Why Global Banks Should Be Unbundled

During the real estate boom global banks were valued at 3 times their equity and their balance sheets responded with a similar increase in assets.  Today investors value global banks at a fraction of their equity.  One dollar of equity is worth 50 cents of value.  The global banks have moved from value creation machines to value destruction machines.

The collapse in the valuation of global banks is explained by their legacies and by prophesies about their future.  Investors are concerned about overvalued assets still on their balance sheets that have not been written down to the market value.  They also have problems evaluating their business models.  The banks have so many franchises that they have become too complex to value.  They are not only too big to fail, they are too complex to value.  Perhaps unbundling their franchises might make them more easy to value.  Instead of building reserves they might go back to their primary job of allocating assets to their most productive uses.

Looking Ahead For Romney Zingers In The Presidential Debate

Romney has been rehearsing the zingers that he intends to use in the presidential debate.  Zingers are one line put downs that he will use paint a negative picture of President Obama.  His campaign team believes that some of the zingers will stick and turn his campaign around.  Dana Milbank, who has been following the Romney campaign,  compares debate zingers with a sugar laden treat marketed by Hostess with the same name.  It is all empty calories with no nutrition.  When Romney or Ryan are asked to provide some nutritional food for thought on the campaign trail they have nothing to offer but empty platitudes.  They hope to win the election by selling zingers.

Is The Era Of Unlimited Growth Nearing An End?

Martin Wolf writes in the Financial Times that we may be reaching the limits of productivity enabled economic growth in the rich nations.  He uses the data and arguments of Prof. Gordon which I posted a few days ago.  He asks a simple question that is behind the analysis provided by Prof. Gordon.  Would you rather give up running water or your cellphone?  His answer is clear.  The innovations, like running water, that were made during our second industrial revolution were more profound than the innovations that are driving growth today.  The US, for example, is on the innovation frontier and productivity is slowing down.  Other nations will catch up with the rich nations, and countries like the US will no longer benefit from rising productivity.  The elite in the rich nations will be well off, but everyone else will less well off.  Wolf tells us to get used to it.

The post that follows below on China shows where the growth will take place.  Emerging economies will have greater access to productivity enhancing technology as they move towards the technology frontier established in rich countries.  They will grow and become more prosperous. Multinational corporations may benefit from global growth but that will not trickle down to the middle classes where they are domiciled.

Building Sustainable Prosperity In China

If China pursues the American Dream of prosperity, we will need another planet as China's middle class develops its own dream of prosperity and consumption.  This article describes some the efforts underway in China to shape a sustainable vision of prosperity among China's growing middle class.

NY State's Attorney General Files Fraud Suit Against Wall Street Banks

Despite widespread fraud, and other criminal activities that took place prior to the collapse of the financial system, there have been no criminal charges against the Wall Street bankers who were primarily responsible for the collapse of a system based upon fraud.  The Attorney General of New York has filed criminal charges against Bear Stearns under a state law that dates back to the Great Depression when Wall Street banks did not escape so lightly from criminal prosecution.

Bear Stearns, which was acquired by JP Morgan in a fire sale, during the bank bailout season.  They are being prosecuting for a failure of due diligence.  They purchased loans that that did not conform to their underwriting standards.  They packaged these loans into securities which they sold to unsuspecting investors.  The securities lost much of their value as the underlying loans went into default.  Instead of protecting the investors who purchased the securities, Bear Stearns demanded cash compensation from the loan originators which it kept.

The NY State Attorney General is prosecuting this case on its own.  Neither the Federal Justice Department, the SEC or other federal agencies are supporting the prosecution.  JP Morgan is fighting the charges.  Therefore, the Attorney General's office will collect more information to support its charges against Bear Stearns/JP Morgan.  This may pave the way for further prosecutions.

Entitlements And Private Equity Firms

We here lots of complaints about entitlement programs that are available to most Americans.  This article contains a list of the entitlements that are expected by private equity managers in return for their role as "job creators". 

The Role Of Economics In The Financial Crisis

Andrew Haldane, who is an Executive Director of Financial Stability at the Bank of England, argues that economics was one of the many factors that contributed to the financial crisis.  He describes the intellectual viruses within economics that played a major role in financial crisis.

History is full of cycles in money and credit that have spilled over the real economy.  They have been ignored for several reasons.  The first reason is academic.  Central banks use DSGE models of the "real economy" in which asset prices, money and credit play a minor role because they have dominated macroeconomics since the 1970's.  The second reason is that inflation targeting assumed a dominant role in central banks.  The rapid rise in the ratio of bank assets to GDP since the 1970's did not concern central banks.  Moreover, bank regulators focused on the health of individual banks instead of system risk in the banking system.  Haldane concludes that economic history should receive more attention in economic curricula and that more attention should be given to the behavior of institutions such as central banks and commercial banks.

The second virus that affected economics is new and more virulent. Conventional economic models are based upon the behavior of representative agents that rely upon linear mathematics.  The financial crisis is better described as a complex interaction of tightly linked financial and social agents.  The system is highly adaptive when it is not stressed.  On the other hand, it behaves in a non-linear and maladaptive fashion when it reacts to fear. The break down in the system, following the collapse of Lehman Brothers, is not well captured by conventional models which assume representative agents.  Its time to move on from the DSGE models that are dominant in academics towards models that capture the system dynamics of the real world.

New paradigms in science do not easily replace dominant paradigms simply because they are contradicted by unpleasant facts.  It will be awhile before academics, whose prestige is based upon prevailing models, are ready to accept a new paradigm. In the meantime it is better to lessen the role that they play in policy making.  There is also an ideology underlying the DSGE models that has become part of our general culture, and which contributed to the financial crisis. It is the ideology of self correcting markets that work well as long a government does not attempt to intervene in the market.