Archive for November, 2011

Is the ECB Really Powerless? (Part III)

Michael Stephens | November 18, 2011

(Update added below)

In our last post on this topic, we found the head of the Bundesbank citing legal obstacles (Article 123 of the EU treaty) as the reason why the European Central Bank cannot step up as lender of last resort.  Can the ECB work around that Article 123 restriction?

In the last couple of days we’ve seen reports of a new, convoluted approach in which the ECB would lend to the IMF, which would in turn directly buy member-state debt.  Marshall Auerback noted another possible workaround, via a mechanism the ECB has already used (though not to the extent that would be necessary):  the ECB can get around the prohibition on buying member-country debt in the primary market by doing so through the secondary market.  (On the ECB buying bonds in the secondary market, Brad Plumer of the Washington Post has a nice quote from Richard Portes of the London Business School:  “If that’s illegal, then officials should already be in jail.  Because they’ve been doing it sporadically since May of 2010.”)

At Modeled Behavior, Karl Smith questions whether this would really work.  He points out that while the ECB has conducted limited buying of this sort in the secondary market, what would be required for the ECB to act as lender of last resort would be unlimited buying.  Smith then runs down the legal obstacles to unlimited ECB operations, citing two provisions that could stand in the way of this secondary market solution:

The first provision says that the ECB cannot target a price for Italian Debt on the secondary market.

The second provision says that ECB cannot guarantee that newly issued Italian debt will stand as collateral under repurchase agreements.

If the ECB were able to do either of the above things then it could provide guaranteed liquidity to the holders of Italian debt and cause the yield to collapse towards the overnight rate.

Smith ends by offering a couple of alternative routes, but in many ways, this may all be beside the point.  If you read between the lines in interviews given by people like Jens Weidmann, what comes through is not simply an expression of regret regarding the obstacles to a lender of last resort function, but something more like an endorsement of the value of these Article 123-type restrictions.  The barriers, in other words, seem to be more a matter of ideology and politics.

Update:  Ramanan adds some serious value to this discussion in comments (go take a look), including a link to a 2006 paper by Wynne Godley and Marc Lavoie in which they consider this very issue of working around the rules prohibiting the ECB from directly financing member-state Treasuries.  From the paper (emphasis mine): continue reading…


The Future of the Eurozone

Michael Stephens |

It has become a cliché that the survival of the European Union (EU) depends on its ability to reform, either through enlargement—greater economic and fiscal coordination in the direction of some sort of federal state—or by getting smaller, with the eurozone becoming a true optimum currency area.

Surprisingly enough, most analysts, including leading EU officials, have sided unequivocally with the former proposition.

In a new one-pager, C. J. Polychroniou lays out the likely scenarios for the eurozone going forward and casts a skeptical eye on the idea that the future path will or should involve tighter economic and fiscal coordination.  The most likely scenario, he argues, is the exit of Greece and possibly Portugal from the eurozone—countries that are really struggling as a result of having given up control over monetary policy.

Read the one-pager here.


Financial Fraud Prosecutions Down 60% Over Last Decade

Michael Stephens | November 17, 2011

(Down 57.7 percent to be exact.)

Sure, Wall Street has returned to claiming its 40 percent share, or so, of all corporate profits, while receiving little more than a regulatory slap on the wrist (which lobbyists are currently working to bring down to a light effleurage), but at the very least, at the end of the day justice will be served for all those in financial institutions and all along the mortgage financing food chain who were engaged in fraud.  So there’s that.

What’s that you say, Syracuse University?  Oh, never mind:

Figure 1: Criminal Financial Institution Fraud Prosecutions over the last 20 years

(Via Catherine Rampell at Economix, who notes that this isn’t the result of some sort of generally more lax approach to federal criminal prosecutions over the last decade—prosecutions for other crimes have almost doubled over the same time span.)

Just to rub it in, read this paragraph from Randall Wray’s policy brief, “Waiting for the Next Crash,” and then take another look at that graph:

… policymakers must recognize that the activities leading up to and through the crisis were riddled with fraud. Fraud, at multiple levels, became normal business practice—from lender fraud and foreclosure fraud to the practice of duping investors into buying toxic securities with bait-and-switch tactics, while simultaneously betting against those securities using credit default swaps. Every layer in the home finance food chain was not only complex but also fraudulent, from the real estate agents to the appraisers and mortgage brokers who overpriced properties and induced borrowers into terms they could not afford, to the investment banks and their subsidiary trusts that securitized the mortgages, to the credit rating agencies and accounting firms that validated values and practices, to the servicers and judges who allowed banks to steal homes, and on to the CEOs and lawyers who signed off on the fraud. Once a bank has made a “liar’s loan,” every other link in the chain must be tainted. And that means every transaction, every certification, every rating, and every signature all the way up to that of the investment bank CEO is part of the cover-up.

Update:  Or, read Matt Taibbi.


The Italian Solution: A Dissent

L. Randall Wray |

Yesterday a group of economists issued a petition to the (new, Berlusconi-free) Italian government. You can read it here. They set out what is mostly good advice based on the premise that Italy should remain in the EMU. Many of my friends signed the petition, but I had to decline. Here is the text of my response to them:

“Dear Friends: I share your concern about the grave situation in Italy. I support much of the petition. In particular, I agree that the ECB must stand ready to buy government debt – indeed, it should announce its intention to drive interest rates for government debt of every member below 3%, and keep buying until it achieves the goal. I also agree that fiscal contraction must be abandoned. There are however three points discussed in the petition on which my views diverge:

a) The solution to the Euro crisis is not to be found in SDRs and the IMF. The ECB can immediately end the problem with government debt. No external help is required, nor should it be sought.

b) The petition should not call for stabilizing debt ratios at current levels. With an ECB backstop, the debt ratio disappears as a matter for concern. It is impossible to say in advance what debt ratio will be required for Italy (and others) to grow back toward prosperity and full employment. There is no point in tying government’s hand to any particular debt ratio.

c) The petition’s statement about “freeing resources” to direct them to promoting full employment is confused. It seems to be based on some loanable funds model. Europe’s problem is that it has far too many “free resources” that are idle – unused capacity: labor, factories – so it does not need to “free” any more. If the petition is discussing “financial resources,” then these are never a scarce resource that needs to be “freed.” I also do not like the statement about taxes. Of course tax evasion should be reduced – but that is a matter of fairness, not “financial resources.”

The first of these points is admittedly minor. The final two points are important. I would like to join my friends in signing the petition but I regret to say that I cannot support arbitrary debt limits (once there is a backstop – and without the backstop then all euro-using governments must reduce their debt ratios tremendously, perhaps to no more than 15% to 20% of GDP), nor a confusing statement on the necessity of freeing resources.”


Among the Minskyans

Michael Stephens | November 16, 2011

Dan Monaco, writing for The Straddler, attended this year’s Minsky Summer Seminar at the Levy Institute and put together an engrossing (and accessible) article that looks at the work of Hyman Minsky, paying particular attention to Minsky’s interpretation of Keynes (including his views about the misinterpretation of Keynes by mainstream economics).  The article is sprinkled with excerpts from Monaco’s interview of Dimitri Papadimitriou:

“Economists have lost their credibility because they do not actually deal with the real world,” Dimitri Papadimitriou, President of the Levy Institute, told me in my conversation with him. …

“Minsky was in some ways a pioneer. He saw that economic theory assumed that everything is known and that there is some tendency of the system to reach for equilibrium and, at times, to reach periods of ‘tranquility,’ as he preferred to call them. Of course, he never believed that stability was possible. He didn’t believe in the invisible hand. There’s a reason why it’s invisible—because it’s not there.”

Read the entire thing here.


A new government in Italy

Gennaro Zezza |

Italy is getting a new government today, which is expected to act rapidly to strengthen the Italian growth potential, thus addressing the public debt “problem.” However, it is doubtful that any new government in Italy can succeed in addressing the European financial crisis without concerted action at the European level.

I endorse at least the following portion of this petition: “…we maintain that the new Italian government should rapidly act through the appropriate European institution, with the required determination and political alliances, to obtain a firm and unlimited guarantee by the ECB on the European sovereign debts…”


Is the ECB Powerless or Unwilling? (Ctd)

Michael Stephens | November 15, 2011

Relevant to the question of the legal limits of relying on the European Central Bank as lender of last resort, Tyler Durden observes Jens Weidmann, head of the Bundesbank, defending the narrow view of the ECB’s role in a recent Financial Times interview:

FT: Can you explain why the ECB cannot be lender of last resort?

JW: The eurosystem is a lender of last resort – for solvent but illiquid banks. It must not be a lender of last resort for sovereigns because this would violate Article 123 of the EU treaty [prohibiting monetary financing – or central bank funding of governments]. I cannot see how you can ensure the stability of a monetary union by violating its legal provisions.

I think the prohibition of monetary financing is very important in ensuring the credibility and independence of the central bank, which allow us to deliver on our primary objective of price stability. This is a very fundamental issue. If we now overstep that mandate, we call into question our own independence.

This looks like two separate arguments:  (1) lender of last resort activities would violate Article 123; (2) this prohibition of LLR activities (“for sovereigns”) is a good idea anyway, because it preserves ECB independence.

The second argument, if this is what Weidmann intends, would imply that a great many central banks that do have LLR roles, including the Fed, lack sufficient independence.  As Brad DeLong argues, this narrow, LLR-less mandate for the ECB represents a radical break with central banking tradition (which, in and of itself, needn’t count as a decisive objection, but it is important to keep all of this in context—in DeLong’s story, Weidmann’s vision for the ECB does not represent some staid, tested, conservative approach).  DeLong:

Our current political and economic institutions rest upon the wager that a decentralized market provides a better social-planning, coordination, and capital-allocation mechanism than any other that we have yet been able to devise. But, since the dawn of the Industrial Revolution, part of that system has been a central financial authority that preserves trust that contracts will be fulfilled and promises kept. Time and again, the lender-of-last-resort role has been an indispensable part of that function.


Keynes vs. Schmeynes Debate

Michael Stephens | November 14, 2011

If you missed last week’s Reuters-sponsored Keynes vs. Hayek debate at the Asia Society, video of the event is attached below, beginning with James Galbraith’s contribution.

The debate, predictably, ended up being more about the last two-and-a-half years of economic policy.  Note also the way in which this turns into a Democratic Keynesianism vs Republican Keynesianism debate; due in no small part to the Wall Street Journal‘s Steve Moore, who argues that instead of Obama’s wretched ARRA, a mixture of tax cuts and spending increases, what we really need is … a mixture of tax cuts and spending increases.  The key to being a Moore-style Schmeynesian, as near as I can tell, is that when describing Obama’s policies one ignores the tax cuts, and when describing Reagan-era fiscal policy one mumbles something about “defense” rather than spending increases.

(Note also Galbraith’s list of Hayek’s later policy preferences, which would place Hayek somewhere in the progressive wing of today’s Democratic Party).


Is This the End of the EMU?

L. Randall Wray |

(cross posted at EconoMonitor)

For more than a decade, I’ve been arguing that the EMU was designed to fail. It was based on the pious hope that markets would not notice that member states had abandoned their currencies when they adopted the euro, thereby surrendering fiscal and monetary policy to the center. The problem was that while the center was quite happy to centralize monetary policy through the august auspices of the Bundesbank (with the ECB playing the role of the hapless dummy whose strings were pulled in Germany), the center never wanted to offer fiscal policy capable of funding essential spending. (See also Nouriel Roubini’s Eurozone Crisis: Here Are the Options, Now Choose and  Marshall Auerback’s piece: The Road to Serfdom.)

Member states became much like US states, but with two key differences. First, while US states can and do rely on fiscal transfers from Washington—which controls a budget equal to more than a fifth of US GDP—EMU member states got an underfunded European Parliament with a total budget of less than 1% of Europe’s GDP. This meant that member states were responsible for dealing not only with the routine expenditures on social welfare (health care, retirement, poverty relief) but also had to rise to the challenge of economic and financial crises.

The second difference is that Maastricht criteria were far too lax—permitting outrageously high budget deficits and government debt ratios.

What? Before readers accuse me of going over to the neoliberal side, let me explain. Most of the critics on the left had always argued that the Maastricht criteria were too tight—prohibiting member states from adding enough aggregate demand to keep their economies humming along at full employment. OK, it is true that government spending was chronically too low across Europe as evidenced by chronically high unemployment and rotten growth in most places. But since these states were essentially spending and borrowing a foreign currency—the euro—the Maastricht criteria permitted deficits and debts that were inappropriate.

Let us take a look at US states. All but two have balanced budget requirements—written into state constitutions—and all of them are disciplined by markets to submit balanced budgets. When a state finishes the year with a deficit, it faces a credit downgrade by our good friends the credit ratings agencies. (Yes, the same folks who thought that bundles of trash mortgages ought to be rated AAA—but that is not the topic today.) That would cause interest rates paid by states on their bonds to rise, raising budget deficits and fueling a vicious cycle of downgrades, rate hikes and burgeoning deficits. So a mixture of austerity, default on debt, and Federal government fiscal transfers keeps US state budget deficits low.

(Yes, I know that right now many states are facing Armageddon—especially California—as the global crisis has crashed revenues and caused deficits to explode. This is not an exception but rather demonstrates my argument.)

The following table shows the debt ratios of a selection of US states. Note that none of them even reaches 20% of GDP, less than a third of the Maastricht criteria. continue reading…


Underutilized Workers Outnumber Job Openings 7 to 1

Greg Hannsgen | November 11, 2011

(Click to enlarge.)

The most recent Bureau of Labor Statistics (BLS) data released this month show an increase in the number of job openings available throughout the United States, as reported by Catherine Rampell in the New York Times “Economix” blog. As of the end of September, there were 3.8 unemployed people per job opening, based on raw data. (Rampell reports a slightly higher ratio, based on seasonally adjusted figures.) These ratios use the official definition of unemployment, leading to a rather low count of the number of workers individually affected by the bad labor market. In the figure above, I compare the number of job openings with the number of unemployed people, using separate bars for each gender. In addition, I include bars representing two more groups that are covered by the BLS’s broad “U6 measure of labor underutilization” but not by the official unemployment rate: 1) those working only part-time for economic reasons; and 2) people who are “marginally attached to the workforce.” The latter group includes discouraged workers and many others who would almost certainly be working if the job market were sufficiently robust.* The green bar on the right shows the total number of people in all of these categories of underutilized workers—about 23.9 million, or 7.0 underutilized workers per job opening.


*Note: Click link below for definitions of these two groups
continue reading…