Reconstituting the Financial System: a Minskian Approach

Transcription

1 Reconstituting the Financial System: a Minskian Approach L. Randall Wray Levy Economics Institute and University of Missouri - Kansas City wrayr@umkc.edu *Part of a Ford Foundation Research Project On Improving Governance Of The Government Safety Net In Financial Crisis.

2 Outline Nature of Crisis: Solvency or Liquidity? Policy Response: Bail-out? How to redesign Financial System To enhance stability To improve policy response

3 Causes of the Collapse The Minsky Moment Minsky s Stages Money Manager Capitalism and the Rise of Shadow Banking Financialization, Layering, Liquidity Fraud

4 Money Manager Capitalism Rising share of profits and value added going to financial sector Shadow banks capture rising share of assets, response of banks and regulators is imitation Layering debt on debt on debt Positions in assets financed through very short term (overnight) borrowing

5 Decreasing Weight of the Banking Sector Shares of Financial Institutions (% of Total Assets) life insurance companies Managed Money Managed Money Funding Corporations Security Brokers and Dealers Real Estate Investment Trusts Finance Companies Issuers of Asset-Backed Securities Agency and GSE-backed Mortgage Pools Government-Sponsored Enterprises Commercial Banking Source: Federal Reserve Flow of Funds Accounts State and Local Government Retirement Funds Credit Unions Saving Institutions Bank Holding Companies Commercial Banking

6 % Pension Fund Total Assets (% of GDP) Private Pension Funds State and Local Government Employee Retirement Funds Source: Federal Reserve Flow of Funds Accounts

7 Financialization of the US Economy Share of the Financial Sector in Corporate Profits and Value Added Source: Bureau of Economic Administration Q1 Profits Value Added

8 Wages and Salaries, %GDP

9 Total Financial Liabilities Relative to GDP GSE Private finance Government Nonfinancial nonfarm corporate 0.5 Noncorporate and farm 0 Households and nonprofit Sources: Historical Statistics of the United States: Millennium Edition (Tables Cj , Ca9-19, Ce42-68, Cj , Cj , Cj , Cj , and Cj ), Historical Statistics of the United States: Colonial Times to 1970 (Series X ), NIPA, Flow of Funds (from 1945). Note: The government sector excludes all financial activities of the government (retirement funds, GNMA, etc.). GSE sector includes government-sponsored enterprises and agency- and GSE-backed mortgage pools (includes, among others, GNMA and FHA pools). "Private finance" excludes the GSE sector and monetary authorities (which are both part of the financial sector in the Flow of Funds accounts). Before 1945, data for financial institutions is computed from data of the Census Bureau by taking all the liabilities (excluding equity) of commercial banks, credit unions, savings institutions, life insurance stock companies, and property and life insurance companies, and by removing private banks notes, all deposits, and life insurance reserves. From 1945, the total financial liabilities of the financial sector excludes, net interbank liabilities of commercial banks, liabilities of monetary authorities, private and public pension fund reserves, money market mutual funds shares, mutual funds shares and the items previously cited. The liabilities of monetary authorities are not included anywhere. Data for the households and noncorporate sectors is deduced from Census Bureau data about net increase in liabilities and by computing backward from the 1945 level.

10 Keynes: When speculation dominates enterprise the job is likely to be ill-done

11 Stability is Destabilizing Greenspan Put Bernanke and Great Moderation No bubbles in sight. Fundamentals are strong Reality: biggest debt, equity, commodity, and real estate bubbles in history Financialization, Globalization, Neo-liberalism, Predator State, Money Manager Capitalism, Ownership Society Propped up by Big Govt and Big Bank No cleansing through debt deflation dynamics

12 Nature of the Crisis Key Question: Liquidity or Solvency Crisis? Bagehot: lend w/o limit, against good collateral, at penalty rate Banks relied on extremely short-term finance, questionable assets refusal to roll-over: solvency problems liquidity crisis Liquidity provisions through alphabet soup facilities Let s Make a Deal ; unusual and exigent 13(3) Our view: inappropriate response, particularly to an insolvency crisis

13 Accounting for the Fed s Response Cumulative through Nov 2011: $29,800,000,000,000 Individual institutions funded up to two years 20% conventional to depository institutions 80% nonconventional (nondepository, markets, assets) 40% questionable by 13(3) restrictions: $11T Highly concentrated among biggest domestic and foreign institutions These figures exclude QE

14 Fed Assets, in billions 1/3/2007 3/1/ /3/2007 1/3/2008 1/3/2009 1/3/2010 1/3/2011 1/3/2012 All other categories Other Assets CBLS AIA/ ALICO Maiden Lane's CPFF TALF Other Credit Extensions (includes AIG RCF) AMLF PDCF and other broker-dealer credit Discount Window Term Auction Credit (TAF) Repurchase Agreements MBS Federal Agency Debt Securities TSLF U.S. Treasuries

15 Percentage Borrowing by Institution, Excluding CBLS Credit Suisse (Switzerland) 4% Citigroup 13.6% Deutsche Bank AG (Germany) 3.6% Goldman Sachs 5.1% BNP Paribas (France) 5.1% Bear Stearns 5% Barclays 5.3% JP Morgan Chase 2.3% Merrill Lynch 12.4% AIG 5.4% Bank of America 5.2% Morgan Stanley 11.6% All others 16.1% Almost 84% involved just 14 institutions! RBS 3.2% UBS AG (Switzerland) 2.2%

16 Conventional vs. Unconventional 3500 All other assets 3000 U.S. Treasuries (includes QE) Unconventional Asset Purchases (MBS & Federal Agency Securities) Unconventional LOLR (TAF,TSLF/TOP, PDCF, AMLF, AIG RCF, TALF, CPFF, ML I,II, & III, AIA/ALICO, CBLS) Conventional LOLR (Discount Window and Repurchase Agreements)

17 Democracy and Accountability Bailout behind closed doors, by two of the least accountable institutions: Fed + Treas Operationally, Fed commitments are equivalent to Treasury s, but with no oversight. Commits by keystrokes. Movement to constrain Fed in US, but misunderstands the issues; Our project: to redirect focus of discussion Independence, Oversight, Democracy, Accountability

18 IMPLICATIONS FOR REFORM Unprecedented response: size, time span, coverage, rate Funder of insolvent institutions, not lender of last resort Bail-out increased size of TBTF, subverted incentives, stretched boundaries of law Dodd-Frank makes a repeat performance difficult (ie: run on MMMFs will be hard to resolve); but policy currently relies on TINA! Congress should insist on greater oversight and transparency especially when problem is insolvency Appropriate roles for Fed vs Treas/FDIC must be established in advance Alternative view: TBTF is TBTExist as a self-supervised for-profit institution that provides essential public functions Next time: don t waste the crisis. In preparation, let s think about what the financial system should do, and shed or downsize the rest

19 Reconstituting the Financial System Minsky Project: Reconstituting Finance to Promote Capital Development of the Economy Requires Proper Framework 1. a capitalist economy is a financial system; 2. neoclassical economics is not useful because it denies that the financial system matters; 3. the financial structure has become much more fragile; 4. this fragility makes it likely that stagnation or even a deep depression is possible; 5.a stagnant capitalist economy will not promote capital development; 6.however, this can be avoided by apt reform of the financial structure in conjunction with apt use of fiscal powers of the government.

20 What do banks do? Like all economic units, take positions in assets by issuing liabilities Anyone can create money Banks are highly leveraged (93-95%), must continually refinance positions If not, make position by selling out position Types: commercial banking, investment banking, universal banking, public holding company Skeptical banker; profits come over time; success of lender requires success of borrower Ephor of capitalism Unfortunately this does not describe banking today

21 What Should Financial System Do?: Key Elements to Promote Capital Development 1. safe and sound payments system; 2. short term loans to households and firms, and, possibly, to state and local government; 3. safe and sound housing finance system; 4. a range of financial services including insurance, brokerage, and retirement savings services; and 5. long term funding of positions in expensive capital assets. NB: there is no reason why these should be consolidated, nor why all should be privately supplied. The real synergy in TBTF institutions: can screw customers six ways to Sunday, with Uncle Sam s implicit guarantee

22 Payments system Clearing at par requires access to central bank Safety requires gov t backing of deposits; in a crisis, 100% coverage If provided by private bank, it plays with house money public-private partnership (PPP); requires close supervision/regs Alternative: postal savings banks

23 Short-term lending Small banks appropriate for financing small loans; returns to scale quickly exhausted If banks are backstopped by govt, mkt incentives are weak Private lending justified only if banks are better underwriters than govt is Loans must be held to maturity to induce proper underwriting Relationship banking rather than markets Finance is not a scarce resource to be allocated by efficient mkts Good borrowers are scarce, underwriting is reqd to find them

24 Housing Finance If housing (or student loans etc) is high social priority, then underwriting is less important US experience: mutuals were best; primacy of interests of owners/shareholders 30 yr fixed rate self-amortizing loan : safe but complex Thrifts devastated by change of ownership rules, then by Volcker experiment securitization & ARMs US experience: adding intermediaries only diverts activity away from public purpose simplest is best. Direct gov t lending, or gov t guarantee of mortgages held to maturity. Stability of long-term mortgages requires pact with central bank to keep interest rates low

25 Range of Financial Services Main synergy of combining services: enhances ability to defraud customers from Lincoln Savings to Goldman Sachs; from 1929 to 2007; from bait and switch to CDS bets against customers Systemically Dangerous Institutions (SDIs): too complex to manage, regulate and supervise Over-compensated top management runs control frauds Too Big To Fail bail-outs, often in secret, and consolidation of power Small enough to fail institutions cannot compete Alternative: stop all growth by SDIs; closely regulate and supervise Alternative: Minsky s Community Development Banks Allowed to offer range of services Community board of directors intensified banking, instead of branching and bank holding company Use crisis to downsize megabanks; offer alternative: downsize or give up bank charter

26 Long Term Funding of Investment Investment banks went public pump and dump, maximize shareholder value (=run a control fraud) Galbraith s The Great Crash and trusts Must prohibit stock buy-backs Role of Pension Funds, other managed money: too much money chasing too few good investments Capital development can be ill-done in both Smithian and Keynesian ways Wrong investments Too little investment TINA : there is no alternative to somewhat comprehensive socialization of investment

27 Conclusions for Reform Reducing concentration plus retaining risk can reorient banks back to relationship banking Role for gov t to play in re-regulating and resupervising There are no magic formulas (capital ratios, living wills, skin in the game) Need to create a system that CAN BE regulated, supervised; resolved in crisis Role for gov t in direct provision of financial services Payments system Direct lending to serve public purpose Guarantees for public-private partnerships

28 L. Randall Wray Professor of Economics, UMKC Senior Scholar, Levy Economics Institute Blogs: NEP: Great Leap Forward:

29 Appendix Details on the Emergence of Money Manager Capitalism: The long-term transformation of the financial sector over the Post-war period to accompany text of presentation

30 Securitization: The basis for leveraged bets Basic idea: pool a bunch of debt (ie mortgages) to act as collateral for securities Why? Insufficient sovereign debt Payments on the debt used to pay the promised interest on securities Can create series of tranches, with different seniorities of varying risk Underwriting standards deteriorate: low doc no doc NINJA (don t ask, don t tell)

31 NEW HOME FINANCE MODEL Jimmy Stewart s Thrift: loan officer, bank teller, home appraiser; public recorder hold to maturity New more efficient Wall Street model: Involves broker, appraiser, lender, servicer, MERS, securitizer, credit rater, rocket scientists and proprietary models, MBS trustee, CDOs squared and cubed, CDSs and monolines, investors, traders, accountants, lawyers, lender processing services; robo-signers, document recovery services (forgery) Model: originate to distribute, pump and dump, foreclose and resell Capitalizing unrealizable home values

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35 APPENDIX III: Unusual and Exigent Lending to Selected Financial Institutions, detailed data Prepared by Nicola Matthews, UMKC

36 Unusual and Exigent, or Long-term Life Support for Insolvent Institutions? Central bank should act as lender of last resort Temporary, costly, and against good assets? The following data, by institution, shows conventional vs nonconventional Fed activites And shows time span Temporary? Good Assets? Costly? No.

37 Bank of America Unconventional LOLR (CPFF, ST OMO, PDCF, AMLF) Conventional LOLR (TAF, TSLF, DW)

38 Bank of New York Mellon Unconventional LOLR (AMLF) Conventional LOLR (none)

39 Barclays Unconventional LOLR (CPFF, ST OMO, PDCF) Conventional LOLR (TSLF, TAF, DW)

40 Bear Stearns Unconventional LOLR (ST OMO, PDCF) Conventional LOLR (TSLF)

41 BNP Paribas Unconventional LOLR (ST OMO, PDCF, CPFF) Conventional LOLR (TAF, TSLF, DW)

42 Citigroup Uncoventional LOLR (PDCF, ST OMO, AMLF, CPFF) Conventional LOLR (TSLF, TAF, DW)

43 Credit Suisse Unconventional LOLR (ST OMO, PDCF, AMLF( Conventional LOLR (TSLF, TAF)

44 Deustche Unconventional LOLR (ST OMO, PDCF) Conventional LOLR (TAF, TSLF, DW)

45 Goldman Sachs Unconventional LOLR (PDCF, ST OMO, CPFF) Conventional LOLR (TSLF, DW)

46 HSBC Unconventional LOLR (ST OMO, CPFF) Conventional LOLR (TSLF, TAF, DW)

47 JP Morgan Unconventional LOLR (AMLF, ST OMO, PDCF) Conventional LOLR (TAF, TSLF, DW)

48 Merrill Lynch Unconventional LOLR (PDCF, ST OMO, CPFF) Conventional LOLR (TAF, TSLF, DW)

49 Morgan Stanley Unconventional LOLR (PDCF, ST OMO, CPFF) Conventional LOLR (TSLF, DW)

50 RBS Unconventional LOLR (CPFF, ST OMO) Conventional LOLR (TAF, TSLF, DW)

51 State Street Unconventional LOLR (CPFF, AMLF) Conventional LOLR (TAF, DW)

52 UBS Unconventional LOLR (ST OMO, PDCF, CPFF) Conventional LOLR (TSLF, TAF, DW)

53 Wachovia Unconventional LOLR (none) Conventional LOLR (TAF, DW)

54 Washington Mutual Unconventional LOLR (none) Conventional LOLR (TAF, DW)

55 Wells Fargo Conventional LOLR (TAF) Unconventional LOLR (none)