Self-recommending, but I also read it and recommend it. Tyler and Scott have commented on it already.
if we purge the system of run-prone financial contracts, essentially requiring anything risky to be financed by equity, long-term debt, or contracts that allow suspension of payment without forcing the issuer to bankruptcy, then we won’t have runs, which means we won’t have crises. People will still lose money, as they did in the tech stock crash, but they won’t react by running and forcing needless bankruptcies.
This sounds somewhat radical to me. On the one hand, you want to allow some financial intermediation, which I might define as opaque financial institutions that hold risky, long-term assets and issue riskless short-term liabilities. On the other hand, you don’t want bank runs. What I would like to see are deposit-like contracts in which under certain conditions penalties may be imposed for rapid withdrawals. In the middle of a bank run, you can withdraw your money, but you lose, say 10 cents on the dollar. That sort of contract would have saved AIG, for example. When Goldman and the other firms that held credit defaults swaps written by AIG wanted to make withdrawals (termed “collateral calls”) they would have had to think twice about it. I made this suggestion in real time, back in 2008.
The interview has many great sound bites, but my favorites are these:
I think coming up with new theories to justify policies ex post is a particularly dangerous kind of economics.
and
the need for special savings accounts for medicine, retirement, college, and so on is a sign that the overall tax on saving is too high. Why tax saving heavily and then pass this smorgasbord of complex special deals for tax-free saving? If we just stopped taxing saving, a single “savings account” would suffice for all purposes!
Of course, we are getting a lot of the “particularly dangerous kind of economics” in the wake of TARP and the stimulus. I wish that the new theories were being developed to better account for reality, whether or not they serve to justify policy.
Finally,
Time-varying risk premiums say business cycles are about changes in people’s ability and willingness to bear risk. Yet all of macroeconomics still talks about the level of interest rates, not credit spreads, and about the willingness to substitute consumption over time as opposed to the willingness to bear risk. I don’t mean to criticize macro models. Time-varying risk premiums are just technically hard to model. People didn’t really see the need until the financial crisis slapped them in the face.
I think of Minsky as offering a useful theory of time-varying risk premiums, but that is probably not what John has in mind.
I have not given you all of the good material in the interview, by any means.
Did people change their attitude toward risk or did they change their outlook?
The prior sentence to the first quote is particularly interesting:
Runs are a feature of how banks get their money, not really where they invest their money.
So, bank deposits are a bit like put options on a highly diversified portfolio of loans. And then, just to be extra safe, since the option is insured by politicians, we regulate them into putting all their investments into houses.
In other news, “we” are punishing JPMorgan for buying during the fire sale. Relatedly, do capital controls limit the ability to buy during the fire sale (and thus keep fire sale prices higher)?
Just for giggles, I googled for about an hour and never could find a summary of what JPMorgan was “charged” with. But they paid $13 Billion with it seems to me no guarantee not to pay more. They payed about $3-4B for Bear Stearns and WaMu. So, had they not bought those businesses (at some risk, and at some aid to an economy in a credit crunch) those firms would likely have gone under and not been around for the government to shakedown…ummm…I mean tax…umm…I mean fine…ummm…wait, I don’t know what that money is called. Even then, of the $13B I don’t know how much stemmed from those bad businesses that were going bankrupt but even had they survived, it’s possible that their “share” of that $13B (which is less than Holder would have preferred I suspect) would be enough to bankrupt them even if their market price tripled from the sale price.
Not to mention, so I’ll mention it, the government caused the tight money- possibly because they saw the subsidized housing market was getting frothy- though they officially refused (until they didn’t refuse any longer) to officially acknowledge asset prices in their indicators (though they did in balance sheet accounting- odd). So, the government is now a dirty bank from the 1800s- credit the borrower just enough rope to hang themselves with- then yank. They don’t do it with as much subtlety and finesse as banks learned to do it, but they don’t need to. Now, dear citizen, we have historically high stock markets and zero interest rates. Have a nice day and Happy New Year!