Greenspan concedes

Tracy W, I think you’re right about one thing, anyway: When we reach a point where Alan Greenspan attributes the current crisis to Republican ideology, I’d say we’ve achieved functional unanimity on the subject in the U.S.

I will leave others more expert on American politics than me to make up their own minds on that hypothesis

So you’re learning humility? I guess that’s good.

I’ve found when I’m learning how to *do* something, I learn faster when I confidently explain on the internet how I’m already doing it. People will explain why I’m wrong.

“I use an exponential distribution for deaths because mostly they come independently of each other.”

“No, use a gompertz distribution because people don’t live forever.” People don’t live forever. Oh yes. Exponential might work for how many seconds until the next death, but each individual person doesn’t keep the same chance of dying, the older they get the more likely they are to die soon.

But when it’s a clash of ideologies then most of what I can learn is _how to make the arguments_. Completely independent of whatever truth they might have. And so it’s almost useless to argue with people who have a different ideology, because what they can teach me is how to better make their arguments, arguments I have no use for.

If you’re the same Tracy I’ve discussed things with before here, you come from an intense libertarian free-market ideology. This is not something that can be true or false, it’s a set of judgements about what’s right and wrong, not about reality at all. Regardless whether we can actually make these ideas work, an increasing number of people believe in them and so we should pay attention to the ideas and look for ways to make them work because of that. Also, when we can use libertarian language to describe what we were going to do anyway, that’s a plus.

As I understand it, your a priori beliefs say that free markets solve problems better than any other method, and other methods usually fail. I expect you to want something other than a free market in justice, though. When law enforcement is left to mercenaries who work for the highest bidder we don’t get a libertarian society, we get feudalism instead.

But I’d expect you to be less sympathetic to attempts to prevent fraud. If somebody freely agreed to a fraudulent transaction, still they freely agreed. They should not have been so trusting. It isn’t anybody else’s business to protect them from their own stupidity. I can sort of sympathise with that.

And yet, our society is built on trust. We trust banks not to spend the money we deposit with them. We trust credit card companies to record our transactions accurately. We trust grocery stores to actually charge us the amounts they advertise. Etc. Lots and lots of trust built into the system, and we’d be severely inconvenienced without it. Should we use a system with far less trust? Maybe buy everything with gold coins, that the merchants test for gold content and reject if they’re too debased?

Most people agree we need some sort of legal protection against fraud. And that’s what this regulation stuff is supposed to do. It should at least reveal some of the warning signs when company you’re about to deal with is likely to cheat you.

In this latest fraud we’ve seen that private protection companies have done badly too. They were rating things AAA that turned out to be frauds.

So, what can we do? If we come up with a system that makes it easier to be sure when you can trust some people, that’s a big convenience for as much of the economy as gets the ease. What can help with that?

My immediate thought to help is don’t elect Republicans because in general they appear to be crooks. But that’s only a negative. Democrats aren’t all angels either. What would actually help?

My prediction is that the market in regulation will persist in a dynamic stochastic general equilibrium.

B in P notes that “[t]here was no real admission or error here.” Which is totally true. Except for the little point where Greenspan admits that “[his] ideology pushed [him] to make decisions that [he wished he] had not made.”

Oh, and his admission (not noted by John) that

I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such as that they were best capable of protecting their own shareholders and their equity in the firms.” [My emphasis.]

So yeah, other than those two admissions of error, there was absolutely no admission of error.

It has always been unclear to me what regulation should have been in place. Would
higher capital reserves have avoided the credit crunch? Probably not based on the magnitude of the problem. More stringent accounting rules? AIG ran into trouble because when its MBS were being written off, it received a credit ratings downgrade, and so the CDSs it held required higher collateral postings. Mark-to-market rules triggered some of the sell-offs that contributed to the crisis. Bans on certain instruments? Which ones? Would CDS be OK if there was an exchange? Banning CDSs when the purchaser had no underlying asset might sound sensible, but could you do that without banning futures contracts? If regulations had been put in place in 1999, what would the equity, housing, and credit markets have looked like over the past decade?

Greenspan’s view is still mystifying. For someone who knows so much economics, it’s weird that he displays so little interest in principal-agent issues.
Not really. Principal-agent dynamics are pervasive; any alternative economic structure has to deal with them as well. A prior criticism of executives was that they did not hold enough stock in their companies, and so the balance of their compensation moved to stock-options. Trying to find a corporate governance model that avoids p-a problems is pretty hard.

It has always been unclear to me what regulation should have been in place.You might start by making a list of the ones in place from FDR’s time until they were repealed during the Clinton Administration. Supplemented by a list of the ones still on the books but not enforced by Bushco. Why don’t you report back to us after you’ve done so.

It has always been unclear to me what regulation should have been in place.

If you’re googling for answers, I recommend the search keywords
“Gramm financial deregulation”.

The fact that former Senator Phil Gramm is one of McCain’s economic advisors is the most damning thing I know about McCain’s judgemen — far worse, in my estimation, than his selection of Gov. Palin as his VP candidate.

”overoptimism”

Another way that can be spelled is RICO. That it hasn’t happened yet may be due to shortage of honest accountants in Justice or/and proof of just how deep the tentacles are entrenched.

For my purposes, Dean Baker is not an economist.

“Right. It was a source of pride to see the Democrats doing their job and holding some accountable. Well done!”
-Bill in Pitt.

Whoa there fella! The time for Democrats to “do their job” was BEFORE the 700 billion (now 2.5 trillion) dollar giveaway plan, not after all that taxpayer loot made its merry way to Switzerland and the Caymans.

Greenspan could have done any or all of these things, but they would all have involved running a different monetary policy from the one which he actually did run. So I think he’s still wrong – he’s trying to pretend that his underlying monetary policy was OK and didn’t contribute to the crisis, but then something else happened. I still don’t agree with that.

I think my point of disagreement with John is that I’m much more inclined to believe that a form of Goodhart’s Law was at work here – meaning that financial innovation will generally mean that any quantitative or qualitative restrictions on bank lending will go out of date very quickly, and so the only way to do monetary policy is through the interest rate. After all, in the narrow banking model of #16, there are still the money market mutual funds, and they would probably be even bigger and more important.

I think the real mistake Greenspan made was to believe in a form of the Lawson doctrine; that current account deficits which were not caused by a budget deficit were “benign and self-correcting” and did not require any monetary policy response.

PersonFromPorlock:
” The great advantage to the market was – until recently – that failed ‘programs’ (i.e., companies) go away; whereas in government, failure is regarded as an argument for bigger budgets.”

This is true. The problems are (a) we’ve seen a trend of mergers in the big boys of Wall Street, until a bunch of them were probably genuinely too big to fail; (b) we’ve seen hedge funds (totally unregulated, privately owned with very few requirements to disclose their business actions) take very large positions, putting some of them into a position where their failure could cause major problems, and (c) certain companies (IIRC, AIG), even though not the biggest of the big, occupied very large critical positions, where their failures would be catastrophic.

In addition, it’s now clear that the rating agencies were 100% compromised, quite deliberately. A major layer of market self-correction had turned into error propagation, instead. Note – this is what happened with Enron; the big boys of Wall Street were quite happy to hop into a dirty bed with an up and coming fraud shop.
This is due to the simple fact that the people in decision-making positions reap huge pots of cash at the end of each year, regardless of what happens later (many of those who are loudly weeping about massive lost valuation of stock holdings in thier companies were pulling down bonuses in the high eight to low nine figures, each and every year for the past decade or two).

” No US administration has burst an asset bubble in the 20th century.”

Nor will they – despite being over one year into this crisis, you still get serious debate about what the gov’t should be doing to “increase” the price of housing in the country. Just like the 1930s, when the new deal programs were very concerned about increasing/stablizing consumer prices over allowing markets to clear at a new, lower level.

Does anyone see a difference in the response to that basic question between McBama or O’Cain? Two sides of their mouths … punish evil wall street, bankers, don’t reward speculators or sloppy levels, don’t make people who played by the rules and did right pay for the mistakes of the bad actors … you can’t square those statements and get us out of this circle of decling credit, asset prices, and general fear…

I don’t agree with Daniel, but otoh, I don’t disagree with him either – call it the weak atheist position. However, one aspect of regulation that is not really discussed all that much are penalties. I would suggest that current penalties are not in line with the offenses, and this is one of those medieval traits that twenty-first century advanced economies cannot afford. A case in point: I was reading in the paper last summer about some guy getting twenty years in prison for his part in an armed robbery, even though he had nothing to do with the bad outcome. Otoh, people who commit fraud to the tune of millions or hundreds of millions of dollars don’t seem to spend all that much time in jail. Arguably, fraud, or poor managment at those levels is worse, much worse, and should be treated accordingly.

I propose that top people, such as those AIG execs so recently in the news, should be given life in prison without possibility of parole. I propose that they be stripped of their estates, all of their assets, all of their cash holdings. I propose that their families receive nothing – and I mean nothing. There should also be strengthened protections for whistle-blowers, and some sort of rewards program, but don’t ask me how the latter works.

Because the fact of the matter is, even when there are clear-cut provisions under the law for the prosecution of specific offenses, the deterrents simply are not enough of a deterrent. That’s got to change.

Something else happened.

One way or another, isn’t that the consensus? Except maybe for Roubini and Dean Baker?

I second ScentOfViolets; that’s really the core of what I’ve been saying. If we were to have mass executions of the big Wall St offenders, then we *might* see some prudence in the next couple of decades; as it is, they’ll look at $10’s of millions now and take the money (our money).

I’m afraid it’s much, much worse than that: they will ‘whore for short-term cash’ and call it scientific.

our corporate leaders will whore for short-term cash

Let’s get real – after several years of making big bucks, the shareholders would have removed any officer of the larger banks that had turned their backs on making outsized returns. their choice wasn’t greed or prudence, it was high returns (and being well-paid :-)) or unemployment.

Of course, you could resign and go media-ward, but after the first two weeks when the collapse didn’t happen, you’d be unemployed and unemployable for being so obviously wrong.

You don’t get rewarded for calling the collapse – you get rewarded for calling the collapse exactly when it happens. Note how many people survived calling the tech crash. All the doubting media figures that I thought were on the money had lost their jobs two years before the house of cards came down – and they certainly didn’t reappear when they turned out to be right in the end…

Tom West 10.25.08 at 9:50 pm

our corporate leaders will whore for short-term cash

Let’s get real – after several years of making big bucks, the shareholders would have removed any officer of the larger banks that had turned their backs on making outsized returns. their choice wasn’t greed or prudence, it was high returns (and being well-paid :-)) or unemployment.

The two statements are not mutually exclusive. And this is why there have to be drastic penalties attached to this sort of behaviour. The choice would then not be between high returns and unemployment, it would be between unemployment and jail. Hard time jail.

Yes, I understand the concept of a sineater that lets the rest of us have all of the fun without the calories. But understanding it is in no way condoning it.

Just a question of fact: did Iceland bankrupt itself under a neoliberal regime?

I have no information, so this is an actual question, though I strongly suspect that the answer is yes.

#42:
It was Bobby Fischer.

This seems to be simple to me. No regulation needed to prevent bubbles, no regulator is going to be better than hundreds of thousands of stockholders in trying to avoid the creation of a bubble. What is most needed for cases like this is a better calculation of inflation. So the price of a house almost doubled in California between 2001 and 2007? Many economists attribute this to very cheap money following the NASDAQ crash. Now we are making money even cheaper to respond to this crash. Next bubble please! Were inflation correctly calculated to take into account house price increases, interest rates would not be allowed to fall so low even under the current system. Other measures that would be helpful is an end to all redlining studies, mortgage deductions and special guarantees for mortgage by the government. The solutions proposed currently would seem to seek to promote more of the same, the government simultaneously is acknowledging to bubble and the dangers it brings, while trying to cause promote lending to homeowners to maintain home price increases. I’m totally confused.

It seems to me that Tom West and Omega Centauri, taken together, pretty much cover the waterfront as to the psychosocial currents at play that impinge upon real people acting in the here and now–and they paint a pretty realistic picture picture of the direction these pressures force participants to take. The extent to which the micro drives the macro in terms of human psychology write large may be seen by numerous examples of Brokerage local office managers riding their biggest producers to huge bonuses despite the dubious ethics (churning of accounts, inappropriate investments, i.e., violation of the “know your customer rule, etc.) of these big producers until the day they are called-out through formal complaints by aggrevied clients unwilling to take the “hush money” of having their accounts made whole. Then, of course, both the Manager abd his biggest producer are fired. But they still have all the bonus money made over the months/years and often simply walk across the street to competing firms desperate for “production” or retire if the bonuses have been well invested. And, as Tom West points out here, had the Office manager of this maverick but money producing broker let him go prior to formal complaints being lodged, the Manager would as likely as not be fired by his superiors if the resultant production of the office fell off as a result. And the shady high numbers producer might never get caught
in any event, so the “ethical” behavior and “sound” judgment of the Office Manager would have gone for naught except for the bringing down of financial ruin and loss of status within the local business community (and the country club) upon himself by
being fired. Human beings don’t change much over time, so, as others here have predicted, we’ll eventually revisit some form of this in a different permutation some time in the future.

One thing I’m surprised no one has made mention of in all this is the analogy of the world-wide financial system to the national power grid. Within the recent past we have seen how a small circuit-breaker/power line failure can render the entire Northeast powerless as the surge/overloads pulse through the system. Only Texas, it seems, warrents this a serious problem. Texas has sealed off the state so that the national grid CANNOT PHYSICALLY CONNECT with the Texas grid–the equivalent of the US withdrawing from the WTO, etc? Perhaps we would be better off with the 19th Century version of international trade insofar as protecting against disasters of this sort. But would we we really want to trade such a system for the day-to-day advantages the present relatively open world-wide free trade system provides when things are “normal?” This is the dilemma we face today-rely upon a system designed
to provide financial services “just in time” with maximum daily/hourly efficiency but that is by nature “brittle” to unforeseen shocks, or build one designed to guard against disasters “just in case” with all the day-to-day redundant inefficiencies and delays that such a heavily armored system would entail……

Virgil, I have long seen the trade-off in those terms too, and thought advocates of just-in-time anything should be required to wear motley.

On the question of jail time, the general belief is that the elite never really serve “hard time” – with the gangs and the roommates named “Pindick”, and I tend to believe this too, though I can’t say I’ve looked into it. If it’s true, what is the legal basis? Judicial discretion? Is equality under the law meaningful if imprisonment means something very different for rich white-collar criminals than for everyone else? If Wall Street swindlers faced the threat of a prison experience of the sort so lovingly documented in low-budget late night fare, would this not focus the mind on the greater good? Let me say that I do much favor safer prisons, but I doubt the Wall Street crowd does, because if they did, we would have them.

On the substantive point, I’m sympathetic to Daniel’s view that the bubble had essentially macroeconomic causes and that regulation of lack of it was not a big part of the story. I don’t understand, tho, why he picks the current account deficit as the macro factor.

I’m not Daniel, but here’s my take on it.

First, I agree with what I understand you to say, Lemuel. When people want to save a lot and there aren’t enough good investments to make, the money will go into ponzi schemes etc. Somebody will come up with a scam to put the money into since it has to go into something. And at some point the investors will notice that they’ve been scammed and it will all fall apart.

So is there a lack of good investments? The USA needs a lot of infrastructure, and we need a lot of alternate energy etc. Why not invest in those? Well, it’s risky. Bridges and tunnels etc for automobiles? We won’t have a lot of automobiles in 20 years as we have them now, and our need for bridges etc might change. We have a lot of wornout railroad track, but how do we want to replace 19th century technology? We haven’t settled on a single 21st century replacement. Choose now and you might choose wrong. Similarly with alternate energy, you could sink a lot of money into the wrong one and it goes bust. Somebody who put a lot of money into canals just before the railroads came ….

Instead a lot of investors tried for investments that would be as safe as houses.

The reason I focus on the trade deficit is it seems to me that’s central to this particular bubble.

Given we have a giant trade deficit, and the savers who want investment opportunities are foreigners.

If they don’t invest here, we are in trouble. And they don’t want risky speculative adventures, they tried that with the dot.com bubble and they don’t want to do it again.

We had to offer them better returns than elsewhere or they wouldn’t want to do it. We needed them to do it. We had to give them a bubble because we needed their money and we had no better way to get it.

The USA needed foreign investors to put their money here. They wanted something safe that had great returns. They liked mortgages so we gave them that. They wanted safe mortgages so we gave them tranches that looked safe. They wanted insurance on their mortgages so we gave them that. They wanted AAA rated stuff so we rated it AAA. They wanted to buy more mortgages than we had available to sell, so we pumped up the housing prices, and when that wasn’t enough we gave mortgages to risky buyers.

If we had given them good investments, they would wind up owning those good investments in the USA.

If you think of the whole thing as a strategy that might be created by somebody who thinks in terms of Taxes Holdum it all makes sense. Not to say it went that way, just that it makes sense that way.

Did it blow up too soon? Or was the plan all along to play one more round of Taxes Holdum with congress? I dunno.

What can we offer foreign investors now? T-bonds are the remaining safe investment, right? Unless inflation goes high, or the current account deficit stays high. Foreigners could prefer to buy tangibles from us at low prices. Wheat, beef, lumber, coal, cement, uranium, ah—oil. But those are most useful when they aren’t in recession too.

Bubbles don’t have to have anything to do with trade deficits. But this particular time it’s foreign savings that we needed to lure into the USA, and we needed a bubble to do it. So the current account deficit looks to me like it was central to the process. And now that it’s over we still need foreigners to give us our money back so we can buy more from them, and we need some new way to persuade them to do it.

(My post got moderated. I wonder if it gets through when I mention Taxes Holdum instead of the other spelling.)

As far as analysis of the macroeconomic aspects of the meltdown is concerned, I have found economist Henry C K Liu to be extremely useful.

“On one level, more effective regulation might have stopped this bubble. On another level we would have gone into recession earlier without the bubble and if one had not happened naturally it would have been necessary for the Bush administration to invent one”
-J Thomas

This and most arguments like this on the subject of the US economy consistently ignores the fact that “growth” based primarily on the accumulation of debt is unsustainable. In an environment in which real wages for workers have stagnated or declined since 1973-74 (as a matter of coordinated corporate/government policy) as jobs have been off-shored and unions destroyed while profits have soared over the same period, debt has taken the place of earnings as the ticket of admission to the “consumer” economy. The limits of this mad affair have now been reached for the American consumer is maxed out and her house is underwater in value.

What to do?

Well, for one thing trying to re-inflate a deflating bubble is doomed to failure as we’re witnessing. The unrealistic housing values which radically contradicted fundamentals, in many cases priced at 3.5 x average incomes, are attempting to correct to where they belong. The bailout/giveaway doesn’t remotely address this core reality. The financial institutions which assumed these risks should be forced to write down these loses and face the reality of their insolvent status. Instead, the Paulson/Goldman Sachs Gang are attempting to address an insolvency crisis with injections of liquidity (essentially taxpayer obligations) in the hopes that the housing bubble–any bubble–can be pumped to life. Meanwhile, the world of the real economy of productive work is left to die on the vine.

“This was a particularly appropriate bubble for our needs. If we had a bubble in something that could be imported, more of the money would have left the country contributing to the trade imbalance. But we hardly import houses at all. (We import some canadian lumber etc.) So it provided jobs for americans more than most other bubble possibilities would have”
-JT

There was nothing remotely appropriate (or sustainable) about this bubble for our actual needs have nothing to do with speculation on the value of McMansions and other cookie-cutter crap homes built in suburban subdivisions (many now ghost towns) farther and farther from job centers. The jobs created during the housing boom did not remotely make up for the millions of high-wage manufacturing jobs shed by American corporations (with generous government assistance) and subsequently off-shored to slave-wage nations. This process must be reversed and American domestic industry restored and protected (as in Japan). Frankly the banking industry should be nationalized and run as a public utility for huge swaths of the system are already populated by zombies that, for all of our sakes, should be put out of their misery.

JT, our ridiculous trade imbalances and budget deficits cannot be sustained nor can our 10 trillion dollar national debt ever be repaid–radical measures are called for I’m afraid. Under no circumstances should the very perpetrators of the present debacle be allowed to offer us the solution as is now the case.

Texas has sealed off the state so that the national grid CANNOT PHYSICALLY CONNECT with the Texas grid—the equivalent of the US withdrawing from the WTO, etc?

This isn’t actually true.

This and most arguments like this on the subject of the US economy consistently ignores the fact that “growth” based primarily on the accumulation of debt is unsustainable.

Agreed. But it was the best the Bush administration could to. Postpone the crisis to the next admnistration. It got us 6 years of fake prosperity and got Bush a second term.

There was nothing remotely appropriate (or sustainable) about this bubble for our actual needs have nothing to do with speculation on the value of McMansions and other cookie-cutter crap homes built in suburban subdivisions (many now ghost towns) farther and farther from job centers.

Agreed. But what bubble would have been better? It was americans (and illegal immigrants) building those McMansions. Most bubbles would have hired fewer americans and more foreigners. And it didn’t make sense to try to build the McMansions closer to job centers because nobody knew which job centers would survive. Get the telecommunications jobs working well enough and they can work from home assuming they’re the cheapest guys who can get the job done.

The jobs created during the housing boom did not remotely make up for the millions of high-wage manufacturing jobs shed by American corporations (with generous government assistance) and subsequently off-shored to slave-wage nations. This process must be reversed and American domestic industry restored and protected (as in Japan).

So you argue for protectionism? But what about the poor economists who insist that free trade is better? Some of them say they have mathematical proofs that we are better off with no government interference even if all our trade partners are interfering with the markets. The last time I argued that free trade might not always be the best for us, everybody who responded laughed at me. They hinted that retaliation for other nations’ subsidies and tariffs etc was even more stupid than retaliation for other nations’ acts of war. Every responsible economist has known better since the 1930’s. Are you telling me that all these responsible economists are wrong? Are you putting yourself up as an expert who knows more than the entire US economics profession? Do you actually have the gaul to argue for protectionism *here*?

See, in a free market everybody in the USA is guaranteed to find his comparative advantage. It’s more efficient for the whole world if we do the jobs that come to us. That way the workers who’re best at the most important jobs will do those, and each of us will fit in where we’re most needed.

It appears that in recent years the jobs the world has most needed americans to do is to create complex financial instruments. It’s unfortunate that there’s currently little demand for that.

Well, over the past 10 or so years I’ve been hearing another argument. The USA has been vitally necessary to the world for its consumers. Nobody else wants to consume as much as they create, and so the USA is all that has kept the world from a giant worldwide depression. Unless the world bails us out the world is going to suffer from lack of consumption.

Similarly, the USA might not be very good at running a reserve currency, but no other nation can do that at all. The world has to have dollars for their reserve currency because there’s no possible alternative.

The argument went that the rest of the world has to bail the USA out, because the US economy as a whole is TBTF. And somehow the same people who used this argument also at the same time argued in favor of completely unregulated free trade.

Frankly the banking industry should be nationalized and run as a public utility for huge swaths of the system are already populated by zombies that, for all of our sakes, should be put out of their misery.

I like that idea. But, consider the possibility that the banks might then be used for political purposes. Wouldn’t it be better to instead have privately owned banks that could continue to be completely separate from the government? While the banks continue to have no influence on the politicians and vice versa, surely we’re better off.

JT, our ridiculous trade imbalances and budget deficits cannot be sustained nor can our 10 trillion dollar national debt ever be repaid—radical measures are called for I’m afraid.

I agree, but what can we do? Unless our politicians or unelected bureaucrats can settle on an effective plan, we’ll have to settle for whatever the free market does, moderated by ineffective political plans.

Under no circumstances should the very perpetrators of the present debacle be allowed to offer us the solution as is now the case.

I agree, but what can we do? Obama came out strongly in favor of giving Bush a trillion dollars to play with, under some loose observation. I’m going to vote for Obama as the second-worst candidate, but I don’t have high hopes. My senators both voted to do that. The democrat isn’t up for re-election. The one who’s up for re-election stepped down, and I think he’ll be replaced by a democrat. My congressman voted for it. He stepped down too and I think he’ll be replaced by a democrat. I can hope my new freshmen representatives will be ready for a change.

Can you suggest a change that has a chance of getting a sold consensus behind it? Something that the large majority of mainstream economists will approve, and that lots of voters will understand and approve, and preferably something that won’t get foreigners trying to pull their money out of the US? Oh, of course it also needs to be bipartisan, something the GOP will back in a spirit of patriotic fellowship.

Sorry to be so sarcastic, I have a bitter taste in my mouth.

All of the posts here seem to implie that this is a uniquely/primarily an American problem. A few months back I was naive enough to think that (that is why I was overweighted in foreign equities). But the reality is that this is now a worldwide crisis. And most of the most severely affected economies are overseas. Sure the ownership of ridiculously risky American generated assets is hurting them. Sure demand destruction for their exports from the Americans is hurting them. But these factors alone couldn’t be that severe to bring down the whole world economy that far. And the most concentrated pain seems to be far from here. I woulda thunk that the severity of effect would decrease with distance (physical and transactional) from the source. But that is not what we are seeing. This crisis is far more systemic in origin than simple foolish Americans relying on unsustainable financial gimmicks. Similar behavior was happening in many countries at the same time. Capital is global, and all the major players were responding to the same pressures.

It looks like the greatest financial cause, was a global glut of savings chasing a global lack of productive investment. This mismatch between opportunity for returns, and expectations was the primary driver for the various bubbles, and financial engineering. Maybe it would be more productive to look for the cause of the imbalance? Lets do a simple though experiment:

(1) Assume you have a capitalist economy that has long enjoyed a robust rate of exponential growth of say 4% per year. This steady rate of growth has allowed investment capital on average to earn a certain real rate of return which is the growth rate, plus a bit because some capital is still required to replace worn our capital goods. The social and economic system adjusts to this environment. All sorts of programs, especially retirement programs are built around this assumption that X% investment returns are a law of nature.

(2) With little notice, the long term rate of achievable growth declines. A new economic era has dawned. But nobody took any notice of it. I claim that the early stage of Malthusian limits is the source of this change. Prior to this time growth could be achieved by simply using more resources, or by making more clever usage of resources. Now, the braindead approach to growth, simply consume more, no longer applies. One of the major methods of growth has been shut off. The new constraints on ways to grow the economy mean that the achievable growth rate has decreased.

(3) All the financial systems, and expectations of the population are blind to this change, and demand the historical rate of growth and return on investment. The system can’t deliver it, but since it isn’t obvious to the general population, no politician dares to see the new paradigm. Clever ways of producing the appearance of the old rate of growth and real rate of investment return are invented.

We have essentially reached a phase change in the world economic system. The old phase, which lasted for roughly 250 years has been replaced by a new less friendly one. The old ways of thriving no longer work. Trying to diddle the details of the economy won’t deliver us back to the old system, although perhaps they will allow us to approach a little closer to the actual physical limitations before we are stopped. Only a substantially new way of thinking about economics will help now, and a restructuring of our societies which reflects the new conditions will have a chance of bring a satisfactory solution.

“Do you actually have the gaul to argue for protectionism here?”
-J Thomas

Yep.

And that bitter taste is really going to spread after January 20th and America awakens (finally) to what these bastards have done.

Fair enough. The only reason I go through these exercises, btw, is to weed out the ideologues whose apparent raison d’etre is to spout bad-faith arguments. I don’t write as exactly as I’d like to either, but in this instance, I thought my meaning was clear enough(this is not always the case, of course.) Hence the suspicion on my part. My apologies.

Now, as to being vague – yes, I’ll certainly cop to that. It was a short post, after all. But part of the point, exactly, is to be vague. Prescriptive legislation as opposed to descriptive legislation. Too often in the latter case has there been extreme attention to details (in the best of cases), only to have businesses decry them as ‘burdensome’ or to figure out away around regulation on the theory that anything that is not forbidden is allowed.

So maybe prescriptive legislation is vague, prone to abusive interpretations, etc. But we’ve tried the other sort, and it apparently doesn’t work for these types of products. Perhaps we do differ philosophically on this point: I would argue that the damage we’ve seen so far is pervasive and extreme, and merits a looser but more inclusive regulation with much stiffer penalties. You apparently argue that the consequences would be worse than what we have now.

You may be right. But until some actual data is collected, it’s all just theorizing, and if you are right, why, we can always try something else. True?

I’m sorry, but this sort of proposal massively smacks of the “someone must pay” mind-set. Never mind that the system failed on dozens of points. Never mind that in all likelihood people were doing what they thought best for their company. Never mind that such policy would be ripe for abuse, utterly arbitrary, and likely used to prosecute whoever was an enemy of the administration.

This is where you have a professional, and professionally motivated bureaucracy to administer these sorts of programs. Well-paid, smart, and imbued with professional ethics. These sorts of people and organizations do exist, you know, e.g., pre-Bush administration FEMA. Bear in mind that what we have right now is already ‘ripe for abuse’ and ‘utterly arbitrary’. Note also that while letting your employees rate material as ‘AAA’ when it’s really junk on the theory that doing so will simply result in companies taking their business elsewhere(as an example) may count as doing ‘what’s good for the company’ . . . it really isn’t. Not in the long run. And this isn’t particularly hard to predict.

Your proposal to penalize ‘poor management’ is far more akin to a professor saying that he will give zero in a course to any student who fails to put ‘sufficient effort’ into the course.

Not surprisingly, some people actually pursue this policy. But ‘putting in sufficient effort’ is not all that hard or arbitrary to judge either, contrary to what you may think. I’m sure that many people here who require that their students turn in a project will agree with me on this one.

So here is what I see as the impasse – we already have evidence that a certain strategy has resulted in a tremendous amount of harm (presumably you agree.) You think the alternative I propose will lead to more, and more pervasive harm; fair enough. But it’s on you to show that there is a reasonably good chance that this is the case. You can’t just throw ‘what ifs’ out there and expect me to disprove them.

“I’m sorry, but this sort of proposal massively smacks of the “someone must pay” mind-set. Never mind that the system failed on dozens of points. Never mind that in all likelihood people were doing what they thought best for their company. Never mind that such policy would be ripe for abuse, utterly arbitrary, and likely used to prosecute whoever was an enemy of the administration”
-Tom West

There is a simple solution to this Tom: the vaunted market those (now hard to find) free market fundamentalists used to jabber so much about should be allowed to work its course. Management greed, incompetence, and stupidity should be “rewarded” with insolvency and, in the case of major banks, receivership with the management dismissed and/or indicted for fraud where warranted.

What should not happen Tom is what is now happening–the mother of all moral hazards. Bankers and other speculators (let’s not call them investors) who caused the fiasco and birthed the Derivatives Beast should be swallowed whole by it, not the taxpayer. Problem solved.

“Presumably Bush will pre-emptively pardon everybody involved.”

While that is a possibility, there is one person he can’t [probably, but AFAIK untested] pardon, and his team did attempt a post office indictment of Clinton [lacking merit, thus w/o success] so that would be possible if enough dots are connected. Pre-emptive pardons at this point would likely be viewed as a tacit admission of guilt that would probably not be forgotten on Jan 21st.

I am not at all surprised by those rote responses JT, however, what I am astounded by is the fact that some of these arguments are STILL being used today after all that has transpired over the past year and the system’s virtual collapse over the past two months.

For those interested, hit The Oil Drum at:

http://theoildrum.com/mode?page=1

then to “Drumbeat” Oct 21, 2008, Agriculture: Unsustainable Resource Depletion

SOV, thank you for a very even handed reply, especially considering the rather aggressive tone of my comment.

Your point about descriptive vs. proscriptive legislation is very well taken, and to be honest, I’d in general tend to agree with you. (There’s *always* ways to game the system and manage the letter while defying the spirit.)

My concern is that in a time of great crisis, there would be almost overwhelming political pressure to find someone guilty of something. I’ll admit I’m not confident that there would be many politicians be willing to sacrifice their careers by holding off prosecuting people who had some hand in the crisis, but might not be worthy of legal sanction.

As far as AIG is concerned, I’ll admit that I may have missed something, but nothing I’ve read has really given me the impression that knowledge of the danger was widespread or in fact taken seriously by anyone until quite recently. (I know that there a very few who did call it right, but quite frankly (1) there’s a lot more people calling for a return to the gold standard, and I think we’re right to dismiss them and (2) many had been calling for lots of other catastrophe’s that didn’t happen, reducing their credibility.)

Now I’m quite prepared to be proven wrong (and it would make me feel better to find some real villains in this tale rather than just human beings), but at the moment, I don’t think the executives at AIG behaved any differently than almost any other human being would in their position, in which case prosecution is simply a matter of punishing whoever happens to be at the wheel when the hurricane hits.

Personally, I consider this sort of crisis to be an inevitable outcome of a high innovation, high efficiency system. (And I don’t mean only banking. I’m quite convinced we’ll face exactly the same sort of crises in farming and medical care.) In my mind, the only question is whether the benefits of the 50 years without crisis are outweighed by the costs of the crisis that naturally accompanies it. I think while we should take measures to try to avoid such crises, we have to acknowledge that there *will* be failures that come at terrible cost.

Okay, we *can* avoid personally being the cause of such crises by regulating our own industry into submission, but eventually either the population or the industry will rebel and vote the regulators out, or the industry will just wither away when their free-er international competitors make mincemeat of them. (I’m Canadian – our banks were mostly ‘good boys’ (heavily regulated), and as a consequence, they’re now almost entirely internationally irrelevant and may yet be buried by the crisis because no-one distinguishes between good and bad in a crisis. As it was, if the good times had rolled on for another few years, our banks would probably have been eaten by the then successful American banks)

As for ratings agencies, I have to ask. Is there anyone who *really* believes that all risk associated with a financial instrument can be quantified so exactly under *any* circumstance? Call it black swans, call it chaos theory, call it the wings of a butterfly, but honestly, should there ever be any rating higher than ‘A’ given the possibility of the un-thought of?

As to those who *knowingly* mis-graded commercial paper, I’d love to see a legal remedy against them (although I suspect they’re in the clear – after all they weren’t defrauding their clients). I don’t suspect there was a lot of that until near the end, and it amazes me that they were taken so seriously after the analogous experience with stock analysts in the tech boom, but I’d be delighted to see purposeful mis-gradings punished somehow.

As an aside, my analogy for this entire crisis is farming. We’ve all read about the dangers of mono-crop farming. And some day, no doubt, it’s going to bite us in the backside big time. But is it realistic to expect any politician to be prepared to pass regulation to prevent it? We’d triple food prices and put most of our farmers out of business when they couldn’t compete with international imports. All for nothing (until the crisis occurs). And when the crisis occurs, would we escape? Not likely anyway.
So, when the great food crisis does occur, who are we to blame?

In the end, the upcoming food crisis is simply the cost we have to expect to eventually pay for massively cheap food. (And if you think food should be more expensive, you’re probably not living in the developing world…)

”As an aside, have any of the bank presidents survived the crisis? They seemed to be resigning by the busload a few months ago.”

Bus? More like Gulfstream 350’s. Poor guys. I know I feel for ’em after they took all that risk and had to jump ship only to find the tide had gone out and they’d have to drag those money sacks through the mud and few in the huddled masses were willing to lend a hand. Or did they?

Martin Bento/

I meant to mention this before now, but there is an excellent article in The Oil Drum
about such “efficient but brittle” systems vs “secure but inefficient” ones entitled:
“The Failure of Network Systems: The Repercussions of Systematic Risk” Oct 25, 2008
(a reprint of a Jan 2008 article by the NZer David Clark) Found @:

http://theoildrum.com/node/4656#more

Considering the original date of the article, a very prescient analysis……

Best—

There’s always ways to game the system and manage the letter while defying the spirit.

Yes.

My concern is that in a time of great crisis, there would be almost overwhelming political pressure to find someone guilty of something.

Well, after a disaster people tend to blame the ruling politicians for not preventing it, regardless of said politicians’ ability to understand, predict, or prevent the problems.

Why shouldn’t we also blame the people who actually caused the problem?

Personally, I consider this sort of crisis to be an inevitable outcome of a high innovation, high efficiency system. (And I don’t mean only banking. I’m quite convinced we’ll face exactly the same sort of crises in farming and medical care.) In my mind, the only question is whether the benefits of the 50 years without crisis are outweighed by the costs of the crisis that naturally accompanies it. I think while we should take measures to try to avoid such crises, we have to acknowledge that there will be failures that come at terrible cost.

Well, if you accept that, then you accept that you don’t know how to price anything. An unknown but terrible part of the cost will come at a time you do not expect. So you do not know what’s efficient.

An efficient market is going to optimise the wrong things. You know ahead of time that it’s optimising the wrong things, but you think it’s important that they be optimised?

Okay, we can avoid personally being the cause of such crises by regulating our own industry into submission, but eventually either the population or the industry will rebel and vote the regulators out, or the industry will just wither away when their free-er international competitors make mincemeat of them.

So you say we can’t regulate because we can’t regulate foreigners. So we have to accept the occasional crisis with terrible consequences. Why are we better off to allow free competition with foreigners who can’t be regulated, at terrible cost? Is there a chance that we’d be better off with free trade only among businesses that have similar regulation? Free unregulated markets are more efficient at optimising for the wrong goals at terrible cost….

As an aside, my analogy for this entire crisis is farming. We’ve all read about the dangers of mono-crop farming. And some day, no doubt, it’s going to bite us in the backside big time.

It does, occasionally.

But is it realistic to expect any politician to be prepared to pass regulation to prevent it?

I dunno. Show me the regulation. There are things we could do better. Some of them would have advantages in the short run. Like, reduced pest problems with smaller monoculture plots etc. What I’d kind of like to see would be temporary tax benefits etc for good practices. You give farmers a break when they do something good. Then when about half of them have tried it you drop that tax break and give them the tax break to try something else good. The ones they like they’ll keep doing.

We’d triple food prices and put most of our farmers out of business when they couldn’t compete with international imports. All for nothing (until the crisis occurs).

So, we have to accept direct competition with unregulated business. Why should we do it that way?

And when the crisis occurs, would we escape? Not likely anyway.

Why not? Suppose for example canada is doing monoculture wheat, and US wheat has a mixture of 12 different genotypes in each plot and scattered plots separated by other crops. Canada gets a plague that destroys 70% of their wheat. Would it spread to the US? If our non-moloculture was done well, it would not. That’s the point. Our wheat prices would rise because we’d share, but we wouldn’t be part of the catastrophe, we’d be part of the solution.

In the end, the upcoming food crisis is simply the cost we have to expect to eventually pay for massively cheap food. (And if you think food should be more expensive, you’re probably not living in the developing world…)

The developing world in general had a collection of farmers who *were* supplying sufficient food for their population, but who can’t compete with our monoculture (which has subsidised fuel). So they wind up underemployed, hanging around slums in their cities. Meanwhile the whole population gets cheap imported food until all of a sudden a catastrophe comes and there isn’t enough food to go around. Is this really an improvement? Why should those nations put up with that?

“Yea, that would be the perfect theoretical solution. Unfortunately, while the firebugs next door may have set their mansion alight, my wooden house is right beside it. So, we try and put their fire out not for their benefit, but for ours”
-Tom West

It’s one thing to douse the firebug’s handiwork but quite another to rebuild the firebug’s house with my savings and my kid’s college tuition .

“Giant moral hazard? Possibly, although that requires the prerequisite that anyone understood what the risks were, and I’m not certain that anyone did (until recently)”
-TW

This conveniently ignores a host of economists and thinkers who called this disaster years ago, way back when the Wizard of Bubble Land (aka Alan Greenspan) was at his apex. This includes notables such as Michael Hudson, Mike Whitney, Dean Baker, Henry C. K. Liu, Nouriel Roubini, and Elaine Meinel Supkis to name just a few.

J Thomas>
So you say we can’t regulate because we can’t regulate foreigners.

What I’m saying that in a democracy, you’re justification (if presented properly) for forcing the citizenry to live substantially worse off than their neighbours will last for a few years. If the crisis hasn’t happened by that point, then for the vast majority of the voters, you’re simply seen as harming them for no reason.

This was not nearly so much a problem when media meant that you were relatively disconnected from your wealthier neighbours. Nowadays, with omnipresent communication and media, you are essentially living next door to people who are considerably wealthier because they’re less cautious. That makes it very hard to maintain policies that don’t have obvious constant benefits.

Of course, it’s our responsibility to try – after all there’s every possibility of avoiding some crises that occur more regularly, but if the crisis doesn’t come soon enough, one should be realistic about the outcome (you get voted out for ‘pauperizing’ the public and your industry ends up not being particularly successful against the rest of the world.

Is this really an improvement? Why should those nations put up with that?

Because for the majority of non-farmers, it *is* an improvement, despite the fact it will cost them big time later on. As I said, this was all easier when you weren’t bombarded with the fact that the rest of the world is paying vastly less for better selection. Now, you’d better provide a damn good reason for holding out on your populace.

If you apply it to the ecology, we have no choice but to encourage mass extinction.

I think you misunderstand – I’m not saying that we *should* go in that direction, I’m saying that there’s an almost irresistible pressure to go in that direction. Of course you encourage safer, less-efficient regulation where possible. You just have to be realistic about the outcome. If the crisis doesn’t come quickly enough, you have to accept that you’ll see your policies (and you, if you’re a politician) tossed out. People are people, and we’re not really built for that level of caution. Just look at how people in well protected vehicles drive less cautiously until they’re back at their preferred level of risk.

”Look, for every policy decision (including the idea of paper money), there’s a bunch of people who will tell you that it’s a bad idea. So obviously you can’t choose policy on the basis of only choosing policies with no opposition. Thus most rational people go with the general consensus. Why should any rational actor choose a few experts against a large number of experts.”

You are assuming the actor is rational to begin with. It’s harvest time and we’re bearing the fruits of a most un-rational actor, one who sought to remove all dissent from the game. The rational actor works towards consensus by integration of opposing views; not by rote, and where possible, pre-emptive elimination of the voices he does not agree with. Of course I am totally unpatriotic for having such subversive thoughts.

In the most brutal terms, if you call a disaster, but cannot make the reasoning behind your conclusion solid and compelling enough to be accepted by the consensus of experts in your field, then you failed.

Here is a wicked idea that I like a lot. Currently economists are not in any way held responsible for their economic claims. I want to change that.

First, I want the government to set up registration for professional economists. There should be no qualifications required, you just sign up if you’re willing to take on the responsibility. Pundits of all sorts can register — academic journalists, journalists, bloggers, whoever. If you register you are entitled to put “Registered Economist” by your name when you make predictions etc.

As a registered economist, when you write in favor or in opposition to an economic plan of any sort, you have the obligation to say “This is a ponzi scheme” or “This is not a ponzi scheme” meaning that it must collapse if it fails to grow fast enough, or that it can survive an indefinite period without growth. You emphatically must answer this question if you are asked it.

If you are later found to have gotten this question wrong, you must serve one to twenty years in prison, at the discretion of the judge. If at some later time it is determined that you were right after all, any remaining jailtime will be cancelled and you will receive compensation for your unjust imprisonment.

People who aren’t registered economists can say whatever they want. But registered economists bet their liberty that they’re right. They will be more trustworthy than pundits who have nothing riding on it.

It isn’t necessary to predict *when* a ponzi scheme will fail. Saying it’s a ponzi scheme is enough. People can invest in known ponzi schemes hoping to make their money before it fails, but that’s their own lookout. If enough people correctly believe it’s a ponzi scheme, somebody is going to knock it over for their own purposes, at their own time. Probably sooner than later.

Why should anybody pay attention to a pundit or economist who didn’t have “Registered Economist” after his name? What good is an economist who doesn’t stand behind his conclusions?

About Sugar import restrictions: Such restrictions are like prohibition. The thing that killed prohibition is that all the negative aspects of the program (corruption of the judiciary, politicians and bureaucrats, etc., leading to the public’s loss of respect for government, plus labeling ordinary people–the speakeasy habitues–as criminals who were ordinary law abiding citizens in every other facet of their life, not to mention the budgetary and manpower costs to government) were highly concentrated upfront while the positive aspects–lower rates of job absentism and spousal abuse with improved health with a lessening financial drain on the health-care system–were highly diffuse and spread out over time measured in decades toward the back end of the problem, (e.g., the cost of preventing a man buying booze in Buffalo, NY was borne in the here and now by the City and State authorities, but the even higher medical costs of alcoholism might not come due until 40 years later in a hospital in Scotsdale Ariz)

Like-wise, when one-third of all jobs in South Louisiana are, directly or indirectly, tied to the sugar industry, the interest in preserving those jobs is highly intense, concentrated, and in the here and now, Candy eaters and other users of sugar, while more numerous, are more diffused and the small increase in the cost of any individual item is only a minor irritant/inconvenience to an individual–but the keeping of low-cost foreign competition from competition in the US is a life and death issue for South Louisiana.

Thus seen from the above example, any program/course of action in which the negative aspects/costs are highly concentrated and front loaded and the positive aspects highly diffuse over time and space–is doomed to failure.

Thus seen from the above example, any program/course of action in which the negative aspects/costs are highly concentrated and front loaded and the positive aspects highly diffuse over time and space—is doomed to failure.

Much easier during a depression when the negative aspects are already present. When the sugar industry in south louisiana is already dead, there’s not so much problem about protecting it.

This in no way explains why the same “experts” who were instrumental in creating and nurturing the crisis are STILL in the driver’s seat offering “solutions”, while those who were correct in their assessments remain marginalized.

How much explanation do you need? The same criminals are still running the US government as a whole. How many years of public unrest did it take before they dumped Rumsfeld? Why would they throw anybody off the troika at this stage in the game?

I’m sorry Lemuel but I just cannot agree. Bubble economies that produce nothing of utility to society as a whole will never work except for a tiny sliver of the population at the elite extreme upper margins. Unsurprisingly, the “solution” to the current crisis seeks to protect the cretins at the top at the expense of the rest of us.

Coldtype, which odf Lemuel’s comments do you disagree with? I haven’t noticed him say anything here that disagrees with your #98.

The reason for my asking for clarification is that the idea of subjecting someone to a life sentence without parole for ‘poor management’ was, to my mind, so ludicrous as to obviously be a misinterpretation my part.

Tom, what about approaching it from the other end.

Put a delay on bonuses for management. Whatever bonus gets offered to a manager of a publicly owned corporation, give him 9% of it now and 91% in ten years — unless in ten years the BOD at that time chooses to cancel it after all. In case of bankruptcy, payment of previous bonuses would have last priority among creditors.

Similarly with stock options. If the corporation *gives* an option to an employee, it should give him the option to buy 9% of his stock in say one year, and 91% in ten years.

This would have obvious benefits for retiring employees — they get their money later when their taxable income is less. And it has obvious benefits to corporations, their payments are delayed. And also if ten years later the company is doing badly, it can just refuse to pay.