Sunday, December 28, 2008

A Keynesian Moment

There is some talk that this is a "Keynesian moment" - meaning that it is a time where Keynesian theory should be implemented.  I think it is such a moment, but in a different sense - when the status quo theory and a generation of economists are discredited.  As pre-Keynesian economics was considered to be invalidated by the Great Depression, so current economics, the kind that praises unlimited free trade, free markets, and globalisation, will be rejected.

Economists aren't making things any better for themselves.   Brad Delong proposes to "drive a recovery" by giving everyone 500 000 dollars to buy a house.  A truly silly idea, no?  You would think he would get whacked from all sides. But no - we have another economist Paul Krugman linking to the post and applauding it.

Why oh why can't we have better economists?

Friday, December 19, 2008

The Fed - Why it will Fail, How it will Fail

Via Naked Capitalism, we learn that the Fed will now lend to hedge funds:

The Fed said on Friday it would offer low-cost three-year funding to any US company investing in securitised consumer loans under the Term Asset-backed Securities Loan Facility (TALF). This includes hedge funds, which have never been able to borrow from the US central bank before, although the Fed may not permit hedge funds to use offshore vehicles to conduct the transactions.

I have nothing against hedge funds per se, but this is sure to raise flags for members of Congress, as well as the public, especially after the Madoff fraud. Why then is the Fed so keen on doing it? Because it is now in exactly the same situation with credit-card debt, as it was with housing debt a year ago. It failed with housing debt, and it will fail with credit-card debt. The latter has reached unsustainable levels, it can't go on. But the Fed refuses to accept this fact, because it needs and wants to keep the American consumer spending. The Fed simply doesn't understand what "unsustainable" means and hopes that by mere force of will (Bernanke's "We will not stand down") it can keep the waves from crashing or force the horse to drink. While Krugman has compared Wall Street to a Madoff-like Ponzi Scheme, the real Ponzi Scheme is now being run by the Fed.

So how will it end? By a classic rush-to-the-exits, in a crowded theater where someone has yelled "fire". The Fed is putting lots of illiquid assets on its balance sheet, which it won't easily be able to get rid of, should the original owners default. It is effectively borrowing short - massively - and lending long - massively. This works until it doesn't. It works, as long as there is confidence that it work. There is confidence that it will work, so long as the participants think everyone else has confidence that it will work. It stops working when enough people decide they don't want to lend short any more. The confidence evaporates, the Ponzi scheme gets blown, and the exits are swamped.

Thursday, December 18, 2008

There Is Justice

In an idea straight from late-night comedy, Bloomberg reports that Credit Suisse is planning to pay some of its bonuses in toxic waste:

The bank will use leveraged loans and commercial mortgage- backed debt, some of the securities blamed for generating the worst financial crisis since the Great Depression, to fund executive compensation packages, people familiar with the matter said. The new policy applies only to managing directors and directors, the two most senior ranks at the Zurich-based company, according to a memo sent to employees today.

Well, bravo to the one at Credit Suisse who thought of this one. I just hope that, when used as a bonus, the waste is valued at the level Credit Suisse is carrying it on its books - no discounts permitted (although, of course, this can just be finagled by giving out more toxic waste).

Wednesday, December 17, 2008

The Logic Isn't There

Free exchange (via Economist's View) writes, in an entry called "The science isn't there:"

First of all, I know that we all consider economics a science, but as sub-fields go, macroeconomics is one of the least science-y. Among the reasons—too many variables, too small samples, no repeatable experiments, and so on. ...

Which is why it's important to have a good, qualitative model of the mechanisms involved to supplement the data analysis.

If I had been eating Corn Flakes, they would have been coming up my nose. Fortunately, not. So, after admitting there's no there for macroeconomics considered as a science, Free Exchange still thinks it's important to have a model. I don't think so. Models should help to make useful predictions; so models are relevant only in subjects which are scientific. Otherwise, they are simply a special type of crossword puzzle - perhaps useful for reflection, but irrelevant to the real world. Sure, economists like them, because they constitute a sort of private language which take time to learn and evaluate, and create a barrier-to-entry to non-economists. And so in a tawdry sense of "useful" - in the sense of keeping the riff-raff out - models may be useful in a non-scientific subject. But they don't improve our knowledge of the real world - because a subject which is not a science cannot.

Tuesday, December 16, 2008

The Rush to Stimulus

There was a rush to war five years ago. A crisis was created, an urgency was declared, action came before thought , and - the Americans messed it up completely.

The Americans are at it again. They are trying to badger foreign governments into stimulating their economy through massive deficit spending because - well, because they can't think of anything else to do, and they imagine that it is better to keep pedaling and risk hitting a wall than fall off straightaway. It's part of the short-term philosophy of life that has sent Americans to the mall and living off their credit cards. The threat of government default doesn't worry them, not because it shouldn't, but because it seems to far-off in the future, and one more trip to the casino beforehand, after all, might save them.

When the Iraq War was being discussed, there was much talk of American "hard power" versus European "soft power." I was always a bit skeptical about this as a distinction, because the Americans are just as expert at soft power as the Europeans, if they only put their mind to it. Case in point, would be the determined Anglo-Saxon media campaign against the Germans, who are resisting going off the deep end and spending money for the sake of stimulus. This is from a Bloomberg article entitled Merkel’s Popularity Sinks on Handling of Crisis, Poll Shows":

Chancellor Angela Merkel’s popularity slumped last week amid criticism that the leader of Europe’s biggest economy is doing too little to stem the country’s slide into recession, a poll showed.

Asked whom they would vote for if the chancellor could be elected directly, 47 percent named Christian Democrat Merkel, compared with 51 percent a week ago, according to a Forsa poll for Stern magazine and RTL television.

That’s still 22 percentage points ahead of Social Democrat Vice Chancellor Frank-Walter Steinmeier, who garnered 25 percent support, 2 percentage points more than a week earlier, Stern said in an e-mailed statement.

Merkel’s declining popularity may reflect criticism that the chancellor is lacking determination to fight the economic downturn. Nobel Prize-winning economist Paul Krugman told Spiegel magazine that Merkel is “misjudging the severity” of the crisis and “wasting precious time.”

Merkel’s declining support may be rubbing off on her party. The Christian Democrats fell 1 percentage point to 37 percent and the pro-business Free Democratic Party, her preferred ally, rose 1 point to 13 percent.

The combined total of 50 percent, maintained for a third week, would still allow the CDU and FDP to form a coalition government if replicated in national elections in September 2009.

So Merkel lost 4 percentages in a week, her party lost 1 point, and her coalition stayed steady - and Bloomberg ties it to her resistance to a stimulus package because at the same time, Herr Krugman told Spiegel he wasn't happy with her. On the contrary, I would say that Merkel understands much better than Krugman the severity of the crisis, and how important it is to keep some money in the till to help people when they need it, two or three years down the road, rather than frittering it away in a go-for-broke strategy based on a failed economic ideology.

What, may I ask, is Krugman's exit strategy?

Saturday, December 13, 2008

Is Deflation Inevitable?

London Banker (via Naked Capitalism) writes: "The result of discouraging domestic and foreign creditors and investors must be inevitable deflation as debt levels become increasingly hard to finance and ultimately contract."

Surely the U.S. can do what Zimbabwe is doing - and Zimbabwe is not encouraging domestic and foreign creditors and investors? So deflation is not inevitable; it depends on choices that the U.S. government and federal reserve make, from hereon in. Maybe we'll get deflation; maybe we'll get deflation then inflation; maybe we'll get inflation then deflation. But I don't think any is inevitable, at least not yet.

Tuesday, December 9, 2008

Brad DeLong Watch - A Posteori Predictions

My son had a team assignment in school recently. The team had to choose some stocks and then track them. There wasn't any reward for selecting the best performing basket, but still, at the second meeting, the team felt obliged to replace surreptitiously one of their stocks with another, which had gained 15% the previous day. Pride, after all, incites as much as greed.

I am reminded of that when thinking of Calculated Risk's challenge to economists to "do some serious soul searching" and write a post why they were wrong about the housing crisis.  Not too many have accepted the tossed-down gauntlet.  Most economists, it seems, prefer to think that part of the job description is never having to say they're sorry.   Brad DeLong is to be commended for having at least taking the challenge seriously enough to provide a reply.

Sadly, he fell guilty to exactly the same temptation that my son's team did.  He wrote:
Let me say what things I was "expecting," in the sense of anticipating that it was they were both likely enough and serious enough that public policymakers should be paying significant attention to guarding the risks that it would create:
(2) A fall back of housing prices halfway from their peak to pre-2000 normal price-rental ratios.

Wow! A halving of housing prices! That's some foresight. Only, if you check previous posts, Brad DeLong sang a different tune. In December 2007, in reply to a Krugman blog entry which said housing prices had "a long, long way down" to go, he wrote:

"A long, long way down" means, I think, "a fifty percent fall along the coasts."

I would cut that in half for two reasons: not 50% but 25% along the coasts, and much less in the interior. First, the likelihood that savings interested in being invested in the secure-property U.S. will be ample over the next generation is high: we will sell political risk insurance to foreign individuals and governments for quite a while yet. So real interest rates are likely to be lower in the past. Second, the zoned zone is not growing--and America's population still is. The gap between heartland and coastal values is likely to grow over time, and that anticipated capital gain should push up prices now.

Perhaps that was a slip of the tongue? No. Here is he again in April 2008:

That [a decline in home prices, back to more or less their pre-bubble inflation-adjusted levels] strikes me as too pessimistic. The rise of Asia and the resulting demand by the rich and by governments for U.S. assets to hedge political risk is likely to keep savings glutting for decades. We aren't buiding more superhighways, there are no major transportation improvements on the horizon, America is filling up, and so land-value gradients are on the rise. If the income distribution continues to erode, we will wind up with higher prices for scarce positional goods--chief among which is location, location, location.

My guess is that we will ultimately give back half of the doubling...

Half of the doubling means, yep, -25% off the peak.

Am I being too hard on Professor DeLong? Almost surely. He did, after all, qualify his "halfway" remarks by saying he thought it was something that needed to be anticipated, not something he thought was going to happen. And he did, as I said, answer Calculated Risk's challenge; kudos to him for at least realizing the question was important. It is not really him, but the others who are silent, for whom we should ask, "Why oh why can't we have better economists?"

Saturday, December 6, 2008

The First Thing We Do

There was a cute story on Bloomberg yesterday, which doesn't seem to have made it online, entitled "Greenwich Hedge Fund Guy Laments Era of Greed," about a party in Greenwich where the guests railed about bankers. It included this choice line:

"The lawyer [at the party] even asserted that all bankers should be shot."

We are truly in uncharted territory when a lawyer can take the moral high road and ask that members of another profession be shot.

Thursday, December 4, 2008

Seling off the Family Silver

Chicago has sold off rights to its parking meters - for 75-years.  In return, it will receive 1.2 billion Usd, which it will use to balance the city budget until 2012, a grand total of 4 years.  This is on top of other assets, which have been sold to raise money in the past few years, such as the Chicago Skyway motorway.

It would seem that Chicago needs to raise taxes or cut services, since there's only so much family silver left to be sold. Making up for a chronic budget shortage, by selling assets is not a solution. What's next?  Sell the right to the sales tax?  The property tax?  

I would have hoped that the economic crisis had damaged the idea that the private sector has an added value compared to the government, and would stymie the march to offload government operations onto the private sector.   Apparently not.

Tuesday, December 2, 2008

Will the Last one Who Leaves...Pay the IMF?

From Bloomberg:
About half of Icelanders aged between 18 and 24 are considering leaving the country, Reykjavik-based newspaper Morgunbladid said, citing a survey of 1,117 people between Oct. 27 and Oct. 29.

“Tens of thousands” will depart, estimated Jesper Christensen, chief analyst at Danske Bank A/S, the biggest lender in neighboring Denmark.
Since the population is only 300 000, that's a pretty big percentage leaving. And since it's the Iceland nation which now owes 4.6 billion dollars to the IMF, that's even more that each man, woman, and child left behind will have to pay.

Which leaves me wondering, what happens if everyone emigrates?  Who pays back the loan then?