Financial Crisis

Tag: Financial Crisis

Excessive Monetary Easing is Part of the Problem

If short term interest rates drop from .1% to .02% does it generate more economic activity?  If long term rates drop from 3% to 2% (or even 1.7% as with 10 year US Treasury Notes), will people want to borrow more given the current economic environment?  Most readers know my pessimism regarding answers to these questions.  The IMF, in its latest global financial stability report, makes the case quite strongly.  Furthermore, as argued previously and by most “Austrians” since Mises and Hayek, overly cheap capital causes a great deal of mis-allocation of capital.  The Financial Times editorial today summarizes the IMF report.

The IMF’s latest global financial stability report says rightly enough that the eurozone crisis, and the row over the US debt ceiling, sparked an increase in risk aversion. But the IMF worries that exceptionally low interest rates are building a fresh credit problem. They have spurred a hunt for yield which, as widely broadcast, has sent too much capital to emerging markets. When capital is too cheap, it is mis-allocated.

The FT editorial concludes:

Either credit markets see reasons for economic cheer that have eluded everyone else, or low interest rates have sparked another round of irresponsible lending.

Review of The Big Short in the JEL

Yale economist Gary Gorton reviews Michael Lewis’s The Big Short and Gregory Zuckerman’s The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History in the latest Journal of Economic Literature.

Here’s how Gorton describes the books:

Their take is that a small band of wacky outsider characters were able to see the coming crash and profit from it, while greedy, corrupt, Wall Street types were not (p. 450).

Indeed, that sounds about right.  Gorton gives the authors credit for telling lively stories and for laying out the mechanics of financial markets that enabled the disaster.  Yet, a major puzzle remains:

[The widespread view is] that subprime vintages prior to 2006 were much safer; it was supported by the data… But, when the crisis came, there was no distinction between pre- and post-2006 vintages. Everything went down in value, including bonds linked to the earlier subprime vintages! Moreover, bonds completely unrelated to subprime risk, like triple-A bonds linked to credit card receivables, auto loans—everything went down in value! (p. 453).

In other words, we still don’t really understand what caused the crisis.

You should get to know the Journal of Economic Literature (JEL).  As the name suggests, the JEL provides literature reviews and book reviews that characterize and evaluate major strands of the economics literature (in addition to classifying pretty much everything in the profession.  Hence the  JEL classification codes).

My brief review of The Big Short is here, and our posts are Michael Lewis’s work are here

The Pope’s Children Revisited

“Economists festivals tend to be so po-faced, so bitchy"

In the wake of Michael Lewis’s recent piece, Professor Galambos reminds me of the excellent “In Search of the Pope’s Children” from 2006.   If you have read the piece on Germany, you might take a look at the first 15 minutes of part 3, which is amazingly prescient given this was done five years ago (like Lewis, McWilliams also invokes a prostitution metaphor to dissect the situation).   The piece also melds well with Lewis’s piece on Ireland.

Of more recent vintage, McWilliams is the author of The Generation Game and Follow the Money, and also launched a comedy tour dedicated to mocking Irish bankers.

Here’s more on the cheeky McWilliams.

Add Germany to the List

Michael Lewis continues his Vanity Fair series with a rather disturbing article — disturbing on many levels — about Germany and the world financial crisis: “It’s the Economy, Dummkopf!

Tyler Cowen at Marginal Revolution calls the piece ” funny, one-sided, slightly offensive, somewhat true.”

I agree with everything except the “slightly” part.  Not for the faint of heart.

ADDENDUM: Walter Russell Mead weighs in.  Paul Krugman expresses some optimism.  Follow his blog for much, much more on the nuts-and-bolts of what’s going on.

Perhaps it is different this time

On my daily rounds of the econosphere, including Professor Finkler’s post here, I note that Ken Rogoff’s Project Syndicate post is getting a lot of traction.

A perusal of the NYT website shows Rogoff here on the USA credit downgrade:

Europe’s plan was to have growth fix the problem. America’s plan was to have growth fix the problem. And that’s not going to work… I think it’s really starting to sink in that we’re not anywhere near an endgame.

And NYT columnist Thomas Friedman cites Rogoff here:

Why is everyone still referring to the recent financial crisis as the ‘Great Recession?’ … The phrase ‘Great Recession’ creates the impression that the economy is following the contours of a typical recession, only more severe — something like a really bad cold. … But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation. … In a conventional recession the resumption of growth implies a reasonably brisk return to normalcy. The economy not only regains its lost ground, but, within a year, it typically catches up to its rising long-run trend. The aftermath of a typical deep financial crisis is something completely different. … It typically takes an economy more than four years just to reach the same per capita income level that it had attained at its pre-crisis peak. … Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a ‘Great Recession.’ But, in a ‘Great Contraction,’ problem No. 1 is too much debt.

As for economists, Tyler Cowen thinks Rogoff’s contributions have legs:

I don’t expect anyone to change their mind at this point, but the “we should have had a much bigger stimulus” argument is unlikely to go down in intellectual history as the correct view.  Instead, Ken Rogoff and Scott Sumner are likely to go down as the prophets of our times.  We needed a big dose of inflation, promptly, right after the downturn.  Repeat and rinse as necessary.  But voters hate inflation and, collectively, we proved to be cowards.  Too bad.

And Peter Klein also cites Rogoff favorably, though Klein conditions his response with respect to what he believes should be the central implication:

The main point is that a recession like the present one is structural, and has nothing do with shibboleths like “insufficient aggregate demand.” I wish Rogoff (here or in his important book with Carmen Reinhart) talked about credit expansion as the source of structural, sectoral imbalances that generate macroeconomic crises.

It’s almost enough to make you want to pick up the vaunted Reinhart and Rogoff book.

UPDATE: Rogoff in the Financial Times

The Second Great Contraction

Professor Gerard’s posting on the debate about the role of fiscal policy starts with the Larry Summer’s point that the debt deal “solves the wrong problem.”  As pointed out previously (see here), I agree with that conclusion.  So, what is the “right problem?”  Kenneth Rogoff’s answer requires  that we understand that this recession is not a typically recession.

The phrase “Great Recession” creates the impression that the economy is following the contours of a typical recession, only more severe – something like a really bad cold. That is why, throughout this downturn, forecasters and analysts who have tried to make analogies to past post-war US recessions have gotten it so wrong. Moreover, too many policymakers have relied on the belief that, at the end of the day, this is just a deep recession that can be subdued by a generous helping of conventional policy tools, whether fiscal policy or massive bailouts.

But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.

Rogoff and Carmen Reinhart (R & R), along with others such as economic historian Harold James, emphasize that economic growth built upon too rapid a credit build-up cannot be sustained with expansionary monetary and fiscal policy. It requires de-leveraging (perhaps, you prefer credit build down), a process that cannot be accomplished quickly and offers little positive in the short run that can be gained to soften the blows. The only solutions require that the real level of debt must be reduced to a sustainable level.  As noted in the Rogoff quotation above, somehow creditors must bear some of the burden (a “haircut” in Wall Street parlance.)  The dynamics of this process lead R & R to deem our most recent period as “The Second Great Contraction.”

Rogoff’s suggests that inflation might be the least costly way to address problem – one might argue it is THE “time honored” policy of choice when governmental commitments exceed its ability to meet them.  Of course, this suggestion is not met with great enthusiasm (see “Kids Prefer Cheese” which argues that Rogoff proposes “theft, pure and simple.”)  Is it the least bad approach?  The answer depends upon one’s view of the functionally of our governance structure.  Let’s just say that “dysfunctional” would not egregiously mis-characterize U.S. governance at present.

Recognition of the right problem and a useful framework for policy discussion must come first.  As Rogoff puts it in the article linked above,

The big rush to jump on the “Great Recession” bandwagon happened because most analysts and policymakers simply had the wrong framework in mind. Unfortunately, by now it is far too clear how wrong they were.

Acknowledging that we have been using the wrong framework is the first step toward finding a solution. History suggests that recessions are often renamed when the smoke clears. Perhaps today the smoke will clear a bit faster if we dump the “Great Recession” label immediately and replace it with something more apt, like “Great Contraction.” It is too late to undo the bad forecasts and mistaken policies that have marked the aftermath of the financial crisis, but it is not too late to do better.

Alan Greenspan on Excessive Risk Avoidance

In today’s Financial Times, former U.S. Federal Reserve Chair Alan Greenspan opines that we can carry risk aversion too far.   Greenspan’s discussion parallels that posted by Professor Gerard related to the interview of Vernon Smith.  In particular, Greenspan argues persuasively that the more we set aside to protect against once in 50 year or once in 100 year adverse events, the less capital we have to devote to productive activities.  He cites bank reserves in excess of $1.5 trillion as excessive private risk aversion.  Regarding public policy, he argues as follows:

What is not conjectural, however, is that American policymakers, in recent years, faced with the choice to assist a major company or risk negative economic fallout, have regrettably almost always chosen to intervene. Failure to act would have evoked little praise, even if no problems subsequently arose; but scorn, and worse from Congress, if inaction was followed by severe economic repercussions. Regulatory policy, as a consequence, has become highly skewed towards maximising short-term bail-out assistance at a cost to long-term prosperity.

This bias leads to an excess of buffers at the expense of our standards of living. Public policy needs to address such concerns in a far more visible manner than we have tried to date. I suspect it will ultimately become part of the current debate over the proper role of government in influencing economic activity.

“The closer you look, the worse it gets”

The economic situation in Greece is downright gruesome, and I have to wonder how bad the social unrest is to become there.  The principal source of my pessimism is a piece from last October where Michael Lewis essentially argues that the situation is hopeless:

But beyond a $1.2 trillion debt (roughly a quarter-million dollars for each working adult), there is a more frightening deficit. After systematically looting their own treasury, in a breathtaking binge of tax evasion, bribery, and creative accounting spurred on by Goldman Sachs, Greeks are sure of one thing: they can’t trust their fellow Greeks.

I saw a couple of updates to that unhappy picture this week.  First up, James Surowiecki in the New Yorker gives an accounting of Greece’s rampant tax evasion, a point Lewis also makes rather starkly. Indeed, the Surowiecki piece reads like an Executive Summary of Lewis’s article, with each arguing that the social and cultural aspects in Greece are broken and are effectively impossible to fix.

The second piece is from Tyler Cowen in the New York Times, where he argues that the situation is pretty dire even without factoring in the social difficulties of implementing meaningful policy reform. Cowen’s piece discusses some of the difficult choices facing the EU, and reminds us that lurking in the background are the potentially large problems of EU members from Italy to Portugal to Spain.  Cowen doesn’t have much hope, concluding that “There’s a lot of news on the way, but probably very little of it will be good.”

Well, enjoy your weekend!

Thoughts on The Big Short

I finished up Michael Lewis‘s The Big Short and I think I found it worthwhile and poignant.   It’s a character-driven piece that follows some of the players — as the title suggests — who shorted the housing market and went to the bank.  To Lewis’s credit, he seems to do a pretty good job of explaining the crazy financial instruments created and deployed to bet against subprime mortgages.  To my debit (?), I still don’t understand what was going on with all of this.

The big villains of the story are certainly the ratings agencies, who could have stopped much of this chicanery in its tracks by rating garbage as garbage rather than as AAA investment-grade bonds.  But, perhaps a pithier point comes in the book’s denouement and is worth quoting at some length:

The people on the short side of the subprime mortage market had gambled with odds in their favor. The people on the other side — the entire financial system, essentially — had gambled with odss against them. Up to this point, the story could not be simpler. What’s strange and complicated about it, however, is that pretty much all the important people on both sides of the gamble left the table rich… Continue reading Thoughts on The Big Short

Who is Dominique Strauss-Kahn? Why Should Anyone Care?

Answers to the first question are obvious.  Strauss-Kahn is the Managing Director of the International Monetary Fund.  As undoubtedly you have heard, he was arrested recently for sexually attacking a maid in his luxury suite at a New York Hotel.  He also was expected to be a strong candidate for the Presidency of France.  His exit from the political scene is imminent.

Why should we care?  Martin Wolf in yesterday’s Financial Times answers that question. I encourage you to read the full article but the operative words are as follows:

“Mr. Strauss-Kahn proved to be a bold decision-maker, an effective politician and a competent economist.  This combination is very rare.  None of the candidates under discussion is likely to do the job as well as he did during the worst of the global and then eurozone financial crises.”

Michael Lewis on Iceland and Ireland and Greece (Oh, my!)

We had a very enthusiastic EconTea today with Bob Atwell and Sarah Bohn, including a cursory discussion of Michael Lewis’ excellent series of pieces over the past two years in Vanity Fair.

Here’s a piece on the rather bizarre Icelandic collapse.

Then another on the Greek disaster.  That doesn’t look good for them.

And, finally, here’s a piece on Ireland that Professor Finkler wrote about a few months back.

Each piece is an interesting mix of sociology, economics, and business, with generally the same result (financial catastrophe), but with different causal factors and different prospects going forward (Iceland still has fish and heat; Ireland will go back to being Ireland; Greece is hosed).  For more on Lewis, check out our previous posts, or simply head over to The Mudd.

Thanks to our guests.  We hope to see you back in Briggs soon.

Keynes v. Hayek, Round 2

It’s here, the second major production from Russ Roberts and John Papola (all new mustaches!). Keep in mind, these guys are sympathetic (clearly) to the Austrian views.

Keynes v. Hayek, Round 2

For more on the Austrians, talk to someone from the Discovering Kirzner reading and discussion group.   And, rumor has it that The Road to Serfdom will be the book choice for the fall term reading group.

Lawrence Scholars in Law Today (Thursday) 5:30

Be sure to get over to the Warch Campus Center Cinema  today at 5:30 p.m to see distinguished alumnus Tony Valukas (Class of 1965) talk about his career and the Lehman Brothers collapse.  Mr. Valukas is a hot commodity right now, and just yesterday the Legal Times points to continued congressional interest in Mr. Valukas’s services.

Congress Keeps Calling on Jenner & Block’s Valukas

A 2,200-page report on the Lehman Brothers bankruptcy is still reverberating on Capitol Hill, where the report’s author, Jenner & Block chairman Anton Valukas, appeared again today to talk about what he found. Continue reading Lawrence Scholars in Law Today (Thursday) 5:30

Q: Who’s Making Those “Record” Corporate Profits?

Tater Skins

Answer: The financial sector.

Felix Salmon, citing a WSJ piece,   reflects upon the very large taters being made by the financial sector.    Without some frame of reference, it is hard to know what to make of the financial sector banking 35% of all of US profits.   So, for some perspective check out Simon Johnson in his Atlantic Monthly piece:

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007

I was discussing an opportunity to attend a financial markets seminar with one of my colleagues, and he correctly pointed out that financial regulations are something I really don’t think about that much. Yet, as time marches on, this seems like a very interesting place to be looking.  Let’s take a peek.

First, there’s Richard Sylla’s review of Rajan and Zingales Saving Capitalism from the Capitalists.  In his review, Sylla provocatively compares Rajan and Zingales to Joseph Schumpeter in their roles as prognosticators of the future of capitalism.

What is the nature of the threat to capitalism? Rajan and Zingales argue that it arises from within the heart of the system, not from limousine liberals, social critics, reformers, and disadvantaged groups on capitalism’s fringes. Established enterprises, the “incumbents,” constantly seek to co-opt the political system and use it to stifle entry to industry, access to financial services, and competitive markets in order to protect their privileged positions and profits. “Capitalism’s biggest political enemies are not the firebrand trade unionists spewing vitriol against the system but the executives in pin-striped suits extolling the virtues of competitive markets with every breath while attempting to extinguish them with every action.” (Sylla, p. 392 citing Rajan & Zingales, p. 276).

I had seen this type of “regulatory capture” argument before, notably from Simon Johnson’s piece that I assign to my regulation class, but I was surprised to see it from the relatively more pro-market Rajan & Zingales.

But they aren’t the only ones.  In “The Inequality that Matters,” libertarian Tyler Cowen looks at the role of the financial sector in increasing income inequality, and comes to this rather unsettling conclusion:

For the time being, we need to accept the possibility that the financial sector has learned how to game the American (and UK-based) system of state capitalism. It’s no longer obvious that the system is stable at a macro level, and extreme income inequality at the top has been one result of that imbalance. Income inequality is a symptom, however, rather than a cause of the real problem. The root cause of income inequality, viewed in the most general terms, is extreme human ingenuity, albeit of a perverse kind. That is why it is so hard to control.


MIT economist Daren Acemoglu has also turned his attention to this matter, with a talk at the annual American Economic Association meetings that he discusses with Russ Roberts on EconTalk.  In it, Acemoglu actually discusses Rajan’s more recent book, Fault Lines (discussed here).

Russ Roberts himself gives a very thoughtful overview of his case for cronyism the capital markets in his piece, Gambling with Other People’s Money, that he discusses in his monologue at EconTalk.

Overall, we’re building up a pretty good reading list here.  We’ll see if we have a seminar on this forthcoming.

From Lawrence to Lehman Brothers, Distinguised Alum Tony Valukas at LU April 7

The Lawrence Scholars in Law program is pleased to announce that distinguished alumnus Tony Valukas (Class of 1965) will Thursday, April 7 at 5:30 p.m at the Warch Campus Center Cinema.

Mr. Valukas’ talk is Lawrence University to Lehman Brothers – a Journey, and it is indeed quite a journey.  According to his biography:

Mr. Valukas has been a partner with Jenner & Block from 1976 through the present, with the exception of his tenure as the United States Attorney for the Northern District of Illinois from 1985 through 1989.  Prior to Jenner & Block, Mr. Valukas held several positions with the U.S. Department of Justice, including Assistant United States Attorney (1970-1974), Chief of the Special Prosecutions Division (1974), and First Assistant United States Attorney (1975-1976)…  Mr. Valukas was appointed in 1991 as Special Counsel to the City of Chicago to investigate and report on the City’s health care system.  He was selected Special Inspector General to the Chicago Transit Authority to investigate vendor fraud, and counsel to the Chicago Housing Authority to investigate vendor and pension fraud.  He has also served as chairman of the Governor’s Task Force on Crime and Corrections for the State of Illinois, a 2-year effort which led to the passage of major prison reform legislation in 1993.

Mr. Valukas is also a former member of the Lawrence Board of Trustees.

That seems like quite a lot, but it certainly doesn’t end there. Continue reading From Lawrence to Lehman Brothers, Distinguised Alum Tony Valukas at LU April 7

Is Facebook worth $50 Billion?

William Cohan (author of House of Cards and other books on the financial industry)  in today’s “Opinionator” in the New York Times opines that Goldman Sachs’ management of an expected IPO for Facebook reflects how the financial system has not really changed despite the most recent crisis.  Boom and bust cycles fed by cheap credit and poor incentives still rule.  Check it out.

What, Me Worry?

For those of you without enough to worry about this holiday season, Calculated Risk has the top 10 economic questions for 2011.  Most of these seem to be macro issues, and 4 and 6 seem to be pretty boilerplate — is economic growth ever not an issue?  Nonetheless, worth your perusal.

With any luck, we’ll be getting the rest of those Schumptoberfest essays up for the holidays.

Will NYC prosper?

The answer depends on whether it manages to preserve its history of entrepreneurship, says Edward Glaeser in his piece Start-Up City in New York’s City Journal. He argues that the strength behind the spectacular economic development New York City has experienced in most of the past two hundred years grew out of entrepreneurship. Industries have come and gone, but the entrepreneurial spirit remained. But will this be the case after the Fall of Finance? Glaeser worries that the financial firms that have come to dominate the City aren’t small and entrepreneurial, but relatively large, possibly undermining that culture of entrepreneurship. Moreover, in several studies and surveys New York state and New York City show up as one of the worst places to do business in the US. One other piece of this picture that I think deserves more attention than Glaeser is granting is the constant influx of immigrants that New York has experienced for a long time. See this paper by Waldinger on immigrants and the famous New York garment industry, or this study by the Kauffman Foundation on immigration and technology entrepreneurs in particular. Of course when great numbers of immigrants became entrepreneurs in NYC, it was in small-scale manufacturing industries such as the garment industry, where no knowledge of English and no higher education were required. My great-uncle has several childhood friends who successfully became such entrepreneurs in the US, and spoke rather limited English to the day they died. It is doubtful that such a mechanism of low-skilled immigrant entrepreneurship could function today. But, as the aforementioned study suggests, technology may be the new garment industry.

The New JEPs are Here!

Things are going to start happening to me now!

Just in time for the end of term, the new Journal of Economic Perspectives is here, the new Journal of Economic Perspectives is here.  And this quarter’s issue is chock full o’ articles* about the state of macroeconomics after the financial crisis, so that should be fun to peruse.

The new JEP also has an article titled “Activist Fiscal Policy” by Alan Auerbach and colleagues, which has been a continuing source of consternation inside and outside of the profession (see here for our previous post on this topic).  Here’s the abstract:

During and after the “Great Recession” that began in December 2007 the U.S. federal government enacted several rounds of activist fiscal policy. In this paper, we review the recent evolution of thinking and evidence regarding the effectiveness of activist fiscal policy. Although fiscal interventions aimed at stimulating and stabilizing the economy have returned to common use, their efficacy remains controversial. We review the debate about the traditional types of fiscal policy interventions, such as broad-based tax cuts and spending increases, as well as more targeted policies. While there have been improvements in estimates of the effects of broad-based policies, much of what has been learned recently concerns how such multipliers might vary with respect to economic conditions, such as the credit market disruptions and very low interest rates that were central features of the Great Recession. The eclectic and innovative interventions by the Federal Reserve and other central banks during this period highlight the imprecise divisions between monetary and fiscal policy and the many channels through which fiscal policies can be implemented.

It’s interesting to look through the article, if for no other reason to look at the variances in estimated multiplier effects for different policy levers.  For example, direct government purchases have a range of 1.0 to 2.5, whereas the extension of the homebuyer credit seems to be self-defeating, ranging from 0.2 to 1.0.  Federal transfers to state and local governments vary depending on whether the spending targets infrastructure, and transfers to individuals range from 0.8 to 2.2.

Wow, we really don’t have a very good idea about how this works.

*Yes, Chock Full O’ Nuts is really a coffee brand.  As we saw in class, it has a lower price elasticity than brands such as Folgers and Maxwell House.

The Fiscal Train Wreck at the End of the Tunnel

Courtesy of a former student of Professor Gerard, Lawrence faculty and students have access to the Roubini website.  I encourage you, especially those of you interested in either international economics or macroeconomics, to pay regular visits to the site.  Recently, Nouriel Roubini – after whom the site is obviously named – penned a short opinion piece entitled “U.S. Fiscal Policy:  A Train Wreck Down the Line?” which lays out some fundamental questions that our political structure has failed to address.  Although next year’s Congress will have different interests than the current group, Roubini’s concerns (and mine too) still obtain.  Check it out.