Economic Argument for Austerity Based on Excel Error?

[fhdz]

Fragilizing? 

Building or maintaining systems which specifically create fragile structures, like houses of cards - or our current financial system. Focusing on trying to predict what the next disaster will be (with an awful track record of doing so) rather than focusing on reducing our exposure to as many different kinds of risks as we are aware of.

[The Minsky Moment]

Some of the policies and procedures that helped cause the financial meltdown are the very policies and procedures that prevent great depressions from recurring.  Policies like using the power of the central bank balance to stabilize the market (which becomes the Greespan or Bernanke put).  Policies like TARP or TALF that effectively retroactively validate risk-taking.  Bailouts to block contagion and maintain confidence (including the no loss to senior bondholders) that generate moral hazard.  And of course the granddaddy of financial moral hazard generators: federally-guaranteed deposit insurance.

One reason the Great Depression was such a disaster was because the banking system at the time was highly fragmented, with lots of small banks each heavily focused in a compact geographic area, and perhaps heavily relianct on narrow product lines.  These banks had little product or gegraphic diversification, limited captial resources, no outside "sources of strength."  They were accordingly prone to failure from a loss of confidence and the contagion from such failure was extreme virulent.  The banking system as it has developed since that time is in a sense a reaction to those weaknesses.  Banks became larger, more diverse in terms of where and how they got their revenues from.  Individually, they are much less "fragile" then the old model George Bailey banks that needed angels and scriptwriters to stay afloat in a crisis.  Of course the cost is the the potential impact from any one failure is greater.

Anyways I don't really see the need to control TBTF as being the big message of the 08 meltdown.  Lehman's problem wasn't that it was too big; on the contrary, it was probably to narrowly focused.  AIG was "too big" but the government bailout worked and Treasury got the money back.  Same with the TARP program.  Those efforts were hugely successful, at least if one discounts any future moral hazard effect.

As for Taleb, I think his books are getting less and less useful over time in terms of thinking about how the economy and financial system worked.  "Fooled by Randomoness" accurately described some of the more common and impactful heuristic biases relating to probability and human decision making.  "Black swan" is a bit of a muddle.  The problem with financiers making dangerous bets wasn't failure to take into account very infrequent or unpredictable events.  The problem was that the fat tail events they ignored weren't really rare or infrequent at all over the time frame in which they operated and they were predictable in gross, if not their exact timing and precise manifestation.  Anyone who read Hyman Minsky would understand that dynamic and its cyclical character.

I haven't read the fragile book so won't comment on that work.  However, I will say that any financial system constructed is going to have unavoidable fragilities; there is no way to construct a truly antifragile financial system without getting rid of the properties that make it an economically useful thing to have.  Leverage and muturity transformation are inherently destabilizing.

[The Minsky Moment]

What about other countries like in the Eurozone? 

As Zanza says, Greece is now in a true full-blown Depression event.  But that is an event that was avoidable, it took a combination of years of corruption and crookedness on the Greek side, and deliberate policy of economic sabotage from the troika to make that happen.

[Iormlund]

What about other countries like in the Eurozone?  They are kind of Western.  Greece and Spain were hit pretty hard.

Depression level GDP contractions are so far only in Greece, which is at 79% of its pre-crisis GDP/capita in real terms. Cyprus is likely to follow this year.
The rest saw pretty bad contractions, but not really comparable to the desperate situation in Greece. The problem is that we are now in year six after the last peak and a lot of countries look nowhere close to regaining that previous peak.

Yeah, it's like watching a crash in slow motion.

GDP is only part of the picture though. Unemployment figures tell a very different story. So does migration - over a million people have left the Spain since 2011 and in Ireland or the Baltics the numbers are just terrifying.

[fhdz]

JR, what's your take on Taleb's suggestion that we should nationalize the banks but at the same time ease regulation on hedge funds?

[MadImmortalMan]

One reason the Great Depression was such a disaster was because the banking system at the time was highly fragmented, with lots of small banks each heavily focused in a compact geographic area, and perhaps heavily relianct on narrow product lines.  These banks had little product or gegraphic diversification, limited captial resources, no outside "sources of strength."

So...we need something that's halfway between what we have now and what we had then?

[The Minsky Moment]

JR, what's your take on Taleb's suggestion that we should nationalize the banks but at the same time ease regulation on hedge funds?

Hedge funds are not heavily regulated now.  The bigger ones do have to register, and there are some disclosure requirements, but it is piddling stuff compared to regulation of deposit taking banks. 

Bank nationalization has been tried before and the results have not been encouraging.  Banks do still perform vital functions that hedge funds don't.  Nationalization likely compromises the effective performance of those functions.  It makes the banks vulnerable to public corruption and rent-seeking that is hard to control on that scale.  It exposes the fisc to the steady drain of deadweight loss through inefficient or suboptimal management.

Actually I am surprised that Taleb would view the state as some kind of foolproof insulation from stresses.  States have their own vulnerabilities and fragilities.

[The Minsky Moment]

So...we need something that's halfway between what we have now and what we had then?

One way or another, you pick your poison.  The predominant response to 08-09 was to accept the reality of the big institutions, but try to control downsides through "prudential regulaion", tougher capital requirements, countercyclical provisioning and the like.  There is a tradeoff here: the more effective the controls are made to increase robustness, the weaker the ability of the institutions to provide liquidity and risk capital to the private economy.  The pendulum swings back and forth as it has in the past and will in the future.

The one thing we human beings can't control is our own future behavior and mental processes.  If people think a bridge is well-built, that doesn't make it more or less robust than it actually is.  There may be uncertainty about how robust the bridge truly is because of inherent imprecision over engineering tolerances.  But even though it is uncertain, it is still and objective physical quality.  The same is not true of a bank or a security.  There mere opinion can profoundly impact reality.  A rock solid bank can collapse due to a purely perceptual shift that takes place entirely in human minds; at the same time, a dubious security can be kept afloat for long periods based on mental euphoria.  A bank is not a bridge.

[fhdz]

JR, what's your take on Taleb's suggestion that we should nationalize the banks but at the same time ease regulation on hedge funds?

Hedge funds are not heavily regulated now.  The bigger ones do have to register, and there are some disclosure requirements, but it is piddling stuff compared to regulation of deposit taking banks. 

Bank nationalization has been tried before and the results have not been encouraging.  Banks do still perform vital functions that hedge funds don't.  Nationalization likely compromises the effective performance of those functions.  It makes the banks vulnerable to public corruption and rent-seeking that is hard to control on that scale.  It exposes the fisc to the steady drain of deadweight loss through inefficient or suboptimal management.

Actually I am surprised that Taleb would view the state as some kind of foolproof insulation from stresses.  States have their own vulnerabilities and fragilities.

I don't think he does; I think he views the strategy as in line with what he terms a "barbell" - instead of looking for the golden mean, making one disproportionately large side of the equation as boring and "safe" as possible with the other side as risky as is feasible - he argues that this would maximize the potential gain from the risk while mitigating heavily against losses - in other words, being able to take advantage of positive Black Swans while providing little downside to negative stressors.

I don't know if he's right or not; I do know that what we have currently isn't working.

[Zanza]

GDP is only part of the picture though. Unemployment figures tell a very different story. So does migration - over a million people have left the Spain since 2011 and in Ireland or the Baltics the numbers are just terrifying.

Ireland and the Baltics have at least stabilized. Their unemployment is now below peak levels and their economies have started growing again. It will take years to reach the peak value again though and some of the emigrants may never come back which will hurt in the future.

[Sheilbh]

What about other countries like in the Eurozone?  They are kind of Western.  Greece and Spain were hit pretty hard.

Depression level GDP contractions are so far only in Greece, which is at 79% of its pre-crisis GDP/capita in real terms. Cyprus is likely to follow this year.

Yeah. I think Cyprus could be even worse, maybe Slovenia too if their situation gets bad. Then we'll get to see how mostly nationalised banks fail.

[Ideologue]

Some of the policies and procedures that helped cause the financial meltdown are the very policies and procedures that prevent great depressions from recurring.  Policies like using the power of the central bank balance to stabilize the market (which becomes the Greespan or Bernanke put).  Policies like TARP or TALF that effectively retroactively validate risk-taking.  Bailouts to block contagion and maintain confidence (including the no loss to senior bondholders) that generate moral hazard.  And of course the granddaddy of financial moral hazard generators: federally-guaranteed deposit insurance.

Solution: punishments for those convicted of the new economic crimes.  Bad CEO?  Lose your assets.  Encouraged risky banking practices and lost?  TAKE A HAIRCUT.

Skin in the game eliminates moral hazard.

[Berkut]

So if Greece is so fucked right now, is it a good time to visit? Should be pretty cheap, right?

[Admiral Yi]

Solution: punishments for those convicted of the new economic crimes.  Bad CEO?  Lose your assets.  Encouraged risky banking practices and lost?  TAKE A HAIRCUT.

Skin in the game eliminates moral hazard.

What's the punishment for elected officials that drive their state or city into bankruptcy?

Throbby: Absolutely.  Nontradeables should be pretty damn cheap right now.

[Jacob]

So if Greece is so fucked right now, is it a good time to visit? Should be pretty cheap, right?

Yeah probably, with the usual caveats about staying out of large groups of disaffected youth while travelling.