Baseline Scenario, October 30, 2009

Yesterday morning I testified to a Joint Economic Committee of Congress hearing (update: that link may be fragile; here’s the JEC general page).  The session discussed the latest GDP numbers, the impact of the fiscal stimulus earlier this year, and whether we need further fiscal expansion of any kind.

I argued that a global recovery is underway and in the rest of the world will likely be stronger than the current official or private consensus forecast, but growth remains fragile in the United States because of problems in our financial sector.  While our situation today is quite different in key regards from that of Japan in the 1990s, the Japanese experience strongly suggests that fiscal stimulus is not an effective substitute for confronting financial sector problems head on (e.g., lack of capital, distorted incentives, skewed power structure). 

We are well into the adjustment process needed to bring us back to living within our means. Although such a process always involves an initial fall in real incomes, growth can resume quickly as the real exchange depreciates.  The idea that we necessarily are in a “new  normal” scenario with lower productivity growth seems far fetched, but continuing failure to deal effectively with the “too big to fail” banking syndrome delays and distorts our adjustment process – it also makes us horribly vulnerable to further collapses.

The fiscal stimulus enacted in early 2009 had a major positive impact, particularly as it was coordinated with other industrial countries – this prevented the global recession from being even deeper (disclosure: I testified to the need for a major fiscal stimulus in October 2008).  But a further broad stimulus at this time is not warranted and the first-time homebuyers tax credit should be phased out.  We should extend unemployment insurance and focus our future efforts on improving the skills of people with less education, e.g., through strengthening community colleges. 

Like all industrialized countries, we also need to look ahead to “fiscal consolidation” in order to stabilize our debt-GDP levels (and pay for the rising cost of Medicare).  The large contingent government liabilities implied by the existence – and potential collapse – of big banks are a major risk to medium-term outcomes.

My written testimony (with some small updates indicated) is below (pdf version).  This is now our revised Baseline Scenario.

Main Points

1. The world economy is experiencing a modest recovery after near financial collapse this spring.  The strength of the recovery varies sharply around the world: 

a. In Asia, real GDP growth is returning quickly to pre-crisis levels, and while there may be some permanent GDP loss, the real economy appears to be clearly back on track.  For next year consensus forecasts have China growing at 9.1% and India growing at 8.0%; the latest data from China suggest that these forecasts may soon be revised upwards.

b. Latin America is also recovering strongly.  Brazil should grow by 4.5% in 2010, roughly matching its pre-crisis trend.  We can expect other countries in Latin America to recover quickly also. 

c. The global laggards are Europe and the United States.  The latest consensus forecasts are for Europe to grow by 1.1% and Japan by 1.0% in 2010, while the United Sates is expected to grow by 2.4% (and the latest revisions to forecasts continue to be in an upward direction).  Unemployment in the US is expected to stay high, around 10%, into 2011.  [Update: the latest quarterly GDP data do not make us want to revise this view]

2. The current IMF global growth forecast of around 3 percent is probably on the low side, with considerably more upside possible in emerging markets (accounting nearly half of world GDP). The consensus forecasts for the US are also probably somewhat on the low side.

3. As the world recovers, asset markets are also turning buoyant.  Recently, residential real estate in elite neighborhoods of Hong Kong has sold at $8,000 US per square foot.  A 2,500 square foot apartment now costs $20 million.  Real estate markets are also showing signs of bubbly behavior in Singapore, China, Brazil, and India. 

4. There is increasing discussion of a “carry trade” from cheap funding in the United States towards higher return risky assets in emerging markets.  This financial dynamic is likely to underpin continued US dollar weakness.

5. One wild card is the Chinese exchange rate, which remains effectively pegged to the US dollar.  As the dollar depreciates, China is becoming more competitive on the trade side and it is also attracting further capital inflows.  Despite the fact that the Chinese current account surplus is now down to around 6 percent, China seems likely to accumulate around $3 trillion in foreign exchange reserves by mid-2010.

6. Commodity markets have also done well.  Crude oil prices are now twice their March lows (despite continued spare capacity, according to all estimates), copper is up 129%, and nickel is up 103%.  There is no doubt that the return to global growth, at least outside North America and Europe, is already proving to have a profound impact on commodity markets.

7. Core inflation, as measured by the Federal Reserve, is unlikely to reach (or be near to) 2% in the near future.  However, headline inflation may rise due to the increase in commodity prices and fall in the value of the dollar; this reduces consumers’ purchasing power. 

8. This nascent recovery is partly a bounce back from the near total financial collapse which we experienced in the Winter/Spring of 2008-09.  The key components of this success are three policies. 

  • First, global coordinated monetary stimulus, in which the Federal Reserve has shown leadership by keeping interest rates near all time lows.  Of central banks in industrialized countries, only Australia has begun to tighten. [Update: and Norway, obviously affected by rising oil prices]
  • Second, global coordinated fiscal policy, including a budget deficit in the US that is projected to be 10% of GDP or above both this year and next year.  In this context, the Recovery Act played an important role both in supported spending in the US economy and in encouraging other countries to loosen fiscal policy (as was affirmed at the G20 summit in London, on April 2nd, 2009).
  • Third, after some U-turns, by early 2009 there was largely unconditional support for major financial institutions, particularly as demonstrated by the implementation and interpretation of the bank “stress tests” earlier this year.

9. However, the same policies that have helped the economy avoid a major depression also create serious risks – in the sense of generating even larger financial crises in the future.

10.  A great deal has been made of the potential comparison with Japan in the early 1990s, with some people arguing that Japan’s experience suggests we should pursue further fiscal stimulus at this time.  This reasoning is flawed.

11.  We should keep in mind that repeated fiscal stimulus and a decade of easy monetary policy did not lead Japan back to its previous growth rates.  Japanese outcomes should caution against unlimited increases in our public debt.

12.  Perhaps the best analysis regarding the impact of fiscal policy on recessions was done by the IMF.  In their retrospective study of financial crises across countries, they found that nations with “aggressive fiscal stimulus” policies tended to get out of recessions 2 quarters earlier than those without aggressive policies.  This is a striking conclusion – should we (or anyone) really increase our deficit further and build up more debt (domestic and foreign) in order to avoid 2 extra quarters of contraction?

13.  A further large fiscal stimulus, with a view to generally boosting the economy, is therefore not currently appropriate.  However, it makes sense to further extend support for unemployment insurance and for healthcare coverage for those who were laid off – people are unemployed not because they don’t want to work, but because there are far more job applicants than vacancies.  Compared with other industrial countries, our social safety net is weak and not well suited to deal with the consequences of a major recession.

14.  The first-time home buyer tax credit should be phased out.

15.  GMAC should not receive a further infusion of government money.  It should be turned down for any kind of additional bailout; as with CIT Group earlier in the summer, this would force a negotiation with creditors and some losses for bondholders (most likely through a pre-packaged bankruptcy process).  This would not cause a general financial panic; probably it would actually strengthen the overall process of economic recovery, as it would move incentives in the right direction.

16.  The lack of skills among people who did not complete high school or who did not attend college is a critical longer term problem in the United States.  The impact of the recession will exacerbate the problems in this regard.  We should respond by further strengthening community colleges, allowing them to offer more vocational skills classes and to provide a viable way for more people to work their way into four-year colleges.

17.  America is well-placed to maintain its global political and economic leadership, despite the rise of Asia.  But this will only be possible if our policy stance towards the financial sector is substantially revised: the largest banks need to be broken up, “excess risk taking” that is large relative to the system should be taxed explicitly, and measures implemented to reduce the degree of nontransparent interconnectedness between financial institutions of all kinds.

The remainder of this testimony reviews current U.S. macroeconomic issues in broad terms, assesses the lessons of Japan’s experience in the 1990s, and make proposals for further essential reform (both fiscal and financial).

Current U.S. Issues

To be a strong global leader in the future, America needs to generate an environment where entrepreneurship, technological innovation, and immigration ensure that the nonfinancial private sector can continue to propel the US economy. 

It is premature to argue that the US economy has stumbled into a “new normal” paradigm that involves slower growth.  The factors that drove our growth over the last 150 years, particularly entrepreneurial startups and the commercialization of invention, remain despite the crisis.  Indeed, these drivers of growth may become even stronger in the future, if we can reduce the wasteful financial sector activities that grew since the 1980s (and really flourished over the past decade) and allocate resources to more productive activities in the future.  

America needs a new framework to harness that growth.   That framework needs to address the following problems with our current economic structure.

Problem 1:  With the recent financial sector bailouts, we have sent a simple message to Americans: The safest place to put your savings is in a bank, even if that bank is so poorly managed, and has such large balance sheet risks, that just six months ago it almost went bankrupt.

Despite being near to bankruptcy six months ago, Bank of America credit default swaps now cost only 103 basis points per year to protect against default, and the equivalent rate for Goldman Sachs is a mere 89 basis points.  Goldman Sachs is able to borrow for five years at just 170 basis points above treasuries.  This is not a sign of health; rather it indicates the sizable misallocation of capital promoted by current policies.  American’s leading nonfinancial innovators would never be able to build the leverage (debt-asset ratio) on their balance sheet that Goldman Sachs has, and then borrow at less than 2% above US treasuries.  The implicit government guarantee is seriously distorting incentives.

Problem 2:  We have not changed the incentive structures for managers and traders within our largest banks.  Arguably these incentives are more distorted than they were before the crisis. So the problems of excessive risk taking and a new financial collapse will eventually return.  Financial system incentives are a first-order macroeconomic issue, as we have learned over the past 12 months.

Today bank management is strongly incentivized to take large risks in order to raise profits, increase bank capital, and pay large bonuses to “compete for talent”.  Since they have access to a pool of funds effectively guaranteed by the state through being “too big to fail”, there is the potential to make large profits by employing funds in risky trades with high upside.  Such activities do not need to be socially valuable, i.e. it could be that the expected return on the investments is negative, but as the downside has limited liability, the banks can go ahead.

Problem 3:  We have not changed the financial regulatory framework in a substantive way so as to limit excessive risk taking.  The proposals currently proceeding through Congress are unlikely to make a significant difference.

Problem 4:  The policy response to this crisis, with very low interest rates and a large fiscal stimulus, is merely a larger version of the response to previous similar crises.  While this was essential to stop a near financial collapse, it reinforces the message that the system is here to stay.  

Problem 5:  The public costs of this bailout are much larger than we are accounting for, and people who did not cause this crisis are ultimately paying for it.   Taxpayers and savers are the big losers each time we have these crises.  We are failing to defend the public purse.  

Our financial leaders have emphasized that our banks are well capitalized, and no new public funds are likely to be needed to support them.  This is misleading.  The current monetary stance is designed to ensure that deposit rates are low, and the spread between deposit rates and loan rates is high.   This is a massive transfer of public funds to the private sector, and no one accounts for that properly. 

It is striking that the Chairman of the Federal Reserve himself, in a recent speech, stated that no more public funds were needed to bail out banks.  His institution continues to provide massive transfers to the banking system through loose credit and low interest rate policy.  That credit could instead go to others; the Federal Reserve has chosen to transfer those funds to banks.  This policy was used in the past to recapitalize banks (e.g., after 1982), but we have now a very different financial sector – with much more capacity to take high risks and a greater tendency to divert profits into large cash bonuses.

Today, depositors in banks earn little more than the Federal Funds rate and are effectively financing our financial system.  We are giving them very low returns on their savings because the losses in the financial system were so large in the past.  This is essentially public money – it is the pensioners, elderly people with savings, and other people who have no involvement in the financial system, that are being required to suffer low returns to support the banks. 

We Are Not Japan

After the bursting of its real estate bubble, at the end of the 1980s, Japan faced a serious problem in its financial sector.  This fact has inspired many people to look for parallels with the current US situation, and – in some cases – to draw the implication that we should pursue further large-scale fiscal stimulus today.

There is a cautionary tale to be learned from the Japanese experience – on the need to promote, rather than to prevent, appropriate macroeconomic adjustment.  But this does not encourage a further expansion in the budget deficit at this time.

The property bubble and general credit bubble in Japan were actually much larger than what we recently experienced in the U.S.  The implied price of the land in the Emperor’s Palace, in central Tokyo, was worth more than all of California (or Canada) at its peak.  Land prices collapses and never recovered.  US house and land prices never got so far out of line with the earning capacity of homeowners.

The Japanese stock market rose to price-earnings ratio of around 80 (depending on the exact measure), also as a direct result of the credit bubble.  The US did not experience anything similar in the last few years.

Japan was – and largely remains – a bank-based finance system.  And their nonfinancial corporate sector was generally much more indebted (often using borrowed money to buy land, but also over-expanding their manufacturing capacity) than was the case in the US.  Total Japanese corporate debt was 200 percent of GDP in 1992 – more than double its value in 1984. The implication was a long period of disinvestment and saving by the corporate sector – in fact, this change from the 1980s to 1990s explains most of Japan’s increased current account surplus after the crisis.  Since Japanese corporates had accumulated too much capital, they exhibited low returns in the post-crisis period.  The US has strong bond and equity markets, and our corporate sector is not heavily indebted – so the cash flow of the nonfinancial sector should bounce back strongly.

In contrast to Japan, the US consumer has much more debt and saves less – in fact, on average over the past decade, the our household sector has saved roughly nothing (partly due to the effects of rising wealth, from higher house prices).  This sector will be weak in the US.  In contrast, in Japan during the 1990s there was no significant increase in household saving (and thus no contribution from this sector to their current account surplus.)

The obvious solution for any country in the situation faced by the US is to let the economy adjust, which implies and requires that the real exchange rate depreciates – so our exports go up, our imports (and consumption) go down.  This is a level adjustment downward in our GDP and standard of living, but then growth will resume on this new basis.

In contrast, Japan did not grow largely due to their over-investment cycle (in real estate, but also plant and equipment).  This created a much more difficult adjustment process, which worked for manufacturing primarily through depreciation of installed capacity and a gradual movement of production off-shore (e.g., to China and other Asian countries).

In addition, another major cause of Japan’s poor performance was its demographics, and the relatively lackluster growth of its trading partners in Asia due to the Asian crisis.  With its working population peaking in 1995, Japan lost a major driver of growth.  The country still has strong enterprises and decent productivity growth in the manufacturing sector, which allows them to grow.  But the pace is naturally slower than when they were “catching up” through the 1980s.  During the last ten years Japan’s has grown around the same pace as some of the continental European nations with better but also poor demographics, such as Italy and Germany (the comparison is from Q1 1998 to Q1 2008).

The Japanese policy reaction was to run budget deficits and maintain very loose monetary policy for over a decade, in an attempt to stimulate the economy and obviate the need for painful adjustment (including job losses, recognizing losses at major banks, and properly recapitalizing those banks).  Today Japanese gross debt to GDP is at 217%, and it is still rising (net debt, even on the most favorable definition, is over 110% of GDP).  The working population of Japan is now declining quickly, and so those people that are required to pay back the debt face ever rising burdens.  There is a real risk that Japan could end up in a major default, or need a large inflation, to erode the burden of this debt since their current path is clearly unsustainable. 

Japan’s policy approach from the 1990s – repeated fiscal stimulus and very easy money – is not an appealing model for the U.S. today.  All dynamic economies have a natural adjustment process – this involves allowing failing industries to decline, and letting new businesses develop where there are new opportunities. 

In fact, while Japan hesitated for over a decade to let this process work (particularly protecting the insiders at their major banks), it has finally moved in this direction.  Unit labor costs in Japan have declined sharply over the last ten years, helping making the country a more competitive exporter.  The forced recapitalization of some major banks, at the end of the 1990s, was also a move in the right direction.

The process of deflation – spoken of with terror by some leading central banks around the world today – actually makes industry more competitive, and while there are negative aspects to it (particularly if the household sector is heavily indebted, as in the US), the modest price declines seen in Japan are not a disaster.  In fact, real GDP per worker in Japan – annualized over the past 20 years – has increased by 1.3 percent per annum; while the comparable number in the US is 1.6 percent.  Over the past 10 years, real GDP per worker (annualized) increased by 1.3 percent in both Japan and the US – and now it turns out that much of the GDP gains in the US financial sector may have been illusory.

The Japan-US comparison is not generally compelling, particularly as Japan ran a current account surplus even during its destabilizing capital inflows of the 1980s.  The current US experience more closely matches the experience in some emerging markets, which have in the past run current account deficits, financed by capital inflows – with the illusion that this was sustainable indefinitely.

The long and hard experience of the International Monetary Fund (IMF) with such countries that have “lived beyond their means” – or over-expanded in any fashion – is that it is a mistake to try to prevent this process of competitive adjustment, i.e., bringing spending back into line with income, which implies a smaller current account deficit or even a surplus.  The adjustment can be cushioned by fiscal policy – and here the IMF has changed its line over the past few years, now offering sensible support for this approach.  But attempting to postpone adjustment with repeated fiscal stimulus is almost always a mistake.

Japan did not want to force its corporate sector to adjust (i.e., in the sense of going  bankrupt and renegotiate its debts), so it offered repeated stimulus.  As a result, it has become stuck with a “permanent” fiscal deficit program which is now threatening their survival as a global economic power, and will – regardless of the exact outcome – burden future generations for decades. 

Some analysts further claim that Japan’s early withdrawal of stimulus is a major factor explaining why they have not returned to robust growth rates.  It is true that Japan introduced a new VAT tax in April 1997 not long before the Asian Financial Crisis began, and the Bank of Japan raised interest rates by 25 basis points in August 2000.  Subsequent to these changes the economy slowed down. 

However, each of these measures were relatively small.  The Bank of Japan reversed course on interest rates quickly, and a negative turn in the economy was surely already in the cards – this occurred at the same time as the global economy slowed down, and a great stretch to argue that a 25 basis point move could explain the poor performance of Japan’s economy for years or decades subsequent.

As long as there are not major adverse shocks from the rest of the world, the US will experience higher savings, a fall in consumption, a recovery in investment, and an improvement in the its net exports (so the current account deficit will become smaller, or stay at its current level even as the economy recovers).  Growth will resume, driven by demographics, technical progress, and entrepreneurship.  The high level of unemployment also implies that rapid growth will be fuelled by willing workers, subject to the right skills being available.

Proposals For Change

The main threats to the recovery scenario come from the financial system, which has developed serious and macro-level pathologies over the past two decades.

We have weak bank regulation and supervision.  Politically we can’t let banks fail: they bend or lobby to change the rules in order to grow big, and then we bail them out. 

New theories of deflation and zero interest rate floors attempt to explain why we need unprecedented large bailouts – with the experience of Japan and the Great Depression of the 1930s offered as partial justification.  More likely, we are on an unsustainable fiscal path with the potential for new financial bubbles.

The following changes should be priorities.

1. Reduce the impact of financial sector lobbying on bank regulation and supervision.  Today the US Treasury is filled with former finance sector workers in key positions responsible for financial sector reform and bailouts.  This is too large a conflict of interest.  We need to close the revolving door between government and the financial sector.

2. Put far greater regulation and closer supervision on the large remaining banks that are clearly too big to fail.  These should be broken up into much smaller pieces, so we have a more competitive system. 

  • When major financial institutions request additional help from the government, such as GMAC, they should be turned down.  This would force their bondholders to take a loss and lead to better incentives for the future.  It is highly unlikely that it would cause a major financial panic.  The financial system is experiencing a sharp bounce back more broadly and GMAC can likely arrange a pre-packaged bankruptcy that would actually allow its debt to rise in value.
  • Banks can syndicate if they need to do large transactions. This is actually what they do for most capital raising transactions. 
  • Banks should draw up “living wills” and raise additional capital as they become larger relative to the system.

3. We should also toughen our monetary policy to send a clear message that we will not maintain a pro-cyclical monetary policy which bails out banks at the end of each crisis.  The cross-liabilities on banks’ balance sheets should be reduced as far as possible to lower the risks involved with letting one fail. By doing this, we would free the hands of those running our monetary policy to take tougher actions to stop the next bubble. 

4. We need to address the inequality driven by our bailouts as a gesture to show that we will defend the public purse beyond the simple accounting in the budget. 

  • Increasingly, there is discussion of taxing “excess risk taking” (reflected in high profits and bonuses) in the financial sector, particularly if that is large relative to the system.  The terms in this debate have not yet been clearly defined and this initiative could go in the wrong direction.  But we should recognize that mismanagement at major banks has created huge negative externalities both for the financial system and for the economy as a whole.  Taxing activities that generate such externalities is entirely appropriate in other sectors, and the same reasoning is likely to be applied for banking also.
  • In addition, we should also require that Goldman Sachs, GMAC, and other non-banks (i.e., those operating without deposit insurance) with access to the Federal Reserve’s window pay a substantial long term annual fee to compensate taxpayers for that access.  This is a valuable insurance policy which they have – at this point – been given for free.

5. We should withdraw the fiscal stimulus over 5 years and aim for fiscal consolidation, including Medicare costs, at that time.  We should use extra spending to target specific issues that will help people improve their skills, but wind down the temporary public works programs that build jobs in the public sector. 

6. All industrialized countries need to make a substantial fiscal adjustment over the medium-run, in order to stabilize public debt levels.  The size of this adjustment depends on assumptions (and policies) regarding longer-run medical costs as the population ages and medical technology becomes more expensive.  The US and almost all other members of the OECD most likely require a fiscal adjustment in the range of 4-8 percentage points of GDP.  In that context, further unfunded or nontransparent contingent public liabilities vis-à-vis the financial sector are untenable; the Japanese experience should be taken as a warning sign in this regard.

7. For the longer-run, we should focus on measures that improve skills for people with fewer years of formal education.  Supporting the expansion of community colleges and other practical skills training is the best way forward, although this will take some time to scale up.

By Simon Johnson, Peter Boone, and James Kwak

81 responses to “Baseline Scenario, October 30, 2009

  1. So Simon, how would you suggest the U.S. should go about bringing the unemployment number down sooner than 2011?

  2. I had a post at “baselinescenario” Oct 15 predicting L curve recovery. I’m usually pretty careful how I use terms, but I think I made a big mistake. L-curve if I understand it correctly now includes deflation, and I certainly do NOT think we will have deflation. I was thinking L-curve just meant a long prolonged period in the same small economic growth rate. I wasn’t aware it included deflation, so I want to apologize for my ignorance and using a term I didn’t fully understand. Sorry.

    Having that little embarrassment fessed up, I basically think we are looking at this picture for 2-3 years. I am NOT a forecasting professional (obviously if I just figured out today what the TRUE definition of L-curve is). I just want to put my 2 cents in.
    1. Very low inflation, no more than 2% (that includes spiky oil prices)
    2. High unemployment over an extended period. I think if unemployment goes below 7% at the end of Obama’s first term, it will be a MIRACLE. So, basically I see it moving at a very very stalwart pace from 10% to 8% unemployment over the next 3 years.
    3. Same as Professor Johnson I see a bigger financial crisis in the future if we don’t have better financial regulations and ENFORCEMENT of those regulations.
    4. It will be official IF President Obama bails out GMAC: He is somewhat ignorant on financial issues. On the other hand, IF he tells GMAC to get their own private financing/bailout, then we still have hope President Obama has his finger on the financial pulse.

    Here is a link I gave before about railroad traffic, which is an important number to watch to judge the recovery. Also truck transport, and demand for corrugated boxes are good numbers to keep an eye on.
    http://markettalk.newswires-americas.com/?p=5423

    Also James Hamilton had some great info up on his Econbrowser blog Oct. 20 discussing the relationship between unemployment and inflation which is worth the time to absorb into your mind. http://www.econbrowser.com/archives/2009/10/unemployment_an.html

  3. Outstanding analysis. It would appear that the overriding cause for the ascent of this banking problem has been the high political leverage that has been used by the “nouveau riche” bankers, who can use their lobbying might to get what they want.

    Until our political system is changed to cause term limits to be put in place, the incentives for Congressmen to act in a way contrary to the benefit of most Americans will continue to be problematic.

  4. I think Simon discussed that. There was/is a large misallocation of capital into the financial sector. If we change the government policies so that capital is flowing properly into sectors of long-term job growth the unemployment will go down.

    Can that be changed in 1-2 years after roughly 25 years of asinine Republican blindness??? Republicans thought you could build an economy taxing a guy drinking a cocktail with a stock certificate in his hand nothing. It doesn’t work.

  5. So many things in this post are spot on that I feel uneasy disagreeing, but I have to contend that the above story is strongly mischaracterizing the Japanese experience and the implications for US policy…

    1) You write that for Japan, Deflation (increasing value of the Yen) was good and natural. You then note that, even in the deflationary environment, Japanese real GDP growth increased commensurately with the US. BUT, you then note that this was entirely financed through national debt, and that the national debt/GDP ratio is 217% (astronomically high).

    You also write: “it is a great stretch to argue that a 25 basis point move could explain the poor performance of Japan’s economy for years or decades subsequent”

    There are some serious failures in this argument, which are deadly if we try to apply them to the US:

    A) The 217% Debt/GDP ratio is a direct result of Deflation. Both by increasing the relative value of debt, and also by de-stimulating private investment/consumption. Politically, this forced the government to step in with stimulus.

    The flip side of your argument can be worded as possible: The Japanese deflation was _so_ bad that even with the government taking on massive debt (217% of GDP in a little over a decade), Japanese RGDP per capita was barely able to keep up with the US (which had serious structural deficiencies).

    B) Interest rates in Japan weren were not low. What matters is REAL interest rates. Moreover, rates were certainly not low relative to what they needed to be to ensure stable nominal GDP growth, or a stable inflation rate (~2%) in a heavily debt-ridden economy.

    Saying that the BoJ had an “Easy Money” policy is relative, and relative to the growth/inflation trajectory, even near-0% inflation is not “easy money”.

    2) You write that BoJ’s 0.25% increase in rates in 2000 was not meaningful. This is incorrect. The REAL impact of the 0.25% change was that it altered expectations of future BoJ policy. This is Paul Krugman’s point about credible signalling. BoJ, due to political factors, was consistently unable to credibly signal that it would do whatever necessary to generate stable inflation.

    And so – as I’ve argued many many times – Japan found itself in a liquidity trap. Your final point is absolutely correct: “There is a real risk that Japan could end up in a major default, or need a large inflation, to erode the burden of this debt since their current path is clearly unsustainable.”

    However, this is directly attributable to the fact that BoJ consistently failed to credibly commit to a stable (2%) inflation (or, even better, NGDP) trajectory.

  6. Other points:

    You write:

    “We should also toughen our monetary policy to send a clear message that we will not maintain a pro-cyclical monetary policy which bails out banks at the end of each crisis.”

    A monetary policy that eases during recessions is actually ANTI-cyclical. (It is pro-cyclical only in the moral hazard aspect.) The problem is not monetary easing in crises (that’s what we NEED). The problem is failure to contain monetary stimulus in the expanion, and the distorted incentives created by the _expectation_ of monetary easing in a recession. There is a big difference here.

    If we cannot contain the incentives created by the expectation that we (rationally) use monetary policy to help prevent economic catastrophe, then THAT is a problem – it is precisely a problem because it constrains out ability to use monetary policy. This was Brad DeLong’s point about “Second Best Punchbowlism”.

    The question is whether we can marshall the capability to contain the moral hazard through adminsitrative mechanisms… if not, then we’re in serious trouble largely because monetary policy is severely weakened.

  7. Thanks, Simon. Let’s hope the dopes in DC listen/understand. Of course, the problem is not brains, it’s balls and bribes.

  8. Asinine Republican blindness?? How bout asinine Obama/Fed blindness? Socialism only leads to ruin. Has every time.

    If you really think this is a recovery you’re nuts. There is nothing in the private sector that is growing except gun and ammo sales. The housing sector growth numbers were very suspect. All the usual indicators in housing show decline. We have the one time effect of the stimulus for short term government and related jobs and the dubious “cash for clunkers” con. Once the stimulus money runs out, the economy will fall back further into depression.

    Income, savings, and lending all are down from the start of Q3.
    That’s recovery?

    The new appraisal rules for banks are depressing housing values 30-40% because the very limited number of ‘approved” appraisers have no incentive to give a realistic appraisal. The incentives are all now for a low ball appraisal. These incentives will only make the housing and mortgage crisis worse, much worse than it was or should be. Until the banks start lending to small business and housing there will be no significant recovery. Businesses will continue to fail and jobs will continue to be lost, until private sector and business friendly policies are adopted in a big way.

    But you are partially right Ted, a bigger financial crisis is coming down the tracks.

  9. This really is an excellent summary of the current position and intelligent policy measures to ensure recovery and mitigate the risk of future crises. Congress is fortunate to have your input. Thank you very much and you are fighting the good fight.

  10. And you so you think that Socialism led to our mess?

  11. 8 years of Bush got us this. And Republican Congress for 6 out of those 8 years. But you can try to blame it on President Obama. Do your best.

  12. I read your testimony, Simon. I wish you had emphasized that the housing market in the U.S. is on life-support with the Fed buying $1.75 trillion in MBS, foreclosures are still rising, etc. I found no reference to U.S. real estate in your statement.

    While you do mention that you expect unemployment to be ~10% through to 2011, the eye-catching number is 2.4% growth in the U.S. next year.

    Given the shaky state going forward of residential real estate, fixed investment and commercial real estate, and combined with downward pressure on personal consumption, I think that 2.4% forecast is wildly optimistic.

    Those who think a weakened dollar will lead to export growth that will lead us out of recession have lost all contact with reality, as this would require years of capital reallocation toward actual production of stuff we could sell overseas.

    Of course you focus on the still-unreformed financial system because being a former IMF economist, you place particular emphasis on that. We are all familiar with the problems there (rents, risk-taking, etc.) But returning to basics, the distinction between availability of credit and demand for credit is not usually made, and if the latter is not there, as the great debt in Middle Class households implies (together with foreclosures, joblessness), then a credit-driven recovery is impossible.

    And what other kind of recovery is possible?

    I can not find 2.4% growth anywhere as government stimulus wanes in 2010. Dave Rosenberg’s analysis of the 3.5% 3rd quarter surge puts growth at 0% after all stimulus is removed.

    I can see Congressmen leaving the room after your testimony saying to themselves — “Umm, 2.4% growth next year — that’s pretty good!”

    Not only is that growth number doubtful, but such a view would render invisible all your other valid points.

    best –

  13. Obama was supposed to represent change and yet his clear policy actions are absolutely as subservient to the financial industry as Bush’s were.

  14. I totally agree with so much of what you say, but I can’t help wishing I could read your thoughts on the enormous secular rise in oil prices. Few mainstream economists want to address Peak Oil, perhaps for fear of ridicule, but increasingly the question might be how can you avoid it? Oil bottomed in this downturn at levels that previously would have been associated with vigorous economic growth. The IEA and other respected experts have warned that the financial collapse has reduced E&P investment enough to lead to another supply crunch sooner rather than later. My concept of Peak Oil is that it is not just a matter of geology but that politics and and economics also play an inevitable role. How do you feel that higher oil prices (and commodities in general) will affect our ability to recover from the downturn? Given long lead times to mitigate the effects of Peak Oil, what do you think the U.S. should the U.S. be doing? If the cost of energy become a principal factor limiting economic growth, how should monetary policy be altered to take this into account?

  15. Have the fates of the elite and the rest of use been effectively and willfully de-coupled?

    There is plenty of money for the interests of the wealthy, but the long slow decline of American education is unlikely to get the remedy that Simon rightly calls for. It appears that we won’t even have a jobless recovery, we will instead have a job-loss recovery.

    The fly in the ointment is that if somebody doesn’t do something for the rest of us soon, personal consumption expenditures are going to continue to languish, new houshold formation will continue to crawl and there won’t be much of a recovery for anyone.

    Unless of course it’s thought to be acceptable to turn America into some sort of second or third world country, where the upper echelon derives their wealth from other parts of the world where the economy is actually growing.

    I find Simon a bit puzzling on the issue of stimulus though. It’s OK to extend unemployment insurance but other forms of stimulus are no good? It’s all cash, whether you pay it out in UI or by filling in revenue shortfalls for state and local government, for example? Is this just a matter of priority in the context of a limited capacity to take on further deficit spending?

  16. Some Thoughts on what brings employment are real reforms based upon Paul Volker, Marcy Kaptur, Alan Greenspan, Robert Reich and of course as I have been posting and sending many towards Simon Johnson.

    Why? Simple, to get a quicker learning curve to these mounting problems as seen in America and around the world, as we can still push reforms before the congress sells us American Taxpayers down the river…

    Go to this link if you wish to read all the articles to date:

    http://www.investors.com/forums/20.aspx

    or Google James Gornick

    These are final thoughts as posted with the following theme…

    Far-fetched the Barbarians Are About To Bring the Next Leg of Financial Crisis…

    How Far-fetched could this be that Goldman Sachs would think to do this move? A move to have the world market come roaring back by 2.3% or greater percentage gains in 12 hours later, on Thursday.

    Big question is; can the big boy’s pull it off over one to two days before the weekend brings Monday hangover of real reality checks from around the world?

    Frankly, this market has lit the crack pipe and even the big boys are at risk. It appears our ethics and morals are not yet quite right! Maybe, Barney Frank and Timothy Geithner can orchestrate, with the help of the closed-door meetings and phone calls, as documented by WSJ as Speed Dial of Geithner from the elite bankers and financial firms. They need to develop a new script to be formalized to dupe the American Taxpayer who is becoming wiser to these antics.

    Review the following video connection:

    http://online.wsj.com/video/author-says-expect-another-financial-crisis/3EE6BE4C-BF5A-41EF-A0BA-C391BDE738CF.html

    http://online.wsj.com/video/hot-stocks-financials-drop/EB13E425-7488-45AD-A003-BB543856B806.html

    Many more to become unemployed if we do not get this right from our Treasury Secretary and Federal Reserve Chairman’s recommendations to congress. The calls made by Paul Volker and Alan Greenspan along with Marcy Kaptur, and Simon Johnson and Robert Reich.

    Read the following critical blog review to know why this downturn is going to be steep…

    http://robertreich.blogspot.com/2009/10/too-big-to-fail-why-big-banks-should-be.html

    The American Taxpayer and investor have fully recognized the current smokescreen now and it is time for a change.

    The trillion-dollar question, Why has no government official questioned the motive of Goldman Sachs call as they made on Wednesday without questioning the integrity or the lack there of, the timing sequence as verified by the volume seen the prior days by the institutions in a panic mode.

    Do you think the SEC should investigate such a claim that was made one day prior to numbers that, as you pointed out as, could this be Far-fetched they planned the release along with the Congress to hear Geithner’s testimony?

    I leave the same trillion-dollar question to this entire discussion forum. What are your takes on such coincidences? These coincidences carried out by the very bankers and financial firms given the trillions of dollars of stimulus along with our government officials. Very Far-fetched that the timing sequences could be this orchestrated to the events unfolding.

    True reforms are what is sought by this writer, as conveyed by Paul Volker, Simon Johnson, Marcy Kaptur and a host of others, are critically needed to up right this ship going under. The markets will go up and they certainly will go down as you start to incorporate other articles and compile their meaning.

    Read this attached article to see the continued unemployment is not shrinking but still rising around the world…

    http://online.wsj.com/article/SB125685805002217223.html

    Thank you Simon Johnson for all of your wisdom and continued efforts…

    I am a Student of Finance helping out the many without a voice for the last few months…

    James Gornick

  17. There are glimmers of hope on the education front. Fortunately for America President Obama is a man who strongly supports education. He has chosen what so far appears to be a real go-getter as his Secretary of Education Arne Duncan . It’s amazing what can be accomplished when you’re a proactive President, instead of sitting back doing nothing and proclaiming “I’m the decider”. Let me also add that the man who wrote this piece in praise of President Obama, is David Brooks of The New York Times. Last time I checked Mr. Brooks is still a Republican.
    http://www.nytimes.com/2009/10/23/opinion/23brooks.html

  18. This post is mainstream academic nonsense. We are engaged in wholesale destruction of what remains of the middle class and will soon be a banana republic in the grip of China and a tiny financial elite. We do not need more green shoots nonsense from financial blogs. We can get that in the NYT. If Americans fall for this they might as well have fought all those wars for nothing, which of course they did.

  19. Regarding the comparison with Japan, I remember that a few months back we were worried that US banks would become zombies just like their Japanese counterparts. Can we say now with certainty that US banks have avoided zombiehood?

    The problem with zombie banks is that they do not inject money in the real economy and are likely to gamble for resurrection.

    My understanding is that US banks now don’t do much lending to US businesses and consumers. Instead they are putting money in emerging markets.

    According to SJ:
    “4. There is increasing discussion of a “carry trade” from cheap funding in the United States towards higher return risky assets in emerging markets. ”

    This sounds a bit like gambling for resurrection to me.

  20. Inflation without COLA for all pensions is a grave injustice.

  21. Yes, it’s tough to not give some of the blame to a Republican President and Republican Congress for so many years. Disclosure, I voted for Bush twice. What a moron I am. OK, now that I’ve destroyed my credibility. . .

    I think the point is that unemployment can’t be fixed quickly or easily. Americans’ complete intolerance for pain never ceases to amaze me. Simon argues in that the $8K housing credit should be removed – housing prices need to fall further and we are artificially propping up those prices. We need to be able to accept the pain of falling housing prices, the falling dollar, falling consumption, etc.

  22. I agree about the comment on what will drive the growth, but consumer debt?

    Or should Americans seize the opportunity to develop a new America?

    Air and water need cleaning, non-polluting energy sources need be developed. Efficient and comfortable transportation, healthy food and quality consumer goods are also needed. And to close, real education, vacations and adequate housing for 100% of Americans.

    As far as the need for a secure retirement, only a trustworthy financial system can foster this.

    Americans can be bold and shoot for the moon.

  23. Thanks for your reply. I’m far from an expert on financial matters, but I just found this blog and I’ve found quite a few posts I plan on studying.

    What I do know about is politics, and every day that passes by without unemployment relief is another day that more people start to blame our financial crisis on our current adminstration, fairly or unfairly. The truth is that if we are still at 10% unemployment by this time next year, then voters will be ready to vote out the Democrats in droves, making it that much harder for Obama to pass through any real reforms. Are there any signs that the administration now sees that there is a large misallocation of capital in the financial sector that needs to be corrected? Are there any concrete steps being taken right now to do something constructive about it?

    Thanks again.

  24. Forcing future generations to pay for pensions that were funded by debt is a much graver injustice.

  25. ““excess risk taking” that is large relative to the system should be taxed explicitly”

    How do we identify “excess risk taking”? If we had identified it in 2005, what would we have done differently to avoid the current debacle?

  26. What if the financial crisis is not our biggest problem?

    I am neither an economist or sociologist but it seems to me a significant percentage of the nation’s labor force cannot compete in a global environment.

    In the long run, education is the answer. But, that could be a very long run.

  27. Excellent summary, I remembered reading the first baseline, which turned out quite accurate.

  28. OMG, no more stimulus is needed, as unemployment continues to rise, unemployment insurance is running out, states are cutting jobs due to lack of revenue, etc?? Sure sounds like another round of stimulus is needed.

  29. If you asked engineers who is eating their bacon, the IT engineers might say India and Brazil.

    Many high skill jobs have become highly offshorable. Recently one even hears of media jobs going that way.

  30. Doesn’t the evidence now show that the stimulus was too small given the need to jolt the economy and keep people in some kind of minimal work. How much stimulus money was wasted on TARP … ? Wall Street profits are stemming now directly from the sale of shares in companies that are aggressively sloughing staff, forcing longer work hours for less pay out of remaining workers and passing health care costs on to employees. Wall Street, free of any need to fret over serious regulation, is already devising new schemes to create derivatives out of companies that hew to an anti-Main Street model of layoff fast and rehire never. So many opportunities to give the SEC bite have been lost to date. Why are we seeing anything positive for the working family in this aggressive return to reaganized clintonomics? Wealth is no longer being created by the financial industry. It is being siphoned. When will the commisars of Greenspanian oldthink get past this garbage-laden, ponzian narrative and talk about creating real wealth for real people? It is so depressing to see the same old loafer being re-shod again and again.

  31. I think you can pretty easily see unlimited Congressional terms as another case of TBTF – distorted incentives, all upside with low risk, delusions of grandeur and their personal greatness…

  32. thank you Simon for the excellent summary.

  33. Simon, James and Peter, I agree with everything you said, but none of it is likely to happen unless we reform campaign finance (and, maybe, lobbying). There’s not much that will happen in our plutocracy without this. No financial reform, no meaningful energy policy, no health care reform, nothing. It is really as simple as requiring that the media show under any officials head during any delivery of any information, a line showing the amount of financial assistance (campaign contributions, etc.) that he or she has received during his campaigns and term in office. This should be done by all media, including magazines and newspapers. You see, we want to blame one party or the other, depending upon our own personal ideology, for the current tragic circumstance, but really virtually every member of Congress has been coopted by our present political schema. And, perhaps we should also show prior affiliations of anyone speaking (like Summers,etal). This needs to be done in print and on air all of the time, like it’s a tattoo.

    If we don’t reform campaign funding, nothing will every happen. Not only that, but we won’t get the best and brightest as our representatives.

    The oligarchy will live until long after I am gone without it.

  34. um. we have deflation. the fed is just still unwilling to come to grips with that fact. it doesn’t fit in with the plans of the fed’s bosses. so all of the monetary stimulus is trying to counteract the massive deflationary forces in the global economy, and monetary policy is not working (for anyone but finance-types). it is just postponing and increasing the eventual reckoning.

    the kind of destruction of credit (which is effectively money) that has taken place over the last year can be nothing but deflationary.

  35. Are we witnessing in our economy what was avoided in the political system by drumming the loyalists out of the Justice Dept? What if that had happened at Treasury?
    How hard is regulatory capture when the regulator-candidates are loyalists sent over by the company?

  36. Simon, I believe folk are puzzling over how our communities, global and national, can operate capitalism so that ethical behavior accords respect and fairness to all participants. Regretfully regulation will not achieve this. What are we to do?

    I came across a Bloomberg article:
    http://www.bloomberg.com/apps/news?pid=20601039&sid=a.Zdl6qgOdV4

    and in the article a link to Caux Round Table. You may already be familiar with this initiative?
    http://www.cauxroundtable.org/index.cfm?&menuid=28&parentid=2
    Promoting ‘moral capitalism’ is athought expressed.
    Could this be a basis for financial practice and give a foundation which all people may accept?

    We need a fix for our current mess but the fix needs foundational principles which underpin both the fix and the new way of doing business.

    What do you think?

  37. We are now facing a very dangerous possibility that current growth is not for real and that we will slip back into a crisis with much less no public spending ammo available, and some basic worldwide bottleneck problems, energy and environment getting much worse. The fact that this year China will be buying more new cars than the US should make us to reflect more on whether the US or anyone else for that matter can really afford to reignite growth in exactly the same unsustainable direction.

    Besides this hearing I also closely followed (live) the hearings of the Financial Services Committee with respect to Systemic Regulations. There I tried as much as I could to push my concerns with respect to how the small not-rated or BB+ or below rated entrepreneurs, and on which we all really depend for a sustainable job recovery, are being crowded out from bank lending while the banks are rebuilding their equity to make up for the ridicule low capital requirements authorized by the regulators for the AAAs.

    Many do recognize that the lack of credit for small entrepreneur but they don’t suggest anything, which could be suggesting they do not know sufficiently about the effect of the regulations in this crisis (or do not want to acknowledge it because that weakens their private political agenda)

    Luckily I can convey that after the first shock of hearing someone daring to speak up for lower capital requirements, most of the people I spoke to and which included congressmen, got it and supported it, and some even went to the point to say a “that’s what I have been saying all the time”.

    I will keep you posted here on Baseline (which I am piggy backing on) about my efforts to increase the bank’s attention to who should be their real customers since, as I say repeat, over and over again, “Banks should not even be in AAA business… that is for the capital markets and for our widows and orphans.”

    And so: “Temporary 4 percent in capital requirements for the BB+ and below or unrated is a bridge for the future we must explore.” As I have mentioned my current set of proposals, which await your helpful recommendations are to be found in http://bit.ly/1Xby8A

  38. Simon, I dare to mention that the emperor is wearing no clothes! We see globalization absolutely destroying the future for many of our children. The driving force behind this globalization is profits alone. A collateral advantage is employment for millions of folk even as our life is dismantled and shipped overseas. How can we achieve some fair deal for both groups? Now we talk of education, retraining, new initiatives but for the average guy in the street, wanting to give his kids a life, who has maybe lost his job as a Detroit auto plant is shuttered, – do we really believe this is a ‘solution’? Meanwhile the new off-shored jobs are exploited. Buy Nike shoes and check the Indonesian manufacturing profit while workers get a pittance. You think this is about to change? Chinese manufacturing employment of rural folk hoping for a regular pay check would close all European and North American manufacturing and still leave millions of unemployed. You think millions of our kids will all get their advanced degrees and then a job on Wall St? Sure we need world disadvantaged folk need a fix for their problem but the current process will never reach a state of equilibrium because the profit-takers see the differentials as an essential part of their profit deals.

    This global problem is too big for me but I believe the solution does not lie in runaway off-shoring. I have a suggestion and it is not to fiddle with currency exchange. Why not adopt a principle that import duties will be levelling mechanism? Zero if the off-shore workers have the same social environment as local workers? Duties to be adjusted as social level convergence is achieved. Exceptions to be managed fairly. I know this is an imperfect solution but it is a lot less imperfect than the current destruction of peoples’ lives. We are losing sight of the reason Americans believe our republic was born.

    We just cannot sentence people lacking capital and unable to fly through a degree course, a life of blighted hopes, or can we?

  39. Quit watching that looped tape of Ron Paul and get out of the basement. The nearby convenience store has people and you can drink a beer (same cost as a year ago).

  40. Happy Halloween!!! Happy Halloween to James, Simon, and the rest of the late night blood-drinkers. Careful who you take candy from and if the local hospitals X-ray candy for free, better check it. Francis Ford Coppola directs here.

  41. rakesh md,frcsc

    So much of the optimism in the rest of the world is related to the recent inflation of the asset bubble. If the US stock market undergoes a substantial correction then say goodbye to the growth in the rest of the world.

  42. Sam,
    “Baseline” is one of the better Econ blogs. “Rortybomb” is quite good hosted by Mike Konczal. There are other good links you can see on the right in the blogroll. I just avoid the British gunk (Economist magazine is the only good stuff the Brits ever turn out, and I mean strictly the magazine and not the other zillion “cash cow” iterations). And I hate basically anything associated with the Wall Street Journal (WSJ) but I’m sure many others would say I’m misleading you. You can get everything you get on WSJ at Bloomberg’s website only the journalism at Bloomberg is 5 times better. And you don’t need to subscribe to Bloomberg to read all the links.

    As far as concrete steps the administration is taking. I don’t know, most the people on this site are left leaning, but we’re pretty hard on President Obama and Lawrence Summers. The stimulus package really saved us from dire straits. The big key to watch (and most visitors on Baseline are obsessed with it for very justified reasons) is how the Banks are regulated after this. Especially capital requirements and the way in which derivatives are traded (assuming they should even be allowed). Many other factors too numerous to list. You’ll get it.

  43. Sam and others,
    I’ve tried to get James Kwak to take any and all WSJ links off the site because of their position AGAINST the Consumer Financial Protection Agency (CFPA). If anyone else agrees with me please let James Kwak and Simon Johnson know with e-mails or post.

  44. “We are well into the adjustment process needed to bring us back to living within our means. Although such a process always involves an initial fall in real incomes, growth can resume quickly as the real exchange depreciates.”

    We’re on the way back to living within our means with the discount rate at the zero boundary, mortgage rates at 5%, max LTV on mortgages still above 95%, and federal subsidies for any long-term debt purchases?

    Not only do I disagree with that, but real incomes have been falling steadily since 1972. Female real incomes have been rising at a slightly greater pace that male incomes have been falling which accounts for the larger real household income. That is not a trend that can continue into the future. When equilibrium is reached between male and female incomes, there will be no room for further real household income growth. That is not a formula for a healthy economy.

  45. The carry trade was already moving from the Yen to the Dollar before the bank takeovers.

    Now that USD is back to 2007 levels, the trade is back on. Nothing unwinds faster than the carry trade, so any tightening of stimulus and easy money from the US will certainly result in some pains globally.

    The comment about US banks not lending to US businesses and consumers seems partly true. I still don’t see these signs of huge drops in consumer lending, but business credit markets are dead. The only credit still flowing freely is real estate lending. The money is being used to re-inflate old bubbles, not support the real economy.

  46. nota: looks like a Faux Round Table…

    http://www.cauxroundtable.org/index.cfm?&menuid=10&parentid=9

    Any time you see a person or organization affiliated with a “centers for business and ethics,” run. These are bible-thumping wolves in wolves’ clothing, rolling themselves up to the gates of the city in big wooden sheep. IMVHO.

  47. They sent out $250 checks to seniors and Republicans were bit-ching about that. Joe Biden was giving reasons/justification to the media like they’d just unleashed a plague.

  48. Mark Thoma reposts Gorby-blather about how our little crisis is showing us thats something was wrong with the Washington Consensus, and other things:

    http://economistsview.typepad.com/economistsview/2009/10/the-berlin-wall-had-to-fall-but-todays-world-is-no-fairer.html

    ************

    Item #6: Sounds good, but this big baggy balloon is going to be deflating for decades to come. A five year plan to get us off the various teats? Hardly.

    Item #7: Someone made mention (on an earlier post?) of an initiative in England to build up vocational education, and how it’s a shame that that venture went kaput, for the most part. Sounds good, in theory, but has anyone done any research/serious thinking about the subject matter that needs to be taught?

    Professors Simon and Peter, you are invited to wade into the commentariat, for the first time ever(?).

  49. hahaha, good one. what’s the price of your house? not as high as a year ago, but not as low as a year from now.

    we’ll see.

  50. And add to that the “grand jury” (read “secrecy” posture of our House and Senate ethics committees regarding inquiries into at least 30 members. Behaviors which in the our world would be called bribery and extortion are mere ethics violations where a quid pro quo (“pay to play”) is conveniently so much harder to prove.
    Pray for global warming which will turn the District of Columbia back into the malarial tidal swamp it was in the early days of our republic. No one will want to be there. (This joke was not intended to open a discussion of climate change, please.)

  51. “Simon, I believe folk are puzzling over how our communities, global and national, can operate capitalism so that ethical behavior accords respect and fairness to all participants. Regretfully regulation will not achieve this. What are we to do?”

    Notabanker: Moral capitalism will return when our culture returns to double-entry book-keeping as its system control language. Without book-keeping’s control language there will be no regulation, therefore look for the steady growth in unfair business practices that began 30 years ago.

  52. UBC,
    well now that is a very interesting post. Am I to understand that the Japanese ex head of, is it Sony is a ‘bible-thumper’? Well God bless him, that is surely better than an avaricious atheist intent on fleecing everyone for his shareholders and paying himself and his cronies multiple billions? I had quickly perused the pdf docs which had not seen such info. Also I had found no reference to Christian beliefs in the principles put forward. What would you have preferred these people to believe? Are you sure you are not dismissing an attempt to underpin a code of practice with a statement of principles?

    Please let us have references illustrating the bad faith and nefarious plans of this group.
    thx

  53. Dan,
    You say, ‘Moral capitalism will return when our culture returns to double-entry book-keeping as its system control language’ else no regulation!

    What aspects of double entry book keeping control language do you see as missing? Bubbles were a feature of previous years. Remember the Tulip bubble in Holland, the South Sea bubble in London? I am doubtful that bank’s love affairs with derivatives, securitization, dark pools and wall to wall fee-mining can be regulated effectively as a result of improving accounting practice, even though the accounting inmprovement you see as necessary is implemented. We are still left with the fundamental question ‘regulated to what end’? As the GS chief said his only duty is to his shareholders. The community in which he has his existence can go hang.

  54. Notabanker: “What aspects of double entry book keeping control language do you see as missing?”

    The most notorious missing element today is how a proper double-entry posts a gambling bet. The “double” is double entry is (1) the value of the artifact in trade that is posted as a unit-value, in debits, and (2) rights to ownership in exchange that is posted in credit-expressions as accounts.

    Each transaction posted tells what value was traded in exchange for whose rights in ownership.

    When the transaction is a bet, there is no value in trade at the time of time of the betting transaction. What is happening is typical of a gambling house that uses chips to tally gains [losses]. The value in trade is not known until the chips are cashed out in order to know who, the bettor or the house, is the debtor versus creditor. Whose who would depend on who won the bet.

    An insurance policy works the same way but on a grander scale.

    When gambling in the form of derivatives came into what we loosely call banking today, no such pooling seems to be taking place. That is a sure indication that a form of posting that is tracking debtor-value set equivalent to creditor-rights is not being used.

    Now I have not studied every book-keeping framework in use, but what I have done is attend enough software conferences and communicated on world wide list serves among software developers to say that in ten years of doing that I never encountered a software developer who understood the double-entry rules.

    I did meet a developer who wrote bond securitization software for Bear Stearns in the 1990s and he had not the first clue as to how double-entry book-keeping works.

    I met another developer who led a team that created a payroll system at Chrysler Corp. This team wrote the entire software system without using a double-entry framework at all. No one on the team knew a thing about double-entry book-keeping.

    Today, just about every refinement in double-entry as a control language is missing today. If look at the reports they look official, but whether they are near correct or not depends upon who is managing the data. If a corporation wants to cheat they seem to be able to do so today as they wish.

  55. “As the GS chief said his only duty is to his shareholders. The community in which he has his existence can go hang”

    Forty years ago both book-keepers and auditors were being held liable for false accounting, where the rules were double entry book-keeping. Why do we send so many young citizens to college if we are not getting better services than when most book-keeper’s had a High School degree.

    GS is clearly breaking the rules of double entry book-keeping. If the law today allows that, why are we talking about “regulation.” We should talking about putting this 650 year old control language in place first and then think about what added enforcement we need.

    Book-keeping is not an invention. It is a social science language designed to record the history of trading of goods and services. A culture cannot get along without it, any more than NASA can travel in space without mathematics.

    There is a great book by Denise Schmandt-Besserat titled “How Writing Came About.” She traces the archeological artifacts to show that accounting began 8,000 years ago. In time number were invented and soon after that, once the value was separated from rights to ownership, writing was invented.

    In those primitive years the books were kept in clay tokens stored in clay envelopes. Book-keeping has always been a serious matter, that is until the computer came into being. We need to fix this major hiccup in our cultural watch. And soon.

  56. nota: Apologies — “bible thumper” was a poor choice of words. I wasn’t thinking about the religious aspect, but rather thumping the bible in a metaphorical way — pretending to be pious in the secular sense.

    The fellow who runs the round table… did you have a look at his cv?

  57. While a “well done” from me might not mean much, it is a general concurrence with your ideas. I have issue one the education based on supply and demand, but that is not what I am writing about.

    I believe and this is where the cultural change, my work comes in that while you might disagree, Sweden and Finland, and then Japan need to be looked at not so much how they handled their past economic downturns, but what happened in the countries when the downturns saw improvements. I first presented this idea to a representative of Senator Kohl, in late January 09 and via email to two other East Coast economists the same week.

    If we look at the UN population charts and Sweden and Finland’s growth rates we will see Sweden not only effectively fixed the banks, but the start of a population bubble. Finland and Sweden have similar economic conditions and share labour between the two countries. Sweden pulled out faster with the start of the births of this period. As anyone who has raised a family knows, children increase family demand for goods and services. Using USDA figures from 2005, it costs 500,000 to raise a child from birth to 17. (I have some issues on how they come to this number, but for a basic formula start, it works and yes I know US numbers are not Swedish numbers, but it will give others, if they wish, a place to look at what I am getting to.)

    In 1977 – 1986 Sweden’s population was basically stagnant and rose from 1986 – 1995 by about 525,000. It has been basically stagnant again since 1996. Its population in 2007 was estimated at 9,148,092. The fertility rate went from 1.68 in 1980, 2.14 in 1990, 1.55 in 2000 and is inching up to 1.91 2008.

    Finland’s fertility rate on the other hand has been dropping since about the mid 1960’s and sits at 1.9 in 2008 and has had a steady but aging population.

    Japan’s population has been declining and was projected to have a .1% drop in their own demand without exports as of 2008.

    What I am saying is that while the banks may be the thing to readily point to for this economic downturn, they should if there is an increasing population have an increase in overall profits caused by population increase therefore making risk less volatile almost like a pyramid scheme.

    Countries grow when they have children to spend on as you are not just paying for yourself, but you and another. Even if both parents work they are still paying for themselves and another. Thus there is an increase of purchases much like a stagnant country selling extra goods to a growing country to increase production for that country. I believe, it is the lack of understanding of population aging that caught the banks where they were and honestly the government or they would not have lowered certain rates and pushed for more housing purchases at lower wage levels, and before anyone thinks I am for the financial sector and what they did as favourable I am not. Currently, the US sits at about 2.0 fertility, not including immigration, we are reaching the top or our population and are leveling, which diminishes our need for housing (which was over built based on poor understanding of a aging population).

    Without immigration and if population is leveling, we will have a better understand after this census, I am guessing we will sit at about 4 -8% below the 2007 –8 high levels once we come out of this caused by the over building of housing and other buildings, plus a general decline in certain goods as an aging population only wants so much stuff. In December, I had called it a brownout, which cannot be fixed with government stimulus. It needs to be worked though with possible incentives to older people who would like to retire with things like flexible property taxes based on retirement income and lost wages from retiring. Banks must be regulated as we go through this period of aging populations or every time some new situation comes about we will be bailing them out. Just so everyone knows I feel China and India will have their days in about 20 years just looking at the UN population charts. We will see, but until then I suggest that everyone read the following: What Exactly Is Going On in Finland by Edward Hugh. 29 Oct 09 http://fistfulofeuros.net/afoe/economics-and-demography/what-exactly-is-going-on-in-finland/

    And if you have your handy copy of “Pocket World in Figures” 2009 Edition from the Economist look at the populations and the percentage of population under 15 vs. the percentage of population over 60. Those with a population that is higher in the over 60 crowd are the countries that are having a hard time with this recession. The US is getting close to joining this group as the baby boomers are just starting to hit this age.

  58. Thanks Dan,
    I don’t recall ever seeing this problem. Are you perhaps seeing the problem in a select industrial/commercial sector? Are you saying this is so widespread that it has caused the current financial system problem?

    How do auditors complete a true audit if the book keeping process is not double entry? Probably most firms use accounting package software (SAP etc?) and surely these packages are accurate?

    Do you have specific practice in mind re this problem? I have assumed that a bank has a general ledger which would not balance without double entry? General ledger accounts have sub-ledgers such as depositor accounts which balance to the general ledger account. Any asset or liability, expense or income not processed via double entry would surely stick out like a sore thumb as the ledgers would not balance. Am I misunderstanding what you are saying?

  59. Hillbilly Daryl

    Simon:

    Great article. However, I believe your points and analysis are premised on assumptions that can no longer be taken for granted. And, furthermore, that many of these assumption are now in fact faulty. In essence, you assume that the situation “on the ground” in the U.S. now, is the same as it was at the end of 2006-i.e. that it has remained constant.

    In my view a number of very important and troubling seismic shifts have occured and/or accelerated in the U.S. that have gone relatively un-noticed, or ignored that will have a profound impact on the effectiveness of your proposals, or anyone else’s for that matter. I’d welcome articles addressing the impact of these:

    1) U.S. BRAIN DRAIN
    For decades the U.S. has been the country that has attracted the world’s best and brightest for education, many of these people stayed in the U.S. after graduation and built careers at U.S. companies and institutions, native and immigrant U.S. citizens never even considered looking elsewhere for opportunity, and U.S. professionals didn’t seek and find career opportunities in other countries. This is not the case today.
    a) Increasing number of world’s best and brightest are returning to their home country, or other countries for opportunities after graduation from U.S. schools.
    b) U.S. Immigrants at all levels are returning to their home countries, or other countries.
    c) Young U.S. professionals are expatriating in increasingly large numbers to China, India, and other foreign countries for opportunity.
    The impact of these three variations on the same theme are highly important to the success of your proposals.

    2)ENTREPRENEURSHIP
    a) Small business owners and the larger middle class in the U.S. have been literally bankrupted.
    b) 1/3 of all U.S. home mortgages are underwater-no equity. Other 2/3 of U.S. homes have lost massive percentages of equity.
    c) Savings, investments, retirement, 401K, 529 funds have been desimated.
    d) Small busines credit REQUESTS are down 30%.
    e) Small business failures and commercial real estate vacancies are soaring.
    f) There is palpable outrage in the small business and entrepreneurial communities that they have been burned, neglected, ignored, overlooked, and forgotten while connected too big to fail institutions and executives have been bailed out-at their expense.
    Thus, a large portion of the U.S. small business and entrepreneurial base built up over several decades is gone. These businesses are forever shuttered. Middle class assets typically used to finance new or existing businesses are utterly depleted-as shown by the 30% reduction in REQUESTS for credit. And, even if this weren’t the case, the appetite to endeavor into entrepreneurship or small business ownership has been greatly reduced-we’ve been burnt-remember what happened last time…

    In sum, I don’t believe that the U.S. continues to attract or retains the best and brightest, or that there exists a pent up 2006 level of entrepreneurship, or the corresponding small business infrastructure. Both of these factors are assumptions that underlie all proposals to solve the problems. We are no longer in 2006. And, applying macroeconomic proposals to solve the U.S. problems without addressing these seismic shifts will fail.

    My wife and I just reverse migrated back to her native Canada with our two children-she’d lived in the U.S. for over 40 years. Our Dutch doctor returned to the Netherlands with his family. Close friends of ours just expatriated to Toronto. Four law school classmates have shuttered their practices, or resigned from their firms and are now in St. Petersburg Russia, Buenos Aires Argentina, Bangalore India, and Shanghai China. All of my international LLM classmates have returned to their native countries, none remain in the U.S. Etc.

    The largest small business in the small town we just left was a 3rd generation business that had grown to 200 employees over decades. In 2006 it expanded and built a new building which was finished in 2008. As of October 1, 2009 it had 30 employees. As of today, October 31, 2009 it is gone. A friend’s small business failed after a too big to fail reneged on its contractually obligated funding commitments, and he exhausted his home equity, 401K, 529, savings, and all other assets in an attempt to keep it going, while waiting for the bank to honor its contract, or the government to remember small businesses.

    You can’t just flip the switch, and restore macro principles, and assume everything is or will be just ducky. Too little attention has been paid to what has been lost by the middle class, and small business. And, not enough attention has been paid to what the U.S. has lost, and inadequate appreciation given to how long it will take to replace it-if it can ever be replaced. There are not legions of fungible entrepreneurs looking to start businesses, and those that do exist won’t be able to found 60 year old businesses that employ 200 people…..

  60. UBC No I haven’t and I note that one of the mentioned name is a Goldman Sachs name. What I am seeking to suggest is an evaluation and maybe construction of a better alternative, not an instant marriage. Simon and James et al are all for fixing bad practice but regulation needs a standard base we all agree. Consider our Constitution as a set of principles on which many regulations stand. Likewise medical practice, jurisprudence, even road rules. Now first we need to state what we need to protect? Then consider how we protect? Regulation, maybe maybe not?
    Unless we have our constitutional bedrock, villains such as Madoff and self-serving banksters and others will CUNNINGLY seek to plunder folk and this is not what our country is supposed to be about! You can create a logical model for this by creating a hierarchical issue diagram and ask who benefits ensuring this question is based on an agreed principle. I’m sure you would be happy if I were not to deliberately cause your death in order to profit. If I were a medical professional? A pharmeceutical provider? An airline operator? Sure it is matter of degree but the principle of not causing deliberately harm or recklessly and deliberately concealing or misrepresenting risk?

    Ignoring the need for a ‘constitutional’ set of principles means our controls and regulations have no firm foundation. Conversely a sound foundation will enhance and simplify construction and operation of rules/regulations?

    Otherwise you are a sucker and not to be given an even break. A rube to be robbed. A revenue source to exploited. A 5 year old child to receive a credit card offer? A new wage-earner receiving a ‘great’ loan deal for a car? Yes, get them hooked and they are your captive revenue generators for life? Sound like drug pushers? You got it pal and its the most vulnerable who get screwed?

    Remember previous wisdom says the heart of man is desperately wicked who can know the depth? There have been plenty of examples and undoubtedly now is a bad scene? Madoff was trusted. People think they can trust bank apparatchiks to benefit them as customers. How about your medicos’ desire to be rich? Your airlines’ desire to get more profit? This concern is truly basic in the real world. Academic chatterers may parade a contrarian spiel but the key issue in your face remains.

    What next?

  61. notabanker
    if I were you I wouldn’t put too much trust in the statement of principles of anybody, Church or atheist alike
    – a couple of days ago I have listened to an interview of Prof. Rudolf Lill a historian who is a pious and devout Catholic through and through (I have let myself being instructed by him for years now) and who is exasperated by what his Church is up to right now
    – I have never ever heard him other than measured and reasonable while now he is accusing the church of trying to achieve absolutist dominance by eliminating the 2nd Vatican council. Unfortunately the interview can only be heard and there is no transcript available. Just in case you know somebody who understands German. btw Cologne is still a battle ground of ideas for Catholics and Protestants. http://www.dradio.de/aod/html/?mod=aod&station=&search=lill&date1_use=1&day1=15&month1=10&year1=2009&date2_use=1&day2=15&month2=10&year2=2009&search_station=1&broadcast=233826&theme=&ACTION_SEARCH=Suchen
    There is a Vatican Bank also which has had a scandal or two going in the past…

    by which I want to say any outfit capable of wielding power over “us” is to be regarded with all the alerts on.

    And as to avarice and being intent on fleecing everyone at least the Catholic Church has a very “good” record on that one (remember one especially “successful” period fuelled the Reformation!), but I don’t think the other churches will be found very much behind. And if they haven’t been as successful then that may be owed to the fact that they never were as dominant as catholics were at the time of the Wiedertäufer with their catchy slogan “Wenn das Geld im Beutel klingt, die Seele in den Himmel springt.” = if the money sounds in the bag, the soul will jump into heaven.

    and just to be clear – the atheists given half a chance to organize as well as the churches do will most likely not achieve a better record

  62. Hillbilly Daryl “There is palpable outrage in the small business and entrepreneurial communities that they have been burned, neglected, ignored, overlooked, and forgotten while connected too big to fail institutions and executives have been bailed out-at their expense.”

    And of course they should be outraged… primarily with the regulators who instead of helping the small business and entrepreneurial communities and who should by far the be those clients receiving the highest priorities from the banks, have set the bank capital requirement for lending to them at 8 percent while helping the already big and prosperous AAAs, assigning them bank capital requirements based on risk of only 1.6 percent.

    The market, through its interest rates spreads, already charge for risk…Who authorized the regulators to unconstitutionally discriminate additionally against perceived risks?

  63. Let us be clear. The US, like many other countries, find themselves now at the crossroad of having to more forcefully decide on whether they want to govern for the current baby-boomers or for the future generations. For the time being it seems few our speaking up for those who will follow us. http://bit.ly/10tjbH

  64. NotaBanker: “Are you saying this is so widespread that it has caused the current financial system problem?”
    I definitely am saying that.

    NotaBanker: “How do auditors complete a true audit if the book keeping process is not double entry?”
    A double-entry can take place with the numbers in each entry being the correct number signs, while the value and rights that the number signs represent are not correct. In simple words: such a book-keeping framework has misplaced rules so that the numbers used are not defining, nor are they assigning, proper a accounting.

    NotaBanker “Probably most firms use accounting package software (SAP etc?) and surely these packages are accurate?”
    The numbers are accurate, but the rules for recording a full and proper history are not being properly enforced by the software code.

    NotaBanker: “Do you have specific practice in mind re this problem?”
    The use of the journal|ledger pattern. The journal is a recording of facts, the ledger reports the state of those facts at a point in time. In thirty years of study, I have yet to see a book-keeping framework that performs the journal|ledger pattern anywhere near what is required to record a reusable history.
    The importance of a reusable history is its ability to ferret out fraud by taking samples of events in that history. That audit trail is not there today because the journal|ledger method is not understood by the software development community.

    NotaBanker “I have assumed that a bank has a general ledger which would not balance without double entry?”
    Correct. The problem in not whether two numbers were entered. Take the mortgage bond scheme as an example. Local banks were buying mortgages with dollars that were in turn quickly sold into AAA bonds that in fact were worth about $0.35 on a dollar.
    The book balanced at that moment, but soon enough the true value of the mortgage became what the mortgagee could afford to pay. The bonds, by then, were in a broker’s ledger, or even sold off from there to pension funds, etc.
    What is worse, the mortgage bond was comingled with other mortgage contracts, all within a single instrument, with no audit trail. A proper journal|ledger application does not allow the comingling of such contracts.
    To know the real value on the bank’s books one has to go back into someone else’s ledger. This is never allowed, so it is an illicit practice.
    Meanwhile to know the real value of the bonds one must calculate the probabilities from real facts that decided the merits of its ‘AAA’ rating. This is necessary since the bond is now a part of the monetary system. The true dollar value cannot be calculated because the mortgages, as collateral for the bonds, are scattered with no known audit trail even possible.
    Todays accounting strategies have scheme after scheme of this type going on today. And all are related to the lack of understanding of the journal|ledger relationship.

    NotaBanker: “General ledger accounts have sub-ledgers such as depositor accounts which balance to the general ledger account.”
    True, and all of what I have said above makes these subsidiary ledgers the product of a single entry system, signaling a bank customer’s right to the ownership of illusory, or even illicit, claims of value. The value was lost in the bond scheme, and who pays that fiddler becomes a game of musical chairs.
    Wall Street, having pulled off the scheme is far better positioned to know when the music has stopped, and so they are getting richer, and richer. (Except for Charles Prince who seamed to be a little hard of hearing of the musical score.)

    NotaBanker: “Any asset or liability, expense or income not processed via double entry would surely stick out like a sore thumb as the ledgers would not balance.”
    Yes, the numbers are in balance. It is the value that is out of balance. A proper book-keeping is designed to protect its Entity from both quantitative and qualitative imbalances. It is the qualitative imbalances handled by a proper book-keeping that the software developer must go back into the code a repair.

    NotaBanker: “Am I misunderstanding what you are saying?”
    It is not a misunderstanding so much as it is an incomplete picture. Persons tend to see book-keeping as bean-counting.
    The promise of a monetary system is that the value earned with be preserved by that system for many, many years. We have gone through a 30 years spell, and Simon has documented this well in the past, where value is being stolen from those of us who build houses that establish a time tested artifacts of value, while Wall Street and Washington are robbing the nation of the benefits of that value. If they knew what they were doing to us they would change their policies. Knowledge programmed into bogus software has dumbed down our culture in the past 30 years. This is unfortunate, and must be repaired.
    Double-entry book-keeping software can do the job. I know this because I created a prototype of the solution to the simultaneous balancing both quantity and quality.

  65. The tea-baggers and other anti-government rabble rousers are focusing on taxes, anti-abortion, anti-gay issues, and totally ignoring the REAL threat to the their own well-being as well as the American way of life.

    Wall St. has stolen more real wealth from Main Street in recent years than was ever taken by the tax man, and given absolutely NOTHING in return. The Wall Street gamblers have not only bet their money, but ours, on convoluted schemes they devised themselves, and now blame us for. They have stolen our pensions, our savings, and in a round about way, our means of livelihood, by assuring that millions of jobs got off-shored for cheap. They have obliterated the rubric that human capital is a plus, and turned it into a minus – a cost to be removed from, or minimized, on a business’s balance sheet. If they had set out to destroy the fabric of this country on purpose, they could hardly have done a better job.

    Just like any good snake oil salesman, they led us to believe that we, too, could be better off – maybe even rich! Just like the diet guru who tells us we can eat ice cream three meals a day and lose 50 lbs., we desperately wanted to believe. We watched CNBC, with the constant drumbeat of affluence via investing. We bought the hype and the promise and the dream. To that extent, we are partially to blame. But we didn’t go looking for them, they came into our living rooms with their dog and pony show.

    Starting with legislation enacted to eviscerate traditional defined benefit pension plans in favor of “self directed” IRAs, encouraging everyone to “become their own money manager”, they pushed laws that threw all the burden and little of the reward onto the middle class. They got NAFTA passed. All the while they have done all they could to promote the health of certain players on Wall Street and they’ve done it on the backs of the American worker.

    Just like in the Wizard of Oz, Wall Street and their pimps in Washington tell us to “Pay no attention to the man behind the curtain!”. The media is complicit in mis-directing our attention, with cries of “Big Government bankrupting our children”. If Main Street America ever wakes up to just how thoroughly we’ve been had by Big Business, the tea-bagger anger will seem like a little tiff.

  66. Simon,

    love the new baseline – thanks for updating. Quick question though: If China, Brazil and other emerging countries are experiencing high levels of GDP growth (and in some cases forecasted to return back to pre-crisis levels as you point out) – what is fuelling this growth? i.e. as a proud alumnus of some your classes, we were made clearly aware that decoupling of global economies was a fallacy. A savings glut in Asia was offset by huge deficits in the US and EU. If US and EU growth is sluggish and we are not going to see a demand led recovery – what then is fuelling China’s pre-crisis GDP growth?

    Would appreciate a little help on this.

    cheers.

  67. As David Rosenberg formerly of Wall Street recently said:”the stock market is divorced from reality.” And it is also true that governments that enriched Wall St by raiding the public treasury (where else can Goldman Sachs
    be on the edge of obliteration and less than 5 months later have billions in bonus money!!?and demand that they are worthy for such treatment). The problem for government is that they can tax and print money and no one to bail them, aka taxpayer, out. What a bloody mess Wall Street has done to USA and world.

  68. This is accurate. However, the Supremes have ruled that much restricting of money is the equivalent of restricting free speech.

    An effective counteraction from Congress would be to take back the airways. Mandate that candidates of a certain threshold would be given, gratis, air time. This would be a good start but not solve all ills.

  69. Can I get a double-Amen.

    In one generation they have changed America from ‘every one gets a chance’ to ‘you take what we give you’. Just waiting for the moment when they demand we get on our knees..

  70. Stimulus spending by the Chinese government, Keynesian style. They have tons of currency reserves they’ve been hoarding for years. D- for you.

  71. Actually, Socialism and it’s corrupt cousin Crony Capitalism got us into this mess.

    And oh, if memory serves didn’t the Democrats block any investigation of the Fannie/ Freddie mess for the eight years of W.

    Now, W should take the blame for:

    • Not pushing much harder against the Democrats for the reform of Fannie and Freddie.

    • Allowing the reserve requirement rules to be dumped for investment banks.

    • Not riding herd on the SEC.

    • Appointing people like Bernacke, Paulsen, O’Neill and Snow. All his Treasury Secretaries were RINO or Democrat Wall Street insiders who looked after Wall Street first, foremost and always, and Main Street almost never. But these were the “right” establishment choices approved and pushed by the media.

    • Allowing the mortgage backed securities mess to get out of hand. When the French banks started to fail in July ’07, and the subprime mess came to light, alarm bells should have been ringing loud and clear for Bush, Bernacke and Paulsen. Bush just delegated the crisis to his insider experts Bernacke and Paulsen and they exploited the looming crisis to prop up their friends and the banks to the detriment of the country.

    • Allowing the TARP mess and bailout to be rushed through without proper debate and a thorough review.

    W listened to his Dad and his Dad’s Wall Street cronies way too much, and it got us into bigtime trouble.

  72. Dan,
    I am definitely one of those who have always seen book-keeping/accounting as a bean-counting service. The idea of anything other than a basic arithmetic record is new to me, given that the journal/ledger records contain references to actual transaction documents. I think such understanding works while debtors remain on the original lending books as individual ledger accounts?

    I note your closing comment: ‘Double-entry book-keeping software can do the job. I know this because I created a prototype of the solution to the simultaneous balancing both quantity and quality’

    I think I am beginning to get the idea. Now re your comment concerning a mortgage bond which clearly is a devil of a problem. What does your system do by correctly using the journal/ledger to ensure mortgage value repayment revenue and market value decay or appreciation is known and accounted and follow any on-selling of the mortgage (individually or bundled)?

    It seems that any on-selling of a loan renders risk management virtually impossible for the new benficial owner, always assuming that there is a first lender earning servicing fees? Does such service include periodic asset valuations? What a dog’s breakfast! I would be very interested to become aware of your solution for this problem.
    thx again.

  73. By your definition, there is no crisis at all – just an adjustment of real incomes. This is quite a matter of speech: a correction, return to the pre-bubble level, or recession. In practice, people got used to the new income level during the boom years, the elasticity is low, and to all practical purposes the recession continues.

  74. Dan,
    NoteaBanker “I note your closing comment: ‘Double-entry book-keeping software can do the job. I know this because I created a prototype of the solution to the simultaneous balancing both quantity and quality'”

    *Quantity* above is a numeric issue while *quality* is a formal language of grammatical expressions.

    Numbers used to measure value as work is the bean counting. Numbers used to identify the quality of economic decisions, such as what and when to buy, and what and when to sell, and etc, are issues that the book-keeper *identifies* into a carefully composed economic history of *the beans traded in the marketplace.*

    It is the design and implementation of this history that insures its reusability. That reusability is the only way to track qualitative changes in value. And that reusability depends upon historical numbers that are in essence words that state facts. And so both the numbers and the words in the liability side of a ledger are categorically different from the numbers and words on the asset side of the ledger.

    To get a visual picture of a proper book-keeping ledger, one that follows the pattern used in industry 50 years ago, and that is even more precise in a properly coded computer program, draw a square on a blank piece of paper. Draw two lines that break the square into four squares. Over the left hemisphere of two squares write the word “Assets.” Over the right hemisphere write the word “Liability.” To the right of the southern hemisphere pair write the word “Cash.” To the right of the northern hemisphere write the word “Capital.”

    In a proper book-keeping the numbers and words, as bean counts versus history, are assets set equivalent to liability. In the orthogonal hemispheres, it is cash set equivalent to capital. “Cash” is defined as the “value” in trade (the bean count) “Capital” is defined as the potential in future trades.

    A proper book-keeping posts transactions as pairs where each of the paired transactions has a debtor|creditor balancing entry. Each pair of transactions must leave both the Asset|liability hemispheres and the Cash|capital hemispheres in the state of equivalent balances.

    In order to maintain this balanced state, contracts cannot be comingled. A Betting transaction, for example, must be treated as an entity within an entity: a joint venture. There is no sign of the joint venture being used in the bond scheme.

    NoteaBanker: “I think I am beginning to get the idea. Now re your comment concerning a mortgage bond which clearly is a devil of a problem. What does your system do by correctly using the journal/ledger to ensure mortgage value repayment revenue and market value decay or appreciation is known and accounted and follow any on-selling of the mortgage (individually or bundled)? ”

    Clearly, when a mortgage broker buys a mortgage from the mortgagee, then sells the mortgage to a brokerage-house to be ground into sausages as bonds the history of the contract between the mortgagee and the mortgage-broker is catching hell. Among other sins that history is seriously affecting both the value of the mortgage and the rights of the mortgagee in terms of the mortgagee proving the fraud that was taking place. It is for such reasons that a proper double entry must take into account the history of contracts that it is recording. Clearly, opportunists have used computer software’s abstract controls to abuse the traditional systems.

    NotaBanker: “It seems that any on-selling of a loan renders risk management virtually impossible for the new beneficial owner, always assuming that there is a first lender earning servicing fees? Does such service include periodic asset valuations? What a dog’s breakfast! I would be very interested to become aware of your solution for this problem.”

    It would be nice to have a lawyer’s comment on this if there is one in the discussion. But clearly the Entity that is servicing the loan would seem to have the greatest liability of injustices caused by this dog fight. It seems to me that the selling of the mortgage itself is improper, once it is comingled with other mortgages. The brokerage buying is in fact buying only the interest proceeds that may or may not be generated by the mortgage that the original broker is servicing.

    The situation clearly, I hope, shows the need for a proper double-entry book-keeping.

  75. Home,

    Real Estate Lending is only flowing freely through the FHA, ( yes reflating the our just burst bubble on easy money to people who have little wherewithall to repay), but the rest of the real estate lending market is in the toilet.

    Denninger and others say there is little demand for credit. I don’t think it is all that black and white. Many businesses needing credit can’t get it, so they are forced to retrench. The lack of available credit after a while becomes a self fulfilling prophecy of little demand for credit because business conditions have been so destroyed already by that same lack of credit. I am personally aware of many, many realistic deals that have gone kaput because of ridiculous bank lending requirements.

  76. Of course many businesses needing credit can’t get it… because the banks, even though they got the funds to lend, don’t have the capital to support that lending, especially when it is lending to unrated entrepreneurs which requires 8 percent in capital.

  77. Over much of our country, our environmental and planning regulatory bureaucracies at Federal/State/Local levels do not permit the construction and operation of any manufacturing and often office facilities that burden the environment whatsoever. And if they do, the processing time and expense is far too burdensome to compete. We have effectively forced much of our manufacturing output overseas, and for the flimsiest of environmental reasons. The vast majority of people don’t understand that sending these plants overseas only harms the environment because these plants overseas will still be built and will be built in a far less regulated and controlled environment.

    Secondly, our tax structure has been rigged to favor Wall Street and not the manufacturers. I am involved with a small wind energy manufacturing company. The tax investment incentives all favor Wall Street and C corporations, not the small individual investors. We have to go through multiple elaborate hoops to structure deals for the individual investor.

    I work with many engineers of foreign birth ( actually 80-90% of the engineers I deal with are foreign born.) They were all educated here. Many foreign engineers and scientists were educated here and returned home to work. Our educational system, besides being way too expensive, is only a problem to the extent that it pushes students into liberal majors like Psych, Poli Sci, Anthropology, History, Engilsh and then Law or MBA in grad school. For our plant, we are having a tough time hiring a novice straight our of school ME for less than $100k. I guess I should have been an engineer.

  78. Any Keynesian style spending in a country that has little in the way infrastructure in its rural areas will create an increase in GDP rather quickly.

    Example: If you do not have a reliable electric grid why bother purchasing electrical appliances that might “make your life easier”. If a reliable grid is brought to the rural area and put in by the local people who intern get reasonable wages for their work letting them then pay for their new electrical appliances GDP will increase quickly. Add exports and the country will get to normal very quickly. Overall increases in the standard of living can feed on itself for a few years. The personal computer and all that goes with it is an example.

    Why does it not work here? Not to sound flippant, but when you have it all what more do you need? We need a technology that will replace not only a major work force like the personal computer which reduced costs at work i.e. the secretary/typist and is needed not only in the work place, but in the home once it gets past the status symbol and into a real working home tool like in the last 10 years. We do not have that type of technology out there and if you say that going “Green” will do that … It won’t. There is no new technology/tool — only modifications of current tools already in use.

    Our stimulus needs to be in the form of small business development. Due to lack of corporate overhead here in the States, small businesses most likely will provide goods and services cheaper then other areas once transportation is added (Fuel will go back up based on increase demand in other countries, commodity investors, dollar, etc. before we see major increases in our GDP and/or any new technology additions. Any arguments against petrol going up I will be happy to hear as this is a fear of mine since early Dec. 08.).

    I would suggest to anyone reading this from Congress that you set up a small business loan program much like the FSA (USDA – Farm Services) where risk is assessed not by “to big to fail banks” or even smaller banks who do not have the money available right now, but by those who have a better understanding of community needs and business supply chain needs. Then set it up like FSA farm loans — since it is taxpayer money, if the small business fails, they are taken apart and everything is sold. Any money that is not recovered by the sale of property if it fails, is then the responsibility of the people who applied for the loan and must be paid keeping taxpayer risk low while providing jobs to the economy that may or may not need additional education.

  79. Simon, I think the crisis the US faces is over consumption fueled by ever increasing credit/debt. Households in the US have stopped borrowing, instead the last fiscal year the US has increased transfers and lowered tax payments by over 400 Billion dollars, in just the increased unemployment benefits, social security, and food stamps, and lower personal tax receipts. The US is borrowing to fuel the consumption based GDP.

    Since consumers have over borrowed then monetary policy will not increase consumption. The direct transfer payments to consumers are required to have an effect.

    The consumption Ponzi scheme has moved from consumer borrowing to US borrowing.

    I am not against the stimuli, but I am concerned that the US is in a death spiral. The number of full time employed in the US is now below year 2000 levels.

  80. So how much exactly is the Chinese stimulus Ted?