David Rosenberg, he of Gluskin Sheff, checks in, a bitter wind from the North:
Never in recorded history has growth coming out of a string of declines been as weak as what we just witnessed. Considering all the government efforts to usher in a V-shaped recovery, what we saw unfold in the real economy in Q3 – admittedly quite divorced from the action in financial markets – was, in a word, sad.
David Rosenberg, he of Gluskin Sheff in Toronto, opines on US unemployment and the likelihood that 12% is not impossible, that structural problems may be around for a while:
Think about it. We haven’t yet hit bottom on employment but that will happen at some point. Employment is not going to zero, of that we can assure you. But when we do start to see the economic clouds part in a more decisive fashion, what are employers likely to do first? Well, naturally they will begin to boost the workweek and just getting back to pre-recession levels would be the same as hiring more than two million people. Then there are the record number of people who got furloughed into part-time work and again, they total over nine million, and these folks are not counted as unemployed even if they are working considerably fewer days than they were before the credit crunch began.
So the business sector has a vast pool of resources to draw from before they start tapping into the ranks of the unemployed or the typical 100,000-125,000 new entrants into the labour force when the economy turns the corner. Hence the unemployment rate is going to very likely be making new highs long after the recession is over — perhaps even years.
Writing in Foreign Policy, John Mearsheimer takes the measure of reality in Afghanistan and the reality of politics here at home and comes to a melancholy conclusion:
…(Obama) will increase the American commitment to Afghanistan, just as Lyndon Johnson did in Vietnam in 1965. The driving force in both cases is domestic politics. Johnson felt that he had to escalate the fight in Vietnam because otherwise the Republicans would lambaste him for “losing Vietnam,” the same way they accused President Harry Truman of “losing China” in the late 1940s.
Obama and his fellow Democrats know full well that if the United States walks away from Afghanistan now, the Republicans will accuse them of capitulating to terrorism and undermining our security. And this charge will be leveled at them for decades to come, harming Democrats at the polls come election time. The Democrats have no intention of letting that happen.
The United States is in Afghanistan for the long haul. As was the case in Vietnam, more American soldiers and many more civilians are going to die in Afghanistan. And for no good reason.
Harold Pollack, head of the Center for Health Administration Studies at the University of Chicago has had it up to here with the posturing and histrionics surrounding the healthcare debate. Writing in The New Republic, his comments are timely and important and worth repeating in full:
During the Bush years, a fellow at the Kennedy School of Government was writing a book called Savin’ it! on abstinence education in the public schools. As part of his research, he contacted then-Attorney General John Ashcroft with a request for personal testimony. His letter noted:
The book’s fourth chapter, ”Role Modelin’ It!” will feature the personal stories of abstinence heroes for our nation’s young people to emulate …I would very much appreciate if you could share your abstinence story. I can tell by your passionate advocacy that you will have a lot to offer this book… I hope you will find the time to inspire the next generation of sex-free leaders.
I don’t know whether the author ever completed this monograph, though he did complete another book soon after.
My next health policy book will include a similar chapter on what you might call budget abstinence heroes: Men and women will proclaim the virtues of fiscal conservatism, and then actually resist the temptation to mess around in the fine print when the adults aren’t looking.
Sadly, I can’t find many self-avowed fiscal conservatives who honor the budget abstinence pledge. Consider these lines from the Washington Post:
House leaders abandoned an effort to include a public option backed by liberals that would establish reimbursement rates to providers based on Medicare. Rural Democrats strongly opposed that approach because of the potentially ruinous effect on doctors and hospitals in their districts, where Medicare rates are generally well below the national average.
Only a few lines later:
House negotiators were able to lower the price tag in part by expanding Medicaid coverage to a broader slice of the population… The adjustment reflects findings by congressional budget analysts that covering the poor through Medicaid–which pays providers far less than Medicare–is far more cost-effective than offering subsidies for private insurance policies.
To recap: Rural hospitals will be protected from efforts to reduce the deficit by imposing Medicare reimbursement rates. Urban hospitals (and patients and states) will be forced to accept a system of far lower reimbursements, in order to spare the federal government the cost of private insurance.
This is not a particular surprise, but the hypocrisy is galling. To avoid the evils of a government-run program moderates say will pay providers too little, we’ll put a markedly larger population into a government-run program that pays providers even less.
I can tolerate another giveaway to rural constituencies who profit from our peculiar political system. When the recipients of such giveaways–Mike Ross, Kent Conrad, and others–are such ostentatious advocates of fiscal discipline, it’s a bit rich.
Money and sex have a way of exposing the hypocrisy in all of us. At least when our kids are old enough to demand our personal abstinence stories, we have the decency to blush.
David Rosenberg of Gluskin Sheff provides an interesting picture of life across the border, and just how much different the economic mess looks from Toronto:
If there is one thing that Canadians are never happy with (in addition to their local hockey team) it is the Canadian dollar. When it was flirting near that record low of 62 cents nearly a decade ago, everyone lamented the future of the Loonie and closer ties to the U.S. were being recommended from various corners of Bay Street. It was too expensive to buy anything that was imported, it was too costly to make that annual trip to Florida, and tickets to a Broadway play were prohibitive. We felt poorer. We must have been doing something wrong.
Fast-forward to today. Canadians are now fretting about a strong currency. After all, it is going to crush our manufacturing sector, kill our export base and undermines our domestic competitiveness. Even the Bank of Canada commented on how the strength in the CAD is dampening our growth prospects, cutting its medium-term GDP growth forecast.
Remember, when currencies move there are going to be winners and losers. In its latest policy statement, the Bank of Canada said that “persistent strength in the Canadian dollar” is going to “slow growth and subdue inflation pressures.” So, in return for softer economic growth coming from a more challenging export outlook, what we get back is lower “inflation pressures.” The winner here is anyone who is seeking to borrow money to buy something because the stronger Loonie will prevent the BoC from taking the interest-rate punchbowl away any time soon.
For Canadian businesses, the silver lining is that it will be easier to attract talent today compared to a decade ago when the Loonie was sinking. Call it the reverse brain drain. Whatever it is, it is a good thing from a productivity standpoint, which is the cornerstone to our standard of living. That is why I think we should embrace this new era of Canadian dollar strength as opposed to resisting it.
For those who remember his dad, Mike, on Boston local news (circa 1970s), Matt Taibbi’s rollicking style is a delight, full of genetic echoes. His Rolling Stone article on Bear Sterns and Lehman — and the naked short-selling behind their demise — is a good read:
Six months after Bear was eaten by predators, virtually the same scenario repeated itself in the case of Lehman Brothers — another top-five investment bank that in September 2008 was vaporized in an obvious case of market manipulation. From there, the financial crisis was on, and the global economy went into full-blown crater mode.
From Roger Myerson’s web page. Something a little more thoughtful than the usual prattle:
A COMMENT ON THE 2009 NOBEL PEACE PRIZE
By giving the Nobel Peace Prize to Barack Obama at this stage, less than one year into his Presidency, the Prize Committee has emphasized the importance of his redefining how American power will be used in the world: with manifest restraint and respect for world opinion. In his first nine months in office, without giving any foreign power a veto over America’s use of military force, President Obama has reassured the world that the military superiority of the world’s greatest superpower will used only with broad consultation and support from other nations throughout the world. This reassurance has greatly reduced international tensions, so that people can feel safer in America and throughout the world. The Peace Prize Committee may be anticipating that President Obama’s acceptance speech could become a clear statement of a new doctrine: that America can retain its position as the world’s dominant military power without serious challenges only if we exercise our dominance according to principles of restraint that the whole world can judge. If Americans embrace such a doctrine and demand that our future presidents should adhere to it, then there may be some real hope of global peace under American leadership for generations to come. In the long run, this accomplishment may be a far greater contribution to peace than mediating a resolution to one international dispute.
Roger Myerson
2007 Nobel Memorial Prize in Economic Sciences
The Chicago School’s most thoughtful response to Krugman so far comes from an unlikely source: libertarian lawyer Richard Epstein. I’m not in the business of printing long pieces, but lacking a subscription to The National Review, I’m linkless in Gaza. I offer it here (the piece will appear in the Oct. 5 issues) in its entireity.
Krugman’s Scapegoats
Rebutting the Times columnist’s attempt to pin the market meltdown on the Chicago School
By Richarard A. Epstein
Hard times demand scapegoats. And demand in the scapegoat market is high right now, with economic malaise lingering after last year’s financial meltdown and bank bailouts. One much-abused scapegoat is the free-market economics of the Chicago School (after the University of Chicago, where many of the school’s proponents made their academic home). The basher-in-chief is Princeton economist and New York Times columnist Paul Krugman, who demanded, “How did economists get it so wrong?” in a recent essay. Krugman’s answer heaped scorn on his Chicago foes, who, he argues, were so blinded by the beauty of their mathematical models that they drove the nation into a deep recession. The only salvation, he says, is the warmed-over Keynesian pump-priming he has long advocated.
Krugman is wrong about both the cause of and the cure for our current mess. A true academic, he operates under the delectable delusion that a credentialed economist (never mind a Chicago School economist!) has a sole hand on the economic-policy tiller. Though the former Princeton professor Ben Bernanke heads up the Fed, huge swaths of economic policy have been shaped by political operatives such as Karl Rove and Rahm Emanuel. At the same time, Barney Frank and Christopher Dodd — not exactly Milton Friedman acolytes — head key congressional banking and finance committees. Whatever witch’s brew they concoct, they don’t use free-market ingredients.
So it is worth asking two questions. How did we get here? How do we get out?
In Krugman’s macroeconomics-dominated world, the first place to look for answers is monetary policy. His Times tirade gloats that former Fed chairman Alan Greenspan — backed by Obama’s economist-in-chief, Larry Summers — mistakenly rejected calls to rein in subprime lending and to stanch the Fed’s flow of cheap money. A grand blooper, to be sure, but not one that originates in Chicago-style economics: No Chicago economist supports either policy. Cheap money sets interest rates at or below the level of inflation — which is to say, it’s a policy of giving away free cash, but only to those who bid up housing prices.
On top of all that, the lax lending-and-guarantee policies of Fannie Mae and Freddie Mac induced private banks to do exactly what we should expect of rational actors: lend on the strength of Fannie and Freddie’s implicit government guarantee rather than on the dubious value of the properties in question. The Hoover Institution’s John Taylor has offered powerful evidence in his pithy book Going Off Track that these wrongheaded policies led to a huge artificial run-up in housing stock — a development that the Chicago School’s sound monetarist polices would have significantly dampened. So Chicago’s response to Krugman on the first count of the indictment is a proud “Not guilty.”
Krugman also misfires by implicitly treating monetary policy as the only game in town. His article never mentions the roles of securitization and mark-to-market accounting in forcing Bear Stearns and Lehman Brothers over the edge. Securitization turns out to be a mixed blessing. By cutting mortgages into slices that could be recombined in finely calibrated tranches, the wizards of Wall Street diversified geographical risk while allowing financial institutions to buy investments tailored to their portfolios. Credit-default swaps offered the illusion of insurance. Credit-rating agencies offered the comfort of a Triple-A certification.
Unfortunately, it is a law of practically Newtonian inevitability that every advance in financial technology brings with it offsetting disadvantages. Securitization was intended to help manage banks’ risks, but it took away an important incentive: Banks originating mortgage-backed securities relaxed their underwriting standards because they knew they could count on guaranteed sales. That deterioration in lending quality really bit when bad times hit — but only after those securities had insinuated themselves throughout the global economy. The quantitative analysts (the math geeks who created the new securities) had had to make certain assumptions about mortgage-default rates and what changes in housing prices would do to them. Unfortunately, they had underestimated the volatility that regulation adds to the mix and had failed to account for the legal protections for mortgage borrowers. They had not done well in assessing the negative impact that systemic delays in mortgage foreclosures would have on underlying real-estate values. They had not accurately priced the statutory “rights of redemption” that in many states allowed homeowners to reclaim properties cheaply after foreclosure. And they had badly underestimated how complicated it would be to renegotiate existing loans on a mass basis, especially when many underwater homeowners were opting simply to stop making mortgage payments while barricading themselves in their homes with a big assist from consumer groups.
Other government errors compounded private-sector failures. First, SEC regulations kept new entrants out of the securities-rating game. Weak information led to unwarranted reductions in the credit ratings for some mortgage-backed securities, which in turn triggered demands for massive infusions of capital to bolster the banks and other institutions that held those downgraded assets. That, in turn, required the afflicted banks to call in loans, sell assets, and seek new investors to beef up their capital reserves. At this point, another SEC favorite — mark-to-market accounting — accelerated the downward fall. When one bank was forced to sell assets, mark-to-market required all the banks to revalue similar assets at the new, substantially lower prices, further depleting their capital cushions and triggering further destructive rounds of forced selloffs and revaluations.
When the financial health of competing banks is uncorrelated, one bank can fetch a decent price by selling off its assets in a market with lots of buyers. But when banks’ losses are correlated — and mark-to-market and other regulations helped ensure that they were — there simply is no market. Rational buyers stay on the sidelines, knowing that the coming sale of assets by one bank will send prices tumbling and force other banks holding those same assets to mark down their prices, which means that they, too, will have to sell. What we have then is a downward cascade in asset prices that stops only after they have fallen well below the value of the underlying securities, usually understood as the discounted present market value of their future cash flows. Those cascades exposed the danger of the Bush administration’s decision to ease reserve requirements for fancy interbank transactions. Credit-default swaps, a form of default insurance that, for regulatory reasons, had migrated to AIG, collapsed under the weight of that avalanche. And the whole system went down.
It’s easy to quibble about the relative proportions of private and public mistakes. But however the blame falls, Krugman is wrong to lay it at the feet of Chicago School economics, which holds that if the government offers a guarantee against bank failures it must also exercise bank oversight.
But Krugman needs to knock the Chicago School out of the intellectual marketplace to make room for his preferred policies, especially the use of Keynesian stimulus spending to jumpstart the economy. And if he is lucky, his denunciation of the alleged failures of the Chicago School might distract the public from the fact that his beloved Keynesian stimulus has been a bust. Keynes’s case for pump-priming may have made sense with Depression-level income taxes, which Hoover’s 1932 Revenue Act raised to a top marginal rate of 63 percent. High taxes force the substitution of inefficient public investment for sensible private investment, and FDR compounded the mistake by blessing, between 1933 and 1935, literally hundreds of industrial and agricultural cartels that killed market innovation and price competition. A better strategy today would be to get rid of the pork, lower marginal tax rates, and eliminate agricultural subsidies and protectionism. But the Obama administration is defiantly marching in the opposite direction: Tax rates will rise in 2011, if not sooner; tariff walls will remain high; unions flex their muscles; and free trade remains under siege as Chinese tires face ill-advised anti-dumping duties.
What makes this already toxic environment worse is the heightened risk of regulatory expropriation. The contretemps over the AIG bonuses was not just about $165 million in compensation. It was about the protection of contracts against government interference; if AIG employees can be browbeaten, so can everybody else. The scandalous terms of the Chrysler and GM bankruptcies sent out an equally strong signal that creditors’ established priority arrangements — a Chicago School imperative — could be upset by political interference. Obama’s approach, so far, relies on sham asset sales that allow politically connected unions to receive preferential treatment over other creditors as a payback for their support. It is not liquidity, as Krugman supposes, that keeps cash at home. It is a quiet, desperate want of confidence that business can be done on honest terms.
Matters get worse on the employment side of the picture. The vaunted Obama stimulus package was supposed to keep unemployment rates below 8 percent. Instead they are creeping toward 10 percent, with an attendant fall in real wages. The generic explanation is that higher taxes and heavier regulation drive down the demand for labor when product markets are roiled by political uncertainty.
Beyond macroeconomics, microeconomic blunders add fuel to the fire. Krugman might have noted that the recent increase in the minimum wage is particularly deadly in the face of falling real wages, especially to workers with few advanced skills. More important, he could have acknowledged that the hare-brained scheme of labor regulation embodied in the misnamed Employee Free Choice Act (EFCA) is a first-class job killer: Who wants to open a business in which a union created by dubious card-check procedures can force the acceptance of a two-year contract dictated by Obama’s Department of Labor? The EFCA is dormant for the moment, but so long as organized labor has clout at the White House, dormant ain’t dead. As if that weren’t bad enough, the prospect of a crudely nationalized health-care system, coupled with the nightmare of a Byzantine cap-and-trade program, will put lots of sensible investments on hold and lots of jobs on ice. Investors want to know what kind of economy they are investing in.
Krugman’s response is to ignore these particulars and issue a call to embrace modern behavioral economics, with its laboratory experiments and endless surveys. But none of that fancy theoretical stuff can begin to justify any of the big-ticket regulatory initiatives Obama wants to foist on the country. Nor can it fix, in some mysterious way, the ills of financial markets. I agree that the Chicago view of efficient markets (the hypothesis that market prices instantly reflect all known information) can’t explain the meltdown, but it helps explain the other 99 percent of the financial landscape. Behavioral economics explains neither. What is needed is some systematic explanation of the linkage between the volatile 1 percent and the predictable 99 percent: When do market trades deviate from fundamental values, and why? My guess is that the answer will likely be found in a better understanding of the interactions between experienced and novice traders.
Krugman offers no fresh ideas of his own; he only vilifies Chicago. His macroeconomic fixation blinds him to the core of good sense in the Chicago School, which argues: Let’s reduce government interference in competitive markets; let’s support strong property and contract rights; let’s invest in sensible public infrastructure, such as law enforcement; let’s adopt a decent anti-monopoly policy; and, yes, let’s promote a stable currency and adopt low, flat taxes.
We haven’t done any of that. So, in a sense, Krugman was right to ask, “How did economists get it so wrong?” He should start by asking himself.
Mr. Epstein is a professor of law at the University of Chicago, a senior fellow at the Hoover Institution, and a visiting professor at New York University’s law school.
Zingales and Cochrane firing on all cylinders in today’s WSJ. Not exactly the message casual observers (Mr. Krugman included) would expect:
The big banks know the government will bail them out, and they are already bigger, more global, more integrated and “systemic” than ever. They are making huge trading profits—profits that must someday turn to losses. If brokerage and banking are “systemically important,” they cannot be married to proprietary trading. Yet the financial-reform plans do not even talk about breaking up this marriage—they hope simply to regulate the behemoths instead.
The blame-it-on-Lehman story leads to a dangerous complacency. If we can persuade ourselves that the fault was just one policy mistake, forced on the feds by silly legal restrictions and not enough bailout power, everything can go back to the cozy way it was before.
This is a convenient story for large banks that dominate the lobbying and communication effort. And it absolves the Fed and Treasury of facing up to their long string of policy mistakes.
We don’t pretend that we could have done any better. That’s the point: A system with so much power vested in so few people, with so few rules, in which crises are managed with 2 a.m. conference calls, cannot possibly do better no matter how good the people at the top. Repeating the Lehman story lets us all ignore the fact that this system cannot go on.
In case you missed it, Amity Shlaes in the Washington Post uses Obama’s Team and Perfect Mark Buehrle (courtesy of Steve Kaplan) to ’splain why pay caps for CEOs are a non starter:
After all, people hire for the long term, not just for one recession or recovery. And talent is rarer than we tend to think. “In a world where skill is in great demand and markets are large — when a lot of money is at stake, whether it’s baseball or finance — market forces insure that those skilled people get paid a lot,” says Kaplan. Pay caps, or even too much harassment from regulators, will drive the talent to jobs where there aren’t such obstacles. The result will be fewer perfect games in the corporate world: “You pay peanuts, you get monkeys,” says Kaplan.
