demandside

Painful to watch political hacks channeling Republican Old Guard.  Stimulus package necessary.

Part of the problem of sorting out the good economics from the bad is the historical range of discussion.  About two weeks.  The Great Depression is involved only because the Right has to debunk the lessons learned there that are completely applicable to the present.

But coming out of Mr. Obama’s attempts to gain bipartisan support for a necessary program to combat the latest meltdown, Republicans are like little plastic wind-up toys, barking the same line they have used for the past ten years.  They are espousing the same policies that got us into this mess.

If Supply Side had any validity would there not be at least one company somewhere in the world who was prospering rather than declining?  The economy is ruled by the demand side.  There is not one company with a great product that is bucking this trend.  The only survivors are those whose exposure to demand destruction is mitigated by being on the low end of the market, by having monopoly, or by being in the business of necessities.

This nonsense has been the core of bad economics for a century.  The Old Guard Republicans are back, with John Boehner as their spokesman, making as little sense as ever.

One of the most absurd contentions is that public infrastructure spending will do no good for jobs, partly because it is not quick enough, while tax cuts have to be made permanent in order to work.  Question mark.

Yes, proper stimulus requires permanent tax cuts for the wealthy, that is the Bush tax cuts, but spending on infrastructure and saving the planet as not quick enough to be of any use.

The tax cuts are gong to create jobs how?  By inducing people to spend on what?

Infrastructure spending is going to create jobs by hiring people to do things.

This line of babble has been running for, as I said, the Cal Coolidge days of quote the business of America is business.  It runs on not because there is evidence to support it, or a paucity of experience to contradict it, but because it has consistent sponsorship from the wealthy.  University chairs are endowed and institutes are funded to be staffed by those of appropriate persuasion.  Since it is not intellectual honesty or rigor that is required, these attributes lag, and a great laziness has grown up.

All the more so in politics, where the sponsorship is more obvious and the required ideology more explicit.  So you have a generation of politicians who only need to find out how to reach an already agreed upon conclusion through whatever the news background of the day is.  It has created a variation of the Wall Street greed, which allowed you to say whatever was necessary to get what you wanted, no matter its relevance or truth.

The Bush tax cuts of 2001 and 2003 produced conservatively $3 trillion dollars in deficit.  We’ll give the Iraq War a trillion and the damage of the economic collapse a trillion.  The Bush years produced maybe three million total new jobs.   A back of the envelope calculation finds that each job cost one million dollars in deficit.

Anyway, it is Idiot of the Week, with John Boehner, head of the House Republicans.  He appeared fit and tanned from the Ohio winter on the talk shows last weekend and then in interviews the following week.

Here he is.

BOEHNER

Calling up the “let people keep their money” from the Bush campaign of 2000 is unfortunate.  Tax cuts, you will recall, could not be sold on that basis, as the average citizen was concerned about fiscal responsibility.  It was only with the advent of the first Bush recession that tax cuts were sold to a bipartisan majority in Congress on the basis of being stimulus.

So Boehner is an expert on what won’t work, or at least he’s had a direct hand in getting those kind of policies adopted.  Small businesses, as you are probably aware, are not the Mom and Pop businesses you and I might think of, but those under $250,000,000 receipts which might write a campaign check.

Government has to do this.  No matter how much money you give to corporations, they are not going to invest in a down economy.  It would be bad business.  The incentives to spend and invest arise only with a return to healthy demand.

They are a parody of themselves.  I am reminded of the damage the stupidity of those who controlled governments across Europe prior to the Great War.  While art and business may have advanced, it was unfortunate that from Russia to Great Britain to Germany, perhaps most notably in the Austo-Hungrarian Empire, government and the military had remained in the hands of the landed aristocrats.  Inheriting land required no particular intelligence and very little was demonstrated in the actions of these leaders, either in government or on the battlefield.

So the Old Guard Republicans trot out the old standards, tax cuts and minimal government.  And they finally succeeded in dismantling the New Deal.  Only to see the conditions that stimulated the New Deal Return.

At least that war ended the millenia of dominanance of the landed and marked the rise of if not the brilliant, at least the competent.  We can only hope this current economic calamity will end the dominance of the economically dull and disingenuous.

And of course, until the sponsorship of the deep pockets disappears, the tired prattle will not disappear.  This is going to be a long time.  One wishes a ruthlessness on behalf of the public similar to the ruthlessness of greed on behalf of the entrenched financial interests.  The public would benefit enormously from the extinction of market fundamentalism.  But a few on Wall Street and Capitol Hill rely on it for their position.

ow to lie about tax cuts

Andrew Leonard Salon.com

Andrew Leonard, Salon.com

response to economists view:

This is wrong, but too often accepted as fact:

from Bruce Bartlett as reproduced on the Economists View Blog

Keynes was right, but many of his followers weren’t. They thought that budget deficits would stimulate growth under all circumstances, not just those of a deflationary depression. When this medicine was applied inappropriately, as it was in the 1960s and 1970s, the result was inflation.

Economists then concluded that it was a mistake to pursue countercyclical fiscal policy, and the idea of “fine-tuning” became a derogatory term. …

In the 1980s and 1990s, economists came around to the view that only monetary policy could act quickly enough to reverse or moderate a recession. … [But…] As we have seen, the Fed could not prevent the greatest financial downturn the world has seen since 1929. This has revived the idea that fiscal policy must be the engine that pulls us out.

The tepid Kennedy tax cut of 1963 was not the cause of inflation.  It was the Johnson guns and butter program.  Johnson made a 10% tax surcharge the centerpiece of his economic policy in his last years.  The last president to be so friendly with taxes.

The inflation of the 1970s had much more to do with oil prices than anything else, and the bungling of them with Nixon’s wage-price freeze.

We never got into deficits in earnest until the 1980s and 2000s, with Reagan and the Bushes.  Nine out of ten dollars in the federal debt come from those years.  To say otherwise is simply wrong, and probably disingenuous.

Keynesian economists were held in high regard in the 1960s.  The stagflation of the 1970s did them in, but only with the constant harping of the Monetarists and the fantasy economics of Supply Side.  We see how well that worked out.  Whether or not they “came around to the view that only monetary policy could act quickly enough…,” it hasn’t worked out that way, as the moderate recession of 2001 needed 1% interest rates for too long along with the huge tax cuts to generate weak GDP and very weak employment growth.  Along with the grotesque mispricing in housing, risk, stocks, and the gross explosion of private debt as well.

As we have seen, the Fed could not prevent the greatest financial downturn the world has seen since 1929.

Could not prevent?  They didn’t even slow the train.  They couldn’t even manage the orderly activity of the banking sector which is their purview.

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Investment and Consumption are part of the recovery, not just government spending

Today, from a listener

Dear sir,

As we plow ahead and jack up the G by any means possible, we should also consider how to support C.

I still have some money in my 401k.  I would gladly use some of that to support my family in a time of hardship.  How about relieving the penalties for early withdrawal of 401k or IRA money?

I don’t know how much C that would generate - but I would be very inclined to use that cushion until things become more stable.

Thanks for thoughts.

Bob

By all means, Bob.  Thank you for this note.  I realized it at the time, and did not make a good enough acknowledgement of the situation of real people when I talked about the imperative of government demand.  The C is the point of the economy.

What Bob is talking about is C plus I plus G plus NX equals Y or total economic output.

It is not that the C is bad.  It is just that there is not going to be enough of it to float the economy.  And in C we are referring to private consumption.  The G is the government spending.

Let’s take this on a couple of levels.  First, directly to the question.  The 401(k).  Of course it is all right with me to eliminate the penalties on the use of savings.  Right now there are entirely too many incentives to save.  The paradox of thrift is in full flower, as everybody saves against the uncertainty, and consequently incomes drop from the absence of spending, and eventually everybody must use their savings to make up for flagging incomes.

Let everybody be aware that I am certainly not making any investment advice here.

It is unfortunate that the private, defined contribution scheme for pensions embodied in the 401(k) and IRA has blown up on us at this time.  And  the more I consider Bob’s note, the more directions it leads.

Let me confine myself today to a couple of more levels.

The C.  The C is not going to be strong enough to carry the economy.  Consumers are, as Nouriel Roubini says, “tapped out, debt burdened and saving less.”  But the C also has to be big enough to stimulate the I in order for any self-correcting mechanism to take place.

That is, the multiplier which we have applied to government spending, is originally, or at least in one early form, called the “Investment Multiplier.”  It is an exogenous spending that stimulates demand.  For private I to come back to a positive number, private C has to be big and growing and require increased investment to generate the goods and services clearly on the horizon.  For GM to be a positive force again, people have to not only buy enough GM cars to get their old plants up and running, but to cause GM to build or expand.

The Government does not need the prospect of profit to generate I, it can use the prospect of disaster.

And be sure there is a lot of I in G, in terms of roads, bridges, education, even some health care.  Likewise there is a lot of C in G.  Police and fire services are indistinguishable from and married to private insurance payments.  Private schools and public schools may be perfectly identical except for which side of the C or G they are accounted for.  Health care for the indigent or publicly insured is poorer, I suppose, but is it any different than health care for the privately insured?

What is in the stimulus package now proposed?  Well, there is lots of C, with the tax cuts that go to individuals.  Plenty of S there, too, which we should talk about, and will in a moment.  There is I in the G, as above, with the expenditures on facilities and services that build for the future and are not consumed in the current quarter.  There is other G, as with the support to state and local governments.  The cops and teachers, you might call it. (You know, I really need to get organized so I can go back and point out that this is the kind of thing, specifically, we were talking about in the first stimulus package.)  And there is the induced C when somebody working on an I or a G takes his paycheck to the grocery store.

Here is David Korten, publisher of Yes Magazine, talking about consumption on a recent edition of Democracy Now!.

KORTEN

David Korten.

So, consume, yes.  Let’s eliminate the penalties on using 401(k)s and IRAs to promote current consumption.  But let’s take a look at the other elementary equation in which C appears, and that is Consumption Plus Savings equals income.

Since total income equals total output,  this C + S = Y is often combined with the above C + I + G = Y and simplified to produce Savings = Investment.  You have to do things like assume away the trade deficit and assume G is paid for by C in the second case, but this Savings equals Investment equation is one of the great bludgeons used against profligate Americans.  Never mind we thought we were being prudent by buying stocks and houses, these are assets, so they don’t count in S.

But more to the point.  The equation is often, very often, almost universally used to force a causation.  Savings equals Investment.  Therefore Savings causes Investment.  This is backwards.  People save to invest.  They don’t invest because there is a pool of savings to be used up.  Aside from this, people invested in American houses with Japanese and Chinese dollars and in Chinese factories with American corporations retained earnings.

But back to this point.  Which is essential.  How about somebody other than Demand Side saying this.  Here, from the

According to classical theory, if unemployment were to rise, consumption would decline, but savings would increase. The increase in savings would lead to lower interest rates, which would lead to greater investment, which would lead to the restoration of jobs–in short, back to full employment. But Keynes rejected this logic. During a recession, lost jobs and wage cuts would lead to a reduction in consumer demand, which meant less incentive for businesses to invest and banks to loan. And, if businesses–skeptical about the rate of return from an investment–failed to invest, more workers would lose their jobs, consumption would decline even further, national income would go down, and any initial increase in savings would be wiped out. The economy would reach equilibrium with a high number of unemployed, which is exactly what happened in Great Britain in the 1920s and 1930s.

Keynes’s theory inverted the relationship between savings and investment. Instead of the amount of savings determining the amount of investment, the amount of investment determined the amount of savings. It also inverted the relationship between consumption and savings. If the inducement to invest was determined at least partly by consumer demand, then the greater the propensity to consume rather than save, the greater the inducement to invest. Consuming, in short, was preferable to saving.

These two inversions had radical implications for government policy. In the past, governments had advocated budget cuts and tax increases, along with wage cuts and lower interest rates, to escape recessions; Keynes was arguing that, except for lower interest rates, these measures made matters worse. And, in a severe recession or depression, when pessimism about future business profits made lenders reluctant to finance investment, even government attempts to lower interest rates wouldn’t help. What was needed instead? Budget deficits, rather than budget balancing, and public investment and income transfer programs designed to put money in the pockets of the poor–that is, the people most likely to spend, not save it.

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Laying out an alternative with Peter Cohan, Felix Salmon, Binyamin Applebaum, Simon Johnson, and Demand Side

Nationalizing the banks means privatizing your taxes,

Today is devoted to Peter Cohan’s idea of creating healthy banks for taxpayers to invest in, rather than propping up sick ones.  We will let Cohan run on a bit because we understand what he is saying and we still do not understand how the bailout of big banks is a solution and not just a bailout of big banks.

The following discussion of the prospects for nationalizing, bad banks, and the rational solution comes by way of canibalizing Warren Olney’s To the Point, with guests:

• Binyamin Appelbaum: National Banking Reporter, Washington Post
• Peter Cohan: President, Peter S. Cohan and Associates
• Felix Salmon: Financial blogger at Conde Nast’s Portfolio.com
• Simon Johnson: former Chief Economist, International Monetary Fund

Johnson has been featured here on Demand Side’s Idiot of the Week.  As chief economist at the IMF, he offered some very odd analysis at the outset of the year, essentially missing the boat.  I do not know if that contributes to his now being at the Sloan School at Harvard.

The options are set up by Applebaum

APPLEBAUM

Peter Cohan has a reaction to the prospect of bad banks

COHAN

Felix Salmon of Conde Naste’s Portfolio.com

SALMON

Now here is the aforementioned Simon Johnson

JOHNSON

What does Mr. Cohan think about collapsing the financial architecture of the Western World with his unconcern for the plight of the megabanks and their creditors?

COHAN

This is from To the Point

We acknowledge Cohan’s more sophisticated understanding, but you may remember — and if you don’t, we are happy to remind you — that the Demand Side prescription for the housing slash credit market collapse was to unpack the securities that were at the root of the problem — the CDOs that could no longer be valued and clogged the arteries of the big banks.  Deal with each mortgage on its own, renegotiate or refinance, a labor of many, but the only way to detoxify the system from the whiz-kids’ laboratory experiment gone awry.  (I guess we’re lucky it wasn’t a biological experiment.)

We thought the Frank-Dodd Short Refi Bill in the spring was going to do this, because it gave lenders the incentives of government guarantees along with the incentive of avoiding more drastic losses that result from foreclosure.  Unfortunately the servicers were not on the same incentive program and the threats of legal action from owners of tranches in the far corners was too threatening.

Our second remendy was to reduce banks that were too big to fail to sizes that could be managed by market forces as well as regulation.  A bank that is “too big to fail,” is by definition outside the market discipline that was the favorite fantasy of former Fed Chair Alan Greenspan.  The great tragedy of the repeal of the New Deal protections culminated in 1999 with the repeal of the final piece of the Glass-Steagall Act, the one segregating investment from commercial banking.

The salvation of the investment houses in the Bernanke/Paulson scheme turned out to be forcing an expansion into commercial banking, perhaps in name only, in order to allow them to benefit from the protections offered commercial banks.

But the banks that are too big to fail are also too big to bail out.

So now we have the spectacle of the U.S. getting deeper and deeper in the swamp.  Some call the fed now “all in.”  We call it a series of spectacular bluffs that were inevitably going to be called.  All because these securities have no market and hence no market value.  Trying to give them a value by government intervention was only going to substitute taxpayer money for the dumb investor’s money.  But that is the plan.

Here, from February 21, 2008, please indulge us.

It reminds me of another observer’s comment.  I hope you will indulge.

response to economists view

This is wrong, but too often accepted as fact:

from Bruce Bartlett as reproduced on the Economists View Blog

Keynes was right, but many of his followers weren’t. They thought that budget deficits would stimulate growth under all circumstances, not just those of a deflationary depression. When this medicine was applied inappropriately, as it was in the 1960s and 1970s, the result was inflation.

Economists then concluded that it was a mistake to pursue countercyclical fiscal policy, and the idea of “fine-tuning” became a derogatory term. …

In the 1980s and 1990s, economists came around to the view that only monetary policy could act quickly enough to reverse or moderate a recession. … [But…] As we have seen, the Fed could not prevent the greatest financial downturn the world has seen since 1929. This has revived the idea that fiscal policy must be the engine that pulls us out.

The tepid Kennedy tax cut of 1963 was not the cause of inflation.  It was the Johnson guns and butter program.  Johnson made a 10% tax surcharge the centerpiece of his economic policy in his last years.  The last president to be so friendly with taxes.

The inflation of the 1970s had much more to do with oil prices than anything else, and the bungling of them with Nixon’s wage-price freeze.

We never got into deficits in earnest until the 1980s and 2000s, with Reagan and the Bushes.  Nine out of ten dollars in the federal debt come from those years.  To say otherwise is simply wrong, and probably disingenuous.

Keynesian economists were held in high regard in the 1960s.  The stagflation of the 1970s did them in, but only with the constant harping of the Monetarists and the fantasy economics of Supply Side.  We see how well that worked out.  Whether or not they “came around to the view that only monetary policy could act quickly enough…,” it hasn’t worked out that way, as the moderate recession of 2001 needed 1% interest rates for too long along with the huge tax cuts to generate weak GDP and very weak employment growth.  Along with the grotesque mispricing in housing, risk, stocks, and the gross explosion of private debt as well.

As we have seen, the Fed could not prevent the greatest financial downturn the world has seen since 1929.

Could not prevent?  They didn’t even slow the train.  They couldn’t even manage the orderly activity of the banking sector which is their purview.

Tax Cuts, Government Spending, Public Goods, and the Stimulus Package from Economist’s View by Mark Thoma

Tax cuts won’t build schools, or any other public good.

And right now, with so much of our infrastructure in need of attention, we need public goods.

We tried the tax cut approach to stimulating the economy once, we had no choice since Bush and the Republicans would not have passed any other type of stimulus package.

Guess what? It didn’t work very well, and we have little to show for it. Had we, say, rebuilt water systems instead, at the very worst we’d have better water. That’s not so bad in any case.

And it’s been interesting, if that’s the right word, to watch the same people who delayed fiscal policy for months and months and months as they insisted that we try tax cuts first now tell us that it will take too long to put the spending in place.

I’ve even heard some who ought to know better argue that because forecasts say the recession will end soon, we can’t possibly get the spending in place soon enough. That is, they argue that by the time the spending hits the economy, the economy will have already recovered

(these are often the same people who reassured us that there was no housing bubble, and there was not worry anyway because the recession, if it hit at all, would be very mild and easily absorbed by our dynamic, flexible economy).

Never mind that forecasts beyond around six months ahead are not much better than a coin flip, and they know it, some forecast somewhere says that the recession will end before spending is in place, and that’s enough for them to take the argument public. What if the forecast is wrong? …

If the argument that the private sector is more efficient than government always prevailed, we wouldn’t have any public goods at all, and that’s not an economy I’d want to live in.

Obviously, there are times when spending on public goods is justified economically, and I’d argue strongly that this is one of those times, i.e. that there are lots of places the government can spend money that have large social returns.

Why would we want to wait until the opportunity cost is very high to reap these returns instead of pursuing these projects now when the cost is lower? If we are going to have to make these expenditures anyway, it doesn’t make any sense to wait.

And one last question. The tax cuts are best crowd argues that government makes poor spending decisions, and this is one of their key objections to spending measures. But doesn’t government make bad tax decisions too? The tax cut advocates like to promote some tax they’ve designed that has wonderful properties on paper, and sounds great on the editorial page, but it’s just as easy to do that with fiscal policy. If you don’t have to confront the reality of the legislative process, and you are free to argue from a theoretical perspective instead, not a dollar will get wasted. But as we saw during the first fiscal stimulus attempt, the one where the “it has to be tax cuts or nothing” types prevailed, the tax cuts that were actually enacted were far from optimal, and there was quite a bit of disappointment in the actual tax cut package that was put into place. And perhaps because of that, the tax cuts had less effect than hoped. I know that the tax cut advocates say that this time government needs to do it right, and they have lots of advice about what “right” is, but, really, given the realities in congress, what makes them think this time will be any different?

Tax cuts won’t build schools.

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Plus Arthur Levitt on banks, Jason Tennert on stocks, George Soros on the bailout

Let us not forget the five trillion dollar Bush stimulus package.  Enormous tax breaks, many of them to business backers.  Enormous deficits.  Low interest rates.

Americans invested trillions of dollars in housing that stimulated a jobless recovery and trillions of dollars in losses.  Combine that with the losses in stocks and the extraction of wealth by the commodities bubble, and you have the prescription of the market fundamentalists for recovery.

The idea seems to be let the government bail out all the huge mistakes because we need the financial markets to create a new bubble.

In fact, it was not the crash of the markets, housing, stocks, commodities, that is the problem.  It is the unrealistic and irrational run-up in housing, stocks and commodities.  The crash of these prices is not because of some natural movement of business cycles, it is because they were bid up by the financial sector.

Thus, the financial sector has to be reformed so as not to deal in bubbles.

The inevitable decline in these asset prices is not the mistake the Treasury and Fed must empty the vaults to correct.  It is their bloated value that was the mistake.  Thus the solution is not to empty the Treasury and turn the Fed into a zombie clone.  The solution is to manage the reduction in these values.

Yes, the stocks that bulked up the pension funds and 401(k)s, the houses that were the piggy banks for retirement, the corporate bonds and leveraged instruments that made hedge fund managers the wunderkind of half a decade, need to revert to a reasonable price, meaning a drastically lower price.  Nothing is more poetically just than a financial cowboy who got tens of millions in bonuses now joining the ranks of the unemployed — except perhaps one who is forced to pay back the income he got for ephemeral gains.

Part of that adjustment is coming in the banking stocks.  Here is Arthur Levitt on with Tom Keene, talking about the collapse of the asset values and the likely outcome — nationalization.

LEVITT

Who is going to borrow is the liquidity trap question.  Nobody is going to borrow without the prospect of profit

The cheap money of the early 2000s led to a run-up in housing, then in commodities, along with unnatural strength in stocks, which seemed to get a bounce with each downsizing or reorganization.  All of it was fueled by leverage, cheap money from the Fed.

Did it work?  Well, we didn’t have down years in GDP.  Unfortunately we were eating the seed corn.

Combine that with $5 trillion in government deficits, including over $1 trillion left by W on his way out of town, and the $10 trillion in private borrowing or more, and you have an immense creation of money by borrowing.  It is this which any new recovery program has to counteract.

The Levitt question, who will borrow?  It is the government who must borrow.  First of all, the government can purchase value with its borrowing — infrastructure, education, possibly a halt to the meltdown of the planet’s climate.  This value is simply being brought forward by the borrowing.  Far different from homeowners who took out home equity to buy a vacation or Ski-doo.  Yet is is the second type of borrowing that is favored by the market and by many otherwise intelligent people on Capitol Hill.

One way of repricing these assets is to borrow at low interest rates and pay back with cheaper dollars.  It is a kind of a tax on capital.  And that can be done if the Fed doesn’t get in the way.  Another way is the systematic write-down of debt — mortgages, corporate, public.  But the first and best way is to let the asset prices fall to their natural levels.

The fat cat financial sector is going to shrink by forty percent.  This is a good thing.  If all goes well, public sector health care will grow by ten percent.  This is a good thing.  The capacity to save the planet will grow enormously.  This is a good thing.

What is a bad is believing we need to recreate the unstable situation of the past so as to give ourselves some sort of stability or preposterous prosperity on which to build the future.  Looking for an analogy, we are trying to treat the symptoms as if it were the disease, and recreate the conditions for the disease.

We took a look at banking with Levitt, before we leave, let’s have a look at the markets with chief investment strategist at Strategas Research, Jason Tennert.  Both these gentlemen come to us by way of Bloomberg.

TENNERT

George Soros:

The right and wrong way to bail out the banks, by George Soros, Commentary, Financial Times:

According to reports…, the Obama administration may be close to devoting as much as $100bn of the second tranche of the troubled asset relief programme funds to creating an “aggregator bank” that would remove toxic securities from the balance sheets of banks. The plan would be to leverage this amount up 10-fold, using the Federal Reserve’s balance sheet, so that the banking system could be relieved of up to $1,000bn worth of bad assets. …

[T]his approach harks back to the approach originally taken – but eventually abandoned – by Hank Paulson… The proposal suffers from the same shortcomings… These measures … would … support … banks at considerable expense to the taxpayer, but would not put the banks in a position to resume lending at competitive rates. …

…

The hard choice facing the Obama administration is between partially nationalising the banks, or leaving them in private hands but nationalising their toxic assets. Choosing the first course would inflict great pain on a broad segment of the population – not only on bank shareholders but also on the beneficiaries of pension funds. However, it would clear the air and restart the economy.

The latter course would avoid recognising and coming to terms with the painful economic realities… The public interest would dictate that the banks should resume lending on attractive terms. However, this lending would have to be enforced by government … because … banks would … focus on preserving and rebuilding their own equity.

Political realities are pushing the Obama administration towards the latter course. It cannot go to Congress and ask for the authorisation to spend an additional $1,000bn on recapitalising the banks because Mr Paulson has poisoned the well… That is what is leading the Obama administration to contemplate reserving up to $100bn … for the “aggregator bank” solution. …

The choice between the two courses is momentous; once made, it will become irreversible. … President Barack Obama can fulfil his promise of a bold new approach only by establishing a discontinuity with the previous team. Congress and the public are right in feeling that too much has been done for the banks and not enough for beleaguered householders. The government ought to take the GSEs out of limbo and use them more actively to stabilise the housing market. Having done so, it could go back to Congress for authorisation to recapitalise the banking system the right way.

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Plus Gregory Mankiw, Idiot of the Week

Today, Nouriel Roubini surfaces in Dubai, Joseph Stiglitz on leadership at the Fed, one forecasting firm says increased economic activity under the stimulus could pay 40 percent of the cost, and finally, Idiot of the Week with N. Gregory Mankiw.

Nouriel Roubini

A bloomberg report yesterday.

Nouriel Roubini rose for a moment in Dubai this week.  We suspect a lot of money is flowing toward the iconic NYU professor who made his reputation on the prediction of the collapse of housing and consequent damage to the financial sector.  His website is subscription only.

“I’ve found that credit losses could peak at a level of $3.6 trillion for U.S. institutions, half of them by banks and broker dealers,” Roubini said at a conference in Dubai yesterday. “If that’s true, it means the U.S. banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis.”

… President Barack Obama will have to use as much as $1 trillion of public funds to shore up the capitalization of the banking sector, following the $350 billion injection by the Bush administration, Roubini told Bloomberg News.

… “The problems of Citi, Bank of America and others suggest the system is bankrupt,” Roubini said. “In Europe, it’s the same thing.”

… “I see commodities falling overall another 15-20 percent,” Roubini said. “This outlook for commodity prices is beneficial for oil importers, it’s going to imply that economic recovery might occur faster, but from the point of view of oil exporters, this will be very negative.”

Joseph Stiglitz

The Rocky Road to Recovery

January 15 Project Syndicate

NEW YORK – A consensus now exists that America’s recession – already a year old – is likely to be long and deep, and that almost all countries will be affected.

…

Fortunately, America has, at last, a president with some understanding of the nature and severity of the problem, and who has committed himself to a strong stimulus program. This, together with concerted action by governments elsewhere, will mean that the downturn will be less severe than it otherwise would be.

The United States Federal Reserve is trying to make amends by flooding the economy with liquidity, a move that, at best, has merely prevented matters from being worse. It’s not surprising that those who helped create the problems and didn’t see the disaster coming have not done a masterly job in dealing with it. By now, the dynamics of the downturn are set, and things will get worse before they get better.

In some ways, the Fed resembles a drunk driver who, suddenly realizing that he is heading off the road starts careening from side to side. The response to the lack of liquidity is ever more liquidity. When the economy starts recovering, and banks start lending, will they be able to drain the liquidity smoothly out of the system? Will America face a bout of inflation? Or, more likely, in another moment of excess, will the Fed over-react, nipping the recovery in the bud? Given the unsteady hand exhibited so far, we cannot have much confidence in what awaits us.

WSJ

January 16

January 15, 2009, 3:44 pm Stimulus Could Pay for 40% of Itself

The type of economic stimulus package being considered by Congress and the incoming Obama administration could have a major effect on economic growth and employment, according to an analysis by the forecasting firm Macroeconomic Advisers.

And in a finding sure to please stimulus backers, the firm thinks a plan could pay for up to 40% of itself via higher tax revenue over the next five years.

Based on assumptions of a … $775 billion package that’s tilted a bit more toward tax cuts, the firm estimates that stimulus would add 3.2% to the level of U.S. gross domestic product by the end of 2010 and add 3.3 million jobs, cutting the unemployment rate by 1.7 percentage points by the end of next year.

“The economy would regain full employment two years earlier than in the absence of the stimulus package and, perhaps more important, reduce the risk of the economy slipping into a deflationary contraction more serious than the recession envisioned in our baseline,” Macroeconomic Advisers said.

Without stimulus, Macroeconomic Advisers thinks the unemployment rate, currently 7.2%, will peak at 9.1% early next year. With stimulus, the peak will be 8.3%.

As we’ve said here, the unemployment rate will hit ten percent in the current year, with or without a stimulus.  We suspect the snapback will be significant, and further stimulus in the form of infrastructure will come on line, generating big re-employment and a substantially lower rate by mid-2010.  This also assumes real and competent restructuring of the banking sector unfreezing the credit system.

We disagree on the outlook absent aggressive government action.  There is no stabilizing mechanism in the economy as currently constituted.  Consumers will not return.  Lending will not return absent the prospect of profit.  The outlook without government is a continuous and deepening stagnation.

This is not the supply side Laffer curve effect, which contended that increasing financial rewards to the top would generate more output by dint of better effort and innovation.  This is a straight increase in GDP from demand.

Now, Idiot of the Week

Greg Mankiw

Being chair of the President’s Council of Economic Advisers under George W. Bush is a short step from being featured on Demand Side’s Idiot of the Week.  Hardly surprising, I suppose, since economic policy in this administration has been primarily in service to the corporate political agenda.  The current chair Edward Lazear made a policy of rosiness during the first six months of the current economic collapse.  Now he is rarely heard from.  The immediate prior chairman was Ben Bernanke, now perhaps our favorite target in his position as head of the Fed..  Previous chairs under Bush have also included the nutso supply sider R. Glenn Hubbard and — in the briefest tenure of all CEA chairs — Harvey Rosen.  Also chair, from 2003-2005, was Gregory Mankiw of Harvard, today’s idiot of the week.  Mankiw’s self-proclaimed largest influence was on the 2003 tax cut of the Bush administration, rammed through even after the 2001 tax cut failed to produce, and now credited with blowing the budget deficit into the stratosphere.

Here, from an appearance on Fresh Air with Terry Gross, we have Mankiw’s analysis, which might be characterized as running around in a circle piddling on oneself.

MANKIW

Nobody knows what to do, therefore perhaps we should do nothing, is apparently this message.  This kind of slippery verbiage reminds me of what Harry Truman said after a meeting with the first chair of the Council of Economic Advisers, Edwin Nourse.  “Give me a one-handed economist.”  On the one hand, on the other hand.

In order, there is little debate on whether a stimulus is needed except from those so long wedded to the economic theories that are now proving fallacious.  When he says, “in my book,” I would like to point out, he is talking about a part of a paragraph near the end.  Better to get Krugman’s book, where the subject is treated with proper attention.

MANKIW

Is there really debate on whether roads, bridges, schools, green energy, current state and local services, and so on pass a cost-benefit test when the cost is not only the loss of the opportunity for these goods and services, but the continued decline of the economy?

Public goods have large benefit-cost ratios as a result of the intrinsic nature of public goods.  Mankiw does not know this because it is not in his interest to know it.

But what are the alternatives?

MANKIW

So the alternatives, or tools, are what we’ve tried that hasn’t worked.  TARP as a stimulus tool and not as triage for a broken banking sector is an interesting twist.  We know Mankiw likes tax cuts in all weather.  Too bad the tax cuts of the first stimulus fell so flat.  Please, this great emphasis on government spending?  We haven’t done it yet.  Here you see a man defending academic turf, not good policy.

MANKIW

I hate this.  The problem with the revenue shortfall is not the tremendous supply side tax cuts that were supposed to but did not pay for themselves, it is the 70-year-old entitlement program of Social Security.  Let’s not mention that the dedicated payroll taxes …  Well, let’s not go there today.  Simply said, the aging of the population is not something that we have suddenly discovered.  Measures were taken in the 1980s to put Social Security on sound footing, where it is today if the government bonds in the trust funds are good.  Mankiw’s uncertainty babble is a smokescreen for advocating cutting Social Security as a way to pay for his tax cuts in the long term.

N. Gregory Mankiw.  Idiot of the Week.

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