August 28, 2019

On the deliberate creation of institutional shitholes

Comment on Brian Romanchuk/Matt Franko on ‘So Are We All MMTists Now?’


Matt Franko recaps: “No there was a policy change post GFC which created different regulatory conditions... ie depositories are required to possess $Ts more as % total assets of Tier1 QUALITY assets in order to comply with the CCAR... TODAY... So the effect of rate increases TODAY UNDER DIFFERENT REGULATORY CONDITIONS has a differing effect than under previous conditions.”

Life insurers, for example, have a demand for very long-term government securities. What they have done in the past is to buy bonds and to put them with the actual purchase prices on the books and to hold them until maturity. This type of buy-and-hold investors did not up-value the bonds when the interest rate fell and accordingly needed no down-valuation in the opposite case. These corporations normally sat on a buffer of hidden reserves that could be activated in case of emergency.

The same holds for banks with a significant share of bonds in their portfolio.

Now, with the continuous decrease of interests since the Volcker heights these buy-and-hold investors were told to be a bit retarded. Why not apply mark-to-market valuation and show the paper profits in the profit and loss account as a sign of the success of a smart investment strategy? And why not increase profit distribution to the shareholders? Quite naturally, mark-to-market was pushed by hedge funds, Wall Street, and other folks with a short time horizon and a commitment to shareholder value.

The drawback of this strategy makes itself felt when the Central Bank switches eventually to a policy of rising interest rates. In this case, paper losses show up in the profit and loss accounts and the structural balance relations deteriorate.

The effect is that the Central Bank is now practically locked-in at the zero interest level. Interest increases tend to automatically put the whole finance sector at risk with spill-overs to the real economy. Mark-to-market eventually shows its ugly face.

All these problems were perfectly foreseeable and could have been avoided by sticking to the tried and tested principles of prudent valuation that were and still are characteristic of an institutionally sound finance sector.

There has been a general trend in the political, social, and economic realm of throwing the principles of sound institution-building overboard with the unsurprising result that a growing number of states has finally turned into institutional shitholes.

MMT’s policy of deficit-spending/money-creation has been and still is a driver of this development.#1

Egmont Kakarot-Handtke

#1 MMT undermines democracy

Twitter Sep 5

Source: Bloomberg