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The Bill Daley Problem

Simon Johnson has posted the article The Bill Daley Problem on his BaselineScenario web site.

The Bill Daley Problem is completely bipartisan – it shows us the White House fails to understand that, at the heart of our economy, we have a huge time bomb.

Johnson goes on to describe the time bomb.

Today’s most dangerous government sponsored enterprises are the largest six bank holding companies: JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley.  They are undoubtedly too big to fail – if they were on the brink of failure, they would be rescued by the government, in the sense that their creditors would be protected 100 percent.  The market knows this and, as a result, these large institutions can borrow more cheaply than their smaller competitors.  This lets them stay big and – amazingly – get bigger.

I wonder if the danger could be ameliorated by explicit statements from the administration to the debt holders of these institutions that they will not be bailed out if the banks go bust.  The statement would explicitly emphasize the great risk these people are taking by investing in these banks.  Of course, we will never find out the answer to my wonder.  No administration, especially not this one, would ever put out such a clear warning.

There a lot of links in the Johnson article which I intend to follow up.

I had been meaning to post something about the appointment of Daley as Obama’s chief of staff as yet another indication that this administration had gone off the rails. Simon Johnson has done all the work and stated the case much more authoritatively than I ever could have done.


I have looked into just a few of the links in Johnson’s article.  The first few were over a year old, which is hardly a sign of peoples’ current thinking.

Then I checked out the link “Gene Fama, father of the efficient financial markets view, gets it better than anyone.” This again raises my doubts as to whether or not Simon Johnson and I are on the same wavelength or not.

Gene Fama is definitely infected with the Chicago School of Economics sickness.  As the father of the theory of efficient markets, he perverts the whole idea in order to defend capitalism.  His theory claims that the market sets prices based on all the current available information. If this were true, then perhaps his claim would be true  that capital could not be allocated any better than the way the free market allocates it.  He too readily dismisses the idea that bubbles are proof of the failure of efficient markets.  He says nobody could have known we had a bubble that was going to burst.  Amongst that crowd of nobodies he must dismiss all the people who were predicting that we were in a bubble and it would burst.  Some of those people included Nouriel Roubini who was complaining about derivatives as the bubble inflated.  Even Warren Buffet was claiming that financial derivatives were financial weapons of mass destruction.  All the people who were warning that the repeal of the Glass-Steagall act during the Clinton administration would lead to disaster turned out to be correct.  (I count myself among the people who were contemporaneously predicting the fallout from the repeal.)  Of course Fama is right that nobody could have predicted the exact date of the burst.

Fama claims that regulation is doomed to fail.  He agrees in a way with Simon Johnson that the idea of banks being too big to fail should be off the table. Instead of regulation we ought to raise capital requirements dramatically to as much as 40%.  I wonder who Fama thinks has the power to raise this requirement?  That wouldn’t be some form of regulator would it?  Couldn’t be.  He doesn’t believe in regulation.

I know, some of what I am saying is too simplistic an argument against Fama, but no more so than Fama’s use of efficient market theory to defend the Chicago School’s theory of how the world ought to work.  They don’t seem to recognize the difference of how something ought to work in a utopian world and the limits on how things can actually work in the real world made up of real people and not some ideal automaton.

If only real people would be completely rational.  If only politicians didn’t behave as politicians do.  If only big corporations didn’t use their resources to buy off politicians.  If only peoples’ lives could be adjusted instantaneously to each turn in the market.  If only people didn’t starve when they could not afford to buy food.

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