Oliver Hart and Bengt Holmstrom Share the 2016 Nobel Price in Economics

The Nobel committee announced today that for their work in contract theory Oliver Hart and Bengt Holmström won the 2016 Sveriges Riksbank Prize in Economic Science in Honor of Alfred Nobel. Charles Duxbury and Mike Bird report on it in the Wall Street Journal today. Moreover the Journal reported in a video:

Evan Peterson, "Why Bengt Holmström, is An Economist You Should Know," Open Markets, October 21, 201.

Bank of America to Fannie Mae: If That's the Way You Want to Do Business, We Won't Do Business with You!

Over a the two decades before the Housing bubble burst, Countrywide Financial became Fannie Mae's biggest supplier of mortgages to securitize. Gretchen Mortgenson and Joshua Rosner document the symbiotic relationship between Angelo Mozilla's Countrywide and Fannie in Reckless Endangerment.  Their relationship was both financial and political as they built up the financial industrial complex that drove the financial system to ruin.  Although Mortgenson and Joshua Rosner demonstrate how these two firms worked with the politicians' and the government's aiding and abetting to degrade credit quality, Fannie is now owned by the federal government.  Under this new management, Fannie wants to only buy mortgages from Bank of America (Countrywide was rescued by Bank of America) on the condition that it can sell it back to the bank if they do not conform to its underwriting standards ex post facto. 

You May Make the Rules, But I Do Not Have to Play the Game

Bank of America has said "No deal!"  It thought it was helping out when it rescued Countrywide only to be hit with one law suit after another from the government.  Bank of America has learned how the government treats those who give the country a helping hand: it bites it until it bleeds.  Exposing oneself to unknown and unlimited liability is not the path to success in banking.

WSJ's David Benoit reports:

Dr. Hoenig, the Hawk: We Need More of Them

Dr. Thomas Hoenig, President of the Kansas City Federal Reserve Bank, has been known as a monetary policy hawk in the past. If he has been part of the Federal Open Market Committee's consensus supporting negative real interest rates, he is a dove no longer. He told the American Economics Association (AEA) meetings, “Experience both in the US and internationally tells us that maintaining large amounts of stimulus over an extended period risks creating conditions that lead to financial excess, economic volatility and even higher unemployment at some point in the future.” Amen!

Hoenig vs. Bernanke

Hoenig and our current Fed Chairman, Ben Bernanke offered opposing views of history at the AEA meetings.

As George Santayana taught us, "Those who cannot learn from history are doomed to repeat it." So at issue is what role monetary policy played in creating the real estate bubble that caused the so called Great Recession of 2007-9. To Hoenig and to me it is clear that the over-expansion of credit that inflated the bubble had as its root cause the Fed's war against the paper dragon of deflation. Negative real interest rates in 2002-2005 and much too low rates in 2006 subsidized the creation of ever more esoteric securities which was the stuff from which Wall Street's leverage binge was made.  Negative real interest rates inflate investment bankers' profits and bonuses, misdirect productive resources into speculation, cause a dangerous correlation of returns, and subsidize the ever increasing financial roundabout production we saw during the recent bubble. Short term interest rates are the price for the raw materials with which investment banks create leverage in securities markets and financial engineers manufacture designer securities.Subsidize the raw materials and increase the supply.

Bernanke is a better student of the Great Depression of the 1930s than of the recent bubble. As John Cassidy relates, that Ben Bernanke "[r]ather than conceding that he and his predecessor, Alan Greenspan, made a hash of things between 2002 and 2006, keeping interest rates too low for too long, he said the Fed’s policies were reasonable and the main cause of the rise in house prices was not cheap money but lax supervision." Cassidy is moved to wonder in the Financial Times whether Ben Bernanke is "Decended From the Bourbons?" recalling "Talleyrand’s quip about the restored Bourbon monarchs: 'They have learned nothing and forgotten nothing.'”

Speech by Federal Reserve Chairman Ben S. Bernanke : "The Future of Mortgage Finance in the United States"

Martin Wolf on the Treasury Plan

The Financial Times'es Martin Wolf advises us that "Desperate times call for desperate measures. But remember, no less, that decisions taken in haste may shape the financial system for a generation. Speed is essential. But it is no less essential to get any new regime right."

Among other things he agrees on a plan proposed by Professor Calomiris: "If, as seems plausible, a scheme that imposes such pain on the financial sector would be rejected out of hand, the next best alternative would be injection of preference shares by the government into decapitalised institutions, on the lines proposed by Charles Calomiris of Columbia University. This would be a bail-out, but one that constrained the behaviour of beneficiaries, not least on payment of dividends. That would make it far better than dropping benefits on the unworthy, via mass purchases of overpriced toxic paper."

The First Global Financial Crisis of the 21st Century

This is an online book.

What Is Good For Wichita Is Hemlock For Wall Street

The strong dollar and the commodity price boom undermine the value of financial assets (see below), but they help U.S. exports. Wall Street's poison is Wichita's tonic. With an export base of aircraft and natural resources, "[s]o many of the things our local economy depends on are doing ... well.”

If you click on KSN you will hear: "'We've been in an economic recession nationwide for probably six months, maybe longer,' said Dr. Malcolm Harris Sr. with Friends University. 'The data is finally catching up with us.'"

Why the Fed Should Raise the Federal Funds Rate Not Lower it Today

I know it is heresy, but the Federal Open Market Committee should raise short term rates today. We are in a dollar crisis. This dollar crisis is at the heart of the financial crisis. The threadbare currency is the street person who dropped in on the high society party and whom no one wants to acknowledge is present.

Reuven Brenner, a partner at Match Strategic Partners and a professor at McGill University, points out that "few are noticing the fact that, since 2002, trillions of dollars worth of business and U.S.-government debt value has evaporated. This happened because the Federal Reserve has neglected the dollar." As the dollar falls, the value of dollar denominated assets fall in euro and yen and pound and Aussie dollar terms. Little wonder foreign investors want to dump U.S. dollar mortgage backed securities which are at the eye of the storm.

Professor Brenner notes, "Alan Greenspan says that a measure of stability will be restored when house prices stabilize, which may be accurate. But why would capital flow into real estate denominated in dollars that are still expected to plunge?" The same is true of financial assets. He advocates a commodity anchor for the dollar, a position I have long advocated myself.

Given that we are unlikely to get a new monetary system, what should be done? We need a coordinated effort of the Federal Reserve with the other major central banks to support the dollar. To accomplish this with credibility, the Fed would need to show its commitment to fight inflation and to restore the exchange rate. That means raising the federal funds rate target. This would cause a political firestorm, but it would be the only way to calm the financial storm that is swamping the U.S. and limit the economic damage from it.

The Fed Has Cut the Discount Rate and Will Lend to Security Firms

The Fed has been busy. They cut the discount rate; they strong armed J.P. Morgan to buy Bear Stearns and Bear Stearns to sell themselves; and they lent J.P. Morgan $30 billion to make all this work. The repo market has seized up and that interferes with the Fed's ability to conduct monetary policy.

Hear more from the Wall Street Journal.

Froma Harrop on the Subprime Mortgage Fiasco

Froma Harrop is right: Henry Potter was, at least, an up front, mean rotten banker: "Nowadays, it's impossible to watch the 1946 holiday movie 'It's a Wonderful Life' and not feel a twinge of respect for Henry F. Potter, the villainous banker played by Lionel Barrymore. Potter was not above drawing the last drop of blood, but at least borrowers knew whom to hate. And if they were late paying, they knew where to crawl."


Froma Harrop nails the problem when she describes the true culprits of our mortgage market meltdown: the brokers who make the big commissions and leave others to pick up the pieces. Good old fashion bankers had to live with their creditors and had a real interest in their making it.

Harrop also names that unindicted co-conspirator too, Alan Greenspan himself: "Former Fed Chairman Alan Greenspan had cheered on the housing bubble that raised home prices to ridiculous levels. And despite the warnings, he ignored the recklessness and downright cons that would inevitably push mortgage market into crisis."

Is Alan the Culprit?

Who or what caused the Mortgage Crisis? Alan Greenspan claims he should not be blamed! He tells us that "Bubbles can not be safely defused by monetary policy before the speculative fever breaks on its on." Of course Fed's flood of liquidity after 9-11 would have had nothing to do with the bubble's inflating in the first place, now would it have?

Those of us with the more mundane worry of whether the crisis will translate into a recession will be reassured The Wall Street Journal already has the remedy: use fiscal policy not monetary policy. The paper's editors believe the dollar's virtue can not take any more ease. Read its editorial, "False Savior."

The Subprime Mortgage Credit Crisis & the Bursting of the Housing Bubble Drops Mortgage Mail Solicitations By 62%

Mintel Comperemedia research tracks direct mail sent to households. Their data show mortgage solicitations in the mail fell 62 percent in the third quarter from the same period last year. Not surprisingly, ARMs (adjustable-rate mortgages) no longer predominate. The proportion of offers for for adjustable-rate mortgages fell from 56 percent to 22 percent.

Prominent mortgage brokers and mortgage banks have gone bust while major players have with drawn from the market.


DM News reports that the Treasury facilitated plan to selectively freeze the rates on some ARMs is causing direct marketing pros to adjust their offers.

The Subprime Mortgage Crisis, Recession, and Citibank

This morning's Wall Street Journal is full of opinion and commentary on our favorite topics.

Alan Greenspan dissects "The Roots of the Mortgage Crisis." He thinks that if it had not been subprime mortgages, then something else would have precipitated a crisis after risk premia had fallen so low.

Also on the Opinion Page, Alan Reynolds analyzes the dollar in his commentary, "Interest Rates and Dollar Fundamentals" and Martin Feldstein advises on "How to Avert Recession."

Meanwhile, Citicorp, parent of Citibank, has decided that Vikram Pandit and Sir Win Bischoff should stay on as CEO and Chairman, respectively. They were both acting in those jobs. You can read about it in Robin Sidel and David Enrich's article. The big question remains: "Can a universal retail/wholesale bank be created like a hothouse plant through mega mergers and acquisitions?" I have my doubts. That certainly not the way the House of Morgan was created. On October 16th, Ms Sidel and Jeffrey McCracken reported increased skepticism that Citi's universal banking strategy was working.

What's a Minsky Moment?

The Wall Street Journal's Justin Lahart reports that the "Minsky moment has become a fashionable catch phrase on Wall Street. It refers to the time when over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand."

Personally, I find John R. Hicks' explanation in A Market Theory of Money far more comprehensive and plausible for what we are now undergoing.