Monday, September 23
The Financial Stabilizers: Part 6 of "From Economic Collective to Police State"
"An engraving of Robespierre guillotining the executioner
after having guillotined everyone else in France"
after having guillotined everyone else in France"
Robespierre with a smart phone
In The Weavers, published Saturday, I took a break from examining the dark side of the new era to pay tribute to its bright side. To invoke Charles Dickens' view of the French Revolution, the dawn of a new era is always the best and worst of times. The new era of his day, the Age of Industrialization, was still unfolding in the tumultous "Springtime of the Peoples" that swept across Europe in 1848, which gave rise to the first police state.
The dawn of a new era can't be ordered, controlled or contained. This doesn't stop guardians of the old era from trying to wrest order out of all the perceived chaos, at least until the new era settles down and aquires some manners. The attempt invariably translates to the "Nobody moves, nobody gets hurt" approach to keeping order -- an approach that has produced the nuttiest (and often the most brutal) regimes imaginable.
So then the problem is always how to make nuttiness work, at least well enough to prevent a putsch or revolutionary regime from immediately collapsing under the sheer weight of its lunacy. In this effort luck plays a large role because people who can make nuttiness work aren't around in large numbers. All the planets have to be properly aligned to produce, say, a Robespierre.
These types are the enforcers, whose first day in office is always a pile of memos that read the same: Think of something, before they break down the doors and hang us from the nearest tree. Thinking of something usually translates to a) identifying who has enough money to mount a counter-revolution, b) designating these people as the cause of everyone's problems, and c) making grisly examples out of them. Thusly, the famous reign of terror, by which vast numbers of disgruntled people are terrorized into putting up with a nutty regime.
Unfortunately for Robespierre he overshot the mark by ignoring the #1 rule of keeping a reign of terror going, which is to do the grisly example-making mostly out of the public eye and let people's imagination substitute for graphic illustrations of what happens to enemies of the people. The French populace became so grossed out by Robespierre's Show and Tell method of example-making that it was he, not the executioner, who was marched to the guillotine.
Thanks to modern technology there's no longer a strict need in many parts of the world for mass executions to impose order. If electronic banking had existed during the French Revolution, Robespierre could have gotten control of the aristocracy with far less gore by relying on a smart phone instead of a guillotine.
That was the lesson of the historic events that unfolded in Nicosia, the capital of the tiny island nation of Cyprus, this March. Tens of thousands of bewildered Cypriots took to the streets to protest the sudden and unexplained freezing of their bank accounts. Given the paltry sum of money at issue, the protesters weren't the target; they were collateral damage in a message the enforcers of the new global financial regulatory regime had designed to be read by everyone, not just the Cyprus government and the world's major banks and bondholders.
The message was the essence of simplicity: From now on, we're in charge.
In charge of what? Ostensibly they're in charge of establishing financial stability in the world so there's not another global financial catastrophe. But of course there's no way to guard every gate, to predict and head off every financial crisis that could morph into a steep worldwide recession. There is a way, however, to protect the Guardians of the Economy here in the United States and in various major trading nations from being brought down by their bad monetary and economic theories. The way is for a small group of people, unelected by the populaces, to establish a globe-spanning regulatory regime that stabilizes the position of the Guardians in the chaotic new era.
In short, there's a way for the Guardians to avoid having to face the consequences of decisions they made in the service of the state or, in the case of the IMF, in the service of several states. The truly historic aspect of the Cyprus Solution is that it represented the first time the IMF's famously ruthless approach to helping troubled 'developing' governments was used on a 'developed' government. (Well, the ruthlessness is famously known in developing countries that have been on the receiving end of IMF policy.)
So the historic event also represented what's known as the chickens come to roost.
But again it came down to luck, to the configuration of the planets. The draconian U.S. financial regulatory regime envisioned by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (which contains in Title II the template and rationale for the freezing of Cypriot bank accounts not to mention American ones), is so complex, so nutty, that no one who initially plowed through the 848 pages of the original bill believed it would get off the ground.
No one, that is, except those who knew about Daniel Tarullo and his pivotal role in the bill's creation and crafting.
Meet a Chief Financial Stabilizer
In his own words Daniel Tarullo has been in and out of government for years, going back and forth between academia and government, where he mastered the mysteries of international financial regulations. He's presently serving as a Federal Reserve Board Governor. But Tarullo isn't any old Fed governor. He was not only the brains behind how to make the Dodd-Frank Act work, he's also President Barack Obama's brain when it comes to financial regulatory matters. And he headed up Obama's economic transition team when Obama first went to the White House.
In addition to his duties at the Fed, this March Tarullo was named to a two-year term as chairman of the Group of 20 Nations Financial Stability Board's Standing Committee on Supervisory and Regulatory Cooperation. And, with Federal Reserve Chairman Ben Bernanke, "Tarullo regularly participates in principal-level meetings of the U.S. Financial Stability Oversight Council and the Group of Governors and Heads of Supervision, the oversight body for the Basel Committee on Banking Supervision." (1)
There is some dispute about how much power Tarullo has gained at the Federal Reserve.(1) I think the dispute is misleading in that he isn't interested in directing monetary policy -- at least, not up to this time. He's a stabilizer, not a guardian. Yet he's amassed so much power in the regulatory end of international and national financial matters that the only reason I don't characterize him as "the" chief financial stabilizer is that there may be other stabilizers whose names will only gradually become known to the public. Tarullo himself only became well known to the American press this summer. As to how that happened --
On July 11 Tarullo gave testimony before a Senate committee on the status of Dodd-Frank's implementation -- not an easy feat because the regulations for the act, which are expected to be at least 30,000 pages on completion, are little more than a third written at this point. Then it was time for him to talk turkey to the American public, which was still blithely unaware it was living under a new regulatory regime that when push came to shove could shove aside virtually all existing U.S. laws and democratic processes in the name of maintaining financial stability. And it was time to get down to brass tacks with the American Financial Community, which closely follows the progress of the new regime because it knows that when grisly examples must be made they will be chosen from amongst the community.
For both those tiresome communication chores with the masses, on July 15 Mr Tarullo elected to chat with Ben White, the chief economic correspondent for Politico, on Ben's morning talk show. The audience was top reporters for the financial press.
Daniel Tarullo's chat was mostly to explain the status of implementing the Dodd-Frank Act as it's currently written. But he also reminded the reporters that the United States is "a nation of delegated powers" and that "those of us charged with financial stability in the USA" have a very weighty burden.
(I don't recall whether this reminder was given during his chat with Ben or during the Q&;A session with reporters at the end of the chat. I saw the live broadcast of the chat on C-SPAN. I haven't reviewed C-SPAN's archived version to learn whether it includes the Q&A; if not, perhaps Politico's video of the event, which is posted on the internet, includes it.)
Now what is financial stability supposed to mean, exactly? It's supposed to mean whatever the U.S. Financial Stability Oversight Council (created under Title I of Dodd-Frank) and the G-20 Financial Stability Board say it means, if they ever get around to defining it exactly.
For those irrational types who just can't stand not knowing what something means if people with delegated power are charged with maintaining it --
Behind all the math, behind all the economic statistics that the Guardians of the Economy refer to when the U.S. economy is faced with serious problems, there have existed since the Great Depression two iron rules for warding off financial calamity:
Rule #1: Terrorize the banks
Rule #2: Terrorize the banks some more
These rules worked reasonably well up until the rise of the shadow banking system, which quite understandably was launched by banks in an attempt to evade said two iron rules. When this shadow system crashed in 2008, the Guardians added another iron rule:
Rule #3: Terrorize everybody who deals with money
Thusly, the Dodd-Frank Act, which by the time of its complete writing and enactment will regulate every single type of financial transaction in the United States and have global reach, and will coordinate with regulations in similar acts written into law in other G20 nations.
Which is to say that sometime between the years 2015-2017, when all the planned regulations in Dodd-Frank are expected to lumber into existence, we're all going to find out exactly what financial stability means.
Governor Tarullo also said that the Federal Reserve's newfound transparency (e.g., talking more to the press) is in part a monetary tool; this so that the most knowledgeable members of the financial press (that would be the reporters invited to hear him speak) could in turn explain Fed thinking to the Financial Community and the public; in this way the masses could better adjust to the realities of the Fed's monetary policy in the post-2008 era.
Tarullo also fell back on his professor's role to give the financial reporters in the audience a few history lessons, so they could better understand why all this new regulation was necessary. However, I would take with a grain of salt his explanation about how the U.S. banking system got into trouble in the 1970s. While it's true that American depositors fled their banks as more lucrative interest-paying options became available, Tarullo forgot to mention why the banks couldn't compete with the nonbank options. It was because they were prevented at the time from doing so by regulations.
I don't recall whether Tarullo told the reporters that he personally planned to continue tightening the stranglehold on American banking practices, but as chair of the Federal Reserve Board's Committee on Banking Supervision, he's already pursued his duties in that regard with such zeal that he's gotten a reputation for being a bully.
Remember: the Federal Reserve Bank isn't exactly a bank
If Mr Tarullo's attitude toward banks seems a little unfriendly for a banker, he's not a banker; he's an attorney. In fact there are no bankers sitting on the Federal Reserve Bank's board; the token banker on the board, Elizabeth Duke, exited on August 31. Unless one wants to claim that board member, attorney, and former government official Jerome H. Powell could be considered a banker because he once worked for an investment bank. But let's not split hairs over Powell's work history; he's not a banker in the way you and I would conceive of one and his credentialing is in the area of law, not banking.
As for the rest of the Fed's board of governors: Ben Bernanke, Janet Yellen, and Jeremy Stein are economists; Sarah Raskin Bloom is an attorney.
If it strikes you as odd that the Federal Reserve Bank's governing board wouldn't be loaded with bankers: the Fed is a bank in the way the World Bank is a bank. As with the World Bank, the Fed has a banking function in that it makes loans to banks (the World Bank loans to governments) but you can't open a savings account with the Fed or ask it for a loan. The Fed is not a banker to individuals any more than the World Bank is.
Another similarity shared by the Fed and the World Bank is that the governments that control them (and the Bank's sister organization, the IMF) fell prey to the same temptation. Through the process of loan writing the World Bank-IMF found it could influence and even in many cases control foreign governments; by this route the Bank could greatly impact entire populations in foreign countries. In the same manner, the U.S. federal government found that through the Federal Reserve Bank it could influence and even direct the course of the U.S. economy via the mechanism of the Fed's loan-making to banks.
The Real World of Statistics vs the Actual World
There is a catch, however, for the IMF-World Bank and the Federal Reserve -- and for the populations affected by their policies: these institutions are dependent on their reading of economic statistics to rationalize loan-making policies. These readings are fraught with oversights and errors due to the nature of data collection and analysis and human nature's shortcomings.
An example of the latter was the Fed's infamous Hamburger Cost of Living Indicator. When one Fed chairman (it might have been Greenspan) found that his reading of U.S. inflation was considerably lower than some Labor Department statistics indicated, he smoothed over the discrepancy so he didn't have to adjust his monetary policy to fit with facts. He did this by figuring that when the skyrocketing price of beef had put steaks out of reach of most Americans, the steak eaters had naturally switched to eating hamburger. Voilà! The increased price of beef did not reflect an increased cost of living for Americans and so was not inflationary!
(The Fed chairman's self-serving chain of reasoning prompted one econometrician to snap that this wasn't a cost of living indicator; this was the cost of survival.)
Aside from fudging there are the simple oversights. An example of such from earlier this year was a statistic that showed increasing housing purchases in the U.S., which is a leading indicator of an improving economy. This indicator works on the reasoning that as finances improve for American wage earners they'll stop putting off a house purchase.
The positive housing statistic set off a panic among "investors" (read, speculators) playing the booming stock market -- a boom which the Fed's quantitative easing policy had gone a long way to creating and sustaining. The investors figured that if the U.S. economy was actually improving, this would cause the Fed to scale back or end QE; just the fear that this might happen panicked the investors, who began dumping stocks.
And so Wall Street analysts practically ran in front of TV cameras at CNBC to wave another statistic -- one that hadn't showed up in the government and Fed's analysis of housing stats. Everybody could relax! It turned out the improved housing purchase statistic was due to BlackRock and other big Wall Street investment firms buying up large numbers of houses and turning them into rental properties (to rent to Americans who were still too poor to buy a house, or still not employed, and/or whose credit wasn't good enough to buy a house). This fresh data indicated QE wasn't going to end any time soon!
The stock market immediately resumed its boom.
(Another reason for the runup in housing purchases, it turned out, was that foreigners were buying U.S. houses for all cash -- houses that were already selling at distressed prices and going for a song to anyone who could finance the entire purchase price with cash.)
In short, reliance on economic statistics to give a reading of the pulse of an economy can cause governments and their central banks (and the World Bank, IMF, etc.) to miss galaxy-size chunks of reality. This has led to the claim that these institutions don't analyze the real world. That's not quite true because the statistics they rely on are real enough. It's just that they aren't actual.
Another catch to dependence on economic models to direct loan-making policies: it created a powerful economic collective entity, the Economic Statistical Person, which as I've pointed out in earlier posts is an abstract phenomenon.
And so, whenever the actual world and actual people sprung a surprise on the IMF, things got terribly messy, as an American World Bank chief economist named Joe Stiglitz finally realized to his horror. However, the consequences of Joe's criticism of IMF and Bank policies point to another catch. Economist Larry Summers, at that time U.S. Treasury Secretary, reportedly ordered the Bank to fire Joe; i.e., to publicly humiliate him instead of quietly ordering him to resign.(2)
The catch is that the democratic process itself was gradually supplanted, even in the most democratic countries, by a de facto rule of economists.
The rule of economists became less de facto and more -- actual -- with the signing of the Dodd-Frank bill into law, and by the luck that there exists someone who can actually make that nutty law work.
1) From the American Banker's July 28, 2013 profile, The Increasing Leverage of Daniel Tarullo
2) Joe eventually got even, and then some. See the report I linked to in my "famously ruthless" comment above.)