A Quick Note In Response to Naked Capitalism

I'm phobic about kleptocracy, not Modern Monetary Theory

Longtime friend Yves Smith of Naked Capitalism published an interview today with Richard Vague, Pennsylvania's acting Secretary of Banking and Securities, that takes issue with my last two Substack pieces on the recent bailouts.

Both Vague and Yves seem to think I've been "acrophobic" about modern Monetary Theory and perhaps unconsciously mired in questionable orthodoxies about debt and government spending. In response to my contention that "we're about to find out that the American economy has been living off dying, dysfunctional, or hyper-leveraged markets for more than a decade," Vague notes:

So Taibbi writes that we’ve been living off highly leveraged markets for more than a decade, and, yes, he’s correct, but we’ve been living off highly leveraged markets for a hundred years or more.

What I’m here to tell people is that the government debt component of this is not the problem. The problem has been and continues to be the private sector debt component of this that is. In a crisis like this, we have the capacity to fund higher levels of government spending and support much higher levels of government debt.

To a comment I made on The Hill: Rising about how the bailout "looks like forever," Vague notes:

This comment belies the fact that we did largely unwind from the last bailout. The Fed unwound much of the market support mechanisms it had put in place, and the total notional value of Federal Reserve swap lines has declined from $583 billion at their peak in the crisis to $349 billion most recently.

The interview was interesting and the kind of critique people like myself who are not experts should take to heart. I did however want to push back on a few things, because I think Vague and I are talking about apples and oranges, at least in some areas. So I wrote Yves a letter, part of which I’m excerpting here because I think there are some issues worth going over here.

Professor Vague seems interested in drawing distinctions between public and private debt, and in making clear that the Great Recession was caused by high levels of private sector debt, not public debt. This seems to be the thrust of the interview, i.e. that I’m erring in warning about high levels of public debt and Fed intervention, implying that these solutions are intrinsically bad when they are not.

I don't see it that way. To me the story of the last several decades of bubble economics is very much about cycles of irresponsible/rapacious private sector behavior followed by public bailouts of increasing size and scope. I see this as one ongoing phenomenon, not two different narratives.

The understanding that the government will be there to clean up the messes of Wall Street has effects on the economy that are both tangible (i.e. the implicit subsidy large banks enjoy vis a vis smaller ones, which one study calculated at $83 billion in annual value in 2013) and intangible (psychological inducements to take on more risk, and trading strategies based on those assumptions, e.g. the “Greenspan Put”). The bailouts of 2008-2009 sent a clear message that much of what we understand as “private sector” activity is actually a quasi-protected, quasi-backstopped pseudo-market, in which explicit and implicit guarantees alike are systematically monetized and turned into profits for a handful of companies and executives.

Just to take one example, how do we classify the Money Market Funds market? The Treasury stepped in to guarantee the $3.4 trillion market in 2008 and it was backstopped again this year. Money Market Funds are supposed to be a cash-like product, similar to bank deposits, except bank deposits come with a series of regulations and capital requirements in exchange for an explicit guarantee. But if in practice Money Market Funds are going to be rescued every time, then we’re just using the government to backstop a more systemically dangerous version of government-insured bank deposits.

Vague is right that the last disaster was caused by private sector craziness that people like Yves and I have talked about many times, in particular the financialized casino built around mortgage products like synthetic CDOs that helped create mountains of deadly leverage that collapsed in 2007-2008.

A lot of right-wing critics, desperate to draw a connection between “social engineering” and the 2008 crash, have tried to place the blame for that crash on Fannie and Freddie and on “affordable housing policy.” I’ve always thought this is inaccurate – as the Financial Crisis Inquiry Commission and many others pointed out, the GSEs were really followers rather than leaders in the MBS boom, and actually made much better and safer decisions about subprime than their private-sector counterparts.

However, when the government and the Fed stepped in to bail out the worst actors of 2008, all of that irresponsible mortgage gambling did end up becoming an essentially government-sponsored activity (though not for the reasons right-wing critics suggested). The companies and individuals who were most irresponsible in the subprime era tended to be rewarded, and many even had their market share and power increased via state interventions after the crash.

I think particularly of Bank of America being bailed out and helped in efforts to acquire Merrill Lynch after making the terrible decision to take on Countrywide, of the AIG counterparties bailed out via the AIG bailout, and of the multiple Fed-aided mergers and extensions of regulatory relief that left companies like JP Morgan Chase, Goldman, and Morgan Stanley even bigger and more systemically dangerous than they were before the crash.

My point in all of this is that when Professor Vague says “we did largely unwind” many of the "market support mechanisms" after the last bailout, I think he’s being overly literal. The last bailout took Too Big to Fail companies and made them Too-Big-To-Failier. The continued conquest of market share by those firms, particularly in relation to smaller regional competitors who don't enjoy implicit support, is to me an uncounted ongoing bailout benefit.

So is the absence of regulatory intervention for bailed-out firms who escape prosecution for misdeeds like Forex or LIBOR manipulation because of fears about “collateral consequences” to these "systemically important" organizations (this was spelled out explicitly by officials like Eric Holder over the years).

But more than anything, the promise of future rescues is in itself an enormous ongoing subsidy, one that played at least some part in a variety of questionable behaviors in the last decades, from seeking out riskier investments to increasing shareholder distributions to shifting strategies toward shorter-term profit schemes.

When I look with suspicion at developments like the Fed expanding its footprint in the economy in response to the crisis, I’m not denying that “the Federal government needs to engage in massive spending to prevent a huge deflationary shock” as Yves puts it, or relying on “questionable orthodoxy” about debt and spending to criticize Modern Monetary Theory.

Maybe MMT is the only way out, maybe not, but what I see is that either way, the latest Covid-inspired plan for "QE infinity" isn't going to produce MMT the way its adherents imagine it. Absent big structural changes, we’re going to have a prolonged intervention in a financialized economy that remains designed to disproportionally push resources to a few actors, while socializing losses.

It’s possible a massive Fed intervention is necessary, but I’m pretty sure putting Black Rock in charge of rescuing its own junk bond ETF or retroactively financing half a decade of airline industry buybacks raise questions unrelated to whether or not MMT is the proper solution to our current economic problems.

Vague is talking about monetary theory. I'm talking about what happens when we pump $5 trillion (for starters) into the economy through people who make Somali sea pirates look like the Better Business Bureau. If I'm phobic, it's more about stealing than government debt! At least for now, I think these are two different issues for reporters like me to worry about.