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?"

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.

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.

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?

Depression Economics

A spectre is haunting the world - the spectre of Depression.  With it depression economics is at hand, as economists dust off their textbooks and look for lessons from the Great Depression.  And what is depressing, is how little economics know, and how little economists are willing to admit it.

It would seem that every Anglo-American economist believes that a big stimulus is needed, to get the economy moving.   In America we are to spend upwards of 1 trillion dollars -  a huge sum.

Now when you are about to spend a truly important amount - money which the American nation does not have - it would seem that there should be some evidence that it will do what one wants.  Is there any evidence that stimulus really gets a nation out of depression?  That is, economists have a model which shows that it does.  Is there evidence from the real world that shows this model is valid?

Paul Krugman writes:  

"Some readers may object that providing a fiscal stimulus through public works spending is what Japan did in the 1990s—and it is. Even in Japan, however, public spending probably prevented a weak economy from plunging into an actual depression."

So, apparently the real world did not do what the models said stimulus should have done.  And Krugman's answer is:  but our models show that things would have been even worse.    Of course they would - if your models tell you to do something, and you do it, then no matter what really happens, your models will tell you that things would have been worse had you not done what you did.  That's what models do.  But what is still lacking is confirmation of the model by reality.  

Well, didn't at least the Great Depression prove that Keynesian stimulus worked?   Let's quote Krugman again:

Now, you might say that the incomplete recovery [of the American economy in the late 1930s] shows that “pump-priming”, Keynesian fiscal policy doesn’t work. Except that the New Deal didn’t pursue Keynesian policies. Properly measured, that is, by using the cyclically adjusted deficit, fiscal policy was only modestly expansionary, at least compared with the depth of the slump.

Okay, fair enough, but then why do we know that Keynesian fiscal stimulus works? Again Krugman:

What saved the economy, and the New Deal, was the enormous public works project known as World War II, which finally provided a fiscal stimulus adequate to the economy’s needs.

Now there are many things I would call World War II, but one of them would not be a "public works project".   In World War II, we weren't building bridges; we were building weapons  and bombs to blow up other peoples' bridges.  But with World War II, the U.S. got lucky; it won the war, and ended up with half of the world's productive capacity.  People often say military spending is non-productive.  But World War II was an exception, at least for America.  All that military spending turned out to be productive, indeed exceptionally productive, a truly wonderful investment on the dollar - for America at least -, because it was used to wipe out the competition.  

So, if World War II is the example in the real world that Krugman thinks corroborates the model of Keynesian stimulus, then it would seem that it was a very particular case, and that other, unique factors could have played a role.  England, for instance, had the same war stimulus, but endured rationing until 1954.

But let's quote Krugman a fourth time

We can argue about whether that's always true, but in times like these, it definitely is. The quintessential economic sentence is supposed to be "There is no free lunch"; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work.

Yes, mass unemployment defines a depression, and it would be better for the unemployed to be doing something productive, rather than nothing. But surely the devil is in the details: "if we can only figure out how to get our hands on it." Krugman doesn't explain how we are to get our hands on it. He doesn't even consider the ontological question: can we get our hands on it?  All we get is hope.  Hope that stimulus will work.  But hope is crappy policy.

I'm not opposed to all economic ideas.  Just the dumb ones.

Note to Obama: Make this Illegal

This is how it begins (from Bloomberg):

The three-member county commission [of Dauphin County, Pennsylvania] voted in August to approve two “range accrual swaps” with Deutsche Bank AG, according to minutes of the meeting. The interest-rate swaps, which involve $42 million of fixed-rate debt, guarantees Dauphin County $816,000 the first year and then wagers taxpayers’ money that short-term interest rates beginning in September 2009 won’t exceed 7 percent. Those rates are 2.2 percent now.

“It’s a way for us to raise revenue for the county,” said Chad Saylor, chief of staff to the county commission. “The only source of revenue we have, much like the school districts here, is the property tax.”

And this is how it ends (today from the WSJ):

Looming large among the reasons the [Massachusetts Turnpike] authority needs the cash are three "interest rate swap" contracts related to the Big Dig that were sealed with UBS AG, Lehman Brothers Holdings Inc. and J.P. Morgan Chase & Co. The deals have gone wrong for the state, adding to its interest burden and confronting it with up to $467 million in potential fees if the firms opt to pull the plug on the
contracts.

"Did anyone know what they were doing?" asks Alan LeBovidge, who walked into the mess a year ago when he became the Turnpike Authority's executive director. Maybe, he says, his predecessors "should have been nice and conservative. It's like going to Las Vegas."

Note to any public official: do not do interest rate "swaps" which have options or knock-ins or knock-outs embedded in them.  If you think you're "raising revenue", think again.  At best you will lose money.  And on average you will lose a lot of money.    You don't know how to evaluate the value of the embedding, and, even if you did know how, you don't have access to the parameters you need in order to be able to do it.  Investment banks have access because they spend time and resources to follow the market and know what volatilities and correlations are actually worth.   And they know what looks good to you, like a fish eying a worm, and how much commission they can hide in their structure.  (Hint:  it's more than you can imagine.)    

Since no public official is likely to heed such advice, here's some more, to some other public officials:  if you are able to legislate or prevent state or town or county officers from entering into such contracts, then do so.  Public officials should be limited to borrowing money with fixed interest rates.  Bonds or loans.  It's not sexy, but it will prevent government agencies from losing the taxpayer's money at the dog races where the betting is run by the mob.

Rogue Trader

What does a nation do when the head of its central bank becomes a rogue trader? From Wikipedia:

A rogue trader is an authorised employee making unauthorised trades on behalf of their employer. It is most often applicable to financial trading, and as such is a term used to describe persons - professional traders - making unapproved financial transactions. This activity is in the grey area between civil and criminal illegality for the reason that the perpetrator is a legitimate employee of a company or institution, yet enters into transactions on behalf of their employer without permission.

Bernanke is out of control.