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March 2009

Matthew Richardson and Nouriel Roubini

Give credit to Timothy Geithner's new toxic asset plan: For the economy to be viable, the financial system must be healthy. For this to occur, the system needs to be cleansed of its poorly performing loans and so-called toxic securities backed by loans. This way, once creditworthy institutions and individuals come to the market looking for capital to borrow, financial firms will be in a position to lend them money.

Secretary Timothy Geithner's new toxic asset plan is a serious step in the right direction in that it creates a public-private partnership to buy the troubled assets of financial firms - in other words, to do the necessary cleansing. Up until now, with all the government bailouts, the financial system has been barely treading water. With this plan, it will still be a hard swim, but, at least, there is a path to shore.

The plan essentially calls for private asset management firms - private equity, hedge funds, mutual funds, pension funds - to invest side by side with the government.

The private investors need the government because there are so many bad loans held in the financial sector that only the government's balance sheet can handle taking them over. The government needs help from private investors so it doesn't get hoodwinked by the banks.

Why will investors participate? The deal is structured so that firms will be responsible only for losses on their initial investment. The hope is that by giving this big "freebie," the government will induce investors to participate, and that competition among them will lead to higher offer prices for the loans and securities, thus encouraging banks to sell them.

A lot of ifs, but if indeed successful, the plan accomplishes mission No. 1, namely the removal of the bad assets from banks' balance sheets. Even if banks wanted to do this on their own, they can't because the market for these illiquid assets has dried up.

But let's not have any illusions. The government bears the risk if and when the investors take a bath on the taxpayer-provided loans. If the economy gets worse, it could get very ugly, very quickly. The administration should be transparent in making clear that there is still a wealth transfer taking place here - from taxpayers to investors and banks.

Also, while this plan is designed by the Treasury, many of the big guarantees are being made by the Federal Deposit Insurance Corp. and the Fed. Why not use only Treasury funds? Well, then the administration would have to deal with Congress. While the populist hysteria of last week suggests this end run might make sense, there is something a little worrying about circumventing the legislative process on such a huge investment.

Moreover, there's the issue of transparency - or lack thereof. No one knows what the loans or securities are worth. Competing investors will help solve this by promoting price discovery. But be careful what you wish for. We might not like the answers.

Finally, we have to anticipate the likelihood that some banks will resist selling their loans and securities. Why? Currently, the government has been giving them the option to keep holding them with the hope that market conditions will improve.

Going forward, the government must insist on the banks' involvement in the new program. The reason that financial institutions must be pressured is that they are the cause of the financial crisis. They took advantage of loopholes to avoid regulatory requirements, taking a huge bet on securities they were never meant to hold in the first place.

What happens if removing toxic assets from a bank's balance sheet at near-market prices shows it is effectively insolvent? Then we will have to face the elephant in the room. We may then have to start asking, "Why keep insolvent banks afloat?" And having asked that, we will have to search for ways to manage the ensuing systemic risk.

Either way, once the plan is fully implemented, we will be entering a new phase of the financial crisis. The water is choppy. Let's hope we are strong swimmers.

Newspapers and Colleges

Kevin Carey:

What Colleges Should Learn From Newspapers' Decline - Newspapers are dying. Are universities next?... Both industries are in the business of creating and communicating information... are threatened by the way technology has made that easier than ever before.... [U]niversities have their own weak point, their own vulnerable cash cow: lower-division undergraduate education. The math is pretty simple: Multiply an institution's average net tuition (plus any state subsidies) by the number of students (say, 200) in a freshman lecture course.... I don't care what kind of confiscatory indirect-cost multiplier you care to add to that equation, the institution is making a lot of money — which is then used to pay for... expensive things that cost more than they bring in. As of today, there's no Craigslist busily destroying the financial foundations of the modern university. Teaching is a lot more complicated than advertising, and universities have the advantage of sitting behind government-backed barriers to competition, in the form of accreditation....

Some people will argue that the best traditional college courses are superior to any online offering, and they're often right. There is no substitute for a live teacher and student, meeting minds. But remember, that's far from the experience of the lower-division undergraduate.... All she's getting is a live version of what iTunes University offers.... She's also increasingly paying through the nose for the privilege.... Perhaps the higher-education fuse is 25 years long, perhaps 40. But it ends someday, in our lifetimes. There's still time for higher-education institutions to use technology to their advantage, to move to a more-sustainable cost structure, and to win customers with a combination of superior service and reasonable price. If they don't, then someday, sooner than we think, we're going to be reading about the demise of once-great universities — not in the newspaper, but in whatever comes next...

I am not sure.

Put it this way: The printed book should have killed the university. Once you have Gutenberg, the original rationale for the lecture course is gone--yet universities survived and flourished. We need to have a much stronger sense of why universities survived the coming of the printed book before we can convince ourselves that they will not survive the coming of the internet.

The shifting of lower-division undergraduate education to cheaper venues does, however, seem likely...

Neoconservatives Lie, About Everything, All the Time

George Packer:

PNAC and Iraq: A commenter I assume to be Gary Schmitt, the former executive director and current senior fellow at the Project for the New American Century, writes to take me to task for my characterization of the organization, saying that PNAC contributed no staff or board members to the Bush Administration. Schmitt is right. I was thinking of the signatories to its statement of principles and its letters on regime change in Iraq—Dick Cheney, Donald Rumsfeld, Lewis Libby, Paul Wolfowitz, Zalmay Khalilzad, Peter Rodman, John Bolton, Richard Perle, and Richard Armitage—none of whom held formal positions in PNAC.... Schmitt also implies that PNAC did not play a role in creating the congressional pressure that ultimately led President Clinton to sign the Iraq Liberation Act when he was badly weakened by the Lewinsky scandal. Read the PNAC letters and the rest of the relevant history and decide for yourself. Finally, Schmitt contends that PNAC was a leading post-invasion critic of the handling of the Iraq War. He should post some of the evidence on the group’s web site, where you can find a lengthy 2005 report called “Iraq: Setting the Record Straight,” an ex-post-facto defense of the WMD justification for the war, as well as links to numerous op-eds by PNAC members fighting rearguard battles against the war’s domestic critics—but no trace of the kind of thoroughgoing criticism that might have come to the attention of PNAC’s signatories, who had become leading Bush Administration officials, and made a difference when it mattered. More than any of its positions, this sort of intellectual slipperiness about the past is what makes me skeptical of the future of the Foreign Policy Initiative, started by two of PNAC’s original founders.

Kick-Starting Employment

PROJECT SYNDICATE: Kick-Starting Employment: BERKELEY - Unemployment is currently rising like a rocket, because businesses that normally would be expanding and hiring are not, and those businesses that would normally be contracting and shedding workers are doing so very rapidly. Businesses that ought to be expanding and hiring cannot, because the depressed general level of financial asset prices prevents them from borrowing money or selling bonds on profitable terms.

In response, central banks should purchase government bonds for cash in as large a quantity as needed to push their prices up as high as possible. Expensive government bonds will shift demand to mortgage or corporate bonds, pushing up their prices.

Even after central banks have pushed government bond prices as high as they can go, they should keep buying government bonds for cash, in the hope that people whose pockets are full of cash will spend more of it, and that this will directly pull people out of joblessness and into employment.

In addition, governments need to run extra-large deficits. Spending - whether by the United States government during World War II, following the Reagan tax cuts of 1981, by Silicon Valley during the late 1990's, or by home buyers in America's south and on its coasts in the 2000's - boosts employment and reduces unemployment. And government spending is as good as anybody else's.

Finally, governments should undertake additional measures to boost financial asset prices, and so make it easier for those firms that ought to be expanding and hiring to obtain finance on terms that allow them to expand and hire.

It is this point that brings us to US Treasury Secretary Timothy Geithner's plan to take about $465 billion of government money, combine it with $35 billion of private-sector money, and use it to buy up risky financial assets. The US Treasury is asking the private sector to put $35 billion into this $500 billion fund so that the fund managers all have some "skin in the game," and thus do not take excessive risks with the taxpayers' money.

Private-sector investors ought to be more than willing to kick in that $35 billion, for they stand to make a fortune when financial asset prices close some of the gap between their current and normal values. If the fund does well over the next five years - returns profits of 9% per year -private investors get a market rate of return on their very risky equity investment and the equivalent of an "annual management fee" equal to 2% of assets under management.

If the portfolio does less well - profits of 4% per year - the managers still get a healthy but sub-market return of 10% per year on their equity. And if the portfolio does badly - loses 1% per year - they lose roughly 70% of their investment. Those are attractive odds. Time alone will tell whether the financiers who invest in and run this program make a fortune. But if they do, they will make the US government an even bigger fortune. And 2% of assets under management is an annual fee that many sophisticated investors have been willing to pay private hedge funds - topped off with an extra fee of 20% of annual profits, which the Treasury is not paying.

The fact that the Geithner Plan is likely to be profitable for the US government is, however, a sideshow. The aim is to reduce unemployment. The appearance of an extra $500 billion in demand for risky assets will reduce the quantity of risky assets that other private investors will have to hold. And the sudden appearance of between five and ten different government-sponsored funds that make public bids for assets will convey information to the markets about what models other people are using to try to value assets in this environment.

This sharing of information will reduce risk - somewhat. When assets are seen as less risky, their prices rise. And when there are fewer assets to be held, their prices rise, too. With higher financial asset prices, those firms that ought to be expanding and hiring will be able to get money on more attractive terms.

The problem is that the Geithner Plan appears to me to be too small - between one-eight and one-half of what it needs to be. Even though the US government is doing other things as well -fiscal stimulus, quantitative easing, and other uses of bailout funds - it is not doing everything it should.

My guess is that the reason that the US government is not doing all it should can be stated in three words: Senator George Voinovich, who is the 60th vote in the Senate - the vote needed to close off debate and enact a bill. To do anything that requires legislative action, the Obama administration needs Voinovich and the 59 other senators who are more inclined to support it. The administration's tacticians appear to think that they are not on board - especially after the recent AIG bonus scandal - whereas the Geithner Plan relies on authority that the administration already has. Doing more would require a legislative coalition that is not there yet.

The Importance of the G-20 Meeting

It looks as though Obama is going to get about half of what he asks for--which is a failure not on his part but on the part of the Europeans. Let's hope that that is enough.

Paul Krugman:

America the Tarnished: Like many other economists, I’ve been revisiting the Great Depression, looking for lessons that might help us avoid a repeat performance. And one thing that stands out from the history of the early 1930s is the extent to which the world’s response to crisis was crippled by the inability of the world’s major economies to cooperate.

The details of our current crisis are very different, but the need for cooperation is no less. President Obama got it exactly right last week when he declared: “All of us are going to have to take steps in order to lift the economy. We don’t want a situation in which some countries are making extraordinary efforts and other countries aren’t.”

Yet that is exactly the situation we’re in. I don’t believe that even America’s economic efforts are adequate, but they’re far more than most other wealthy countries have been willing to undertake. And by rights this week’s G-20 summit ought to be an occasion for Mr. Obama to chide and chivy European leaders, in particular, into pulling their weight.

But these days foreign leaders are in no mood to be lectured by American officials, even when — as in this case — the Americans are right...

Dan Froomkin on the Torture of Abu Zubaida

Dan reports on what the Washington Post now prints as front-page news--something it ould have printed three years ago:

White House Watch - Bush's Torture Rationale Debunked: Abu Zubaida was the alpha and omega of the Bush administration's argument for torture. That's why Sunday's front-page Washington Post story by Peter Finn and Joby Warrick is such a blow to the last remaining torture apologists. Finn and Warrick reported that "not a single significant plot was foiled" as a result of Zubaida's brutal treatment -- and that, quite to the contrary, his false confessions "triggered a series of alerts and sent hundreds of CIA and FBI investigators scurrying in pursuit of phantoms."

Zubaida was the first detainee to be tortured at the direct instruction of the White House. Then he was President George W. Bush's Exhibit A in defense of the "enhanced interrogation" procedures that constituted torture. And he continues to be held up as a justification for torture by its most ardent defenders. But as author Ron Suskind reported almost three years ago -- and as The Post now confirms -- almost all the key assertions the Bush administration made about Zubaida were wrong. Zubaida wasn't a major al Qaeda figure. He wasn't holding back critical information. His torture didn't produce valuable intelligence -- and it certainly didn't save lives. All the calculations the Bush White House claims to have made in its decision to abandon long-held moral and legal strictures against abusive interrogation turn out to have been profoundly flawed, not just on a moral basis but on a coldly practical one as well. Indeed, the Post article raises the even further disquieting possibility that intentional cruelty was part of the White House's motive.

The most charitable interpretation at this point of the decision to torture is that it was a well-intentioned overreaction of people under enormous stress whose only interest was in protecting the people of the United States. But there's always been one big problem with that theory: While torture works on TV, knowledgeable intelligence professionals and trained interrogators know that in the real world, it's actually ineffective and even counterproductive. The only thing it's really good as it getting false confessions. So why do it? Some social psychologists (see, for instance, Kevin M. Carlsmith on have speculated that the real motivation for torture is retribution. And now someone with first-hand knowledge is suggesting that was a factor in Zubaida's case. Quoting a "former Justice Department official closely involved in the early investigation of Abu Zubaida," Finn and Warwick write that the pressure on CIA interrogators "from upper levels of the government was 'tremendous,' driven in part by the routine of daily meetings in which policymakers would press for updates...

"'They couldn't stand the idea that there wasn't anything new,' the official said. 'They'd say, "You aren't working hard enough." There was both a disbelief in what he was saying and also a desire for retribution -- a feeling that 'He's going to talk, and if he doesn't talk, we'll do whatever.'"' The Post story also makes it clear that some people with great reality-denying skills remain at the upper levels of the government: "Some U.S. officials remain steadfast in their conclusion that Abu Zubaida possessed, and gave up, plenty of useful information about al-Qaeda," Finn and Warwick write. "'It's simply wrong to suggest that Abu Zubaida wasn't intimately involved with al-Qaeda,' said a U.S. counterterrorism official, speaking on the condition of anonymity because much about Abu Zubaida remains classified. 'He was one of the terrorist organization's key facilitators, offered new insights into how the organization operated, provided critical information on senior al-Qaeda figures...and identified hundreds of al-Qaeda members. How anyone can minimize that information -- some of the best we had at the time on al-Qaeda -- is beyond me.'" But who are these people? How can they still possibly believe this given all the evidence to the contrary? What are they doing still in government?

Author and investigative reporter Suskind first exposed the rampant fallacies of the administration's Zubaida narrative in his explosive June 2006 book, The One Percent Doctrine. See my June 20, 2006 column for a summary. But mainstream news organizations, unable to match Suskind's sources, largely refused to acknowledge his reporting. Indeed, in September 2006, when the White House for the first time publicly acknowledged the existence of a secret CIA detention and interrogation program, Bush had no qualms about putting Zubaida front and center. In a major speech, he proudly described how Zubaida -- "a senior terrorist leader and a trusted associate of Osama bin Laden" -- was questioned using the CIA's new "alternative set of procedures" and then "'began to provide information on key al Qaeda operatives."

All lies and euphemisms. But all reported pretty much straight at the time by a mainstream media that, if it noted Suskind's reporting at all, did so as an afterthought...

Republicans: The Stupid Party

Lee Fang:

Think Progress» Rep. Paul Ryan Concedes GOP Alternative Budget Would Increase The Deficit ‘A Lot’: Last week, the House GOP presented its alternative budget proposal. Members of the media, including conservative commentators, widely panned the document for being scant on details and appearing more as “campaign-style talking points.” Rep. Paul Ryan (R-WI), ranking member of the House Budget Committee, has said he will release yet another budget proposal, but this time with more specifics. Though Ryan has been most critical of the deficit impact of Obama’s budget, he has been unable to assess the deficit impact of his own budget. After being repeatedly asked this weekend by Bloomberg’s Al Hunt about “how large” the deficit would be under the Republican plan, Ryan finally respond, “A lot”:

HUNT: But the Obama budget deficit is $1.4 trillion. How, roughly, how large will yours be?

RYAN: Their budget deficit is $1.8 trillion. […]

HUNT: Gimme an idea of how large yours will be?

RYAN: A lot. Let’s put it that way.

HUNT: Pardon me?

RYAN: Now I can’t give you the specific numbers because we’re still waiting for some numbers back from CBO. But clearly we don’t want to have this kind of run up of deficits and debt....

As ThinkProgress previously noted, Rep. Mike Pence (R-IN) also stumbled and refused to offer a number when questioned by MSNBC about the deficit under the GOP plan.

The Bush Administration: An Oral History of the Bush White House. The threat of 9/11 ignored. The threat of Iraq hyped and manipulated. Guantánamo and Abu Ghraib. Hurricane Katrina. The shredding of civil liberties. The rise of Iran. Global warming

An excerpt:

Cullen Murphy and Todd Purdum: there were detailed discussions and briefings on cyber-security and often terrorism, and on a classified program. . . . he seemed—I was disturbed because he seemed to be trying to impress us, the people who were briefing him. . . . The contrast with having briefed his father and Clinton and Gore was so marked. And to be told, frankly, early in the administration, by Condi Rice and [her deputy] Steve Hadley, you know, Don’t give the president a lot of long memos, he’s not a big reader—well, shit. I mean, the president of the United States is not a big reader?

Tim Geithner Is Not a Tool of Wall Street

Edward Luce writes:

America’s liberals lay into Obama: The liberal backlash against President Barack Obama has begun with many prominent left-leaning economists in the US attacking the administration’s plans to bail out the banks.

Paul Krugman describes the toxic asset purchase plan as “cash for trash”. Jeffrey Sachs calls it “a thinly veiled attempt to transfer hundreds of billions of US taxpayer funds to the commercial banks”. Robert Reich depicts Tim Geithner, Treasury secretary, as a prisoner of Wall Street while Joe Stiglitz says the plan “amounts to robbery of the American people”. On the blogosphere and beyond, Democratic economists accuse Mr Obama – along with Mr Geithner, and Lawrence Summers, the president’s senior economic adviser – of taking dictation from the same financiers who have brought the economy to the brink of depression.

Mr Reich, who was Bill Clinton’s Labour secretary in the 1990s before resigning over the former president’s reluctance to pursue a strong public investment agenda, says that he and his colleagues fear a replay of the Clinton years under Mr Obama. Mr Reich now talks of the “Paulson-Geithner approach” to demonstrate what he sees as the continuity between Hank Paulson, George W. Bush’s last Treasury secretary, and the current administration. Mr Reich says bank nationalisation is the only answer to today’s crisis. “Bill Clinton chose to pursue a set of policies that Wall Street agreed with but at the expense of his long-term agenda of boosting public investment,” says Mr Reich. “Bill Clinton’s Wall Street agenda in the end brought America and the world crashing down with it. I hope we are not seeing history repeat itself with Mr Obama.”

Not every Democrat agrees. Brad DeLong, a former Clinton official, says that every banking crisis – barring the Great Depression – has been resolved by government recapitalisation of the banking sector, as Mr Obama is likely to attempt in the near future. Nor, says Mr DeLong, is it fair to paint Mr Geithner as a creature of Wall Street. “Hank Paulson is a man who grew up in American finance and cannot imagine a world in which America does well and its financial sector does badly,” he says. “Tim Geithner, by contrast, is a bureaucrat and a policymaker. He has never pulled down a multibillion-dollar bonus. They are not the same type of people.”

But in reality the division is as much political as economic. Most of Mr Obama’s liberal critics argue he should have gone to Congress already and asked for a lot of money for bank recapitalisation. His defenders say that would be political suicide until the populist mood on Capitol Hill has died down. “We have to ask ourselves: Do we want to revive our economy, or do we want to punish the bankers?” says Mr DeLong. “I don’t agree that we can do both.”

I should have said "multi-million dollar bonus." Tim Geithner has never pulled down a multi-million dollar bonus. He has never pulled down a multi-billion dollar bonus either, but rather few people have...

Cosma Shalizi Takes Me to Probability School. Or Is It Philosophy School?

After I accuse Cosma Shalizi of waterboarding the Rev. Dr. Thomas Bayes, he responds:

Cosma Shalizi: Cosma Shalizi Waterboards the Rev. Dr. Thomas Bayes: Hoisted from Comments: I am relieved to learn that the true model of the world is always already known to every competent statistical inquirer, since otherwise it could not be given positive prior weight. I would ask, however, when our model set became complete? And further, when did people stop using models which they knew were at best convenient but tractable approximations?

Less snarkily, these two examples are out-takes from what I like to think is a fairly serious paper on Bayesian non-parametrics with mis-specified models and dependent data:

described less technically here:

The examples were simple sanity-checks on my theorems, and I posted them because they amused me.

Thus Cosma Shalizi takes me to probability school. Or perhaps he takes me to philosophy school. It is not clear.

Let me give an example simpler than one of the ones Cosma Shalizi gave. Rosencrantz is flipping a coin. Guildenstern is watching and is calling out "heads" or "tails." It is a fair coin--half the time it comes up heads, and half the time it comes up tails. Before Rosencrantz starts flipping, Guildenstern's beliefs about what the next flip of the coin will bring are accurate: he thinks that there is a 50% chance that the next flip of the coin will be heads and a 50% chance that the next flip of the coin will be tails.

Because Guildenstern starts with correct beliefs about what the odds are for the next flip of the coin, you might think that there is nothing for Guildenstern to "learn"--that as Rosencrantz flips, Guildenstern will retain his initial belief that the odds are 50-50 that the next flip of the coin will be heads or tails. But there is a problem: Guildenstern is not a human being but rather is a Bayesian AI, and Guildenstern is certain that the coin is biased: it thinks that there is a 50% chance it is dealing with a coin that lands heads 3/4 of the time, and a 50% chance it is dealing with a coin that lands tails 3/4 of the time, and its initial prediction that the next flip is equally likely to be heads or tails depends on that initial 50-50 split.

What happens as Rosencrantz starts flipping? The likelihood ratio for an H-biased as opposed to a T-biased coin is 3z, where z=h-t and h is the number of heads and t is the number of tails flipped, which means that the posterior probabilities assigned by Guildenstern after h heads and t tails are:

P(H | z) = 3z/(3z + 1)

P(T | z) = 1/(3z + 1)

And the estimate that the next flip will be heads is:

(3/4)P(H | z) + (1/4)P(T | z) = (3z+1 + 1)/(4(3z + 1))

If the number of heads and tails are even, then Guildenstern (correctly) forecasts that the odds on the next flip are 50-50. If the n flips Rosencrantz has performed have seen two more heads than tails--no matter how big n is--then Guildenstern is 90% certain that it is dealing with an H-biased coin and thinks that the chance the next flip will be heads is 70%. If the n flips Rosencrantz has performed have seen ten more heads than tails--again, no matter how many flips n there have been--Guildenstern is 99.9983% sure that it is dealing with an H-biased coin and will forecast the odds of a head on the next flip at 74.9999%.

How will Guildenstern's beliefs behave over time? Well, this passage from Shalizi's more complex example applies:

Three-Toed Sloth: The sufficient statistic z [for P(H)]... follows an unbiased random walk, meaning that as n grows it tends to get further and further away from [zero], with a typical size growing roughly like n1/2. It does keep returning to the origin, at intervals dictated by the arc sine law, but it spends more and more of its time very far away from it. The posterior estimate of the [probability of an H-biased coin thus wanders from being close to +1 to being close to [0] and back erratically, hardly ever spending time near zero, even though (from the law of large numbers) the sample mean [fraction of heads] converges to zero...

So Guildenstern spends all of its time being nearly dead certain that it is dealing with an H-biased coin or nearly dead certain that is dealing with a T-biased coin--but it switches its belief occasionally--even though there is almost surely never any statistically significant evidence for H-bias against the null hypothesis that the coin is fair and 50-50. There is an allowable set of beliefs for Guildenstern that will lead it to make the right 50-50 forecast of the odds on the next flip: if Guildenstern simply continues to believe that there is no evidence either way for H-bias or T-bias. But Guildenstern's beliefs are not those beliefs and do not converge to those beliefs: look far enough out into the future and you see that Guildenstern is almost sure either that the coin is H-biased or that the coin is T-biased, and has virtually no chance of being unsure about in which direction the bias lies.

Thus Guildenstern's processing of the data is not sensible, is not smart, is not rational, is not human--but it is Bayesian. For positive values of z, Guildenstern thinks "there are fewer heads than I would expect for an H-biased coin, but this could never come about with a T-biased coin; the coin must be H-biased: I am sure of it." A sensible agent, a smart agent, a rational agent, a human agent would think: "Hmmm. Right now I am sure that the coin is T-biased, but 100 flips ago I was sure that the coin was H-biased. I know that as I get more evidence my beliefs should be converging to the truth, but they don't seem to be converging at all. Something is wrong." But there is nothing in the Bayesian agent's little brain to allow it to reason from the failure of its beliefs to converge to the conclusion that there is something badly wrong here.

But it seems, intuitively, that Guildenstern should be able to make good forecasts. The the prior that Guildenstern started with does admit of beliefs that would lead to accurate forecasts of the next coin flip: all Guildenstern has to do is to doubt that it has enough information to decide about the bias of the coin. Indeed, Guildenstern's initial beliefs generate the right forecast of probabilities for the next flip. So, given that Guildenstern starts out with a set of beliefs that supports and generates the "right" forecast probabilities, given that there really isn't enough information to decide about the bias of the coin--there can't be, for the coin is not biased--and given that Bayesian learning is a kind of learning, why doesn't Guildenstern simply keep its original beliefs and keep making good forecasts? Shalizi has identified a case in which it seems that a Bayesian agent should be able to learn enough to make good predictions, but cannot in fact do so.

Shalizi has gotten his Bayesian AI Guildenstern to confess. But has he done so by legitimate means? Or by waterboarding? The probability theory question, or perhaps the philosophy question, is: Is this a problem for the Bayesian way of looking at the world? Or only a demonstration that torture elicits confessions?

J. M. Keynes Comments on the Current Crisis

Non-Standard Monetary Policy: Robert Lucas on Non-Standard Monetary Policy 2008:

A dead end? Not at all. The Fed can satisfy the demand for quality by using reserves -- or "printing money" -- to buy securities other than Treasury bills. This is the way the $600 billion got out into the private sector...

Maynard Keynes on Non Standard Monetary Policy 1937:

If the monetary authority were prepared to deal both ways on specified terms in debts of all maturities, and even more so if it were prepared to deal in debts of varying degrees of risk, the relationship between the complex of rates of interest and the quantity of money would be direct. The complex of rates of interest would simply be an expression of the terms on which the banking system is prepared to acquire or part with debts; and the quantity of money would be the amount which can find a home in the possession of individuals who — after taking account of all relevant circumstances — prefer the control of liquid cash to parting with it in exchange for a debt on the terms indicated by the market rate of interest. Perhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement which can be made in the technique of monetary management....

Ben Bernanke (2009) is following their advice. I'd say that, when Robert Lucas and Maynard Keynes agree, they probably have a point.

I am Robert Waldmann and Brad DeLong approved this message.

Cosma Shalizi Waterboards the Rev. Dr. Thomas Bayes

Bayesian inference gone horribly wrong. Cosma Shalizi:

Some Bayesian Finger-Puzzle Exercises, or: Often Wrong, Never In Doubt: The theme here is to construct some simple yet pointed examples where Bayesian inference goes wrong, though the data-generating processes are well-behaved, and the priors look harmless enough. In reality, however, there is no such thing as an prior without bias, and in these examples the bias is so strong that Bayesian learning reaches absurd conclusions....

Example 1:... The posterior estimate of the mean [of the generating process] thus wanders from being close to +1 to being close to -1 and back erratically, hardly ever spending time near zero, even though (from the law of large numbers) the sample mean [of the sufficient statistic] converges to [the true mean of the generating process of] zero....

Example 2:... As we get more and more data, the sample mean converges almost surely to zero (by the law of large numbers), which here drives the mean and variance of the posterior to zero almost surely as well. In other words, the Bayesian becomes dogmatically certain that the data are distributed according to a standard Gaussian with mean 0 and variance 1. This is so even though the sample variance almost surely converges to the true variance, which is 2. This Bayesian, then, is certain that the data are really not that variable, and any time now will start settling down....

It is a violation of the Geneva Convention to force a Bayesian statistician to begin analysis with a prior that places a weight of zero on the true underlying generating process, isn't it?

Are We Handcuffed by Golden Fetters?

Paul Krugman writes:

What’s our gold standard?: I’ve just reread Eichengreen and Temin, The Gold Standard and the Great Depression, which does a great job of showing how the “gold mentality” — what they call mentalite, with an accent — paralyzed policymakers. (The longer-form version, with more personal color, is Liaquat Ahamad’s Lords of Finance.) What E&T show is that circa 1930 key decision-makers had spent so many years equating adherence to gold not just with prosperity, but with morality, decency, civilization itself, that they couldn’t even contemplate breaking with that orthodoxy — even in the face of total catastrophe. I think we’re more flexible now. But my sense is that the mystique of finance is playing a somewhat similar role.

More on this when I’m not waiting for a delayed plan at O’Hare.

My view is that we are not now bound by golden fetters--that by and large we know what to do and how to do it to keep the world economy out of a depression. But, I would say, there are three groups of people who are trying to handcuff us with today's equivalents of the golden fetters that constrained economic policy and made the Great Depression so great. Each group is doing so for its own reasons:

  1. Out of ignorance: the modern-day Chicago School of economists, which is arguing against effective use of policies to manage aggregate demand because they have never read Metzler or Friedman (or Keynes), and never thought at all seriously about the transmission mechanisms by which changes in monetary policy (and fiscal policy) affect the price level in the long run and affect output, employment and demand in the short run.

  2. Out of malevolence: the Republican members of congress and all their intelletual enablers who would have fallen in line behind what are now the policies of the Obama administration had McCain won the election and had they been the policies of the McCain administration instead--but who are right now opposed because they think making Obama's presidency a failure is the road to electoral success in 2010 and 2012.

  3. Out of justice: avoiding depression requires supporting asset prices--which means that for many financiers the wages of overspeculation will be not bankruptcy but fortunes. People rebel against the fact that in a financial crisis the banking sector has got the rest of us by the plums, and that there is no effective way to make sure they get their justice without creating prolonged mass unemployment for the rest of us.

Maynard Keynes Discusses the Current Crisis, Parts I-III

Hoisted from comments: Robert Waldmann writes:

Grasping Reality with Both Hands: Ex-College Roommates Write Letters: Self referential blog commenting: Uhm, Brad, don't expect to have a monopoly on Keynes Comments on Current Events Blogging. I'm up to III already:

Ex-College Roommates Write Letters

Robert Waldmann:

Dear Brad,

...Anyway, I really think you ought to have posts of the form: "Maynard Keynes Discusses the Current Crisis part MDCCLXXIV." It seems to me that he is one of the most insightful commentators on current events, in spite of the disadvantage of writing say 70 years ago.

This, despite the mildly embarrassing URL, is searchable and cutandpastable:



Geithner Plan Self-Referential Comment Blogging

I feel shy about quoting too much of what I have published in "The Week" here--Frank Wilkinson is paying me good money (well, not "good" money: hand-signed checks on the Nation payscale is what we are talking about here) to drive traffic to But I will quote Matthew Yglesias quoting me:

Matthew Yglesias: Brad DeLong’s Case for the Geithner Plan: What exactly it means to be “for” the Geithner Plan is, at this point, a bit hard to say since nobody seems to think it’s adequate to the problems we face, but among those who clearly think it’s desirable for the plan to go forward as one step among many, Brad DeLong has been the most convincing non-administration defender. Read this extended remix to get a clear since of what an optimistic take on the plan would be. And whether or not you find that convincing, I at least find this to be almost certainly right:

Q: But if even the Obama administration thinks this plan will accomplish only 3/4 of the job, why aren’t they doing more? Why not do the entire job?

A: Voinovich.

Q: Voinovich?

A: Republican Senator George Voinovich of Ohio is the sixtieth vote in the Senate–the one required to close off debate, avoid a filibuster and move to a vote on final passage of a bill. If the Obama administration wants to do anything that requires legislative action, it needs Voinovich and 59 other senators on board. The White House’s legislative tacticians appear to think that 60 senators are not on board–especially after last week’s AIG scandal. The Geithner Plan is something the administration can do on authority it already has. Doing more would require a congressional coalition that, at present, does not exist.

Another way of looking at it is that the administration has a real-but-limited ability to ask members to cast tough votes they don’t necessarily want to cast. Doing something they can do without an additional vote makes it more likely that they can ask congress to cast those tough votes on the budget and on health care rather than on bank bailouts.

And commenter Kafka writes:

Why Wall Street loves Geithner and his bank bailout plan: FROM: Money quote:

Now we have the plan: It’s similar to former Secretary Hank Paulson’s plan to buy toxic assets from bank balance sheets but with a twist–the Federal Deposit Insurance Co. and Federal Reserve will give private investors cheap leverage. For private investors like PIMCO, this means they’ll be able to enhance potential returns with government leverage. It also means, since the government will be granting them non-recourse loans, that if these securities ultimately fall in value, the private investors are protected–they can hand the securities back to the government and walk away.

To which I reply:

Since most of these troubled assets are held by banks, the FDIC has already effectively given them non-recourse loans–if the value of the troubled assets in the end doesn’t cover the value of bank deposits, the bank shareholders walk away and the FDIC ponies up. I don’t understand how moving these FDIC commitments out of the banks and into these Treasury-sponsored funds changes anything.

An Answer to a Question from Michael Berube...

The question is left as an exercise for the reader:

Monty Python's Flying Circus - "Oscar Wilde": monty python sketches: cheese shop, four yorkshiremen, oscar wilde, are you embarrassed easily?, australian table wines  
Monty Python's Flying Circus - "Oscar Wilde" [ from Monty Python's Flying Circus, third season, first shown 18.01.1973 ]

The Players:

Terry Jones - The Prince Of Wales;
Graham Chapman - Oscar Wilde;
John Cleese - James McNeill Whistler;
Michael Palin - George Bernard Shaw;

The Scene:

London, 1892; 16 Tite Street, Chelsea: The residence of Mr Oscar Wilde. Hansom cabs gallop past outside. In the drawing room, a crowd of suitably dressed folk are engaged in typically brilliant conversation, laughing affectedly and drinking champagne.

THE PRINCE OF WALES: Ah, my congratulations, Wilde. Your play is a great success. The whole of London's talking about you.

OSCAR WILDE: Your highness, there is only one thing in the world worse than being talked about, and that is not being talked about.

(There follows fifteen seconds of restrained and sycophantic laughter)

THE PRINCE OF WALES: Oh, very witty, Wilde ..... very, very witty.

JAMES McNEILL WHISTLER: There is only one thing in the world worse than being witty, and that is not being witty.

(Fifteeen more seconds of the same)

OSCAR WILDE: I wish I had said that Whistler.

JAMES McNEILL WHISTLER: Ah, you will, Oscar, you will.

(more laughter)

OSCAR WILDE: Your Highness, do you know James McNeill Whistler?

THE PRINCE OF WALES: Yes, we've played squash together.

OSCAR WILDE: There is only one thing worse than playing squash together, and that is playing it by yourself.


OSCAR WILDE: I wish I hadn't said that.

JAMES McNEILL WHISTLER: But you did, Oscar, you did.

(a little laughter)

THE PRINCE OF WALES: Well, you must forgive me, Wilde, but I must get back up the Palace.

OSCAR WILDE: Your Majesty, you're like a big jam doughnut with cream on the top.

THE PRINCE OF WALES: I beg your pardon?

OSCAR WILDE: Um ..... It was one of Whistler's.

JAMES McNEILL WHISTLER: I didn't say that.

OSCAR WILDE: You did, James, you did.

THE PRINCE OF WALES: Well, Mr. Whistler?

JAMES McNEILL WHISTLER: I- I meant, Your Majesty, that, uh, like a doughnut your arrival gives us pleasure and your departure merely makes us hungry for more.

(laughter and congratulations)

JAMES McNEILL WHISTLER: Yes, thank you. Right, Your Majesty is like a stream of bat's piss.



JAMES McNEILL WHISTLER: It was one of Wilde's.

OSCAR WILDE: It sodding was not! It was Shaw!


GEORGE BERNARD SHAW: I, um, I, ah, I merely meant, Your Majesty, that, ah, you shine out like a shaft of gold when all around is dark.

THE PRINCE OF WALES: Oh, ho-ho, very good.

GEORGE BERNARD SHAW: Right. Your Majesty is like a dose of clap.



GEORGE BERNARD SHAW: Before you arrive is pleasure, but after is a pain in the dong.

THE PRINCE OF WALES: I beg your pardon?

GEORGE BERNARD SHAW: It was one of Wilde's.




OSCAR WILDE: Uh ..... uh, wha-, wha- .....

GEORGE BERNARD SHAW: Come on, Ozzy, now, tell us all about it.

OSCAR WILDE: Wha-, what I meant, Your Majesty, uh-h-h .....

(general heckling from the crowd)

JAMES McNEILL WHISTLER: Let's have a bit of the old wit then!

OSCAR WILDE: What, what-


OSCAR WILDE: What I-, what I meant was .....

GEORGE BERNARD SHAW: Come on, Ozzy, .....

JAMES McNEILL WHISTLER: Give us a bit of the wit, Oz.

OSCAR WILDE: Um, w-w-what I meant, Your Majesty, w-was ..... oh ..... (blows a raspberry)

(The Prince shakes Wilde's hand. Laughter all round.)

THE PRINCE OF WALES: Oh! Excellent! Excellent, Wilde! Very witty, Wilde.


THE PRINCE OF WALES: Can you come and do that up the Palace some time? Extremely funny, ha-ha-ha...

The Revised, Extended Geithner Plan Catechism

We are live at The Week:

The crisis -- and Geithner plan -- explained:

Q: What is the problem?

A: The problem is that unemployment is rising like a rocket.

Q: Why is unemployment rising like a rocket?

A: Because those businesses that normally would be expanding and hiring right now are not expanding and hiring. This is compounded by the fact that businesses that would normally be contracting right now are indeed contracting -- rapidly.

Q: Why aren't the businesses that ought to be expanding and hiring doing so?

A: Because they cannot borrow money or sell bonds on terms that make it profitable for them to expand and hire.

Q: Why can't they borrow or sell bonds on normal terms?

A: Because banks and investors are loath to take on any more risk, they’re demanding that businesses seeking financing offer them usurious terms, which the businesses cannot do and still profitably expand.

Q: So why are the securities on Wall Street right now distressed and low-value?

A: Because banks, investors, and other financial intermediaries don't think they are worth very much.

Q: Why don't banks, investors, and other financial intermediaries think they are worth very much?

A: Six factors: (a) the housing boom was accompanied by the creation of a lot more assets--principally mortgage-backed securities and their derivatives. As supply and demand dictates, when there is more of something, it is worth less; (b) some of these securities were initially sold at prices that only a fool, thinking a bigger fool would come along to buy them at an even higher price, would ever pay; (c) there is a recession on and so firms have a greater chance of defaulting on their securities; (d) traders working for Wall Street firms are irrationally panicked after having been hammered for a year and a half; (e) those working for Wall Street firms that are now undercapitalized (because they have been hammered for a year and a half) assign a very high cost to risk because it materially increases the chance that their firm will vanish next month; (f) the risk level of these securities is much higher than normal because professional investors no longer trust their own financial models or know how their models compare to the models of other traders...

Republicans: The Stupid Party

A budget without numbers! What will they think of next!

The DNC is on the case:

The House Republican "budget" was appearently unveiled today. Don't miss Hari's quote below

Please find, below, our reaction to the House Republican "budget" proposal released this afternoon:

I'm all for changing the way we do business in Washington, but proposing a 'budget' that doesn't use numbers may be too much for me. After 27 days, the best House Republicans could come up with is a 19-page pamphlet that does not include a single real budget proposal or estimate. There are more numbers in my last sentence than there are in the entire House GOP 'budget.' While there had been talk that House Republicans were overriding their Senate counterparts to offer a budget alternative, it's clear after this announcement that neither of them have anything to offer but criticism --DNC National Press Secretary Hari Sevugan.

FLASHBACK - This Morning Before The Release of the House GOP "Budget" - Politico: So the entire House GOP elected leadership will join Rep. Paul Ryan (R-Wis.), the ranking member of the Budget Committee, for Thursday’s event. “It’s the old ‘I want to see it in writing,’” said a top House Republican official. “They’re going to see it in writing.” Another official said: “We need to hold something up and say, ‘Here are our charts. Here are our graphs. It’s real.’” [3/26/09]

This Afternoon After the Release of the House GOP "Budget" - MSNBC: "It Does Not Have, In the Sense of a Traditional Budget, Numbers."

Contessa Brewer: Mike Viqueira joins me now. I am very frustrated Mike because we’ve been waiting for this, we cut away from the President to hear the big build up: Republican have a plan, they have ideas, they’re not the Party of No. And, all I heard in that news conference is what they don’t like about the President’s plan.

Mike Viqueira: Well Norah - Uh Contessa, not Norah, Contessa, I am going to pass that along. They did hold up this uh John Boehner hold up this budget book here and said now we have a plan here is our budget. What it is is, it is a plan in the broad sense of the term. It outlines what the President wants to do in the various policies areas like energy and healthcare and entitlement reform and things of that nature and it talks about what Republicans want to do in very broad terms. It does not have, in the sense of a traditional budget, numbers with estimates, an estimate for how much they would reduce the deficit things of that nature.

Tyler Cowen: Timeo Stimulus Dona Ferentes

Tyler Cowen fears fiscal stimulus:

Marginal Revolution: Fiscal stimulus and German unification: For all the talk about the Great Depression, we are missing one historical analogy for a program of large fiscal stimulus, namely Germany after the Berlin Wall came down.  The two countries united, lots of money was spent and lots of money was borrowed.  West Germany had a modern economy with both manufacturing and services.  At the time Germany had unemployed resources, especially if you count the labor moving from East Germany to West Germany as grossly underemployed and available for higher-return projects.  The results were less than wonderful. The higher demand boosted measured gdp growth in the short run (bananas and porn, plus reconstruction) but Germany fell into economic stagnation.... The higher taxes and debt then kept the German economy down for many years. Few Germans were happy with the economic fallout from this "stimulus." And that was with a relatively well-functioning financial system and a reasonable amount of initial optimism. You can list many dissimilarities between German unification and the current U.S. situation...

The big difference, of course, is that the German central bank did not play ball with the program. The Bundesbank upset the applecart by offsetting expansionary fiscal policy with extremely contractionary monetary policy.

I don't know anybody who thinks fiscal policy boosts output if the monetary authority doesn't play ball. But right now Ben Bernanke is not only playing ball, he is funding the construction of an entire new stadium...

I Feel as Though I Should Buy Several More Houses...

Conforming mortgages look like amazing deals--especially if you think that the Federal Reserve won't be able to unwind its reserve expansion without some inflation.

Michelle Donley of Marketwatch:

30-year fixed mortgage rate hits record low: NEW YORK (MarketWatch) -- The national average interest rate on the benchmark 30-year, fixed-rate loan averaged 4.85% in the week ending Thursday, setting a new record low dating back to 1971, according to Freddie Mac's weekly survey. That rate is down from last week's 4.98% and the year-ago 5.85%. The 15-year fixed-rate loan averaged 4.58%, a record low dating back to 1991, down from the week-ago 4.61% and the year-ago 5.34%. The five-year Treasury-indexed hybrid adjustable-rate mortgage averaged 4.96%, compared with 4.98% a week ago and 5.67% a year ago. One-year Treasury-indexed ARMs averaged 4.85% this week, down from last week's 4.91% and the year-ago 5.24%.

I feel like I should refinance my house, up the mortgage to 80%, and go out and buy two more houses. What's property selling for in Carmel these days, anyway?

From 1972: James Tobin on the "Ricardian Equivalence" of Government Debt and Taxes

James Tobin (1972), "Friedman's Theoretical Framework," Journal of Political Economy 80:5 (October), pp. 852-863:

The crucial issue is whether government interest-bearing time debt is of any significance. If not, then an increase in the quantity of money has the same effect whether it is issued to purchase goods or to purchase bonds. If all kinds of debt matter, then the genesis of new money makes a difference. To borrow an overworked metaphor, is a "rain" of Treasury bills promises to pay currency in three months or less-of no consequence for the price level, while a "rain" of currency inflates prices proportionately?

It may be true that the debt involves an expected stream of taxes equivalent to the stream of interest. But the two streams do not wash out. Bills and bonds share some of the attributes, and perform some of the functions, of the currency they promise to pay. The government has a monopoly of their issue, as it does of currency. As long as the government does not expand the supply of these assets to the point where the public no longer pays an interest premium for their advantages, they will be valued more highly than the corresponding stream of taxes. The tax liabilities forced into public balance sheets are not the same in maturity, risk, convenience, etc., as the government obligations of which they are the counterpart. The tax liabilities will be discounted at the rate appropriate for the incomes on which the taxes are levied...

DeLong: Lessons from the New Deal for Today

Before the United States Senate Committee on Banking, Housing and Urban Affairs: LESSONS FROM THE NEW DEAL: Economic Policy

Tuesday, March 31, 2009. 02:30 PM. 538 Dirksen Senate Office Building:

The witness on Panel I will be The Honorable Christina Romer, Chair, Council of Economic Advisors.

The witnesses on Panel II will be: Dr. James K. Galbraith, Lloyd M. Bentsen Chair, Lyndon B. Johnson School of Public Affairs, University of Texas at Austin; Dr. J. Bradford DeLong, Professor of Economics, University of California Berkeley; and Dr. Allan M. Winkler, Professor of History, Miami (Ohio) University.

March 25, 2009 DRAFT:

Download now or preview on posterous

Posted via email from at Brad DeLong's Scrapbook

The Stimulus Package Looks a Lot Smaller Now...

We are going to need a bigger one in September, which means it has to be put into the budget resolution now.

Menzie Chinn:

Here are the latest CBO forecasts of the output gap and unemployment rate, as well as counterfactual gap and rate that would have taken place in the absence of the stimulus package.



Source: CBO, A Preliminary Analysis of the President's Budget and an Update of CBO's Budget and Economic Outlook, March 2009.


Notice that the no-stimulus counterfactual output gap and unemployment rates are noticeably worse now than only a month ago (see this post). For 2010, the February counterfactual was -6.3% of GDP, now around -10%; the February counterfactual for 2010 was 8.7% unemployment, now it's nearly 11% (I'm eyeballing the current counterfactuals off of Figures 2-1 and 2-2). The January outlook is discussed here. My guess is that that "massive" stimulus is going to look a lot less "massive" given the severity and duration of this recession.

Posted via web from at Brad DeLong's Scrapbook

AIG: We Did Our Best, and Need Better Tools

Ben Bernanke and Tim Geithner try to use the AIG bonus scandal to argue that they should be trusted more and not less.

Andrew Ward and Tom Braithwaite of the FT:

Treasury urges new powers to intervene: The Obama administration joined forces with Ben Bernanke on Tuesday to press Congress for powers that would enable regulators to seize control of troubled financial groups including “non-banks” such as insurer AIG. In a rare joint appearance before the House financial services committee, the Federal Reserve chairman and Tim Geithner, Treasury secretary, also called for an oversight body to monitor big financial institutions that pose systemic risks.

Mr Bernanke said if such tools were available when the government moved to rescue AIG in September “they could have been used to put AIG into conservatorship or receivership, unwind it slowly, protect policyholders and impose haircuts on creditors and counterparties as appropriate”. The Fed chairman said the AIG case highlighted the “urgent need” for a new resolution authority modelled on the Federal Deposit Insurance Corporation, which protects depositors when banks fail. Such an authority would be able to seize non-banks as well as the holding companies that control big banks.

Responding to questions about $165m in bonuses paid to AIG executives after the insurer was bailed out, Mr Bernanke said he had wanted to sue to block the payments but was advised this move could be successfully challenged in court. Mr Bernanke and Mr Geithner defended their handling of the AIG bail-out but said the government needed stronger tools to prevent similar turmoil in future...

Late to Bed, Early to Rise...

Felix Salmon:

The New Econoblogger A-List: It's the invite everybody wants to have gotten: were you invited to join Treasury's econoblogger conference call? Clusterstock, Dealbreaker, and Paul Kedrosky found the golden ticket in their inboxes, and Brad DeLong asked a question -- although one would hope that Treasury would be talking to him informally anyway.

As for the list of people who didn't get an invite, they include John Hempton, Yves Smith, and me; rumor has it that obvious names like Mark Thoma,[1] Nouriel Roubini, Tyler Cowen, and Calculated Risk weren't invited either, but I haven't checked. Certainly the call seems to have been very short; if many econobloggers did get the invites, they quite possibly -- like Kedrosky -- didn't get them in time.

Still, a golden star goes to Brad DeLong: going by Dealbreaker's timing, he received the email at 5:19am his time, and was on the call at 7am his time. There's the kind of conscientious econoblogging which gets you the coveted invitations!

[1]Update: Mark emails to say he got an invite. Abnormal Returns got one too. As did Steve Waldman.

Geithner Plan Roundup

Phil Izzo:

Secondary Sources: Taxpayer Robbery, Corporate Taxes, Geithner Notes - Real Time Economics - WSJ: Taxpayer Robbery: Reuters reports that Joseph Stiglitz is very unhappy with the Geithner plan to buy troubled assets. “‘The Geithner plan is very badly flawed,’ Stiglitz told Reuters in an interview during a Credit Suisse Asian Investment Conference in Hong Kong. U.S. Treasury Secretary Timothy Geithner’s plan to wipe up to $1 trillion in bad debt off banks’ balance sheets, unveiled on Monday, offered “perverse incentives,” Stiglitz said. The U.S. government is basically using the taxpayer to guarantee against downside risk on the value of these assets, while giving the upside, or potential profits, to private investors, he said. ‘Quite frankly, this amounts to robbery of the American people. I don’t think it’s going to work because I think there’ll be a lot of anger about putting the losses so much on the shoulder of the American taxpayer.’” Separately, the New York Times has an interesting debate on the plan between Brad DeLong, Simon Johnson, Paul Krugman and Mark Thoma. Krugman is most critical, while DeLong is the most hopeful...

Jeffrey Frankel:

RGE - Reactions to Geithner’s Public-Private Investment Program: Many reactions to the plan that Secretary Tim Geithner announced today have been negative, both from the left and the right.  Paul Krugman is one, and he makes some good points.But the proposal has its defenders.  One is Brad DeLong, who also makes some good points.   The Geithner Plan is an improvement over the Paulson plan in that, when ”toxic assets,” now called “legacy assets,” are bought from the banks, their prices are set by private bidding (from hedge funds and private equity companies), rather than by an overworked Treasury official pulling a number out of the air and risking that the taxpayer grossly overpays for the assets.   It is true that we might end up with some form of temporary bank nationalization before we are done, but Alan Blinder  has pointed out some neglected counter-arguments to that course of action.My basic feeling is: let’s give the plan a chance.  I debated it on NPR’s On Point this morning...

OK, Stocks for the Very, Very Long Run...

John Authers claims that from 1969-2009 U.S. ten-year Treasury bonds provide as high returns as stocks:


Posted via web from at Brad DeLong's Scrapbook.

I get that bonds are still beating stocks by 1.2% per year since 1969. I will investigate...

And, of course, since the start of the Cowles Commission index in 1870 stocks are still beating long-term Treasuries by 3.3% per year; since the start of the twentieth century stocks are still beating bonds by 3.6% per year; and since the end of World War II 3.6% as well.

Of course, going forward the current value of the Graham Ratio--of stock prices to the ten-year lagged moving average of real earnings--predicts that stocks will beat ten-year Treasuries by an average of 7.5% per year over the next decade...



U.S. Treasury - Daily Treasury Yield Curve

Neurological Evidence of Money Illusion

Bruce Bartlett sends us to:

Inflation 'felt' to be not so bad as a wage cut: Contact: Dr. Bernd Weber
[email protected]
University of Bonn

Economists and brain researchers in Bonn have discovered a neuronal cause of the so-called 'money illusion'

What would you prefer: a three per cent wage rise at five per cent inflation? Or a two per cent wage-cut with stable prices? Many people, faced with this choice, would take the first option, although the true purchasing power of their income sinks in both cases by exactly the same amount, namely two per cent. Researchers at Bonn University and thhe California Institute of Technology have now discovered the cerebro-physiological cause underlying this so-called "money illusion". This effect is of great practical relevance in that it explains, for instance, why financial policy and inflation can have a beneficial effect on employment and economic growth.

Many people view a rise in their income as a good thing, even when the increase is completely negated again by inflation. This effect is called the "money illusion", and many economists are of the opinion that it should not exist. After all, the true purchasing power of the income remains exactly the same. So, for a rational market activist it should be of absolutely no concern under these conditions whether his nominal income sinks or rises. However, laboratory experiments and field studies have repeatedly confirmed that this effect does indeed exist.

Professor Dr. Armin Falk and Dr. Bernd Weber of Bonn University have now approached this topic of the money illusion from a completely different angle. Falk is an economist and Weber a brain researcher – an unusual alliance. Both have been trying to discover which neuronal processes underlie economic decisions. For this purpose, they arranged for their test subjects to "play" economic situations while, at the same time, they monitored their brain processes.

Experiments in the Brain Scanner

A total of 24 subjects participated in the study which has just been published. Whilst recumbent in a scanner, they were called upon to solve simple problems. Success brought a financial reward. At the same time, as the experiment evolved, the fluctuations in the blood oxygen saturation of diverse areas of their brains were monitored. This reading indicates the degree of activity in the relevant area of the brain. The prize-money was not subsequently paid out in cash, but the successful test subjects were allowed to choose goods from a catalogue – including CDs, sun cream or computer accessories.

"We had now confronted our test subjects with two different situations", Falk explains. "In the first, they could only earn a relatively small amount of money, but the items in the catalogue were also comparatively cheap. In the second scenario, the wage was 50 per cent higher, but now all the items were 50 per cent more expensive. Thus, in both scenarios the participants could afford exactly the same goods with the money they had earned – the true purchasing power had remained exactly the same." The test subjects were perfectly aware of this, too – not only did they know both catalogues, but they had been explicitly informed at the start that the true value of the money they earned would always remain the same.

Despite this, an astonishing manifestation emerged: "In the low-wage scenario there was one particular area of the brain which was always significantly less active than in the high-wage scenario", declares Bernd Weber, focusing on the main result. "In this case, it was the so-called ventro-medial prefrontal cortex - the area which produces the sense of quasi elation associated with pleasurable experiences". Hence, on the one hand, the study confirmed that this money illusion really exists, and on the other, it revealed the cerebro-physiological processes involved...

New York Times Crashed-and-Burned Watch (Adam Nagourney/Peter Baker Edition)

Shut it down. Shut it down now.

Shorter Adam Nagourney and Peter Baker:

We lied about George W. Bush for eight years--pretended he was a competent president running a rational administration when we were dining out on stories of his and his administration's fecklessness all across Washington--and now that we have a competent president running a rational administration, we're going to lie in the other direction for the next eight years.

Todd Gitlin:

"Enervating": The president was "not...fiery and inspirational," write Peter Baker and Adam Nagourney in the morning NYT. "Placid and unsmiling, he was the professor in chief, offering familiar arguments in long paragraphs -- often introduced with the phrase, 'as I said before' -- sounding like the teacher speaking in the stillness of a classroom where students are restlessly waiting for the ring of the bell.

"This was Mr. Obama as more enervating than energizing."

In one Baker-Nagourney sentence, even a compliment is only a prologue to a dig that, come to think of it, might help explain why they're so petulant:

He showed his usual comfort with a wide array of subjects, even as he excluded the nation's big newspapers from the questioning in favor of a more eclectic mix.

My italics but their pique. Take that, Barack Obama, you pompous pedagogue, stringing together whole sentences and indeed paragraphs as if Americans were entitled to hear a line of reasoning. Take that if you dare to exclude "the nation's big newspapers" even as they prove less big every day.

Contrast, for a moment, NYT coverage of George W. Bush's first press conference, on Feb. 22, 2001, a month into his first term. Bush, wrote Frank Bruni in the operative clause of his lede, "sought to redirect public attention to, and amass public support for, his proposed $1.6 trillion tax cut."

That is, Bush had a political goal and pursued it. He was purposeful. His style of pursuing it wasn't Bruni's prime subject. The fact that some of his statements made no sense, or worse, was not worthy of notice.

Take a look at the transcript of Bush's press conference. Here's one exchange in the midst of a discussion of Iraq sanctions:

Q. How would you characterize sanctions that work, sir?

MR. BUSH. Sanctions that work are sanctions that, when a -- the collective will of the region supports the policy. That we have a coalition of countries that agree with the policy set out by the United States. To me, that's the most effective form of sanctions. Many nations in that part of the world aren't adhering to the sanction policy that had been in place. And as a result, a lot of goods are heading into Iraq that were not supposed to. And so a good sanction policy is one where the United States is able to build a coalition around the strategy.

This wasn't just a syntactical and logical mishmash. It was a clue--a mighty revealing one, as it turned out--to the mind of George W. Bush. Note: When pressed, Bush defined "work" as "agree with the policy set out by the United States." Things are good when they go our way. Effectiveness means toeing the American line. Long before September 11, George W. Bush was displaying his definitive assumption about how to rule. But that tree fell in the forest when Frank Bruni wasn't paying attention. Rather, Bush's press conference, Bruni wrote,

offered Mr. Bush an opportunity both to be heard over the din of questions about the Clinton pardons and to test his dexterity in front of scores of reporters with something of a safety net beneath him. "To test his dexterity." From what Bruni wrote, Bush must have passed the test, since the fact that Bush's answer about sanctions overtly made no sense (though covertly signaled something important) was not deserving of notice.

But at least when George W. Bush stood tall in the White House we didn't have any of that persnickety, fussy, lugubrious, pompous, professor stuff, and the nation's watchdogs fidgety students weren't bored out of their gourds "waiting for the ring of the bell."

Krishna Guha Worries About Governance

I agree with him in the general, but each time a particular case comes along somehow I trust the Federal Reserve and the Treasury more than I trust Congress, and wish them untrammeled discretion:

Governance concerns over clean-up drive: With Barack Obama’s administration constrained by congressional hostility to allocating any more taxpayer funds for financial bail-outs, the Federal Reserve and the Federal Deposit Insurance Corporation are in effect bankrolling the new toxic asset purchase programmes.... [T]he existing Fed and FDIC financing commitments raise serious governance questions. Both have explicit legal mandates to address financial stability and expertise to contribute, but there is no disguising the fact that their biggest advantage is their ability to allocate funds without approval from Congress.

In the case of the FDIC any losses will, in principle, by born by the banking industry itself. Sheila Bair, the FDIC chairman, said the institution would charge up-front fees and, if necessary, institute a special levy. But with the banking industry in a parlous state, the FDIC may have to lean on its credit line with the Treasury, which Congress is considering expanding dramatically. It is possible to imagine scenarios in which the banks were never able to repay the losses collectively, requiring the taxpayer to take the hit.

Meanwhile, while in the first instance the Fed funds its programmes by creating money, many of these operations may ultimately have to be refinanced with government debt.... Fed credit easing also by definition influences the relative allocation of funds to different sectors, even if its purpose is to restore wider financial stability and support the economy...

The Rollout of the Geithner Plan

Edward Luce and Krishna Guha write:

Toxic asset plan is biggest hurdle for Obama team: The Obama administration faces its biggest test today when Tim Geithner, US Treasury secretary, unveils a plan to take hundreds of billions of dollars of toxic assets off banks' balance sheets. Today's announcement, the success of which will help determine whether an increasingly besieged administration regains full credibility in its handling of the financial crisis, follows a weekend of frantic leaking, with both the Treasury and the White House denying being the sources....

Before the last launch... several contradictory versions of it had been put out in public. The final stretch before today's announcement resembles a similar loss of message discipline across the Obama administration and among its partner agencies...

And I still do not know what happened...

American Enterprise Institute: World's Worst Thinktank (Yet Another Charles Murray Edition)

A correspondent writes:

Once, for reasons I cannot recall, I agreed to serve as a discussant at AEI... on economic returns to religion.... I noted that there appeared to be significant differences in economic outcomes by religion (Jews do well, for example), and commented that this might be because of unobserved heterogeneity. Murray, another discussant, said that [the] research could answer the question about the "true religion," since obviously the ones most blessed should gain the most financially. I thought that only at AEI would people subject God to a market test...

Let's give the mike to The Παντοκράτωρ:

The ground of a certain rich man brought forth plentifully: And he thought within himself, saying, "What shall I do, because I have no room where to bestow my fruits?" And he said, "This will I do: I will pull down my barns, and build greater; and there will I bestow all my fruits and my goods. And I will say to my soul, 'Soul, thou hast much goods laid up for many years; take thine ease, eat, drink, and be merry'." But God said unto him, "Thou fool, this night thy soul shall be required of thee: then whose shall those things be, which thou hast provided?" So is he that layeth up treasure for himself, and is not rich toward God.

If There Is Any Justice, Bobby Jindal's National Political Career Is Over

Dan Joling of AP:

The Associated Press: Volcano monitors spot on with warnings: ANCHORAGE, Alaska (AP) — A month after Louisiana Gov. Bobby Jindal complained about wasteful spending in President Obama's economic stimulus package, including money for "something called 'volcano monitoring,'" Alaska pilots were grateful for such expenditures. The Alaska Volcano Observatory was ready with warnings to flight officials when Alaska's Mount Redoubt blew five times Sunday night and Monday morning, sending potentially deadly ash clouds north of Anchorage.

The volcano, about 100 miles southwest of Alaska's largest city, blew at night and even after sunrise was socked in by clouds, obscuring dangerous ash that can clog jet engines and knock aircraft from the sky. However, readings from seismometers and atmospheric pressure sensors alerted scientists that an eruption had occurred. Weather radar confirmed the presence of an ash cloud that ascended more than 11 miles above sea level. "Without instruments in the ground, we would not have been able to tell you this was coming," said John Power, a geophysicist with the U.S. Geological Survey at the Alaska Volcano Observatory.

Volcano monitoring became a political issue when Jindal gave the Republican response to President Obama's message to Congress on the economic stimulus package. Jindal said the package was "larded with wasteful spending," including $140 million for volcano monitoring. U.S. Sen. Mark Begich, D-Anchorage wrote Jindal and said volcano monitoring is a matter of life and death in his state. He made the point again after the eruptions. "I sleep better knowing the scientists are at work at the AVO keeping track of this activity," he said by e-mail...

Chris Carroll Reassures Me that I Am Not Crazy...

He, too, thinks that the Geithner Plan is a reasonable way for the Treasury to spend $100B of TARP money:

Treasury rewards waiting: [T]he US Treasury’s plan to rescue the financial system is a lot savvier about the relationship between financial markets and the macroeconomy than are the usual-suspects: critics from both left and right who are already pouncing on the Geithner plan.... [T]he Treasury has absorbed the main lesson from the past 30 years of academic finance research: asset price movements mainly reflect changes in investors’ collective attitude toward risk. Perhaps the reason this insight has not penetrated, even among academic economists, much beyond the researchers responsible for documenting it, is that it has not been expressed in layman’s terms. Here’s a try: in the Wall Street contest between “fear” and “greed,”  fear fluctuates much more than greed (in academic terms, movements in  “risk tolerance” explain the bulk of movements in asset prices). Such extravagant movements in investors’ average degree of risk tolerance have proven impossible to reconcile with economists’ usual benchmark ways of understanding peoples’ attitudes toward risk.

One [unsuccessful] response has been to try to reverse-engineer a “representative consumer”....

The second response to the market’s remarkable fluctuations in risk attitudes is more in tune with Warren Buffett’s view, following his mentor Benjamin Graham, that market prices move much more than can be justified by the sober judgment of someone with a long horizon and stable preferences....

Which brings us back to the Treasury’s plan. The details flow from an overarching view that... [market] risk aversion has become not just problematic but pathological. The different parts of the plan reflect different approaches to trying to coax private investors back into the market by reducing their perceived degree of risk to levels that even a skittish risk-shy hedge fund manager might find tempting. The government and the private investor would be partners in a Buffett-like arrangement in which the assets would be held long enough that the investors can expect to receive payments that have justified the waiting....

[T]he problem with the Paulson plan was never fundamentally with the idea that there were problems in the market for toxic assets, but with the idea that the right way to fix that problem (and everything else wrong with the economy!) was simply to have the government drastically overpay.... [T]he new plan from the Treasury gives private investors (who know more than Treasury about the likely payoffs of these securities) the pivotal role in competing to set the prices.... The private investors currently on the sidelines are not fools and have no incentive to lose money on the deal....

[I]t may be necessary to make any bank that participates agree to the sale of all their toxic assets, to prevent the kind of cherry picking.... And there is good reason to be very careful to minimize the possibility of “heads-I-win, tails-the-government-loses” kinds of bets. But broad-brush denunciations are unhelpful...

John Berry: "You Can't Govern Out of Anger"

Yes, you can. But it's not likely to go well.

John Berry of Bloomberg:

Some politicians and prominent economists and analysts want the government to stop fooling around with schemes to prop up ailing banks and just take them over. Then what? Then the government would have to run these immense, international banks.... Such an effort would take place in a climate of public distrust of anyone associated with large financial institutions -- and an equal level of distrust of the government on the part of employees of banks. That’s a prescription for a debacle....

Instead of nationalization, the Obama administration, with the Federal Reserve’s backing, must help the banks repair their balance sheets. The $1 trillion Treasury program announced yesterday has a good shot at doing that....

The politicians have to just lay off AIG. The economy isn’t going to have a solid recovery from this recession until financial markets are functioning normally again. And that’s not going to happen until banks are able and willing to extend credit once more. A first step is for the Senate to reject the punitive and legally dubious AIG-inspired bonus tax approved by the House.... As I’ve said before, it’s probable that many of the questionable assets can be profitable for long-term investors because they are backed by home mortgages that still are for the most part performing rather than in default....

There’s not enough uncommitted TARP money to provide all the equity support that’s needed. The Federal Reserve is providing an enormous amount of leverage through its balance sheet. However, at some point Congress is going to be asked to provide more TARP financing, and currently the response would be a very loud, “No!” Paul McCulley, manager of Pacific Investment Management Co.’s Short-Term Fund, said in a March 19 speech that Congress should come up with more TARP money. If it refuses, he said, the Fed would have to keep stepping in to “leverage the darn daylights” out of the TARP dollars. That may well be what it will come to if Congress doesn’t begin to show some political courage...

Why Friends Don't Let Friends Step Inside the American Enterprise Institute

Matthew Yglesias considers the AEI at one remove:

Charles Murray’s Praise of Human Misery: I kind of scanned Charles Murray’s recent big AEI speech expecting to read something interesting, since I’d seen quite a few conservatives offer it lavish praise. As best I could tell, though, his argument is that the problem with a social democratic model is that it makes people too fat and happy, thus depriving them of the higher contentment offered by suffering and misery. Damon Linker has a good summary:

But that’s not all. Because genuine happiness, for Murray, requires spending one’s life striving to overcome an endless series of challenges and obstacles, the lavish European safety net ensures that individual Europeans will never experience spiritual contentment or satisfaction. The assumption seems to be that a life of leisure — or at least a life with open access to health care, quality child care, generous unemployment insurance, and 4 - 6 weeks of guaranteed vacation time a year — will be an unhappy one. (It doesn’t sound half-bad to me, but I’m a Euro-loving liberal.)

Luckily, though, there is the American alternative (at least until Barack Obama gets through with us). Unlike coddled Europeans, Americans face the constant possibility of personal economic catastrophe. They work their lives away just to make ends meet, never knowing if they’ll be rewarded for their efforts by being fired by their employer or impoverished by medical bills after a life-threatening illness. And that constant insecurity is what opens up the possibility of genuine happiness for them, because if they manage to survive, let alone thrive, they’ll know that they did it on their own, without the help of the state, through heroic acts of self-reliance. This ideology — equal parts Christian masochism, Emersonian individualism, and Nietzschean striving — forms the core of American exceptionalism, according to Murray.

It’s really that weird, and as Linker notes has important similarities with the Donner Party conservatism that John Holbo found in David Frum’s Dead Right.

It's a wonder that Charles Murray doesn't come out against water treatment plants--after all, unless you fear that today might be the day your baby dies of dysentery, you can never be truly happy...

Simon Johnson Does Not Like the Geithner Plan Either

He writes:

Breaking The Bank « The Baseline Scenario: My problem with Monday’s expected announcement from Mr Geithner doesn’t have much to do with the details of the public-private partnership.  I doubt this will work, because I don’t see the incentive for banks to sell assets at less than the value currently on their books.  Right now, they have the government right where they want it - look at the body language and words of leading CEOs. The government feels that it cannot take over large banks, there is no bankruptcy-type procedure that would work, and only deference to the CEOs of major financial institutions can get us out of this mess.  This is a conscious strategy decision from the very highest levels....

Instead, I propose the following. If Secretary Geithner’s scheme works, we draw the lesson that our banks became too big and we aim to make them smaller....  We need simple caps on bank size, leverage relative to the economy and - this is harder - measures of interconnected tail risk (i.e., is everyone making the same kind of crazy loans?).  Design a system with this in mind: regulators get captured and super-regulators get super-captured.

If the scheme doesn’t work, we draw the exact same lesson.  And, of course, we should expect Chairman Bernanke to move forward with his Plan B (or is it Plan Z?): inflation....

[O]ur top political leadership needs to really sell some version of the following message.  We let the banks get out of control and the cost will be enormous; our debt/GDP ratio will in all likelihood rise from around 40% to over 80%.  We cannot afford to have the same problem again.  We must break the power of banks before they break us all. And if you don’t think banks can do that much damage to economies, just look around outside the United States - the world is full of countries where growth is slowed or distorted by a financial system that becomes too powerful.  This is not about tweaking the existing U.S. regulatory system; it is about complete change and - in many senses - turning back the clock to a financial system that was simpler, smaller, and much less dangerous.