“Panics are not irrational
events. Panics happen when information
arrives about a coming recession. It is
the fact that there are potential problems with banks that causes a run. It is not the other way around, that runs
cause problems for banks. We will see
that this underlying problem of runs is distorted when consumers and firms do
not run because they expect the government to act; but runs are still the
underlying problem.” – Gary Gorton, Chapter 1: Introduction, Page 5
“Banks create debt so that people and firms have a way to
transact. To produce debt that people
and companies find useful for transactions is not easy. It would be best if this debt were riskless,
like modern government-produced money, because then it would be very easy to
transact. People and companies would
accept the money without questions. But
private firms cannot create riskless debt, and that is the basic problem. Unlike other products, bank debt comes with a
kind of contractual warranty: if you don’t want it anymore, the bank has to
return all your cash. But there cannot
be enough cash, because the cash is lent out, leading to a multiplying process
creating more than a dollar of bank debt for each dollar of cash. The cash cannot be returned fast enough.” – Gary
Gorton, Chapter 1: Introduction, Page 6
“Markets are liquid when all parties to a transaction know
that there are probably not any secrets to be known: no one knows anything
about the collateral value and everyone knows that no one knows anything. In that situation it is very easy to
transact. The situation where there is
nothing to know or nothing worth knowing – no secrets – is desirable and allows
for efficient transactions.” – Gary Gorton, Chapter 4: Liquidity And Secrets,
Page 48
Review
Is This An Overview?
Financial crises are inherent in a market system. Financial crises occurred before and after a
centralized currency, before and after the development of a central bank. Each crisis has different characteristics,
but a common structural cause. Financial
crises occur when people and firms do not want the product of a bank. The product of a bank, is debt. Debt is used for transactions. Different eras have different forms of bank
debt, such as banknotes and repurchase agreements. The debt is not riskless, and banks do not
hold the cash needed to repay all the debt, as they lend out cash.
Debt is used for transactions, which depends on the lack of
secrecy. That each party knows the value
of the collateral being exchanged, and neither knows more than the other. But when people become uncertain of the value
of bank debt, people trigger a bank run.
No matter the form of the debt, crisis are caused by an avoidance of
what the bank have to offer. Crisis are
triggered by the panic that ensues.
A panic caused by problems with the banks, rather than
panics causing the bank problems. A
financial crisis is when many consumers and firms are demanding more cash from
the banking system than what the banks can provide, a contractual demand that
the banking system cannot satisfy.
Events that cause a crisis are unpredictable, but the financial systems’
fragility can be observed. Financial
system fragility depends on the amount of credit outstanding. Before a financial crisis, there is a credit
boom that increases the financial systems’ fragility.
Caveats?
This book provides an introduction to the cause of financial
crises. More research would be needed
understand any specific crisis.
The book can be difficult to read. There are a variety of excerpts provided to
be historic evidence to claims, but they have mixed results. The excerpts can help explain the situation
or be distracting.
Questions to Consider while Reading the Book
•What is the raison d’etre of the book? For what purpose did the author write the book? Why do people read this book?
•What are some limitations of the book?
•To whom would you suggest this book?
•Does using math in economics make economics more scientific?
•How is economic knowledge formed?
•Why did economists not think a crisis was possible?
•What is the Quiet Period?
•What is the cause of a panic?
•What is a financial crisis?
•Is each crisis different?
•What is the purpose of debt?
•Does debt have a contractual warranty?
•How does the bank use cash?
•What are the kinds of bank debt?
•What happens when the government intervenes?
•What is the Free Banking Era?
•What is a banknote detector?
•How does secrecy effect transactions and debt?
•What is liquidity?
•What is ‘breaking the buck’?
•What is securitization?
•What is ‘flight-to-quality’?
•What are clearinghouses?
•What happens during a boom period that affects a crisis?
•What are credit booms?
•Do banks want to use the discount window during a crisis?
•Why is the banking system considered too big to fail?
“The main mechanisms for intervention were fourfold: (1) loans to banks; (2) recapitalization; (3) asset purchases; and (4) state guarantees for bank deposits, bank debts or even for the entire balance sheet. Everywhere the crisis struck, states were forced to take some combination of these measures. The agencies involved were central banks, finance ministries and banking regulators. What summary statistics cast as cool enumerations were, in fact, frantic, improvised solutions that emerged from barely coordinated sessions of all-day, all-night problem solving. As the crisis intensified it put the financial and political resilience of states to the test. Broadly speaking, this produced four types of outcomes, which reflected the degree of immersion in global finance, the resources of the states at risk, the shape of the governing elite and the balance of power within the financial sector itself.” – Adam Tooze, Chapter 7: Bailouts, Page 167
“The contrast in fortunes between Wall Street and Main Street was increasingly intolerable. The big banks had been bailed out. Some of the most unscrupulous bosses might face legal action, but they were not facing personal ruin. They retired to lifestyles of wealth and comfort. None had gone to jail. And those at the top of the tree on Wall Street were bouncing back apparently without shame or second thought. The bonus season in 2009 was better than ever.” – Adam Tooze, Chapter 13: Fixing Finance, Page 306
“The IMF’s headline was stark. The “overarching risk” to the world economy was of an intensified global “paradox of thrift.” As households, firms and governments around the world all tried to cut their deficits at once, there was an acute risk of global recession.” – Adam Tooze, Chapter 18: Whatever It Takes, Page 423
Review
Is This An Overview?
Finance is internationally
integrated. Banking activity,
regulations, and political policies from one state has an international
effect. A financial crisis in one state
can trigger an international crisis.
Each state can respond differently based on their political and economic
institutions, based on those who have the power to influence the decisions
being made, but the responses effect other states as well. Each state tends to want what is best for
their people, even if that is not the best for the international community,
which can then hurt the future of the state.
Financial products
that were meant to reduce risk, in practice created risk with the consequent of
a crisis. To prevent the crisis from
escalating, the banks were bailed out.
The financial industry got rewarded with bonuses, while the rest of
society had to pay the costs of the bailouts.
Debt was used to resolve debt, making states more indebted. To pay for the debt, many states tried to
reduce their deficits by reducing spending.
But reducing spending not only hurt their own societies, but also risked
an international economic crisis.
Caveats?
The 2007-2009 financial crisis forms
the basis of the book, along with the sequence of events that happened before
and after the crisis. Reflecting on
historic conditions and international politics that culminated into the crisis,
and the policy outcomes of the decisions made during the crisis. The focus is on the sequence of events, not
on their explanation or interpretation.
Explanation of events is limited, and can sometimes be politically
motivated. As such, this is not an
introductory book. The reader should understand
how finance operates and interacts with politics before reading, or research
each sequence of events further while or after reading about them.
Questions to Consider while Reading the Book
•What is the raison d’etre of the book? For what purpose did the author write the book? Why do people read this book?
•What are some limitations of the book?
•To whom would you suggest this book?
•How does politics effect finance?
•How financially integrated are states?
•What is the paradox of thrift?
•What did the GSE’s do?
•What is securitization?
•How did states regulate banks?
•Why did states bailout banks?
•Who paid for the consequences of the financial industry?
•How does state action effect other states?
•What are the consequences of a state with large debts?
•What happened in Ukraine?
•What happened in Greece?
•Is the Great Recession an American crisis?
•What effect did stimulus have?
•How did monetary policy behave?
Book Details
Publisher: Penguin Books [Penguin Random House LLC]
“There was little or no effective
“quality control.” Again, in theory,
markets are supposed to provide this discipline. Firms that produce excessively risky products
would lose their reputation. Share
prices would fall. But in today’s
dynamic world, this market discipline broke down. The financial wizards invented highly risky
products that gave normal returns for a while – with the downside not apparent
for years. Thousands of money managers
boasted that they could “beat the market,” and there was a ready population of
shortsighted investors who believed them.
But the financial wizards go carried away in the euphoria – they
deceived themselves as well as those who bought their products. This helps explain why, when the market
crashed, they were left holding billions of dollars’ worth of toxic products.” –
Joseph E. Stiglitz, Chapter 1: The Making Of A Crisis, Pages 13-14
“Moral authority might even be put into doubt, given that the
bailouts appeared bent on rewarding the very parties that had brought America
and the world to the edge of ruin. The
public outrage at the financial sector, which had used its outsize profits to
buy the political influence that first freed financial markets from regulations
and then secured a trillion-dollar bailout, would likely only grow. It was not clear how long the public would
tolerate the hypocrisy of these long-time advocates of fiscal responsibility
and free markets continuing to argue against help for poor homeowners on the
grounds of moral hazard – that helping them out now would simply lead to more
bailouts in the future and reduce incentives to repay loans – at the same time
that they made unbridled requests of money for themselves.” – Joseph E.
Stiglitz, Chapter 2: Freefall And Its Aftermath, Pages 39-40
“The entire series of efforts to rescue the
banking system were so flawed, partly because those who were somewhat
responsible for the mess – as advocates of deregulation, as failed regulators,
or as investment bankers – were put in charge of the repair. Perhaps not surprisingly, they all employed
the same logic that had gotten the financial sector into trouble to get it out
of it. The financial sector had engaged
in highly leveraged, non-transparent transactions, many off balance sheet; it
had believed that one could create value by moving assets around and
repackaging them. The approach to
getting the country out of the mess was based on the same “principles.” Toxic assets were shifted from banks to the
government – but that didn’t make them any less toxic.” – Joseph E. Stiglitz,
Chapter 5: The Great American Robbery, Page 144
Review
Is This An Overview?
The financial industry is meant to
manage risk, allocate capital, and mobilize savings, all while keeping
transaction costs low. But the financial
crisis in 2007 showed that the financial industry failed their function. They mismanaged risk, misallocated capital,
and indebted people, all while imposing high transaction costs. The crisis was made by the financial
industry, something that was done to the financial industry and everyone.
Financial markets
focused on maximizing returns, no matter the risks involved for the borrower. Mortgage companies generated many
inappropriate mortgages, and gave them to people who did not understand their
effects with the assumption that housing prices would keep rising. The mortgages were repackaged into financial
instruments by banks, which made the securities products more complex. An attempt to reduce the risk, but in
practice just shifted the risk. The
rating agencies did not check the risk of the securities, but still gave the securities
approval as the rating agencies were paid when they provided favorable ratings.
The financial
industry analysts deceived themselves and their clients about the worthiness of
the products. Having purchased many of
the toxic assets themselves. When the
crisis occurred, banks did not know the value of their own assets, nor those of
other institutions. Therefore, could not
lend. The government bailed out the
banks, but that did not stop the banks from blaming the government. The Federal Reserve has historically been
willing to bailout banks, which created moral hazard as the banks took greater
risks with a high expectation of being bailed out again. While banks were being bailed out, banks used
the money to pay dividends and bonuses, while denying government assistance to
the rest of society because it would have created moral hazard. In effect, the government had rewarded the
people responsible for the financial crisis rather than seek
accountability.
What Did The Financial Industry Do?
Securitization process repackaged mortgages and bundled
them. The innovative financial products
were designed to shift risk from banks, while generating fees. They were designed to avoid accounting and
regulatory restraints.
The financial sector used their profits to buy political
influence, that gave them deregulation and bailouts. Banks had actually successfully lobbied the
government for deregulation. Regulators
got captured by those they were supposed to regulate. Giving financial markets a lot of influence
as to how they are regulated. Giving
subsidies to wealthy companies has become known as corporate welfare. Even with the government assistance, banks
blamed the government for the crisis anyway.
How Was The Crisis Handled And Resolved?
Rather than hold accountable the people who were responsible
for the crisis to pay for the crisis, the government rewarded the banks for
their efforts in ruining the economy. It
was thought inappropriate to have taxpayers who did not contribute to the
housing boom, to pay for those who did.
Therefore, the lenders should have paid, because the lenders failed to
do their job and assess risk. The banks
claimed that paying for the damages would have impeded the recovery. Also, the people responsible for the crisis,
were put in charge of the repair. They
applied the same ideas that got them into trouble.
The government gave banks money, to enable banks to lend the
money out. But the banks did not
lend. The money was used by banks to pay
dividends and bonuses rather than restart lending. As the banks knew that they might not
survive, they just took the money for themselves. The Federal Reserve even started paying banks
interests on their reserves, thereby dampening lending further.
The government did not help the rest of society such as
homeowners, unemployed, or alternative ways to stimulate the economy. Banks claimed to not want to give homeowners
bailouts because that would disincentive replaying loans, while at the same
time were asking the government for money for themselves. For an effective stimulus package, it should
have been responsive and supported investments to increase jobs.
The government took over various bank assets. But shifting toxic assets to the government,
does not get rid of the toxic assets.
The mortgages were restructured, which stretched payments for which they
got more fees. But this just delayed the
consequences.
Caveats?
Book provides an overview of what
happened. Many popular criticism are
made about the financial system, and the arguments are consistent, but
there seems to be information missing.
The author notes various hypocritical contradictions within
the claims being made by banks.
Consistent logic, but the claims are being referenced as the financial
system rather than the individuals. As
in different people within the financial system can make different and opposing
claims, but does not mean that the individuals are making the contradictions.
The proposed solutions would have had their own
consequences, and needed to be developed further to be applicable.
Uses popular assumption because they appear credible, such
as claiming that financial services were free and unfettered markets. Although there were products that did not
have appropriate regulations, financial services had been one of the most
regulated industries.
Questions to Consider while Reading the Book
•What is the raison d’etre of the book? For what purpose did the author write the book? Why do people read this book?
•What are some limitations of the book?
•To whom would you suggest this book?
•Why did the crisis happen?
•What is the purpose of financial markets?
•How did financial markets fail?
•How did mortgage companies influence the crisis?
•What did banks do with mortgages?
•What is securitization?
•How were rating agencies involved?
•Why did the financial industry purchase toxic assets?
•Why did lending cease during the crisis?
•Why did banks take high risks?
•Why were banks bailed out?
•What did banks do when they took government money?
•Who was held accountable for the crisis?
•How did the Federal Reserve influence bank lending?
•How should the government be involved?
•How should the government have provided stimulus?
•How should the government have responded to the crisis?
“The Bretton Woods system of fixe but adjustable exchange rates broke down because no major country or group of countries was willing to subvert domestic policy to improve international policy. Exchange rate stability was a public good; no country was willing to pay much to supply it. The United States chose to maintain high employment even if its policy required rising inflation, as it did after 1965.” – Allan H. Meltzer, Chapter 5: International Monetary Problems, 1964-1971, Page 754
“Friedman and Schwartz (1963) emphasize the importance of money growth and inflation. Their work was well known but largely ignored by most members of FOMC. Economists in the Nixon administration understood the importance of money growth for inflation but yielded to political pressures.” – Allan H. Meltzer, Chapter 7: Why Monetary Policy Failed Again in the 1970s, Page 860
“the Volcker FOMC, Volcker himself, and his successor Alan Greenspan put greater weight on inflation control. Interest rates increased at times during recessions or periods of rising unemployment if needed to control inflation. By 1994 the Federal Reserve finally accepted monetarist criticism and adopted counter-cyclical policies by reducing money growth during expansions and raising it during contractions.” – Allan H. Meltzer, Chapter 9: Restoring Stability, 1983-86, Page 1206-1207
Review
Overview:
During this era, the Federal Reserve had to deal with high
unemployment and high inflation, known as stagflation. Myopic in policy, which produced temporary
economic fixes. The short-term seemingly
random policy changes were made without much concern for long-term consequences
of its actions. There was more pressure
on lowering unemployment than inflation, which caused the government to
stimulate the economy while reducing pressure on anti-inflation programs. Errors in understanding the interactions
between economic factors precipitated in procyclical bias.
The Federal Reserve learned from its experiences, and made
changes such using different economic models for decision making, and changing
how they interact with the economy and citizens. During 1975, Congress tasked the Federal
Reserve to publicly announce a 12-month money growth target, have long-term
policies for economic production, and make reports to Congress at open hearings
before the banking committees. Volcker,
and successors, changed how the Federal Reserve operated by focusing more on
inflation control, and using counter-cyclical money growth policies.
Addendum:
There was conflict between domestic and foreign
objectives. Governments were not willing
to sacrifice domestic policy of lower unemployment for international
policy. Much like many nations, the
United States focused on high employment even at the expense of inflation. Citizens choose temporary unemployment over
wage reduction, making wages sticky.
Controlling inflations requires patience and persistence,
which the Federal Reserve lacked during the era. Lacked long-term objectives, and ability to
achieve them. There was research and ideas
about managing money growth and information.
They were ignored by the FOMC, while government economists accepted
them. Even though government economics
accepted that money growth led to inflation, it yielded to political pressures. Monetary policy had managed economic factors
to maintain economic stability when the Federal Reserve started to reducing
volatility of output and limiting inflation.
Caveats?
This is not an introductory book on
monetary policy. To understand much of
the history presented, would require the reader to have a background in
monetary policy.
Questions to Consider while Reading the Book
•What is the raison d’etre of the book? For what purpose did the author write the book? Why do people read this book?
•What are some limitations of the book?
•To whom would you suggest the book?
•What is stagflation?
•How did the Federal Reserve make decisions?
•What did the Federal Reserve learn from this era?
•How did the Federal Reserve manage employment, and inflation?
•How did international objective influence national policy?
“Independence should be strengthened. Responsibility for policy outcomes should not be avoided in discussions of independence. An independent central bank can cause unemployment or inflation. The public generally blames the administration and Congress for these outcomes. They may lose office. Federal Reserve officials may be criticized, but they retain their positions. Following the two major errors of the twentieth century, the Great Depression and the Great Inflation, no Federal Reserve officials had to resign.” – Allan H. Meltzer, Chapter 1: Introduction, Page 22
“March 1951 Accord with the Treasury changed the Federal Reserve’s formal status from subservient to co-equal partner with the Treasury. The Treasury remained responsible for debt management; the Federal Reserve gradually regained authority to change market interest rates, reserves, and money.” – Allan H. Meltzer, Chapter 2: A New Beginning, 1951-60 , Page 250
“The main factors driving professionalization were the increased demands that governments and the public placed on economic policy, the growing sophistication of financial services and economic analysis, the widespread use of these services, and the frequent crises in the international monetary system. No to be overlooked was the presence of a new generation of economists who had developed Keynesian economics and were eager to use their tools to improve the country’s economic performance.” – Allan H. Meltzer, Chapter 3: The Early Keynesian Era: A Low-Inflation Interlude, 1961-65 , Page 280-281
Review
Overview:
The Federal Reserve took responsibility for economic
stabilization and fiscal policy. In
addition to the normal duties of the Federal Reserve, the Federal Reserve was
tasked with managing the unemployment rate.
This arose because citizens were demanding maintenance of economic
prosperity. Greater interest in Federal
Reserve operations by Congress, challenged the Federal Reserve’s independence.
This was a Keynesian Era, for many of the economists
developed Keynesian methodology, and wanted to try out their tools. Keynesian economists became prominent within
politics. Keynesianism took a proactive
approach to the economy, by using discretionary resources for smoothing
business cycles. The Federal Reserve did
improve its ability to resolve crises, but at a cost of incentivizing further
bailouts. There was also a high rate of
inflation. The Federal Reserve was
limited in its ability to manage inflation because of other regulations.
Responsibility, and Accountability:
Historically there was a need to separate the power to
spend, and the power to finance spending by expanding money. Rules such as the gold standard rule, and
balanced budge rule enforced the separation between fiscal and monetary policy. Both rules lost prominence by 1951.
The Federal Reserve regained authority to manage interest
rate, reserves, and money during 1951.
Making the Federal Reserve co-equal partners with the Treasury, rather
than subservient to the Treasury.
William McChesney Martin ended the struggle of power between
Washington and New York, with Washington in charge. Greater cohesion of the System also made the
System susceptible to political pressure.
Although Congress could be punished for Federal Reserve
action via voting, the Federal Reserve maintained a separation between
responsibility and authority. Even after
having major economic failures, no Federal Reserve officials was asked to
resign. A way to align responsibility
and authority is by coordinating a transient policy objective between Federal
Reserve Chairman and the Secretary of the Treasury. Not meeting the objective would require an
explanation, or a resignation if the explanation was not accepted.
Policies Followed:
Policy followed by the United States was Too Big To Fail,
where size of financial firms excused them from failure and obtained
bailouts. The author claims that size
should not prevent a failure. The
institution can remain, but with different management and a loss to the
stockholders.
Many banks resisted joining the System to avoid par
collection, and costly reserve requirements.
Even without membership, all banks had to par collect and adhere to
Federal Reserve’s reserve requirements by Congress.
Under the Employment Act, the Federal Reserve was tasked
with reducing the unemployment rate. The
emphasis on employment came from congressional interest in Federal Reserve
operations and decisions. Which also
included more frequent congressional hearings.
Policy coordination sometimes challenged the Federal reserve
independence.
Federal Reserve members questioned the rate that banks
should repay their debts. Wanted to
apply pressure for repayment, but without causing other banks to borrow.
Economic Ideas, and Economists:
Economists gained more political power during the
1960s. Demand for their services was due
to frequent international monetary crises, and public policy. Services that improved due to
professionalization of monetary policy.
There was conflict within economic perspectives. A battle of ideas between Monetarists and
Keynesians. Monetarists claimed that
monetary authority determined the stock of money but public demand determined
the price level. Wanting to follow rules
of policy, rather than discretionary policy.
Discretionary policy created uncertainty in planning for future
actions. Keynesians thought that
discretionary policy can stabilize an inherently unstable economy by adjusting
expenditures, tax rates, and interest rates.
The monetarists thought that the private sector is self-stabilizing and
that government policy usually made outcomes worse.
Caveats?
This is not an introductory book on
monetary policy. To understand much of
the history presented, would require the reader to have a background in monetary
policy. Supplementary research might be
needed to understand the context of the disagreements of monetary policy ideas.
Questions to Consider while Reading the Book
•What is the raison d’etre of the book? For what purpose did the author write the book? Why do people read this book?
•What are some limitations of the book?
•Why was the Federal Reserve tasked with managing fiscal policy, such as the unemployment rate?
•How did oversight of the Federal Reserve change?
•How did Keynesian economists want to manage the economy?
•What was the conflict between Monetarists and Keynesians?
•How did the Federal Reserve manage inflation?
•Is the Federal Reserve accountable for its responsibilities?
•Why was there a separation between the power to spend and power to finance? What changed with these views?
•How did William McChesney Martin influence Federal Reserve policy?
“Fears that a privately owned bank would place the bank’s interest above the public interest had to be reconciled with concerns about empowering the government to control money.” – Allan Meltzer, Chapter One: Introduction, Page 2
“They wanted the central bank to damp fluctuations in market interest rates, particularly those created by the seasonal demand for currency and the financing of crop harvest, and to encourage the development of a broad national market in commercial paper and bills of exchange patterned on the London Market.” – Allan Meltzer, Chapter Three: In the Beginning, 1914 to 1922, Page 65-66
“The belief spread that the Federal Reserve had learned how to maintain prosperity, damp recessions, and prevent inflation. The return of many countries to the gold standard by 1927 reinforced the view that the world economy was on a stable foundation and that inflation and deflation were unlikely to occur.” – Allan Meltzer, Chapter Four: New Procedures, New Problems, 1923 to 1929, Page 253
Review
Overview:
The Federal Reserve framework came from considering the functions of European central banks, mainly the Bank of England. Even before Federal Reserve operations, there were fears that either the central bank could be used for temporary political advantages, for government could abuse the public control of money. Alternatively, others feared that as a private bank, it would favor its own interests above the public interest. What the Federal Reserve was meant to do was stabilize business cycles, and encourage a national financial market. An accepted central bank role is to be lender of last resort, to prevent financial panics from spreading further.
There were many policy debates, with uncertainty about what to do, and the impact of monetary policy. There were doubts that monetary policy was even effective. At times the Federal Reserve had overconfidence in its ability to control business cycles, for business cycles did not end. In practice the Federal Reserve changed from a passive role, to an active role, while sometimes not doing enough. Being politically influenced to do more than was desired. Politics was not only an external influence, for internally there was a power struggle between the regional banks and the Board.
Origins:
When the Federal Reserve was envisioned, leading central banks were privately owned institutions with public responsibilities. Their duties were to provide currency for payments, and lender of last resort during exigent times. It was by late 19th century, that the central bank raison d’etre was understood to be lender of last resort, which was a responsibility to preventing widespread financial institutions failures. To prevent the failures of institutions which would otherwise be solvent.
Based on records of Bank of England, they believed that a central bank can reduce panics by serving as lender of last resort. Even open market operations as a tool were influenced by the Bank of England.
Power Within The Federal Reserve:
It was not the founders intent to precipitate in creation of a central bank, or a powerful institution. They might not have germinated the process, if they had known to what it would lead. It was not even until the McFadden Act of 1927 that gave permanence to the Federal Reserve. The Federal Reserve Charter was initially temporary, much like its predecessors.
The Board and regional banks did not have synergy. The regional banks created a Governors Conference to discuss policies, with the Board wanting to limit their interactions. The Governors Conference was considered a competitor to the Board’s authority. The governors did ask the Board to send representatives, and sent summaries of the meetings to the Board. It was the Banking Act of 1935 which created the Federal Open Market Committee and shifted power to the Board.
Learning Monetary policy:
Policies had unintended consequences which the Federal Reserve members did not like or want. But after practicing monetary policy, and seeing the impact that the policies had, learned from their failures. There was and is a lot of uncertainty to the impacts of policy changes, for the evidence they had was that monetary disturbances had no lasting effect.
There were three initially accepted rules for monetary policy. 1) The use of the discount rate to protect gold stock and exchange rate. 2) Become lender of last resort during panics. 3) Accommodate needs of trade and agriculture by discounting commercial paper.
Banks themselves had a choice to become members within Federal Reserve System. Banks were resistant to become members because of par collection of checks cleared at the Federal Reserve Banks, and the reserve requirements that did not earn interest. Certain programs with the Federal Reserve System seemed to favor banks with clients in particular industries.
Federal Reserve was more passive until wartime experience taught it to look for more active approaches. Sometimes the Federal Reserve was more passive, but then political pressure made them take action.
For each World War, the Federal Reserve was in the service of the Treasury to finance the war effort. A role that compromised Federal Reserve independence. The problem was extricating itself from the Treasury.
To facilitate quality outcomes, some thought that the Federal Reserve needed more power, others thought that the Federal Reserve needed more independence.
Caveats?
This is not an introductory book on monetary policy. To understand the decisions made would require a background in monetary policy terminology and tools.
There is often not enough history provided about the situation that the Federal Reserve was reacting to. To understand the context of the decisions would need supplementary research on the economic conditions during the era.
Questions to Consider while Reading the Book
•What is the raison d’etre of the book? For what purpose did the author write the book? Why do people read this book?
•What are some limitations of the book?
•What provided the framework for the Federal Reserve?
•What is a central bank meant to do?
•Why was there a power struggle within the Federal Reserve?
•What tools do central banks have?
•What monetary effect do central banks have?
•What did the Federal Reserve do during the Great Depression?
•Was the Federal Reserve able to stabilize business cycles?
•What were some fears about central banks?
•How active as the Federal Reserve in managing the economy?
“Investing isn’t a certainties game. Can’t be. Capital markets are far too complex. Instead, investing is a probabilities game.” – Ken Fisher, Introduction, Page xiv
“While there is no actual evidence of that, ever since, way too many investors believed beta reflects future risk, despite hearing and knowing that past performance isn’t indicative of future results.” – Ken Fisher, Bunk 19: Beta Measures Risk, Page 76
“History is one important tool for shaping forward-looking expectations. It should never be your sole guide, but history is a terrific debunkery tool helping you see the world just a bit more clearly.” – Ken Fisher, Part 5: History Lessons, Page 136
Review
Overview:
Investing is difficult, otherwise many would be investing and earning a lot. Even long time profession investors and advisors, make a lot of mistakes. Financial markets are really complicated, making investing based on probabilities rather than on certainty. Although the focus of the book debunking myths, which claim to be more certain than reality shows. The book’s lesson, is error reduction. By not following myths, the error rate can be reduced. Not completely, but less errors means a lot more successes. The way the myths are debunked is by challenging the myths, by checking the history and data of the myths. Questioning the myths, then testing and verifying claims made. For the myths presented, and the many myths not in the book, the reader and investors are asked to challenge them. To challenge not only the myths, but also the author’s own claims.
Caveats?
Although the arguments express complexity of the ideas, the claims from the myths are sometimes dismissed too eagerly. Dismissing potentially valuable lessons. Reducing the errors of the myths, can turn them into a better source of information.
This is not an introductory book. To get a lot of value out of reading the book, the reader needs to know a lot of the language, the jargon of finance and investing. As the book tries to be a guide on what to avoid in investing, the idea is to consider how the debunked myths influence the reader’s participation in financial markets.
Questions to Consider while Reading the Book
•What is the raison d’etre of the book? For what purpose did the author write the book?
•What are some limitations of the book?
•What are some myths that you believe or believed?
•Which myths do (did) you favor?
•How are the myths debunked?
•How to protect from financial fraud?
•How should someone think of finance and investing?
“Recognizing these analogies and precedents is an essential step towards improving our global financial system, both to reduce the risk of future crisis and to better handle catastrophes when they happen.” – Carmen Reinhart, and Kenneth Rogoff, Preface, Page xxv
“Debt intolerance is defined as the extreme duress many emerging markets experience at external debt levels that would seem quite manageable by the standards of advanced countries.” – Carmen Reinhart, and Kenneth Rogoff, Chapter 2: Debt Intolerance: The Genesis of Serial Default, Page 21
“The fact that lenders depend on a sovereign nation’s willingness to repay, not imply its ability to repay, implies that sovereign bankruptcy is a distinctly different animal than corporate bankruptcy.” – Carmen Reinhart, and Kenneth Rogoff, Chapter 4: A Digression On The Theoretical Underpinnings Of Debt Crises, Page 52
Elaborate Review
Overview:
Before a financial crisis, there is often a perception that this time is different. A belief that crises are a part of the past, or only other places suffer them. This happens to be a very costly piece of investment advice. The claim partly stems from improved evaluation techniques, that previous rules of valuation are not applicable, which is heavily backed up by rigorous analysis. Along with thinking that the lessons from prior failures have been learned, and that the boom being experienced has appropriate fundamentals and is built on good policy. This is one similar feature that occurs before a crisis. Another similar feature between various crises is excessive debt accumulation. Each crisis might appear different, but they have many similar features. Understanding these similar features, means being able to reduce the risk of future crisis and to better handle each crisis. The authors utilize various quantitative methods to show the general trends within crises.
Financial crises have been around since the development of money and financial markets. Highly indebted institutions, whether public or private, can keep credit rolling until confidence in them has collapsed, and lenders disappear, creating a crisis. During a crisis, investors withdraw from risk taking generally, rather than specific sources. Even countries face that problem as their credit can be taken away if other countries with similar issues are having problems.
Fickle expectations that destabilize banks, also apply to governments especially when they are borrowing external debt. It is normal for emerging markets to have sovereign external debt defaults. Development of their social, political, and economic aspects into becoming an advanced market can take a while, but will graduate away from defaults. Governments have found ways to rid themselves of serial default on sovereign debt or very high inflation. But serial banking crisis still remain.
Normal function of a bank is to borrow short term, and lend long term. A crisis can occur if they cannot fund their short-term obligation, with the illiquid long-term assets. Some governments borrow with short term maturities because of the benefit of lower interest rate. The problem of relying on short term borrowing is that confidence can change, and remove a source of funding.
Although there are similarities between private and public financial crisis, there are differences as well. Governments do not default in the same manner that private institutions do. Governments do not cease to exist with a default, and defaulting requires more considerations than economic and financial cost-benefit analysis as social and political factors needs to be considered.
Private institutions and individuals have clearly defined rights, such as assets being taken over when undergoing bankruptcy. Creditors do not necessarily have that option with governments, even if on paper they do. For sovereign nations, it is not just ability to repay debt that matters, but also willingness.
Caveats?
This is primarily a quantitate account of crises. Looking at statistical trends rather than detailed descriptions of various crisis. There are very brief descriptions of various crises. The general explanations of various aspects of a crisis are short, and might need more research to understand the problems. A basic understanding of finance and statistics would help in reading the book.
As the book looks at trends in data, what the authors recognize is the need for better data. Much of the data was hard to obtain, contains suspect data, and lot of missing data. Improving the quality of the data, can improve an understanding of particular trends within the data.
Questions to Consider while Reading the Book
•What is the raison d’etre of the book? For what purpose did the author write the book?
•What are some limitations of the book?
•Why do people claim that ‘this time is different’?
•Is each crisis unique?
•What are the similarities and differences between public and private default crisis?
•What do financial institutions do?
•Why do governments and private institutions borrow?
Alan Greenspan served as the Chair of the Federal Reserve from 1987 to 2006. This book covers Greenspan’s early life, becoming an economist, intellectual influences, personal life, presidential advisor, and time during the Fed. Along with views on policies and economic ideas. Being challenged and learning how to improve an understanding of economics and of human beings. Greenspan was an analyst but tasked with policies which had political aspects. During the Fed, Greenspan was involved with trying to calm the markets after many crises occurs such as the Mexican peso crisis, Russian debt crisis, and the trouble with Long-Term Capital Management. While trying to prevent other crises such as inflationary pressures, U.S. debt size, the tech bubble, and the housing bubble. With Fed independence in question, Greenspan defended Fed independence from political maneuverings. To Greenspan, world affairs seem to have to have gotten much more turbulent.
General Life:
From trying to understand Greenspan’s father’s book, to working at Townsend-Greenspan, Greenspan was an analyst. Seeking how the abstract models were tied to the real world. Filtering through various observations and facts to understand what has happened. Seeking as much detail to facilitate an understanding of the behavior of a particular segment of the world. Focusing on how the data was produced to create forecasts.
Influenced by Ayn Rand who would consider any idea from anyone, and argue the idea on its merits. Rand is well known for going against Communism, which Rand considered would collapse under its own corruption. Championing capitalism as the ideal form of social organization. Within the group that Ayn Rand hosted, Greenspan’s views were challenged. Ayn Rand taught Greenspan to learn more about human values which broadened the way Greenspan thought about models thereafter. Ayn Rand objectivism philosophy was too strict for Greenspan and created may contradictions.
On The Federal Reserve:
Congress initiated protection of the Fed from political influence, but politics still tries to influence the Fed. While the presidency is subject to a variety of short-term demands, the Fed tries to maintain long-term economic viability. Economic policy from the Fed are very much subject to the political process.
Greenspan dealt with many U.S. presidents, and saw their terrible sides that the public did not normally get to see. The government would enact terrible policies, such as price controls, knowing full well that it would hurt the economy, but enact it anyway because businesses and consumers wanted.
The chair of the FOMC leads discussion about what policies in which everyone can participate and raise claims and concerns. At one point, the recordings of the meetings were asked to be disclosed but that would have changed the content of the meetings. They would become prepared speeches rather unfettered debate.
The Federal Reserve’s policies are made by the FOMC (Federal Open Market Committee.) Which directs the Fed to either buy or sell treasury securities, or alternative financial assets. Buying securities increased the money in the economy and reduces short-term interest rates. While selling securities does the reverse, reduces the money in the economy and increases short-term interest rates. With the FOMC operations, they can tailor how the economy performs, but the reaction of the market to the operations is often uncertain. With inflationary pressures, the Fed slows the economy by making money more expensive to borrow. The Fed tries not to abuse their power by not telling banks what to do, such as to or not to make loans. Such power would damage the functioning of the market.
Monetary policy has changed in response to pressure. From not indicating the direction of interest rates, to being transparent about operations. Not disclosing the targeted interest rate changed kept markets uncertain, which caused them to have a buffer to either direction.
Greenspan favors property rights because they protect against arbitrary seizure. As regulator, there are three rules of thumb that Greenspan has which are: 1) Regulations that comes from a crisis need to be modified afterwards, 2) having several regulators causes them to keep each other in check, 3) regulations need to be revised or removed based on usefulness.
Thoughts on Economics
Before well-developed markets, suppliers would not state the accuracy of their inventory as it would weaken bargaining power. As markets gradually became better, suppliers became very willing to state what they had in their inventory. Division of labor has become sophisticated as to make everyone dependent on interactions and exchange of goods and services. Referencing that the way to cripple an economy is to target its economic infrastructure of payment systems. Removing that would force business to rely on inefficient physical exchanges.
The way people thought of debt has changed over time. There was a time when the U.S. president felt ashamed for a deficit, and even apologized for having a deficit. An argument that Greenspan has made for a very long time was to reduce the debt. Debt limits the response any government can make. During a recession, it limits the ability of a government to address the economic problem. During 1999-2000, the government ran a surplus, as in spent less than it was taking in via taxes. There were questions about Feb operations if Treasury securities could not be used.
Keynesian policies became popular in response to the Great Depression, but declined during the 1970s with the inability to deal stagflation. In an economic contraction, Keynes argued that government could create demand which would enable increased economic activity.
Within a centrally planned economy, production and distribution are determined by instruction. What resources are to be given, what is to be produced, and to whom the product is for are all determined. Along with predetermined wages and employment. The consumer has no option to but to be a passive recipient of whatever is to be produced. There is no impetus to develop the economy.
The Cold War was a contest about different views of economic organization, not just ideologies. For many years the Soviet Union and the U.S. appeared evenly matched. The problem is that Soviet Union did not capture the dynamism of economies, that production shifts faster than could be anticipated.
A natural experiment was done using Germany after WWII. Starting with the same culture, history, and values but after the split between East and West Germany, the regions became vastly different.
Caveats?
The book does not provide much information about most opposing views other than that there were opposing views. Without the reasons for the opposing views, and with the reasons for the views held, the book creates a bias in which the author’s views appears more right than they might actually have been.
As this book follows many major events, the events are not always given a background other than that there was a crisis that needed to be managed. Some of these events had Fed intervention and have become precedents for future actions. There seems to be a lack of recognition that some actions of the past, created forthcoming problems. The Fed seems to be the victim within the crises, and the institution that continued to prevent further escalation.
There is a distinct lack of problems that the Fed has caused. This would have been important to note in the book, as it would have indicated areas of governance that need adjusting, and a guide on how to avoid doing the same mistakes.
Questions to Consider while Reading the Book
•What is the raison d’etre of the book? For what purpose did the author write the book?
•Who is Alan Greenspan?
•Who influenced Greenspan?
•Who was Ayn Rand?
•What economic ideas does Greenspan favor?
•What are the benefits and disadvantages of communism and capitalism?
•What did Greenspan do before the Federal Reserve?
•How did Greenspan advise presidents?
•What are Greenspan thoughts on political leaders?
•What is the purpose of the Federal Reserve?
•What did Greenspan do while Chair of the Fed?
•How did Greenspan handle the various crises?
•Why is the Federal Reserve’s independence threatened?
•What is the FOMC?
•How does the Federal Reserve regulate the economy?
•How did the Federal Reserve change overtime?
•What dd Greenspan think was in store for some the world nations?
