demandside

Plus Richard Posner, Idiot of the Week, and more

4.29.09 News

The Chrysler bankruptcy was reportedly triggered by the unwillingness of hedge funds to make a deal.  We wonder, and in fact, suspect, that the unwillingness was stimulated by the derivatives of credit default swaps.  As we reported last week, insurance provided by CDS’s makes bondholders less willing to deal in potential bankruptcy, since they get paid in full.

The bank’s stress tests were described by David Goldman as “The stress test snooze”

April 24th, 2009, he wrote on his Inner workings blog Inner workings blog http://blog.atimes.net/?p=926 Banks were modestly higher after the Federal Reserve’s non-release of non-information of non-tests on — I almost wrote non-banks, but they actually are banks, more or less. What began as a tail-covering public relations stunt by Geithner turned into a potential embarrassment for the administration, which wants to show that it is being tough, pre-emptive and responsible, but doesn’t really want to do anything to make waves. Why should he? This post is brief because there is not much more to say about banks for the interim. They will range trade. The big action is over. Happy weekend.

Also on April 24, Floyd Norris wrote in the New York Times Subprime Loans, Corporate-Style, Will Fuel Defaults

Correction Appended

The loans went to borrowers who might never before have been allowed to borrow. When they found repayment difficult, they were permitted to refinance their loans, generating fees for the lenders and postponing the ultimate reckoning. Then the credit markets turned and both the borrowers and lenders were in deep trouble.

So it went with the subprime mortgage crisis. And so it is now going with corporate loans and bonds. It appears that defaults on leveraged loans and corporate bonds will soon rise to levels not seen since the Great Depression.

If that does happen, a wave of corporate bankruptcies will deal another blow to the American economy, and present the Obama administration with more painful decisions about possible bailouts — bailouts that could be made directly or indirectly by persuading bailed-out banks to make loans that might not seem wise to the bankers.

One reason for the rise in defaults is that this is a severe recession. But it is not the principal one.

Calculations by Moody’s Investors Service show that as of the beginning of April, a record 27 percent of speculative-grade debt issuers had a rating on their senior debt ranging from Caa down to C. These are the lowest rungs of credit quality — rungs that once rendered a borrower ineligible for a loan.

The default rate on leveraged loans and speculative grade bonds is rising rapidly. “We expect the default rate to get to the range of 14 percent by the end of the year,” said Kenneth Emery, a senior vice president of Moody’s. That compares to peak default rates of 10 to 12 percent during the last two recessions, in 1991 and 2001.

…

How did we get into this mess? The story is remarkably similar to the tale of subprime mortgages. Lenders who were making money by putting the loans into pools became more and more eager to make loans, and less and less concerned about their quality.

The way the loan securitization market developed, the most profitable loans to make were those rated B or even B-minus, levels of debt below the old standard for most junk bonds. There was a market for some Caa paper, even though such loans historically often landed in default.

Borrowers who ran into problems could refinance their debt, creating new rounds of fees for the banks making the loans and obscuring the problems with credit. And with the economy booming, there were not that many problems anyway.

The secret to all this was the collateralized loan obligation, or C.L.O. As with mortgage securities, the rating agency models figured that 70 percent of the money that went into financing single-B rated loans could be financed with AAA-rated paper.

As time went on, the big banks making the leveraged loans became more and more competitive, figuring the secret to profits was in making the loans and securitizing them — not necessarily getting them paid back. It was financial alchemy, but the AAA-rated paper was popular with buyers like banks and insurance companies, whose capital rules treated such securities as virtually risk-free. They wanted more such paper, and the big banks obliged.

“C.L.O.’s bought about two-thirds of corporate loans from 2004 to 2007,” said David Preston, a structured products analyst at Wachovia Securities. But there are now no new C.L.O.’s being created, and many of the old ones may soon be barred from reinvesting repayments in new loans — in part because so many existing loans are being downgraded by the rating agencies.It all sounds absurd now. But at the time, any bank that refused to lower standards on mortgage loans or on corporate loans risked plunging profits as all the business went to competitors. That might not have happened if regulators had been willing to step in, as some of them wanted to do. …

THE ARTICLE IS WORTH READING IN ITS ENTIRETY.  WE ABBREVIATE IT HERE FOR REASONS OF TIME.  BUT HERE ARE A COUPLE OF THE MORE INTERESTING PARAGRAPHS.

But Alan Greenspan, the chairman of the Federal Reserve when the credit party grew delirious, was the dominant regulator. He saw no need to interfere with markets. It might have been different if he had understood markets and the flaws that were leading to disaster. Instead, he worshipped markets.

Defaults are now rising because of the recession, but the news could get even worse. Unlike most mortgages, leveraged loans and junk bonds are not scheduled to be gradually paid off over the life of the loan. Instead, they come due and must be refinanced. Moody’s reports that leveraged companies need to refinance $26 billion in loans this year, $44 billion in 2010 and $120 billion in 2011. If credit markets remain tight, we could see lots of defaults even among companies that are doing well enough to make their interest payments.

…

And in California, Attorney General Jerry Brown

is making news ahead of his run for the Governor’s chair.

martin.zimmerman@

latimes.com

On the much-ballyhooed TALF program, Mark Thoma at Economist’s view reports,

The TALF program intended to increase auto loans, student loans, and credit card lending has a lot in common with the Geithner public private investment plan to remove toxic assets from bank balance sheets, including the valuable non-recourse loan feature. The fact that the TALF program is not living up to expectations - not even close - leads to questions about whether the Geithner plan will encounter similar problems.

Thoma cites a Washington Post article,

Federal Program to Boost Private Lending Struggles to Get Money to Consumers, by Neil Irwin,

In its first two months, the government’s signature initiative to support consumer lending has fallen well short of expectations, deploying only a fraction of the amount officials had hoped to extend to stimulate auto loans, student loans and credit card lending. …

Under [the Term Asset-Backed Securities Loan Facility, or] TALF, private investors … put up a relatively small amount of money to be matched with a larger loan from the Federal Reserve. The combined funds are then used to purchase newly created, highly rated securities, which in turn fund a wide range of consumer and business lending.

…

Officials envisioned TALF supporting tens of billions of dollars a month in new lending, saying it could eventually total $1 trillion. But in March, when it was launched, it backed only $4.7 billion in auto loans and credit cards. For April, it logged only $1.7 billion.

…

The Public-Private Investment Program, designed to buy loans and securities from banks, is structured similarly to TALF. …

Thoma says, ”

And the differences between the PPIP and TALF programs that I can think of, e.g. that the PPIP has toxic assets as part of the bargain, and some of the banks will need a bailout so the reassurances about executive pay, etc. can’t be made in these cases, are additional factors working against the PPIP’s success. Stimulus from the market

Demand side stimulus, Keynesian stimulus, traditionally is seen as deriving from government spending or tax cuts.  It is hard to find an economist or politician today who argues for no use of these.  Even the sacred tax cuts for the rich, established under the supply side prediction that they would lead to ever greater output, are now defended from the demand side.  That is, reversing these tax cuts will reduce much needed demand for products and services.

But demand side stimulus can come from the market as well, if the appropriate incentives are in place.

The supply side market stimulus is most often seen in state tax breaks to businesses to encourage them to site a factory or other facility in the neighborhood.  The theory goes that the new private facilities will produce jobs which will make the economy better.  But as Yogi Berra said, “In theory there is no difference between practice and theory.  In practice there is.”

All too often the new facilities undershoot their targets.  Some local businesses may be pleased, but rarely will it stop their complaining about the taxes which necessarily shift away from the newcomers and onto the current rate base.  And at bottom, studies have shown, there is a tendency for businesses to site according to more salient factors, then just game the local jurisdictions to cut their tax exposure.  More primary to business siting decisions, for example, are — one, two and three — market access, four, workforce availability, five transportation in and out, six educational facilities, and among the category of “also may be important” comes tax considerations.

And even here, the supply side stimulus is a zero sum game.  When one jurisdiction is chosen, the others are neglected.  If one community scores a Wal-Mart, businesses in all affected communities suffer.

But regardless of any of this, there are market-based measures that can stimulate from the demand side.

One is the forward commitment procurement process.  You may remember Dr. Jonathan Frost, featured repeatedly here on the podcast, advocating this technique.  Government simply commits to purchasing products in the future which meet the desired specifications.  Frost used the example of the British prison system’s procurement of a zero-waste mattress.

They described the attributes they wanted in a mattress.  In this case, not being flamable, usable as a weapon, and so on, and particularly including the attribute of producing no waste for the landfill.  The prospect was described by some as impossible.  Even if such a product could be produced, it would be prohibitively expensive.

In fact, they received over thirty responses to their proposal, and the one selected produced a mattress that actually — when disposal costs were included — was more economical than the previous version.

A more famous example cited by Frost is the mandate by the state of California for a halving of emissions from automobiles.  This was issued in the 1970s when the atmosphere of Southern California was nearly viscous with pollutants.  The premise was that autos could not be sold into the California market unless they met strict emission requirements.

Of course, the common response was that even if such a product could be produced, it would be prohibitively expensive.  The actual outcome, after billions in overwhelmingly private investment activity, was the catalytic converter and skies cleaner by far more than half.

The two salient features are the simplicity of the mandate — two paragraphs describing the product as to its emission effects — and the absence of government interference or micromanaging.  A great error of the ethanol debacle, for example, was to describe the technology, not the desired result.  Let the market do what it does best, innovate to the desired outcome

And here let us extend what is really a long digression.  One of Frost’s insights was the difference between R&D and innovation.  Research and development is always successful, he says, because you always discover something you didn’t know.  It is essentially an intense study.  Innovation is extremely difficult and often not successful.  You begin with an idea of the desired result and the process of innovation is essentially a creation of a path from here to there.

It is difficult, expensive, and as said often not successful.  The only reason to do it, Frost says, is because there is no other option.  That is the situation we have with global climate change.  There is no option other than solving the energy and transportation carbon problem.

End of digression.

The point we began with was that by mandating an emission level in order for automobiles to be sold into the California market, that state generated tens of billions of dollars in private investment and economic activity.  The same sort of opportunity could generate multiples of that number without a dime of public spending.

For example, if the national government mandated zero emission vehicles within ten years, and the mandate were credible, we would be looking at a complete turnover of the automobile fleet in addition to the investment in technology up front.  New plants, facilities, et cetera.  This is economic activity.  This is stimulus that produces jobs.

Would it be economically efficient?  Unless you believe that the destruction of the planet’s climate is economically efficient, the answer has to be yes.

And it overcomes a basic dynamic of depression, the collapsing consumption function.  We’ll go into this more deeply in another podcast, but the basic idea is that people are hoarding and cutting back spending in the face of economic uncertainty.  This restriction of spending is exacerbating the downturn.  Also discouraging spending from the monetary side is the collapse of credit markets, including pullbacks in credit cards, and you have a downward vector greater by perhaps a factor of three than the sum of the upward vectors of the stimulus and the various ad hoc measures being cobbled together by the Fed and Treasury.

Of course, a ten-year turnover over of the auto fleet is not realistic.  A workable plan would involve the mandate — the carrot of being able to sell cars — and penalties for gas guzzlers.  But this is another point on which Frost and I agree.  Taxes cap-and-trade schemes are not sufficient.  They will lead simply to expensive use of the same technologies.  The mandate, the necessity to innovate, is essential.

That said, you would generate a lot of investment and a substantial turnover of the fleet by higher carbon taxes.  Simply higher oil taxes.  The runup in oil prices between October 2007 and July 2008 brought to the fore a new generation of energy options and sold a lot of Toyota Priuses.  The retreat in oil prices carried many of these survival options out with them.

In this case, you generate new economic activity by making the status quo too expensive.

So those are market-based stimulus techniques that are economically efficient.

These could be combined with publicly sponsored stimulus in the form of infrastructure spending to create real progress, both in the short-term economic situation and in long-term security and stability.  Notice the publicly sponsored stimulus overcomes the problem of a declining consumption function by taxation.  This is forced consumption of public goods.  It is stimulative, but not necessarily a cut in taxes.

04.29.09 Forecast

Mark Thoma is coming close to the captured regulator position with regard to the Fed’s handling of the financial crisis.

http://economistsview.typepad.com/economistsview/2009/04/using-antitrust-law-to-break-up-banks-that-are-too-big-to-fail.html

http://economistsview.typepad.com/economistsview/2009/04/the-professionals-are-not-being-held-accountable.html

In a couple of posts linked on the web site, including his post entitled “The Professionals are not being Held Accountable” on Economist’s View, Thoma addresses this point.  In one he cites Michael Pomerleano

http://blogs.ft.com/economistsforum/2009/04/the-crisis-holding-the-professionals-to-account/

Viral V. Acharya and Rangarajan Sundaram.  The latter two point out: “The US recapitalization scheme … is … generous to the banks in that it imposes little direct discipline in the form of replacement of top management or curbs on executive pay, and secures no voting rights for the government“.

We seem to forget one of the successful lessons from the late 1980s savings and loan crisis in structuring positive and negative incentives: holding accountable the directors and officers, lawyers, accountants of the banks, investment banks and the rating agencies. … The Office of Thrift Supervision, which regulates the US’s thrifts, and its sister agency, the Resolution Trust Corp which was in charge of disposing of the assets of failed S&Ls, embarked on a deliberate deterrence strategy targeting lawyers, accountants, directors and officers of failed thrifts that aided and abetted the excesses leading to the S&L crisis. The intent was to discourage future abuses and recover some of the lost taxpayer funds. …

In the US, we are told that there are no culprits in the crisis. The attitude of the policy makers, regulators, bankers and traders involved in the crisis is virtually fatalistic, treating the crisis as an inevitable “force majeure”.

(Demand Side point:  According to Wikipedia, force majeure, literally superior force, refers often to a common clause in contracts which essentially frees both parties from liability or obligation when an extraordinary event or circumstance beyond the control of the parties, such as a war, strike, riot, crime, or an event described by the legal term “act of God” (e.g., flooding, earthquake, volcano), prevents one or both parties from fulfilling their obligations under the contract. However, force majeure is not intended to excuse negligence or other malfeasance of a party, as where non-performance is caused by the usual and natural consequences of external forces (e.g., predicted rain stops an outdoor event), or where the intervening circumstances are specifically contemplated.

Returning to Thoma, Pomerleano, Acharya and Sundaram.

All of them were observers and “no one saw it coming”. In short, the crisis is a Lemony Snicket’s “Series of Unfortunate Events”.

In reality the regulators that should have kept a close eye on the rapid growth of the shadow banking system were complacent, and the boards did not have the background in the industry and didn’t understand the risks. It is clear that the policy makers and regulators lack the moral authority to lead us out of the crisis. …

The US Treasury plans to rely on the same firms and people that were involved in leading to the crisis to get us out of it. … Clearly, nothing learned, nothing gained from the S&L crisis or the Swedish experience. Maybe this will change.

Saying it’s not your fault you crashed the ship into the rock because the rock was underwater and hidden - nobody could have seen it coming - loses its force when you are navigating in waters that are known to be rocky. Even if you have the latest sonar based upon fancy, innovative math that is supposed to detect the rock before you hit it, and even if regulators were supposed to clearly map and mark all danger, if you hit it anyway, there’s a reason why captains are expected to go down with - or at best be the last ones off - the ship. It ensures they’ll do all they can to avoid hitting it in the first place.

Unquote

This is getting very close to the Demand Side position that the Fed and other financial regulators are no different than examples throughout government where oversight bodies have become captives to the industries they are supposed to regulate.  The Fed’s continued insistence on rescuing the financial institutions rather than stabilizing the banking functions in new, smaller, credible institutions is the ultimate proof.

 Standard Podcasts: Play Now | Play in Popup | Download | Hits (270)

We’re baaaack, with Joseph Stiglitz, Brad DeLong, Idiot of the Week, and more

The Story:  Demand Side, the podcast, fell victim to the logistics of life over the past two weeks.  Lost in the shifting dimensions of job, home, and love lie two podcasts which we will attempt to recover over the next weeks, even as we continue forward.

One early recovery is the Idiot of the Week segment for the first week of april, the period that included the G-20 meeting in London.  We will present that today.

The History Note this week is staffed by the eminent Berkeley economist and historian Brad DeLong.

Joseph Stiglitz provides a most concise and useful characterization of the Geithner plan to deal with toxic assets.

In view of the continued inability to face economic reality with regard to the financial sector, we are revising our forecast, though not significantly.  We extend the horizon for unemployment recovery a bit.

And in all we take our typical potshots at the economics that has failed our society so well.   The well-heeled spnsors Supply Side and Market Fundamentalism now prefer Corporate Welfare-ism.  They gouged the society on both ends, with inefficiency when times were good and bailouts when their get-rich schemes collapsed.

More concerning to us are the academic hacks who practice intellectual dishonesty by pretending this experience does not disprove their failed notions.  The proofs of market efficiency become ever more fanciful, and require ever more absurd leaps of logic and faith.  All this to salvage a year or two on academic careers built on sand, and all to the detriment of clear navigation of the economy for the rest of us.

WE ALSO ADMIT OUR NEW AND IMPROVED DEMAND SIDE BLOG AT DEMANDSIDEBLOG DOT BLOGSPOT DOT COM HAS SUFFERED NEGLECT OVER THE FIRST PART OF THE MONTH.  WE EXPECT THIS AND THE THE FORTHCOMING BOOK A PUNDIT’S GUIDE TO DEMAND SIDE ECONOMICS TO BE BACK ON TRACK BY THE FIRST OF MAY.

First, the news.

This flash from Ben Bernanke last week:

“Something went wrong”

by way of Bloomberg and Mark Thoma’s Economist’s View Blog:

Federal Reserve Chairman Ben S. Bernanke said the collapse of U.S. lending will probably cause “long-lasting” damage to home prices, household wealth and borrowers’ credit scores.

“One would be forgiven for concluding that the assumed benefits of financial innovation are not all they were cracked up to be,” the Fed chairman said… “The damage from this turn in the credit cycle — in terms of lost wealth, lost homes, and blemished credit histories — is likely to be long-lasting.” …

“Something went wrong,” Bernanke said. “We have come almost full circle with credit availability increasingly restricted for low- and moderate-income borrowers.” …

Bernanke ought to have been content, but wasn’t, and continued

“Regulation should not prevent innovation, rather it should ensure that innovations are sufficiently transparent and understandable to allow consumer choice to drive good market outcomes,” … “We should be wary of complexity whose principal effect is to make the product or service more difficult to understand by its intended audience.”

Innovation in financial instruments is proven to be inefficient and dangerous.  The products and services of the real economy is where innovation ought to be concentrated.  Bernanke is so far behind the curve he is still heading north while the economy is heading south.

Joseph Stiglitz, like Ulysses, Nouriel Roubini, Dean Baker, and others has apparently been named “Nobody.”  As in Nobody saw the collapse coming.  “Nobody” predicted what is happening now. And so on.  Perhaps even, “Nobody” has the answer.  In any event, this capsule of the Geithner plan from Bloomberg is from one of the lost episodes.  It is clear, concise and accurate.

STIGLITZ

Joseph Stiglitz.  This is elementary.  Attempts to finesse and end-run the reality are doomed to die in the Siberia of policy error.  Only when we face facts will we get the financial sector fixed.

Let’s append here a note from Salon Dot Com’s Andrew Leonard published last week.

As if credit default swaps needed any more bad press! The Financial Times’ Henny Sender reports today that credit default swaps may have left two big-name companies with no other option than to declare bankruptcy this week, instead of concluding out-of-court restructuring deals with their debt holders.

Here’s how it works: A lender buys the bonds of a company — let’s say General Growth, the huge mall operator that declared bankruptcy this week. But then, hoping to hedge against the risk that General Growth might default on its bond obligations, the lender purchases a credit default swap protecting against that event from another party, in effect buying insurance against the chance that those bonds will go bust.

But the kicker is that owning a credit default swap on General Growth bonds turns out to make the lender less willing to cut a deal that would allow General Growth to avoid bankruptcy, because the lender can get paid in full in the event of that bankruptcy by collecting on the insurance policy. So it’s better for the lender to force the company to its knees rather than come to a less disastrous arrangement.

“We have seen CDS becoming a significant factor” when negotiations on out-of-court restructurings fail, said Alan Kornberg, the partner in charge of the bankruptcy practice at Paul, Weiss, Rifkind, Wharton & Rice, speaking generally. “We used to talk about the practice theoretically but now we see cases where it is hard to get lenders to agree to tender or to compromise and then you find out that these holdouts had significant CDS protection.”

Warren Buffet was never so right as when he called derivatives “weapons of mass destruction.” No matter which direction you point them, someone gets blown up.

That’s Andrew Leonard in Salon dot Com from Friday, April 17.

And on the Tax Tea Parties a week ago.  As Republican Bruce Bartlett says, tax protesters “are not entitled to be taken seriously”

Such belly-aching about taxes entitles these people to a one-way ticket to Somalia.  AS IF taxes were the cause of any of the economic problems today.  A clear breakdown in the Market First ideology of these nuts is at the root of the greatest crisis in the last seventy years.  Yet they blame taxes.

Government may have contributed, but it was the incompetent and corrupt government of George W. Bush and his non-oversight of everything environmental and economic that have put us in the place we are today.

To take the Tea Partiers on their own, if immaterial point, Bartlet says:

Last week, I presented data comparing taxation in the United States to other major countries and concluded that Americans are not especially overtaxed. … But what if we compare U.S. taxes today to those in the past? Are Americans more heavily taxed than those in earlier years, and do polls show greater dissatisfaction with taxes today? … [I]t is hard to find evidence that taxes are rising or unusually high. …

In response to these facts, some critics say that it is not today’s taxes that concern them, but those that will have to be paid in coming years as a result of the large spending and deficits being projected. …

I have problems with this argument as a justification for the sudden appearance of tea parties to protest taxes. First, many protesters implicitly assume that that the deficit has increased solely as a result of Barack Obama’s policies. But in fact, the Congressional Budget Office was projecting a deficit of more than $1 trillion this year back in January…

It’s true that projected deficits have gotten larger since January. But much of this resulted from deteriorating economic conditions that would have occurred even if John McCain were president.

…

I strongly suspect that many of those that loudly denounced the Obama stimulus package for its impact on the deficit would have cheered the McCain stimulus package even though it would have increased the deficit by about the same amount.

Proof of this proposition is that there were no tea parties during the years when George W. Bush was turning the surpluses of the Clinton years into massive deficits. … Those protesting this week were only protesting because it is a Democrat who has increased the deficit. When a Republican did worse, it’s like Emily Litella used to say, “Never mind.”

…

People should remember that while they have the right to their opinion, they are not entitled to be taken seriously. That only comes from having credibility gained by the correct presentation of facts and analysis and a willingness to be even-handed–criticizing one’s own side when it is wrong and not only speaking up when the other party does the same thing.

Robert Reich is also tired of hearing complaints about taxes:

In his “A Short Citizen’s Guide to Kooks, Demagogues, and Right-Wingers On Tax Day,” Reich says No one likes to pay taxes, so tax day typically attracts a range of right-wing Republicans, kooks, and demagogues,

…

1. “Americans pay too much in taxes.” Wrong: The United States has the lowest taxes of all developed nations.

2. “The rich pay too much! The top ten percent of income earners pay over 72 percent of all income taxes!” Misleading: The main reason the rich pay such a large percent is they’ve become so much richer … in recent years. If you look at what they pay as individuals … you’ll see a steady decline over the years. …

3. “The bottom 60 percent pay only 3.3 percent of the taxes!” Misleading again. Most Americans are paying more in sales taxes than they ever have. Property taxes have also been rising at a steady clip. And Social Security taxes have also risen

Diverging from Reich here, you can find the tax burden if it were to include all taxes would be relatively flat.  I have the chart and will put it up on the blog when we find it.  When tax-o-phobics get to cherry pick the data, of course, they select the federal income tax and ignore everything else.

Taxes are the means of financing public goods.  Nothing more.  If you want roads, you pay taxes.  If you want schools, you pay taxes.  You cannot buy public goods with a credit card.  Public goods are the best deal going.

Back to Reich’s guide.

4. “Obama is raising your taxes!” Wrong. Obama is cutting taxes for 95 percent of Americans, by about $400 per person a year… Only the top 2 percent will have a tax increase, but even this tax increase is modest. Basically, they go back to the rates they were paying under Bill Clinton… And they won’t start paying this until 2011 anyway.

5. “The huge debts we’re racking up will cause your taxes to rise!” Wrong again. When it comes to the national debt, as I’ve said before, the relevant statistic is the ratio of debt to the gross domestic product.

…

6. “We have a patriotic duty to stand up against Washington taxes!” Just the opposite. We have a patriotic duty to pay taxes. …

An acquaintance from law school, now a partner in one of Washington’s biggest and wealthiest law firms, explained to me one day over lunch how he and his partners use tax rules to create offsetting taxable gains and losses, and then allocate the gains to the firm’s foreign partners who don’t pay taxes in the United States. That way, they keep the losses here and shelter their income abroad. I noticed he had an American flag lapel pin. “You’re supporting our troops,” I said, referring to his pin. “Yup,” he replied, entirely missing my point.

True patriotism isn’t cheap. It’s about taking on a fair share of the burden of keeping America going.

Robert Reich

Okay, more than enough news

It’s time for

Idiot of the Week

This from the lost podcast of the first week of April.

It is a most curious curiousity that economists want to talk politics and politicians want to talk economics.  But curiouser is that politicians are doing better than economists.

As we’ve noted, a majority of economists think the earth is made of green cheese and the sun rises in the west.  And all agree that politicians have made a hash of the rescue of the economy.  Most all fail to note that the crisis was and is a function of free markets gone feral.

Once New Deal strictures tamed a rogue private banking sector.  Not long after those strictures were relaxed the excesses returned, cybernetically engineered into more complex and global and lethal strains.

Unfortunately this leaves the mainstream of economists — who have risen in promence in proportion to their willingness to adhere to a free market orthodoxy while ignoring the corporate oligarchy around them with nothing to talk about.  Or as in today’s idiot, with less than nothing to talk about.

We lead off with Gordon Brown, describing the nut of the problem.

Doofus Magee, AKA Arvin Subriamanian follows with a weak nonresponse.  The interviewer is Warren Olney of To the Point.

IDIOTS

Protectionism is the least of our worries.  Trade has collapsed with the exporting nations not from any protectionist measures, but because demand has collapsed.  The radical preference for free trade, of course, ignores the environmental impacts of transportation and other elements, but here the point is that the issue is raised to the level of significance when it is not significant.

To say that the Doha Round is an avenue to further trade liberalization is to ignore the evidence for the last round.  A free trade agreement can be written in a dozen pages.  It is the managed trade for the benefit of the powerful that takes the thousands of pages commonly found in the WTO agreeements.

And at the beginning, following Gordon Brown’s address of the problems of hot money, you see the complete inadequacy of these yokels when it comes to dealing with issues for which they have no sponsors in the corporate community.

So.  Arvin Subriamanian and Wolfgang Moonchow.  Idiots of the Week.

Now the History Note with Brad DeLong

Questioned by Tom Keene on Bloomberg on the Economy about whether there has ever been a situtation of plus ten percent unemployment with the overlay of financial crisis, DeLong replies.

DELONG

Brad DeLong.  One of the phony issues of the American Enterprise Right Wing is the supposed failure of the Roosevelt response to the Great Depression.  Because this response is so informative to today’s situation, the Right must mask and distort the history in order to mask and distort the appropriate policy.

One prominent contribution to this effort is Amity Schlaes’ book The Forgotten Man.  This is a book which could not have been written while those who had direct experience of the actual events were still alive.  Serious consideration of the absurd and intellectually dishonest propositions of the book depends on a certain level of ignorance.  The book has been embraced by advocates of market efficiency as a means of bolstering their own failing constructions.

Now and finally, the forecast.  We are pushing out two quarters our projection for the recovery of employment to take account of the ineffectual policy response to the financial sector meltdown.  Harking back to the beginning of today’s podcast and Joseph Stiglitz, until the losses incurred by the financial cowboys are directly addressed and assigned, a vigorous recovery cannot begin.  The current response is another attempt to finesse the problem, and it has to fail.

We were perhaps alone among forecasters to project employment leading the recovery rather than lagging it.  Now we’ve changed that call.  The bad news, we believe, WILL stimulate the correct policy response and that response will precipitate the recovery, just not as soon as we originally believed.  We need to be clear.  It will take further policy action to generate recovery.  It is not baked in.  We remain confident that the Obama administration is equipped to recognize the situation in real time and take those policy actions.

 Standard Podcasts: Play Now | Play in Popup | Download | Hits (274)

Plus News and James K. Galbraith on the Geithner Plan Today Idiot of the week and the history note are combined on the subject of the commodities bust of 2008.  And we let James K. Galbraith speak to the point regarding the Geithner plan.

But first the News.

IDIOT

Idiot of the Week and the commodities bubble.

Perhaps the greatest story never told is that of the commodities bubble and bust of 2007-08.  Not to say nobody noticed the tripling of oil prices and the abrupt collapse in July 2008.  Many people noticed, but it was treated like a summer storm, violent and in some places devastating, but entirely natural and now it’s over.  In fact, it was a financial bubble exactly on the order of the dot.com boom and the housing boom, only shorter and sharper.  AND MORE GLOBAL.  Commodities producers around the world are still reeling

But let’s jump right in.  Here is — from Inside Business with Jeff Colvin, managing editor of Fortune Magazine.  This episode is dated July 28, 2008, three weeks after the peak of oil prices and the Demand Side call that the bubble had burst.

COLVIN

Now here is Steven Hanke of Cato from a more recent interview on Bloomberg, peddling the preposterous claim that it was the relative strength of the dollar that drove oil and commodity prices.  These Monetarists are like cultists who see magical properties in the currency.  It’s a medium of exchange, for God’s sake.  The only thing supernatural about it is your fetish and the fever of adherence to theories that repeatedly do not work.

Currency and commodities prices are, of course, related.  But the causal arrow runs in the opposite direction to Hanke’s claims here.  You need the local currency to buy commodities, so the dollar trades down when the price of commodities goes up.  The reverse happens when you don’t need so much of the local currency.

This guy is an example of the economics that does not work that is marbled through the Fed and the capitalism that is failing.

HANKE

So, there you have it, a two-fer.  Jeff Colvin and Steve Hanke.  Idiots of the Week!

But to continue with the history note, here are a couple of voices speaking on the same subject.  First Fed-Ex Founder and CEO Fred Smith, certainly not my favorite person, but here:

SMITH

Smith puts his finger on the tremendous shock to the consumer that the boom in commodity prices was.  Note the shock was much greater because at the time it did not look like commodity prices were ever going to fall.  This uncertainty caused a great deal of stress.

Now to somebody who does know what he is talking about, from a fundamentals point of view.

SCHORK

That is Stephen Schork, president of the Schork Group.  Also concerned, like Colvin of Fortune, with what doesn’t make sense.

Now to save our voice without sacrificing utility, we reproduce some comments from James K. Galbraith to Democracy Now! earlier in the week.

GALBRAITH:

Transcript from Democracy Now! follows:

JAMES GALBRAITH: … The difficulty I have with that is that I think that plan is based upon an excessively optimistic assessment of the prospects for those assets.

And what Secretary Geithner said yesterday, that these assets were issued to consumers that in many cases did not understand what they were getting into and that they were magnets for fraud, both of those remarks are absolutely true. But once one, I think, takes that into account, effectively, you realize that the prospects for capital losses on those assets are really very, very high, the recovery rates are likely to be quite poor, and that we’ve already seen that with banks that the FDIC has taken over, specifically with IndyMac in California.

And so, that suggests to me that this is a—this plan would have the effect of transferring the losses to the taxpayers without exacting any serious consequences for the banks that essentially created the fiasco. And since the financial system has to shrink one way or another, if you protect the largest banks, as I think the Treasury plan does, then the consequences will fall on other financial institutions, which are relatively well managed and which did not take part in the—to the same degree in the subprime debacle. And those would tend to be smaller banks. And I think it’s really—it’s likely to be—promote an unmanageable banking structure, if we go that route.

And secondly, it’s not going to solve the problem which everybody would like to see solved, which is the complete breakdown of the credit system. It’s not going to bring the economy back to life by the vehicle of new bank spending.

…

We hear this expression that credit flows are blocked and that there is a need to get credit flowing again. And it really is—it’s a metaphor. And I think it’s a revealing metaphor, if it in fact reflects the way in which high officials of the government are thinking about the problem. The idea of a flow, of course, is something that comes from on high and goes down below. A blockage is a kind of plumbing problem.

The difficulty is credit isn’t like that. Credit is a bilateral contract. It’s a relationship between a lender and a borrower. And the problem is not that the lenders don’t have money to lend. The problem is, in very large part, that there are no prospects or very few prospects for profit in the economy, and therefore, borrowers, business borrowers aren’t coming in to ask for loans for economic expansion. And secondly, on the residential and household side, households are strapped. They’re desperate to hang onto the cash that they have. They’re trying to pay down their debts, not to get into new debts. For that reason, they’ve stopped buying cars and stopped buying houses for the time being. And then, even if they did want to come in, in many cases, they don’t have the collateral that they had last year or the year before, because the value of their houses has fallen. So those are the problems of the underlying economy, the consequences, to be sure, of the collapse of the housing—of the subprime housing bubble.

But they’re not problems that can be solved by simply adding new reserves, new capital, to the banks. And, in fact, we’ve seen that the banks are flush with cash. They’re largely sitting on it. And to the extent that they’re not sitting on it, they may be using it for things like acquisitions, acquisitions of other banks, for instance. So the effect of the program is actually to expand the market share and the market power of the largest institutions. And again, to me, that is deeply problematic, because we’ve got banking institutions that are so large at this point, they’re so complicated, so opaque, so deeply involved in offshore tax havens, shell corporations and complicated derivatives, that they can’t be managed, let alone regulated.

The top executive officers didn’t know, to a very large extent, or at least by their own testimony, they didn’t know, the risk exposure of their own institutions. And they made catastrophic mistakes on the scale of tens and scores of billions of dollars, because they didn’t have effective internal controls. And if you don’t have the internal controls, there’s just no way that an outside regulator can get a grip on the systemic risk that the institution may be causing. So my view is, if you want to have a system that has appropriate checks and balances, the institutions in that system have to be of a scale such that the regulators, which Secretary Geithner properly said yesterday must be strengthened, but they also have to have the basic capacity to deal with the institutions that they’re regulating.

…

It is not the case that the securitization of subprime mortgages is a long-term phenomenon. It is something which has been a practice, prevalent practice, for about eight years at the maximum. Before that, the markets would not have contemplated the massive securitization of loans which are subprime.

What does the subprime mean? Subprime means loans that do not meet the standards for a normal mortgage loan that could be taken up by the secondary markets, by Fannie Mae and Freddie Mac. And so, those loans are characteristically loans that don’t have documentation, that don’t have proper credit histories on the borrowers, and where the appraisals seem a little funny. And in the case of the subprime loans in the middle of the decade, there was systematic fraud in the appraisals, systematic overstatement of what the houses were worth, because the bigger the loan that you gave, the bigger fee you could book. And so, these are markets that should never—historically didn’t exist and should not have been allowed to develop. They’re intrinsically unsafe. And so, from that point of view, Paul, of course, is exactly right, that the—trying to restore these markets, trying to go back to the normal of two years ago, is really trying to go back to a situation that is historically abnormal and intrinsically unstable.

And in some ways, you can say what the Treasury plan actually is is a way of creating a new derivative, a new bond, if you like, which the Treasury has half the capital and provides 85 percent of the value of the purchase in the form of a low-interest, non-recourse loan that’s designed to make the purchase of these so-called assets from the banks a highly profitable proposition for hedge funds and private equity investors and others who are in a position to risk their capital without having to face fiduciary consequences.

And so, you know, it’s something which—I suppose there may be investors out there who think that they could make money off of this, but I’ll tell you who it would be particularly attractive to, if they could get away with it, and that is the banks themselves or people acting on their behalf, because what it would mean is that, in effect, the banks can transfer—someone acting on behalf of a bank could arrange for the transfer of a dollar’s worth of these bad securities at face value for seven-and-a-half cents of risk. And that means that you’re really, in effect, creating a conduit, which would just take these losses off of the books of the banks, put them on the books of the Federal Deposit Insurance Corporation. And I would say that would solve the problem for the banks, but it wouldn’t solve the problem for anybody else.

James Galbraith, courtesy of Democracy Now!

 Standard Podcasts: Play Now | Play in Popup | Download | Hits (331)