Ok folks, we had some fun in part 1 where the good people at econstories.tv contrasted classical economist Friedrich Hayek (Austrian School of Economics) with the father of Keynesian economics John Maynard Keynes via a well done rap song. Our friends over at Greenbackd are unabashed adherents to the Austrian model (Toby has written several excellent posts on the topic) while Team Obama thus far has favored the Keynesian school in their economic policy with programs like stimulus and cash for clunkers. These distinctions are important as they fundamentally shape how their adherents view the regulation of our financial system which is a vital subject given the implosion of our financial system in late 2008. Before I give my thoughts let’s visit with Wiki and get some background, first on the Austrian School:
According to Austrian School economist Joseph Salerno, what most distinctly sets the Austrian school apart from neoclassical economics is the Austrian Business Cycle Theory:
The Austrian theory embodies all the distinctive Austrian traits: the theory of heterogeneous capital, the structure of production, the passage of time, sequential analysis of monetary interventionism, the market origins and function of the interest rate, and more. And it tells a compelling story about an area of history neoclassicals think of as their turf. The model of applying this theory remains Rothbard’s America’s Great Depression.
Austrian School economists focus on the amplifying, “wave-like” effects of the credit cycle as the primary cause of most business cycles. Austrian economists assert that inherently damaging and ineffective central bank policies are the predominant cause of most business cycles, as they tend to set “artificial” interest rates too low for too long, resulting in excessive credit creation, speculative “bubbles” and “artificially” low savings.
According to the Austrian School business cycle theory, the business cycle unfolds in the following way. Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system. This in turn leads to an unsustainable “monetary boom” during which the “artificially stimulated” borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital resources to be misallocated into areas which would not attract investment if the money supply remained stable. Economist Steve H. Hanke identifies the financial crisis of 2007–2010 as the direct outcome of the Federal Reserve Bank’s interest rate policies as is predicted by Austrian school economic theory. Continue reading “Slabbed takes the regulatory challenge part 2: Which school do you belong to?”
Dedicated to a reader. I’m off to buzzards roost and will check back later. (h/t Russell)
Friedrich Hayek, Nobel-prize winning economist and well-known proponent of free markets, is having a big month. He was last seen rap-debating with John Maynard Keynes in the viral video above, (in which Hayek is portrayed as the sober voice of reason while Keynes overindulges at a party at the Fed). His 1944 book, “The Road to Serfdom,” provided the theme for John Stossel’s Fox Business News program on Valentine’s Day.
One week ago Tuesday I sat in front of my Television spellbound watching PBS Frontline’s profile of Brooksley Born, a former Clinton Administration agency head who has since been termed the “Credit Crisis Cassandra” by the media. As the show ended all of my questions regarding the ineptitude of Obama’s economic team were answered and then some. Before we get to the answers we must first explore how Ms Born, as head of a sleepy federal agency in the Commodity Futures Trading Commission, tried to rein in and regulate over the counter derivatives of the same kind that imploded our financial system back in late 90’s. Lets begin with a story the Washington Post ran on the subject last May for the background:
A little more than a decade ago, Born foresaw a financial cataclysm, accurately predicting that exotic investments known as over-the-counter derivatives could play a crucial role in a crisis much like the one now convulsing America. Her efforts to stop that from happening ran afoul of some of the most influential men in Washington, men with names like Greenspan and Levitt and Rubin and Summers — the same Larry Summers who is now a key economic adviser to President Obama.
She was the head of a tiny government agency who wanted to regulate the derivatives. They were the men who stopped her.
The same class of derivatives that preoccupied Born — including the now-infamous “credit-default swaps” — have been blamed for accelerating last fall’s financial implosion. But from 1996 to 1999, when Born was the chairman of the Commodity Futures Trading Commission, the U.S. economy was roaring and she was getting nowhere with predictions of doom.
So, upstairs in the big house in Kalorama, Born tossed and turned. She woke repeatedly “in a cold sweat,” agonizing that a financial calamity was coming, she recalled one recent afternoon.
Special thanks to Chris Sposato. If memory serves there were a dirty (half) dozen “guaranteed” Cat Bond issues connected to Lehman. The second to come tumbling down belongs to Bermuda based Aspen Insurance Holdings, Ltd. and their special purpose entity Ajax Re Ltd. The associated ri$k to take a hit is covered earthquake damage in California. The story itself begs additional research as this deal sounds as if there might be Cat Bonds stuck inside Cat Bonds with a (subprime) Mortgage Backed Security twist. The list of players per the article is very convoluted as well. The Royal Gazette has the Bloomberg story:
Ajax Re Ltd., a catastrophe bond sold by Bermuda-based Aspen Insurance Holdings Ltd., is likely to default on an interest payment this month, Standard & Poor’s said, the second such security hurt by Lehman Brothers Holdings Inc.’s collapse.
S&P said it may downgrade $100 million of debt issued through Ajax Re Ltd. to D, the lowest grade, from CC, citing an “imminent interest payment default”, according to a statement from the New York-based ratings company yesterday.
Aspen sold the bonds in 2007 to protect against claims from Californian earthquakes.
The Securities and Exchange Commission says it has agreed with Bernard Madoff on a deal that could eventually force the disgraced money manager to pay a civil fine and return money raised from investors.
The agency said Monday the agreement states that Madoff cannot contest allegations of civil fraud and that possible penalties will be decided “at a later time.”
The SEC says that it has submitted the agreement to a federal judge in Manhattan, who will review it.
The deal will not affect a continuing criminal investigation of Madoff who authorities say has described his investment activities as a $50 billion Ponzi scheme.
Sup was kind enough to email me his take on recent State Farm actions in Florida and IMHO is spot on. First let’s back up to Nowdy’s post yesterday which featured a recent article from the Insurance Journal:
Florida Chief Financial Officer Alex Sink is urging State Farm Florida to “immediately” let its agents do business with other insurance companies for their more than one million policyholders now that State Farm is withdrawing from the state.
But State Farm has rejected the idea.
Sink called State Farm Florida’s contracts with its agents “inappropriate” for limiting them to placing business only with State Farm but stopped short of calling the arrangement illegal.
Has State Farm really cast their agents adrift as Nowdy’s setup piece implies? Or are they an army of financial destruction? Sup pick’s it up from here:
One must read between the lines as to SF’s position on not provinding alternative markets for their agents with their recent decision to non-renew all Homeowner polices in FL. On the surface it seems like a simple business decision based on their contract and historically Direct Writers only allowed their agents to sell their products. Continue reading “Paper Moon or Death Star? The Farm Strikes Back in Florida”
Given the current financial mess that resulted from unsound and ill advised financial practices my total amazement at certain of the state insurance regulators for allowing insurance companies to count such silly things as deferred income taxes in their capital computations is mind boggling. Anyone else remember the industry meme the past 6 months repeated by paid insurance industry shills like Robert Hartwig of the Insurance disInformation Institute that this was a bank problem and that insurers were financially strong? Financially strong enterprises don’t spend time getting regulatory blessing to cook their books. In fact I’ll go a step further and publicly advise what I’m telling my paying clients, If your bank or insurer counts silly things like their net deferred tax asset as capital, run don’t walk for the door. Simply put it means they are in severe financial distress. In Allstate’s case details have emerged in the national media as to the extent of their problem. We begin at the WaPo:
Allstate, the big insurer, last week declared that despite unprecedented trouble in the markets, it remains financially strong.
But tucked deep inside a company report is evidence that Allstate changed its bookkeeping last year in ways that improve its financial appearance.
One accounting change added $347 million. Another delivered a year-end boost of $365 million.
Allstate’s actions illustrate a broader risk to investors, policyholders and people looking for insurance. Insurers have been asking regulators to let them operate with thinner financial cushions or to pad those cushions with assets they could not otherwise count. For anyone trying to assess the companies’ financial strength, the changes can cloud the picture. That could make it harder for people to make sound decisions when buying policies or annuities to protect their families.
Cat bonds that is and certainly they have been topical this week here on slabbed. Let’s begin by taking a trip back in time to the Bloomberg story we linked on Willow Re, an Allstate SPE (special purpose entity) earlier this week:
The issuer has notified Standard & Poor’s that it will not have sufficient funds to make the scheduled interest payment,” S&P analyst Gary Martucci in New York wrote in the statement.So-called cat bonds have gained popularity as a way for insurers to protect against natural disasters, and buyers demand outsized returns because they risk losing their entire investment to the insurer if the catastrophe is large enough. With Willow Re and other bonds backed by Lehman, investors are on the verge of losing a portion of their stake because of a financial calamity instead of a natural one.“The market was already pricing Willow Re in the area of 50 cents,” said Christophe Fritsch, head of insurance-linked securities at Axa SA in Paris. “New deals will improve dramatically. Investors will make sure that they will only be exposed to insurance risk and won’t take credit risk.”
Over the past few days, I’ve read or read over all 400 along with related news articles, blog posts and the like. Without belaboring the point, I’ll add that I read all with the eyes of someone both trained and experienced in the design/redesign of systems of service.
The “official” publications propose to “modernize the outdated U.S. Financial Regulatory System” with the usual problem-based approach to system development/reform of government that results in the more things change, the more they stay the same. In this case, however, the proposed changes are based on a misunderstanding of the problem.
Among those in government or entities of or linked to the financial system, there appears to be almost universal agreement the problem is the patchwork of state/ federal regulatory oversight over a collection of entities that make up a financial system but that there is no real system.