Streetwise Professor

EUphoria has broken out again with the ECB announcement that it would engage in “unlimited” buying of short term (maturities<3 years) Spanish, Italian, etc., debt . . . under certain conditions.

The crucial condition is that the beneficiaries of Mario’s largesse formally apply for and receive assistance from the EU’s bailout mechanism, the European Stability Mechanism (ESM).  Since this assistance comes with conditions, all of the political and credibility issues are still in play.  The game of chicken between the mendicant countries and Germany will continue.

My read on this announcement is as follows.  Over the past year plus there has been concern that the ESM and its predecessor the ESF did not have sufficient funds to save a big country like Spain.  So there were all sorts of plans mooted to lever ESF/ESM resources.  The most recent included a proposal to give the ESM a banking license, allowing it to borrow from the ECB, thereby permitting it to lever its capital.  This proposal foundered on German opposition.

The ECB announcement seems crafted to achieve the same objective.  Instead of the ESM providing higher levels of funding to Spain, etc., by borrowing through the ECB after negotiating bailout conditions, the ESM and the ECB will work in parallel.   The ECB will effectively lend directly to the bailed out instead of lending indirectly through the ESM.  So both alternatives involve conditionality and the use of ECB resources to supplement ESM resources.

The allocation of credit risk may well be different under the two alternatives, but I haven’t had time to sort through that.  That issue is likely to be crucial, though, and impact negotiations between the ESM and the countries requesting assistance.  The ESM and the countries that fund it (I’m looking at you, Angela!) know that an ESM bailout will get the ECB involved, and that involvement will create credit risk and the potential for monetization.  These countries will take that into account when deciding whether to provide support and the conditions under which it is provided.

Meaning that fundamentally things haven’t changed all that much.  The crucial issue is still the political dynamic between the countries with the money and the countries that need it.  Draghi hasn’t changed that problem one bit.  Indeed, he has just raised the stakes in the negotiations, making them all the more fraught and complicated and less likely to succeed.  Levering up the ESM (whether directly or indirectly) also levers up the risks, stakes, and complexity in any negotiation.

Which means that in my opinion, as with most “solutions” proffered up by the Euros, this is a great shorting opportunity.  It hasn’t changed the fundamentals in Spain, which are getting worse by the day.  It hasn’t reduced the fundamental difficulties (moral hazard, credibility and crucially distributive effects) associated with any bailout.  Which means that when Spain is in extremis, which seems inevitable, a deal will be very hard to accomplish, especially in light of bailout fatigue in Germany.  In other words, the ECB action affects the outcome conditional on achieving a bailout agreement, but crucially it also affects the likelihood and terms of such an agreement.  The market has focused on the first issue, and is ignoring the second.  But I think that the second is fundamentally far more important.

Bill Clinton’s DNC speech was vintage Clinton mendacity.  It was long-too long for a point-by-point response, so I’ll limit my comments to some of the standout lowlights.

Starting with the beyond cartoonish version of the Republican philosophy:

“This Republican narrative, this alternative universe says that…
(APPLAUSE)
… every one of us in this room who amounts to anything, we’re all completely self-made. One of the greatest chairmen the Democratic Party ever had, Bob Strauss, used to say that every politician wants every voter to believe he was born in a log cabin he built himself.”

Always beware when anyone says “every one of us” and “completely.”  Sure tip-off to a straw man argument, a grotesque exaggeration.

In the Clintonian (and Obamaian) telling, Republicans are more Randian than Ayn.  Not even close.

The same caution about absolutes goes for “always” (emphasis added):

Unfortunately, the faction that now dominates the Republican Party doesn’t see it that way. They think government is always the enemy, they’re always right, and compromise is weakness.

And just who said “you’re on your own?” Gotta name?  A quote?:

You see, we believe that “We’re all in this together” is a far better philosophy than “You’re on your own.”

In brief, Clinton flogged a theme you are likely to hear ad nauseum in the next 60 odd days (and they will be odd!): the Social Darwinist Republicans vs. the Kind, Compassionate, Communitarian Democrats.

Then there’s this whopper:

One of the main reasons we ought to re-elect President Obama is that he is still committed to constructive cooperation.

Constructive as in “I won”? I guess in the Obamathaurus “constructive cooperation” means “do what I want.”

Clinton was at his con man/Music Man best when trying to explain why Obama deserves re-election, despite the stuttering recovery.  You see, Prosperity is Just Around the Corner! But you have to “renew the president’s contract” in order to achieve it:

Now — but he has — he has laid the foundations for a new, modern, successful economy of shared prosperity. And if you will renew the president’s contract, you will feel it. You will feel it.

Uhm, channeling Herbert Hoover isn’t exactly that persuasive.  But that presumes, I guess, that people with a bigger megaphone than I will point out the Hooveresque parallel.

The con man vibe was only reinforced by the cheap TV evangelist “I believe” trope:

Folks, whether the American people believe what I just said or not may be the whole election. I just want you to know that I believe it. With all my heart, I believe it.

(APPLAUSE)

Now, why do I believe it? I’m fixing to tell you why.

“I’m fixing”? Spare me the faux corn pone populism. (When was the last time Clinton was in Arkansas, anyways?)

The other analogy that comes to mind is Tinker Bell.  If you only believe, children, Tinker Bell will live and the economy will thrive!

Some of the most laughable parts of the speech were when Bill ventured into the realm of economics.  As when he discussed the administration’s (insane) fuel economy standards proposal:

Now, the agreement the administration made with the management, labor, and environmental groups [note the corporatist, not to say fascist undertones here] to double car mileage, that was a good deal, too. It will cut your gas prices in half, your gas bill. No matter what the price is, if you double the mileage of your car, your bill will be half what it would have been. It will make us more energy independent. It will cut greenhouse gas emission. And according to several analyses, over the next 20 years, it will bring us another 500,000 good, new jobs into the American economy.

So, first of all, we are apparently too stupid to make choices to cut our gas bill in half.  After all, we have the choice now to buy high MPG autos instead of Escalades, but us idiots apparently don’t understand that will cut our gasoline bills in half.  So we have to be forced to buy such vehicles. Could it be, perhaps, that fuel economy is not the only attribute that we value in automobiles?

A perfect illustration of the we-know-better-than-you-idiots, anti-choice mindset that infests the Dems.  Except where abortion is concerned, of course.   (Sort of on topic: Is Sandra Fluke as stupid as she seems? Does Georgetown Law School really want her as their poster child?)

Second of all, despite all the self-confidence of the delivery, the economics are cracked.  Both theory and empirical evidence prove otherwise.  If you reduce the marginal cost of driving a mile by forcing people to drive more fuel efficient vehicles, they will drive more miles, whereas Bill’s calculation assumes that the number of miles driven will be the same. Thus, CAFE advocates always-always-overstate the fuel consumption effects of their coercive policies.

Not to mention the body count of forcing people into smaller, lighter vehicles.  (Bill certainly didn’t mention it.)

And the last line reeks of the seen-unseen problem. Costs are not benefits.

His disquisition on energy was risible:

The president’s energy strategy, which he calls all-of-the-above, is helping, too. The boom in oil and gas production, combined with greater energy efficiency, has driven oil imports to a near 20-year low and natural gas production to an all-time high. And renewable energy production has doubled.

A good part of the import decline is due to the fact that a weak economy results in weak demand for fuel.  And Obama didn’t have a damned thing to do with natural gas production increases.  His administration (notably the FDA)  is fighting the technology that has made it possible.  It is worse than the rooster claiming credit for the sunrise.

And all of the above? Don’t make me laugh.

This was also rich:

Today, interest rates are low, lower than the rate of inflation.

Uhm, true-but that’s nothing to brag about: it is unquestionably the symptom of a weak economy.  Negative real interest rates last occurred in the late-70s.  That was such a great time.  I remember it fondly.

Again, the economics genius.

I could go on.  But you get the idea.

A spate of news out of China all points in one direction: a slowdown, and perhaps a severe one.  Whether it is stock prices, PMIs, or data from the banking sector, or capital flows, the signs are all quite bearish.  The perpetual China bulls are doing their best Alfred E. Newman “What? Me worry?” imitation, claiming that the omniscient and omnipotent Chinese government will order another stimulus splurge that will propel Chinese growth back to stratospheric levels.

Interestingly, the Chinese government seems to be reluctant to oblige.  And with good reason, IMO.  The economy is already wildly unbalanced, with investment representing an entirely disproportionate share of GDP.  What’s more, much of this investment has been malinvestment.  As Baldingsworld points out, the signs are everywhere, such as 50 percent vacancy rates in apartments and massive investments in wind electricity generation capacity that doesn’t actually generate, you know, any electricity.  (Another competition we should lose, Barry!)  I’ve already blogged about the appalling returns on Chinese investments in solar: that post has sparked a lot of comments on Seeking Alpha. Then there are the bridges that fall down.  Then too there is the accumulation of large quantities of inventory of stuff like copper, coal, and iron ore (that shows up as investment) that just sits there.

And the phenomenon is economy wide.  The IMF notes that China’s manufacturing capacity utilization is 60 percent-as compared to US utilization at about 80 percent (which is low by historical standards).  Capacity utilization began to decline with the onset of the crisis, but has continued to drop post-stimulus, suggesting that much of the capacity resulting from stimulus measures has been unutilized, or underutilized.

Now all of this investment, when made, contributed to GDP and represented a healthy fraction of Chinese GDP growth.  To those of you who actually consume (or get utility) from “aggregates”, this is wonderful news!  But the joke is on you. Paying people to dig holes (or eat the inedible) may contributes to GDP-but you end up with holes (or indigestion).

Investment involves a sacrifice of current consumption (including consumption of leisure), and makes sense only if it generates a sufficiently large increase in future consumption.  Empty apartments, collapsed bridges, idle factories, piles of inventory, and oversized pinwheels do not produce any consumption gain.  The resources used to create them were wasted.

Thinking from a real options perspective makes things look even worse.  Real options theory says that under conditions of uncertainty, it is better to wait to invest because information about the value of the investment is revealed over time: just as one should only exercise a call on a stock early if pays a dividend, one should exercise the option to invest only when the immediate flow of services/consumption from the investment-the dividend-is sufficiently large to offset the information-driven benefits of waiting.  Empty apartments and underutilized factories and disconnected windmills are not generating any flow of services/consumption/dividends.  Indeed, inasmuch as they depreciate and require maintenance, they are producing negative flows.  Thus, the investments in them are at best premature, and at worst a total waste: in the future, information may reveal that the resources should have been used to produce something else.

Investment for investment’s sake, or to produce some economic aggregate number that gets people to ooh and aah (based on the fiction that the increase in the aggregate corresponds to an actual increase in the production of, or the potential to produce, things people actually value) is a waste.  Moreover, it is typically a drag on future economic performance, in part because worthless assets funded by borrowing weakens the banking system making it more difficult to finance truly valuable investments, in part because worthless assets aren’t yielding income or enhancing the productivity of labor.

You get something like Japan, now in year 21 or so of its Lost Decade.  Or worse.  And in China, worse is a very real possibility.  Moribund economic performance is a conformist society like Japan’s doesn’t lead to social convulsions.  China’s history is one of  convulsions.  Which is no doubt why China’s government stimulated like crazy in 2009.  That bought time.  But reality eventually intrudes.  Malinvestment can only go on for so long.  The wealth it creates is chimerical, and people are not happy when the fantasy is revealed as such. And 1.3 billion unhappy Chinese is not a comforting thought.

I have lived through the time when first the USSR and then Japan were touted as economic titans that would leave the US in the dust.  Amazingly, the optimism about China has been even more extreme.  And, methinks, the comedown that China will experience will be just as extreme.

Corruptocrat Jon Corzine is whining about the MF Global Bankruptcy Trustee’s decision to assist customers who lost money as a result of the MFers in their attempts to recoup their losses by suing Corzine and other executives of the firm:

Corzine, along with other current and former MF executives, filed an objection in court on Wednesday arguing that their ability to defend themselves would be hurt if trustee James Giddens is allowed to assign his legal claims to plaintiffs in existing cases.

The executives are defendants in multiple lawsuits accusing them of mismanaging the firm and playing a role in its October 2011 collapse.

“Nothing in the Bankruptcy Code authorizes such limitations on the objectors’ rights and defenses or an enlargement of the trustee’s rights,” lawyers for Corzine and the other executives wrote in documents filed in U.S. Bankruptcy Court in Manhattan.

If allowed to join the customer cases, Giddens would have the right to limit the information and documents available to the executives through discovery, as well as dictate which documents the executives would turn over to plaintiffs, lawyers for Corzine and the other executives wrote.

Sorry.  I’m getting all choked up.   Hard to type through the tears.

JK.  MF him.

It looks like Corzine is going to skate on criminal charges, as in a reversal of usual procedure prosecutors appear to be focusing on low level employees, and not as a way of getting at bigger-and rotten-fish like Corzine.  (I’m sure that he’s a made man in the Democratic Party and a big fundraiser for Obama has absolutely nothing to do with that.)

Given that, one can only hope that he spends a good part of the rest of his life in civil legal torments, and ends up coughing up large sums to the injured customers who he victimized.  For regardless of his culpability in diverting segregated customer funds, his recklessness was the proximate cause of their losses: his ill-judged and ill-designed (i.e., improperly funded) bet on PIIGS debt put the firm in the straits that led someone to consider it necessary to take money that wasn’t the firm’s in a vain attempt to save it.  Moreover, even if he did not give the order to use seg funds, it happened under his watch: the choice is between scienter and negligence.  It still stuns me that a guy who was head of a major clearing firm claimed ignorance of the mechanics of the clearing process.  I guess he was too busy figuring out how to gamble his firm to resurrection.

So encroach away, Mr. Giddens!  Rough justice perhaps, but that’s exactly the kind Corzine deserves.

Maybe that’s a disturbing mental image, but the title is more than apt given Gensler’s recent NYT oped, “Libor, Naked and Exposed.”  As is his wont, demonstrated repeatedly on Frankendodd-related issues such as clearing and SEF mandates, Gensler presents a misleading and distorted analysis to advance some regulatory or political agenda.

Gensler questions the integrity of Libor.  This is certainly understandable in the light of the deluge of revelations in the past couple of months.  But the “evidence” that Gensler uses to justify his skepticism is completely off point, and certainly grossly overstates the impact of any manipulation on this important benchmark rate.

The first comparison Gensler makes is between Libor and Euribor.  He notes that dollar Euribor is about double dollar Libor.  But what Gensler omits to say is that this is an apples to horse apples comparison, given the major differences between the banks in the Libor and Euribor panels.  The former includes major banks (crucially, TBTF banks that benefit from the implicit and explicit support of governments and central banks), and most notably major US banks with ready access to dollar funding.  The latter includes something of a dog’s breakfast of foreign banks.  It has two Spanish and one Portuguese cajas and five German landesbanken, for crissakes.  And Dexia! The Euribor panel banks are all weaker, and don’t benefit from the same safety net as the banks in the Libor panel.  Moreover, since the beginning of the crisis, foreign banks have much greater difficulty in securing dollar funding than US banks.  Even big European banks (such as French giants like Paribas)  have faced acute dollar funding problems.  This is one reason why they have been deleveraging, and selling off dollar assets.  The Euribor banks almost certainly have even worse problems.

This issue of fragmentation of funding markets also bears on Gensler’s second piece of evidence: the divergence between Libor and the dollar rate implicit in FX swap prices. Gensler treats the violation of the interest rate parity relation as an indicia of manipulation.

But again, this reflects the acute problems European banks have faced in securing dollar funding.  They can borrow in Euros, but have to swap it into dollars to fund their dollar assets.  They are willing to, and the market is making them, pay a premium to execute this transaction.

Gensler claims “this divergence between theory and practice has yet to be adequately explained.”  Really?  It is well-understood.  Don’t believe me?  How about some economists from the New York Fed?  They investigated this issue in detail in 2009, and concluded that the divergence in the basis between the FX swap implied USD rate and USD Libor was caused by the dislocations associated with the financial crisis.

Indeed, Gensler’s oped implicitly recognizes this: he notes that implied and Libor rates have not been aligned “since 2008.”  Hmm.  What happened in 2008?  Think, think, think.  A financial crisis maybe?  Could that be it?  I’m thinkin’.

One key piece of evidence that FRBNY economists  Coffey, Hrung, Nguyen, and Sakar present is that the basis blowout was not limited to Libor.  It was also present when they used the New York Funding Rate produced by ICAP.  It was also present when they used Eurodollar deposit rates.

Look, anybody who has followed this knows that basis relationships that had been steady as a rock for years went haywire starting in August, 2007.  (Happy Anniversary!)  The CDS-cash bond basis went haywire.  Interest rate spreads (e.g., OIS-Libor) went haywire.  Spreads between borrowing rates across banks have become much more dispersed and become much more volatile.  (This relates directly to the Euribor-Libor comparison: banks are much more heterogeneous now than in, say, 2006, making comparisons between averages across different groups of banks much less meaningful now than then.)

This pertains to another piece of evidence: the lack of comovement between bank CDS spreads and their Libor submissions.  This could be informative, particularly in normal times, but it is problematic during crisis times.  CDS spreads and yields on the underlying cash bonds diverged dramatically, and often exhibited little comovement, during the period of the crisis.  CDS spreads were being driven by liquidity and risk aversion issues.  If the CDS-cash bond basis became much more volatile, it’s not at all surprising that the CDS-Libor spread also became much more variable, given that CDS and cash bonds have closer kinship than CDS and unsecured short term borrowings.

Noticing a pattern here? Basis relationships of every sort became much more volatile during the crisis period, and hence are far less reliable evidence of manipulation in Libor than would have been the case more than 5 years ago.  In essence, Gensler is trying to tell time with a broken watch.

Recall that Gensler mentions “the divergence between theory and practice.”  Anybody who has been paying attention understands why that’s true.  The theory is predicated on an assumption of frictionless financial markets.  Financial markets where capital and liquidity constraints are not binding, thereby permitting arbitrageurs to eliminate swiftly divergences in prices across related markets.  That was a reasonable approximation of reality in say, July, 2007: certainly in July, 2005.  It is completely unreasonable post-August, 2007.

Or as the FRBNY economists put it:

The widening of the basis illustrates the breakdown in arbitrage relationships that has afflicted many markets during the financial crisis. For example, eurodollar interest rates in New York and London diverged during the crisis-as did yields on corporate bonds and credit default swaps, which are closely related securities.  The element common to all of these phenomena was increased funding costs, which impeded arbitrageurs from shrinking the basis between these types of securities.  In addition, counterparty credit risk became prominent, and previously risk-free arbitrage trades suddenly became risky . . . funding constraints and counterparty risk explain the rise in the basis and the relative importance of each factor changed as the crisis evolved. [Emphasis added].

Since then, the coefficient of financial friction has reached record levels.  Capital and liquidity and funding constraints are binding everywhere, and binding hard.  In particular funding markets-and Libor is a measure of a funding costs for some banks-have been dysfunctional for 5 years.  Severely dysfunctional.  Most of the European banking system relies on the ECB for funding.  Markets across regions that were once highly integrated are now fragmented as never before.

This is particularly important for dollars.  Having access to dollar funding via deposits and access to the Fed (like major US banks) is completely different than having to raise dollars through wholesale markets, like most European banks that have been hit hard by the flight of US money market funds and other sources of dollar liquidity.  This is what drives things like the Euribor-Libor differential, and the swap-Libor basis.

Hell, there is fragmentation of funding even within currency areas, in particular, the Eurozone.  European subsidiaries are attempting to fund their local lending with local deposits, especially in countries where conversion risk (i.e., the risk that a country will leave the Euro) is acute.  For instance, Italian subsidiaries of French banks are funding their loans to Italian businesses with local deposits, rather than money from the parent banks.

In other words, Gensler is relying on a textbook model that presumes a frictionless world.  That ain’t our world, today.  The textbook needs to be thrown out.  But Gensler uses it as his bible.

There are two explanations of this, both quite frightening.

The first is that he really doesn’t understand this.  That he doesn’t understand that the financial system has suffered cataclysmic shocks and doesn’t work the way it used to.   It would inspire confidence, wouldn’t it, that an individual playing a crucial role in reshaping that financial system through the promulgation of rules under Frankendodd doesn’t understand why things are working-or not working-the way they are?

The second is that he is a fan of the band Say Anything.  That he knows that his “evidence” has nothing to do with Libor manipulation, but he is saying it to advance some regulatory or political agenda.

I’m betting on the second alternative, because Gensler is a serial offender in this: look back at my posts from 2009 and 2010 and you will see numerous times where I called BS on the former Goldman managing director for making ludicrous statements about financial markets-all of which were calculated to justify Frankendodd and a massive expansion of Federal regulation of derivatives markets.

Regardless of the reason, one thing is clear: Gensler’s misleading analysis lies naked and exposed. This is not to say that Libor was not manipulated.  It is to say that what Gensler hypes is not evidence of the existence of manipulation, or the magnitude of its effect.

It is unfortunate that he penned such a distorted oped, given that his agency provided a very rational proposal to reform the Libor fixing process in its Barclay’s settlement order.   Gensler should limit himself to promoting that proposal, rather than writing pieces that sow confusion and promote misunderstanding about a highly contentious issue that could have huge and costly impacts on banks-and hence on the world financial system, stressed as it already is.  That is not constructive.  It is irresponsible and dangerous.

I have long been a China bear, even before the financial crisis.  (Bearishness here means that I believe China has many structural weaknesses that make it highly unlikely it will achieve the  prodigies that China bulls predict.)  A major reason for this bearishness has been the Chinese financial system.  For years, bad loans have been buried. More recently, the combination of financial repression and the need to get bad loans off bank balance sheets have encouraged the development of a shadow banking system that makes the West’s look positively staid and stable by comparison.

This is illustrated quite graphically in an excellent special report on Reuters.  Do read the whole thing, but here are my takeaways.  First, as just noted, financial repression which depresses returns on bank accounts encourages savers to look for higher return-and higher risk-alternatives.  Second, shadow banking mechanisms such as “Wealth Management Products” are being used to fund very dodgy assets and get them off bank balance sheets.  Third, these shadow banking products involve maturity, credit, and liquidity transformation.  In many cases, the degree of transformation is extreme, with very short term liabilities (as little as a few weeks) used to fund long maturity, non-performing, extremely illiquid assets  Fourth, the degree of disclosure about these products is appalling.

In brief, there are all the ingredients of a run present there.  Indeed, if the Reuters characterization is correct (and I have heard the same or worse from those who have major skin in the game), this system is far more fragile than the web of ABCP, SPVs, liquidity puts, subprime MBS and CDOs and CDO squareds that collapsed in the US in 2007-2008.

Woefully uninformed investors have no ability to discriminate between good and bad trust companies, wealth management products, etc.  Bad news about a few, or a big one, quite likely would lead to a spike in suspicion about all of them: given the highly dubious quality of the underlying assets (resulting to a considerable degree to the malinvestment caused by the government’s stimulus efforts in 2008-2009), such bad news is quite likely to arrive.  This would spark a run on the entire shadow banking sector (because investors cannot discriminate given the near complete opacity), which given the extreme maturity mismatches and the illiquidity of the underlying assets would lead to a collapse in short order.  Some of this would blow back onto banks, threatening their solvency.  But even if banks walk away from related trust companies, etc., investors in the shadow banking products would be ruined.  This could have social ramifications that no doubt petrify the ruling Communist Party.  Even absent social disturbances caused by infuriated investors seeing their wealth evaporate, and the associated potential for a government crackdown, the decline in wealth would lead to a sharp reduction in consumption, slowing Chinese economic growth; putting a drag on the world economy (especially commodity producing countries); and exacerbating the already unprecedented imbalance between investment and consumption.

The heavy hand of the Chinese government has contributed mightily to this state of affairs.  Distortions of prices (notably interest rates) and misallocations of capital through a banking system that favors state owned enterprises and forces entrepreneurs who generate the real growth to rely on shadowy sources of capital, currency management, the focus on export and investment oriented growth, all exacerbated by the response to the 2008-2009 crisis have led to the development of a warped financial system that is extremely fragile.  More fragile, almost certainly, than the one that imploded in the US and Europe 4-5 years ago.

When will a collapse come?  The coordination game, multiple equilibrium nature of these things makes that very hard to predict.  A small change can lead to a jump to a run equilibrium.  The risk is there, just as a huge pile of dead underbrush in a forest poses the risk of a conflagration at any instant.  When the spark or the carelessly discarded cigarette or the lightning strike will set it off is impossible to predict.  But one must be very lucky indeed to avoid a big fire when the conditions are so favorable.

Today is Milton Friedman’s 100th birthday.  I consider myself his intellectual grandson.  He was the thesis advisor to my thesis advisor (Lester Telser).  There is a strong degree of affiliation between his views and mine-not surprisingly, since he decisively shaped the intellectual environment that shaped me.

Even though he has been dead six years, Friedman remains an influential figure-and a polarizing one.  Indeed, the financial crisis and subsequent economic turmoil have intensified the battle over his legacy.  Today you can find numerous encomiums to Friedman today.  But to many, he personifies the capitalist or “neo-liberal” ideology that wreaked economic havoc.  The controversy over the Milton Friedman Institute at Chicago, right at the height of the crisis, is one example.  Or Naomi Klein’s screed Disaster Capitalism, which identifies Friedman as the main intellectual architect of said disaster.

Part of the reason that those on the left feel free to bash him is because he isn’t around to defend himself or his views.  And the fact that he was so effective as both a scholar and a polemicist is part of the reason he is so despised on the left.  He got in their heads in the 60s and 70s, and has never left, even though he has departed this earth.  Almost singlehandedly he challenged the professional consensus within economics (the reigning Keynesian orthodoxy) and the political consensus throughout the country (big government liberalism), and although he did not vanquish either, he certainly put them on the defensive.  He debated and wrote and argued prolifically and tenaciously, and like some modern David slew many Goliaths.  His main adversary at the time was Paul Samuelson.  Yes, Samuelson was a great economist, but he is not remembered today either in economics or society at large the way Friedman is.

The sad thing is that the left routinely excoriates Friedman as inhumane, when he was in fact anything but.  He passionately believed that liberty was good for its own sake, but that it was the best way to alleviate human misery and encourage human development.

I wish Friedman had lived to comment on the financial crisis of 2008, and the slow motion crisis in Europe right now.  I am sure that he would have given those who lay the blame for these at his feet (and those of his intellectual and political acolytes) more than they could handle.

Happy Birthday, Milton.  You are missed, but your influence lives.  Everyone passes on, but the ideas of a select few live on far after their passing.  Milton Friedman is one of those few.

Timmy! is in Europe, to lecture the Europeans (yet again) on the need to get their house in order.  After all, his trips have been so wildly successful before, in the same way as Rodney Dangerfield shows were wildly successful.  Or in the same way as Geithner’s “very tough” action on Libor took care of that problem.

His trip has a special urgency now, because Obama fears that economic “headwinds” from Europe will interfere with his reelection prospects.

Germany’s finance minister, Wolfgang Schäuble, has been known to give Timmy! verbal lashings in the past, and he did deliver a preemptive rejection of what Geithner is pushing Europe-and Germany specifically-to do:

Wolfgang Schäuble, Germany’s finance minister, has dismissed speculation about any Spanish request for eurozone support in buying its sovereign bonds, and ruled out making more concessions to help Greece, on the eve of talks on the eurozone crisis with Tim Geithner, US Treasury secretary.

The tough German resistance to launching any new initiative in the two most embattled member states of the eurozone looks set to clash with Washington’s constant appeal for action to stem contagion in the crisis.

Schäuble was on good behavior in the aftermath of his meeting with Geithner, and avoided the stinging rebukes he had delivered in the past.  Instead, the two limited themselves to exchanging banalities so light that it must have taken a large number of sandbags to keep them from soaring off into the heavens, like the Wizard of Oz.  They agreed that it would be a good thing to avoid a Eurozone crisis, and that everything should be done to achieve that:

The statement said that Messrs. Geithner and Schäuble “emphasized the need for ongoing international cooperation and coordination to achieve sustainable public finances, reduce global macroeconomic imbalances, and restore growth.”

The two stressed “the need for policy makers to adopt and implement all reform steps required to deal with the financial crisis and crisis of confidence,” while noting that top EU officials have said they will do whatever is necessary to fix the crisis.

Ah.  “Whatever is necessary.”  The new mantra.  Like what, specifically?  “Whatever is necessary.”  What is necessary?  “All reform steps required.”  What are those? “Whatever.” Whatever (in the snotty teen sense of the word) is right.

Sort of like saying that it would be a great idea to have fat free ice cream that tastes just like Hagen Dazs.  Pretty much everyone likes the idea, and definitely nobody has the slightest idea how to make it a reality.

ECB head Mario Draghi has gone out on a limb with his “whatever is necessary” promise.  Foolishly, a lot of investors have crawled out there with him.  I’m betting that Merkel, Schäuble, and Germany generally are going to saw it off, mainly because “whatever is necessary” to save the Euro is likely to impose crushing burdens on Germany that Germans will not accept.  I can’t see any mutually acceptable bargain here.  And certainly Timmy!’s and Obama’s hectoring isn’t going to make a bargain any more likely.

Timmy! is deeply offended by SIGTARP Barofsky’s assertion that he was too close to Wall Street while he was head of FRBNY. In related news, Geithner defended himself against allegations that he had not been sufficiently aggressive in his handling of the LIBOR situation:

“We, at least I, first learned about those concerns in the early parts of spring of 2008 and we acted very quickly at that stage. At that time, this is in the spring of 2008, we took a very careful look at these concerns, we thought those concerns were justified,” Geithner said.

“And we took the initiative to bring those concerns to the attention of the broader U.S. regulatory community, including all the agencies that have responsibility for market manipulation and abuse,” he said, citing a specific meeting of the president’s working group on financial markets.

Note this:

The first trove of documents from the New York Fed showed that Barclays had flagged concerns as early as 2007 and Geithner sent the email to Bank of England Governor Mervyn King in June 2008 with the Libor recommendations.

So let’s review the timeline:

• In August, 2007 Barclays admits to FRBNY personnel that it submitted misleading LIBOR quotes, and claims that this practice is widespread.
• In April 2008 the WSJ runs an article providing evidence that banks were systematically underreporting LIBOR rates.
• In June 2008-AFTER the WSJ article-FRBNY sends a letter to the BOE suggesting procedural and governance changes to LIBOR in order to reduce the incentive to misreport.  This letter says nothing about Barclay’s admission that it had in fact misreported LIBOR 10 months earlier.
• BOE does nothing.  FRBNY does nothing.  FRBNY does not follow up when BOE does nothing.

So I guess we now now what “all I could” means in Timmyspeak.

I would have more respect for Geithner had he said: “Given the state of the banking system it would have been catastrophic to pursue aggressively misreporting of LIBOR.” The weaseling-not so much.  That is truly offensive.  (The “We, at least I, first learned” weaseling is particularly offensive.  Just where did the buck stop at FRBNY?)

Incidentally, the NYT has turned on Geithner for his role-or lack thereof-in cracking down on the misreporting.  Moreover, it has come out in support of Gary Gensler as a replacement for Geithner, in the event of a 2d Obama term:

And when the time comes to choose a new Treasury secretary — Mr. Geithner has said he does not expect to remain if President Obama is re-elected — the next president would do well to look for candidates among the regulators who have distinguished themselves by their willingness to confront the banking system’s manifest problems. One such person is Gary Gensler, the chairman of the Commodity Futures Trading Commission, which pursued the rate-rigging allegations against Barclays, securing a record fine and referring the matter to the Justice Department for criminal investigation.

A couple of things.  First, the CFTC acted almost five years after the initial information came to light: that’s confrontation?  Second, has the NYT maybe like heard of MF Global?  Peregrine?

Admittedly, a Gensler Treasury would probably be well down on the list of debacles in the event of Obama’s reelection.  But a debacle it would be, and the LIBOR case-in which the CFTC worked with DOJ and the BOE-is hardly sufficient grounds to justify Genlser’s elevation, especially in light of the two confidence-shattering, and unprecedented, breaches of customer fund segregation that occurred on his watch.

But then again, DC has always been a living, breathing, pulsating embodiment of the Peter Principle, so it just might happen.

That the European Bank for Reconstruction and Development believes that Russia is anything but “an island of stability”, being instead a high beta economy that will suffer substantially if the crisis in Europe worsens:

Russia’s economy is more vulnerable to the effects of the euro zone’s fiscal and banking crises as commodity prices fall, the European Bank for Reconstruction and Development said Wednesday.

Starting in October, the EBRD slashed growth forecasts for eight economies in Central Europe, or CEB, and the Baltics and seven economies in Southeastern Europe, or SEE, citing their close trade and financial links to the euro zone.

With strong growth elsewhere in the global economy supporting prices for oil and other raw materials, the EBRD’s forecasts for Russia were largely unchanged. But in its latest report on the outlook for the economies in which it invests, the bank said the impact of the currency area’s prolonged crisis will spread further east and drag Russia down.

“The negative spillovers are reaching east, and to Russia in particular through two main channels: lower commodity prices and a general reduction in risk appetite,” said Piroska Nagy, the EBRD’s director for country strategy and policy.

You can see the channels work in real time.  Right now oil is being buffeted by two conflicting forces: developments in the Eurozone involving primarily Spain and Italy, and developments in the Middle East involving Iran and Syria.  Bad (good) news about the situation in Spain drives down (up) the price of oil; increased (reduced) fears that Iran will do something aggressive in the Straits of Hormuz drives up (down) the price of oil.  And the Russian stock market and the ruble move nearly in lockstep with these movements.

The EBRD is not alone.  Maplecroft, a political risk think tank, also believes Russia’s economic fate depends on what transpires in the Eurozone:

Countries in central Europe and Scandinavia as well as commodity-exporting African countries Ivory Coast and Mozambique are also among the 17 economies classed as being at “extreme risk”, while the BRICs quartet of big emerging market nations Brazil, Russia, India and China is also highly exposed, the survey showed.

. . . .

Arab Spring countries Tunisia, Egypt and Libya follow closely behind, while Russia, Brazil and India were also tagged with a high exposure to the euro zone crisis.

Of the BRIC group of major emerging countries only China was ranked with no more than a medium exposure to the euro zone.

In other words, Russia will suffer substantially if things go pear shaped in Spain (as they are likely to do, IMO, given the daily blob like growth of the problem with regional bailouts, bank problems, and a looming deepening of the recession), without the consolation of pleasant weather and nice beaches.