Should Central Banks Be De-Fanged?

Holman W. Jenkins writes:  Ben Bernanke wishes otherwise, but his historical reputation won’t rest only on his efforts to save the financial system, but on his contribution to the meltdown in the first place by letting Lehman fail.

“We had little doubt a Lehman failure would massively disrupt financial markets and impose heavy costs . . . on millions of people around the world who would be hurt by its economic shockwaves. . . . I never heard anyone from the Fed or the Treasury suggest that letting Lehman fail would be anything other than a disaster, or that we should contemplate allowing the firm to fail. . . . Lehman needed to be saved. We lacked the means to do so,” writes Bernanke.

When Lehman weekend rolled around in September 2008 and it wasn’t clear yet that even AIG would be saved, we were flummoxed. Fed intervention seemed a no-brainer, given the assumptions and priorities that have driven such decisions in the past.  The Fed worried about the “end of our resources” and having to face the potential collapse of WaMu, Citigroup, Merrill Lynch and others with “no political support.”

Let’s try a thought experiment: Suppose President Bush, Candidate Obama, Nancy Pelosi and Harry Reid had all taken to their respective soapboxes and demanded that the Fed stop a Lehman crash. Would Mr. Bernanke have failed to bail out Lehman over a legalism? Of course not.

Maybe he and Hank Paulson were right: The highly political moment would have produced a populist backlash that would have inhibited their future rescue efforts.  It doesn’t follow that the Fed would have taken losses. Lehman, after all, was liquidated in a world in which Lehman had been allowed to fail. Second, the Fed can print money.

Less spin would be useful right now for one important reason: Politicians and the public still haven’t grown up about the too-big-to-fail problem. Mr. Bernanke says CEOs and shareholders won’t be eager to repeat the experience of Bear Stearns, Lehman, etc. If only it were so. Creditors were largely bailed out. That means, in the quest for competitive returns, shareholders and CEOs in the future inevitably will be led to press the limits on leverage because lenders believe them implicitly government-backed.

Mr. Bernanke is correct when he says the Lehman panic, not the relatively modest losses on subprime mortgages, caused the global crash. But let’s spell it out. Since the Great Depression, largely due to the scholarship of people like Mr. Bernanke, investors and savers were conditioned to believe the U.S. government would not let the failure of a mere financial institution crater the world economy. Now their confidence in the safety net was mortally shaken.

The time to worry about moral hazard is before a crisis, not in the middle of one.

John Kay writes:  More than a half-century ago, John Kenneth Galbraith presented a definitive depiction of the Wall Street Crash of 1929.  Embezzlement, Galbraith observed, has the property that “weeks, months, or years elapse between the commission of the crime and its discovery. This is the period, incidentally, when the embezzler has his gain and the man who has been embezzled feels no loss. There is a net increase in psychic wealth.” Galbraith described that increase in wealth as “the bezzle.”

Warren Buffett’s business partner, Charlie Munger, pointed out that the concept can be extended much more widely. This psychic wealth can be created without illegality: mistake or self-delusion is enough. Munger coined the term “febezzle,” or “functionally equivalent bezzle,” to describe the wealth that exists in the interval between the creation and the destruction of the illusion.

From this perspective, the critic who exposes a fake Rembrandt does the world no favor: The owner of the picture suffers a loss, as perhaps do potential viewers, and the owners of genuine Rembrandts gain little. The finance sector did not look kindly on those who pointed out that the New Economy bubble of the late 1990s, or the credit expansion that preceded the 2008 global financial crisis, had created a large febezzle.

It is easier for both regulators and market participants to follow the crowd. Only a brave person would stand in the way of those expecting to become rich by trading Internet stocks with one another, or would deny people the opportunity to own their own homes because they could not afford them.

The joy of the bezzle is that two people – each ignorant of the other’s existence and role – can enjoy the same wealth.  Shareholders in banks could not have understood that the dividends they received before 2007 were actually money that they had borrowed from themselves.

Investors congratulated themselves on the profits they had earned from their vertiginously priced Internet stocks. They did not realize that the money they had made would melt away like snow in a warm spring.

Fair value accounting has multiplied opportunities for imaginary earnings, such as Enron’s profits on gas trading. If you measure profit by marking to market, then profit is what the market thinks it will be. The information contained in the accounts of the business – the information that should shape the market’s views – is to be derived from the market itself.

And the market is prone to temporary fits of shared enthusiasm. There are numerous routes to bezzle and febezzle. In a Ponzi scheme, early investors are handsomely rewarded at the expense of latecomers until the supply of participants is exhausted. Such practices, illegal as practiced by Bernard Madoff, are functionally equivalent to what happens during an asset-price bubble.

The essential story of the period from 2003 through 2007 is that banks announced large profits and paid a substantial share of them to their traders and senior employees. Then they discovered that it had all been a mistake, more or less wiped out their shareholders, and used taxpayer money to trade their way through to new levels of reported profit.

The essential story of the eurozone crisis is that banks in France and Germany reported profits on money they had lent to southern Europe and passed the bad loans to the European Central Bank. In both narratives, traders borrowed money from the future. And then the future came, as it always does, turning the bezzle into a bummer.

Prime Minister Nawaz Sharif on Wednesday said Pakistan’s economy has been stabilizing due to prudent policies of current government.i

Sharif has urged the United States (US) for the withdraw travel advisories on Pakistan and grant access to Pakistani products to its markets.

In his address with the US-Pakistan Business Council in Washington, he highlighted how Pakistan has emerged as an attractive and thriving market for business and investment opportunities,.

“Pakistan has greatly improved its internal security situation, as well as achieved effective governance and public service delivery, resulting in robust economic indicators, in a short span of time,” Sharif said.

“We are confident that the improved security situation in Pakistan would lead to withdrawal of travel advisories on Pakistan.”

Pakistan has one of the most attractive investment regimes in the world, allowing foreign investors 100% repatriation of profits and easy convertibility into foreign exchange, he noted.

“Numerous investment opportunities are available in the energy, consumer goods, food & agriculture, housing, health care, education; finance Services, capital markets, information technology, oil & gas and infrastructure sectors of Pakistan.”

“No region has lagged as far behind in the world today as South Asia. To lift our people out of poverty, we must first of all establish peace in the region,” said the Pakistan PM. “We, therefore, seek good relations with all its neighbors.”

United States Treasury Secretary, Jack J. Lew talked to Sharif. Lew congratulated Pakistan for successfully implementing the government’s economic reform agenda which has resulted in macro-economic stability, rebuilding of foreign exchange reserves, and continuing reforms in the energy sector.

He also expressed the desire to deepen economic cooperation between the two countries.

PM Sharif underlined the government’s policies aimed at structural, energy, fiscal and monetary reforms in the short and medium term which have led to improved economic indicators for Pakistan.

He briefly touched on the legislative progress the government has made in the financial, taxation and other relevant fields.