demandside

Plus our apologies for not reading the right charts.  We should lead with our apology, but we’re not going to.  We’ll squeeze it in after a couple of short notes of news and before our history note with Brad DeLong.

News

Today

From the WSJ: Three Banks Suspend Their TARP Dividends (ht jb)

Treasury spokeswoman Meg Reilly said Monday that “a number of banks” that got taxpayer-funded capital under TARP are no longer paying dividends to the government.

…

“Here the government has given the banks money at great terms, but the fact that they can’t keep up with it is worrisome,” said Michael Shemi, an investor at New York hedge-fund firm Christofferson, Robb & Co. “It tells you of the deep problems of community and regional banks.”

White House: 10 percent unemployment within months

And finally,

Apologize

We flirted with the idea of Alan Harvey as idiot of the week, but we have had no repeat appearances so far and this person’s blunders did not quite merit making him the first such repeat offender.  The observant among you may have noticed some of the detail in Saturday’s forecast piece did not match the charts.  Yes, we can read charts.  No, we did not have the correct ones in front of us.

Our apologies

The correct ones are those on the blog now and up on the web site soon.  Why we have so many vehicles with so little time, I don’t know.  Maybe we’ll get that repeat trophy after all.

A couple of things we did not make explicit.  One, our belief that employment growth will lead the recovery, not lag.  Two, the place of a forecast as the proof of the economic understanding behind it.

Nothing is so noisome to us as the protests by the mainstream that while they  may have gotten the forecast wrong, it was because events were unprecedented and unpredictable.  They cannot see what is coming, because they are looking backward.

For example, right now the financial sector is still locked up.  It and the economy are floating on a river of federal borrowing.  Yet you hear all too often that we are just about to return to normal, get back to the status quo, and so on.  I suppose if GDP goes positive, these folks will say the crisis is over and we can all go back to our work.  This would be, of course, the favorite outcome of the financial cowboys who have led us into this ditch.

Enough of that.  Maybe we’re a little defensive about our screw-up with the details.

Equality

One of the tenets of Demand Side we have not made explicit recently is the proposition that more equal distribution of income is more efficient and stable and leads to a more robust economy.  You may remember that one of the similarities between the crash of ‘29 and the crash of ‘08 was the historically large disparity between the rich and the rest of us.

This is, of course, an anathema to the supply side, whose notion is that giving more to one class will encourage them to produce more — that class being the investing and entrepreneurial class, that is, the rich.

In fact, in a market economy, more equal income means more equal access to incentives.  It also means a better economy.  We’ll get to Brad DeLong and the history note on this point in just a moment.

But one of the more intersting studies I can remember was one which surveyed self-reported happiness levels across different cultures.  it turns out that it is not the absolute level of income that matters at all in self-reported well-being, but the relative wealth.  If your hut has a bamboo mat on the floor and your neighbors have only dirt, you may report the same level of happiness as someone who has a Lexus in his garage when his neighbors have only Toyotas parked on the street.

Another, much more recent, study, demonstrated that excessive rewards may actually retard performance, as people stress too much and over think.  We believe you see very poor moral performance when the stakes are high.

All of which leads us into today’s history note and its author Brad DeLong.  I found this in DeLong’s U.S. Economic History lectures at Berkeley on iTunes.

DELONG

Brad DeLong is professor of Economic History and chair of the Department of Political Economy at Berkeley.  In the latter occupation he has been quite distracted since the Obama Administration shanghaied his department’s Christina Romer and he lost David Romer in the transaction.

Why stop here?  Some innovative researcher should examine the postwar United States.  When economic equality was greatest — in the 1950s and 1960’s — so too was prosperity and growth.

Listen Now:

 Standard Podcasts: Play Now | Play in Popup | Download | Embeddable Player | Hits (180)

Charts at http://demandsideblog.blogspot.com/

You can see on the charts for unemployment how well our forecast has tracked actual numbers on unemployment.  Everything is pointing to ten percent in the third quarter.

From that point the pessimistic scenario bends slightly, but continues to a high of twelve percent in mid 2010 and then only rounds down gradually, still being over ten percent in 2011 and only reaching nine percent at the end of that year.

The baseline scenario has been revised to round more gradually down from its ten percent peak, but drops below six percent as soon as 2011, much earlier than some of my fellow doom-sayers.

The optimistic scenario sees a sharper turn and a somewhat quicker return to normal.

With regard to GDP — Again our forecast tracks actual numbers fairly well, though more in the shape than the levels.  We contest the official numbers for real GDP because they are deflated by a measure that miscounts oil imports.  But we are happy enough.  But for this reason, we have mapped both real and nominal numbers and include GDP in three charts.

Pessimistically, real GDP could remain negative until the middle of 2010, and arrive at a steady state of only one percent.  Not even enough to take care of population growth.

Baseline, we see GDP returning to a strong near four percent level by the end of next year, although this level is supported mightily by government borrowing.  We have not charted net real GDP yet.  That is our measure of GDP net of government borrowing.  You may remember it from previous forecasts, along with the startling statistic that one hundred percent of GDP growth under Republican presidents since 1980 has been borrowed by the federal government.

Optimistically, the economy under the influence of strong public goods production and a commitment to fighting climate change, stabilizes at plus four percent real GDP,  This allows a virtuous feedback from employment growth into the private sector, but again requires the growth of the public sector.

We are confident in the competence of this president.  We need to see a big change in the approach to the banking sector and we need to be willing to rebuild America by rebuilding America.  Granting these, there is no reason we cannot rebound strongly together.  Separately we will sink.  More generalities after:

Assumptions!  Assumptions! Assumptions!

The Pessimist Scenario assumes:

• No change in the Big Banks First policy regarding the financial sector
• The commodities bubble now underway is not met at the pass by government countermeasures.
• Health care reform is passed, but without the public option.
• No new or significant fiscal stimulus.

The Baseline Scenario assumptions we’ve already gone over:

• New significant stimulus, including help to states and localities
• A viable public option in the health care reform package
• Oil prices moderate, and the commodities bubble is short-lived

The Optimistic Scenario:

• A full public option included in health care
• Commodities bubble is short-lived
• Full reform of the banking sector, including structuring markets to exclude government guarantees of derivatives and breaking up the big banks
• Fiscal stimulus is paired with climate change alarm
• Revenue is enhanced with carbon taxes and higher rates on the wealthy.

All assume

• The consumer economy is buried under the rubble of the crash of the financial markets.
• An end to the Great Recession has to come on the back of public goods

Of no concern to us is:

• Strength or weakness in financial markets.  Lower stocks will lower effective borrowing rates.  Strength in stocks will gin up confidence.
• Dollar weakness or strength.  Dollar weakness mirrors strength in the price of commodities, particularly oil.  Although we have argued for a decade that the trade imbalance eventually means a weaker dollar, that is not so true in the short term in an economic crisis.
• Budget deficit.  The larger the deficit the more fiscal stimulus is likely to have been administered, but also the more pressure builds to raise interest rates and resist needed reforms.

Picking the trajectory

Demand Side has done well in its forecasts since we began podcasting in October 2007.  We rushed to print, or to pod, because we wanted to call the onset of the recession before too many others.  Not to worry.  Only after six months of the actual experience did the majority of economists, including all the Fed’s governors, recognize the beast.

Then there are those, like Chris Rupkey who suggest — as captured on Bloomberg — that the recession is already over.  Confusing his loafers for a subway sandwich.  This man is employed as chief financial economist for Bank of Tokyo-Mitsubishi and was obviously auditioning aggressively for idiot of the week.  But he was trying too hard.  Nobody is that …  Nobody can sincerely believe that an economy is growing again when it is losing over 300,000 jobs a month.  Sorry, Chris.

More worrisome are the shortfalls in the official forecasts from the Treasury and Administration.  A couple of weeks ago we pointed out that unemployment levels identified in the stress tests of banks have already been exceeded.  Now we are reminded, courtesy of Brad DeLong,

http://delong.typepad.com/sdj/2009/06/comment-for-the-economist-on-christina-romer-2009-the-lessons-of–1937.html

that the trajectory suggested in the back up to the stimulus bill is also being left in the dust.

Last December’s Unemployment-Rate Forecast and Outcome to Date

Source: Romer and Bernstein (2009).

Christina Romer is head of Obama’s Council of Economic Advisers.  Jared Bernstein is chief economist to the vice president.  They produced a paper last fall mapping unemployment going forward with and without stimulus.  Not surprisingly, the path for projected unemployment without stimulus arced above that for the economy with stimulus.  Unfortunately for all, both with and without lines are foothills compared to the steep slope of the outcome so far.

See the blog for the chart.

We are reminded of John Maynard Keynes’ observation that it is better to be approximately right than precisely wrong.  It is for this reason and the fact that we have a day job that we allow our old forecasts to stay up so long.

For context — we originally called the economic downturn in 2007 from the following perspective.  The low interest rates of the Greenspan era had papered over a basically weak economy — remember the so-called jobless recovery — with a housing bubble.  Yes, we did call it a bubble.  Look it up.  Without housing there was no engine of growth and the underlying weakness would be exposed.  We downgraded that forecast in early to mid 2008 because we saw the Fed had completely missed the boat and was addressing the problem with overhyped monetary policy.

No.  We did not see the systemic collapse of the financial sector until 2008, nor the problems from securitization until they were upon us.  But we did see it before the Fed and Treasury.  And we recognized ineffective policy response when it plainly didn’t work.  To our mind, the unwillingness of the Fed to admit a systemic crash occurred prevented them from setting the bones of the victim and persuaded them to continue the administration of antibiotics.  That approach continues to this day.  Perhaps the patient won’t die.  But this is living?

We were ready for the downturn in 2007 because we watch interest rates and oil prices very closely.  Both had risen in 2006 and into 2007 and the lags pointed to a turnaround to the down side.  The same thing happened in 1999-2000, when oil prices rose and Greenspan hiked interest rates right into the teeth of those price rises.  And we called it then — also too early.  Also not recognizing the role of corruption and fraud preying on the boom.

Although it called the dot.com crash and the housing crash, the predictors were the oil prices and the interest rates.  Believe us or not, we were among the few who didn’t buy the New Economy and among the few more who didn’t buy a house.  You can find it published in our previous web products.

We make a point of this, because we have a problem now.  The interest rate is low, but is contradicted by the availability of credit’s also being low.  Normally low interest means easy credit.  No longer — banks are prowling the night searching for hosts upon whom to feed and extend their non-useful lives.  The low interest they get from the Fed is not translating.

Only the government can borrow cheap and invest and that’s what they should be doing.  Until they do in sufficient scale to affect employment, there will be no turnaround.

The key to a long-term view is to realize the consumer is dead.  Thus the consumer-based economy will not recover.  Thus attempts to return to the status quo — for example, arguably the bank bailout scheme or targeting mortgage rates — will not work.  Housing and personal consumption expenditures will not lead the recovery as they have in the past.  Or if they do, that will mean we are in 2015.

In reflecting on this revision to the forecast we have come to realize that our baseline assumed policy choices that were not made, or at least have not yet been made.  In particular, we see the banks being put on taxpayer life support where we expected to see a restructuring.  The housing market has still not been given its demand side help.

We admit significant naivete.  Political realities may be beyond our ken.  Entrenched banking interests will not go meekly into the dark night. Looming depression to us is green shoots to others and so does not provide the appropriate motivation.

But we expected better, too, from the political change.  The economic object lesson of the complete failure of free market fundmentalism should have delivered a better response from policy makers.  We cannot believe that corporate welfarism is really the economic system that is going to carry the day.

That said, it is still a Democratic administration.  Historically, since the transition to peace after the Second World War, only Jimmy Carter has seen significant recession.  Employment has always increased and unemployment decreased with a Democrat in the White House.  Even Roosevelt after the first crash of market fundamentalism was able to turn things around.

Much is made of the lessons we have learned from the Depression.  To our mind, they are the wrong lessons, particularly at the Fed.  But the constituency of the Democrats is the demand side, so we expect when they are served, which we hope will be soon, things will pick up.

We’ll update the economic performance by president charts soon.  But this is a good point.  It is not because of a penetrating understanding of economic principles that Democrats do better, it is because they are politicians serving a constituency that matters.

Listen Now:

 Standard Podcasts: Play Now | Play in Popup | Download | Embeddable Player | Hits (193)

Plus George Soros.  The Demand Side forecast has been accurate beyond most.  This is an extension of the forecast and involves two new scenarios.

The low-tech forecast from Demand Side

All the high-flying forecast models have broken down.  The Demand Side forecast does better than the Bull Chips.

Not by brilliance, but because we are looking in the right direction.

First some news on the international scene.  From Robert Kuttner, full piece on the blog,

Here is a report of an incipient trade war between two of the world’s biggest exporters.

And here is George Soros on the impact of trade, plus a brief outlook from the astute billionaire and philanthropist.

SOROS

George Soros.  Much more of this interview from the BBC’s business daily at the end of today’s podcast.

Now to the forecast.

It is not that there is any particular sophistication in our forecast that it has done so well in difficult times, it is just that the forecast adopts the demand side perspective.

We’ll get to the details on the next podcast.  Today the theory.

Waiting for profits to increase before the economy can turn around, a canard repeated by last week’s Idiot of the Week, is ass-backwards.  The prospect of profit must increase, not the fact of profit.

The difference is the crucial difference.

Prospect is forward-looking and involves investment.  Entrepreneurs identify a need and fill it.  The investment is important.  it is the beginning of the business cycle, such as it exists.

The fact of profit means the investment is paying off, not that any new investment is required.  In fact, companies habitually maintain this profit by discouraging investment from competitors by one means or another.  Continued profits may mean a good investment has been made in the past, but it may equally mean a protected industry or the aging of the business cycle.

When we use the word investment, we are not referring to buying stocks, but in real investment.  Equities and debt issues from companies do not necessarily mean a new plant or better mousetrap — or more jobs.  They are purchases of existing investment and may very well be made for defensive purposes or to take advantage of a market advantage or some other reason.  Financial investments, in particular, are — as we have discovered to our dismay — not jobs-producing investment.

We use the concept of business cycle not because we put much stock in it as a prime descriptor of what is going on, but because it is familiar.  The concept is much more useful when applied to segments of the economy, the sectors, than it is when applied to the economy as a whole.  The entrepreneur is always looking forward, hence there is no particular reason for demand to fade unless the profits portion is too large or concentrated in cohorts that do not spend or invest.  Such unbalanced profits distribution simply drains the multiplier.

The past two recessions, for example, were brought on by speculative financial bubbles.  This is not a business cycle.  It is demand alternately stimulated and crushed by perceptions of wealth, as paper values of stocks and houses rise and fall.  It may stimulate investment, but because these perceptions are in a bubble, that investment is inevitably distorted.

One might argue that the investment boom of the late 1990s actually ameliorated the downturn in the 2000’s.  The real improvements in productivity reducing, perhaps, the decline in perceived wealth.  Be that as it may, and it is only speculation:

Demand creates the prospect of profit.  But what creates demand?  One might foresee that a water shortage will increase the demand for water, and so invest in that commodity.  But it must be effective demand.  You will not make a profit if people cannot create effective market demand by having the income to purchase.

In our current case, what creates demand is government spending and investment, and its translation into private investment.

One of the great calamities afflicting young economists is segregating C + I + G + NX.  Consumption plus investment plus government spending plus net exports.  On one hand, it is an accurate description of output, since it covers all the bases.  On the other hand, it is simply a labeling exercise which often gets its tags wrong.  C includes consumer durables, some education and health care.  G includes a lot of education, health care, infrastructure spending and activities such as national defense.  All of this might be better thought of as investment in a real form.  The I includes only investment by businesses and residential housing.  Business inventory may include chewing gum.

Not to beat this horse too long, but the return on education per dollar is about six times that of residential investment,

What creates demand?  Investment.  Government spending.  But it is also released by economic security.

You heard our simple modeling of the various stimulus packages where we highlighted the falling consumption function.  The consumption function is the proportion of new income that is spent.  In good times, with stable prospects, more of one’s income may be spent.  In bad times, with uncertain prospects, the tendency is to save.  You can see the savings rate spiking right now.  Private pullback has more than offset public stimulus.  We’ll have a comment on the savings rate and the flagellation of the American consumer in an upcoming podcast.

But let’s walk around this point a bit.

What is so important economically about the health care fix?  It will create security and return confidence in consumers.  So serious has been the body blow to the balance sheet of households that confidence will not return without a tangible reason.  Universal health care can be one reason.  Secondarily it will reduce the many types of burdens of profit-first health care delivery on the budgets of households, government and business.

What destroys demand?  Withdrawal of investment and government spending — and a falling consumption function.

All other things equal, one would use government spending to balance a drop in investment spending such as we have seen since 2007 with the drop in residential and business investment.  This has not happened.  Not only has there been the pull-back in the household and business sector we noted above, but the contraction in state and local government spending has also offset much of the federal expansion.  The financial collapse and credit crunch piled on an enormous subtraction in investment and employment far above what might have occurred in the expiration of a housing bubble absent the blunders in securitization, mortgage innovation and derivatives.

We could go on.

But to the forecast.

As we’ve said, our baseline forecast assumes policy advances at the federal level in three areas:

(a) Removing the zombie banks from the economic field and reforming the financial sector,

(b) Fiscal stimulus, and

(c) Improvements in social insurance and homeowners’ assistance.

We did not mention homeowners assistance this time, until now, but it is important not only to stabilize the consumption function but also to stabilize the housing market.  These clearly are not in place to the level we imagined, but neither have policymakers exhausted their allotment of time.  The response may come as the facts make themselves more clear.

Prospects going forward are uncertain to the degree that we are going to break out the forecast into optimistic, baseline, and pessimistic scenarios.  The differences are based entirely on government policy choices.  We recognize that economics is a science of human behavior.  The behavior of millions aggregated is, however, more predictable than that of a few in government or powerful corporations that may have idiosyncratic incentives.

You’ve heard some of the assumptions for the baseline.  We’ll go into the details, including the numbers in the next podcast.

Listen Now:

 Standard Podcasts: Play Now | Play in Popup | Download | Embeddable Player | Hits (209)

Can intrusive regulation or a “clearinghouse” manage the unmanageable?

06.13.09

Today. The Rule of Law or the Rule of Money.  It may be time to choose sides.

We take a Demand Side look at regulation in financial markets, with contributions from William Cohan, author of the new book House of Cards, and from Adam Leviton, Associate Professor of Law at Georgetown.

That comes after a few short notes of news.

U.S. consumer sentiment rose in June — to 69 from 68.7 in May.  Calculated Risk, our favorite source for news, says right now consumer sentiment is still very weak.  He suggests that consumer sentiment is a coincident indicator - it tells you what you pretty much already know.  Not so.  It is volatile, but leading.  Consumers said in November 2007 that the U.S. was already in recession or likely to go there.  Economists, ever the lagging indicator, got to fifty percent predicting recession about May 2008.

Consumer confidence in a typical recession lies in the 60 to 80 range.  In good times under Reagan it was in the 90 to 100 range.  Clinton saw long periods in this range, but also the 1997-2000 period in the 100 to 110 range.  After 2000, it has been very volatile, beginning at 100 but bouncing down to 80 and back, spending most of the time between 80 and 90 until it collapsed in mid-2007.

Retail Sales in May: On a monthly basis, retail sales increased 0.5% from April to May (seasonally adjusted), but sales are off 10.8% from May 2008 .  Much of the one-month April-May increase was due to higher gas prices.

Under old news, take another look at the mortgage market through the chart on the blog.  ARMS, option Arms and Alt-A’s will not see the peak of resets and recasts until 2011.  The outlook for housing is dreadful, absent the demand side remedies we have suggested.

And from the Fed:  The Beige book announcement : “reports from the twelve Federal Reserve District Banks indicate that economic conditions remained weak or deteriorated further during the period from mid-April through May. However, five of the Districts noted that the downward trend is showing signs of moderating. Further, contacts from several Districts said that their expectations have improved, though they do not see a substantial increase in economic activity through the end of the year.”

All news is abbreviated from our favorite blogger, Calculated Risk.

Now.

The response to recent the financial collapse from the Federal Reserve and Treasury displays how completely the nation’s politics have come under the rule of the banks and financial houses.

Nothing is more emblematic of the systemic collapse than the bailout of AIG.  To quote maintain order unquote the government took on hundreds of billions of dollars in private contracts, credit default swaps.  By taking on, what I mean is paying off.

Those were not regulated or organized by the government.  They did not come under the purview of the government.  The primary reason they were outside government jurisdiction and oversight was the insistence and direction of the very parties who engaged in the great majority of them.  Yet these are the very parties that the government, led by Fed Chairman Ben Bernanke, made whole.

The issue is now whether to create government regulation for credit default swaps.  The likelihood that a clearinghouse rather than an exchange will be the forum for trading these contracts clarifies the issue.  These are not securities by any standard.  They are contracts.  Every dollar we paid to backstop AIG, the chief seller of these contracts, went to fulfill an obligation we were not responsible for.  You might think we would now have the right to look at these contracts.  Sorry.  Secret.

Ben Bernanke has been given high marks for aggressive action, but here with assistance from the Treasury he has gone renegade, leaving the rule of law and acknowledging the rule of money.  Bernanke’s chief interest is, by whatever means possible, to make certain the banking institutions do not fail.  His academic work and intellectual capital is invested in the premise that the Great Depression could have been avoided if the banking institutions had been saved.  I am not a scholar of the Depression, but it does not take too much knowledge of history to know that the banks of that era — National City and the rest — were no better than the current crop.  Saving them would likely have done no more good than saving the megabanks of today in zombie form has done.

Bernanke is testing his theory in real time with our economic future and that theory is coming up thorns.

The public’s interest should be to reform the banking structure and function so it works, not bail out the big institutions, their officers and shareholders.  This supply side welfare is destined to fail.  Compare to GM and Chrysler.  Liabilities and prospects are not so much different in proportion between the auto makers and Bank of America, Citi or American Express, yet the official path forward involved a lot more front-end sacrifice for the car makers.  Too bad Ben Bernanke does not serve Big Auto.

Even now, after the indirect bailout through the AIG back door, which simply gave money to banks involving no obligation to repay, and after immense loans and guarantees from the Fed, the largest banks have left the business of productive lending, and are now in the business of gouging their current customers and maximizing the spread between borrowing from the U.S. central bank — us — at zero percent and lending to us at as high a level as possible, keeping in mind we are guaranteeing against our default.

This policy has little to do with rebuilding the common economy and is only a further burden on demand side recovery.  It is as Joseph Stiglitz says corporate welfarism.

An increase and strengthening of effective demand is the only route to economic recovery.  Muddling through as financial houses attempt to recoup their losses may satisfy enough among the powerful to be politically viable, but economically it is disaster.  It is a disaster for tens of millions of people in this country and many more across the globe.  By “politically viable” here, I mean it may not cost those in power their seats.  In a larger sense of “politically viable,” it is not, because it is capture of government by the corporate oligarchy and hence a defeat for representative democracy.

There are many who say this has already happened.  I am among them.  But this is a new level, where the rule of money, not of law is so egregious that it amounts to an explicit capture of the state.

Which brings us back to today’s subject:  Regulation.

Our principle for regulation at Demand Side is to structure markets and avoid additional intrusive inspection of market participants.  We can leave that to current laws on fraud and abuse.  All the time being aware that any restrictions are only the first shot in a game where the object of the participants is to discover a way around the restrictions.

What does it mean to structure the market?

First, What is the market?

The Market is nothing more, at its root, than the event of purchase and sale.  The product sold at this moment can be specified and standardized.  The venue of sale and conditions for inspection can be declared.  The terms of sale, warranty and so on can be standardized.  This market can be structured, made transparent and efficient.

The market, more abstractly, is sometimes taken to be the general condition of supply and demand. The market for transistors or the market for legal services, for example.  Neither this abstraction, nor the market participants are the market itself.  Also outside the market are the so-called externalities that afflict us and that we’ve argued should be internalized into the market by steps to bring their costs into the event of purchase and sale.

Mr. Market, the one who speaks to all the analysts, who then relay to us “The Market is saying,” “The Market wants … “  and so on, does not exist or speak in a way other than by the purchase-sale event.

Regulation should standardize products — apples should be graded, toasters forced to show they are electrically sound, automobiles built to appropriate standards, mortgages not fraudulent, derivatives be of such specifications that they can be traded like stocks and bonds.

A Financial Products Safety Commission with some other title that I don’t have at hand has already gotten preliminary approvals.  This is good.

With respect to market participants, Regulation should content itself with the New Deal stricture that participants not be so large they control the market by monopoly power.  They can also not be too big to fail.  Companies that are too big have escaped the gravitational pull of Market discipline.  Or they have become quasi planets themselves and threaten to pull the economy out of any stable orbit.

If regulation concentrates on what can and cannot be sold, in what venues it can and cannot be sold, then there is no problem with transparency, because government is describing the product not asking the seller to disclose.  Concern that financial innovation will be discouraged is misplaced, particularly in the rubble of the economy that innovation has produced.

There is no need for elaborate innovative financial products.  Hedging is a term straight out of gambling.  It refers to complicated bets, not investment.  Innovation is good in real products.  Innovations in pricing are what has turned mortgages and mortgage securities into toxic paper.

Enough for today.

Revisiting Ben Bernanke on the way out, however.  Once W’s chief economist, Bernanke was chosen by the financial industry to regulate them because he was devoted to the industry, not because he had any intention of acting on behalf of the public to manage the industry.  The Fed has control of monetary policy — one-half of economic policy.  It is the central bank, owned by their constituent private banks.  Well outside control by representative government, the Fed and Bernanke are operating on the dictum Big Banks First.

It is a recipe for disaster.  It cannot work.  It can only burden the economy and legitimate finance — to the detriment of all.

There is a very interesting interview on this subject by Andrea Orr at the Economic Policy Institute web site under the title Too complex to regulate?  Link online.

http://www.epi.org/analysis_and_opinion/entry/too_complex_to_regulate/#When:18:45:12Z

It begins quote:

Lawmakers seeking to prevent a repeat of the greatest financial meltdown since the Great Depression are considering ways to impose tighter regulations on big investment banks, where trading of credit default swaps and other derivatives reached unsustainable levels, helping bring the economy to the brink of disaster in 2008. Although they are commonly described as a form of insurance against defaults on home mortgages, the credit default swaps sold by A.I.G. and other firms became so widespread and complex over the past decade that it became almost impossible for the banks themselves, let alone outside regulators, to sort out the real value of these popular investments or assess the risk.

The rise in trading of derivatives … also underscores how far so many banks have strayed from what should be their main mission of providing lending to individuals and small businesses to help support growth in the general economy. Critics note that derivatives trading escalated to a rapid back-and-forth exchange of paper certificates where the value often had little connection to real economic activity.

If “Too Big to Fail” and “Too Connected to Fail” have become the slogans justifying the repeated government bailouts of some major banks and insurers such as A.I.G., these firms’ continued resistance to tighter government restrictions might be summed up as “Too Complex to Regulate.”

That complexity is neither necessary nor useful,

The interview features Robert Johnson, who previously served as managing director of Soros Fund Management and as chief economist for the Senate Banking and Budget Committees; and Sony Kapoor, a former investment banker who now heads a think tank concentrating on rethinking Development, Finance, and Environment.

One sample question:

Q. The trading of derivatives and credit default swaps, which are at the core of the current economic instability, are often presented as something that is too complex for the average person to understand. Why?

Johnson: They (the banks) make things hard to understand so they cannot be easily copied, which enables them to charge a higher profit margin. Complexity in and of itself doesn’t help them avoid regulation, but their declaration of instruments such as credit default swaps as stock when they are actually insurance contracts was a misnaming designed to avoid regulation.

Kapoor: Wall Street has a very strong incentive to make things as complex as possible. Complexity is used as a tool to fool regulators and to avoid tax. You set up new subsidiaries, you make new products that haven’t been addressed by regulations. Regulators are very hard-pressed to get any information. …

See the rest online

For further context we turn now to Adam Leviton, Associate Law Professor at Georgetown, here exerpted from NPR’s Fresh Air, speaking nominally to the question of credit cards.

LEVITON

Adam Leviton

And an additional note from William Cohan, author of the new book House of Cards, A Tale of Hubris and Wretched Excess on Wall Street.  Cohan also authored the best selling The Last Tycoons.

COHAN

William Cohan

And now something completely different.

We leave you with the observation that oil and some commodities are spiking back up again.  Is this Goldman Sachs going back to the well or a spontaneous new financial bubble?  Whatever it is it is not supply and demand for the real product.  Oil or whatever.

Here we have the view of Gerard Minack from Morgan Stanley Australia.

MINACK

For those of you who don’t speak fluent Australian, I’ll translate the key point.

“Look at the commodiites and look at the commodities where there are futures exchanges behind them, I.E. non-commercial players can get a hand on the price.  Voila!”

Voila indeed, a new bubble.

Listen Now:

 Standard Podcasts: Play Now | Play in Popup | Download | Embeddable Player | Hits (206)

Ptolmeic Astronomy

Idiot of the Week returns with David Malpass, now of Encima Global, formerly of Bear Stearns, and always with an eye to his constituents of strong dollar Republicans.

First some short words from three prominent economists:  Larry Summers on the economic outlook, Robert Shiller on why home prices may keep falling, and my favorite Joseph Stiglitz on socialism for the rich or the corporate safety net that means our politics is in danger.

Truth be known, one of my least favorite economists is the brilliant Lawrence Summers now of the National Economic Council, the president’s economic counterpart to the National Security Council.  Summers was one of the three amigos — Rubin, Greenspan and Summers — of the Clinton economic miracle.  In that position, he helped along the dismantling of the New Deal’s Glass-Steagall structure that has allowed the banks to become too big.  He was the chief proponent of Timely Targeted and Temporary, the stimulus that didn’t work in the early part of 2008.

We understand that Obama needed immediate legitimacy and credibility for his economic policies and that one of the ways he did it was hire the Clinton economic team.  Our objection to Summers is not entirely on policy grounds.  We feel a continual posturing going on in the pauses of his characteristic verbal cadence.

So a piece in the New York Times on Sunday was not entirely unwelcome to our eyes.

Obama’s Economic Circle Keeps Tensions High

By JACKIE CALMES Published: June 7, 2009 New York Times http://www.nytimes.com/2009/06/08/us/politics/08team.html?ref=business

WASHINGTON — President Obama was getting his daily economic briefing one recent morning when a fly distracted him. The president swatted and missed, just as the pest buzzed near the shoes of Lawrence H. Summers, the chief White House economic adviser. “Couldn’t you aim a little higher?” deadpanned Christina D. Romer, the chairwoman of the Council of Economic Advisers.

Mrs. Romer was joking, she said in an interview, adding, “There are only a few times that I felt like smacking Larry.” Yet few laughed in the president’s presence.

If the Oval Office incident was meant as a lighthearted moment, it also exposed the underlying tensions that have gripped Mr. Obama’s economic advisers as they have struggled with the gravest financial crisis since the Depression, according to several dozen interviews with administration officials and others familiar with the internal debates.

By all accounts, much of the tension derives from the president’s choice of the brilliant but sometimes supercilious Mr. Summers to be the director of the National Economic Council, making him the policy impresario of the team. The widespread assumption, from Washington to Wall Street, was that the job would be Mr. Summers’s way station until the president could name him chairman of the Federal Reserve when Ben S. Bernanke’s term expires early next year.

And the Times Piece goes on, though it does little to back up the claim of tensions.  Whether Summers will go to the Fed or not is very much up in the air.  I would be surprised unless he convinces somebody that he would not take the job and run the world with it.

For context, here is some audio of Summers from the BBC’s Business Daily talking about the economy.

SUMMERS

Larry Summers, Chair of the National Economic Council.

Now to Housing.

One of the recent claims is that house prices are falling less rapidly than they were before.  Declining at a slower pace, is the term.  We believe this is wrong.  Even in the math.  If zero were the base, it would be conceivable.  But house prices are not going to fall to zero.  They have some positive value.  If this positive value is in any way significant, then the denominator of the percentage fall gets smaller faster than in the case of a zero base.

It’s too damn bad the solution chosen was not an effective Home Owner’s Loan Corporation or effective protection in bankruptcy.  Instead it is the supply side of the market that is being salted with free money from the Fed to bring down mortgage rates.  This may help those in good shape to refinance and generate some better cash flow, but that is going directly into the savings account and is not going to help demand.

Here is housing expert and noted economist Robert Shiller’s take.  This is the Shiller of the Case-Shiller Home Price Index.  From the same edition of the New York Times.

Why Home Prices May Keep Falling, by Robert Shiller, Commentary, NY Times: http://www.nytimes.com/2009/06/07/business/economy/07view.html

Home prices in the United States have been falling for nearly three years, and the decline may well continue for some time.

Even the federal government has projected price decreases through 2010.

…

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient. … If people acted as the efficient-market theory says they should, prices would come down right away, not gradually over years, and these cycles would be much shorter.

But something is definitely different about real estate. Long declines do happen with some regularity. And … we still appear to be in a continuing price decline. … One could easily believe that people are a little slower to sell their homes than, say, their stocks. But years slower?

Several factors can explain the snail-like behavior of the real estate market. An important one is that sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers … have no reason to hurry because they are not really leaving the market.

Furthermore, few homeowners consider exiting the housing market for purely speculative reasons. … And they don’t like shifting from being owners to renters… Among couples…,… any decision to sell and switch to a rental requires the assent of both partners. Even growing children, who may resent being shifted to another school district and placed in a rental apartment, are likely to have some veto power.

In fact, most decisions to exit the market in favor of renting are not market-timing moves. Instead, they reflect the growing pressures of economic necessity. This may involve foreclosure or just difficulty paying bills, or gradual changes in opinion about how to live in an economic downturn. This dynamic helps to explain why, at a time of high unemployment, declines in home prices may be long-lasting…

Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.

There’s more.  Links online.

Now to the best economist of the twenty-first century.  Joseph Stiglitz.

Stiglitz was at the Council of Economic Advisers in the 1990s, where Christina Romer now sits.  He also served at the World Bank.  Stiglitz and Summers were not on the same page in the Clinton White House.   This article from Project Syndicate.

Joseph Stiglitz in an article on Project Syndicate http://www.thejakartapost.com/news/2009/06/09/america039s-socialism-rich-corporate-welfarism.html

America has expanded its corporate safety net in unprecedented ways, from commercial banks to … automobiles, with no end in sight. In truth,… this is an extension of long standing corporate welfarism. The rich and powerful turn to the government to help them whenever they can, while needy individuals get little social protection.

We need to break up the too-big-to-fail banks; there is no evidence that these behemoths deliver societal benefits that are commensurate with the costs they have imposed on others. And, if we don’t break them up, then we have to severely limit what they do. They can’t be allowed to do what they did in the past - gamble at others’ expenses.

This raises another problem with America’s too-big-to-fail, too-big-to-be-restructured banks: they are too politically powerful. Their lobbying efforts worked well, first to deregulate, and then to have taxpayers pay for the cleanup. Their hope is that it will work once again to keep them free to do as they please, regardless of the risks for taxpayers and the economy. We cannot afford to let that happen.

Joseph Stiglitz.  As I read it, Stiglitz is saying the financial crisis is becoming a political crisis and may well take the political process down.

Mark Thoma’s interview simulation with Ben Bernanke is also very much worth reading, but it would be better with a good Bernanke voice impersonation, which I do not have.  Catch the link on the blog.

http://economistsview.typepad.com/economistsview/2009/06/-bernanke-current-economic-and-financial-conditions-and-the-federal-budget-.html

Now to idiot of the week.

We considered on this edition of idiot of the week comparing David Malpass to the Ptolmeic astronomers, an image I’ve used in the past for supply siders who must invent ever more elaborate and complicated intellectual machinery to do what demand side does so simply, easily, effectively and convincingly.  But Brad DeLong hijacked the Ptolmeic astronomy analogy this week with a piece in the Times attacking Judge Richard Posner and his Chicago School apology A Failure of Capitalism.

We skewered Posner on Idiot back in April for the same book, though I see we misidentified him as Robert Posner.  Not the same.

Here’s DeLong on Posner.

DELONG

Back to Idiot of the Week, not Posner, Not DeLong, but David Malpass.  I started to compare Malpass to the Ptolmeic astronomers because of his insistence on making a way for the facts to fit an unworkable scheme.

MALPASS

Seems to make sense.  Does it work.

Here is Malpass in August 2008, nine months ago, just before the systemic collapse of the financial sector.  As I mentioned, Malpass was chief economist at Bear Stearns.  ‘nuf said.

MALPASS

David Malpass, strong dollar, corporate welfarist, IDIOT OF THE WEEK!

We conclude with this question.  If Citi fails, what happens to the toxic stuff on the Fed’s balance sheet?  Can the Fed become a zombie?

Footnote:

Ptolmeic Astronomy

1. All motion in the heavens is uniform circular motion.
2. The objects in the heavens are made from perfect material, and cannot change their intrinsic properties (e.g., their brightness).
3. The Earth is at the center of the Universe.
4. The 55 concentric circles around the earth are set in motion by the prime mover outside the last.

Listen Now:

 Standard Podcasts: Play Now | Play in Popup | Download | Embeddable Player | Hits (207)