Scare Tactics and the Financial Crisis

The Stiglitz-Prescott view:

Here is Nobel prize-winner Joseph Stiglitz quoted by Free Exchange:

We’ve really extended the safety net beyond to big to fail, and my view is that there’s been no convincing argument that any of this was ever needed. It was based on the notion of fear — that if you didn’t do it, the whole financial set of markets would fail. Economics would have suggested that if you did a debt to equity conversion, converting long-term debt into equity, the financial institution would be well capitalized, there would be no reason to panic, and there would be more confidence in the market. But those who saw an opportunity to use scare tactics to get what they wanted did use those scare tactics, and it worked.

Here is Nobel prize-winner Ed Prescott quoted by Brad DeLong:

[P]eople got scared.... The press scared people. People running for office scared people. Bernanke scared people; Paulson scared people.... [P]eople began not to know what was going to happen. Then they stopped investing--by investing, I mean getting a new car or fixing up your house. And that led to the economy--it was depressed a bit that fourth quarter of last year...[With] benign neglect the economy would have come roaring back quite quickly...

Free Exchange says that Joseph Stiglitz's views are "insane" and Brad DeLong says that Prescott "does not live in the consensus reality with the rest of us." I am not sure why they are so confident.

I'm not sure why they are either.

The Crisis: A Failure or a Vindication of Economics?

John Taylor:

In my view, the financial crisis does not provide any evidence of a failure of modern economics. Rather the crisis vindicates the theory. Why do I say this? Because the research I have done shows that the crisis was caused by a deviation of policy from the type of policy recommended by modern economics. It was an interventionist deviation from the type of systematic policy that was responsible for the remarkably good economic performance in the two decades before the crisis. Economists call this earlier period the Long Boom or the Great Moderation because of the remarkably long expansions and short shallow recessions. In other words, we have convincing evidence that interventionist government policies have done harm. The crisis did not occur because economic theory went wrong. It occurred because policy went wrong, because policy makers stopped paying attention to the economics.

By the way, Taylor has just started blogging. (HT Russ Roberts)

Bailouts

Despair.com (HT Peter Klein)

John Taylor on the Financial Crisis

EconTalk:

John Taylor of Stanford University talks with EconTalk host Russ Roberts about the fundamental causes of the financial crisis of 2008. Taylor argues that the housing bubble of the early 2000s was caused by excessively loose monetary policy, in particular, a sustained period of excessively low interest rates pursued by the Federal Reserve. Other topics covered include rules vs. discretion in monetary policy and the risks of inflation in the coming months. The conversation concludes with a discussion of the impact of the current crisis on future monetary policy and the field of macroeconomics.

The Geography of a Recession

Catherine Rampell:

O.K., some of you complained about the clarity of the county-by-county unemployment slideshow (from the Federal Reserve Bank of St. Louis’s GeoFRED site) that I posted last week.

So: For your viewing pleasure, here’s a Times-made, interactive version, showing seasonally unadjusted unemployment rates around the country in May 2009. Many thanks to the Times graphics editors for this useful tool.

Boldly Going Where No One Has Gone Before

Robert Samuelson is worried about Obama's budget deficits. Nick Schulz puts this into a graph to help better understand what lies ahead:



I'm worried too.

(HT Russ Roberts via Greg Mankiw)

The Founders Put the Contract Clause in the Constitution for a Reason

Chrysler and the rule of law:

The Obama administration’s behavior in the Chrysler bankruptcy is a profound challenge to the rule of law. Secured creditors — entitled to first priority payment under the “absolute priority rule” — have been browbeaten by an American president into accepting only 30 cents on the dollar of their claims. Meanwhile, the United Auto Workers union, holding junior creditor claims, will get about 50 cents on the dollar.

The absolute priority rule is a linchpin of bankruptcy law. By preserving the substantive property and contract rights of creditors, it ensures that bankruptcy is used primarily as a procedural mechanism for the efficient resolution of financial distress. Chapter 11 promotes economic efficiency by reorganizing viable but financially distressed firms, i.e., firms that are worth more alive than dead.

Violating absolute priority undermines this commitment by introducing questions of redistribution into the process. It enables the rights of senior creditors to be plundered in order to benefit the rights of junior creditors.

Read the whole thing.

(HT Josh Wright)

Penny Wise, Pound Foolish

Megan McArdle:

It's hard to think about the Federal Budget in terms we can understand. A moderately successful American will, over the course of a forty year career, earn several million dollars. But we don't even see all that money all at once. Numbers a million times bigger than our total lifetime earnings literally boggle the imagination.

One enterprising videoblogger, however, has undertaken to illustrate the impact of Obama's recently announced $100 million in budget cuts:

Gendered Job Losses

Catherine Rampell:

We’ve written a few times about how job losses during this recession have been disproportionately male. Heather Boushey, a senior economist at the Center for American Progress (a liberal think tank), pointed me toward a piece she just wrote with updated numbers on this trend.

It also includes an interactive graphic that shows where women’s and men’s jobs have been lost or gained, broken down by industry. Here’s a snapshot of the chart:

While both sexes have experienced a net job loss since the recession began, in almost every sector that hemorrhaged jobs, most of the jobs lost belonged to men. And in two out of the three sectors that netted payroll gains, the vast majority of new positions went to women.

On thing about this chart puzzles me: Why did men on net lose jobs in the government, while women gained so many? I assume this reflects a difference in the kinds of jobs that were lost and gained (e.g., outdoor jobs cleaning town sidewalks or somesuch, versus indoor jobs teaching first-graders). It’s unclear from just these numbers, though.

Good question.

How Ideas Trump Economic Crises: A Surprising Lesson From 1929

GMU Professor Alex Tabarrok speaks at TED about the power of economic growth and the spread of ideas:

The "dismal science" truly shines in this optimistic talk, as economist Alex Tabarrok argues free trade and globalization are shaping our once-divided world into a community of idea-sharing more healthy, happy and prosperous than anyone's predictions.

As Housing Market Dips, More in U.S. Are Staying Put

The New York Times:

Stranded by the nationwide slump in housing and jobs, fewer Americans are moving, the Census Bureau said Wednesday.

The bureau found that the number of people who changed residences declined to 35.2 million from March 2007 to March 2008, the lowest number since 1962, when the nation had 120 million fewer people.

Experts said the lack of mobility was of concern on two fronts. It suggests that Americans were unable or unwilling to follow any job opportunities that may have existed around the country, as they have in the past. And the lack of movement itself, they said, could have an impact on the economy, reducing the economic activity generated by moves.

Home ownership rates have risen, and owners are typically less likely to move than renters. Two-earner families have become more common, and finding employment for both spouses in a new location can be challenging. Americans’ median age has been climbing, and it is younger people who usually move most often.

“It does show that the U.S. population, often thought of as the most mobile in the developed world, seems to have been stopped dead in its tracks due a confluence of constraints posed by a tough economic spell,” said William H. Frey, a demographer with the Brookings Institution.

A good reason to rent until the financial crisis is over?

Read more on the impact of home ownership on unemployment here.

"You Can't Borrow Your Way Out of Debt"

Daniel Hannan, MEP for South England, giving a speech against Prime Minister Gordon Brown. I wonder if our government's going to take a lesson from this? Unfortunately, I'm not too optimistic on that count.



The Governor of the Bank of England is also warning Gordon Brown that the UK cannot afford another economic stimulus in the budget. How long until the US gets into similar shape? I'm afraid our politicians won't stop until we get there.

Bush Deficit vs. Obama Deficit

This is unlikely to lead to good things.

Dear A.I.G., I Quit!

The resignation letter from Jake DeSantis, a VP of AIG's finanical products unit, to Edward Liddy, AIG CEO.

I am proud of everything I have done for the commodity and equity divisions of A.I.G.-F.P. I was in no way involved in — or responsible for — the credit default swap transactions that have hamstrung A.I.G. Nor were more than a handful of the 400 current employees of A.I.G.-F.P. Most of those responsible have left the company and have conspicuously escaped the public outrage.

After 12 months of hard work dismantling the company — during which A.I.G. reassured us many times we would be rewarded in March 2009 — we in the financial products unit have been betrayed by A.I.G. and are being unfairly persecuted by elected officials. In response to this, I will now leave the company and donate my entire post-tax retention payment to those suffering from the global economic downturn. My intent is to keep none of the money myself.

I take this action after 11 years of dedicated, honorable service to A.I.G. I can no longer effectively perform my duties in this dysfunctional environment, nor am I being paid to do so. Like you, I was asked to work for an annual salary of $1, and I agreed out of a sense of duty to the company and to the public officials who have come to its aid. Having now been let down by both, I can no longer justify spending 10, 12, 14 hours a day away from my family for the benefit of those who have let me down.

Read the whole thing.

Obama's Radicalism Is Killing the Dow?

A financial crisis is the worst time to change the foundations of American capitalism.

Mr. Obama's $3.6 trillion budget blueprint, by his own admission, redefines the role of government in our economy and society. The budget more than doubles the national debt held by the public, adding more to the debt than all previous presidents -- from George Washington to George W. Bush -- combined. It reduces defense spending to a level not sustained since the dangerous days before World War II, while increasing nondefense spending (relative to GDP) to the highest level in U.S. history. And it would raise taxes to historically high levels (again, relative to GDP). And all of this before addressing the impending explosion in Social Security and Medicare costs.

I do not expect all of this to end well. And I think that is a gross understatement.

Debt Rule of Thumb for Students

Are too many students overborrowing?

"A good rule of thumb is if you borrow more than your expected starting salary, it's going to be hard to repay your debt, and if you borrow more than twice, you're at a very high risk of default."

Indeed.

I think far too many students look at student loans as free money. It seems like parents, lenders, and other adults in the students' lives should be doing a much better job informing them about the perils of too much debt and the difficulty of paying off massive loans. This is particularly bad when students don't take into account their expected future earnings.

One of my profs in my PhD program encouraged us not to fear student loans and to look at them as cheap money. I always felt like this type of blanket advice presumed far too much about the future.

I may err on the side of being too debt averse, but this propensity has helped keep me from getting into any sort of deep financial mess while in school. When taken too far, debt can be a form of slavery -- restricting future options and financially handicapping students for years (decades?) to come. With the current financial crisis, now more than ever is a time to be extra-careful with those student loans.

(HT Center for College Affordability and Productivity)

US Auto Sales Plunged 41% in February

We can bail out their companies, but that doesn't mean people will buy their cars:

U.S. auto sales plunged yet again in February, falling 41% to 688,000 vehicles, according to Autodata Corp. The steep drop left car makers worried the market may not yet have bottomed out.

Almost all auto makers suffered significant setbacks. General Motors Corp.'s sales fell 53% from February 2008 to 126,170 cars and light trucks while Ford Motor Co.'s dropped 48% to 99,050.

Import brands also suffered. Toyota Motor Corp.'s sales slid 40% to 109,583, Honda Motor Co.'s fell 38% to 71,575 and Nissan Motor Co.'s dropped 37% to 54,249.

So exactly why are we bailing these guys out? Call me crazy, but keeping people working in poorly managed companies to make things nobody wants to buy doesn't seem like a very good way to stimulate the economy.

What One Economist Has Learned From the Finanical Crisis

Seth Roberts:

Three things, he said:

1. Finance professors have all been working for hedge funds. Their research has been about how to price derivatives and options. In other areas of economics, the research topics are much broader and include policy questions.
2. Macroeconomics hasn’t made progress since the 1930s.
3. Recommendations what to do about the crisis, even from economics professors, are based on very little they learned in graduate school. They hardly differ from opinions. Listening to his colleagues’ recommendations, he thought they would be backed up by something solid. They weren’t.

As I've written several times before, I have been highly skeptical of the validity of most of macroeconomics. I wish I had been wrong.

As the Dow Keeps Dropping, the President is Running Out of People to Blame

(A graph of the Dow Jones Industrial average since the passage of the stimulus bill.)

The Wall Street Journal:

As 2009 opened, three weeks before Barack Obama took office, the Dow Jones Industrial Average closed at 9034 on January 2, its highest level since the autumn panic. Yesterday the Dow fell another 4.24% to 6763, for an overall decline of 25% in two months and to its lowest level since 1997. The dismaying message here is that President Obama's policies have become part of the economy's problem.

Americans have welcomed the Obama era in the same spirit of hope the President campaigned on. But after five weeks in office, it's become clear that Mr. Obama's policies are slowing, if not stopping, what would otherwise be the normal process of economic recovery. From punishing business to squandering scarce national public resources, Team Obama is creating more uncertainty and less confidence -- and thus a longer period of recession or subpar growth.

That's just what I was saying a couple days ago.

The Lost Decade

Actually, it's worse that that. Today, the Dow dropped below 7,000 for the first time since 1997. The government's current spending spree and talk of massive legislation is only adding to market uncertainty, spooking investors, and making things worse. Obama's constant pessimism isn't helping matters.

More on this here.