Although the Jr. Deputy Accountant was rather unimpressed with this speech from the Kansas City Federal Reserve President, I thought there were some excellent observations from the speech that I would like to call further attention to. The first observation as an update to the often quoted John Maynard Keynes, “In the long run, we are all dead but our children will be left to pick up the tab.”
Unfortunately the overall political apathy among the youth will have them taking on this burden without much of a fight as it is assumed nothing can be done about it. Alternatively the next generation may be assuming that the actions of today will not cause catastrophic consequences tomorrow and all will be worked out with some political wizardry.
In our efforts to fix the oversight process for our financial system, we should not misdiagnose the patient. Unfortunately, I’m afraid we are witnessing some regulatory malpractice now. The emphasis on reform at this moment is to change the structure of the regulatory system rather than address the fundamental weakness of that system. Leading to this crisis were a series of steps that eliminated or compromised financial standards that had served to support sound financial practices for generations. For the most part, these rules were simple in form, understandable and enforceable. They served to constrain excessive leverage and undisciplined growth using simple leverage ratios, and focused on fundamental underwriting standards such as limits on loan-to-value.
It seems that he’s saying we are taking a sledgehammer to a thumbtack. Essentially the problems that got us into this mess were not gaping regulatory loopholes, but rather small cracks that were widely exploited. Whether he is right or wrong about this, a proper understanding of the problem is necessary before a solution can be appropriately prescribed. We have huge symptoms to treat, but the underlying problem may not be so large as the symptoms imply.
Capitalism is a process of success, failure and renewal, and for it to work properly, institutions must be allowed to fail, no matter their size or political influence. [emphasis added]
Amen. This has been stated before, but it’s nice to see it coming from the inside rather than the outside. He goes on to talk about the “implied subsidy” of institutions that are too big to fail and how they will suffer “moral hazard” from this implication. Going on to talk about the problems with our trade imbalance there is another learning point for the country.
At it’s peak [the annual trade deficit], this equates to almost $900 billion that the U.S. has borrowed from the rest of the world on an annual basis. If this were being used to finance productive investment, I would not be overly concerned because the returns we earn could finance the cost of borrowing. Unfortunately, however, a large share of U.S. imports is for consumption.
So here we draw the good debt/bad debt distinction. Do we have anything to show for all this money we spend or is it frittered away on cheap trinkets and improved national distractions? This combined with a nearly nonexistent savings level shows that for the most part we have run up huge debts to fund an expensive lifestyle, not debts to fund entrepreneurial activities or innovative endeavors.
We’re funding safety nets and busy work while the less developed world invests heavily to catch and overtake our position. If we continue to kick this can down the road there will be a tipping point where our national credit dries up and there won’t be enough cash flows to tax it out.