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April 2009
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12:57am Sunday April 5, 2009 (link)
From a recent email to a friend:Everyone is looking for someone to blame for the bad economy, which is part of the larger cultural process of looking for a narrative that "explains" this whole crisis.
I was amused last week when the NPR program Planet Money (which runs a podcast Mon/Wed/Fri) had to sort-of apologize to its listeners. They had run that debt/gdp graph that showed borrowing getting out of hand ever since the 80s. Some of their listeners emailed in with outrage that "it sounds like you are trying to blame the public for this mess! (how dare you?!)" As if buying overpriced houses were the most natural thing in the world...
So one narrative is that evil bankers did this to us. Most recently, Simon Johnson an ex-IMF guy, wrote a piece here that compared the U.S. situation to the kind of third-world problem the IMF deals with. His narrative was that moneyed elites capture government, and knowing that they can't lose on their financial dealings (because of having the government in their pockets), make more and more risky deals, until it all falls apart.
A Greenwald article here takes this a step further, implying that evil bankers plan to impoverish us all, by creating these crises and then insisting on austerity measures that only hurt little people. There's a book called The Shock Doctrine by Naomi Klein that's in the same vein.
There are other points of view. For example, the IMF has been criticized for misdiagnosing the Asian crisis. They treated it as if governments were insolvent due to overspending, when in fact many were running surpluses. The real problem was hot money leaving those countries and creating credit crunches. The solution then would have been more liquidity. Instead, the IMF insisted on austerity and caused many of the Asian economies to shrink painfully, impoverished much of the new middle classes, as well as the poor.
The result of that, from what I've read, is that many Asian countries (including China) determined to store up huge foreign exchange reserves, so that they would not be vulnerable to hot money flows or have to go to the IMF in the future. You could regard that as one part of the current problem -- China's determination to keep large amounts of dollars contributed to low interest rates and the housing bubble in the U.S..
The IMF also became so unpopular that the EU insisted on cutting its budget by 20%. Now they are understaffed and underfunded to do anything about the current crisis. This recent tripling of their funds by the G20 conference will reverse that, but they will have to staff up again.
The "evil bankers control the world's governments" idea doesn't really stand up either. First, a lot of these guys don't plan that far ahead. You should read Liar's Poker by Michael Lewis, if you haven't already. Or read this new article about the software for mortgage backed securities. It also gives some glimpses into the financial world:
The world around me, though, had become bizarre. At the time, I had an odd sensation that mortgage traders felt they had to outdo the loutish behavior in Liar’s Poker. The more money they made, the more juvenile they became. What do you expect from 30-year-old megamillionaires whose overwhelming aspiration was something vaguely called Hugeness? They had wrestling matches on the floor. Food-eating contests. Like little kids, they scrambled to hide the evidence when the head of fixed income paid his rare visits to the floor.
The Henry Paulson's of the world aren't acting like this, but they don't want a crash either. They just want to stand on the bridge and collect their tolls. They want all the traffic they can get, and tolls as high as they can make them. They don't want the bridge to collapse.
If you are looking for explanations, you have a lot to choose from. A lot depends on how far back you want to reach.
If you think of the crises as starting in 2007, then you want to blame the government for mishandling Lehman and the bailouts. If only they'd done X, we wouldn't have had this crisis, just a normal recession. Personally, I think that's BS. Once the housing bubble got huge, there was no easy way to unwind it.
If you think the housing bubble is the problem, then you look at Greenspan's actions with interest rates after 2000, or perhaps you blame China for sending too much money into the U.S. (or you blame the U.S. for running persistent trade deficits, or both countries.) You could blame Congress for pushing housing too hard, or blame the banks for their ARMs and no-doc loans, or blame consumers for overspending on housing.
Personally, I think no politician or regulator has the nerve to pop a bubble while it's going on. Everyone enjoys the bubble too much. If Greenspan had deliberately tried to kill the dot-com bubble, people would have screamed that he was destroying American technological progress. If he had popped the housing bubble, Congress would have screamed that he was destroying the American Dream. Current home-owners would have called for his head if prices had dropped due to Fed action. It's just not realistic to expect politicians to kill bubbles once they are in progress.
I do think securitization was fundamentally a problem, since it broke the link between the people evaluating the risk of a mortgage and the people supplying the money. Back when banks played with their own cash, they had mortgage review committees and took it all very seriously. Once they could just resell mortgages, it was "good credit score is enough". I don't think mortgage quality would have declined as much (and therefore, prices would not have increased as much) without securitization. But securitization only made the bubble worse, it didn't cause it. There have been real estate bubbles all around the world for most of modern history. This was just a bad one.
Reaching farther back, you could say this was all just a big credit bubble that started in the 80s, with the dot-com bubble and housing bubble just manifestations of that. You'd be looking at the "Greenspan put" -- the idea that the Fed was lowering interest rates in every crisis, and creating moral hazard. I think there's something to that. We went a long time without a serious recession, and that does change people's expectations of risk. I do think the normal course of the economy is for people to take more and more risks, as good investments get scarcer and scarcer (which has to happen, since the smart money has already taken all the good investments.) Eventually, this collapses and we get a recession. Call it the financial version of the old "inventory cycle adjustment" theory of recessions. With the Fed preventing financial recessions, risk built up to unsustainable levels. We don't seem to understand that, in the long run, you'd really prefer lots of brush fires every few years to one huge conflagration every generation. Lots of little earthquakes that relieve the tension, instead of a Big One.
If you blame credit, you'd also really be looking at the trade problems between Japan and U.S. and China and U.S.. For China, you can blame currency manipulation, but I'm not sure you can say the same about Japan. The dollar/yen rate has been all over the map for the last 25 years, from over 300 yen to the dollar down to 90 or less. The U.S. did continually yack about a "strong dollar" during that whole period, but I'm not sure we did anything explicitly to strengthen or weaken it.
But again, I doubt specific policies were really all that important. When China and (to a lesser extent) India entered the world economy in the 80s and 90s, that added hundreds of millions of people (not counting the rural populations that didn't have much effect.) It was crazy not to expect some kind of financial reaction. Like having a sumo jump into the pool and not expect a splash.
I have also read that the whole system of fixed exchange rates set up in the post-WWII era broke down sometime in the 70s (not even sure of that) due to inflation, and deliberate attempts to cut the strength of the dollar (see Plaza Accord.) You read an argument along these lines from gold bugs and other "hard money" guys, who argue that giving governments the power to print money ultimately destabilizes the whole economy. These credit bubbles form because of inflationary pressures, or changes in the money supply or whatever.
And you can even reach back into the 70s, and say that the inflation then broke the world financial system and set the stage for these later problems. See The Great Inflation and Its Aftermath, by Robert Samuelson (which I haven't read.)
For example, I've read that securitized mortgages were a response to the inflation of the 70s and early 80s, which lead to the S&L crisis. Savings and Loans had 30 year mortgages at 5% on their books at the same time they were paying out 8-10% on CDs and savings accounts. This bankrupted them all. The solution could have been variable-interest rate mortgages (which I think is the standard in Europe), but instead we went with securitization. That let the banks get interest rate risk off their books by selling the mortgage on to investors. If rates changed radically again, they weren't exposed.
Personally, I think the economy is too complicated to understand with these simple explanations. I don't think it's stable. How could it be when politicians pass waves of regulations changing everything from interest rates to exchange rates to taxes to investment laws, and when whole new players like China enter the world economy? And once a bubble gets underway, people enjoy it too much and would hate any government that tried to take it away. Crashes are just the price of bubbles, which have to end sometime. When it does end, you are left with bad investments that will never return what you paid.
There were plenty of sensible warnings during both the dot-com and housing bubbles. Skeptics pointed out how stupid it was to value companies with no profits at millions of dollars, or how stupid it was to pay $750,000 with nothing down for fixer-uppers. No one listened. The skeptics were called "perma-bears" or just laughed at on those financial TV programs. What do you expect government to do in a situation like that? There are lots of calls for more regulation now, but regulation during the bubbles had no effect.
I also think that what everyone wants right now is a return to 2006. They aren't going to get it. The money wasted during the bubble is gone. It got spent on granite countertops, not on an investment that will actually return value and help people pay off their loans. Once all the losses are written off, all the unaffordable houses marked down and sold (or demolished), growth can start again from the new level. Until that happens, there's just going to be a lot of shouting.
Government can make this a lot worse, but I doubt they can make it better. I would just spend the cash protecting people on the bottom from real disasters -- homelessness or unaffordable medical bills. These attempts to bail out financial institutions are mostly a waste of money.
However, when it comes to dealing with the crisis, Megan McArdle points out that you don't have a lot of choice in who you listen to. You can listen to politicians who wouldn't know a CDS if it bit them on the ass, and get random, populist gesturing. You can listen to academic economists, who will fill your ears with "on the one hand this, and on the other hand that, and there are no studies that definitely support the proposition that the multiplier for government spending exceeds 1.0..." Etc. Nothing you can rely on, in other words.
The ones you are going to rely on for advice on fixing a banking system are bankers. And they will inevitably hire their friends, protect their own banks, and do other kinds of self-dealing, either explicitly, or just because that's the way they think. And they can point out that the economy runs on credit, and banks/hedge funds etc. supply that credit. So you can't force banks to take a hit. That would be cutting off your nose to spite your face...
I'm very interested in how this turns out. I do think that government in general tries to do too much, and this one in particular is really overreaching. But the one thing I don't expect is a nice neat explanation for all of this. People are still arguing about the causes and end of the Great Depression, 80 years later. And what they thought they knew is turning out all wrong, now that we are having another crisis.
So I wouldn't take any of these opinion pieces seriously.
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