James Landrith is...Taking The Gloves Off: syndicated

left-libertarian blogger, publisher, USMC veteran and civil liberties activist

 

The Contradictions of Secretary Geithner 
May 20, 2009
D. W. MacKenzie

In a recent interview Treasury Secretary Timothy Geithner admitted that Federal Reserve monetary policy “was too loose for too long.” Geithner’s remark has been met with much enthusiasm. Is this not a major concession on his part? Has Geithner not laid the blame for the 2008 crisis squarely at the Fed’s doorstep? Some of us claim that Geithner has admitted to an Austrian explanation for the 2008 crisis. If true, this would be a major concession on Geithner’s part. Such a concession would run contrary to the policies that Mr. Geithner is supposed to implement as Treasury Secretary to President Obama.

Geithner sees three causes behind the crisis. The first cause was, as previously noted, loose Fed policy. Oddly Geithner commented favorably on what the Fed has done over the past six months. Low interest rates are supposedly helping to turn this crisis around. So Geithner sees loose policy during the Subprime Boom as too low for too long, yet lauds an even looser policy. He explains that The Fed was too loose then when investors were too optimistic, but now that financial markets are frozen and investors are pessimistic, monetary laxity is fine. More specifically, Geithner blames “irresponsible judgments by individuals in the financial system for an unsustainable rise in debt.” Could it be that people assumed excessive debt because Fed policy was too loose for too long? Mr. Geithner is, for some reason, unable to see the connection between the low interest rates that result from loose Fed policy, and excessive borrowing.

Geithner’s second reason for the boom and bust is that the governmental supervisory system “was way behind the curve, risk built up outside of the regulatory framework,” and banks were overleveraged. According to Geithner, over the past ten years executive compensation became detached from reality, and this compensation created incentives that “overwhelmed” all the checks and balances against excessive risk taking. Geithner’s answer to this alleged problem is new government regulation to restrain risk taking, regulation of leverage, and regulation of incentive compensation. These measures are about “preventing the next boom.” Once again, Geithner has ignored the likelihood that loose Fed policy was the main driver of the Subprime Boom. Geithner is overlooking all that the Federal Government did to promote subprime lending by banks (see Anatomy of a Train Wreck: Causes of the Mortgage Meltdown by Stan J. Liebowitz.)

The third and final reason Geithner listed is that “governments were late to move. They were late to put in place the kind of forceful fiscal stimulus we now have in place . . . it took a while for people to recognize the urgency of the situation and be willing to legislate the kind of broader authority that any government needs to get through a financial crisis.” This is not surprising. Nobel Laureate Milton Friedman explained how long and variable lags prevent timely implementation of changes in government policies. There is a recognition lag to all policies, and the legislative process causes a lengthy ‘administrative lag’ in fiscal and regulatory policies.

Strangely, Geithner recognizes that the private sector has already moved to solve its own problems. In an earlier interview Geithner said:

“[T]he financial system will be dramatically different. It’s already dramatically different. Again, if you look at the scale of adjustment and restructuring in the financial system, it’s already happened. It’s profound in scope already. So if you just look at the system today relative to what it was through [sic] three years ago in terms of the institutions that existed then, and their basic shape has changed dramatically. . . . This will clean out a lot of the excesses and bad practices, and those that don’t get cleaned out just by experience and knowledge now, better regulation oversight, better rules to the game, enforced more cleanly, we’ll fix.”

Geithner’s desire for greater regulation is particularly hard to understand given his views on existing changes in the financial system. The financial system is already dramatically different because experience has cleaned out excesses and bad practices, but we need new regulations? Even if we accept the idea that the crisis derived partially from lack of regulation, Geithner’s own words indicate that that the private banks have moved faster than the Federal Government to correct faulty practices. Why then should we trust them to prevent further crises? Geithner claims that this is the “best managed crisis” because they acted “earlier and stronger” to deal with these problems, yet he also describes delays in government action as “tragic.” Of course, Geithner sees his own management as the best, and earlier efforts as weak and delayed. But he has no better ability to foresee future events, and no special powers to effect changes in policy more rapidly. If anything, recent experience indicates that the private sector moves faster in dealing with serious problems than can federal officials.

Geithner claims that he is “designing into these programs a credible capacity to dial back and exit.” For example, Obama and Geithner have an “ambitious and tough with plan with clear choices for bringing deficits down to a sustainable level.” At this point Obama’s proposed spending cuts are miniscule as compared to his planned spending increases. Given the track record of Federal Government, the likelihood of Obama’s new Federal Spending being dialed back seems quite small. In fact, the expansion of government during crises typically exceeds post crisis retrenchment[1].

The case that Geithner makes for his policies is both self-contradictory and contrary to fact. Geithner wants to build a “stronger and more sustainable recovery,” but at the same time he is promoting a more extreme version of the monetary policy that he thinks contributed to the last unsustainable boom. He is also pushing for new regulation of risk, leverage, and compensation in response to a crisis that was driven by government policies that encouraged risky Subprime lending. There is a great need for reform. What we actually need is to prevent inflationary monetary policies as well as Federal efforts to direct the economy through regulation, as these are the types of action that caused the subprime housing boom and subsequent crisis. Ironically, Geithner’s goal of preventing yet another unsustainable boom and crash can be achieved only by ignoring his advice, because his policies are based on faulty logic and a misinterpretation of available facts.

A Time of Reckoning for the Poor 
May 20, 2009
Alvaro Vargas Llosa

WASHINGTON—In the last few years, an abundance of consumer demand, credit and investment coming from the rich nations combined to pull millions out of poverty worldwide. Because the bubble-induced international conditions showered every corner of the planet, it was unpopular to point out that some countries were still in need of major reforms and would not continue to prosper indefinitely.

Now that the feast is over and the day of reckoning is here, one way to sort the chaff from the wheat is to look at the 2009 Institutional Quality Index, authored by economist Martin Krause for the International Policy Network. It ranks countries according to how much economic freedom, democracy and rule of law they provide. Since countries with higher scores have attracted more funds and capital than those with lower scores in recent years, the latter will likely be in deep trouble for years to come due to the changed international conditions.

In 2007, net capital flows amounted to $929 billion in emerging countries; this year the figure will be a mere $165 billion. It sounds comical, but poor countries in the last couple of years have been lending more money to rich countries than the other way around. The drying up of international funding and investment will make competition ferocious for whatever money is available; only nations that improved their institutions when few were asking questions will get those dollars.

Having good institutions does not simply mean having an open economy. It means underpinning the open economy with the rule of law—that is, strong legal protections for persons and property. In fact, the rule of law is so crucial that countries with relatively big and bureaucratic governments oftentimes do better than those with more open economies but more precarious legal safeguards. This is why Latin America ranks behind Central Europe and Asia, or why Uruguay and Costa Rica are ranked much higher than Mexico and Peru, where economies are more open but the rule of law is weaker.

Cultural legacies may help explain the tendency of areas such as Central Europe (pre-communism) and those Caribbean islands with “common law” traditions (British colonialism) to outperform others. And historical reasons may account for the fact that Chile, where institutional stability was greater in the 19th century, tends to do better than its neighbors even when reform stalls. In any case, the evidence tells us that the countries with a greater combination of economic freedom and rule of law are going to be much more attractive in this post-bubble scenario characterized by very scarce international funding and investment.

Southeast Asia, Central Europe and Latin America are much better placed than, say, the Balkan nations or Eastern European laggards such as Russia, Ukraine and Belarus. But there are big differences within each region. The slowing down of what had been an impressive wave of reform in Vietnam and Hungary in recent years has made those countries more vulnerable than Malaysia and Slovakia to the international conditions likely to prevail in the next few years.

There is nothing predetermined about a country’s destiny: 632 million Chinese and 117 million Indians who overcame dire poverty in the last two decades attest to that. But governments that did not reform their institutions in times of plenty are now going to face popular pressure to redistribute wealth and bend or trample the law in order to meet social claims. The outcome will be even weaker institutions in those countries.

By all indications, Russia, Turkey, Argentina, Venezuela, Indonesia and Nigeria, to name but a few that profited from the commodities boom, will see their institutional flaws crudely exposed—and their populations will suffer. By contrast, those such as Peru, Colombia, Slovenia, Qatar, Botswana, Mauritius and Kuwait in which markets and the rule of law made progress, in some cases much more than in others, will probably outpace many of their neighbors.

The real stake for developing nations today is not so much the drying up of funding and investment but the winnowing and sifting process that is making clear which societies were living in the real world while others were simply dreaming. The result will be the restoration of the link between institutions and economic growth that the bubble had temporarily severed.