QuoteObama's conservatism may not prove good enough
By Martin Wolf
Published: May 12 2009 19:56 | Last updated: May 12 2009 19:56
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"If we want things to stay as they are, things will have to change." Thus wrote the Sicilian writer Giuseppe di Lampedusa, in The Leopard. This seems to me the guiding principle of the Obama presidency. To many Americans, he seems a flaming radical. To me, he is a pragmatic conservative, albeit one responding to extraordinary times. In his own way, Mr Obama is following the path trodden by Franklin Delano Roosevelt.
Nowhere is his conservatism more obvious than in the handling of the economic crisis. What we have seen unfolding, from the president's choice of Lawrence Summers and Tim Geithner as his principal policy advisers, to last week's "stress tests", is classic conservative policymaking. The aim is simply to get the show back on the road. As Mr Obama told The New York Times: "I'm absolutely committed to making sure that our financial system is stable." Stability is a quintessentially conservative aim. Many radicals on the right and left insist that undercapitalised banks should be recapitalised right now. But Mr Obama sees this as far too risky.
The results of the stress tests were a big step along the road the administration is taking. They impose enough pain to appear credible, but not enough to be disruptive. The 10 affected banks will easily raise the needed money: a total of $75bn (€55bn, £59bn). Their market valuations duly soared.
Douglas Elliott of the Brookings Institution has provided a comparative analysis of how the US regulators reached their conclusions.* He contrasts their numbers with those of the International Monetary Fund, in its latest Global Financial Stability Report, and Nouriel Roubini of RGE Monitor and New York University. He also allows for the fact that the IMF and Mr Roubini look at all losses in US banking, while the tests apply to 19 institutions that hold some 70 per cent of US banking assets.
Estimated losses for 2009 and 2010 by the US regulators, the IMF and Mr Roubini are $535bn, $321bn and $811bn, respectively. So regulators were noticeably more risk-aware than the IMF, albeit less so than Mr Roubini. Against these losses are set the expected earnings (after dividends) over these years, plus a provision for 2011 losses. Here the regulators estimate earnings at $363bn, against an assumed $210bn for the IMF and Mr Roubini. This means the reduction in capital is estimated at $172bn by the regulators, $111bn by the IMF and $601bn by Mr Roubini. But, after allowing for planned capital-raising and excess earnings in the first quarter of 2009, the final reduction in capital is just $62bn for the regulators and a mere $1bn for the IMF, but as much as $491bn for Mr Roubini.
There are two important numbers in the above analysis: possible losses, and the buoyancy of earnings. Yet there is a final number of no less significance: how much capital does a bank need? The answer is: how long is a piece of string? Since many of these banks are deemed too big to fail, taxpayers are risk-bearers of last resort. The capital requirement depends partly on how well the government wants to be cushioned against possible losses and partly on how well bond-holders want to be insured against the possibility that government might refuse a rescue.
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At the end of 2008, the ratio of total common equity to US banking assets was 3.7 per cent. Without the explicit and implicit insurance provided by government, it would surely have been higher. As the IMF notes, in the mid-1990s, before the leverage boom, the ratio was 6 per cent. In the 19th century, before deposit insurance, it was much higher still.
The conclusions are three: first, the government's exercise is more conservative on losses than that of the IMF, albeit far less so than Mr Roubini's; second, most of the capital to be raised will come from the earnings of a banking system able to borrow on the favourable terms arranged by the central bank and then to lend more expensively to its customers; and third, the target capital ratios – Tier 1 risk-weighted capital of 6 per cent of assets and Tier 1 common equity capital of 4 per cent – are not especially onerous.
The purpose of the exercise was indeed conservative: to make it credible, though not certain, that the existing banking system and assets can survive the likely battering. This has been done well enough to satisfy the markets. But these banks will also be unable to expand their balance sheet significantly in the near future.
The biggest question is how far this exercise will help restore the economy. Commercial banks provide only a quarter of financial sector credit in the US, down from close to 40 per cent in the mid-1970s (see chart). Much of the rest came from various forms of securitisation. Unless and until the latter markets reopen fully, private sector credit is likely to be constrained. How far that constraint is binding depends on how far highly leveraged borrowers are willing to borrow, particularly when the collateral against which they borrow has lost value. For this reason, it is the huge stimulus – the least conservative parts of the economic package – that will deliver the recovery. These are also the least upsetting to the interests of powerful lobbies, particularly in finance.
More radical approaches – allowing more banks to default, for example – would have increased uncertainty in the short run and so undermined the return to stability Mr Obama craves. But here the president must reckon on a longer-term danger: that the rescued financial system will, in time, start to lay the foundations for another and possibly still bigger financial crisis in the years ahead.
Ensuring the rescue of a financial system packed even more than before with complex and "too-big-to-fail" institutions may well be the cautious response to this crisis. But it leaves the government with the even more onerous task of imposing effective regulation in future. Unhappily, the record of regulation of generously insured financial systems is extremely poor. The mobilised self-interest of highly rewarded players easily overwhelms the constraints imposed by far less well-rewarded and almost certainly less able regulators.
The more the crisis unfolds, the more evident it is that incentives in the financial system were (and are) badly distorted. I sympathise with the conservative approach to crises, but not if it leaves in place the plethora of perverse incentives that created them. At the end of this, then, there will be one big test: will the number of institutions thought "too big to fail" be as large as now and, if so, how will they be controlled? If the answers are still not clear, there will need to be yet more change.
*Implications of the Stress Tests, May 11 2009, www.brookings.edu
Write to [email protected]
More columns at www.ft.com/martinwolf
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"Logic clearly dictates that the needs of the many outweigh the needs of the few."
I think he's more conservative than both sides expected him to be. That's just fine by me.
When I saw the headline, I thought the writer was going to be a batshit insane-type. But then I realized he was only talking about the banking stuff.
As far as oversight is concerned, the SEC should be brought under the FBI.
Is Pres Obama too conservative like some of his supporters claim, or a flaming socialist like some of his opposition claims? ;)
Quote from: CountDeMoney on May 17, 2009, 09:37:34 PM
As far as oversight is concerned, the SEC should be brought under the FBI.
I thought you hated those guys?
Quote from: DGuller on May 17, 2009, 07:41:51 PM
I think he's more conservative than both sides expected him to be. That's just fine by me.
I think he is just a smart guy who knows (and probably always knew) that governance is not about the extremes. Running against Bush though, he had to appeal to the frothing crazy Moveonistas, so he sounded a lot more frothing crazy than he really was - and now those same *real* frothing nutjob liberals are getting pissed he isn't really all the nutty. He is a reasonable, practical guy.
He is by no means Conservative though. He is a reasonable, rational, practical
liberal, and leans rather socialist.
Quote from: Berkut on May 18, 2009, 08:36:45 AM
He is by no means Conservative though.
He's easily as conservative as FDR. :lol:
What a silly article. So supporting a stable financial system is all you have to do to be a conservative these days?
Quote from: derspiess on May 18, 2009, 09:20:56 AM
What a silly article. So supporting a stable financial system is all you have to do to be a conservative these days?
Yeah, seems good business/political policy direction, and not a left or right political issue. Though for people/groups who see the economic/financial collapse as ways to push through significant, or even more radical business change along the lines of their agenda perhaps, then something along the lines of staying the course (even with more regulations to prevent future such issues) would probably seem conservative.
To be fair, there is a certain subset of Democrats would want to see Obama go all Allende on the US economy, and don't have enough of a sense of history to realize that would lead down the same path it did then. To them, nothing any reasonable President does will be enough.
Quote from: KRonn on May 18, 2009, 09:43:44 AMYeah, seems good business/political policy direction, and not a left or right political issue. Though for people/groups who see the economic/financial collapse as ways to push through significant, or even more radical business change along the lines of their agenda perhaps, then something along the lines of staying the course (even with more regulations to prevent future such issues) would probably seem conservative.
Well Martin Wolf and the Financial Times are hardly radical. What Wolf's suggesting is that if Obama's only goal is to stabilise the financial system and get it back to where it was - which is a conservative desire and is neither as radical as letting them collapse, or nationalisation, break-up and re-privatisation - then he could just be storing up trouble. If we end this financial crisis with as many institutions that are too big to fail and without a change in the financial system (especially credit rating agencies and so on) then we're just waiting until the next time the government has to bail them all out.
QuoteWhat a silly article. So supporting a stable financial system is all you have to do to be a conservative these days?
Yes. The radical options would be to let the banks fall or root-and-branch reform.
Edit: Also Wolf is very worried that the deficit countries are basically being asked to stabilise the system and then start spending again which would be dangerous because consumer credit's likely to get tightened (personal debt relative to earning has tripled in the last couple of decades in the US, and even more in the UK), business spending's tough and the government won't necessarily be able to do much more. The surplus countries - China, Germany and so on - need, in his view, to get spending up so that they help the ones in deficit recover.
Roubini hates America.
OMG, Il Gattopardo is in my top 15 films evah! :mmm:
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Quote from: Neil on May 18, 2009, 08:18:42 AM
Quote from: CountDeMoney on May 17, 2009, 09:37:34 PM
As far as oversight is concerned, the SEC should be brought under the FBI.
I thought you hated those guys?
I do. Which is why it is only fitting that they go after the other guys I hate even more.
Quote from: Sheilbh on May 18, 2009, 05:43:21 PM
Yes. The radical options would be to let the banks fall or root-and-branch reform.
Most people when they read the word conservative don't think "anything that isn't radical."
Quote from: Admiral Yi on May 18, 2009, 11:22:55 PM
Most people when they read the word conservative don't think "anything that isn't radical."
If Iwere trying to define conservatism I'd say a preference for stability, a resistance to change and opposition to radical solutions, however radical the circumstances.
But of course it's a muddy phrase, like all ideology because it's caught between a tradition, innovators, the self-appointed protectors and its opponents. All of which have some impact on what it means. So of course you're right.
Quote from: Sheilbh on May 18, 2009, 05:43:21 PM
Quote from: KRonn on May 18, 2009, 09:43:44 AMYeah, seems good business/political policy direction, and not a left or right political issue. Though for people/groups who see the economic/financial collapse as ways to push through significant, or even more radical business change along the lines of their agenda perhaps, then something along the lines of staying the course (even with more regulations to prevent future such issues) would probably seem conservative.
Well Martin Wolf and the Financial Times are hardly radical. What Wolf's suggesting is that if Obama's only goal is to stabilise the financial system and get it back to where it was - which is a conservative desire and is neither as radical as letting them collapse, or nationalisation, break-up and re-privatisation - then he could just be storing up trouble. If we end this financial crisis with as many institutions that are too big to fail and without a change in the financial system (especially credit rating agencies and so on) then we're just waiting until the next time the government has to bail them all out.
Good point about the problems of restoring the same system to fail again, and I do support regulations to address the problems. I would have hoped that regs would have been put in place prior to the meltdown, given that some of the problems were being given due concerns. That's annoyed me, the failure of business and legislation that helped lead to this very expensive crisis we're all going through. I may not want heavy change in the economic systems, but I fully expect some regulations to address the things that have gone wrong. I'll be very annoyed if government fails at that, again.
Quote from: Admiral Yi on May 18, 2009, 11:22:55 PM
Most people when they read the word conservative don't think "anything that isn't radical."
Well it should. Conservatism literally means wanting to conserve what is there.
But of course people in the US who call themselves 'Conservative' actually want to make fairly radical changes. That is because in American discourse all political terms are all but meaningless as a description of actual ideology.
Quote from: KRonn on May 19, 2009, 08:12:56 AMI'll be very annoyed if government fails at that, again.
I think you're far too anti-government on this. There were numerous failings.
The one that I think is most likely to repeat itself is that emerging economies will continue to build up ridiculous reserves so that they are, to some extent, insulated from the global economy (this was what many of them learned in response to the Asian financial crisis); that means the money will flow, overwhelmingly, into the US again.
The consumer culture got fucked up. The personal debt of the average American tripled from the mid-80s to now, in the UK it's even worse. We didn't have a problem because our government had a deficit, we had a problem because we all did. I think the much discussed greed of Wall Street and the City was a problem but it was just a magnification of what was happening on 'main street', as it were.
Then there was a general cultural failing which was, I suppose, partly due to economists. We had a post-Thatcher, post-Reagan consensus. The sort of regulations required to stop the 'too big to fail' stuff from happening would have required the government to use anti-trust monopoly to split businesses up. The opposition would have been enormous, not least on languish because the consensus was, overwhelmingly, that tighter regulation wasn't needed and that the banks were okay to be that big because they were 'safe as houses'.
The Fed also deserves some blame. I believe some economist who came up with a rule of how to predict interest rates that actually became a rule of how to set interest rates (Taylor?) places most of the blame, in his new book, on the Fed because under Greenspan they abandoned that rule, I think after 9/11.
I think blaming government for getting the regulation wrong is a right wing version of blaming corporations because they paid far too much in salaries. I don't think business can be trusted to self-regulate, especially if they're able to get to such a state that the government will almost have to bail them out or watch the entire system collapse. We had a social and a cultural problem that was, frankly, systemic. From credit card bills to preposterous takeovers, from light-touch regulation to too low interest rates there was a failing.
I'm actually quite sympathetic because my understanding is that on conventional economic theories that have predominated in recent years this sort of thing shouldn't have happened. Unfortunately it did. The challenge which I think is the largest and the most important governments worldwide have faced in decades is how do you preserve the good while building a new system. How do you keep the benefits of globalisation, which have been enormous, while mitigating the costs? This'll be especially important for the 'angel' countries who are suffering as much if not more than the 'devils' like the US and UK. They're locked in for now but we really need them to become more involved.
My view on the stress tests, by the way, was that they were good because they allowed for more. If this fails and we enter a second period of free-fall and panic in a few months time then there is more that can be done, such as nationalisation (theoretically, Obama's political capital could be shot by then as I think his numbers will start dropping pretty soon). That may still be necessary. I believe that the response to this that the US would call for were it affecting any nation but the US would be to nationalise the banks, break them up, work a system for the bad debt and then re-privatise.
The trouble is if the stress tests don't succeed then Obama may regret his conservatism if he's unable to be necessarily radical further down the line and they could fail to alter the system in the ways it may need changing.