Austerity: The History of a Dangerous Idea by Mark Blyth

There is nothing ambivalent about Mark Blyth’s view of austerity: he is against it. Blyth’s Austerity is more than a brief against today’s accepted form of treatment for all that ails a slumping economy - it is an intellectual history of a powerfully attractive idea, though in Blyth’s view, a dangerous one. Austerity fails for a number of reasons: it is unfair (it hurts the poor), it cannot be pursued simultaneously by all (someone must spend to ignite economic expansion), and (most damning) history shows it doesn’t work.

Blyth admits to being a Keynesian. There is no shame in that: many neo-Keynesians are calling for an end to austerity. Blyth states, however, that he need not prove Keynes right (“for what it’s worth, he was right, but that’s in another book”); his goal here is simply to prove austerity wrong.

While austerity figures in contemporary U.S. politics, it is predominantly a European fix and fixation, famously imposed on Greece, Spain, Ireland and Portugal as a condition for European and IMF support in response to the Euro Crisis. Blyth begins the book by correcting the dominant narrative: Greece aside, the Euro Crisis did not originate by reckless government spending, but in private irresponsibility. Excessive private sector lending (provoked by cheap borrowing costs associated with the adoption of the Euro) sank the banks in Ireland and Spain (and their respective economies); the states became indebted in attempting to clean up the mess. Setting this history right is important -- as part of the moral authority for the imposition of austerity is a judgment of state fault. Austerity is not merely an economic prescription -- it is a punitive response. As Blyth points out, there was little else Spain or Ireland could have done. Their banks were not only too big to fail; they were "too big to bail" -- that is, their liabilities were beyond the state’s capacities to absorb. Hindsight suggests the better course might have been to abandon the banks -- but that course would have presented other grave difficulties. By shouldered bank indebtedness, several European states wildly exceeded the European limits on budget deficits and overall indebtedness. So why, Blyth asks, is the Euro crisis consistently described as a sovereign debt crisis? One must blame the state in order to justify the imposition of austerity.

The Bankers' New Clothes: What's Wrong with Banking and What to Do about It by Anat Admati and Martin Hellwig

I have the odd habit, with academic writing, of first reading the notes and then returning to the central text. I like to see the foundation of a work. Would that I had read the notes to The Bankers' New Clothes first! For The Bankers' New Clothes is really two books which I had read in sequence (slave as I was to the Kindle's primitive formatting). The first book -- the primary text of 228 pages -- seemed simple-minded, sometimes shrill and often tedious. It argues for a significant increase in the amount of 'capital' (a specialized term in banking regulation) banks should maintain. The second book - the 107 pages of dense notes -- reveals a much more subtle, more flexible and more open understanding of the issues. This 'book' is more useful and persuasive. I recently heard co-author Anat Admati speak in Los Angeles. She described her surprise when first viewing the book as published, that it was so 'short' when the notes were stripped away and shuttled to the back of the book. It matters (Kindle take note) how books are presented; I would have had a better impression on my first read had these rich notes been on the page or gathered at the end of each chapter. And perhaps these authors will speak up the next time they write for the broader public.

Admati and Hellwig are on a mission. They fervently believe that banks should be required to hold more capital than present rules require. And by more, they mean much much more. From current rules that require, depending of the measure, 3 to 7 percent of a bank's assets, to something on the order of 20 to 30 percent. They demonstrate that such higher levels of capital (think of this like the ratio of equity to the fair market value of a house) would significantly increase the robustness of the entire banking system, relieving the state from facing new rounds of bailouts. Moreover, as the leverage of bank's decrease, banks will be less likely to attract the risk-seeking buccaneers that have managed our great financial institutions into the ground.

Bull by the Horns: Trying to Save Main Street from Wall Street and Wall Street from Itself by Sheila Bair

Bull by the Horns is part defense of past action, part call-to-action. Sheila Bair served as chairman of the Federal Deposit Insurance Corporation, one of the chief federal bank regulators, from 2006 through 2011 -- and thus rode the entire wave of the Financial Crisis. By her own account, she clashed with officials of both the Bush and Obama Administrations (in important cases, these were the same individuals). And throughout these times she was the most prominent woman in United States financial regulation.

Bair becomes the FDIC in this story -- she absorbs its mission and makes it her own. The FDIC has a peculiar mission -- and it has never been the only law in banking. Bair believes in deposit insurance but not bailouts. Deposit insurance is paid to depositors in the event of bank failure; bailouts are payouts to shareholders, bondholders and management in the same circumstances. There is a distinction here -- but perhaps not as self-evident a one as Bair imagines. Both deposit insurance and bailouts (under the Too Big to Fail doctrine or otherwise) create moral hazard. Bair though sees banking policy through the FDIC lens -- depositors (up to the FDIC limits) are to be given continuous access to their funds in the event of failure; shareholders and bondholders are to be wiped out and -- at least in most cases -- bank management is to be fired. All very by the book. Which is to say, Bair wants the bank resolution system to work as it is promised to work -- which of course is not at all what happened following the Financial Crisis.

Moreover, Bair seems to have little sympathies for the other agencies involved in federal banking regulation, unless their objectives accidentally converge with those of the FDIC. The Office of the Comptroller of the Currency and the Office of Thrift Supervision are consistently dismissed as completely captured by the institutions they regulate; the Department of Treasury is a political instrument of the White House (although Treasury is often portrayed as a rogue department under Timothy Geithner). The Fed is okay most of the time -- Bair is generally admiring of Bernanke -- but the New York Fed is a different story. Throughout the book, Bair signals which players were friends and which -- the greater number -- were enemies. In all, it is a very personal book: Washington is a field for contesting personalities.

ECB's new role as eurozone bank regulator

Early Thursday morning (December 13) eurozone finance ministers agreed to take a first step toward establishment of a banking union. The agreement will grant supervisory powers to the European Central Bank (ECB) - at least with regard to the 200 or so largest banks headquartered in the eurozone. Large European banks located outside the eurozone (chiefly UK banks) will continue to answer to national authorities. With the accretion of these new powers and responsibilities, the ECB will come to resemble the Federal Reserve which functions as both as a monetary authority and as the chief regulator of large banks operating in the United States.

The political accord reflects a compromise between the competing visions of France and Germany. France had desired a complete transfer of bank supervision to the ECB, effectively extinguishing national regulation. Under this approach all banks located within the eurozone would become 'European' in character. Germany resisted; Germany has been desirous of sheltering its politically powerful regional banks from European control. A reported late-night compromise between France and Germany has resulted in a mixed system - with the eurozone's 200 largest banks falling under the authority of the ECB and the remaining 5,800 or so smaller banks (including virtually all of Germany's regional banks) continuing under the oversight of national regulators.

Still the eurozone finds itself a good distance away from a true banking union. As conventionally understood, a banking union involves three features: common and centralized supervision, a common deposit insurance scheme and a centralized mechanism for taking over insolvent banks. The current decision achieves at best only the first element. Moreover, the EU summit determined to postpone action on the remaining items - deposit insurance and insolvency scheme - for at least six months. These missing features involve politically touchy sharing of financial burdens.

Collateral Knowledge: Legal Reasoning in the Global Financial Markets by Annelise Riles

I was entranced by the prospect of reading Annelise Riles' Collateral Knowledge, given my eclectic (some would say scattershot) interests. Riles delivers a sophisticated and insightful anthropological treatment of the management of various legal questions facing Japanese banks entering OTC swap transactions. Global finance, ethnography, tasty legal theory: what fun!

And yes, Riles pulls it off. She promises an "ant's-eye view" of these stories, consistent with traditional ethnographic method. While the original intended targets of her observation were Japanese bank regulators, she later realizes the 'back-office' personnel (including the lawyers overseeing the documentation of the transactions) were as central in the process of the law-making.

Riles examines two crucial points of tension in the swap practices of Japanese banks. The first is the utilization (under Japanese law) of the institution of collateral: the posting of property to secure repayment of a debt. The book's title, Collateral Knowledge, plays on this and other meanings of "collateral." All commercial lawyers understand how collateral should work: it should freely pass the pledged assets into the hands of the favored creditor in the event of a debtor's default. And so the mission of a bank lawyer (in this case, one dealing with a Japanese bank) is to assure his principals that these functional expectations are met. This is hardly a simple matter where (in an example given by Riles) the swap is between a Japanese bank and a UK bank, posted to their respective Cayman Island subsidiaries and involving Chinese and Singaporean currencies. The swap raises peculiar difficulties, as neither party knows ex ante whether it will be a net creditor or net debtor of the other -- and so both may need to post, maintain and adjust collateral supporting the transaction. The standard industry forms, drafted by British and American lawyers and routinely used by the Japanese banks, are "literally nonsensical" to the Japanese, according to Riles.

Volcker: The Triumph of Persistence by William Silber

So what would a Democrat central banker look like -- if there could be one? Resembling Paul Volcker, answers William Silber. That said, it is hard to recognize much in Volcker's policies marking him as a Democrat. Nixon did not trust him -- but that alone scarcely defines a Democrat. Volcker famously endorsed Barack Obama in the 2008 election -- but then so did Republican Colin Powell.

Silber adores Volcker -- which weakens Silber's ability to answer (or even ask) tough questions. It is clear that Silber believes Volcker saved the dollar -- and that he is a swell guy to boot. Pity poor Mrs. Volcker who spends an isolated life in a series of ratty apartments while her husband chases glory (in public service, mind you) rather than wealth. Neither Volcker nor Silber seem to realize what a lousy husband he was -- and Mrs. V. was too tactful to point this out.

The Silber account establishes Volcker's self-sacrifice -- and I suppose there's some foundation for it. Volcker spends many years as an underpaid public servant while having far more lucrative opportunities in the private sector. Yet one gets the sense that Volcker is simply more comfortable in the world of the Fed than he would ever have been in a bank. Generals are willingly generals -- there is something (glory? military music?) that draws them to their role. Their renunciation of wealth and a stable home-life only prove their ambition. While we should be grateful for their service, it is not clear that the generals are sacrificing anything. And so perhaps it is with Volcker.

There's good character present -- Volcker likes cheap cigars and hates potted plants. He doesn't really care about his shoes -- and silently worships confident political stars like John Connally. His devotion is peculiarly institutional: not to the United States, but rather to the Fed and its mission, as he perceives it, protecting a sound dollar. Silber's worshipful treatment of Volcker places Volcker's character in the center. The fundamental excellence of who Paul Volcker is (an excellently common man) spills over into his professional life. The strange mixture of talent, insecurity and ambition suits him to his mission.

Paper Promises: Debt, Money and the New World Order by Philip Coggan

As its subtitle suggests, Philip Coggan's book examines the relationship between debt and money and its implications for the 21st century economy. Coggan takes us through familiar territory (the nature of money) and familiar debates (Keynesianism vs. monetaristm), yet offers a novel framing that make this book a valuable read.

Coggan has an unusual view of the fundamental divide in political economy. Rather than seeing class struggle everywhere, Coggan treats the conflict between creditors and debtors as the central fracture motivating politics, though he notes that -- all things being equal -- creditors tend to be wealthier (and fewer in number) than debtors.

In speaking of debt, Coggan slides (perhaps too easily) between private and public debt. The debt that interests Coggan is the burgeoning debt that tends toward default (as opposed to the under-remarked debt that is extinguished by repayment in the ordinary course). This is the persisting debt that in usual times is rolled over upon each maturation. He writes of unsustainable debt -- again, both private and public -- that will of necessity lead to some degree of default. In the case of public debt, the default scenarios include -- importantly -- devaluation, a course open to most states to reset the exchange value of the money in which a debt is expressed and thus unilaterally reduce the value of the debt (as expressed in some other value, such as gold or a harder currency).

For most states, there is a limit to this strategy. Devaluation has consequences. It may throttle domestic expectations, igniting inflation. And devaluation -- in a global society -- has consequences, distributing at least some of the lost value to other countries (by readjusting the terms of trade) as well as to the disappointed creditors. Devaluation will also make future borrowing more difficult.

But -- of late -- there appeared the possibility for at least one country to escape the devaluation trap. The United States has enjoyed an extraordinary privilege, in that its currency seemed to be highly valued notwithstanding its horrific trade deficits. This reflects its historical (though waning) primacy in world economic affairs. What matters now is the role of this particular national money as place for storage of value: China (as do Japan and others) continues to re-funnel its vast export earnings into dollar-denominated obligations of the U.S. Treasury, thus keeping prevailing U.S. interest rates low. Exchange values may reveal more about capital flows than trade balances, Coggan argues.

This perceived signal within the U.S. economy is a green light for expansion. Prior to the 2007 financial crisis, this green light released a frenzy of asset acquisitions, including the real estate bubble. And even now, the continued low interest rates may serve to mask the severity of the U.S. debt crisis. Confronting the debt crisis may be postponed (though not avoided) through the simple expedient of increasing the U.S. money supply.

Money today is simply debt, Coggan reminds us. Money has been detached from its historic anchors (precious metals), as each sovereign seeks to discover the sweet spot between too little and too much money. The likely course is one of oscillation, where the costs of each extreme is regularly felt. Post-crisis austerity, while an upright policy, may lead to a downward spiral, as consumers pull back current expenditure to service debt (their own and, via taxes, those of the state), magnifying economic contraction. And too much debt can drive away the creditors -- the monolithic bond market James Carville fears -- as they come to believe that 'borrowing' is just a ruse to transfer their accumulated stores of wealth to others. Better to hoard (if that remains possible).

Moving debt into the future has been a viable strategy - but it resembles a Ponzi scheme, in that success depends in part of an increasing number of new players, the upcoming generations. Their ability to work off the burdens of their grandparents may depend on the prospects of their grandchildren, and so on. But the intergenerational strategy seems to have limits as well, as advanced economies (such as the United States, Japan and Europe) feature extremely low population replacement rates. In an odd way, pushing the U.S. debt back onto China (through a devaluation of the dollar against the renminbi) has both an international and an intergenerational aspect, given China's continued projected population growth.

Coggan paints a rather bleak future, involving inevitable U.S. decline. More crisis is ahead, as the mountain of public and private debt is either devalued or postponed - or results in outright default.

Abandoning the Euro, Saving the Euro

The Euro crisis tests more than the viability of the current currency arrangements. The sovereign debt crisis affecting Greece and Ireland, Italy and Spain is also testing the limits of wider European democracy. The status quo will likely be abandoned. The open question is whether the Euro crisis will lead to deeper integration among the EU Member States (as an artifact of a Euro rescue) -- or whether a collapse of the Euro will signal a retreat from the past achievements of the European project.

The European Union began as a common market for goods and services. A common European currency space is a more recent development -- the Euro serves as the currency of most (but not all) EU Member States. Adoption of the Euro has reduced trading costs, and has led to more transparent prices.

The Euro crisis is first and foremost a sovereign debt crisis, initially affecting a handful of EU Member States running unsustainable deficits. The sovereign debt crisis is itself an artifact of the establishment of the Euro -- neither Greece nor Spain would have been able to borrow as much in their former currencies (or on such favorable terms) as they were able to using the Euro. Prior to the Euro crisis, the financial markets valued Euro-denominated Member State obligations similarly. As the crisis developed, lenders became far more discriminating, demanding much higher Euro interest rates from weaker Member States (such as Greece and Spain) than from others.

European Limits on Banker Bonuses

The EU's Council has prepared its draft legislative package implementing the Basel III banking reforms -- known as CRD IV. Attention now shifts to the European Parliament for its response, expected this autumn. A complex process of reconciliation will follow. On one point the Parliament has drawn a line in the sand: the eventual CRD IV must contain significant limits on contingent compensation paid to bankers. The Parliament's starting point is a one-to-one ratio cap: bankers' bonuses cannot exceed annual salaries.

Basel III did not impose any limits on bankers' compensation -- although several European members of the Group of 20 had sought bonus restraints during the negotiation. Nor does Basel III restrict the ability of Europe -- or any other Basel party -- from imposing additional requirements on its banks. Europe's imposition of bonus limits in CRD IV may be described as "Basel III Plus" -- an additional term beyond the basic Basel III mandates.

There is a broad perception that the bonus culture of New York and London contributed to the 2007 financial crisis. Bankers seduced by the prospect of large contingent payments caused their firms to undertake inappropriate levels of financial risk. New limits on bonuses, in this telling, are needed to eliminate the distortion in risk appetite generated by prevalent compensation practices. But bonuses have their defenders -- and not just the bankers who receive them. There remain policymakers (albeit more likely those overseeing markets in New York and London) who continue to believe that bonuses are necessary to attract the creative talent that will drive economic growth.

European Politics and the Regulation of Bank/Insurance Firms

On prior occasions, European implementation of the Basel bank regulatory system had proceeded rather mechanically. The Europeans actively participated in the Basel II process, reached agreement with the world's other major banking powers, and then faithfully enacted Basel norms into EU law. This has not been the case with the latest product of Basel: Basel III. While Europe once again exerted its influence during the negotiation, it has been decidedly less determined to give full effect to its Basel III undertakings in EU legislation. And the reason -- it should be no surprise -- is politics.

The linkage between Basel III and the European implementation (known as CRD IV) involves three levels of politics: global, European and national. The uncharacteristic European reluctance to carry out the Basel III mandates to the letter results from the varying distributions of influence at each level of the lawmaking game. A case in point: so-called 'bancassurance' -- financial conglomerates that are part bank, part insurance company. France's Societe Generale and Credit Agricole are two large examples of 'bancassurance'.

The treatment of bancassurance was a sticking point in the Basel III negotiations. The United States and others (including the United Kingdom, an EU member state) identified the problem of 'double counting' equity capital in bancassurance. Basel III requires banks to maintain adequate amounts of high-quality (Tier 1) equity capital. This capital acts as a loss-absorbing buffer, protecting depositors and other bank creditors. In a similar spirit, insurance regulators demand that insurers maintain adequate equity to protect policyholders in the event insurers experience losses.

Bank Capital Reform in the Shadow of the Euro Crisis

European banking reform continues to develop alongside of - and perhaps in spite of - the ongoing Euro crisis. A significant EU reform package - involving a new directive (Capital Requirements Directive IV, or CRD IV) and a new regulation (Capital Requirements Regulation, or CRR) - is making its way through the EU legislative institutions. These reforms are driven in large part by Europe's undertakings within the global Basel system: Europe has committed to implement much of the most recent Basel package of reforms (known as Basel III) by January 2013.

One of the chief requirements of the Basel III reforms is to increase both the quantity and quality of the 'regulatory capital' banks must hold. This capital is intended to operate as a financial shock absorber in the event of large losses - assuring a bank's continued solvency and sparing shareholders (and - in a worse case - taxpayers) pain. Basel III is a system of minimum standards - countries are expected to comply with Basel III's requirements but are free to impose higher standards. And several countries (Switzerland, for example) have determined to require their banks to maintain even more regulatory capital than what Basel III demands.

The combination of common minimum standards and regulatory flexibility is familiar to the EU Member States: it is a feature of most EU-level regulation, known as "harmonization". But in its most recent drafts of CRD IV and CRR, the EU proposals called for "maximum harmonization," a design where the Basel III minimum standards serve to fix mandatory standards for the implementing EU Member States. Basel III requires that national regulators impose a minimum capital requirement for so-called Tier 1 capital ratio of 6 percent. By its terms, the Basel III framework permits countries to impose higher Tier 1 capital ratio requirements. But to permit each EU Member State to impose its own Tier 1 capital ratio requirement (so long as it exceeds the Basel III minimum) would introduce competitive and operational stresses within the somewhat unified European banking market. These concerns in turn have motivated EU officials to prefer "maximum harmonization" whereby all EU Member States would enact identical Tier 1 capital ratio obligations.