McCulley: We need the political will to socialize the losses

Paul McCulley of PIMCO made a few comments back in March which caught my attention.  Given how well banks are doing this earnings season, I thought it relevant to quote him here.  The essence of his remarks was this:

  • Deleveraging is a self-reinforcing vicious cycle brought upon by the Paradox of Thrift.  In order to stop this downward deflationary spiral, we need the political will to socialize losses from which privatized gains have already been made.  While this socialization of losses is unseemly and maddening, it is wholly necessary.

Personally, I don’t buy it.  McCulley is talking his own book. It is a self-serving statement.  Nationalization or stuffing bondholders are equally good ways of stopping this spiral. Nevertheless, here is what he had to say:

The present crisis, in textbook terms, is a case of the dual, mutually reinforcing maladies of the Paradox of Thrift and the Paradox of Leverage. In many respects, they are the same disease: what is rational at the individual citizen or firm level, notably to increase savings out of income or to delever balance sheets, becomes irrational at the community level.

If everybody seeks to increase their savings by consuming less of their incomes, they will collectively fail, because consumption drives production which drives income, the fountain from which savings flow. Likewise, if everybody seeks to delever by selling assets and paying down debt, or by selling equity in themselves, they can’t, as the market for both assets and equity will go offer-only, no bid.

Both of these maladies require that the sovereign go the other way, (1) dis-saving with even more passion than the private sector is attempting to increase savings, thereby maintaining nominal aggregate demand and thus, nominal national income; and (2) becoming the bid side for the levered private sector’s offer-only markets for assets and equity. It really is that simple, at least on paper, as Keynes and Minsky wisely taught.

The problem with the desirable textbook solution is that it suffers from constrained political feasibility. Actually, dealing with the Paradox of Thrift is practically much easier, even if less critically important, than dealing with the Paradox of Deleveraging. While Congress may belly-ache and wrangle incessantly about the precise size and composition of fiscal stimulus packages, it is safe to say that but for a few wing nuts, we are all Keynesians now in the matter of cracking the Paradox of Thrift.

In contrast there is limited political consensus for using the sovereign’s balance sheet and good credit to break the Paradox of Deleveraging. Put differently, while we may all now be Keynesians, we are not all Minskyians. What is ineluctably needed involves socializing the losses of a banking system – both conventional banking and shadow banking – after the spectacular winnings of the Forward Minsky Journey were privatized. It simply doesn’t sit well politically. In fact, it stinks to high heaven.

Thus, to quote my partner Mohamed El-Erian, we must contemplate a scenario in which the economically desirable solution is not politically feasible, while that which is politically feasible may not necessarily be economically desirable. Last Sunday, on 60 Minutes, Ben Bernanke addressed this nasty reality directly when he said that perhaps the most severe risk we face is the lack of political will.

In my view, the Geithner-Summers-Bernanke bailouts are very much a case of socializing the losses, as bank earnings this quarter attest. So McCulley is getting his wish. Let’s see whether this method of dealing with the crisis has longer-term benefits.

The Thinking Behind the Stimulus and Bailout Programs – Paul McCulley

  1. barryschaeffer says

    McCulley’s comments are COMPLETELY self serving, since Pimco is getting massively bailed out by the PPIP and the rest. No wonder Bill Gross is the first in line to “support our Treasury Secretary” by bidding for those Toxic Assets, with you and me on the line to eat the losses (or should I say our kids and grandkids?).


  2. QuantReaper says

    McCulley can go fuck himself repeatedly

    I can do it for him with a socialized broomhandle

  3. Kid Dynamite says

    McCulley has the political will to brazenly talk his own book (as you noted) under the guise of doing whats best for the country.

    no need for me to rant here, as you’ve nailed it already

  4. Anonymous says


    According to Bloomberg (April 17): ‘ The Public-Private Investment Program, PPIP, designed to buy bad assets from banks, “is a really bad program,” Stiglitz said. It won’t accomplish the administration’s goal of establishing a price for illiquid assets clogging banks’ balance sheets, and instead will enrich investors while sticking taxpayers with huge losses.
    “You’re really bailing out the shareholders and the bondholders,” he said. “Some of the people likely to be involved in this, like Pimco, are big bondholders,” he said, referring to Pacific Investment Management Co., a bond investment firm in Newport Beach, California. ‘

    Which gives a nice perspective on why Janet Yellen recently praised not just Minsky but – quite correctly – McCulley as an old hand in Minskyite analysis. This is how McCulley put it in his talk in the 17th Annual Hyman Minsky Conference:

    ‘Let me tell you that, while the Levy Institute is a think tank, Minsky’s work is not just think-tank work. It’s also not just policy-wonkish work. It has real, practical implications in the world that I live in. At PIMCO, we manage three-quarters of a trillion—with a t—debt units. They’re sometimes called bonds, but here I think I should call them debt units. I introduced our CIO, Bill Gross, to Minsky’s thinking about six years ago, when we had the corporate scandals associated with WorldCom and Enron and so forth. We were in an investment committee meeting, and I said, “Bill, it’s very simple: it’s a Minsky moment”—a phrase I’d coined back in 1998. And he said, “What do you mean? Who is this Minsky guy?” I said, “Bill, you have got to get up to speed here.” So he said immediately, “Give me his work.” I had my copy of Stabilizing an Unstable Economy (1986) right on my shelf at the office, so I lent it to Bill. He read it cover to cover. By 2006, he had become a disciple, if you will. I say “disciple” because the whole framework of Minsky has a very simple core thesis. We all know it: stability is destabilizing, because market participants, or economic agents, being human beings, extrapolate stability into infinity. And, if you extrapolate stability into infinity, then you inherently take on ever more risky debt structures. That is a Nobel Prize concept, that the world is not inherently mean reverting on the basis of value. The world is inherently momentum-driven. Human beings are inherently reflexive. Intellectually, we know to buy low and sell high, but emotionally, we can’t bring ourselves to do that; we tend to do the exact opposite, which imparts an intense procyclical character to capitalism. Perhaps even worse, it imparts procyclicality to regulatory structures. Not only are the kids and the frat party procyclical, but the guidance counselor is too. That’s a reality of financial markets.’

    So, we are all Minskyites now…but as you said, serving the interests of PIMCO is not necessarily in the interests of ordinary Americans (or ordinary folks anywhere)…Or, borrowing a line from McCulley´s talk:

    “The definition of a Ponzi unit is when you borrow money to buy an asset and the income from the asset is not only insufficient to amortize the principle but also insufficient to pay the interest in full. When there is zero down, that creates the next step beyond Ponzi. The Ponzi unit isn’t defined by the terms of whether or not the borrower has skin in the game; it’s the deficiency of cash flow to pay interest or amortize the principle. It’s agnostic, essentially, on the issue of skin in the game. A unit is Ponzi squared if it has all the characteristics of a Ponzi unit and you’ve got no skin in the game, because then you have something extremely valuable
    being given to the speculator for free: an at-the money call and at-the-money put. None of us would pass up that kind of thing.”


  5. Name says

    The deflationary spiral is badly needed. It is the cure that will purge these malinvestments from the economy and redistribute the factors of production through bankruptcy from the incompetent to the hopefully not so afflicted.

    The reason you’ve never heard of the great depression of 1920, despite being a far more severe financial crisis than the great depression, is that nobody decided to dick around with the economy. They let the medicine do it’s work and the economy was back on its feet in a couple of years.

    What we are doing now is exactly the same as that which created and sustained the great depression for 17 years, only far worse. It would not surprise me to see a total collapse like Russia; and frankly, that too is much needed to wipe the slate of government clean and start fresh without all the leeches.

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