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Judge Posner,

As much as I enjoy reading your posts related to the financial crisis, I miss the days when you would write on completely different topics from one week to the next. You might discuss criminal law one week, Intellectual Property the next, doping in sports, and so forth. I miss the variety.



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Few human influenza virus infection in pigs. But in recent years also found a number of human cases of swine flu infection, most of them with direct contact with sick pigs have been people.

Roger Chittum

This concern with political influence in the financial system seems of a piece with hand-wringing by others about regulatory over-reaction. Have you also written to warn about the dangers of the financial system taking control of the political system and making both subject to oligarchs?


Why is it that prices going down is so awful? Why are you so ideologically committed to preventing goods from becoming more affordable?

I sense you're leaning on some very rickety moneterist economics.



The old military-industrial complex has now morphed into the financial-political complex with far worse consequences. It has destroyed both the financial system and any semblance of a representative democracy (republic). The Federal Reserve bank and its members and the government (the political machinery) are in a mutually protective relationship. Independence of our central bank? that is a bad joke. There are sufficient examples over the past 30 years to suggest that the political class uses the central bank to correct bad fiscal policy and the central bank does what it can to make the political hacks look good. Check out any congressional hearing at which the "witness" is a fed chairman. The name of the hearing chairan is always Peter and the name of the "witness" is always Paul.


From adverse perspective, have you ever estimated the ponderance of possible consequences if Fed did not take these actions which allay its independence in your view?

David Heigham

Central banks are given independence of the political process, by the political process, for a purpose. When they fail to discharge that purpose satisfactorily, their independence is always at risk; and properly so.

Prima facie, many central banks and other financial regulators, including the Federal Reserve, failed in their regulatory purpose in the lead up to the current crisis. The political process (which also failed to perceive the dangers) now needs to consider what lessons are to be learnt, what changes are needed and which financial regulatory agencies should have their purposes revised.

All that seems business being conducted as it should be in circumstances which are unusual, but in their general characteristics almost inevitably recurrent.

As to the lessons to be learnt, I judge that the housing bubble as such was no proper business of the Federal Reserve. However, the creditworthiness of new financial instrumente, including those derived from mortgages, was proper Fed business and was neglected. That neglect allowed the leveraging which produced the housing bubble; and allowed the obscure tangle of derivatives liabilities.


It all seems too manipulative.


First, do we need a central bank given that we did not have one for the first 125 years of the nation's existence?
Second, if the answer to the first question is "yes", then why is the Fed currently allowed to stray from it's original mandate to be the lender of last resort, i.e., to provide liquidity for those institutions having such a problem? It is a far cry from that to the perfomance of the Federal Reserve in the last 6-8 monts including, as Judge Posner noted, the allegation recently made against Paulson and Bernanke concerning pressuring B of A to purchase Merrill.
I believe that the Framers would be astounded to see so much power concentrated in what are essentially private banks nominally run under government auspices.


Ah Yes ... "Politics does make for strange bed fellows". The real question becomes, "Can they get of that bed when it becomes necessary"? Only time will tell. For the good of the Nation, I hope the answer is yes and that the Private Financial Infrstructure does not subsume the Federal Reserve and Treasury. If they do, for the good of the Country, we may be forced to Nationalize.


As my friend P. J. O'Rourke says, "politics IS the problem".


Neil: I keep wondering about the decisions not to nationalize. On the one hand it seems a cleaner way of mopping up the mess and then selling off the businesses in appropriate categories and in much smaller sized institutions.

But! how would it have looked for America's most "conservative" administration to come out padlocks in US Marshal's hands that Monday morn.

Too, we'd be saddled with the whole mess, I assume with "management" absolved of their negligence and lining up to be highly paid consultants on the government dime, err.... millions.

Do you get the feeling there is more rot than has yet been revealed by the excavation so far?

Ha! A friend has a temp job at Gottschalks helping to sell off the final inventory and fixtures; always a sad time in retail as folks are working hard for the same crummy pay with the result being that of being out of work in another rapidly contracting sectors. She wondered aloud as to what might be done with the space. Ahh, yes don't we all.

Jim: Liked your first post but let's agree that your friend O'rourke doesn't bring much wisdom with his "humor". Having a government, or any endeavor larger than a solo walk in the woods, without "politics" or politicians is a bit like trying to build a house w/o carpenters.


Posner asks whether the Fed is losing its independence. He shows some concern for their not being brave enough to have slowed housing, but I've more concern that they were asleep at the switch.

Most of us don't think too much about whether the roll-back of Glass-Steagal and the consequent mergers of goliaths and mixing of activities that were once competitors operating at arm's lengths was a good idea or not.

(I thought not, but my opinion might have been swayed by a strong suspicion that Phil Gramm has long used his PhD in econ for subversive and self-serving purposes only.)

Many of us have heard about derivatives, fewer of us lay-folk had some idea how they worked but VERY few would have had any idea how they were being worked and how massive was their impact on the worlds's financial sector.

MY concern is "independent" or not, that the Fed has the tools to know about these movements of capital....... or should I say analogs in the place of capital? But didn't? Or knew but didn't say or do anything? I mean come on Prof Posner this was not some small "error" of judgment as to whether to tighten by a few basis points.

Or put another way, while the Fed governors/bankers were meeting and discussing a bit of tweaking, did none of them know that the likes of Goldman were "printing" money at a rate never seen before? Did they not ask something along the lines of "Where the hell is all this money coming from to fund unprecedented numbers and amounts of mortgages?"

Or? perhaps in a casual moment over some lunch during the eight year period of unprecedented home appreciation in virtually every market, "How do you suppose these no doc loans for folks with credit scores under 50 are working out for those buying gobs of 'em?"

I understand that spotting bubbles MIGHT be difficult, but surely a few rudimentary econometrics combined with peering out the window once in a while would have divulged the anatomy of the housing/derivates ---- sorry I can only call it a Ponzi.

Posner seems still unaware that the non-banks "created" far more money via massively leveraged derivatives than did the Fed.

In short........ are we more fearful, as Posner suggests of their spinelessness, or of their ignorance? How could they have missed this for eight years when they and legions of assistants have access to the best of computer information and modeling?

In Posner's conclusion he suggests that when the Fed and a host of others finally woke up and did what was necessary and unavoidable that it was those actions that opened them up to being less "independent?"

How so? When they finally discovered that instead of being in a mildly inflationary environment that instead the world's "financial sector" was short a few tens of trillions and would be facing a deflation that would break eardrums unless something bold and clearly in their purview was done? Isn't that what we expect them to do? Independently?


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Jack, I have the dubious feeling that the current "Financial Infrastructure" was and has been built on shifting sands as opposed to bedrock. A Financial Infrastructue without an Agricultural, Industrial, or Commercial foundation and base is bound to fail. Alarming, huh?



I think the point is that politics has become a "thing" for it's own sake and not in the rational service of the community. It is like saying all food has to be fried. When poor old Arlen Specter at age 80 thinks that there is no one in Pennsylvania who could do his job as well as he, there must be a certain delusion in the process. Or when Dick Durbin lists on his web site that his occupation is "legislator', things have become somewhat unbalanced.


I like Arlen Specter. I voted mostly for Democrats in the last election, Obama and all, But I voted for Specter because I think he does a good job, and does what he thinks is best for the country. If you use the criteria that he has to "think he's the best person in the world to represent Pennsylvania" you restrict your office to be held only by cocky idiots. He's far and away the person I feel has done the best job representing me. He was a Republican before the current asshats took over the party, then compromised with them for what I felt was too long already, while they used their power to undermine him. Obama is in the running for that crown, but if he wants it he'd better get his act together, and Arlen is in what looks to me like a SPECTACULAR bargaining position to help make things happen. And things need to happen, filibustering until this problem goes away is not acceptable.

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Uzair Kayani

Note that the Fed supported the deregulation of Credit Default Swaps (CDS). These are probably the most important derivatives in financial markets today because they allow highly leveraged institutions like banks to hedge their risks. In a CDS, the risk of the loans that these banks make are taken over by counter-parties like AIG or foreign investors. The CDS is economically an insurance contract but it has never been regulated like insurance. It is also traded like a security but it was never regulated as a security either. It was traded, like most derivatives, under a caveat emptor philosophy. There lies the puzzle: why did it seem like a good idea to implement caveat emptor in the derivatives market when every analogous market had abandoned such a hands off approach?

It appears that the Fed came to see CDSs as a panacea for financial crises like Long Term Capital Management. Mr. Greenspan discussed CDSs after reviewing the LTCM incident;. Find below Mr. Greenspan's note on CDSs in his book, "The Age of Turbulence" at pages 371-72:

"A recent financial innovation of major importance has been the credit default swap. The CDS, as it is called, is a derivative that transfers the credit risk, usually of a debt instrument, to a third party, at a price. Being able to profit from the loan transaction but transfer credit risk is a boon to banks and other financial intermediaries, which, in order to make an adequate rate of return on equity, have to heavily leverage their balance sheets by accepting
deposit obligations and/or incurring debt. Most of the time, such institutions lend money and prosper. But in periods of adversity, they typically run into bad-debt problems, which in the past had forced them to sharply curtail lending. This in turn undermined economic activity more generally.
A market vehicle for transferring risk away from these highly leveraged loan originators can be critical for economic stability, especially in a global environment. In response to this need, the CDS was invented and took the market by storm. The Bank for International Settlements tabulated a worldwide notional value of more than $20 trillion equivalent in credit default swaps in mid-2006, up from $6 trillion at the end of 2004. The buffering power of these instruments was vividly demonstrated between 1998 and 2001, when CDSs were used to spread the risk of $1 trillion in loans to rapidly expanding telecommunications networks. Though a large proportion of these ventures defaulted in the tech bust, not a single major lending institution ran into trouble as a consequence. The losses were ultimately borne by highly capitalized institutions—insurers, pension funds, and the like—that had been the major suppliers of the credit default protection. They were well able to absorb the hit. Thus there was no repetition of the cascading defaults of an earlier era."

The idea, supposedly, was the CDS counter-parties were so rich that they could save the banks, and therefore the economy, in case of major defaults. This has turned out to be wrong. Too many counter-parties were duds.


Uzair, CDS Derivatives: I loan Mr. X one million dollars. Mr. X sells the loan to Mr. Y, who turns around and sells it to Mr. Z in Antigua. Everyone's fat and happy. One problem, Mr. Z is a dummy Corporation, Mr. Y has fictious address on Wall Street and Mr. X is a name on a headstone. Question, "What happened to the million dollars"?
Answer, "I pocketed it".

Derivatives are nothing new, they're just a new twist on the old "Shell/Con Game". Now take this to the level of multi-trillion dollar level and one gets an understanding of the extent and depth of the problem.



Nice explanation on derivatives. Probably spot on.

I have long thought that we in this country spend way to much attention to "what" happened and not enough on "why" it happened. According to Martha Stout, a psychologist at Harvard who has studied the subject for years, about 4% of persons are born without a conscience, sociopaths if you will. In the United States that would be 12 million persons, many of whom have talent and ambition and rise to positions of prominence in commerce and/or politics. Think the total combined population of New York and Chicago made up of Blagojevichs or Madoffs or Hitlers. Put a clever financial scheme in a few of their hands and Eureka!


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Jim, That's what Law and Regulation is all about. Somehow, we seem to have lost the concept somewhere along the road.


Neil: I suppose, legally, the question is did "someone" make the Ponzi just complex enough that nearly all of the perps can claim to have "just been doing their jobs" and to have known nothing? Yah...... sure! I'll bet Wall Street drinking holes rang with predictions of the whole thing tumbling down.

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