Tuesday, July 29, 2014

Track the problem to its source


Central banks don't buy liabilities.


Steve Roth says

A a year or so back I highlighted David Beckworth’s great post on Helicopter Drops... I’ve been pinging ever since to see a response to that post from Market Monetarist opinion-leader Scott Sumner... I won’t rehash it all here but rather point you to Nick Rowe’s wonderfully successful effort to bring it all to conclusion, synthesizing Market Monetarist and New Keynesian thinking into support for a policy proposal that I think Post-Keynesians and MMTers would also jump on with gusto...

And that was pretty much it. I had to follow Steve's links to discover the topic. Started with Beckworth on helicopter drops:

Fiscal policy geared toward large government spending programs is likely to be rife with corruption, inefficient government planning, future distortionary taxes, and a ratcheting up of government intervention in the economy. So I will pass on this type of fiscal policy. Fiscal policy, however, that largely avoids these problems and directly addresses the real issue behind the aggregated demand shortfall--an excess demand for safe, money-like assets--I will endorse. And that form of fiscal policy is a helicopter drop, a government program that gives money directly to households.

Oh, says I. Giving money directly to households. Yeah, that reduces the debt-per-dollar ratio. That works. I like it.

I don't like Beckworth's reasoning -- that "the real issue behind the aggregated demand shortfall [is] an excess demand for safe, money-like assets". No. The problem did not begin with the sudden increase in demand for safe, money-like assets. The problem began when normal assets started getting "toxic". Or rather, the crisis began with toxic assets. The problem goes much farther back in time.

I went back to Steve Roth's and followed the link to "Nick Rowe’s wonderfully successful effort". Nick's post -- Oh! I read that one already. Read and commented on it I think... Yup. That's probably not good, if there is all this backstory that Steve and others have been following for "a year or so"...

Oh, well.


At WCI, Nick makes me shudder:

How much money should the central bank print and buy things with? As much as is necessary, to hit the NGDP target. And if it runs out of other things to buy, like government bonds, or commercial bonds, or......, then it should buy newly-produced things, if necessary. And if that means it is buying too much, and getting too big, then raise the NGDP target and the implied inflation rate and the implied tax on holding currency.

... If the central bank runs out of things to buy and needs to buy new bridges to hit its NGDP target, and if the government doesn't want the central bank owning bridges, the government should buy those bridges financed by issuing bonds, and let the central bank buy those bonds.

The central bank should just keep buying things, Nick says, until the path of NGDP is where we want it. Even if it has to buy bridges.

That's what I was responding to, in my comment:

No. If you have to say the central bank should buy "newly-produced things, if necessary" then I have to say you misunderstand the problem.

In the normal economy Nick would never say such a thing. Even two years ago, probably, Nick would not have said such a thing. But the central bank has been unable to solve the problem, so the human reaction function keeps turning up the pressure.

It is as if Nick knows the central bank should be able to solve the problem -- and that if it fails, the failure must be because the central bank wasn't trying hard enough. But this evaluation of central bank policy is based on the assumption that bank policy has been right all along, and we only need more of the same. I don't think that's the case.


When the central bank sells something, it takes money out of the economy and puts something else in. When it buys something, it puts money into the economy and takes something else out. When the Federal Reserve was buying up toxic assets, it was putting "safe, money-like assets" into the economy and taking the toxic assets out.

But if toxic assets seem to be the problem, then really the problem is whatever it was that made the assets toxic. You have to track the problem to its origin. You don't wait till the shit hits the fan and then say it's the stinky mess that's the problem.

Toxic assets? That was a result. You have to ask: What made the assets toxic? The assets became toxic because the liabilities became unaffordable.

When people could no longer afford to make the mortgage payments, mortgage-backed securities became toxic.

The problem is not that assets went bad. The problem is what made them go bad. Track the problem to its source. Liabilities became unsustainable; therefore, assets became toxic. Central banks bought up toxic assets, but left liabilities to fester.

The Federal Reserve's balance sheet is now almost five times its pre-crisis size, but still the problem is not solved. Nick says let them just keep buying assets until the problem is solved. But it did not work, and it will not work, and here is the reason: The problem is not in the assets. The problem is in the liabilities.

Central banks don't buy liabilities. So central bank policy has not solved the problem, and cannot solve the problem. The liabilities are still there. No matter how many assets the central bank buys, the liabilities remain.

That's why I like the "helicopter drop". It puts money into the economy. Some of that money goes directly into the hands of people who might use it to pay down their debt. That decreases liabilities and hopefully it decreases toxic liabilities. Pot luck, yes, but it's better than buying bridges.

3 comments:

jim said...

Art wrote:

"When the Federal Reserve was buying up toxic assets, it was putting "safe, money-like assets" into the economy and taking the toxic assets out."

I must have missed that. When was the central bank buying toxic assets?

Art wrote:
"When people could no longer afford to make the mortgage payments, mortgage-backed securities became toxic."

Some people could not afford to make mortgage payments on some types of mortgages and that led to the demise of some types of mortgage backed securities that had financed those mortgages, but the federal reserve
has never purchased those types of securities. You've been duped by the spin doctors that say toxic mbs exist and the FRB buys mbs therefore the FRB must be buying toxic mbs as if it is not possible to tell which MBS are toxic.

The securities that the federal reserve has purchase have all been profitable. The federal reserve has turned over billions of dollars in profits that those securities have generated to the US Treasury. The govt takeover of Freddie and Fannie has also produced billions in dividend profits for the Treasury.

Its shocking the extent to which you have swallowed the Wall Street money lenders disinformation campaign hook line and sinker. The story that Freddie and Fannie were financing toxic loans is pure fiction.

It was private financing that created all the toxic MBS. To see who was financing the toxic loans all you have to do is look at the loan loss data. Private label mortgage backed securities financed about 20% of the loans but suffered 50% of the loan losses. In-house financing by deposit taking institutions ( banks, S&Ls and credit unions) accounted for 33% of the loans and had 24% of the losses. Freddie and Fannie funded about 45% of the loans and had only 14% of the loan losses.

https://www.economy.com/mark-zandi/documents/2013-06-26-Resurrection-of-RMBS.pdf

Jazzbumpa said...

Without gainsaying any of Jim's excellent points, I'll take a different tack.

"When people could no longer afford to make the mortgage payments, mortgage-backed securities became toxic."

This isn't false, but it rather misses the point. First off, the assets were toxic because the inherent risk levels were mis-stated, misunderstood or ignored. Crap and junk was tranched out and presented as if it were AAA quality; and innocent people bought it on that basis.

Second, borrowers could no longer afford to pay either because the loans were structured to become unaffordable, people lost their income, or both.

Mis-stated risk levels result from lax regulation and the ready to burst bubble. Job losses result from off-shoring [which, as an aside, is often a very poor business decision] and the results of the recession. In the alleged recovery employment has not rebounded.

http://research.stlouisfed.org/fred2/graph/?g=GAo

Market monetarists like Beckworth and Sumner are smart guys, but their reasoning is flawed. they define monetary policy not in terms of either money or policy, but as GDP growth, which is a resultant. This is either circular reasoning or assuming the conclusion.

It's all done to avoid having to think about fiscal policy, which they assume to be both ineffective [on zero evidence] and more corrupt than whatever else goes on in the business world, all of which is either naivety, ideological blindness, or flatly disingenuous.

Cheers!
JzB

jim said...

Jazz wrote:
"the assets were toxic because the inherent risk levels were mis-stated, misunderstood or ignored."

Although that describes some loan arrangements accurately, it probably is accurate for less than half of the toxic loans at the height of the bubble. In most cases The borrower and lender fully understood that the loan would not be affordable. These loans can be divided into two groups. The first was speculators who understood that that they had less than 2 years to resell the house at a substantially increased price to come out ahead. The other group was people with poor credit records who believed that after a couple years of building equity and a record of payment they would be eligible to refinance to a loan arrangement that was affordable. Both of these two groups with similar sub-prime borrowing strategies had great success for the many years that home prices were rising rapidly.