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March 24, 2009

Scenes From the Lives of the Great Economists
Posted by Patrick at 03:21 PM * 77 comments

Paul Krugman contemplates the Geithner Plan.

Comments on Scenes From the Lives of the Great Economists:
#1 ::: Ken Houghton ::: (view all by) ::: March 24, 2009, 04:26 PM:

Ouch! Though painfully accurate.

#2 ::: Randolph ::: (view all by) ::: March 24, 2009, 04:40 PM:

I think Krugman's remarks on Larry Summers are revealing. Summers, of course, is a colleague of Krugman's. He is also a sexist jerk. Well-mannered and corrupt is apparently hard for Krugman to grasp. And, dear gods, Brad Delong's "well, it may do some good, and it's better than nothing," is the thinking of a man who has way too much trust in authority.

...and what of Obama?

#3 ::: Giacomo ::: (view all by) ::: March 24, 2009, 04:43 PM:

"well, it may do some good, and it's better than nothing"

Isn't that another variation of the Thatcherite fallacy?

#4 ::: Chris Quinones ::: (view all by) ::: March 24, 2009, 04:53 PM:

If I forget thee, O Glass-Steagall Act, let my right hand cash in for trillions. Or something.

#5 ::: albatross ::: (view all by) ::: March 24, 2009, 06:37 PM:

Honestly, all policy responses to the economic crisis at this point seem to have the flavor of that bit in Wall-E, in which Wall-E is in the departing space ship, hitting every knob, button, and lever in a desperate attempt to find something that will open the door. I am convinced that, when this new proposal is enacted, we will see the same pattern as all the other responses:

a. Tremendous amounts of money will be spent, with little or no hope of ever seeing any of it back.

b. Future policy options will be closed off.

c. A number of well-connected folks will turn out to get a huge windfall from the whole thing.

d. No actual improvement in the world's situation will be noticeable.

e. However, the administration and its friends will claim that if they hadn't done this thing, the economy would be still worse.

f. Next month, a new Grand Strategy of the Week will be announced, with similar fanfare and likely outcomes.

#6 ::: Bruce Cohen (SpeakerToManagers) ::: (view all by) ::: March 24, 2009, 07:39 PM:

albatross

f. Next month, a new Grand Strategy of the Week will be announced, with similar fanfare and likely outcomes.

And it will be the same as the previous Grand Strategy, just with different serial numbers, and a fresh coat of paint.

#7 ::: Bruce Cohen (SpeakerToManagers) ::: (view all by) ::: March 24, 2009, 07:43 PM:

As I remarked earlier today in the context of the bankers' threat to obstruct the process by slowdowns on providing information for the stress tests:

The proper response to this blackmail is a forced takeover of AIG and all the other institutions that are "too large to fail", remove all the executive officers, rescind all bonuses, nullify all stock options, and reduce all salaries by at least 20%. Then promote out of the lower ranks to the executive positions, and keep removing them and promoting others until they clean up the toxic assets mess they made. Once that's done, break them up into separate organizations that can be allowed to fail. Then reward the employees who are left who actually solved the problem.

#8 ::: Marna Nightingale ::: (view all by) ::: March 24, 2009, 07:43 PM:

I originally read this as "Scenes from the Livers of the Great Economists". And was much bemused thereby, though I suppose at this point reading the entrails of economists[1] is about as good an approach as any now being tried...

[1] Only such economists as die natural deaths, or I suppose these days one could examine the organs of living ones in situ, given proper medical equipment. I wasn't suggesting we go round some up and slice them open, as this would be Very Wrong Indeed.

#9 ::: Randolph ::: (view all by) ::: March 24, 2009, 07:53 PM:

Not sure I know what the Thatcherite fallacy was. One point, though, that Delong has right: if the Senate gets to vote on a real plan, it won't go; half the Democrats are conservatives. I wish the Senate conservatives would take on the debt for their own damn education!

#10 ::: Marna Nightingale ::: (view all by) ::: March 24, 2009, 08:06 PM:

Randolph @9:

Not sure I know what the Thatcherite fallacy was

I confess my first thought was "it was so dark; there were so many", but Wikipedia suggests that it is "a (falsely) logical argument of the form:

We must do something
This is something
Therefore, we must do this."

#11 ::: Kip W ::: (view all by) ::: March 24, 2009, 08:51 PM:

If I forget thee, O Glass-Steagall Act, let my right hand cash in for trillions. Or something. I remember this from The Outer Limits: "Demon with a Glass-Steagall Hand."

#12 ::: Bruce Cohen (SpeakerToManagers) ::: (view all by) ::: March 24, 2009, 09:06 PM:

Marna Nightingale @ 8

I think the liver referred to is that of the first great economist, the inventor of money, who, for his innovation, was chained to a rock and daily had his liver eaten by an eagle. It has not come down to us whether onions were served as well.

#13 ::: P J Evans ::: (view all by) ::: March 24, 2009, 09:32 PM:

#6
I'm not sure they even change the serial numbers any more. At least, not beyond adding a digit and claiming it's now a whole! new! plan.

#14 ::: Serge ::: (view all by) ::: March 24, 2009, 10:02 PM:

Thatcherite? Is that like Professor Cavor's antigravity substance, or that crap from Krypton?

#15 ::: David Harmon ::: (view all by) ::: March 24, 2009, 10:40 PM:

Marna Nightingale, #8: I suppose these days one could examine the organs of living ones in situ, given proper medical equipment.

OK, now that's a thought for some suitably-genred writer to consider!

Bruce Cohen #12: But fava beans are unlikely, and Chianti positively anachronistic....

#16 ::: TexAnne ::: (view all by) ::: March 25, 2009, 12:18 AM:

Bruce, 12: To be sure, the Onion is well-served by all of this.

#17 ::: heresiarch ::: (view all by) ::: March 25, 2009, 12:51 AM:

Randolph @ 2: "Summers, of course, is a colleague of Krugman's. He is also a sexist jerk. Well-mannered and corrupt is apparently hard for Krugman to grasp."

If I read this correctly, you are arguing that "sexist jerk" equals "well-mannered and corrupt?" I really don't follow.

Yes, Larry Summers has shockingly retrograde ideas on the place of women in the sciences. He may also be a terrible economist. And a liar. But they are none of them the same thing. What you just did there? It's called ad hominem.

#18 ::: Randolph ::: (view all by) ::: March 25, 2009, 01:14 AM:

heresiarch, #17: sigh. I say Summers is corrupt because of his professional conduct--he's one of the people who made this mess we got into and here he is digging us deeper. The entire intellectual basis of his career has been exploded. Anyone with a normal sense of shame would have refused the job he currently has. The sexism, and the way he expressed it as president of Harvard, I see as confirmation: the man apparently has little empathy for people outside of his social circle. What's striking is that Krugman apparently likes Summers and so I think Summers is probably well-mannered. I suppose Summers is pleasant to people he regards as his peers or as useful. I think Krugman does not fully grasp that Summers is a different person when Krugman is not around.

#19 ::: heresiarch ::: (view all by) ::: March 25, 2009, 04:13 AM:

Randolph @ 18: That's a quite reasonable sentiment with which I have no complaint.

#20 ::: Patrick Nielsen Hayden ::: (view all by) ::: March 25, 2009, 04:18 AM:

An interesting piece of perspective from Ezra Klein.

Also, for those Making Light readers who haven't seen it: World-class economist (and occasional Making Light commenter) Brad de Long defends the plan. And a followup.

#21 ::: Randolph ::: (view all by) ::: March 25, 2009, 04:51 AM:

Heresiarch, thank you.

The NYT is also hosting a discussion that includes Krugman, Delong, Thoma, and Simon Johnson. What I find striking is that even the plan's defenders think it doesn't go far enough. Delong and Johnson think it's a tolerable start, and there will be time for corrections later, Krugman thinks things could get "ugly," as he put it to Amy Thompson, if quick action isn't taken, Thoma discusses monitoring and quick response (forgive me for egregious oversimplification.) The Administration's best policy depends on political behavior, on who is going to jump in which direction, especially in the Senate, and that doesn't admit of easy answers. Obama probably has the best grasp of the situation and, for obvious reasons, he can't tell us what he really thinks, or what his strategy is. Me, I've decided we need to kick a bunch of Senators out--they're acting like Lords. But that's not going to happen in time to make a difference in this situation.

Think it over...Krugman probably knows more about how these collapses occur in history than just about anyone.

#22 ::: Randolph ::: (view all by) ::: March 25, 2009, 05:41 AM:

As a final insomniac thought...I think Krugman's going to end up with some high office or other, will-he, nill-he. When the dust settles, he seems to know best, and I think Obama is capable of recognizing that, though it may take a horrific failure to bring that recognition about.

#23 ::: ajay ::: (view all by) ::: March 25, 2009, 06:19 AM:

11: or the Larry Niven short story, "What Use Is A Glass Steagal?"

#24 ::: Earl Cooley III ::: (view all by) ::: March 25, 2009, 06:32 AM:

I'm not certain that merely making Krugman Secretary of the Treasury would give him a long enough economic lever to move the world; regime change in China with Krugman as the new dictator might suffice.

#25 ::: heresiarch ::: (view all by) ::: March 25, 2009, 07:22 AM:

It's especially hard to figure out what the administration really believes about the plan because all their public statements are part of the plan, a sort of meta-plan confidence-building exercise. Even if Obama, Geithner, and Summers are using the plan to set the stage for later nationalization (like Delong suggests), they can't say it, because saying so will guarantee that the Geithner plan fails. To the extent that this is a problem of confidence, not of fundamentals (and I'd split the difference between Krugman and Delong and call it 10% confidence, 90% fundamentals), the administration simply can't afford to show any nuance (i.e. admit any doubts) without stabbing themselves in the back.

#26 ::: Bill Higgins-- Beam Jockey ::: (view all by) ::: March 25, 2009, 09:02 AM:

I very much enjoyed Kip's comment #11, quoting Chris Quinones at #4:

If I forget thee, O Glass-Steagall Act, let my right hand cash in for trillions. Or something. I remember this from The Outer Limits: "Demon with a Glass-Steagall Hand."

I wish to point out that P J Evans's remark at #13 was not intended as a response to Kip, but it works as one:

#6
I'm not sure they even change the serial numbers any more. At least, not beyond adding a digit and claiming it's now a whole! new! plan.

Adding a digit. Trillions. Heh.

#27 ::: John L ::: (view all by) ::: March 25, 2009, 09:18 AM:

I think Yves over at Naked Capitalism has it right; Geithner and Summer are going at this all wrong. It's not an illiquidity problem, it's an insolvency and confidence problem and throwing money at it isn't going to work.

Banks don't want to lend money because they don't want to take on additional risk. Consumers don't want to borrow because they've got too much debt already and are afraid they'll be the next to lose their jobs. Investors don't want to invest because they're afraid the Next Big Thing will become another CDS disaster. Meanwhile, banks already have so much bad debt on their books that any money given them by the Treasury just goes on their books as an asset to compensate for the deficits; they see no incentive to lend it out.

Geithner's proposal to have the Treasury backstop private investors in buying up these 'toxic assets' is going to end up with us owning these worthless pieces of paper. The prices will be inflated by investors and banks (yes, even the ones who own the assets) bidding on them, and when the private sector finds they can't sell them for that price, the Treasury will buy them back at an agreed upon value.

It's similar to Bernancke's "cash for trash" plan, only this time there's additional layers of complexity and bullshit to make it look like the market will let these assets reach their true value. Either way we'll still end up owning them and spending real money on imaginary worth.

I've discussed this with my wife (who doesn't necessarily agree, but can't refute it either) that the entire financial crisis wasn't on Obama's agenda during the campaign, and so he has had to primarily rely on his advisors for direction. Unfortunately, he chose advisors who are literally in bed with Wall Street, and have their best interests in mind rather than the country's.

Now he's in so deep that if this plan falls apart, it may completely derail any other goal Obama has for the rest of his Presidency. I think that's where all this reluctant support from various economists is coming from; they want this plan to succeed because failure means Obama's Presidency will fail along with it.

#28 ::: David Harmon ::: (view all by) ::: March 25, 2009, 09:22 AM:

heresiarch @#25: the administration simply can't afford to show any nuance (i.e. admit any doubts) without stabbing themselves in the back.

Rather, I'd say that they can't admit any doubts, because the Rethuglicans would take that as a "sign of weakness", and launch a "feeding frenzy".

#29 ::: David Harmon ::: (view all by) ::: March 25, 2009, 09:27 AM:

PS: It's not about the administration "stabbing themselves" in the back, it's about the Rethuglicans backstabbing the administration!

They're already doing so every chance they see, and they're looking for any opportunity to cut off Obama's balls entirely, much as they did with Bill Clinton (and Jimmy Carter before him).

#30 ::: Lori Coulson ::: (view all by) ::: March 25, 2009, 10:05 AM:

IMVHO, they're throwing money at the wrong end of the equation (sp?) -- the only way people are going to start buying again is if they have money.

So give every taxpayer $100K and turn them loose.

#31 ::: albatross ::: (view all by) ::: March 25, 2009, 10:11 AM:

John L #27:

To be fair, nobody can be an expert at everything. Obama is by all accounts a very smart guy, but I'd guess he had little more depth of understanding of the intriciacies of the financial world than the average law professor or congresscritter, up until it blew up in his (and our) face. So I think he has little choice but to rely on those experts.

I suspect that one reason there are so many different prominent economists associated with him is that he's trying not to become the captive of his advisors, despite knowing very little about the whole area. Thus, Geithner, Summers, Volker, Goolsbee, Romer, etc. This is probably also partly behind the slowness to fill the Treasury appointments, and the sense of uncertainty that's surrounded a lot of this administration's economic policy so far.

#32 ::: John L ::: (view all by) ::: March 25, 2009, 10:17 AM:

Albatross,

I agree Obama's a smart man, but this crisis blew up so suddenly he didn't have time to sit down and listen to different viewpoints on how to handle it before deciding on a course of action, or choice of advisors.

He has a wide range of economists in his inner circle but they aren't all equal; from all accounts I've read, Volker's presence and influence with Obama has been minimized by Geithner and Summer, who now are the gatekeepers for economic news and advice to the President. That's not a good idea no matter who is the President, or what the subject matter is.

#33 ::: P J Evans ::: (view all by) ::: March 25, 2009, 10:34 AM:

ajay @ 23
I can only say "oyyy!"

#34 ::: Carrie S. ::: (view all by) ::: March 25, 2009, 11:17 AM:

I vote for Lori Coulson's plan at #30. I know I'd be a lot better off if I had a hundred thousand dollars. My mortgage company wouldn't have to worry about me defaulting, and neither would my car loan. :)

#35 ::: Micah ::: (view all by) ::: March 25, 2009, 11:23 AM:

It's similar to Bernancke's "cash for trash" plan, only this time there's additional layers of complexity and bullshit to make it look like the market will let these assets reach their true value. Either way we'll still end up owning them and spending real money on imaginary worth.

I'd say it's significantly better than the "cash for trash" plan. In that system, the we would need to hire people to make purchases solely with our money and hope that the purchases were good.

Instead, we're getting people to pay money to make the purchases. Yeah, when transactions go bad we will soak most of the loss, but in "cash for trash" we would soak all of the loss and the managers would have less incentive for success.

So, it's better than terrible... I think... Is that good?

#36 ::: David Harmon ::: (view all by) ::: March 25, 2009, 11:39 AM:

One thought that occurs to me... why not "part-nationalize" the banks, by demanding voting stock, at market prices, in exchange for their bailouts? That way, the government wouldn't need to take over the banks entirely, but it would become a major stockholder -- with a Treasury-appointed representative at the stockholder's meetings, if not a seat on the Board of Directors!

So why isn't this being discussed, or what am I missing?

#37 ::: John L ::: (view all by) ::: March 25, 2009, 11:42 AM:

Geithner's latest plan for these toxic assets involves the private money getting all the profits while the Treasury absorbs all the loss. Plus, only a 7% private participation is hardly a 'buy in', not to mention pulling money out of FDIC to cover the investors.

If you believe these toxic assets actually have worth, then the investors will end up making a profit and the Treasury might see some of our money returned at some point in the future. If they don't have worth, then the investors will get their money back and the Treasury will have nothing. That's hardly a good deal and it looks a lot like the eventual outcome of the 'cash for trash' plan.

#38 ::: Raphael ::: (view all by) ::: March 25, 2009, 12:10 PM:

Err, Lori Coulson, Carrie S., if we assume that only half the people in the US pay taxes, that would mean 15 trillion Dollars. AFAICS that's more than all the other recent money infusions combined, and I guess so much in one sum might really trigger hyperinflation.

More generally, yes, it is too bad that Obama keeps relying on Summers, Geithner and friends on finance matters. Perhaps that's the downside of his trust in people who are certified to know their stuff- generally, that trust is a good thing- especially after Bush- but in this case, it seems trusting people with lots of training, credentials, and experience in diagnosing imbalances of patients' humours.

#39 ::: Caroline ::: (view all by) ::: March 25, 2009, 12:17 PM:

David Harmon @ 36: I really don't know. I heard that discussed by a panel of business, law, politics, and accounting professors last year, as a model that had been successful elsewhere in similar situations. It makes sense to me (of course, just outright nationalizing the banks makes sense to me at this point). I think it's that it suffers the same political liability as outright nationalization -- people will scream "Socialism!"

#40 ::: P J Evans ::: (view all by) ::: March 25, 2009, 12:29 PM:

Maybe if they went back to the old phrase for it - 'seizing [insolvent/nearly insolvent] banks' - instead of calling it 'nationalization', people would be more receptive.

#41 ::: Serge ::: (view all by) ::: March 25, 2009, 12:30 PM:

Caroline @ 39... people will scream "Socialism!"

The other day, my wife told me that some blogs were having spam-filtering problems because the word 'socialism' also contains the word 'Cialis'. Curse those erections that last 4 hours or more, espeially when the Invisible Hand of the Free Market is involved.

#42 ::: Raphael ::: (view all by) ::: March 25, 2009, 12:40 PM:

Oh, myself @38 "but in this case, it seems trusting people with lots of training, (...)" should be "but in this case, it seems to mean trusting people with lots of training,(...)".

#43 ::: Chris W ::: (view all by) ::: March 25, 2009, 12:48 PM:

John L:

I don't see any support for your assertion that the private investors will come out even if the assets in question tank. They are still putting up 7% of the price, and stand to lose that amount (i.e. their whole investment.)

There are a couple of important points to this:

1) The price being paid is not whatever the banks say their assets are worth, it's what other institutions are willing to bet they are worth.

2) These assets do have some underlying value. Even if half of the homes in a pool go into foreclosure, and the foreclosed homes end up selling for only half of the balance of the mortgage, that pool is still worth 75% of the value of the original loans.

3) These prices will be inflated by the government's involvement. That's the idea. The assumption behind this plan is that right now there's so much uncertainty around this assets that no one is willing to buy them even at a price that would reflect their real value.

It seems that whether or not this is a good plan revolves around four numbers:

A = The price various banks paid for these assets and currently have them on their books at.

B = The actual value of these assets when all is said and done, based on how many of those homeowners are going to continue to pay their mortgages, and what price can be got for the houses banks foreclose on.

C = The lowest price the banks can afford to sell these assets for and still remain solvent.

D = The price someone would be willing to pay right now for these assets.

Everyone agrees that B is significantly lower than A, these assets are not worth what the banks paid for them. D is currently just a tiny fraction of A, clearly lower than C, and it seems reasonable to guess that D is also lower than B, i.e. lack of capital and risk-averseness is making people even more afraid of these assets than they ought to be (given perfect information and perfect rationality.)

This plan is based on two assumptions:

-You can use a public auction with government backing to move D closer to B without wildly overshooting and putting the government on the hook for private investors' irresponsibility.

-And this is the biggie: B is greater than C. The banks have been saying all along that if they could just get a fair price for all of their assets, they would be completely solvent. I actually doubt that such statements are flat out lies, but they may be based on an overly rosy assessment of the "real" value of some assets. If they're right this plan has a fair chance of resolving these things without causing any more bloodshed. If not, the banks fail anyway, and we're put in a situation where the Swedish model (temporary nationalization with a government guarantee on all debts) is the only option.

#44 ::: Fragano Ledgister ::: (view all by) ::: March 25, 2009, 12:55 PM:

Serge #41: No, no, the problem there is state assistance preventing the invisible hand of the market achieving natural equilibrium (or whatever you want to call it). I'm sure you're familiar with the work of Onan Smith.

#45 ::: John L ::: (view all by) ::: March 25, 2009, 01:11 PM:

"I don't see any support for your assertion that the private investors will come out even if the assets in question tank. They are still putting up 7% of the price, and stand to lose that amount (i.e. their whole investment.)

There are a couple of important points to this:

1) The price being paid is not whatever the banks say their assets are worth, it's what other institutions are willing to bet they are worth.

2) These assets do have some underlying value. Even if half of the homes in a pool go into foreclosure, and the foreclosed homes end up selling for only half of the balance of the mortgage, that pool is still worth 75% of the value of the original loans.

3) These prices will be inflated by the government's involvement. That's the idea. The assumption behind this plan is that right now there's so much uncertainty around this assets that no one is willing to buy them even at a price that would reflect their real value. "

That's why FDIC is getting involved, to backstop the investors' stake in the auction. PIMCO CEO Bill Gross thinks it's a win-win situation for his company, which should set off all sorts of alarm bells.

1) The banks holding these assets will be allowed to participate in the auction. That's akin to you bidding on your own house in an auction to drive up the final price.

2) If they have some worth, why aren't they trading at that price right now? From what I've read, it's not just mortgages; these assets are now bundled together with all sorts of loans, including college, credit card and car loans, making sorting out what's behind them in real worth very difficult.

3) Well yes, government guarantees of worth will certainly result in an inflation of the assets' worth. Isn't the intent, though, to get them traded again, not just purchased? If investors purchase them at an inflated price and then cannot sell them for a profit, all that happens is they end up in the Treasury's hands and the private investors get paid for their troubles, and we the taxpayer get stuck with the bill.

#46 ::: Chris W ::: (view all by) ::: March 25, 2009, 02:18 PM:

That's why FDIC is getting involved, to backstop the investors' stake in the auction. PIMCO CEO Bill Gross thinks it's a win-win situation for his company, which should set off all sorts of alarm bells.

Yes, the FDIC is backstopping 85% of the purchase price, and 7.5% is government equity. In essence the government is trading a limit on the downside for a disproportionate amount of the upside. If the auctions are fair and the assumptions underlying the plan are correct (both big ifs, I grant you) then there's no reason why this shouldn't be a win-win for everybody, at least compared to the current situation, where we're facing either mass bankruptcies or completely frozen financial markets.

1) The banks holding these assets will be allowed to participate in the auction. That's akin to you bidding on your own house in an auction to drive up the final price.

I agree, that's problematic. The details of this matter a lot, though. And I'm guessing that there's a delicate balancing act between allowing companies to inflate the prices of their own assets and allowing companies to screw over each other by forcing each other to take much less than they believe these assets are actually worth. I'm not defending, here, I'm just saying I'd need to look really closely at all of the regulations surrounding the auctions to have an informed opinion about the advisability of any one piece.

2) If they have some worth, why aren't they trading at that price right now? From what I've read, it's not just mortgages; these assets are now bundled together with all sorts of loans, including college, credit card and car loans, making sorting out what's behind them in real worth very difficult.

You've answered your own question. These are really hard to value, and most companies are understandably skittish about touching anything that even looks like a risk in this environment. Markets are not just irrational when they are excessively high.

3) Well yes, government guarantees of worth will certainly result in an inflation of the assets' worth. Isn't the intent, though, to get them traded again, not just purchased? If investors purchase them at an inflated price and then cannot sell them for a profit, all that happens is they end up in the Treasury's hands and the private investors get paid for their troubles, and we the taxpayer get stuck with the bill.

I'm still not sure how the investors are supposed to make money off of this, though. They're still bidding $100 for an asset, paying $92.50 for it and then getting reimbursed $85 when it turns out to be worthless. (Of course, if the bank buys the asset from itself at an inflated price, they could screw the government this way, see my comment above about how important the details of the auctions are to this plan.)

Overall, I find myself a reluctant cheerleader for this plan, since I think it has a fifty-fifty chance of being either a least bad option or a complete waste of time and money.

But to return to my exercise in mental algebra, I feel like a lot of the criticism is based on an unspoken assumption that these assets are completely worthless and any price paid represents a direct subsidy to the banks. Those may be true, but those are different assumptions from those being made by Geithner et al. This plan flows rather logically from the assumptions they are making, and to argue against the plan you need to argue against those assumptions, not just assert that any sort of backstop to the banks is going to result in the government getting screwed.

#47 ::: James D. Macdonald ::: (view all by) ::: March 25, 2009, 02:42 PM:

I just have to say that reading discussions of the economy by intelligent, articulate, well-informed people beats the heck out of reading sound-bite slogans by dittoheads.

#48 ::: David Harmon ::: (view all by) ::: March 25, 2009, 02:53 PM:

Chis W #46: They're still bidding $100 for an asset, paying $92.50 for it and then getting reimbursed $85 when it turns out to be worthless.

You seem to be assuming that all the assets in question are worthless. That's not beyond possibility (if the Black Swan really craps on them), but it's hardly certain. Taking this deal would represent a bet that out of a given batch of derivatives, the ones that don't fail will return at least enough profit, to cover that 7.5% loss on the ones that do fail. I have no idea if this is a reasonable bet.

#49 ::: Chris W ::: (view all by) ::: March 25, 2009, 03:42 PM:

David Harmon:

Interesting, I wasn't thinking in terms of applying this rule to a whole range of pools of assets. Once again, the devil is in the details here.

At no point is there an incentive for the investor to knowingly overpay (unless they're buying their own assets). But, it turns out that the less accurate the auctions are in predicting real value, the better the banks do out of the bargain.

E.g. if all of the assets end up being sold later with prices in a range of + or - 15% of the auction value then the investors are basically providing leverage to the government. The government gets 50% of the loss or gain for putting in only 7.5% of the capital.

But if the range of sale prices is much wider (and there are as many assets that flop as there are that succeed wildly.) the government gets hosed. Assume the extreme case where half of the assets can't be sold at all and half the assets are sold for twice the price they were auctioned for. In that case the investor puts up $185 for two assets, makes $142.50 ($200 minus $50 for the government's profit minus $7.50 for the government's capital) on one and gets reimbursed $85 on the other, for a profit of $42.50. The government lays out $15, pays $85 in reimbursement and ends up subsidizing the investor to the tune of $42.50.

I don't think this is quite as big a problem as those numbers imply, since the investors still have no incentive to pay more than they think an individual lot is worth, but it does suggest that the banks have an incentive to cut up their holdings in to lots of small, opaque pools, and that the government should be exerting some oversight in order to prevent that and diversify the pools somewhat.

I'll be pleasantly surprised if anyone here actually knows enough about the arcane details of the auction regulations to have an informed opinion on whether this issue is being addressed.

#50 ::: John L ::: (view all by) ::: March 25, 2009, 03:46 PM:

Buiter thinks it's a great way to suck money out of the Treasury; one of his big concerns is the mixing of "bad assets" (defaulted loans, etc), and "toxic assets" (the 'who knows what they're worth type):

http://blogs.ft.com/maverecon/

Meanwhile, Volker is being asked to work on the tax code:

http://www.nakedcapitalism.com/

#51 ::: David Harmon ::: (view all by) ::: March 25, 2009, 04:03 PM:

Chrish W #49: the investors are basically providing leverage to the government.

Which is the point here...

The government gets 50% of the loss or gain for putting in only 7.5% of the capital.

Um, that's 7.5% of the capital and 85% indemnity for failure! Basically, this is an attempt to salvage whatever genuine value is left in the derivatives, without letting their liabilities scare off the (currently gun-shy) market.

You raise the question of whether the indemnity applies to the yield at maturity, or to the next market sale price. I would hope it's the former, but I don't really know. For that matter, how do these second-order derivatives mature, expire, or whatever?

#52 ::: Earl Cooley III ::: (view all by) ::: March 25, 2009, 06:04 PM:

Serge #41: Curse those erections that last 4 hours or more, especially when the Invisible Hand of the Free Market is involved.

Ah, so "wonk" is actually a typo for "wank" after all. That certainly makes sense.

#53 ::: Bruce Cohen (SpeakerToManagers) ::: (view all by) ::: March 25, 2009, 06:07 PM:

So far, the only optimism we've seen about the value of the CDSs and similar instruments is from the institutions holding them. You may remember that several of the large banks holding those instruments valued them at face for their financial reporting, then reported huge losses when they revalued, or simply took them out of the list of assets. And there's probably more of that devaluing to come; no one knows who holds those instruments, or how much face value they represent.

How can anyone set a real value on these things? They've been sliced and diced so thoroughly that there's no way to determine the risk for any one of them, so no one wants to touch any of them. As risk-averse as the banks have become, why should they pay anything at all if they stand to lose anything? Or any other investor, for that matter? If the taxpayers take all the risk they'll be happy to buy the things, but if that risk is limited such that the buyers could, in a worst-case scenario, lose all their investment, why would they?

#54 ::: Danny Yee ::: (view all by) ::: March 25, 2009, 06:38 PM:

Another contrarian economist you might like is the Australian Steve Keen. His Debt Deflation blog is covering current events and he has written a book Debunking Economics which is a general attack on neoclassical economics.

#55 ::: heresiarch ::: (view all by) ::: March 25, 2009, 07:31 PM:

David Harmon @ 28: "Rather, I'd say that they can't admit any doubts, because the Rethuglicans would take that as a "sign of weakness", and launch a "feeding frenzy". "

That's a problem too, but that's not what I'm talking about.

Imagine Obama comes out and says, "I hope the Geithner plan works, but frankly, we're probably going to have to nationalize most everything anyway." What private investor is going to put their money into the market at that point?

To use Chris W's useful summary, all this is an attempt to drive up D, which is a number that exists only in the minds of investors. It's a purely psychological maneuver. As such, impressions matter. How confident Obama seems in public will affect how much confidence the investors pick up in turn.

#56 ::: Serge ::: (view all by) ::: March 25, 2009, 07:53 PM:

Earl Cooley @ 52... In French, the Stock Exchange is called La Bourse. 'Bourse' is the French word for 'purse' and is also a quaint word to describe a man's genitalia. In other words, his package. Ah, the stimulus package...

#57 ::: Steve Downey ::: (view all by) ::: March 25, 2009, 09:13 PM:

@53 - The CDOs have been sliced and diced to high heaven. Those are the toxic assets. The CDSs are the mutually assured destruction provision that are squeezing the financial institutions from the other side. Collateralized Debt Obligations and Credit Default Swaps.

Until we can get the CDSs unwound, another major institutional default would ripple through the industry as the floating side counterparties had to pay billions out, with no assets to sell to get back into compliance, causing more insolvent banks.

#58 ::: Rob Rusick ::: (view all by) ::: March 25, 2009, 10:02 PM:

Serge @41: Invisible Hand job?

(shorter Fragano Ledgister @44)

#59 ::: Randolph ::: (view all by) ::: March 25, 2009, 10:23 PM:

Socialism! (Mike Davis on Bill Moyers.)

#60 ::: Serge ::: (view all by) ::: March 25, 2009, 10:52 PM:

Rob Rusick @ 58... Pork Futures?

#61 ::: Randolph ::: (view all by) ::: March 26, 2009, 08:16 AM:

Roubini weighs in. Generally on the Delong "better than a poke in the eye with a sharp stick" side. Next, the Senate...

#62 ::: Randolph ::: (view all by) ::: March 26, 2009, 08:21 AM:

Galbraith. Generally on Krugman's side, but more radical, and more willing to talk about corruption.

#63 ::: albatross ::: (view all by) ::: March 26, 2009, 03:50 PM:

Steve #57: Are CDS squeezing most financial institutions? I know they clobbered AIG (who couldn't come up with the collateral required in their CDS contracts, due to monumentally dumb mismanagement of risk), but how big a part of the other big banks' problems is that?

#64 ::: albatross ::: (view all by) ::: March 26, 2009, 04:24 PM:

Jim #47:

To me, this is the real explanation for the ongoing death of mainstream print media, and the continuing loss of trust and prestige and power of the MSM more generally.

MSM Case:

a. You read articles in the newspaper on the financial crisis. At best, these articles quote Delong or Krugman or whomever. 90+% of the article is written by a journalist who at best has some kind of business or finance or economics background, and at worst has no idea what he's talking about.

b. The views you are exposed to on the crisis are chosen by the journalist and his editor. Views they don't like, don't understand, or don't know about need not apply.

c. Explanations are space-limited, even when someone at the paper knows enough to write them. Tutorials are rare.

d. Very occasionally, editorials by some interesting, knowledgeable person will show up. This is as likely to be William Kristol as Paul Krugman. Again, the views are range-restricted, and the explanations limited to a small number of words.

e. Everything (except possibly the editorials) is edited by one or more intermediaries--journalists and editors. At best, this introduces misunderstanding and ignorance of the subject matter. At worst (and very often, IMO) it introduces spin based on the journalist's/editor's political beliefs, social ideas, community standards, and (most importantly) financial/professional interests. Ideas or comments or facts that offend important sources or advertisers or corporate parents get cut.

Net Case:

a. You read the words of Delong, Krugman, etc., directly. You may misinterpret them, but at least the words you get came directly from them. You can also find summaries or discussions of these writings on other blogs, if you need or want a summary.

b. A vast range of views is available, and it is not constrained by the size of some journalist's rolodex. It turns out that there are views in the world other than those of Democrats and Republicans. However, you're on your own to evaluate these; some are dead wrong, some are batsh-t nuts, some sound nuts but turn out to have something important to say, etc. (But you can use blogs and other sources you trust to find interesting takes on things that aren't entirely nutty.)

c. There's no space limitation, only your own limits of time and interest.

d. There are also journalists' reports on these issues, which attempt to summarize and connect experts' discussions. However, with wide choices, you can find journalists who actually have some idea what they're talking about. And blogged reports virtually always link to their sources, and many allow comments and discussions.

e. Nobody is in charge of what is allowed to be discussed. Even if all the reporters' sources in the finance world are urging support for the latest bailout, and threatening to refuse further phone calls and pull out ads of anyone who doesn't play cheerleader, you can still find criticisms of the bailout. Even if war fever and effective press control has the MSM parroting the party line on Iraqi WMDs, you can find other sources that take a different tack. This includes news organizations both in the US and overseas.

The difference between these two cases is vast, and irreversible absent some kind of massive suppression of internet discussion. The New York Times may well find a workable business model, but they'll never again have the influence they had in 1999, any more than NBC news will. There are problems with this (some kinds of dedicated reporting is really valuable, and it's not clear how that gets paid for, or protected from various kinds of harassment absent the newspaper/TV newsroom sort of institution, frex). But it's an enormously good thing.

#65 ::: Steve Downey ::: (view all by) ::: March 26, 2009, 07:19 PM:

albatross @63
It's hard to say exactly, but there's still sellers for CDSs, against institutions like Goldman, AmEx, JPMorgan, UBS and CitiGroup. Cassano at AIG wasn't the only one who thought they were selling insurance against the impossible.

AmEx looks like they're thought to be in trouble. 2 years ago the fixed side of a CDS against AmEx was around 0.20 percent. Now it's over 6.00%.

AIG is an unusual case. The insurance company basically got taken for a ride by their new financial products group. The tail wagged the dog, and without the controls in place, and other professionally obnoxious jerks to call him out, the head of the group went ahead and bet the whole company.

#66 ::: chris ::: (view all by) ::: March 26, 2009, 08:03 PM:

@#43: As I understand it, Krugman's objection to the plan is that (in his opinion) B is not much greater than D, and almost certainly less than C, and *someone* has to hold the bag when this becomes known.

What makes all the interesting arguments even between people who know what they are talking about and aren't dishonest political shills is that B is unknown and we're not really sure about C. B varies from asset to asset and C varies from bank to bank based on how involved they are (which they are not eager to disclose), and of course D varies depending on what Wall Street had for breakfast, and is what the plan seems to be attempting to manipulate.

If the banks unload their assets for the future plan-inflated "market" value E, which is greater than C, then the banks live regardless of B - they don't care about B anymore after they have sold. If E is less than C they die (or more likely, refuse to sell and the plan has accomplished nothing). However, if E is less than *B* then the public-private partnerships that bought up the assets go broke and the government eats almost all the loss. Did I mention nobody knows what B is?

The only way this plan works smoothly is if B > E > C, which unfortunately requires B > C, an optimistic assumption and one not shared by Krugman.

It seems clear to me though that if B is less than C, the existing banks that are in over their heads both deserve and need to fail. Keeping incompetent banks in business serves nobody. We need a banking sector. We don't need banks managed by reckless fools.


P.S. The second controversy is whether the failure of this plan (if it fails) will prove that we need a stronger plan, or whether Republicans will say that government intervention has failed and the government needs to butt out, and people will believe them. (Republicans will definitely say that - heck, they'll probably say it even if government intervention is succeeding - the question is whether people will believe them.) Krugman is also a pessimist on *this* point, which is why he doesn't join in the "it might work, and we've got nothing to lose" crowd - he thinks we have a limited number of shots at the problem for political reasons and shouldn't waste one on this.

P.P.S. I'm not Krugman, I just read him occasionally. My apologies if I misrepresented any of his positions.

#67 ::: Randolph ::: (view all by) ::: March 26, 2009, 11:43 PM:

Meantime, AIG acts creepily in another area.

Personally, I coming around to the view that the appropriate strategy is to occupy their offices until the entire current board and executive staff resign.

#68 ::: Patrick Nielsen Hayden ::: (view all by) ::: March 27, 2009, 01:56 AM:

Thanks, Randolph, for linking to Roubini and Galbraith, both of whom are very much worth reading. Every one else: Go follow Randolph's links and read.

Roubini's guardedly-pro-Geithner-Plan position is particularly interesting because Roubini is the current holder of the "Most Frequently Right About Everything" crown in the field of medium-term macroeconomic prognostication. Galbraith is interesting because even now most of us don't talk enough about the role of plain old corruption in bringing American business and the American economy to its current pass. (This is a point that has also been harped upon by that pundit Teresa Nielsen Hayden.)

#69 ::: albatross ::: (view all by) ::: March 27, 2009, 01:37 PM:

Patrick #68: Galbraith's dad also had some famously interesting/entertaining things to say about fraud and financial crises. To quote:

At any given time there exists an inventory of undiscovered embezzlement in - or more precisely not in - the country’s business and banks. This inventory - it should perhaps be called the bezzle - amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.

The fraudulent loans were, ISTM, a kind of left-handed example of this. There wasn't cash missing from the safe and sitting in an embezzler's pockets (or more likely, his bookie's pockets). Instead, there were assets whose value was based partly on a falsehood (that some care had been taken to make sure the income, appraised value, and other information on the loan document was legit), and partly on the unstated assumption that home prices would keep rising (thus continuing the environment in which defaulting on a payment just means the bank takes back the rapidly-appreciating asset from you and sells it to the next sucker). So long as that second assumption was true, it masked the bezzel, at least in terms of keeping it from showing up in the payments the MBS investors could expect.

#70 ::: albatross ::: (view all by) ::: March 27, 2009, 01:56 PM:

I also liked this article on Naked Capitalism, discussing the way the funding for this proposed bailout is being sourced, due to the administration's wish not to go to Congress and ask for more bailout money.

The sequence of proposals seems to me to always be trying to rewind the tape somewhat, to go back to a time when the current set of big financial players were solvent and trustworthy, housing prices were stable and higher than at present, and stock prices were much higher. With solvent, trustworthy big financial institutions, financial markets can work much better. With stable house prices and stock prices, much higher than the present ones, the assumption that those prices represent real wealth available to consumers can lead to the level of consumer spending that was keeping our economy turning for the last several years. That is, all these bailout plans seem to be aiming at preventing painful changes, like having a lot of big banks be closed down or broken up and sold off by the FDIC, or acknowledging that lots of our recent apparent economic success was illusory, based on imaginary wealth that has evaporated.

But I just don't see how we can go back. After several rounds of help for the biggest financial institutions, they seem to never quite come clean--another few months from now, I expect there will be more toxic assets, which were not disclosed or were assumed not to be so bad, which will then be pulling down those banks. Three years ago, companies like AIG, Citibank, Goldman, and Lehman were assumed to be basically trustworthy with money, competently run, stable. Who believes that now? Would you like to invest in stock or bonds for one of those companies, after the next bailout (or maybe, the one after that)? Further, banks' willingness to lend will still be driven by their assessment of risk--which has to include both the recognition that we're facing a hell of a recession, and that our risk management tools need a bit of work.

The house and stock markets are even more impossible to rewind the tape on. The knowledge, down at a visceral level, that house prices don't always have to keep rising, that they can fall like a rock and wipe people out, the knowledge that stock prices can and may plummet and eat your retirement funds at any time, those won't go away no matter what we do to prop up prices. So people won't spend money on the assumption they have wealth based on an expanding bubble. Which means that they won't imagine they have wealth that's not really there, which means they'll spend a lot less, which means a big recession.

When we're done spending all our money, political capital, etc., trying to piece back together the comfortable world of 2004, I keep thinking we're going to be in a much worse place to make the adjustments necessary to live in the world of 2010.

#71 ::: chris ::: (view all by) ::: March 27, 2009, 06:50 PM:

@#70: I think you're right, but if convincing people that they have wealth they don't have stops working as a way of getting them to spend money they don't have on things they can't afford, we might be forced to take really radical steps like making sure they *do* have some money.

If inflation can be defined as too much money chasing too few goods, I wonder if an asset bubble can be defined as too much money chasing too few good investment opportunities? And, of course, an investment in a productive business is only good if you expect the customers to be able to afford the product.

Which all suggests to my non-Nobel-Prize-winning brain that when a tiny investor class has huge piles of money while the majority's income stagnates, there will be very few *good* places to invest that money (because the customer base's income is stagnant and, therefore, they can get all the products they can afford from existing businesses) and they will therefore invest it badly (note: a loan is an investment from the point of view of the lender, and a bad loan is a bad investment).

The fix is to redistribute money away from high-MPI, low-MPC people towards low-MPI, high-MPC people until you achieve a reasonable balance - where productive enterprises get funded, but wild speculation and Ponzi schemes don't. If you can do this without putting too obvious a government thumb on the scales, fine, but it has to be done one way or another, or you're just going to have a string of bubbles and few successful productive businesses because of anemic demand for goods and services.

In short, while the failure of communism may (or may not) demonstrate that too little income inequality is bad for an economy, the failure of Wall Street demonstrates that too much income inequality is *also* bad for an economy. There is a happy medium, and we're on the "too unequal" side of it.

Un-stagnate the wages of the majority. Let the benefits of increased productivity actually reach the people doing the producing, and not just the managers and owners. (IMO, the person who made the sandwich I ate for lunch today produces more actual value on a typical day, such as today, than Vikram Pandit. Certainly they produce much more than Bernard Madoff or Ken Lay during the height of their careers.) Then you'll see some aggregate demand, I bet.

#72 ::: Earl Cooley III ::: (view all by) ::: March 27, 2009, 08:46 PM:

chris #71: The fix is to redistribute money away from high-MPI, low-MPC people towards low-MPI, high-MPC people until you achieve a reasonable balance

Although cannibalism is indeed a dramatic and tasty solution to economic problems, I don't think I can adequately make the distinction between Munching Plump Industrialists (MPI) and Munching Plump Capitalists (MPC). Someone with specific training in economics would have the advantage, it would seem.

#73 ::: Leroy F. Berven ::: (view all by) ::: March 27, 2009, 08:55 PM:

Earl @ 72:

Think of it as an opportunity to solicit informed recommendations, on the relative merits of the various flavors of Soylent Green.

#74 ::: Bruce Cohen (SpeakerToManagers) ::: (view all by) ::: March 27, 2009, 09:05 PM:

chris @ 71:
What's broken in our economy right now is the engine that's been running it for the last 30 years or more: consumer spending. The problem with the solutions that have been proposed so far is that they all attempt to start the engine up again and run it just like before. IMO it would be better to find a way to drastically reduce the role of consumption in driving the economy. That in itself would be a step towards reducing carbon emissions and energy use, and if all we give up is cheap doodads and disposable trinkets, I don't think we'll have lost much.

#75 ::: Serge ::: (view all by) ::: March 27, 2009, 09:44 PM:

Leroy F Berven @ 73... the relative merits of the various flavors of Soylent Green

"La Pastorale"

#76 ::: heresiarch ::: (view all by) ::: March 27, 2009, 11:38 PM:

chris @ 71: "If inflation can be defined as too much money chasing too few goods, I wonder if an asset bubble can be defined as too much money chasing too few good investment opportunities?"

Yes, that's it exactly. It's an important point which I've only heard being made by Martin Wolf. The impetus behind all these weird, experimental financial tools was a huge flow of money entering the U.S. market from the rest of the world. There was all this money, but nowhere to invest it. So they manufactured and invented new investment opportunities; since people liked investing in American mortgages, they created more mortgages for people to invest in, and so on.

Ironically, most of that money was flowing from the developing world, which desperately needs money to build infrastructure and fund growth, to the developed world, which had so little use for it that they had to invent things to do with it.

#77 ::: Earl Cooley III ::: (view all by) ::: March 28, 2009, 02:11 AM:

Ok, I think I have it ferreted out; MPI is "marginal propensity to invest" and MPC is "marginal propensity to consume". My cannibalism post was an attempt to shock the poster into annotating those unexplained economic acronyms. Ah, well. Many thanks to Google's Book Search.

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