Why no one is agreeing with Brown’s additional ‘plan’ March 26, 2009Posted by larry in economics.
Tags: bailout, Buiter, derivatives, economics, Galbraith, Krugman
Brown’s desire to pump more money into the banking sector is either being received unenthusiastically or rejected. There will be a number of reasons for individual responses. But one will be that it will be folly to put any additional funds into a set of institutions that are insolvent, can be shown to be insolvent, and whose directors (who have mostly not been replaced) brought their banks to ruin. It would be not unlike shipping your money to a black hole from which it will never return nor could any return be generated.
In 2007, Fitch Ratings sat down with a sample of 45 loan documents and discovered that fraud was involved in the majority of these loans. Some of them were tagged as questionable but the loans were granted nevertheless. Some of these were structured investment vehicles, many of which were devised to avoid regulation or to commit outright fraud.
What Fitch found is only the tip of the iceberg. The derivatives market debt, which is predominantly responsible for the current financial crisis, not subprime loans though they were the trigger for the collapse, in estimated to be massively in excess of world GDP. And this was in 2007, before the collapse.
The gross world product (GWP) for 2008 is estimated to be $70.65tn (purchasing power parity) or $78.36tn (official exchange rate) (CIA World Factbook). The derivatives debt is estimated by some to be as high as $1.5 quadrillion. This is obviously much greater than the world GDP. There is obviously no way that this can be paid down. It must in some way be written off.
Krugman has objected to Geithner’s plan, which he contends is nothing more than the Paulson plan redesigned. And to show how serious the current situation is, he has calculated a significant comparison of 1930 with now (from his blog, The Conscience of a Liberal).
“the change in industrial production, measured in logs, from the previous peak in 1929-30 and 2007-9.
[I am not allowed to post an image here so I will just have to provide you with the URL. Apologies. http://krugman.blogs.nytimes.com/.]
At first, the current recession didn’t hit industrial production all that hard. But the pace accelerated dramatically last fall, so that at this point we’re sort of experiencing half a Great Depression. That’s pretty bad.”
James K. Galbraith, in a piece in the Washington Monthly issue for March-April 2009 and in interviews, has suggested ways of dealing with what are irreparably insolvent banks, as has Willem Buiter, in his Mavercon blog for the Financial Times. Both advocate at the very least a radical restructuring of the banking system. *
It is clear that neither Brown’s not Geithner’s plans will work. Galbraith contends that this may well be because Geithner and his colleagues are trapped in old ways of thinking – this may leave them unable to think themselves out of the real box in which they find themselves. If they are trapped in old ways of thinking, then they have to be let go and others found who can think “outside the box”.
The Governor of the Bank of England recently made a public statement that no more money was available for fiscal stimulation. This statement is not quite as pellucid as it might appear to be. There certainly is no more money to plough into insolvent banks. But it may be possible to do a Roosevelt and provide money for projects that will generate tax revenue which will fund further projects utilizing a kind of multiplier effect. For this to work, it must me the major part of any financial package, not a subsidiary part. So far, it hasn’t been.
The rejection of Brown’s stimulus package by others can not be taken at face value. It is not enough to know that they reject it; one must also know why they reject it. Only then can one know how they are viewing the recession and how they view dealing with it. This is important because this recession, being global in scope, requires a coordinated global response. On that, Brown is undoubtedly right. This is because the banking institutions and hedge funds that created this problem in the first place are global institutions whose effects, including their indebtedness, are global in reach.
* Donald Moggridge argues that something akin to the Marshall Plan was needed to get the US out of the Great Depression – what Roosevelt did was good but not enough. (Donald E. Moggridge, “Policy in the Crises of 1920 and 1929”. In Financial Crises: Theory, History and Policy, C. P. Kindleberger and J. P. Laffargue, eds. (1982))