Macro-wreckonomics: a 30,000-foot view

Gillian Tett, the Financial Times' credit markets whiz, has a detailed account today of how credit derivatives markets went bad. Framing the sorry tale of bad loans packaged in opaque securities and parked off-balance sheet in special investment vehicles is a sidebar that drains a bit of blame by bringing the macroeconomic causes into sharp focus:

there is a strong case to be made that the current crisis is in the strictest sense a crisis of globalisation, fostered and transmitted by the rapid and deep integration of very different economies. Fast-growing developing countries with underdeveloped financial systems were exporting savings to the developed world for packaging and re-export to them in the form of financial products.

The global economy during the period of boom and savings glut had something in common with the old communist workers' joke: we pretend to work and they pretend to pay us. The current variant for emerging economies was, we work, you pretend to pay us, we prop up the value of your pretend payments. Our banking system drowned in a flood of cheap money:

The collapse in market discipline and regulatory supervision was most extreme in securitised markets for US housing finance. Yet it is hard to see this as simply a crisis of financial innovation when there was excessive risk-taking in many other areas. At the same time that US and UK banks were amassing subprime mortgage securities, they were also making mispriced loans to private equity. Austrian banks were making risky loans to households in eastern Europe and Japanese banks were buying corporate equities. This suggests larger economic forces were at work.

Wolf Munch Rock Awards II

cont. from Wolf Much Rock Awards I, here

Martin Wolf, the FT’s chief economics columnist, also wrote an end-of-year retrospective, in this case focused on the likely fallout from the subprime crisis. Like Rachman, he introduces his list of observations casually– in this case, of reasons Why the credit squeeze is a turning point for the world: “Why do I believe this? Let me count the ways.”

Wolf, like Rachman, doesn’t use lists as ideological bludgeons to suggest he’s cornered the market in causality in a neat ideological package wrapped around a simple solution. This is not “The Eight Steps Central Banks Must Take to Avoid a Depression.” In fact Wolf offers up more questions than answers:

Third, the crisis has opened up big questions about the roles of both central banks and regulators. How far, for example, do the responsibilities of central banks as “lender-of-last-resort” during crises stretch? Should they, as some argue, be market-makers-of-last resort in credit markets? What, more precisely, should a central bank do when liquidity dries up in important markets? Equally, the crisis suggests that liquidity has been significantly underpriced. Does this mean that the regulatory framework for banks is fundamentally flawed? What is left of the idea that we can rely on financial institutions to manage risk through their own models? What, moreover, can reasonably be expected of the rating agencies? A market in US mortgages is hardly terra incognita. If banks and rating agencies got this wrong, what else must be brought into question?

Those questions would seem to point toward a need for a firmer government hand on the economic tiller. But the next point tacks the other way:, toward less intervention:

Fourth, do you remember the lecturing by US officials, not least to the Japanese, about the importance of letting asset prices reach equilibrium and transparency enter markets as soon as possible? That, however, was in a far-off country. Now we see Hank Paulson, US Treasury secretary, trying to organise a cartel of holders of toxic securitised assets in the “superSIV”. More importantly, we see the US Treasury intervene directly in the rate-setting process on mortgages, in an attempt to shore up the housing market. Either, or both, of these ideas might be good ones (though I strongly doubt it). But they are at odds with what the US has historically recommended to other countries in a similar plight. Not for a long time will people listen to US officials lecture on the virtues of free financial markets with a straight face.

In fact, each of Wolf’s eight points reads like a discrete essay. Each highlights either lessons learned or questions raised, and in each case, Wolf goes where the evidence takes him. Not all of his essays are so free-form; some point toward a policy prescription. But generally, these pieces are inquiries, not briefs – essays in the original sense of “trials,” thought processes laid out on the page.