Greenspan concedes

by John Quiggin on October 24, 2008

There’s been a fair bit of debate about what, if anything, the current crisis means for economic policy and political philosophy more generally. A lot of this has been hung up on issues of terminology, which I will do my best to avoid here and in future.

Coming to substance, quite a few people have argued that the crisis doesn’t really signify very much, and that, once it is resolved, things will return to pretty much the way they were a couple of years ago. I disagree.

This concession of error by Alan Greenspan is, I think, pretty strong evidence against the view that the crisis is not so significant, in policy or ideological terms.

First up, Greenspan gave little or no support to the silly Republican talking point (repeated by quite a few commentators here in Australia) that the crisis was caused by marginal government interventions like Fannie&Freddie and the Community Reinvestment Act. On the contrary, he stated

The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of the crisis) would have been far smaller and defaults accordingly far lower

And Greenspan conceded that his faith in deregulation had led him into erroneous policy decisions

“You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others,” said Representative Henry A. Waxman of California, chairman of the committee. “Do you feel that your ideology pushed you to make decisions that you wish you had not made?”

Mr. Greenspan conceded: “Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”

To sum up, Greenspan’s concessions and the big interventions we’ve seen already lead me to believe that this crisis will result in much tighter regulation of financial markets and a much more central and explicit role for governments in the management of financial and economic risks.

How much this matters for bigger questions of what kind of political philosophy will predominate depends very much on the importance you attach to risk management as a central feature of public policy and as ground contested between democratic governments and financial markets. I’ve argued for a long time that risk is crucially important, and therefore see the failure of financial markets to manage it as having fundamental implications for the way in which society will be organised in future.

{ 102 comments }

1

Tracy W 10.24.08 at 12:44 pm

I make a prediction. There will be tighter regulation, but it won’t be any better in quality than historical regulation of, say, the 1970s (except, apparently, for the USA, a country for which I have been told that all the problems of government are due to Republicans being in power, I will leave others more expert on American politics than me to make up their own minds on that hypothesis). Eventually the continual frustrations of regulation will drive a movement for deregulation roughly similar to that of the 1980s and 1990s.

2

politicalfootball 10.24.08 at 1:03 pm

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.

3

P O'Neill 10.24.08 at 1:42 pm

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. He was shocked, shocked, that banks’ management don’t act in the interest of shareholders. He’s never heard of limited liability, moral hazard, adverse selection, asymmetric information, imperfect monitoring?

4

J Thomas 10.24.08 at 1:43 pm

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?

5

Bill in Pittsburgh 10.24.08 at 4:04 pm

There was no real admission or error here, just the statement (heard how many times in this administration), that no one could have predicted what happened. No one, not a single human (ignoring all those who predicted exactly this failure in the economy structure this individual created and encouraged). Right. It was a source of pride to see the Democrats doing their job and holding some accountable. Well done!

6

Michael Drake 10.24.08 at 4:13 pm

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

7

lemuel pitkin 10.24.08 at 5:01 pm

Greenspan’s concession looks like a perfect example of what Daniel Davies was calling the stupid bankers and their stupid stupidity argument. Which doesn’t, of course, mean that it’s wrong…

8

Michael Drake 10.24.08 at 6:17 pm

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.

9

mpowell 10.24.08 at 6:26 pm

7: Yep. But my take away from that thread was that Davies was proposing that this explanation was wrong and that there was an alternative explanation, but that he wasn’t really sure about whether it was really the right explanation or not himself. My feeling (however uninformed) is that he is probably right in regards to the overall recession we are experiencing, but somewhat wrong regarding the banking crisis. Monetary policy that pushes bubbles too far lead to a worse recession than engineering a so-called ‘soft landing’. But better regulation may have prevented institutions for whom trust is important (banks) from adopting leveraged positions in risky markets. But even if we didn’t have this banking problem, our real economy would still have struggled eventually due to a lack of demand.

10

c.l. ball 10.24.08 at 7:41 pm

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.

11

jcs 10.24.08 at 11:13 pm

Is human nature such that we require regulation? Even if it could be established demonstrably that, in theory, free markets are superior than any alternative economic system, are humans so corrupted by self-interest and greed that in practice regulation becomes necessary to prop up any economic system? If the answer is “yes”, then doesn’t this preculde the possibility of a truly free market system? If the answer is “no”, then does this give us good reason to be confidednt that once the current crisis has passed we can resume our financial practices without requring any additional regulation confident that we have all learned a lesson?

12

Steve LaBonne 10.24.08 at 11:31 pm

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.

13

J Thomas 10.24.08 at 11:49 pm

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

I say, the basic idea behind regulation should be to prevent fraud. (I consider that dumping toxic waste when you’ve promised not to, is fraud.)

Commerce runs much smoother when buyers and sellers can trust each other. Setting things up so that buyers and sellers can reliably trust each other, is a central thing for regulating them. To the extent it works, they have lower overhead because they don’t have to vet each other. VISA gets a lot of its clout because when something gets bought on a valid VISA card it will be paid, and nonpayment is something that VISA can take up with its customers. You can buy things without waiting for the check to clear. The seller can sell things without waiting or taking a big risk. And if you buy something and feel like you’ve been cheated you can call VISA about it. VISA regulates commerce. Not perfectly, but well enough that people willingly pay the overhead.

So that’s my ideal. Regulation should work to prevent fraud. With the mortgages, it might not have been fraud. Maybe the guys who put together the tranches really thought they were doing the right thing. And maybe the private companies that certified the results thought it was the right thing. And maybe the companies that insured the results thought they were good for it. If you happen to make grievous errors that make you billions and billions of dollars, that isn’t sufficient reason to assume you knew what you were doing. But regardless of their intentions it would probably have been better if they’d been stopped sooner.

Would higher capital reserves have avoided the credit crunch?

I doubt it. We had a trade deficit around three quarters of a trillion dollars. So either foreigners sit on those dollars, or they loan them to us. When they got tired of loaning us money and loaning us money to pay the interest on the previous loans, what would happen?

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.

Less stringeng accounting rules wouldn’t have helped. AIG needed to be solvent and they weren’t. Having accounting rules that revealed the situation was probably better than having accounting rules that hid it. But the visible problems came because AIG was not doing well enough, and there are no accounting rules which could have fixed that.

Mark-to-market rules triggered some of the sell-offs that contributed to the crisis.

If you’re camping out below a likely avalanche and you sneeze and the avalanche starts, you triggered the avalanche with your sneeze. But if it wasn’t that it would have been something else. Don’t go there. Just don’t go there. Maybe Mrs. O’Leary’s cow started the Chicago fire, but a whole lot of people set up a situation that any random cow could start.

Bans on certain instruments? Which ones? Would CDS be OK if there was an exchange?

I’d say transparency is good. If you sign a document you don’t understand, you’re a sucker. I’m not sure how that can be regulated.

If regulations had been put in place in 1999, what would the equity, housing, and credit markets have looked like over the past decade?

I can’t be sure. What would things be like if they were different? My guess is that we would have had a crisis sooner. Foreigners were lending us a whole lot of money, and they were lending us the money to pay the interest on the previous loans. At some point they were going to stop or at least slow down, but in the short run they accepted collateral — houses. When we ran out of good mortgages to give them, we created bad mortgages and they didn’t take enough of them.

If we hadn’t done that, our crisis would have come sooner. Maybe milder. Maybe we’d have faced the real problem quicker, instead of getting bogged down with gumming up our credit markets and trying to fix them, when the fundamental cause for our lack of liquidity (may be? is?) that foreigners don’t want to keep lending us more money.

14

joel hanes 10.25.08 at 12:08 am

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.

15

Canadian 10.25.08 at 12:25 am

John is drawing the wrong lesson from the economic failure of the Bush admininistration. Consider the counterfactual experiment in which Kerry won the election. I don’t know about what he would have done about Iraq but its close to 100% he would not have burst the housing bubble. No US administration has burst an asset bubble in the 20th century.
The current administration will (and should) be punished by the polls for the current failure. There is nothing ideological about punishing an incumbent administration for bad economic performance. This is a well known regularity of US political economy. If we are still feeling miserable four years from now, Obama will be a one term president. Obama will be aware of that fact and will thus disappoint many of his more ideological supporters.

16

John Quiggin 10.25.08 at 1:02 am

What should have been done?

A combination of things, amounting to defining a sharp boundary between a publicly-guaranteed tightly regulated banking sector and a non-bank financial institution sector where there is a clear commitment to allow insolvent or illiquid institutions to fail. Within the guaranteed sector, institutions should only be able to invest in a prescribed set of financial instruments, and lend to households and business but not to NBFIs.

As J Thomas said, that would have brought home the unsustainability of the trade deficit much more quickly.

This I guess is also my response to Daniel’s post a while back. If it weren’t for the stupid bankers and their stupid stupidity (more precisely, the complex of moral hazard, overoptimism and asymmetric risk allocation that made up the entire system), the macro problems that are at the bottom of the crisis could never have been amplified so far.

17

a 10.25.08 at 1:43 am

IMHO the most significant change in regulation would be: banks should not and cannot be trusted to calculate their own risk. So regulators must be able to calculate themselves the risk at a bank – which is not the case now, due to the complexity of the products, their dependence on numerous parameters which require real effort to observe or estimate, and often just the sheer size of the book.

But just remember, money corrupts and lots of money corrupts a lot. If any activity can make lots of money with less regulation, it is a sure bet that the activity will spend lots of money trying to influence the process so that indeed there is less. Which I think implies that, we will put in regulation only to see it disappear precisely when we need it the most.

18

MarkUp 10.25.08 at 2:49 am

”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.

19

John Emerson 10.25.08 at 3:32 am

“Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”

“Oh, dear. That didn’t seem to work. My, my, my. I really feel quite bad about this.”

Shouldn’t that motherfucker have showed some humility and modesty before he screwed things up? What’s he plan to do now, wave goodbye and stroll off into retirement?

DeLong adores this guy, though he’s starting to fudge a bit.

And what are the chances that this was just a bland, delayed action, John Galt ratfuck? We know that Greenspan was a Randian fanatic 40 years or so ago. Do we know that he ever changed? Maybe he just became a little more discreet.

Somehow I’m the crazy man and Greenspan is the genius. And it’s true that I don’t know much, but I know better than to trust economists.

20

John Emerson 10.25.08 at 4:12 am

For my purposes, Dean Baker is not an economist.

21

John Emerson 10.25.08 at 4:56 am

Applications to be declared Not An Economist will be taken at http://trollblog.wordpress.com/. I also will be taking applications for the designation “Not An Analytic Philosopher”.

22

Coldtype 10.25.08 at 6:19 am

“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.

23

John Quiggin 10.25.08 at 7:11 am

If making the wrong call on Iceland is considered a vital qualification, I’m also not an economist, I guess

http://johnquiggin.com/index.php/archives/2008/10/08/iceland/

24

dsquared 10.25.08 at 11:52 am

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.

25

PersonFromPorlock 10.25.08 at 12:12 pm

One of the practical objections to government-directed economies is that sometimes you get government directors like Greenspan – and there’s no guarantee a Democrat would be any less purblind.

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. I really don’t see any alternative to market failure as discipline and I hope we can eventually work out regulations that stick businessmen with the consequences of their actions quickly enough and locally enough that we can afford to let them fail.

26

Barry 10.25.08 at 1:07 pm

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).

27

John Emerson 10.25.08 at 1:28 pm

My understanding is that Russia and the Scandinavian countries will unite to save Iceland, and then consolidate their navies in order to press the Danish claim to Hans Island. The Canadians may choose to join the Arctic Alliance rather than fight. At that point, Alaska will be exposed, and I say give it to them.

28

Bush pilot 10.25.08 at 1:52 pm

” 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…

29

lemuel pitkin 10.25.08 at 4:07 pm

I’m glad to see that John Q. and Daniel agree that they disagree. Too often in the blog world, people only argue with idiots and ideological opponents. Debates with friends are much more productive, IMHO.

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. Have there really been no bubbles in settings without big current account deficits? The Japanese bubble of the 1980s, for instance, look very similar to the US bubbles.

The essential requirement, rather, seems to be a big savings glut relative to the demand for investment. In classical theory, this is supposed to be impossible because the interest rate will fall, lowering savings and making lower-return projects acceptable. The central insight of The General Theory is that the interest rate doesn’t work this way; Keynes argued that savings have to fall to match investment demand through reduced income instead, either temporarily in a recession or in longer-term stagnation. But in modern economies, there’s a third possibility, which is that the excess savings give rise to a speculative bubble instead.

Regulation might prevent this but it’s not easy; I agree with Daniel that the demand for speculative assets is the key variable in whether you get a bubble, since it’s very hard to keep someone from supplying them. And given a savings glut, it’s not even obvious that the no-bubble alternative is preferable. If all that liquidity had not poured into the mortgage market, would the labor and capital that went into building houses have been used for some better purpose, or would they just have sat idle?

30

ScentOfViolets 10.25.08 at 4:36 pm

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.

31

John Emerson 10.25.08 at 5:07 pm

What we need to do is 1.) abolish the Federal reserve system and b.) go on the gold standard. Simple.

32

John Emerson 10.25.08 at 5:16 pm

Something else happened.

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

33

Tom West 10.25.08 at 7:51 pm

Two points: Popping a bubble is pretty much a certain way to get voted out. Hurting a lot of people today to “perhaps” prevent a *huge* number of people from being really hurt tomorrow is not going to win votes. Especially given that there’s no consensus for what should be considered a bubble.

Second of all, if the time between extra reward and inevitable tragedy lasts for more than a few years, you might as well hop on the bandwagon. If it’s a big enough trend, you’ll (1) get fired by your shareholders for turning your back on the huge rewards long before the end comes, (2) get bought out by your much richer peers who are raking it in, or (3) be wiped out anyway when the crunch comes because in the panic of the downturn, no-one is going to distinguish between you who was prudent and your peers who weren’t.

(For regulators, it’s what happens at the polls when your well-regulated industry gets eaten alive by foreign competitors because of “unnecessary” regulation.)

As long as someone somewhere is willing to take the risks, eventually everyone will *have* to join the risk-takers club (or become irrelevant).

In this game, you can’t win, you can’t break even, and in our globalized world, you can’t even get out of the game. Not when humans are essentially incapable of remaining cautious after a few years of good news.

Thus my verdict: After we pull out of the current, most countries will be back to business as usual within a decade, with a few countries choosing to have their banking industry sink into international irrelevance by maintaining strict prudent regulation.

34

Barry 10.25.08 at 8:20 pm

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).

35

PersonFromPorlock 10.25.08 at 9:17 pm

Barry: oh, yes, I quite agree; our corporate leaders will whore for short-term cash and call it virtue. And I think one of the best things the President – any President – could do would be to trumpet the fact from the bully pulpit. But don’t hold your breath. And I’m not really sure that shame works any more, anyway.

36

ScentOfViolets 10.25.08 at 9:32 pm

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

37

dsquared 10.25.08 at 9:42 pm

As long as someone somewhere is willing to take the risks, eventually everyone will have to join the risk-takers club (or become irrelevant).

I add, as I have added before, that a world in which this wasn’t the case would be one in which monetary policy was impossible. We have an economic theory of what such a world would look like, courtesy of Edward Prescott and Robert Lucas, but as I’ve said before to various blogospheric audiences of well-meaning Keynesians, do you really want to go there?

38

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.

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…

39

John Quiggin 10.25.08 at 10:07 pm

To restate: a regulatory framework that allows for unrestricted financial innovation is one where the bad consequences of overly expansionary monetary policy are initially concealed, but ultimately amplified. Greenspan’s monetary policy mistakes and the mistakes of regulatory policy were two sides of the same coin, and I don’t see the point in saying that monetary policy is primary.

40

ScentOfViolets 10.25.08 at 10:52 pm

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.

41

Omega Centauri 10.26.08 at 12:26 am

I want to take a somewhat longer view of things. (OK, so this is partly to obscure the fact that I don’t really understand economics and finance)! Wasn’t a fundamental problem for the US economy, and the political powers that be, that the expectations of continued exponential growth were becoming increasing impossible to meet. For any politician to admit to a belief that his constituents expectations for exponential growth are unsustainable (or worse to propose policy that acknowledges an end to growth) would be a career ending move. Hence, the incentive to allow obscure fudges (financial engineering, unsustainable borrowing, etc.) to put off the day of reckoning. With these sorts of incentives and expectations, operating at multiple levels, it is inevitable that things are going to progress until one or more tipping points are reached. From this viewpoint the details of the various financial shenanigans, and of how they unravel may not be of great import. The real issue is that we have embedded ourselves into a belief system based upon the unsustainable (exponential growth forever). Unsustainable processes will always reach their limits. If I look at the recent world economy from the standpoint of basic resources (fossil fuels, fertile soil, mineral ores, etc.) I see that per-capita, a lot of them have peaked (quantity per person per year is now decreasing). As long as we expect that the average person can grow exponentially richer, while maintaining a growing (or even steady) population these constraints are going to become critical. I submit, that we have already reached some important Malthusian limits. It is even worse than simple resource divided by world population decreasing, but resources divided by the world population which can effectively compete for them is rapidly crashing. The recent financial whirlwind has temporarily brought the world economy back below the current resource limits (that is why commodity prices have crashed from their recent record highs). Any prescription for fixing the financial affairs of the world which fails to address the more fundamental issue of finite resources is doomed to serious disappointment once the limits are reached early in the recovery.

42

John Emerson 10.26.08 at 12:49 am

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.

43

roger 10.26.08 at 12:52 am

Surely, Brooksley Born, Clinton’s head of the CFTC, has been proven right – the derivatives market should have fallen under the CFTC, and – I think – they should have instituted elementary regulations, including instituting a market for derivative instruments and simply disallowing certain slice and dice issues that intentionally obscured value.
But the deregulation of the financial services sector was secondary to what was fundamental about the economy for the past thirty years – crushing labor’s bargaining power and – in classic fashion – extracting higher profits as a consequence. The disparity in wealth was, in a sense, brilliantly bridged by making middle America buy into its own relative impoverishment – on the one hand, diminished wage and benefits increases over time, on the other hand, the 401(k). It was the perfect Rube Goldberg machine. Eventually, though, as with all perpetual motion schemes, the central flaw = that a consumerist economy could grow as the real purchasing power of the consumer shrank = blew it up.

44

roy belmont 10.26.08 at 2:05 am

#42:
It was Bobby Fischer.

45

Tom West 10.26.08 at 3:22 am

And this is why there have to be drastic penalties attached to this sort of behaviour.

Whoa! Jail time? Are you serious?

I don’t want to misrepresent you here, so let me ask you to clarify two things before I reply.

What crime do you think the bank executives committed?

Who among those who helped contribute to the crisis should also be charged? Rating agencies? Local mortgage brokers? Policy makers who kept interest rates down? Politicians who attempted to increase the home-ownership rate? Cash holders looking for better returns? Those who took advantage of the relaxed lending standards?

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.

I’m sorry, I don’t quite understand – why would seeking the highest return require forgiveness. That’s the *point* of the stock market. Now the stock holders might feel cheesed that no-one warned them about the risk (mostly because it seems that no-one inside the bank realized the risk either), but that seems a different matter…

46

JR 10.26.08 at 3:49 am

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.

47

ScentOfViolets 10.26.08 at 4:03 am

Tom West 10.26.08 at 3:22 am

And this is why there have to be drastic penalties attached to this sort of behaviour.

Whoa! Jail time? Are you serious?

I don’t want to misrepresent you here, so let me ask you to clarify two things before I reply.

What crime do you think the bank executives committed

The shoe is on the other foot, actually; I don’t want to misrepresent you here, but are you seriously trying to imply that I think large numbers of crimes under current laws have been committed?

Because if that’s the case, I can instantly dismiss you as a complete loon, probably a libertarian[1].

Your call.

[1] I think the reading of what I wrote is rather obvious and uncomplicated; I don’t see how anyone can read this sort of thing into the text unless they are a hopeless partisan.

48

virgil xenophon 10.26.08 at 4:15 am

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……

49

Martin Bento 10.26.08 at 4:46 am

John Emerson,

Although you’re being a bit flippant in this thread (nothing wrong with that, and Lord knows Greeny deserves no better), you’ve made the comment about Randian ratf*ck before, so I suppose you mean it. But I wonder it you could flesh out what you’re suggesting. I haven’t read Atlas Shrugged, so I have only a vague notion of this “John Galt” stuff. If I’m not mistaken, though, it involves the elite pulling out of society, letting it fall to shyte, and forming their own utopian country club commune or something. It’s true that the Bush family purchased a parcel in Paraguay twice the size of San Francisco, beside a much bigger parcel owned by Moon, and atop one of the world’s largest aquifers, which seems very strange. But I don’t see why people who can go anywhere and enjoy the fruits of the whole world would want to hide out in the jungles of Paraguay. What are they going to get there that they can’t get at Bohemian Grove? Or have I got it entirely wrong? What is the objective of the ratf*ck?

50

Martin Bento 10.26.08 at 4:57 am

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.

51

J Thomas 10.26.08 at 5:11 am

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 Texas Holdem 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 Texas Holdem 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.

52

J Thomas 10.26.08 at 5:18 am

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.)

53

Coldtype 10.26.08 at 7:28 am

“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”
-J Thomas

On the contrary JT the lack of regulation was fundamental to this catastrophe. Had the FDR era regulations remained in place MBS, CDO, SIV, and CDS are acronyms without meaning.

54

Coldtype 10.26.08 at 8:07 am

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.

55

J Thomas 10.26.08 at 9:13 am

“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”
-J Thomas

On the contrary JT the lack of regulation was fundamental to this catastrophe. Had the FDR era regulations remained in place MBS, CDO, SIV, and CDS are acronyms without meaning.

I was quoting somebody else, and my post got moderated. I thought it might be because of a g*mbling reference and fixed that, but accidentally left off the emphasis that would show it was quoted.

I’m not sure what it means to say it did or didn’t have macroeconomic causes. But I think we’re talking at different levels. It’s like we could ask why a war starts, and a soldier in the fighting might say that he’s fighting because the guys on the other side are shooting at him and he’s ordered to shoot back. Which is true on one level. On another level, the enemy’s offensive is where that soldier is instead of somewhere else because their strategy has decided that this is an important objective for them to take. And on yet another level the war started because of a disagreement in which neither side could bring themselves to back down.

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.

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.

Better regulation might have prevented it, but if there had been effective regulation then it would have been necessary for the Bush administration to deregulate it.

Is that macroeconomics?

56

Coldtype 10.26.08 at 12:36 pm

“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.

57

Tom West 10.26.08 at 12:54 pm

Are you seriously trying to imply that I think large numbers of crimes under current laws have been committed?

SOV, if *I* said that someone should go to jail and serve hard time, *I* would be implying that I believed that that person was guilty of crimes under current law.

However, that seemed sort of extreme, so I asked for clarification.

Do you believe that the executives committed crimes under current laws?
If not, what sort of laws do you believe *should* be on the books that they would have violated?

As for libertarian loonism, being generally on the left part of the spectrum, I will tolerate unsupported conclusions from the right, but have far higher standards for my own side. I will admit to being deeply suspicious of the “someone’s got to pay” sentiment that tends to occur in almost any major crisis. Hence my request for clarification.

58

Alex 10.26.08 at 1:04 pm

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.

59

Coldtype 10.26.08 at 1:06 pm

Oh, one last thing. This really ticks me off.

60

J Thomas 10.26.08 at 1:58 pm

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.

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ScentOfViolets 10.26.08 at 3:06 pm

Tom West 10.26.08 at 12:54 pm

Are you seriously trying to imply that I think large numbers of crimes under current laws have been committed?

SOV, if I said that someone should go to jail and serve hard time, I would be implying that I believed that that person was guilty of crimes under current law.

News flash: I’m not you. Nor do I read as sloppily as you – if that’s indeed what it is. Why don’t you go back and actually look at what I wrote:

Arguably, fraud, or poor managment at those levels is worse, much worse, and should be treated accordingly.

However, that seemed sort of extreme, so I asked for clarification.

Why didn’t you read what I wrote instead? And now that this has been pointed out to you, do you think you could manage a simple, ‘Sorry about that, I was mistaken’? Or is this where you affect some sort of indignation, where you attempt to say that somehow your misunderstanding is my fault?

I’ll repeat: the ball is in your court.

Do you believe that the executives committed crimes under current laws?
If not, what sort of laws do you believe should be on the books that they would have violated?

I will deal with this as soon as I’ve established that you’re a fairly reasonable person. The evidence so far does not indicate that this is the case.

As for libertarian loonism, being generally on the left part of the spectrum, I will tolerate unsupported conclusions from the right, but have far higher standards for my own side. I will admit to being deeply suspicious of the “someone’s got to pay” sentiment that tends to occur in almost any major crisis. Hence my request for clarification.

I’m not ‘on your side’. I’m not even particularly liberal. But you’re right about having some standards, among them, reading comprehension. Note that I did not say that ‘someone has got to pay’, nor did I give ‘unsupported conclusions’. I said that penalties should be much, much stiffer so that there are fewer discussions about ‘someone having to pay.’

This reminds me of something that happened a few weeks back. When I give a quiz, it happens that some finish before others, and that I allow them to leave before class is over. Now, despite my repeated requests, there was a certain sort of ‘absentmindedness’ that had some students not closing the door behind them. When specifically confronted, repeat offenders would say they ‘just forgot’. As if I had to prove that they hadn’t, yadda yadda. So I announced that anyone leaving the class early who did not close the door behind them would receive a straight ‘zero’ on their quiz. Surprise, after the next quiz, only two people ‘forgot’ to close the door behind them. At the next class period, I had one of them raising their hand, and demanding to know why they got a zero. I told them why, they proceeded to argue, and I cut them off, saying that was it, and that if they had a problem, take it up with the department head – oh, and here’s their phone, office number, and email.

Another surprise – since that time, no one has ‘forgot’ my policy. The bottom line is that, for some people at least, tough penalties do deter certain types of behaviour. Especially the sort of behaviour that these sorts have tried excuse by saying they ‘forgot’.

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Omega Centauri 10.26.08 at 3:38 pm

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.

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Tom West 10.26.08 at 4:19 pm

SOV, thank you for your reply. Indeed all the evidence of your position was there in writing, I apologize for forcing you to go back over the previous material. I’ll endeavour to remember in future that what you write is exactly what you mean. (I’ll admit to not being similarly exact unless I’m spending hours crafting my writing.)

Then let me make my position clear. 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.

Apparently it wasn’t.

‘Poor management’ is so utterly ill-defined and time-specific (it was great management until it wasn’t) that it seems almost begging for abuse. I’m terrified to think what uses the current administration would have put such regulations to (at least before the current fiasco).

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.

Why not just make ‘greed’ or ‘arrogance’ criminal charges as well? That way we can make people pay that we ‘know’ are guilty. At least that’s a charge that’s unambiguous and could certainly be successfully leveled at whowever we feel should suffer for the current crisis.

Your classroom example is illuminating. The crime was specified exactly. 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.

And yes, I agree that deterrence works. But the cost of deterrence has to be measured not only by the change in the behaviour of the deterred, but in what is says about the deterrers.

Anyway, I will completely understand if you choose not to reply. I suspect our world-views are too far apart to be able to constructively learn much from each other. On the other hand, if you do feel it’s worth your effort to reply, you do have my thanks in advance.

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Coldtype 10.26.08 at 4:35 pm

“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.

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J Thomas 10.26.08 at 5:00 pm

Omega Centauri, I think you’re right.

I’d expect the consequences to be different in nations that have been primarily borrowing, versus nations that have been primarily lending. I’m not sure what to expect in either case, though. Both will suffer disruptions.

However the deals work out about the existing debt, still debtor nations will continue to need to import things that are hard for them to make for themselves, and they will need hard currency to do so — not dollars. They must have an emphasis on making stuff for export. Roads and railroads headed toward ports. Investment in stuff to export. Low-paid labor to make exports, not stuff the workers can buy for themselves.

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.

Haven’t people run into similar problems before? Like, there was a time when everything was slowing down for lack of wood. But they sped up faster when we switched to coal. And things started slowing down when the easy coal was gone, but we sped up more switching to oil (and then found more coal). Find an alternate energy source that’s cheaper than oil, and the growth could speed up until we run into a different limiting factor.

Why aren’t we doing more alternate energy? We’d get economy of scale with higher volume. And costs will go down as we advance along the learning curve. Maybe part of the problem is that chaotic oil markets make alternate energy risky.

If there were trade barriers that made imported oil less available and consistently expensive, then we’d have a stronger incentive to invest in alternate energy. Also in energy conservation of various sorts.

Here’s a result from bacterial genetics. Say your bacteria have an environment they aren’t well-adapted for. Perhaps an energy source they can’t metabolise well. In the real world they’d get out-competed by something that handles that energy source better and it wouldn’t be an issue, but in the lab they do evolved. Given a choice between evolving a better enzyme for the rate-limiting step versus making more of the existing enzyme, they usually do the latter. This is because it’s hard to find an improved enzyme, and the improvement is likely not to be a large one, likely 10% or so at most. But it’s easy to get a gene duplication, and if two copies of the gene result in twice as much enzyme, the result is a 100% increase minus the cost of doubling the enzyme. Similarly with four copies, or more copies. And then when you get a mutant version in one copy, it only affects a fraction of the enzyme that gets made. It has less effect, and when things change and most of the duplicate copies of the gene are lost, the good version will likely be lost too.

It’s just far, far easier to get an improvement by doing the same things in a different ratio than to do something new.

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ScentOfViolets 10.26.08 at 5:02 pm

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.

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PersonFromPorlock 10.26.08 at 5:04 pm

ScentOfViolets 10.25.08 at 9:32 pm
I’m afraid it’s much, much worse than that: they will ‘whore for short-term cash’ and call it scientific.

To be fair, that’s more academics looking for grants than business leaders.

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Coldtype 10.26.08 at 5:10 pm

“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.

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J Thomas 10.26.08 at 5:12 pm

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

Yep.

OK! When I argued that free trade might not be completely thought out to be right in all circumstances, several people told me I just plain didn’t understand and when I did understand I’d see that free trade is always best.

https://crookedtimber.org/2008/10/13/its-a-total-surprise/

If you’re interested you might search for J Thomas in the thread and look for things I responded to and things responding to me. But it probably wouldn’t be interesting, just the same old rote responses with no thought behind them.

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

Various people are saying that we have to be bipartisan and just put it all behind us, that if we get bogged down noticing who did it then we won’t have time to fix things.

Presumably Bush will pre-emptively pardon everybody involved.

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MarkUp 10.26.08 at 5:44 pm

“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.

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Omega Centauri 10.26.08 at 6:12 pm

J Thomas:

While this is similar to some past energy source transitions (wood to coal, whale oil to petroleum) is has a real feel of being more fundamentally different this time. Its not just oil (or even energy as a whole, energy from longlasting sources isn’t that hard of a problem), but it is a whole host of other resource limitations all happening at nearly the same time. Fertilizer, food, iron ore, copper, the list of commodities whose skyrocketing prices were a major concern just a couple of months ago. And the ability of our planet to absorb the changes we’ve been making to her is also reaching its limits. It really looks like business as usual, plus a few technological tweaks, and regulatory tweaks won’t cut it this time around. I think a big part of the problem this time, is that the effective world population which can effectively compete for these resources has increased greatly. This is the big impact of globalization. No longer is it just the population of the OECD, but via the globalization of opportunity, billions more have a shot at the good life. The effective demand for all sorts of critical resources is increasing several times faster than population growth, at the same time as many of the geologic supplies are being depleted. Making better use of whatever critical resources we have can no longer be an incidental thing, it must become the primary driver of the world economy. That is a major paradigm shift, that I think few are yet aware of.

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Coldtype 10.26.08 at 6:34 pm

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.

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virgil xenophon 10.26.08 at 6:59 pm

Yes, Omega Centauri, I was just over at The Oil Drum the other day reading a quite compelling post and subsequent discussion about whether “peak” phosphate production had been reached, and it’s consequences for agriculture and food production vs growing demand world-wide–and that unlike oil, there are not really any economically viable alternatives. Major paradigm shift indeed.

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virgil xenophon 10.26.08 at 7:30 pm

For those interested, hit The Oil Drum at:

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

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

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roy belmont 10.26.08 at 7:50 pm

Not immediately pertinent but this “It was americans (and illegal immigrants) building those McMansions” contains something that’s at least as insidious as the economic meltdown.
Those McMansions spacious as they may be are basically made out of cardboard, glue, and mud.
The mud, stucco, has as constituted now a pretty short utility life, because it’s formulated to be cheap rather than durable. Then it will begin to break down.
As it goes it will expose the underlying cardboard, or OSB, which is ground-up wood fibers stuck together with resin. The resins are highly toxic, and outgas toxins bigtime as they degrade.
Those houses are going to deteriorate fairly quickly, and they’ll become poisonous and carcinogenic when they do. They’ll offer the illusion of shelter even then, and if things get dystopic enough people will avail themselves, out of necessity.
Which is a pretty tight analogy for where the money came from to build and buy them in the first place.

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Tom West 10.26.08 at 9:01 pm

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…)

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Tom West 10.26.08 at 9:13 pm

ColdType>

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.

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.

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

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). Unless investors realized that the banks were a lot riskier than other investments, the only moral point being lost by the bail-out is that the stock market is a risky beast, and anyone can arbitrarily lose their shirt. (Obviously they should invest in something safe like real-estate :-))

This is not the lesson one wants to teach investors if you want anyone to invest in your industries :-).

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MarkUp 10.26.08 at 10:28 pm

”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?

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J Thomas 10.26.08 at 11:54 pm

Its not just oil (or even energy as a whole, energy from longlasting sources isn’t that hard of a problem), but it is a whole host of other resource limitations all happening at nearly the same time. Fertilizer, food, iron ore, copper, the list of commodities whose skyrocketing prices were a major concern just a couple of months ago.

Many of those could be much-alleviated with cheap power. With cheap power you can make fertilizer, you can afford to use lower-grade ores, you can farm more intensively, etc. It’s all connected, and power makes a big difference.

And the ability of our planet to absorb the changes we’ve been making to her is also reaching its limits.

That one is harder.

I think a big part of the problem this time, is that the effective world population which can effectively compete for these resources has increased greatly.

That’s a great big problem for the guys who’ve been using those resources inefficiently. It’s only an opportunity for the rest of the world. To the extent they get stuff that’s worth having at good price that they couldn’t have before, they’re better off. To the extent that the stuff isn’t worth having at what it costs, they can do without and be no worse off than before. Not counting problems like water quality etc.

Making better use of whatever critical resources we have can no longer be an incidental thing, it must become the primary driver of the world economy.

That’s another opportunity. A bunch of investment opportunities.

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virgil xenophon 10.27.08 at 12:11 am

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—

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Tom West 10.27.08 at 1:36 am

“efficient but brittle” systems vs “secure but inefficient”

Virgil, thank you very much for the pointer to the article. It pretty much sums how I view the problem (which I derived from Thomas Homer-Dixon’s book “The Upside of Down” which talks similarly about the danger of efficiency), except with a lot more detail (and some lovely explanation about how it can take a while for the problems to become visible).

The trouble is that there’s really no way around it for rarely occurring problems. If you choose to be safe and inefficient, your competition will eat your lunch (and you) before the crisis occurs. (Or the voters will demand the benefits of efficiency when they see their neighbours reaping the rewards.)

So, I figure we’ll just have to pay the price of efficiency.

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J Thomas 10.27.08 at 1:39 am

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?

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J Thomas 10.27.08 at 1:51 am

The trouble is that there’s really no way around it for rarely occurring problems. If you choose to be safe and inefficient, your competition will eat your lunch (and you) before the crisis occurs. (Or the voters will demand the benefits of efficiency when they see their neighbours reaping the rewards.)

Tom, the main problem I have with your argument is that it is self-refuting.

If you apply it to the ecology, we have no choice but to encourage mass extinction. Get rid of every species that isn’t the most useful to us right now.

If it was right, it would be wrong.

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Coldtype 10.27.08 at 2:18 am

“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.

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John Quiggin 10.27.08 at 9:38 am

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Tom West 10.27.08 at 11:56 pm

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.

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Tom West 10.28.08 at 12:15 am

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.

I’m sorry, but they failed.

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.

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. Agreed it’s a very high bar, but realistically, it’s the only bar we’ve got.

(And yes, I’m a big fan of Brad Setser’s blog, but then, as the saying goes, I’ve predicted 7 of the last 3 recessions (and seen all my favourite financial columnists lose their jobs because they called crashes years too soon).

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MarkUp 10.28.08 at 12:54 am

”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.

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J Thomas 10.28.08 at 2:21 am

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.

There are lots of counterexamples. Like, the sugar lobby has gotten subsidies for US sugar and trade restrictions on imported sugar for longer than I’ve been alive. When I was a kid there were Reader’s Digest articles about it, and it keeps right on chugging along. I guess people don’t feel like it hurts them enough to complain much? Similarly with shoes. I was surprised when I visited france and found shoes that would cost $100 in the USA on sale for $20. Eventually we found ways around that. We imported shoes that were almost complete and did the last little bit of work here and labeled them Made In USA, etc. But for a long time people paid far too much for shoes in the USA and did nothing about it even though Reader’s Digest exposed the scam.

So there’s something else going on.

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.

I want to separate this into two cases. One case, there is a small but unknown chance of catastrophe. In that case I’m not sure what to do. We can decide what risk is acceptable but we can’t measure the risk of catastrophe. My general thought would be to set up safe enclaves and subsidise them, so something will be left if the catastrophe comes.

The second case, the catastrophe is nearly certain but we can’t be sure when it will arrive. This is the ponzi scheme case. I want to generalise that, I’ll call it a ponzi scheme if for any reason you get a catastrophe when the snowball stops growing. Not just when earlier investors are paid by the later investor’s input. If it has to grow or it fails, then it *will* fail because nothing grows consistently all the time forever.

I’m not certain which of these our current crisis came from. Could the bubble have slowed down without popping? If so it was not a ponzi scheme by my use of the phrase.

“If an ignorant person or an insane person incites trouble, it is the fault of authority for not predicting and preventing that trouble.” It is the government’s responsibility to prevent bubbles when those bubbles do not fit the government’s goals. Bubbles sequester increasing amounts of capital when that capital might be used much better (though at lower returns). Then they disrupt things. Not good.

There is more than one way to stop a ponzi scheme. Punishing your own citizens for participating as you say has the flaw that they will feel punished until it fails, and maybe even afterward. But a strong government might find a way to stop the scheme’s growth for a time, and if that makes it collapse — the problem is solved. Local governments, faced with a chain letter among their stupidest citizens, publish reports that a chain letter scam is circulating and that it’s illegal to use the postal service for such scams, and the thing collapses right then. The people who got caught by it get upset that the government stopped it before they got their money out, but most of the citizens just feel glad they missed out on the scam.

About US food dumped on third-world nations:
Because for the majority of non-farmers, it is an improvement, despite the fact it will cost them big time later on.

Improvement. Cost them big time later on. Something does not add up here. You could say the same thing about heroin except that people think it isn’t an improvement. Though people who first get addicted to it do feel like it is. Is that a good analogy?

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.

Sure. A ponzi scheme grows, and the early investors make lots of money and spread the word. And if it gets big enough it sucks enough money out of everything else that they wither and there’s no good alternative. It seems like almost irresistable pressure, to participate in growing the bubble. It’s the responsibility of the authorities to divert that pressure. Preferably by preventing the problem in the first place, if necessary by doing something sneaky that resolves it before it gets too big.

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J Thomas 10.28.08 at 2:51 am

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?

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Tom West 10.28.08 at 10:09 am

It is the government’s responsibility to prevent bubbles when those bubbles do not fit the government’s goals.

This is tricky. In the case of the USA, it *did* fit the government’s goals of increasing home ownership, especially among non-traditional home owners. An admirable goal, but not necessarily an implementable one.

The people who got caught by it get upset that the government stopped it before they got their money out, but most of the citizens just feel glad they missed out on the scam.

Only if they recognized it as a scam. I remember a rash of one term governments that used interest rates to squash inflation some 20-30 years back. They were successful as there was no resurgence of inflation. However, they were generally viewed as having induced a recession for no good reason. Most citizens will not recognize that they averted catastrophe. (And there’s still debate as to whether there was a catastrophe in the offing.)

Improvement. Cost them big time later on. Something does not add up here.

Admittedly, I should have said “perceived improvement”.

You could say the same thing about heroin except that people think it isn’t an improvement. Though people who first get addicted to it do feel like it is. Is that a good analogy?

Not bad :-). However, it would be closer if the vast majority viewed heroin as a unmistakable good.

“Registered Economist”

I think the idea is a little harsh :-), though some attempt to hold economists accountable might well be in order. However, there are three flaws.

One, predicting the outcome of a policy is pretty much like predicting the weather. There are approximately a zillion unknowns, so for any given policy there’s an almost infinite number of outcomes, although many far more likely than others. When I say there’s a 90% chance of success, do I get punished for failure, even when I predicted it should occur 10% of the time?

Two, let’s be clear here. The net effect will be to *increase* the homogeneity of opinion among economists. It requires real arrogance to be so certain that you’ve seen what no other economist in the world has seen that you’re willing to risk (insert penalty here).

Three, these events occur so infrequently, the odds that you have more than two such events in a given career are not high. That strongly reduces the chance that being correct about one thing makes you more likely to be correct about another (and thus worth listening to).

I will say, by the way, that your sugar example *is* an example of where the government can enact policy that is not in the (perceived) best interest of the consumers. You can get away with a lot and not get punished as long as the perceived cost is not too high.

However, in the end, large scale comparisons will get you. There’s no way to get around that median after-tax incomes in the rest of the developed world are about 2/3’s the American levels. When that’s thrown in your face, courtesy of the media/internet/better communications every day, of course your relative wealth drops like a rock even if your doing well compared to your physical neighbours.

That’s what makes low efficiency, high safety policies so hard to execute in the long run.

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virgil xenophon 10.28.08 at 12:01 pm

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.

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J Thomas 10.28.08 at 12:54 pm

“It is the government’s responsibility to prevent bubbles when those bubbles do not fit the government’s goals.”

This is tricky. In the case of the USA, it did fit the government’s goals of increasing home ownership, especially among non-traditional home owners.

I agree that it fit the government’s goals. I disagree that the Bush administration gave a damaged rat stomach for increasing home ownership as an end goal.

The Bush administration wanted a bubble they could sell to foreigners. With our trade imbalance they needed foreign “investment”.

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J Thomas 10.28.08 at 12:56 pm

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.

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Coldtype 10.28.08 at 2:35 pm

“Thus most rational people go with the general consensus. Why should any rational actor choose a few experts against a large number of experts[?]”
-Tom West

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. Why does Al Capone have seat on the Chicago Crime Commission?

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J Thomas 10.28.08 at 3:20 pm

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?

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lemuel pitkin 10.28.08 at 4:57 pm

Late in the day but I think J Thomas gets it about right in 55:

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.

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.

Better regulation might have prevented it, but if there had been effective regulation then it would have been necessary for the Bush administration to deregulate it.

That’s leaving aside the question of whether any realistic regualtion could in fact have prevented the bubble. But the essential point is it’s probably not correct to see regulation as exogenous here.

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Coldtype 10.28.08 at 6:19 pm

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.

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Coldtype 10.28.08 at 8:05 pm

For what it’s worth, economist Michael Hudson (a ‘failure’ in Tom West’s estimation), explains this far better than I.

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J Thomas 10.28.08 at 8:42 pm

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

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Coldtype 10.29.08 at 3:54 am

Perhaps I’ve read too much into Lemuel’s comment regarding regulation but this asset bubble would not have been feasible under the FDR era regulations. They were quite deliberately deconstructed in order to clear the way for “innovations” such as leverage ratios of 80:1, derivatives markets, and the other exciting casino banking features. So certainly the bubble itself could have been prevented. The larger issue of course is the overall pattern of wage deflation and deindustrialization over the past thirty years in favor of an economy oriented towards speculation which has contributed very little to most American citizens–with the notable exception of unsustainable debt. Deregulation of the financial sector was the mechanism used to effectively hijack the American economy in interests of Wall Street.

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J Thomas 10.29.08 at 12:42 pm

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.

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