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April 2009

Best Thing on the Financial Crisis: Barry Eichengreen: The Last Temptation of Risk

Barry Eichengreen:

The Last Temptation of Risk: THE GREAT Credit Crisis has cast into doubt much of what we thought we knew about economics. We thought that monetary policy had tamed the business cycle. We thought that because changes in central-bank policies had delivered low and stable inflation, the volatility of the pre-1985 years had been consigned to the dustbin of history; they had given way to the quaintly dubbed “Great Moderation.” We thought that financial institutions and markets had come to be self-regulating—that investors could be left largely if not wholly to their own devices. Above all we thought that we had learned how to prevent the kind of financial calamity that struck the world in 1929. We now know that much of what we thought was true was not. The Great Moderation was an illusion. Monetary policies focusing on low inflation to the exclusion of other considerations (not least excesses in financial markets) can allow dangerous vulnerabilities to build up. Relying on institutional investors to self-regulate is the economic equivalent of letting children decide their own diets. As a result we are now in for an economic and financial downturn that will rival the Great Depression before it is over.

The question is how we could have been so misguided. One interpretation, understandably popular given our current plight, is that the basic economic theory informing the actions of central bankers and regulators was fatally flawed. The only course left is to throw it out and start over. But another view, considerably closer to the truth, is that the problem lay not so much with the poverty of the underlying theory as with selective reading of it—a selective reading shaped by the social milieu. That social milieu encouraged financial decision makers to cherry-pick the theories that supported excessive risk taking. It discouraged whistle-blowing, not just by risk-management officers in large financial institutions, but also by the economists whose scholarship provided intellectual justification for the financial institutions’ decisions. The consequence was that scholarship that warned of potential disaster was ignored. And the result was global economic calamity on a scale not seen for four generations.

SO WHERE were the intellectual agenda setters when the crisis was building? Why did they fail to see this train wreck coming? More than that, why did they consort actively with the financial sector in setting the stage for the collapse? For economists in business schools the answer is straightforward. Business schools see themselves as suppliers of inputs to business. Just as General Motors provides its suppliers with specifications for the cold-rolled sheet it needs for fabricating auto bodies, J. P. Morgan makes clear the kind of financial engineers it requires, and business schools deem to provide. In the wake of the 1987 stock-market crash, Morgan’s chairman, Dennis Weatherstone, started calling for a daily “4:15 Report” summarizing how much his firm would lose if tomorrow turned out to be a bad day. His counterparts at other firms then adopted the practice. Soon after, business schools jumped to supply graduates to write those reports. Value at Risk, as that number and the process for calculating it came to be known, quickly gained a place in the business-school curriculum. The desire for up-to-date information on the risks of doing business was admirable. Less admirable was the belief that those risks could be reduced to a single number which could then be estimated on the basis of a set of mathematical equations fitted to a few data points. Much as former–GM CEO Alfred Sloan once sought to transform automobile production from a craft to an engineering problem, Weatherstone and his colleagues encouraged the belief that risk and return could be reduced to a set of equations specified by an MBA and solved by a machine.

Getting the machine to spit out a headline number for Value at Risk was straightforward. But deciding what to put into the model was another matter. The art of gauging Value at Risk required imagining the severity of the shocks to which the portfolio might be subjected. It required knowing what new variables to add in response to financial innovation and unfolding events. Doing this right required a thoughtful and creative practitioner. Value at Risk, like dynamite, can be a powerful tool when in the right hands. Placed in the wrong hands—well, you know. These simple models should have been regarded as no more than starting points for serious thinking. Instead, those responsible for making key decisions, institutional investors and their regulators alike, took them literally. This reflected the seductive appeal of elegant theory. Reducing risk to a single number encouraged the belief that it could be mastered. It also made it easier to leave early for that weekend in the Hamptons. Now, of course, we know that the gulf between assumption and reality was too wide to be bridged. These models were worse than unrealistic. They were weapons of economic mass destruction. For some years those who relied on these artificial constructs were not caught out. Episodes of high volatility, like the 1987 stock-market crash, still loomed large in the data set to which the model was fit. They served to highlight the potential for big shocks and cautioned against aggressive investment strategies. Since financial innovation was gradual, models estimated on historical data remained reasonable representations of the balance of risks.

WITH TIME, however, memories of the 1987 crash faded. In the data used by the financial engineers, the crash became only one observation among many generated in the course of the Great Moderation. There were echoes, like the all-but-failure of the hedge fund Long-Term Capital Management in 1998. (Over four months the company lost $4.6 billion and had to be saved through a bailout orchestrated by the Federal Reserve Bank of New York.) But these warning signs were muffled by comparison. This encouraged the misplaced belief that the same central-bank policies that had reduced the volatility of inflation had magically, perhaps through transference, also reduced the volatility of financial markets. It encouraged the belief that mastery of the remaining risk made more aggressive investment strategies permissible. It made it possible, for example, to employ more leverage—to make use of more borrowed money—without putting more value at risk. Meanwhile, deregulation was on the march. Memories of the 1930s disaster that had prompted the adoption of restrictions like the Glass-Steagall Act, which separated commercial and investment banking, faded with the passage of time. This tilted the political balance toward those who, for ideological reasons, favored permissive regulation. Meanwhile, financial institutions, in principle prohibited from pursuing certain lines of business, found ways around those restrictions, encouraging the view that strict regulation was futile. With the elimination of regulatory ceilings on the interest rates that could be paid to depositors, commercial banks had to compete for funding by offering higher rates, which in turn pressured them to adopt riskier lending and investment policies in order to pay the bill. With the entry of low-cost brokerages and the elimination of fixed commissions on stock trades, broker-dealers like Bear Stearns, which had previously earned a comfy living off of such commissions, now felt compelled to enter riskier lines of business. But where the accelerating pace of change should have prompted more caution, the routinization of risk management encouraged precisely the opposite. The idea that risk management had been reduced to a mere engineering problem seduced business in general, and financial businesses in particular, into believing that it was safe to use more leverage and to invest in more volatile assets.

Of course, risk officers could have pointed out that the models had been fit to data for a period of unprecedented low volatility. They could have pointed out that models designed to predict losses on securities backed by residential mortgages were estimated on data only for years when housing prices were rising and foreclosures were essentially unknown. They could have emphasized the high degree of uncertainty surrounding their estimates. But they knew on which side their bread was buttered. Senior management strongly preferred to take on additional risk, since if the dice came up seven they stood to receive megabonuses, whereas if they rolled snake eyes the worst they could expect was a golden parachute. If an investment strategy that promised high returns today threatened to jeopardize the viability of the enterprise tomorrow, then this was someone else’s problem. For a junior risk officer to warn the members of the investment committee that they were taking undue risk would have dimmed his chances of promotion. And so on up the ladder.

WHY CORPORATE risk officers did not sound the alarm bells is thus clear enough. But where were the business-school professors while these events were unfolding? Answer: they were writing textbooks about Value at Risk. (Truth in advertising requires me to acknowledge that the leading such book is by a professor at the University of California.) Business schools are rated by business publications and compete for students on the basis of their record of placing graduates. With banks hiring graduates educated in Value at Risk, business schools had an obvious incentive to supply the same. But what of doctoral programs in economics (like the one in which I teach)? The top PhD-granting departments only rarely send their graduates to positions in banking or business—most go on to other universities. But their faculties do not object to the occasional high-paying consulting gig. They don’t mind serving as the entertainment at beachside and ski-slope retreats hosted by investment banks for their important clients. Generous speaker’s fees were thus available to those prepared to drink the Kool-Aid. Not everyone indulged. But there was nonetheless a subconscious tendency to embrace the arguments of one’s more “successful” colleagues in a discipline where money, in this case earned through speaking engagements and consultancies, is the common denominator of success. Those who predicted the housing slump eventually became famous, of course. Princeton University Press now takes out space ads in general-interest publications prominently displaying the sober visage of Yale University economics professor Robert Shiller, the maven of the housing crash. Not every academic scribbler can expect this kind of attention from his publisher. But such fame comes only after the fact. The more housing prices rose and the longer predictions of their decline looked to be wrong, the lonelier the intellectual nonconformists became. Sociologists may be more familiar than economists with the psychic costs of nonconformity. But because there is a strong external demand for economists’ services, they may experience even-stronger economic incentives than their colleagues in other disciplines to conform to the industry-held view. They can thus incur even-greater costs—economic and also psychic—from falling out of step.

WHY BELABOR these points? Because it was not that economic theory had nothing to say about the kinds of structural weaknesses and conflicts of interest that paved the way to our current catastrophe. In fact, large swaths of modern economic theory focus squarely on the kind of generic problems that created our current mess. The problem was not an inability to imagine that conflicts of interest, self-dealing and herd behavior could arise, but a peculiar failure to apply those insights to the real world. Take for example agency theory, whose point of departure is the observation that shareholders find it difficult to monitor managers, who have an incentive to make decisions that translate into large end-of-current-year bonuses but not necessarily into the long-term health of the enterprise. Risk taking that produces handsome returns today but ends in bankruptcy tomorrow may be perfectly congenial to CEOs who receive generous bonuses and severance packages but not to shareholders who end up holding worthless paper. This work had long pointed to compensation practices in the financial sector as encouraging short-termism and excessive risk taking and heightening conflicts of interest. The failure to heed such warnings is all the more striking given that agency theory is hardly an obscure corner of economics. A Nobel Prize for work on this topic was awarded to Leonid Hurwicz, Eric Maskin and Roger Myerson in 2007. (So much for the idea that it is only the financial engineers who are recognized by the Nobel Committee.) Then there is information economics. It is a fact of life that borrowers know more than lenders about their willingness and capacity to repay. Who could know better what motivation lurks in the mind of the borrower and what opportunities he truly possesses? Taking this observation as its starting point, research in information economics has long emphasized the existence of adverse selection in financial markets—when interest rates rise, only borrowers with high-risk projects offering some chance of generating the high returns needed to service and repay loans will be willing to borrow. Indeed, if higher interest rates mean riskier borrowers, there may be no interest rate high enough to compensate the lender for the risk that the borrower may default. In that case lending and borrowing may collapse. These models also show how borrowers have an incentive to take on more risk when using other people’s money or if they expect to be bailed out when things go wrong. In the wake of recent financial rescues, the name for this problem, “moral hazard,” will be familiar to even the casual newspaper reader. Again this is hardly an obscure corner of economics: George Akerlof, Michael Spence and Joseph Stiglitz were awarded the Nobel Prize for their work on it in 2001. Here again the potential problems of an inadequately regulated financial system would have been quite clear had anyone bothered to look.

Finally there is behavioral economics and its applications, including behavioral finance. Behavioral economics focuses on how cognition, emotion, and other psychological and social factors affect economic and financial decision making. Behavioral economists depart from the simpleminded benchmark that all investors take optimal decisions on the basis of all available information. Instead they acknowledge that decision making is not easy. They acknowledge that many decisions are taken using rules of thumb, which are often formed on the basis of social convention. They analyze how, to pick an example not entirely at random, decision making can be affected by the psychic costs of nonconformity. It is easy to see how this small step in the direction of realism can transform one’s view of financial markets. It can explain herd behavior, where everyone follows the crowd, giving rise to bubbles, panics and crashes. Economists have succeeded in building elegant mathematical models of decision making under these conditions and in showing how such behavior can give rise to extreme instability. It should not be a surprise that people like the aforementioned George Akerlof and Robert Shiller are among the leaders in this field. Moreover, what is true of investors can also be true of regulators, for whom information is similarly costly to acquire and who will similarly be tempted to follow convention—even when that convention allows excessive risk taking by the regulated. Indeed, these theories suggest that the attitudes of regulators may be infected not merely by the practices and attitudes of their fellow regulators, but also by those of the regulated. Economists now even have a name for this particular version of the intellectual fox-in-the-henhouse syndrome: cognitive regulatory capture.

And what is true of investors and regulators, introspection suggests, can also be true of academics. When it is costly to acquire and assimilate information about how reality diverges from the assumptions underlying popular economic models, it will be tempting to ignore those divergences. When convention within the discipline is to assume efficient markets, there will be psychic costs if one attempts to buck the trend. Scholars, in other words, are no more immune than regulators to the problem of cognitive capture. What got us into this mess, in other words, were not the limits of scholarly imagination. It was not the failure or inability of economists to model conflicts of interest, incentives to take excessive risk and information problems that can give rise to bubbles, panics and crises. It was not that economists failed to recognize the role of social and psychological factors in decision making or that they lacked the tools needed to draw out the implications. In fact, these observations and others had been imaginatively elaborated by contributors to the literatures on agency theory, information economics and behavioral finance. Rather, the problem was a partial and blinkered reading of that literature. The consumers of economic theory, not surprisingly, tended to pick and choose those elements of that rich literature that best supported their self-serving actions. Equally reprehensibly, the producers of that theory, benefiting in ways both pecuniary and psychic, showed disturbingly little tendency to object. It is in this light that we must understand how it was that the vast majority of the economics profession remained so blissfully silent and indeed unaware of the risk of financial disaster.

WITH THE pressure of social conformity being so powerful, are we economists doomed to repeat past mistakes? Will we forever follow the latest intellectual fad and fashion, swinging wildly—much like investors whose behavior we seek to model—from irrational exuberance to excessive despair about the operation of markets? Isn’t our outlook simply too erratic and advice therefore too unreliable to be trusted as a guide for policy? Maybe so. But amid the pervading sense of gloom and doom, there is at least one reason for hope. The last ten years have seen a quiet revolution in the practice of economics. For years theorists held the intellectual high ground. With their mastery of sophisticated mathematics, they were the high-prestige members of the profession. The methods of empirical economists seeking to analyze real data were rudimentary by comparison. As recently as the 1970s, doing a statistical analysis meant entering data on punch cards, submitting them at the university computing center, going out for dinner and returning some hours later to see if the program had successfully run. (I speak from experience.) The typical empirical analysis in economics utilized a few dozen, or at most a few hundred, observations transcribed by hand. It is not surprising that the theoretically inclined looked down, fondly if a bit condescendingly, on their more empirically oriented colleagues or that the theorists ruled the intellectual roost. But the IT revolution has altered the lay of the intellectual land. Now every graduate student has a laptop computer with more memory than that decades-old university computing center. And she knows what to do with it. Just like the typical twelve-year-old knows more than her parents about how to download data from the internet, for graduate students in economics, unlike their instructors, importing data from cyberspace is second nature. They can grab data on grocery-store spending generated by the club cards issued by supermarket chains and combine it with information on temperature by zip code to see how the weather affects sales of beer. Their next step, of course, is to download securities prices from Bloomberg and see how blue skies and rain affect the behavior of financial markets. Finding that stock markets are more likely to rise on sunny days is not exactly reassuring for believers in the efficient-markets hypothesis.

The data sets used in empirical economics today are enormous, with observations running into the millions. Some of this work is admittedly self-indulgent, with researchers seeking to top one another in applying the largest data set to the smallest problem. But now it is on the empirical side where the capacity to do high-quality research is expanding most dramatically, be the topic beer sales or asset pricing. And, revealingly, it is now empirically oriented graduate students who are the hot property when top doctoral programs seek to hire new faculty. Not surprisingly, the best students have responded. The top young economists are, increasingly, empirically oriented. They are concerned not with theoretical flights of fancy but with the facts on the ground. To the extent that their work is rooted concretely in observation of the real world, it is less likely to sway with the latest fad and fashion. Or so one hopes. The late twentieth century was the heyday of deductive economics. Talented and facile theorists set the intellectual agenda. Their very facility enabled them to build models with virtually any implication, which meant that policy makers could pick and choose at their convenience. Theory turned out to be too malleable, in other words, to provide reliable guidance for policy. In contrast, the twenty-first century will be the age of inductive economics, when empiricists hold sway and advice is grounded in concrete observation of markets and their inhabitants. Work in economics, including the abstract model building in which theorists engage, will be guided more powerfully by this real-world observation. It is about time.

Should this reassure us that we can avoid another crisis? Alas, there is no such certainty. The only way of being certain that one will not fall down the stairs is to not get out of bed. But at least economists, having observed the history of accidents, will no longer recommend removing the handrail.

Yes, Byron York *Is* This Stupid

Byron York:

Beltway Confidential: The black-white divide in Obama's popularity: [T]he president['s]... sky-high ratings among African-Americans make some of his positions appear a bit more popular overall than they actually are.... Those opinion differences are clear in the traditional "right track-wrong track" question, a key indicator of the public's mood. Thirty-four percent of whites say the country is headed in the right direction, while 56 percent believe it is "seriously off track." For black Americans, 70 percent say the country is headed in the right direction, with just 23 percent saying it is off track...

For York, "actually" means "what white people think."

Why oh why can't we have a better press corps?

Notes for April 29 Econ 210a Class: "Thirty Glorious Years"

John Maynard Keynes (1926), "The End of Laissez Faire"

Paul Krugman, "Introduction" to John Maynard Keynes, The General Theory of Employment, Interest and Money

Barry Eichengreen (1996), "Institutions and Economic Growth: Europe Since 1945," in Nicholas Crafts and Gianni Toniolo (eds), Economic Growth in Europe Since 1945 (Cambridge University Press), pp. 38-72

Mancur Olson (1996), "The Varieties of Eurosclerosis: The Rise and Decline of Nations Since 1982," in Nicholas Crafts and Gianni Toniolo (eds), Economic Growth in Europe Since 1945, (Cambridge, Cambridge University Press), pp.73-94

J. Bradford DeLong (1995), "America’s Only Peacetime Inflation: The 1970s," in Christina Romer and David Romer, eds., Reducing Inflation: Motivation and Strategy (University of Chicago Press), pp.-,

The End of the Presumption of Laissez-Faire

John Maynard Keynes (1926), "The End of Laissez Faire"

The idea of a divine harmony between private advantage and the public good is already apparent in Paley. But it was the economists who gave the notion a good scientific basis. Suppose that by the working of natural laws individuals pursuing their own interests with enlightenment in condition of freedom always tend to promote the general interest at the same time! Our philosophical difficulties are resolved-at least for the practical man, who can then concentrate his efforts on securing the necessary conditions of freedom. To the philosophical doctrine that the government has no right to interfere, and the divine that it has no need to interfere, there is added a scientific proof that its interference is inexpedient. This is the third current of thought, just discoverable in Adam Smith, who was ready in the main to allow the public good to rest on 'the natural effort of every individual to better his own condition', but not fully and self-consciously developed until the nineteenth century begins. The principle of laissez-faire had arrived to harmonise individualism and socialism, and to make at one Hume's egoism with the greatest good of the greatest number. The political philosopher could retire in favour of the business man - for the latter could attain the philosopher's summum bonum by just pursuing his own private profit. Yet some other ingredients were needed to complete the pudding. First the corruption and incompetence of eighteenth-century government, many legacies of which survived into the nineteenth. The individualism of the political philosophers pointed to laissez-faire. The divine or scientific harmony (as the case might be) between private interest and public advantage pointed to laissez-faire. But above all, the ineptitude of public administrators strongly prejudiced the practical man in favour of laissez-faire - a sentiment which has by no means disappeared. Almost everything which the State did in the eighteenth century in excess of its minimum functions was, or seemed, injurious or unsuccessful. On the other hand, material progress between 1750 and 1850 came from individual initiative, and owed almost nothing to the directive influence of organised society as a whole. Thus practical experience reinforced a priori reasonings. The philosophers and the economists told us that for sundry deep reasons unfettered private enterprise would promote the greatest good of the whole. What could suit the business man better? And could a practical observer, looking about him, deny that the blessings of improvement which distinguished the age he lived in were traceable to the activities of individuals ‘on the make’? Thus the ground was fertile for a doctrine that, whether on divine, natural, or scientific grounds, state action should be narrowly confined and economic life left, unregulated so far as may be, to the skill and good sense of individual citizens actuated by the admirable motive of trying to get on in the world...

Let us clear from the ground the metaphysical or general principles upon which, from time to time, laissez-faire has been founded. It is not true that individuals possess a prescriptive ‘natural liberty’ in their economic activities. There is no ‘compact’ conferring perpetual rights on those who Have or on those who Acquire. The world is not so governed from above that private and social interest always coincide. It is not so managed here below that in practice they coincide. It is not a correct deduction from the principles of economics that enlightened self-interest always operates in the public interest. Nor is it true that self-interest generally is enlightened; more often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these. Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately. We cannot therefore settle on abstract grounds, but must handle on its merits in detail what Burke termed “one of the finest problems in legislation, namely, to determine what the State ought to take upon itself to direct by the public wisdom, and what it ought to leave, with as little interference as possible, to individual exertion.”...

I will illustrate what I have in mind by two examples. (1) I believe that in many cases the ideal size for the unit of control and organisation lies somewhere between the individual and the modern State.... (2).... The important thing for government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all.... Many of the greatest economic evils of our time are the fruits of risk, uncertainty, and ignorance. It is because particular individuals, fortunate in situation or in abilities, are able to take advantage of uncertainty and ignorance, and also because for the same reason big business is often a lottery, that great inequalities of wealth come about; and these same factors are also the cause of the unemployment of labour, or the disappointment of reasonable business expectations, and of the impairment of efficiency and production. Yet the cure lies outside the operations of individuals; it may even be to the interest of individuals to aggravate the disease. I believe that the cure for these things is partly to be sought in the deliberate control of the currency and of credit by a central institution, and partly in the collection and dissemination on a great scale of data relating to the business situation, including the full publicity, by law if necessary, of all business facts which it is useful to know...

Paul Krugman, "Introduction" to John Maynard Keynes, The General Theory of Employment, Interest and Money

In the spring of 2005 a panel of “conservative scholars and policy leaders” was asked to identify the most dangerous books of the 19th and 20th centuries. You can get a sense of the panel’s leanings by the fact that both Charles Darwin and Betty Friedan ranked high on the list. But The General Theory of Employment, Interest, and Money did very well, too. In fact, John Maynard Keynes beat out V.I. Lenin and Frantz Fanon. Keynes, who declared in the book’s oft-quoted conclusion that “soon or late, it is ideas, not vested interests, which are dangerous for good or evil,” [384] would probably have been pleased.... Stripped down, the conclusions of The General Theory might be expressed as four bullet points: (1) Economies can and often do suffer from an overall lack of demand, which leads to involuntary unemployment. (2) The economy’s automatic tendency to correct shortfalls in demand, if it exists at all, operates slowly and painfully. (3) Government policies to increase demand, by contrast, can reduce unemployment quickly. (4) Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach. To a modern practitioner of economic policy, none of this – except, possibly, the last point – sounds startling or even especially controversial. But these ideas weren’t just radical when Keynes proposed them; they were very nearly unthinkable. And the great achievement of The General Theory was precisely to make them thinkable...

Barry Eichengreen (1996), "Institutions and Economic Growth: Europe Since 1945," in Nicholas Crafts and Gianni Toniolo (eds), Economic Growth in Europe Since 1945 (Cambridge University Press), pp. 38-72

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Economic growth in Europe since 1945 - Google Book Search

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Mancur Olson (1996), "The Varieties of Eurosclerosis: The Rise and Decline of Nations Since 1982," in Nicholas Crafts and Gianni Toniolo (eds), Economic Growth in Europe Since 1945, (Cambridge, Cambridge University Press), pp.73-94

Economic growth in Europe since 1945 - Google Book Search

J. Bradford DeLong (1995), "America’s Only Peacetime Inflation: The 1970s," in Christina Romer and David Romer, eds., Reducing Inflation: Motivation and Strategy (University of Chicago Press), pp.-,

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Tim Geithner and the Swedish Model

James Surowiecki:

The Sweden Example: The Balance Sheet: Ryan Avent beats me to the punch by pointing out the most important part of today’s Times’ story on Tim Geithner, namely that in the summer of 2008, after the collapse of Bear Stearns but before the meltdown of Lehman Brothers, Geithner proposed having the government guarantee the debts of all U.S. banks. The plan was shot down as politically untenable, but, as Ryan points out, had it been put into effect, we would most likely not have seen Lehman go under or had to deal with the incredibly negative consequences of that failure. More important, perhaps, by reducing the threat of panicked runs on bank debt (since those debts would have been guaranteed), such a guarantee would also have made it easier for regulators and banks to deal in a transparent fashion with the toxic-asset problem. That’s why the very first step in Sweden’s much-admired solution to its banking crisis in the early nineteen-nineties, was, yes, a guarantee of all bank debt. As one of the regulators involved in that effort put it, the guarantee “was provided in order to restore confidence and to ease the immediate pressure on banks,” by ensuring “the stability of the payment system and to safeguard the supply of credit.”

Given all this, Ryan is perplexed that Yves Smith... dismisses Geithner’s proposal... her conviction that any plan to deal with the banking system has to require bank bondholders to take a major hit. In other words, for Smith, the Swedish solution is not the right one. Nationalizing the banks, and wiping out the shareholders, isn’t enough: you have to impose significant pain on the banks’ debtholders, too. Lots of nationalization advocates believe that a debt guarantee is a bad idea. But one of the things that’s made the debate over nationalization confusing is that many of these same people, while arguing that bank debtholders should take a hit, also say that what the U.S. should do is emulate Sweden.... [T]his doesn’t make any sense. At the heart of the Swedish solution was the guarantee of all bank debt, ensuring that bondholders would not take a hit. And the Swedes, at least, thought that guarantee was essential to making their plan work.... [N]ationalization supporters should be clear: if they want to cram down the debtholders, then they don’t want the U.S. to follow the Swedish model. You cannot “Go Swedish” and “wipe out bond holders” at the same time.

There are nationalization advocates who really do want the U.S. to emulate Sweden, including most notably Paul Krugman, who’s said, “Sweden guaranteed all [bank liabilities]. If forced to say, I would go the Swedish route; but of course we can’t do that unless we’re prepared to put all troubled banks in receivership.” But many supporters of nationalization are just invoking Sweden in order to prove that there’s a historical precedent for successful nationalization, while at the same time arguing that the U.S. should reject a crucial part...

So let me be clear: for sixteen months now I have been a Swedish-model advocate who wants to guarantee bank bondholders. I thought and think it is the best practical road out of this mess.

Bad Banks Are Not an Adverse Supply Shock

Nick Rowe asks a question:

Worthwhile Canadian Initiative: Banks, Aggregate Demand, and Aggregate Supply: can understand how bad banks could affect the AS curve. Long-run growth comes from the Long Run Aggregate Supply curve moving slowly rightward over time as savings create investment that adds to the stock of capital and increases productivity. A good banking and financial system will encourage savings and investment, make sure the investments are the most productive ones, and make the LRAS curve move rightwards more quickly over time.

Even in the short run a good banking and financial system will be important in re-allocating capital between growing and declining sectors, if there are shifts in relative demand. If people want fewer cars and more restaurant meals, but banks cannot shift loans from car manufacturers to restaurants, the Short Run Aggregate Supply curve may shift left, because the restaurants won't be able to expand to meet demand, and car manufacturers' prices or wages may be sticky downwards. If you see the financial crisis as causing the recession by shifting the SRAS curve left, then monetary and fiscal policies, which shift the AD curve right, are not the appropriate cure...

But if bad banks have shifted the AS curve inward, then right now we should have stagflation: depression and inflation, as output falls and prices rise. We don't. The argument that fiscal and monetary policies won't reduce unemployment to normal levels because we have a supply side problem is completely incoherent in an AS-AD framework.

Benefit-Cost Analysis

The extremely sharp-witted Rob Stavins gets one wrong.


Harvard UniversityAn Economic View of the Environment: Does economic analysis shortchange the future?: Much skepticism about discounting and, more broadly, the use of benefit-cost analysis, is connected to uncertainties in estimating future impacts.... Benefits also depend on the values future generations would attach.... But how can we predict future generations’ values?  Economists and other social scientists try to infer them through surveys and by inferring preferences from individuals’ behavior. But these approaches are far from perfect, and at best they indicate only the values or tastes of people alive today. The uncertainties are substantial and unavoidable, but they do not invalidate the use of discounting (or benefit-cost analysis).  They do oblige analysts, however, to assess and acknowledge those uncertainties in their policy assessments, a topic I discussed in my last post (“What Baseball Can Teach Policymakers”), and a topic to which I will return in the future...

But he does not mention the elephant in the room: cost-benefit analysis sums up Benthamite utilities of individuals weighting each one's by the inverse of their personal marginal utility of wealth. The richer you are, the lower your marginal utility of wealth, and the more weight your preferences get in benefit-cost analysis. This is a problem. This is especially a problem when real interest rates are high, for when real interest rates are high the future is (relatively) poor and thus gets (relatively) little weight.

More Congratulations to Emmanuel Saez

Peter Orszag congratulates Emmanuel Saez: "Emmanuel's energy, intelligence, and dedication are deeply impressive—as was his ability to explain, despite his French accent, a complicated research project that I worked on with him to a group of H&R Block workers administering it..." But perhaps Emmanuel's most impressive accomplishment is that he has been personally denounced on the editorial page of the Wall Street Journal.

OMB - Blog Post - Congratulations to Emmanuel Saez: SMy co-author and friend Emmanuel Saez was awarded the John Bates Clark Medal on Friday. The prize, which is awarded to the best American economist under the age of forty, is one of the highest honors the economics profession can bestow upon one of its own. Emmanuel is deeply deserving of the honor—his work on income inequality and taxation has helped to shape my own thinking on these matters, and it had no small influence on the President's Budget.

Emmanuel is perhaps best known for his detailed examination of how wages at the top end of the U.S. income distribution have evolved over the past century. He and his co-author Thomas Piketty discovered that the overall pattern for the share of income accruing to those in the top 10 percent is U-shaped (see chart 1 below). Thus, the share going to the top 10 percent was around 45 percent from the mid-1920s to 1940, but then declined to approximately 33 percent during World War II. Emmanuel attributes this fall-off to the sharp reduction in capital incomes brought about by the war and the revenue increases needed to finance the war effort. After the war, the share of income accruing to the top 10 percent remained essentially flat until the late 1970s, when it began climbing dramatically, ultimately surpassing its pre-war highs. Indeed, in 2006, the top 10 percent earned 50 percent of national income, a higher share than even in 1928, the peak year of the "roaring twenties" stock market bubble.

Chart 1: Share of Total U.S. Income Accruing to the Top 10%, 1917-2006

Path Finder

Perhaps even more interesting than his findings about the evolution in earnings for the top 10% is what he found when he isolated data from just the top 1 percent of earners—namely, that virtually all the historical fluctuation in the share of income going to the top 10 percent was due to fluctuations in income within the top percentile alone (see chart 2 below). Stated differently, the dramatic changes in income inequality seen in the United States over the last century are almost entirely a function of how well the very highest earners did at any given point in time.

Chart 2: Decomposing the Top 10% of U.S. Income Share into Three Groups, 1913-2006

Loading 201COMB - Blog Post - Congratulations to Emmanuel Saez201D

And in the most recent past, the very highest earners did very well indeed, capturing almost three-quarters of total income growth in the economic expansion of 2002 to 2006, while the remaining 99 percent of the U.S. population split among themselves the final 25 percent of the increase. (What makes this trend all the more concerning is something that Emmanuel and his co-authors demonstrated in another paper: that this dramatic increase in incomes at the very top has not been mitigated by an increase in income mobility, which can be seen in the relatively stable probability of staying in the top 1 percent of earners from one year to the next since the early 1970s.)

Emmanuel's work on income inequality has helped to point the way for the Administration in its pledge to rebalance the tax code, with a tax cut going to 95 percent of working Americans while asking those at the very top to contribute more. The inequality that has arisen over the past three decades is not going to go away overnight, and it has been driven by many factors—including a decline in the growth rate of college-educated workers. But where the prior administration used changes in the tax code to exacerbate these trends, this Administration thinks that the tax code should be used to mitigate them because an economy in which all can enjoy success is one that is strong for us all.

Emmanuel's energy, intelligence, and dedication are deeply impressive—as was his ability to explain, despite his French accent, a complicated research project that I worked on with him to a group of H&R Block workers administering it. I look forward to reading his work for years and decades to come.

Mostly Bad News: The GDP Release

That crack reporter Insert Byline for CNBC reports on the real GDP decline:

GDP Down 6.1%: The U.S. economy contracted at a surprisingly sharp 6.1 percent rate in the first quarter as exports and business inventories plummeted. The drop in gross domestic product, reported by the Commerce Department on Wednesday, was much steeper than the 4.9 percent annual rate expected by economists and followed a 6.3 percent decline in the fourth quarter. GDP, which measures total goods and services output within U.S. borders, has now dropped for three straight quarters for the first time since 1974-1975.

The data came as the Federal Reserve resumed a regular two-day meeting. The Fed, which has cut interest rates to almost zero and pumped about a trillion dollars into the economy to try and break its downward spiral, is expected to leave policy unchanged at the meeting. "There won't be positive growth until the second half of the year probably, but the fall in the second quarter, if it's negative at all, will be far smaller," said Michael Darda, chief economist at MKM Partners in Greenwich, Conn...

That means that production this spring will be a full 3.5% below what it was in the second quarter of last year, when it ought to be 3.0% above.

The only bright sign is that so much of the decline was a fall in inventories. That means that there will be less pressure on firms to cut back employment further than there would be if they were staring at oceans of unmoving inventories:

The advance report from the Commerce Department showed business inventories plunged by a record $103.7 billion in the first quarter, as firms worked to reduce stocks of unsold goods in their warehouses. That sliced 2.79 percentage points from the overall GDP figure. Excluding inventories, GDP contracted 3.4 percent...

links for 2009-04-29

A Statement by Brad DeLong

In response to:

A Statement by Senator Arlen Specter:

I have been a Republican since 1966. I have been working extremely hard for the Party, for its candidates and for the ideals of a Republican Party whose tent is big enough to welcome diverse points of view. While I have been comfortable being a Republican, my Party has not defined who I am. I have taken each issue one at a time and have exercised independent judgment to do what I thought was best for Pennsylvania and the nation.

Since my election in 1980, as part of the Reagan Big Tent, the Republican Party has moved far to the right. Last year, more than 200,000 Republicans in Pennsylvania changed their registration to become Democrats. I now find my political philosophy more in line with Democrats than Republicans.

When I supported the stimulus package, I knew that it would not be popular with the Republican Party. But, I saw the stimulus as necessary to lessen the risk of a far more serious recession than we are now experiencing.

Since then, I have traveled the State, talked to Republican leaders and office-holders and my supporters and I have carefully examined public opinion. It has become clear to me that the stimulus vote caused a schism which makes our differences irreconcilable. On this state of the record, I am unwilling to have my twenty-nine year Senate record judged by the Pennsylvania Republican primary electorate. I have not represented the Republican Party. I have represented the people of Pennsylvania.

I have decided to run for re-election in 2010 in the Democratic primary.

I am ready, willing and anxious to take on all comers and have my candidacy for re-election determined in a general election.

I deeply regret that I will be disappointing many friends and supporters. I can understand their disappointment. I am also disappointed that so many in the Party I have worked for for more than four decades do not want me to be their candidate. It is very painful on both sides. I thank specially Senators McConnell and Cornyn for their forbearance.

I am not making this decision because there are no important and interesting opportunities outside the Senate. I take on this complicated run for re-election because I am deeply concerned about the future of our country and I believe I have a significant contribution to make on many of the key issues of the day, especially medical research. NIH funding has saved or lengthened thousands of lives, including mine, and much more needs to be done. And my seniority is very important to continue to bring important projects vital to Pennsylvania's economy.

I am taking this action now because there are fewer than thirteen months to the 2010 Pennsylvania Primary and there is much to be done in preparation for that election. Upon request, I will return campaign contributions contributed during this cycle.

While each member of the Senate caucuses with his Party, what each of us hopes to accomplish is distinct from his party affiliation. The American people do not care which Party solves the problems confronting our nation. And no Senator, no matter how loyal he is to his Party, should or would put party loyalty above his duty to the state and nation.

My change in party affiliation does not mean that I will be a party-line voter any more for the Democrats that I have been for the Republicans. Unlike Senator Jeffords' switch which changed party control, I will not be an automatic 60th vote for cloture. For example, my position on Employees Free Choice (Card Check) will not change.

Whatever my party affiliation, I will continue to be guided by President Kennedy's statement that sometimes Party asks too much. When it does, I will continue my independent voting and follow my conscience on what I think is best for Pennsylvania and America.

All I can say to Senator Specter is: spend the next year working as hard to court the Democratic base as you have worked to court the Republican wingnut base over the past decade, or I am maxing out for every single challenger you face in the Democratic primary.

Just saying...

The White House Press Conference

Dan Froomkin has a modest proposal:

Send Krugman to the Press Conference: President Obama holds a prime-time press conference tomorrow night to mark his 100th day in office, and if the major news organizations really want to make it interesting, they won’t send their White House corrrespondents.... [N]ews organizations should send the beat reporters — or even columnists — who have the deepest knowledge and expertise in the subject at hand. This would not only result in more probing questions, but more thoughtful and challenging follow-ups. What I want to see are tough, detailed exchanges driven by people who really know what they’re talking about and aren’t too intimidated to push back and drill down when necessary. So if the New York Times or The Washington Post decide that their top priority tomorrow night is to probe Obama about his highly speculative bank bailout proposals, they should send someone who could really mix it up with the president — like Paul Krugman, or Steven Pearlstein....

White House correspondents, by contrast, are generalists — and most of them are former political reporters.... They are also beholden to the press office for the continued access they need to do their jobs.

I’m not saying, by the way, that Obama’s previous two prime-time press conferences were a total loss. He was commanding and resolute at his first, on February 9. He deftly used his second.... He’s always erudite and articulate — such a change from his predecessor. But he also tends not to say anything new. His talking points, as it were, are vastly more extensive and fully developed than those of the last guy, but he sticks to them with the same tenacity. A press conference, however, should be the occasion for reporters to probe beneath the placid surface of a president’s regular pitch in search of a clearer view into his thought processes....

[T]he White House press corps just isn’t up to it. Ana Marie Cox wrote earlier this month in The Washington Post’s Outlook section that the modern White House correspondent’s job is, well, a joke: “Here are some stories that reporters working the White House beat have produced in the past few months: Pocket squares are back! The president is popular in Europe. Vegetable garden! Joe Biden occasionally says things he probably regrets. Puppy!” She explained: “It’s not that the reporters covering the president are bad at their jobs. Most are experienced journalists at the top of their game — and they’re wasted at the White House, where scoops are doled out....”

And that’s the generous view...

I am not sure that it would work--or, rather, I am not sure that Robert Gibbs would let it happen. Could Obama go toe-to-toe with either Pearlstein or Krugman if either of them were in a cranky mood and wanted to trip him up? I have never seen the aftermath of a hostile oral exam by Krugman or Pearlstein. I have seen the aftermath of a hostile oral exam by Summers: the candidate hid under the desk, whimpered, and would not come out until coaxed out by pizza and his significant other brought by taxicab from 30 blocks away...

If I were Obama and if I were to be questioned by subject-matter experts, I would insist (a) that each press conference be confined to one fairly narrow issue area, and (b) that I have five lifelines--phone-a-friend, double-dip, ask-the-press-audience, and ask-the-nationwide-tv-audience, and the ability to answer any one question with "puppy!!!"

That said, I think it would be a major win for the country if Dan's proposal could be put into effect. And I note that it looks a lot like the old "Meet the Press"--where there would be three questioners, all of them journalists who cared and knew something, rather than one Tim Russert- or David Gregory-like character.

links for 2009-04-28

What Good Is Modern Finance?

Modern finance exists to (i) channel purchasing power from households with savings to businesses with investment projects, (ii) improve corporate governance, and (iii) diversify risks. It has been a bust as far as (ii) and (iii) are concerned. And do we really need more than stocks and bonds if we are to do (i)? The argument that derivatives markets need to remain open is an argument that they help in (iii). And that is not a slam dunk.

Paul Krugman joins the attack on modern finance:

Money for Nothing: On July 15, 2007, The New York Times published an article with the headline “The Richest of the Rich, Proud of a New Gilded Age.” The most prominently featured of the “new titans” was Sanford Weill, the former chairman of Citigroup, who insisted that he and his peers in the financial sector had earned their immense wealth through their contributions to society. Soon after that article was printed, the financial edifice Mr. Weill took credit for helping to build collapsed, inflicting immense collateral damage in the process. Even if we manage to avoid a repeat of the Great Depression, the world economy will take years to recover from this crisis.

All of which explains why we should be disturbed by an article in Sunday’s Times reporting that pay at investment banks, after dipping last year, is soaring again — right back up to 2007 levels. Why is this disturbing? Let me count the ways.

First, there’s no longer any reason to believe that the wizards of Wall Street actually contribute anything positive to society, let alone enough to justify those humongous paychecks.... From the 1930s until around 1980 banking was a staid, rather boring business that paid no better, on average, than other industries, yet kept the economy’s wheels turning. So why did some bankers suddenly begin making vast fortunes? It was, we were told, a reward for their creativity — for financial innovation. At this point, however, it’s hard to think of any major recent financial innovations that actually aided society, as opposed to being new, improved ways to blow bubbles, evade regulations and implement de facto Ponzi schemes....

Bernanke['s]... examples of “good” financial innovations were (1) credit cards — not exactly a new idea; (2) overdraft protection; and (3) subprime mortgages.... [I]n a free-market economy... it’s up to the private sector to decide how much its employees are worth. But... Wall Street is no longer, in any real sense, part of the private sector. It’s a ward of the state.... One can argue that it’s necessary to rescue Wall Street to protect the economy as a whole — and in fact I agree. But given all that taxpayer money on the line, financial firms should be acting like public utilities, not returning to the practices and paychecks of 2007.

Furthermore, paying vast sums to wheeler-dealers isn’t just outrageous; it’s dangerous. Why, after all, did bankers take such huge risks? Because... the temporary appearance of success — offered such gigantic rewards....

[T]he real reason financial firms are paying big again is simply because they can.... There’s a palpable sense in the financial press that the storm has passed... bankers seem to believe that a return to business as usual is just around the corner. We can only hope that our leaders prove them wrong, and carry through with real reform...

The locus classicus of this attack, of course, is Simon Johnson, who views Wall Street the way an IMF Special Action Executive operative views a hypertrophied, inefficient, unproductive sector in some small country that needs to borrow from the IMF...

David Warsh Has Lost His Mind

Warsh writes:

Economic Principals: The American newspaper industry has fallen on hard times, and its authority has dimmed, at least for the moment. But the conservators of its traditions quietly took an admirable stand last week. The Pulitzer Prize Board passed over The New York Times columnist (and Princeton professor) Paul Krugman and gave its 2009 commentary award to Eugene Robinson... for columns on the election of the first African-American president that exhibited “graceful writing and grasp of the larger historic picture.” Krugman and Regina Brett, of the Cleveland Plain Dealer, were runners-up....

[T]here is something about Krugman’s newspaper journalism that chafes. True, he gets half-a-dozen scoops a year. He has become a columnist of enormous influence. He is an energetic blogger, too. Yet he often cloaks his claims in professional authority, overstates them, omits arguments that undermine his case, and is a bit of a bully.

Being one of two runners-up for commentary--being number two or three--is a mark of high distinction for Paul Krugman. David Warsh's interpretation of it as a slam against Paul is... extremely weird at best.

I think something else is going on here in David's mind--best summarized by a sentence from one of David Warsh's fellow journalists: "that Paul Krugman was totally right about almost everything doesn't make me like or forgive him."

Why oh why can't we have a better press corps?

Washington Post Crashed-and-Burned-and-Smoking Watch (Lori Montgomery and V. Dion Haynes Edition)

Is there any reason--other than a combination of incompetence and political bias--that the second half of the lead sentence is not "but she and her husband make more money than all but 0.6% and are in the richest 800,000 of the 140,000,000 American households"?


Montgomery and Haynes:

Small Businesses Brace for Tax Battle: Gail Johnson doesn't think of herself as wealthy. The former pediatric nurse has spent 20 years building a chain of preschools and after-school programs that accommodate sick children so working parents can keep their jobs.... In a typical year, she and her husband make more than $500,000, according to her accountant, a figure that throws them squarely into the ranks of the richest Americans -- and makes them a prime target for the Obama administration's tax policy.... If Obama's tax plans are enacted, her accountant estimates that her federal tax bill -- typically, around $120,000 a year -- would rise by at least $23,000, a 19 percent increase. "You hear 'tax the rich,' and you think, 'I don't make that much money,'" said Johnson, whose Rainbow Station programs are headquartered near Richmond. "But then you realize: 'Oh, if I put my business income with my wages, then, suddenly, I'm there'"...

Plus the special bonus:

Small Businesses Brace for Tax Battle: Republicans and business groups argue that Obama's plan to tax the rich would strike some of the nation's most productive businesses.... Most of these businesses make much less than $200,000 a year, though the precise figure is in dispute. Treasury Secretary Timothy F. Geithner has said the tax increase would affect about 2 percent of taxpayers with small-business income. An analysis by the Bush Treasury Department found that 7 percent of filers with business profit were in the top brackets in 2006. More recently, the nonpartisan Joint Committee on Taxation, which evaluates tax policy for Congress, projected that 3 percent of filers with business profits -- about 750,000 taxpayers -- were likely to face higher taxes in 2011 under Obama's proposal. Whatever the figure, Republicans argue that those who fall into the upper brackets tend to be firms with the greatest capacity for job creation...

Montgomery and Haynes can't be bothered to use Teh Google to even try to find out why opinions on shape of earth differ. If they had:

Chye-Ching Huang and James Horney: [M]any of the roughly 650,000 [high income] filers with small-business income... are merely passive investors who have nothing to do with running the business.... [T]he [Bush] Treasury Department [uses a] relatively broad definition of “small business.” Under the Treasury definition, for example, the $84 of income President Bush received in 2001 from a passive investment in an oil and gas company7 made him a “small-business owner.” About 35 percent of “small-business owners” with incomes above $200,000, and about 58 percent of “small-business owners” with incomes over $1 million, received some or all of their business income in the form of passive investments. The Treasury definition also counts as “small-business income” the fees that CEOs are paid for sitting on corporate boards...

they would have found out--surprise, surprise--that the Democrats' number is the right one if you are worrying about not the income of the rich guy but the capacity for job creation.

Ramesh Ponnuru, Fool

Ramesh Ponnuru writes:

Sidestepping the Issue - Ramesh Ponnuru: Based on my reading, the leading argument against prosecutions is that it would be imprudent, divisive, poisonous, etc., and therefore an abuse of prosecutorial discretion. I don't know if that argument will or should carry the day. It seems to me to be an important but decidedly second-order consideration. Surely the primary question is whether laws were broken; and if there is serious reason to believe that they were, then shouldn't there be a presumption in favor of investigation? An argument against prosecution that appears to concede that laws may have been broken, or treats the question as an afterthought, seems to me to be unlikely to prevail. The people who strongly oppose investigation and prosecution would be on stronger ground, it seems to me, making the argument that it is simply outlandish and absurd to think that policymakers violated the law. Can that argument be made?


Quality Control, FT, Quality Control: You Can Do Better than This (Waterboarding-as-Torture Edition)

Clive Crook writes:

Clive Crook - Obama’s needless fight over torture: Many just take it for granted that waterboarding is torture, and hence illegal. The convoluted legal defences in the memos are so false, in their view, that they compound the crime. The bizarre care the memos prescribe to guard against lasting physical harm to suspects, for instance, is dismissed as a sham that only makes the enterprise more disgusting. Not so fast. Common sense may tell you waterboarding is torture, but the law is less clear-cut. Congress should make waterboarding a crime, for the reasons I have stated, and it has had many chances before and since 9/11 to do so. The fact is, it has chosen not to. Some of those in Congress now calling for prosecutions, including Nancy Pelosi, speaker of the House, were briefed about these methods in the panic-stricken aftermath of 9/11 and offered no objection. It is worth noting that the methods in question were adopted from the training US soldiers undergo to resist interrogation. This underlines the fact that using these methods lowers the US to the level of its enemies. But it also suggests that distinctions may be made between waterboarding and, say, breaking on the rack...

Paul Begala:

Paul Begala: On November 29, 2007, Sen. McCain, while campaigning in St. Petersburg, Florida, said, "Following World War II war crime trials were convened. The Japanese were tried and convicted and hung for war crimes committed against American POWs. Among those charges for which they were convicted was waterboarding."... Politifact, the St. Petersburg Times' truth-testing project (which this week was awarded a Pulitzer Prize), scrutinized Sen. McCain's statement and found it to be true. Here's the money quote from Politifact:

McCain is referencing the Tokyo Trials, officially known as the International Military Tribunal for the Far East. After World War II, an international coalition convened to prosecute Japanese soldiers charged with torture. At the top of the list of techniques was water-based interrogation, known variously then as 'water cure,' 'water torture' and 'waterboarding,' according to the charging documents. It simulates drowning.

Politifact went on to report:

A number of the Japanese soldiers convicted by American judges were hanged, while others received lengthy prison sentences or time in labor camps.

The folks at Politifact interviewed R. John Pritchard, the author of The Tokyo War Crimes Trial: The Complete Transcripts of the Proceedings of the International Military Tribunal for the Far East. They also interviewed Yuma Totani, history professor at the University of Nevada-Las Vegas, and consulted the Columbia Journal of Transnational Law, which published a law review article entitled, "Drop by Drop: Forgetting the History of Water Torture in U.S. Courts."

Either a retraction and correction, or a clarification by Clive Crook that he believes that the International Military Tribunal for the Far East committed miscarriages of justice when it hanged members of the Kempitai for waterboarding Americans would be appreciated. One or the other seems to be called for.

I Missed Henry Farrell's Observance of Charles Krauthammer Day!

I cannot believe it. This was one thing I definitely want to observe every year:

Hope You Had a Happy Krauthammer Day!: I forgot to note a very special anniversary yesterday. April 22nd is the date on which Charles Krauthammer opined:

Hans Blix had five months to find weapons. He found nothing. We’ve had five weeks. Come back to me in five months. If we haven’t found any, we will have a credibility problem.

You’ve now had six years. How’s that credibility looking?

Every time the Washington Post takes one step forward by, say, hiring Ezra Klein it then takes 536 steps back by publishing Charles Krauthhammer.

Is Anything Karl Marx Wrote After He Turned Thirty Worthwhile?

Circling around again to Chris Bertram's whine about how lousy my "evaluating Karl Marx as an economist" lecture is, and how he would do something else:

Explaining Marx to newbies: Suppose I were lecturing about Karl Marx: I’d do the same thing. I’d probably start by discussing some of the ideas in the Manifesto about the revolutionary nature of the bourgeoisie, about their transformation of technology, social relations, and their creation of a global economy. Then I’d say something about Marx’s belief that, despite the appearance of freedom and equality, we live in a society where some people end up living off the toil of other people. How some people have little choice but to spend their whole lives working for the benefit of others, and how this compulsion stops them from living truly truly human lives. And then I’d talk about Marx’s belief that a capitalist society would eventually be replaced by a classless society run by all for the benefit of all. Naturally, I’d say something about the difficulties of that idea. I don’t think I’d go on about Pol Pot or Stalin, I don’t think I’d recycle the odd bon mot by Paul Samuelson, I don’t think I’d dismiss Hegel out of hand, and I don’t think I’d contrast modes of production with Weberian modes of domination...

Something occurs to me: Bertram thinks that the lecture should be exclusively about the Communist Manifesto and before. Karl Marx wrote the Communist Manifesto when he was 29, drawing substantially on what Engels had written about the condition of British textile workers in Manchester in his Condition of the Working Class in England when he was 23. Chris Bertram doesn't think that what either of them wrote about for the rest of their lives is worth wrestling with.

That is, I think, a much harsher judgment of Karl Marx-as-economist than I would deliver...

links for 2009-04-27

Britain Is Off the Euro

And Paul Krugman thinks that is a very good thing:

A quick note on Britain: Paul Krugman Blog: The Darling budget is basically a confession that Britain doesn’t dare do any significant discretionary fiscal stimulus. But it should be pointed out that Britain is getting a serious monetary expansion — much more than other troubled European economies.... Britain has, despite worries about its budget, managed to cut rates significantly vis-a-vis the core eurozone countries... the fall in the pound has made British products a lot more competitive.

I think the Spanish comparison is instructive. Like Britain, it’s had a major housing bust. But Spain has basically had nothing happen to offset that shock.

So I’m actually fairly hopeful about Britain; right now, the fact that it’s not on the euro is serving it well.

Pushpin as Good as Poetry?

From the Onion:

Pushpin Industry Thriving In Recession | The Onion - America's Finest News Source: Since Edwin Moore's invention of the pushpin in 1900, people have turned to these inexpensive office supplies en masse during economic recessions. In the 1930s, pushpins were used by President Roosevelt to display signage detailing various New Deal social programs; in the recessions of the mid-1970s and early '90s, families affixed unpaid bills, help wanted ads, and inspirational posters to the wall with the versatile fasteners.

In the current economic slump, pushpin sales have risen 79 percent, and retailers are struggling to keep them in stock.

Analysts agree that the industry is experiencing a growth not seen since 1983, as consumers who once thought nothing of spending $30 or $40 on an impulse item, such as DVDs or an MP3 player, have found themselves with less disposable income. With an average price point of 62 cents for a card of 60, pushpins—or "thumbtacks," as they are sometimes known—provide an attractive alternative to the average consumer.

"This is a great time to be in pushpins," economist Brad DeLong said. "In a soft economy, people turn to family for support, and they want pictures of their loved ones in a place where they can see them, only they can't afford to have those photos professionally framed. That makes the pushpin a very hot commodity"...

How Much Are TARP Assets Worth?

Jon Faust has a nice piece at Real Time Ecinomics pushing back against the claim that TARP assets are "worth" only two-thirds of what the government paid for them. The government is patient capital without much relative exposure to these financial market risks. Yet the valuation formulas assume that the government is like other market participants--very short-term and highly risk averse.

In most scenarios going forward the government makes money on it's TARP assets. In those in which it doesn't because asset markets stay this depressed, we don't much care that it loses money: we have other, worse things to worry about.

links for 2009-04-25

This Is What "Par Value" Is For

An interesting return to nineteenth-century practice by KKR. In the nineteeth century they told you how much extra money they might call on you for if capital requirements turned out to be larger than initially projected:

KKR asks for cash to help buy-out portfolio: By Martin Arnold in London and Henny Sender in New York: Kohlberg Kravis Roberts has asked investors to contribute as much as €730m ($970m) to support struggling portfolio companies in its 2005 European buy-out fund, amid preparations for a rush of similar moves by other big private equity groups. Investors are wary of the so-called annex funds that are being prepared by several private equity groups to finance debt restructurings and top-up investments at companies held by their recent buy-out funds, which are running short of cash.

The move by KKR emerged as the private equity group announced Friday that it was delaying the deadline until August for deciding whether to proceed with its planned New York initial public offering, via a delisting of its Amsterdam-listed fund. The planned annex fund by KKR – in which the private equity group plans to invest €16m of its own money – mirrors similar moves by venture capital funds after the dotcom bubble burst and they were left short of cash to support their investments. KKR plans to waive its 1.5 per cent management fee on the planned annex fund and to allow investors to transfer commitments into the new vehicle from its third European fund, which was raised last year and is largely uninvested....

One large European private equity investor said annex funds ran the risk that they could be used to prop up failing investments. “A lot of [private equity] general partners are looking at annex funds,” said the investor. “But one needs to be very careful as there are plenty of pitfalls out there, not least the risk of throwing good money after bad.” To determine which companies to support and which to abandon will be one of the greatest challenges facing the buyout firms in coming months....

Several of the companies in KKR’s 2005 fund have been written down by more than 90 per cent, such as ProSiebenSat.1, the German pay-TV broadcaster; Pages Jaunes, the French directories business; and NXP, the Dutch chipmaker. KKR has been buying debt at big discounts in some of the companies, such as ProSeibenSat.1. KKR’s biggest European deal is Alliance Boots, the pharmacy chain, which was Europe’s largest ever leveraged buy-out when it was bought for £11.1bn in May 2007. Boots has been written down by 41 per cent, partly due to the weaker pound.

links for 2009-04-24

links for 2009-04-23

Gene Healy Is a National Treasure...

Every time I get fed up with the Cato Institute and decide to dump everything that spews out of it automatically to /dev/null, Gene Healy writes something to pull him back.

I think that the Republican Party needs to die because it does not believe that "adherence to our values distinguishes us from our enemy"--it adheres to no values whatsoever. I hope that it will, and that Gene Healy will be at the core of its replacement:

Of Course It Was Torture: Thursday, the Obama administration released previously classified memos detailing interrogation techniques used against enemy prisoners.... Bush administration lawyers assured the CIA that waterboarding detainees and keeping them awake for a week or more was perfectly legal.... Conservative legal analyst David Rivkin, one of Bush's most reliable defenders, insists that "any fair-minded observer" would conclude that the documents prove that "the Bush administration did not torture." But... Rivkin's assertion is on a par with left-wing diehards' claim that President Clinton didn't commit perjury.

Let's start with waterboarding. If it's not torture, then maybe we owe an apology to the Japanese soldiers we prosecuted for it after WWII. It felt "like I was drowning," Lieutenant Chase Nielsen testified in a 1946 war crimes trial, "just gasping between life and death."... [T]he policy was, at the very least, criminally stupid.... Bush administration defenders prefer to describe each technique in isolation, glossing over the fact that it was the relentless combination of such tactics for extended periods that made them rise to the level of torture.... Read the descriptions military personnel provided of prisoners' reactions to "enhanced interrogation": "Detainee began to cry. Detainee bit the IV tube completely in two. Started moaning.... Yelled for Allah. Urinated on himself.... Trembled uncontrollably." Does that meet the statutory definition? Gosh yes, that's a tough legal question.

The point here isn't to make you shed a tear for Al Qaeda prisoners; mass murderers (actual or aspiring) are pretty hard to feel sorry for. But anyone who understands the issue ought to feel some remorse over the damage our policy did to the rule of law and American interests abroad....

Imagine if, shortly after 9/11, someone had told you that the US government would adopt an interrogation policy based on Chinese Communist techniques designed to elicit false confessions. You'd have thought that person was pretty cynical. But he'd turn out to be exactly right.... SERE was adopted in the wake of the Korean War to train American soldiers to resist abuse by rogue regimes. After 9/11, we put those techniques to work to interrogate terrorist suspects. It's hardly surprising, then, that... "We spent millions of dollars chasing false alarms." Beaten savagely by Egyptian torturers, one victim of our "extraordinary rendition" program concocted a story about Saddam Hussein giving Al Qaeda WMD training. That story made it into Colin Powell's UN Security Council speech selling the Iraq War.

In his ill-fated presidential campaign, Republican congressman Tom Tancredo got his biggest applause line when he cheered for torture in a May 2007 debate: "I'm lookin' for Jack Bauer!" The real thing is a lot less glamorous—and a lot less effective—than what you see on TV. Around the same time Tancredo was mugging for the cameras, General David Petraeus issued an open letter to his troops warning against the use of torture: "Adherence to our values distinguishes us from our enemy." That's a principle we should keep in mind going forward.

Steve Benen Takes Jonathan Martin to School

Jonathan Martin writes:

A Democratic president thrills a French audience by telling it that America has been "arrogant." He brushes aside 50 years of anti-communist orthodoxy by relaxing restrictions against Fidel Castro's Cuba. He directs his attorney general to ease a crackdown on medical marijuana and even plays host to the Grateful Dead in the Oval Office.... He has been blithely crossing ideological red lines and dancing on cultural third rails -- the kinds of gestures that would have scorched an earlier generation of Democrats -- with seeming impunity. Obama's foes, and even some of his allies, are a bit mystified...

Steve Benen takes Martin to school:

The Washington Monthly: There's no need to be "mystified" when the president remains unscathed by silly and inconsequential "controversies" manufactured by partisan hacks. Indeed, some of these flaps -- remember when it was a huge deal that Obama chuckled during a "60 Minutes" interview -- are so nonsensical, it's become pretty easy for the typical American to tune out conservative outrage as background noise. They're the Republicans who cried wolf.

It also seems that Obama isn't taking any meaningful hits because his policy agenda is fairly close to the one he presented during the campaign. Martin questions, for example, why the president has gotten away with a more progressive policy towards Cuba. Maybe it's because he already told us he'd do exactly that?... President Obama's agenda is in line with Candidate Obama's agenda. He wants to raise taxes on the wealthy while cutting them for the middle class? He wants to reform the health care system? He wants a withdrawal timeline for U.S. troops in Iraq? Perhaps the president "skates" on these issues -- all of which the right finds outrageous -- because it's what voters hired him to do.

Impeach George W. Bush. Impeach Richard Cheney. Impeach Donald Rumsfeld. Impeech Condi Rice. Impeach Them Now

Yes, they did torture people to elicit false confessions that would give them an excuse to attack Iraq.

Jonathan Landay should not say "find" evidence. He should say "manufacture" evidence. Otherwise the story s good:

Report: Abusive tactics used to seek Iraq-al Qaida link: The Bush administration applied relentless pressure on interrogators to use harsh methods on detainees in part to find evidence of cooperation between al Qaida and the late Iraqi dictator Saddam Hussein's regime, according to a former senior U.S. intelligence official and a former Army psychiatrist.... A former senior U.S. intelligence official familiar with the interrogation issue said that Cheney and former Defense Secretary Donald H. Rumsfeld demanded that the interrogators find evidence of al Qaida-Iraq collaboration.

"There were two reasons why these interrogations were so persistent, and why extreme methods were used," the former senior intelligence official said on condition of anonymity because of the issue's sensitivity. "The main one is that everyone was worried about some kind of follow-up attack (after 9/11). But for most of 2002 and into 2003, Cheney and Rumsfeld, especially, were also demanding proof of the links between al Qaida and Iraq that (former Iraqi exile leader Ahmed) Chalabi and others had told them were there." It was during this period that CIA interrogators waterboarded two alleged top al Qaida detainees repeatedly — Abu Zubaydah at least 83 times in August 2002 and Khalid Sheik Muhammed 183 times in March 2003 — according to a newly released Justice Department document. "There was constant pressure on the intelligence agencies and the interrogators to do whatever it took to get that information out of the detainees, especially the few high-value ones we had, and when people kept coming up empty, they were told by Cheney's and Rumsfeld's people to push harder," he continued. "Cheney's and Rumsfeld's people were told repeatedly, by CIA . . . and by others, that there wasn't any reliable intelligence that pointed to operational ties between bin Laden and Saddam, and that no such ties were likely because the two were fundamentally enemies, not allies." Senior administration officials, however, "blew that off and kept insisting that we'd overlooked something, that the interrogators weren't pushing hard enough, that there had to be something more we could do to get that information," he said.

A former U.S. Army psychiatrist, Maj. Charles Burney, told Army investigators in 2006 that interrogators at the Guantanamo Bay, Cuba, detention facility were under "pressure" to produce evidence of ties between al Qaida and Iraq. "While we were there a large part of the time we were focused on trying to establish a link between al Qaida and Iraq and we were not successful in establishing a link between al Qaida and Iraq," Burney told staff of the Army Inspector General. "The more frustrated people got in not being able to establish that link . . . there was more and more pressure to resort to measures that might produce more immediate results." Excerpts from Burney's interview appeared in a full, declassified report on a two-year investigation into detainee abuse released on Tuesday by the Senate Armed Services Committee.

Senate Armed Services Committee Chairman Carl Levin, D-Mich., called Burney's statement "very significant." "I think it's obvious that the administration was scrambling then to try to find a connection, a link (between al Qaida and Iraq)," Levin said in a conference call with reporters. "They made out links where they didn't exist." Levin recalled Cheney's assertions that a senior Iraqi intelligence officer had met Mohammad Atta, the leader of the 9/11 hijackers, in the Czech Republic capital of Prague just months before the attacks on the World Trade Center and the Pentagon. The FBI and CIA found that no such meeting occurred.

A senior Guantanamo Bay interrogator, David Becker, told the committee that only "a couple of nebulous links" between al Qaida and Iraq were uncovered during interrogations of unidentified detainees, the report said. Others in the interrogation operation "agreed there was pressure to produce intelligence, but did not recall pressure to identify links between Iraq and al Qaida," the report said. The report, the executive summary of which was released in November, found that Rumsfeld, former Secretary of State Condoleezza Rice, and other former senior Bush administration officials were responsible for the abusive interrogation techniques used at Guantanamo and in Iraq and Afghanistan...

This Looks to Be Very Interesting indeed...

From the WWCCWIHP:

The Wilson Center's Cold War International History Project (CWIHP) will host a two-day scholarly conference on 20-21 May 2009 to examine the contents of the [Vassiliev] notebooks and their implications for our understanding of Soviet espionage in the United States. Conference participants will include John Haynes, Harvey Klehr, and Alexander Vassiliev, co-authors of Spies: The Rise and Fall of the KGB in America, contributors to a June special edition of the Journal of Cold War Studies, as well as other intelligence history specialists. For more details download the conference agenda.

Though Vassiliev's access was not unfettered, the 1,115 pages of densely handwritten notes that he was able to take shed new and important light on such critical individuals and topics as Alger Hiss, the Rosenberg case, and "Enormous," the massive Soviet effort to gather intelligence on the Anglo-American atomic bomb project.

Alexander Vassiliev has donated his original copies of the handwritten notebooks to the Library of Congress with no restriction on access. They are available to researchers in the Manuscript Division. Electronic copies of the original notebooks, transcribed Russian versions, and translated English versions are available for download free of charge from the CWIHP website.

I.F. Stone: Premature Anti-Fascist Watch (Mirror of Wildernesses Department)

Ken Houghton reports that Harvey Klehr, John Earl Jones, and Alexander Vassiliev accuse I.F. Stone of being a premature anti-fascist: of seeking in the late 1930s to help the Soviet Union defend itself against the Nazi threat by passing along tidbits of information, and that this was a bad thing.

I did not know that there was anybody who believed that the national security of the United States was impaired by working to contain Hitler in the mid 1930s. But it appears that Klehr, Jones, and Vassiliev do.

The tidbit of information that they cite, as reported by the NKVD to Moscow Center in 1936:

Pancake [Stone] reported that Karl Von Wiegand works in Berlin as a correspondent for the Hearst agency “Universal Service.” He had been ordered to maintain friendly relations with Hitler, which was supposedly dictated by the fact that the German press was buying the agency’s information. Hearst is in a deal with German industry to supply the latter with a large consignment of copper. Wiegand does not agree with Hearst’s policy. He turned to Pancake’s boss for advice...

This disturbs me for three reasons. First, even Pat Buchanan does not think that helping Stalin against Hitler in the late 1930s is a blameworthy act: helping Stalin against Hitler is a mitzvah. Second, there is something wrong with historians who write about how Stone worked "closely with the KGB"--the Committee for State Security--when the KGB was not organized until 1954. In the late 1930s the sinister and murderous people who worked in Dzherzhinsky Square were part of the NKVD. Third, when the most striking example you can find of "working closely with the NKVD" is passing along journalistic gossip that Hearst does not want his reporters to antagonize the Nazis and the eporters are pissed--well perhaps you should fine a less mendacious title for your article than "I.F. Stone, Soviet Agent--Case Closed."

Here are Klehr, Jones, and Vassiliev:

I.F. Stone, Soviet Agent--Case Closed: Over the next several years, documents recorded in Vassiliev’s notebooks make clear, Stone worked closely with the KGB.... The KGB recruited journalists in part for their access to inside information and sources on politics and policy, insights into personalities, and confidential and non-public information that never made it into published stories. Certain journalistic working habits also lent themselves to intelligence tasks. By profession, journalists ask questions and probe.... Stone assisted Soviet intelligence on a number of such tasks: talent spotting, acting as a courier by relaying information to other agents, and providing private journalistic tidbits and data the KGB found interesting. In May 1936, for example, the KGB New York station told Moscow:

Pancake [Stone] reported that Karl Von Wiegand works in Berlin as a correspondent for the Hearst agency “Universal Service.” He had been ordered to maintain friendly relations with Hitler, which was supposedly dictated by the fact that the German press was buying the agency’s information. Hearst is in a deal with German industry to supply the latter with a large consignment of copper. Wiegand does not agree with Hearst’s policy. He turned to Pancake’s boss for advice...

Commenting on Stone’s work as a KGB talent spotter and recruiter, the KGB New York station reported, “Pancake established contact with Dodd. We wanted to recruit him [Dodd] and put him to work on the State Dep. line. Pancake should tell Dodd that he has the means to connect him with an anti-Fascist organization in Berlin.” William A. Dodd, Jr., was the son of the U.S. ambassador to Germany and an aspiring Popular Front activist with political ambitions.... Stone... provid[ed] him with a contact in Berlin when he went to join his father at the embassy. Stone also passed on to the KGB some information Dodd picked up from the American military attaché in Berlin about possible German military moves against the USSR and the name of a suspected pro-Nazi embassy employee...

That Hearst is telling his journalists not to antagonize the Nazis seems to be journalistic gossip that might be a little bit useful in preparing to fight against Hitler--and the transmission of which to the USSR in 1936 would tend to enhance rather than harm the national security of the United States and the peace and good order of the world. But I can understand how those who wished that Hitler rather than Stalin had won the war and dominated post-World War II Europe might disagree.

The most interesting passage in Klehr, Jones, and Vassiliev's Commentary piece is:

The Soviets knew little about Truman when he succeeded to the presidency, and in June 1945 Moscow Center told Pravdin, then chief of the New York KGB station:

Right now the cultivation of Truman’s inner circle becomes exceptionally important. This is one of the Station’s main tasks. To fulfill this task, the following agent capabilities need to be put to the most effective use: 1. In journalistic circles—--Ide, Grin, Pancake... Bumblebee. Through these people focus on covering the principal newspaper syndicates and the financial-political groups that are behind them; their relationships with Truman, the pressure exerted on him, etc...

Of the four journalists listed... “Bumblebee” was... Walter Lippmann, the most prominent opinion columnist of the day. Lippmann knew Pravdin only as a Soviet journalist with whom he traded insights and information...

Klehr, Jones, and Vassiliev say that Lippman was not an NKVD spy, yet it appears that Moscow Center thought he was one of their spies: one of their "agent capabilities." The pressure on Pravdin and his fellows to report that they had recruited more agents and more important agents than they in fact had must have been immense.

The Bush Administration: Malevolent, Not Ignorant

Scott Shane and Mark Mazzetti put an improper frame around the torture issue. Not to do the staffwork on a policy--and not to check the staffwork that others have done--is making a decision to be deceived. But Shane and Mazzetti hide their eyes from that fact:

In Adopting Harsh Tactics, No Inquiry Into Their Past Use: The program began with Central Intelligence Agency leaders in the grip of an alluring idea: They could get tough in terrorist interrogations without risking legal trouble by adopting a set of methods used on Americans during military training. How could that be torture?... [W]ithout a single dissent from cabinet members or lawmakers, the United States for the first time officially embraced the brutal methods of interrogation it had always condemned.... [N]o one involved — not the top two C.I.A. officials who were pushing the program, not the senior aides to President George W. Bush, not the leaders of the Senate and House Intelligence Committees — investigated the gruesome origins of the techniques they were approving with little debate.

According to several former top officials involved in the discussions seven years ago, they did not know that the military training program, called SERE, for Survival, Evasion, Resistance and Escape, had been created decades earlier to give American pilots and soldiers a sample of the torture methods used by Communists in the Korean War, methods that had wrung false confessions from Americans.... George J. Tenet, the C.I.A. director who insisted that the agency had thoroughly researched its proposal and pressed it on other officials, did not examine the history of... waterboarding.

The top officials he briefed did not learn that waterboarding had been prosecuted by the United States in war-crimes trials after World War II and was a well-documented favorite of despotic governments since the Spanish Inquisition; one waterboard used under Pol Pot was even on display at the genocide museum in Cambodia. They did not know that some veteran trainers from the SERE program itself had warned in internal memorandums that, morality aside, the methods were ineffective. Nor were most of the officials aware that the former military psychologist who played a central role in persuading C.I.A. officials to use the harsh methods had never conducted a real interrogation, or that the Justice Department lawyer [i.e., John Yoo] most responsible for declaring the methods legal had idiosyncratic ideas that even the Bush Justice Department would later renounce.

The process was “a perfect storm of ignorance and enthusiasm,” a former C.I.A. official said.... Today... Bush administration officials are finger-pointing. Some blame the C.I.A., while some former agency officials blame the Justice Department or the White House. Philip D. Zelikow, who worked on interrogation issues as counselor to Secretary of State Condoleezza Rice in 2005 and 2006, said the flawed decision-making badly served Mr. Bush and the country.

"Competent staff work could have quickly canvassed relevant history, insights from the best law enforcement and military interrogators, and lessons from the painful British and Israeli experience,” Mr. Zelikow said. “Especially in a time of great stress, walking into this minefield, the president was entitled to get the most thoughtful and searching analysis our government could muster.”...

Leaked to the news media months after they were first used, the C.I.A.’s interrogation methods would darken the country’s reputation, blur the moral distinction between terrorists and the Americans who hunted them, bring broad condemnation from Western allies and become a ready-made defense for governments accused of torture. The response has only intensified since Justice Department legal memos released last week showed that two prisoners were waterboarded 266 times and that C.I.A. interrogators were ordered to waterboard one of the captives despite their belief that he had no more information to divulge...

John Kay Weighs in, Calling for a Practical Macroeconomics

Me? I think that we ought to be turning out a lot of macroeconomic historians and historians of economic thought, and that only they should be allowed to serve in government or comment on public affairs at least as far as the business cycle is concerned.

John Kay at the FT:

John Kay: How economics lost sight of real world: The past two years have not enhanced the reputation of economists.... Although more economic research has been done in the past 25 years than ever before, the economists whose names are most frequently referenced today, such as Hyman Minsky and John Maynard Keynes, are from earlier generations. Since the 1970s economists have been engaged in a grand project. The project’s objective is that macroeconomics should have microeconomic foundations. In everyday language, that means that what we say about big policy issues – growth and inflation, boom and bust – should be grounded in the study of individual behaviour.... Most economists would claim that the project has been a success... the criteria are the self-referential criteria of modern academic life....

But policymakers and the public at large are, rightly, not interested in whether models are rigorous. They are interested in whether the models are useful and illuminating – and these "rigorous" models do not score well here.... That people respond rationally to incentives, and that market prices incorporate information about the world, are not terrible assumptions. But they are not universal truths either. Much of what creates profit opportunities and causes instability in the global economy results from the failure of these assumptions. Herd behaviour, asset mispricing and grossly imperfect information have led us to where we are today.

There is not, and never will be, an economic theory of everything....

Keynes... explain[ed] that economic understanding required an amalgam of logic and intuition and a wide knowledge of facts, most of which are not precise: “a requirement overwhelmingly difficult for those whose gift mainly consists in the power to imagine and pursue to their furthest points the implications and prior conditions of comparatively simple facts which are known with a high degree of precision”. On this, as on much else, Keynes was right.

Politico Says: "Opinions of Shape of Earth Differ"--and Won't Interview Anybody Who Thinks It Is Round

Why oh why can't we have a better press corps? Yet more evidence that the world would be a better place without the Politico:

Today it is Andie Coller and Patrick O'Connor, who drop a notch below "he said, she said" journalism: they write a story about Amity Shlaes by interviewing Amity Shlaes and her side alone:

Why GOP is devouring one book: Andie Coller and Patrick O'Connor : House Republicans are tearing through the pages of Amity Shlaes’ “The Forgotten Man” like soccer moms before book club night. Shlaes’ 2007 take on the Great Depression questions the success of the New Deal and takes issue with the value of government intervention in a major economic crisis.... “There aren’t many books that take a negative look at the New Deal,” explained Republican policy aide Mike Ference, whose boss, House Minority Whip Eric Cantor of Virginia, invited Shlaes to join a group of 20 or so other House Republicans for lunch earlier this year in his Capitol suite. “Republicans are gobbling it up — and so are other lawmakers — because it tells you what they did, what worked and what didn’t.” “It’s been suggested as required reading for all of us, I think,” said Erica Elliott, press secretary for Rep. Scott Garrett (R-N.J.) — who himself notes that his chief of staff “stole” his hardback copy, so he had to purchase a paperback....

It’s not hard to see what Republicans find compelling about the book. Shlaes... presents a vision of the Great Depression that challenges the conventional wisdom that casts Herbert Hoover as a goat, FDR as a hero and the New Deal as the country’s salvation....

Critics of the book... have challenged Shlaes’ use of data, noting, for example, that the unemployment statistics she uses do not count Works Progress Administration jobs. Shlaes defends her approach, arguing that make-work jobs are not evidence of economic growth.... Others, such as Matthew Dallek, a fellow at the Woodrow Wilson International Center for Scholars, have called her take “revisionist”; Shlaes said she is simply recounting what she found.

It’s clear, however, that she brings a certain perspective to her task. As she told Reason magazine in January: “The government is like a lobster. It will eat anything, it wants to survive, it will compete with anything, and it can be a cannibal. When you look back at the ’30s using the public choice lens, what you discover is the extent to which the Depression wasn’t about a virtuous government and bad businesspeople. Rather, it was about people in office competing with the private sector for power.”...

“Definitive isn’t the word I would use,” Shlaes said. “I just thought, ‘Maybe there’s more to the story, and if I find more, I’ll try to capture that in the book,’” she said. She notes that she is a “history writer with a journalism background, not an economist,” and that it was not her intent to write a polemic — rather, it was to tell the stories of individuals who lived through and helped shape the era.... Shlaes herself stops short of asserting that a laissez-faire approach would have been more successful than the one Franklin D. Roosevelt took. “We don’t know — because we weren’t there — what would have happened if they had left the market alone,” she said. Or, as she puts it in the book, “Of course Hoover and Roosevelt may have had no choice but to pursue the policies they did. They may indeed have spared the country something worse — an American version of Stalin’s communism or Mussolini’s fascism.”

Actually, we do know. All of the five major economies of the world started out the Great Depression pursuing for the most part the orthodox gold-standard non-New Deal policies of the 1920s. All five of them had fierce political debates about whether to switch to a "New Deal." All eventually switched to their own version of the New Deal--Japan and Britain in 1931, Germany and the U.S. in 1933, and France not until 1937. Japan and Britain recovered fastest and most completely; Germany and the U.S. were in the middle; and France was the worst. Odds are that had the U.S. "left the market alone" until the late 1930s--as France did--production and employment in the U.S. in the late 1930s would have been no higher than in 1932: that there would have been no recovery from the Great Depression at all.

But Coller and O'Connor can't be bothered to take the time to even interview those who say that the shape of the earth is round.

Michael Tomasky on How Newt Gingrich Has No Rightful Place in American Politics or Government


Michael Tomasky: Did an Obama judicial nominee really express a preference for Allah over Jesus?: From the second I read the sentence, I knew there was something fishy about it. Many years' experience in reading and then looking into rightwing canards set off the usual alarm bells in my head. So I know how these things work. But even I was shocked after I looked into the truth of the matter. My daily readings led me to an interview with Newt Gingrich in Christianity Today. The former speaker was asked whether opposition to tax increases was an adequate "uniting message" for his party. Gingrich replied that there had to be more to the party's story. For instance, he said:

You have Obama nominating Judge Hamilton, who said in her ruling that saying the words Jesus Christ in a prayer is a sign of inappropriate behavior, but saying Allah would be OK. You'll find most Republican senators voting against a judge who is confused about whether you can say Jesus Christ in a prayer, particularly one who is pro-Muslim being able to say Allah. That seemed, frankly, ridiculous. I happened to know that the "Hamilton" in question was from Indiana.... I also happened to know that "her" first name was David, so Gingrich could not get even this basic fact straight.... So I wanted to know more.... [A] search returned thousands of rabid posts from the wing-o-sphere about this judge who thinks Indianans should be allowed to pray to Allah but not to Jesus.... [E]ventually I found my way to... Hamilton's actual decision... Hinrichs v Bosma.... Naturally, it's all a lie, but as I said, even I was shocked at how rancidly despicable a lie it was....

Hamilton's decision is eminently calm and even-keeled... he relies on two decisions from the fourth judicial circuit... the country's most conservative.... Wynn v Town of Great Falls. The town council opened its meetings with a prayer that regularly mentioned Jesus Christ.... Not only did Hamilton rely on the country's most conservative federal circuit court, he specifically cited an opinion written by one of the most conservative jurists on that court. Judge J Harvie Wilkinson is always on the short list when a US supreme court seat opens up during a Republican presidency. But even Wilkinson wrote....

We cannot adopt a view of the tradition of legislative prayer that chops up American citizens on public occasions into representatives of one sect and one sect only, whether Christian, Jewish or Wiccan. In private observances, the faithful surely choose to express the unique aspects of their creeds. But in their civic faith, Americans have reached more broadly. Our civic faith seeks guidance that is not the property of any sect....

[H]ere's where the lie comes in... what did [Hamilton] say about Allah?... [T]he decision doesn't so much as mention Allah.... Read this paragraph, from page 49:

The Speaker has also suggested that such an explicit caution about Christian references "would be the first known religious viewpoint discrimination in connection with the Indiana House invocation."... The criticism is misguided. The decisive point of constitutional law is that a practice of sectarian prayer favouring any particular religion violates the establishment clause. From the evidence here, it is clear that the letters asking invited clerics to "strive for an ecumenical prayer" have not been sufficient to prevent many Christian speakers from using the prayer opportunity to advance and even to proselytise Christianity. The same strictures will apply to sectarian Jewish or Muslim prayers, for example. This record, however, shows no efforts by Jewish or Muslim clerics to use the prayer opportunity to advance their particular religions. At this juncture, there is no need to be more specific in the injunction as to what would amount to a sectarian prayer in those traditions.

The same strictures will apply!... [T]he wingers have taken the last sentence of this paragraph, yanked it completely out of context, and then taken the extra step (or two or three) of insinuating that of course, this kind of Godless heathen is exactly the sort of nominee you'd expect from a secret Muslim president....

I'd like to report that this is unusual, but this kind of slippery illogic is standard operating procedure on today's right. Find something that might inflame opinion and stoke prejudice, and pump it. Doesn't matter that it isn't really true. By the time the other side explains that it isn't true, we'll already have won. They know that no one's going to read page 49 of a legal opinion. As it happens this time someone did, but often, alas, they're right.

These are sick, sick people. May their Jesus consign them to history's ash heap.

Republicans Less Popular Than Venezuela

Chris Bowers:

Open Left:: Republicans Less Popular Than Venezuela: As part of my irregular series documenting unpopular stuff that is more popular than Republicans, (see Legalizing Marijuana more popular than Republicans, and Republicans less popular than China), new polling from CNN indicates that anti-American, oil-cartel, socialist block forming Venezuela is now viewed more favorably than the Republican Party.

Wall Street Journal Crashed-and-Burned Watch: Can't Anybody Here Play This Game? Edition

They publish Mark Penn, who writes:

America's Newest Profession: Blogging: It takes about 100,000 unique visitors a month to generate an income of $75,000 a year...

Ummmm... I get about a million page views a month all in all--which I think translates into about 100,000 unique visitors--and I make $3,000 a year off the weblog. It's a play in the intellectual influence game, a sounding board, a clippings file, and a loss leader.

The fact that Mark Penn is out without a keeper amazes me.

The fact that the Wall Street Journal is out without a keeper amazes me.

UPDATE: Mark Penn responds to critics:

As far as the $75,000, the Technorati report says that of those bloggers who had 100,000 or more unique visitors, the average income is $75,000. True, it's not the median, but it is the average. We can quibble about how easy it is to make this kind of money -- but the point is, the huge potential is there.

Words fail me. The innumerate stupidity--IT BURNS!!!! For the first time I understand the intonation with which senior economic advisers to Hillary Rodham Clinton in late 1991 said the words "Mark Penn."

Department of "Huh?"

Tim Geithner says:

tg-94: Treasury Secretary Tim Geithner Written Testimony: Congressional Oversight Panel: Currently, the vast majority of banks have more capital than they need to be considered well capitalized by their regulators...

I know that I was not pleased to hear that. The failure to assure us that the vast majority of bank assets are in well-capitalized institutions seemed to me to speak volumes. Nobody ever thought that the vast majority of banks are not well capitalized--it's the highly leveraged New York high flyers.

Yet the market liked it.

Kiran Stacey in the FT: / Markets - Financials rise as Geithner calms bank fears: US stocks rebounded on Tuesday as Tim Geithner, the Treasury secretary, allayed fears over the health of the banking industry. Mr Geithner told a congressional panel that “the vast majority” of banks had more capital than needed, which encouraged buyers to enter the market after Monday’s bruising sell-off, during which the financial sector dropped 11 per cent.

Citigroup picked up 10.2 per cent to $3.24, helped by comments from its chief executive Vikram Pandit that it would “repay every dollar” of bail-out money. Bank of America, which fell nearly 25 per cent on Monday following warnings in its results about deteriorating credit conditions, gained 9.2 per cent to $8.76...

Robert Solow Reviews Richard Posner

Robert Solow on the Current Economic Crisis, and Richard Posner:

How to Understand the Disaster: The plainspokenness I mentioned is what makes this book an event. There is no doubt that Posner has been an independent thinker.... [Yet] much of his thought exhibits an affinity to Chicago school economics: libertarian, monetarist, sensitive to even small matters of economic efficiency, dismissive of large matters of equity, and therefore protective of property rights even at the expense of larger and softer "human" rights. But not this time.... Here is one of several...

Some conservatives believe that the depression is the result of unwise government policies. I believe it is a market failure. The government's myopia, passivity, and blunders played a critical role in allowing the recession to balloon into a depression, and so have several fortuitous factors. But without any government regulation of the financial industry, the economy would still, in all likelihood, be in a depression; what we have learned from the depression has shown that we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails. The movement to deregulate the financial industry went too far by exaggerating the resilience—the self-healing powers—of laissez-faire capitalism.

If I had written that, it would not be news. From Richard Posner, it is. The underlying argument--it is not novel but it is sound--goes something like this. A modern capitalist economy with a modern financial system can probably adapt to minor shocks--positive or negative--with just a little help from monetary policy and mostly automatic fiscal stabilizers.... It is easy to be lulled into the comfortable belief that the system can take care of itself if only do-gooders will leave it alone. But that same financial system has intrinsic characteristics that can make it self-destructively unstable when it meets a large shock. One such characteristic is asymmetric information: some market participants know things that others don't, and can turn that knowledge into profit. Another is the capacity of financial engineering to produce securities so complicated and opaque....

In that kind of world, imagine a period of low interest rates. Once a set of profit opportunities is found, big operators will be tempted to borrow so that they can play with much more than their own capital, and thus make very large profits. This has come to be called "leverage.".... In the past, 10-to-1 leverage would have been about par for a bank. More recently, during the housing bubble that preceded the current crisis, many large financial institutions, including now-defunct investment banks such as Bear Stearns and Lehman Brothers, reached for 30-to-1 leverage.... Why did I do such a risky and, as it turned out, stupid thing? Well, it had worked in the past, and made a lot of money for many people. If I had backed off, others would probably have continued to make money for a while. I would have looked like a fool, and very likely an unemployed fool....

All those banks and others are now unwilling to lend to one another because they fear that the potential borrower is already broke and will be unable to repay. And so the credit markets freeze up and ordinary businesses that need credit for ordinary business purposes find that they cannot get it on any reasonable terms. This is what happened in September 2008 when the commercial paper market—--he market for daily business borrowin--ceased to work. The breakdown of the financial system exacerbates the recession....

I have deliberately kept this story stylized, omitting the juicy details... complicated derivative securities... greed, stupidity, and corruption. Posner does not ignore those things. They provide an irresistible target for amusement and contempt. I wanted instead to focus on the central role of leverage....

Posner starts the story, reasonably enough, with the period of easy money and low interest rates that began in 2001 as the Fed's normal response to the recession of that year, and lasted until the middle of 2004.... About 1.2 million private housing units were started in 1990, 1.6 million in 2000, and 2.1 million in 2005. Posner emphasizes the corresponding run-up in house prices, and he is right to do so. But the housing boom was not just a financial fact. By 2005 the country had clearly built many more houses, maybe two or three million more, than it could afford to occupy and finance. There would have been a housing slump in any case. We have had housing booms and slumps before, with consequences no worse than an interval of slow growth or a brief downturn.... What made this housing boom different, of course, was... mortgage-backed securities.... Moody's and Standard and Poor's were paid by the same institutions whose securities they were supposed to be judging.... To make matters worse, the fever spread to other assets: stock prices doubled in the five years 2003–2007. When the implosion came in 2007, enormous amounts of what had been perceived as wealth--true, eventually spendable wealth--simply disappeared.... Nothing concrete had changed. Buildings still stood; factories were still just as capable of functioning; people had not lost their ability to work or their skills or their knowledge of technology. But a population that thought in 2007 that they had $64.4 trillion with which to plan their lives discovered in 2008 that they had lost 20 percent of that....

Most commentary, at large, in Posner's book, and in this review, has been about how the financial collapse damages the real economy.It might be thought that somehow fixing the financial mess would automatically fix the real economy. That is not so, for at least two reasons worth mentioning. In the first place, all that vanished wealth cannot be restored.... Secondly, the restoration of credit flows is not just a matter of clarifying and strengthening the balance sheets of banks and other lenders. It takes two to make a loan: a solvent and willing lender and a credible borrower. In a deep recession, there are not enough credible borrowers....

There are other weaknesses in Posner's remarks on the real economy. For example, more than once he says that the various antirecessionary measures—like fiscal stimulus, bailouts—are very "costly" and "may do long-term damage to the economy." He does not explain what these costs and damages are. Sometimes he seems to have budgetary costs in mind. But bailouts are mostly transfers from one group in society to another, for example from taxpayers to financial institutions and their owners. They are certainly not ethically satisfying transfers, but it is not clear how they do long-term damage to the economy. The components of a fiscal stimulus package are costs to the federal budget; but to the extent that they put otherwise unemployed labor and idle industrial capacity to work, they do not impoverish the economy; in fact, they enrich it. (Of course, one would prefer useful projects to wasteful ones.) If fiscal stimulus works, even imperfectly, there is no doubt which way the benefit–cost ratio goes.

Posner is on much firmer ground in worrying about the very large increases in the money supply and in the interest-bearing public debt that are left behind by antirecessionary policy. Even there, we do not know how skillful and lucky the Federal Reserve will be at mopping up excess liquidity....

There is an even odder chapter called "A Silver Lining?" In it Posner flirts with the idea that a recession, even a depression, has a good side. It weeds out inefficient firms and practices. This is a little like saying that a plague is not all bad: it cleans up the gene pool. No doubt there is some truth to this idea of a purifying effect. But the notion that it could possibly compensate for years of lost output and lost jobs seems wholly implausible. There is certainly no calculation of economic costs and benefits behind the thought of a "silver lining."...

The Obama administration has been trying to inject enough clarity and capital into the balance sheets of banks so that they can resume providing credit for businesses and consumers. The job of regulatory reform has had to wait.... The financial system does have a useful social function to perform, and that is to make the real economy operate more efficiently. Some human institution has to collect a nation's savings and put them at the disposal of those who have productive ways to use them. Risks arise in the everyday business of economic life, and some human institution has to transfer them to those who are most willing to bear them. When it goes much beyond that, the financial system is likely to cause more trouble than it averts...

DeLong Smackdown Watch: Marx on India

Apropos of DeLong: Understanding Marx Lecture for April 20, 2009, Michael Perelman--whose knowledge of the history of economic thought far exceeds mine--takes exception to my classifying Marx's writings on the British in India as Marx in his "prophetic mode"

Michael Perelman: I have done some work on the subject. It was not Marx the prophet. The articles [on India] were directed toward Henry Carey, who was undermining Marx's position on the New York Tribune. The story is very interesting, including others, including Frederick Law Olmstead.

Marx says that Carey sent him at least one book. I have tried to locate Marx's correspondence with Carey, but have been unsuccessful.

I am not sure. When I read Marx's:

All the English bourgeoisie may be forced to do will neither emancipate nor materially mend the social condition of the mass of the people, depending not only on the development of the productive powers, but on their appropriation by the people. But what they will not fail to do is to lay down the material premises.... Has the bourgeoisie ever done more? Has it ever effected a progress without dragging individuals and people through blood and dirt, through misery and degradation?... The bourgeois period of history has to create the material basis of the new world... universal intercourse founded upon the mutual dependency of mankind... the development of the productive powers of man.... When a great social revolution shall have mastered the results of the bourgeois epoch... and subjected them to the common control of the most advanced peoples, then only will human progress cease to resemble that hideous, pagan idol, who would not drink the nectar but from the skulls of the slain...

I definitely hear the voice of Daniel and see the Great Social Revolution coming on clouds of glory...