Freefall by Joseph Stiglitz:
Even if one disagrees with Stiglitz's ideological biases, this exposition of recent economic events is excellent, both accurate and fair in its criticisms. Stiglitz also provides a good discussion of the trade imbalances that afflict the world economy, as globalization is his specialty. Best is the challenges he presents to his fellow economists. But it's not without its blemishes. Since I have given the book five stars I will skip over the kudos and address its weaknesses.
Stiglitz sets up a weak strawman in market "fundamentalism," as most serious free market advocates eschew dogma and see a limited role for government, especially to insure open and competitive markets. Stiglitz himself admits the dominant role of markets and only argues for a subjective "balance" between govt regulation and markets. This continuum can be freely debated, as many of the recent market failures stemmed from circumventing free market principles. Most of the violations Stiglitz cites boil down to inside actors using political or economic power to secure "heads we win, tails you lose" outcomes. This is what happened across the banking system as we privatized the returns and socialized the risks with bailouts. A functioning market economy relies on trust and must prevent blatant violations of the rules of voluntary exchange. Thus the crisis was not a repudiation of free markets, it was both a failure of risk management and a warning regarding the abuse of market principles.
The policy debate over govt regulation too often slips into the idea of the regulatory bureaucrat rather than the dynamics of self-regulation based upon competing interests. Our political democracy relies on competing interests and a governing structure for checks and balances, with minimal monitoring. Our market structures should strive to do the same with competitors policing each other. Stiglitz mostly steers clear of this distinction while conceding that much of the blame for the financial crisis was the agency problem that befell not only the private sector, but also the public sector. Regulatory "capture" is a serious concern for regulating the financial sector.
Stiglitz correctly castigates the Bush and Obama administrations for laxness and ineptness in managing the crisis, but whitewashes the Clinton years, when much of the financial deregulation was enacted. The Clinton regime was instrumental to the Democratic courtship of Wall Street and Stiglitz himself was a prominent Clinton economic adviser. Obama has picked up where Clinton left off, reappointing many from his team. (Hope and change turned out to be more of the same.) For its part, Wall Street is an equal opportunity player in Washington.
The most controversial issue is probably Stiglitz's unwavering support of Keynesian demand stimulus. There is reason to suspect this cure-all for a deflating economy, but Stiglitz dismisses all doubts. However, the effectiveness of demand stimulus depends on the Keynesian multiplier, which in turn depends on a healthy banking system extending credit in response to credit demand from the private sector. In the aftermath of a debt deflation, both of these conditions fail in robustness. With a balance sheet recession, it may well be that the Keynesian multiplier is closer to zero than the hoped for 1.5. Another way to look at this is that Keynesian policies may be appropriate after a collapse in prices due to massive deleveraging but much less effective in preventing that collapse. The Japanese experience suggests that propping up a zombie banking system can dangerously prolong the post-bust correction. In this context the Fed's policy of reflation is likely to yield more crippling asset bubbles.
The most productive discussion is when Stiglitz turns on his fellow economists. His criticism of the dominant neoclassical paradigm is spot on, especially when it comes to macroeconomic theory. Our current macropolicies are so confused because our theoretical tools are less useful in a nonlinear world and this is especially true in the world of finance. Rational actor assumptions have limited value in a real world where people are loss averse, heterogeneous and adaptable in their preferences, and show a tendency to herd behavior. Our most intractable policy problems are those of skewed or maldistributions, whether they be income and wealth inequality, global warming, health care, hunger or energy. Mathematical models based on fixed preferences, simultaneous equations, and equilibrium conditions are not amenable to distributional dynamics. Thus, the solution to inequality always regresses back to initial conditions, like education or material endowments. Instead, our policies should be addressing the access and distribution of financial capital and the dynamics of our financial markets. The rich are getting richer off their leveraged capital and political influence, not their good looks or brains.
Given that managing uncertainty may be the best we can do in public policy, Stiglitz correctly argues for the dominant role of risk management. But he also fails to consider how risk and uncertainty is most effectively managed through decentralization and diversification. This is accomplished through wide and deep markets. Social insurance pooling may be an important corollary to private risk management where private markets are incomplete, but is far less efficient and prone to unmanageable moral hazard costs. Think how many would choose to cash in their 401(k) or private pension for Social Security promises, or their private health insurance for Medicare? The bottom line is that health care and retirement funding are private goods and forcing them into the public goods model only hampers their production and distribution. We may need a safety net, but that's as much as the empirical data supports. Entitlement reform will require private substitutes and this makes it critical we insure that markets function as intended. This may be the best argument for financial market reform.
I suppose one could write a book instead of a review, but Stiglitz has already written one that offers the reader much food for thought. I suggest not taking anything for granted, as Stiglitz has his own ideological agenda to hoe. But he does a very commendable job in debunking much of the partisan-motivated bloviating.
Friday, October 29, 2010
Monday, July 19, 2010
Geithner's Gamble
The recent G-20 summit in Toronto has provoked a contentious debate over world economic policy. The US economic troika of Treasury Secretary Geithner, NEC director Summers, and Fed Chairman Bernanke are pushing a reluctant European Union to accelerate fiscal stimulus and rescue the debt-laden economies of its weakest members. In their eyes, the singular objective is strong, balanced, and sustainable growth as they conjure up fear of another Great Depression. The Europeans counter that such advice is economically unreasonable and politically inappropriate. Furthermore, it demonstrates a profound lack of understanding of European realities. Faced with the unsustainable public spending of Greece, Spain, Portugal and Italy, they argue that sustainable growth cannot be not based on governments injecting cash they don't have, with mere hopes of fiscal restraint. Probably thinking more of the Weimar Republic than the Great Depression, their voting publics seem to agree.
Thus, the debate appears to have reached an impasse. But the Europeans are likely to blink first when confronted with the pain of near-term deflation and deleveraging. Unfortunately, the Geithner plan (or GSB for short; for conspiracy theorists, the acronym's resemblance to "Goldman Sachs bank" is purely coincidental) looks more and more like a Hail Mary pass in a game of fantasy policymaking. It embraces a stark contradiction between unrestrained fiscal stimulus in a political environment that is panicking over excessive debt. So GSB asks for credible plans to stabilize debt-to-GDP levels, while warning against withdrawing fiscal stimulus. It reminds one of St. Augustine's lament to God: "Give me chastity and continence, but not just yet."
Regrettably, these macroeconomic debates are distracting us from some stubborn economic truths that become more apparent at the micro level. In other words, what people are doing at the individual and firm level in their daily lives. I will argue that the GSB plan is unlikely to succeed because it fails to directly address the gross incentive distortions of these underlying behavioral functions that underpin all macroeconomic models.
We know for economies to grow, people need to work, save, invest, and consume, no matter what national flag they fly. However, we hear that the citizens of developed countries save too little and consume too much while those in emerging nations do the opposite. Macroeconomics assures us these will balance out in the long run – reality tells us in the long run we are all dead, maybe sooner. Look closely: GSB warns how imbalances must be corrected, but then advocates policies that reinforce the wrong behaviors. For example, US consumers need to pay down excessive debt by saving more and consuming less. But that has negative consequences for GDP and job growth. So US economic policy subsidizes low interest rates, punishing savers and rewarding profligate debtors. At the same time our leadership has recklessly increasing fiscal spending and borrowing, incurring new liabilities for taxpayers with bailouts that prevent prices from reaching an equilibrium. Without accurate prices, people who need to decide the proper mix between consuming, saving, and investing are flying blind. The result is that any surplus funds sit idly in the piggy bank rather than being invested.
One doesn’t need an economics degree to figure out the consequences of distorting incentives to such a degree: less saving, more consumption, and excessive liquidity that doesn't find its way into new production. This yields few new jobs and anemic GDP growth that more reflects trading in asset bubbles rather than the production of new goods and services. On an international basis, this only encourages export-led countries like China, India, and Germany to continue providing credit in order to buy their export goods. The game goes on until the next collapse. With each failure, politicians demand more power and control to do the wrong things. Yes, uncertainty and loss of confidence bedevil the best intentions.
Is this really the best course we can follow? Hardly.
First, the Geithner spin on the current financial environment is probably overly optimistic. Low interest rates and low Treasury rates are less a sign of confidence than a costly premium on liquidity in an environment that is deleveraging in the private sector and exploding with new debt in the public sector. GSB cannot speak to these truths until it becomes politically expedient, but if the stock market recovery is real, we should expect a broadening of support across all sectors and firm sizes. If it reverses or narrows with mergers and acquisitions, the booming market is more likely a sign of excess liquidity.
Second, yes, we run a real risk of a sustained deflationary environment, but the fears of deflation and deleveraging causing the next Great Depression are overblown. Most scholars conclude that the Depression was not caused by lack of spending, but overly restrictive monetary policy and that the fiscal stimulus of the New Deal most likely prolonged the downturn. Bernanke insures us under his command there is little chance of overly restrictive monetary policy. His hand will only be forced by the bond market and Treasury yields.
More important, the policies of the last twenty plus years have rewarded debtors and asset holders to the detriment of savers and workers. It's time to redress this imbalance if we wish to return to a sustainable path. We may need controlled deflation rather than controlled inflation. While certain financial interests (i.e., debtors and debt leveraging) will strongly object to changing the rules of the game, financial prudence has been on the short end of national economic policy for far too long.
Lastly, the most challenging political task is to advocate for an international economic model that recognizes and reinforces the basic formula for wealth creation: hard work, restrained consumption, and prudent saving and investing. National success is less about maximizing GDP growth than it is about the distribution of resources across time and across populations to insure sustainability and stability over the long run. A sustainable market system must be able to manage demographic and technological cycles, but our abilities are only hampered by credit-debt cycles that are engineered purely through bad policy.
This goes for emerging economies like China and India as well. A society that does not consume, has little reason to save and invest, and a society that does not save and invest has little to consume. This probably means slower but more stable growth with fewer reversals. It probably means more equity investment than debt. But we have seen the alternative and it is a casino. A return to fundamentals is the only way we can fulfill our commitment to raise living standards across all countries far into the future.
Thus, the debate appears to have reached an impasse. But the Europeans are likely to blink first when confronted with the pain of near-term deflation and deleveraging. Unfortunately, the Geithner plan (or GSB for short; for conspiracy theorists, the acronym's resemblance to "Goldman Sachs bank" is purely coincidental) looks more and more like a Hail Mary pass in a game of fantasy policymaking. It embraces a stark contradiction between unrestrained fiscal stimulus in a political environment that is panicking over excessive debt. So GSB asks for credible plans to stabilize debt-to-GDP levels, while warning against withdrawing fiscal stimulus. It reminds one of St. Augustine's lament to God: "Give me chastity and continence, but not just yet."
Regrettably, these macroeconomic debates are distracting us from some stubborn economic truths that become more apparent at the micro level. In other words, what people are doing at the individual and firm level in their daily lives. I will argue that the GSB plan is unlikely to succeed because it fails to directly address the gross incentive distortions of these underlying behavioral functions that underpin all macroeconomic models.
We know for economies to grow, people need to work, save, invest, and consume, no matter what national flag they fly. However, we hear that the citizens of developed countries save too little and consume too much while those in emerging nations do the opposite. Macroeconomics assures us these will balance out in the long run – reality tells us in the long run we are all dead, maybe sooner. Look closely: GSB warns how imbalances must be corrected, but then advocates policies that reinforce the wrong behaviors. For example, US consumers need to pay down excessive debt by saving more and consuming less. But that has negative consequences for GDP and job growth. So US economic policy subsidizes low interest rates, punishing savers and rewarding profligate debtors. At the same time our leadership has recklessly increasing fiscal spending and borrowing, incurring new liabilities for taxpayers with bailouts that prevent prices from reaching an equilibrium. Without accurate prices, people who need to decide the proper mix between consuming, saving, and investing are flying blind. The result is that any surplus funds sit idly in the piggy bank rather than being invested.
One doesn’t need an economics degree to figure out the consequences of distorting incentives to such a degree: less saving, more consumption, and excessive liquidity that doesn't find its way into new production. This yields few new jobs and anemic GDP growth that more reflects trading in asset bubbles rather than the production of new goods and services. On an international basis, this only encourages export-led countries like China, India, and Germany to continue providing credit in order to buy their export goods. The game goes on until the next collapse. With each failure, politicians demand more power and control to do the wrong things. Yes, uncertainty and loss of confidence bedevil the best intentions.
Is this really the best course we can follow? Hardly.
First, the Geithner spin on the current financial environment is probably overly optimistic. Low interest rates and low Treasury rates are less a sign of confidence than a costly premium on liquidity in an environment that is deleveraging in the private sector and exploding with new debt in the public sector. GSB cannot speak to these truths until it becomes politically expedient, but if the stock market recovery is real, we should expect a broadening of support across all sectors and firm sizes. If it reverses or narrows with mergers and acquisitions, the booming market is more likely a sign of excess liquidity.
Second, yes, we run a real risk of a sustained deflationary environment, but the fears of deflation and deleveraging causing the next Great Depression are overblown. Most scholars conclude that the Depression was not caused by lack of spending, but overly restrictive monetary policy and that the fiscal stimulus of the New Deal most likely prolonged the downturn. Bernanke insures us under his command there is little chance of overly restrictive monetary policy. His hand will only be forced by the bond market and Treasury yields.
More important, the policies of the last twenty plus years have rewarded debtors and asset holders to the detriment of savers and workers. It's time to redress this imbalance if we wish to return to a sustainable path. We may need controlled deflation rather than controlled inflation. While certain financial interests (i.e., debtors and debt leveraging) will strongly object to changing the rules of the game, financial prudence has been on the short end of national economic policy for far too long.
Lastly, the most challenging political task is to advocate for an international economic model that recognizes and reinforces the basic formula for wealth creation: hard work, restrained consumption, and prudent saving and investing. National success is less about maximizing GDP growth than it is about the distribution of resources across time and across populations to insure sustainability and stability over the long run. A sustainable market system must be able to manage demographic and technological cycles, but our abilities are only hampered by credit-debt cycles that are engineered purely through bad policy.
This goes for emerging economies like China and India as well. A society that does not consume, has little reason to save and invest, and a society that does not save and invest has little to consume. This probably means slower but more stable growth with fewer reversals. It probably means more equity investment than debt. But we have seen the alternative and it is a casino. A return to fundamentals is the only way we can fulfill our commitment to raise living standards across all countries far into the future.
Wednesday, June 23, 2010
The Politics of Risk and the Risk of Politics
Barack Obama has reached for the mantle of a transformative presidency, aspiring to recast our national social contract in the interest of greater equality and fairness. In cooperation with a Democratic-controlled Congress, he has pursued this goal by expanding Federal authority in response to economic crises and supporting interventions into finance and banking, automobile manufacturing, health care, and environmental policy. This strategy adopts the “statist” philosophy of economic risk management by centralizing governmental authority and control over private markets.
Ironically, this Europeanization of US public policy is occurring exactly when sovereign debt crises and taxpayer bailouts are casting an ominous cloud over the European model. It seems public sector risk may turn out to be more dangerous than private sector risk. But if we can connect recurring financial crises to the long-term erosion in the economic health of states, we should seriously question whether statism offers the best array of policies to manage the uncertainties of the modern world.
Let us begin with the international financial crisis. A surplus of world savings channeled by excess credit creation drove people in the developed world to overborrow and concentrate debt and risk in overpriced housing assets. Banks then distilled these risky assets in securitized debt obligations and sold them to investors worldwide. What ensued was risk mismanagement on a colossal scale, as the concentration of leveraged debt made the crash far worse than dotcom or tulip bulb mania. This shell game violated all we know about prudent risk management and sucked in politicians, central bankers, financiers, the housing industry, and citizens alike.
The response has been to substitute massive public credit for shrinking private credit, while seeking new means to regulate financial risk and reward. This sounds a bit too much like the dog that bit us. In terms of public policy it means more centralized political control over central banks and the financial sector, with unpredictable market distortions yielding more liabilities and burdens for taxpayers. The net result will be an increase in systemic risk exposure.
Let us now turn to the crisis of welfare statism. The modern social welfare state is more accurately labeled the social insurance state, as its spending priorities are dominated by programs related to old age pensions, health care, and the risks of unemployment and poverty. Social insurance has been the developed world’s primary political response to systemic risk. Regrettably, it may impose the least efficient means to manage risk, with the most costly consequences.
Financial risk is managed by saving, pooling, hedging and, most important, asset diversification. The key concepts are savings and diversification, as these underpin the logic of insurance pooling. A financially sound insurance pool must align contribution and benefit ratios according to known actuarial data and demographic trends. The Bismarckian model of social insurance faces the same criteria.
The inconvenient truth is that our social insurance programs, like Social Security and Medicare, are not really insurance pools, but pay-as-you-go transfer schemes. We tax younger workers to immediately pay out benefits to older, retired citizens. This design inflicts a host of problems and costs.
First is the agency problem. Pay-as-you-go means our Social Security and Medicare taxes have not been saved in a “trust” fund, rather they are doled out in benefit promises and used to fund other political priorities through general revenues. This is the problem of political and bureaucratic “agents” following their own short-term incentives. This is also how we get “too big to fail” and runaway budgets.
The second problem is moral hazard. Because taxes to fund entitlement transfers crowd out private savings and lead us to believe the government is saving for us, private savings decrease. This means we cannot adequately fund the economic growth necessary to fund future social insurance liabilities. The alternative has been to borrow from abroad, mostly from the Chinese.
The third problem is demographics, as birth rates decline and longevity increases. We have heard how the “trust” funds will run out or overburden younger workers as baby boomers age.
We can readily measure the consequences of our policy failures in societal risk management. Household savings rates in the U.S. have dropped from an average of 10% in the 1970s to less than 1% just before the financial crisis in 2008. The immediate response to the crisis jumped the rate to 6%, but this was offset by roughly a trillion dollars in new public debt. (Estimates for China’s household savings rate range from 25-50%)
US public debt as a percentage of GDP now fluctuates around 80%. This compares to Japan at 192%, Italy at 115%, Greece at 108%, France at 80%, and Germany at 77%. Chile, which privatized its social insurance three decades ago, services a public debt at 9% of GDP.
Our current account deficit, which measures how much more we import than export, persists at 3% of GDP while China runs a 6% surplus. In simplest terms, the Chinese are lending us money to buy their goods.
A recent survey by the Peter G. Peterson Foundation of US political leaders from both parties found unanimous agreement that US structural deficits due to entitlement programs would cause a financial collapse of US public finances within ten years unless the programs were reformed.
The reality is that a true national insurance program cannot be a shell game that transfers resources from one group to another. The nation must accumulate real savings to be invested to fund future needs. The danger of our current treatment of risk management through entitlements is that we are not really insuring against our risks, but merely passing them on to others. This is neither moral, nor economically viable.
Our only chance of solving these problems must focus on managing economic risk by boosting savings and promoting the widespread diversification of assets. The increased concentration of political, economic, and financial power currently dominating the developed world is antithetical to such solutions and financial reform should not risk reinforcing a Wall Street-Washington oligarchy. This gets us back to the regulation of finance and banking.
The unfocused blame put on markets for our financial crises is disingenuous. The heavy reliance on credit and debt, the opacity of financial technology, the capture of regulatory agencies by the industries they regulate, and volatile asset markets are all symptoms of misguided policies. History and theory have both shown how functioning private markets are most efficient in allocating and managing diversified risk. The best financial regulation, then, is not another politicized agency, but the continued promotion of open, competitive, and transparent financial markets. The caveat for financiers is that failure and bankruptcy are essential features of free markets.
A world described by risk and uncertainty is like a sea full of hidden icebergs. Politicians like to reinforce social solidarity and national cohesion by claiming we are all in the same boat and must pull together. Mr. Obama seems to favor this metaphor, but, in terms of systemic risk, it also fits the Titanic analogy. A more useful metaphor is that we are all in different boats on the same sea. This can apply to countries, states, cities, markets, workplaces, and families. The multiplicity and diversity of institutional structures is a lesson conveyed by nature through biodiversity—all we need do is apply the lesson.
As one Greek citizen was quoted on his country’s latest crisis: “It could be a chance to overhaul the whole rancid system and create a state that actually works.”
Ironically, this Europeanization of US public policy is occurring exactly when sovereign debt crises and taxpayer bailouts are casting an ominous cloud over the European model. It seems public sector risk may turn out to be more dangerous than private sector risk. But if we can connect recurring financial crises to the long-term erosion in the economic health of states, we should seriously question whether statism offers the best array of policies to manage the uncertainties of the modern world.
Let us begin with the international financial crisis. A surplus of world savings channeled by excess credit creation drove people in the developed world to overborrow and concentrate debt and risk in overpriced housing assets. Banks then distilled these risky assets in securitized debt obligations and sold them to investors worldwide. What ensued was risk mismanagement on a colossal scale, as the concentration of leveraged debt made the crash far worse than dotcom or tulip bulb mania. This shell game violated all we know about prudent risk management and sucked in politicians, central bankers, financiers, the housing industry, and citizens alike.
The response has been to substitute massive public credit for shrinking private credit, while seeking new means to regulate financial risk and reward. This sounds a bit too much like the dog that bit us. In terms of public policy it means more centralized political control over central banks and the financial sector, with unpredictable market distortions yielding more liabilities and burdens for taxpayers. The net result will be an increase in systemic risk exposure.
Let us now turn to the crisis of welfare statism. The modern social welfare state is more accurately labeled the social insurance state, as its spending priorities are dominated by programs related to old age pensions, health care, and the risks of unemployment and poverty. Social insurance has been the developed world’s primary political response to systemic risk. Regrettably, it may impose the least efficient means to manage risk, with the most costly consequences.
Financial risk is managed by saving, pooling, hedging and, most important, asset diversification. The key concepts are savings and diversification, as these underpin the logic of insurance pooling. A financially sound insurance pool must align contribution and benefit ratios according to known actuarial data and demographic trends. The Bismarckian model of social insurance faces the same criteria.
The inconvenient truth is that our social insurance programs, like Social Security and Medicare, are not really insurance pools, but pay-as-you-go transfer schemes. We tax younger workers to immediately pay out benefits to older, retired citizens. This design inflicts a host of problems and costs.
First is the agency problem. Pay-as-you-go means our Social Security and Medicare taxes have not been saved in a “trust” fund, rather they are doled out in benefit promises and used to fund other political priorities through general revenues. This is the problem of political and bureaucratic “agents” following their own short-term incentives. This is also how we get “too big to fail” and runaway budgets.
The second problem is moral hazard. Because taxes to fund entitlement transfers crowd out private savings and lead us to believe the government is saving for us, private savings decrease. This means we cannot adequately fund the economic growth necessary to fund future social insurance liabilities. The alternative has been to borrow from abroad, mostly from the Chinese.
The third problem is demographics, as birth rates decline and longevity increases. We have heard how the “trust” funds will run out or overburden younger workers as baby boomers age.
We can readily measure the consequences of our policy failures in societal risk management. Household savings rates in the U.S. have dropped from an average of 10% in the 1970s to less than 1% just before the financial crisis in 2008. The immediate response to the crisis jumped the rate to 6%, but this was offset by roughly a trillion dollars in new public debt. (Estimates for China’s household savings rate range from 25-50%)
US public debt as a percentage of GDP now fluctuates around 80%. This compares to Japan at 192%, Italy at 115%, Greece at 108%, France at 80%, and Germany at 77%. Chile, which privatized its social insurance three decades ago, services a public debt at 9% of GDP.
Our current account deficit, which measures how much more we import than export, persists at 3% of GDP while China runs a 6% surplus. In simplest terms, the Chinese are lending us money to buy their goods.
A recent survey by the Peter G. Peterson Foundation of US political leaders from both parties found unanimous agreement that US structural deficits due to entitlement programs would cause a financial collapse of US public finances within ten years unless the programs were reformed.
The reality is that a true national insurance program cannot be a shell game that transfers resources from one group to another. The nation must accumulate real savings to be invested to fund future needs. The danger of our current treatment of risk management through entitlements is that we are not really insuring against our risks, but merely passing them on to others. This is neither moral, nor economically viable.
Our only chance of solving these problems must focus on managing economic risk by boosting savings and promoting the widespread diversification of assets. The increased concentration of political, economic, and financial power currently dominating the developed world is antithetical to such solutions and financial reform should not risk reinforcing a Wall Street-Washington oligarchy. This gets us back to the regulation of finance and banking.
The unfocused blame put on markets for our financial crises is disingenuous. The heavy reliance on credit and debt, the opacity of financial technology, the capture of regulatory agencies by the industries they regulate, and volatile asset markets are all symptoms of misguided policies. History and theory have both shown how functioning private markets are most efficient in allocating and managing diversified risk. The best financial regulation, then, is not another politicized agency, but the continued promotion of open, competitive, and transparent financial markets. The caveat for financiers is that failure and bankruptcy are essential features of free markets.
A world described by risk and uncertainty is like a sea full of hidden icebergs. Politicians like to reinforce social solidarity and national cohesion by claiming we are all in the same boat and must pull together. Mr. Obama seems to favor this metaphor, but, in terms of systemic risk, it also fits the Titanic analogy. A more useful metaphor is that we are all in different boats on the same sea. This can apply to countries, states, cities, markets, workplaces, and families. The multiplicity and diversity of institutional structures is a lesson conveyed by nature through biodiversity—all we need do is apply the lesson.
As one Greek citizen was quoted on his country’s latest crisis: “It could be a chance to overhaul the whole rancid system and create a state that actually works.”
Tuesday, April 27, 2010
The Cast of Villains in the Financial Crisis
Good article in the NYTimes outlining the full cast of characters in the financial crisis. A full cast still on the stage...
This is what I call Casino Capitalism and Crapshoot Politics.
This is what I call Casino Capitalism and Crapshoot Politics.
Monday, April 19, 2010
Tea Parties = CAP
Michael Barone's article addresses the nature of the anti-political backlash of the Tea Parties. It's is the same thing I have described as American citizens' political demands for choice, autonomy, and minimal protection from risks they can't control.
The media portrayal of the Tea Party phenomenon is misleading and can only hurt those who dismiss TPs as a fringe movement in the coming elections.
The media portrayal of the Tea Party phenomenon is misleading and can only hurt those who dismiss TPs as a fringe movement in the coming elections.
Thursday, April 8, 2010
Let's Get Real.
I love this excerpt from Peggy Noonan's article in the WSJ:
This week's Financial Industry Inquiry Commission hearings were so exciting, such a public service. The testimony of Charles Prince, former CEO of Citigroup, a too-big-to-fail bank that received $45 billion in bailouts and $300 billion in taxpayer guarantees, was riveting. You've seen it on the news, but if you were watching it live on C-Span, the stark power of his brutal candor was breathtaking. This, as you know, is what he said:
"Let's be real. This is what happened the past 10 years. You, for political reasons, both Republicans and Democrats, finagled the mortgage system so that people who make, like, zero dollars a year were given mortgages for $600,000 houses. You got to run around and crow about how under your watch everyone became a homeowner. You shook down the taxpayer and hoped for the best.
"Democrats did it because they thought it would make everyone Democrats: 'Look what I give you!' Republicans did it because they thought it would make everyone Republicans: 'I'm a homeowner, I've got a stake, don't raise my property taxes, get off my lawn!' And Wall Street? We went to town, baby. We bundled the mortgages and sold them to fools, or we held them, called them assets, and made believe everyone would pay their mortgage. As if we cared. We invented financial instruments so complicated no one, even the people who sold them, understood what they were.
"You're finaglers and we're finaglers. I play for dollars, you play for votes. In our own ways we're all thieves. We would be called desperadoes if we weren't so boring, so utterly banal in our soft-jawed, full-jowled selfishness. If there were any justice, we'd be forced to duel, with the peasants of America holding our cloaks. Only we'd both make sure we missed, wouldn't we?"
--------
OK, Charles Prince didn't say that. Just wanted to get your blood going. Mr. Prince would never say something so dramatic and intemperate. I made it up. It wasn't on the news because it didn't happen.
It would be kind of a breath of fresh air though, wouldn't it?
Thursday, April 1, 2010
Alan Greenspan on the Financial Collapse
Have to agree. Greenie gets it only half right. Bubbles thrive on leveraged credit. The Fed can easily dampen excess leverage and also send the right signals to the shadow banking system to reduce moral hazard. We didn't get the "Greenspan Put" from the Easter Bunny.
Alan Greenspan on the Financial Collapse
Posted using ShareThis
Alan Greenspan on the Financial Collapse
Posted using ShareThis
Thursday, January 7, 2010
Debt Crisis = A Failed Policy Paradigm
The financial crisis of 2008 paved the way for the employment crisis of 2009, which has now paved the way for the upcoming public finance crisis of 2010. Most federal, state and municipal budgets are strained to the breaking point while the economy still has not found its footing. Meanwhile our national politics is obsessed with expensive overhauls of environmental policy and healthcare reform. Our latest policy strategy is an attempt to borrow and spend our way to prosperity, ala Japan of the past twenty years.
It’s tempting to point to a few simple causes of these economic misfortunes, such as mortgage subsidies, loose credit standards, or excess financial leverage, but the truth is that we are experiencing the fallout of a failed policy paradigm.
This paradigm was rooted in the past century with the creation of the Federal Reserve in 1913, the Employment Act of 1946 and the Humphrey-Hawkins Full Employment and Stabilization Act of 1978. It’s a paradigm dependent on many admittedly useful policy tools, including both Keynesian demand stimulus and the Austrian school’s theory of money and credit, the monetarism of Friedman, as well as the supply-siders of the 1980s.
So, in what ways have these approaches failed?
The policy goals are clearly stated: stable GDP growth and full employment. But the economic results have been decidedly mixed: the growth of real incomes laden with an exploding entitlement state, structural budget crises, widening wealth disparities, a catastrophe-prone banking system, and volatile asset markets. We’ve heard the term “systemic risk” bandied about the recent financial crisis, but this report card captures the true risks of the system we’ve created.
Politically and socially, Americans clearly want a society where a growing middle class thrives, opportunity exists for individual success and advancement, and a prosperous elite accepts the responsibilities of power not to exploit the weak and disadvantaged. Instead, our political economy is hollowing out the middle class, creating more dependency among the poor, and fostering a culture of corruption and irresponsibility among the elites . Elsewhere I’ve characterized this current state of affairs as Casino Capitalism and Crapshoot Politics.
Second question: why has our democratic politics failed to deliver? The short answer: Our government is doing too much of what it shouldn’t be doing and not enough of what it should.
Free market economies are very good at producing wealth by harnessing the incentives of market participants. Market prices are valuable information signals that tell everyone how much of each good to produce. Governments, however, no matter how enlightened, cannot attain this efficiency. But, due to the political imperative to “do something” in response to countless demands, they feel compelled to try. Thus the focus on “growing the economy” and “creating jobs.”
Unfortunately, these goals often demand incompatible policies, highlighting the differences between the private and public sectors. Private firms earn profits (i.e., create wealth) by increasing productivity, often by reducing labor costs. However, the public sector follows no profit criteria, so the government increases employment without attention to productivity. Thus, with more public sector jobs we create more employment while producing less. At the same time, the growth of the public sector empowers a politically powerful public union interest in its continued expansion. This is no way for a nation to grow rich.
When we peal away the logic we find the true goal of public sector job creation: political redistribution of the economy’s wealth-creating capacity in order to mitigate the effects of markets. This is not an unworthy societal goal, but our public policies adopt counterproductive means to achieve it.
To be fair, the political problem arises because private markets are agnostic towards the distributional effects of their success. Inequality, poverty, pollution, environmental degradation, the concentration of economic and political power—all these are unfavorable distributional effects of markets that give rise to political demands. The question is over how government should meet these demands.
The 20th century attempt to tax and redistribute wealth has landed the modern welfare state in a cul-de-sac of exploding budgets, rising costs of living, slower economic growth and structural unemployment. We’re robbing Peter to pay Paul and neither – except for a relative handful of bureaucrats and rent-seeking capitalists - is better off for it. This adds up to less opportunity all around. Again, the problem is with our failed paradigm. We need to align our policies with behavioral incentives without surrendering our policy goals to an agnostic market mechanism.
To construct a new paradigm we might do best to return to first principles of what Americans want: freedom, opportunity and justice. In order to enjoy these principles, citizens need to be empowered with choice, autonomy, and protection from unmanageable risks. Only functioning free and competitive markets can provide the necessary resources.
So, what should be the proper role for government?
The maldistribution of resources can be mitigated if citizens participate in the wealth creating process as more than an input labor cost. Public policy should cease deficit spending to promote employment and instead look to creating the necessary environment for private risk-taking, saving, investment, and production. This includes insuring market competition and mitigating the effects of economic risk and uncertainty. Tax and regulatory policies should promote the widespread accumulation, diversification, and access to capital to empower individuals and families with the necessary resources to build wealth and insure themselves against uncertainty. Where private insurance markets are incomplete, there is a role for limited social insurance to fill the gap.
Numerous specific policies flow from this general paradigm shift, for example, we can stop penalizing savings through overly loose credit and onerous tax policies on interest and dividend income. There is no reason not to have a tax-free threshold for capital income that reflects the desired savings level of the median annual income household.
Why have we stuck with a failed policy paradigm? Part of the answer is the Kuhnian nature of scientific revolutions, but the pursuit of power and influence by narrow interests is certainly a determinant factor. Economically and socially, we know where we need to go. Getting there politically is another matter. Our present political leadership (of both parties) certainly is not taking us in that direction.
It’s tempting to point to a few simple causes of these economic misfortunes, such as mortgage subsidies, loose credit standards, or excess financial leverage, but the truth is that we are experiencing the fallout of a failed policy paradigm.
This paradigm was rooted in the past century with the creation of the Federal Reserve in 1913, the Employment Act of 1946 and the Humphrey-Hawkins Full Employment and Stabilization Act of 1978. It’s a paradigm dependent on many admittedly useful policy tools, including both Keynesian demand stimulus and the Austrian school’s theory of money and credit, the monetarism of Friedman, as well as the supply-siders of the 1980s.
So, in what ways have these approaches failed?
The policy goals are clearly stated: stable GDP growth and full employment. But the economic results have been decidedly mixed: the growth of real incomes laden with an exploding entitlement state, structural budget crises, widening wealth disparities, a catastrophe-prone banking system, and volatile asset markets. We’ve heard the term “systemic risk” bandied about the recent financial crisis, but this report card captures the true risks of the system we’ve created.
Politically and socially, Americans clearly want a society where a growing middle class thrives, opportunity exists for individual success and advancement, and a prosperous elite accepts the responsibilities of power not to exploit the weak and disadvantaged. Instead, our political economy is hollowing out the middle class, creating more dependency among the poor, and fostering a culture of corruption and irresponsibility among the elites . Elsewhere I’ve characterized this current state of affairs as Casino Capitalism and Crapshoot Politics.
Second question: why has our democratic politics failed to deliver? The short answer: Our government is doing too much of what it shouldn’t be doing and not enough of what it should.
Free market economies are very good at producing wealth by harnessing the incentives of market participants. Market prices are valuable information signals that tell everyone how much of each good to produce. Governments, however, no matter how enlightened, cannot attain this efficiency. But, due to the political imperative to “do something” in response to countless demands, they feel compelled to try. Thus the focus on “growing the economy” and “creating jobs.”
Unfortunately, these goals often demand incompatible policies, highlighting the differences between the private and public sectors. Private firms earn profits (i.e., create wealth) by increasing productivity, often by reducing labor costs. However, the public sector follows no profit criteria, so the government increases employment without attention to productivity. Thus, with more public sector jobs we create more employment while producing less. At the same time, the growth of the public sector empowers a politically powerful public union interest in its continued expansion. This is no way for a nation to grow rich.
When we peal away the logic we find the true goal of public sector job creation: political redistribution of the economy’s wealth-creating capacity in order to mitigate the effects of markets. This is not an unworthy societal goal, but our public policies adopt counterproductive means to achieve it.
To be fair, the political problem arises because private markets are agnostic towards the distributional effects of their success. Inequality, poverty, pollution, environmental degradation, the concentration of economic and political power—all these are unfavorable distributional effects of markets that give rise to political demands. The question is over how government should meet these demands.
The 20th century attempt to tax and redistribute wealth has landed the modern welfare state in a cul-de-sac of exploding budgets, rising costs of living, slower economic growth and structural unemployment. We’re robbing Peter to pay Paul and neither – except for a relative handful of bureaucrats and rent-seeking capitalists - is better off for it. This adds up to less opportunity all around. Again, the problem is with our failed paradigm. We need to align our policies with behavioral incentives without surrendering our policy goals to an agnostic market mechanism.
To construct a new paradigm we might do best to return to first principles of what Americans want: freedom, opportunity and justice. In order to enjoy these principles, citizens need to be empowered with choice, autonomy, and protection from unmanageable risks. Only functioning free and competitive markets can provide the necessary resources.
So, what should be the proper role for government?
The maldistribution of resources can be mitigated if citizens participate in the wealth creating process as more than an input labor cost. Public policy should cease deficit spending to promote employment and instead look to creating the necessary environment for private risk-taking, saving, investment, and production. This includes insuring market competition and mitigating the effects of economic risk and uncertainty. Tax and regulatory policies should promote the widespread accumulation, diversification, and access to capital to empower individuals and families with the necessary resources to build wealth and insure themselves against uncertainty. Where private insurance markets are incomplete, there is a role for limited social insurance to fill the gap.
Numerous specific policies flow from this general paradigm shift, for example, we can stop penalizing savings through overly loose credit and onerous tax policies on interest and dividend income. There is no reason not to have a tax-free threshold for capital income that reflects the desired savings level of the median annual income household.
Why have we stuck with a failed policy paradigm? Part of the answer is the Kuhnian nature of scientific revolutions, but the pursuit of power and influence by narrow interests is certainly a determinant factor. Economically and socially, we know where we need to go. Getting there politically is another matter. Our present political leadership (of both parties) certainly is not taking us in that direction.
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