Economics/Finance

Hot/cold on the heels of Iceland’s quasi-default, the Roger Lowenstein in the NY Times urges underwater/negative equity homeowners to “Walk Away From Your Mortgage!”. . Lowenstein’s key point is that businesses (including those owned or controlled by the banks themselves) treat default as a straightforward business decision, to be adopted whenever it is profitable to do so. Lowenstein gives a number of examples where leading banks like (inevitably) Goldman Sachs have engaged in strategic default and urges his readers to do likewise. The piece is in a section headed “The Way We Live Now” and it’s striking that it’s taken more than 100 years for the business ethics of Augustus Melmotte to percolate through to the American middle class

To be fair, it’s only in the last thirty years or so that such ethics have become dominant in the corporate sector, to the point where a board that rejected profitable opportunities to stiff their creditors would now be regarded as having violated its fiduciary obligations to shareholders (particularly if the creditors are workers). And despite all the talk about shareholder value, a CEO who passed up opportunities for personal enrichment at the expense of shareholders would be regarded by his or her fellows as a mug.

Millions have defaulted already – (one in eight mortgages is currently in arrears). Bankruptcy is once again as common as divorce. When defaulting on debt is this common, it is hard to sustain any sort of social stigma or internalised notion that this is anything other than a financial option, like refinancing an existing loan. And, as with divorce, we must soon be reaching the point where most people who take out loans will do so in the knowledge that default is an option.

The question is – can the consumer credit system survive this? Probably it can, but the system will need some radical changes. It’s worked for several decades on the basis of creditworthiness criteria that work on the assumption that (nearly) everyone will repay their debts if they can. Until recently, the checks could also rely on the assumption that people would be more-or-less honest in the information they provided in their applications. The financial system, by promoting ‘liar loans’ colluded in the destruction of the second assumption, and by leading the way in strategic default, helped to destroy the first.

The problem for lenders now is that they will increasingly have to act on the assumption that their borrowers (including those who appear creditworthy on the old standards) are planning, at a minimum, to use default as an insurance option. The only good way to protect against this is to demand lots of secure collateral. That means less liberal credit (and, given higher default rates, higher interest rates) for everyone and no credit at all for lots of us.

Iceland has a population of about 300,000 , about 140,000 taxpayers and pre-crisis GDP of about $12bn. The Royal Bank of Scotland has about 140,000 employees and pre-crisis net profit of about £8.5bn – they’re about the same size as entities. Iceland, like RBS, did very well out of the debt bubble and picked up assets all over the world in an impressive but ultimately unsustainable spending spree. And in a final point of similarity, Iceland, like RBS, owes the British government a hell of a lot of money as a result of the bursting of the bubble.
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The financial crisis has, justifiably, enhanced the reputation of Karl Marx as an economic thinker. Marx was the first economist to treat crises and panics as an inherent feature of capitalism rather than as an inexplicable, but fortunately temporary, departures from a natural equilibrium.

Unfortunately, most of his analytical effort, and even more, that of the school of thought that followed him, was devoted to pointless exercises in value theory[1]. Marx’s discussion of crisis rested mainly on the idea of the falling rate of profit which seemed at the time to be both a theoretical inevitability and an observable trend. But with technological progress, there’s no necessity for the rate of profit to fall consistently, and it hasn’t. There are other ideas in Marx that might be developed to yield a better theory of crisis, but nothing resembling a systematic theory.

And, in the current crisis, Marxian economics seems to be pretty much Missing in Action. I haven’t seen much and what I have seen hasn’t added much, in analytical terms, to the standard left-Keynesian analysis. Perhaps the problem is that just about everyone expects capitalism, in one form or another, to survive this crisis, contrary to the orthodox Marxist view where crises become ever more severe and eventually precipitate the revolutionary overthrow of the entire system. But it’s equally possible that I haven’t been looking in the right places.

Readers of my blog have pointed me here, which has some good stuff, but, as I said, isn’t much different from the standard left-Keynesian analysis[2]. Can anyone recommend a distinctively Marxian analysis of the current crisis?

fn1. If I get time, I’ll write a longer post on this point. In short, the idea underlying debates about value theory was that since the sale proceeds of production are divided between the owners of inputs to production (labour, capital, and land in the C19 division) there must exist some natural way of determining the share of the value of output for which each group is responsible. This is essentially an idea about average values, since averages added across a group are equal to the total for that group. But, as the neoclassical revolution of the 1870s showed, prices are determined by marginal costs and marginal rates of substitution and these don’t equal averages. Subsequent attempts to rescue a substantive role for value theory as opposed to price theory by Marxians, Austrians and Sraffians, not to mention the neoclassical marginal productivity ethics of JB Clark and others, have gone nowhere.

fn2. Except for this piece, which reads more like Cochrane or Fama with some added Marxist verbiage

For me the big change that came with the last decade was blogging. I started in 2002, and it’s been a big part of my life (sometimes too big) ever since. So, when it came to review the decade, the obvious place to look was the Wayback Machine, which captured my old blogspot blog on 27 July 2002. Looking at the blog as it was then, two things jump out at me

* Looking at the blogroll, I feel like the last of the Mohicans. The bloggers of those days have nearly all retired, and hardly any has a solo blog anymore. CT is something of an exception – quite a few of us still keep our personal blogs going. Mine is here.

* I’m singing the same song now as I was all those years ago. The top post on the page is about how the financial crisis has discredited the efficient markets hypothesis, trickle down economics, privatisation and so on. Of course that was the dotcom financial crisis of 2000-01. I think a few more people are paying attention this time around, but we will have to wait and see.

Some work of mine on presumed and informed consent for organ donation has been picked up by Catherine Rampell at the New York Times’ Economix blog. It’s a good summary of the paper. We’ve had some discussion before about this stuff on CT, in the context of the possible introduction of a presumed consent rule in Britain.

Here’s the New York Times obituary. Here is his surprisingly thin Wikipedia entry.

Charles Rowley “laments the cowardice”:http://charlesrowley.wordpress.com/2009/12/09/the-dog-that-does-not-bark/ of his erstwhile band of brothers. In verse, no less (or, if you insist, ‘verse’).

Where are all the real business cycle theorists who once argued that business cycles reflect Pareto-optimality? Where are all the monetarists who used to worry about the inflationary implications of massive increases in the money supply? Where are all the financial economists who used to thrust the efficient capital market hypothesis down the throats of Wall Street brokers? Where are all the law-and-economics scholars who used to boast of the efficiency of the common law? Where are all the New Classical rational expectations scholars who used to explain why systematic fiscal and monetary policies cannot influence macroeconomic activity? Where are all those Friedmanians who used to argue so effectively in support of capitalism and freedom?

Where? Where indeed?

Where have all the free market soldiers gone?
Why, they have run for cover, almost every one!
Their models have failed, their math is undone.
They need new statistics and that is no fun.
They dig into trenches to evade the socialist gun.
Their escape routes are cut off, nowhere else to run.
They hide in the darkness and avoid the free market sun.
Come out, come out, counter-attack and be done!

On Monday I went to The Economist’s World in 2010 Festival, on the invitation of erstwhile CT guest-blogger, Matthew Bishop. It was a witty and thought-provoking romp through a range of issues such as the global economic crisis and the prospects for unemployment, global warming and Copenhagen, whether the Republicans will storm next year’s mid-term elections and, of course, who will win the 2010 World Cup. The panels were sprightly with lots of back and forth, and were interspersed by 10-minute talks from all sorts; DC schools chancellor Michelle Rhee, celebrity chef Joses Andres, the buyer for Politics and Prose, Mark LaFramboise and a fascinating graphic and information designer, Nicholas Fenton, whose work is as beautiful as Edward Tufte’s and who produces his own Personal Annual Report (comparison of prices paid per mile in 2008: airline: $0.05; driving:$0.15; New York subway: $0.93; gym: $5.26. Sightings of Michael J. Fox: 1. My boyfriend helpfully pointed out that a proper bloke’s personal annual report would also include helpful stats such as how much sex was had, solo or otherwise, average time, some quality measures, etc. etc. But I’m sure Felton was far too busy cataloguing belly button lint for that.)

Each speaker had to make a prediction for 2010. Predictions are good ways to extrapolate present trends, but I’ve been wary of their usefulness since I attended a conference in August 2001 and we predicted the biggest threat to the world was tension between India and China.

Lest I be accused of burying the lead, the combined predictions for 2010 were: [click to continue…]

Brian Lenihan (Ireland’s finance minister) puts the best face he can on the external limits constraining Ireland’s economic decision making in his “budget speech today:”:http://www.budget.gov.ie/Budgets/2010/FinancialStatement.aspx

In the recent Lisbon referendum the Irish people reaffirmed our place at the heart of Europe. This was the right decision for our economy, for our future and for our children. The single currency has provided huge protection and support to Ireland in the current crisis. It has prevented speculative attacks on our currency and provided funding to the banking system. But, membership of monetary union also means devaluation is not an option. Therefore the adjustment process must be made by way of reductions in wages, prices, profits and rents.

As a small open economy, Ireland would probably have devalued to help cushion the shock, if it had not been an EMU member with no effective control over its currency. Given EMU membership, devaluation (and exit from the system) would probably have been a “very bad idea”:http://www.independent.ie/business/irish/currency-devaluation-may-look-an-easy-option-but-its-a-trick-on-workers-1653712.html. Ireland is hoping to make the best of a bad job, adding levies, increasing taxes and making swingeing cuts to public sector pay so as to shore up its fiscal position.

The problem is that all the fiscal rectitude in the world cannot protect you from “contagious crises of confidence”:http://www.irisheconomy.ie/index.php/2009/12/08/who-blinks-first-ireland-greece-the-ecb-and-the-bank-guarantee/.

One of the “signals” that could instigate a sudden stop in Ireland is a sudden stop somewhere else, particularly somewhere with regional or trade connections. This is why bad news for Greece is bad news for Ireland. If Greece hits a sudden stop, Ireland will wobble, and will be the next in line for a sudden stop in Europe. There is another simultaneous game being played: the ECB and its bailout policies playing a reputation game against member sovereign governments and their fiscal discipline. Again, the Greek situation is bad for Ireland. … Ireland has done everything (so far) that the ECB could reasonably ask of her to impose fiscal discipline and restore competitiveness. If it were only Ireland at risk of a sudden stop, the ECB could be very accommodating about bailout assistance. The ECB would not let a well-behaved minnow like Ireland cause market turmoil. If a sudden stop was brewing and Irish bond yields rocketed up, the ECB could easily mop up any excess of Irish sovereign bonds, killing the run, and later tell some convenient story about why this did not violate EMU no-bailout guidelines. On the other hand, we now know that the Greek government has deliberately and substantially falsified its national accounts over recent years. … no political will to impose any meaningful discipline on tax and spending … adherence to the Growth and Stability Pact is a charade. If the ECB bails out Greece, all semblance of future fiscal discipline throughout the Euro zone is lost. … How can the ECB bail out Ireland if it refuses to bail out Greece?

Greek government bonds “tumbled”:http://www.ft.com/cms/s/0/7e219354-e48b-11de-96a2-00144feab49a.html today. It may very possibly be that Ireland is in the worst of both worlds – suffering the unmitigated agonies of fiscal rectitude imposed by the EMU’s straitjacket, but with at best highly uncertain prospects of support in the event of a new crisis of confidence. Brian Lenihan won’t be sleeping well the next couple of weeks.

I’m a bit hesitant to link to this (as I’m not an elderly right wing economist, I’m worried I might be accused of “belittling the other”), but it’s super-duper awesome! Charles Rowley, familiar to long time CT readers for his “ruminations”:https://crookedtimber.org/2003/07/20/worldly-philosophers/ on the corruption of the profession of political science (we’re all in hock to the federal government) and his “bizarre attack”:https://crookedtimber.org/2009/07/28/anger-and-greif/ on Avner Greif (see “here”:http://www.springerlink.com/content/e4477g1412453627/ for Greif’s reply), “now has his own blog”:http://charlesrowley.wordpress.com/. It’s everything that one might possibly hope for. My favorite so far is the bit telling us that:

bq. the massive fist of free market ideas once again will smash through the false consciousness of Keynesian dreams, and voters will rush to elect leaders such as Margaret Thatcher and Ronald Reagan

‘cos it’s a level of rhetorical styling that I haven’t seen since I used to pick up the newsletter of the Maoist International Movement (the title is a bit of a misnomer; the cadres all seem to hang out in Ann Arbor, Michigan) when I was a graduate student in statistics boot camp. But the Obama=Sykes, Larry Summers=Fagin “post”:http://charlesrowley.wordpress.com/2009/12/05/youve-gotta-pick-a-pocket-or-two-boys/ runs a very close second:

bq. The question that remains to be answered is whether the futures of Larry and Barack will mirror those of Fagin and Sykes. Will some fortuitous Oliver chance across the paths of these shady characters before they can fulfill their dreams while destroying the market system that created the wealth that they covet? Will both meet the dreaded drop in 2012, if not before? Or will pocket-picking accelerate to the point at which Atlas Shrugs and the wealth-creators remove themselves from the economy, leaving those who cannot create wealth to share in the economic collapse of a negative-sum game as the United States begins a long decline into economic mediocrity?

This is a man who was surely born to blog. Update your bookmarks.

Update: “The Fun Continues”:http://charlesrowley.wordpress.com/2009/12/08/a-great-deal-of-ruin-in-a-nation/

bq. As private investment is increasingly crowded out by government expenditures, and as entrepreneurship is dashed by national socialist policies – as indeed was the case in the US throughout the the first two administrations of FDR – the once-powerful engine of the US economy will sputter and then die. Unlike in 1945, in 2019 the United States will not bestride a shattered world economy like some hegemonic Colossus. Rather its _state capitalist,_ [HF: emphasis in original] social market economy will struggle just to maintain existing living standards, while newly-emergent, vibrant market economies demonstrate to a former master the awesome power of laissez-faire capitalism.

If Tyler Cowen hadn’t confirmed that this blog was the genuine article, I’d suspect it of being a clever fraud perpetrated by an old-school lefty – the ‘Staatsmonopolistischer Kapitalismus=Nationalsozialismus’ identity has fallen out of fashion since the collapse of the GDR, and it is rather odd to see it being revived as a defense of free markets.

I recall a short but striking conversation with the formidable Piero Sraffa at the Economics Faculty cocktail party after Dennis Robertson’s Marshall Lectures. I well knew that it was Sraffa whom Wittgenstein had described as his mentor during the gestation of the Philosophical Investigations, but I still ventured a rather simple-minded remark about the obvious importance of the fact-value distinction to the social sciences. He turned on me his charming smile and glittering eyes. Did I really suppose that one could switch from fact to value as if simply moving a handle? His voice rose and his Italian accent grew sharper. “Fact, value! Value, fact! Fact, value! Value, Fact! FACT, VALUE! VALUE, FACT!” I beat a swift and chastened retreat. — W.G. Runciman, Confessions of a Reluctant Theorist, 18.

In response to some comments, I’ve written a little bit about the representative agent assumption in Dynamic Stochastic General Equilibrium Models. I argue that, given the underlying DSGE assumptions, you won’t get very much extra by including heterogeneous agents.

But, I intend to say in the “Where next” section, it seems likely that heterogeneous and boundedly rational individuals, interacting in imperfect and incomplete markets will generate ’emergent’ macro outcomes that are not obvious from the micro foundations. Of course, this is going to be a prospectus for a theory, not the theory itself.

In the meantime, comments on my snippet would be much appreciated.

Update Looking at the responses, I think just about everyone has missed the point, which suggests that maybe I didn’t make it very well.

I’m not saying that heterogeneity doesn’t matter, but that introducing (tractable) heterogeneity into a DSGE model isn’t likely to yield radically different predictions about macroeconomic outcomes. If that’s correct, then if you think DSGE models work well (for some evaluative procedure), you can be relaxed about using representative agents. And if you don’t think DSGE models work well, the representative agent assumption isn’t the problem, or at least it isn’t the only problem.

Since my statement of the situation didn’t help much, I’ll present it as a question instead. Can anyone point me to a DSGE-style model that derives strongly non-classical results from the introduction of heterogeneity? Or, failing that, does anyone have a convincing argument that such results should emerge?

I’m aware of course that, in general, anything can happen with aggregation across heterogeneous agents, so I’m not much interested in arguments for agnosticism starting from that point. End update

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“Via Mark Thoma”:http://economistsview.typepad.com/economistsview/2009/10/the-pundits-dilemma.html, Mark Liberman presents us with “The Pundit’s Dilemma”:http://languagelog.ldc.upenn.edu/nll/?p=1824.

Overall, the promotion of interesting stories in preference to accurate ones is always in the immediate economic self-interest of the promoter. It’s interesting stories, not accurate ones, that pump up ratings for Beck and Limbaugh. But it’s also interesting stories that bring readers to The Huffington Post and to Maureen Dowd’s column, and it’s interesting stories that sell copies of Freakonomics and Super Freakonomics. In this respect, Levitt and Dubner are exactly like Beck and Limbaugh.

We might call this the Pundit’s Dilemma — a game, like the Prisoner’s Dilemma, in which the player’s best move always seems to be to take the low road, and in which the aggregate welfare of the community always seems fated to fall. And this isn’t just a game for pundits. Scientists face similar choices every day, in deciding whether to over-sell their results, or for that matter to manufacture results for optimal appeal.

In the end, scientists usually over-interpret only a little, and rarely cheat, because the penalties for being caught are extreme. As a result, in an iterated version of the game, it’s generally better to play it fairly straight. Pundits (and regular journalists) also play an iterated version of this game — but empirical observation suggests that the penalties for many forms of bad behavior are too small and uncertain to have much effect. Certainly, the reputational effects of mere sensationalism and exaggeration seem to be negligible.

(to avoid falling into my own version of this dilemma, I should acknowledge straight up that while I’m disappointed with the Freakonomics phenomenon _ex-post_, I was quite optimistic _ex-ante_ )

From the NYT on the remarkable profitability of Goldman Sachs

A big reason for Goldman Sachs’s blowout profits this year has been the willingness of its traders to take big risks — they have put more money on the line while other banks that suffered last year have reined in such moves. Executives say there are big strategic gaps opening up between banks on Wall Street that are taking on more risks, and those that are treading a safer path.

Hmm. I’d be willing to take big risks if I knew the Fed and the US Treasury were standing by, ready to pick up all my losing bets. In the circumstances, the guys at GS doubtless stand amazed at their own moderation in creaming off a mere $20 billion for the year.

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