demandside

Sliding the sludge from the Fed to the Treasury

demandside — Tue, 30 Jun 2009 20:11:30 +0000

plus Bad Economics with DeLong and Krugman and a note on the public option from Uwe Reinhardt

07.01.09

The current fable that is being promulgated in Washington is that the Fed was an unwilling participant in backstopping the banks. Taking onto its balance sheet the toxicity of the securitized mess and the troubles of AIG is reportedly fiscal policy that was somehow delegated to the Fed in an emergency. It is a concern on the Street that the Fed is no longer quote independent unquote.

The spin is supposed to end up with the Treasury taking on the garbage that the Fed has contracted for. What a great idea!

But this is blarney. Ben Bernanke is the primary proponent of the save the banks first strategy for dealing with a financial breakdown. He made his academic reputation on this theory and he spared no effort in attempting to prove it when he became top banker. He was no unwilling participant.

It would be a big mistake to ratify his screw-up by letting the taxpayer accept it through the Treasury.

Bernanke was the draftsman of the scheme, albeit not the architect. In fact, the Fed is not independent. It is captive to the banks. Bernanke was chosen for his banks-first position and he has followed their line closely.

As Chris Whalen of Institutional Risk Analytics said in the testimony we read last time,

the views of the existing financial regulatory agencies and particularly the Federal Reserve Board and Treasury, should get no consideration from the [Congress], since the view of these agencies are largely duplicative of the views of JPM and the large OTC dealers .

We will continue with Whalen’s testimony in a moment, but the larger point is this. There is no getting by with a financial sector that runs the central bank. There is no realistic scenario in which the banks get bailed out of their incredible blunders and the economy survives for the rest of us. The current window dressing notwithstanding.

This answer is a favorite on Wall Street because it continues the employment of those who work there. This is not efficient, nor even viable, in the long term, nor in the medium term, and is pretty hard to choke down in the short term.

It is not a choice between the GOOD, a corporate solution which may be a bit less efficient and a bit more costly, and the BEST, a restructuring and resolution of things. It is a choice between fixing it now or fixing it later at a higher cost. Or if it doesn’t get fixed, breaking the economy entirely.

Now we continue with excerpts of Chris Whalen’s testimony before a subcommittee of the Senate Banking Committee, link online, or just google Chris W-H-A-L-E-N Senate Banking Testimony June 22.

3) Basis Risk & Derivatives:

The entire family of OTC derivatives must be divided into types of contracts for which there is a clear, visible cash market and those contracts for which the basis is obscure or non-existent. A currency or interest rate or natural gas swap OTC contract is clearly linked to the underlying cash markets or the “basis” of these derivative contracts, thus both buyers and sellers have reasonable access to price information, and the transaction meets the basic test of fairness that has traditionally governed American financial regulation and consumer protection.

With CDS and more obscure types of CDOs and other complex mortgage and loan securitizations, however, the basis of the derivative is non-existent or difficult/expensive to observe and calculate, thus the creators of these instruments in the dealer community employ “models” that purport to price these derivatives. The buyer of CDS or CDOs has no access to such models and thus really has no idea whatsoever how the dealer valued the OTC derivative. More, the models employed by the dealers are almost always and uniformly wrong, and are thus completely useless to value the CDS or CDO. The results of this unfair, deceptive market is visible for all to see – and yet the large dealers, including JPM, BAC and GS continue to lobby the Congress to preserve the CDS and CDO markets in their current speculative form.

In my view, CDS contracts and complex structured assets are deceptive by design and beg the question as to whether a certain level of complexity is so speculative and reckless as to violate US securities and anti-fraud laws. That is, if an OTC derivative contract lacks a clear cash basis and cannot be valued by both parties to the transaction with the same degree of facility and transparency as cash market instruments, then the OTC contact should be treated as fraudulent and banned as a matter of law and regulation. Most CDS contracts and complex structured financial instruments fall into this category of deliberately fraudulent instruments for which no cash basis exists.

What should offend the Congress about the CDS market is not just that it is deceptive by design, which it is; not just that it is a deliberate evasion of established norms of transparency and safety and soundness, norms proven in practice by the great bilateral cash and futures exchanges over decades; not that CDS is a retrograde development in terms of the public supervision and regulation of financial markets, something that gets too little notice; and not that CDS is a manifestation of the sickly business models inside the largest zombie money center banks, business values which consume investor value in multi-billion dollar chunks. No, what should bother the Congress and all Americans about the CDS market is that is violates the basic American principle of fairness and fair dealing.

…

To that point, consider the judgment of Benjamin M. Friedman, writing in The New York Review of Books on May 28, 2009, “The Failure of the Economy & the Economists.” He describes the CDS market in a very concise way and in layman’s terms. I reprint his comments with the permission of NYRB:

“The most telling example, and the most important in accounting for today’s financial crisis, is the market for credit default swaps. A CDS is, in effect, a bet on whether a specific company will default on its debt. This may sound like a form of insurance that also helps spread actual losses of wealth. If a business goes bankrupt, the loss of what used to be its value as a going concern is borne not just by its stockholders but by its creditors too. If some of those creditors have bought a CDS to protect themselves, the covered portion of their loss is borne by whoever issued the swap.

“But what makes credit default swaps like betting on the temperature is that, in the case of many if not most of these contracts, the volume of swaps outstanding far exceeds the amount of debt the specified company owes. Most of these swaps therefore have nothing to do with allocating genuine losses of wealth. Instead, they are creating additional losses for whoever bet incorrectly, exactly matched by gains for the corresponding winners. And, ironically, if those firms that bet incorrectly fail to pay what they owe-as would have happened if the government had not bailed out the insurance company AIG-the consequences might impose billions of dollars’ worth of economic costs that would not have occurred otherwise.

“This fundamental distinction, between sharing in losses to the economy and simply being on the losing side of a bet, should surely matter for today’s immediate question of which insolvent institutions to rescue and which to let fail. The same distinction also has implications for how to reform the regulation of our financial markets once the current crisis is past. For example, there is a clear case for barring institutions that might be eligible for government bailouts-including not just banks but insurance companies like AIG-from making such bets in the future. It is hard to see why they should be able to count on taxpayers’ money if they have bet the wrong way. But here as well, no one seems to be paying attention.”

4) CDS & Systemic Risk

While an argument can be made that currency, interest rate and energy swaps are functionally interchangeable with existing forward instruments, the credit derivative market raises a troubling question about whether the activity creates value or helps manage risk on a systemic basis. It is my view and that of many other observers that the CDS market is a type of tax or lottery that actually creates net risk and is thus a drain on the resources of the economic system. Simply stated, CDS and CDO markets currently are parasitic. These markets subtract value from the global markets and society by increasing risk and then shifting that bigger risk to the least savvy market participants.

Seen in this context, AIG was the most visible “sucker” identified by Wall Street, an easy mark that was systematically targeted and drained of capital by JPM, GS and other CDS dealers, in a striking example of predatory behavior. Treasury Secretary Geithner, acting in his previous role of President of the FRBNY, concealed the rape of AIG by the major OTC dealers with a bailout totaling into the hundreds of billions in public funds.

Indeed, it is my view that every day the OTC CDS market is allowed to continue in its current form, systemic risk increases because the activity, on net, consumes value from the overall market - like any zero sum, gaming activity. And for every large, overt failure in the CDS markets such as AIG, there are dozens of lesser losses from OTC derivatives buried by the professional managers of funds and financial institutions in the same way that gamblers hide their bad bets. The only beneficiaries of the current OTC market for derivatives are JPM, GS and the other large OTC dealers.

It is a bitter reality that we have bailed out a predatory and parasitic activity, and that activity continues to drain the economy.

June 26, 2009, 3:14 pm A thought about macroeconomics Paul Krugman http://krugman.blogs.nytimes.com/2009/06/26/a-thought-about-macroeconomics/

Brad DeLong and Paul Krugman have been sort of tag-teaming the Great Ignorance which seems to have overtaken much of the economics profession — the “rediscovery” of old fallacies about deficit spending and interest rates, presented as if they were deep insights, the bizarre arguments presented by economists with sterling reputations.

Now, no doubt this is partly about politics, which, as Brad says, makes some people stop thinking like economists.

But there’s something else, says Krugman. Doing real macroeconomics — the tradition that runs through Keynes and Hicks — actually involves thinking about interdependent markets, in a way many economists never learn to do. At minimum you have to keep straight the relationships among the markets for goods, bonds, and money; if you try to think about either interest rates or the price level in terms of just a single market — interest rates determined by supply and demand for lending, price level by quantity of money, full stop — you get it all wrong, especially in times like the present.

…

It’s a sad story, says Krugman, and it may have real negative consequences for the world.

Brad DeLong

returns the serve

http://delong.typepad.com/sdj/2009/06/paul-krugman-urges-greg-mankiw-to-pay-more-attention-to-quality-control.html

citing a Krugman post on health care.

To DeLong, the thing to note about the economists–the Mankiws, the Lucases, the Beckers, the Barros, and all the rest–who have pledged allegiance to the Republican Party this year is how much they have stopped thinking like economists. When an economist thinks about American health care, he or she begins with what we give up and what we get: we give up $1 trillion dollars in real resources a year relative to other countries, and we get… what?… not much.

But this is not how Mankiw or Becker approach it. When an economist thinks about nominal demand, he or she thinks about (a) the money stock and (b) the determinants of velocity–the incentives people have to spend their money quickly or to tend to hoard it. But that is not how Lucas or Barro think when they claim that fiscal policy cannot affect nominal demand.

that from Brad DeLong.

But the Barros, Lucases, Beckers and Mankiws are to me simply hacks selected for their politics, not economists who have selected political parties. The chairs they occupy and the position in the profession are well feathered by the interests they promote and defend.

To complete the story, here is the piece which occasioned the DeLong-Krugman observations.

Paul Krugman:

Live long and prosper: Via Andrew Gelman, Greg Mankiw describes the use of international comparisons of life expectancy as part of the argument for reform as “schlocky.” Grrr. Not many serious advocates of reform use the life expectancy differences to argue that health care is clearly better in other advanced countries than it is in the United States; when it comes to care, the general assessment seems to be that it’s comparable, with no advanced country having a clear advantage. The reform argument actually goes like this:

1. Every other advanced country has universal coverage, protecting its citizens from the financial risks of uninsurance as well as ensuring that everyone gets basic care.

2. They do this while spending far less on health care than we do.

3. Yet they don’t seem to do worse in overall health results.

So Greg suggests that maybe it’s all because we have an unhealthier lifestyle — what Ezra Klein calls the well-we-eat-more-cheeseburgers argument…. [W]e’re spending 6 or 7 percent of GDP more on health care than other countries — call it a trillion dollars a year — without any clear advantage. That’s not the sort of thing you wave away with a casual suggestion that maybe we have bad habits…. [Second,] people have thought about this — and tried hard to measure it… the huge McKinsey Research Institute… tried to quantify the costs of lifestyle-related issues — and found that it didn’t explain much. Third, read Atul Gawande!

Bottom line: this is the most important domestic policy issue we face. It deserves more than casual just-so stories about how the kids American health care might, despite all appearances, be all right.

Now to clear the taste of bad economics from our mouths, let’s turn to a real expert, Uwe Reinhardt from Princeton, an acknowledged expert and clear thinker.

REINHARDT

So.

Good economics requires a health care solution. The public option is a health care solution. It is required.

Banking regulation with Chris Whalen and others

demandside — Sat, 27 Jun 2009 21:49:27 +0000

Plus the incredible climbing savings rate … or is it so incredible? And Idiot of the Week. Bank of Tokyo Mitsubishi is going to send their economists in waves until we pick one. So we do. Ellen Zentner!

Before we get to that and the rest, a dip into the week’s happenings in the nation’s capitol. The inestimable Barney Frank introduced the concept of weaponized Keynesianism in this segment from a Boston radio show.

FRANK

Weaponized Keynesianism indeed.

The president doesn’t need much cover. The next day he announced a veto threat. As contexted by Stan Collender:

The White House yesterday did something that should truly warm the hearts of deficit hawks everywhere: it threatened to veto the 2010 military authorization bill over two big spending issues — the F22 and the alternate engine for the F35.

Although both of these programs were questioned for years by the Bush White House, Congress kept insisting that the Pentagon spend the money anyway and the president always went along. This year, The F22 was a target of Secretary of Defense Robert Gates ….

The Obama veto threat is a much bigger deal than it seems.

First, the White House didn’t have to do it. It’s threatening to veto an authorization bill that, even if it’s adopted, won’t actually spend any money. That will happen later in the year with the appropriation. That means that the administration is drawing the line now and trying to stop the spending for both programs from gaining any momentum. That’s a good sign…. Second, the veto threat came in the midst of the much bigger fight for the White House on health care. The White House could have backed away so that it didn’t antagonize the members who support these programs… but it didn’t. Again, another good sign for deficit hawks who want proof of the president’s devotion to reduced spending…

Now , we decry the flagellation of the American saver

The citizen has taken a beating from the self-righteous in recent days for not saving in the 1990s and the first part of this decade. Americans became profligate in their own eyes and the eyes and the eyes of many at the same time their incomes were stagnating. But is that the real story? Jan Hatzius, chief economist at the great evil, Goldman Sachs, had this to say to Tom Keene on Bloomberg.

HATZIUS

Indeed. Big new investment in stocks and housing exactly corresponds to the decline in savings. In fact, (blush) many people thought they were being smart savers. And many who sold the stocks or houses agreed. Remember the piggy bank for retirement the house was supposed to be? Remember how if you took any period of seven consecutive years, stocks never went down. Well, both turned out to be false promises and — not coincidentally, we would argue — disappointed at precisely the wrong time.

Equity peddlers made this explicit pitch — save in your stocks. Your portfolio, as it were. Your house.

Now you have to deal with us. The demand siders. We look at the savings rate as the inverse of the consumption function. When the savings rate goes up, the consumption function goes down. But it is only in a private goods first society that you get beaten up for not spending. From the demand side, saving is not bad news if that savings is captured and turned into investment. It is bad news if it is not, it just turns things into even more sluggish growth.

Unfortunately, much of the so-called saving is de-leveraging. That is, payilng down debts. And as such it does nothing to create investment. Credit and money taken together produce demand. If credit is contracting and money is expanding, demand is not going to set records.

But that is another story. And we already have another story. The derivatives market and banks focusing on the testimony of Chris Whalen, of Institutional Risk Analytics. First, however, Idiot of the Week!

ZENTNER

No, Ellen, it does not take one quarter of zero point two percent growth to mean the end of the Great Recession. If employment is collapsing at 300,000 plus. That is contraction. We don’t care if it is not one of your coincident components. Ellen Zentner. Bank of Tokyo Mitzubishi! Idiot of the week!

Now to Chris Whalen. Whalen testified before the Senate Committe on Banking, Housing and Urban Affairs last week and I spent a good deal of time isolating those remarks for you. Because I read his testimony beforehand. Unfortunately, he did not stick to his script. Here’s a capsule of what he said. I’ll come back and flesh it out with a bit of his prepared testimony.

WHALEN

That is Chris Whalen, who is as good as there is on banks. When he strays into economics, like most bankers, he gets lost. But here he is very good.

Now from his prepared testimony, link here: http://banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=1f354557-7b1f-4ffd-9014-e80435bc55b8

quoting:

When you think about OTC derivatives, you must include both conventional interest rate and currency swap contracts, single name credit default swap or “CDS” contracts, and the panoply of specialized, customized gaming contracts for everything and anything else that can be described, from the weather to sports events to shifting specific types of risk exposure from one unit of AIG to another. You must also include the family of complex structured financial instruments such as mortgage securitizations and collateralized debt obligations or “CDOs,” for these too are OTC “derivatives” that purport to derive their “value” from another asset or instrument.

2) Bank Business Models & OTC

Perhaps the most important issue for the Committee to understand is that the structure of the OTC derivatives market today is a function of the flaws in the business models of the largest dealer banks, including JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Goldman Sachs (NYSE:GS). These flaws are structural, have been many decades in the making, and have been concealed from the Congress by the Fed and other financial regulators.

The fact that today OTC derivatives trading is the leading source of profits and also risk for many large dealer banks should tell the Congress all that it needs to know about the areas of the markets requiring immediate reform. Many cash and other capital markets operations in these banks are marginal in terms of return on invested capital, suggesting that banks beyond a certain size are not only too risky to manage – but are net destroyers of value for shareholders and society even while pretending to be profitable.

Simply stated, the supra-normal returns paid to the dealers in the closed OTC derivatives market are effectively a tax on other market participants, especially investors who trade on open, public exchanges and markets. The deliberate inefficiency of the OTC derivatives market results in a dedicated tax or subsidy meant to benefit one class of financial institutions, namely the largest OTC dealer banks, at the expense of other market participants. Every investor in the global markets pay the OTC tax via wider bid-offer spreads for OTC derivatives contracts than would apply on an organized exchange.

The taxpayers in the industrial nations also pay a tax through periodic losses to the system caused by the failure of the victims of OTC derivatives and complex structured assets such as AIGs and Citigroup (NYSE:C). And most important, the regulators who are supposed to protect the taxpayer from the costs of cleaning up these periodic loss events are so captive by the very industry they are charged by law to regulate as to be entirely ineffective. As the Committee proceeds in its deliberations about reforming OTC derivatives, the views of the existing financial regulatory agencies and particularly the Federal Reserve Board and Treasury, should get no consideration from the Committee since the view of these agencies are largely duplicative of the views of JPM and the large OTC dealers .

3) Basis Risk & Derivatives:

The entire family of OTC derivatives must be divided into types of contracts for which there is a clear, visible cash market and those contracts for which the basis is obscure or non-existent. A currency or interest rate or natural gas swap OTC contract are clearly linked to the underlying cash markets or the “basis” of these derivative contracts, thus both buyers are sellers have reasonable access to price information and the transaction meets the basic test of fairness that has traditionally governed American financial regulation and consumer protection.

With CDS and more obscure types of CDOs and other complex mortgage and loan securitizations, however, the basis of the derivative is non-existent or difficult/expensive to observe and calculate, thus the creators of these instruments in the dealer community employ “models” that purport to price these derivatives. The buyer of CDS or CDOs has no access to such models and thus really has no idea whatsoever how the dealer valued the OTC derivative. More, the models employed by the dealers are almost always and uniformly wrong, and are thus completely useless to value the CDS or CDO. The results of this unfair, deceptive market are visible for all to see – and yet the large dealers, including JPM, BAC and GS continue to lobby the Congress to preserve the CDS and CDO markets in their current speculative form.

…

4) CDS & Systemic Risk

While an argument can be made that currency, interest rate and energy swaps are functionally interchangeable with existing forward instruments, the credit derivative market raises a troubling question about whether the activity creates value or helps manage risk on a systemic basis. It is my view and that of many other observers that the CDS market is a type of tax or lottery that actually creates net risk and is thus a drain on the resources of the economic system. Simply stated, CDS and CDO markets currently are parasitic. These market subtract value from the global markets and society by increasing risk and then shifting that bigger risk to the least savvy market participants.

My takeaway from this is that banks involved in this sort of gaming are not producing anything or supporting production, but are simply a drain on the rest of the economy. Supporting them in this effort is only stretching out the problem.

06.23.09 High Speed Rail Senate Hearing - Part 3 of 3

demandside — Fri, 26 Jun 2009 17:17:15 +0000

Demand Side special relay of Part 3 of an unedited version of a Senate subcommittee’s hearing entitled

“High-Speed Passenger Rail: How Fast Will It Get Here?” http://commerce.senate.gov/public/index.cfm?FuseAction=Hearings.Hearing&Hearing_ID=648ade58-c0fa-43db-82b3-9e71eefa9259

The hearing took place on Tuesday, June 23. Demand Side relays an unedited version of this meeting in three parts. Today’s includes opening statements by members, and witnesses who are, in order:

Edward G. Rendell Governor of Pennsylvania Co-Chair, Building America’s Future

Robert Eckels Chairman Texas High Speed Rail and Transportation Corporation

Joseph Szabo Administrator Federal Railroad Administration

Susan Fleming Director of Physical Infrastructure Issues GAO

joseph Boardman President and Chief Executive Officer Amtrak

Tom Skancke Commissioner National Surface Transportation Policy and Revenue Study Commission

06.23.09 High Speed Rail Senate Hearing = Part 2 of 3

demandside — Fri, 26 Jun 2009 14:35:54 +0000

AUDIO ADJUSTED Demand Side special relay of Part 2 of an unedited version of a Senate subcommittee’s hearing entitled

“High-Speed Passenger Rail: How Fast Will It Get Here?” http://commerce.senate.gov/public/index.cfm?FuseAction=Hearings.Hearing&Hearing_ID=648ade58-c0fa-43db-82b3-9e71eefa9259

The hearing took place on Tuesday, June 23. Demand Side relays an unedited version of this meeting in three parts. Today’s includes opening statements by members, and witnesses who are, in order:

Edward G. Rendell Governor of Pennsylvania Co-Chair, Building America’s Future

Robert Eckels Chairman Texas High Speed Rail and Transportation Corporation

Joseph Szabo Administrator Federal Railroad Administration

Susan Fleming Director of Physical Infrastructure Issues GAO

joseph Boardman President and Chief Executive Officer Amtrak

Tom Skancke Commissioner National Surface Transportation Policy and Revenue Study Commission

06.23.09 High Speed Rail Senate Hearing - Part 1 of 3

demandside — Wed, 24 Jun 2009 18:39:58 +0000

Demand Side special relay of Part 1 of an unedited version of a Senate subcommittee’s hearing entitled

“High-Speed Passenger Rail: How Fast Will It Get Here?” http://commerce.senate.gov/public/index.cfm?FuseAction=Hearings.Hearing&Hearing_ID=648ade58-c0fa-43db-82b3-9e71eefa9259

The hearing took place on Tuesday, June 23. Demand Side relays an unedited version of this meeting in three parts. Today’s includes opening statements by members, and witnesses who are, in order:

Edward G. Rendell Governor of Pennsylvania Co-Chair, Building America’s Future

Robert Eckels Chairman Texas High Speed Rail and Transportation Corporation

Joseph Szabo Administrator Federal Railroad Administration

Susan Fleming Director of Physical Infrastructure Issues GAO

joseph Boardman President and Chief Executive Officer Amtrak

Tom Skancke Commissioner National Surface Transportation Policy and Revenue Study Commission

The hearing is brought to order by Senator Rockefeller who references a rail accident which took place on June 22, in which a Washington D.C. Metro train slammed into the rear of another during the evening rush hour on Monday, killing at least six people and injuring at least 64 others in the worst disaster in the 33-year history of Washington’s rapid transit system.

Lautenberg, Rockefeller, Thune, Hutchinson and Warner.

Equality as economically efficient with Brad DeLong

demandside — Tue, 23 Jun 2009 19:07:29 +0000

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

The Federal Reserve Bank of Philadelphia has released the coincident indexes for the 50 states for May 2009. In the past month, the indexes have increased in one state (North Dakota), decreased in 47, and were unchanged in the other two (South Dakota and Vermont), for a one-month diffusion index of -92. Over the past three months, the indexes have increased in one state (again, North Dakota) and decreased in the other 49 states, for a three-month diffusion index of -96.

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.”

Note: missing up to six dividend payments was allowed under the TARP agreement, so this isn’t a default.

White House: 10 percent unemployment within months

WASHINGTON (AP) — The White House says double-digit unemployment is coming sooner than previously acknowledged.

White House spokesman Robert Gibbs says the president expects the nation will reach 10 percent unemployment within the next few months.

In an interview with Bloomberg last week, President Barack Obama said he expected the nation to reach 10 percent unemployment sometime this year.

The current unemployment rate reached a 25-year high of 9.4 percent in May.

While many analysts expect the recession to end by late summer, they warn that unemployment will stay high into next year.

And finally,

State income-tax revenue fell 26% in the first four months of 2009 compared to the same period last year, according to a survey of states by the nonprofit Nelson A. Rockefeller Institute of Government.

http://www.rockinst.org/pdf/government_finance/state_revenue_report/2009-06-18-state_revenue_flash.pdf

The report … is one of the most up-to-date measures of how deep the recession is digging into Americans’ wallets and, consequently, state coffers. … The time span notably includes the April 15 deadline for filing taxes, a critical time for states to collect revenues.

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.

Forecast II

demandside — Mon, 22 Jun 2009 04:54:20 +0000

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.

Forecast I

demandside — Tue, 16 Jun 2009 05:07:28 +0000

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,

Left Out in Europe by Robert Kuttner http://www.huffingtonpost.com/robert-kuttner/left-out-in-europe_b_215437.html

The European left, such as it is, got clobbered in the recent elections for the European parliament. In the next parliament, center-right parties will have almost twice as many seats as social democrats. Of left parties, only the Greens gained slightly. Far-right nationalistic parties picked up strength.

This should hardly come as a surprise. Over the past generation, especially in places like Britain, Germany, and the Netherlands, Europe’s center-left has worked hard to neuter itself as an opposition force, rivaling free market parties in an embrace of high finance and heedless globalization.

…

The EU, once a possible instrument of social democracy on one continent, itself has become something of a Trojan Horse. Its basic document, the Maastricht Treaty, makes free movement of capital, goods, services, and persons a core constitutional doctrine. Social protections are secondary.

Robert Kuttner

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

http://economistsview.typepad.com/economistsview/2009/06/china-accused-of-predatory-pricing-in-india.html China accused of predatory pricing Amy Kazmin Financial Times June 16

India’s small and medium enterprises have warned that they are suffering because of cheap imports from China. They are urging New Delhi to accelerate anti-dumping investigations and impose tougher safety and quality checks on Chinese products. The appeal for greater government protection came amid rising tensions between New Delhi and Beijing over trade, after a high-profile dispute over an Indian ban on Chinese made toys.

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

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.

Regulation and Market Structure

demandside — Fri, 12 Jun 2009 20:23:03 +0000

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.

Economists Summers, Shiller, Stiglitz and Idiot of the Week — David Malpass

demandside — Wed, 10 Jun 2009 03:24:30 +0000

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

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