« Interest rates are an overly blunt instrument to battle market bubbles »

L’intervention de Barkley Rosser lors de la conférence « The Financial Crisis, the US Economy, and International Security in the New Administration », New York, 14 novembre 2008.

par Barkley Rosser, Jr
Langue : anglais - Traduction : S’inspirer des banques canadiennes

I would like to raise five issues, and maybe the tone will be little different from the previous two speakers, who have talked about cat- ching crooks. The first issue has to do with how much time we should spend on worrying about new institutions. The second one is about battling bubbles. The third deals with the infamous mark-to-marketing. The fourth with what should be done about housing. Finally, I would like to say some words about the safest banks in the world, the Canadian banks.

As for the first issue, I want to raise a cautionary point. We have this glorious moment of crisis. We’re all enjoying it to some degree, those of us who haven’t gone broke, and partly that’s because there’s this chance to do all sorts of new things. But even in a situation like this, there is, as they say, a limited amount of political capital. What do you focus your political capital on? I would say that what you should focus on is getting good rules, good regulations and good peo-ple in it - not so much on trying to create new bodies or new institutions. I don’t want to pick on any; there have been quite a few thrown out during our discussions. But most of the actions that have been proposed can be accomplished by existing institutions. As James Galbraith pointed out, we have all array of institutions that were crea- ted in the New Deal and the Great Society. Many of them have been sort of moribund or at least not very active; they have had bad leaders or even corrupt leaders. But with better leaders and new rules, many of them can do many of the very desirable things that have been proposed today.

An example in my mind of bad organization activity – and I fear the Democrats are more prone to this – comes from the Homeland Security Department. This was supposed to solve our problems. We made a huge restructuring, pulling all these agencies together and creating a new level of bureaucracy, focused on keeping out terrorists from abroad. But then hurricanes hit New Orleans, and we discover that FEMA(8) is under the Department of Homeland Security, and that the Department of Homeland Security didn’t give a hoot about hurricanes, so we can’t count on assistance from FEMA. In other words, you can really mess things up through restructuring. I understand that there is a big argument about this. The central bankers say, « don’t do much. Tweak the existing institutions ». Others say, « let’s create new institutions ». But I think you can have really new policies and major reforms and focus on that rather than on the question whether we should create this or that entity.

« Interest rates are an overly blunt instrument to battle market bubbles."

Now that doesn’t mean I’m totally against creating new entities. At least one of them we might be able to fit into an existing entity is Paul Davidson’s Homeonwers Loan Corporation, HOLC. I suspect we could probably put that activity into the Housing and Urban Development Department, which of course was created in the 1960s, while HOLC was a creation of the 1930s. I think this is a very good activity, we need something like that; but I think we could probably do it with existing institutions.

There has also been some talk, especially for credit default swaps, that we need a central exchange and stop having them being exchan- ged over the counter. This will give us more transparency, we’ll know how much of them are out there - and it looks to me like something we really need to have. But it may well be that we can do that through the Commodity Futures Trading Corporation or something else. The fewer new entities we create, the better off we are. We should be focusing on the actual policies, the actual activities, and getting people into these places that have the right attitudes and are com- mitted to doing something. The institutional structure should be lean and clean and mean.

Now the second question, the question about battling bubbles. I’ve talked about some of the things I’m talking about today to a number of colleagues, some of whom are very pro-free market. This is the one that really gets them upset. And I’m also going to give warnings about this. This is a very difficult one. In fact, let me note the warnings up front, and then I’ll suggest what we should do:

We have seen some efforts to do this in the past, and some of them were really disastrous. Here’s the tool that shouldn’t be used: interest rates. Having the Federal Reserve use interest rates to battle bubbles is, I think, using an overly blunt instrument. What is the great awful example? 1929 and 1930. Why did the Federal Reserve not have an expansionary monetary policy when the Stock Market crashed in 1929? Well, they were trying to squeeze the bubble out of the stock market. They succeeded but we also got the Great Depression.

By the way, how do you know there is a bubble? Alan Greenspan resisted trying to battle bubbles precisely for that reason. Some people laughed and said, « he should have seen it. Why didn’t he do some- thing?" And I do think he should have done something. But a lot of people have forgotten that he made a vague effort to do something about the Stock Market bubble, making a complete fool of himself. It was his famous speech warning against irrational exuberance in 1996. The market dropped the next day but then it turned around and went roaring off; and I’m not sure that the dollar has ever been back down that low again. And Greenspan really doesn’t like being caught and made to look silly. And he looked silly.

After that he was burned. He said, « I don’t want to get into this business ». And there are huge theoretical arguments here that I’m not going to get into. Still, I think that the body that ought to keep track of this is the Council of Economic Advisors. Let it be the body that tries to figure out if there are bubbles in certain markets.

So how should we respond? We need a variety of flexible policies and actual agencies that carry them out. The actual reaction depends on the bubble: different bubbles go different ways. Some go up and then they suddenly crash - you see that more in commodities - some go up gradually and come down gradually - mostly in the housing sector - and others still do the period of financial distress - this, by the way, is the most common. This third kind of bubble goes up, declines for a while and then crashes. That’s what happened with the credit and financial derivatives market. It peaked in August of 2007, crashed on September 17, thirteen months later. I warmly recommend you Charles P. Kindleberger’s great book, Maniacs, Panics, and Crashes: Kindleberger shows that out of 47 historical bubbles, 37 looked like that.

Now part of what you do depends on what kind of a bubble it is, since you can attack them in various ways. I think what we need today is innovative approaches. Margin requirements are an obvious thing for certain kinds of markets, restricting certain kinds of lending practices and housing, building housing. Paul Davidson talked about buffer stocks. We had an oil bubble earlier that was tough, and we made a mistake: we shouldn’t have been adding a strategic petroleum reserve. Sell oil out of the strategic petroleum reserve.

In any case, you use particular bodies to deal with particular bubbles. If it’s an agricultural commodity, you go through United States Department of Agriculture, and your measures must be very precise - not some blunt instrument that hits the whole economy. I realize that this is very difficult and probably most controversial; but I think it should be attempted.

As for mark-to-marketing accounting, I don’t think I need to go through the argument of why this is destabilizing. We forced banks to sell off assets to raise capital. When the value of the assets goes down, of course the selling itself pushes these values further down. So naturally this must be destabilizing.

This is a quite complicated issue. The mark-to-marketing accounting has come in from the Basel II accord, combined with capitaliza- tion requirements; and this agreement is something that took a very long time to be achieved. I’ve talked to a number of accountants, and they really don’t want to see mark-to-marketing gotten rid of. I can see that there’s a very valid argument for using mark-to-marketing. So you don’t get rid of it. Rather, you try to go around it. And one way to do it is what they’re doing in Germany - apparently the Fed is thinking about this as well. If a German bank promises to hold an asset to maturity, you allow it to value it at what they bought it for, or what it’s going to be paid in for, whatever. You don’t apply the mark-to-market rule. This moves some assets from that rule without getting rid of the whole system. Now, as some people have pointed out, what you do here is to make banks promise. But how do you know they will keep their promise? That can be quite tough.

Another idea is to look at the nature of the funding. A lot of the mark-to-marketing is a day-to-day evaluation. But let’s say you’re being funded by longer-term securities; then you can base it on that. In both cases, what it boils down to is to find a way to tweak the mark-to-marketing system, to smooth things out, without creating volatility.

Now let me say a word about the housing sector. First, some people have proposed foreclosure vouchers as a possible solution. There are some problems with this, but I think it’s an interesting idea. What you do is issue these vouchers based on income so poorer people will get more of them. You can use them to help pay a mortgage if you’re in danger of being foreclosed. There’s been a lot of discussion about how can we help poor people who are in danger of losing their homes, and how we save their houses from being dumped on the market in a forced way. I have some questions about this proposal, but I think it’s an interesting idea.

Another interesting idea is the so-called shared appreciation mortgage. This is apparently something that had been done in the past: you renegotiate a mortgage with the lender and get a lower prin- ciple, while the lender gets the right to share in any appreciation of the housing value that might occur later on. This presumably encourages lenders to allow some renegotiation of a mortgage to a lower amount.

But there’s a real deep conflict here. A lot of people have been arguing, and I largely agree, that as long as housing is going down in value - and we’re probably only about halfway down from the bubble; if you want a rough estimate of how long it’s going to take us to get down, I would say another two years - the sub-prime mortgage crisis will continue. We have had this giant house of cards built on ultimately bad sub-prime mortgages that are blowing up. As long as housing prices keep going down, we’re going to have more of these things blowing up. So a lot of people want to stop them from going down.

There’s certainly a very strong argument for this, but I guess I’m in the camp of those who think that we actually must get the housing prices down. Who likes expensive housing? Well, people who own their own house and want to use it to borrow. I want to use my home equity loan to send my kid to college. But housing is very expensive and lower-cost housing is a good thing for people trying to get in on the market. People say, « we have these people who can’t afford their mortgages »; but if the housing prices aren’t too high, then they can afford the mortgages. I mean, part of this whole sub-prime and exotic mortgage thing was trying to get people in these overblown bub- ble-priced houses that they couldn’t afford, offering them interest-rate-only and negative amortization mortgage. I nevertheless think we need mechanisms to help people and try to keep them in their houses while this process is going on.

Finally, let me just mention that we should take a closer look at the Canadian banking system. They are heavily capitalized, very conservative and they are not failing. They’re clean and lean and mean. The regulations are pretty simple, but they work. And then one last thing: I disagree with Bill Black about the need to revive Glass-Steagall, we don’t need it back.

(8) FEMA : Federal Emergency Management Agency

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