REVIEW OF MISHKIN – “Spread of Fin. Instab.”
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 (borrower) is concerned with “the return on capital”, the former 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: http://www.ft.com/cms/s/0/6a9874d6-7023-11e0-bea7-00144feabdc0.html#axzz1KP1dDuqs
)
Mishkin’s
“Systemic Risk and the International Lender of Last Resort” returns to
these problems from the “global” perspective. Here it is well to remember
Shin’s discussion in the FAZ interview (linked above) about the changing role
of “exchange rate flexibility” in stabilizing
national economies since Friedman championed the added “flexibility” it
lent them to pursue “domestic goals”. The fact is that after the GFC exchange
rates have performed perversely in that they have been affected by “sovereign
debt” and by “risk-off” considerations, especially where the Fed has pursued
“unconventional” (or “non-standard”) policies. The “carry trade” is a
destabilizing new phenomenon (discussed by Shin) because it leads to capital
inflows in countries that are seeking to tighten money supply (cf Australia and
now Brasil), and the converse. This danger could be staved off when money flows
were less rapid and securities markets (derivatives) less “liquid”: yet now these
pose serious “systemic risks” (check out Roe’s article at “project-syndicate”
where he stresses the “speed” and “priority of asset-seizing” or
“crystallization” for derivatives in destabilizing businesses). http://lecercle.lesechos.fr/economistes/autres-auteurs/221134617/fukushima-and-derivatives-meltdowns
Here is a quote
from Kaminsky et al. that Mishkin cites, which almost faithfully reproduces the
current situation in terms of US rates and the stupid faith many repose on
“emerging markets”: “For example, in the late 1970s, soaring commodity prices,
low and sometimes negative real interest rates (as late as 1978, real interest
rates oscillated between minus 2 percent and zero) and weak loan demand in the
United States made it very attractive for U.S. banks to lend to Latin America
and other emerging
markets—and lend they did. Capital flows, by way of bank lending, surged during
this period, as shown in Figure 1. By the early 1980s, the prospects for
repayment had significantly changed for the worse. U.S. short-term interest
rates had risen markedly in nominal terms (the federal funds rate went from
below 7 percent in mid-1978 to a peak of about 20 percent in mid-1981) and in
real terms (by mid-1981, real short-term interest rates were around 10 percent,
the highest level since the 1930s). Since most of the existing loans had either
short maturities or variable interest rates, the effects were passed on to the
borrower relatively quickly. Commodity prices had fallen almost 30 percent
between 1980 and 1982, and many governments in Latin America were engaged in
spending sprees that would seal their fate and render them incapable of repaying
their debts,” (p64).
The “Conclusions” section of this paper is
interesting as an obvious “precursor” of the “This Time IS Different” book with
Vincent Reinhart. Now, this type of analysis is of limited application where
there is “financial autarky” (one thinks of the US
and Japan
above all), or when there are “compensating effects” from the lack of suitable
“safe havens” as alternatives to the country that is “over-indebted”. In the
case of the US, not only is there a high degree of “autarky” (the Fed holds
nearly 70% of the treasuries debt), but also the Fed’s policy is clearly aimed
at “punishing” mercantilist countries (China and Germany above all) that seek
“to export” their domestic class tensions to the rest of the world, creating
excessive “liquidity” in the US that results in speculative bubbles. Whilst
China and Germany wish to “offload” the burden of adjustment of present
imbalances on to the US, the latter refuse “to deflate” and are now waiting for
the powerful inflationary forces they are unleashing on Germany and China to
work their lethal effects – until they and the “emerging countries” hit a wall
and capital inflows hit a “sudden halt or stop”, with destabilizing effects
(politico-economic) that no-one can foretell or specify. Small wonder Martin
Wolf is very worried!
And the minute this occurs, far from rising, US debt
yields will be bound to fall. The US will be once again the only
place where capitalists can feel “safe” and politics will have beaten “economic
science” to a pulp! This is the “Alice
in Wonderland” world – the “looking-glass”, the “topsy-turvy”, the “upside
down” world that I have been trying to foreshadow.