Category: Economics

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Criticism Financial Crisis Holy Cross

Profiling Holy Cross Grad Mark Walsh

Devin Leonard for the Times wrote this weekend about Mark Walsh, formerly of Lehman Brothers. The article portrays him as one of Wall Street’s top deal makers whose decisions were one of the major factors that led directly to the fall of the bank. Yet the article is also strangely positive in describing Walsh. 

What stood out for me most were the numerous connections Walsh has to me. As the article describes his brief biography:

Mr. Walsh grew up in Yonkers, the son of a lawyer who once served as chairman of the New York City Housing Authority. He attended Iona Preparatory School in New Rochelle; the College of the Holy Cross, where he majored in economics; and, finally, the Fordham University School of Law.

And then a bit later:

He bankrolled Tishman Speyer in its purchase of the Chrysler Building in 1997.

I am a fellow alumnus of Holy Cross – a fact which by itself causes me to be irrationally positive about individuals, from Chris Matthews to Bob Cousy to Obama speechwriter Jon Favreau. He also went to Fordham Law – which is one of the schools I am considering. And I currently work in the Chrysler Building. All tenuous connections, but enough to make me root for the guy.

Of course, it’s hard to get around the damning nature of this reporting:

[I]t wasn’t long before Mr. Walsh found a way to do an even bigger deal with Mr. Speyer’s company. In May 2007, Lehman and Tishman Speyer offered to buy Archstone-Smith Trust, a $22 billion deal struck at the peak of an already dangerously frothy market. Tishman Speyer put up a mere $250 million of its own equity. Lehman, in a 50-50 partnership with Bank of America, put up $17.1 billion of debt and $4.6 billion in bridge equity financing.

The most enlightening aspect of the article were the way in which it spotlighted the oddness of what was going on. Leonard describes one of Walsh’s biggest clients pulling out his money saying that:

 [T]he real estate market — and, indeed, the entire financial system behind it — was becoming increasingly bizarre.

In an example of this from 1997 – well before this observation – Leonard describes one of Walsh’s coups – how he managed to steer Lehman clear of the financial crisis resulting from the failure of Long Term Capital Management that Nassim Nicholas Taleb had predicted at the time:

On the eve of the financial crisis brought by the near collapse of Long Term Capital Management in 1998, Lehman flushed $3.6 billion in commercial real estate loans through its securitization machine, avoiding some of the losses that crippled other firms, including Nomura and Credit Suisse.

I hate to say it – but I have no idea what that means. And that’s not unintional – at least according to a lecture given by Financial Times reporter Gillian Tett at the London School of Economics. (A lecture very much worth listening to – and which I will blog about later.)

But to demonstrate the oddly positive take on Walsh, here’s how Leonard concludes his piece:

His friends say they believe that Mr. Walsh will eventually emerge from the rubble of Lehman’s collapse and return to deal-making.

“Guys like this are very rare,” says Mr. Rosen, the developer. “He’ll be back. He picked up the phone and people listen. Nobody can take that away from him.”

Back in the game perhaps – but hopefully a bit wiser.

Categories
Criticism Economics Politics The Opinionsphere

Taxing the Wealthy

[digg-reddit-me]Liberal orthodoxy has made the state dependent on a volatile source of revenues – high income tax rates on the wealthy.

That’s George Will in his most recent column. As phrased, I’m not sure it makes sense. A tax rate is not a source of revenue. A tax is. And while an income tax rate can be volatile – that doesn’t seem to be Will’s point – it is that the revenue generated from the tax is. So, let me correct Mr. Will:

Liberal orthodoxy has made the state dependent on a volatile source of revenues – taxes paid by the wealthy.

Now, I won’t argue about the volatility of any financial strategy based on depending on just a few individuals to generate revenue. 

But let’s pose a hypothetical for a moment. What if those that made over $200 million were taxed at a lower rate than everyone else – let’s say 18% – and those who made less than $100,000 were taxed at a 35% rate. And what if – even given this, the revenue generated from taxing those making over $200 million far exceeded the vast majority who made less.

Wouldn’t that complicate things just a bit?

And now, what if it were true?

The stats here are national – not based on California which Will is talking about. And there are only concerning the top 400 taxpayers who despite being just over 1/one millionth of the population, pay nearly 2% of all income taxes. But based on my previous research, I’m pretty confident the pattern holds – that those at the top of the income scale pay a lower rate of taxes than those at the bottom (Warren Buffett famously explained that he was taxed at a lower rate than his secretary)  – and yet because wealth and income is so concentrated in America, the richest 5% pay about 60% of all taxes.

Volatility is built into any system in which wealth is concentrated – which is why I’m not sure Will’s point here is well-founded. What does he suggest is a more stable type of taxation? If wealth were distributed more broadly, then our economic system – and tax revenues  – would undoubtedly be more stable – but I doubt this is what Will wants. If consumption were taxed rather than income, then the system would likely be even more unstable – especially in a downturn such as now when everyone is cutting back. So, what is the solution?

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Barack Obama Domestic issues Economics Financial Crisis History Politics The Opinionsphere

The Value of a Safety Net

Jean Edward Smith points out the obvious yet neglected truth about Franklin Delano Roosevelt’s achievements:

The safety net provided by the New Deal allows time for government to move deliberately.

This is one of the extraordinary things about the legacy of FDR – that even as the nature of the state itself has changed significantly since he was president, the institutions he created still serve some – if not the same purpose – as they did back then.

Today, the safety net created by Roosevelt is an essential stabilizing factor in our society – on the order of regular elections, a civil society, a judiciary, a balance of powers. 

The initial intention of these social safety net programs was consisent with the nation-states of the day, as they competed to see who could provide a minimal standard of living for various at risks groups – such as the elderly and the poor. But today it is far more useful as a stabilizing factor allowing businesses and government officials and individuals adequate time to respond appropriately to financial crises.

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Economics Financial Crisis The Opinionsphere

Theories of the Financial Crisis: Misjudging Risk

[digg-reddit-me]The bankers – whose enormous salaries were earned based on their skills at judging risk and making money – caused a financial cataclysm because they disastrously misjudged the riskiness of the complex financial instruments they created and sold.

This was the lesson I learned in the immediate days after the financial crisis – and it still explains a great deal of what happened. (Of course, there was also a good deal of outright fraud and the perversity of short-term incentives in which bankers could profit exorbitantly if they made profits regardless of how their investments turned out over the long-term.)

Cognitive errors may have contributed to the misjudging of risk. Megan McCardle for example gave a compelling description of different cognitive errors which contributed to the financial crisis – including the recency effect which she describes:

People tend to overweight recent events in considering the probability of future events.  In 2001, I would have rated the risk of another big terrorist attack on the US in the next two years as pretty high.  Now I rate it as much lower.  Yet the probability of a major terrorist attack is not really very dependent on whether there has been a recent successful one; it’s much more dependent on things like the availability of suicidal terrorists, and their ability to formulate a clever plan.  My current assessment is not necessarily any more accurate than my 2001 assessment, but I nonetheless worry much less about terrorism than I did then.

These cognitive errors were so damaging because they were programmed into the models for minimizing risk that the “quants” created to divvy up mortgages and just about everything else that could be bought and sold. 

Michael Osininski tried to claim some share of the blame in a recent New York magazine article – as one of the top “quants.”  Osininski described how he had an inkling of the disaster ahead:

[T]he world I had helped create started falling apart. I hadn’t anticipated it, but at the same time, nothing about it surprised me.

Last month, my neighbor, a retired schoolteacher, offered to deliver my oysters into the city. He had lost half his savings, and his pension had been cut by 30 percent. The chain of events from my computer to this guy’s pension is lengthy and intricate. But it’s there, somewhere. Buried like a keel in the sand. If you dive deep enough, you’ll see it. To know that a dozen years of diligent work somehow soured, and instead of benefiting society unhinged it, is humbling. I was never a player, a big swinger. I was behind the scenes, inside the boxes. My hard work, in its time and place, merited a reward, but it also contributed to what has become a massive, ever-expanding failure.

Jordan Ellenberg described how these models that purported to minimize risk actually just compressed the risk into “one improbable but hideous situation” in a manner similar to that of the 400 year old sucker bet, the Martingale. For example, Wall Street bankers combined hundreds of mortgages into securities in the belief that while some of the mortgages might default – most would not. The more mortgages you combined, the safer the investment was – as only a small percentage of mortgages typically defaulted. Unless something went very wrong. Comparing Wall Street bets to the Martingale, Ellenberg described the bet Wall Street was making:

(0.99) x ($100) + (0.01) x (catastrophic outcome) = 0

Wall Street bankers thought that the collective assets they were trading were worth $99 each in this estimate – rather than $50 as they would be if each asset were judged individually. 

One of the few people who saw this misjudging of risk as the inevitable cause of a financial crisis was Nassim Nicholas Taleb who wrote that Wall Street had consistently ignored the possibility of what he called “Black Swans” and what Ellenberg described as an “improbable but hideous situation.” Taleb has placed a great deal of blame on the mathematical models used by the quants and on the hubris of the bankers and traders who believed that they were created wealth when they were instead building an elaborate house of cards.

While he was running his own hedge fund in the 1990s, he turned his own knowledge of his lack of knowledge – and others’ lack of knowledge – into enormous profits. It came at the expense of losing a little money 364 days of the year – but making enormous profits in that one remaining day. He would bet on market volatility – which he understood financial firms repeatedly underestimated.

Taleb was castigating Wall Street barons for years as they hubristically bet greater and greater sums of money – making leveraged bets that the market would continue to rise.

Taleb’s key insight is that we know very little of the world itself – and will be more often fundamentally wrong than right. The example he uses is the Black Swan as described by David Hume:

No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.

This fundamental unknowability of the world must inform our actions, and perhaps points to some solutions. Taleb himself recently wrote a list of steps we should take to create a world more resistant to Black Swans. But his overall philosophy insists that we must attempt to resolve this crisis by tinkering with different solutions, and seeing what works, while being mindful that our actions will inevitably have consequences we do not imagine. And remember – at any point – a black swan could come around and reshape our world suddenly – as 9/11 did, as the assassination of the Archduke Ferdinand to start World War I, as did the invention of the personal computer, as has this financial crisis. The solution will not come from our determined application of fixed ideas, but by our openness to the possibility that we may be wrong, even as we are determined to act. We must see the shades of gray and acknowledge that we do not fully understand the world, yet still act – tinker, if you will. 

In this, Taleb seems to have reached a philosophical end point similar to the famous libertarian economist Friedrich Hayek who in his Nobel Prize speech explained that “we needed to think of the world more as gardeners tending a garden and less as architects trying to build some system.”

To tinker, to garden, to nudge – all of this points to a more modest liberalism, a market-state liberalism.

[Image courtesy of robokow licensed under Creative Commons.]

Categories
China Economics Financial Crisis

Theories of the Financial Crisis: The Chinese-American economic imbalance

[digg-reddit-me]John P. Judis summarized this theory of the crisis in The New Republic, “Economists know the fatal flaw in our system – but they can’t agree how to fix it.” Judis described how America has relied for decades on a “tortuous financial arrangement that knits together its economy with those of China and Japan”:

This informal system has allowed Asian countries to run huge export surpluses with the United States, while allowing the United States to run huge budget deficits without having to raise interest rates or taxes, and to run huge trade deficits without abruptly depreciating its currency. I couldn’t find a single instance of Obama discussing this issue, but it has been an obsession of bankers, international economists, and high officials like Federal Reserve Chairman Ben Bernanke. They think this informal system contributed to today’s financial crisis. Worse, they fear that its breakdown could turn the looming downturn into something resembling the global depression of the 1930s…

China depends on exports to the United States, and the United States depends on capital from China. If that special economic relationship breaks down, as it seems to be doing, it could lead to a global recession that could morph into the first depression since the 1930s.

Judis’s article seems to rely heavily on the analysis of Nouriel Roubini wrote most prolifically on this subject and predicted this system was approaching a crisis point in 2006. In a paper written with another prescient economist Brad Setser, Roubini pointed out the instability inherent in a system in which:

The US absorbs at least 80% of the savings that the rest of the world does not invest at home….[And] Social peace in China comes at the expense of political peace in the US.

Historian Niall Ferguson pointed the historical anomaly this represents as:

Usually it’s the rich country lending to the poor. This time, it’s the poor country lending to the rich.

Mark Landler explained the dynamic at work – and how it led to the current crisis – in a New York Times piece that was part of that newspaper’s “The Reckoning” series looking in depth at issues that led to the crisis:

In the past decade, China has invested upward of $1 trillion, mostly earnings from manufacturing exports, into American government bonds and government-backed mortgage debt. That has lowered interest rates and helped fuel a historic consumption binge and housing bubble in the United States…

By itself, money from China is not a bad thing. As American officials like to note, it speaks to the attractiveness of the United States as a destination for foreign investment. In the 19th century, the United States built its railroads with capital borrowed from the British.

In the past decade, China arguably enabled an American boom. Low-cost Chinese goods helped keep a lid on inflation, while the flood of Chinese investment helped the government finance mortgages and a public debt of close to $11 trillion.

But Americans did not use the lower-cost money afforded by Chinese investment to build a 21st-century equivalent of the railroads. Instead, the government engaged in a costly war in Iraq, and consumers used loose credit to buy sport utility vehicles and larger homes. Banks and investors, eagerly seeking higher interest rates in this easy-money environment, created risky new securities like collateralized debt obligations.

“Nobody wanted to get off this drug,” said Senator Lindsey Graham…

As Chinese money flooded into the American market, it created bubbles in which prices were inflated.

The primary beneficiaries of these bubbles were the economic elite whose jobs were not being outsourced or undercut by Chinese manufacturing and who owned stock, housing, or other assets which increased in value due to the added funds sloshing around in the financial system.

The American government similarly benefited from this Bretton Woods II as they were able to engage in wars, increase domestic spending, and lower taxes all at the same time – all without paying a higher interest rate on their deficit spending.

Financial firms made huge amounts of money as the inflow of the world’s savings bid up the prices of the assets they were buying and selling – and of course, they took the first cut of any profits from the sales – and assessed numerous fees for whatever it was they were doing. With an excess of capital, borrowing is cheap – which allows firms to make massive leveraged bets – also increasing their profits as well as their risk of being wiped out.

Lower wage workers benefited to a lesser extent as cheap Chinese goods – especially as sold by Wal-Mart – increased their buying power even as their wages stagnated over the past decade. Coupled with the easy credit resulting from the excess of money in the financial markets, the majority of workers were able to approximate a rising standard of living even as their wages stagnated – undercut by competition from abroad.

Until now – as this whole house of cards is falling apart. 

China is hoping the solution is to jump start it’s own domestic consumption – which might be difficult due to a wariness on the part of many Chinese about their future prospects: 

China kicked off its own campaign to encourage domestic consumption, which it hoped would provide a new source. But Chinese save with the same zeal that, until recently, Americans spent. Shorn of the social safety net of the old Communist state, they squirrel away money to pay for hospital visits, housing or retirement.

This accounts for the savings glut identified by Mr. Bernanke.

The way things are going now – it seems we’re screwed unless the Chinese people stop being so responsible thrifty and start spending like drunken American sailors. A paradox of thrift indeed.

—–

It should be noted that while I – and most of the authors I cite – specifically talk about the Chinese-American relationship, the points being made apply to East Asia in general – especially Japan which has contributed to the imbalance nearly as much as China.

Continue reading “Theories of the Financial Crisis: The Chinese-American economic imbalance”
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Economics Financial Crisis Humor Videos

The Not Incredible Adventures of the Down and Out Dollar

[digg-reddit-me]Saturday Night Live’s tribute this weekend to Amy Poehler included this great (and newly relevant) skit that I missed back in 2005:

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Categories
Barack Obama Economics Financial Crisis Mexico National Security Politics The War on Terrorism War on Drugs

7 Reasons to Legalize Marijuana

[digg-reddit-me]

On this April 20th, the case to legalize marijuana is a no-brainer. There are at least 7 things that could be accomplished by legalizing it:

  1. Stabilize Mexico. The drug cartels are waging a war against the Mexican government and each other funded mainly by the profits from marijuana sales in the United States. Legalizing marijuana would create an opportunity for the current government’s attacks on the cartels to succeed – as the cartels would need to scramble to find alternate sources of revenue while fighting a war against a military bolstered by American aid.
  2. Stop wasting money on a failure. Barack Obama called the war on drugs “an utter failure.” Since he took office, he has vowed to cut the fat from the federal budget and eliminate failed programs. At a time when our tax dollars are at a premium, why should we continue to waste money on a failed government program?
  3. Protect the legitimacy of our laws. Almost half of all Americans admit to have tried marijuana – including 3 of our past 3 presidents – which means that they all broke the law. Such flagrant law-breaking undermines respect for the Rule of Law – and more important, once Americans break the law they can see how distorted the government propaganda campaign against marijuana is – further undermining respect for the government. America is currently waging a war on its citizens the likes of which have rarely been seen in history – as we imprison a greater percentage of our population than any other nation on earth and continue to militarize our police as they stop enforcing community standards and instead impose federal policies using extreme force.
  4. Stop aiding terrorists. According to a 2004 Congressional report, the illegality of drugs has incentivized a vast system of money laundering, smuggling, and corrupting of government officials – as well as created failed states and lawless regions – all of which aid terrorists seeking to carry out attacks on the United States. The criminalization of marijuana creates the biggest incentive on all of these fronts.
  5. Reduce crime. The War on Drugs has been militarizing America’s police forces and eating up resources which has led to a statistical uptick in non-drug related theft and violent crime synchronous with this shift. As police resources are spent enforcing federal drug laws – arresting, testifying, surveiling – and as the police become more militarized and distant from the communities they are charged with policing – serious non-drug related crimes increase. One report quantified this by explaining that every additional drug arrest leads to an increase of 0.7 Index (serious) crimes [page 6 of the pdf].
  6. Stimulate the economy. Obama may have tittered at the question, but there is precedent – the repeal of the prohibition of alcohol when FDR took office during the Great Depression. 
  7. …I’ll let Tim Meadows make the final point for legalization by explaining why not to smoke marijuana:

[Image by Torben H. licensed under Creative Commons.]

 

Continue reading “7 Reasons to Legalize Marijuana”
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Barack Obama Financial Crisis Politics The Opinionsphere

A Typically Wrong-headed Krauthammer Column

[digg-reddit-me]Charles Krauthammer in a typically insightful yet wrong-headed article carries out an intriguing thought experiment:

Five minutes of explanation to James Madison, and he’ll have a pretty good idea what a motorcar is (basically a steamboat on wheels; the internal combustion engine might take a few minutes more). Then try to explain to Madison how the Constitution he fathered allows the president to unilaterally guarantee the repair or replacement of every component of millions of such contraptions sold in the several states, and you will leave him slack-jawed.

I’m somewhat surprised that Krauthammer knows who James Madison is – given his reluctance to acknowledge the Constitution places any limits on executive power in the realm of national security in direct contravention of Madison’s understanding of his Constitution. But I suppose Krauthammer rationalizes that away by explaining that the Constitution is not a “suicide pact” and thus in times of physical danger can be safely stored away – but in an economic emergency, it must constrict the president as much as possible to preserve the status quo. But by exclaiming how shocked Madison would be at power politics, Krauthammer manages to make Madison out to be a naif – rather than the student of human nature and power that he was.

Still, one can rightly imagine Madison questioning how we got here. So, I will answer Madison’s hypothetical question, namely – “How is it that the limited government he constructed in his Constitution can allow the president to unilaterally guarantee the repair or replacement of every component of millions of such contraptions sold in the several states?”

Because, Mr. Madison, in 1929, with a small percentage of Americans gaining control of a large chunk of the nation’s economy, the market broke down and the government was forced to assume some partial responsibility for the well-being of it’s its citizens and to curb the excesses of the markets.

Then, in 1980, the government began reducing it’s its responsibility for the well-being of its citizens and removing the safeguards put in place to prevent another disasterous market breakdown. This led to another thoroughly undemocratic concentation of power – which the public accepted in return for the assurance that their standard of living would constantly improve. And so it was under Ronald Reagan that the government became responsible for assuring constant economic growth that would benefit all classes of society, at least a bit.

And now, that arrangement has come to a screeching halt. 

Obama is proposing a new social bargain – a fact which Krauthammer recognizes. But Krauthammer sees this bargain in terms that were relevant in the 1980s – as a resurgence of the Great Society liberalism he grew to hate. But instead, Obama proposes a new market-state liberalism – in which the government accepts a responsibility to referee and more actively maintain the markets and to provide investments that are too capital-intensive and long term for corporations with their limited time horizons to finance. Obama also believes it is the government’s role to reduce the disruption and instability that the creative destruction of capitalism wreaks. The end goal is to create a more level playing field and mainly through soft government pressure prevent destabilizing concentrations of power.

Krauthammer though only sees Lyndon Johnson reborn intent on “leveling” society and reducing the inequities between the rich and the rest of us. Krauthammer explains that for Obama the “ultimate social value is fairness” – and Krauthammer means this as a bad thing. The subtlety that Krauthammer sidesteps is that Obama is in favor of fair processes rather than enforcing some pre-determined fair ends. This was the traditional position of the conservative – but it is position that conservatives have long since abdicated. Presumably when he criticizes fairness, Krauthammer believes that markets should strive for efficiency rather than fairness – but he neglects to make any case that our current market structure is efficient. 

Michael Osinski described in New York magazine the logic of how money is awarded on Wall Street:

I was very good at programming a computer. And that computer, with my software, touched billions of dollars of the firm’s money. Every week. That justified it. When you’re close to the money, you get the first cut. Oyster farmers eat lots of oysters, don’t they?

This describes neither a fair nor an efficient way of distributing resources. What “conservatives” such as Krauthammer do not realize is that capitalism, like democracy, is merely the least-worst system of managing the market – and that just as democracy’s excesses must be managed, so must capitalism’s. Krauthammer does not seem to accept that the structure of governance is changing with globalization – as the nations of the world are evolving into market-states. It was the beginning of this shift that led to Ronald Reagan’s and Margaret Thatcher’s success. Although some conservatives saw these successes as a return to a pre-Great Society or a pre-New Deal America, they represented instead a shift forward, an evolution from nation to market-state. Liberals lost elections because their solutions no longer spoke to this evolved America – and they could not see the sand shifting beneath themselves. They were stuck in the past.

But now – as Niall Ferguson has admitted – it is only the liberals who are providing a coherent answer to the challenges we face.

Krauthammer – like far too many conservatives today – is stuck pretending we face the challenges of the 1980s all over again. Until conservatives like him notice the sand shifting beneath them, they will have little to offer. As a well-functioning democracy requires at least two functioning political parties, I hope they get their heads our of the sand sooner rather than later.

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Barack Obama Domestic issues Economics Financial Crisis Health care The Opinionsphere

The Master Plan Always Has Flaws

Daniel Drezner at Foreign Policy summarizes my feelings about Krugman in almost as complete a way as Evan Thomas did:

The fundamental question is whether Krugman is a brilliant hedgehog, an insecure pain in the ass, or – as frequently is the case – both at the same time. 

One suspects that Krugman is at least part right – and that Obama and his team realize this. Obama’s response to the financial crisis has been significant – and more than any government response in history – but it is dwarfed by the scale of the crisis, as Krugman is fond of pointing out. Nicholas Lemann in the New Yorker tries to explain why Obama seems to be ignoring Krugman’s advice so far:

[Obama] has to address the crisis, and he is trying to add enough new controls to the system to prevent a repeat of it, but it looks as if his heart is with the big new programs in his budget and with his foreign-policy initiatives. Bank nationalization would drive the stock market down and increase theagita of people with 401(k) plans. Moderate Democrats in Congress would further soften in their support for the Administration’s legislation. The price of bank nationalization might be Obama’s super-ambitious plans in other realms, which, if history is a guide, are likely to pass only in this first year of his Presidency. If they do pass, he will have generated tax revenues from affluent people for social purposes far beyond those of the House’s tax on A.I.G. bonuses, and he will have significantly eased the distress of people who can’t get good health care or education. That is a lot to put at risk.

At the same time, Obama’s team seems to think that, to quote my post of yesterday:

[I]n the short term, the Geithner plans will work to restart the “old” economy. In this moment before that happens though, pressure from Europe and internal critics as well as a desire to avoid a repeat of this fiasco will enable enough forward-looking, gradualist regulation and legislation to correct the long-term problems with high finance.

E. J. Dionne Jr. in the Washington Post explains where the administration’s focus is:

Obama’s top budget officials seem confident that they can deal with this immediate difficulty. His larger challenge is to take on the politics of evasion promoted by those who would indefinitely delay health-care reform, energy conservation and the expansion of educational opportunities. Already, his lieutenants are signaling how he will cast the choice: between “taking on the country’s long-term challenges” or just “lowering our sights and muddling through,” as one senior aide put it.

If Geithner is responsible for fixing the current crisis, Peter Orszag is responsible for the long-term outlook – of balancing Obama’s plans to expand government’s role and stabilizing our deficit spending. As Jodi Kantor in the New York Times explained:

Mr. Orszag embodies the administration’s awkward fiscal policy positioning: big spending now, with a promise to scrub the budget of waste and a bet that economic recovery and changes to health care will gradually reduce the deficit.

A lot of pieces need to fall together for this to work. I have confidence in each piece of this plan – but together, the venture seems a bit bolder than is wise.

Perhaps this is a perfect moment in history for Obama’s plan – and Obama has the insight to see this; perhaps Obama is a master of politics who is able to get all of these items through; but it’s hard for me not to be discomfited by the manner in which everything is coming together.

Categories
Barack Obama Economics Financial Crisis Politics The Opinionsphere

Financial Markets : Real Economy (Is There a Proper Balance?)

[digg-reddit-me]Simon Johnson’s article in The Atlantic Monthly continues to generate attention and controversy. His thesis is essentially this:

In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people.

But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

Top investment bankers and government officials like to lay the blame for the current crisis on the lowering of U.S. interest rates after the dotcom bust or, even better—in a “buck stops somewhere else” sort of way—on the flow of savings out of China. Some on the right like to complain about Fannie Mae or Freddie Mac, or even about longer-standing efforts to promote broader homeownership. And, of course, it is axiomatic to everyone that the regulators responsible for “safety and soundness” were fast asleep at the wheel.

But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. [my emphasis]

My only worry about Johnson’s argument is that he portrays the crisis as the result of individuals’ actions. His experience with emerging economies trained him to view the “Masters of the Universe” as oligarchs corrupting politics. But what I think is going on is more insidious. The problem is not that democracy is becoming oligarchy – although this is a danger we are closer to than we realize given the escalating consolidation of wealth – it is a financial sector that has grown out of balance with the real economy. ((With again the caveat that this is not backed up as much with economic analysis but with my sense and knowledge of politics, government, and history.)) Johnson and Paul Krugman both point this out repeatedly in their work – but neither of them identifies this as the problem. They instead see this as a symptom.

They are probably right – but I have a nagging suspicion that the core of this financial crisis – and that of the Great Depression – is at root a similar imbalance between the size of the financial markets and the size of the real economy.

Fundamentally, it seems there must be a limit as to what percentage of an economy can be managed by the financial markets. Just as the centralization of decision-making in the government can lead to inefficiencies, so can the centralization of decision-making in large financial instituions. Many of these factors that Johnson and Krugman talk about – increasing income disparity, asset bubbles, solvency issues, etcetera – can easily be seen as causes and/or effects of this central imbalance.