PROBLEMS WITH THE DESIGN OF THE EURO: Responses MMP Blog #16

By L. Randall Wray

Sorry, got to be brief—for an explanation go here:
I’ll have to punt a bit on some of the techie details onoperations within the Euroland. Maybe we can come back to them later.
Q1 Anon: Weren’t the design flaws of the euro intentional,that is, what neolibs wanted?
A: Yes, probably true. I’m not an expert on Europeanpolitics. But let me say that there is no evidence that they thought it wouldcome to this—with a likely default by Greece that will escalate into a possibledestruction of the whole project. By contrast, MMTers did!
Q2 Roberta: We’re all artists.
A: ??? I guess so!
Q3 Philip: How do governments borrow from the ECB?
A: Well, technically that is prohibited—the ECB was not tobuy government debt. That was the beauty of the system—governments had to sellto markets, therefore they would be subject to market discipline and would notrun up excessive deficits.
Hey, how’s that working for them so far? Not so good. Youall know the stories. Goldman helped them hide the debts. Markets did notunderstand that these are not sovereign nations—until it was too late. AndFrench and German banks loaded up on high risk Greek debt. The rest is history;or at least will soon be. Market discipline does not work. Ever. Never.
Q4 James: Aren’t euro nations much like US states?
A: First prize! By Jove he’s got it. That’s the problem.They are like US states with no Washington backing them.
Q5: Rvaucbns: What is the endgame for the euro?
A: I urge you to read Dimitri Papadimitriou’s piece over atHuffPost:
I’m planning to write something up soon.
Q6: Neil: what about lender of last resort in the EMU?
A: By design there was not supposed to be one. Marketdiscipline was supposed to work. Each individual country was supposed to beresponsible for its own banks—but since they were not sovereign they could notdo a Timmy-Benny $29 trillion bail-out. The ECB lends to individual CBs againstcollateral; they’ve had to widen what was acceptable. But it won’t be enough.
Q7: What is SGP
A: Yes it is stability and growth pact
Q8 Joe and Hugo: Are there net financial assets in Euroland?
A: Yes; first there are dollars. In Euros, yes individualnational governments create them but as discussed in the blog they’ve got toworry about clearing across borders since ultimately those are convertible ondemand to ECB euro reserves and the ECB is not supposed to buy government debt.
Q9 Dario: why do markets only “partially” recognize thatdowngrades of sovereign debt do not matter?
A: They do not fully understand, so there is usually a bitof uncertainty surrounding a downgrade. Then they realize the sky did not fall,markets for sovereign debt recover, and rates go back where they were. Unlike adowngrade of Greek debt.
NEXT WEEK: We might take a bit of a diversion because we gota long and interesting comment on the differences between real and financial. Ithink it will be worthwhile to get all that clear.

Ben Kenobi Launches Operation Twist: Will it Save the Republic?

By Stephanie Kelton

The Federal Open Market Committee (FOMC) just announced that it’s going to begin another round of asset buying, this time offsetting its purchases of longer-dated securities with sales of shorter term holdings. The goal? Flatten the yield curve. The hope? Engineer a recovery by helping homeowners refinance at lower rates and making broader financial conditions more attractive to would-be-borrowers.  

At this point, it looks like Obi-Ben Kenobi realizes that Congress isn’t going to lend a hand with the recovery. Indeed, as a scholar of the Great Depression, he’s probably deeply concerned by the “Go Big” 
mantra that is now drawing support from people like Alice Rivlin, former Vice Chair of the Federal Reserve.  And so it is Ben, and Ben alone, who must fight to prevent the double-dip. It is as if he’s responding to the public’s desperate cry, “Help me Obi-Ben Kenobi. You’re my only hope.” Will it work?  Not a chance, but that conversation is taking place over at Pragmatic Capitalism, so drop in and find out why.  Below is a description, taken from the full FRB press release, that describes just what the Fed is going to do.  May the force be with us all.



“To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.”

Don’t forget that beginning this Friday, NEP will kick off a new series called “Say W-h-a-a-a-h-t?” We’re keeping track of the craziest, boldest, and most surprising statements, stories, and videos we run across each week and we’ll share them with you every Friday. 


Keep sending us your favorites and watch for ours beginning next Friday. Tweet your recommendations to @deficitowl, submit them through Facebook at New Economic Perspectives, or e-mail them to us at [email protected]

Why it’s So Hard to Sign Progressive Petitions

By Stephanie Kelton

Every day or so, someone sends me a petition via e-mail. Today, I got this one from a group called CredoAction. They’re urging people to tell the Super Committee to keep their hands off Social Security, Medicare and Medicaid, and they wanted my support. I read the petition, but I could not, in good faith, sign it. And so I did what I often do — I took the time to draft an explanation and send it to the anonymous “contact” behind the petition. Here’s what I said:

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Why do Banking Regulators bother to Conduct Faux Stress Tests?

By William K. Black
(Cross-posted from Benzinga.com)

One of the many proofs that banking regulators do not believe that financial markets are even remotely efficient is their continued use of faux stress tests to reassure markets. But why do markets need reassurance? If markets do need reassurance that banks can survive stressful conditions, why are they reassured by government-designed stress tests designed to be non-stressful?

Stress tests were first mandated for Fannie and Freddie by statute. Fannie and Freddie’s managers referred to them as “nuclear winter” scenarios – impossibly unlikely and stark disasters. The managers used the ability of Fannie and Freddie to pass the stress tests as proof that the institutions were safe and so well capitalized that they could survive even a lengthy depression. In reality, Fannie and Freddie had exceptionally low capital levels. Fannie and Freddie met their capital requirements under a newly toughened version of the statutory stress test weeks before they collapsed and were revealed to be massively insolvent.

AIG passed its stress test immediately before it failed. The three big Icelandic banks passed their stress tests shortly before they were revealed to be massively insolvent. Lehman passed its stress tests. The stress tests ignored the actual primary causes of losses and failures – extreme losses on fraudulent liar’s loans and CDOs.

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Upcoming Appearances

Catch our bloggers live and in person.  Bill Black speaks tonight at UMKC and Marshall Auerback will speak at an event in Amsterdam on Wednesday, Sept 21st, and he will speak in Dublin on Thursday, Sept. 22nd.  Visit our Upcoming Appearances page for more details.
And here is the rest of it.[[ NOTE: If this is a Primer posting, it must have ‘MMP’ as the last label or it will not be removed from the NEP homepage ]]

Why David Brooks Misses the Real Source of Moral Decay: Thirty Years of Class Warfare Against the Working Class

By June Carbone*

The New York Times told two separate stories earlier this week, with no apparent recognition that they might be related. On September 12, David Brooks published a column decrying the moral “relativism and nonjudgmentalism” of the young. On September 13, a front page story announced that “Soaring Poverty Casts Spotlight on ‘Lost Decade,’” explaining how the economic decline of the bottom half of the population over the past decade has grown worse during the financial crisis.

What do the two stories have to do with each other? Brooks writes as though the country has – or should have – a set of shared values. Yet, he ignores class and cultural differences in the way values are formed and expressed. In doing so, he fails to address the most critical question the country faces: how can we maintain a sense of shared values when the institutions that support one part of the country flourish at the expense of those critical to the part of the country in decline. In short, the decline of the middle class and the soaring poverty rates the second story describes are far more significant issues than anything in Brooks’ column.


Brooks misses the connection between the two because he conflates a centuries-long phenomenon – the development of modernism — with more recent changes that are appropriately a source of concern: the decline of community. Studies of the difference in values between modernists and traditionalists emphasize, as does Brooks, the importance of community. These researchers find that traditionalist communities, whether they consist of specific church groups, developing world nations or working class neighborhoods, tend to be characterized by close kin networks, while modernist communities have networks more likely to be defined by something other than blood ties.  These differences mean that the source and content of moral transmission varies: modernists tend to rely on individualized internalized values transmitted within private networks while traditionalists depend more on the health of institutions that articulate and reinforce pubic values.

In the United States, the differences between kin based traditionalist networks and individualistic, modernist ones tend to be strongly associated with class. In the Italian-American community of my youth, for example, my father simply moved in with my mother and grandfather when they married. We lived next door to an aunt and uncle. Another aunt and uncle and three of their four grown children lived on the next block. My mother spoke to her sisters every day. I never had a babysitter to whom I was not closely related. And we all attended the same church. I realized only as an adult that while we all identified as Catholics, our views ranged from deep devotion to profound skepticism. Yet, we were imbedded in close-knit family networks that tended to reinforce Catholic teachings about acceptable behavior.

All that changed when my cousins and I attended college far from home. We have each made individual decisions about what church to attend and what identities to embrace. I have had far more intense discussions about my moral and philosophical views with my college-educated colleagues than I ever did with the family members or co-religionists of my youth. The discussions occur in part because we do not share the same assumptions about the source of values.

This selection, articulation, and promotion of individual values takes more effort than my home community’s allegiance to a particular religion or ethnicity. It also requires respect for the views of others. The ability to combine strong individual values with tolerance in a diverse society is what education for democracy means. It is a critical legacy of the Enlightenment and the foundation of modernist societies.

In contrast, traditionalist approaches, which rest on morality that is “revealed, inherited and shared,” require strong institutions. Institutional leadership, rather than individual virtue, is necessary to combine group allegiances with public tolerance and to mediate the tensions between group interests and membership in a broader society.

What Brooks doesn’t tell you is that the real crisis in contemporary American society is the weakening of the institutions that serve those on the losing end of the American economic ladder. One of the startling observations in the Moynihan Report of the mid-sixties was his finding that as jobs disappeared from rustbelt inner cities so, too, did church attendance. A half century later, Brad Wilcox has found the same thing among the working class more generally. With economic decline that has disproportionately affected traditionalist America, the institutions that produced cohesive communities, including churches, schools, families and civic organizations, are in decay. Modernity with all its faults, however, is not the principal source of the problem. And the risk Brooks does not acknowledge is that attacks on modernity in the name of morality often become attacks on tolerance. Let’s address the real sources of institutional decay and stop conflating the challenges of the last few years with the cultural changes a millennia in the making.

* The author is Edward A. Smith/Missouri Chair of the Constitution Law and Society University of Missouri-Kansas City

Today’s Modern Money Primer

In the next series of blogs we will look in more detail at fiscal and monetary operations of a nation with a sovereign currency. Before we do that, let us briefly examine the case of the Euro. There is no way the system as designed could possibly survive a significant financial crisis. And a crisis began in 2007. Due to flaws in the set-up, it was obvious (at least to those who adopted MMT) that the original arrangement was not sustainable. Read more…

MMP Blog #16: The Unusual Case of Euroland: The Non-Sovereign Nature of the Euro and the Problems Raised by the Global Financial Crisis

By L. Randall Wray

In the next series of blogs we will look in more detail at fiscal and monetary operations of a nation with a sovereign currency. Before we do that, let us briefly examine the case of the Euro. Let me say that we will not address the unfolding crisis across Euroland in detail. The reason is that events are moving too quickly and we do not know where they will lead. This primer in some sense needs to be “timeless”—anything specific that we discuss will quickly become outdated. The fundamental point to be made here is that the Euro arrangement was flawed from the beginning. Crisis was inevitable—as I have been writing since the mid 1990s. There is no way the system as designed could possibly survive a significant financial crisis. And a crisis began in 2007. Due to flaws in the set-up, it was obvious (at least to those who adopted MMT) that the original arrangement was not sustainable. We could not say for sure how the resolution would turn-out, but a fundamental change would be required.

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It Takes Real Skill to Lose $2 Billion

By L. Randall Wray
Sometimes you come across a story that really warms the cockles of your heart. I am talking, of course, about the report on UBS’s star trader, Kweku M. Adoboli who lost $2 billion. He is only 31 years old. Now, what had you accomplished by the time you were 31? Mr. Adoboli had risen through the ranks to the point that he was entrusted with a trading account that let him accumulate a loss of $2 billion. Imagine this guy’s potential! Limitless opportunities await him on Wall Street—at least, once he gets out of prison. And he could open a “think tank” like Michael Milken, devoted to proving that his trades might possibly have made good if only the world had cooperated.

Look, it’s easy to make billions on Wall Street—any dopey trader can do that. You can always follow the example set by John Paulson. Approach Goldman Sachs and propose that the firm let you pick the worst possible toxic waste assets, bundle them into securities, and then Goldman sells them to its own clients. Upward of 98% of the bad assets prove to be, well, bad, and both you and Goldman make out like bandits, and the clients get screwed. Duping customers is the sure-fire investment bank way to make profits. You cannot help but funnel client’s money to traders’ bonuses. It is impossible to lose, and that is why Wall Street is doing just fine, thank you, while the global economy collapses all around us.

Mr. Adoboli presumably tired of the sure thing. According to reports, he was supposed to be working in exchange traded funds, matching buyers and sellers in a high volume, low risk market where risks are easily hedged. That is sort of like the investment bank equivalent of a Jimmy Stewart thrift. Obviously, no one wants to do that kind of business—earning spread money. And so investment banks have created an infinite number of schemes to dupe sellers and buyers, trading for their own account while betting against clients.

But that’s the sure thing. Mr. Adoboli instead—according to various reports—tried to take advantage of price differentials between traded index securities and underlying stocks, and avoided hedging risk.
It’s hard to lose money in investment banking, but if you are really, really clever you can find a way to do it.

I hope he gets his bonuses this year. Initiative deserves reward. After all, the big banks continued to pay stupendous bonuses when the financial crisis hit, rewarding traders and CEOs for record losses. The argument, of course, was that in a time of such distress, no bank could afford to lose such highly skilled help. Where would they find replacements able to dream up losing propositions?

Now, UBS will need to keep Mr. Adoboli on retainer or they’ll lose him to a competitor looking for a star with potential to lose big bucks. After a stint punching out license plates, he’ll rise to the top of some investment bank. I’ll put my money on him—as the next Bob Rubin, Lloyd Blankfein, Dick Fuld, John Thain, Hank Paulson or Joe Cassano, all richly rewarded for driving their institutions into the ground.
No one remembers the CEOs or traders who actually make money for their shareholders. Name one. That’s what I thought, you can’t. Because it’s child’s play. We remember the Nick Leesons, the guys with real vision and willingness to take risk, and ability to run up losses.

Even John Paulson got tired of the easy, sure thing. He’s now on a fantastic losing streak. He’s down 40% this year. Yes, I know he made $5 billion last year betting on gold. But gold is a fool’s bet. Look, when Dallas hedge fund manager J. Kyle Bass dupes the University of Texas into buying a billion dollars in gold bars, you know gold has become the sucker’s bet. Poor Paulson does not realize he is on the client side of a Vampire Blood Sucking Squid trade this time!

After all, investment banks only lose the money of clients and shareholders. Who cares? Wall Street is just a crap shoot, with other people’s money—heads Wall Street wins and tails everyone else loses. Why all the fuss?

Think about it this way. Let us say you go to Las Vegas to lose $2 billion (maybe you are the treasurer for a pension fund) and start feeding the slot machines as quickly as you can. The problem, of course, is that you are going to win occasionally—so you’ve got to get those coins back into the slots. Your goal is to lose, say, $1000 per day. Maybe you’ve got to put $1850 on average per day into the one-armed bandits to average a loss at that daily rate. It’s going to take you about 5500 years to lose $2 billion. That shows you the long odds that Mr. Adoboli was up against—he’s only 31 and he’s already lost his first $2 billion.

That folks, is skill.  

In related news you cannot miss three similarly heart-warming stories.
1. In a new book to come out this week by Ron Susskind (Confidence Men: Wall Street, Washington, and The Education of A President) we’ll see how Timmy Geithner saved the world from a rookie President Obama who ordered the Treasury to develop a plan to shut down the biggest banksters. Fortunately, Geithner thought better of that, so instead he worked with the Fed to provide a $29 trillion dollar rescue package to keep the banksters in business. If he had actually listened to his president, who knows whether Mr. Adoboli would have been able to lose those billions. 
2. Former Senator Bob Graham urged President Obama to reopen and investigation into the Bush Administration’s rescue of Saudis in the aftermath of 9-11. You see, most of the terrorists involved were Saudis and they almost certainly had help from rich and prominent Saudis living in the US. Fearing a backlash, investigation, and possible prosecution they asked President Bush to make a wee little exception to the grounding of all aircraft. Bush launched a fleet of jets to rescue them. All this had been exposed long ago by Michael Moore, but new information sheds lights on close connections between particular terrorists and rescued Saudis. Since the Bushes and the Bin Ladens are close family friends (even closer than the Bass brothers), all stops were pulled to sweep them out of the country. You’ve got to love the loyalty.
3. And speaking of loyalty, what do you do when your best bud dies? You take him bar-hopping of course. Especially if you live in Denver, where they not only serve drunks, but even corpses! When two guys found their buddy dead, they loaded him into the car and headed to the bar. The dead guy paid. After a couple of bars, his friends dropped him back at home to rest in peace, then they hit the ATM machines using his card. He won’t need the money in the sweet hereafter, after all. (The only Bush angle I could find is that brother Neil helped to bring down Silverado in Denver, with Uncle Sam footing the billion dollar loss. But we know those Bushes like to party and I’m sure they appreciate the spare-no-opportunity-to-party initiative taken.)