Wednesday, October 29, 2008

Chin Up, People!

The Times reports:
Consumer confidence fell to its lowest level in at least 40 years, a survey said Tuesday, as falling home prices and steep declines in the stock market took a sharp toll on the faith of Americans in the economy.

A widely watched survey by the private Conference Board, which dates back four decades, plunged to its lowest reading on record in October as Americans reported fewer jobs and smaller incomes and curtailed plans for major purchases like cars and appliances.

Americans also say they believe the economy will worsen before it improves — a sign of deeply engrained pessimism that reflects a year of painful declines in stocks, jobs and home values....
Lowest in forty years? Lower than 1981-82? 73-74? We have a long way to go before it's that bad, and I doubt things will get that far.

We Are All Keynesians Now

Robert Lucas: "I guess everyone is a Keynesian in a foxhole." From Justin Fox, "The Comeback Keynes" (extended quote here).

Apparently you can't get out of a foxhole by assuming a ladder...

Sunday, October 26, 2008

Flight to Safety?

One of the bigger ironies of the financial crisis is that the US has troubled financial institutions, a plunging stock market and a ballooning government budget deficit and demand for our government bonds is increasing: (keep in mind that the price and yield are inversely related). And now we also see a spike in demand for our currency: (foreign currency per dollar). Even the presumably relatively safe Pound and Euro took a plunge last week: (note that the scale is opposite, so the Dollar is still appreciating). However, the Japanese Yen seems relatively immune, relative to the Dollar, which means it is also jumping in terms of other currencies: In troubled times, demand for assets deemed "safe" (or "liquid" or "quality") traditionally goes up, which is why things like emerging market debt and junk bonds often suffer, regardless of the virtues (or lack thereof) of the issuers. But it is quite remarkable that, for all that is going wrong in the US, we are still on the receiving end of this flight to safety effect.

How much of this to attribute to virtue versus good fortune is a good question for international economists and economic historians to contemplate. More immediately, despite all their prudent reserve-building since the crises of the late 1990's, emerging markets are once again getting hit hard. Dani Rodrik sees an urgent need for IMF action. See also Arvind Subramanian, Brad Setser and Naked Capitalism.

From a US standpoint, although we are better off with a flight into, rather than out of our currency and assets (which would cause a huge spike in long-term interest rates), the Dollar's rise is hardly benign. Until recently, the mostly-non-panicky drift downward of the Dollar was helping turn around the current account deficit - a sustained move in the other direction would be trouble for exporting and import-competing industries (indeed, Rodrik fears this could lead to protectionism).

Another Devil in the Details?

The Treasury is using its recapitalization to encourage consolidation in the banking sector, but it is not doing anything to force banks to actually lend money, according to the Times' Joe Nocera:
On Thursday, at a hearing of the Senate Banking Committee, the chairman, Christopher J. Dodd, a Connecticut Democrat, pushed Neel Kashkari, the young Treasury official who is Mr. Paulson’s point man on the bailout plan, on the subject of banks’ continuing reluctance to make loans. How, Senator Dodd asked, was Treasury going to ensure that banks used their new government capital to make loans — “besides rhetorically begging them?”

“We share your view,” Mr. Kashkari replied. “We want our banks to be lending in our communities.”

Senator Dodd: “Are you insisting upon it?”

Mr. Kashkari: “We are insisting upon it in all our actions.”

But they are doing no such thing. Unlike the British government, which is mandating lending requirements in return for capital injections, our government seems afraid to do anything except plead. And those pleas, in this environment, are falling on deaf ears.

Yes, there are times when a troubled bank needs to be acquired by a stronger bank. Given that the federal government insures deposits, it has an abiding interest in seeing that such mergers take place as smoothly as possible. Nobody is saying those kinds of deals shouldn’t take place...

We have long been a country that has treasured its diversity of banks; up until the 1980s, in fact, there were no national banks at all. If Treasury is using the bailout bill to turn the banking system into the oligopoly of giant national institutions, it is hard to see how that will help anybody. Except, of course, the giant banks that are declared the winners by Treasury.

It is worth noting that the Canadian banking system, which is an oligopoly of giant national institutions, appears to be holding up quite well.

Friday, October 24, 2008

The End of the 1980's?

Since the 1980's began when video killed the radio star, perhaps that is the wrong medium to declare their end, which I did in a commentary for the local NPR station:
Ronald Reagan was fond of an aphorism attributed to Thomas Jefferson: the government which governs least, governs best. During the debate over the financial rescue, one Republican Congressman described the legislation as a coffin on top of Ronald Reagan's coffin. That the proposal he was criticizing came from a Republican President and his Wall Street treasury secretary shows how much things have changed.Regulation is not the only area of economic policy where the 1980's mentality is coming to an end. The so-called supply side economics that motivated the tax cuts under Reagan and George W. Bush has also been discredited by events...


This "interactive graphic" of US economic indicators from the Times is truly impressive.

Bernanke, white knight upon a firey steed?

"Helicopter Ben" rides to the rescue.

And yes, I believe those are the helicopters from "Apocalypse Now" - who doesn't love the smell of swap lines in the morning? (Hat tip: Mankiw)

Roll Over, Ayn Rand

and tell Herbert Spencer the news. The Times reports:
[A] humbled Mr. Greenspan admitted that he had put too much faith in the self-correcting power of free markets and had failed to anticipate the self-destructive power of wanton mortgage lending.“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” he told the House Committee on Oversight and Government Reform.
Floyd Norris: "What was missing was a regulator who understood markets, rather than worshiped them."

Since some of my students seem to actually like Ayn Rand, I will outsource the obligatory Rand-bashing to Dean Baker, who does it well. Actually, I do think Greenspan does deserve some credit for admitting error, at least a little bit. As Keynes said, "when the facts change, I change my mind. What do you do sir?"

Update (10/25): This video at Calculated Risk reveals uncanny parallels between Greenspan and Smooth Jimmy Apollo and Captain Renault.

Update #2 (10/26): Although Greenspan was a member of Rand's circle and contributed several chapters to "Capitalism: The Unknown Ideal," the Rand-ites have apparently excommunicated him (see also the comments to this post). Hat tip: Marginal Revolution.

Wednesday, October 22, 2008

A Devil in the Details

Although Secretary Paulson's move towards using the $700 billion war chest to add to bank capital (i.e., make equity investments in them) rather than buying "troubled" assets has been widely applauded, the terms are not good, according to Willem Buiter:
Unfortunately, Treasury Secretary Hank Paulson’s injection of $125 billion into the nine banks (out of a total capital injection budget provisionally set at $250bn (but bound to rise to probably around twice that amount), carved out of the $700 bn made available (in tranches) by the 2008 Economic Stability Emergency Act, was almost a free gift to these banks. In this it was different from the case of AIG, where the Fed and the Treasury imposed rather tough terms on the shareholders and obtained pretty favourable terms for the US tax payer generally. It was also unlike the case of Fannie and Freddie, where the old shareholders are likely not to recover anything.

In the case of the Fortunate Nine, the injection of capital is through (non-voting) preference shares yielding a ridiculously low interest rate (5 percent as opposed to the 10 percent obtained by Warren Buffett for his capital injectcion into Goldman Sachs). Without voting shares, the government has no voice in the running of these banks. It also has no seats on their boards. By contrast, in the Netherlands, the injection of €10bn worth of subordinated debt into ING bank comes with a price tag that includes two government directors on the board and a government veto over all strategic decisions by the bank.

In addition, in the the case of the Fortunate Nine, there are no attractively valued warrants (options to convert, at some future time, the preference shares into ordinary shares at a set price or at a price determined by some known formula). Quite the opposite, the preference shares purchased by the US state, can be repurchased after three years, at the banks’ discretion, on terms that are highly attractive to the banks. The US tax payer is not only getting a lousy deal compared to private US investors like Buffett, (s)he is also doing much worse than the British tax payer in the UK version of Paulson’s capital injection (£37 bn so far out of provisional budget of £50bn). The UK preference shares have a 12 percent yield and come with government-appointed board members.

The terms are not good for the US taxpayer, that is, but they are favorable Paulson's financial sector friends. I would feel much better if Bernanke - or the Obama administration - was running the show.

Tuesday, October 21, 2008

Recession Hits Home

I had thought myself personally rather immune from the effects of the economic downturn until I received some very bad news in the cookie aisle, confirmed by this Battle Creek Enquirer report:
Citing rising food and fuel costs, two subsidiaries of Archway & Mother's Cookie Company Inc. have filed for bankruptcy, effectively shutting down the firm's U.S. operations.

In a news release, Archway said the subsidiaries, Mother's Cake & Cookie Co. and Archway Cookies LLC, filed for Chapter 11 bankruptcy on Monday in the U.S. Bankruptcy Court for the District of Delaware.

The announcement came three days after the company sent notices to the cities of Battle Creek and Ashland, Ohio, stating that the two locations would close, putting approximately 160 people out of work, 59 of those in Battle Creek.
Can these guys get a bailout, please?

And if "rising food and fuel costs" are really the problem, can't they change their mind now that the downturn has caused commodity prices to fall?

The next stimulus check goes straight into cookies.

Sunday, October 19, 2008


The FT profiles the "Man in the News: John Maynard Keynes." Ed Crooks writes:
The key to Keynes was his commitment to preserving the market economy by making it work. He was dismissive of Marxism but believed the market economy could survive only if it earned the support of the public by raising living standards.

The role of the economist, he believed, was to be the guardian of “the possibility of civilisation”, and no economist has ever been more suited for that role.

In the Washington Post, Keynes' biographer Robert Skidelsky writes "We Forgot Everything Keynes Taught Us" -

No one has bettered Keynes in his understanding of the psychology of financial markets. "Most . . . of our decisions to do something positive . . . can only be taken as a result of animal spirits . . . If animal spirits are dimmed . . . enterprise will fade and die" is one famous remark. "Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done" is another. Professional investment, he wrote, is like "a game of Snap, of Old Maid, of Musical Chairs," whose object is to pass on the Old Maid -- the toxic debt -- to one's neighbor before the music stops. What makes the game toxic is not greed, which is universal, but uncertainty masquerading as certainty.

"The outstanding fact is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made," Keynes wrote in his great book "The General Theory of Employment, Interest, and Money" in 1936. We disguise this uncertainty from ourselves by assuming that the future will be like the past, that existing opinion correctly sums up future prospects, and by copying what everyone else is doing. But any view of the future based on "so flimsy a foundation" is liable to "sudden and violent changes. The practice of calmness and immobility, of certainty and security suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct . . . the market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning yet in a sense legitimate where no solid basis exists for a reasonable calculation." Keynes accused economics of being itself "one of these pretty, polite techniques which tries to deal with the present by abstracting from the fact that we know very little about the future."

While Skidelsky is right that Keynes' discussion of the psychology of investment booms and busts is too often neglected - it has been left out of the "Keynesian" economic models in our textbooks - I woudn't go so far as to say that we've forgotten everything Keynes taught us. A number of people have lately been invoking another important Keynesian lesson, the role of government in propping up "effective demand" through fiscal policy.

In the Guardian, Brad DeLong explains how policymakers dealing with the financial crisis have gone from Plan A through Plan F. Next up:

If Plan F fails, we move to Plan G: we pull the Keynesian fire alarm and begin an enormous government infrastructure building programme in the whole North Atlantic to keep away depression.
Paul Krugman is ready to break the glass:

[R]ight now, increased government spending is just what the doctor ordered, and concerns about the budget deficit should be put on hold...

[T]here’s not much Ben Bernanke can do for the economy. He can and should cut interest rates even more — but nobody expects this to do more than provide a slight economic boost.

On the other hand, there’s a lot the federal government can do for the economy. It can provide extended benefits to the unemployed, which will both help distressed families cope and put money in the hands of people likely to spend it. It can provide emergency aid to state and local governments, so that they aren’t forced into steep spending cuts that both degrade public services and destroy jobs. It can buy up mortgages (but not at face value, as John McCain has proposed) and restructure the terms to help families stay in their homes.

And this is also a good time to engage in some serious infrastructure spending, which the country badly needs in any case. The usual argument against public works as economic stimulus is that they take too long: by the time you get around to repairing that bridge and upgrading that rail line, the slump is over and the stimulus isn’t needed. Well, that argument has no force now, since the chances that this slump will be over anytime soon are virtually nil. So let’s get those projects rolling.

Wednesday, October 15, 2008

Waiting on a Recovery

"I'm confident in the long run, that this economy will come back." - Pres. Bush

"In the long run, we are all dead." - J.M. Keynes

Update (10/19): Paul Krugman has the long version of the Keynes quote.

Saturday, October 11, 2008

Encroachment of Ideas

The Treasury's apparent shift towards using its $700 billion war chest for recapitalization instead of asset purchases suggests they are coming around to a view that many academic types have held all along. The Journal reports:
Many economists believed that the heart of the government's initial plan to pay $700 billion for toxic assets was aimed at the wrong target. Purchasing mortgage securities from banks wouldn't do anything to kick-start lending and get credit flowing again, they said. Rather, banks would use the proceeds they got from the Treasury to pay off debtors, and those debtors would use the proceeds to buy safe assets.

They said a wiser course -- the one the Treasury now seems to have come around to -- was for government to rebuild the badly depleted cash levels on bank balance sheets. That would cushion institutions against future losses, giving them the wherewithal to lend again. Other hitches in the original plan include coming up with a price for mortgage securities that is above the "fire sale" level they would draw on the open market, but not so high that taxpayers end up getting taken for a ride.

The Treasury move is a sign of how, as international efforts to contain the crisis continue this weekend at meetings of the International Monetary Fund and World Bank, economists' ideas for solutions are influencing policy and entering the public discourse.

Hat tip (not surprisingly) to Mankiw, who says "score one for the ivory tower."

Near the end of the General Theory, Keynes wrote: "Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back." Perhaps we should make that: "blogger of a few days back."

That's the sentence immediately after the one I cited in this recent post, noting that the Congressional modifications to the proposal included opening the window for an equity component which Paulson is now jumping through (nice work, Senator Dodd).

Here's the quote in context, which closes the General Theory:

At the present moment people are unusually expectant of a more fundamental diagnosis; more particularly ready to receive it; eager to try it out if it should be even plausible. But apart from this contemporary mood, the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest. But, soon or late, it is ideas, not vested interests, which are dangerous, for good or evil.
Keynes continues to be very relevant.

Friday, October 10, 2008

The Failure of Supply-Side Tax Policies

Writing in the Times' Economix blog, Princeton's Uwe Reinhardt makes the case against the argument - now standard boilerplate "supply side" Republican rhetoric - that tax cuts lead to higher investment and GDP:
From a macroeconomic perspective, however, changes in tax rates are but one of many factors that drive the time path of gross domestic product (G.D.P.), savings, investment, employment and other such variables. By itself, changing tax rates steers the economy about as much as would tapping an elephant on the leg with a chopstick. There may be some effect, but typically it is small and dwarfed by other effects.
He provides a chart showing that the share of investment in GDP fell during the Reagan/Bush years (i.e., in the wake of the 1981 tax cuts), rose in the Clinton years (i.e., following the 1993 tax increase), and has fallen again since the 2001 and 2003 tax cuts. A point he doesn't make: this pattern would be consistent with the hypothesis that "crowding out" prevails - i.e., that government borrowing, which ballooned in the Reagan and (to a lesser extent) G.W. Bush administrations, displaces private investment.

Nonetheless, some economists are still apparently on board, as this statement released by the McCain campaign shows. Jonathan Chait writes:
First, 100 economists is not actually all that many, given the number of economists in our country. Second, the list of signatories actually has only 90 economists on it. (Count for yourself.) This trouble with basic arithmetic might explain the McCain campaign's stated beliefs in such fallacies as tax hikes always cause revenues to fall.

Was the campaign unable to find 100 economists? The list certainly does not suggest excessive discrimination about credentials. It's heavily larded with GOP apparatchiks now residing in the right-wing think tank world (my favorite is "economist" George Schultz of the Hoover Institution), as well as two signatories who list their affiliation as "McCain-Palin 2008." The takeaway here is that, even with the most generous standards, the campaign couldn't find 100 economists in the country to badmouth Obama's proposals, let alone endorse their own.

I'd disagree slightly: some of the signatories do actually have pretty strong academic credentials. But we do know that most economists support Obama; I'm sure if his campaign tried, they could gather a more impressive list.

Hmm... back in July, McCain had an endorsement from 300 economists... have 210 of them jumped ship?

Wednesday, October 8, 2008

Professor Obama

Noam Scheiber says that Barack Obama's experience as a professor gave him the edge in last night's debate:
Obama really benefitted from his years as a law professor. He was fluent and very much at ease walking and talking at the same time. He had a professor's knack for making eye contact and maintaining it while he walked a questioner through a multi-step response. And his answers were much more concrete and intuitive than I'd ever heard them. It's as though it took fielding questions from ordinary people to remind him of this latent professorial talents.
I have found that such talents, unfortunately, do not come automatically with being a professor.

Furnish an Elastic Currency

One of the main reasons for establishing the Fed was to create a "lender of last resort." The Federal Reserve Act passed in 1913:
To provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.
Over time, this function of the Fed has receded into the background, but it is now again front and center, as the Fed continues to step up its lending activity, and is now even planning to buy commerical paper. Econbrowser offers an excellent summary of the action, so far, on the Fed's balance sheet.

On the Times' new economics blog, David Leonhardt has praise for Bernanke.

Friday, October 3, 2008

The Economist Asks Some Economists

The Economist has surveyed economists' opinions about McCain and Obama. The results are overwhelmingly in Obama's favor:They didn't just ask any economists - the survey was sent to 683 NBER research associates, an elite subset of academic economists, of which 142 responded. A somewhat broader sample of American Economic Association members (a less elite group - even I am in it) surveyed by Scott Adams also favored Obama, though less overwhelmingly (see this earlier post).