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March 2009

The New YorK Times: "Opinions on Shape of Earth Differ" Is Now Mandatory House Style

Felix Salmon watches the New York Times crash and burn:

The NYT's Blogophobia: What's with the sudden blogophobia at the NYT?... Craig Whitney's astonishingly tone-deaf memo... the legal department's heavy-handed nastygram trying to shut down Apartment Therapy.... Here's Whitney:

Blogs on the news side of are not the personal, private blogs of the contributors, but blogs of Times employees, whose reputations depend on readers' trust in their impartiality... As in print, our headlines on analysis should try to capture the debate rather than taking sides in it. (One recent lapse: 'Amazon Plays Dumb in Sales Tax Debate.')

Yes, this is the blogs they're talking about. That was a great headline, on a great blog entry: it should have been getting plaudits, not brickbats. The whole concept of "impartiality" is problematic enough in a straight news story; trying to maintain it on a blog does rather defeat the purpose of setting up the blogs in the first place. And does the NYT really want its editors to deliberately make the blog headlines as boring as possible?

As for the DMCA takedown notice, here's Apartment Therapy's Maxwell Gillingham-Ryan:

What is so surprising about this is that we've heard NOTHING from them at all about this, and would not only have complied with their request if they'd asked us, but we'd also have liked to discuss how we could work WITH them in the best way, continuing to cover them and drive traffic. This is totally indirect and out of the blue.... This also seems to signal a bit of a war by the Times on blogs in general, as we can't be the only ones. By going after the host and bypassing the sites, they have chosen to threaten someone who is hardly responsible and asking them to put pressure on us...

The details aren't clear -- Maxwell didn't post the notice itself. But the gist seems to be that the NYT was upset about Apartment Therapy using its images in blog entries linking back to the NYT. Which is something which can nearly always be worked out with a friendly email; there's no excuse for reaching straight for the nuclear option of sending DMCA notices to a website's hosting service. On the web, it's pretty important not to needlessly piss off the people who drive you traffic; it's also pretty important to stand out with interesting and provocative content. The NYT used to grok this, and I'm sure that its web team still does. But clearly someone higher up has decided to start fixing a site that isn't broken. I fear for the consequences.

8:45 AM EDT Monday

Siobhan Hughes:

Geithner to hold briefing Monday on toxic assets plan: WASHINGTON (MarketWatch) -- U.S. Treasury Secretary Timothy Geithner will on Monday provide details about the government's latest plan to help rid banks of toxic assets clogging the financial system. The Treasury Department said in a press release that it will hold the briefing at 8:45 a.m. EDT on Monday. The Treasury Department's program involves setting up a new investment fund to buy mortgage-related securities and other assets weighing down bank balance sheets. The new Public Private Investment Program would combine taxpayer money with private funds, aiming to buy loans and free up banks to renew lending. The Wall Street Journal earlier reported that the Treasury could announce the new three-part plan as early as Monday.

The World Is Divided into Four Groups of People

This weekend, at least, the world appears to be divided into four groups of people:

  • People who have no opinion of the Geithner Plan because they have not been briefed on it...
  • People who are strongly opposed to the Geithner Plan because Tim Geithner is a socialist who wants to destroy American finance...
  • People who are strongly opposed to the Geithner Plan because Tim Geithner is a corrupt plutocrat who wants to give Americans' money to the princes of Wall Street...
  • Lucien Bebchuk and me...

The Intellectual Decline Collapse of Chicago School, Part LIX

bdbd points out, in comments:

Grasping Reality with Both Hands: Ricardian Consumers and Fiscal Policy Once Again: [John] Cochrane's piece [contributing to the Economist debate is odd all the way down... [see] Keynes' 1930 essay "Economic Possibilities of our Grandchildren".

Yes indeed. The Economist's moderators did a bad job in letting things go by--in giving the representatives of Chicago not only their own private positions but their own private facts. Cochrane does begin his piece:

John Cochrane: Nobody is Keynesian now, really. Keynes distrusted investment and did not think about growth. Now, we all understand that growth, fuelled by higher productivity, is the key to prosperity...

What did John Maynard Keynes say? This:

John Maynard Keynes (1931), "Economic Possibilities for Our Grandchildren": We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the nineteenth century is over; that the rapid improvement in the standard of life is now going to slow down.... I believe that this is a wildly mistaken interpretation of what is happening to us. We are suffering, not from the rheumatics of old age, but from the growing-pains of over-rapid changes.... The increase of technical efficiency has been taking place faster than we can deal with the problem of labour absorption; the improvement in the standard of life has been a little too quick; the banking and monetary system of the world has been preventing the rate of interest from falling as fast as equilibrium requires. And even so, the waste and confusion which ensue relate to not more than 7½ per cent of the national income; we are muddling away one and sixpence in the £....

[D]own to the beginning of the eighteenth century, there was no very great change in the standard of life of the average man living in the civilised centres of the earth.... This slow rate of progress, or lack of progress, was due to two reasons-to the remarkable absence of important technical improvements and to the failure of capital to accumulate. The absence of important technical inventions between the prehistoric age and comparatively modern times is truly remarkable.... The modern age opened; I think, with the accumulation of capital which began in the sixteenth century.... From that time until to-day the power of accumulation by compound interest, which seems to have been sleeping for many generations, was re-born and renewed its strength. And the power of compound interest over two hundred years is such as to stagger the imagination. From the sixteenth century, with a cumulative crescendo after the eighteenth, the great age of science and technical inventions began, which since the beginning of the nineteenth century has been in full flood--coal, steam, electricity, petrol, steel, rubber, cotton, the chemical industries, automatic machinery and the methods of mass production, wireless, printing, Newton, Darwin, and Einstein, and thousands of other things and men too famous and familiar to catalogue.

What is the result? In spite of an enormous growth in the population of the world, which it has been necessary to equip with houses and machines, the average standard of life in Europe and the United States has been raised, I think, about fourfold. The growth of capital has been on a scale which is far beyond a hundredfold of what any previous age had known. And from now on we need not expect so great an increase of population. If capital increases, say, 2 per cent per annum, the capital equipment of the world will have increased by a half in twenty years, and seven and a half times in a hundred years. Think of this in terms of material things--houses, transport, and the like. At the same time technical improvements in manufacture and transport have been proceeding at a greater rate in the last ten years than ever before in history. In the United States factory output per head was 40 per cent greater in 1925 than in 1919. In Europe we are held back by temporary obstacles, but even so it is safe to say that technical efficiency is increasing by more than 1 per cent per annum compound. There is evidence that the revolutionary technical changes, which have so far chiefly affected industry, may soon be attacking agriculture. We may be on the eve of improvements in the efficiency of food production as great as those which have already taken place in mining, manufacture, and transport. In quite a few years-in our own lifetimes I mean-we may be able to perform all the operations of agriculture, mining, and manufacture with a quarter of the human effort to which we have been accustomed.

The Economist on the Financial Rescue

Someone at the Economist writes:

Weekend link exchange: Financial rescue edition: SO, THE latest details on the Obama administration's plan to shore up the banking system have been leaked.... One prong is simply an expansion of the Term Asset-backed Securities Loan Facility (TALF!).... Another prong is a move to create public-private funds that will be capitalised by private money matched dollar-for-dollar with goverment money (and potentially leveraged by government loans). These funds will seek to buy toxic securities backed by mortgages and some other kinds of debt. Finally, there is a plan to create privately-managed funds financed overwhelmingly by the FDIC and the Treasury, but with some equity from private investors on the line. These funds would bid at auctions for pools of bad assets being sold by troubled banks.

The first place to start reading about the plans is at Brad DeLong's site, where he offers an FAQ post that probably reflects, to a certain extent, the adminstration's thinking.... As Mr DeLong explains, there is a decent chance the plan will work, so long as "work" is understood to mean "address one small aspect of the banking crisis—amounting to perhaps one quarter of the $4 trillion in bad stuff out there—and a smaller still aspect of the overall economic crisis". It's not the plan, in other words; it's part of a plan.

One needn't click too far to find critics of the plan. Start will Paul Krugman, who reacts initially with "despair", and who subsequently responds to Mr DeLong's post. Then there's Yves Smith (extremely sceptical!), Calculated Risk, and Robert Waldmann. Plenty of others, too. James Kwak offers a fairly reasonable critique of the plan, writing:

In the best-case scenario: (a) the government’s willingness to bear most of the risk encourages private investors to bid enough to get the banks to sell; (b) the economy recovers and the assets increase in price from the prices paid; (c) the investment funds pay back the Fed (which makes a small spread between the interest rate and the Fed’s low cost of money); and (d) the government gets some of the upside through its capital investments. (I think the main purpose of that government capital is to deflect the criticism that all of the upside belongs to the private sector.) In the worst-case scenario, the market stays stuck because the banks have unrealistic reserve prices. Perhaps the idea is that, in that case, the TALF will allow the government to (over)pay whatever it takes to bail out the banks.

And then, in a follow up post he engages with a questioning reader on the merits of nationalisation.

I am still digesting the plan and the responses (and I will be interested to see the full details tomorrow). My supposition is that administration officials are very reluctant to nationalise for some very good reasons. Nationalising an enormous bank like Citigroup or Bank of America, or both, might be the thing to do, but there are some pretty substantial risks—a meltdown half as bad as the one last autumn would eliminate any chance of a recession bottom this year. Moreover, nationalisation isn't reversible This plan, on the other hand, might not work. It might do some good, however. At the very least, it could help indicate which markets and institutions are afflicated by illiquidity, and which are really and truly (and hopelessly) afflicted by insolvency. And then a few months down the road, if Citi and Bank of America are still looking hopeless, well, nationalisation remains an option.

This, I think is their thinking. The problem is (and it's a really dangerous problem) that policy is beginning to bump up against some serious logistical constraints. I live in the bubbles of Washington and the economic blogosphere, but the roars from inside those bubbles are loud enough that they must be audible on the outside. And the AIG fiasco looms large in the background. Everyone is upset—the bankers, the legislators, and the voters. The uncertainty and the anger from these parties may begin to compromise the adminstration's ability to act, on the financial rescue and on other economic policies and on the presidents agenda more generally.

If Treasury officials have determined that nationalisation is too risky, given their extensive look at information to which most of us don't have access, then it's well that they have chosen not to nationalise. You don't want leaders to act simply because everyone is demanding action. At the same time, it's not enough to roll out a policy like this and hope the public receives it well. Clearly this reaction could have been foreseen, and it certainly appears as if nothing has been done to preempt and mitigate it.

This plan might be the best option, but the administration has manifestly not made the case that it is, and that's a problem. If the president feels that this policy can work, he needs to sell it hard enough to buy enough time to allow it to work, and to allow him a second shot if it doesn't. If he can't accomplish that, then it doesn't matter how much better this policy looked relative to alternatives on paper. It's worse, in that case, than nothing.

I suspect that at least one of the reasons the Obama administration is not nationalizing the banks right now is named "Voinovich": getting 60 votes in the Senate for bank nationalization is no easy task with this Senate until the administration can demonstrate that it has gone the extra mile.

I did have a comment on the Economist's description of my post as "probably" "to some extent" "reflect[ing]" administration thinking:

Mesdames and Sirs--

You write: "probably" and "to some extent." Don't you know? These are my guesses--the White House operator keeps dumping my calls to the "comment" line rather than putting me through to Larry Summers's office, and nobody is answering the main NEC number this Sunday...

Brad DeLong

I Think Paul Krugman Is Wrong

I find that a scary sentence to write. If the past decade has taught me anything, it has taught me that mistakes are avoided if you follow two rules:

  1. Remember that Paul Krugman is right.
  2. If your analysis leads you to conclude that Paul Krugman is wrong, refer to rule #1.

So why do I have a positive and Paul a negative view of the Geithner Plan? I see three reasons:

  1. The half empty-half full factor: I see the Geithner Plan as a positive step from where we are. Paul seed it as an embarrassingly inadequate bandaid.

  2. Politics: I think Obama has to demonstrate that he has exhausted all other options before he has a prayer of getting Voinovich to vote to close debate on a bank nationalization bill. Paul thinks that the longer Obama delays proposing bank nationalization the lower it's chances become.

  3. I think the private-sector players in financial markets right now are highly risk averse--hence assets are undervalued from the perspective of a society or a government that is less risk averse. Paul judges that assets have low values beceuse they are unlikely to pay out much cash.

More on this third later...

UPDATE: LATER: One way to think about it is that the privates are placing a low market price on distressed securities because they place a high weight on future scenarios in which the prices of distressed securities fall still further: in such scenarios they will really need cash really badly, and the additional losses that would be generated if they further extending their positions and if such scenarios came to past would be extremely painful--institution-destroying, and hence to be avoided at all costs.

The government, however, is the agent of society at large. As such, it is close to risk neutral: only the losses associated with truly great depressions get substantial extra weight. It doesn't care much about bad news that leads to further declines in the values of toxic assets it holds: if worst comes to worst, it can always offset them by printing more money and so generating an inflation that is annoying and painful but not something to be avoided at all costs.

It is this difference between the (extremely low) risk tolerance of private financial intermediaries and the (relatively high) risk tolerance of the government and of society at large that creates the rationale for a program like the Geithner Plan.

The Geithner Plan FAQ

Q: What is the Geithner Plan?

A: The Geithner Plan is a trillion-dollar operation by which the U.S. acts as the world's largest hedge fund investor, committing its money to funds to buy up risky and distressed but probably fundamentally undervalued assets and, as patient capital, holding them either until maturity or until markets recover so that risk discounts are normal and it can sell them off--in either case at an immense profit.

Q: What if markets never recover, the assets are not fundamentally undervalued, and even when held to maturity the government doesn't make back its money?

A: Then we have worse things to worry about than government losses on TARP-program money--for we are then in a world in which the only things that have value are bottled water, sewing needles, and ammunition.

Q: Where does the trillion dollars come from?

A: $150 billion comes from the TARP in the form of equity, $820 billion from the FDIC in the form of debt, and $30 billion from the hedge fund and pension fund managers who will be hired to make the investments and run the program's operations.

Q: Why is the government making hedge and pension fund managers kick in $30 billion?

A: So that they have skin in the game, and so do not take excessive risks with the taxpayers' money because their own money is on the line as well.

Q: Why then should hedge and pension fund managers agree to run this?

A: Because they stand to make a fortune when markets recover or when the acquired toxic assets are held to maturity: they make the full equity returns on their $30 billion invested--which is leveraged up to $1 trillion with government money.

Q: Why isn't this just a massive giveaway to yet another set of financiers?

A: The private managers put in $30 billion and the government puts in $970 billion. If we were investing in a normal hedge fund, we would have to pay the managers 2% of the capital and 20% of the profits every year. In this case, the private managers' returns can be thought of as (a) a share of the portfolio's total return proportional to their 3% contribution, plus (b) a "management incentive fee" of (i) 0% of the capital value and (ii) between 0% (if the portfolio returns 3% per year) and 9% (if the portfolio returns 10% per year)--much less than hedge-fund managers typically charge. the Treasury is only paying 0% of the capital value and 17% of the profits every year.[1]

Q: Why do we think that the government will get value from its hiring these hedge and pension fund managers to operate this program?

A: They do get 17% of the equity return. 17% of the return on equity on a $1 trillion portfolio that is leveraged 5-1 is incentive.

Q: So the Treasury is doing this to make money?

A: No: making money is a sidelight. The Treasury is doing this to reduce unemployment.

Q: How does having the U.S. government invest $1 trillion in the world's largest hedge fund operations reduce unemployment?

A: At the moment, those businesses that ought to be expanding and hiring cannot profitably expand and hire because the terms on which they can finance expansion are so lousy. The terms on which they can finance expansion are so lazy because existing financial asset prices are so low. Existing financial asset prices are so low because risk and information discounts have soared. Risk and information discounts have collapsed because the supply of assets is high and the tolerance of financial intermediaries for holding assets that are risky or that might have information-revelation problems are low.

Q: So?

A: So if we are going to boost asset prices to levels at which those firms that ought to be expanding can get finance, we are going to have to shrink the supply of risky assets that our private-sector financial intermediaries have to hold. The government buys up $1 trillion of financial assets, and lo and behold the private sector has to hold $1 trillion less of risky and information-impacted assets. Their price goes up. Supply and demand.

Q: And firms that ought to be expanding can then get financing on good terms again, and so they hire, and unemployment drops?

A: No. Our guess is that we would need to take $4 trillion out of the market and off the supply that private financial intermediaries must hold in order to move financial asset prices to where they need to be in order to unfreeze credit markets, and make it profitable for those businesses that should be hiring and expanding to actually hire and expand.

Q: Oh.

A: But all is not lost. This is not all the administration is doing. This plan consumes $150 billion of second-tranche TARP money and leverages it to take $1 trillion in risky assets off the private sector's books. And the Federal Reserve is taking an additional $1 trillion of risky debt off the private sector's books and replacing it with cash through its program of quantitative easing. And there is the fiscal boost program. And there is a potential second-round stimulus in September. And there is still $200 billion more left in the TARP to be used in other ways.

Think of it this way: the Fed's and the Treasury's announcements in the past week are what we think will be half of what we need to do the job. And if it turns out that we are right, more programs and plans will be on the way.

Q: This sounds very different from the headline of the Andrews, Dash, and Bowley article in the New York Times this morning: "Toxic Asset Plan Foresees Big Subsidies for Investors."

A: You are surprised, after the past decade, to see a New York Times story with a misleading headline?

Q: No.

A: The plan I have just described to you is the plan that was described to Andrews, Dash, and Bowley. They write of "coax[ing] investors to form partnerships with the government" and "taxpayers... would pay for the bulk of the purchases..."--that's the $30 billion from the private managers and the $150 billion from the TARP that makes up the equity tranche of the program. They write of "the Federal Deposit Insurance Corporation will set up special-purpose investment partnerships and lend about 85 percent of the money..."--that's the debt slice of the program. They write that "the government will provide the overwhelming bulk of the money — possibly more than 95 percent..."--that is true, but they don't say that the government gets 80% of the equity profits and what it is owed the FDIC on the debt tranche. That what Andrews, Dash, and Bowley say sounds different is a big problem: they did not explain the plan very well. Deborah Solomon in the Wall Street Journal does, I think, much better. David Cho in tomorrow morning's Washington Post is in the middle.

[1] Too many people are saying that this was too much of an apples-to-oranges comparison. What the private investors get is not a management fee--it is an equity return, proportional to their equity participation. On the other hand, the private investors do get the ability to borrow non-recourse at a subsidized interest rate--and the fact that the government's debt investment is non-recourse makes it very equity-like.

My preferred way to cut the Gordian knot is to say that the "management fee" the privates are getting is the difference between the profits they will get and the 3 percent of the profits from the portfolio that their putting up 3 percent of the money should get them--which I calculate, assuming that the government charges an interest rate of 3 percent) to vary between 0 percent of the profits (if the portfolio yields only 3 percent per year) to 9 percent of the profits (if the portfolio yields 10 percent per year).

Ricardian Consumers and Fiscal Policy Once Again

John Cochrane wrote:

Economist Debates: Keynesian principles: The basic Keynesian analysis... is simply wrong. Professional economists abandoned it 30 years ago when Bob Lucas, Tom Sargent and Ed Prescott pointed out its logical inconsistencies.... Robert Barro's Ricardian equivalence theorem was one nail in the coffin. This theorem says that [fiscal] stimulus cannot work because people know their taxes must rise in the future...

Kevin Quinn comments:

This is surely disingenuous on Cochrane's part - I hope it is, at any rate. Ricardian equivalence, it is true, implies that deficit-financed tax cuts cannot affect demand. Deficit-financed temporary increases in Government spending, on the other hand, can. Consumption falls today, because the present value of future taxes is higher by the amount of the spending increase, but not by as much as G rises. The reduction in the present value of life-time income implies that the [present value of the] sum of reductions in current and future consumption will be equal to the increase in G, so the reduction today will be small.

Moreover, if the spending is for public investment with a return equal to the private rate of return, life-time income is unaffected and there is no fall in consumption at all. And if the rate of return is greater than the private return, C will increase along with G!...

One of the strangest and most bizarre misconceptions of the modern Chicago School is this belief: that because in Ricardian-equivalence situations tax changes do not affect aggregate demand that Ricardian-equivalence means that government purchase changes do not affect aggregate demand either. As Kevin explains, that is simply not the case. And I cannot imagine how anybody could have ever concluded that it was the case.

Jeremy Bulow and Paul Klemperer: Reorganizing the Banks

How Jeremy Bulow and Paul Klemperer would do it

Reorganising the Banks: Focus on the Liabilities, Not the Assets

*Summary:[1] 1. We cannot efficiently value or transfer “toxic” assets - so a good plan cannot depend upon this. 2. The UK’s Special Resolution Regime, or one similar to that of the US FDIC, can cleanly split off the key banking functions into a new "bridge" bank, leaving liabilities behind in an "old” bank, thus also removing creditors’ bargaining power. 3. Creditors left behind in the old bank can be fairly compensated by giving them the equity in the new bank. 4. We can pick and choose which creditors we wish to “top up” beyond this level, but should not indiscriminately make all creditors completely whole as in recent bailouts. 5. Coordinating actions with other countries will reduce any risks.

As we pour good money after bad in trying to save the banks, far too much time and attention has been focused on attempting to value or transfer or shore up the so-called “toxic” assets. This is natural enough, since they arguably caused the crisis, but it’s also wrong. Here’s why:

Flaws of the Current Approach

First, the toxic assets are very difficult to value. Many are held by only one or two owners so there is no real market even in good times. And even if a hedge fund buyer and a bank seller both thought that an asset was worth 50, the bank might demand 80 in the hopes of receiving that price in the next government bailout. Furthermore, the banks may be the “natural” owners of these assets. Say a bank makes a construction loan. Even if the loan sours, the bank may be the most knowledgeable party to hold and possibly renegotiate the loan.

Purchasing or guaranteeing “toxic” assets creates other problems too. Putting aside the obvious inequity of paying bank creditors a “risk premium” for having invested in failed businesses, how can we ever again rely on market signals to allocate capital efficiently among banks if their capital structures are effectively guaranteed by the government? And under schemes like the recent Citigroup, RBS and Lloyds bailouts, banks’ incentives to manage the “insured” assets are drastically reduced, as the government bears up to 90 percent of any marginal losses.

Perhaps most important, the obvious fiscal risks associated with the huge incremental costs of current policies may undermine confidence far more than paying off creditors in full may temporarily boost it, however superficially-attractive the latter approach may seem.

Re-establishing a healthy banking system is crucial, but doing so through the purchase of toxic assets is costly, inefficient, and risky.

How to reorganize the banks

How then can we make banks healthy without separating the “bad assets”? The answer is, instead, to separate the “bad liabilities”.

Take Citigroup, for example. At the end of 2008 the bank had roughly $1.8 trillion in liabilities on its consolidated balance sheet, of which less than $800 billion were deposits. Say Citi’s assets were worth $1.5 trillion. A new (“bridge”) bank that included all the assets plus say $1 trillion of the old bank’s most senior liabilities would still be comfortably well capitalized, even if the asset values were overestimated. The original bank would be left with all the equity in the new bank, worth $500 billion, and the remaining $800 billion in liabilities.

The original bank would still be insolvent, but that would not prevent the healthy new bank from operating efficiently and making good loans. If a risky original bank's marginal cost of funds is, say, 10 percent it will not be profitable for it to make new riskless loans at 7 percent, even if the market riskless rate is zero. By contrast, because the new bank is well capitalized, it can borrow on sensible terms if it has a profitable investment to fund.[2]

Giving the old bank an equity stake in the new bank is the best way to compensate the holders of old bank’s liabilities to the full liquidation value -- but not more than that value -- of their claims. It may also facilitate the reorganization of the old bank if, as is likely, it goes into bankruptcy, since creating marketable equity in the new bank resolves the difficulty of valuing the old bank's assets, and avoids any need to sell the new bank on to a third-party -- a transaction from which the government might be unlikely to get full value.[3]

The reorganization could be managed under a regime like the UK’s Special Resolution Regime (SRR) or similar to that of the US Federal Deposit Insurance Corporation (FDIC)[4] (there may be other possibilities too). The government’s role ends when the old bank has sold its shares or allocated them amongst its creditors.

Who loses?

Paying all creditors at least their liquidation claims is probably a pre-requisite for maintaining market confidence. It is anyway mandated by the Fifth Amendment in the US and by Human Rights legislation in Europe, and it is enshrined as the “no creditor worse off” principle in the recently-enacted UK Banking Act. So both the FDIC and the SRR assure the non-guaranteed creditors of the banks that they will be paid at least as much as they would receive under a liquidation of the institution, but not that they will get back every penny they are owed.[5]

Under a liquidation the junior creditors would suffer losses of $300 billion in our example (and the old bank’s shareholders would be wiped out), unless there were further government subsidies. A key virtue of isolating the junior liabilities rather than the troubled assets is that while the government may then choose to subsidize some of the junior creditors’ losses, it can more easily get off its current path towards subsidizing them 100 percent.

For example, in the U.S. system the order of priority for debts is the following: (1) administrative expense of liquidation; (2) secured claims up to the value of collateral; (3) domestic deposits (both insured and uninsured); (4) foreign deposits and other general creditor claims; (5) subordinated creditor claims; and (6) equity investors. Recently issued subordinated debt has been guaranteed by the government, which would therefore take any loss on those securities in a reorganization. (The UK prioritisation is a little different; in particular, it does not make domestic deposits senior to foreign deposits or other general creditors).

For a large bank like Citi or Bank of America the first three categories would be placed in the new bank, and so would be fully protected. Foreign depositors should probably also be made whole. As when the Icelandic banks defaulted, countries will try to “ring fence” the operations within their borders if their deposits are not paid. Furthermore, not paying foreign deposits would lead to tit-for-tat behavior and might increase systemic risk. Making these depositors whole, and protecting domestic depositors in a jurisdiction like the UK that does not have depositor preference, may give them more than their liquidation values, so the government would have to either infuse the new bank with enough capital that the claims of the remaining creditors would be worth as much as in a no-intervention insolvency, or make a cash payment directly to the old bank. (The infusion to the new bank makes its equity more valuable and therefore raises the value of the claims of the “original bank” creditors in insolvency. The amount of the equity infusion or cash payment is easily calculable if the new bank’s stock is traded, as explained in this note.[6])

However, other general creditors (other than those with a government guarantee) including non-guaranteed bondholders and owners of credit default swaps that are not fully collateralized need not be paid in full. The government may, if it wishes, choose to pay these creditors more than they would receive in liquidation. (It can even buy their claims from the old bank at full value and place them in the new bank.) But because the old bank’s creditors’ leverage would be reduced to their financial claims, and they would not have the threat of bankrupting the new healthy bank were they not paid in full, this need only be done when not doing so would contribute to systemic risk.

If there is still concern that the new bank is undercapitalized, the government can infuse more equity, but in contrast to the current situation the infusion would no longer have to be large enough to pay off the junior creditors.

Finally, coordinating actions with other countries would resolve the concern that some have expressed that if one country alone fails to bail out a category of creditors, its institutions will find it hard to raise funding in the future. International coordination may also make it politically much easier to favour some groups of systemically-important creditors (especially foreign ones) over others.

For some banks, particularly those whose liabilities are almost entirely deposits, this approach may save little money relative to the current bailouts. And, of course, if it is systemically important to make every creditor completely whole, then there is no saving at all. But if the authorities do not believe that any bank creditors can be asked to lose a penny then they should say so. We can then stop worrying about things like whether, if the government buys (or “insures”) the troubled assets from the banks the government pays fair price or an extra couple of hundred billion, since in this case any overpayment simply reduces the amount the government will ultimately have to pay to make good all the creditors, by an equal amount.

If governments feel that they need to absorb more of the risk in the system, they should consider whether providing subsidies to bank creditors is the most effective use of their funds.


A plan that isolates the bad liabilities rather than the bad assets of the banks, and pays the owners of those claims everything they legally deserve in liquidation but does not fully immunize them from losses, will achieve three major objectives. It will help unfreeze the credit markets by creating healthy banks able to lend. It will assure that depositors are paid in full, and all creditors are paid at least their entitlement. And it will make the bailout cheaper for the government, increasing its flexibility. Finally, as an additional benefit, paying creditors based on market values rather than government guarantees reduces moral hazard in bank finance, and increases the prospect of better monitoring by sophisticated private creditors in determining the future allocation of capital across financial institutions.

There will be a lot more we will need to do to solve the financial crisis -- let's not make the bank bailouts more expensive than absolutely necessary.

[1] While presented in the form of a plan, what follows is intended to raise questions that deserve answers, rather than make definitive recommendations; some of this might require other legal means than those suggested here.

[2] Why do undercapitalized banks have difficulty funding good, relatively safe loans? First, because any new capital raised is effectively bailing out the senior creditors: if any capital raise has to come primarily from junior creditors, as is likely since the supply of depositors’ funds is relatively fixed, the senior creditors benefit because there will be more collateral available to secure their claims. If the new funds are used for any new zero net present value investment, then any gain of the senior creditors must be matched by an equal loss for the junior creditors --- regardless of the riskiness of the new investment. So an undercapitalized bank will need a higher return on even the riskiest investments, if the funding must come from issuing more equity or junior debt. Second, shareholders in a risky bank are biased against safe investments. Say that a bank that wished to borrow 80 pounds had to promise to return 100 – reflecting a 20% chance of not paying -- even when the riskless interest rate is zero. Say that it could make a riskless investment with these funds that would pay off 90-- well above the riskless market rate (of zero). The sum of these two transactions would be a bad deal for the shareholders, because they will receive 10 pounds less if the bank is able to pay all its obligations in full, and nothing otherwise. In addition, the probability that they will wind up with nothing will increase, because the risky assets the bank already holds will need a 10 pounds higher payoff to pay off the bank’s debts in full.

[3] We have put all the assets, including the "toxic" assets, into the new bank, because this avoids the need to value or trade them (except to the extent that the market will estimate the value when putting a price on the new bank’s equity). A possible danger--depending in part upon regulatory rules--is that the new bank might nevertheless feel under pressure to sell these assets to improve its regulatory capital position. In that case, the "bad assets" might be better left behind in the old bank if the old bank’s liquidation procedures did not create even greater pressures to sell rather than to run to maturity or renegotiate, etc., as appropriate. (A plan that credibly focuses the government’s bailout efforts on liabilities rather than assets should reduce the difficulties of trading the troubled assets, but it may still be inefficient to trade them.)

[4] An important difficulty in the US is that the FDIC procedures cannot be applied at the bank holding company level (where some large US banks hold significant assets and liabilities) rather than at the bank level, and subsidies may also be required at the holding company level to curtail system risk. It is easy to imagine a situation where the operating banks are themselves insolvent and perhaps appropriate for a “bridge” bank reorganization, while at the same time the holding company would be required to go through Chapter 11 of the bankruptcy code in the US. In this case the US government might perhaps provide Debtor in Possession financing to the holding company as it resolved its affairs.

[5] In fact, the SRR guarantees only that creditors will get back what would have been their liquidation values in the absence of prior government assistance. So the benefits they gained from the recent government schemes to insure their assets could be discounted from their liquidation values to compute their guaranteed minima. Whether the benefits that some groups of creditors gained from earlier bailouts, including the Lloyds/HBOS merger, can also be "taken back" by the government is beyond our legal expertise.

[6] Say for example, that a bank had liabilities in the amounts of L1 and L2, both equal priority, but the government wished to elevate the seniority of L1 by making it a debt of the new bank. If the new bank, with this liability, establishes an equity value of E and a debt value of L1, the value of the L2 claim becomes E, whereas its previous value as an equal priority claim was ((E+L1) times L2/(L1+L2)), so the amount of a fair cash payment to the old bank is the difference between these values, which equals (L2-E) times L1/(L1+L2). (This reflects the facts that the excess of liabilities over assets is (L2- E), and the owners of L1 originally bore share L1/(L1+L2) of these losses).

Needed for AIG and the TARP: Silicon Valley Compensation Schemes

The engineers of Silicon Valley startups are significantly smarter and work a lot harder than do the traders of Wall Street. Some of the engineers of Silicon Valley make fortunes: they are compensated with relatively low salaries and large restricted equity stakes in the startup businesses they work for, and so if the businesses do well they do very well indeed--in the long run, in the five to ten years it takes to assess whether the business is in fact going to be a viable and profitable going concern. And the engineers of Silicon Valley have every incentive to use all their brains and all their hours to make their firm viable and successful: they get their cash only at the end of the process. They don't get big retention bonuses if they stick around until the end of a calendar year. They don't get big payouts if they report huge profits on a mark-to-market basis.

The traders of Wall Street, by contrast, get their money largely up front. If the mark-to-market position is good, they get paid--even though it is almost surely the case that nobody has tried to actually sell the entire position to somebody else. If the strategy produces short-run profits, they get paid--even though not nearly enough time has passed for anybody to be able to assess what the risks involved in the strategy truly are. They get "traders' options"--we claim that we have made you a lot of money, we claim that the positions and strategies we have left you, the stockholders, with are sound, we claim that we have correctly managed our risks--but we are not interested in putting our own personal money where our mouths are but instead we insist on getting our fortunes up front.

The failure of the major institutions of Wall Street to adopt Silicon Valley compensation schemes in the 1980s and 1990s was always a great worry to regulators and policymakers. The strong view was that the venture capitalists of Silicon Valley knew what they were doing and were acting as prudent and responsible agents of their investors when they insisted on SVCS for their startups. So why didn't the shareholders of the major banks do the same with their traders, quants, and strategists? The decisive argument in regulatory and policymaker bull sessions about this issue was that this was the shareholders' business--that if the shareholders of these companies thought that there was good reason to elect board members and CEOs who did not impose SVCSs, the government should be cautious about stepping in. And the argument that "maybe the shareholders know of some good reason not to adopt SVCSs" no longer applies: we are the shareholders, we know of no reason, and we see no reason not to align the interests of our employees at AIG and at TARP-receiving companies with the long-run interests of the U.S. Treasury.

Therefore: punitive taxes on excessive immediate cash payouts paid by TARP and other government financial commitments are, I believe, completely appropriate. But thou shalt not bind the mouths of the kine that tread the corn: traders and financial executives who are willing to work very hard for what are now government-owned enterprises should be offered the carrot of long-term restricted equity stakes: that if they do their jobs well and if the government makes a healthy return because of their skill, forethought, and diligence, they should make healthy returns as well.

Punitive taxes on compensation that takes the form of long-term restricted equity stakes is a dangerous and destructive move. If the compensation bill that emerges from the conference committee does not allow TARP-receiving companies to offer such SVCSs, then Obama should veto it.

And if the traders of Wall Street then quit en masse? If they say that they are going to "Go Galt" if they don't get their traders' options to take the money upfront after assuring us shareholders that they have made us a lot of money, that their positions and strategies are sound, and that they have prudently managed the risks? Well, then that tells us something about what they really think the true value of their work product has been.

A Note on Paul Krugman's Reflections on Fiscal Aspects of Quantitative Easing (with Gratuitous Toy Story Reference)

Paul Krugman thinks about monetary policy:

Fiscal aspects of quantitative easing: The big policy news this week has been the Fed’s decision to buy $1 trillion of long-term bonds, going beyond the normal policy of buying only short-term debt. Good move — but it’s probably worth pointing out that yes, this does expose the Fed, and indirectly the taxpayer, to some risks. And in so doing, it blurs the line between fiscal and monetary policy.... The Fed is... printing $1 trillion of money, and using those funds to buy bonds. Is this inflationary? We hope so! The whole reason for quantitative easing is that normal monetary expansion, printing money to buy short-term debt, has no traction thanks to near-zero rates. Gaining some traction — in effect, having some inflationary effect — is what the policy is all about. The problem may come when the economy recovers... there will come a time when the Fed wants to withdraw that extra $1 trillion of money it created. It will presumably do this by selling the bonds it bought back to the private sector....

[W]hen the economy recovers... long-term interest rates will rise.... Suppose that the Fed has bought a bunch of 10-year bonds at 2.5% interest, and that by the time the Fed wants to shrink the money supply again the interest rate has risen to 5 or 6 percent.... Then the price of those bonds will have dropped.... My back of the envelope calculation looks like this: if the Fed buys $1 trillion of 10-year bonds at 2.5%, and has to sell those bonds in an environment where the market demands a yield to maturity of more than 5%, it will take around a $200 billion loss. I’m not complaining.... But we should go into it with our eyes open.

Paul thinks (correctly, I believe) that the prices of Treasury bonds are higher than they will be in the long run, and thus that the Fed is buying high and will be selling low. But, as I understand it, Paul also thinks (correctly, I believe) that the prices of private-sector bonds are too low--that is our problem: that firms that ought from a social-welfare point of view to be expanding can't expand because they cannot get financing on any but usurious terms. If true, then in the long run the prices of private-sector bonds will go up.

Since buying Treasury bonds and buying private bonds for cash should have similar effects on the overall structure of asset prices, this raises a natural question: why not have the Federal Reserve buy those assets that are undervalued (private bonds, because the risk discount right now is too high) rather than those assets that are overvalued (Treasury bonds, because the duration discount right now is too low)? In that case the Fed would be buying low and selling high--and making, not losing money for the Treasury in the long run.

The answer in normal times is that open-market operations in Treasuries do not play favorites among corporations (although they do play favorites among sectors, either penalizing or rewarding sectors whose capital or output is of long duration), just as revenge is not a concept believed in on Buzz Lightyear's planet. However, then Buzz Lightyear grabs Woody by the throat and says: "But we are not on my planet, are we?"

We are not in normal times right now, are we?

The Intellectual Decline Collapse of the Chicago School, Part XLIV

Sigh: John Cochrane Is completely wrong. He writes:

Economist Debates: Keynesian principles: The basic Keynesian analysis... is simply wrong. Professional economists abandoned it 30 years ago when Bob Lucas, Tom Sargent and Ed Prescott pointed out its logical inconsistencies.... Robert Barro's Ricardian equivalence theorem was one nail in the coffin. This theorem says that [fiscal] stimulus cannot work because people know their taxes must rise in the future...

Barro's "Ricardian equivalence" case describes the conditions under which tax cuts do not affect interest rates or consumption spending. Barro's case has no implications whatsoever for the effect of government spending increases on employment, production, and output. None.

It gets worse. Cochrane writes:

Economist Debates: Keynesian principles: How can borrowing money from A and giving it to B do anything? Every dollar that B spends is a dollar that A does not spend.... Neither fiscal stimulus nor conventional monetary policy (exchanging government debt for more cash) diagnoses or addresses the central problem: frozen credit markets...

"Frozen credit markets" means that private intermediaries cannot borrow money from A and give it to B. And if Cochrane is right that "[e]very dollar that B spends is a dollar that A does not spend," then every dollar that B does not spend is a dollar that A spends. So if government deficit spending cannot do any good to boost employment, frozen credit markets cannot do any harm to reduce employment either.

But frozen credit markets have reduced employment: the unemployment rate has gone screaming toward the sky like a rocket:

Path Finder

How can this be, when all that frozen credit markets mean is that B cannot borrow from A, and so B does not spend but A does? And if B not borrowing from A because of frozen credit markets can have a big negative effect on employment, then is there any reason not to think that the government borrowing from A and spending it might not have, through similar mechanisms, a big positive effect on employment?

Perhaps Cochrane has some more complicated story in mind. Perhaps the goods that B would have spent his or her money on are goods made in high-value capital-intensive production processes while the goods that A would have spent his or her money on are goods made in low-productivity production processes, and that the shift in demand from B to A has reduced labor productivity and reduced the real wage, and as a result of this fall in the real wage a huge number of workers--5.2 million--have decided that at current wage levels it is worth their while to take vacations?


Path Finder

I can't see any sign of real employee compensation cost declines as a result of the frozen credit markets at all. The terms on which you get a job--if, of course, you can get a job right now--are the same this year as they were last year or the year before. It's just that, scaled by population growth, 5.2 million fewer people have jobs this year than had them two years ago.

Tim Fernholz on the Obama Budget

He writes:

TAPPED Archive | The American Prospect: A new Congressional Budget Office report released today analyzes the president's budget projections and finds that costs are higher than were initially expected by the administration. Peter Orszag, director of the Office of Management and Budget, just spoke with reporters about the findings. He harped on a simple message: This is normal, it's part of the budget process, and everything is running smoothly. His explanation for the differences between the projections of his office and the CBO (which he recently led) came in several parts; first, the CBO is working with newer data than the OMB had when it was writing this projection, second, they make different technical assumptions about the impact of a wide range of policies, and third, even small changes in revenue or cost assumptions are magnified in the overall deficit number....

Minor additional thought: The report does basically say that the recession is going to end in the fall of 2009 because of the stimulus and the Fed's aggressive actions. Wonder if critics will mention that inconvenient fact when they start going after the president's plan?

AIG, Bonuses, and "I Told You So"

Paul Krugman says "I TOLD YOU SO!":

AIG: Preliminary thoughts on the tax bill:

  1. It’s not the way you should make policy — it’s clumsy, and it will punish some innocent parties while letting the most guilty off scot-free

  2. But — there wasn’t much alternative at this point. And for that I blame the Obama people.

I’ll leave to others the question of who knew or should have known that the bonus firestorm was coming; but it’s part of a pattern. At every stage, Geithner et al have made it clear that they still have faith in the people who created the financial crisis — that they believe that all we have is a liquidity crisis that can be undone with a bit of financial engineering, that “governments do a bad job of running banks” (as opposed, presumably, to the wonderful job the private bankers have done), that financial bailouts and guarantees should come with no strings attached. This was bad analysis, bad policy, and terrible politics. This administration, elected on the promise of change, has already managed, in an astonishingly short time, to create the impression that it’s owned by the wheeler-dealers. And that leaves it with no ability to counter crude populism.

The situation can still be recouped--a switch of Wall Street from Traders' Option Compensation Schemes to Silicon Valley Compensation Schemes would be a good thing. Certainly J.P. Morgan would be absolutely astonished at what we have now--and would be asking every shareholder of every bank if they were crazy.

I must say I feel like saying: "I told you so" as well:

  • Last March I warned that it was time for the government to nationalize Fannie and Freddie and set them to work borrowing at the Treasury rate and buying up and reworking every mortgqge in the country...

  • Last August I warned that it was time to go to the Swedish model of bank nationalization and recapitalization...

  • Last October I warned that government injection of capital into banks needed to be accompanied by government oversight of operating decisions...

  • Last November I warned that TARP-favored companies could not be or be perceived as being firms that took government money with one hand and gave it out to the Princes of Wall Street with the other...

  • Last December I warned that the populist requirement that the guilty of Wall Street suffer would place very tight constraints on anything the government could do...

Now I am wracking my head for extra things to tell people so that I can say "I told you so" later on. Here is one:

  • Put a provision for a $1T extra fiscal stimulus in the Budget Resolution to be triggered if the economy continues to sink between now and August.

Robert Waldmann on Market Failure, Fiscal Policy, and Unemployment

Hoisted from Comments:

Robert Waldmann: Meanwhile, Over at the Economist...: "Mr Zingales points out that economists usually require evidence of market failure before recommending that governments step in" -- Patrick Lane. So Zingales as interpreted by Lane considers the increase in the unemployment rate not to be "evidence of market failure," nor does Zingales/Lane consider a decline of GNP to be evidence of market failure. This is a very strong claim -- not that there is no proof of market failure but that there is no evidence.

I would have a guess as to what someone might mean if someone claimed that the facts aren't evidence of market failure... [that] we should conclude that markets have failed only when there is a good model of market failure in which everyone behaves optimally and there is no possible model in which markets don't fail which more or less fits the facts under discussion.... [S]ince we aren't focusing on other data, it doesn't matter that the equilibrium model is inconsistent with many facts which aren't under discussion...

FDR Done Did Good

On the Wall Street Journal editorial page, George Bittlingmayer and Thomas Hazlitt remind us that FDR's radical policies--regulating the banking system, abandoning the gold standard, abandoning the goal of balancing the short-term budget, and committing the government to an anti-laissez faire program of interventionist social democracy--were an extraordinary and immediate success:

GEORGE BITTLINGMAYER and THOMAS W. HAZLETT: [Roosevelt's] first step was to stem the banking panic with a national bank holiday (many states had already imposed their own). He closed troubled institutions, injected capital into the healthy ones, and reassured Americans that their deposits would be safe. His approach met with quick success. The New York Stock Exchange, closed during the bank holiday, opened up 15% on March 15. By July 3, the Dow Jones Industrial Average was 93% above its close on March 3, the day before Inauguration Day in 1933...

Jake Tapper Runs and Hides...

Adam Serwer:

TAPPED Archive | The American Prospect: Huh, I wonder why Jake Tapper, press access warrior, has blocked me from following his Twitter feed. Time for a blogger ethics panel?

UPDATE: Tapper has also blocked Talking Points Memo.

Bonus Tapper: His exchange with White House Press Secretary Joe Gibbs over "transparency that you and the president herald so much." I think you're supposed to believe in transparency too, Jake.

Doug Holtz-Eakin Talks Sense About AIG, the TARP, and Bank Nationalization

Now that the McCain Campaign Parasite has been removed from his brain, he is back to normal--and definitely worth listening to:

Doug Holtz-Eakin: I remain convinced that the financial crisis is the greatest threat to the U.S. economy. It should be the top policy priority and, since I think it will be very expensive, the top budgetary priority as well. Unfortunately, at the moment it does not appear that either the public or the Congress displays any willingness to devote more taxpayer dollars to addressing the crisis. We need to shift the policy tactics and the public perception right now.

The right thing to do is to apply the principles of responsibility and competition... failed, insolvent banks cannot be permitted to continue to operate using taxpayers’ subsidies. Letting these “zombies” walk the financial system was at the heart of the savings and loan crisis and the slow Japanese recovery from its financial crisis. These institutions should be taken over, their management and shareholders suffer the consequences of their failure, and the assets re-sold to private sector entities as fast as is feasible. That’s good policy: discipline failure, promote real competition, and use assets effectively in the private sector. (Adam Posen is really smart on this topic. Read his testimony, here.)

Doing business that way eliminates “bailing out the banks” and “saving AIG” from the public discussion, and hopefully will make taxpayers more willing to open their wallets to solving the problem....

The other key aspect of this strategy is the rapid-as-possible sale of assets to the private sector...

Michael Whitney of Service Employees International Union Makes a Catch

Interesting slip-up by the Wall Street Journal:

Wall Street Journal: Employee Free Choice Act "does not remove the secret ballot": Corporate front groups' one-line attack on the Employee Free Choice Act is the false claim that it somehow eliminates the secret ballot option.... But it seems one of their closest allies is finally willing to acknowledge the truth. In this morning's Wall Street Journal, the corporate-friendly editorial board admits:

"The bill doesn't remove the secret-ballot option from the National Labor Relations Act," wrote the WSJ.

There you have it. The Employee Free Choice Act "doesn't remove the secret ballot."... Think Progress has the dirt:

The acknowledgment by the WSJ that the legislation doesn't eliminate the option of a secret-ballot election is surprising given that it has been one of the most aggressive pushers of the false meme:

  • "Democrats in the House passed the Employee Free Choice Act, a measure that rewrites the rules for union organizing by eliminating secret-ballot elections." [WSJ, 3/8/07]

  • "Labor wants to trash the secret-ballot elections that have been in place since the 1930s." [WSJ, 10/17/08]

  • "Mr. Pryor knew the GOP would block the bill, which gets rid of secret ballots in union elections." [WSJ, 1/2/09]

  • "Big Labor's drive to eliminate secret ballots for union elections has united American business in opposition." [WSJ, 3/11/09]

It's great to see the Wall Street Journal has seen the light. Next time you hear a corporate-funded front group pushing this lie, tell them to read the Wall Street Journal to get the facts.

AIG Retention Pay

David Leonhardt:

Retention Pay for A.I.G. Workers to Fix Their Mess: "We cannot attract and retain the best and the brightest talent to lead and staff the A.I.G. businesses — which are now being operated principally on behalf of American taxpayers — if employees believe their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury." — Edward Liddy, chief executive, American International Group

Ah, retention pay. It has been one of the great rationales for showering money on chief executives and bankers regardless of how well they are doing their jobs.... In the booming 1990s, companies supposedly had to pay retention bonuses because executives had so many other job opportunities.... Now comes Mr. Liddy, the government-appointed chief of A.I.G., defending multimillion-dollar bonus payments for the people who run the small division that brought down the company. If the government doesn’t let them have their money, they will walk away, Mr. Liddy says, and nobody else will know how to clean up their mess....

Nothing highlights the fiction of performance-based pay quite so well as retention bonuses. It turns out that, at least for chief executives, retention bonuses are almost entirely unnecessary. A few years ago, when the economy was still expanding, I looked into every large company that had changed chief executives over the previous six months. Not a single boss at any of them had left for another job. Such departures are so rare that Booz & Company’s annual study of executive turnover doesn’t even include a category for them. The benefits of the job — the pay, the perks, the gratification that comes from running a company well — are too good to leave, even for a similar job.

The situation is a little different for jobs below the top level, particularly on Wall Street. Surely, if the employees of A.I.G.’s notorious financial products division were to be denied their bonuses — a big chunk of their annual compensation — many might leave. The nub of Mr. Liddy’s argument is that these departures would be a terrible thing. But there are several weaknesses with this argument. The first is that the original explanation for these bonuses was rather different. When they were devised in early 2008, months before the first bailout, as Mr. Liddy’s letter to the government on Saturday explained, “A.I.G. Financial Products was expected to have a significant, ongoing role at A.I.G.” The idea, he said, was to guarantee “a minimum level of pay for both 2008 and 2009.” So the rationale for A.I.G.’s retention bonuses is as malleable as the rationale for chief executives’ bonuses....

The second problem with Mr. Liddy’s argument has to do with Mr. Liddy himself. His defenders have noted that the government brought him out of retirement to fix A.I.G. and that he presumably puts a higher priority on doing a good job than pleasing A.I.G.’s employees.... But he is also a product of the current, broken executive pay system....

Simon Johnson, a former chief economist at the International Monetary Fund, has pointed out that in financial crises, bankers often exaggerate the difficulty of cleaning up their mess. They do so partly to justify their own continued importance and also to fight off calls for a government takeover of banks. In reality, Mr. Johnson says, the mechanics of cleaning up hobbled banks turned out to be fairly straightforward during other recent crises, like the Asian one in the ’90s....

The larger question is how to change the rules on corporate pay to reduce the odds of future crises.... The bonus scandal offers Mr. Obama and Mr. Bernanke a chance to get ahead of the curve — so long as they come up with changes that extend well beyond A.I.G.... Across-the-board caps on pay don’t make sense. But perhaps the government can prevent companies from claiming a corporate tax deduction on any pay above a certain threshold. The current limit, which is $1 million, applies only to base salaries and thus has little meaning. Or perhaps companies can be penalized if they pay bonuses based on short-term profits, as A.I.G., Lehman Brothers and just about every other company recently has. The Fed made a suggestion along these lines recently, but it didn’t do anything more than ask nicely....

Given the damage that’s been caused by our decidedly unmeritocratic system of paying executives, the most irrational course of all would be the status quo...

More New Deal Denialist Truth Squadding from Eric Rauchway

Eric Rauchway on George Bittlingmeyer and Thomas Hazlett:

Just when I thought I was out. « The Edge of the American West: It’s hard to exaggerate the incoherence of the WSJ editorial, “FDR’s Conservative 100 Days”. The authors write... FDR did not launch his New Deal with a program that roiled financial markets.” No: he shut down the banks, and reopened about eighty percent of them with federal assurance that they were sound. This helped restore confidence in the American financial system. And, FDR said, “I hope you can see from this elemental recital of what your government is doing that there is nothing complex, or radical in the process.”

The authors also quote Raymond Moley saying, “It cannot be emphasized too strongly that the policies which vanquished the bank crisis were thoroughly conservative.” And then they add mention of the Economy Act, which cut the budget dramatically. Now, you might note, as Ed Kilgore does, that you want to be careful quoting Moley, who “left the Roosevelt administration midway through 1933, and then devoted much of the rest of his long career to New Deal-bashing, contemporary and revisionist.”

Or you might want to use your common sense. Yes, it is in some sense “conservative” to save the banking system—it helped, as Moley also said, save capitalism. But is it in any sense more conservative than what Obama’s doing? No; Obama’s so far avoided shutting down all the country’s banks for a week, and keeping 20 percent closed for even longer. Which, by the way, is no recommendation of Obama’s policy; with each day it seems a less conservative measure might be a good idea.

But set all that aside: most hilariously, the WSJ authors’ measure of Roosevelt’s conservative success is that “By July 3, the Dow Jones Industrial Average was 93% above its close on March 3, the day before Inauguration Day in 1933.” Yet their account of the hundred days stops with the Economy Act, on March 14. Between March 14 and July 3, you had also (among other measures) the

  • Civilian Conservation Corps / Reforestation Relief Act, which employed young men chiefly for the maintenance of public lands;
  • Agricultural Adjustment Act, which taxed processors to subsidize reduction of farm crops;
  • Federal Emergency Relief Act, which allocated $500m as unemployment relief to the states;
  • Tennessee Valley Authority Act, which established federal management of the Tennessee River and its watershed, to generate lower electricity rates (among other purposes);
  • Banking Act of 1933, which among other things separated commercial and investment banking;
  • National Industrial Recovery Act, which created federally sanctioned industry cartels to set prices and wages and which strengthened the right to unionize.

I look forward to the WSJ editorial explaining how these conservative policies contributed to the market rally evident by July 3, 1933.

Greg Ip on Alan Greenspan

From the Economist:

He had the power | Free exchange: ALAN GREENSPAN’s defence of the Federal Reserve in the formation of the housing bubble restates a familiar argument—it raised short-term interest rates but long-term interest rates did not follow, and housing is most sensitive to long-term rates.... Mr Greenspan asserted on a number of occasions that while America might have local housing bubbles, there was no national housing bubble. Yet he now asserts there was a global housing bubble. It has always puzzled me how he could go from seeing local bubbles to a global bubble without at some point diagnosing a national bubble. By failing to diagnose a national housing bubble until it was already well inflated, the Fed under Mr Greenspan escaped the obligation to do anything about it.

But had the Fed recognised it, should, or could, it have done anything about it? Mr Greenspan argues that irrespective of whether it should, it could not, because it did not control long-term interest rates. I disagree.... Yes, the linkage between the short- and long-term rates weakened. But at some point, it probably would have reappeared. The Fed could have gotten the long-term rate up had it raised the short-term rate enough. And even if the long-term rate remained stable, the economy, and housing demand, would eventually have wilted as other components of financial conditions tightened.

How much is enough? It’s hard to say, but perhaps 8% or 10%. The problem is that this would have been so draconian, that the entire economy would have tanked.... This is a legitimate defence of the Fed's actions. But saying the Fed had the power to stop the bubble but chose not to exercise it is different from saying it was powerless.... There was, of course, an alternative between letting the bubble inflate and inviting recession. Had Mr Greenspan and his colleagues concluded housing prices were too high and there was value in taming them, they could have used regulatory tools instead of monetary policy. They could have insisted on a margin requirement for home purchases—no one could put down less than 20% unless they obtained mortgage insurance. (At the peak of the bubble, the widespread use of second liens made 100% loan-to-value mortgages without insurance commonplace.) This would have been politically difficult since it would have deprived lots of people the opportunity to own a home.... It would have also contradicted Mr Greenspan’s own deregulatory impulses...

Tyler Cowen Wants to Become a Fisherian-Pigovian-Vinerian-Hawtreyan

Tyler writes:

Marginal Revolution: Irving Fisher on the liquidity trap: The very healthy influence of Scott Sumner has induced me to read the Irving Fisher works I had never looked at before.  Wow.  It's Fisher, not Keynes, who is the prophet of our times and the superior analyst of the Great Depression.  Circa 1932, Fisher wrote: the depression of 1929-32, while the volume of deposit currency in member banks was falling 21 per cent, the velocity of it was being reduced by 61 percent....a mere new supply of money, to replace what has been liquidated or hoarded, might fail to raise the price level by failing to get into circulation...a mere increase in M might prove insufficient, unless supplemented by some influence exercised directly on the moods of people to accelerate V -- that is, to convert the public from hoarding.

One wishes that Keynes were so clear. And what is the best way to restore confidence and break the liquidity trap?  Restoring confidence in banks, so that a multiplier, working through credit, may be effective again.  Fisher also suggests negative interest on reserves and he outlines in detail how this might be done. That is all from his Booms and Depressions, First Principles, a very sophisticated work.  Pigou, Hawtrey, and Viner are also all worth reading; they are more advanced in their thinking than Keynes was willing to admit. Hail Irving Fisher, still one of the most underrated economists of the 20th century.  By the way, 1936 - 1932 equals 4.

Here is what Pigou said about Keynes (after Pigou hqd gotten over his snit, of course): his Marshall lectures, Keynes’s General Theory: A Retrospective View:

Nobody before [Keynes], so far as I know, had brought all the relevant factors, real and monetary at once, together in a single formal scheme, through which their interplay could be coherently investigated...

You need the bond market and the goods market

Government-Run Financial Stabilization Programs on a Pan-Galactic Scale

God! Don't let British editors choose your headlines. Just saying. Chris Carroll:

Punter of last resort : The financial meltdown that shifted into high gear last September has flushed into public view many surprising facts. One of the strangest is the existence, in the economics profession, of a bizarre religious cult. This cult adheres to the dogma that the “price of risk” is the Holy of Holies that can properly be set only by the immaculate invisible hand of the financial marketplace; and cult members seem to believe, to paraphrase President Lincoln from a rather different context, that “If the Market wills that the economic crisis continue until every dollar of economic activity created by the taking of risk shall be repaid by another dollar destroyed by a newfound fear of risk, so it still must be said that the judgments of the Market are true and righteous altogether.”...

This game brings to mind Joan Robinson’s comment that “utility maximization is a metaphysical concept of impregnable circularity,” and Larry Summers’s remark (quoted by Robert Waldmann) that the day when economists first started to think that asset prices should be explained by the characteristics of a representative agent’s utility function was not a particularly good day for economic science.... As DeLong (2008) has recently reminded those of us who are susceptible to the lessons of history (see also Kindleberger (2005)), the “lender of last resort” role of the central bank has always been, during a panic, to short-circuit the catastrophic economic effects of a collapse of financial confidence (in today’s terminology, ‘an increase in the price of risk’). Some economists, of course, view narrative history in the DeLong and Kindleberger mode as irrelevant.... For the numerically inclined, however... controlling a market price of risk is something the Federal Reserve has done since it first opened up shop... the shortest-term interbank lending rate for which data are available (on a consistent basis) from before and after the founding of the Fed. Figure 1b shows the month-to-month changes in this interest rate. The only reason this rate is now viewed as ‘risk-free’ is that the Fed takes away the risk:

  Do the advocates of the risk-is-holy view really believe that we were better off in a real free-market era when interbank rates could move from 4 percent to 60 percent from one month to the next (as happened in 1873)? And how long do they think such a system would last?... A less extreme version of essentially the same dogma states that while it is acceptable for the central bank to suppress the aggregate risk that would otherwise roil short-term interest rates, the Fed should ignore all other manifestations of financial risk. It is, if anything, harder to construct a coherent economic justification of this point of view than of the strict destructionist view that says the Fed should not exist at all.... [T]here is, at least, a perception that this way of operating is hallowed by time and practice.... But... Robert Barbera, Charles Weise, and David Krisch show... that... the Federal Reserve’s choice of the short run interest rate has been powerfully correlated to market-based measures of risk....

Given the Fed’s pattern of past responses to risk and economic conditions (as embodied in risk-augmented Taylor rules), the implied value of the short term interest rate right now should be somewhere below negative 3.3 percent (actually even lower, since these projections do not reflect the dire recent news). Since interest rates cannot go below zero, the Fed must do something else to boost the economy. The obvious answer is to do everything possible to rekindle the appetite for risk – even if that means taking some of that risk onto the Fed’s balance sheet....

Let’s put it this way: Simple calculations show that the current price of risk as measured by corporate bond spreads amounts to a forecast that about 40 percent of corporate America will be in bond default in the near future. The only circumstance under which this is remotely plausible is if government officials turn these dire forecasts into a self-fulfilling prophecy....

Back when the financial system was almost entirely based on banks, the solution to such a problem was that the Federal Reserve would act as the ‘lender of last resort’ to quell the panic. In the new financial system where banks are a much smaller share of the financial marketplace than they once were, the Fed’s appropriate new role seems clear: It needs to intervene more broadly than before, in public markets (as has already been done for the commercial paper market) as well as for banks...

How large a scale are we talking about here? I can't help but think that we are calling for a $4 trillion operation--$4 trillion of bank reserves and Treasury debt created, $4 trillion (at current market values) or risky assets pulled onto the government's balance sheet.

Can the U.S. government do this without cracking the U.S. Treasury bond's status as safe asset in the world economy? I think so. But we will see...

Ah. Supply and Demand Does Work for the Dollar After ALl

Peter Garnham of the FT:

Dollar falls as haven status slips: The dollar resumed its fall against major currencies on Thursday after a sharp sell-off in the previous session following the Federal Reserve’s surprise decision to embark on a quantitative approach to monetary policy. The announcement by the Fed on Wednesday that it was to buy $300bn in long-term Treasuries surprised investors who were expecting the central bank to wait to see the effect of previously announced measures to ease credit conditions.

Sean Shepley at Credit Suisse said although this final step towards full-on quantitative easing in the US was desirable and ultimately necessary, it went against the grain of recent Fed commentary and came earlier than anticipated. He said the Fed decision was “significantly bearish” for the dollar for several reasons. “The decision will allow the Fed to reverse quickly the shrinkage in its balance sheet that has occurred in recent weeks and will allow the monetary base to begin expanding again,” he said. “The Fed’s commencement of significant purchases of US Treasuries probably involves taking foreign investors out of their Treasury holdings, at least indirectly, creating a need for these investors to acquire other US assets or to sell dollars.”

The dollar, which had its weakest performance against the euro since the creation of the single currency in 1999 in the previous session, fell further on Thursday. The dollar fell 0.7 per cent to $1.3616 against the euro, lost 1 per cent to $1.4451 against the pound , dropped 0.7 per cent to SFr1.1300 against the Swiss franc and eased 1.3 per cent to Y94.72 against the yen...

Ross Douthat on teh Real Story: Ezra Klein Is Awesome

Ross Douthat on the Rise of the Juicebox Mafia:

The Rise of Ezra Klein: Ross Douthat: maybe the email list is just a wonderfully high-minded attempt to "illuminate standard political reporting with expert policy commentary," with no partisan purpose whatsoever. How should I know? I'm not on it! Either way, though, isn't the real story here not the list itself, but the man behind it? I mean, email chains come and go, but the ability to bring your elders together for a common purpose is a rare thing indeed in media-intellectual circles. Isn't it possible that we're seeing the emergence of Ezra Klein as the William F. Buckley of movement liberalism - the wunderkind around whom older thinkers orbit, with JournoList as the equivalent of National Review in the Fifties, and with your Paul Krugmans, Jeffrey Toobins and Joe Kleins playing Willmoore Kendall or James Burnham to his WFB?... Ezra's organizational genius is ultimately the story here, his modesty about his own importance notwithstanding.

Let me, however, say that neither Paul Krugman, Jeff Toobin, Joe Klein nor anyone else on J-List bears any resemblance whatsover to Wilmoore Kendall.

Remember this?:

As this columnist never misses a chance to say, it isn't that the Liberals aren't anti-Communist; they are merely anti-Communist in a peculiar sort of way... [that] automatically exclude[s] effective anti-Communist action. And they cannot go along when the community sets out to do something about [i.e., lynch] its Communists...

Note that for Wilmoore Kendall, "Communists" includes all African-American "agitators"...

And remember this?:

[Harry] Jaffa's Lincoln sees the great task of the nineteenth century as that of affirming the cherished accomplishment of the Fathers by transcending it.... The idea of natural right is not so easily reducible to the equality clause, and there are better ways of demonstrating the possibility of self-government than imposing one's views concerning natural right upon others. In this light it would seem that it was the Southerners who were the anti-Caesars of pre-Civil War days, and that Lincoln was the Caesar Lincoln claimed to be trying to prevent; and that the Caesarism we all need to fear is the contemporary Liberal movement, dedicated like Lincoln to egalitarian reforms sanctioned by mandates emanating from national majorities, a [Civil Rights] movement which is Lincoln's legitimate offspring. In a word, it would seem that we had best learn to live up to the Framers before we seek to transcend them...

Note that when Kendall writes "Caesar" he means "illegitimate tyrant," when Kendall writes "egalitarian reforms" he means "allowing African-Americans to vote," and when he writes "live up to the Framers" read "abandon any attempt by federal courts or the national legislature to interfere with the peculiar institutions of the American South as they stood in 1950." Abraham Lincoln--and Harry Jaffa--would agree that there are better ways of demonstrating the possibility of self-government than imposing one's views concerning natural right upon others. That's why they objected to Southerners' holding African-Americans as slaves: what could possibly be a greater "imposition"? For a Union army under the command of General Ulysses S. Grant to say to rich white Southerners that they cannot hold African-Americans as slaves would seem to everyone--except Willmoore Kendall--a lesser imposition than for the Mississippi militia under the command of Jefferson Davis to say to poor African-Americans that they are slaves. Oh. And the "transcending" that Kendall italicizes in the first of my quotations from him above? That's code for "under Jaffa's interpretation, Abraham Lincoln is, at best, a fellow traveler of the communists."

Let me say that neither Paul Krugman, Jeff Toobin, Joe Klein nor anyone else on J-List bears any resemblance whatsover to James Burnham.

Remember this?:

Francisco Franco was this century's most successful ruler...

Or this?:

The McCarthy issue was used by the American Communists as their channel back into the stream of Popular Frontism. The Communists, in fact, invented the term "McCarthyism," and devised most of the ideology that went with it.... The liberals, on a roaring civil rights jag... lowered their guard and the Communists closed.... "[A]nti-McCarthyism" as a movement... was a united front, the broadest and most successful the Communists have ever catalyzed in this country...

Justin Fox: Helicopter Ben

Here we go. Finally action on a scale that might be a third as big as will ultimateby be needed.

Justin Fox:

Helicopter Ben finally hauls out the helicopter: The Federal Open Market Committee, that group whose interest rate decisions we used to care about back before the Federal funds rate settled down around 0.15%, moved markets this afternoon with its announcement that it was going to buy lots more mortgage securities (up to $750 billion more) and start buying long-term Treasuries (up to $300 billion worth) for the first time in a very long time.... [T]hr Fed's move into the long-term Treasury market is a momentous and somewhat unsettling one. As the federal government issues trillions in new debt to finance stimulus spending and the daily operations of government, the quasi-governmental Fed will now be buying hundreds of billions of it, in the process creating new money.... It's a very weird, somewhat circular transaction, and it was last done in a big way during World War II.... Milton Friedman described this kind of transaction as the functional equivalent of a "helicopter drop" of money, and after Ben Bernanke mentioned this in a speech in 2002 he became known as Helicopter Ben. Now he's finally living up to the name.

Will it work?...

I say yes--but needs to be done on a larger scale.

So Say We All!

Edward James Olmos on the social construction of race. Eric Rauchway:

He kept his shoes on. « The Edge of the American West: On his authority as Admiral of the battlestar Galactica, Edward James Olmos addresses a crowd in the United Nations chamber and gets them to condemn the constructedness of race with a shout of “So say we all!” Apart from the, I believe, indisputable general awesomeness of this moment, I’m not sure there’s that much else to say.

The Washington Post Crashed-and-Burned Watch

Dean Baker has not yet posted on either of these Washington Post articles:

But somehow I am sure that he will. The Washington Post:

Politicians Of Both Parties Pile On AIG.: [W]e were more skeptical than most about the "populist" backlash against the $165 million in bonuses that went to some employees of government-owned AIG.... The firm is hemorrhaging knowledgeable employees at precisely the time when it -- and therefore we -- need them most.... [T]he attorney general of New York, Andrew M. Cuomo, among other Democrats, floated the argument that the AIG employees should get stiffed because "it is only by the grace of American taxpayers that members of Financial Products even have jobs, let alone a pool of retention bonus money." True. But the bonuses were set in motion well before the U.S. takeover of AIG.... [T]his has not been a stellar moment for [Obama] who came into office arguing that "the time has come to set aside childish things." With hundreds of billions of dollars in necessary repairs to the financial system still to come, Mr. Obama must find a way to explain those costs...

Ruth Marcus - Grin and Bear the Bonuses: Could we put down the pitchforks for just a moment and have a reasonable discussion about the bonuses at American International Group?... The sums are staggering.... The public is worked up, increasingly convinced that its money is being flung around recklessly, to a gang of extortionists at AIG and at European banks, without any hint that the fundamental problem is being fixed.... [H]ammering the AIG employees to give back their bonuses risks costing the government more than honoring the contracts would. The worst malefactors at AIG are gone. The new top management isn't taking bonuses. Those in the bonus pool are making sums that... are significantly less than what they used to make. Driving away the very people who understand how to fix this complicated mess... isn't particularly cost-effective....

But, you ask, what about autoworkers who are being squeezed to renegotiate their contracts? Those renegotiations mostly involve the future terms of employment, though, it is true, they also could affect retiree health benefits. If an autoworker doesn't want to show up on the assembly line under the terms of a new deal, he or she doesn't have to. That's different from telling AIG employees they're not getting the amount on which they agreed for work they've already performed...

The principle that "if your firm goes spectacularly bankrupt and costs taxpayers tens if not hundreds of billions of dollars, you don't get any bonuses" seems an eminently reasonable one. But not to Ruth Marcus or Fred Hiatt.

Why We Own AIG

Brad Setser writes:

Brad Setser: Follow the Money: “Concretations of risk, plagued with deadly correlations”: The FT’s Gillian Tett makes a simple but important point: AIG’s role in the credit default swap market meant that a lot of risk that the bank regulators thought had been dispersed into many strong hands ended up in a single weak hand. Tett:

.What is equally striking, however, is the all-encompassing list of names which purchased insurance on mortgage instruments from AIG, via credit derivatives. After all, during the past decade, the theory behind modern financial innovation was that it was spreading credit risk round the system instead of just leaving it concentrated on the balance sheets of banks.

But the AIG list shows what the fatal flaw in that rhetoric was. On paper, banks ranging from Deutsche Bank to Société Générale to Merrill Lynch have been shedding credit risks on mortgage loans, and much else. Unfortunately, most of those banks have been shedding risks in almost the same way – namely by dumping large chunks on to AIG. Or, to put it another way, what AIG has essentially been doing in the past decade is writing the same type of insurance contract, over and over again, for almost every other player on the street.

Far from promoting “dispersion” or “diversification”, innovation has ended up producing concentrations of risk, plagued with deadly correlations, too. Hence AIG’s inability to honour its insurance deals to the rest of the financial system, until it was bailed out by US taxpayers.

If the US creates a “systemic risk” regulator, it should be on the lookout for similar concentrations of risk. One other point. The fact that several of AIG’s largest counterparties are European financial firms is by now well known. What is I think less well known is that the expansion of the dollar balance sheets of “European” financial firms — the BIS reports that the dollar-denominated balance sheets of major European financial institutions (UK, Swiss and Eurozone) increased from a little over $2 trillion in 2000 to something like $8 trillion (see the first graph in this report) — played a large role in the US credit boom. As the BIS (Baba, McCauley and Ramaswamy) reports, many European banks were growing their dollar balance sheets so quickly that many started to rely heavily on US money market funds for financing. And if an institution is borrowing from US money market funds to buy securitized US mortgage credit, in a lot of ways it is a US bank, or at least a shadow US bank. Consequently I think it is possible to think of AIG as the insurer-of-last resort to the United States’ own shadow financial system. That shadow financial system just operated offshore. There was a reason why investors in the UK were buying so many US asset backed securities during the peak years of the credit boom.

More Council on Foreign Relations Crashes and Burns in Real Time Blogging

A right-wing economic policy guru lurker agrees with me in email:

That certainly is an odd program to discuss the Great Depression... big name[s] and/or adherence to the view that New Deal policies made the depression worse... no panel on Fed policy... [nothing on] the international sector... all the bad stuff Hoover did was systematically ignored as if every mistake was Roosevelt’s and Roosevelt’s alone... CFR has decided to compete with the Heritage Foundation as the nation’s most right wing think tank..

Juice-Box Mafia: Grand Hegemon Ezra Klein Speaks

Ezra is politer than he should be about the headline on Michael Calderone's piece. If Calderone wants to build rather than destroy his own reputation, he needs to apologize to Ezra for the headline. If Calderone doesn't care about his own repuation, he won't.

Just saying:

EzraKlein Archive | The American Prospect: It is true: I am the coordinating force behind a vast, tentacular conspiracy involving every journalist and policy wonk in Washington, DC. To this I say: It's all true. My power is immense. My enemies will be crushed. My bling shines fierce. Mwahahahahaha. Sort of. Mike Calderone's story on Journolist basically gets the list serv right, though the Politico headline, the Drudge headline, and so forth get it quite wrong. There are a lot of off the record list servs floating around Washington, DC. There's one for bloggers, three for feminists, a couple for national security reporters, a handful for progressive organizers, and dozens more I know nothing about....

Journolist is meant to serve a very specific purpose. The work of this site has always been to illuminate standard political reporting with expert policy commentary. In that, I've been helped by the many experts who have adopted the medium as their own: Mark Thoma, Brad DeLong, Paul Krugman, Matthew Holt, Peter Orszag, Andrew Gelman, Larry Bartels, Dani Rodrik, John Sides, among others. As a journalist, it's hard to always know who to call or which questions to ask. The joy of those blogs is that I don't have to guess what experts think is important: They simply explain what they think is important and I can use, or follow-up on, the information. But not all policy experts have blogs. Many are frankly unsettled by the medium. They've been trained to view published material as almost sacrosanct: The product of much review and long reflection. That's great, but it doesn't obviate the value of off-the-cuff expertise. Sometimes I need to know about Pakistan before the ICG releases its report. Happily, in my experience, most wonks were more than willing to provide quick commentary e-mail. Which is why I created Journolist. The idea, then as now, was to foster a safe space where policy experts, academics, and journalists could freely talk through issues, bringing up the questions they considered urgent and the information they thought important, with the result being a more informed commentariat. It's been of immense value to me, and through that, of value to my readers.

As for sinister implications, is it "secret?" No. Is it off-the-record? Yes. The point is to create a space where experts feel comfortable offering informal analysis and testing out ideas. Is it an ornate temple where liberals get together to work out "talking points?" Of course not. Half the membership would instantly quit if anything like that emerged. There are no government or campaign employees on the list. More to the point, there are a number of folks who are straight news reporters and consciously eschew partisanship. Also, Erick Erickson writes:

I’m told such luminaries as David Shuster at MSNBC, Keith Olbermann, Rachel Maddow, a host of New York Times magazine writers, Frank Rich, and others all collaborate on this list.

I'm not sure who told him that. Not one of those people is on Journolist. If they were, I imagine I'd get booked for more spots on Maddow. It is true that the list is center to left. That's not about fostering ideology but preventing a collapse into flame war. The emphasis is on empiricism, not ideology...

The Juice-Box Mafia: World Domination Edition

UPDATE: I called Michael Calderone. He says that he did not write the headline. he reiterates that he did not write the headline: "read the piece!" he says. He won't say that he thinks the headline is right. He won't say that he thinks the headline is wrong.

Why am I not surprised that Michael Calderone of Politico gets it wrong?

JournoList: Inside the echo chamber: For the past two years, several hundred left-leaning bloggers, political reporters, magazine writers, policy wonks and academics have talked stories and compared notes in an off-the-record online meeting space called JournoList. Proof of a vast liberal media conspiracy? Not at all, says Ezra Klein, the 24-year-old American Prospect blogging wunderkind who formed JournoList in February 2007. “Basically,” he says, “it’s just a list where journalists and policy wonks can discuss issues freely.” But some of the journalists who participate in the online discussion say — off the record, of course — that it has been a great help in their work...

It's not an echo chamber. I have never seen a less echo chamber-like space in my life. The headline is simply wrong.

And I can assure you that Calderone is misleading at best and mendacious at worst when he writes about how (a) Ezra Klein says that it is not a vast liberal media conspiracy, (b) "[b]ut some of the journalists who participate..."

Looks to me like Calderone simply did not do his homework.

After the jump, as is so often the case, Calderone calms down and provides a little information:

Indeed, the advantage of JList, members say, is that it provides a unique forum for getting in touch with historians and policy people who provide journalists with a knowledge base for articles and blog posts. [Matthew] Yglesias, who writes an eponymous blog hosted by the Center for American Progress, noted that “the combined membership has tentacles of knowledge that reach everywhere,” adding that “you can toss out a question about Japan or whatever and get some different points of view.”

[Eric] Alterman said it’s important that there are “people with genuine expertise” on the list. “For me, it’s enormously useful because I don’t like to spend my time reading blogs and reading up-to-the-minute political minutia,” he said. “This list allows me to make sure I’m not missing anything important.”... “The roster includes some of the savviest authorities on everything from behavioral economics to Ben’s Chili Bowl,” [Mike] Allen said. “It’s a window into a world of passionate experts — an hourly graduate education”...

And then Calderone provides some misinformation as well:

Michael Goldfarb, a former McCain staffer and conservative blogger.... Asked about the existence of conservative listservs, Goldfarb said they’re much less prevalent. “There is nothing comparable on the right. E-mail conversations among bloggers, journalists and experts on our side tend to be ad hoc,” Goldfarb said. “The JournoList thing always struck me as a little creepy.” [Mickey] Kaus, too, has seemed put off by the whole idea, once talking on BloggingHeads about how the list “seems contrary to the spirit of the Web.” “You don’t want to create a whole separate, like, private blog that only the elite bloggers can go into, and then what you present to the public is sort of the propaganda you’ve decided to go public with,” Kaus argued...

Basically, Ezra Klein's Journolist is the Juice-Box Mafia: it is the people whom Ezra thinks are smart enough, committed enough to discussion and learning and education, and good-hearted enough to be worth emailing regularly--and the rest of us free-ride on the virtual space that is Ezra's network.

Economic History Seminar: Jeremiah Dittmar: Ideas, Technology, and Economic Change: The Impact of the Printing Press


Was the new information technology associated with city growth?... Between 1500 and 1600 cities where printing presses were established... grew 60% faster.... I show that cities that adopted printing had no such advantage prior to adoption and that the association of adoption and subsequent growth was not due to printers anticipating future city growth or choosing auspicious locations... OLS, difference-in-difference, and synthetic matching...

Richard Clarida Is Not an Optimist


A lot of bucks, but how much bang?: Because of the severe damage to the system of credit intermediation through banks and securitisation, policy multipliers are likely to be disappointingly small.... Policy multipliers are greater than 1 to the extent the direct impact of the policy on GDP is multiplied as households and companies increase their spending from the increased income flow they earn.... Historically, multipliers on government spending are estimated to be in the range of 1.5 to 2, while multipliers for tax cuts can be much smaller, say 0.5 to 1. But these estimates are from periods when households could – and did – use tax cuts as a down payment on a car or to cover the closing costs on a mortgage refinance....

So where does this leave us? A LOT is riding on the efforts of the Fed and other central banks to stabilise the financial system and restore the flow of credit. Officials recognising these challenges are now seriously considering “non-traditional” policies that combine monetary and fiscal elements. Cutting rates to (near) zero has not been a mistake, but it has been ineffective – really the most striking example of ‘pushing on a string’ I have witnessed in my lifetime. The reason, again, is the impaired credit intermediation system....

Altogether, between the MBS, CPFF, and TALF programs, the Fed is committing nearly 2 trillion dollars of financing to the private sector. While these sums may be necessary to prevent an outright economic collapse that extends and deepens into 2011 and beyond, it is not clear to me that they are sufficient to turn the economy around so that it returns to robust growth. Moreover, based on the Fed’s just released economic forecast and Chairman Bernanke’s recent testimony to the Senate Banking committee, the Fed is also not convinced that these policies are sufficient to turn the economy around...

Great Depression Revisionism Blogging: The Council on Foreign Relations Crashes-and-Burns in Real Time...

The speaker's list for the Council on Foreign Relations "A Second Look at the Great Depression" conference on March 30 is out, and it is a doozy--even the Heritage Foundation would never have dared to put forward a speaker's list so partisan, so biased, and with so few speakers with more than an inch-deep knowledge of the Great Depression. Jamie Galbraith, Nick Taylor, and Jonathan Alter are all by themselves holding down the center and the left of the political spectrum. And Jamie and Richard Sylla are the only people holding down the non-Chicago and non-goldbug-wingnut part of the economic spectrum.

In general, when you have a panel at a conference about an issue, you find (a) the smartest and best-informed person who thinks "yes," (b) the smartest and best-informed person who thinks "no," and (c) somebody thoughtful in the middle to hold the balance. That is... not the strategy that the Council on Foreign Relations has followed in this case.

Over the weekend I have gotten two three four copies of the program in the email--all with accompanying commentary that sounds somewhat... panicked:

The CFR Board is aware of the situation...

Who would you recommend as replacement speakers? Preferably not more New Deal-denialists..."

The CFR... is... perhaps belatedly getting worried about a lack of balance...

A perverse part of me wants to watch them go ahead...

They are looking to make the speaker's list less biased...

A Second Look at the Great Depression and New Deal

Monday, March 30, 2009 — 8:15 AM to 6:00 PM

Welcoming Remarks: Richard N. Haass, President, Council on Foreign Relations

Session One: 1929: Bubble or Growth? Irving Fisher was the Yale economist who argued that market prices were not too high in 1929 and was rewarded with half a century of ridicule. There is evidence that Fisher may not be so far off, and that the more illusionary we deem growth in the 1990s, the more likely we are to demand fiscal, financial, and monetary policy shifts or reform.[1] * Edward C. Prescott * Benn Steil * Richard Sylla

Session Two: Nice Work If You Can Get It: The Role of Labor Policy: Did labor policy under Hoover and Roosevelt make the Depression worse, keep it the same, or actually pave the way to recovery? Labor policy and wages are again an issue today in regard to auto companies’ legacy obligations, new union legislation (“card check”), or public-sector union obligations for state governments. * Price V. Fishback * Lee E. Ohanian * Richard K. Vedder * James F. Hoge Jr.

Session Three: Infrastructure Spending to Grow: What did we learn from the Depression era spending programs of the New Deal? Will spending, especially infrastructure spending, take us to recovery? How political is such spending? * Ellen R. McGrattan * Nick Taylor * Anna J. Schwartz * Simon Constable

Session Four: Keynote: Why a Second Look Matters * Robert E. Lucas Jr. * Carl J. Schramm, President and CEO, Ewing Marion Kauffman Foundation

Session Five: The New Financial Deal: What can we learn about reforming today’s financial markets from those of the 1930s? What does the Depression tell us the new architecture should and should not do? * John Cochrane * Thomas F. Cooley

Session Six: Today’s Path to Growth: What Do the 1930s Tell Us About Now? * James K. Galbraith * Jonathan Alter * Amity Shlaes

at the Harold Pratt House, 58 East 68th Street, New York, New York 10065

This event will be on the record.

As I see it, Cochrane and Lucas are smart enough to always be worth listening to no matter what they are talking about. Alter and Taylor know stuff about politics in the 1930s. Galbraith knows stuff about politics and economics in the 1930s. Fishback and Sylla know a great deal about the economics of the 1930s. Those six belong in their places on the program. The rest do not--they don't know enough about the issues they are talking about to be on the stage rather than in the audience.

It's not as though people who are qualified to be on the stage--who actually know stuff about the Great Depression--are hard to find. Where is Eugene White? Hugh Rockoff? Michael Bordo? Claudia Goldin? Robert Higgs? Jeremy Atack? Peter Temin? Bill Sundstrom? Charlie Calomiris? Chris Meissner? Chris Haynes? Kris Mitchener? David Wheelock? Lee Alston? Peter Lindert? David Mowery? Robert Whaples? Eric Rauchway? Marc Flandreau? Barry Eichengreen? Christie Romer? Ben Bernanke? Doug Irwin? Tim Hatton? Richard Portes? Ken Rogoff? Gary Walton? Thomas Ferguson? A.P. O'Brien? J.R. Vernon? Robert Shiller? Richard Grossman? Mark Thomas? Robert Gordon? Joseph Mason? Pierre Siklos? Theda Skocpol? Margaret Weir? Gary Libecap? Maggie Levenstein? Naomi Lamoreaux? Michael Bernstein? Dan Raff? Dan Nelson? Sally Clarke? David Hounshell? Louis Johnston? Jeff Miron? Ken Snowden? Jim Hamilton? Susan Carter? Steve Cecchetti? Sanford Jacoby? Josh Rosenbloom? Bob Margo? John Wallis? Farley Grubb? Alex Field? And a host of others from all political and analytic perspectives whose knowledge of the Great Depression swamps those of the Council on Foreign Relation's speakers.

Why oh why can't we have better thinktanks?

It looks as though Richard Haass badly needs to do some house cleaning. And if he won't, then Carla Hills and Robert Rubin need to get involved.

[1] You may ask what this means. I don't know. It seems ignorant and illiterate. First of all, Irving Fisher was ridiculed not for saying that the market was fairly-valued in 1929 but for saying that the market was not going to go down: that it had reached a plateau that was "permanent"--that investments in stocks were no longer risky. There is no evidence that Fisher was not so far off: the market did go down in 1929, 1930, 1931, and 1932. And then we shift to "the more illusionary we deem growth in the 1990s, the more likely we are to demand fiscal, financial, and monetary policy shifts or reform"--which seems to be neither a coherent thought nor connected to the issue of market valuation in 1929.

Fear of Reese Witherspoon Look-Alikes on the Pill

I was once approving of Ross Douthat as a New York Times oped columnist. But that was when I was younger. And easily misled.

From Ross Douthat, Privilege, bottom of p. 184:

One successful foray ended on the guest bed of a high school friend's parents, with a girl who resembled a chunkier Reese Witherspoon drunkenly masticating my neck and cheeks. It had taken some time to reach this point--"Do most Harvard guys take so long to get what they want?" she had asked, pushing her tongue into my mouth. I wasn't sure what to say, but then I wasn't sure this was what I wanted. My throat was dry from too much vodka, and her breasts, spilling out of pink pajamas, threatened my ability to. I was supposed to be excited, but I was bored and somewhat disgusted with myself, with her, with the whole business... and then whatever residual enthusiasm I felt for the venture dissipated, with shocking speed, as she nibbled at my ear and whispered--"You know, I'm on the pill..."

What squicks me out is (a) that the real turnoff for Ross Douthat is that she has taken responsibility for her own fertility and gone on the pill, and (b) that Ross Douthat does not take this to be a learning moment--is not self-reflective enough to say "Hmmm... If there are other men like me who are turned off by women who take responsibility for fertility control, isn't that likely to be a cause of more abortions?"

Combine that with what Ross Douthat's dismissal of Belle Sawhill's point that free-as-in-beer (but not free-as-in-no-hassle) birth control appears to prevent 1/5 of abortions--and there is an awful lot here not to like, and an awfully good reason to think that Tyler Cowen or Kerry Howley or Virginia Postrel or any of a large number of other candidates would be an infinitely better choice for the job.

And, of course, there is the other point: here is a Reese Witherspoon look-alike who has offered Ross Douthat the extremely precious gift of wanting to make love to him, and he writes her into his book in this way with what look to be sufficient identifying details. You can write that paragraph in a way that is calculated to try to make her feel bad about herself should she ever read it; you can write that paragraph in a way that does not try to make her feel bad about herself should she ever read it; normal human sociability and empathy suggests that one should try to do the first second; Ross Douthat chooses to do the second first.

A Note on Friedrich Hayek and Lionel Robbins in the Great Depression...

Larry White continues his war with Milton Friedman over Friedman's condemnation 25 years ago of "the London School (really Austrian) view that I referred to... when I spoke of 'the atrophied and rigid caricature [of the quantity theory] that is so frequently described by the proponents of the new income-expenditure approach and with some justice, to judge by much of the literature on policy that was spawned by the quantity theorists'. This time I appear to be Friedman's proxy:

Lawrence White: DeLong acts as though he is unaware (though elsewhere he has indicating having read my paper) Hayek's and Robbins' monetary policy norm was not that the central bank should let a deflationary monetary contraction procede. Rather, the central bank should stabilize nominal income MV, meaning expand M to offset a drop in V, and expand the monetary base to offset a drop in the money multiplier...

Since Friedman can no longer speak, let me say that I still agree with him. I think that White's painting of Hayek and Robbins as people who wanted to stabilize MV is completely wrong--it is Ben Bernanke and the inflation targeters who want to stabilize MV, not Hayek and Robbins. If you had asked Hayek back at the time, he would have said that increasing the monetary base from 1929-1933 in order to offset the decline in monetary velocity was the very last thing that he wanted to see done. Stabilizing MV at its 1929 level was not on his or Robbins's agenda by any means.

In fact, he did say so.

Let me pull out his 1932 denunciation of monetary policies that stabilize the price level:

Hayek (1932), "The Fate of the Gold Standard": ...the extraordinary influence exercised by two particular representatives of... the concept of a systematic stabilization of the price level... Irving Fisher and Gustav Cassel... succeeded in making the concept of price stabilization as the objective of monetary policy into a virtually unassailable dogma... the influence of which upon actual developments it is impossible to overestimate....


It was not a big step from the desire to be released from the unpleasant necessity of adapting the general standard of living to the lower level of national income by reductions in wages and prices, to a theoretical justification of a monetary policy which rendered inoperative the tendencies of the gold standard in that direction.... The most important error is the distinction drawn between temporary movements of gold... [which] should not be allowed to bring about any changes in the domestic volumes of credit, and 'genuine' movements.... What is left unexplained in this is why movements of gold should under any circumstances represent movements of capital that are not genuine.... [T]he great monetary theorists of the classical period from Ricardo onwards always insisted that a non-metallic circulation of money ought always to be so controlled that the total volume of all money in circulation changes in just the same way as would happen if gold alone were in circulation....

[T]he artificial prevention of the fall in prices... up to 1929... is not meant to depict the fall in prices which has occurred since then as innocuous.... Instead of prices being allowed to fall slowly [from 1918 to 1929]... such volumes of additional credit were pumped into circulation.... Whether such inflation merely serves to keep prices stable, or whether it leads to an increase in prices, makes little difference...

UPDATE: amv comments:

DeLong is again making uniformed claims. In support of Horwitz, I quote Hayek from The Constitution of Liberty (1960/2008):

This means that when at any time people change their minds how much cash they want to hold in proportion to the payments they make (or, as the economists calls it, they decide to be more or less liquid), the quantity of money should be changed correspondingly. However we define 'cash,' people's propensity to hold part of their resources in this form is subject to considerable fluctuation both over the short and over long periods, and various spontaneous developments (such as, for instance, the credit card and the traverlers' check) are likely to affect it profoundly. No automatic regulation of the supply of money is likely to bring about the desirable adjustments before such changes in the demand for money or in the supply of substitute for it have had a strong and harmful effect on prices and employment. (p. 284)

The automatic regulation is, for instance, Friedman's k-rule.

amv is both right and wrong. He is right in that while writing The Constitution of Liberty Friedrich Hayek wrote like an orthodox Chicago monetarist--a Friedmanite. He is wrong in claiming that this is an accurate summary of Hayek's position either while he was a leader of the LSE-based Austrian School contra Keynes during the Great Depression or indeed of Hayek's long term thinking. The phase during which Hayek was (or perhaps thought it impolitic not to pretend to be) a Friedmanite came after his monetary-overinvestment phase and before his private-money phase.

More representative of his enduring thought, I would argue, is the Hayek of a later period Hayek who would flat-out deny even the possibility of the government's altering M in order to offset changes in V:

[W]e never know what the quantity of money in this sense is. I think the rule ought to be that whoever issues the money must adapt the quantity so that the price level will remain stable. But to believe that there is a measurable magnitude which you can keep constant, with beneficial effects, I regard as completely wrong. I don’t like criticizing Milton Friedman not only because he is an old friend but because, outside of monetary theory, we are in complete agreement. Our general views on what is desired and what is not are almost identical until we get on to money. But if I told him what I said before, that I very much doubt whether monetary policy has ever done anything good, he would disagree. He personally is convinced that a good monetary policy is a foundation for everything...

Horwitz, by contrast, in comments is simply incoherent: if you stabilize Q by stabilizing MV then you automatically must be stabilizing P, for PQ = MV. As long as you are trying to stabilize Q, saying "Hayek's correct arguments against stabilizing P... [are not] denying his belief that stabilizing MV is the correct policy norm..." makes no sense at all.