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Reinhart, Rogoff, and Bhide Warn America and World

Posted by Larry Doyle on July 15, 2011 9:09 AM |

I love reading the work of intelligent economic ‘giants’ who both get it and eloquently share it.

On a daily basis we suffer from the charlatans roaming the halls of Capitol Hill to those occupying the offices of global media moguls.

Some of the individuals in Washington (hello Barack!!) may believe the public does not and can not understand the nuances of major economic issues. In the process, the clowns spew forth volumes of nonsense and bulls&*t which has suffocated the debate needed to restore some measure of integrity to our social fabric.

Let’s turn off  the volume on the nonsense and embrace, elevate, and spread some truth and real wisdom. 

In reading the works of these giants, we do not need to view the world from the perspective of liberal vs conservative. We only need to focus on understanding the truth. Yes, the truth, that badly needed and all too often lacking virtue.

Who are these giants? Sense on Cents Economic All Stars Carmen Reinhart, Kenneth Rogoff, and Amar Bhide. (for a full listing of all the SoC Economic All-Stars scroll down in the left hand sidebar).

Kenneth Rogoff - World Economic Forum Annual Meeting Davos 2009

What are the real implications of the out of control debts rung up by our political charlatans? Why should you be VERY concerned by our nation’s deficit?

Carmen Reinhart and Kenneth Rogoff jointly highlight that our national and global economies can not and will not truly grow under the weight of these debts. Bloomberg recently highlighted Reinhart-Rogoff Warn Rising Government Debt Levels Threaten Global Economy,

“While we expect to see more than one member of the Organization for Economic Cooperation and Development default or restructure their debt before the European crisis is resolved, that isn’t the greatest threat to most advanced economies,” they wrote. “The biggest risk is that debt will accumulate until the overhang weighs on growth.”

Reinhart and Rogoff took issue with “prominent public intellectuals” who play down the significance of the debt and argue that the U.S. should take advantage of low yields on Treasury securities to launch another big fiscal stimulus.

One such intellectual is Nobel laureate Paul Krugman, whom Reinhart and Rogoff don’t mention by name. Krugman, a Princeton University professor and a columnist for The New York Times, has castigated Obama and other policy makers for focusing on cutting the budget deficit and has called for increased government spendingto help bring down the 9.2 percent unemployment rate.

“It would be folly to take comfort in today’s low borrowing costs, much less to interpret them as an ‘all clear’ signal for a further explosion of debt,”

Reinhart and Rogoff said their study of financial crises shows that public obligations are often significantly larger than official figures suggest. Case in point: the debt of mortgage financing firms Fannie Mae and Freddie Mac, which was never officially guaranteed by the U.S. government until the financial crisis hit.

Based on their research on the experiences of 44 countries for up to 200 years, nations with public debt in excess of 90 percent of GDP suffer 1 percent lower median growth of their economies, the economists wrote.

The long term fiscal malfeasance practiced in Washington has brought our nation to the precipice. Collectively we have allowed our politicians and those to whom they answer to f$*k our nation and especially our future generations.

We ultimately have ourselves to blame for our ‘walking pneumonia’ economy. Our situation will only get worse unless we expose the charlatans and demand some real ‘sense on cents’ accountability.


Speaking of accountability, let’s check in with our new Sense on Cents favorite Amar Bhide. This giant warns us that proposed banking reforms and increased capital standards do not begin to address the real issues within our financial behemoths.

Bhide highlighted his concerns recently in writing at Project Syndicate, Bank Regulation’s Capital Mistakes,

Imagine that the arguments triggered by the Hindenberg disaster were about the fire extinguishers and parachutes that airships should carry, rather than about the design flaws that might cause them to ignite. Unfortunately, today’s debates about banking reform have just this character.

Bank regulation, like lending, was once decentralized and judgment-based. Regulators relied mainly on examination of individual loans rather than capital-to-asset ratios. A typical bank exam would include scrutiny of every single business loan and a large proportion of consumer loans. Capital adequacy was a matter of judgment: examiners would figure out how large a buffer a bank ought to have, taking into account its specific risks.

Regulators then shifted to edicts requiring banks to maintain a specified capital cushion, thick enough to cover potential losses. This approach presupposes that bank assets and exposures can be accurately measured. In fact, the financial statements of mega-banks are impenetrable works of fiction or wishful thinking.

The problem goes beyond deliberate obfuscation. J.P. Morgan and Deutsche Bank have paid substantial sums to settle charges ranging from bribery to illegal foreclosures to abetting tax evasion. Ruling out the connivance of top executives raises an alarming question: Does Jamie Dimon, J.P. Morgan’s highly regarded CEO, have as little grasp of the exposures embedded in his bank’s nearly $80 billion derivatives book as Tony Hayward, the hapless ex-CEO of BP, had of the hazards of his company’s ill-fated rig in the Gulf of Mexico?

Indeed, ignorance about what is actually at risk makes debates about the right formula for capital buffers surreal. Moreover, the use of mechanistic rules to determine capital adequacy has also inadvertently encouraged systemic imprudence.

Smarter capital requirements – better Basel rules – aren’t the answer. Rigid, top-down uniformity is essential in the specification of weights and measures and the issuance of currency and coin. Bank lending and regulation, by contrast, must incorporate local knowledge, because, in a dynamic, unregimented economy, each borrower, loan, and bank is different (though some general guidelines can help). The seemingly objective top-down approach ignores the idiosyncratic nature of risk and assumes that one mortgage loan is like the next.

We can no longer afford to rely on old-fashioned examination for mega-banks loaded with mass-produced risks. And because stockholders or raiders can’t force streamlining, governments  must require these banks to shed activities that no one can manage or regulate and stick to hands-on case-by-case lending. With huge profits and bonuses at stake, mega-banks won’t readily abandon their model-based businesses; but, unless that happens, placing most of our bets on top-down rules would be reckless folly.

What is Bhide really telling us about these banks? The same thing that Second Curve Capital’s Tom Brown said on a Bloomberg interview this morning. THESE BANKS ARE INHERENTLY TOO LARGE AND TOO RISKY. BREAK THEM UP AND BREAK UP THE OLIGOPOLY THAT GOES ALONG WITH THEM.

I find it regrettable that our national debate about our future does not embrace the wisdom of these giants. Perhaps you can help in an even small way and share their work. You would be doing America and the world a favor.

Unless and until our nation understands the risks highlighted by Reinhart, Rogoff, and Bhide, I recommend that you navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.



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