Somebody in Charge: A Solution to Recessions?

211 Pages·2011·2.888 MB·English

by  Pierre Lemieux (auth.)

Somebody in Charge
Somebody in Charge
A Solution to Recessions?
PierreLemieux
somebodyincharge
Copyright©PierreLemieux,2011.
Softcoverreprintofthehardcover1stedition2011 978-0-230-11269-8
Allrightsreserved.
Firstpublishedin2011by
PALGRAVEMACMILLAN®
intheUnitedStates—adivisionofSt.Martin’sPressLLC,
175FifthAvenue,NewYork,NY10010.
WherethisbookisdistributedintheUK,EuropeandtherestoftheWorld,
thisisbyPalgraveMacmillan,adivisionofMacmillanPublishersLimited,
registeredinEngland,companynumber785998,ofHoundmills,Basingstoke,
HampshireRG216XS.
PalgraveMacmillanistheglobalacademicimprintoftheabovecompanies
andhascompaniesandrepresentativesthroughouttheworld.
Palgrave®andMacmillan®areregisteredtrademarksintheUnitedStates,
theUnitedKingdom,Europeandothercountries.
ISBN 978-1-349-29461-9 ISBN 978-0-230-11847-8 (eBook)
DOI 10.1057/9780230118478
LibraryofCongressCataloging-in-PublicationData
Lemieux,Pierre.
Somebodyincharge:asolutiontorecessions?/byPierreLemieux.
p. cm.
Includesbibliographicalreferences.
1. Recessions. 2. Financialcrises—Prevention. 3. Economic
policy. I. Title.
HB3711.L572011
338.5(cid:2)43—dc22 2010037347
AcataloguerecordofthebookisavailablefromtheBritishLibrary
DesignbyIntegraSoftwareServices
Firstedition:March2011
10 9 8 7 6 5 4 3 2 1
TransferredtoDigitalPrintingin2012
Contents
ListofCharts vii
Acknowledgments ix
AFewAcronyms xi
Introduction:AdultSupervision 1
1 TheLimitsofAuthority 9
2 Keynes’sOldClothes 39
3 TheCarofCollectivism 63
4 TheLaissez-FaireScapegoat 83
5 TheCrimeScene 103
6 MonetaryMeddling 123
7 TheState’sAnimalSpirits 133
Conclusion:TheEmperor’sNewClothes 155
Notes 165
Bibliography 185
Index 201
List of Charts
1 TotalgovernmentexpenditurespercapitaintheUnitedStates 69
2 RegulatoryexpendituresbytheU.S.federalgovernment,
1960–2007 75
Acknowledgments
Iwishtothankafewcolleagueswhohavereadpartsofthemanuscriptofthis
book: Christian Calmès (Department of Management Sciences, University
of Québec in Outaouais), Mark Brady and Jeff Hummel (Department of
Economics, San Jose State University), and David Henderson (Naval Post-
graduate School and Hoover Institution). I spent the winter of 2009–2010
as a visiting scholar at the Department of Economics at San Jose State
University, where many colleagues suggested useful ideas during informal
conversations. Alex Tabarrok of George Mason University’s Department of
Economics as well as an anonymous referee provided useful criticism on a
previousversionofthemanuscript.IalsowanttothanktheAureaFounda-
tion (Toronto) and its advisor George Jonas for a grant that allowed me to
spendtimeawayresearchingandwritingthisbook.Ofcourse,noneofthese
colleagues,friends,orinstitutionsisresponsibleforanymistakeIhavemade,
nordotheynecessarilysharetheopinionsIexpress.
A Few Acronyms
ABCP Asset-backedcommercialpaper
ARM Adjustable-ratemortgage
BEA BureauofEconomicAnalysis
BLS BureauofLaborStatistics
CBO CongressionalBudgetOffice
CDO Collaterizeddebtobligation
CDS Creditdefaultswap
CPI Consumerpriceindex
GDP Grossdomesticproduct
GSE Government-sponsoredenterprise
IMF InternationalMonetaryFund
MBS Mortgage-backedsecurity
NBER NationalBureauofEconomicResearch
OTS OfficeofThriftSupervision
OMB OfficeofManagementandBudget
RBC Realbusinesscycles
S&L SavingsandLoansAssociation
SIV Specialinvestmentvehicle
SPV Specialpurposevehicle
TARP TroubledAssetsReliefProgram
Introduction: Adult Supervision
On August 9, 2007, at about 9:30 Eastern time, traders knew
somethingverywrongwashappening.
Traders buy and sell securities (stocks, bonds, etc.) for their own
companiesorfortheircustomers.JPMorganChase,forexample,hasanum-
beroftradingroomsinitsheadquarterstoweronParkAvenueinNewYork
City.Itscredittradingroom,whichdealswithcreditinstruments(asopposed
tostocks),hasseveralhundredtradingdesks,eachwithtwoorthreecomputer
screens,and occupies awhole floorof thetower.Atthat time, sometraders
startedshoutinginageneralbrouhaha:theyhadneverseenwhatwashappen-
inginthemoneymarkets.Themoneymarketisthepartoffinancialmarkets
whereshort-termcreditinstruments—thatis,creditinstrumentswithmatu-
ritiesoflessthan13months—aretraded.Thismarkethadbeentenseforthe
wholesummer,andthesituationhadworsenedduringtheprevioustwodays.
Now,suddenly,moneymarketinterestrateswereshootingupbyseveralbasis
points(orhundredthsofpercentagepoints).Especiallyhitwasasset-backed
commercialpaper(ABCP).Commercialpaperismadeofshort-term(maxi-
mumofnine-monthmaturity)promissorynotesissuedbylargecompanies.
ABCP is a sort of commercial paper backed (guaranteed) by some specific
underlyingassetslikemortgages,andgenerallyhasmaturitiesof30–90days.
The rates on ABCP went up from 5.35 percent to 5.95 percent. Moreover,
ascommercialpapermatured(asloansbecamedue),manyborrowerscould
only roll them over for a period of one day.1 Banks which had been willing
tolendtoeachotherovernight(bankswithtemporarilyexcessreserveslend
to those with temporarily low reserves) at slightly more than 5.25 percent
now required as much as 6 percent.2 These increases in short-term interest
rateswererequiredbylenderstocoveramysteriousnewrisk.Thescarewas
simultaneouslyspreadingtotradingroomsaroundtheglobe.
What could look to an external observer as small increases in money
market rates or a temporary freeze on the commercial paper market was a
manifestation of a deeper—a very deep—problem. Analyzing this problem
willtakeusmuchbeyondtheeconomiccrisisthatstartedin2007.Thisbook
isaboutmorethaneconomiccrises.
2 ● SomebodyinCharge
But in order to start, we need to understand a few concepts in finance.
We have just seen what commercial paper, interbank loans, and the money
marketare.Afewmoreconceptsarenecessarytounderstandwhatfinanceis
andwhatitdoes.
A“security”is an instrumentthat gives its holder a claim ona streamof
future revenues produced by real assets (factories, for example) or by other
securities.Thestreamofrevenuecanbeexpressedbyaninterestrateoryield
on a bond (or other form of loan), or by a dividend on a share of stock.
One way or another, a security is a claim on real resources, that is, goods
or goods producing goods. Negotiable contracts on securities, which give
the right to buy or sell securities, or the latter’s flows of revenues, belong
toamorecomplextypeofsecuritiescalled“derivatives.” Wecanviewsecu-
rities as sophisticated forms of loans, since a loan also gives the creditor a
claim on some of the debtor’s revenues. By conceiving securities as loans,
we can better see the whole point of finance: it is for people who want to
save, that is, to consume less today and more tomorrow, to transfer their
actual claims to real resources to those who want to consume more today
and less tomorrow or to producers who want to produce more for the
future.
These transfers of claims are often done through “financial institutions.”
Banks are financial institutions that borrow money with one hand and
lenditwiththeother—thatis,theyengageinintermediationbetweensavers
and borrowers. We can distinguish two kinds of banks, although the dif-
ference is a question of degree. Commercial banks take deposits from the
public and relend part of those, in order to pay interest to their depositors
and to make a profit. A commercial bank’s depositors are its main lenders.
Investment banks do not take deposits from the general public but finance
themselves mainly by borrowing large amounts of money from investors
and corporations. They are involved not only in commercial loans to busi-
nesses but also in purchasing the latter’s securities, brokering securities,
and advising their customers on their financial structures and activities—
including such things as mergers, acquisitions, and IPOs (“initial public
offerings,” that is, when a firm first issues stock on an exchange). In the
broadestsense,investmentbankscanbedefinedasincludingsecuritiesbro-
kers and dealers. A bank can be and is—in most times and countries, with
rare exceptions like the United States—a mix between a commercial and
an investment bank; such a bank is called a universal bank. As intermedi-
aries, banks have one distinctive feature: they borrow short and lend long;
the loans they get from their depositors (or other short-run lenders) can
be called back with a very short or no advanced notice, while the loans
they make are callable only over a certain period of time. You can take
your money out of the bank at any time, but the bank can’t make you pay