demandside

When the ethical element is missing, can collapse be far behind?

After some news, we look the collapsed premise of Ayn Rand’s novel Atlas Shrugged.  It now appears that rather than lifting anything the Atlases are rolling their load ahead of them and over the rest of us.  We wonder why we don’t tax them instead of giving them a free ride.

We then touch on some research on how altruism survives in a world of selfishness, and we finish up with some Jeffrey Sachs offering perspective.  This copy is from a couple of months ago.  Let’s see how it has held up.

First the news.

Fed Minutes:

http://www.federalreserve.gov/newsevents/press/monetary/fomcminutes20090429.pdf

I always forward to those Fed minutes that reveal the forecasts of the FOMC members.  This was an innovation Ben Bernanke installed after he became chair and before the stuff hit the fan.  It has given me hours of enjoyment by displaying just how at sea these nabobs of the central bank, arguably the most powerful economists in the country, are.  It was meant to be a way of delivering an implicit inflation target to the markets.  So far, the predictions are following the data rather than the other way around.

Again this time the forecasts from April have virtually all migrated out from under the dotted lines of the January forecasts on GDP and unemployment and inflation for virtually all time horizons except the most remote.  There is no tracking of the actual versus the predicted path of the economy.  Transparency is not a hallmark of the Fed.

Mark Thoma, Economist’s view http://economistsview.typepad.com/economistsview/2009/05/geithner-interview.html

Geithner Dismisses GOP Socialism Charge as ‘Ridiculous’, Federal Eye: Washington Post http://voices.washingtonpost.com/federal-eye/2009/05/geithner.html

Treasury Secretary Timothy Geithner admits private investors are worried about investing in new government-backed commercial mortgage securities and dismisses as “ridiculous” a recent Republican National Committee resolution stating that Democratic policies bordered on socialism. …

Update: Calculated Risk comments on Geithner’s remarks: http://www.calculatedriskblog.com/2009/05/geithner-fails-to-correctly-describe.html

Although there were many factors in the housing and credit bubble, the two keys were: 1) rapid innovation in the mortgage industry (securitization, automated underwriting, rapidly expanded wholesale lending, etc), and 2) a complete lack of oversight by regulators. … Geithner failed to mention the rapid changes in lending and the failure of government oversight as the two critical causes of the bubble. Either Geithner misspoke or he still doesn’t understand what happened - and that is deeply troubling.

Denounced for decades as a millstone preventing growth and competitiveness, particularly by free-market advocates in the United States, the French government’s dominant role in economic activity has suddenly found new favor at home and grudging respect abroad.

The crisis has landed hard in France, just as it has elsewhere. European Union specialists estimated last week that the number of unemployed is likely to rise to more than 3 million by next year as factories close. But the French economy is expected to shrink by just 3 percent, markedly less than in Britain or Italy, largely because of the country’s traditionally high level of government spending, they added. From the Wall Street Journal also via Calculated Risk: http://www.calculatedriskblog.com/2009/05/banks-lobby-to-game-ppip.html

… Banking trade groups are lobbying the Federal Deposit Insurance Corp. for permission to bid on the same assets that the banks would put up for sale as part of the government’s Public Private Investment Program. … The lobbying push is aimed at the Legacy Loans Program, which will use about half of the government’s overall PPIP infusion to facilitate the sale of whole loans such as residential and commercial mortgages.

Federal officials haven’t specified whether banks will be allowed to both buy and sell loans …

Some critics see the proposal as an example of banks trying to profit through financial engineering at taxpayer expense, because the government would subsidize the asset purchases. … “The notion of banks doing this is incongruent with the original purpose of the PPIP and wrought with major conflicts,” said Thomas Priore, president of ICP Capital, a New York fixed-income investment firm overseeing about $16 billion in assets.

Hopefully the answer will be a resounding “NO”. The purpose of PPIP is to remove the toxic legacy assets from the bank’s balance sheet, not to allow the banks to game the program at taxpayer expense.

Either a buyer or a seller be - but not both, says Calculated Risk.  We agree.

…

The premise of the Ayne Rand fantasy novel Atlas Shrugged is that certain members of society are far more productive than others and so are underpaid for their services.  If they went on strike, all would suffer.

from enotes http://www.enotes.com/atlas-shrugged

the mysterious John Galt begins a revolution against the existing order, believing that the parasitic society would destroy itself if its competent and hardworking members would simply stop working. But first, the protagonists must learn how to let go of the ties of obligation, responsibility, and guilt connecting them to the abusive community in all aspects of their lives.

the political and industrial parasites support each other and live off of the creative and productive “giants” who remain and must support them on their shoulders. The apathy of the people is summed up in a new slang expression, “Who is John Galt?” which conveys hopelessness, fear, and a sense of futility, as well as everything unachievable and imagined.

from Wikipedia http://en.wikipedia.org/wiki/Atlas_Shrugged

Rand stated that the idea for Atlas Shrugged came to her after a 1943 telephone conversation with a friend who asserted that Rand owed it to her readers to write a nonfiction book about her philosophy. Rand replied, “What if I went on strike? What if all the creative minds of the world went on strike?”

Rand then set out to create a work of fiction that explored the role of the mind in man’s life and the morality of rational self-interest, by exploring the consequences when the “men of the mind” go on strike, refusing to allow their inventions, art, business leadership, scientific research, or new ideas to be taken from them by the government or by the rest of the world. Leonard Peikoff noted that “Atlas Shrugged did not become the novel’s title until Rand’s husband Frank O’Connor made the suggestion in 1956.” The working title throughout her writing was The Strike.

According to Barbara Branden, the change was made for dramatic reasons––Rand believed that titling the novel “The Strike” would have revealed the mystery element of the novel prematurely.

…

In the final section of the novel, Taggart discovers the truth about John Galt, who is leading an organized “strike” against those who use the force of law and moral guilt to confiscate the accomplishments of society’s productive members. With the collapse of the nation and its rapacious government all but certain, Galt emerges to reconstruct a society that will celebrate individual achievement and enlightened self-interest, delivering a long speech (fifty-six pages in one paperback edition) serving to explain the novel’s theme and Rand’s philosophy of Objectivism, in the book’s longest single chapter.

Anyone with a sense of reality can get through only about three pages of this nonsense.  The society of collapse it begins with bears resemblance to nothing so much as the Great Depression, caused by unbridled free markets.

Rand was unfortunate in her choice of steel and railroads as industrial vehicles for her heroes.  Steel rose on the back of the War.  Railroads on the back of a gargantuan land give-away.  Neither rose from its own.

It is the fact that the benefits of the society flow to the powerful.  The barons of industry collect income far beyond their contribution.  Of course, these folks bear no resemblance to the Atlases of Rand’s imagination.  They are organization men who control corporations titularly owned by stockholders, but run primarily for the benefit of their executive teams.

It is no accident that the dicta of Rand when allowed to work into the society, say through the auspices of disciple Alan Greenspan or through the Reagan Revolution, have resulted not in prosperity, but in collapse.  Those who have end run the law and ignored moral imperatives have simultaneously run the society over the cliff.

Mighty scarce these days are advocates of the free market who ascribe no role for the government today.  Much more common are those who say we must rescue the prodigal financial institutions from the enormous mess they made so they can again operate in their former styles.  We have transitioned into an unsteady corporate welfarism, which allows the private sector the profits and assigns the losses to the public sector.

How are we going to pay for this mess?  This is often the segue into how irresponsible the government is to run deficits.  Today I would like you to consider how can we asssign the costs to those who incurred them.

I would like to suggest we tax the wealthy.  It is no stretch to say that those who retain wealth today are those who benefitted from the out-of-control market fundamentalism and financial sector excesses of the past decade.  By taxing the wealthy we will be taxing the beneficiaries, if not the culprits, of this massive error.

The Atlases of the world exist only as convenient folk figures to justify the coddling of the wealthy.  Economic actors, from the minimum wage worker to the CEO, all act from incentives.  To think that those at the top deserve outsized incentives while those at the bottom can be content with the incentive of subsistence is contorting the idea of incentive.

In fact, the wealth of a market society automatically flows to the talented.  They have a monopoly, as it were, and can benefit just as any monopolist can benefit.  Corporations often think they can corner the market of talent in a particular area just to ride on this monopoly.  Of course, all too often, the talented develop better in a garage than on floor three of module A-6.

But take for example sports.  The top twenty stars get millions.  The next five hundred get some lesser millions.  Below that, even if only a small gradation in talent different, the reward is a particle of the others.  We could go on.

The point is that it is a distortion and an illusion that Atlases exist in today’s society.  Rewards are cornered by the powerful, often the monopoly power associated with talent, but more often simple political or institutional power.  However they are cornered, the role of the government is to access them for the benefit of the society upon which these gains have been made.

morals and selfishness

March 18 http://economistsview.typepad.com/economistsview/2009/03/selfish-punishment.html March 18, 2009 “Selfish Punishment”

How does altruism survive?:

Thriving on Selfishness, by Marina Krakovsky, Scientific American:

It’s the altruism paradox: If everyone in a group helps fellow members, everyone is better off—yet as more work selflessly for the common good, cheating becomes tempting, because individuals can enjoy more personal gain if they do not chip in. But as freeloaders exploit the do-gooders, everybody’s payoff from altruism shrinks.

All kinds of social creatures, from humans down to insects and germs, must cope with this problem; if they do not, cheaters take over and leech the group to death. So how does altruism flourish? Two answers have predominated…: kin selection, which explains altruism toward genetic relatives—and reciprocity— the tendency to help those who have helped us. Adding to these solutions, evolutionary biologist Omar Tonsi Eldakar came up with a clever new one: cheaters help to sustain altruism by punishing other cheaters, a strategy called selfish punishment.

“All the theories addressed how altruists keep the selfish guys out,” explains Eldakar… Because selfishness undermines altruism, altruists certainly have an incentive to punish cheaters—a widespread behavior pattern known as altruistic punishment. But cheaters, Eldakar realized, also have reason to punish cheaters…: a group with too many cheaters does not have enough altruists to exploit. … That is why, he points out, some of the harshest critics of sports doping, for example, turn out to be guilty of steroid use themselves: cheating gives athletes an edge only if their competitors aren’t doing it, too. … …

Demand Side suggests that the altruists make a point of hiring policers and acknowledging that the more altruists there are the better off everybody is, so that the rewards to cheating are then much higher as well.

Jeffrey Sachs Huffington Post

http://www.huffingtonpost.com/jeffrey-sachs/capitalism-and-moral-sent_b_177637.html

March 28, 2009

In recent days, both Tom Friedman and David Brooks urged us to take our attention away from the trivialities of the AIG bonuses (just 0.001 percent of GDP, sniffed Brooks), to focus on truly weighty macroeconomic matters. Friedman bade us to look forward to, and support, the next mega-bailout of the banks, and Brooks applauded the leadership of Mssrs. Geithner and Summers in leading the G20 to macroeconomic stimulus and a rejuvenation of the International Monetary Fund.

Both pieces had the feel of planted stories, with insider tips about what’s coming next and praise for the economics team as it battles against little minds in Europe and populist sentiments at home. Whether or not the stories came from Washington, both stories are wrong. There is no tradeoff of great macroeconomic themes and attention to little details like AIG and Merrill bonuses. We can focus on both the bonuses and the macro-economy. Indeed, we must. Nor is the concern over the bonuses mere populism. It is, rather, woefully overdue attention to the core issues of reckless greed and arrogance that did so much to get us into the current fix.

During the last 20 years Wall Street has had its way with us. On a bipartisan basis it provided the Treasury Secretaries, filled the regulatory agencies, paid itself unconscionable bonuses, and stuffed the campaign coffers. The greed knew no bounds. The distortions of public policy — right up to Greenspan’s infamous decision to leave financial regulation up to the firms themselves — have wrecked the world economy.

The fascinating thing about this greed is that it is so deeply ingrained that neither the bankers themselves nor our economic leadership understands just how disgusting and dangerous it is. Even after the music stopped, to use Chuck Prince’s now famous simile, the bankers keep dancing - with our money. They continue to grab billions of taxpayer dollars (in Merrill’s case) or at least hundreds of millions of dollars (in AIG’s case) with giddy abandon, in full view and with a straight face. And our economics officials declare that this is unavoidable or too dangerous to curb. Contracts are sacred, unless of course it is union contracts, in which case we should demand that wages and benefits be cut as conditions for government help.

The great scholars of capitalism, from Adam Smith to John Maynard Keynes, understood full well that a functioning economic system depends not on greed, but on moral sentiments and an acceptable social contract between the rich and the rest of society. The rich can make money, of course, but they must not flaunt it or consume it frivolously. Instead, they must invest their wealth for social benefit, whether in business or in philanthropy, or in both as in the case of history’s most celebrated capitalist-philanthropists, from Andrew Carnegie and John D. Rockefeller to Bill Gates and Warren Buffett. It is only the dangerously arrogant rich or the servants of the rich who believe that morals don’t matter in the great matters of finance.

Here is how Keynes famously described the “psychology” that propelled the first successful era of global capitalism in the late 19th century and early 20th century.

Herein lay, in fact, the main justification of the capitalist system. If the rich had spent their new wealth on their own enjoyments, the world would long ago have found such a régime intolerable. But like bees they saved and accumulated, not less to the advantage of the whole community because they themselves held narrower ends in prospect . . . The capitalist classes were allowed to call the best part of the cake theirs and were theoretically free to consume it, on the tacit underlying condition that they consumed very little of it in practice. The duty of ’saving’ became nine-tenths of virtue and the growth of the cake the object of true religion.

Understanding the need for a moral code in the economy will enormously help the economics leadership not only to weather the storm of outrage that has rightly hit Washington and Wall Street over Wall Street’s rampant and continuing abuses, but also to fashion — finally — a successful solution to the tottering banking system. The stalemate over banking has arisen because the economics team has been unwilling to take on the bank shareholders and management. It now reportedly plans to clean up the banks’ assets through a new alliance of hedge funds and taxpayer dollars. That simply won’t happen.

The public won’t tolerate such games for another round. The public won’t accept more money going into financial bailouts until the banks are clearly being run for public benefit, not for the private gain of undeserving shareholders, management, and traders. America will not right itself until it regains a moral compass in economic affairs. That will require a new generation of financial leaders who will forswear the abuses of the past generation of Wall Street leaders. The faster that the economics team and Congress heed the public call for simple justice and decency in financial matters, and the more rapidly that translates into a true Wall Street clean up, the faster will come the economic recovery.

Jeffrey Sachs

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Plus readings from Reich and Kuttner, on health care and zombie banks, and News!

The Fed’s monetarism has had an impact on the real economy equivalent to that of a wish and a prayer.  We got an interesting new insight on why that is last week from two Credit Suisse strategists.  You’ve heard of the shadow banking system.  Courtesy of Tom Keene’s interview, Credit Suisse’s James Sweeny and Carl Lantz point out there is also a shadow money supply.

We offer a straightforward rendition of their premise and why it makes hash of the hysterics.

There is also politcally savy commentary from Robert Reich on health care and Robert Kuttner on the banks.  Again no idiot this week.  But we do have some news.

Japan’s Economy Shrank Record 15.2% Last Quarter

STOP

Stock market strength around the world is likely due to liquidity searching for a rising asset.  Likewise the strength in oil and some other commodities.  While we think oil at sixty dollars makes the world a healthier place, we are watching for some stability.  Another consistent rise is consistent only with another financial boondoggle.

BACK TO BLOOMBERG

May 18

Meanwhile the TED spread has decreased further over the last week, and is now at 61.97. This is the difference between the interbank rate for three month loans and the three month Treasury. The peak was 463 on Oct 10th and a normal spread is around 50 bps.

May 17

From the WSJ:

Mr. Orszag … urged patience when it came to seeing results from the government’s $787 billion economic-stimulus plan, noting that only $100 billion has been allocated since the legislation was enacted three months ago.

“It takes time to get money out the door wisely,” he said.

More on health care from Robert Reich later in the podcast.

David Goldman at Inner Workings relates there is a

Calculated Risk reports that the Federal Reserve reports that delinquency rates rose sharply in Q1 in all categories.

Also from Calculated Risk

Now the real news

The shadow money stock:

It can be argued that the Fed and Ben Bernanke have been engaged in a massive effort to inflate a way out of the current economic contraction.  So far, no inflation.  Demand Side has not been shy about pointing out the impotence of the Fed’s policy.  But what are the nuts and bolts?

Two economists from Credit Suisse, James Sweeney and Carl Lantz went on Bloomberg and presented the concept of the shadow money stock.  There’s a more academic treatment out just this last weekend on the Zero Hedge blog, link on the web site.

http://zerohedge.blogspot.com/2009/05/chasing-shadow-of-money.html

It’s a concept which after one hears it seems almost too obvious.

During times of strong demand and liquid asset markets, those assets are held in lieu of money and serve the purpose of money.  For example, during the housing boom, housing was extremely liquid as a financial asset.  Not only could you sell it almost by accident if you answered the door wrong, you could also tap its market value easily and immediately via a home equity loan.

Let me start again with a straightforward rendition of the premise.

The shadow money stock is money the market itself creates in order to finance a boom.  Money in the sense of a medium of exchange.  In a boom there is not enough cash to go around, so collateral will be used as near money or shadow money.

Many assets can be converted into cash easily in a boom.  Take the example of the house we led off with.  Homeowners held less cash in checking accounts and other forms because they knew that virtually overnight they could get low interest money out of their homes.

Similarly, government bonds can be taken to the Repo desk and for a one percent haircut converted to cash.  During the boom, private bonds and asset-backed securities of less than perfect ratings could easily be converted to cash, with say a five percent haircut.

People used their cash to buy things and these other assets as the rainy day fund.  When the downturn came, the value of the assets went down, yes, but also the terms for borrowing against them, including the haircut became more onerous.

For example, a bank once willing to loan on 90 percent of the value of your house became willing to loan only on 70 percent.  The value of trillions of dollars of securities became useless as collateral as their markets became illiquid.

Friedrich Hayek, quoted on Zero Hedge, put it this way. (abbreviated)

Lantz and Sweeney calculated that at the peak of the boom there was six trillion dollars in the traditionally defined money stock.  The private shadow stock accounted for $9.5 trillion, and government-based shadow money a whopping $11 trillion.  Thus the shadow money stock dwarfed the traditionally defined M2.

Remember the shadow money stock is a boom time phenomenon, and creates a lower demand for real money than one would expect.  It contributes to the experience of stable or even falling interest rates during times of expansion.  Not what one would expect.

Lantz reading of recent statistics indicates that today every one dollar increase in the base money increases M2 by one dollar.  In more normal times each dollar of base money will increase M2 by 8.5.

The size of the shadow money stock was estimated by multiplying the haircut percentage against the asset base.  For example, the value ofthe housing stock times the level of potential borrowing against it.  Say during the boom, a homeowner could borrow against 90 percent LTV — loan to value — and now it is 80 percent.  Plus — or minus in this case — the reduction in actual value.  Lantz and Sweeney estimate that the total drop was $3.5 trillion.

They also suggest this was offset completely by an increase in the government shadow money stock, following the huge new borrowing needed to finance the deficit as well as the aggressive liquidity measures of the Fed, and presumably including the expansion of the Fed’s balance sheet in the conversion of dodgy private securities into full faith and credit.  This huge increase in liquidity has been the source of muchhand wringing about potential inflation.  Bernanke issued notice that the Fed is “focused like a laser on the exit strategy.”

In fact, according to Lantz and Sweeney, this explosion of liquidity was necessary simply to accommodate the demand for cash occasioned by the crisis.  Absent this money growth, the collapse of the private shadow money stock would have led to severe, or more severe deflation.

Lantz suggests concern over inflation is ridiculously premature, and predicts much of the unwind of the liquidity measures from the government will occur naturally, as government programs get paid back and rescuemeasures for the banks wind down.

Our observation at Demand Side is that monetarists who can so clearly describe the monsters hiding under the bed will become ever more hysterical as things begin to turn around.  We suspect that the adults will choose to calm them, rather than follow the more effective policy measures.  The efforts to calm them will be counter-productive to the real economy.

At the risk of dislocating an elbow, we’d like to make the note that we’ve made a couple of comments that look good from this new perspective.  Deleveraging we have said is a process of money contraction.  This was an insight that arose from instinct, not instruction.  Here is the instruction.

Another self administered pat on the back follows from our observation in early 2008 that credit cards as near money enabled spending from the stimulus to be smoothed, in a downward slope, to reflect the restrictions on this form of money.

In fact, the actions of banks and credit card companies demonstrate clearly the error of the Fed-Treasury plan to allow zombie banks to continue among the living.  These insolvent institutions have no choice but to maximize revenues from the spread.  That is, they may borrow cheaply, but this will not be passed on to their credit card clients, who will get only the maximum rate laws allow.

This note from the New York Times

The larger point is that money is a much broader phenomenon than we have been used to thinking.  At the same time, the Fed’s control of money is much narrower.  In a boom, with confidence in asset values, the effective money supply will expand as collateral becomes near-money.  In a bust the effective money supply will convulsively contract, as assets become less liquid, banks lend less and keep more in reserve, and all parties hold traditional, not shadow cash against a rainy day.

The threat of inflation is much lower than widely assumed, since as things pick up, the government shadow money stock will tend to be reduced.  Programs end.  Loans are paid back.  Et cetera.

Another blow to the quantity theory of money.

Now on to health care with former Labor Secretary and current Berkeley professor Robert Reich, who writes on his blog:

Single payer health care is the most efficient.  We need the most efficient.  No legislation will be complete without a route to this efficiency.  I don’t know what the politics are.  Every Congressman and Senator should get a call from their concerned constituents.

Now Robert Kuttner

Collateral Damage and Double Standards

Robert Kuttner is co-Editor of The American Prospect and a senior fellow at Demos.

That’s it for this week.  Next week we are doing Atlas Dumped.  What happens when the John Galts of the world show up as not contributing, but doing significant damage to the society?  Is it still necessary to give them preferential treatment?

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At one time, the New Economics of Keynesianism was almost universally accepted.  No longer.

Today, we have copy from Joseph Stiglitz on the spring of the zombies and John Irons on offshore tax havens.  No Idiot of the Week, but an extended history note.  First, some news.

From Calculated Risk.

Nouriel Roubini appeared on CNBC looking plump and pleased.  It is an ill wind that blows nobody good.  Roubini’s correct predictions have made Doctor Doom’s house calls quite lucrative.

Capacity utilization means no private sector investment in traditional industries for years to come.  It also means that demand pull inflation is not in the cards anytime soon.

Unemployment continues upward, but a lot of cheer was taken from the break in initial claims for unemployment.

Since the recession will not be resolved by a return of consumer spending, Demand Side expects this is a very dim light at the end of the tunnel.  Certainly we are not backing off our prediction of many months ago that ten percent unemployment is baked in.  We likely will see twenty percent or very near it in the broad U-6 measure.

Now, today, on the difficulty of sorting through the mish mash of economic schemes.  Every analyst, economist, or commentator has a different scheme.  It was not always the case.

Thus, The history note:

In the mid - 1960’s, it is no exaggeration to say, and Lord Eric Roll in his definitive History of Economic Thought did say, “… the New Economics enjoyed an acclaim unprecedented in its speed and intensity.”

Economics and economists had penetrated the policy-making framework as never before.  in the Depression, the New Deal Brain Trust around FDR drew some economists in, but by the 1950s and 1960s there was a systemic and institutional presence of economists in countries around the globe.

And as Lord Roll puts it …

“for at least over thirty years after the appearance of Keynes’ General Theory, the status of economics, largely with the kind associated with his name and general approach, increased steadily until it reached a position of authority, both as a branch of social science and as a perceived tool for the better ordering of human affairs, unparalleled in its history and unequalled by any of the other of the non-physical sciences.”

This is not the situation today.  A recent edition of Business Week lampooned economists as people who could not agree on what had happened, on what to do, on what would happen, and would be wrong anyway.

In a moment we will look at what happened to change the situation from a condition in which economics and economists were held in high regard to one in which they are … not.  But first, let me emphasize that the high standing and respect accorded to economists int he postwar years prior to 1970 is not my invention.  The clear perception among politicians and the public was that Keynesian economics, demand side economics, had been refined and perfected and was responsible for that period of growth, prosperity, low unemployment and modest inflation.

What happened?

Two things:  The stagflation of the 1970s and early 1980s and a counter-revolution.

Much could be said about the stagflation.  It occasioned Richard Nixon’s wage-price freezes, initially well-received, and later experienced as disruptive and counter-productive.  Still ill-appreciated is the role of oil prices, energy prices, not just as demand shocks, but as directly eroding wages and incomes.  Whatever might be said, the stagflation exploded the illusion of precision which economists had gathered around themselves, and offered the opening for a politically led counter revolution that unseated the orthodoxy of the New Economics.

I choose the words “politically led” very carefully.  The Monetarist laissez faire supply side scheme that replaced the Keynesian conventional wisdom was by no means generally accepted among economists or among nations, though it has achieved sway among bankers.  The revolution against Keynesianism was decidedly not a revolution led by economists.  At most there was a civil war during which time the elections of Thatcher and Reagan put the new dogma into the seats of power in some influential countries.

Supply Side has never really been a branch of economics.  More a parasitic vine.  No serious academic lineage has followed it.  Its advocates are not housed primarily in universities, but are centered in corporate-sponsored Right Wing think tanks like the American Enterprise Institute and the Heritage Foundation.

Monetarism, laissez fair, New Classical math-based, and Rational Expectations schools have enjoyed far less consensus among economists than the Demand Side schools that preceded them, although they too have been the beneficiaries of significant corporate sponsorship, in the form of endowed chairs and business school boosterism.  However that may be, none of these schools carries any pretense of precision into the second year of this current recession.

The hybrid Monetarism and laissez faire philosophy that controls the Fed and Treasury can claim no precision now after so many years of false promises and predictions.  To have the financial potentates still at the helm after so many protests that they had not seen it coming is one of the great ironies of the current year.  The Rational Expectations and the mathematical strains of the New Classical school are clearly wrong or irrelevant.  Libertarian bias sometimes masquerades as a market efficiency theme, but both are as completely out of place looking forward as they were in describing the corporate oligarchy that rose up behind the smokescreen of Reaganism.

The current crisis and its depth are impossibilities from the points of views espoused by these folks only a couple of years ago.

That said, until this recession, the collapse of this housing market and this financial sector, and for the twenty years prior, for an economists to be Keynesian or Demand Side in approach was to be hopelessly naive and stuck in the past, and to look for employment at the Post Office.

Keynesianism may have been defeated by a motley coalition of political opportunists, corporate connivers and academic hacks, but it WAS defeated.

I took my degree from a large state university in 1995.  The name Keynes appeared about twice — literally during my undergraduate education.  It was not until after graduation I even learned how to pronounce the name of the greatest economist of the Twentieth Century.  Only subsequent to the 2007 housing collapse and financial debacle did KEENES become Keynes again to the policy maker and the media talking head.

Paul Krugman’s blog the other day said something about this period.  Where is it?

The IS-LM model was an invention of John Hicks, later Sir John Hicks.  He won the Nobel Prize for it, which did not prevent him from later recanting, or more accurately, ascribing its relevance only to a narrow part of reality.  But it was mathematical, and Keynesian.  I’m not sure by this whether Krugman, DeLong or any others actually advocate this scheme.  A paper Krugman wrote at that time makes this note:

Hicks and the IS-LM were searching for precision and found it in irrelevance.  But the formulation remained the central Macro formulation, event absent Keynes’ name.  It is best ignored for the present.

The Keynesian policies in play today are the federal infrastructure spending, the aid to states and local governments and assistance to health and education systems.  You might also add the New Deal programs of social security and unemployment insurance as base supports of demand, but which are not strictly Keynesian.  I combine the two in the definition of Demand Side.

These are the measures of which JMK would have approved.

Compare the “Timely Targeted and Temporary” tax cuts of early 2008, which was plainly a bust from the beginning from a Demand Side perspective.  If you’ve been with us, you heard us among the voices discounting the efficacy of these checks to individuals, no matter their political popularity.  The primary sponsor of Timely Targeted and Temporary was, of course, Larry Summers.  As we predicted from before the beginning here on the podcast, that triple T stimulus was a non-starter in the real economy.  Republicans and Conservative economists who continue to insist on tax cuts as being effective are ignoring this evidence.

Those who expect big things from loan guarantees and making nice with the banks so they will lend are destined for disappointment from the same cause.  The consumer is not going to be the engine it once was.  The why’s go beyond the fact that his/her net worth is going negative fast and his/her income is dropping on average, but we won’t go into them here.

Getting back to Timely Targeted and Temporary.  Didn’t work any better than tax cuts for the rich.

The entire Monetarist scheme to refloat the banks is from the Demand Side perspective a Monetarist scheme to refloat the banks.  To us there is no clear reason why it should work as a remedy for the economy, since there is no clear motivation to invest or borrow or lend absent demand strength.  It’s great to have a good ferry, but if nobody wants to go across the river, nobody will benefit, even the ferry.

The idea that the financing function of the economy will be saved by salvaging the companies that screwed it up is dubious on its face.  Or that ratifying their bad decisions by having the government cover them with taxpayer money?  It does not stand the test of common sense, let alone the Demand Side theory.  In fact, it’s hard to see whose theory it does test out in.  Perhaps the theory that those who control the government set the policy.

But this IS the history note.  And the note is simply the contrast.  First between the economic consultants of the New Deal and the economic establishment that grew out of Keynesianism to such prominence in the third quarter of the Twentieth Century, and second the contrast between that and the current Tower of Babel.  The rise of Keyneisanism and Demand Side, its successful revolution against classical laissez fair and broad acceptance, to the unseating of that consensus by a commercial-political-economic gang that had no coherent or widely accepted replacement philosophy, sharing only the common trait of being contrary.

Anyway, that’s the abbreviation of the Cliff Notes version of the Keynesian Revolution, the establishment of the first coherent policy framework, and the subsequent fall into intellectual chaos.

Before we leave, we’d like to put a period on the following sentence:  Rational Expectations theory has collapsed under the weight of reality.  One of the seminal works of Rational Expectations was the article in a 1974 issue of the Journal of Political Economy entitled “Are Government Bonds Net Wealth?” by Robert Barro.  In the article, Professor Barro argued that there is no difference between taxation and borrowing in financing government expenditure.  Economic agents will regard borrowing as only postponing taxation and will increase their savings to meet that future taxation, thus compensating for government deficits.  They will not view government bonds as part of their wealth.

Again weak from common sense angles, history and evidence of savings patterns during periods of high deficits — until the present — disprove the position.  The practice of government in stimulating the economy dismisses the concern.  The current stimulus is not yet into results, so we do not point to that.  But most damaging is the obvious “flight to quality” which has depressed returns on U.S. bonds — the U.S. being the greatest deficit nation.  This undeniable phenomenon blows the idea that economic agents do not see government bonds as part of their wealth into many smithereens it cannot be possible to but the nonsense back together again.

So, now into more recent history

Shrinking loopholes By John Irons 05-07-09 http://www.epi.org/analysis_and_opinion/entry/shrinking_loopholes/#When:17:44:39Z

Earlier this week, the Obama Administration announced several important proposals to close loopholes that allow multinational corporations to avoid paying taxes, and to crack down on illegal tax evasion by individuals.  These proposed changes are certainly a move in the right direction.

It is now well documented that corporations have been exceptionally successful at using every legal means to game the system to reduce their tax obligations. For example, the GAO has noted that 83 of the 100 largest U.S. corporations have subsidiaries in tax havens; and in 2004 U.S. multinational corporations paid taxes amounting, on average, to just 2.3 percent of their $700 billion in foreign income. Not only do current tax rules allow corporations to dodge their responsibility, but they also create perverse incentives to keep capital investments abroad,  thus encouraging companies to create jobs offshore rather than here at home.

The measures outlined by the administration would also crack down on individuals’ use of tax havens and secretive banks abroad.  By requiring certain banks to share information with the U.S. and by devoting more resources to international tax enforcement, the IRS would have a fighting chance of catching these law-breakers.

The revenue raised by these changes would be used to extend the Research and Experimentation tax credit that was intended to encourage R&D here in the U.S. The tax credit is typically extended piecemeal in one- or two-year increments by Congress. While the current tax credit can and should be improved, adding a measure of certainty is important to allow businesses to properly plan for future expenditures. By paying for the extension, the administration is showing a commitment to fiscal responsibility.

While there are still many tax policy challenges ahead, these common-sense changes are a good first step toward modernizing the tax code so that multinational corporations and wealthy individuals cannot dodge their obligations.

05.08.09

The Spring of the Zombies , by Joseph Stiglitz, Commentary, Project Syndicate: http://economistsview.typepad.com/economistsview/2009/05/stiglitz-the-spring-of-the-zombies.html

As spring comes to America, optimists are seeing “green sprouts” of recovery… The good news is that we may be at the end of a free fall. The rate of economic decline has slowed. The bottom may be near - perhaps by the end of the year. But that does not mean that the global economy is set for a robust recovery any time soon. Hitting bottom is no reason to abandon the strong measures that have been taken to revive the global economy.

This downturn is complex: an economic crisis combined with a financial crisis. Before its onset, America’s debt-ridden consumers were the engine of global growth. That model has broken down, and will not be replaced soon. … The collapse of credit made matters worse; and firms, facing high borrowing costs and declining markets, responded quickly, cutting back inventories. Orders dropped abruptly …

We are likely to see a recovery in some of these areas… But examine the fundamentals:… real estate prices continue to fall, millions of homes are underwater…, and unemployment is increasing… States are being forced to lay off workers as tax revenues plummet.

The banking system has just been tested to see if it is adequately capitalized - a “stress” test that involved no stress - and some couldn’t pass muster. But, rather than welcoming the opportunity to recapitalize, perhaps with government help, the banks seem to prefer a Japanese-style response: we will muddle through.

“Zombie” banks - dead but still walking among the living - are, in Ed Kane’s immortal words, “gambling on resurrection.” Repeating the Savings & Loan debacle of the 1980’s. the banks are using bad accounting… Worse still, they are being allowed to borrow cheaply from the United States Federal Reserve, on the basis of poor collateral, and simultaneously to take risky positions. …

The American government, too, is betting on muddling through: the Fed’s measures and government guarantees mean that banks have access to low-cost funds, and lending rates are high. If nothing nasty happens - losses on mortgages, commercial real estate, business loans, and credit cards - the banks might just be able to make it through… In a few years time, the banks will be recapitalized, and the economy will return to normal. This is the rosy scenario.

But experiences around the world suggest that this is a risky outlook. Even were banks healthy, the deleveraging process and the associated loss of wealth means that, more likely than not, the economy will be weak. And a weak economy means, more likely than not, more bank losses. …

Fixing the financial system is necessary, but not sufficient, for recovery. America’s strategy for fixing its financial system is costly and unfair, for it is rewarding the people who caused the economic mess. But there is an alternative…: a debt-for-equity swap.

With such a swap, confidence could be restored to the banking system, and lending could be reignited with little or no cost to the taxpayer. It’s neither particularly complicated nor novel. Bondholders obviously don’t like it - they would rather get a gift from the government. But there are far better uses of the public’s money, including another round of stimulus. …

In spite of some spring sprouts, we should prepare for another dark winter: it’s time for Plan B in bank restructuring and another dose of Keynesian medicine.

That from Joseph Stiglitz

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Plus Wm. Poole, Idiot of the Week, news and notes on regulation

05.07.09

Today, the Forecast Bulb is Dimming as a result of the inability to turn the financial ship fast enough.  We engage in a lengthy, well, rant about the seeming imperviousness of institutional bias to evidence, experience, fact and fate.  Then some notes on regulation.  In between it is Idiot of the Week with Bill Poole, formerly of the St. Louis Fed, now of the Cato Institute.

First the News:

Abbreviating the news today:

Unemployment:

Initial claims, the four-week moving average, has taken a step downward, back to 623,500, off over 32,000 from the peak.  The continued claims continues to go straight upward, but it is possible that a glimmer of light is appearing.  Say it with me, infrastructure spending, aid to states, stimulus package.  This does not, repeat not, mean that the unemployment rate will back off any time soon.  And the run-up in both initial claims nad continued claims, even just to this point, is the worst it has been in modern history.

Stress Tests

It is not news that the banks made big blunders in lending and securitizing and took big losses and are now insolvent.  What is now generating news is that the Treasury Department’s stress tests will show this.  This is generating lots of criticism of the tests.  Kind of like blaming the breathalizer for being drunk.  Maybe if the police didn’t let on you are drunk you could drive home safely.

Housing

Mid to high range residential property is defaulting now like subprimes.

Manufacturing

The ISM number rose to 43.7 in April from 40.8 in March, indicating gutting of the manufacturing sector is almost complete.  No.  Indicating a slower contraction, but still contraction.  The gutting comment is my editorial.

From Last Week

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — decreased at an annual rate of 6.1 percent in the first quarter of 2009 …

Real personal consumption expenditures increased 2.2 percent in the first quarter, in contrast to a decrease of 4.3 percent in the fourth. …

Real nonresidential fixed investment decreased 37.9 percent in the first quarter …

Nonresidential structures decreased 44.2 percent …

Equipment and software decreased 33.8 percent …

Real residential fixed investment decreased 38.0 percent …

So PCE increased (as expected), but investment slumped sharply in all categories.

And just a last note from the real world:

Cities are the world’s primary contributors to greenhouse gas emissions – and yet they will be the first to suffer from the consequences of climate change, such as storms and rising sea levels.

Enough news Forecast Bulb Dimming

The long-term bulb is dimming on the Demand Side forecast.

One might call it the return of realism or inversely the disappointment of the naive.  And many of you may have already arrived at this point.

It has been with some dismay that Demand Side has watched the economy foundering, the tools and theories of the establishment being crushed by events, and yet no realization that anything has to change.  The consumer society has died.  A  new economy based on strategic goals like the survival of the planet and its inhabitants, the avoidance of chaos and suchlike is demanded.

Unfortunately most folks live in a soup of experience out of which they cannot see.  They feel secure in or dependent on the current trajectory, or see no alternative.  Those who are supposed to be watching and weighing the broader movement of things are, we have come to accept, captured by narrow self-interest.

It is not that the blind alley into which we running our society is invisible or that our economic technocrats are being defeated by the seduction of an army of Mata Hari’s.  It is that the establishment is established in immovable institutions whose continued existence depends on a return to the lost land of consumer finance.  Irrespective of the fact that the lost IS lost and cannot be recovered, all the forces of Wall Street are at the disposal of those who promise its return.  The leviathans of the earlier day, the Citibanks and Bank of Americas and so forth, are sprawled across the road to recovery with no capability, even if they had the intention, to reform.  The houses of Finance and also of Academia are run by individuals whose entire investment is in a failed economic scheme.  While their hope of gain is miniscule, it is greater than if they were to admit that the fallen house of cards was a house of cards to begin with.  Were they to do that, they would lose their place as dealers.

Simply put, since they depend on a consumer society and a complex scheme of rational markets and corporate oligarchy, they will spare no effort in assuming or projecting one.  Of course, nothing will materialize to support them.  Only zombie forms dependent on indulgences from the taxpayer and regulator are possible.

These are not passive supplicants at the public trough.  By no means.  Those on Wall Street are in Simon Johnson’s terms, oligarchs.  Demand Side the book used the term corporate oligarchy.  Those in Academia are shielded by tenure, obscure mathematics, or a culture of debate.  Nonetheless they are wrong and dangerously wrong.

The fact that they are wrong was not the problem with the Demand Side forecast.  Our problem was the delusion that once the supply side charade was vaporized and the intellectual foundations of the system disintegrated, as an obstacle it would fall of its own weight.

Indeed, the first part has occurred, the vaporization and disintegration, but the established system posses not dead weight, but momentum, the momentum of self-interest.  Rather than capitulation, each new crumbling has witnessed the invention of new rationalizations and excuses.

The most pernicious variation of this is the inneffectiveness of monetary remedies under the Fed and Treasury.  More than eighteen months ago the Fed began its expansionary monetary policy and its special facilities for the financial sector.  All this time it was not enough medicine, according to the Fed, not that the medicine was ineffective.  Now, barely a month after the beginning of the fiscal stimulus, we are seeing signs of some stability in the real economy.  Outlandishly, Fed apologists ascribe it to monetary policy.

In today’s Idiot, we feature …. Poole, former Fed official and unrepetent Libertarian trying to concoct out of the disgusting and decadent a potion palatable enough to force down the throats of the unwitting.  That is, a way of explaining how stupidity in monetary policy and incompetence in regulation did NOT lead to the current crisis, and is instead, the way out.  In Mr. Poole you see the perfect example of a nabob of orthodoxy who is willing to let the ship go down rather than give up his captaincy.

In any event, it is not dead weight we are left with, but momentum.  This momentum is sending the old order careening through an out-of-control institutional system — the financial sector — into the real economy and through the body politic.  The damage is justified by either, “It was an act of nature, “Nobody saw it coming,” “We couldn’t do anything,” or “We’re doing everything we can.”  That the collapse continued so long and continues to continue gives lie to this whole line of defense.  If we didn’t see it coming eighteen or twenty months ago, perhaps we can see it now.

The fact remains that the economy is crumbling, has crumbled, and those who are in charge have not altered that fact, nor even altered the trajectory appreciably.  Citibank and Bank of America are no less problems for the economy today than they were when the whole “float them on a sea of taxpayer loans” scheme began.  The great earnings triumphs of the past few weeks which to some have meant new hope for this sector, to others have meant the big squeeze on the credit card and Scroogian credit conditions.  They’d better make money when they’re getting it at zero.

You have seen here at Demand Side that we correctly predicted the crash.  We increased our gauge of its severity as it approached with no effective policy preparation.  Our projections have held up well.  AND we haven’t tweaked them semi-weekly.

Even today’s change is to the long-run, outside-the-charts forecast.  Those charts on the web site, which we occasionally or semi-occasionally revise are still intact.

The point is not that we have been so right, but that the Fed and others who sip the Monetarist kool-aid have been so wrong.  And not so much that they have been wrong, but that they have not changed course nor revised their analysis.  They have never questioned the Monetarist remedies.  Each passing month of ineffectiveness only raises their alarm about the severity of the problem.  It cannot be that their medicine doesn’t work.  It can only be that this is a new and more virulent strain of the disease.  Phooey.  The disease has become more dangerous because it has gone so long without effective treatment.  The entrenched financial interests have suborned non-answers as the first line of defense.

The mechanics of the economy are not so difficult, and are in fact well understood by some.  I was glad to see that Joe Stiglitz went to dinner at the White House, along with Paul Krugman, last week.  You hear people like Dick Durban, Senator of Illionois, admit that Wall Street controls Washington.

I personally think you need to be a pretty good politician to become president and that Obama may be picking his fights at this point.  Getting health care through and getting the stimulus in place will be fully enough.  The consequences of ineffecitve policy will soon enough generate political will.  Whether it will be enough to overcome the entrenched financial czars remains to be seen.

The difference between mechanics and institutional interest can be seen pretty clearly in money.  As we’ve said many times, money is simply a means of exchange, from one worker to another, from then to now, from this nation to that nation.  We’ve also said, however, that money flows to power.  So the mechanics of money are corrupted when institutions are allowed inordinant or unbalanced power.  Even in the flows of money.

As an aside that really has little to do with the subject.  My wife is Russian.  She grew up in the Soviet era and she sometimes says proudly, “People always had enough money.”  A lot of the reason for that was there was nothing to buy.  Apartments were free.  Likewise health care, education.  But the stores were empty.  Money had a different use there, I guess, than as a medium of exchange.  Or at least it was a long-handled exchange.

But even the mechanics are corrupted when the manuals are so full of bull.  William Poole later, but here is David Malpass on Bloomberg.  Malpass is a Wall Street analyst.

MALPASS

This is straight out of the Chicago School.  There cannot be any stimulus because it is — what is the word? — ah yes, “crowding out” private activity.

Somehow we could have tens of trillions of dollars of private stimulus borrowing in the Greenspan years without this effect crowding out needed public investment, but the moment the public sector borrows to build a road or energy efficient future, it becomes ineffective.  The only economic growth can come from the private sector.  No wonder we have tens of thousands of acres of empty houses and at the same time crumbling infrastructure and dilapidated health and education systems.

How can effective action on the economy be undertaken when the debate is stuck in the flat Earth - round Earth era?

The entire effectiveness of Monetarist pap is of the same nature.  Never has a theory survived so much evidence and experience contradicting it.  The Fed has reduced interest rates to zero and created more money than ever before by a factor of four or five.  Now maybe there are some green shoots.  Never mind the fiscal stimulus.

And you can bet when the economy does stabilize, it will be because the Fed’s measures finally kicked in.  Bernanke went from a scholar of the Great Depression whose theory was that the failure to save the banks was the critical error.  He has proven that even compromising the balance sheet of the central bank and getting hundreds of billions out of the taxpayer does not save the banks.  As we’ve said, it is the banking function that must be maintained and rehabilitated.  The banking institutions need to suffer the same fate as any real economy firm who sold toxic products to the public.

Instead it is becoming clear that Bernanke will go from eighteen months ago being “the man who would save the system with his aggressive policy response” to today “the man who has done all he can be expected to do and now it’s time for somebody else to step up” to in the future “the man whose clear vision led us out of the mess.”

In fact, Bernanke has had little more effect than a man waving a rag at the sun to get it to go down.  Timothy Geithner has become his assistant.  They cannot do the things that will work because that way lies over the bodies of the financial institutions who are their chief sponsors.

Anyway, I was glad to see Joe Stiglitz and Paul Krugman up at the White House talking off the record.  That probably means a lot was said by all parties.  I hope they heard from the President that as soon as the political dynamics allow there will be real change in treatment of these oligarchs.

Although efficient and productive outcomes will not happen absent the correct policy choices, there is no guarantee that these choices will either sooner or later be chosen.  It is entirely possible for the entrenched financial interests to produce a future in which they are profitable and everybody else is not.  We are told that a healthy economy cannot come back without a healthy banking sector.  That is true.  But a healthy banking sector will not be comprised of zombie leviathans kept alive by regular taxpayer and central bank transfusions.

The

Now to IDIOT OF THE WEEK

William Poole,

Poole was for ten years President and CEO of the Federal Reserve Bank of St. Louis and is now a senior fellow at the notorious Cato Institute

POOLE

Bill Poole is not David Malpass.  He is marginally more independent.  Poole is better identified as a technocratic regulator.  And his comments here were excerpted from some on Bloomberg that were somewhat more cogent.

Neither is Poole Dennis Gartman or another of those whose need for sales determines both his politics and his economics, and for whom even the closing of Cayman Island tax shelters is anti-American.

That said, Poole was selected as Fed honcho precisely because of his ideological biases.  The Fed is full of Monetarist zealots who gather like Trekkies and reinforce to each other the importance of their vacuous line of attack and conduct impotence support sessions.

Here Poole serves our purposes first by counting backward from results — if the slackening of the pace of deterioration can be called results — to the cause, here noted as last September.  Then we are assured that the nine or twelve, or maybe six months, more or less would APPEAR to put recovery — if it happens — PRECISELY in line with the Monetarist predictions.  Unfortunately, the Fed’s easing began about a year prior to the September date Poole selects, even if Bernanke’s unprecedented aggressiveness is to Poole in hindsight too timid.

The second segment here is Poole’s at-sea-ness with regard to regulation.  Well, I guess I missed it.  The causes of the crisis passed in the night.  We have got to get these people out of here.  Regulation?  Why bother?

William Poole, IDIOT OF THE WEEK

But let’s stay on the subject of regulation.

Here’s a post from Calculated Risk which includes comments by Ben Bernanke on this subject.

From May 7

REGULATION

There is no question that the Fed failed to adequately perform their regulatory responsibilities during the housing and credit bubble. … Part of the problem was supervisory responsibility were split between various state and Federal regulators. As Fed Chairman Ben Bernanke notes in this speech, under the Gramm-Leach-Bliley Act of 1999, the Fed “serves as consolidated supervisor of all bank holding companies, including financial holding companies.” Although the Fed missed significant problems at these holding companies, many of the problems were at mortgage brokers, and commercial banks that were not regulated by the Fed.

The regulators that I spoke with in 2005, at various agencies, were all concerned about the impact of the housing bubble and lax lending standards. But it was difficult to get the various regulators to coordinate. And several people told me confidentially that the Fed and the OTS were blocking efforts to tighten lending standards. So more consolidated supervision is required - but part of the problem during the bubble was that a few key individuals were able to block the efforts of other regulators.

So I think a framework to identify systemic problems would be an important addition.

Fed Chairman Ben Bernanke offers some suggestions:

(Now quoting from Bernanke.  Be patient.)

monitoring large or rapidly increasing exposures–such as to subprime mortgages–across firms and markets, rather than only at the level of individual firms or sectors;

assessing the potential systemic risks implied by evolving risk-management practices, broad-based increases in financial leverage, or changes in financial markets or products;

analyzing possible spillovers between financial firms or between firms and markets, such as the mutual exposures of highly interconnected firms;

ensuring that each systemically important firm receives oversight commensurate with the risks that its failure would pose to the financial system;

providing a resolution mechanism to safely wind down failing, systemically important institutions;

ensuring that the critical financial infrastructure, including the institutions that support trading, payments, clearing, and settlement, is robust;

working to mitigate procyclical features of capital regulation and other rules and standards; and

identifying possible regulatory gaps, including gaps in the protection of consumers and investors, that pose risks for the system as a whole.

Precisely how best to implement a macroprudential agenda remains open to debate. Some of these critical functions could be incorporated into the practices of existing regulators, or a subset of them might be assigned to a macroprudential supervisory authority. However we proceed, a principal lesson of the crisis is that an approach to supervision that focuses narrowly on individual institutions can miss broader problems that are building up in the system.

Aside from replicating the stilted language of a college sophomore, Bernanke and others miss the boat completely with regard to regulation.

It is the market that needs to be regulated.

The products need to be of standard size and their specifications thoroughly examined.  Mortgages, for example, need to be financing instruments that can be counted on for no hidden surprises so the buyer and seller can deal on the property in question without worry.  Credit cards do not need nine pages of three point type.  One agency can examine and pass on all terms and credit card issuers can compete on rates, rather than try to make money on hidden fees.  The financial innovation, so called, is not a better mousetrap, it is a more obscure and opaque financial arrangement.  There is no need for 57 varieties.  These are financing instruments to support real products and services.

Some, including Stiglitz, have advocated a Financial Products Safety Commission that would investigate new financial products for their toxicity.  What a good idea.

And the size of the market participants needs to be regulated.  For some reason it is still accepted wisdom that bigger is better with regard to banks.  There is no support for this.  By having banks that are small enough to fail, we reinstitute market discipline. Big is good for the banks because it comes with the free too big to fail insurance from the taxpayer so they can run out to the end of the risk spectrum.  But it is not good for the economy nor the taxpayer.  There are no economies of scale with banking.  It is the personal one-on-one relationship between borrower and lender that was lost by bigness that contributed the most to the cascade of bad loans that is sinking these institutions now.

Fully two-thirds of Bernanke’s suggestions involve mitigating the problems associated with institutions that are too big.  The fact that Europe has big banks only means that Europe has the same problems.  Glass-Steagall got it right.  We can see that now.

The pretense that there have been efficiencies or access to new money that somehow created value above what has been lost in this debacle is not even raised in serious conversation, at least not explicitly.  The private banking system has crashed the economy by its own hand.  Let there be no question.  It was not the government.  Unless by that you mean the government didn’t stop them.  And now we need regulation.

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