Tuesday, 24 March 2009

The Stone Axe of Economic Policy

Now there it is. We have kept trading down the policy tools. By now, only the stone axe is left. Just as the super-sophisticated inflation targeting (or almost that, in the case of the Fed) has by now been replaced by the 1 trillion intervention (a.k.a. The Round Large Red Panic Button), the fiscal intervention has reached a new peak (or low - depending on your point of view) with the Geithner-plan.

Most commentators failed to notice that the markets rallied due to the expected relief of the banks, rather than a positive systemic impact. And, in this case, the two are not the exactly the same. From the troubled banks’ point of view, this is great, for they will get to rid themselves of the burden their ‘expected-not-to-perform’ assets pose. (Although, the usual devil will be in the exact definition of these.) But, from the systems point of view, only a small step forward.

The state provides almost all the funds, takes most of the risk (and most importantly, the entire bad side of the tail of the distribution), in a move which cannot be seen anything else than outsourcing an auction operation to a bunch of investment management firms. At rather high fees, one might add. This is not private-public-partnership, this is a public-hires-private game.

The funniest thing is that the structure of the Geithner-plan is the same as the investment banking bonus system, the subject of that ludicrous ‘debate’ of the past weeks. Think about it: an investment manager (a) plays with others’ money, (b) has only very limited pain if the portfolio goes sour, (c) has a very high payoff if he gets lucky -- a large part of which is being paid in the form of a ‘bonus’, and (d) in return he is expected to structure and manage risk in the best interest of his employer. The Geithner-plan is exactly the same.

To be fair, this plan, if seen through, will indeed serve as a small step from the system’s point of view. Perhaps even two small steps. First, it could reduce the uncertainty about what is on the balance sheet of the US banks. The ‘toxic assets’ will come out onto the daylight, and will be assessed by the financial market. If economic theory is still to be trusted, this will be the best assessment one might ever achieve. Second, the relieved banks could stop being completely paralysed and start operating as banks should.

The trouble is that although transparency will increase, we will still not know what to do with it. The risk valuation problem, the phenomenon that lies at the origin of the rise of toxic assets, will be still here. And they will be until we move economic modelling from national to global level, and thus allow ourselves to describe the economic processes encompassing all the factors that affect our financial assets. (With the added trouble - as this blog pointed out before - that we do not have the theory that could provide such a truly global framework.)

Furthermore the trouble with the banks getting rid of their shackles is that this in itself will not make them return to the market, and behave just as before. The less-troubled, and the non-so-troubled didn’t do it, why would the newly-relieved do it? Same song: until effective policy emerges, there will be little economic incentive to do so. Effective policy in a global economy means global policy. Unpopular as it may be.


  1. Maybe nuke would be a better analogy than the stone axe, no? There are not many axes that could go bang this loud.

  2. Nuke or stone axe, the same thing in a way.

    It is amazing how much the framework we think in has changed. Just half a year ago, this package, the Geithner plan would have been literally unimaginable. Not that it would have seemed unlikely; rather people would not have been able to think it.

    We learn as much about the nature of economics these days, as about the nature of its subject matter.

  3. How can you talk about the end of policy? You have not seen the impact of either Geithner Plan or the Fed's intervention. It is a bit too early to judge.

  4. Thanks. This was very helpful.

  5. Time for global action, Barack Obama writes. Interestingly, the language stays rather constrained.

  6. tamas, this is a great point, again. why don't you expound on what the global government you keep implying would look like? it would interesting to contrast your scientific view to that of the mad crowd.

  7. in the meantime the obama administration is tied down in a ridiculous witch hunt.

    have you read the brill resignation letter of a mid-level aig group manager? kudos to the few who dared to stand up to the populists from the very begining

  8. I could not agree more with the previous comment, by Bee. Tamas, please, please expound away.