"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Thursday, April 29, 2010

Really great links - Greece - Robert Mundell - Scott Sumner is back

Tyler Cowen - Greece - "The assessment seems to be this:
        What a growing number of investors suggest is really needed is a “shock and awe” figure, enough to convince the markets that peripheral European economies will not be left to fail.
        For better or worse, I do not expect such a figure is forthcoming. I also do not see how such a figure would do more than postpone the basic problem, which is that several European economies have been pretending to be much wealthier than they really are and to make financial plans on that basis."

Robert Mundell on the Financial Crisis (Sean Rushton) - "Mundell argues the recent crisis had three distinct parts.
        Part One was the real-estate bubble and subsequent bank-solvency crisis, which began in 2006. He says the bubble was generated primarily by the dollar’s fall after 2001, as U.S. monetary authorities made clear they wanted a lower dollar to improve exports. As the greenback dropped on foreign exchanges and against gold and other commodities, investors pursued the classic inflation hedge: They borrowed and bought hard assets, expecting to repay the debt with cheaper future dollars. Real estate, already roaring due to 1997’s expanded housing tax deduction, went into overdrive, goosed by subprime lending and mortgage securitization.
        Part Two of Mundell’s analysis is the most intriguing and least understood aspect. He argues that, as the real-estate bubble burst, large quantities of fresh liquidity were demanded by the public and banks. In summer 2007, the world’s central banks supplied it and no liquidity crunch developed. But by summer 2008, spooked by rising inflation, the U.S. Federal Reserve failed to provide adequate cash, leading to dollar scarcity. Four key symptoms of tight money appeared within months: the dollar rose 30 percent against the euro; gold fell 30 percent; oil fell 80 percent; and the inflation rate dropped from 5.5 percent to negative levels. As a result, Mundell believes, Lehman Brothers collapsed, the stock market went into free fall, and a near-panic ensued. This phase was entirely preventable and constitutes one of the worst mistakes in Fed history, Mundell says. The crisis eased in early 2009, as the Fed upped the money supply, but the damage was done.
        Part Three of Mundell’s analysis is the recession of 2008–09, with bailouts, rising unemployment, and skyrocketing deficits. He predicts decent growth this year, but believes unemployment will remain high and the recovery will be weak."

Scott Sumner - Goldman Sachs - "I made a nice return on ‘junk bond’ investments in the 1990s, so count me as someone not shocked by the colorful adjectives in GS emails. Does this mean GS did not violate the law? Here is where I would fall back on my post-modernism. There is no yes or no answer to that question. If one wants to get highly technical, I suppose that every single big bank in America is violating the law on an almost daily basis. How could it be otherwise? Our business law system is unimaginably complex, the legal equivalent of the distance to Alpha Centauri. (“Show me the man and I’ll find you the crime.”) The real question is: If the SEC knew these facts about GS, but the 2007-08 financial crisis had never occurred, would GS have been prosecuted? Or to put it another way; is the prosecution political?"

Tuesday, April 27, 2010

Really great links - The Dodd-Lincoln Frankenstein - China - Krugman - Predatory lending

Craig Pirrong - Bailout fund - "The $50 billion dollar “bailout fund” has drawn the most attention, and the most fire, but it’s small beer compared to other things in the bill.
        Most importantly, as I’ve noted repeatedly, the fundamental source of too big to fail is the inability of the government to commit not to bail out creditors of a failing or failed institution. Increasing the discretion of authorities responsible for resolution reduces ability to commit.
        And the Dodd bill does just that. It gives the FDIC and the Treasury and the Fed tremendous discretionary authority to make creditors whole on the taxpayers’ dime. This discretionary authority is almost completely free from any Congressional check. Moreover, this authority has effectively unlimited access to the public purse.
        To sum up: instead of constraining regulators’ ability to bail out creditors of big financial institutions, the bill expands their discretion; instead of increasing the credibility of commitments not to bail out by limiting access to government funds, the bill undermines credibility by giving the Fed and the executive branch virtually completely discretionary authority to pay as much as they want to the creditors of large financial institutions."

Hans Genberg, Wenlang Zhang - Can China save the world by consuming more? - "Would an increase in Chinese domestic demand meaningfully reduce global imbalances and improve US and European employment prospects? This column says that Chinese policy has a relatively small impact on developed economies' macroeconomic circumstances. It estimates that major reduction in Chinese saving would improve US employment by less than one quarter of a percentage point."

Paul Krugman - Epistemic Closure In Macroeconomics - "Also, a macroeconomist emails:
        With perhaps some exaggeration … editors at four out of five top journals simply refuse even to read papers which feature nominal rigidities! With the promotion criteria of way too many departments being simply counting publications in top five journals anybody can pretty much guess what sort of incentive structure this has created in the profession …

Arnold Kling - Predatory lending - "Finally--and this will get me in big trouble--I have to rant about the notion of a consumer financial protection agency. I know that it's axiomatic that poor people are helpless victims. But in the case of these mortgages, that is a really hard sell. The banks did not take from poor people. They gave to poor people. If you were lucky enough to get one of these exotic mortgages when house prices were still going up, then you got to reap a nice profit on your house. If you were not so lucky, you lost...close to nothing. I'm sorry, but if you borrowed up to 100 percent of the value of the house or more, then all you really lost were your moving expenses.
        What about predatory lending? As I understand it, the idea of predatory lending is to saddle the borrower with an expensive mortgage so that you can foreclose on the property and sell it at a profit. How many times did that happen? Have you read of a single instance in the past three years where the bank made a profit on a foreclosure?
        I am always ready to feel sorry for poor people because of their poverty. But I cannot feel sorry for somebody who was given a basically free option on a house and the option didn't happen to come into the money."

Monday, April 26, 2010

Really great links - Greece - Greece II - Paul Krugman - Resolution Authority - Monetary policy and bubbles - Goldman

Nick Rowe - Greece - "It's difficult to know what will happen in the Eurozone. My own guess, for a worst-case scenario, is that we will see multiple Argentinas. No country will want to leave the Euro, but some might have no choice. The only way for a government to pay wages will be in scrip. That scrip will become a new national currency. They will rewrite the laws to make debts payable in the same national currencies."

Tyler Cowen - Questions that are rarely asked - "Was it predatory lending when they gave money to Greece?"

Paul Krugman - Ponzi and financial sector profits - "So I’d suggest that what we did between 1980 and 2008 was to replace a financial system in which profits were created by lack of competition with a system in which profits were created by misinformation and misperceptions — a giant, if mostly (not entirely) unintentional Ponzi scheme, which finally went bust."

Adam Levitin - Resolution Authority: What's Wrong With the Dodd Bill - "The Dodd bill gets things right on first principles: there needs to be some type of resolution authority, and it needs to provide the ability to impose haircuts on creditors. The bill accomplishes that much. But it goes way off the rails on a critical issue that has received virtually no discussion: how the resolution authorization process is supposed to work.
        There's been a good deal of ink spilled recently over how to regulate systemic risk, but little consideration of the institutional design of resolution authority. Who gets to decide to pull the plug on a troubled firm? And who gets to decide to provide support for other firms or sectors of the economy? "

Masaaki Shirakawa - Governor of the BoJ - Monetary policy and bubbles - Austro-Japanese economic theory - "There has already been considerable debate about the relationship between monetary policy and emergence of bubbles. One thing is clear: over-confidence is the core factor which breeds a bubble. In that sense, bubbles do not transpire from expectations of a continuation of low interest rates alone. This is, however, only a half of the truth. The other half is that bubbles do not materialize without expectations that low interest rates will continue. For me, the key question, which applies to many central banks including both the Bank of Japan and the Federal Reserve, is that, why we, as central banks, maintained interest rates at such a low level, in spite of the uneasiness we felt at that time toward the bubble-like symptoms."

Interfluidity - Goldman CDO - Hedging vs. speculation  - (H/T Broken Symmetry) - "As an investor, one always should ask oneself the question, “why would taking this position be more beneficial to me than to a counterparty willing to escape or oppose it?” Here are three answers: i) Personal situation: the asset is more valuable to me than to others (I need wheat in two months!); ii) speculative: I simply know better than my counterparty. iii) hedging: I suspect the average counterparty is overweight this exposure, and is willing to offer what would be a decent value to someone whose portfolio is uncorrelated with the exposure. Unless one assumes both efficient markets and homogenous investors, all three of these things are reasonable to think about, and I think successful investors do think about them routinely. If an investor does not believe herself to have special information about the “fundamental” value of a contract or commodity, she still may believe that hedging demand for a product is one-sided, and that would tilt in favor of taking the other side of that trade at the margin. Obviously, suspecting that wheat farmers need to hedge wouldn’t be sufficient motivation for buying August wheat contracts. But when choosing between a menu of imperfect investments, the existence of imbalanced hedging interest can be important information. With standardized products, that is something one can try to learn and understand.
        With a bespoke product, one cannot. With a bespoke product, there is generally an initiating party (Paulson for our CDO, perhaps an industrial firm looking to hedge an idiosyncratic risk). The counterparty to a bespoke contract (e.g. an investment bank) usually knows something about the initiator and can divine something about its motivation. The counterparty to a bespoke product should generally not be anonymous. If the counterparty remains anonymous, it should at least be identified that there is an identifiable initiating counterparty. Otherwise, there would be terrible scope for tailoring products based on precise information asymmetries that the non-initiating counterparty wouldn’t suspect.
        If Goldman could have met Paulson’s needs by stitching together positions in the CDS market without constructing a CDO, there would have been no issue: Those are standard markets, and participants understand that there is both speculative and hedging demand, and traders with more and less information. Traders make statistical inferences, for better and for worse.
        But Goldman met Paulson’s demand for a bespoke product by creating a new counterparty and pretending the new counterparty was the initiator of the trade, not the responding to external demand for a custom product. Not knowing who is the initiator and who is the respondent is seriously harmful: market-makers and traders pay great attention even in standardized markets to where trades fall in the bid/ask spread, and adjust pricing actively based on that information. Ordinarily, someone who needs a special product that cannot be synthesized (at convenient prices) from available markets has to reveal their need, allowing potential counterparties to evaluate the source (is this counterparty hedging an industrial risk, or do they know something). That information would crucially determine the pricing and willingness of a counterparty to transact.
        Goldman actively camouflaged who initiated and who was responding to Paulson’s demand for short positions in certain securities. It created a single bespoke counterparty that believed itself to be the initiator. Goldman hid from that counterparty information that it knew, and that generally any one party responding to some other party’s complex and specific demands would either learn as a matter of course or demand to be revealed. ABACUS investors thought they were in an ordinary CDO deal, initiated by longs in cooperation with a facilitating investment bank, buying an optimized portfolio in standard markets that included both speculative and hedging demand. That was not their situation at all. Their information was worse than the information an individual transactor would have purchasing a stock or in the RMBS CDS market (no specific knowledge but a decent probability distribution). And the stakes were much higher, because they were entering into a large transaction with one counterparty. If this had been a large transaction spread across many counterparties, their statistical inferences about the degree of spec/hedging interest and information asymmetry might have been accurate. In this case, they would have had to assume an almost worst case scenario to be accurate, but didn’t know that."

Friday, April 23, 2010

Really great links - The power of banks - FOMC - Goldman - Unemployment - SEC

Tyler Cowen - Do big banks control our government? - "If you do wish to break or limit the power of the major banks, running a balanced budget is probably the most important step we could take. It would mean that our government no longer needs to worry so much about financing its activities. Of course such an outcome is distant these days, mostly because American voters love both high government spending and relatively low taxes."

Tim Duy's Fed Watch - The Sweet Spot - "The real question is when will the easy money end. And on that point, Fed officials last week suggested they intend to let the good times roll and remain on the sidelines.
        Bottom Line: A more aggressive policy stance might be correct for Main Street, but I suspect would upend what is currently a nice little equilibrium on Wall Street. Raising the prospect that the Fed was trying to raise the inflation target would cement fear that interest rates will move dramatically higher in the years ahead. In contrast, the current state of the economy, with steady growth combined with low inflation and high unemployment, offers considerable certainty for market participants by putting the Fed on the sidelines. And that certainty is a valuable commodity."

Greg Zuckerman - Goldman - "Q.: So do you think even if Goldman had disclosed what the S.E.C. says it should have, regarding Paulson’s role, the investors would’ve made the same decision on it?
        Zuckerman: Yeah, I don’t think many investors would have had a second thought about taking the other side of a trade of John Paulson’s back in 2006 or early 2007. He was seen as a tourist investor dabbling in real estate, and some people thought he was out of his league—even Goldman Sachs thought he was out of his league. Josh Birnbaum, a top trader at Goldman, sat across from Paulson in his office and warned him about what he was doing."

Tyler Cowen - Is current unemployment all about aggregate demand? - "I don't want to oversell the minimum wage hike + unemployment compensation extension + means-testing hypothesis here, but surely it deserves a mention as one relevant factor. Those are real factors too.
        I also see that wages, and the job market, are more flexible today than in a long time, with so much service sector employment, so much flex-time and part-time, and such a low rate of unionization. In most AD theories that implies the job market bounces back relatively quickly yet that is not what we observe."

Stephen Bainbridge - The Timing of the SEC's Goldman suit - "I agree that there's reason to be concerned about the timing of the suit, but I suspect the suit's not about helping Obama's Wall Street legislation. Instead, I suspect the WSJ got it right:
        Last Friday, the same day that the government unexpectedly announced its Goldman lawsuit, the SEC's inspector general released his exhaustive, 151-page report on the agency's failure to investigate alleged fraudster R. Allen Stanford. Mr. Stanford was indicted last June for operating a Ponzi scheme that bilked investors out of $8 billion. He has pleaded not guilty.
        Guess which of these two stories was pushed to the back pages? The SEC did its part by publishing the Stanford report so deep in its Web site that more than a few of our readers had trouble finding it. Yesterday, the SEC management's response to the report was available on the agency's homepage, yet it provided no links to the report itself.
        In its own way, the Stanford calamity is arguably worse than the SEC's Madoff bungle. In the Madoff case, passionate outsider Harry Markopolos could find no one at the SEC who took the time to understand the scam, cared enough and had enough authority to shut down the fraud. In the Stanford case, we see numerous SEC insiders over many years urging—at times begging—the enforcement staff to take action, to no avail."

Wednesday, April 21, 2010

Really great links - Aggregate demand failure - Goldman - Goldman II - USA vs. China

Bill Woolsey - Aggregate demand failure - "How do you know that aggregate demand is deficient? If cash expenditures have fallen below their trend growth path, and the levels of prices and wages have not fallen in proportion, then the presumption should be that aggregate demand is too low, that there is an excess demand for money, and that the market interest rate is above the natural interest rate.
        Never, never, never look at market interest rates and the quantity of money and compare them with historically "normal" levels.
        If some aggregate measure of production has fallen, and in the particular markets where it has fallen, there are shortages and higher prices, then deficient aggregate demand is probably not the problem.
        If aggregate production has fallen and in the markets where output fell there were surpluses (that is, production was cut because it couldn't be sold,) but that there are other markets where demand, production, prices, employment are all rising. Further, the rate of expansion in production is being limited by bottlenecks of various sorts. Complains about finding workers with specific skills, prices of key materials rising and the like, then there is a difficult judgement call. How significant are these expanding industries relative to the contraction ones. Is the unobservable excess demand in these markets greater than the reduction in output?
        If there are no such markets with increased demand, and every market is in surplus, then it is clear. There is obviously an excess demand for money generating the problem."

Brad DeLong - Goldman - "But in general acts of market exchange are win-win, for people trade off things they don't value very much for the things they value a great deal. I give the barista behind the coffee machine money--generalized purchasing power. She gives me coffee. Beforehand, she had too much coffee and not enough money. Beforehand, I had too much money and not enough coffee. Afterwards we are both happier and both better off.
        Now let's move to finance. The problem with finance is that we are not treating coffee for food, or CD players for clothes, but that we are instead trading money for money. The win-win benefits from exchanges of goods for goods are obviously there. The win-win benefits of trading money for money--where are they? It turns out that they are there. There are, actually, four:
        Trading money now for money later: people who want to save now and spend later can make win-win trades with people who want to spend now and save later.
        Risk: people who are unusually averse to risk in general can make win-win trades by trading off some of the risks that they are bearing to people who are unusually tolerant of risk in general.
        Insurance: people who are holding a lot of one big risk can reduce the risk of catastrophic loss by paying a great many others to each take a small piece of that risk.
        Information: people who have information that prices are going to rise can make win-win deals with people who have information that prices are going to fall--although here the win-win is not for the participants in the trade: for them it is zero-sum, and the winners are those others who observe the market price at which the trades occur.
        And here we come to the crux of the SEC's Goldman Sachs case. The SEC alleges that Goldman Sachs claimed to the buyers of the ABACUS 2007-AC1: $2 Billion Synthetic CDO Referencing a static RMBS Portfolio security that it was a deal of type (3) constructed primarily by ACA Management, LLC when it was in fact a deal of type (4) constructed primarily by investor John Paulson, and that this claim by Goldman Sachs was a misstatement of a material fact--an active attempt by sellers to mislead buyers, and thus to erase the win-win character of the deal."

Goldman II - A Wall Street participant who wishes to remain anonymous says - Naive version of the story - "Perhaps the reason that Goldman Sachs is so outraged at being accused of playing the investors in Abacus by concealing from them material information--that John Paulson played a big role in selecting the portfolio--is that they are totally innocent. Perhaps they were not trying to play the investors in Abacus by handing them a sub-standard produc. Perhaps, instead, they were trying to play John Paulson--a man who showed up with irrational expectations, eager to make bad bets, and who would have lost heavily had not he struck it freakishly lucky.
        The overwhelming probability, GS thought, is that Paulson will be the loser--but because his expectations are irrational he's willing to take the short side. So the important thing is to keep this big fish who promises to give us lots of money on the hook. Let him pick the underlying securities--it really doesn't matter, and it gives him the illusion of an edge. Don't bother telling Paulson's role to IBX and company--it really doesn't matter, and it might spook them off and then we might lose the real pigeon while we hunt for more counterparties to take the long side.
        And, the GS people probably still think: It should have worked. Only a truly freakishly freakish mischance produced not only a crash but a freakishly hard and fast crash so that Paulson looks like a genius. But he isn't--he's a gambler who got lucky. And the idea that we weren't doing our duty to our long-side clients while we tried to land this particular fish--well, perhaps the people at GS think, that's simply insulting. We were injured when bad luck not only let this fish get away but get away with some of the money that is rightfully ours. And now we are being insulted by the SEC to boot. This is intolerable..."

Michael Pettis - Chinese savings and the wealth effect - "Declining interest rates in the US usually (but not always) mean that Americans feel richer because the market value of their homes, stocks and bonds has risen. Declining deposit rates in China usually mean that Chinese feel poorer because the return on their savings relative to their implicit discount rate has declined."

Monday, April 19, 2010

Really great links - Bank earnings - Banking crisis - Leverage and cost of bank equity

John Hussman - Bank earnings - "It seems equally unwise to celebrate "favorable" bank earnings reports that are exclusively driven by reduced loan loss provisions, particularly when the volume of impaired loans has not declined proportionately. Keep in mind that Enron and Worldcom were able to report outstanding earnings for a while by adjusting the manner by which revenues and expenses were accrued. I suspect that the U.S. banking system has become a similar breeding ground for innovative accounting."

Andrew Haldane - Banking crisis - "For the authorities, it poses a dilemma. Ex-ante, they may well say “never again”. But the ex-post costs of crisis mean such a statement lacks credibility. Knowing this, the rational response by market participants is to double their bets. This adds to the cost of future crises. And the larger these costs, the lower the credibility of “never again” announcements. This is a doom loop.
        The “St Petersburg paradox” explains how a gambling strategy which starts small but then doubles-up in the event of a loss can yield positive (indeed, potentially infinite) expected returns. Provided, that is, the gambler has the resources to double-up in the face of a losing streak. The St Petersburg lottery has many similarities with the game played between the state and the banks over the past century or so. The banks have repeatedly doubled-up. And the state has underwritten any losing streak. Clearer practical examples of a policy time-consistency problem are unlikely to exist."

Andrew Haldane - Leverage and cost of bank capital - "It is possible to go one step further and argue that higher bank capital ratios could potentially lower banks’ cost of capital. The size of the premium demanded by holders of equity is a longstanding puzzle in finance – the equity premium puzzle. Robert Barro has suggested this puzzle can be explained by fears of extreme tail events. And what historically has been the single biggest cause of those tail events? Banking crises. Boosting banks’ capital would lessen the incidence of crises. If this lowered the equity premium, as Barro suggests, the cost of capital in the economy could actually fall.
        In the mid-1980s, an attempt on the world domino-toppling record – at that time, 8000 dominos - had to be abandoned when the pen from one of the TV film crew caused the majority of the dominos to cascade prematurely. Twenty years later a sparrow disturbed an attempt on the world domino-toppling record. Although the sparrow toppled 23,000 dominos, 750 built-in gaps averted systemic disaster and a new world record of over 4 million dominos was still set. No-one died, except the poor sparrow which (poetically if controversially) was shot by bow and arrow. So to banking. It has many of the same basic ingredients as other network industries, in particular the potential for viral spread and periodic systemic collapse. For financial firms holding asset portfolios, however, there is an additional dimension. This can be seen in the relationship between diversification on the one hand and diversity on the other. The two have quite different implications for resilience.
        In principle, size and scope increase the diversification benefits. Larger portfolios ought to make banks less prone to idiosyncratic risk to their asset portfolio. In the limit, banks can completely eradicate idiosyncratic risk by holding the market portfolio. The “only” risk they would face is aggregate or systematic risk.
        But if all banks are fully diversified and hold the market portfolio, that means they are all, in effect, holding the same portfolio. All are subject to the same systematic risk factors. In other words, the system as a whole lacks diversity. Other things equal, it is then prone to generalised, systemic collapse. Homogeneity breeds fragility. In Merton’s framework, the option to default selectively through modular holdings, rather than comprehensively through the market portfolio, has value to investors."

Thursday, April 15, 2010

Really great links - Fed funds rate - Lehman fraud - Labor hoarding - HAMP - Urban agglomeration and nazis

John Kemp - Market should prepare for autumn rate “exit” - "To bridge the gap, the Committee has agreed its “forward guidance” is no longer conditioned “on the passage of any fixed amount of calendar time.” Extended period could now mean anything from a couple of months to several years; it is no longer meant to indicate about six months. Instead the forward guidance is explicitly conditioned on the evolution of the economy.
     The extended period language has now been emptied of any useful content. It means the Fed is not ready to raise rates immediately, and sees no imminent reason to boost them, but could do so at any time, with only minimal warning."

James Chanos - Lehman fraud - "I think there ought to be a lot of criminal indictments in what we saw, because you have to understand that the -- what John Kenneth Galbraith called the nub of the crime -- was simply taking aggressive marks on illiquid derivatives and hard-to-value securities, calling it profit, and paying yourself 50 cents on the dollar a bonus. You were stealing from your shareholders."

David Henderson - Tyler Cowen's Speech at APEE - "Quoted "the wise Garett Jones": "Labor hoarding is so 20th century." Translation: because of the web, employers can go out and hire workers when they need them, so why keep them on the payroll.
     During this recession, there is easier substitutability from durables into things that are fun and cheap, like gaming and reading blogs, which is why durable sales have fallen off the cliff.
     There is a substantial probability (0.1 < p < 0.5) that in the next 30 to 50 years we will in the stationary state where the extra wealth thrown off by growth will go almost entirely to the elderly and health care costs of those same elderly. Think Japan, except that there are fewer rent-seeking fights among the Japanese special interests. (On this last, I'm reminded of something Bob Crandall of Brookings said at a conference I was at in 1985 when explaining where there are so many fewer lawyers in Japan than in the U.S. Said Crandall, "In Japan, the fix is in.")"

Arnold Kling - HAMP - "Why is the HAMP program working so poorly? My answer was that what Washington was attempting to do was take two complex business processes--loan origination and loan servicing--that have been developed over a period of years, and mash them together, almost reversing the order, into a completely new process, and to do this on the fly, without any allowance for differences in local conditions or individual circumstances. It did not surprise me that this was not working.
     I did not say this at the hearing, but I will write here that this is indicative of what is wrong with the Obama Administration. These folks with no management or business experience think that they can make all sorts of changes happen by just writing regulations or laws and snapping their fingers. They have no concept of what a business process is, much less how to develop one and roll it out. If you think HAMP is a fiasco, just wait and see what happens with their health insurance reform."

Arnold Kling - "In fact, I would be prepared to argue that the economic advantages of urban agglomeration are the biggest obstacle to libertarian reforms of any sort. The advantages of urban agglomeration weaken the "exit" option for citizens, which in turn gives government officals leeway to conduct all sorts of abuses. If Jews in Europe did not want to leave behind what was familiar in the 1930's in the face of Nazism, then most people are going to put up with a lot of government stupidity and over-reach here."

Tuesday, April 13, 2010

Really great links - Financial innovation and instability - Synthetic CDOs - Detecting bubbles - Greece

Nicola Gennaioli, Andrei Shleifer, and Robert Vishny - Financial Innovation and Financial Fragility - (H/T Salmon) - "We present a standard model of financial innovation, in which intermediaries engineer securities with cash flows that investors seek, but modify two assumptions. First, investors (and possibly intermediaries) neglect certain unlikely risks. Second (less crucially), investors demand securities with safe cash flows. In the model, security issuance is excessive, and financial markets become extremely fragile. As the previously unattended to risks are recognized, investors fly to safety and the excessive volume of innovation accelerates this flight. Financial innovation can make both investors and intermediaries worse off, and lead to instability even without leverage or fire sales. The model mimics several facts from recent historical experiences, and points to new avenues for possible financial reform."

Felix Salmon - The silver lining to synthetic CDOs - "Think about it this way: both CDOs and synthetic CDOs resulted in losses for investors on the long side. But In the world of CDOs, demand for paper ended up creating a disastrous building boom which diverted resources from more productive activity, skewed local tax revenues, and created the precondition for the wave of foreclosures which is likely to continue for the foreseeable future.
In the world of synthetic CDOs, by contrast, demand for paper just ended up making a bunch of shorts extremely rich: all the other real-world repercussions of the CDO market were actually avoided.
I’m not saying that the world of synthetic CDOs was a good thing. In fact, I’ve explained why I think that it was harmful. But the point that investors started moving from CDOs to synthetic CDOs marked the point at which the housing bubble stopped growing: the move played a significant role in ending the real-world housing insanity. If banks could create synthetic CDOs out of thin air, they no longer needed to encourage subprime originators in the Inland Empire to give $600,000 mortgages to itinerant strawberry pickers, just to keep their channels full."

Edward Chancellor - Detecting bubbles - "And bear in mind Mr Odlyzko’s wise advice. You don’t need any special skills or complicated models to detect a bubble. All that is required is “common sense, an ability to do simple arithmetic, and knowledge of a few basic facts about the economy”."

Baseline Scenario - Greece saved for now - is Portugal next? - "The Greek government, helped by the market threat of a near term collapse, appear to have strong armed the other eurozone countries into a generous package without making efforts to change seriously their (Greek) fiscal policy. This is good for near term calm, but it does not solve any of the inherent problems now manifest in the eurozone.
Often assistance packages of this nature just help “smart money” to get out ahead of a default. This could be the case here; 40-45 billion euros total money could last roughly one year. Both Russia and Argentina got large packages in the late 1990s but never regained access to private markets, so eventually everything fell apart.
Sunday’s package should make it possible for Greece to borrow short-term but it takes courage to lend for 5 or 10 years to the Greeks unless there is much more fundamental change."

Really great links - Stability of short term interest rates and bubbles - Greece - Gary Gorton

FT Alphaville - Boringness of central banks to blame for bubbles - From Deutsche Bank’s Francis Yared and Abhishek Singhania - "We argue that in fact, that central banks’ predictability during the 2004-2007 tightening cycle contributed to the compression of the risk premium in fixed income markets and, therefore, indirectly to the excessive leverage that built up over that period."

Ambrose Evans-Pritchard - Greece - "EU officials react with outrage to comparisons with Argentina, but as Mr Johnson says "Greece is far more indebted, is much less competitive in global markets, and needs a greater fiscal and wage adjustment".
Argentina's public debt was 62pc of GDP in 2001: Greece will top 120pc this year. Its budget deficit was 6.4pc: Greece's was 16pc last year on a cash basis. Its current account deficit was 1.7pc: Greece's was 11.2pc in 2009.
The cleanest option for Greece is an Argentine default with a 65pc haircut for creditors, and exit from the euro. Argentina recovered fast after liberation. Greece could expect "decent growth" by mid 2011.
True, but Greece is just "the tip of the iceberg", in the words of China's central bank. The design faults of EMU have left all Club Med trapped in debt deflation or perma-slump. Europe's banks are in turn stuck with fatal exposure. You cannot safely uncork Greece without risking a chain reaction."

Aleph blog - Book Review: Gary Gorton - Slapped by the Invisible Hand - "But what makes this book a winner is that he lays bare the root cause of the crisis: we need safe short-term liabilities in order to transact. Banks provide the short term medium of commerce, so that no one has to consider whether their dollars are changing in value month after month.
But when there are alternatives to banks that seem cheaper in the short run in creating stable securities, the banking system gets hollowed out. That can be as simple as money market funds, or as complex as AAA structured securities that finance complex obligations.
At such a point, being a bank is not so valuable, and banks mimic the innovations in order to compete.
Though not an innovation, repo funding was a star of this crisis. Repo funding is a short-term means of gaining liquidity through borrowing while offering high quality liquid assets as collateral. It is very stable most of the time, but when liquidity gets scarce, the system as a whole can unwind.
The book focuses on “safe” liabilities: bank deposits, both before and after deposit insurance, repo funding, and AAA short securities from securitizations. People want to keep their purchasing power safe. But when the safety of any safe security comes under question, the system falls apart.
That is the nature of a systemic crisis. What is previously regarded as safe is not safe."

Friday, April 9, 2010

Really great links - Debt crisis: USA vs. Argentina - Bernanke is (too) proud - China's bad loans - Debt bubbles vs. equity bubbles

Brad DeLong - Liveblogging John Cochrane - USA vs Argentina - "We know what it looks like when the market expectations are that expected future primary surpluses are as high as they can go, and cannot go any higher. It looks like Argentina in 2000. In times like that, the discount factors on government debt are low because government debt is perceived--rightly--as being very risky, and the current consumer price level moves essentially one-for-one with additional debt issue. That is not where we are right now. We are not there at all. The discount factors on U.S. Treasury debt are not low because such debt is perceived as risky given the inability to finance more of it by raising future primary surpluses. Instead, the discount factors on Treasury debt are very high as the market perceives U.S. Treasury debt to be extraordinarily safe. And the price level is definitely not moving proportionately with additional debt issue...
Important things that I had not known before that I learned from the paper:
1. That if you add in a Phillips-curve friction--so that production and employment fall in deflation--and a credit-channel friction--so that the interest-rate spread and thus the interest rates on Treasurys depend on the capitalization of the banking sector--then the fiscal theory of the price level strongly militates for a helicopter drop of money to banks as the best policy to fight a financial crisis and the resulting recession: a TARP, a TALF, a PPIP, or its left-wing version of bank nationalization is exactly what the government can do to most effectively stem and cushion the deflation.
2. How large is the fall in the primary surpluses Peter Orszag and his successors will have to raise in order to amortize the debt without accelerating inflation. The marginal investor has long believed that the U.S. debt is very safe--that no matter what happens, Peter Orszag and his successors will be able to raise the primary surpluses needed to amortize the debt without a big rise in the price level. As a result of the financial crisis, the required future primary surpluses have fallen roughly in half, so that we now have much more fiscal headroom than we had three years ago (if, that is, the long end of the Treasury yield curve can be taken as rational forecasts of the interest rates at which the debt will be rolled over and amortized)."

Ben Bernanke - Thinks he has avoided the mistakes that led to Great Depression and compares himself to Roosevelt - "The lesson has been learned. In the current episode, in contrast to the 1930s, policymakers around the world worked assiduously to stabilize the financial system. As a result, although the economic consequences of the financial crisis have been painfully severe, the world was spared an even worse cataclysm that could have rivaled or surpassed the Great Depression.
That lesson brings me to the second one--policymakers must respond forcefully, creatively, and decisively to severe financial crises. Early in the Depression, policymakers' responses ran the gamut from passivity to timidity. They were insufficiently willing to challenge the orthodoxies of their day--such as the liquidationist doctrine of Mellon and others, or the rigid adherence to the variant of the gold standard adopted after World War I. A key turning point, in the United States, came with Franklin Roosevelt's commitment to bold experimentation after his inauguration in 1933. Some of his experiments failed or were counterproductive, but his decisions to declare a bank holiday upon taking office in March 1933 and to sever the link between the dollar and gold helped arrest the descent of the U.S. financial system and set off a strong, albeit incomplete, recovery.
In the Depression, effective policy responses came only after three to four years of financial crisis and economic contraction. In our own time, policymakers acted sooner and with greater force than in the 1930s. For example, in October 2008, just weeks after the sharp intensification of the crisis, the Congress authorized the Troubled Asset Relief Program (TARP) to support stabilization of the financial system. It was far from perfect legislation, but it was essential for preventing an imminent financial collapse. For its part, the Federal Open Market Committee, the monetary policymaking arm of the Federal Reserve, sharply and proactively cut its target for short-term interest rates from the fall of 2007 through 2008. After the target could go no lower, the Committee embarked on an unprecedented (for the United States) program of long-term securities purchases, recently completed, to support private credit markets, including the mortgage market.
Also, in the spring of 2009, the Federal Reserve led the Supervisory Capital Assessment Program, known as the bank stress test. In some ways, its effect was similar to Roosevelt's national bank holiday. During the holiday in 1933, banks temporarily shut their doors. Examiners were dispatched to evaluate them, and banks that were declared sound reopened to renewed depositor confidence. In the 2009 stress tests, multidisciplinary teams of examiners, economists, financial experts, and other specialists calculated how much capital 19 of the nation's largest bank holding companies would need to remain healthy and continue lending during a hypothetical worse-than-expected economic scenario. The Treasury Department committed to supplying additional capital as necessary from the TARP. Critics had warned that the stress test could backfire, but as it turned out, the release of the results last May helped restore confidence in banks, and many institutions have since been able to raise capital from investors and repay the capital the government had injected."

Michael Pettis - China's bad loans - "As I have discussed often in earlier posts, pessimists are starting to worry about excessive debt levels in China, about which they are very right to worry, and many are predicting a banking or financial collapse, which I think is much less likely. Optimists, on the other hand, are blithely discounting the problem of rising NPLs and insisting that they create little risk to Chinese growth. Their proof? A decade ago China had a huge surge in NPLs, the cleaning up of which was to cost China 40% of GDP and a possible banking collapse, and yet, they claim, nothing bad happened. The doomsayers were wrong, the last banking crisis was easily managed, and Chinese growth surged.
But although I think the pessimists are wrong to expect a banking collapse, the optimists are nonetheless very mistaken, largely because they implicitly assumed away the cost of the bank recapitalization. In fact China paid a very high price for its banking crisis. The cost didn’t come in the form of a banking collapse but rather in the form of a collapse in consumption growth as households were forced to pay for the enormous cleanup bill.
When US leverage was rising and the world growing quickly, the cost of that collapse in consumption was easily masked by China’s surging trade surplus, but it was real nonetheless. The bank recapitalization resulted in a brutal exacerbation of China’s already unbalanced growth model, and made it all the more vital for consumption in China to surge, especially as the world’s appetite for Chinese trade surpluses is dwindling rapidly. As happened in Japan after 1990, when households were forced to clean up their own massively insolvent banks, the consequence could be a slowdown in consumption growth just as the country is being forced to rebalance its economy towards consumption.
If there is another surge in NPLs and government debt, once again the banks will need to be recapitalized, but the cost this time will be much more difficult to manage. If NPLs surge, in other words, don’t expect a banking collapse. Expect further downward pressure on consumption growth."

Kenneth Rogoff - "When equity bubbles burst, investors who made money in the boom typically swallow their losses and the world trudges on, for example after the bursting of the technology bubble in 2001. But when debt markets collapse, there inevitably follows a long, drawn-out conversation about who should bear the losses. "

Thursday, April 8, 2010

Really great links - Greece and Argentina - Great depression - Great moderation - Contingent debt - Healthare and socialism

Baseline Scenario - Greece and Argentina - "There are disconcerting parallels between Argentina’s catastrophic decade, 1991-2001, which ended in massive default, and Greece’s recent and impending difficulties. The main difference being that Greece is far more indebted, is much less competitive in global markets, and needs a commensurately greater fiscal and wage adjustment. "

Liaquat Ahamed - Great depression - "At one point in their book, the authors draw a comparison between the position of Britain in the early twentieth century and the current position of the United States. I was surprised that they did not make more of the parallels. Through much of the nineteenth century Britain was the linchpin of the world financial system. It was the capital supplier of last resort during crises and acted countercyclically as the economic locomotive for the world. But, almost bankrupted by the First World War, it was no longer able to fulfill that function after 1919. The mantle of leadership should have passed to the United States. But American leaders were too parochial and insular to seize the opportunity. Thus, during the 1920s and 1930s, the United States was unwilling to lead and Britain unable.
American economic historian Charles Kindleberger used to argue that ultimately the Great Depression happened because of this failure of economic leadership on the world stage. He believed that a well-functioning global economy required one country to act as the leader, in effect to do more than its fair share of keeping the global economy moving, fully recognizing that smaller countries will freeload off of its efforts. If we are at a similar transition point in world leadership, if the United States has indeed been knocked off its pedestal in much the same way as was Britain in the early twentieth century, it does not bode well for the ability of the global economy to navigate its next storm."

Jordi Gali & Luca Gambetti - Great moderation - "In that regard, and as discussed in more detail below, our evidence is consistent with a decline in the size of nontechnology shocks as well as more effective countercyclical policies in response to those shocks. The hypothesis of a change in policy is reinforced when the variations in the responses to technology and nontechnology shocks are considered jointly. Some key features of those changes can, in principle, be explained by the adoption, since the early 1980s, of a monetary policy that focuses on the stabilization of inflation, for that policy would also tend to stabilize output in response to a variety of demand shocks while accommodating the changes in potential output resulting from technology shocks. Furthermore, the gradual change in the response of labor productivity to nontechnology shocks (with an eventual change in the sign of that response) is consistent with a declining importance of labor hoarding by firms, possibly as a consequence of better labor input
management practices or more flexible labor markets (that make it less costly to hire
and fire workers in response to changes in demand)."

Richard Squire - H/T Alex Tabarrok - Contingent debt - "This Article identifies a pervasive opportunism hazard created by contingent debt that lawmakers and scholars have overlooked. If liability on a firm’s contingent debt is especially likely to be triggered when the firm is insolvent, the contract that creates the debt transfers wealth from the firm’s creditors to its shareholders. A firm therefore has incentive to engage in correlation-seeking — that is, to incur contingent debts that correlate, or that through asset purchases can be made to correlate, with the firm’s insolvency risk. The consequence is an overuse of contingent debt that destroys social wealth through overinvestment, higher borrowing costs, financial distress, and potential systemic risk. Correlation-seeking is especially pernicious because, unlike other forms of shareholder opportunism such as asset substitution, it can reduce risk to shareholders even as it increases shareholder returns."

Arnold Kling - Healthcare reform - "A point that White makes is that nobody has every tried to implement market socialism in practice--not even in Poland, where Oskar Lange had a high position. I would suggest that market socialism represents an intellectual bait-and-switch, where the reality is that socialism reverts to command and control. Note that as the political process grinds on, the approach to reducing carbon has evolved away from carbon taxes and even from cap-and-trade to more command-and-control style.
I see health care policy on the same track. If you search carefully, you will find some prominent Obama people who once supported using consumer cost-sharing as a market incentive to "bend the cost curve." No more. Even "pay for performance" is fading into the policy background. Instead, increasingly, the evolution is toward price controls, which in turn will mean command-and-control allocation of medical services.
What I am saying is that whatever the theoretical merit of having government use decentralized market mechanism to implement collectivist ideals, the trend in practice is that centralized ends wind up being pursued by command-and-control means. Again, I will explore this more in a subsequent post. What I would claim is that it is not simply a matter of people trying market mechanisms, having them fail, and reverting to command-and-control. Instead, they revert to command-and-control without trying market mechanisms. I want to speculate on why that is the case."

Wednesday, April 7, 2010

Really great links - Schrödinger’s Banks - Paul Krugman - Monopoly and exit - Negative swap spreads - Neurophilia

Interfluidity - "Errors in reported capital are almost guaranteed to be overstatements. Complex, highly leveraged financial firms are different from other kinds of firm in that optimistically shading asset values enhances long-term firm value. Yes, managers of all sorts of firms manage earnings and valuations to flatter themselves and maximize performance-based compensation. And short-term shareholders of any firm enjoy optimistic misstatements coincident with their planned sales. But long-term shareholders of nonfinancial firms prefer conservative accounts, because in the event of a liquidity crunch, firms must rely upon external funders who will independently examine the books. The cost to shareholders of failing to raise liquidity when bills come due is very high. There is, in the lingo, an “asymmetric loss function”. Long-term shareholders are better off with accounts that understate strength, because conservative accounting reduces the likelihood that shareholder wealth will be expropriated by usurious liquidity providers or a bankruptcy, and conservative accounts do not impair the real earnings stream that will be generated by nonfinancial operations.
Are we doomed to some post-modern quantum mechanical nightmare wherein “Schrödinger’s Banks” are simultaneously alive and dead until some politically-shaped measurement by a regulator forces a collapse of the superposition of states into hunky-doriness?"

Paul Krugman - Savings and trade balance - "But what really gets me is that Joe [Stiglitz] is thinking of savings as an independent determinant of the trade balance. I tried to clear this up 23 years ago; here we go again. Imagine that US savings rise and China’s savings fall, holding the exchange rate constant. Does this painlessly reduce the US trade deficit?
No, it doesn’t. Most of the fall in US demand is a reduction in demand for US-produced goods and services; most of the rise in Chinese demand is a rise in demand for Chinese-produced goods and services. So the net effect is to raise unemployment here and create inflationary pressures there — unless something shifts demand from Chinese to US goods. And that something should be the exchange rate."

Rajiv Sethi - Hirschman, exit and voice - "While it is commonly believed that most organizations would prefer that their customers or members had no exit option at all (as in the case of a monopoly) Hirschman argues, instead, that monopolists would welcome a modest degree of competition in order to shed their most vociferous customers:
[There] are many... cases where competition does not restrain monopoly as it is supposed to, but comforts and bolsters it by unburdening it of its more troublesome customers. As a result, one can define an important and too little noticed type of monopoly-tyranny: a limited type, an oppression of the weak by the incompetent and an exploitation of the poor by the lazy which is the more durable and stifling as it is both unambitious and escapable."

Self-Evident - Negative swap spreads - "Recall the negative swap spread perfect arbitrage: Borrow short at LIBOR; use that to buy Treasuries; swap the fixed Treasury coupons for (floating) LIBOR; use those payments to pay interest on the short-term loan; and roll the short-term loan every three months.
What could possibly go wrong?"

Language log - Neuroscience vs. financial analysis - "Getting back to the "explanatory neurophilia ≅ physics envy" idea, it seems to me that there are some analogies but also some striking differences. The research of Weisberg et al. on "The Seductive Allure of Neuroscience Explanations" suggests that logically irrelevant neuroscience impresses novices and outsiders, but not experts. In contrast, Lo and Mueller argue that the seductive allure of irrelevant but interesting mathematics has distorted the judgment of the most highly-regarded economists and financial analysts.
For those who are interested in the sociology of economics (about which I obviously know very little), I recommend Deirdre McCloskey's The Secret Sins of Economics (summary and discussion here)."

Monday, April 5, 2010

Really great links - Greenspan and subprime - ending QE - labour supply elasticity

Michael Burry - Greenspan and subprime - "In February 2004, a few months before the Fed formally ended a remarkable streak of interest-rate cuts, Mr. Greenspan told Americans that they would be missing out if they failed to take advantage of cost-saving adjustable-rate mortgages. And he suggested to the banks that “American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.”
Within a year lenders made interest-only adjustable-rate mortgages readily available to subprime borrowers. And within 18 months lenders offered subprime borrowers so-called pay-option adjustable-rate mortgages, which allowed borrowers to make partial monthly payments and have the remainder added to the loan balance (much like payments on a credit card).
Observing these trends in April 2005, Mr. Greenspan trumpeted the expansion of the subprime mortgage market. “Where once more-marginal applicants would simply have been denied credit,” he said, “lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately.”
Yet the tide was about to turn. By December 2005, subprime mortgages that had been issued just six months earlier were already showing atypically high delinquency rates. (It’s worth noting that even though most of these mortgages had a low two-year teaser rate, the borrowers still had early difficulty making payments.)"

Ambrose Evans-Pritchard - Even ending QE amounts to tightening - "Work by Berkeley Professor Barry Eichengreen shows that global trade, industrial output, and stock markets all crashed at a faster rate over the six terrifying months after the Lehman crisis than during the early 1930s. How quickly we forget, and how easily we are seduced by a 76pc stock rally into thinking it was a storm in a teacup. Just wait until the day fiscal retribution comes.
The $1.7 trillion created out of nothing will vanish as the bonds are sold on the open market. Not too quickly, let us hope. Easy money must cushion the blow of spending cuts. Even talk of ending QE amounts to tightening. While the US economy has begun to create jobs again – plus 114,000 in March, stripping out short-term census workers – there were false dawns in 2002 and 1982. The broader U6 jobless rate nudged up to 16.9pc."

Ambrosini - Labour supply elasticity - "The micro people threw fits though because their estimates of the response of labor supply to tax changes is much less extreme than Prescott’s finding suggest. They basically find labor supply curves are vertical. This would mean that taxes simply can’t have an effect on labor supply.
For a while, these guys had me convinced because, in general, micro/labor types do a much better job of identification and I trust their estimates more than I trust macro estimates. More recently, however, macro people1 have been making the case that the “labor supply elasticity” estimated by the micro people is different from the “labor supply elasticity” the macro people estimate. The difference isn’t due to statistical methodology, we were just calling two different things the same thing.
Of course, its the macro elasticity that matters for tax policy, though"

Saturday, April 3, 2010

Really great links - Bernanke and Bear Stearns - Sovereign defaults - Uncertainty about the plans of the Obama administration - Elinor Ostrom - Counterfeiting

Robert Barro - Bernanke and Bear Stearns - "Well Bernanke was thinking that way in April 2008. I remember talking to him at the time, just after the Bear Stearns initial intervention. I got a chance to ask him a question about why they were so aggressive at that time when things didn’t look so bad. And his response was that basically he was worrying about a Depression-type scenario – and trying to act early to nip that in the bud.
I think they made a big mistake by not bailing out Lehman Brothers – I think they recognized that two days later. That was Paulson’s individual fault and responsibility from what I can gather. "

Economist - "Greece cannot afford to be sanguine. The Argentine example shows that the averages mask considerable variation. And there are several reasons to think that Greece’s experience in the event of a default would be worse than the norm. The academic research focuses on emerging markets because that is where all recent defaults have been. The impact of a Greek default, which would be the first by a rich country since the second world war, may be greater. If Greece defaulted, it would do so when the global economy is still weak, credit is scarce and other sovereign borrowers are raising lots of money. So markets may be less welcoming than other recent defaulters have found them. Greece’s use of the euro also means that it cannot devalue: that implies it would have to impose fairly high haircuts on creditors and might face a higher-than-average increase in its cost of borrowing.
Another element to the costs of default may also alarm Greek policymakers. Messrs Borensztein and Panizza find that political leadership changed in the year of default or the year after in half of the 22 cases they study. That is twice the usual probability of such change. These political costs, at least, are unlikely to vary.
Sovereign defaults do not just affect the governments of countries that fail to honour their promises. Another IMF study finds that defaults lead to a 40% decline in external credit to private companies in the defaulting country. Even countries that do not default are sometimes affected by the fallout. In the aftermath of the 1980s debt crisis, for instance, credit to developing countries as a whole (including non-defaulters) dried up. Other rich countries with strained public finances may also have lots to worry about if Greece defaults."

Tyler Cowen - "One point I made is that the slow aspects of the recovery do not, contrary to some accounts, seem to stem from uncertainty about the plans of the Obama administration. I see at least two reasons for this doubting this account:
1. Output has recovered much more rapidly than the labor market; last quarter gdp growth exceeded five percent yet employment is essentially flat. The labor market is one of the least regulated sectors of the American economy, so it would be odd if regulation were causing the slow aspects of the bounceback. Many of the extant government-blaming hypotheses predict slow output growth, not rapid output growth and slow labor market participation.
2. Arguably health care and finance have been subject to the most regulatory uncertainty. Yet the health care sector has held up OK and banks have made a very strong comeback in terms of profits."

Interview with Elinor Ostrom - "FRAN: So public shaming and public honoring are one key to managing the commons?
ELINOR: Shaming and honoring are very important. We don’t have as much of an understanding of that. There are scholars who understand that, but that’s not been part of our accepted way of thinking about collective action.
ELINOR: One that I read early on that just unglued me—because I wasn’t expecting it—was the work of Robert Netting, an anthropologist who had been studying the alpine commons for a very long time. He studied Swiss peasants and then studied in Africa too. He was quite disturbed that people were saying that Africans were primitive because they used common property so frequently and they didn’t know about the benefits of private property. The implication was we’ve got to impose private property rules on them. Netting said, “Are the Swiss peasants stupid? They use common property also.”
Let’s think about this a bit. In the valleys, they use private property, while up in the alpine areas, they use common property. So the same people know about private property and common property, but they choose to use common property for the alpine areas. Why? Well, the alpine areas are what Netting calls “spotty.” The rainfall is high in one section one year, and the snow is great, and it’s rich. But the other parts of the area are dry. Now if you put fences up for private property, then Smith’s got great grass one year—he can’t even use it all—and Brown doesn’t have any. So, Netting argued, there are places where it makes sense to have an open pasture rather than a closed one. Then he gives you a very good idea of the wide diversity of the particular rules that people have used for managing that common land."

Steve Landsburg - "Is it okay for me to counterfeit if the central bank is not being sufficiently expansionary?"

Thursday, April 1, 2010

Really great links - narrow banking is not banking - human capital - USA vs. Western Europe - banksters

Paul Krugman - narrow banking - shadow banking - "I think of the whole bank regulation issue in terms of Diamond-Dybvig, which sees banks as institutions that allow individuals ready access to their money, while at the same time allowing most of that money to be invested in illiquid assets. That’s a productive activity, because it allows the economy to have its cake and eat it too, providing liquidity without foregoing long-term, illiquid investments. If you were to enforce narrow banking, you would be denying the economy one of the main ways we manage to reconcile the need to be ready for short-term contingencies with the payoff to making long-term commitments.
Where Greg goes astray here, I think, is by trying to apply Modigliani-Miller, which says that capital structure doesn’t matter. If you look at the assumptions behind that argument, you realize that it requires that all assets be perfectly liquid. They aren’t, of course — and that’s precisely why we need banks.
And anyway, how would you enforce it? Yes, you could require that depository institutions be narrow banks — but depository institutions aren’t where the problem is. The recent crisis was centered in repo — and as Gary Gorton (and others) insist, repo — overnight loans in which many businesses park their funds — are money just as much as bank deposits are. And if depository institutions were forced to be narrow banks, even more funds would migrate to shadow banks. So would you try to ban repo? Where does it stop?"

Frances Woolley - human capital - "Whether or not human capital theory is true determines the best response to the demographic challenges much discussed this blog. If education makes people more productive, then more education can increase the productivity of our economy – possibly enough so that fewer workers are able to support the large number of pensioners. If, however, education is basically about sorting workers – if people are getting more and more degrees in hope of eventually capturing that one elusive stable professional job with benefits – then the best way of responding to the demographic crisis is to scale back post-secondary education. Doing so would effectively increase the size of the working age population substantially, easing demographic problems."

Scott Sumner - USA vs. Western Europe - "When I started studying economics the US was much richer than Western Europe and Japan, but was also growing more slowly than other developed countries. They were still in the catch-up growth phase from the ravages of WWII. But since Reagan took office the US has been growing faster than most other big developed economies, and at least as fast in per capita terms. They’ve plateaued at about 25% below US levels, when you adjust for PPP. This is the steady state. The big question is why.
Take a look at the data for Germany and Italy. On average they collect .416 of GDP in taxes, as opposed to the .282 ratio in the US. And yet the average amount collected is only slightly higher than US tax revenues.
Here’s the $64 dollar question for which I’ve never seen progressives provide a satisfactory answer. Why is per capita GDP in Western Europe so much lower than in the US? Mankiw seems to imply that high tax rates may be one of the reasons. I don’t know if that’s the answer, but if it’s not my hunch is that the factors that would explain the difference are other government policies that the left tends to favor (strong unions, higher minimum wages, more regulation, generous unemployment insurance, etc.) So I think Mankiw is saying that if we adopt the European model, there really isn’t a lot of evidence that we’d end up with any more revenue than we have right now. Further evidence for this hypothesis is that the few developed countries that do have much lower tax rates than the US (Hong Kong and Singapore) now have much higher per capita GDPs (PPP) than Western Europe. Yes, they are small and urban, but Western Europe is full of small countries of about 6 million people that have less than 5% of the population in farming.
Of course the progressives’ great hope is that we’ll end up like France. But Brazil also has high tax rates, how do they know we won’t end up like Brazil? For those who like cultural explanations, I’d point out that the US has many people of Spanish, Italian, German and British descent, but not many of French descent. And those 4 European countries raise about as much revenue as the US, but with much higher tax rates and much lower incomes."

Interfluidity - "I myself don’t use the term “banksters”. And I sympathize with TED. I like financial industry professionals, personally. I enjoy meeting bankers. They are usually smart, interested in the arcane crap I’m interested in, and assholes of the sort that I enjoy sparring with. Bankers are great fun, and they are not bad people.
But we are who we are collectively as well as individually. Large organizations can and do evolve to do evil things while isolating people individually from illegal or morally uncomfortable acts. That capacity can confer tremendous advantages over smaller, more personal and accountable, collectives. It’s harsh, but we don’t get a pass just because the particular lever we are paid to pull only shifts a cog in a vast machine whose overall function we don’t control. As moral agents, it is not enough to follow the law and let pecuniary incentives guide us. We have to take responsibility for the behavior of the collectives to which we belong.
Calling out misdeeds by hard names helps. Words like “looting”, “theft”, “fraud”, and “scam” are fair descriptions of a lot of common practices, even if some of the perpetrators worked 18 hour days putting together pages 120 through 237 of mind-numbing prospecti and meant only to earn a living."

The Money Demand