Arnold Kling  

Three Links from Mark Thoma

Some Preliminary Political Eco... Time Consistency...

Chosen from among those here.

1. Gretchen Morgenson and Louise Story write,

authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them

Where are the customers' yachts? I can think of some ways in which financial innovation differs from other forms of innovation. One difference is that financial innovation often serves the purpose of regulatory arbitrage--devising an instrument to comply with the letter of regulation while evading its spirit. Another difference is that financial innovation often is used by clever Wall Street bankers to separate less sophisticated investors from their money. In that sense, it is sort of like innovation in stealing credit card information. In the case of bankers outsmarting their clients, you can blame the victims for failing to be wary or to protect themselves.

I guess people have little choice but to place at least some trust in investment bankers, even though that trust can easily be violated. Kind of like government.

2. Mark DeWeaver thinks that some of China's industrial capacity is not so impressive.

Consider cement production, where, according to the China Cement Association, 38% of capacity consists of "shaft" kilns. These have been obsolete in most of the rest of the world for over a century, and accounted for less than 3% of production even in 1957, when most of China's cement plants were imports from Eastern Europe. Nowadays, however, shaft kilns are a favorite of local governments because they can be built cheaply and quickly and generate growth and employment. Achieving economies of scale and lessening environmental impacts simply are not priorities.

Read the whole thing.

3. Matt Yglesias meditates on elites and masses.

we've outsources primary responsibility for macroeconomic stability to a quasi-independent technocratic institution that's primarily influenced by elite opinion rather than mass sentiments. This model is problematic in some ways, but in principle one of its advantages should be an ability to do the right thing at a time when the public may be confused by analogistic reasoning. Unfortunately, the same skew in favor of elite opinion also seems to me to give the Fed a skew in favor of elite interests and joblessness is primarily a problem at the moment for the sort of people who aren't likely to be invited to any FOMC members' Christmas parties.

From the Wall Street and Washington perspective, the banking system is the key to the whole economy. It makes sense to transfer wealth to the banks, and that money has to come from ordinary people. Ordinary people will not make that transfer voluntarily (in Unchecked and Unbalanced I offer the thought-experiment of having Henry Paulson fund TARP with donations). So you have to take wealth from ordinary people for their own good. Who is Matt Yglesias to question that?

See also Peter Boone and Simon Johnson on why Ben Bernanke should not be reconfirmed.

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COMMENTS (4 to date)
wm13 writes:

I had understood the phrase "regulatory arbitrage" to mean not compliance with the letter of the law rather than its spirit (a pretty common activity), but a much more precise phenomenon: the creation and sale of a product which is regulated under regime "A" but competes against products regulated under regime "B". The two different regimes might be regimes imposed by different governments, or different agencies of the same government, or other similar possibilities.

An example would be SUVs, which as I understand are treated as trucks for CAFE purposes, but compete against (and, indeed, have largely displaced) station wagons. Or VOIP phone service, which as an "internet service" is largely unregulated and untaxed and therefore enjoys an advantage over regulated and heavily-taxed phone service. As these examples make clear, the phenomenon is hardly limited to financial services.

By the way, please note that the purchasers of CDOs and MBS are not exactly widows and orphans: they are insurance companies, investment funds and the like. The executives and managers at those places have plenty of yachts. The losers (like the guys at AIG, Lehman or Wachovia) may have had to sell some yachts, the winners (like the guys at Goldman and JPM) may have bought some more yachts, but no one has missed a meal.

David C writes:

"So you have to take wealth from ordinary people for their own good."

Are parents or legal guardians allowed to take things from their children for their own good?

I stress the legal guardians part because legal guardians are unrelated to the child in the same way that governments are unrelated to adults. Why is there a cut-off between children and adults? Is it because adults are over the age of 18? Isn't that distinction entirely arbitrary? If an adult makes a mistake, why is morally wrong for a government to correct that mistake? If a child makes a mistake, why is it morally okay for a legal guardian to correct that mistake? Just what is the distinction other than an arbitrary age boundary?

Milton Recht writes:

Always, take Gretchen Morgenson with a grain of salt and two aspirin.

Putting together a bundle of securitized mortgages for sale is a form of underwriting and there is a period where the underwriting firm is at risk from the sale. It is commonplace to hedge some of that risk, which is a bet against the security.

Firms bet against their customers to protect themselves from the risk inherent in all IPOs and public underwritings. For firms that engage in creating new securities, such as securitized mortgages, it is the prudent thing to do.

Firms that frequently securitize mortgages can save money if they use a long-term hedge that lasts for several underwritings.

Colin k writes:

This line was the money quote for me:

"Deutsche, which declined to comment, at the same time was selling synthetic C.D.O.’s to its clients, and those deals created more short-selling opportunities for traders like Mr. Lippmann."

You can argue that CDO investors kept saying "awful food--and such small portions" to a certain point. What it looks like is that they kept finding ways to package securities for the rubes so long as they (the I-bankers) were able to take the other side of the bet (or sell it to a better friend). Thisis Vegas-style bookmaking, only I suspect the Street boys take a much bigger vig.

The real question for me is, to what extent did the banks disclose their counter-writing activities? One suspects that a lot of buyers' appetites might have been lessened had they known the milk was being mixed with lead paint.

The real question for me is, did the banks disclose

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