Saturday morning cartoon

"A financial expert says what?"

"What?" Burn.

Seriously, isn't it time to start replacing our lawyer jokes with financial expert jokes?

But, my friends, this is not the point of my hasty instabellman post. Since before the meltdown started, er, melting, Matthew Yglesias has been pointing out that, for all the money and status we allocate to the wizards of the financial services sector, what we have actually purhcased is our current shit sandwich. 

I think he has a pretty good point. And just so one of these instances is recorded here on the Blog of Record, I give you Matt Yglesias:

I think Fareed Zakaria’s efforts to look on the bright side of the economic crisis probably go too far, but I certainly agree with this point:

The financial industry itself is likely to shrink, and that’s not a bad thing, either. It has ballooned dramatically in size. Curry points out that “30 percent of S&P 500 profits last year were earned by financial firms, and U.S. consumers were spending $800 billion more than they earned every year. As a result, most of our top math Ph.D.s were being pulled into nonproductive financial engineering instead of biotech research and fuel technology. Capital expenditures went into retail construction instead of critical infrastructure.” The crisis will stop the misallocation of human and financial resources and redirect them in more-productive ways. If some of the smart people now on Wall Street end up building better models of energy usage and efficiency, that would be a net gain for the economy.

Indeed. I mean, in principle taking a large proportion of quantitatively skilled people and having them apply their technical chops to the financial markets could be a good thing if doing so ushered in an exciting new era of genuinely superior financial wizardry. But instead, Keynes observation that “The game of professional investment is intolerably boring and over-exacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll” seems just as true today as it was two or eight decades ago. Meanwhile, smart scientists and engineers are still producing useful stuff.

The agony of David Brooks

David Brooks continues his journey through the stages of grief, frequently circling back to denial. But he really skewers the GOP in his most recent column. My favorite bit:

House Republicans led the way and will get most of the blame. It has been interesting to watch them on their single-minded mission to destroy the Republican Party. Not long ago, they led an anti-immigration crusade that drove away Hispanic support. Then, too, they listened to the loudest and angriest voices in their party, oblivious to the complicated anxieties that lurk in most American minds.

Now they have once again confused talk radio with reality. If this economy slides, they will go down in history as the Smoot-Hawleys of the 21st century.

But I am confused by this:

What we need in this situation is authority. Not heavy-handed government regulation, but the steady and powerful hand of some public institutions that can guard against the corrupting influences of sloppy money and then prevent destructive contagions when the credit dries up.

So, we need a steady and powerful hand that isn't heavy handed? Thank God conservatives continue have a clear message for America!

Wingnut Econ through the years

So, as of Tuesday's close, the Dow is lower than on the day George Bush took office in 2001.

I doubt any of our conservative interlocutors from 2004-5 are still reading this blog, but just in case any of them are, I'd like to go into the wayback machine and recall that, throughout the Bush presidency these folks made the claim that Bush had turned the economy around through his two-pronged approach of tax cuts and prayer.

Liberals argued that the ballyhooed recovery, such as it was, was only benefiting the Americans whose personal fortunes put them at the very top end of the economic scale. And, more to the current point, we pointed out that recovery wasn't based on strong fundamentals, but instead was a phantasmal recovery based on a fairly disturbing housing bubble.

Wingnut economists and bloggers, while occasionally acknowledging the housing bubble, refused to believe that this was the engine of their pseudo-recovery. And here we are, when the whole thing has predictably melted down, the market is back where we started, and things are looking grim. And the wingnut response?

Yep, you got it. Blame Democrats for the housing bubble.

Just say it, Byron

Do It, Nancy [Byron York]

When it comes to the bailout plans, from a Democratic perspective: If it is House Republicans who are the problem, who cares what they think? Isn't it a distinguishing characteristic of the House that the majority can pretty much do what it wants? It's the Senate where the minority can make lots of trouble and slow down the process. In the House, we have seen Nancy Pelosi and her top lieutenants steamroll over Republican objections time and again in all sorts of legislative matters. Before Pelosi, we saw a Republican majority do similar things. So if Pelosi wants the bailout to happen, and House Democrats are united behind her, why don't we have a bill? | corner |

Meaning what, exactly? Do you, Byron York, think that the revised Bush plan is a good one and that you want it passed, despite public sentiment and the resistance of your own party? Or do you, Byron York, think it's a bad idea, and politically unworkable, and just want to watch the Dems melt down?

Personally, I haven't been convinced that the bailout is necessary, despite my vanishing 401k. I kind of hope they can't agree on how to spend 700 billion dollars.

What about you, Bellman readers?

Hey buddy, can you spare a trillion?

The question of the day is whether the Paulson Plan is a starting point for negotiations or a declaration of what the administration intends to do. This morning's news of the Fed's reclassification and escalated oversight of Goldman Sachs and Morgan Stanley seems to indicate that Paulson is steaming ahead full speed.

Another way to ask the question is to ask whether the technocrats, now exiled for nearly eight years, can push hard enough to insure that reasonable policies are adopted. Krugman seems to speak for the emerging consensus among the technocrat peanut gallery in his column today.

The logic of the crisis seems to call for an intervention...the financial system needs more capital. And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.

That’s what happened in the savings and loan crisis: the feds took over ownership of the bad banks, not just their bad assets. It’s also what happened with Fannie and Freddie. (And by the way, that rescue has done what it was supposed to. Mortgage interest rates have come down sharply since the federal takeover.)

But Mr. Paulson insists that he wants a “clean” plan. “Clean,” in this context, means a taxpayer-financed bailout with no strings attached — no quid pro quo on the part of those being bailed out. Why is that a good thing? |Krugman|

Part of the answer, probably, is that Wall Street is really happy with the Paulson Plan. To the extent that confidence will carry us through the crisis, that counts in its favor.

One thing is clear. If the Democrats have any chance at all of significantly modifying the shape of the government's response to the financial crisis, taking that chance requires that they come up with a clear alternative and invest significant political capital in getting their own plan through.

Another thing that's clear is that John McCain, just as he did during his many years chairing the Commerce Committee, is abdicating all responsibility of any kind. His plan, as he revealed Thursday and Friday, is to stand on the sideline and blame "Washington insiders." Count on him to double down on that message.

The conventional wisdom is that the crisis helps Obama because the Democratic brand is so strong on the economy. Maybe so, but McCain is betting that no matter what the government does, it will be unpalatable to most voters. If there's a fight over policy, as there should be, McCain is going to characterize it as Democrats holding the economy hostage to special interests and back room deals. It's no surprise, to me at least, that McCain released a Rezko ad this morning. Expect more of the same as we push past the moment of crisis and focus on fixing blame for the increasingly severe economic downturn.

Predatory bailout?

The defense of the Paulson Plan, as I understand it, is that the assets the government is planning to buy are going to appreciate in value and so this isn't just a trillion taxpayer dollars given away to the investor class, but is also a great opportunity. In other words, the idea is that the market has undervalued these assets and that whoever buys them will make a handsome profit down the road.

And that all sounds great, but you have to ask why the assets are undervalued. Krugman rejects the plan on the grounds that it only makes sense if you assume that the problem is a liquidity problem. I think his point is that Paulson seems to think that demand for mortgage derivatives has collapsed because of a lack of investment capital rather than because of a fundamental problem with housing stock.

And, of course, if that's what Paulson thinks then the Fed Chief is off his rocker, because there clearly is a fundamental problem with housing stock. There was a bubble. It collapsed.

My guess is that Paulson's assumption is a little bit different. He's merely assuming that the debt will be collectable. In short, the plan makes the government the collection agency of last resort. I can think of reasons why Norquist and Rove would approve, but the rest of us should question whether this is the best or only place where leverage could be applied.

And another thing: How much would it cost to make the paper good? $700 billion will pay a lot of bills. In 2006, the average mortgage payment was about $1600. To make the math easy, let's assume the figure is now $2000. On that assumption, the $700 billion could be used to make 350 million monthly mortgage payments. That works out to five mortgage payments per home-owning American household. As long as the plan is to throw money at the problem, why not pay everyone's mortgage through the final day of the Bush Administration?

Wanna wanna let it burn

The distractions of the campaign can make you forget how maliciously irresponsible the Republican Party has become:

"Once again the Fed has put the taxpayers on the hook for billions of dollars to bail out an institution that put greed ahead of responsibility and used their good name to take risky bets that did not pay off," said Sen. Jim Bunning, R-Kentucky, a member of the Senate Banking Committee.

A spokesman for Sen. Richard Shelby of Alabama, the top Republican on the committee, said the senator "profoundly disagrees with the decision to use taxpayer dollars to bail out a private company" and is upset the government has sent an inconsistent message to the markets by bailing out AIG after it just refused to save investment bank Lehman Brothers from bankruptcy. |CNN|

Opposition to a clearly necessary step speaks for itself. Truth be told, the likes of Shelby and Bunning are probably glad Congress wasn't consulted. What they're doing now is warming up for the post-bailout fight about the extent of regulatory oversight. Care to guess which side they'll be on?

And by the way, how do you square the circle of blaming greed for this crisis? There are no significant allegations of shoddy accounting or fiduciary irresponsibility. At every level, from home buyers accepting sub-prime loans to lenders offering those loans to derivatives traders betting on the security of those loans to insurers backing those bets, every actor was doing exactly was free market absolutists like Bunning and Shelby thinks that they should be doing. They were seeking to maximize profit.

I'm no economist, but the basic shape of the current crisis is clear enough. It begins with a wide range of policies with generally bipartisan support that overly favored investment in housing, investments which were almost entirely based on credit. Next, the decades long Republican campaign against regulation meant that there was limited oversight over the financial sector's handling of this huge mountain of debt. Throw in the bankruptcy bill and a weak economy, and Bob's your uncle.

This is what is sometimes called a cascading failure. No one thing caused it. Instead, the interaction of several independent factors brought about the crisis.

What's striking is that despite the complexity of the cause, the blame is abundantly clear. At almost every step, the underlying explanation for how we got into this mess is the laissez faire economic ideology that Republicans have been campaigning on for decades. I mean, can you even believe that derivatives remain substantially unregulated seven years after Enron?

I want to say two words to you. Just two words. Paper shredding.

Down in Tulsa, my grandfather Gus pulled his family through the Great Depression managing a gas station. Uncle Bob sometimes mentions "the farm", but my father's memory doesn't go back that far. I've been wondering, what if the bottom drops out? What's a good job to have? I don't want to say the sky is falling, but basic institutions of the market are failing almost daily. The ground under the foundations looks sandy.

In related metabellman news, this blog is accepting applications for resident economist.

To return to our strengths, we're going to need a name for the next historical era. I suggest, "the contraction". Got something better?

Bonus Content: Humbly submitted to you as the official song of the contraction:

Fizz

This housing bubble is starting to look serious. So much so, in fact, that I'm reconsidering my enthusiasm for the weak dollar. The main good thing about the weak dollar is that it makes American exports relatively cheaper compared to goods produced elsewhere. Unfortunately, the collapse of the housing bubble has done more than weaken the dollar. It has also made it very difficult to secure credit. Which means that, despite the weak dollar, we aren't seeing increased investment in the manufacturing sector. It's as if the invisible hand were in a sling.

All that said, I wouldn't say that I'm behind this proposal. Seems to me that lack of access to capital is not really the factor that explains the failure of the American auto industry. On the other hand, something is going to have to be done about the credit crunch because without investment the economy can't grow.

Lastly, there will be plenty of time later for libertarians to lecture us about the terrible cost, in terms of freedom, of averting global economic meltdown. For now, though, all the libertarians need to step out of the way while the adults get down to business and try to keep this (under-regulated) mess from snowballing into another Great Depression.

John Sidney McCain III and the Republican Party are Bad for America

I think many have been distracted by the polarizing figure of Sarah Palin. Please recall:

George W. Bush and the Republican party started an unjust war with Iraq based on fabricated evidence. John Sidney McCain III has been a vocal proponent of continuing the war. Barack Obama opposed the war from the start.

George W. Bush and the Republican party have made kidnapping, torture, and indefinite imprisonment without habeus corpus "business as usual". John Sidney McCain III, a former POW, opposed legislation that would ban specific torture practices. Barack Obama opposes torture and supports the Unites States Constitution.

George W. Bush and the Republican party took over a country with record budget surpluses and economic growth and created staggering debt, unemployment, and recession. John Sidney McCain III supports the current economic policy. Barack Obama supports windfall taxes on oil company profiteering, creating new jobs by developing green technology, supporting small business, fair trade, workers' rights, and other measures.

George W. Bush and the Republican party have enacted an energy policy written by oil company executives. The current energy policy has driven rapid increases in energy prices, increased reliance on foreign oil, and record profits for oil companies. John Sidney McCain III supports the current energy policy and supports increased domestic drilling for oil. Barack Obama supports rapid development of alternative energy sources.

John Sidney McCain III is inextricably linked with the current Republican administration's failures. He plans to continue these failed policies, and so would his vice president. 

What other failed policies do you want to see stopped? Post them in the comments.

If you seek a pleasant peninsula, look about you

Here in Michigan, when someone wants to tell you where in the state something is what they do is raise their right hand as if taking an oath and then point at their palm. You see, if you look at a map of Michigan it sort of looks like the flat of the hand. Except, that is, for the upper peninsula, which is properly referred to as the you pee, and which can be represented by making the Boy Scout sign with your left hand and then holding that (again, palm out) over the right hand, slightly tilted, on the pinkie side, but isn't.

Which I mention by way of giving context to of the Michigan Economic Development Corporation's current ad campaign. Here's Gov. Granholm introducing the theme:

“CEOs are choosing Michigan for their business growth because they think Michigan is a great place to do business,” Granholm said. “We want those CEOs sharing that story with the world so that when other businesses are looking for a place to grow and create jobs, they look at Michigan first. MEDC’s advertising focuses on companies and CEOs who capitalized on Michigan’s business resources to give them a global competitive edge.”

The initiative will highlight Michigan’s key business-attraction tools including its competitive business environment, its world-renowned universities, its highly skilled workforce, its status as the world’s research and design hub, and its new, $2 billion 21st Century Jobs Fund. Together, these tools give Michigan businesses “The Upper Hand.”

That tag line -- 'giving Michigan business the upper hand' gets repeated, by Jeff Daniels no less, at the end of each of the TV ads.

To a Michigander, the practice of pointing at the hand gives this slogan an overt meaning which is at once banal, immediate, and difficult to resist. But come on. This is a dog-whistle for the investor class, a signal that the state will take the side of capital in disputes with labor. The invisible hand, as they say, helps those who help themselves.

Which isn't to say that I'm not sympathetic, on a whole lot of levels, with the goals and (explicit) arguments of the campaign. Jobs are good, good jobs are better, arguments that link jobs to investments in university funding are best of all.

And maybe I'm just an optimist because I haven't lived here through the last thirty years of economic stagnation and contraction, but it seems to me that the fundamentals look good for growth in the state. The MEDC campaign is right that Michigan has a very skilled workforce. What the ads don't mention, but which everyone knows perfectly well, is that a whole lot of the people who make up that workforce are unemployed or underemployed. Another thing they don't mention is the weakness of the dollar, but that can only help.

In which I question the basis of everything

If you've read The Wisdom of Crowds, if you've read A New Kind of Science, if you run SETI @ home, or if you have ever had your mind expanded by any flavor of chaos theory, you, dear reader, are probably a sucker for the idea that new ways of looking at the word--and especially new ways of harnessing the awesome information-processing power that is all around us--is likely to yield spectacular predictive power. I know I am.

And you probably thought Intrade and it's ilk--which purport to predict all kinds of unrelated real-world results based on the mystic power of market forces--are a pretty nifty idea. I know I did.

But is there any evidence whatsoever that predictive markets actually predict future results better than any other kind of analysis? Every election cycle we hear about the predictive markets, but we never hear about the follow up. From the perspective of a media-watcher, this makes it the functional equivalent of some random town in some random state that has a 98 percent success rate of predicting the next president based on their local outcome. And, just like those stories, there is never any follow up.

So this year I've paid marginally (no market pun intended) more attention to the results of the predictive markets, and what have I seen is that the market has followed the trends rather than using the awesome aggregate intellect of their user base to anticipate any developments whatsoever. On Intrade, for example, this example sums it up for me:

Barack Obama’s chances of winning the Democratic nomination have risen sharply in the last four days, with Intrade on Monday giving him a 70 per cent probability of taking the prize against just 30 per cent for Hillary Clinton.

With the exception of a brief leap following his strong victory in the Iowa caucuses on 3 January, Mr Obama’s chances had been rated at substantially below 50 per cent all year.

If I weren't such a sucker, I could probably have predicted their prediction problem. You can follow the links from the wikiepd page for some more detailed and scientifically sound analysis of why predictive markets suck so very badly at what they are set up to do, but permit me oversimplify for rhetorical effect:

Predictive markets fail because, although they use the machinery of actual markets, they aren't actual markets in one crucial respect: There is nothing of actual value being bought or sold. It is simply a complex form of betting on outcomes (no wonder, given that Intrade was founded by Irish bookies). With the actual value of the underlying commodities and securities completely removed, the actual incentives for long-term, reasonable traders are likewise absent. What you are left with are day-traders and other nogoodniks whose activities, while more complex, are really no different than betting on a horse to show down at the track.

The same trouble is plaguing real markets, as well. We haven't managed to actually remove the underlying value of the commodities and companies being traded, but increasingly baroque financial packages have managed to obscure that value to such a degree that even very savvy financial institutions are being caught by surprise when they discover what is actually contained in many of their securities.

For markets to work well, at assigning value or predicting changes in value, there must be incentives for the long game, meaning that there must be real and transparent underlying value.

Not that I'm against gambling! But I do prefer straight up books to the hijinks at Intrade. I hear the odds on Obama are looking pretty good....

Without raising any questions of conscience

Yesterday, while being lectured on the virtues of turning off unnecessary lights, I found myself thinking about carbon taxes. One of the reasons that I don't find appeals to personal environmental virtue very compelling is that I hold the heretical (for a radical) view that the various environmental problems that face us can best be addressed through market based solutions. The basic problem, as I see it, is that free markets have failed to appropriately distribute environmental costs because those costs are treated as externalities rather than included in transaction prices. The solution therefore lies in regulations which correct these failings of free markets.

A question, then, is what to think of environmental nagging. On the one hand, widespread sensitivity to the environmental impact of our choices is likely to enhance the political prospects of the sorts of reforms that I favor. On the other hand, self-righteous prigs are annoying as fuck. It's a pickle.

Muscle and blood and skin and bones

If you haven’t already, you should check out this week’s New York Times Magazine article on gold farming. For what it’s worth, it seems to me that the phenomenon is somewhat paradoxical from an economic point of view.

On the one hand, it illustrates the capacity of the free market to detect and meet consumer needs. Some players of MMORPGs do, in fact, desire to avoid the drudgery of slowly gathering the resources necessary to level up. That fact is perceptible to entrepreneurs, and it turns out that China, with its combination of relatively low labor costs plus relatively sophisticated technological infrastructure, is able to house firms capable of meeting that need at a price acceptable to consumers.

On the other hand (and this is the point where you would expect me to decry the fact that the needs are, apparently, entirely artificial and utterly trivial, but I won’t), the phenomenon also illustrates the capacity for firms in a free market to act in ways that ignore, or even actively frustrate, consumer needs. Take, for example, Blizzard Software. Their response to the existence of a market for gold coins, and the subsequent hordes of Chinese gold farmers playing World of Warcraft, has been to file lawsuits against resource auction sites and to attempt to identify and close the accounts of gold farmers. But Blizzard could, if it wished, create salable gold coins itself at no cost, thereby adding the whole revenue of the World of Warcraft gold farming industry to it’s bottom line as pure profit. Surely this is something that the people at Blizzard have noticed, and yet they’ve decided not only to leave money on the table, but also to attempt to prevent other firms from filling the market niche that they’ve left open.