Rationalizing Nationalizing

A little bit more exploration of the economy (call it alliterative easing):

So the Fed has admitted that quantitative easing is part of the plan. For those who are only learning what this means for the first time during this living-history lesson (like myself), it means increasing the monetary supply to grease the economy, doing what would ordinarily cause inflation in better times. Japan did this famously in the 90s, with little success, so the plan here is to do it better and quicker to make it work.

What they are doing is pumping money into the economy by buying up assets, increasing their balance sheet with cash drawn from, for lack of a better term, nowhere. More cash = more spending, which might ordinarily drive up prices, but now they are just hoping to increase revenue flows.

Unfortunately, it doesn't seem to be working yet. The banks from which the assets are being bought are just depositing the cash back into the Fed Reserve, which does serve to deleverage them from bad assets, but doesn't help the economy. The credit impasse seems to be sticking, because the banks aren't lending the money back out. Meanwhile, Treasuries are being sold like hot cakes, with the 3-month bill return being almost zero. Bad things that could happen include: the treasury market crashing and the dollar crashing, deflation, and more companies failing as a result of credit problems, which would only increase the amount of assets that the Fed would still need to take out of the market to keep it where it is.

But the main issue, as I see it, is that this shows that the Fed is not pushing for nationalization, as I had argued a couple of times previously. Or, at least they say that their not, because to say so could cause a HUGE panic among investors, who fear the phrase as much as they love "open market".

But, the fact that the quantitative easing is not working only pushes the case for nationalization, and not just from my teleological standpoint. Firstly, and most obviously: if the banks aren't doing what they need to be doing on their own, somebody (or some legislation) will eventually have to force them to do so. Secondly: if there is a currency crash, the country will have to take such drastic steps not only to prevent our economy from going down the tubes, but from all the dollar-backed currencies from going down the tubes. This is a lot more pressure than just the irrational red-baiting fears of "investors". Economists, eventually, always look at the facts. Thirdly: if Treasuries stop selling, something else must prop up the dollar. Now, I admit I'm not an economist, so I don't have a reference list of other options that aren't nationalization (my teleology laid bare). However, if the "open-market" policies of the Fed aren't having an effect, like for example, if treasuries aren't being bought and the value of the dollar is decreasing, controlling the supply of the bills on the open market could be used to control the price: like a repo to oneself. This would be more efficient than the open-market buying of assets, or of other repos. It could be carefully modeled and controlled.

And fourthly, aside from monetary policy: there is the matter of industry. This is the important one, because nationalizing the banks is all well and good, but if the industry is not coordinated as well, you might as well not even bother. The key to national control of infrastructure and economy, in my opinion, is coordination, direction, and execution. These are the benefits that a nationalized economy could have (stress the "could") that a free-market economy will never have.

Which brings us to that trying threesome, the American auto industry. They were sent back to Detroit in shame yesterday, because they could not convince Congress that they had a good plan. This is good, because it means that they will not just be handed cash, and also because it means the next time they will get the help they need. I hope it comes in the form of partial nationalization. I think that Congress realizes that they cannot convert themselves into profitable industries, let alone "automakers for the next century" without a drastic plan that will cost a lot of money to begin with. Operating cash is going down the drain. They need investment, and with investment comes direction, coordination, and execution (hopefully). And because the UAW will necessarily be included in any saving legislation, this could be a good beginning for nationalizing movements in American industry in concert with workers groups, and not just industrial leaders.

At least, I hope so. Or, the Fed and Congress could just keep pushing cash into the economy, hoping for a break in the liquidity trap, which may happen after long enough. Or it could all go down the tubes, and then, of course, the zombies.

The zombies do have a plan for the economy. Not nationalization, but cannibalization! (In America, first you get the assets, then you get rotting, then you get the flesh!)

Let's All Be Banks!

Update to yesterday's post:

It appears that Philadelphia, Phoenix, and Atlanta have written to Sec. Paulson, requesting funds from TARP to support pension plans, and other things.

If these cities are allowed to "convert into banks", then we are proceeding down the course of the nationalization I mapped out. First banks and insurers, large financial entities, are incorporated into the "single balance sheet", then industry (GM), then municipalities. Market and Industrial Zone-Entities (MIZE, consider it coined!). Leaders of the entities are allowed to retain control, but all monetary liquidity, assets, and debt are flowed through the Fed system.

Of course, they won't let those cities become banks. Instead, they just say, "nope, just wipe out the pensions, but keep building highways." Fair enough, I guess. This isn't the Soviet Union, after all!

But more to the point, it doesn't matter that they won't get TARP funds. The Fed is becoming the single market, whether they like it or not. But, can they handle that role....

Don't Worry About the Government

I'm watching my favorite show again: The House Committee of Oversight and Government Reform. Some day I will write them a theme song and intro-clip.

Today was Hedge Fund Day: lots of testimony.

I was enjoying Professor Andrew Lo's (MIT Financial Engineering Laboratory Director) testimony. He drew the distinction between risk and systemic risk.

Risk is easily understandable; one invests, and one may, via capitalization, achieve positive returns or one may lose. Systemic risk is the sort of risk that is currently driving the government's reaction to this evolving economic situation. It is generally understood as risk that would create a collapse of the system. This is the basis of the "too big to fail" phenomenon, that is spurring gigantic bailouts of individual companies. Clearly this is a problem, because the scale of the risk, the inherent denominator of capitalistic investment, is now being plied to the strength of the system as a whole. In other words, if a capitalist entity fails, capitalism fails. Others would put this as, if a market entity becomes market, then if that entity fails the market goes with it. I would say they are the same thing (in this case, systems of debt/capital commodification).

Above are some network diagrams of the correlations among hedge fund indexes. Sweet, huh?

Looking at things as a network is always a good schematic, in my opinion. Nothing is an island, and that certainly goes for financial systems. And, if we are discussing systemic risk, then certainly interconnections and correlations between risk is very important, as Professor Lo argues.

In fact, let's hear it from Professor Lo (from his written testimony before the committee):

"By looking at the financial system as a single portfolio, several useful measures of systemic risk can be derived by applying the standard tools of modern portfolio analysis."

WHAT??? verrrrrripppperrrrererrrrrrrrrrrrrrrrrr.... (the sound of the pdf being rewound)

"By looking at THE FINANCIAL SYSTEM AS A SINGLE PORTFOLIO, several useful... etc."

Now, let's cut to a single, modern portfolio, one doing very well right now.

The graph is shamelessly stolen from the excellent blog, Calculated Risk, which you should definitely read if you are interested in any of this sort of crap.

The portfolio, as you see, is that of the Federal Reserve. The president of the Dallas Fed predicted it will go to $3 trillion in assets by the end of the year. That is 20% of the GDP.

Let's recap. Because of systemic risk, the Fed is buying assets and lending out money like never before. The best way to analyze risk in the current markets is to view the market as a single system. And now the Fed is quickly, at an incredible rate, becoming the lynch pin of that single system, both in terms of the networks of where the debt flows are coming from (they have gone from being the lender of last resort to the biggest and only lender).

Get it yet? To fix the problem of an incredibly complex and massive system of value, it is best solidified into one system, for the continued maintenance of that value.

NATIONAL - IZ - ATION

Now: this isn't nationalization in the models of nationalization as it has occurred elsewhere in history. We are on entirely new ground here. This means two things, as I currently see it.

One: we will not have the economy "seized". Instead, companies will continue to try and save what assets they have by running to the Fed's door to keep their companies from going under, until eventually, the Fed controls so much of the country's economy (i.e. not only will the government determine monetary policy, they will control debt policy) and we will see a reverse panic. Everyone will take their money to the bank to keep it safe and valuable. To keep businesses operating, the government will have to spend, and, eventually direct large parts of the economy and its markets via its "owned" companies to keep the country going. Regulation will morph into direction/ownership, not by authority, but by de facto conditions.

Two: because this is a unique situation, it will become a positive feedback loop. Companies will not see it coming until it is too late, and they will be forced to go to the Fed like everyone else. This is the nature of the panic. But it will also be make it an unplanned nationalization, because it will be rolling, and not planned from the beginning. This means that many things could go wrong.

The question that I'm thinking about in my head is, what would the country look like with a nationalized economy? It would not be "state-owned", that's for sure. Not in this country, go back to Cuba! But it would be drastically different. If one considers American capitalism before the great depression to the SEC and Fed controlled economy afterward, we see an incredible difference in the philosophy of the market. No doubt there will be a major shift after this "second great depression", and nationalization is what it may look like.

Clearly companies will not be dissolved into worker combines. However, I can see carefully calibrated "free markets" of related industries that work within current anti-trust laws in managed competitions like those for federal contracts. This could mean strange things for free trade; I think it might drastically reduce the number of companies in particular industries, however, unless the economy, at the same time as it unifies into a "single portfolio", is managed into zones of much smaller size that will reduce the size of corporations and their national influence. Anti-trust could be taken along regional boundaries.

Bureaucracy would increase, with all these regionalized regulatory zones and entities. I think that this regulation would be the link that would be the national arm of the economy, and also divide it into regions and industries. Call them market divisions, if you wish. Fed banks, in addition to maintaining the reserves of cash, would also maintain those of debt, selling regionalized treasuries and industry securities, the way that it does government securities now.

The biggest question is what would happen to the individual worker. I would hope that an increase of union influence, combined with a larger number of member workers and an overhaul of their bargaining power would allow the workers to enter these new market zones as equals in the productive relationship, but I have a feeling we will end up the forgotten partner, and the better functioning of the macroeconomy will encourage its controllers to take more surplus value from the workers on the micro level.

Now, I'm going wildly out on a limb here, talking about things of which I have only a limited, amateur understanding. But, there will clearly be more regulation by the time we're through, and if this regulation is clever, it will act with a better understanding of systemic risk, which, perhaps, is what the folks in the Fed think they are doing now by buying tons of pieces of businesses. There's no doubt that we are moving towards nationalization right now, more than ever before. The only question is how far it will go, and by the fact that it does not seem to be having much more effect in the economy other than acting as a giant asset magnet.

we will see...