Category Archives: Economic crisis

Iceland’s bank collapse report

After Iceland’s three big go-go banks all collapsed in fall 2008, the country’s parliament (Althingi) established a Special Investigation Commission to investigate and analyze the processes leading to their collapse. The SIC delivered its report to Althingi on Monday.
The English version of its key chapters is here.
A hat-tip for that to Calculated Risk, who wrote, “It has it all – regulatory capture, oblivious politicians, shadow banking, loans to shareholders to buy shares and more.”
Calc also has some informative excerpts from the SIC report in that post.
Here in the U.S., Congress proceeded in a much more stately (= slow) fashion. It did not establish its Financial Crisis Inquiry Commission until May last year, five months after Althingi did so. And the FCIC will not be submitting its report until December 15.
That’s a pity, because we as citizens really need to gain a clear picture of what went wrong in the go-go years– especially if our legislators are to enact new laws to try to prevent another massive meltdown like the one of September 2008. (A resurrection of the Glass-Steagall protections, anyone?)
The FCIC is giving us a bit more information than we had before. But it still feels awfully slow. And many of the banks have returned straight to same kind of predatory practices they were engaged in before.

A Turning Point?

from President Obama‘s press conference on the results of the recently concluded G20 Summit Meeting in London:

    Earlier today, we finished a very productive summit that will be, I believe, a turning point in our pursuit of global economic recovery. By any measure, the London summit was historic. It was historic because of the size and the scope of the challenges that we face, and because of the timeliness and magnitude of our response.

The G-20 is made up of the finance ministers and central bank governors of 19 countries plus a representative of the European Union, established in 1999 “to bring together systemically important industrialized and developing economies to discuss key issues in the global economy”. The G20 had high hopes for its recent summit meeting in London.

    The G-20 will need to send a strong signal that it is prepared to take whatever further actions are necessary to stabilise the financial system and to provide further macroeconomic support.

What happened? Was it really a turning point? Here are comments on the major G20 promises from me and others.

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Milanovic: ‘The crisis of maldistribution’

note: I am very happy to publish the following short essay on the economic
crisis by the distinguished economist Branko Milanovic, a senior associate with the
Carnegie Endowment for International Peace and for a long time a lead economist
in the World Bank’s research department. Milanovic is
an expert on income and wealth distribution both within and among countries,
and was the author of Worlds
Apart: Measuring International and Global Inequality
(Princeton UP, 2005.)
Like all JWN content, this essay is published under a Creative Commons License. ~HC.

The crisis of maldistribution

By Branko Milanovic,

Carnegie Endowment for International Peace

The current financial crisis is
generally blamed on feckless bankers, financial deregulation, crony capitalism,
and the like. While all of these elements may be true, this purely financial
explanation of the crisis overlooks its fundamental reasons. They lie in the
real sector, and more exactly in the distribution of income across individuals
and social classes. Deregulation, by helping irresponsible behavior, just
exacerbated the crisis; it did not create it.

To go to the origins of the crisis,
one needs to go to rising income inequality within practically all countries in
the world over the last 25 years. In the United States, the top 1% of the
population doubled its share in national income from around 8 percent in the
mid-1970s to almost 16 percent in the early 2000s. (Piketty and Saez,
2006).  That replicated the
situation that existed just prior to the crash of 1929, when the top 1% share
reached its previous high watermark 
In the UK, the top 1% receives 10% of total income, a share greater than
at any point since World War II (Atkinson, 2003, Figure 3).  In China, inequality, measured by the
Gini coefficient (the most common measure of inequality), almost doubled
between 1980 and 2005. The top 1% of the population is estimated to garner
around 9% of national income. Even more egregious were developments in Russia,
where the combined total wealth of thirty-three Russian billionaires listed on
the Forbes list in 2006 was $180 billion as against total country’s GDP of
about $1,000 billion that same year (Guriev and
Rachinsky, 2008).  Just before his
downfall, the richest oligarch, Michael Khodorovsky
had an estimated income equal to average Russia-wide incomes of 250,000 people.
(The same number for Bill Gates and the United States in 2005 was 75,000.)
Think of it. With his income alone, that is without touching
a penny of his wealth,
Khodorovsky could create (if need be) an army of
quarter million people. No wonder the Kremlin took notice, and Khodorovsky
ended up in jail. But the time of oligarchs in Russia did not end with him.
Similarly, in Mexico, Carlos Slim’s wealth, prior to the crisis, was estimated
at more than $53 billion. Assume a conservative return of 7% on his assets, and
that gives an annual income of $3.7 billion with which, given Mexican GDP per
capita in the same year, Slim could command even more labor than Khodorovsky:
440,000 people. These are only a few examples. But they were replicated, albeit
on a smaller scale, in practically all countries of the world.

What did it mean? Such enormous
wealth could not be used for consumption only. There is a limit to the number
of Dom Perignons and Armani suits one can drink or
wear. And, of course, it was not reasonable either to “invest” solely in
conspicuous consumption when wealth could be further increased by judicious
investment. So, a huge pool of available financial capital—the product of
increased income inequality—went in search of profitable opportunities
into which to invest.

But the richest people and the
hundreds of thousands somewhat less rich, could not
invest the money themselves. They needed intermediaries, the financial sector.
Overwhelmed with such an amount of funds, and short of good opportunities to
invest the capital, as well as enticed by large fees attending each
transaction, the financial sector became more and more reckless, basically
throwing money at anyone who would take it. Eventually, as we know, the bubble

But its root cause was not to be
found in hedge funds and bankers who simply behaved with the greed to which
they are accustomed but to large inequalities in income distribution which
generated much larger investable funds than could be profitably employed. The
under-consumptionist explanation of crises, of course, has a long history.  When the times are good, such theories
are covered by oblivion and often held in disrepute. But when the economy
implodes, people remember them. Keynes in 1936 brought them back from
semi-obscurity in which they vegetated between the early 20th
century (when they were used to explain European colonial expansion) and the
Great Depression.  Begrudgingly, he
granted them a measure of respectability. But, in the roaring 1990’s, they were
forgotten.  Moreover, as underconsumptionism had an unmistakable Marxist pedigree,
it always seemed suspect to those brought up in the Marshallian tradition, and
later to neoclassical economists.

But today, when we face the need to
explain the crisis, there are, it seems, only two possible culprits: to lay the
entire blame on the human factor and greed (which would be rather odd for the
economists to do since they routinely praise greed as the spiritus movens of all change), or to look for structural causes
of the crisis. It may not be entirely  coincidental that Robert Lucas,
a Chicago economist and the recipient of the Nobel prize in economics, was the
man who both declared in 2003 (as we were recently reminded  by Paul Krugman) that “the central
problem of depression-prevention has been solved”, and a year later,  poured scorn on all these concerned
with rising inequality by writing that “of the tendencies that are harmful to
sound economics, the most seductive, and …the most poisonous, is to focus on
questions of distribution.” If you do not understand why income distribution
may be important, it seems natural not to get it that crises are not a thing of
the past.


Robert Lucas (2004), “The Industrial revolution: past and
future”, Federal Reserve Bank of Minneapolis, pp. 5-20. 2003
Annual Report Essay.
Available at

Atkinson, Tony (2003), “Top incomes in the
United Kingdom over the Twentieth Century”, December 2003.

Thomas Piketty and Emmanuel Saez, “Income Inequality in the
United States, 1913-1998”, Quarterly Journal of Economics, February 2003.

Thomas Piketty and Emmanuel Saez (2006), “The evolution of
top incomes : a historical and international
perspectives”, American
Economic Review
, vol.96, no.2, 2006, p. 200-2005.

Sergei Guriev and Andrei Rachinsky (2008), “The evolution of personal wealth in the
former Soviet Union and Cental and Eastern Europe”,
in James B. Davies (ed.), Personal Wealth from a Global Perspective, Oxford, UNU-WIDER
Studies in Development Economics, 2008.

Climate of Change?

In a recent NYTimes article entitled “Climate of Change” Paul Krugman wrote:

    Elections have consequences. President Obama’s new budget represents a huge break, not just with the policies of the past eight years, but with policy trends over the past 30 years. If he can get anything like the plan he announced on Thursday through Congress, he will set America on a fundamentally new course.

Baloney. from a recent news report:

    Obama Budget to Boost Military Spending $20.4B
    President Barack Obama wants to increase spending on the U.S. military by $20.4 billion in 2010. . .
    The president unveiled a federal budget for 2010 that would increase defense spending to $533.7 billion. This year the military is receiving $513.3. The difference is a 4 percent increase, the White House said Feb. 26.
    The $533.7 billion does not include money for fighting the wars in Iraq and Afghanistan, or about $20 billion that is to be spent on nuclear weapons and other military items outside the Defense Department.
    Obama wants $130 billion for the wars – down from $144 billion being spent this year.
    The three elements combined – the “base” budget, war funding and nuclear weapons – would push 2010 spending to about $683.7 billion. Spending for 2009 is about $681 billion.

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Killer Jobs Programs

The economy is heading south and people are being laid off. Congress-critters and governors, and politicians in general, are being asked to come up with “shovel-ready” projects that will put people to work. But what about people that can’t or won’t shovel?
The Pentagon has some jobs programs too. Some of them involve getting into uniform, and enlistments are up. Others involve working for military contractors like KBR. We covered them in the piece about finding newly-unemployed George Bush a job.
There are other Pentagon jobs programs that go right into every congressional district. They include military bases and military procurement. They say all politics is local, and in this time for intensive economic recovery planning congress-critters are interested in military procurement now more than ever.
Remember the peace dividend? Forget it. War pays better dividends, and you need to buy a lot of stuff to fight a war. So if the country is at war, and it is at war thanks to some people who profit from it, and if you need even more stuff to fight wars yet uninitiated, then military procurement has to be high on the jobs program list in every US congressional district.
Call them the killer jobs programs.

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Madoff: Symbol of the Age of Deregulation

More details have been coming out about the role that giant-scale Ponzi artist Bernie Madoff played in the whole Age of Financial Deregulation (a.k.a. casino capitalism), here in the US.
On Thursday, Madoff was indicted in federal court in New York for having committed securities fraud regarding the $50 billion of other people’s money he lost by running his Ponzi scheme.
Notable among Madoff’s affiliations is that he was a past Chairman of the board of the Nasdaq stock exchange, and treasurer and board member of Yeshiva University in New York. Among the investors whose money he lost were Jewish philanthropic organizations, some of them with strong interests in Israel. (Recently Sheldon Adelson and Sam Zell, who have both been large-scale supporters of Israel’s settler movement, have also lost huge amounts of money. I can’t find out yet whether Madoff supported pro-settler or pro-withdrawal movements in Israel.)
The Seeking Alpha blog had a fascinating post about Madoff yesterday, written by someone described only as “fund manager ‘Cassandra'”.
Cassandra wrote that he (or just possibly she) could never figure out what it was that Madoff had been doing all these years to generate a steady stream of income for his investors. She– yes, thanks to commenter Larry I’ve discovered she is a she— also had never met anyone who had formerly worked as a trader for Madoff, which she found strange.
My understanding is that because Madoff was supposedly executing his own trades, rather than running them through an outside institution, he was able to hide what he was doing– or, as it may turn out, not doing at all– from the scrutiny of everyone except his auditor. And crucially, the auditor used by Bernard L. Madoff Investment Securities LLC was listed as Friehling & Horowitz, who was described in this Bloomberg piece as, “an auditor operating out of a 13-by-18 foot location in an office park in New York City’s northern suburbs.”
The Bloomberg piece noted that investment adviser Jim Vos of Aksia investigated Madoff Securities intensively in 2006 and identified a number of red flags:

    Among the … “red flags” cited by Aksia was the “high degree of secrecy” surrounding the trading of the feeder fund accounts, which provided capital to Madoff Securities, and its use of a trading strategy that appeared “remarkably simple,” yet “could not be nearly replicated by our quant analyst.”
    Friehling & Horowitz operates from a storefront office in the Georgetown Office Plaza in New City, sandwiched between a pediatrician’s office and another medical office…
    A woman who works in a nearby office, who didn’t want to be identified, said Friehling doesn’t come to the office regularly. When he does, he is the only person there…

Not exactly the kind of auditorial capacity one needs, to be able to keep track of $50 billion worth of investments…
Back to Cassandra. She wrote at length about his own, apparently longstanding mystification about the source of Madoff’s presumed ‘success’ as an investor:

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AIG execs still acting like bandits

In September, the Bush administration announced it would fork $152 billion over to insurance giant AIG to bail it out of its mounting financial woes. Now, AIG CEO Edward Liddy has confessed in writing to Rep. Elijah Cummings that some 168 senior employees of the firm are being awarded what are called “retention payments”, ranging from $92,500 to $4 million this year. (HT: Calculated Risk.)
When will the President and the congressional leadership stop this immoral madness??
Kudos to Rep. Cummings for staying on the case of the greedy card-sharps who run AIG.
The Wall Street Journal is meanwhile reporting that AIG currently owes Wall Street’s biggest firms about $10 billion for speculative trades (i.e. bets) that have soured. I can’t read the portion of the story that’s behind their paywall. But the comments page there is running heavily against the AIG execs who’ve been letting all this happen.
So what’s happening is that $10 billion of our taxpayers’ money that Bush and Paulson handed to AIG is now going straight through AIG to other big Wall St. firms– and those top execs at AIG who have done this to us are expecting us taxpayers to pay them hefty bonuses (under the fancy name of “retention payments”) to reward them for their actions… and also, presumably, to make sure they stay on with AIG…
Excuse me? Why does AIG– or the American people, who now own 79.9 percent of the company– still “need” these greedy monsters to stay on the firm’s payroll?
In case anyone’s interested I could tell you I’ve never earned anything near $92,500 in a single year. Far less $4 million!
But then, I’ve also never engaged in “speculative trades” with other people’s money that helped any institution lose any portion of $10 billion.
Sack the lot of them. Get some competent managers in to run the people’s AIG, for goodness’ sake.

Paulson fails to melt Chinese hearts

Time was, when there was a problem of any size in the global economy, the countries affected would send their finance ministers running to Washington to get help from the two big Washington-based financial institutions, the World Bank and the IMF. No longer. Today, it is US Treasury Secretary Hank Paulson whose country is in deep, deep trouble. And he’s gone cap-in-hand to the only place that can throw a lifeline to him (and all the rest of us in the western world): Beijing.
Paulson’s mission has not, thus far, been going very well.
This is a huge, truly world-defining story. I don’t know why the WaPo hasn’t given it a lot more prominence.
The Daily Telegraph‘s Malcolm Moore reports from Shanghai today that Lou Jiwei, the chairman and chief executive of China’s biggest sovereign wealth fund, the $200 billion China Investment Corporation, said that China

    had no intention of “saving” the West from the financial crisis. “Right now we do not have the courage to invest in financial institutions because we do not know what problems they may have,” said Mr Lou.

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Buiter takes on Bernanke for his non-transparency

In his latest blog post today, former ECB chief economist Willem Buiter lays heavily into Fed chief Ben Bernanke for his refusal to disclose vital data about the– now– trillions— of dollars’ worth of actual or potential liability the Fed is exposing US taxpayers to via its latest chummy financial bailout programs.
Buiter bases his criticism on Bernanke’s stonewalling response to a lawsuit Bloomberg News filed November 7 to gain information about the lending the Fed has made to private banks. Blooomberg, he writes, “wants to know the identities of the borrowing banks, how much each one borrowed, and the assets the Fed has accepted as collateral for these loans by the Fed.”
Bernanke has refused, claiming that such disclosure would be “counterproductive.” Buiter gives us this evaluation of what he describes as “Chairman Bernanke’s ‘nyet'”:

    Chairman Bernanke’s arguments for not releasing the requested information are 10 percent correct, 90 percent self-serving Fed-accountability-avoiding twaddle.
    Let me start by noting that, even if it were true that revealing the requested information would violate commercial confidentiality, that such a violation would create stigma for the borrowing banks and that such stigma would result in material damage to the stability of the financial system, it would not automatically follow that the information in question should be kept secret. There are things that are even more important than commercial confidentiality, bank stigma and financial stability. Accountability for the use of public money could be one of these things. At the very least there would be a clash of competing public interests. This conflict should not be resolved through a unilateral decision by just one of the interested parties, the Fed.
    It is correct that the immediate revelation of the identity of a borrowing bank could be so market-sensitive, because of stigmatisation effects, that confidentiality as regards the identity of the borrower makes sense for a limited period. But for a limited period only. After six months, nobody cares. After a year, nobody remembers. Once the loan has been repaid, the stigma issue is no longer relavant.
    The key point is that, for democratic accountability for the use of public money to exist, there has to be certainty that at some point there will be full revelation of the identity of each borrowing institution, how much it borrowed, on what terms, and against what collateral. While there can be a finite (but short) delay in divulging the identity of the borrower, all other information – the amounts borrowed (collectively and by individual anonymous borrowers) should be in the public domain immediately. Even in the most paranoid of worlds, there is no reasonable argument, other than an unwillingness to be held accountable for possible mistakes, for not releasing, instantaneously, the terms on which the borrowing occurred and the nature and valuation of each specific item of collateral offered .
    It should be obvious why it is essential that all information be in the public domain, that is required to assess the Fed’s valuation of the collateral at the time the loan was made. This is the information required to assess the magnitude of the ex-ante subsidy the Fed provided to the borrower – the quasi-fiscal subsidy, if any, provided by the Fed, based on the information available at the time the loan was made…

He notes that the pricing function performed by the central banks that are intervening in the current crisis can help to shore up confidence in the entire system– but that Bernanke, like the chiefs of the ECB and the Bank of England, won’t even reveal what models it uses to assign value to the assets it is scooping up (many of which may indeed be highly toxic.)
He comments:

    As long as the models/methods used by the central banks to calculate the theoretical prices are not in the public domain, and as long as we are not provided with the detailed actual valuations/prices of each security accepted as collateral, I will not believe a word I am told. This form of Publikumsbeschimpfung [insulting the audience] by the central banks is simply not acceptable in a democratic society. It is not their money they are playing with. It is our money.

He also notes that as the crisis proceeds, the Fed will be acquiring assets that are ever riskier and riskier, concluding,

    Most of the internationally active US banks are dead banks walking, supported and held upright by a cast of Federal puppeteers with mixed track records. Even with the state support they are receiving or are expected to have access to should the need arise, the creditworthiness of these banks, as reflected in their credit default swap (CDS) spreads and their spreads over US Treasuries (which themselves now have rather larger CDS spreads than they used to have before the crisis) is poor indeed.
    That leaves the Fed, and behind the Fed the US tax payer or the beneficiary of existing US public spending exposed to the credit risk on the collateral backing the loans…
    I consider the Fed’s stonewalling of the Bloomberg News request for information – the refusal to provide any information because a small component of the requested information was deemed to be commercially confidential – to be outrageous and unacceptable. The same holds for the refusal of the ECB and the Bank of England to put in the public domain their models, methods and myths for pricing illiquid assets.
    As regards the specific request of Bloomberg News, a short delay in making public the identities of the individual borrowers (sellers of securities to the Fed) may under certain conditions be justified. All other information (what collateral was offered, what securities were purchased, valuations, terms etc.) must be in the public domain immediately. Central banks have no immunity from accountability for the use of public resources. Congress, the Courts, the media, the tax payer and the public at large should reject Chairman Bernanke’s ‘nyet’ to a legitimate request for information.

Well, let’s see the extent to which the very badly “captured” (by the bankers’ brainwashing) US Congress, courts, and media will be prepared to challenge Bernanke… I am not holding my breath.

Buiter announces collapse of western financial system

Willem Buiter is the former chief economist of the European Bank for Reconstruction and Development. He’s not only smart; he’s well-informed and thoughtful. Today he wrote on his blog:

    We have no longer just a crisis in the financial system. We have gone even beyond the stage where there is a crisis of the financial system. The western (north-Atlantic) financial system we knew has collapsed. If I may paraphrase that great ensemble of Nobel-prize winning financial wizards, Monty Python’s Flying Circus:
    “This financial system is no more! It has ceased to be! ‘It’s expired and gone to meet its maker! ‘It’s a stiff! Bereft of life, it rests in peace! If you hadn’t nailed ‘it to the tax payer’s perch it’d be pushing up the daisies! ‘Its metabolic processes are now ‘istory! ‘It’s off the twig! It’s kicked the bucket, it’s shuffled off its mortal coil, run down the curtain and joined the bleedin’ choir indivisible!! THIS IS AN EX-FINANCIAL SYSTEM!!”

He then comments– in terms that echo quite a bit of what I was writing here yesterday (though he does it more pithily),

    What is to be done? Banks that don’t lend to the non-financial enterprise sector and to households are completely and utterly useless, like tits on a bull. If they won’t lend spontaneously, it is the job of the government to make them lend. Banks have no other raison d’être.

Hear-hear to that last sentiment!
He writes that “the coercive powers of the state” are now required to get the banks to lend to the non-financial sector and to households, and suggests three ways this might be done. All look– from the point of view of the present owners and CEOs of the banks– fairly draconian. (One is the full-scale nationalization of the banks.)
Buiter also explicitly names the position the major banks are taking right now as a “bank lending strike.” He is quite correct to do so. By not lending, the banks are hoping governments will shovel yet more and more money their way, with little or no quid pro quo. They are holding society hostage. Governments must intervene– and not simply by shoveling money to the banks but by getting the economy going with or without the cooperation of the banks, while enacting emergency legislation that will force the banks to cooperate.
I am still very worried indeed that we will see no action of this kind in the US. Bush’s cabinet, Obama and his economic-team-in-waiting, and the Democratic leaders of Congress present and future all seem united– with just a few isolated exceptions in Congress– in being completely in hock to the bankers and their worldview. (What Buiter, back in May, called “cognitive regulatory capture.'” I would call it brainwashing.)
What a pity we don’t have a few more Buiters here in the US.