Category: Financial Crisis

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Economics Financial Crisis Politics The Opinionsphere

The Reagan Revolution (cont.)

There’s been quite a strong response to Paul Krugman’s column last week blaming the financial crisis on Ronald Reagan. William Greider from the left and Richard Posner from the right both made the case that it was actually Jimmy Carter who’s to blame. But I think Andrew Leonard in Salon has the best take on the whole meta-debate over the debate:

The continuing influence of the banking industry on Congress, on which point we witness new revelations nearly every day, should be enough to underline how both parties succumb all too willingly to the financial blandishments lavished by Wall Street. I’m sure Krugman would acknowledge that. Despite Posner’s dismissal of Krugman as a Democratic partisan, it is well worth noting that Krugman has been far harder on the Obama administration’s economic policy moves than your typical Republican partisan was on George Bush until late in his second term.

But there’s a different, perhaps more profound sense in which Reagan really did do it. Momentum for deregulation may have gotten started during the Carter administration, but the ideological case for it didn’t crystallize until the election of Reagan in 1980. From that point on, the predisposition to loosen the reins on the financial industry became explicit. Both parties helped get us where we are today, but one party in particular identified itself with the all-knowing wisdom of the markets. And that party is paying the price.

I still like the formulation I used – that does not lay the blame directly on Reagan or his advisors – but indirectly:

To some degree, these changes had positive effects – as the market was freer, as the economy grew, as corporations thrived, as the overall wealth of America grew.

But they spelled trouble down the road. The stimulus spending and tax cutting, the informal Bretton Woods II agreement, and concentration of wealth created an unstable system. Internally, the society was imbalanced as extremes of wealth and power were accumulated by a small minority. This eventually undermined the very free market and democratic discourse that is essential to the American tradition. A course correction later might have saved the Reagan vision – and for a time it seemed as if Bill Clinton’s moderate presidency had, as middle class wages finally began to grow again – but Bush doubled down on Reaganism when he should have pared back, and we are left with this mess.

Is this collapse Reagan’s fault? I wouldn’t say so. But he set the initial course towards this iceberg, even if the iceberg was out of sight at the time he set the course. He – and the 1980s revolutions in finance, economics, and government that his administration supported and enabled – are the true authors of this economic collapse, even if they cannot be blamed for not forseeing it.

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Economics Financial Crisis Libertarianism Political Philosophy Politics The Opinionsphere

Brink Lindsey v. Paul Krugman

Last night taking the train home, I started reading Brink Lindsey’s essay in Reason countering Paul Krugman’s analysis of inequality in American history – and specifically what has caused inequality to worsen.

Now – my head was a bit fuzzy as I have a pretty bad head cold at the moment – but I found Lindsey’s argument was rather persuasive. Surprisingly so – as I’ve cited Krugman’s arguments on this issue many times on this blog (including here and here). I also recognize Lindsey’s phrase describing Krugman’s view holds an essential truth about this progressive understanding. I myself tried to express this – in a way to diffuse the charges of socialism during the campaign – “Leave It To Beaver Socialism.”  Here’s my description of the goal of Obamanomics:

Obama’s economic plan is not about socialism or revolution or any such radicalism. He’s not that type of politician. The goal of his Obamanomics (if you will) is not a socialist paradise or a European-style market socialism but a restoration of the economic justice that made 1950s and 1960s America so stable. Unless you think Leave It To Beaver took place in a socialist nation, then Obama’s economic plans shouldn’t strike you as far left.

At the time, I both recognized the power of postulating an ideal past which we should hearken back to – and understood that this is the root of reactionary politics. There is a proper way to understand history – and to try to achieve a balance that once existed. But very easily, with a slight misstep, you find you are trying to recreate a now defunct world – which is the founding myth that every reactionary subscribes to.

Lindsey concludes his essay:

[R]easonable people disagree hotly about what ought to be done to ensure that our prosperity is widely shared. But the caricature of postwar history put forward by Krugman and other purveyors of nostalgianomics won’t lead us anywhere. Reactionary fantasies never do.

Powerful stuff, true or not. And it is certainly making me reevaluate my understanding of the historical causes of inequality in 20th century America. I’ll have to read the essay again with a more clear mind. I tried looking for a progressive debunking of the essay – but all I found were attacks on Lindsey or Reason or libertarianism.

To be clear though – I haven’t abandoned my Krugman-inspired view of the economic history of 20th century America yet – and Lindsey’s argument was better at poking holes in the story offered by Krugman than giving a convincing portrait of its own. I suspect the truth may be found by accepting that liberal and conservative policies together led to the growing inequality we are experiencing today.

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Economics Financial Crisis The Opinionsphere

Theories of the Financial Crisis: Greed

[digg-reddit-me]

George Will may seek to defend greed (Or maybe not – it’s actually kind of hard to tell.) – along with Ayn Rand and other market fundamentalists.

But just about everyone else lists it as a fundamental cause of the financial crisis. Will tries to make the case that free markets punish greed. But what Will presumes is that an unregulated market is a free market – and on this fundamental point he is wrong. The market Will describes is not one heavily regulated by the government – but it is regulated by ebay which in this instance takes on the role of the government for this small market. The financial markets on Wall Street though were largely unregulated – especially the shadow banking system (which was created in such a way as to be unregulated) – and they were in this sense free from government interference. But they were controlled by a small number of individuals – and in this sense were part of a world where freedom was available only to a princely few. Will makes the point that greed is an immutable human characteristic – and thus does not account for the booms and busts of our business cycle (and of financial crises such as this.) But what does is the combination of perverse incentives for short-term profit (indeed a form of legal fraud), a relaxation of the regulations designed to keep the markets stable that tends to occur when Republicans have power, and greed.

There has always been an historical wariness in America about the combination of greed and concentrations of wealth – focusing on a national bank, on various financiers, on “the malefactors of great wealth” and indeed, on Wall Street. The people, in their wisdom, could see that this concentration of financial power undermined the democratic distribution of political power. But by the 1980s, there was an additional reason to be wary – as Ronald Reagan unleashed a money revolution. This money revolution – like all revolutions – was the commingling of many forces – globalization, the ad-hoc Bretton Woods II agreement, and the relaxation of regulations and reduction of taxes. This revolution helped to concentrate an increasing percentage of the world’s wealth in the hands of a small number of Wall Street (and also London) bankers. The function of these bankers – their expertise – was to balance risk and profit to their customers’ satisfaction – to maximize profit for themselves and their customers while minimizing (or controlling for) risks. As a small percentage of individuals accumulated more and more wealth around the world, these individuals entrusted more and more of this wealth to Wall Street bankers – and the more money the bankers controlled, the bigger their cut. As Michael Osinski explained in a piece for New York magazine:

When you’re close to the money, you get the first cut. Oyster farmers eat lots of oysters, don’t they?

This closeness to the money created an easy money culture – in which enormous sums money were distributed whether they was deserved or not and the culture began to prize attempts to satisfy the bottomless desire that is greed. Wall Street bankers took on the culture of gamblers – except with the market going up, everyone made money. The long boom began to create perverse incentives – as risks began to seem safer, as luck and a rising tide and short term profits made everyone seem like geniuses, they all became accustomed to a certain lifestyle. Financial innovations sought to overturn many of “the fundamental rules of banking” including “that default risk is an inevitable liability of the business.” The combination of innovation and the culture of greed and gambling led to greater and greater risks being taken.

As steady foundations of banking – both as a business and as a culture deteriorated – and as the cautionary tales of Oliver Stone’s Wall Street and Liar’s Poker morphed into guides – a new culture of excess developed – excessive greed, excessive pay, excessive drinking, excessive spending, excessive personal risks, and eventually excessive professional risks. Wall Street bankers began to betray all the symptoms of the easy money culture – like gamblers whose knew their earnings were ephemeral and that every up would be followed by a down to be followed by an up – as long as they could stay at the table. But as Matt Taibbi wrote,  “this was a casino unique among all casinos, one where middle-class taxpayers cover the bets of billionaires…”

Osinski tells a story of how this easy money culture affected the individuals:

Now that I was spending more time on the floor, I wondered why the men’s room always stank. Then one afternoon at three, when I was in there taking a leak, I discovered the hideous truth. Traders had a contest. Coming in at eight, they never left their desks all day, eating and drinking while working. Then, at three o’clock, they marched into the men’s room and stood at the wall opposite the urinals. Dropping their pants, they bet $100 on who could train his stream the longest on the urinals across the lavatory. As their hydraulic pressure waned, the three traders waddled, pants at their ankles, across the floor, desperately trying to keep their pee on target. This is what $2 million of bonus can do to grown men.

This easy money culture warped the incentives at Wall Street firms as well – as they were structured in such a way as to generously reward short-term success (without controlling sufficiently for long-term failure.) Rather than being paid large salaries, most of a banker’s income was handed out in enormous bonuses based on yearly performance. As long as fees were generated, as long as this quarter’s profits were growing – bankers would be rewarded with enough profits to last a lifetime. This alone is enough of an incentive to cause massive fraud. But at the same time, the culture of Wall Street ensured that money would be spent ridiculously, ostentatiously, and quickly. 

Perhaps no one has been more articulate in his visceral disgust for the excesses of Wall Street than Matt Taibbi of Rolling Stone. 

[I]t’s time to admit it: We’re fools, protagonists in a kind of gruesome comedy about the marriage of greed and stupidity. And the worst part about it is that we’re still in denial – we still think this is some kind of unfortunate accident, not something that was created by the group of psychopaths on Wall Street whom we allowed to gang-rape the American Dream.

The story of AIG – in its way – symbolizes better than anything else what this culture did to Wall Street. Back to Taibbi:

AIG is what happens when short, bald managers of otherwise boring financial bureaucracies start seeing Brad Pitt in the mirror. This is a company that built a giant fortune across more than a century by betting on safety-conscious policyholders – people who wear seat belts and build houses on high ground – and then blew it all in a year or two by turning their entire balance sheet over to a guy who acted like making huge bets with other people’s money would make his dick bigger.

A culture of greed and excess – a lack of respect for tradition – a market free only to a princely few – negligence bordering on fraud with regards to the evaluation or risk – and an increasing percentage of the world’s wealth concentrated in the hands of a few. Together, these were the recipe for this financial disaster. 

The problem with greed is that it is unsustainable. It exists in a cycle, like all unsustainable desires. Government regulation, like morality, seeks to control and channel greed in less destructive ways – to mitigate the effects of this cycle. The true cause of this financial crisis was not greed – but the ideology that held that finally the immutable human vice of greed had been overcome with clever financial innovation and the magic of the market.

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Barack Obama Financial Crisis Law Politics The Opinionsphere

Obama and the Rule of Law


[digg-reddit-me]Right-wingers and some conservatives are trying out a new approach in their attacks on Obama – as you can see from the growing meme on the right that Obama has no respect for the Rule of Law. I’ve come across this meme in a George Will column, a Wall Street Journal editorial, and in a blog post by Jim Manzi for the National Review / The American Scene all last week. All three authors have focused on one particular event – Obama’s role in the Chrysler sale/bankruptcy/bailout. I for one am glad to see the National Review and Wall Street Journal finally coming around to accepting the importance of the Rule of Law after eight years of promoting George W. Bush’s blatant disregard for the law – but I digress.

The past eight years have demonstrated to many Democrats and liberals the vital importance of the respect for the Rule of Law to a well-functioning state – as President Bush concentrated more and more power in the White House and asserted authorities both beyond and over the law – which is why an accusation that President Obama is not respecting the Rule of Law must be taken seriously.

It is hard though to take the example all three authors use seriously – Obama’s intervention in the Chrysler mess. I can understand why people might object to what Obama did – if you consider unions to be a malevolent force, you certainly don’t want them helped out – and it is unseemly that they donated so much to Obama only to be rewarded now (of course, the creditors also gave Obama a great deal of support.) But neither of these objections is based on Obama disrespecting the Rule of Law.

Certainly, even these authors are not accusing Obama of disrespecting the Rule of Law in the same manner as George W. Bush – who did not believe he was bound by law when acting to protect Americans. The unitary executive theory he accepted and Cheney, Addington, and others used, is a direct assault on the idea that the president is bound by the law. Obama does not take this position.

These authors make a big point of the fact that Obama is abrogating contracts – but this objection is a bit silly. Obama is not a party to these contracts – and thus has no obligation to honor them personally. The Contracts clause of the Constitution – the Law which it is being alleged Obama has broken – was meant to constrain the individual states rather than the President or even the Congress. Congress was in fact given the power to abrogate contracts through bankruptcy proceedings in the Constitution. Obama – in intervening in the case of Chrysler – helped to negotiate an out-of-court settlement of the matter. Out-of-court settlements happen all the time – and are welcomed by overburdened judges who see it as better to allow all sides to come to an agreement rather than having to order them to agree.

To call this a violation of the Rule of Law is disingenuous at best.

What these authors are right to be concerned about is the concentration of power that undermines the system of the Rule of Law – as the government’s role in backstopping the finance and auto industries leaves it with enormous leverage. But their fears should be allayed by the fact that most of these interventions are temporary. (Of course, George Will is on the record disbelieving this based on the old adage – as are all of Will’s beliefs – that once government has taken a power, it will not give it up.)

Liberals have continued to voice a different set of concerns about Obama’s respect for the Rule of Law – pointing to the many Bush administration positions Obama has accepted. But they key difference between Bush and Obama is that even as Obama may be putting forward positions on these issues which are controversial, Obama has given the sense he will concede if his legal means of asserting these claims are defeated. Bush in at least one instance refused to end a clearly illegal program despite the fact that his own Justice Department had declared it illegal. 

I do find a few areas of concern. The power of the executive branch has grown enormously in the financial crisis – between the Stimulus Bill and the bank bailout. While in the short-term this may be necessary, if steps are not taken, this would undermine the balance of power between the federal government and the states. While this in itself is not a violation of the Rule of Law – it does weaken the system which together helps maintain the Rule of Law. And it is this that conservatives and right-wingers seem to be ojecting to – but their rhetoric about the Rule of Law being disregarded is hyperventilationist – and for those who did not likewise say the same of our previous president, hypocritical.

But by far the most disturbing manner in which Obama is undermining the Rule of Law is in how his administration is keeping Bush’s policies on the matter of Bagram. The Supreme Court’s ruling on the rights of detainees to certain basic rights at Guantanamo was in a large part based on the idea that our government should not be able to deprive an individual of rights merely by moving them to a particular location. But this is exactly what the Obama administration is claiming with regards to the detainees brought to Bagram from around the world. Our nation’s freedoms are grounded in our traditions. This includes a respect for contracts, a balance of various powers, and an energetic chief executive – but at it’s base, our traditions are grounded in a single, fundamental restriction on the state. To quote Winston Churchill:

The power of the executive to cast a man into prison without formulating any charge known to the law, and particularly to deny him the judgment of his peers, is in the highest degree odious, and the foundation of all totalitarian government whether Nazi or Communist.

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Barack Obama Conservativism Criticism Economics Financial Crisis Liberalism Political Philosophy The Opinionsphere

The intellectual deterioration of the conservative movement

Richard Posner has written one of those posts that gets talked about despite it’s lack of hyperventilation – it’s a thoughtful, reflective piece on what he calls the “intellectual deterioration of the once-vital conservative movement in the United States.” Posner summarizes the deteriotion:

[T]he policies of the new conservatism are powered largely by emotion and religion and have for the most part weak intellectual groundings [such that]the face of the Republican Party [has] become Sarah Palin and Joe the Plumber. Conservative intellectuals [have] no party.

Posner sees this decline as a symptom of the movement’s success. I think he’s half right.

Philip Bobbitt posited some time ago his theory of the evolution of the state – from princely city-states to kingly states to imperial states to the modern nation-state. The next step – according to Bobbitt – the one to which we are already evolving – is the market-state. And while a nation-state was legitimized in the eyes of it’s people by ensuring people were provided for (thus setting up the economic battle of the Cold War, as capitalism and Communism competed on this front), the market-state is legitimized by offering the maximum amount of opportunity for it’s citizens. Bobbitt’s theory is interesting – and if not entirely perfect, it is certainly useful. 

Given this structure, you can easily understand how the nation-state liberalism of Lyndon Johnson gave way over time to the market-state liberalism of Bill Clinton and Barack Obama. By this reading, conservatism did not so much win any more than nation-state liberalism “won.” Both were appropriate responses to their times.

Unfortunately for it’s proponents, conservatism (like nation-state liberalism in the 1970s) did not evolve with the times, but remained staticly committed to the principles that worked so well three decades earlier. The innovative ideas of the 1980s have become the brittle orthodoxies of the present. As conservative historian Niall Ferguson explained – “only the left” has a credible response to the issues of our day. The Right is still fighting the battles they won decades ago.

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Economics Financial Crisis Foreign Policy Pakistan Politics

How Pakistan Is Like AIG

[digg-reddit-me]nex·us n., pl. nexus or -us·es.

  1. A means of connection; a link or tie: “this nexus between New York’s . . . real-estate investors and its . . . politicians” (Wall Street Journal).
  2. A connected series or group.
  3. The core or center: “The real nexus of the money culture [was] Wall Street” (Bill Barol).

[Latin, from past participle of nectere, to bind.]

This Sunday, America witnessed Pakistani President Zardari’s disgraceful performance on Meet the Press. He pandered; he obfuscated; he shirked any responsibility or blame; he turned briefly eloquent – and then outrageously self-righteous. It was clear that he is not one tenth the politician his wife was – and it seems not one tenth the leader. She may have been corrupt (as it seems was he) – but he appears to lack her communicative gifts or her aptitude for politics. On top of it, his management style seems be Bush-level incompetence. The most ridiculous point Zardari tried was to invoke AIG’s bailout as an argument to give more money to Pakistan.

David Gregory – to his credit – asks the tough question – the question that needs to be asked of Pakistan’s leader (especially given stories like this) although Gregory does manage to shift responsibility for the criticism of Zardari off to another reporter:

The question a lot of people ask is are you – is Pakistan really committed to that war?  In The New York Times Dexter Filkins, who, who’s reported from Afghanistan and Pakistan, writes this:  “Whose side is Pakistan really on?  …  Little in Pakistan is what it appears.  For years, the survival of Pakistan’s military and civilian leaders has depended on a double game:  assuring the United States that they were vigorously repressing Islamic militants–and in some cases actually doing so–while simultaneously tolerating and assisting the same militants.  From the anti-Soviet fighters of the 1980s and the Taliban of the 1990s to the homegrown militants of today, Pakistan’s leaders have been both public enemies and private friends.  When the game works, it reaps great rewards:  billions in aid to boost the Pakistani economy and military and Islamist proxies to extend the government’s reach into Afghanistan and India.”

Zardari’s responded:

[W]hat billions are you talking about?  Like I said, a billion dollar a year?  That’s not even – altogether, this aid package is not even one tenth of what you gave AIG.  So let’s face it; we need, in fact, much more help.

This isn’t the first time Zardari has found it prudent to invoke AIG to justify giving more billions to Pakistan – he apparently disconcerted lawmakers a few days earlier this week – as the New York Times reported:

[W]hen he asked for financial assistance, he likened it to the government’s bailout of the troubled insurance giant, American International Group.

While it is probably true that Zardari needs more funds – his pique at being asked to justify these funds is galling – especially when so much of it was apparently spent preparing Pakistan’s military to fight India instead of the Taliban. Though this analogy is politically stupid – it does bring up an interesting parallel.

AIG has been the nexus of the financial crisis in much the same way that Pakistan is the center of the threat of strategic terrorism. 

When synthetic CDOs were invented, they were structured in such a way as to create positions that were safer than AAA-rated debt. (An explanation of what this means here.) These positions were called super-senior. Yet the ever “cautious” bankers decided to hedge against even these supposedly risk-free positions – allowing them to free up more capital, so that for the purposes of regulation, it was treated as if they had not lent out any money at all. They decided to buy insurance, calling this insurance a credit default swap, hedging against the risk that even this super-safe investment would go bad. There was one big player in this, one firm that provided so much of this insurance which led to this boom in lending and enormous leveraged positions – AIG – who insured these super-safe debts with nary a plan to deal with defaults. After all – these debts were super-senior – there would only be defaults if historically unprecedented numbers of these mortgages went south. (Precedent only went back forty years or so with modern macroeconomic record-keeping.) AIG Financial – a small part of the AIG empire which spanned insurance across dozens of industries around the world – decided to leverage the entire company to insure these products – leading to enormous profits in the short-term – and systematic risk as soon as things went bad. If AIG had not been able to pay on its insurance to the big banks, things would likely have been worse.

Pakistan meanwhile is the land of Dick Cheney’s nightmares, where WMDs, nuclear weapons, terrorists, and a teetering state all exist. Pakistan combines all of the elements national security experts fear could have disasterous consequences if they come together. As Barton Gellman describes Pakistan’s importance in his excellent biography of Dick Cheney:

The nexus, if it was anywhere, was in Pakistan – a nuclear state whose national hero sold parts to the highest bidder, whose intelligence service backed the Taliban, and whose North-West Frontier Province became a refugre for al Qaeda.

What it comes down to is that both are too big – and too connected – to fail. Both have had billions of American dollars pumped into them to prop them up. Both have prompted outrage as they have seemed to use this money to benefit themselves and not for the purposes it was intended. Both are controlled by leaders whose hands were far from clean in creating the current crisis. Neither the leadership of Pakistan nor the leadership of AIG have taken responsibility for the crisis that occurred oin their watch – in their realm of control – blaming America and the world at large for their problems instead.  Perhaps because of this, the leadership of both seem to believe that they deserve to be rewarded for their efforts rather than held accountable for their significant failures. Yet even so, the costs of the failure of either is likely catastrophic.

Maybe this is the point Zardari was trying to make – his way of taunting us with the fact that he knows we cannot allow him to fail – just like AIG.

[Image by cogito ergo imago licensed under Creative Commons.]

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Barack Obama Economics Financial Crisis

Theories of the Financial Crisis: Animal Spirits

[digg-reddit-me]David Brooks is a reliable barometer of the opinions and beliefs of the Washington establishment (and I don’t mean that as an insult.) The figure he cuts is a rather odd combination of an amateur (but insightful) anthropologist and a insider protecting the system. All of this makes it significant to note that David Brooks has on several occasions stated that the root of this financial crisis is a “loss of confidence.” He has stated this in several of his columns, including his one immediately following the September 15 freefall:

At its base, the turmoil wracking the world financial markets is a crisis of confidence.

Many of Geithner’s critics have said that he is treating the financial crisis primarily as a liquidity crisis – which is defined as “a ‘general feeling of mistrust in the banking system’ conducting to a temporary disappearance of credit.” This is a common form that a crisis of confidence in the financial system takes.  

The Congressional Oversight Panel in their report [pdf] written to evaluate the TARP bailouts, for example, described what they saw as one of Geithner’s asusmptions :

One key assumption that underlies Treasury’s approach is its belief that the system-wide deleveraging resulting from the decline in asset values, leading to an accompanying drop in net wealth across the country, is in large part the product of temporary liquidity constraints resulting from nonfunctioning markets for troubled assets. The debate turns on whether current prices, particularly for mortgage-related assets, reflect fundamental values or whether prices are artificially depressed by a liquidity discount due to frozen markets – or some combination of the two.

Paul Krugman has also often made this point – stating that Geithner seems to be acting as if we were in a liquidity crisis – in which the loss of confidence is the cause of the problem – instead of a solvency crisis – in which the loss of confidence is a symptom of the problem. 

Geithner, for his part, rejects this assertion that he is treating the problem as a liquidity crisis. When asked, he said it was, as all financial crises are, a combination of the two.

If this is primarily a crisis of confidence, there have been a number of historic examples of how these were contained. For example, this is a description of the resolution of the Panic of 1907 – in which J. P. Morgan’s timely intervention demonstrated how this could be done:

Shipments of gold were on the way from London to New York, and confidence had returned to the French Bourse, “owing,” reported one paper, “to the belief that the strong men in American finance would succeed in their efforts to check the spirit of the panic.” During a panic, confidence is almost as good as gold.

As politicans saw how these crises could be contained – and as they realized Morgan who had successfully beaten back several of these panics was getting near his end – they created the Federal Reserve to officially take on the role Morgan had been unofficially occupying, the lender of last resort and de facto regulator. 

As panics are short, they generally do not affect the fundamentals of the economy – but in a liquidity crisis such as this, restoring confidence is a more delicate task. It involves restoring what John Maynard Keynes referred to as “animal spirits” – those positive energies that cause people to be trusting and optimistic that are essential to a thriving economy. As Keynes wrote in his seminal work, The General Theory of Employment, Interest, and Money:

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. [my emphasis]

This idea of animal spirits has created an opening for what appears to be Obama’s favorite branch of economics – behavioral economics. While economics generally treats human beings as homo economics, rational, self-interested (indeed, selfish), individuals who act entirely to serve their best interest (and who know what their best interest is) – behavioral economics takes a more scientific view of human beings. They try to understand human behavior through testing and real-life examples rather than through theoretical models. Some of Obama’s top advsiors from Cass Sunstein to Austan Goolsbee are known to be proponents of behavioral economics. And a recent article by Chrystia Freeland in the Financial Times, suggests that Obama’s administration may be using behavioral economics to solve this crisis, describing how “emotions might yet save the economy“:

Judging by the upbeat economic message we have been hearing from the White House, the Treasury and even the Federal Reserve over the past six weeks, that is a shrewd guess. The authors argue that “we will never really understand important economic events unless we confront the fact that their causes are largely mental in nature”. Our “ideas and feelings” about the economy are not purely a rational reaction to data and experience; they themselves are an important driver of economic growth – and decline.

I don’t have the expertise to judge if this crisis is one of solvency or confidence or whatever else it may be. But at this point there is a feeling – almost of a wind at the back of the economy. (I certainly hope this is the case.) It does seem to me that the lack of confidence is a major cause (rather than merely a symptom) of this crisis; and Obama’s gradualist approach, with every move telegraphed and thus predictable – seems to be generating confidence.

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Financial Crisis Humor National Security Pakistan Politics The Bush Legacy The Opinionsphere The War on Terrorism

Must-Reads of the Week

1. Inhuman. Andrew Sullivan, who has been one of the most insightful commenators on torture, discusses the term “inhuman”:

It’s odd, isn’t it, that we use this word to describe abuse and torture of prisoners. The reason it’s odd is that I’m not sure any animals torture. Yes, they can kill and maim and inflict dreadful suffering in the process of killing, eating or fighting. But the act of intentionally exploiting suffering, of lingering over some other being’s pain – using it as a means to an end – is not an animal instinct, unless I’m mistaken.

And so torture is in fact extremely human; it represents in many ways humankind’s unique capacity for cruelty.

2. 30 Rock. Jonah Weiner discusses 30 Rock’s odd conservative streak at Slate. The explanations he posits for this conservatism are perhaps beside the point, but interesting nonetheless:

Of course, 30 Rock was conceived during the reign of George W. Bush, which might help explain its ideological complexity. The show has been consistently critical of Bush, but perhaps 30 Rock began as a way to explore—and mine for gallows humor—the crisis of identity many liberals began to feel in his second term, when the Karl Rove playbook had seemingly replaced the laws of physics, when the “reality-based community” (including Liz Lemon’s Upper West Side) felt like an island populated by the marginal, flip-flopping, arugula-munching few.

3. Animal Spirits. Chrystia Freeland writes for the Financial Times that the Obama team seems to have accepted the premise of a recent book by behavioral economists about economic crises:

Judging by the upbeat economic message we have been hearing from the White House, the Treasury and even the Federal Reserve over the past six weeks, that is a shrewd guess. The authors argue that “we will never really understand important economic events unless we confront the fact that their causes are largely mental in nature”. Our “ideas and feelings” about the economy are not purely a rational reaction to data and experience; they themselves are an important driver of economic growth – and decline.

4. A Taliban Strategist Speaks. To The New York Times. Perhaps the most interesting article I have read about the Taliban’s plans in the Af-Pak region – though I have to wonder why this man would be speaking to a Western newspaper about the Taliban’s strategy. That said, you can judge the article for yourself. I pass it on as it seemed plausible to me:

One Pakistani logistics tactician for the Taliban, a 28-year-old from the country’s tribal areas, in interviews with The New York Times, described a Taliban strategy that relied on free movement over the border and in and around Pakistan, ready recruitment of Pakistani men and sustained cooperation of sympathetic Afghan villagers.

His account provided a keyhole view of the opponent the Americans and their NATO allies are up against, as well as the workings and ambitions of the Taliban as they prepared to meet the influx of American troops.

It also illustrated how the Pakistani Taliban, an umbrella group of many brands of jihadist fighters backed by Al Qaeda, are spearheading wars on both sides of the border in what for them is a seamless conflict.

5. Fool’s Gold. This one is actually a must-listen podcast of a talk given at the London School of Economics. Gillian Tett is a journalist for the Financial Times who recently wrote a book about the financial crisis and what led to it from her view as someone with a background in anthropology reporting who was reporting on derivratives before it was an exciting beat.

Bonus: Polar Insanity. Tim Wu writes in Slate about the perplexing desire of so many people – including himself –  to make the expensive trips to the polar regions:

Every so often, an iceberg floats by that is grander and more beautiful than any cathedral, though it lacks any history or even a name. What’s almost as shocking as its appearance is its anonymity: beauty untainted by fame. Most of these perfect objects will never be seen by human eyes. They float around and slowly melt by themselves, unappreciated and utterly indifferent to that fact.

Unnamed, plentiful beauty feels unearthly and almost decadent, like Sinbad the Sailor’s cave. It is alien to the typical human experience of finding everything we really desire to be scarce, expensive, or behind some temple curtain. It has always struck me that no one bothers to build museums in places of extreme natural beauty, and in Antarctica the effect is magnified. If an iceberg the size of Manhattan showed up outside town one day, why would you bother going to an art exhibit?

Categories
Economics Financial Crisis History The Opinionsphere

Theories of the Financial Crisis: The Government Did It!

[digg-reddit-me]

The first person out of the box promoting the idea that the current financial crisis was actually caused by the government (specifically Democrats in the government – and even more specifically Barack Obama) was Rush Limbaugh. On the day Lehman fell (this crisis’s equivalent of September 11), Rush Limbaugh was already trying to exploit it for partisan gain – claiming “Capitalism Isn’t the Problem: Government Caused This Crisis.” On this date of crisis, Limbaugh had already unveiled in a near-complete form what was to become the Republican party’s position on the crisis. He embraced positions that had previously been associated with the Austrian School of Economics – but without much of the ideological baggage they had with them. He only embraced as much of them as was politically convenient – and he applied them only so far as they made Democrats look bad. He also began blaming Barney Frank for this crisis – something which many other right-wingers picked up on. Though I for one find it hard to see how this person who was a member of a Congressional minority had so much power to influence the entire economy and cause this severe crisis and the causal chain has never been made clear. At least to me.

Within a few days of the near-collapse of the financial system – with the crisis still causing panic – Limbaugh was already trying out names he could use to brand the crisis – from the “Democrat-Caused Financial Crisis” to the “Obama Recession.” None of them quite caught on as most people with common sense found it hard to blame Barack Obama for a crisis that occurred before he had won the presidency. But the right faithfully repeated this meme. (It has often seemed to me that Rush Limbaugh – with his vast influence via memes and love of pranks – is a forerunner of and competitor to 4chan.)

I need to say two things going into this: (1) for my analysis, I am merely standing on the shoulders of economists more knowledgeable than I – when it comes to economics especially, I am – clearly – just an interested amateur; and (2) I came to this issue biased against this theory of the financial crisis – although not with my mind closed to it. The best expression of why I started out biased against this idea is probably the analogy Tyler Cowen used while debunking it. Cowen invoked the legal principle of the “thin skull” – in which someone at fault is considered responsible for all the damage caused by their actions, even if a person without a thin skull would not have been seriously hurt by such damages. For example, if you were responsible for a car accident and the other party was injured seriously as they had a thin skull which was damaged much more than a normal skull when it banged into the side window, you would be responsible for even the extraordinary damages resulting from that individual’s medical condition. Cowen explains that those seeking to blame the government for the business cycle and/or the current economic crisis:

…are postulating a very thin skull for markets and then blaming government for the disaster which results from government’s glancing blow to that skull.

A surprising amount of the debate over what caused the current crisis centers around the causes of and solutions to the Great Depression. The reason for this is not because there is widespread disagreement about this among historians or economists – but because the Republican party has embraced recent revisionist histories to make their case against the current intervention. The traditional understanding – between Keynesian and members of the Chicago School is that the Great Depression was made worse by the application of variations of this “thin skull” theory – as Herbert Hoover heeded advice to do little or nothing to combat the financial crisis – preferring to allow the market to fix itself. As Paul Krugman describes (from a 1998 Slate column):

The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression—with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore “sham” prosperity by expanding credit and the money supply.

But Amity Shlaes authored a recent history of the Great Depression to dispute this traditional understanding which had made her a hero of Republicans everywhere who have begun to cite her book more often than the Bible – almost. Shlaes passes herself off as an intellectual, but seems to be as partisan as Paul Krugman on his worst days. And her understanding of economics is quite shallow compared to the Nobel prize winner’s. Jonathan Chait in The New Republic took on Shlaes book – pointing out the holes in Shlaes revisions – how she attempted to blame liberalism for causing the crisis despite the fact that liberals had been out of power for the eight years before the depression started – and for the first three years after. She manages to pull this off by claiming that Herbert Hoover was a secret liberal interventionist – and blames Hoover’s meager attempts to stop starvation for undermining the recovery that her ideology maintains was imminent. Shlaes also fails to account for how we finally got out. As Chait explains:

[T]he classic right-wing critique fails to explain how the economy recovered at all. In one of his columns touting Shlaes, George Will observed that “the war, not the New Deal, defeated the Depression.” Why, though, did the war defeat the Depression? Because it entailed a massive expansion of government spending. The Republicans who have been endlessly making the anti-stimulus case seem not to realize that, if you believe that the war ended the Depression, then you are a Keynesian.

James Glassman’s influential arguments (in some circles) against any stimulus plan seem to have been inspired mainly by Shlaes’s flawed history.

Today’s crisis appeared at first glance (to most economists and us less enlightened citizens) to have been caused not by government interference but by private bankers controlling vast sums of money taking dumb risks with little government oversight. In time, other factors have come to the forefront, but this basic explanation seems right. Yet right-wingers and the Republican party continue to insist that government intervention was the cause – often out of what they see as a political necessity.

But on the other hand, there are some who seem to have less of a partisan interest in blaming the government for this crisis – and have embraced the Austrian School of Economics out of conviction rather than temporary partisan gain. Ron Paul, for example, blames both Democrats and Republicans for causing this mess. He seems to accept this “thin skull” logic and he has become an influential proponent of the Austrian school of economic thought. This school had its heyday in the 1920s as a result of Hayek, Mises, and others grappling with the issues of that time and perhaps most importantly discovering the business cycle. But this theory was largely abandoned as many saw it as responsible for worsening the Great Depression – as during the first years of the crisis, portions of the Austrian School’s prescriptions were tried. The theory was largely developed before the invention of central banks and while currency was still on the gold standard – but it had important insights in its time. Contemporary proponents such as Ron Paul tend to blame the changes to the financial system created to manage the boom-and-bust business cycle for causing the boom-and-bust business cycle. Yet this cycle has been part of capitalism since it’s inception – and has been managed since Great Depression by central banks and others using Keynesian theory and its successors relatively successfully. 

The appeal of this Austrian School of though though – aside from the partisan appeal for Republicans who are allowed to blame everything on liberals – is a moral one. It functions as a kind of religion-like palliative, telling a comforting story of sin and redemption. The Austrian business cycle tells of a recurring morality tale in which virtue is corrupted, until the sin of easy credit leads to the fall of the system. Then, the Market cleanses the world and virtue is restored to it’s proper place. The proper role of the economist in this is to act as a kind of priest – urging the people to stay true to this belief system in the face of adversity – to keep their faith that eventually the god of the Market will make everything better.

This fits well with the religious right of the Republican party – and perhaps this is why despite the theory’s rejection by most mainstream economists as outdated, it is gaining adherents among the Republican party, including the “rising star” Michelle Bachman.

[Image licensed under Creative Commons courtesy of elandru.]

Categories
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.