Long Slide in the Post-Crisis

Some good books on the financial crisis have come out in the past month, including two I've bought but am still waiting to get time to read. One is 13 Bankers, by Simon Johnson and James Kwak (who also run the blog Baseline Scenario, an excellent source for blow-by-blow commentary on the ongoing struggle for a soupçon of financial reform. Another is Econed, by the author of the blog Naked Capitalism, which details the intellectual failures of doctrinal US economics and their real world impact.

Kwak has a good review of another of the good recent books, The Big Short by Michael Lewis.  Kwak gets at the crucial problem with the financial system in general, which is that the supposedly iron logic of objective market forces to which financial players are all subject in fact masks rules made up by a fairly small number of insiders to maximize their take.  Here's just a taste:

The problem was that the banks, as the swap dealers, got to decide what the swaps were worth. So, for example, Charlie Ledley bought an illiquid CDS on a particular CDO from Morgan Stanley. Five days later, in February 2007, the banks started trading an index of CDOs that promptly lost half its value. But, as Lewis writes, “With one hand the Wall Street firms were selling low interest rate-bearing double-A-rated CDOs at par, or 100; with the other they were trading this index composed of those very same bonds for 49 cents on the dollar” (p. 162).* That is, the market price of the already-issued CDOs didn’t affect the sale price of new CDOs. And what’s more, Ledley’s broker insisted that the price of his CDS (which should have soared as the index of CDOs fell) had not changed. Here you see the banks simultaneously ignoring a market price in two separate ways: once so they can continue selling new assets that are extremely similar — worse, if anything — to assets that they are trading as garbage; and again so they can avoid sending collateral to their hedge fund client.

Got that?  It's people making stuff up, and making a pile of dough as a result. This is finance that has nothing to do with investment, productive or otherwise. Its only impact on society is to damage it.  The rest of us are supposed to believe in its objectivity and defer to the outcome.  How far along are we in knowing enough to think otherwise?

We're looking as usual at a huge gap between the insight of experts and that of the general public.  A sign of where the public discussion is can be found in Jane Hamsher's comment on the its basic non-existence.

The social damage continues to spread. People are looking at Portugal next, and even the best financial commentators, like Simon Johnson, counsel cuts and austerity till the end of financial time.

For example, just to keep its debt stock constant and pay annual interest on debt at an optimistic 5 percent interest rate, the country would need to run a primary surplus of 5.4 percent of G.D.P. by 2012.  With a planned primary deficit of 5.2 percent of G.D.P. this year (i.e., a budget surplus, excluding interest payments), it needs roughly 10 percent of G.D.P. in fiscal tightening.

It is nearly impossible to do this in a fixed exchange-rate regime — i.e., the euro zone — without vast unemployment.  The government can expect several years of high unemployment and tough politics, even if it is to extract itself from this mess.

Neither Greek nor Portuguese political leaders are prepared to make the needed cuts.

Greece's crisis has settled into semi-permanence in the style that is becoming typical of our new post-crisis era: permanent low-level anxiety, permanent austerity, and permanent stagnation in wages. All of this is imposed with a financial logic of inevitability. The continuous message is that there is no escape.  Greece is looking at a lost decade for its society. The West is dealing with a crisis caused by its small, arrogant, uncaring, incredibly rich financial sector by downgrading the resources and the vision of its societies.  After ten more years of this, what visions and aspirations will be left?