Archive for the ‘Krugman’ Category

Obama Still Thinks After Economy Recovers; Bank, Finance Good Times Can Return?

March 27, 2009

On Monday, Lawrence Summers, the head of the National Economic Council, responded to criticisms of the Obama administration’s plan to subsidize private purchases of toxic assets. “I don’t know of any economist,” he declared, “who doesn’t believe that better functioning capital markets in which assets can be traded are a good idea.”

The New Yok Times

Leave aside for a moment the question of whether a market in which buyers have to be bribed to participate can really be described as “better functioning.” Even so, Mr. Summers needs to get out more. Quite a few economists have reconsidered their favorable opinion of capital markets and asset trading in the light of the current crisis.

But it has become increasingly clear over the past few days that top officials in the Obama administration are still in the grip of the market mystique. They still believe in the magic of the financial marketplace and in the prowess of the wizards who perform that magic.

The market mystique didn’t always rule financial policy. America emerged from the Great Depression with a tightly regulated banking system, which made finance a staid, even boring business. Banks attracted depositors by providing convenient branch locations and maybe a free toaster or two; they used the money thus attracted to make loans, and that was that.

And the financial system wasn’t just boring. It was also, by today’s standards, small. Even during the “go-go years,” the bull market of the 1960s, finance and insurance together accounted for less than 4 percent of G.D.P. The relative unimportance of finance was reflected in the list of stocks making up the Dow Jones Industrial Average, which until 1982 contained not a single financial company.

It all sounds primitive by today’s standards. Yet that boring, primitive financial system serviced an economy that doubled living standards over the course of a generation.

After 1980, of course, a very different financial system emerged. In the deregulation-minded Reagan era, old-fashioned banking was increasingly replaced by wheeling and dealing on a grand scale. The new system was much bigger than the old regime: On the eve of the current crisis, finance and insurance accounted for 8 percent of G.D.P., more than twice their share in the 1960s. By early last year, the Dow contained five financial companies — giants like A.I.G., Citigroup and Bank of America.

And finance became anything but boring. It attracted many of our sharpest minds and made a select few immensely rich.

Underlying the glamorous new world of finance was the process of securitization. Loans no longer stayed with the lender. Instead, they were sold on to others, who sliced, diced and puréed individual debts to synthesize new assets. Subprime mortgages, credit card debts, car loans — all went into the financial system’s juicer. Out the other end, supposedly, came sweet-tasting AAA investments. And financial wizards were lavishly rewarded for overseeing the process.

But the wizards were frauds, whether they knew it or not, and their magic turned out to be no more than a collection of cheap stage tricks. Above all, the key promise of securitization — that it would make the financial system more robust by spreading risk more widely — turned out to be a lie. Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.

Sooner or later, things were bound to go wrong, and eventually they did. Bear Stearns failed; Lehman failed; but most of all, securitization failed.

Which brings us back to the Obama administration’s approach to the financial crisis.

Much discussion of the toxic-asset plan has focused on the details and the arithmetic, and rightly so. Beyond that, however, what’s striking is the vision expressed both in the content of the financial plan and in statements by administration officials. In essence, the administration seems to believe that once investors calm down, securitization — and the business of finance — can resume where it left off a year or two ago.

To be fair, officials are calling for more regulation. Indeed, on Thursday Tim Geithner, the Treasury secretary, laid out plans for enhanced regulation that would have been considered radical not long ago.

But the underlying vision remains that of a financial system more or less the same as it was two years ago, albeit somewhat tamed by new rules.

As you can guess, I don’t share that vision. I don’t think this is just a financial panic; I believe that it represents the failure of a whole model of banking, of an overgrown financial sector that did more harm than good. I don’t think the Obama administration can bring securitization back to life, and I don’t believe it should try.

We Can’t Agree To Economic Cures Because Economists Can’t Agree

February 2, 2009

Economist Paul Krugman, the winner of the Nobel prize in economics, is embarassed by what he calls the weak arguements of other economists against the stimulus.

This small quote from his blog gives a nice review of schools of thought on this subject that have developed over the years:

There are certainly legitimate arguments against spending-based fiscal stimulus. You can worry about the burden of debt; you can argue that the government will spend money so badly that the jobs created are not worth having; and I’m sure there are other arguments worth taking seriously.

Yes indeed says, for one, John Cochrane, Professor of Economics at the University of Chicago Booth School of Business.

Cochrane and some 50 other economists have allied together to dispute Krugman and the Obama stimulus.

Dropping money from helicopters is “fiscal stimulus,” and that will surely goose demand before it quickly leads to inflation. Usually though, “stimulus” means by debt that the government plans to pay back, and is supposed to work without inflation. Does it? Many arguments reflect classic fallacies. 

The Obama economic team has not announced a clear schedule of future spending controls or tax increases that can pay off the new debt, and the Federal Reserve has already more than doubled the money supply and is widely announcing its intention to do much more.  (We don’t need to see higher tax rates, we need to see higher revenues or lower spending. A plan for higher rates can choke off growth implying lower revenues.)  On the other hand, they have not announced the opposite, a determined intention to inflate rather than pay off the debt, which would give the maximum inflationary demand punch.


In any case, let us hope this is not the plan. Just because a little demand goose followed by inflation is possible doesn’t mean it’s a good idea. The inflation that will result from a trillion dollars of money permanently dropped on the economy, and the real economic dislocation of such a major inflation, is frightful to contemplate.

Read John Cochrane:

Obama Has To Spend More, Eliminate Tax Cuts — Krugman

January 12, 2009

The Obama plan would have its maximum impact in the fourth quarter of 2010. Without the plan …  the unemployment rate in that quarter would be a disastrous 8.8 percent. Yet even with the plan, unemployment would be 7 percent — roughly as high as it is now.

After 2010, the report says, the effects of the economic plan would rapidly fade away. The job of promoting full recovery would, however, remain undone: the unemployment rate would still be a painful 6.3 percent in the last quarter of 2011.

Above: Paul Krugman by Fred R. Conrad/The New York Times

Read the entire essay from Paul:

Obama Stimulus: Trapped Between Too Little Rock and Paul Krugman Nightmare