Magneto trouble

INSERT DESCRIPTIONNo, not him

One of my favorite Keynes quotes comes from Essays in Persuasion, in which he tried to explain the nature of the Great Depression, which was still in its early stages, and declared that “we have magneto [alternator] trouble.” The economic engine was as powerful as ever — but one crucial part was malfunctioning, and needed to be fixed.

That’s about where we are now. The defective alternator is the financial system. We replaced the old, bank-centered system with a high-tech gizmo that was supposed to be more efficient — but it relied on fancy computer chips to function, and it turns out that there were some fatal errors in the programming.

Anybody know a good mechanic?

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tai March 10, 2008 · 4:27 pm

Was the new-fangled financial gizmo the real problem? Or did it simply manage to treat the symptoms of the underlying problem until the system collapsed upon itself. I vote the latter, with the underlying condition our wealth/resource allocation problem.

Jim McCarthy March 10, 2008 · 4:34 pm

In the old banking system, banks (commercial and investment)sold debt instruments to raise money to lend.

In the new banking system, banks (commercial and investment) sold debt instruments to raise money to lend.

The core problem is not the structure but that the “value” of the debt was highly inflated – the failure of credit underwriting. If the AAA tranche was really AAA, there won’t be an issue.

The structure comes in to play in that the players are rewarded for convincing the buyer that the debt is worth more than it is – and not penalized when caught.

The sellers of these lemons should be penalized. But we shouldn’t forgot that the investors who bought the lemons are also at fault. Portfolio managers are paid to know what they’re buying.

What we need is not just a new magneto, but also an educated driver.

roublen March 10, 2008 · 4:36 pm

It seems to me that, in part, we’re facing a failure of imagination: we can’t imagine what will replace housing as the driver of our economy. It seems to me that three plausible answers are preventive health, energy-efficiency (like zero-emission vehicles for short-haul delivery fleets), and last-mile fiber for fast broadband. How about creating three new institutions, Treadie Mae, Connie Mae, and, er, Fibie Mae, to make it easier to finance spending in these 3 areas;)?

JEFFREY LACKOWITZ March 10, 2008 · 4:40 pm

Your comments about the Fed bailing out the banks and FNMA by guaranteeing their debts may not work even if it comes to that. The Fed may no longer be seen as credit worthy. Their guarantee may be worthless due to the already tremendous Federal debt adn unbalanced federal budget.

Hank Roberts March 10, 2008 · 4:44 pm

Hmmmmm.

Remember when the USSR collapsed because its financial system was overburdened by its defense expenses?

This
//www.fourmilab.ch/evilempire/
was topical in the news
//www.fourmilab.ch/autofile/www/chapter2_99.html
at the time.

Prophetic? You tell us ….

Chief Debt Officer (CDO) March 10, 2008 · 4:44 pm

Let’s resurrect Paul Volcker!

Scott Ferguson March 10, 2008 · 4:48 pm

The juxtaposition of the photo is worth the click

SteveB March 10, 2008 · 5:01 pm

Thomas Palley on his web site suggests that the Fed allow non-bank institutions to use the Term Auction Facility. Is that a legal and workable solution to the financial lockup?

LD Fraley March 10, 2008 · 5:15 pm

Was the magneto the only problem in the 1930’s? I think not. There are too many explanations for the Depression to say it was only one item.

Today’s magneto may be the near larcenous behavior of the Wall Street bunch, but maybe it only surfaced in the first pass at analyzing why the motor stopped.

If we look further, the USA has been outsourcing jobs at an ever increasing rate for nearly two decades. When a plant or office closes in an area the workers either have to move or work for half their previous wage. The remaining economic activity cannot support the existing infrastructure.The value of real estate in that area drops to less
than half. This includes houses, schools, roads,
offices, plants etc. The investors, who financed all this, take the hit.

What makes this look like a major overhaul or trip to the junkyard is the estimate by Dr. Alan Blinder that 40 million jobs will be lost over the next decade or so. Not only manufacturing but everything that can be done over the internet will go.

New jobs need to be created and the infrastructure necessary to support them needs to be financed. A lot of questions here. One, how do you finance something with a 30 year mortgage that has an economic life of 5 years.

Maybe our presidential candidates who are plumbers (throwing kitchen sinks at each other) should take some auto mechanics (economists) advice and then tell us how thay plan to get the jalopy running.

Moma March 10, 2008 · 5:44 pm

Should replace it with a Japanese part, oh wait, theirs sputtered out too…. Maybe use an European part….

don March 10, 2008 · 6:24 pm

Your posts, and much of the other commentary, seems focused on short run cures for a short run problem. But there is a very real and growing problem in our economy – namely, for some years, personal saving has been negligible, and both the private and government sectors have been huge net borrowers. Suppose we stop the current tendency to retrench and keep up our spendthrift ways. Is that your solution? What happens, then, when the huge fiscal overhang (retirement of the baby boomers) comes?

JakeR March 10, 2008 · 6:26 pm

The magneto provided (and still does, on at least some light aircraft) the spark. The alternator (generator on older vehicles) provides power to the accessories and to recharge the battery. Please do a bit of fact checking before you pontificate on non-economic subjects.

Michael McKinlay March 10, 2008 · 6:53 pm

This is not magneto trouble.

This is the engine running with out oil … the oil is the trust that banks and investors have to have to make the system function.

The Federal Reserve has also betrayed that trust and must be replaced with a public central bank that creates credit money, money that doesn’t need debt to be created.

apikoros March 10, 2008 · 7:07 pm

I agree with Mr. McKinlay.

Back in the 1970s, when Volkswagens were too numerous to worry about saving, there used to be a “sport” at VW events called an engine blow. An engine would be mounted on a test stand, the oil would be drained, the engine fired up and run until it seized.

Finance is the lubricant of our economy (and by “our” I mean the world’s). Since August the world’s economies have been running without that finance. I wonder how long that can continue and what the cost of the “rebuild” is going to be.

Schrodinger March 10, 2008 · 9:01 pm

At the deepest level, I think the problem is a secular decline in the ethics of American society and its business elite in particular. This has been caused by the boomer generation reaching management positions. In the 60s it was sex and drugs. Today it is CDOs and HELOCs and subprime.

Wall St. hires a lot of very smart people and I think many of them realized that the mortgages they were writing were garbage. The trouble is that the people just didn’t care.

They took their salaries and fees and tried to find some sucker to dump the garbage on. That’s what the whole securitisation industry was all about. Wrap the garbage up, spray it with perfume and AAA ratings, and then sell it to some sucker as a prime investment.

The people creating these mortgages and securities knew very well that they did not want this stuff in their own portfolio. In an earlier era ideas and honor and reputation would have but a brake on the excesses but with the boomers it is all about doing what feels good and damn the consequences.

donna March 10, 2008 · 10:14 pm

I think the problem is in the illusion that money actually creates anything itself, rather than as a facilitator of trade of things with value.

Thinking money itself has all the value leads to all kinds of trouble.

Andrew Gould March 10, 2008 · 10:36 pm

In physics, we call these a “phase diagrams”,
and the transition between states is
called a “phase transition”.

Reid Cunningham March 11, 2008 · 5:06 am

Minor gearhead point but the old equivalent of the alternator was the generator. The more modern equivalent of a magneto is a distributor. In some ways if helps with the metaphor. A magneto builds a chared distributes the charge to the right place at the right time. Money is flowing today, but it is not reaching the right people and the timing is way off.

Thanks for the posts, they have been very helpful in providing a real world economics education.

Some Bear March 11, 2008 · 7:40 am

What does the FMI has to say about this ?

I thought it was it’s job to have advices & remedies to economic crisis ? If I remember well, it already did alot of good to alot of countries with hailed advices & policies..

Dennis March 11, 2008 · 8:20 am

Unfortunately, fixing “errors in the programming” doesn’t help unless you know in great detail how the program is supposed to operate — i.e. — you have your business process nailed down. With all the new instruments and services out there, I fear our financial system doesn’t model itself well to a good solution.

Evileconboy March 11, 2008 · 9:14 am

It would be much much cooler if this problem was being caused by a Super Villain and not the banking sector.

M. Brodie March 11, 2008 · 10:29 am

I think this is a job for an engineer rather than a mechanic – Bernanke et al might be content to tinker around the edges with a spanner but no amount of small-scale fixes will sort out the problems inherent in the system. An engineer is what’s needed to re-design things from scratch and make sure the financial component doesn’t malfunction so badly ever again.

pdc90dem March 11, 2008 · 1:49 pm

Aye, decadant corporate culture and dwindling ethics were the root of problem. We need a new spirit of progressive regulation to counter future abuses such as these, but that won’t dig us out of the hole that were in. As far as solving our current economic problems, I would advocate a relatively Keynesian approach: a large increase of governmen -targetted in strategic places such as infrastructure and alternative-energy development. The government’s approach to send everyone a tax refund check will only provide a termporary bump, in my opinion, as so few consumer goods are produced here in America. Rather it would be much more efficient for the government to directly invest in America.

RealThink March 11, 2008 · 6:07 pm

I aggree with Mr McKinlay in that the problem is that the engine is short of oil.

I disagree with Mr McKinlay in what the lacking oil is. The needed oil is PHYSICAL crude. Not the kind of liquidity any central bank can provide.

Isn’t $109 a barrel enough? How high a price is needed for economists to understand it?

In the new scenario where output is constrained by PHYSICAL limits, injections of liquidity only serve to increase the price of the limiting resource, its alternatives (grains and oil seeds through the biofuel arbitraging mechanism) and competing currencies which cannot be printed (gold) or are perceived not to be printed in such scale (euro).

Do a test yourself. Run a report from Feb 4 from
//www.gmtfo.com/reporeader/OMOps.aspx
See that the total amount of sloshing REPOs bottomed the first week of February at 15B. On Mar 10 they were 67B, mostly backed by MBS. Then look at price charts of WTI, gold and the euro. All three bottomed the first week of February. (“Bottomed” is a way of saying. $86, $888 and $1.44 are not exactly deep bottoms.) See what the injected USDs are doing?

This is the way from here: an ever higher oil price encourage more and more diversion of agricultural feedstock into biofuel production. The global poor wanting to eat effectively compete with the global wealthy and middle class wanting to fill up their tanks. Who gets outbid? What does “demand destruction” mean in this scenario?

If my thinking is too much reality for this blog, I will accept indications from Prof Krugman to get lost. I will only demand a comeback milestone, such as “until WTI is at 150″.

Doug March 12, 2008 · 11:49 am

It’s only a slight overstatement to say that the ONLY thing that Wall Street has done in the past 30 years is to create and sell new types of derivatives. But financial derivatives are snake oil. Commodity derivatives are not snake oil – they are insurance. It makes good business sense for one company to buy risk from multiple commodity providers: risk buyers provide a useful service, and have a resonable expectation of profit through the use of spreading risk over many risk sellers. Risk sellers give up an increment of profit in exchange for reduced risk that gives them a better chance of weathering literal storms. This is a good exchange for both parties.

Financial derivates are different, because the holder of a financial asset has nothing to spend to buy insurance other than his risk premium. Once he spends his risk premium, he has given up the expectation of greater profit that he took on the additional risk to get.

Financial derivaties are not bought – they are sold. The buyers are bimbos bamboozled by Wall Street pedigrees. The sellers, in many cases, have bamboozled themselves.