demandside

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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