I am pretty pessimistic now about the next 8 years. (Yes I think Obama will be re-elected. FDR had no problem with re-election, and the economy was awful. But he was an amazing orator and could blame it on the previous Republican buffoon. Same today.)
However, I do want to point to two positive trends, amidst the general march toward central planning. First, like FDR with alcohol, I think it is very possible that there will be a serious rollback of the Drug War as the Great Depression II intensifies. The government will be able to save money (from cutting the DEA and releasing all of the nonviolent drug offenders) and even raise new revenues from taxing marijuana and possibly harder drugs if they go that far.
A relaxation of the Drug War is really critical now, because there is going to be so much unrest in big cities during the next few years. If it’s ever a good time to stop the flow of billions of dollars into the pockets of violent drug gangs, it’s right before the Great Depression II hits, I think.
Second positive trend: Sure it’s just talk, but I have to say I’m impressed with how “weak” Obama allowed himself to be in this message to the Iranians. Yeah yeah, of course it was mostly done to impress American voters, but Obama looks like he’s the kind of guy who isn’t afraid to walk away from a fight. To repeat: I am NOT saying he is fundamentally changing foreign policy. I’m saying that it’s big of him to give this message, knowing what the talk radio hosts etc. will do with it, in the same way that I was impressed by Sarah Palin’s Saturday Night Live performance.
…is of the ratings agencies. Seriously, if you had to pick a single group who were most directly responsible not in terms of moral culpability, but in terms of their huge intellectual mistakes being directly tied to the housing bubble…well it’s gotta be the ratings agencies. I couldn’t find how many total employees Moody’s, Fitch, and S&P have, but I bet it’s a fairly small group of people, given how much influence they had. Don’t get me wrong, Greenspan had more per capita influence on the housing bubble, but you can’t tell the story of what happened without invoking the absolutely horrendous job the ratings agencies did.
So what I was originally going to post is that these firms have largely emerged unscathed. After all, AIG shareholders have gotten trounced, as well as the shareholders of other firms that got in over their heads and benefited the most during the boom years. But I don’t see S&P posting billion dollar losses. It’s true, the agencies’ profits are down, but that’s because of the general downturn in the credit markets; it’s not that their former customers are taking their business elsewhere.
But there’s a new twist: Dan Simmons sent me this WSJ article that explains that the ratings agencies might see up to a billion-dollar windfall from the Fed’s recent announcement of further experiments in hyperinflation. In any deal spurred by the Fed’s program, the ratings agencies need to come in and provide the requisite labeling–for a fee. This part’s great:
Now the government is in the uncomfortable position of rewarding these same firms through a new program that will result in numerous companies issuing securities. If the ratings companies are wrong this time around, the Federal Reserve and the Treasury — and therefore taxpayers — will be on the hook for some losses.
A Federal Reserve spokesman declined to comment. At a Senate hearing in Washington earlier this month, Fed Chairman Ben Bernanke said the central bank has looked at the models of the major rating companies and is “comfortable” they can rate securities eligible for the new program “in an appropriate way.”
The reason that Moody’s et al. are invulnerable to competition is–you guessed it!–government regulation. When banks, life insurance companies, and other heavily regulated financial institutions buy financial assets, they typically need a minimum rating (e.g. AA or better). (This regulation is intended to ensure that your life insurance company can pay your wife when you die.)
But then that begs the question: Who is an acceptable rater of the bonds a bank buys? The bank president can’t simply call up his brother-in-law and have him send over a notarized letter declaring everything on the books is a AAA.
Although I think the rules for being an acceptable rating agency are in theory open to a wide field of competition,* in practice the regulations ensure that Moody’s et al. have a cartel.
If any companies should be liquidated because of their executives’ mistakes during the housing boom, it is the ratings agencies. But instead of heads rolling, they get a nice cut of every injection of new Fed money into the credit markets.
*von Pepe chides me in email and says that the government really is picking the cartel. The SEC requires the ratings for the regulated buyers to be performed by “Nationally Recognized Statistical Rating Organizations,” and if you check out the definition of this phrase, it turns out that only the Big Three of Moody’s, Fitch, and S&P qualified up to a few years ago, and now only 7 or so qualify. But that was my point, that if you read the actual regulation, it doesn’t say, “You need to get your rating from Moody’s,” but in practice to comply with the regulation you have to go to the big boys.
Wow I stumbled across these (1, 2, 3) on YouTube. It was from an interview I gave a while ago, sometime in early 2008 I believe. Note that I follow Ilana Mercer on Part 1 about 10:20 into it. We talk about the financial crisis, mortgage market, etc.
I’m sorry kids, but I have to call it like I see it. And in this blog post Brad DeLong blows up Chicago’s John Cochrane. If you’re a guest on a talk radio show, I think it’s fine to say (as Cochrane does) that the government can’t create jobs because every dollar it spends ultimately comes from the private sector.
However, if you are writing actual economics, you have to be much more nuanced. It is possible for the government to “create jobs,” but so what? The way to answer DeLong and Krugman is to say that periods of unemployment are necessary as the market redirects misallocated workers. You can’t just point to accounting, as Cochrane and some others do. For one thing, it’s not really correct, and for another, DeLong and his smug fans will tear you apart.
In that light, let me take two pot shots at Cochrane myself. (And incidentally, I’m not saying Cochrane is dumb, or that his general views of macroeconomics are wrong. I’m just saying, he was sloppy at times on the crucial points.)
* When pointing out how much modern economists know more than Keynes, Cochrane says:
We all now understand the inescapable need for markets and price signals, and the sclerosis induced by high marginal tax rates, especially on investment. Keynes recommended that Britain pay for the second world war with taxes. We now understand that it is best to finance wars by borrowing, so as to spread the disincentive effects of taxes more broadly over time.
But wait a second. A little while later Cochrane also writes:
Robert Barro’s Ricardian equivalence theorem was one nail in the coffin. This theorem says that [fiscal] stimulus cannot work because people know their taxes must rise in the future. Now, one can argue with that result. Perhaps more people ignore the fact that taxes will go up than overestimate those tax increases. But once enlightened, we cannot ignore this central question. We cannot return to mechanically adding up today’s consumption, investment and export demands, and prescribe the government demand necessary to attain some desired level of output. Every economist now knows that to get stimulus to work, at a minimum, government must fool people into forgetting about future taxes, an issue Keynes and Keynesians never thought of.
Hmmmm. Let’s say Britain is fighting World War II and has raised taxes enough to cover the spending. But with those crippling tax rates, the most productive people don’t work as much, and a bunch of low-skilled people get laid off.
So the British government uses a time machine to call an important economist from the future. They get lucky and get Cochrane on the horn. They ask him if they should borrow the money to pay for the war, so that they can cut taxes and try to stimulate the economy. I believe Cochrane’s answer would be, “Yes we now know you should do that, but we also know it won’t work.”
* In his effort to rip the Keynesians, Cochrane says:
Our situation is remarkable. Imagine that an august group of Nobel-prize-winning scientists and government advisers on climate change were to say: “Yes, global warming has been all the rage for 30 years, but all these whippersnappers with their fancy computer models, satellite measurements and stacks of publications in unintelligible academic journals have lost touch with the real world. We still believe the world is headed for an ice age, just as we were taught as undergraduates back in the 1960s.” Who would seem out of touch in that debate? Yet this is exactly where we stand with fiscal stimulus.
Holy cow John, you keep talking like that, and I’m going to buy The Return of Depression Economics. Why don’t you compare them to evangelicals next? Then you’d really raise my sympathy and make me doubt your confident assurances that you’ve got it all figured out.
Anyway, Krugman’s post is worth reading if for nothing else than this: “I think quantitative easing (it’s really qualitative easing, but I give up on trying to fix the terminology) is the right way to go.” Thank you Dr. Krugman! I have been wondering what in the heck quantitative easing could even mean. (It’s not like the Fed used to cut interest rates from funny to amusing, but now they are cutting them from 2% to 1%.)
But Krugman also makes the important observation that the Fed will lose money if there is indeed a Treasury bubble. And that means that even if he wanted to, Bernanke couldn’t merely “unwind” his terrifying pumping up of the Fed’s balance sheet in order to withdraw all of the new reserves from the system. As Krugman says:
But here’s the rub: if and when the economy recovers, it’s likely that long-term interest rates will rise, especially if the Fed’s current policy is successful in bringing them down. Suppose that the Fed has bought a bunch of 10-year bonds at 2.5% interest, and that by the time the Fed wants to shrink the money supply again the interest rate has risen to 5 or 6 percent, where it was before the crisis. Then the price of those bonds will have dropped significantly.
And this also means that selling the bonds at market prices won’t be enough to withdraw all the money now being created. So the Fed will have to sell additional assets; if the rise in interest rates is at all significant, it will have to get those assets from the Treasury. So the Fed is, implicitly, engaged in a deficit spending policy right now.
My back of the envelope calculation looks like this: if the Fed buys $1 trillion of 10-year bonds at 2.5%, and has to sell those bonds in an environment where the market demands a yield to maturity of more than 5%, it will take around a $200 billion loss.
Good times at the Austrian Scholar’s Conference. Tom Woods sent me this. He loves it, but I suspect it’s due to his narcissism. I love his talks too, because he usually has an anecdote involving my naughtiness.
True story: After this talk, a guy came up to me and was waving his arms around saying, “Whoa Dr. Murphy you must be part Italian!”
So I said, “Oh, was I moving my hands a lot?”
Then he goes, “No, I just thought you gave a lively talk.”
If you think about it, you will realize just how awkward a situation I had created.
Ladies and gentlemen, start your engines! I don’t trust the BLS’s “seasonal adjustments,” but at face value they say CPI rose 0.3% in January and then 0.4% in February, for an annualized rate of almost 4.3% for the new year. I think next year we will laugh that people were still worried about deflation at this late a stage.
* Rose and White warn the Fed that it is committing the opposite mistake that (according to Friedman) the Fed committed during the 1930s.
* Arnold Kling has a great post about financial regulation.
* Not sure what I’m saying here.
* James Fogal sends the YouTube below. I got this guy.