Only one firm matters

An extraordinary proportion of people with training and experience in finance have worked at the highest levels of every recent presidential administration. Four of the last six secretaries of the Treasury fit this description. In fact , all four were directly or indirectly connected to one firm: Goldman Sachs. This is hardly the historical norm : of the previous six Treasury secretaries, only one had a finance background .

In 2001, following revelations of accounting irregularities, Enron verged on collapse, which meant that Citigroup, a major lender, would lose a significant amount of money. Fulfilling a request made by Michael Carpenter, head of Citigroup’s investment banking unit, Rubin called Peter R . Fisher, then undersecretary of the Treasury and asked him to consider advising the bond – rating agencies against an immediate downgrade of Enron’s debt. In other words , Rubin (a Democrat ) lobbied Fisher (a Republican ) to help bail out Enron. ( So much for Washington’s ideological divide.)

What Rubin did was technically legal, as The Economist explained, only because Bill Clinton , in his last days as president , had canceled an executive order that barred top officials from lobbying their old departments for five years after leaving office.

Source: Zingales, Luigi. A Capitalism for the People: Recapturing the Lost Genius of American Prosperity (p. 68). Basic Books. Kindle Edition.

Today, of course, there is far more money riding on the models than in the 1980s – and when it comes to positive feedback, size matters. Indeed, another example of positive feedback is the relationship between the financial sector and regulators. As the sector increases in size, it gains more influence over the government; this allows it to change regulations in its favor, which allows it to grow even larger, and so on, until it becomes Goldman Sachs.

  • Sometimes called Government Sachs, because of the remarkable ability of its alumni to go straight into senior levels of government, perhaps related to the fact that the firm is a leading corporate donor to political campaigns (Baram, 2009). It is even better represented at central banks. Four of the Federal Reserve’s 12 regional banks  are currently headed by former Goldman Sachs executives. Only five banks have voting power, in a rotating fashion, and in 2017 ex-Goldmanites will hold four of these votes. Together with Mark Carney at the Bank of England and Mario Draghi at the European Central Bank, this means that interest rate decisions for much of the world’s economy are made by people who came from a single firm. Nothing to see here, move along.

Source: Wilmott, Paul; Orrell, David. The Money Formula: Dodgy Finance, Pseudo Science, and How Mathematicians Took Over the Markets (Kindle Locations 4524-4527). Wiley. Kindle Edition.


Steve Bannon on capitalism

In 2014 he did a live Skype interview for a conference on poverty at the Vatican. BuzzFeed ran it during the campaign under the headline “This Is How Steve Bannon Sees the Entire World.”

It shows an interesting mind at work.

The West is currently facing a “crisis of capitalism,” he said. The world was able to recover after the world wars in part thanks to “an enlightened form of capitalism” that generated “tremendous wealth” broadly distributed among all classes. This capitalism was shaped by “the underlying spiritual and moral foundations . . . of Judeo-Christian belief.” Successful capitalists were often either “active participants in the Jewish faith” or “active participants in the Christian faith.” They operated on a kind of moral patrimony, part tradition, part religious teaching. But now the West has become more secular. Capitalism as a result has grown “unmoored” and is going “partly off track.”

He speaks of two “disturbing” strands. “One is state-sponsored capitalism,” as in China and Russia. We also, to a degree, see it in America. This is “a brutal form of capitalism” in which wealth and value are distributed to “a very small subset of people.” It is connected to crony capitalism. He criticizes the Republican Party as “really a collection of crony capitalists that feel they have a different set of rules of how they’re going to comport themselves.”

The other disturbing strand is “libertarian capitalism,” which “really looks to make people commodities, and to objectify people, and to use them almost.” He saw this strand up close when he was on Wall Street, at Goldman Sachs . There he saw “the securitization of everything” and an attitude in which “people are looked at as commodities.”

Capitalists, he said, now must ask: “What is the purpose of whatever I’m doing with this wealth? What is the purpose of what I’m doing with the ability that God has given us . . . to actually be a creator of jobs and a creator of wealth?”

With both these strands, he says, the middle class loses ground. This has contributed to the “global revolt” of populism and nationalism. That revolt was fueled, too, by the financial crisis of 2008. None of those responsible on Wall Street were called to account: “No bonuses and none of their equity was taken.” The taxes of the middle class were used to bail them out. [Link]

This was taken from Peggy Noonan’s recent column in WSJ. Her column is titled, ‘Declarations’. The paragraphs capture the views of Steve Bannon on capitalism. Did not know that he used to be associated with Goldman Sachs too.

I would not characterise it as an ‘interesting take on capitalism’ as Peggy Noonan has done. It is a rather correct/apt view on capitalism. Clearly, a thinking man whom President Trump appears to have dumped in favour of his son-in-law, Jared Kushner. I hope appearances are deceptive.

Shareholder value maximisation

Just managed to read two white papers that James Montier had written in March. One was titled Six Impossible Things to do before breakfast’. He decided to disagree with his Chief Investment Officer, Ben Inker. My sympathies lie with James Montier. I wrote a short piece in January for MINT as to why this time might not be different as Ben Inker and Jeremy Grantham had been inclined to argue, lately. To be clear, there is no presumption that I am right (or James Montier is) and that they are wrong.

The other piece (slightly longer but not very and eminently readable, in any case) was about secular stagnation and neo-liberalism. Again, no marks for guessing where my sympathies lie. I am fully on board with James Montier. If you are reading it, do not miss footnote no. 12.

I was interested in the paper by Asker, et al that James Montier had cited. One complaint about Montier’s pieces is that the references are not fully cited. Not that one is complaining that these good pieces are being made available for free (just a registration required at and second, it is not that difficult to locate the cited works.

Asker’s piece (co-authored) is about private firms (unlisted) investing more than listed firms in the United States. Very interesting and useful empirical work. Shareholder Value Maximisation has been reinterpreted as Short-term Stock Price Manipulation, in reality and it runs counter to long-term Enterprise Value Added. Only capital investment generates long-term returns and not financial engineering.

All of these are the natural fallout of the neo-liberal agenda that has been in place since the Eighties to which the monetary policy of the Federal Reserve has contributed greatly.  Few at the expense of many and markets at the expense of society.

You can find Asker’s paper here and a presentation on the paper here.

One thought that Donald Trump would fix it, considering how effective and rousing his last campaign advt. was. But, it appears that it is all unravelling too fast. Well, that sad story is another subject for another occasion.

Why is finance pro-cyclical?

There are many explanations to this. I discuss them in my classes. But, a nice and elegant explanation was offered by Mr. Fabrizio Saccomanni, former Minister of Economy and Finance in Italy at a BIS Special Governors’ Meeting in Manila in February 2015 and I quote:

As I have argued in the past (Saccomanni 2008), although global financial intermediaries operate in a highly competitive environment, they have uniform credit allocation strategies, risk management models and reaction functions to macroeconomic developments and credit events. Thus, competition and uniformity of strategies combine, in periods of financial euphoria, when the search for yield is the dominant factor, to generate underpricing of risk, overestimation of market liquidity, information asymmetries and herd behaviour; in periods of financial panic, when the search for safe assets is predominant, they combine to produce generalised risk aversion, overestimation of counterparty risk and, again, information asymmetries and herd behaviour. [Link]

Nice. I like it. The statements are testable hypotheses. I like it because I have long held the view that competition in the financial services industry is not the same as competition elsewhere in the real world. That does not mean that the optimal number of firms in the banking industry is ONE but that competition requires regulation and ‘leaning against the wind’ norms – countercyclical credit buffers come to mind – to ensure that competition in the banking industry is not welfare-subtracting for the economy.

What to do about spillovers?

Our results provide new insights. We find economically and statistically significant spillovers from the United States to EMEs and smaller advanced economies. These spillovers are present not only in short- and long-term interest rates but also in policy rates. In other words, we find that interest rates in the United States affect interest rates elsewhere beyond what similarities in business cycles or global risk factors would justify.

We also find that monetary spillovers take place under both fixed and floating exchange rate regimes, which lends some support to the conjecture in Rey (2013, 2014) that the global financial cycle constrains monetary policy irrespective of the exchange rate regime.

From a policy perspective, our findings suggest that neither are interest rates fully independent nor is monetary policy fully unconstrained when economies and financial markets are closely integrated. Even under flexible exchange rates, central banks – though technically able – seem to find it difficult to conduct a monetary policy that is based purely on domestic factors and which ignores monetary developments in core advanced economies. Furthermore, our findings also shed some light on the causes of the persistently low interest rates that have prevailed globally over the past seven years. Back-of-the-envelope calculations based on our results suggest that easy monetary conditions in the United States have exerted considerable downward pressure on interest rates elsewhere. [Link]

These are from the paper, ‘International Monetary Spillovers’ published in the 3Q2015 Quarterly Review of the Bank for International Settlements.

In his Per Jacobsson Memorial Lecture in 2012, Dr. Y.V. Reddy recognises the difficulty of managing spillovers but does not offer solutions:

Public policy is conducted at the national level, but at the same time, globalisation of economies, often driven by technology, is a reality, and the global macroeconomic environment is an outcome of national policies in a framework of nebulous global governance arrangements. The challenge for national central banks is to find space for the conduct of their own policies in an increasingly inter-dependent global economy.

Too much global policy coordination might lead to the universalisation of risks of policy mistakes. The main contention is that good finance is essentially a function of good economic policies, and such good policies are primarily national, though significantly impacted by the global macroeconomic environment – which, as already mentioned, is not a product of design. [Link]

This is interesting, however:

It is true that successful arrangements for global coordination while retaining space for national public policies are working well in certain sectors, such as aviation, telecoms and the internet. But they seem to get into difficulties in regard to macroeconomic policies and finance. Clearly, there is a need to explore why global agreements work reasonably well in some sectors, leading to acceptable and assured outcomes, while when it comes to macro policies and finance such agreements appear difficult to arrive at – and what we can learn from them.

The spillover issue suggests a few solutions in no particular order of importance or categorisation into financial, macro, domestic and global.

(1) Selective and time-bound application of capital controls and quantitative restrictions including the use of higher risk weights for bank exposure to sectors receiving too much credit and equity – from domestic and foreign sources

(2) Regular, gradual and moderate foreign exchange reserve accumulation

(3) Bailing-in of creditors during banking crises. Living wills and insurance funds from premiums paid by banks can be part of the solution

(4) Encouraging domestic consumption and gradually lower reliance on U.S. consumer

(5) United States to de-emphasise the importance of asset prices for macro-economic growth and stability. The Federal Reserve assigns too much weight to the wealth effect transmission to macro aggregates, especially from the stock market. That has resulted in many other problems too, including the leaking of insider information on a systematic basis to financial institutions, investors and the media.

In other words, the United States needs a new monetary policy framework that incorporates financial cycles and financial stability and not just employment, price stability and stability of long-term interest rates.

(6) United States to conduct more symmetric monetary policy than now

(7) Federal Reserve to obsess far less about managing and minimising market volatility

(8) Less emphasis on forward guidance and transparency in the monetary policy framework of advanced countries. This will moderate risk taking in financial markets which are globally integrated and hence the risk-taking goes global. To the extent they are restrained in the United States, the restraint will also spill over to capital markets around the world. This is a virtuous spillover. Indeed, this is the logic behind suggestions (5) to (7) too.

(9) Higher capital requirement for banks. This will restrain endogenous money creation by banks. That will, in turn, moderate credit and capital flows to emerging economies.

(10) Re-introduction of separation of retail-commercial from investment banking. Same outcome as in (9) as it will moderate risk taking by financial institutions.

(11) This last one is admittedly a hypothesis. For many reasons – benign and not-so-benign – policymaking in the United States is captured by China. One of the benign explanations is that, for U.S. policymakers, China has become another ‘Too big to fail’ institution. Hence, their nervousness about conducting normal monetary policy. One more reason for asymmetric monetary policy. This results in a sub-optimal monetary policy in the United States which is then transmitted to the rest of the world with integrated and pro-cyclical capital markets.

Postscript: the possibility of a multi-polar world of currencies must be deemed remote now. China’s yuan might be part of the SDR basket. But, it is unlikely to be an international currency. China does not have the stomach for it. Its actions in recent years have demonstated that its penchant for control overrides the objective of internationalisation. The Euro is unlikely to become an alternative, ever.

Hence, the reform of the American monetary policy framework is the only hope. Will the Chinese ‘capture’ of American policy in benign or not-so-benign ways end?

Will the Trump administration rise to the challenge on both? My answer, five months ago, would have been more optimistic than it is now.

(For completeness, you can find Raghuram Rajan’s suggested solutions for the spillover problem in his speech delivered in New York in May 2015).

Financialisation is hale and healthy

There was so much talk about revolving doors between Wall Street and regulators. Mervyn King who wrote so eloquently about banks in ‘End of Alchemy’ ended up an advisor to Citigroup. Willem Buiter who was in the MPC in BoE did the same. Former Heads of Government do the same. Robert Zoellick and Robert Rubin come to mind. Former as Goldman Sachs advisor and the latter in Citigroup.

It is not for nothing that financial firms pay huge sums to have these people in their rolls. The latest is Blackrock that has agreed to pay a very generous sum to George Osborne, former British Chancellor, for very little work. The story is here.

So, the dominance of Finance has not really ended. The fight still has to be made and the road ahead remains long.

This blogger makes some good comments:

What are they buying? It’s not his economic expertise – he’d struggle to get a minimum wage job on that account – nor even his contacts. Instead, BlackRock is offering an incentive to the world’s finance ministers. It’s telling them that they too can get big money if they behave themselves in office*.

Such behaviour consists of giving the industry a favourable tax regime, lightish regulation, and ensuring a good flow of easy money. Osborne’s policy of fiscal conservatism and monetary activism had the effect of boosting asset prices (pdf), to the benefit of firms like BlackRock**.

It’s through mechanisms like this that capitalists gain undue influence over the state: there of course several other mechanisms, not all of which are exercised consciously or deliberately.

This influence isn’t perfect – we’d probably not have had Brexit if it were – but it exists. The idea that democracy means equality of political power is a fiction in capitalism.

You might think this is a Marxist point. I prefer, however, to think of it as a Cohenist one:

Everybody knows the fight was fixed
The poor stay poor, the rich get rich

Except that not everybody does know the fight is fixed, because the question of how capitalist power is exercised – like other questions such as whether capitalism impedes productivity or whether hierarchy is justifiable – is not on the agenda. But then, the issue of what gets to be a prominent political question and what doesn’t is another way in which power operates to favour capitalists.

I like this blog. Just ‘stumbled’ upon it. Don’t remember how. Even this post is a simple one and it makes sense.

Further on central bank independence

My friend shared with me an article by Shri. A.V. Rajwade on central bank independence. It is about a week old.

Some thoughts triggered by that article:

In recent times – post-1970 experience of stagflation – goverments decided  – inspired by academics – to cede more powers to a technocratic central bank for three reasons:

(1) It would be seen as a credible and large-hearted, long-term, visionary response to the problem of inflation: “We created inflation and we are now tying our own hands by transferring the power to another institution which does not carry our structural deficiencies.

(2) It was also convenient. Blame can be passed on to someone else. That situation did not arise because inflation was held back by a variety of factors.

(3) The economic paradigm changed in the Seventies. Fiscal policy and Keynesianism gave way to rules. Discretion was de-emphasised. Unfortunately, only the discretion of the elected representatives was de-emphasised but the discretion of unelected and largely unaccountable technocrats increased with the framework of central bank independence.

I think it was also a very clever move to insulate from public scrutiny the influence of the interest of financial markets on public policy. An aloof, opaque, technocratic institution blessed with the perception of non-corruptibility is an ideal smokescreen for creating policies that favoured financial markets and financial interests. Democratic politicians would be subjected to harsher scrutiny. Ph.Ds with beards (or not) from elite universities would not be subjected to a similar treatment. They automatically got the benefit of doubt in the incestuous world of intellectuals-policymakers and the commentariat.

Journalists and commentators wanted to be seen as less in thrall to politicians but more to intellectuals. The latter is more respectable and acceptable. Hence, central bankers escaped tough scrutiny. That suited everyone, including the politicians!

These three factors explain how the idea of central bank independence took root in western economies in the 1970s.

To the extent that inflation is now welcomed and finance is being throttled back (let us see what President Trump does), automatically the case for an independent central bank is weakened.

Further, central banks have also invited the possibililty of losing their independence into their hallowed portals by conflating monetary policy with fiscal policy, with open contemplation of helicopter money – monetisation of fiscal stimuluses and with negative interest rates.

They overstepped and they have to be reined in. This is an outcome in accordance with the laws of nature.

But, economic frameworks, concepts, policies and prescriptions have a context. The context for developing economies is very diferent from the above discussion.