi (2008) have also highlighted this line of causation.
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A savings glut didn’t cause the housing bubble. A cheap credit glut (along with lax regulations and mortgage underwriting standards) did. The cheap credit was supplied by the Greenspan Fed. Note that while Krugman now agrees with the savings glut theory, a cheap credit glut is exactly what he promoted in 2002:
FROM http://www.nytimes.com/2002/08/02/opinion/dubya-s-double-dip.html?scp=4&sq=krugman%20mcculley%20bubble&st=cse
“To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.”
I’m glad I am not the only one who finds conflating savings with financing or “investment.” There was nothing stopping banks from allowing the money to sit and compound interest and force them to make loans they knew that people weren’t going to be able to pay.
They can try to blame borrowers all they want. A borrower isn’t getting paid (in many cases six figures)to weigh and exercise sound financial choices That’s what banks are supposed to do. Greedy? Absolutely. Criminal? You betcha in quite a few cases.The two are not mutually exclusive by any stretch of the imagination.
I believe you are correct. I also suspect the “loose credit” was policy from the top of our federal government puhed down into the banking sector.
Some force had to be driving the “loose credit”, stated income and non income, underwriting standards.
The lack of sever reaction by the government lends credence to the whole mess being orchestrated by the government, to which the banks were willing partners.
The timing is significant as well. The bubble was inflating during the 2003 presidential election, and appears a good vehicle for driving a “feel good” reelection campaign.
This could also be coupled with a belief they could delay the inevitable and not face any consequences until the end of Bush II’s presidency.
This excellent piece by masaccio stands on its own, but I would just add that a crucial part of the story is the relentless search by accumulated capital for higher returns than the real economy can provide, and the financial chicanery and instability that result, but I suppose even liberal economists like Krugman don’t want to besmirch themselves by paying attention to Marx.
Congress has delegate to banks the power to “coin money.” That money is supposed to be backed by rational loans. Subprime mortgages were not backed by rational loans. What the bankers did was the monetary equivalent of issuing money backed by lead instead of gold during the days of the gold standard.
Debt was used to buy debt, which was used to buy debt. Isn’t that the accompaniment of most crashes? And at some point someone says, “Hey, this can’t go on forever.” and there is a scramble to sell all at the same time. And then austerity ensures that the maximum damage will be done because loans that would have been good cannot be repaid because of austerity.
Excellent point about all that ill-gotten gains squirreled away that needed to be invested. It is no mystery what almost every TBTF bank has gotten caught in money laundering.
The crash was just three or four months premature. The Republican Party was tainted by it, but…
Oilbomber and the Democrats have done a suberb job swimming in all the Republican’s shit. And the Sequester too.
Both Houses and The Presidency and they fucked up almost everything. Oilybomber retained most of the worst of the leftover Bushies (and he reconstituted the worst of the Clinton retreads).
The Illegal Drug Trade is surely one of the most profitable of all remaining old-fashioned businesses (not shuffling paper, but the genuine sale of goods and services – a quaint idea).
It is no mystery what almost every TBTF bank has gotten caught in money laundering.
What else can the poor bastards do to make a buck?
That is sort of right, isn’t it? The problem is that you don’t need much capital in the basic business, just some farmers, trucks and light assembly workers. That means that the profits aren’t recycled into the business. And, they can’t be brought easily into the light of day where they could act as investment capital. So, they accumulate as financial claims. It works the same way with oil and gas: once you have the infrastructure in place to drill and collect the oil and gas, you don’t need much more to get more. You just move the rigs, put in some collecting machinery and sell into the international markets. Someone else can risk the capital on the refineries and gas stations.
All that excess money wants a return, as kapock @4 says. It doesn’t go back into the consumption stream, and it doesn’t buy anything much from the real economy.
There are solutions to that problem.
It still is, TD.
What do you call QE III where U.S. government bonds are issued, then purchased by the same government to hold interest rates down?
One point that’s often lost in these discussions is how bank regulation is supposed to work by making sure that lending institutions have healthy capital ratios.
Wall Street investment houses got all the advantages of federally chartered banks in the dead of night at the height of Paulson’s Treasury Dept. meltdown hysteria. Regulation was displaced by sleight of hand FASB accounting rule changes and massive bailouts that continue to this day.
As for capital ratios, who needs them when you have all of your highly leveraged derivative risk laid off upon mono-lines and AIG’s quant wizards, and they got bailed out too.
The 99% living in the real economy are left to fend for themselves.
As Yaakov Smirnoff used to say, “What a country …”
Another excellent piece, Mr. M.
It would seem to me that government could (and most certainly should) enter into public-private partnerships to bring infrastructure up to 21st century standards. Presumably, there are Hundreds of $Billions (if not $Trillions) in liquid assets that are earning next to nothing in this interest rate environment. Why not put that liquidity to work? This would benefit the investors in the form of ROI, employment would rise, more taxes would be collected at the local, state and federal levels, and the country would be positioning itself to compete in the 21st century.
I must be missing something here (read: plenty), but (other than the obvious political impediments, which are a given) this just doesn’t seem all that complicated.
Tarpley: 1% Wall St sales tax (wh would both decrease risky activity & raise revenue for USG), $3 trillion infrastructure spending, financed by FRB balance sheet, 100 year bonds, zero int rate.
The one solitary hope that I hold out for this nation’s economy is that some Anon hacker infiltrates the bank accounts of AIG, Citigroup, and Goldman Sachs, and all the other top Wall Street firms, and all of their precious executives, and distributes the money equally to every other bank account holder among the 99% in the USA.
The biggest problem is that those at the very top do not want a solution. Orwell got off on that riff, in his various books about the situation… Why do modern nation states have endless wars against other nations? (Iraqi War being an excellent example.) The policies of the few are punitive, not only so the rich can collect almost all of the monies and financial gains, but also so they can feel important. And it is not something a person can logically understand – what psychologically healthy person can understand the philosophy of sociopaths?
Haxors for the 99%, really?
A more likely tactic would be consumer activism in support of micro/macro community based personal & business credit where deposits support lending to the real, local economy, rather than mega credit that flows to Wall Street speculation.
Your solution for the excess money is to provide it ANOTHER revenue stream?
I prefer taxes to “Public-Private-Partnerships”.
Tax Capital Gains, Dividends, Passive Income and Income in the identical manner.
That includes removing the SS (payroll) tax cap.
Good point. Increasingly, I tend to frame fact-patterns such as these with an underlying assumption that the players are, in fact, sociopaths. Perhaps I’m being a simpleton about it, but I’m not really inclined to accept anything else as a premise. Do these people want to make money and acquire power? Of course. But when such goals become the be-all and end-all, when too much is never enough, that’s when the line has been crossed…at least to my way of thinking. Further, I’m not sure I’ve ever seen it this bad, and I find myself wondering whether it really has gotten worse, or I’ve just become more jaded and cynical. (In fact, it’s probably both.)
This is a very good point. It isn’t like these entities aren’t already enjoying the most egregious of subsidies. Is there another way? The fact remains that earnings on idle cash are minimal right now.
All good suggestions. Given corrupt legislative and executive branches, I see making them a reality as being quite difficult, however.
What a complete crock of shit! You can theorize, crunch numbers, analyze charts and pontificate until the cows come home but unless you call it for what it is you will never get it. Fraud and criminalality is what drove the bubble and the resultant bust. Trying to explain that with economic theory is just plain stupid. Shoulda been nationally televised “perp walks.”
It’s already happening; it’s called new toll roads with EZ-Pass or mail billing to scanned license plates. And private charter schools. And ….
Book Salon up with David Brin’s Existence (Novel) hosted by Siun
In other words they were all flim-flamming each other along with the general public.
Once the scams began to go sour, the thing fell apart.
Public-Private Partnerships (PPP) are almost always a rip-off of the taxpayer. They are always sold to the taxpayer as a money saving idea but always turn out to be more expensive than the previous publicly funded solution. See Britain’s healthcare experience with PPP. Also look at Chicago’s parking meter fiasco. Businesses love PPP because they always end up making much more money and it’s a much more certain revenue stream for them. I believe on of Dennis Kucinich’s first acts as a public servant was to prevent the sale of Cleveland’s power authority to PPPs. That’s ended up saving that city tens of millions of dollars ($195 million according to Wikipedia) while other city’s have been broken by the constant increases in prices of electricity in their privatized systems.
Clearly I shouldn’t have used the term “public-private,” as it carries connotations which I did not intend to convey. My bottom line was and is that there’s $Trillions on the sidelines, infrastructure needs to be repaired and/or updated, and millions of people are out of work.
So is there a way to get things moving without giving the store away, which has increasingly become the norm over the past decade or longer?
Now I’m sure. Miinsky is a cousin.
X2
Why don’t we just go back and tie the amount of paper currency in circulation to the amount of gold? Or money supply? or whatever, just tie it something that man cannot control. Since the amount of gold is finite, so should be the amount of printed currency, or currency in circulation. Lets stop creating money out of thin air, and make it scarce again. I guarantee you an increase in interest rates. This will a game changer. No country will be able to afford trade, as it will drain gold, and no one will be able to spend the money they don’t have. This should bring back some rationality to our economic system. All the economies have gone off the rails, since money is being printed at incredible rate. Lets make money valuable again.
Firstly all bubbles are driven by credit. Every single one ever has been the result of credit supplying the money, liquidity, into the favored asset.
Savings,bank savings that is, were the traditional source of money for banks to extend credit. However that is all so old fashioned. One, traditional bank lending went from being the main source of systematic credit to a secondary one, because of securitization. Now banks did the securitization but this is not traditional bank lending. Savings, traditional bank savings you should realize have been punished and discouraged by low rates for 20+ years. So first stocks became the new ‘savings’ then residential real estate. Bank deposits have shrunk over time as a percent of GDP and at any rate there are still too much of them as the $1.6 trillion of bank ‘excess reserves’ deposited with the Fed attest.
The ‘savings’ glut story was first fashioned with China as the source. This was stupid however. China wasn’t ‘saving’. Instead their central bank was returning the dollars we sent them. Returning by buying GSE mortgage backed securities, to fuel the bubble, at Greenspan’s urging, and Treasuries. The dollarsthey first had gotten to a large extent by printing Yen and trading them for the dollars their domestic companies had been paid in. How the savings glut became associated with the US system is beyond me as we know traditional ‘savings’ had fallen for years. Besides which as I said, they being a source of domestic bank credit had an ever diminishing effect on overall system credit supply.