Wall Street and the fiscal cliff

The Wall Street Bourbons: Ils n’ont rien appris, ni rien oublié. Except that they’re now Keynesians.

Four take-aways from this National Journal story:

1. Wall Streeters are “all Keynesians now.” (No Hayekians in hedge funds?) Like all sane people, they want the government, in a situation of prolonged inadequate final demand, to boost final demand, rather than shirinking final demand by raising taxes or cutting expenditures. None of them seems to be afraid of bond vigilantes. None of them is leaving coupons under his pillow for the Confidence Fairy.

2. They’re simply incredulous that anyone believes anything about the public interest firmly enough to motivate action, and they regard such beliefs – whether Red Team beliefs that the welfare state is economically unsustainable and morally degrading or the Blue Team belief that the richest country in the history of the world shouldn’t deprive dying poor people of hospice care to balance public budgets – as signs of immaturity, if not of an Axis I disorder called “ideology.”

3. Reporter Nancy Cook agrees with them on (2):

Part of the financiers’ amazement comes from the fact that politicians cannot to overcome well-worn ideologies—an idea foreign to the New York culture of deal-making, where the only true orthodoxy is the bottom line. … As long as Washington policymakers remain wedded to political ideology and positioning instead of facing the country’s big economic issues, New York will never truly get its sister city down south.

4. The Streeters’ direct responsibility for having crashed the economy through the reckless way they played with Other People’s Money hasn’t put any hole at all in their smug arrogance. Their job, in their view, is to pocket as much of that OPM as possible without actually going to jail, and Washington’s role is to get out of the way of their ability to do so. If Washington acts otherwise, that just demonstrates once again the moral superiority of the deal-making, bottom-line culture and those who live it.

I tend to agree with what I take to have been the Geithner-Larry Summers view that there was no way, in the situation of early 2009, to expropriate these expropriators without risking another Depression. Maybe there’s no way now. But that doesn’t make doing so eventually a less central policy goal.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com

23 thoughts on “Wall Street and the fiscal cliff”

  1. On January 6, 2009, Ron Chernow wrote an Op-Ed piece in the NY Times titled Where Is Our Ferdinand Pecora? I saved it on my computer under a different file name: Those Bastards Had the Record at Hand.

    Anybody who thinks we need “Wall Street” as we currently know it ought to go find that column and read it slowly, maybe twice, and then consider this:

    (a) After banking was returned to its dull, boring, stodgy existence under Glass-Steagall, we managed to conduct successfully the greatest industrial and commercial mobilization in the history of the world to fight WW2.

    (b) After that we managed to have a sound, strong and growing economy (yes, with normal cycles, but no disasters) for the Eisenhower and Kennedy years, even while the top federal income tax bracket was NINETY PERCENT.

    (c) After that we managed to have a sound, strong and growing economy (yes, with normal cycles, but no disasters) for the next sixteen years, even with all the political upheaval.

    Old fashioned banking, keeping retail separate from investment separate from insurance separate from real estate, is boring, and it doesn’t pay bankers so much money as they’re used to getting now, but it worked just fine.

    1. The fetishization of Glass-Steagall in the wake of the financial crisis is silly at best and dangerous at worst.

      1). I have yet to see a single convincing (i.e. logically rigorous and factually informed) argument as to why the repeal of Glass-Steagall led to the financial crisis. The are a number of causes of the financial crisis, but the most important were the fact that 1) relatively unnoticed changes in SEC rules and other banking regulations made it possible (and therefore, in a competitive market, almost necessary) for banks to increase their leverage to dangerous levels and 2) derivative securities were and remain largely unregulated. That plus a real estate bubble (for which BOTH parties share in the “blame,” such as it is) is more than enough to explain the crisis. #1 can be fixed relatively easily assuming there is proper political will to do so. #2 is a bitch of a problem. Derivative securities have gotten a very bad rap since 1998, but the modern economy is remarkably dependent on them. The presence of derivative markets makes it much easier for businesses to operate globally and makes it much more feasible to produce cheap raw material inputs, which in turn benefits every single living human being on the planet. The problem of how to safely regulate derivative markets without choking off this very useful activity is VERY difficult. But in any event, neither #1 or #2 have anything to do with the repeal of Glass-Steagall.

      2). Investment banker compensation has skyrocketed in the last 20 years not because Glass-Steagall was repealed but because 1) the scale of financial transactions has increased (the fees on a $1B deal are 5X higher than the fees on a $200M deal) and 2) the real costs of providing investment banki services has fallen (a single analyst with Excel and a Bloomberg terminal is more productive than 10 c. 1992 analysts). And even though #1 and #2 have happened there has been almost no price pressure on investment banking services ( for a variety of reasons – almost none of which are related to government regulation or lack thereof). The fact that the same institutions can combine commercial and investment baking is irrelevant. Purely structural forces have led to the expansion of investment banker compensation.

      3). Obsess of the 1998 meltdown will recall that at one point Bank of America, under heavy back-room pressure from the Feds, stepped in and bought Merrill Lynch right before the latter imploded. Tis transaction provided necessary stability to the financials markets. And without it the TARP check that the government had to write would have been even bigger – possibly in feasibly so. But guess what? Had Glass-Steagall still been on the books the transaction would have been illegal. And the financial crisis would have been that much worse.

      4). Not to mention the fact that Glass-Steagall was repealed during the heyday of the Clinton administration (and signed enthusiastically by the sitting President). A decade is an awfully long lag between a regulatory “cause” and a real-economy “effect.”

      By all means if there are sensible regulations that can help prevent another financial crisis we should consider such. But re-instating Glass-Steagall will do approximately NOTHING to shore up the stability of the financial system and will impose needless and friction and cost on the industry as a whole. A childish, ultimately ineffectual move if there ever was one.

      1. “The presence of derivative markets makes it much easier for businesses to operate globally and makes it much more feasible to produce cheap raw material inputs,makes it much more feasible to produce cheap raw material inputs…”

        Do you have a source for these claims? The former justifies simple foreign-exchange hedges, and assumes globalised markets are a costless good thing. The second sounds suspiciously like the PR presentations about Norman Rockwell farmers hedging next year’s wheat crop. Together these are a tiny part of the modern and out-of-control financial derivatives business, speculating on any imaginable asset class. The promoters offer a fool’s gold dream of making risk disappear while actually making it more concentrated and invisible.

        The up-to-date case for the re-separation of retail and “investment” banking is made in the British Vickers Report, which I wrote about here and here.

        1. A source for these claims? Well, I actually work with large global companies, and have the opportunity to see the tactics that they employ to manage risks. And those tactics rely on the presence of large and diverse derivitives markets across a wide range of asset classes. Relatively vanilla foreign exchange derivitives are indeed sufficient to manage the currency risk of operating in multiple geographies, but they are by no means sufficient to manage the operational risks of doing so. And the ability to mange operational risks lowers the costs of doing business intentionally and thus increases the flow of international trade. The world would be poorer, full stop, if it were more costly to do business across borders. If you disagree that’s fine I suppose – you’re entitled to your opinion. But at least then have the consistency to advocate for dramatically higher formal tariffs. Because international trade is either a boon to be encouraged or a scourge to be fought.

          There is indeed speculation in derivitives markets. But guess what? There is just as much speculation, if not more so, in the markets (currency hedges, agricultural derivitives) that you seem to approve of as there is in the markets for derivative securities on other assets classes. And as I noted, it is devilishly hard to regulate away the speculation without also regulating away the beneficial activity of the markets themselves.

          1. = = = A source for these claims? Well, I actually work with large global companies, and have the opportunity to see the tactics that they employ to manage risks. = = =

            How did Boeing do on “managing the risk” of the 787 project? I’m sure their treasury department uses very sophisticated financial instruments; did those financial transactions offset executive management’s plan to break the union of skilled engineers by outsourcing the design work to low-cost “centers of excellence”? How about Airbus on the A400? Leehman Brothers on their entire portfolio? Wachovia? MF Global?

            Surely you can see that persons who are heavily involved in the financialization world do not have the distance and level disinterest necessary to evaluate its net benefits and side effects rigorously?


      2. I am interested in your #2. Why has there been no price pressure?

        And if in fact there has not been, what does that say about our notions of competition, etc.? Isn’t there a prima facie case that the big IB’s are acting as a cartel?

        1. I suspect it’s a somewhat idiosyncratic situation vs. cartel behavior in the classic sense. Price pressure typically enters markets when either there are new entrants or when existing players cut price to steal or maintain share. It’s difficult for new entrants to come into investment banking. Partly because is a high fixed cost business where scale gives real advantages. A small upstart would be at a huge disadvantage upon entry into the market and would remain so likely for years until they built scale. Given that such an upstart would need to compete for professional talent with the established banks this makes it difficult.

          And the established banks – even the relative laggards – aren’t incentivized to cut their fees because in this business price is a signal for quality. If Goldman Sachs charges 7% of a deal’s value in fees and a struggling rival charges 5.5%, then the smart corporate CFO would likely think to himself or herself “I could save 1.5% by ging with the lower rocked guys but if they screw it up I’m going to be down a lot more Han 1.5% and clearly they wouldn’t be offering lower fees unless they weren’t as good. Wrong thinking perhaps but not stupidly wrong. And the buyers of these services (mostly CFOs) have little to gain by saving a bit on the fees and a care to lose if a deal blows up. So they go with the risk averse strategy.

          It’s not like this is a rare or obscure phenomenon. Say Harvard costs $50K per year and the honors college at th university of Illinois charges Illinois residents $15K. I suspect that the are a lot of students who have both options who rationally believe that Harvard is probably not worth $35K more per year. But very few famines wil choose U Illinois. Because when’s it’s your life/your kid, you tend to be really scared of the Big F-Up.

          1. That makes sense.

            But it does mean that they are operating as a cartel, whether they actively collude or not, which in turn means they are extracting more than they should from the economy, and producing less. That of course comes as no surprise to anyone.

            I’m old enough to remember the days when lots of managers buying mainframe computers relied on the principle that “No one ever got fired for buying IBM.” It’s the same thing here, but unlike what happened with IBM this situation seems unlikely to change.

          2. Barry:

            I enjoy the content of this particular blog, but your note is indicative of one of the least appealing aspects of the culture of the comboxes here. Namely that any statement that challenges the comfortable consensus among the regulars is very quickly met with replies of “citations please!” or “where is your evidence?!”

            The same level of scrutiny is almost never demanded of those making statements that reinforce the consensus. It’s echo chamber behavior. When someone challenges the orthodoxy, they are dismissed if they cannot provide references to double-blind experiments which prove their points beyond the shadow of a methodological or mathematical doubt, no matter how reasonable those points are. But when someone makes a statement that the bulk of the audience here finds to be comfortably reinforcing of their worldview it is accepted as truth even if it on the far edges of plausibility.

            On the specific issue here I’ve noted that I have specific, insider knowledge of the practices under discussion. I have no intention of providing additional details because doing so would compromise the confidentiality of information that I have promised to protect. You may choose to discount what I say for that reason. But I have zero personal incentive to lie in a combos discussion on a (no offense to the hosts here) quite obscure blog.


            Well I suppose the choice you have is between people who understand the topic, but by virtue of being close to it are “tainted” and thus not to be trusted, or people whose motives are above reproach due to their lack of involvement in the activity under discussion but then thus don’t really know what they are talking about.

            I’m not trying to be snarky (well, not much). This is a legitimate problem on issues of high technical complexity where direct information is only really available to, or understandable by, practitioners. There are of course economists and policy wonks who claim to understand these issues well. But if they have not previously in their careers worked in the industry then they typically don’t fully understand thenunderlying facts. Because the data that is available for them to work with is not the complete set of data needed to form a full understanding.

          3. @stephen–yes, you do have insider knowledge but even among those who don’t there are at least some who have sufficient pattern recognition abilities to note that the less our government regulates the financiall sector the greater the catastrophe that sector leads us to. some of your points are cogent in today’s environment of lax statutory regulation but these same points would be obviated by increased and more effective regulation–e.g. your comments about the current disincentives for fee cutting.

            i stand by my 8:31 pm comment.

        2. It is difficult to get a man to understand something when his salary depends upon his not understanding it. – Upton Sinclair.

  2. Mark,

    It’s not that there was no way to take the folks who caused the collapse out of effectively running the system (expropriate hardly seems the right word for taking away ill-gotten gains).

    Joe Kennedy, Senior provided some pointers in the Thirties.

    It’s that the political will is lacking and that there is no national force strong enough to push the White House and the Hill in the right direction.

  3. OK, here’s something I don’t understand: “… shrinking final demand by raising taxes”. As long as the government spends what it takes in it seems to me that final demand should be unaffected, even though what is demanded will be different. I understand that taxes may reduce how much people are willing to work but that’s a different issue.

    Depending on who the increased tax revenue comes from — the very rich, for example — final demand might even be increased.

    1. Yes, if increased taxes are matched dollar-for-dollar with increased spending, the macro effect might be close to a wash. But, holding spending constant, higher taxes lead to less final demand in the short run.

      1. Mark, that brief paragraph is a nice summary of the Keynesian approac to stimulating an economy in the doldrums, and making up for it in times of plenty.

        If you raise taxes above spending when the economy is strong, you can pay down debt you incurred to stimulate when the economy was weak. Had a fellow named Clinton who understood that a few years ago.

        For some reason the Reagan acolytes believe, as a religion, that it was lowering taxes that fixed the sagging economy. They overlook that one little detail, the HUGE Keynesian boost created by the bottom line–gigantic deficit spending. The factor wasn’t the size of the taxes, it was the net stimulus effect of the deficit.

    2. It’s a classic proposition that an increase in a balanced budget is stimulative net, provided taxes are progressive overall. The government takes money away from rich folks who will save a lot of it, and spend it on construction workers and teachers who will save less of it.

      1. This is especially true in America, where poor people often spend 104% of their income for years on end in a consent-based consumer sharecropping game (so long as the real estate sector moves forever forward we can just keep selling off equity in the house to make ends meet… right?). But hey, what would life be without having 3 or 4 apple products that are basically the same but have different names.

  4. We could at least try for a transaction tax. A small one would discourage the Churn and parasitic High Frequency Trading strategies, while having no effect on the investment strategies followed by most Americans, nor on those who invest for the long or eel the moderate term.

    1. Warren, your paragraph highlights one of the key points of what’s gone haywire in so much modern financial trading. Instruments (not only equities, but also credit papers of many types, and insurance on them as well) are “traded” that have nothing to do with “investment,” per se, but are merely chips in a gambling game. For “investors,” their purchases of stock are a bet on the value of the company. They bet on the future of the value, and thus allow the earlier bettors to collect on their wise earlier bets. “Day traders” and the like, however, are betting on the “ticks” (i.e., the upticks and downticks) on the chart, with little regard for the value of the underlying “investment.”

      I find it very annoying when those traders are called “investors.”

      And since the most successful real investor–Warren Buffett–agrees with me, I will remain convinced and smug on that point.

  5. Stephen, I’m sorry that your feelings were hurt. I should have remembered that you Masters of the Universe have rhin skins.

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