Emi Nakamura and Jon Steinsson: "Fiscal Stimulus in a Monetary Union: Evidence from U.S. Regions"
A Note on the Federal Reserve Dissenters’ Extremely Strange Supply-Side Logic

Over at Crooked Timber, Daniel Davies Turns into an Internet Troll...

…by defending his profession against the charge of wrecking the global economy.

Daniel Davies:

But who’s the real criminal? It’s me, isn’t it?: Joris Luyendijk.. has made at least one major discovery: People in the Guardian comments section really, really hate bankers….

I’ve got a Twitter account and some spare time, and as a result, have been collecting[1] prime specimens of banker abuse. So far, I’ve gathered that I, personally, have stolen from every single benefits claimant in England, and that Sir Fred Goodwin (crime: got a big pension, managed a bank poorly) is clearly a bigger criminal than Sir Anthony Blunt (crime: betrayed dozens of serving agents to Stalinist Russia). And, of course, during the recent London riots, dozens of variations on “who is the real criminal – the man who smashes a shop window and steals an iPod, or the man who gets paid a bonus?”

Because, at the end of the day, Dr Harold Shipman murdered 52 infirm old women in order to steal money from their wills, but bankers, get bonuses. Who is the real criminal, eh??

It is without any anticipation of popularity or agreement (or even any real hope of not being called an asshole on my own blog, although I must say that would be jolly nice if you were in the mood) that I tell you that I think this is all rather a pack of bollocks….

Macroeconomic events have macroeconomic causes, not microeconomic ones. Bad, stupid products[2] like Option ARMS or subprime buy-to-let teaser mortgages, were not invented by the industry out of sheer cackling evil; they were invented because they were the only way to get the people into the houses, given how expensive property had become. This was, as Dean Baker keeps reminding us, a housing bubble first and foremost and a financial bubble second; we are in a recession basically because of the disappearance of a huge amount of household sector wealth.

How expensive property had become … this is one that I’d like to linger on, because it rather points out that the number of people who a) benefited from and b) causally contributed to, the bubble and bust is rather bigger than you might think….

[M]aking a big deal about “the bankers caused this crisis/stole from us/etc” is a big mistake. And that’s basically for the simple reason that there is no hope for egalitarian politics if you are going to build it on such weak grounds…. The demands of egalitarian justice are not based in some convoluted proof that the rich have in some way stolen from the poor. The case for redistributive taxation does not rest on bankers’ bonuses being stolen goods, or even on them being undeserved. If you try to agitate for egalitarian policies based on this kind of argument, you are never going to make a strong case, because in the first place, “bankers” didn’t actually steal that money, for the most part, and secondly, if you are giving all the agency to “bankers” then you are accepting the first premis of the “wealth creators” rhetoric, and this is going to destroy you, politically, across the business cycle…. Money for the banking sector bailouts hasn’t come out of the mouths of babes and Sure Start centres; the austerity measures were a specific and separable decision, made by people who ought to be held accountable for it.

So my basic message here is that economics isn’t a morality play, even in the face of a depression. Even morality isn’t a morality play, most of the time. I wasn’t actually responsible for the housing crash and nor were most of my mates. We didn’t close down your local library or put your student fees up; that was the coalition government who did that. In general, if you want to build a better society, the message from the more thinking and socially responsible element of the financial sector is “send us the bill and spare us the lecture”.

Alas! I think that the bankers did do it.

FRED Graph  St Louis Fed 97

Lets start at the height of the U.S. housing boom in 2005:III, when residential construction reached its peak value as a share of potential GDP. At that moment it dawned on lenders that Option ARMS and subprime buy-to-let teaser mortgages were really not the best businesses to be in, and it dawned on potential borrowers that Option ARMS and subprime buy-to-let teaser mortgages were really not the best financial liabilities to assume--especially because they came bundled with an overpriced house. So after 2005:III the U.S. residential construction sector began to shrink. And it shrank, and shrank, and shrank. By the end of 2007--a little over two years later--it was down by 2.5% of potential GDP as housing prices fell and mortgage financing dried up.

But had the economy slid into recession? No. As residential construction stood down, exports stood up. Foreigners earning money from selling imports to the U.S. no longer invested their earnings in MBSs. Instead, they bought exports from the U.S. Residential construction down by 2.5% of potential GDP, exports up by 1.9% of potential GDP--the market economy was doing fine. It was rebalancing in response to a shock to fundamental expectations just as Jean-Baptiste Say would have said it ought to back in 1803. And Friedrich Hayek's claim--the claim of the entire Marx-Mellon-Hoover-Hayek axis, in fact--that a speculative bubble orgy like 2004-2006 was a sin that had to be paid for in blood and pain and fire and unemployment? Wrong, up until the end of 2007.

FRED Graph  St Louis Fed 97 1

But what happened in the two years after the last quarter of 2007? Housing construction continued its decline, even though at the start of 2008 it was plausible and by the end of 2008 it was undeniable that the housing bust had been sufficiently long and deep to erase any Hayekian overbuilding of residences. And throughout 2008 equipment investment and exports fell off the cliff, gradually at first and then at a stunning pace.

Why did they do this? It wasn't because, as Daniel claims, of "the disappearance of a huge amount of household sector wealth. It did disappear. But wealth had disappeared before--remember Black Monday on the stock market in 1987, or the collapse of the dot-com boom?--without it triggering a Lesser Depression. It was because people recognized that banks that were supposed to have originated-and-distributed mortgage-backed securities had held on to them instead, that as a result a large chunk of the $500 billion in subprime losses had eaten up the capital base of highly leveraged financial institutions, and that you were running grave risks if you lent to a bank. The run on the shadow banking system that followed was the source of the crash as financing for exports and for equipment investment vanished, and then the whole thing snowballed.

No banks losing track of the risks they were running and holding on to assets that were supposed to be originate-and-distribute, no financial crisis, no credit crunch, and no Lesser Depression. The housing bubble would have deflated, unemployment would now be near 5%, exports would have boomed, and our biggest worry right now would probably be a "weak dollar".

Instead, I somehow find myself in this strange alternate universe...