Crisis Economics (2): trechos do livro de Nouriel Roubini

‘Crisis Economics’
By NOURIEL ROUBINI and STEPHEN MIHM
The New York Times Review of Books, May 6, 2010

Excerpted from Crisis Economics: A Crash Course in the Future of Finance by Nouriel Roubini and Stephen Mihm. Reprinted by arrangement with The Penguin Press, a member of Penguin Group (USA), Inc. Copyright (c) May, 2010.

For the past half century, academic economists, Wall Street traders, and everyone in between have been led astray by fairy tales about the wonders of unregulated markets and the limitless benefits of financial innovation. The crisis dealt a body blow to that belief system, but nothing has replaced it.

That’s all too evident in the timid reform proposals currently being considered in the United States and other advanced economies. Even though they have suffered the worst financial crisis in generations, many countries have shown a remarkable reluctance to inaugurate the sort of wholesale reform necessary to bring the financial system to heel. Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages.

Throughout most of 2009, Goldman Sachs chief executive Lloyd Blankfein repeatedly tried to quash calls for sweeping regulation of the financial system. In speeches and in testimony before Congress, he begged his listeners to keep financial innovation alive and “resist a response that is solely designed to protect us against the 100-year storm”.

That’s ridiculous. What we’ve experienced wasn’t some crazy once-in-a-century event. Since its founding, the United States has suffered from brutal banking crises and other financial disasters on a regular basis. Throughout the 19th and early 20th centuries, crippling panics and depressions hit the nation again and again. The crisis was less a function of sub-prime mortgages than of a sub-prime financial system. Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out. The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess.

The road to recovery will be a long one. For starters, traders and bankers must be compensated in a way that brings their interests in alignment with those of shareholders. That doesn’t necessarily mean less compensation, even if that’s desirable for other reasons; it merely means that employees of financial firms should be paid in ways that encourage them to look out for the long-term interests of the firms.

Securitization must be overhauled as well. Simplistic solutions, such as asking banks to retain some of the risk, won’t be enough; far more radical reforms will be necessary. Securitization must have far greater transparency and standardization, and the products of the securitization pipeline must be heavily regulated. Most important of all, the loans going into the securitization pipeline must be subject to far greater scrutiny. The mortgages and other loans must be of high quality, or if not, they must be very clearly identified as less than prime and therefore risky.

Some people believe that securitization should be abolished. That’s short-sighted: properly reformed, securitization can be a valuable tool that reduces, rather than exacerbates, systemic risk. But in order for it to work, it must operate in a far more transparent and standardized fashion than it does now.

Absent this shift, accurately pricing these securities, much less reviving the market for securitization, is next to impossible. What we need are reforms that deliver the peace of mind that the Food and Drug Administration (FDA) did when it was created.

Let’s begin with standardization. At the present time, there is little standardization in the way asset-backed securities are put together. The “deal structures” (the fine print) can vary greatly from offering to offering. Monthly reports on deals (“monthly service performance reports”) also vary greatly in level of detail provided. This information should be standardized and pooled in one place.

It could be done through private channels or, better, under the auspices of the federal government. For example, the Securities and Exchange Commission (SEC) could require anyone issuing asset-backed securities to disclose a range of standard information on everything from the assets or original loans to the amounts paid to the individuals or institutions that originated the security.

Precisely how this information is standardized doesn’t matter, so long as it is done: we must have some way to compare these different kinds of securities so they can be accurately priced. At the present time, we are stymied by a serious apples-and-oranges problem: the absence of standardization makes comparing them with any accuracy impossible. Put differently, the current system gives us no way to quantify risk; there’s far too much uncertainty.

Standardization, once achieved, would inevitably create more liquid and transparent markets for these securities. That’s well and good, but a few caveats also come to mind. First, bringing some transparency to plain-vanilla asset-backed securities is relatively easy; it’s more difficult to do so with preposterously complicated securities like Collateralized Debt Obligations (CDOs), much less chimerical creations like the CDO2 and the CDO3.

Think for a moment about what goes into a typical CDO. Start with a thousand different individual loans, be they commercial mortgages, residential mortgages, auto loans, credit card receivables, small business loans, student loans, or corporate loans. Package them together into an asset-backed security (ABS). Take that ABS and combine it with 99 other ABSs so that you have 100 of them. That’s your CDO. Now take that CDO and combine it with another 99 different CDOs, each of which has its own unique mix of ABSs and underlying assets. Do the math: in theory, the purchaser of this CDO is supposed to somehow get a handle on the health of 10m underlying loans. Is that going to happen? Of course not.

For that reason, securities like CDOs — which now go by the nickname of Chernobyl Death Obligations — must be heavily regulated if not banned.

In their present incarnation, they are too estranged from the assets that give them value and are next to impossible to standardize. Thanks in large part to their individual complexity, they don’t transfer risk so much as mask it under the cover of esoteric and ultimately misleading risk-management strategies.

In fact, the curious career of CDOs and other toxic securities brings to mind another, less celebrated acronym: GIGO, or “garbage in, garbage out”.

Or to use a sausage-making metaphor: if you put rat meat and trichinosis-laced pig parts into your sausage, then combine it with lots of other kinds of sausage (each filled with equally nasty stuff), you haven’t solved the problem; you still have some pretty sickening sausage.

The most important angle of securitization reform, then, is the quality of the ingredients. In the end, the problem with securitization is less that the ingredients were sliced and diced beyond recognition than that much of what went into these securities was never very good in the first place.

Put differently, the problem with originate-and-distribute lies less with the distribution than with the origination. What matters most is the creditworthiness of the loans issued in the first place.

Equally comprehensive reforms must be imposed on the kinds of deadly derivatives that blew up in the recent crisis. So-called over-the-counter derivatives — better described as under-the-table — must be hauled into the light of day, put on central clearing houses and exchanges and registered in databases; their use must be appropriately restricted. Moreover, the regulation of derivatives should be consolidated under a single regulator.

The ratings agencies must also be collared and forced to change their business model. That they now derive their revenue from the firms they rate has created a massive conflict of interests. Investors should be paying for ratings on debt, not the institutions that issue the debt. Nor should the rating agencies be permitted to sell “consulting” services on the side to issuers of debt; that creates another conflict of interests. Finally, the business of rating debt should be thrown open to far more competition. At the present time, a handful of firms have far too much power.

Even more radical reforms must be implemented as well. Certain institutions considered too big to fail must be broken up, including Goldman Sachs and Citigroup. But many other, less visible, firms deserve to be dismantled as well. Moreover, Congress should resurrect the Glass-Steagall banking legislation that it repealed a decade ago but also go further, updating it to reflect the far greater challenges posed not only by banks but by the shadow banking system.

These reforms are sensible, but even the most carefully conceived regulations can go awry. Financial firms habitually engage in arbitrage, moving their operations from a well-regulated domain to one outside government purview. The fragmented, decentralized state of regulation in the United States has exacerbated this problem. So has the fact that the profession of financial regulator has, until very recently, been considered a dead-end, poorly-paid job.

Most of these problems can be addressed. Regulations can be carefully crafted with an eye toward the future, closing loopholes before they open. That means resisting the understandable impulse to apply regulations only to a select class of firms — the too-big-too-fail institutions, for example — and instead imposing them across the board, in order to prevent financial intermediation from moving to smaller, less-regulated firms.

Likewise, regulation can and should be consolidated in the hands of fewer, more powerful regulators. And most important of all, regulators can be compensated in a manner befitting the key role they play in safeguarding our financial security.

Central banks arguably have the most power — and the most responsibility — to protect the financial system. In recent years, they have performed poorly. They have failed to enforce their own regulation, and worse, they have done nothing to prevent speculative manias from spinning out of control.

If anything, they have fed those bubbles, and then, as if to compensate, have done everything in their power to save the victims of the inevitable crash. That’s inexcusable. In the future, central banks must proactively use monetary policy and credit policy to rein in and tame speculative bubbles.

Central banks alone can’t handle the challenges facing the global economy. Large and destabilizing global current account imbalances threaten long-term economic stability, as does the risk of a rapidly depreciating dollar; addressing both problems requires a new commitment to international economic governance. The International Monetary Fund (IMF) must be strengthened and given the power to supply the makings of a new international reserve currency.

And how the IMF governs itself must be seriously reformed. For too long, a handful of smaller, ageing economies have dominated IMF governance. Emerging economies must be given their rightful place at the table, a move reinforced by the rising power and influence of the G20 group.

All of these reforms will help reduce the incidence of crises, but they will not drive them to extinction. As the economist Hyman Minsky once observed: “There is no possibility that we can ever set this right once and for all; instability, put to test by one set of reforms, will, after time, emerge in a new guise.” Crises cannot be abolished; like hurricanes, they can only be managed and mitigated.

Paradoxically, this unsettling truth should give us hope. In the depths of the Great Depression, politicians and policy-makers embraced reforms of the financial system that laid the foundation for nearly 80 years of stability and security. It inevitably unraveled, but 80 years is a long time — a lifetime.

As we contemplate the future of finance from the mire of our own recent Great Recession, we could do well to try to emulate that achievement. Nothing lasts forever, and crises will always return. But they need not loom so large; they need not overshadow our economic existence.

If we strengthen the levees that surround our financial system, we can weather crises in the coming years. Though the waters may rise, we will remain dry. But if we fail to prepare for the inevitable hurricanes — if we delude ourselves, thinking that our antiquated defenses will never be breached again — we face the prospect of many future floods.

Crisis Economics: o livro do momento - Nouriel Roubini

O livro do Mr Doom, em pessoa, o profeta do apocalipse financeiro...

Prophet-Making
By PAUL M. BARRETT
The New York Times Review of Books, June 17, 2010

CRISIS ECONOMICS
A Crash Course in the Future of Finance
By Nouriel Roubini and Stephen Mihm
353 pp. The Penguin Press. $27.95

In late March, the former Federal Reserve chairman Alan Greenspan told Al Hunt of Bloomberg Television that the financial crisis had been a “once in a century” shocker. “We all misjudged the risks involved,” Greenspan said. “Everybody missed it — academia, the Federal Reserve, all regulators.”

Well, not everyone. A number of prominent scholars warned long before the meltdown of 2008 that something awful was approaching. Greenspan and his successor, Ben Bernanke, chose to ignore the alarms.

One of the most articulate pessimists was Nouriel Roubini, nicknamed Dr. Doom by the news media. Roubini, a professor at the Stern School of Business at New York University, told an audience of fellow economists at the International Monetary Fund as early as Sept. 7, 2006, that the United States faced a cata­strophic housing bust, a crash in the market for mortgage-backed securities, the collapse of major investment banks and a deep recession. Most listeners seemed “skeptical, even dismissive,” Stephen Mihm reported in The New York Times Magazine. The moderator of the event joked, “I think perhaps we will need a stiff drink after that.”

Now Roubini is taking his victory lap. Writing with Mihm, an associate professor of history at the University of Georgia and the author of that admiring August 2008 Times Magazine profile, Roubini clearly relishes an I-told-you-so opportunity in his book “Crisis Economics: A Crash Course in the Future of Finance.” Why shouldn’t he? Readers hungry for more of the professor’s grim analysis will appreciate his erudition. Even people who aren’t finance buffs ought to read and heed his words.

To his credit, Roubini doesn’t merely recount how right he was. After a brisk recap of Wall Street’s scariest hours since the Great Depression, he turns to the question of the moment: how to prevent such debacles in the future?

That’s no graduate school exam question. As I write this, the United States Congress is trying to iron out kinks in a broad financial regulatory reform bill. Sadly, lawmakers have been debating halfway measures whose inadequacy becomes all the more striking in comparison with Roubini’s bracing agenda. His ideas aren’t all politically feasible, but that doesn’t make them any less sensible.

Roubini begins with an indisputable paradox. The government’s emergency rescue plan — the distasteful but necessary Wall Street bailouts and deficit-­enlarging stimulus spending — staved off global depression and brought about a dramatic stock market recovery. It also drained whatever fleeting political will existed to rein in Wall Street in a serious way. The surviving megabanks have brazenly paid out record bonuses, even though they owe their very survival to taxpayer largess.

Let’s start with those fingernails-on-the-blackboard bonuses. Roubini notes that the main problem isn’t their size, grating as that may be. The real trouble is that investment bank traders are paid huge bonuses for making reckless bets that yield short-term returns. They aren’t penalized when their gambling ultimately costs their employers money (or drives the firms out of business). This leads to a casino culture lacking common-sense caution. One potential remedy: put bonuses into a pool held in escrow for several years. If a trader’s record proves solid, he or she gets a payout. If not, the bonuses are nullified. Greater prudence would kick in, and, not coincidentally, overall compensation would shrink.

Only government could impose across-the-board pay reform. Since Wall Street would have collapsed without the ­taxpayer-financed rescue, Roubini says, Congress should have mandated a ­bonus-escrow system as a condition of the bailouts. Mesmerized by Wall Street campaign dollars and terrified of being branded “socialists,” lawmakers never seriously considered the idea. It didn’t help that President Obama surrounded himself with bank-friendly economic advisers like Lawrence Summers and Timothy ­Geithner.

The sorry performance of the three major private credit-rating agencies — Standard & Poor’s, Moody’s Investors Service and Fitch Ratings — played a critical role in the financial mess. Over and over, they stamped AAA ratings on the sausage-like securities made up of poisonous minced mortgages. Congress has debated imposing modest new requirements that the rating agencies make their operations more transparent. Roubini demands more drastic action. He would have government end the tradition of the sausage-making investment bankers paying the raters for their grades, a whopping conflict of interest if ever there was one. Roubini recommends that the agencies should be limited to accepting pay from investors in securities. Further, he urges a smart deregulatory move: removal of the agencies’ certification by the Securities and Exchange Commission as “nationally recognized statistical rating organizations.” This publicly blessed oligopoly, intended to maintain high standards, has only inhibited competition that would bring down the price of security-rating services.

Lawmakers have been debating provisions that would shed some additional light on the opaque market in derivatives. Those are the voluminous Wall Street deals that were supposed to dilute risk by spreading it but instead contributed to a risk epidemic. Heck, Roubini writes, let’s just identify the most dangerous ones and ban the suckers. He nominates credit default swaps, the quasi-insurance policies sold by American International Group, among others, which paid off when designated bonds went bad. Since we don’t allow people to insure their neighbors’ houses against fire, for fear of encouraging arson, why allow traders to bet on bonds blowing up? We shouldn’t.

Eliminating all bad loans will never happen. Since banks will always make mistakes, Roubini argues, they should be required to retain more capital and maintain higher levels of liquid assets (cash and securities that can be sold quickly). The legislation under consideration by Congress would authorize regulators to stiffen capital and liquidity rules. But the legislation would leave it to regulators to provide specific numbers. Roubini wouldn’t give the civil servants so much discretion.

Capital requirements are connected to Roubini’s most radical suggestion. He would force financial conglomerates to retain capital relative to all the risks posed by their various units. “This requirement would reduce leverage and, by extension, profits,” he writes. “Ideally, sending the message that bigger isn’t better would lead these firms to break themselves up.”

That’s right, break themselves up. Unfortunately, the implicit assumption that some banks have grown “too big to fail” has become explicit. Roubini maintains that we should pressure the biggest of them to contract, until they’re small enough that their demise wouldn’t bring down the rest of Wall Street.

With the federal safety net removed, an organization like Citigroup would act more prudently. Repeatedly rescued by the government since the Great Depression, Citigroup shouldn’t continue in its current unmanageable form, Roubini asserts. “Any bank that needs that much help doesn’t deserve to exist.” If Citigroup’s board of directors doesn’t share this view, the N.Y.U. economist advocates legislation that would authorize regulators “to break up banks and other financial institutions that are so large, leveraged and inter­connected that their collapse would pose a danger to the entire financial system.” The plutocrats might well perk up and do the job themselves.

Dr. Doom operates far beyond the horizon of what most experts consider plausible. Based on his track record, we would be wise to catch up to him.

Paul M. Barrett is an assistant managing editor at Bloomberg Businessweek.

Excerpt: ‘Crisis Economics’ (May 7, 2010)