Republican myopia, another similarity with 1929
Posted in Uncategorized by demandside on February 8th, 2009 Monday’s Backcast goes to 1929 and 2008, and visits with Galbraith, Stiglitz, Krugman and Soros
02.09.09
Being Monday, this is the Monday Backcast
The Great Crash of 2008.
Prior to 2008, in the larger history of economics and finance, as John Kenneth Galbraith wrote in his Short History of Financial Euphoria, no year stands out as does 1929. Like 1066, 1776, 1914, 1945, it is richly evocative in the public memory. This is partly because the speculative excess of the 1920s ended that year and partly because the ensuing crisis was, in Galbraith’s words,
“the most extreme and enduring crisis that capitalism had ever experienced.”
“1929 is also remembered because there were then evident all the elements of the euphoric episode and especially the powerful commitment to presumed financial innovation. This last included, as ever, the rediscovered wonders of leverage … and the parade of publicly celebrated genius. … Then came the crash and the eventual discovery of the severe mental and moral deficiencies of those once thought endowed with genius and their consignment, at best, to oblivion, but more grimly, to public obloquy, jail, or suicide.
“The justification of the expansion was the political, social and economic order that was associated with the benign and, inevitably, Republican administration of Calvin Coolidge and his Treasury Secretary, Andrew W. Mellon. … Most of those who manage investment operations or who have sizable amounts of money to invest are, indeed, Republican in their politics. Naturally, perhaps inevitably, they believe in the politicians they support, the doctrines these profess, and the economic advantage flowing therefrom. It is especially for those seemingly so blessed to be persuaded of the new and approximately infinite opportunities for enrichment inherent in a Republican age under a Republican regime. So in 1929, “
and we add to Galbriath so before the crash of 2008.
This warning from Galbraith ought to be paired with another date. 1933. It was only in March 1933, more than three years after the crash, that the Republican administration was replaced. The administration of Franklin Roosevelt began, with as many fits and starts as that of the current Obama administration. But before it was done, and within the next three and a half decades, the New Deal of Franklin Roosevelt and the exploration of Keynesian economics established the framework of the modern economy.
In the current instance, although the financial disaster may be of greater magnitude in terms of breadth and depth, the New Deal HAS occurred and the social safety net of Social Security, Medicare, and Unemployment Insurance IS in place with its floor under demand. In 1932, joblessness meant an old age of humiliation and deprivation. Those unlucky enough to be without family were often without hope.
That said, we surely cannot afford to reinvent the wheel with regard to restructuring the financial sector, supporting the housing market with a Home Owners Loan Corporation style renegotiation of mortgages, and most of all with a strictly demand side stimulus package.
And I know we repeat ourselves when we say tax cuts, particularly business tax cuts, just do not provide the change in dynamics that increases in employment provide. The reductions in aid to states and municipalities and and reductions to direct spending on jobs from infrastructure, education, green energy, and so on that have been extracted by the Republicans are nothing less than a body blow to the economic recovery. This is no time for political posturing, but Republicans after eight years of profligacy are now rushing to resurrect their images as fiscal conservatives and are pandering at the same time with the old, failed tax cut on every day except February 29.
It is becoming gruesomely apparent that hard experience will again be needed to get people to abandon their self-interest for the interest of the society as a whole. We are not going to make it through this without working together. It’s either hang together or hang separately.
Now, in honor of Monday’s backcast, here is a clip from Demand Side one year ago. February 7, 2008. Then we’ll move into Stiglitz, Krugman and Soros, as much as possible in five minutes.
CLIP
From February 7, 2008, one year ago.
Here is a brief quote from an interview of Joseph Stiglitz by Deutche Welle
DW-WORLD: Many experts fear that while things are bad now, we haven’t seen the worst of the crisis yet. Do you share the belief that we are facing a long decline that could rival the great depression?
Joseph Stiglitz: We live in a very different world than during the Great Depression. Then, we had a manufacturing economy. Now we have a service-sector economy. Many people in the in the United States are already working part time because they can’t get full-time jobs. People are talking more about the ‘comprehensive’ measures of unemployment, and these show unemployment at very high levels, around 15 percent. So it clearly is a serious downturn.
Another big difference between now and the Great Depression is then we didn’t have a safety net. Now we have unemployment insurance.
Economists Nouriel Roubini and Nassim Taleb, who predicted the global economic downturn, have called for a nationalization of banks in order to stop the financial meltdown. Do you agree?
The fact of the matter is, the banks are in very bad shape. The U.S. government has poured in hundreds of billions of dollars to very little effect. It is very clear that the banks have failed. American citizens have become majority owners in a very large number of the major banks. But they have no control. Any system where there is a separation of ownership and control is a recipe for disaster.
Nationalization is the only answer. These banks are effectively bankrupt.
February 7, 2009, 5:36 pm
What the centrists have wrought
I’m still working on the numbers, but I’ve gotten a fair number of requests for comment on the Senate version of the stimulus.
The short answer: to appease the centrists, a plan that was already too small and too focused on ineffective tax cuts has been made significantly smaller, and even more focused on tax cuts.
According to the CBO’s estimates, we’re facing an output shortfall of almost 14% of GDP over the next two years, or around $2 trillion. Others, such as Goldman Sachs, are even more pessimistic. So the original $800 billion plan was too small, especially because a substantial share consisted of tax cuts that probably would have added little to demand. The plan should have been at least 50% larger.
Now the centrists have shaved off $86 billion in spending — much of it among the most effective and most needed parts of the plan. In particular, aid to state governments, which are in desperate straits, is both fast — because it prevents spending cuts rather than having to start up new projects — and effective, because it would in fact be spent; plus state and local governments are cutting back on essentials, so the social value of this spending would be high. But in the name of mighty centrism, $40 billion of that aid has been cut out.
My first cut says that the changes to the Senate bill will ensure that we have at least 600,000 fewer Americans employed over the next two years.
The real question now is whether Obama will be able to come back for more once it’s clear that the plan is way inadequate. My guess is no. This is really, really bad.
What all but 5 Republicans support
Paul Krugman
Thirty-six out of 41 Republican Senators voted for the proposed DeMint amendment to the stimulus bill — a massive package of permanent tax cuts that would create a huge hole in the budget, while doing very little to help the economy.
There isn’t much room for bipartisanship when 87.8% of the other party is totally irresponsible.
George Soros: The Crash of 2008
George Soros: Reflexivity as the New Paradigm
The mark-to-market problem: Michael Milken’s wisdom about market inefficiency
The best credit analyst who ever lived, the Einstein of forensic accounting and the Da Vinci of the deal, is of course Michael Milken, who in my view was unfairly scape-goated for the excesses of the high yield market of the 1980s. In 1997, his Milken Institute held a conference in Los Angeles at which Milken sat on a panel with a group of Nobel Prize winners, including Kenneth Arrow, Harry Markowitz, Eugene Fama and Gary Becker. In opposition to (most of) the economists, who argued that efficient markets knew how to price securities and that mark-to-market accounting would benefit the banking system, Milken made this observation: the whole US banking system would have been insolvent on a mark-to-market basis in 1981 and again in 1991. Banks always will be insolvent on a mark-to-market basis in deep recessions. Do we really want to liquidate the banks in every recession? Milken asked. Answer came there none from the Nobelists.
Why can’t markets see over the rise and mark securities according to their long-term value? Why should we rely on the wisdom of the marketplace? Let’s put the question practically: why was the multi-trillion-dollar universe of structured securities vastly overpriced before July 2007 and vastly underpriced by the middle of 2008? It was obvious to anyone with eyes that this was the case. …
Now you can’t get rid of the AAA’s at 35 cents on the dollar, and it is obvious that they are cheap. I have in front of me yet another hedge fund pitchbook showing that unlevered returns are available on mortgage-backed securities in the 20 percent range under extreme stress scenarios. The trouble is that the existing hedge funds already own hundreds of billions of dollars of these securities and don’t have the capital to keep holding them. Suspending redemptions only postpones the inevitable, and they will have to sell at cheap prices. My investment thesis is that the cheap securities will fall into the laps of the commercial banks, allowing them to maintain a zombie-existence with positive cash on cash returns, which is why I like bank preferreds at yields in the mid-teens or even 20s better than common.
Institutional behavior made these assets rich before 2007, and institutional behavior makes them cheap now.
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