Commentary on Political Economy

Sunday 3 July 2011

From “KRISIS: Draft Chapter on ‘Notes On Minsky’
REVIEW OF F. Mishkin’s “Spread of Financial. Instability”
Mishkin begins by stating that the finance industry plays a crucial role in allocating capital for productive activities – and he leaves out “profit”! He then goes into “information asymmetries”, mainly of two types – (a) differential between lenders’ and borrowers’ risk, and (b) a corollary of (a), “immoral” behaviour by borrowers. There is obviously a “division of labour” between the “owners of capital” (Finanzkapital) and its “users” (industrial capital). So this division engenders a “functional differentiation” between the “global” interests (literally!) of capital through the “pooling” of “many capitals” through the “uniform rate of profit” – which means that there is, first, a “concentration of capitals” (to be opposed to the “concentration of labour-power by capital” through the division of social labour); and then the “particular” interface of the antagonism in the place of production for “valourisation”. Finanzkapital is therefore a kind of “insurance” for capital – a “social capital” that thinks in “strategic” ways (Schumpeter and Marx) about the overall direction of the valourisation process – it is therefore far more “political” or, again “strategic”.
The “asymmetry” starts here: - in the fact that Finanzkapital wishes to valorise itself independently of the production process. So there is a “speculative” tendency in it that is in conflict with the “reality” of wage-relation antagonism. But then this antagonism is “trans-ferred” onto the “investment decision” side, particularly if finance is “deregulated” and there is growing “competition” (that is, anarchy and conflict) between different capitals. The “competition” is simply the fact that each “entrepreneurial” capitalist has to confront particular workers in particular situations – no more, no less.
Keynes and Kalecki and Minsky see the “hiatus” (the money “bridge” or the “slip ‘twixt cup and lip”) in the “individual” investment decision between “lender” and “borrower” – almost as if it were an eternal truth. But in fact the dichotomy is between the “reproductive” needs of “social capital” in its “planificatory” aspect, and the “immediate, local” antagonistic role of the production process. Whereas the latter (the borrower) is concerned with “the return on capital”, the former (the lender) is also concerned with “the return of (!) capital”! For capital overall there is no difference between “borrower” and “lender”. And this goes to the entire notion of “risk”: different levels of “risk” may affect the “distribution” of profit between capitals, but not the overall level of “profit” and therefore “value” extracted by capital from living labour so as to command it.
It is the very “degree” of concentration of capitals, the “sociality” of capital, which is engendered by the necessary “concentration of capital” of workers in the division of social labour – it is this “overcoming of the Trennung” that forces capital to become “social”, that is, to confront workers as a “class”. Workers force capitalists to group into a class – to organise valorisation on a social scale, which involves “reproductive functions” as well. And the more these are “regulated” by a central “political” organisation (government, bureaucracy), the more there is “control of growth”, the greater becomes “the growth of control”.
The problem is that this “political control of growth” (of social reproduction and valorisation) then comes necessarily into contradiction with the need to keep the valorisation process “private”, that is, “decentralised” so that the Trennung, the fiction of the division of individual labours, can be maintained through the “wage relation” – reward according to “productive allocation” of capital!! So here we have come back full circle to Mishkin – except that now we understand what is happening much more deeply than before!
In particular, what we understand is that those “information asymmetries” (the moral hazard, the free-rider and principal-agent problems) are far more complex than Mishkin makes out and involve the “functional separation” of capital in its distinctive “moments” of valorisation!! “Risk” is one of the aspects of this functional separation in that the internal distribution of profit depends on the perceived amount of “risk” a given investment involves. Let us recall that “risk avoidance” is the aim of some capitalists – the “rent-seeking behaviour” – which threatens the “stagnation” of the system (cf. Krugman’s “liquidity trap” study for Japan and Europe).  But capital as a whole is oriented to “profit”, which involves the “risk” of the process of valourisation, from M to M’ through P (the process of production). This is why Keynes acutely perceived that “money is the bridge between the present and the future”. Every time capital is “invested” there is a risk that there will not be a “return on capital” or indeed (with Mark Twain) the “return OF capital”!
But the wage relation cannot stand still – because of its “antagonism”, which pushes the capitalist to become an “entrepreneur”, to “innovate” so as to re-define and re-structure the political command of capital as dead labour over living labour. Schumpeter alone of the great bourgeois economists saw this with enviable perspicacity. He has been cursed or burdened most unjustly with the “Schumpeterian rent” badge because he identified Cantillon’s “entrepreneurial profit” (the compensation a merchant receives from the “profits” of capital investment) for “risking” the transition to “market” of produced goods. But there is no “profit” in Schumpeter’s “Kreislauf” in the Marxian “accumulative” sense; there is “profit” only as simple reproduction – this is the “neo-Ricardian” meaning of Kalecki’s “workers spend what they earn and capitalists earn what they spend”. Both Keynes and Kalecki completely ignore the Schumpeterian “problematic” – the “Dynamik” of capital (versus the “Statik” of the Kreislauf) – the whole problem of capitalist “Entwicklung” – not “growth” (!) but capitalist “trans-crescence”, “growth-through-crisis”!
Next, Mishkin deals with the “free-rider” problem (p58). This is an aspect of the “risk-aversion” of capital as each capitalist seeks “safety in numbers” or simply “piggy-backs” on the “information” gathered by others (see also Akerlof on “lemons”, which started the whole AI shebang). The so-called “Great Moderation” amplified this “problem” because of the ability of Western capital “to circumvent” wage antagonism by realising “profits” from investment in “emerging markets” (China above all). Apart from the teratogenic by-product of the Chinese dictatorial “monster” it created, the “reflux” of the profits allowed and encouraged Western Finanzkapital to find “creative” ways of “investing” this capital which – in the absence of a “realistic confrontation” with workers – lulled capitalists and governments alike into believing that “inflation was conquered” by central-bank instruments and policies, whereas in fact the “conflict” had been deflected onto “debt”, with the well-known results. Once more we find that whenever capital seeks “to elide and elude” working-class antagonism, it ends up “blind”. And this “blindness” is what creates “excess or fictitious capital” whose “collapse” then needs to be “rescued” by the State in an ever-growing spiral of intervention and interference (“in-gerence”) into the “private” capitalist economy to ensure social reproduction. This is where almost every bourgeois economist mistakes the effect for the cause!
Mishkin at p60: “Governments also impose regulations to ensure that financial institutions adhere to certain standard accounting principles and disclose a wide range of information that helps the market assess the quality of the financial institution’s portfolio and the amount of the institution’s exposure to risk. More public information about the risks incurred by financial institutions and the quality of their portfolios can better enable stockholders, creditors, policyholders, and depositors to monitor these institutions, and so act as a deterrent to excessive risk taking.”
This paragraph illustrates clearly the passage from “individual risk” (the “coal-face” of wage-relation antagonism), through to its “objective assessment” by financial institutions. Then on to the threat that these “assessments” are “copied” by other “institutions” (free-rider) and thence the need for State intervention… “to regulate” the “symmetry” of the information available – as to the “real” situation of class conflict in the wage relation. The question arises therefore of why the State is called upon increasingly to confront directly the “effectiveness” of the wage relation as against letting “private capital” take care of that “conflict”. And the reason is that “inflation” is no longer the “monitor” of this conflict because high rates of unemployment reduce the “profitability” of capital too – with the consequence that capital needs to turn to “financial” escamotage to realise “fictitious profits” through asset-price bubbles! So down comes Minsky’s and Fisher’s explanation of “instability” as “debt-deflation”. The contract structure of debt and the eventual debt-deflation are a “consequence”, an effect, not a cause! This is what Minsky never understood because of his Keynesian-Kaleckian neo-Ricardian “underconsumptionist” bias!
Whenever the State is unwilling to intervene “directly” and resolve “politically” the reproductive needs of the capitalist economy, it seeks to use “indirect” methods – legal and regulatory – to ensure, first, that private capital does not climb on Pegasus (“irrational exuberance”) and, second, that any “crack” does not worsen into a “panic” (LOLR, deposit insurance) – see Mishkin, pp60-1. But this opens up the dilemma of “regulation” or “supervision” – which in reality are not “alternatives” but different “degrees” of “ingerence” by the State. This is an absolutely “crucial” stage of the distinction between “formal” and “informal” State “crisis management” of the capitalist economy and of social reproduction: indeed, the State “intervenes/interferes” only to the extent that the former threatens the latter (we called this “functional or strategic separation”).
So listen to this from Mishkin: “This brief survey shows that information problems are a central feature of financial systems and explains why financial systems are structured the way they are. These same informational problems explain why financial instability occurs as we will see below,” (p62).
Remarkable how Mishkin thinks that “info problems… e x p l a i n why financial instability occurs”!! They do nothing of the sort, of course!
FAZ Interview with Shin: “Es existiert heute kein theoretischer Rahmen, der die direkte Inflationssteuerung mit monetären Analysen verbindet. Es ist unsere Aufgabe als Wissenschaftler, diese Dichotomie zu überwinden. Aber ich bin zuversichtlich, weil sich gerade junge Wissenschaftler diesen Themen zuwenden.”
Shin calls it a “dichotomy” but I would call it either an “existential dilemma” (or “Angst” with Vittori) or “conundrum”. Note also Shin’s reference to “science”… But let us continue with Mishkin. When he proffers explanations he comes up with four salient ones: “The asymmetric information analysis [63] we have used to understand the structure of the financial system suggests that there are four categories of factors that lead to financial instability: increases in interest rates, increases in uncertainty, asset market effects on balance sheets, and problems in the banking sector.”
Nowhere does Mishkin “explain” why interest rates rise or uncertainty, with “consequent” (therefore an “effect”, not a cause) balance-sheet problems (wonderful this “balance-sheet” description of “valourisation” problems!) and banking-sector problems. Let us look more closely at the “internal” dynamic Mishkin describes of these “factors” (he dares not use the word “causes”). Now listen to this beauty: “As demonstrated by Stiglitz and Weiss (1981), asymmetric information and the resulting adverse selection problem can lead to credit rationing in which some borrowers are denied loans even when they are willing to pay a higher interest rate.” (This is called “credit selection”.)
In other words, higher demand for loans makes lenders more reluctant to lend because they perceive that “risk” is rising and, in fact, it leads to loans being made to the “riskiest” investments – a version of Gresham’s Law’s inversion where “bad loans drive out the good” (recall that Gresham’s Law – “good money drives out the bad” is entirely false because the opposite [hoarding!] is true! Akerlof’s “lemons” analysis dealt with this apparent paradox or “externality”.) This is a “paradox” (not of thrift or of toil or of wealth [Smith and Hegel] but rather…) of lending, whereby “risky investments” rise just as “fictitious profits” also rise, and so does the interest rate as “the uniform rate of profit”. It is the Adrian and Shin “risk-taking channel” due to the lower “value-at-risk” (VaR) for lenders. This means that if, for reasons we will not examine here, the rate of inflation remains low… it is difficult or impossible for capital to know “who has been swimming naked” (Buffett) in “the tide that raises all boats”! Differently put, capital “realises” in asset-price gains what it cannot through the more direct “channel”, that is, the opposite of the “risk-taking channel” (the word used by Adrian and Shin about the shift to “riskier” investments that follows the announcement of lower interest-rate regimes from central banks [the Fed]).
Here is Mishkin (p63): “The theory behind credit rationing can be used to show that increases in interest rates can be one factor that helps precipitate financial instability. If market interest rates are driven up sufficiently, there is a higher probability that lenders will lend to bad credit risks, those with the riskiest investment projects, because good credit risks are less likely to want to borrow while bad credit risks are still willing to borrow. Because of the resulting increase in adverse selection, lenders will want to make fewer loans, possibly leading to a steep decline in lending that will lead to a substantial decline in investment and aggregate economic activity. Indeed, theoretically, a small rise in the riskless interest rate can sometimes lead to a very large decrease in lending and even a possible collapse in the loan market.6”
Thus, any attempt by a central bank “to prick the bubble” by raising rates can unleash the “debt-deflation” Fisher theorised. And what central banker will be able to tell capitalists that it is time to slow down? (Cf Posen on “why asset bubbles should not be pricked”.) There are political repercussions also in terms of employment, particularly if inflation happens to be low. So there are two opposing forces: on one hand is the need to close the “risk-taking channel”, which is the path of least “resistance” (literally!) for capital; but on the other there is the ever more untenable “output gap” in terms of the “employment of social resources” together with, even worse, the capitalist push “to employ capital in ‘profitable’ ways when there is no apparent ‘inflation’”! The picture is getting clearer now.
This induces us into the question of what “risk-taking channel” means: we are asking “what is it about certain late investments in a ‘cycle’ that makes them ‘risky’?” And obviously the answer has to do with the “stagnation” of “valourisation”, so that just at the time when capital is riding high on the wave of profits and high interest rates, what is happening “in reality” is that a lot of capital (value) is being destroyed just at that time (at the apex of the investment cycle) because “real value” gets mixed up (through “toxicity”) with “fictitious value” – and that is when the bubble bursts.
“A dramatic increase in uncertainty in financial markets, due perhaps to the failure of a prominent financial or nonfinancial institution, a recession, political instability, or a stock market crash, makes it harder for lenders to screen out good from bad credit risks. The increase in uncertainty, therefore, makes information in the financial markets even more asymmetric and may worsen the adverse selection problem. The resulting inability of lenders to solve the adverse selection problem renders them less willing to lend, leading to a decline in lending, investment, and aggregate activity,” (p64).
The “adverse selection problem” is the lenders’ equivalent of the very fine line between “regulation” and “supervision” – between “market liberalisation” and “dirigisme” (see De Cecco on “LOLR”) – that the State and the central bank must walk. And it cannot, as Mishkin himself soon makes clear. Obviously, he is trying to locate an “external cause” (stock market crash or interest rates or political instability) as the origin of financial implosion, but there is every reason to believe that the financial system has become inherently unstable long before the other “markets” collapse. So Mishkin needs to tell us why stock markets crash or interest rates rise (we do not deal with “political instability” or unexpected “corporate collapses” and other “exogenous shocks”).
On p66, Mishkin gets closer to the crunch when he argues that: - “In economies in which inflation has been moderate, which characterizes most industrialized countries, many debt contracts are typically of fairly long duration. In this institutional environment, an unanticipated decline in inflation leads to a decrease in the net worth of firms. Debt contracts with long duration have interest payments fixed in nominal terms for a substantial period of time, with the fixed interest rate allowing for expected inflation. When inflation turns out to be less than anticipated, which can occur either because of an unanticipated disinflation as occurred in the United States in the early 1980s or by an outright deflation as frequently occurred before World War II in the United States, the value of firms’ liabilities in real terms rises so that there is an increased burden of the debt, but there is no corresponding rise in the real value of firms’ assets. The result is that net worth in real terms declines. A sharp unanticipated disinflation or deflation, therefore, causes a substantial decline in real net worth and an increase in adverse selection and moral hazard problems facing lenders. The resulting increase in adverse selection and moral hazard problems (of the same type that were discussed in assessing the effect of net worth declines earlier) will thus also work to cause a decline in investment and economic activity.”
In other words, low inflation can lead to problems with the debt contract term structure of asset prices and their income streams. But this only shows that the “debt contracts” had implicitly unsustainable repayment conditions attached to them, and we still need to explain why this happened in turn!
We go back to rising interest rates… and their effect on banks’ net worth, with consequent contraction in credit and financial collapse (p68).  But again this begs the question of how banks “overstretched” themselves in the first place – and here the weakness of “regulation and supervision” following “liberalisation” resurfaces: “After a financial liberalization, bank supervisors frequently find themselves without either the expertise or the additional resources needed to appropriately monitor banks’ new lending activities. The result of insufficient resources and expertise both in banks and in their supervisory institutions is that banks take on excessive risks, leading to large loan losses and a subsequent deterioration in their balance sheets,” (p70).
We still have not tackled the meaning of “risk” – but we draw closer to it when we read that “sufficient resources”, that is, regulation and supervision, could fix the “selection and moral hazard problems” (which are virtually identical). So let us see how Mishkin proposes to deal with this. Even if there were sufficient resources, he says, we would still encounter “the principal-agent problem”.
“The second reason why the regulatory process might not work as intended is explained by recognizing that the relationship between voters-taxpayers on the one hand and the regulators and politicians on the other creates a particular type of moral hazard problem, the principal-agent problem. The principal-agent problem occurs when agents have different incentives from the person they work for (the principal) and so act in their own interest rather than in the interest of their employer. Regulators and politicians are ultimately agents for voters-taxpayers (principals) because in the final analysis tax-payers bear the cost of any losses when the safety net is invoked. The principal-agent problem occurs because the agent (a politician or regulator) may not have the same incentives to minimize costs to the economy as the principal (the taxpayer),” (p70).

This is extraordinary! Mishkin is telling us that “politicians and regulators”…  “may not have the same incentives to minimize costs to the economy as the principal (the taxpayer)” – assuming that “taxpayers” all share the same “incentives” anyhow! So financial crises have everything to do with the “divergence of incentives” between different social “agencies”. Put in this simple “principal-agent” form, this “conflict of interests” becomes insuperable because it is simply “definitional”. When trying “to solve” this problem, we will need to look into the “interests” and why they are in “conflict”. Mishkin is trying “to reduce” capitalist crises to simple problems of “asymmetric information” – to a misunderstanding or a “technical” problem! – the usual twaddle about “a complex society” (cf. Hayek’s “co-ordination”). But now it looks as if the conflict is far more “antagonistic” because it involves the entire “political system” (the principal-agent problem).

The curious thing is that it is low inflation that allows the longer term of debt contracts that pave the way for  “debt deflation” when interest rates rise suddenly and disinflation occurs. So what we have is an “uneven development”, a “dys-synchrony” between low inflation (in consumption goods prices) and high diversion into the “risk-taking channel” (in asset markets). The two find it hard “to co-exist” (hence Vittori’s “angoisse existentielle” of central banks – and Mishkin’s and Shin’s insistence on “financial stability” as an overall “goal” of central banking). Mishkin emphasises the need for both price and financial stability – stressing that raising interest rates to quell inflation may well spark a credit implosion (pp91-2): “It is often forgotten that a goal of price stability means not only that inflation should be kept low, but also that price deflations should be avoided. Our analysis has shown how price deflations in industrialized countries can be an important factor promoting financial instability and even lead to a prolonged financial crisis, as occurred during the Great Depression in the United States or recently in Japan. Thus, the prevention of financial instability suggests why central banks must work very hard to prevent price deflations. The prevention of price deflations is as important an element of the price stability goal as prevention of inflation.19”

Yet another crucial point involves the apparent contra-diction between resourcefulness, preparedness and “tempestivity” (speed) in the “regulatory/supervisory” functions… together with “liberalisation of financial markets”! Mishkin again at p84: “Although deregulation and liberalization are highly desirable objectives, the asymmetric information framework in this paper indicates that if this process is not managed properly, it can be disastrous. If the proper bank regulatory/supervisory structure is not in place when liberalization comes, the appropriate constraints on risk-taking behaviour will be nonexistent…. Although financial deepening is a positive development for the economy in the long run, in the short run the lending boom may outstrip the available information resources in the financial system, helping to promote a financial collapse in the future.
“The dangers in financial deregulation and liberalization do not mean that countries should not pursue a liberalization strategy. To the contrary, financial liberalization is critical to the efficient functioning of financial markets so that they can channel funds to those with the most productive investment opportunities.”

Note the “critical” bit. Of course, if you buy the “channel funds to most productive investment opportunities” bit, you’ll buy anything! So, more seriously, here is another dilemma: there is the “dilemma” of “liberalisation/supervision” (under the “moral hazard” rubric) and the dilemma of “representation/supervision” (under “principal-agent” rubric). On the latter, Mishkin observes: “Fourth, because prompt corrective action is so important, the bank regulatory/supervisory agency needs sufficient independence from the political process in order that it is not encouraged to sweep problems under the rug and engage in regulatory forbearance. One way to ensure against regulatory forbearance is to give the bank supervisory role to a politically independent central bank. This has desirable elements as pointed out in Mishkin (1991), but some central banks might not want to have the supervisory task thrust upon them because they worry that it might increase the likelihood that the central bank would be politicized, thereby impinging on the independence of the central bank. Alternatively, bank supervisory activities could be housed in a bank regulatory authority that is independent of the government,” (pp82-3). The real problem with “independence” is that the entire political apparatus available now is inadequate for the task – unfit for the purpose (in consumer law). (Cf this “astute” piece in the FT on ECB “unconventional” measures: )

No comments:

Post a Comment