Economic Crisis – Page 27 – artdiamondblog.com

The Bailouts Are Like Giving Bottles of Scotch to Drunkards

Printing press for $20 bills. Source of photo: online version of the NYT article quoted and cited below.

(p. 4) “We got into this mess to a considerable extent by overborrowing,” said Martin N. Baily, a chairman of the Council of Economic Advisers under President Clinton and now a fellow at the Brookings Institution. “Now, we’re saying, ‘Well, O.K., let’s just borrow a bunch more, and that will help us get out of this mess.’ It’s like a drunk who says, ‘Give me a bottle of Scotch, and then I’ll be O.K. and I won’t have to drink anymore.’ Eventually, we have to get off this binge of borrowing.”

“This is a dangerous situation,” says Mr. Baily, essentially arguing that the drunk must be kept in Scotch a while longer, lest he burn down the neighborhood in the midst of a crisis. “The risks of things actually getting worse and us going into a really severe recession are high. We need to get more money out there now.”
. . .
The most frequently voiced worry about the bailouts is that the Fed, by sending so much money sloshing through the system, risks generating a bad case of rising prices later on. That puts the onus on the Fed to reverse course and crimp economic activity by lifting interest rates and selling assets back to banks once growth resumes.
But finding the appropriate point to act tends to be more art than science. The Fed might move too early and send the economy back into a tailspin. It might wait too long and let too much money generate inflation.
“It’s a tricky business,” says Allan H. Meltzer, an economist at Carnegie Mellon University, and a former economic adviser to President Reagan. “There’s no math model that tells us when to do it or how.”

For the full story, see:
PETER S. GOODMAN. “Debt Sweat; Printing Money and Its Price.” The New York Times, Week in Review Section (Sun., December 28, 2008): 1 & 4.
(Note: ellipsis added.)

Bailouts Reduce Resources Left for Entrepreneurs

Columbia University Professor Amar Bhidé has authored two important books on entrepreneurship. Some of his thoughts on the current economic crisis follow:

(p. A15) Our ignorance of what causes economic ailments — and how to treat them — is profound. Downturns and financial crises are not regular occurrences, and because economies are always evolving, they tend to be idiosyncratic, singular events.

After decades of diligent research, scholars still argue about what caused the Great Depression — excessive consumption, investment, stock-market speculation and borrowing in the Roaring ’20s, Smoot-Hawley protectionism, or excessively tight monetary policy? Nor do we know how we got out of it: Some credit the New Deal while others say that that FDR’s policies prolonged the Depression.
. . .
Large increases in public spending usurp precious resources from supporting the innovations necessary for our long-term prosperity. Everyone isn’t a pessimist in hard times: The optimism of many entrepreneurs and consumers fueled the takeoff of personal computers during the deep recession of the early 1980s. Amazon has just launched the Kindle 2; its (equally pricey) predecessor sold out last November amid the Wall Street meltdown. But competing with expanded public spending makes it harder for innovations like the personal computer and the Kindle to secure the resources they need.

Hastily enacted programs jeopardize crucial beliefs in the value of productive enterprise. Americans are unusually idealistic and optimistic. We believe that we can all get ahead through innovations because the game isn’t stacked in favor of the powerful. This belief encourages the pursuit of initiatives that contribute to the common good rather than the pursuit of favors and rents. It also discourages the politics of envy. We are less prone to begrudge our neighbors’ fortune if we think it was fairly earned and that it has not come at our expense — indeed, that we too have derived some benefit.

To sustain these beliefs, Americans must see their government play the role of an even-handed referee rather than be a dispenser of rewards or even a judge of economic merit or contribution. The panicky response to the financial crisis, where openness and due process have been sacrificed to speed, has unfortunately undermined our faith. Bailing out AIG while letting Lehman fail — behind closed doors — has raised suspicions of cronyism. The Fed has refused to reveal to whom it has lent trillions. Outrage at the perceived use of TARP funds to pay bonuses is widespread.

For the full commentary, see:

Amar Bhidé. “Don’t Believe the Stimulus Scaremongers.” Wall Street Journal (Tues., FEBRUARY 17, 2009): A15.
(Note: ellipsis added.)

Bhidé’s two books on entrepreneurship are:
Bhidé, Amar. The Origin and Evolution of New Business. Oxford and New York: Oxford University Press, 2000.
Bhidé, Amar. The Venturesome Economy: How Innovation Sustains Prosperity in a More Connected World. Princeton, NJ: Princeton University Press, 2008.

Distinguished Macroeconomist Irving Fisher Lost a Lot in the 1929 Crash

Irving Fisher is widely viewed as one of the handful ot top United States economists of the 1920s and 1930s. In addition, he focused on topics that today are considered part of macroeconomics. His not forecasting the economic downturn can be given different interpretations. Some, such as Taleb, would attribute it in part to fundamental uncertainty. Until recently, many economists would have said that Fisher still had a lot to learn, but we are now know more than him.
That may be true, but we still have a lot to learn.

(p. 5) IRRATIONAL exuberance? As the nation entered recession in the summer of 1929, there were still plenty of economists, business leaders and politicians who looked to the future with optimism. And why not? The Dow Jones industrial average was soaring. Then the stock market bubble burst on Oct. 24, which led to several days of panicked selling — an opening bell for the worldwide economic collapse that soon followed. Here’s what some leading politicians, economists and business leaders had to say in the months before and after the crash. Sound familiar?
. . .
Irving Fisher, professor of economics at Yale University, in The New York Times, Sept. 6, 1929. He ended up losing much of his wealth in the crash:
“There may be a recession in stock prices, but not anything in the nature of a crash.”
. . .
The Harvard Economic Society, November 1929:
“A severe depression like that of 1920-21 is outside the range of probability. We are not facing protracted liquidation.”

For the full story, see:
“Word For Word; I’m Having a Flashback; A Storm Unforeseen, Always About to Pass.” The New York Times, Week in Review Section (Sun., October 11, 2008): 5.
(Note: no author is listed.)
(Note: ellipses added.)

80% of Officials Base Infrastructure Decisions on Politics

Source of graph: online version of the NYT commentary quoted and cited below.

(p. B1) It’s hard to exaggerate how scattershot the current system is. Government agencies usually don’t even have to do a rigorous analysis of a project or how it would affect traffic and the environment, relative to its cost and to the alternatives — before deciding whether to proceed. In one recent survey of local officials, almost 80 percent said they had based their decisions largely on politics, while fewer than 20 percent cited a project’s potential (p. B6) benefits.

There are monuments to the resulting waste all over the country: the little-traveled Bud Shuster Highway in western Pennsylvania; new highways in suburban St. Louis and suburban Maryland that won’t alleviate traffic; all the fancy government-subsidized sports stadiums that have replaced perfectly good existing stadiums. These are the Bridges to (Almost) Nowhere that actually got built.

For the full commentary, see:
DAVID LEONHARDT. “Economic Scene; Piling Up Monuments of Waste.” The New York Times (Weds., November 18, 2008): B1 & B6.

“Firms that Made Wrong Decisions Should Fail”

Anna J. Schwartz.

Source of image: online version of the WSJ article quoted and cited below.

(p. A11) Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She’s not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, “A Monetary History of the United States” (1963). It’s the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.
. . .
These are not, Ms. Schwartz argues, the same thing. In fact, by keeping otherwise insolvent banks afloat, the Federal Reserve and the Treasury have actually prolonged the crisis. “They should not be recapitalizing firms that should be shut down.”
Rather, “firms that made wrong decisions should fail,” she says bluntly. “You shouldn’t rescue them. And once that’s established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich.” The trouble is, “that’s not the way the world has been going in recent years.”
Instead, we’ve been hearing for most of the past year about “systemic risk” — the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake.
Ms. Schwartz doesn’t buy it. “It’s very easy when you’re a market participant,” she notes with a smile, “to claim that you shouldn’t shut down a firm that’s in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that’s their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn’t have to save them, just as it didn’t save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what’s been going on.”

For the full story, see:
BRIAN M. CARNEY. “OPINION: THE WEEKEND INTERVIEW with Anna Schwartz; Bernanke Is Fighting the Last War.” The Wall Street Journal (Weds., OCTOBER 18, 2008): A10.
(Note: ellipsis added.)

FDR’s Treasury Secretary Morgenthau Concluded that Big Spending Stimulus “Does Not Work”

Henry Morgenthau, Jr.

Source of portrait: http://en.wikipedia.org/wiki/Henry_Morgenthau,_Jr.

Henry Morgenthau, Jr. was FDR’s Secretary of the Treasury from 1934-1945. In the following important quote, he admits that the big New Deal stimulus spending programs had failed.

(p. 2) We have tried spending money. We are spending more money than we have ever spent before and it does not work. And I have just none interest, and if I am wrong . . . somebody else can have my job. I want to see this country prosperous. I want to see people get a job, I want to see people get enough to eat. We have never made good on our promises. . . . I say after eight years of this administration we have just as much unemployment as when we started . . . . And an enormous debt to boot!

Source:
Folsom, Burton W., Jr. In New Deal or Raw Deal? How FDR’s Economic Legacy Has Damaged America. 4th ed. New York: Threshold Editions, 2008.
(Note: ellipses in Folsum’s version of the quotation.)

Folsum says that this statement was from testimony before the House Ways and Means Committee in May 1939; and can be found in Morgenthau’s Diary entry for May 9, 1939 at the Roosevelt Presidential Library.

Source of book image: http://www.flickr.com/photos/roscoe/3121498653/

Bailouts Damage “System Based on the Premise that Risk Can Bring Failure, as Well as Rewards”

Source of the cartoon: online version of the WSJ quoted and cited below.

(p. A8) William O. Perkins III says he turned a $1.25 million profit trading Goldman Sachs Group Inc. stock last week.

You would think that would count as a pretty good paycheck for the Houston energy trader. Instead, the experience left him so angry about the demise of capitalism that he says he has decided to spend his profits on advertisements attacking President George W. Bush’s planned $700 billion Wall Street bailout.
. . .
So he says he bought Goldman Sachs at $129 a share. The stock fell, so he bought more at $100 a share. It fell again, and he bought at $90. The next day it rallied and he sold out at an average price of $130 a share, for a net gain of about $1.25 million over three days of trading, he said.
Trouble was, the stock didn’t rally because of the fundamental strength of the company, Mr. Perkins said. It rallied because the federal government announced that it would rescue Wall Street from its own subprime follies, he said.
“The stock did OK because the government came in and said, ‘No one can fail,'” he said. “It’s capitalism on the way up and communism on the way down.”
His success left him furious, and he decided that someone had to speak out about the damage such a plan would cause to a system based on the premise that risk can bring failure, as well as rewards.

For the full story, see:

MICHAEL M. PHILLIPS. “Trader Makes a Quick $1.25 Million on Rescue, Then Slams It.” The Wall Street Journal (Weds., SEPTEMBER 24, 2008): A10.
(Note: ellipsis added.)

Rajan Foresaw Risks of Financial Disaster

“Raghuram Rajan, shown at 2005 symposium, warned of rising risks.” Source of caption and photo: online version of the NYT article quoted and cited below.

I praised Rajan’s analysis in a blog entry back in January 2008. Rajan deserves credit for seeing the situation earlier and more clearly than most other experts:

(p. A7) To outline his fears about the U.S. economy, Raghuram Rajan picked a tough crowd.

It was August 2005, at an annual gathering of high-powered economists at Jackson Hole, Wyo. — and that year they were honoring Alan Greenspan. Mr. Greenspan, a giant of 20th-century economic policy, was about to retire as Federal Reserve chairman after presiding over a historic period of economic growth.
Mr. Rajan, a professor at the University of Chicago’s Booth Graduate School of Business, chose that moment to deliver a paper called “Has Financial Development Made the World Riskier?”
. . .
He says he had planned to write about how financial developments during Mr. Greenspan’s 18-year tenure made the world safer. But the more he looked, the less he believed that. In the end, with Mr. Greenspan watching from the audience, he argued that disaster might loom.
Incentives were horribly skewed in the financial sector, with workers reaping rich rewards for making money, but being only lightly penalized for losses, Mr. Rajan argued. That encouraged financial firms to invest in complex products with potentially big payoffs, which could on occasion fail spectacularly.
. . .
Mr. Rajan is now focused on coming up with ways to avoid a regulatory backlash akin to what happened during the Great Depression, when governments around the world threw up protectionist barriers and clamped down on financial markets.
Instead of heavy regulation, he says, the incentives of Wall Streeters need to change so that punishments for losing money are in line with rewards for earning it.
At the start of 2008, he suggested that bonuses that financial workers make during boom times should be kept in escrow accounts for a period of time. If the firm experienced big losses later, those accounts would be drained.
Facing withering criticism over the bonuses paid out in the boom, financial giant UBS and Wall Street firm Morgan Stanley have recently announced they’re adopting policies along the lines of what Mr. Rajan proposed.
Mr. Rajan also urges other safeguards. Along with Chicago colleagues Anil Kashyap and Harvard economist Jeremy Stein, he’s come up with a plan to create a form of financial-catastrophe insurance that firms would buy into.

For the full story, see:
JUSTIN LAHART. “Mr. Rajan Was Unpopular (But Prescient) at Greenspan Party.” The Wall Street Journal (Fri., JANUARY 2, 2009): A7.
(Note: ellipses added.)

Japan’s Stimulus Package Stimulated Debt, but Not Recovery

Source of graphs: online version of the NYT article quoted and cited below.

(p. A10) In the end, say economists, it was not public works but an expensive cleanup of the debt-ridden banking system, combined with growing exports to China and the United States, that brought a close to Japan’s Lost Decade. This has led many to conclude that spending did little more than sink Japan deeply into debt, leaving an enormous tax burden for future generations.

In the United States, it has also led to calls in Congress, particularly by Republicans, not to repeat the errors of Japan’s failed economic stimulus. They argue that it makes more sense to cut taxes, and let people decide how to spend their own money, than for the government to decide how to invest public funds. Japan put more emphasis on increased spending than tax cuts during its slump, but ultimately did reduce consumption taxes to encourage consumer spending as well.

For the full story, see:
MARTIN FACKLER. “Japan’s Big-Works Stimulus Is Lesson.” The New York Times (Fri., February 5, 2009): A1 & A10.

“The soaring Marine Bridge in Hamada, Japan, built as a public works project, was almost devoid of traffic on a recent morning.” Source of caption and photo: online version of the NYT article quoted and cited above.

“This is a Crisis of Excessive Debt”

Source of book image: http://ecx.images-amazon.com/images/I/41gD4n5UkHL._SL500_.jpg

Niall Ferguson has a recent book on money that has received a great deal of attention (but that I have not yet seen). Here are some of his views, as expressed at the 2009 World Economic Forum, in Davos, Switzerland:

(p. B4) “Even before Obama walked through the White House door, there were plans for $1 trillion of new debt,” said Niall Ferguson, a Harvard historian who has studied borrowing and its impact on national power. He now estimates that some $2.2 trillion in new government debt will be issued this year, assuming the stimulus plan is approved.

“You either crowd out other borrowers or you print money,” Mr. Ferguson added. “There is no way you can have $2.2 trillion in borrowing without influencing interest rates or inflation in the long-term.”
Mr. Ferguson was particularly struck by the new borrowing because the roots of the current crisis lay in an excess of American debt at all levels, from homeowners to Wall Street banks.
“This is a crisis of excessive debt, which reached 355 percent of American gross domestic product,” he said. “It cannot be solved with more debt.”
While Mr. Ferguson is a skeptic of the Keynesian thinking behind President Obama’s plan — rather than borrowing and spending to stimulate the economy, he favors corporate tax cuts — even supporters of the plan like Mr. Zedillo and Stephen Roach of Morgan Stanley have called on the White House to quickly address how it will pay for the spending in the long-term.

For the full story, see:
NELSON D. SCHWARTZ. “Global Worries Over U.S. Stimulus Spending.” The New York Times (Fri., January 29, 2009): B1 & B4.

The latest Ferguson book, is:
Ferguson, Niall. The Ascent of Money: A Financial History of the World. New York: Penguin Press, 2008.

Japan’s Huge Stimulus Spending Led to Economic Stagnation

(p. A2) Rep. Paul Ryan of Wisconsin, a young and economically astute Republican leader, has numerous problems with the economic-stimulus package working its way through Congress, but essentially they boil down to this: He fears the U.S. is repeating the mistakes Japan made trying to get out of its own economic ditch in the 1990s.
The Ryan critique is important in part because it’s popping up with increasing frequency among congressional Republicans.
. . .
Here’s the critique in a nutshell: Japan in the early 1990s, like the U.S. today, saw a real-estate bubble burst, spawning a banking and credit crisis that drove the whole economy down, hard. The Japanese then tried stimulating the economy with giant doses of government spending, which didn’t pep things up — but did bring on deficits that required tax increases later, dragging out Japan’s problems for years.

For the full commentary, see:
GERALD F. SEIB. “CAPITAL JOURNAL; Avoiding Japan’s Stimulus Miscues.” Wall Street Journal (Tues., FEBRUARY 2, 2009): A2.
(Note: ellipsis added.)