Month: September 2008

Republican talking point whack-a-mole, yet again

John Quiggin42 Comments

The argument by talking point style that characterizes all sections of the political right in the US has been evident as usual in relation to the financial crisis, so I guess it’s time to play whack-a-mole yet again. The most prominent points I’ve seen are

* It’s all the fault of the Community Reinvestment Act, which forced banks to lend to low-income borrowers. Quite a few people have pointed out that many of the subprime loans weren’t required under CRA. More to the point, given that the market structures in the bubble made mortgages a fungible asset, the CRA was a nonbinding constraint. It’s clear that many more subprime loans were given out in the bubble years than were required under the Act and that the excess was greatest in the areas where the bubble was worst. The CRA had no effect at all under these conditions.

* If regulation were the problem, how come the hedge funds haven’t been affected? In fact, it was the failure of Bear Stearns hedge funds that signalled the spread of the crisis beyond the subprime mortgage market. And the main reason hedge funds haven’t yet been hit by the crisis of the past few weeks is that they don’t allow redemptions except at stated dates (for most of them it will be next Tuesday. Perhaps there won’t be a problem, but that’s not what the markets think. In any case, those making the claim seem to be unaware of the redemption restrictions.

Betting on yourself

John Quiggin16 Comments

Robert Waldmann of Angry Bear has a fascinating post exploring the possibility that sharp movements in the value of Lehman senior debt could be explained by the possibility that Lehman had sold Credit Default Swaps on itself. Since a CDS is insurance against the possibility of default on debt, this is a no-lose bet for Lehman. If the firm survives, they collect the premiums and pay nothing and, if it doesn’t the losses are borne by the creditors. And, as Waldmann points out, it’s not crazy to buy such a CDS, since it will retain some value in bankruptcy. If you’ve already sold a lot of Lehman CDS yourself, there’s a significant hedging benefit. So both parties benefit, and the losers are the existing bondholders. Waldmann has an interesting optimization exercise to show that optimal (for Lehman) use of the CDS option could explain the collapse in the value of Lehman bonds.

Thinking about this, I’m more and more convinced that Warren Buffett’s description of derivatives as financial weapons of mass destruction applies in spades to CDSs.

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Neoliberalism defined

John Quiggin75 Comments

I’ve been arguing since the dotcom boom and bust that the poor performance of (particularly US) financial markets provides strong evidence against the claim that neoliberalism provides a coherent and effective alternative to social democracy. One objection that’s been made to this argument is that “neoliberalism” is a poorly-defined pejorative. It’s true all political terms are elastic and it’s hard to find any that are used, with more or less the same meaning, by both friends and foes. The only one I can think of is “social-democratic”, though you could perhaps make a case for “liberal” in the US sense. Words like “conservative”, “democratic” and “socialist” have become just about meaningless.

By contrast, I think “neoliberalism” is a comparatively well-defined term. It’s mostly, though not exclusively used in a pejorative sense, so perhaps something like “free-market liberalism” would be better. This post from 2002 gives my definition and some reasons why I thought then that neoliberalism was a failure. I don’t see much reason to revise my assessment in the light of events between now and then.

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Free markets: a proposed trade

John Quiggin25 Comments

Since the collapse of the US financial system became undeniable, I’ve been struck by the number of people insisting that this has no implications for free-market policies because the US (and particularly its financial sector) is not truly a free-market economy. [1]

In the spirit of market economics, I want to offer a trade to all such people. I will agree that
(a) the US is not a free-market economy, and its failures do not constitute evidence against the claim that a pure free-market economy is the best possible form of social organization
(b) no other actually existing society is, or has ever been, a free-market economy, and no actual or conceivable events anywhere constitute evidence against the claim that a pure free-market economy is the best possible form of social organization
(c) In discussion with parties to the agreement, I will not contest the claim that a pure free-market economy is the best possible form of social organization

All I ask in return is that the counterparties to the deal agree not to advocate, oppose, criticise, or comment on any policy or political position that might actually be implemented, to ensure that the purity of the free-market ideal is not compromised by actual experience.[2]

fn1. Since I haven’t checked, I’ll assume that this set of people has zero overlap with those I once debated who insisted that the supposedly superior performance of the US economy over social-democratic competitors demonstrated the superiority of free market economics.
fn2. I’m willing to make the same offer to Marxist-Leninists and (two for the price of one) to combine both offers for free-market Marxist-Leninists

Postdicting the meltdown

John Quiggin45 Comments

My column in yesterday’s Fin started with the observation “The pace of events in financial markets has been so rapid that any projection of events in the short term seems likely to be obsolete soon after it is printed.”

Ignoring my own advice, I wrote a piece yesterday for Crikey (over the fold) which included the prediction “The largest remaining savings & loan firm, Washington Mutual is unlikely to survive into next week, with the most likely outcome one involving a large scale default on its mortgage obligations.” By the time it appeared today, it was a postdiction.
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