Evidence and economic reform

An article in the latest issue of federal Treasury’s Economic Roundup publication argues for the importance of evidence in ‘creating a broad base of community support for reform’. The authors, Joann Wilkie and Angelia Grant, use the economic reforms since 1983 as their case study.

I’ve no doubt that evidence and analysis was important in shaping elite views on economic reform. I’m not sure, however, that they make a convincing case on public support for the reform process. The main reason for saying this is that the polling we have suggests that the public opposed most of the specific economic reforms, with mixed survey results on their attitudes towards the whole reform process.

The problem is evident in contradictions within the article. The authors say that influential experts and commentators were important in ‘convincing the public to support tariff reform’. But their own data a couple of pages on clearly shows that most people continue to support tariffs. Wilkie and Grant note, as I did in a 2004 article, that polling does show understanding of the argument that free trade benefits consumers. However, on my analysis concern about jobs is the over-riding consideration.

Similarly, privatisation almost always polls poorly, and while there were some mixed results in early industrial relations polling, opinion was strongly against WorkChoices.

Though Wilkie and Grant note the problems of the benefits of economic reform being long term, it took a very long time to get positive poll results from the reform package as a whole. While Michael Pusey drew some very imaginative inferences from his mid-1990s survey data, only a minority of his respondents were clearly positive about economic reform, with the largest group being neutral. In a 2001 Saulwick poll there were more positive people, but still a minority. Only in a 2004 repeat of the Saulwick poll did a majority, 52%, declare themselves ‘better off’ as a result of economic reform.

Clearly the politics of this are more complicated than offering policy-related evidence, of which plenty was available, or of offering compensation or transitional assistance (another Wilkie and Grant suggestion), on which many billions were spent. The apparent paradox we need to explain is that despite the negative polling on economic reform, few economic reforms became major political issues and the period of reform was one of high stability in Australian federal politics. After three changes of government in the last eleven years of the ‘Australian Settlement’ (1972, 1975, 1983), there were only two in the 24 year period of reform (1996 and 2007).

I think several factors were important. One is that though the means of economic reform were radical, the goals were not. Restoring Australian employment and prosperity were completely mainstream objectives. If we examine the issues surveys of the 1980s and 1990s, economic issues were by far the most important issues or problems voters wanted governments to fix. Generally voters know very little about policy detail, but they can identify problems.

On this theory, the evidence that counted electorally was not on any of the specific reforms. Rather, it was the evidence of Australia’s improved macroeconomic performance. Being part of daily experience, and regularly reported in simple summary numbers, this is evidence that can sink in even among ill-informed voters. So long as the macro numbers were trending the right way, it was evidence that whatever the politicians were doing was working.

Another important factor was the strength of the elite consensus, which meant that for many of the reforms debate did not spill over into an electoral contest. This meant that even if the public did not support the reforms, there were limited electoral alternatives. Economic reactionaries such as One Nation and the Greens did increase their support in the 1990s, but never threatened the major parties in a fundamental way – perhaps partly because neither party had any credibility at all as macroeconomic managers.

The one clear case in which an economic reform had significant negative political consequences was WorkChoices. Two of the factors which had helped earlier economic reforms, the prominence of economic issues in the problems voters wanted solved, and elite consensus, were absent. And though the actual number of losers wasn’t likely to be large in the context of the total electorate, because many people feared that they might be losers it had greater direct impact on voters than earlier reforms that were concentrated in particular industries.

While of course policy evidence should be made available to the public, and the case for economic reform argued in public forums, the main influence of policy on the politics of economic reform was indirect, via its role in maintaining elite consensus through the initial phases of reform.

44 thoughts on “Evidence and economic reform

  1. “Though Wilkie and Grant note the problems of the benefits of economic reform being long term ….”
    .
    Oh, I think we’re just starting to see the long term benefits of 30 years of ‘neo-liberal’ ideas of economic reform, should be even clearer this time next year.
    .
    A lot of the ‘evidence’ for economic reform seemed to many people to be the opposite of common sense. Common sense doesn’t always turn out to be right, but in this case it looks like it will be: there are complex environmental / social factors that were never considered in the studies that produced this ‘evidence’ for the benefits of globalisation etc
    .
    It didn’t surprise me when Nicholas Stern described climate change as the biggest market failure in history, or that Alan Greenspan is in a state of ‘shocked disbelief’ – this was just economists realising that economists had ignored all sorts of other evidence, because it contradicted their own cherished ideology.
    .
    I suspect that Wilkie and Grant think that once the Treasury has spoken everyone should accept it as incontovertible truth. But we have other sources of information, and experience as well. In a couple of years we may well look back at the evidence in Treasury and Reserve Bank reports and advice and see in the light of history that it was only evidence of limited thinking.

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  2. So Rusell, which neoliberal reform enacted during Australia’s economic reform program contributed to the global financial crisis? Actually, since I know you can’t answer that cogently, not even (or perhaps especially) by drawing on your vaunted common sense, perhaps would might tell me the significance for economic reform of Stern’s comment about greenhouse being a market failure. Before answering, you might do well to consider the difference between neoliberalism and what Australian policy economists think and advise. Actually, that will probably stretch you a bit much too, requiring as it would that you engage with some facts rather than continue spouting your glib Puseyesque banalities.

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  3. A factor in the elite consensus was that the people against economic reform were, with a handful of exceptions like Quiggin, incapable of making a coherent, factually-informed arguments.

    For workplace issues, the tenured industrial relations club at universities plus the unions meant that the debate was much stronger.

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  4. Andrew,

    you would need to show how Workchoices was actually reform.

    In some ways it merely increased regulation.

    Moreover there is no evidence that it actually changed anything.

    On the other hand there is evidence both the other cases did change the economy albeit without popular support

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  5. BBB – For the purposes of this analysis, I think we can set aside the non-optional extras of massive bureaucracy that seemed to go with any Coalition policy in the government’s fading years. Key things that were actually causing the government political grief, such as permitting employment contracts that reduced wages or conditions, were clearly on the agenda of economic reformers.

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  6. “So Russell, which neoliberal reform enacted during Australia’s economic reform program contributed to the global financial crisis?”

    Ian McFarlane has asserted that the anti-competitive effects four pillars policy, long a target of neoliberal reformers, were probably responsible for our relative immunity from the crisis.
    http://business.smh.com.au/business/four-pillars-policy-saved-us-macfarlane-20090302-8mdt.html

    And your general point seems disingenuous, unless you are going to deny that globally, neoliberal* reforms associated with financial deregulation were a primary cause of the crisis.

    * I’m just quoting you quoting Russell, and don’t want to get into a dispute about terminology.

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  7. Tom

    I put ‘neoliberal’ that way to avoid terminology disputes – we know what is meant by it: deregulation, privatisation, free trade etc.
    .
    I don’t say that what Australia did caused the GFC, but that we were following, less fanatically than the U.S., the same policies that have caused it.
    .
    I cited Stern’s ‘market failure’ remark, because neoliberals believe that markets know best. Apparently, they don’t.
    .
    As to what Australian policy economists have advised, I think I would have been aware if there had been a lively, broad debate going on amongst them about these issues. There have been some dissenters, but, and I could be wrong, mainstream policy economists have been working from within the neoliberal paradigm.

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  8. Can there ever be elite consensus on economic reform – particularly labour market reform – when Labor is in opposition? Labor in power in the 80s and early 90s may have led reforms, and been (generally) supported in doing so by the Coalition, but Labor in opposition simply pandered to its union base. And why would that ever change?

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  9. “Ian McFarlane has asserted that the anti-competitive effects four pillars policy, long a target of neoliberal reformers, were probably responsible for our relative immunity from the crisis.”

    John, given that the strongest defenders of the four pillars policy were Paul Keating and Peter Costello, can we then conclude that these two were not ‘neoliberal reformers’?

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  10. Russell

    Nick Stern was also one of the signatories in a letter pleading with Thatcher to stop the UK economic reforms. His climate science report applied a discount rate and cost of capital so low that makes the entire study meaningless.

    He ought to be the last person to used as a voice to explain market failure.

    John Quiggin Says:

    Ian McFarlane has asserted that the anti-competitive effects four pillars policy, long a target of neoliberal reformers, were probably responsible for our relative immunity from the crisis.

    Interesting. So I take it then that the relative lack of competition prevented the banking system from collapsing here too? Is that it?

    So the quasi failures of the late 80’s and early 90’s where the state government banks failed en masses, the ANZ and Wetptach were on life support was caused by what exactly? Too many banks? 🙂

    John, one of these days you’re going to shock me and say say something unpredictable that isn’t ideologically driven. I’m holding my breath and counting…. 1 cat and dog, two cat and dog……..

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  11. JC,

    Still, Stern has been, at the World Bank, LSE and the U.K. Treasury, working at the top of these pillars of conventional economic thinking, so a reasonable figure to cite ??
    But anyway, we have lots of evidence of the serious ecological damage caused by our economic activity – how has that evidence been appropriately taken into account by the market? Why have so many mainstream economists ignored the importance of that evidence?

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  12. “Thank you Russell for confirming your ignorance of what policy economists think and advise”
    .
    Which is, or more appropriately generally was? At least from the government outcomes we had in the last decade, I think Russell is broadly right — our agenda was not dissimilar to a moderate version of the US one (privatization, new infrastructure constructed via private involvement (including monopolies), movement of risk to the individual from the government etc., all of which was bought with a fair bit of middle-class pork). Given this brought us a lot of the riches, and not such a bad hang-over, it obviously wasn’t too bad a policy to follow.
    .
    As for Stern — I think his claim about market-failure is proved correct. Even if people accept something needs to be done about global warming (which appears true for most people in most countries that matter), no-one will do anything about it unless forced to (even if forced via a “market” solution).

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  13. Still, Stern has been, at the World Bank, LSE and the U.K. Treasury, working at the top of these pillars of conventional economic thinking, so a reasonable figure to cite ??

    Well no, not really. Stern appears to be a dinosaur and his Bio seems to suggest it.

    Any economist with his salt wouldn’t have signed a letter opposing the Thatcher reforms of the 80’s unless they were driven by politically driven ideological boundaries. Seeing he has never apologized nothing he says could ever be taken seriously in the fieled of economics.

    I find it amusing that Stern the Thatcher reforms opposer has now morphed into Stern the Stern the Climate science economist guru. Denialism of economic laws such as free trade and zero tariffs doesn’t count obviously as regular denialism I guess.

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  14. I don’t see what global warming has to do with the arguments for and against economic reform. The problem of global warming does not arise from economic liberalisation, but from the difficulty of securing co-ordinated action amongst states to price or otherwise restrict carbon emissions. Global warming would still be an issue even if the world was made up of self-interested autarkic command economies, because such economies would have the same incentives to free-ride on the abatement effort of others as do modern day market economies.

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  15. “I don’t see what global warming has to do with the arguments for and against economic reform.”
    .
    Do you include de-regulation as part of ‘economic reform’? (Won’t it be nice if, over the next few years, economic reform comes to mean re-regulation!). I was attempting a link between let-it-rip deregulated commerce, supposedly based on some sort of economic evidence of its benefits, and the disastrous consequences that can have when it ignores other evidence. You need to look at ALL the evidence and steer economic activity towards the best outcome. Relying on de-regulated markets won’t get you there.

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  16. “Any economist with his salt wouldn’t have signed a letter opposing the Thatcher reforms of the 80’s ”
    .
    JC, bringing up something someone did three decades ago is a fairly cheap shot. I’m not sure when you got to Aus, but you’ll be pleased to know that John Howard made a mess of the economy with Fraser (at a not dissimilar time), but since people voted him in, obviously they were willing to forgive him for it, which shows most people think you can reform or learn something within a three decade period. I don’t remember Howard apologizing for that mess either.

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  17. Anyone want to open a book on the likelihood of John’s coming back to answer my question?

    JC, what are the odds?

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  18. Four pillars highlights differences within the broad free market constituency over whether takeovers and mergers should be blocked to promote competition. Though as an issue it never seems to have spread far beyond the banks themselves; no mentions at all on CIS website and only 2 on IPA.

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  19. What the ‘four pillars’ issue means is that the picture of policymakers taking their cues from some ‘neoliberal’ textbook is false.

    And, pace John, anyone who thinks that the current financial crisis was caused by financial deregulation needs their head read. The crisis wasn’t caused by ‘de’-regulation. However, plain ‘stoopid’ regulation (Basle I and II, anyone?) and regulators going to sleep on the job were certainly contributors.

    The main causes of the crisis were: too much money being made available too cheaply in the US financial system; regulations which encouraged – and in some cases required – mortgage lenders to lend to people who were clearly incapable of ever repaying their debts; and financial institutions relying too heavily on inappropriate mathematical models to manage their risks.

    I wonder what the luvvies will say when the heavily regulated European banks start falling over. The ‘neoliberal’ tag will lose all credibility if applied to policymakers in France and Germany!

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  20. Jeremy,

    I think that one of the aspects in which Australian neoliberalism differs from American neoliberalism is in the social contract between government and citizens. Hawke’s achievement was to reform the economy as much as Thatcher reformed the U.K.s but without the horrible, violent social divisions. The bargain here was that the victims of restructuring the economy would be looked after with retraining, welfare safety nets etc.
    .
    So Keating and Costello are neoliberals, but with Australian characteristics.

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  21. Though the British welfare state is bigger than Australia’s – the difference is more that the British trade unions used violence in an attempt to protect their interests, while the Australian trade unions were coopted through the Accord.

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  22. It wasn’t only unions and the welfare state – what about the “The Battle of Trafalgar”?
    .
    Thatcher applied her principles more and more ruthlessly, Hawke negotiated. I think Thatcher is probably still the most hated person in Britain, whereas Whitlam, Fraser, and Keating are all being forgiven.

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  23. You’ll have to jog my memory on the 20th century Battle of Trafalgar – a poll tax riot in Trafalgar Square?

    Britain’s problems were worse than Australia’s, and they lacked elite consensus, with British Labour being 15 years behind Australian Labor in modernising. Thatcher had the personality needed to deal with this kind of opposition. Hawke and Keating were the right mix for Australia.

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  24. The left may have forgiven Fraser, but the right have not. I accept the mitigating factor that the political mood on reform did not change until well into his term, but he has been unrepentant in retirement. Voting him out in 1983 was a good decision.

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  25. Jeremy

    Good that you bring up the Basel accord. In the 90’s I distinctly recall going to credit committee meetings and listening to the bank’s push for securitization coming from both the board level (to the plebs like us) and the regulators when I wasn’t falling asleep (it was allowed as traders weren’t thought of highly) ?

    The idea took hold then that the concentration of risk and the inability of the S&L’s to remove loans from their books was partially the cause of the banking crisis at the time.

    The Basle Accords promoted securitization by the way capital would be allocated: less for a security and more for a straight loan. At the time the SEC was strongly promoting mark to market rules even going to extent of extending the rule to straight loans.

    Anyways I always remember when these credit dudes were talking breathlessly about the virtues of mark to market and securitization I would think to myself that these guys didn’t really know what they were talking about. What would happen if a good part of the balance sheet stuffed with securities needed to be marked down. In all honestly it wasn’t what I thought about every night for weeks, but it was like a thought that used to go through my mind whenever they talked about it.

    Now we know what happens. So yea, I agree the Basle accords had a hand in the seizing up of the system by placing emphasis on securities needing far less capital allocation, as well as market to market rather than straight loans. I’m amazed this hasn’t really come up, or at least I haven’t read about it.

    I would agree with all your points and add this one.
    The problem is that we always look to plug holes and we end up creating another damn burst. We’re just not smart enough to figure out all the complexities, least of all bankers.

    What i find amusing is that these days it’s only the bankers who are are greedy and dumb. The mortgage takers of course were simple victims to the Wall street greed.

    Banks lose money and they’re greedy. Rio takes on 50 billion of debt to expand it operations and has to be bailed by the Chinese.. well that’s not greedy.

    If there was no demand for loans banks wouldn’t have made them. Let’s get this right if a customer goes into a bank, applies for a loan meets the criteria and the bank has the capacity to make the loan then it does what any commercial enterprise would do. They make the loan.

    If you want to see fewer loans then make sure interests aren’t set too low.

    Every single major element spells massive government failure at all levels.

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  26. Conrad says:

    As for Stern — I think his claim about market-failure is proved correct. Even if people accept something needs to be done about global warming (which appears true for most people in most countries that matter), no-one will do anything about it unless forced to (even if forced via a “market” solution).

    Have you considered the proposition that even if you used Stern’s assumption there is no need for action/mitigation.

    Here’s why… even if we used all of Stern’s scientific assumptions we should do zip on AGW in terms of mitigating.

    Current GDP is around US$65 trillion.

    Stern’s suggests that we will experience a 20% drop in GDP by 2100 if we do nothing.

    Well okay.

    Long term GDP has been accelerating and we could safely imply a growth rate of 3.5% over the next 91 years. I actually believe this is on the conservative side.

    Unmitigated GDP in 2100 will be $1,488 trillion at 3.5% less 20% . So unmolested GDP in 2100 could be $1190 trillion.

    Stern says we need to spend 1% of GDP to mitigate over this period.

    So the growth rate therefore falls to 2.5% and molested/ mitigated GDP then becomes $614 trillion.

    1% on a high growth number makes a hell of a lot of difference.

    Stern also didn’t assume any changes in technology over that time.

    So it isn’t that obvious to mitigate and it isn’t that obvious we have any market failure to speak of. All the market is doing is trying to match buyers and sellers as efficiently as possible. Only economic dinosaurs would suggest otherwise.

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  27. “All the market is doing is trying to match buyers and sellers as efficiently as possible.”
    .
    How is the market trying to do anything? It’s just a mechanism and will be used by the most powerful to their advantage. I saw this on the Reuters site a couple of days ago:
    “The U.S. Congress could move quickly this year to give the White House new tools to knock down barriers to U.S. exports and protect U.S. industries from unfair foreign trade, a senior Democrat said on Tuesday. “We hope to move it expeditiously,” Rep. Sander Levin …. ”
    .
    New tools, protection from unfair foreign trade – this market isn’t just going to be about efficiency, is it? Markets are part of an economic game that’s more about power and advantage than efficiency.

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  28. And I should have added – who cares how efficiently you’re doing something, if what you’re doing leads you to be incinerated. It’s more important that you realise that you have to change to be doing something else.

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  29. Russell at #6: Do you include de-regulation as part of ‘economic reform’? (Won’t it be nice if, over the next few years, economic reform comes to mean re-regulation!).

    Once again Russell, you show your deep ignorance of what policy economists think and advise. Perhaps you should start back with the National Competition Council’s excellent* 1997-98 Annual Report on what competition policy – the highpoint of “economic rationalism”, apparantly – actually involved, namely increases as well as reductions in regulation, depending on the circumstances, and no presumption in favour of privatisation. Also no presumption against greenhouse and other environmental policy interventions, community service obligations or redistributive policies. No simplistic neoliberal agenda there.

    A host of IAC/IC/PC reports over the last three decades have also advocated higher regulation, or retention but improvement in existing regulation, in many circumstances – just look at the PC’s recent report s on gambling, infrastructure access regimes, broadcasting and consumer policy.

    And even the 2005 Regulation Taskforce” – set up by Howard to cut red tape – explicitly recognised the need for regulation in various instances, particularly in relation to financial markets.

    The world of policy making, and the considerations brought to bear by policy economists, are far more complex than your simplistic Puseyesque banalities allow for. Still, on past form, I doubt that will prevent you from continuing to parade them.

    ___

    * I admit to some parental bias in this assessment.

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  30. Quiggin at #6 says Ian McFarlane has asserted that the anti-competitive effects four pillars policy, long a target of neoliberal reformers, were probably responsible for our relative immunity from the crisis.

    I agree entirely, but this simply highlights the difference between “neoliberalism” and the economic reform program undertaken in Australian over the last thirty years – which is one of my central points.

    And your general point seems disingenuous, unless you are going to deny that globally, neoliberal* reforms associated with financial deregulation were a primary cause of the crisis.
    As I have pointed out previously on your blog, I do not need to defend neoliberalism as I do not support it. The point of my question was to illustrate the limited relevance of the approach to policy in Australia over the last thirty years to recent global events. You say you don’t want to get into (another) debate about definitions, John, but this comments thread, like ones that appear following many of the posts on your own blog, show the problems of failing to define such terms tightly and apply them rigorously, notwithstanding the entertainment value entailed in the grand narrative.

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  31. JC,

    all I was pointing out was that if you want to stop global warming, it won’t stop by governments doing nothing, which was what Stern suggested (i.e., CO2 will keep on going up). Whether that happens to be a good or bad thing is irrelevant to that argument.
    .
    Personally (1) I think the only way anything will happen is if some cheaper technology comes along, which seems likely even in the nearish future as thin-film solar technology gets better and cheaper (which could easily supply non-base load); and (2) many people don’t care about non-related others after they die anyway (indeed we don’t care about people on the Earth now), even if they pretend to (or at least we show no actions to we suggest we do), which means Sterns discount rate is wrong, but that has nothing to do with GDP — it’s that we don’t particularly care if the Earth is in what we at the present time would consider a mess in 100 years.

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  32. If we are going for the “full effect” of economic reforms how about the economic growth from 1983-now, the dramatic long-term drop in unemployment, the taming of inflation, the massive moves out of poverty, etc?

    As for policy in Australia, it seems to have been notably successful, so it is hard to see what economic reformers had to apologise about.

    As for the GFC-cum-GEC, the use of land-use restrictions to turn houses into inflation-beating-assets creating the housing bubbles and US federal policy encouraging lending to the riskier were clearly factors in the former. Cannot comment on Basel I and II, but it is, at the very least, plausible to say that American prudential financial regulation did not work as well as Australia’s. But neither did the UK’s, Japan’s, …

    Trying to get the proper balance between private and public action is not easy, particularly in financial matters. But the current crisis is very far from being unambiguously about insufficient regulatory action. It is much more plausibly about a bad mix of too much and too little.

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  33. So the PC has “no presumption against greenhouse and other environmental policy interventions”. But in how many of their investigations did they include a full environmental impact assessment of their recommendations?

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  34. Good on you JC. It’s good to hear an ‘inside story’ on how all these problems started.

    What is interesting is that, if you look at the origin of all the behaviour which contributed to the current financial cataclysm, you won’t find anything resembling a zeal for deregulation. The problems were essentially caused by overconfidence, sloppy thinking, genuine mistakes and political pressure to meet short-term populist goals.

    As you said, even traders could pick a problem with the proposed regulatory reform. So did many other people. But unfortunately the Basel proposals carried the day, leaving us with …

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  35. Jeremy, of course not everyone would agree with you:

    Which seems more or less what Rudd wrote in his Monthly essay, including this point:

    “At the international level, bank risk is regulated by the Basel Accord. Yet the Basel II guidelines, published in June 2004, have now been demonstrated to be inadequate because they left the determination of risk to flawed credit-ratings processes and the banks’ own “self-regulated” internal assessment models. Even then, the Basel rules were easily circumvented using innovative financial structures: structured investment vehicles were deliberately employed to shift risk off bank balance sheets. As Joseph Stiglitz has argued, “many of America’s big banks moved out of the ‘lending’ business and into the ‘moving’ business,” focusing on originating loans, repackaging them and selling them on, with little emphasis on their traditional role of assessing risk and screening credit worthiness. Instead, the crucial risk-assessment function was passed, in large part, to the ratings agencies ….”

    Jeremy, what do you have to say about the rating agencies – “sloppy thinking, genuine mistakes”?

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  36. At the international level, bank risk is regulated by the Basel Accord. Yet the Basel II guidelines, published in June 2004, have now been demonstrated to be inadequate because they left the determination of risk to flawed credit-ratings processes and the banks’ own “self-regulated” internal assessment models.

    Let me answer.
    Well that’s bullshit because banks are directed by Basel regulation in terms of the capital adequacy requirements relating to the asset side of the balance sheet.

    Banks use internal guidelines in terms of how they asses risk, however VAR is a pretty standardized model and the various elements of VAR etc. is checked by the banking examiners, risk managers, external auditors and internal auditors to determine if the assessed risk is adequately measured. Clearly Rudd doesn’t know what he’s talking about or he would have mentioned that VAR itself is a hugely flawed risk assessment model that could actually cause systemic loss when its limitations are not understood.

    Even then, the Basel rules were easily circumvented using innovative financial structures: structured investment vehicles were deliberately employed to shift risk off bank balance sheets.

    Which should mean that banks ought to walk away from the SIV’s if there isn’t a guarantee from the parent company. If they aren’t walking away then it’s their decision, as they certainly don’t owe anyone any money as a result of the SIV’s if there isn’t a guarantee.

    I’m pretty sure there wasn’t otherwise the examiners etc. would have demanded they consolidate the SIV’s or at least present them as contingent liabilities.

    As Joseph Stiglitz has argued, “many of America’s big banks moved out of the ‘lending’ business and into the ‘moving’ business,” focusing on originating loans, repackaging them and selling them on, with little emphasis on their traditional role of assessing risk and screening credit worthiness.

    Gee Joe, welcome to the real world where the SEC has demanded market-to-market accounting and the Basle accords have placed heavy capital allocation demands on straight lending in a bid to create a bigger securities market so as to avoid risk concentration. Stigliz shouldn’t comment on this subject as everything I’ve read from him proves he doesn’t understand it or is simply playing left wing politics.

    Instead, the crucial risk-assessment function was passed, in large part, to the ratings agencies ….”

    No it wasn’t, as the rating agencies role hasn’t really changed all that much. The real problem was that VAR was used along with CDO risk model subsets to determine CDO risk weighting where risk was simply collated and people simply trusted them (risk models)… Kinda like AGW, hey… in terms of relying the models.

    Jeremy, what do you have to say about the rating agencies – “sloppy thinking, genuine mistakes”?

    They screwed up big time, which goes to show that risk should also be assessed by non-geeks as they tend to understand how markets works a lot more.

    Here’s the simple problem the math geeks didn’t address in their models. What the hell happens if the entire market is saturated with this junk and you can’t get out? Geeks simply assumed there would be an ongoing market for these products and didn’t figure that the underlying assets could take a dive (real estate) while there would simply be no credit market left to speak of. They also didn’t expect huge national declines in the real estate market as that has not happened since the War.

    Rudd talks about this stuff when if fact he knows nothing about. In fact he ought to focus on learning if he’s capable or simply concentrating on improving his diplomatic skills.

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  37. Coming back to comprehensible English ….. and what Jeremy said about deregulation not contributing to the GFC. Here’s another quote, this one from The Nation:

    “The Fed’s control mechanisms have been severely undermined by a generation of deregulation and tricky innovations that have substantially shifted credit functions from traditional banks to lightly regulated financial markets. ”

    True or false?

    Here’s a bit more:

    “The central bank was undermined more gravely by further deregulation, which encouraged the migration of lending functions from traditional bank loans to market securities, like the bundled mortgage securities that are now rotten assets. Greenspan became an aggressive advocate of the so-called modernization that created Citigroup and the other hybridized mega-banks–the ones in deep trouble. Old-line banks lost market share to nonbanks, but they were allowed to collaborate with unregulated market players as a way to evade the limits on borrowing and risk-taking. In 1977 commercial banks held 56 percent of all financial assets. By 2007 the banking share had fallen to 24 percent.

    The shrinkage meant the Fed was trying to control credit through a much smaller base of lending institutions”

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  38. Russell:

    Do you know anything about US banking or just the stuff up because you have read numerous sites that suggest the US was lax with regulation?

    US banking is about the most over-regulated in the world. I worked at the large I-bank/bank and regular US bank as a local hire for 15 odd years.

    This is what i saw as far as regulation goes.

    1. New York state examiners
    2. Fed examiners
    3. Futures bodies examiners
    4. Federal Reserve exminers.
    5. Sec
    6 NASD reporting requirements daily and monthly
    7 internal auditors
    8. External auditors
    9. Compliance department
    10. Risk department.
    11. NYSD and other stock exchange reporting requirments

    I didn’t deal with these people because my area wasn’t as regulated as some others like bonds or equities.

    But anyone that says the US financial system is under-regulated is either off the rocker or simply straight out lying or both.

    There was a very good reason to remove Glass Steagal in the US during the Clinton Administration, it wasn’t working as the rise of the securities markets and the demise of straight lending was simply making a mockery of the whole thing. In fact the final nail in the coffin of Glass Steagal was finally hammered last year when the last two remaining brokerage firms were turned into banks. Glass Steagal is dead and should have never been set up.

    “The Fed’s control mechanisms have been severely undermined by a generation of deregulation and tricky innovations that have substantially shifted credit functions from traditional banks to lightly regulated financial markets. ”

    True or false?

    Totally false as the strategy was to make the credit markets as securitized as possible in order to spread risk and avoid concentration. In fact regulation actually promoted that.

    The central bank was undermined more gravely by further deregulation, which encouraged the migration of lending functions from traditional bank loans to market securities, like the bundled mortgage securities that are now rotten assets.

    The writer is either on drugs, lying or is a complete bozo. The entire regulatory apparatus was set up to promote securitization. In fact the whole western banking system was going that way. The idea was that one loan wouldn’t bring a bank down and securitization would help the originating bank make a loan, bundle it up as a security and then on sell with the hope of making a further spread. The idea was that the bank would have the ability to spread the risk if it needed liquidity in a hurry and so avoid another S&L episode.

    Greenspan became an aggressive advocate of the so-called modernization that created Citigroup and the other hybridized mega-banks–the ones in deep trouble.

    You mean that Greenspan tried to modernize the US banking system and make it look more like those of other countries where there are fewer banks but lots of branch like here? The idea behind Citibank was that its global reach would allow it to diversify its risk profile and in fact this strategy wasn’t what brought the bank down. The toxic assets were all accumulated in NY in the origination department. It’s brokerage and the international operations were actually very profitable.

    Old-line banks lost market share to nonbanks, but they were allowed to collaborate with unregulated market players as a way to evade the limits on borrowing and risk-taking.

    Yes and the same thing has happened here with the advent of cash management trusts and the ability to receive interest and have a cheque book against a brokerage account.

    In 1977 commercial banks held 56 percent of all financial assets. By 2007 the banking share had fallen to 24 percent.

    So what and see above.

    The shrinkage meant the Fed was trying to control credit through a much smaller base of lending institutions”

    Lets get this straight. The Fed and every other central bank conduct its money market operations through the commercial banking system, either directly or indirectly. Control of credit first and foremost is through the banking system which is essentially the commercial banking system. That hasn’t changed and will not change.

    Moreover changes to the money supply M1 is directly impacted through commercial banks, which where cheque accounts and bank deposits ultimately reside.

    The fall of Lehman had no direct impact on the money supply because Lehman was not a commercial bank. It was a shadow bank. and guess what, shadow banks frequently fail as evidenced by the number that failed through the 80’s, 90’s in the US and elsewhere.

    You know we just had a shadow bank fail last Friday in case you don’t realize. Babcock and Brown were placed in liquidation. Apart from its business lines it was actually no different than Lehman. In fact on a proportional basis the failure was as big as Lehman Bros. Lehman had $800 billion is liabilities and BnB had $50 billion. The US economy is about 15 times bigger than ours so that makes these two failures about equal. Is anyone calling for more regulation here as a result? Of course not, that’s because we continue to live with the myth that the US is unregulated in comparison

    Most of what is being written these days is crap.

    The blame for the crash rests solely with the Fed for keeping interests down for too long and seeming to provide a too big to fail moral hazard.

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  39. I wasn’t aware that any serious economist thought that neo-liberalism was the primary cause of the current economic problems. It simply makes no sense.

    The banking sector is far more regulated than the non-banking sector. And the cause of the problems was obviously some mix of (1) poor (not insufficient) regulation with (2) expansionary monetary policy and (3) mistakes in the assessment of risk.

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  40. JC and John, you’ve said it much better than I could myself.

    I don’t know for sure why the ratings agencies were giving AAA ratings to packages of sub-prime mortgages. I strongly suspect that it had something to do with inappropriate risk assessment and the sloppy thinking that underlay it, as well as genuine mistakes. But I’m willing to bet the house that it had nothing to do with Hayek.

    Perhaps if we had details about the deregulation that was supposed to have happened, rather than just broad assertions that deregulation occurred, we could take the discussion further.

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  41. Jeremy – read the article linked to in post 36. And where do the ratings agencies get their money from?

    JC – you obviously have detailed knowledge of how these things work, but so do a lot of other people who would disagree with you. Jane D’Arista who, amongst other things, was a staffer on the House Banking Committee and wrote a book called The Evolution of U.S. Finance, has written a 32 page paper, published Jan 09, which starts off:
    .
    “In December 2007, the Fed’s belated proposals for regulating all mortgage lenders suggested that it was engaged in the proverbial closing of the barn door after the horses were out. Why it had not thought such restrictions were needed earlier seemed evidence of its ideological commitment to deregulation rather than a pragmatic assessment of developments that could cause market disruption and systemic fragility.
    But the Fed’s ideological commitments extended beyond its failure to monitor and control poor lending practices and fraud. Fed authorities also ignored ways in which monetary policy itself has lost the ability to stabilize financial markets and the economy those markets are intended to serve. The Fed’s monetary influence weakened as it chose to champion deregulation and innovation and gave market forces a larger role in determining credit expansion. It paid no attention to the way that foreign capital inflows drove up the supply of credit and ignored the explosion in debt that unchecked credit expansion produced. And, as debt soared, the Fed ignored the asset bubbles it fueled…. “

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  42. JC – you obviously have detailed knowledge of how these things work, but so do a lot of other people who would disagree with you. Jane D’Arista who, amongst other things, was a staffer on the House Banking Committee and wrote a book called The Evolution of U.S. Finance, has written a 32 page paper, published Jan 09, which starts off:

    Okay… and what does she say?
    .
    “In December 2007, the Fed’s belated proposals for regulating all mortgage lenders suggested that it was engaged in the proverbial closing of the barn door after the horses were out. Why it had not thought such restrictions were needed earlier seemed evidence of its ideological commitment to deregulation rather than a pragmatic assessment of developments that could cause market disruption and systemic fragility.

    So D’Arista seems to totally ignore that almost every single related part of the US government was engaged in promoting home ownership at almost any cost. Almost every single US department and agency was involved in the policy of home ownship.

    But the Fed’s ideological commitments extended beyond its failure to monitor and control poor lending practices and fraud.

    Nonsense. The woman is a complete turkey. The Fed’s ideology was never used as a cover to allow fraud and other illegal activities. In fact the Fed warned time and time again about the excesses particularly with regard to Fred and Fan and the congress stopped it.

    Fed authorities also ignored ways in which monetary policy itself has lost the ability to stabilize financial markets and the economy those markets are intended to serve.

    The woman clearly doesn’t understand monetary policy. To suggest the Fed is incapable of perusing and anti expansionary monetary policy is simply laughable.

    The Fed’s monetary influence weakened as it chose to champion deregulation and innovation and gave market forces a larger role in determining credit expansion.

    Oh so let me get this straight, Free market economics champion’s inflationary expansionary monetary policy. Why waste time reading this swill?

    It paid no attention to the way that foreign capital inflows drove up the supply of credit and ignored the explosion in debt that unchecked credit expansion produced.

    Umm does the stupid woman understand that under a floating exchange rate regime capital flows (unless there in unsterilized FX intervention) don’t affect money supply? Can she show how sterilized invention has a direct impact on broad money and M1? I bet she can’t because it doesn’t happen.

    And, as debt soared, the Fed ignored the asset bubbles it fueled…. “

    Yes, the Fed created the monetary expansion that allowed the bubble go unchecked. That’s basically what we need to know. Everything else she says is nonsense.

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  43. I think one of the most powerful arguments against the ‘deregulation and neoliberal reform caused the financial crisis’ argument is that our banks have been deregulated for a long time now, and yet we aren’t likely to experience anything like the financial-system crisis facing other countries.

    The reasons for the crisis are much more mundane, as JC and John have pointed out, and they stem from problems with human behaviour and institutions which only good regulation and a good regulator can hope to fix.

    The problem with proposing an ideological cause for this crisis (‘neoliberalism did it’) is that it encourages an ideological solution (‘replace neoliberalism’), which won’t solve the problem because the causes lie elsewhere. And, by giving the impression that the problem is easily fixed, will actually prevent those causes from being addressed.

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