Way Too Big To Save

By Simon Johnson

Listening to US officials, talking to legal experts, and waiting for an intense Senate debate on financial reform to begin, you can easily form the impression that “too big to fail” adequately describes our most serious future systemic banking problems.  It does not.

In September 2008, the large banks and quasi-banks at the heart of our financial system faced failure – and they were saved in the most immediate sense through actions taken by the Federal Reserve, but TARP (passed by Congress and run Treasury) also played a significant supporting role. 

The Bush administration threw a small fiscal stimulus into the mix in early 2008, hoping to stave off recession; the Obama administration committed a much larger package at the start of 2009, aiming to prevent anything like a Second Great Depression.  This fiscal policy response was in direct reaction to problems caused by the overextension and near failure of the financial system

Do not make the mistake – for example of Secretary Geithner, talking to the New Yorker – of thinking (or implying) that “saving the financial system” did not involve spending a lot of taxpayer money to support the real economy.  Remember that if the economy crashes, asset prices fall, and banks’ problems become even more severe.

And try to avoid three further mistakes that are currently common.

  1. “Because the government will lose little on its TARP capital injections into banks, the financial rescue ends up not being costly.”  The true fiscal cost arising from our recent financial excesses is the increase in net government debt held by the private sector.  This will likely amount to around 40 percentage points of GDP (i.e., relative to what the Congressional Budget Office’s baseline would have been otherwise).  That’s a huge fiscal cost.
  2. “Deficits don’t matter.”  Eventually deficits matter – the fiscal costs incurred in saving our financial system mean higher taxes, relative to what would otherwise have been the case, for you and your children.  This is not a call for precipitate fiscal austerity; that would be a disaster.  But eventually we will get our fiscal house in order – and then don’t send to know for whom the tax bell tolls; it doesn’t doesn’t tinkle for Hank Paulson.
  3. “We can save our financial system in the future, if we have the right tools – in the form of an appropriately designed resolution authority.”
    • Such an authority is impossible to achieve, because it would require cooperation between governments (known as a cross-border resolution authority) and that is impossible.  (If you don’t know why, here’s the explanation.)
    • Even if you had an authority that worked, e.g., for purely domestic financial entities, it is a leap of faith to assume it would not be compromised by our political process (again, more background explanation here.)

Let’s take that leap of faith and say we use the favorite scheme of Gerald Corrigan from Goldman Sachs – he is widely promoting conservatorship as a transition to wind-down for large complex financial institutions – and let’s say that it “works”.  Presumably this would mean something like the situation with AIG since September 2008, run somewhat more effectively –perhaps without the obnoxious bonuses.  But would that really lower the fiscal costs of stabilizing the economy in the face of a major financial shock?  And could we afford those fiscal costs?

Maybe.  But the experience in Europe is definitely not encouraging.  The Irish state is in serious trouble because major banks failed and were “saved”; let’s not even talk about Iceland (where banks assets peaked around 11-13 bigger than GDP, i.e., the size of the entire economy).  And Switzerland faces serious risks – with banks that had peak assets over 8 times GDP – that the international community apparently just wants to ignore (perhaps because Switzerland is not in the G20 or the even the European Union).

In the UK, one bank (RBS) had assets that were more than GDP (1.25 times, by some estimates).  Ask yourself this: if Citigroup, which was around $2.5 trillion before the crisis (including the off-balance sheet commitments, let’s call that just under 20 percent of GDP) had actually been $5 trillion, would our problems now be larger or smaller?  What if Citigroup – or whoever becomes our biggest bank – reaches $10 trillion or $15 trillion in today’s dollars and then fails, how would you feel about that?

The administration proposes – in one part of the Volcker Rules – to cap the size of individual banks relative to total nominal liabilities of the financial system.  That makes no sense at all – go talk to the Irish, the British, the Swiss, or the Icelanders (when they become less furious and are willing to talk).

Big banks have a funding advantage – the implicit government guarantee makes it easier for them to raise capital and cheaper for them to borrow money.  They will become larger.  There are no economies of scale in banking above $100 billion in total assets, but this is not about economics.  It’s the politics of becoming large in order to become even bigger – building your empire, and paying yourself and your people a lot more money (in the good times) and making it more likely your fiefdom survives (in bad times).

The biggest banks in some European countries today are already too big to save.  Unless we take immediate and real action to reduce the power – and size – of our largest banks, we are heading in exactly the same direction.

Is the Senate finally ready to address this issue?

67 responses to “Way Too Big To Save

  1. Boiled down to its essence, the pro-bailout argument is:

    1) The financial system incurred huge debts – let’s argue about culpability later

    2) To save the economy, the government had to save the financial system directly – indeed, finance is the ONLY industry that is so important to the economy that it merits direct salvation

    3) The only way to save the financial system involved incurring huge debts, wherein the taxpayer absorbed bad bank debts.

    A tremendous amount of ink has been spilt arguing about whether we “should” or “should not” have had the government bail out the banks directly (e.g. whether we should have paid the price now, or paid it later).

    But amidst this all, I have been utterly struck by the default acceptance of point #2 – that the only way to save the economy was to directly save the financial system first. Indeed, even the opponents of bailouts have de facto accepted this argument (their response being, _don’t_ save the economy – depressions are good for the soul).

    My big bone of contention with all of the anti-bailout folks has been with their “alternate” plan, which was to shut up and “take our medicine” – Great Depression 2.0. This was the only way out, they argued. Stripped down to its core, the fundamental justification for this position relies on the sanctity of debt – that the value of debt (of which the US dollar is one manifestation) is of paramount importance no matter the consequences, and that any weakening of the sanctity of debt would mean the fall of civilization.

    The same argument was made with regard to the gold standard in 1930-1933.

    The great failure of the Obama Administration has been to accept point #2 as well – to accept a false choice between Depression 2.0 and Bailout Nation. Its failure has been the refusal to offer an alternate path that prevents Depression 2.0 without instigating a stream of unending Bailouts. And the consistency of its position can only confirm that it _believes_ what it is saying, and that it believes in the basic superiority of the current financial architecture.

  2. I plan on moving to iceland where the people have the courage and ability to stand u to the banks

  3. “Is the Senate finally ready to address this issue?”

    No. Not until at least half its members are gone, I think.

  4. It has never been spelled out by President Obama and his economic team as to what exactly would have been the unmitigated disaster had the taxpayers NOT bailed out the largest banks.

    Although, having read enough Baseline blogs and commentary threads, I think we know by now the Administration’s reasoning, and the subsequent circumstantial evidence that surfaced since then.

  5. “Is the Senate finally ready to address this issue?”

    Not Now!

    Maybe after the next election, or the one after that, or the one after ……

    Have you noticed how Dodd, who is no longer seeking re-election, has finally been acting in the public interest?

  6. “The true fiscal cost arising from our recent financial excesses is the increase in net government debt held by the private sector.”

    No. The true cost is the lost GDP that can never be recovered (the “Output Gap“).

  7. Great point. The scale of the regulated has far outstripped the scale of the regulators. It’s been a problem for a long time, and not just with banks.

    Either scale up the regulation (good luck) or scale down the regulated (good luck) or just realize that the series of panics that started in the 1990′s will continue to play out until the desperation of the folks getting battered leads to some inevitable restructuring.

  8. …of course.

    And is that Hank Paulson or Henry Paulson?

    I’m getting confused!

  9. roger erickson

    StatsGuy, Beth, engineer27, LosGatosCA … until you four run for Congress, there can’t be any change. There’s no one in there now who has their head screwed on straight, even if their heart is in the right place. We really do need just a tad more operational logic as well as domain expertise in Congress.

  10. StatsGuy’s point above that the U.S. federal government could have let the big banks fail, forced holders of bank debt to write down their losses (while honoring deposits insured by the FDIC), and then proceeded to spend a virtually unlimited amount of money on the “real,” (non-FIRE) sector of the economy to prevent a collapse in aggregate demand is so simple and obvious that I just can’t see why so many people don’t get it. I mean even Jon Stewart demonstrates he gets it when he asks members of the past two administrations who come on his show why they couldn’t have just bailed out home-owners directly.

    The neo-liquidationist out there who want everyone to “take their medicine,” have obviously never spent a day working with people who are truly poor. More than one in five children in the United States experience “food insecurity,” at some point every month:

    http://www.frac.org/html/hunger_in_the_us/hunger_index.html

    At the school where I teach one in three students receive free or subsidized lunch and breakfast. And State education budgets continue to be cut. These are the people who suffer when our country undergoes debt-deflation. How much medicine should they take?

  11. engineer27 is correct, what is important is not the debt/GDP ratio, but the output gap. I would further add that government debt (by which I presume Professor Johnson means treasury securities) held by the private sector is not a cost for the private sector, but an ASSET of the private sector. Since we are no longer living under the gold standard the public sector is free to create as many assets for the private sector as it wants without incurring any additional liabilities. The money to pay for deficit spending doesn’t come from taxes or anywhere else for that matter. You may not like this, but it is the operational reality of our monetary system. Increasing government debt increases the assets of the private sector. The only limit is real out-put capacity. Going beyond that will result in inflation. With a trillion dollar output gap, negative core-inflation rates, and long-term bond yields around their historical average, I don’t see inflation as a problem any time soon.

  12. Is the Senate ready to address this issue? LOL

    I wish this was just an economic/business issue and we could all calmly agree that banks have no economy of scale past $100b and so, the the good of all, we should have reasonable limits on bank size. Oh perfect world!

    But this issue is simply politics and so will be decided by who has the most political weight: the banks money or the people’s wrath (hint: it’s not looking good for the people).

    People (that means YOU) have to take the matter into their own hands. Help an organization (there are several now) that is working on a real political solution like fixcongressfirst.org

  13. “The great failure of the Obama Administration has been… to accept a false choice between Depression 2.0 and Bailout Nation.”

    This is a key point for me, and it is very well put. The defenders of the Obama administration always respond to criticism by saying: “What would have preferred? A great depression?” As though there were only two options, to do nothing or to do what was done.

    The real issue is not whether or not the govt should have intervened, but in way it should have intervened. The fact that the administration and Geithner — not to say members of Congress — don’t want even to have that discussion is a deeply depressing thing for me.

    Anyway, great post StatsGuy.

  14. It was baked in the cake. There hasn’t been a refusal to offer an alternate path that prevents Depression. We are in a Depression and it’s going to get very deep. The only choice would have been a path that could have prevented the parasites from enriching themselves as much.

  15. With a year to look back I think AIG should have been allowed to become bankrupt. The credit default swaps were financial innovation that falsely promoted the buying and selling of sub prime(junk bond equivalent) CDS. The anti bailout crowd only emerged after the risk of the great depression subsided. In politics, the experts only come forward when there is no possibility of their solution being adopted. The original bailout was proposed by two staunch free market cheerleaders, Hank Paulson and Big Ben. The Ron Paul crowd is just pissed off they haven’t made more money on their gold bars.

  16. The argument against the bailout is that we already have a resolution process for financial failure. It is called bankruptcy.

  17. This is a political argument. The level of public sector debt matters to those forced to service it and to those whose assets are destroyed by the inevitable inflation it produces. For those who have nothing, save nothing, plan for nothing, MMT probably strikes a responsive cord.

  18. NKlein wrote:

    “At the school where I teach one in three students receive free or subsidized lunch and breakfast. And State education budgets continue to be cut. These are the people who suffer when our country undergoes debt-deflation. How much medicine should they take?”

    I guess we’ll all find out soon enough.

    Mar. 9, 2010 – Clusterstock

    “Teacher’s Pension Forced To Invest In Chicago Parking Meters, As Shortage Of Good Assets Makes It Impossible To Get Yield”

    http://tinyurl.com/y9vwsux

  19. Jackrabbit wrote:

    “Is the Senate ready to address this issue? LOL”

    Not until they agree which end of their boiled egg should be cracked first.

    “Jonathan Swift tells us that the two islands – warring over which end of an egg should be broken first. Because each side is so closed-minded (and stuck in their point of view) they war.”

    Gulliver’s Travels

    http://www.123helpme.com/view.asp?id=11893

  20. Seems alot of politicians believe they are too big to fail as well.

    Some public hangings in Washington could set the tone for enough is enough.

    Until then all this scribbling of righteous indignation amounts to nothing more than the complaining of the powerless.

  21. Don’t forget to add “An electorate that rewards thoughtful action and expertise.”

  22. bungalowbill

    You’re really a schoolteacher? You seem to have to much knowledge and intelligence for that.

  23. Elect Warren Mosler from Connecticut to the senate.

  24. Robert Smith

    President Obama came into office facing a financial sector that had been using the country’s money as it’s private Casino stash. But like us, he didn’t understand how.

    Obama had to quickly rely on advice from financial experts that he assumed were Americans first and capitalists second. His campaign was centered around change for Americans.

    But, the financial sector is made up of capitalists… in American clothing. Its reason for being is to make money and it had lost badly at the Casino. It needed to cover its losses quickly and make us believe that the only solution was to bail it out and quickly.

    So Obama’s team did and believed the financial sector learned its lesson and now would lend us money. But they didn’t. They are, after all, addicts with fancy algorithms.

    They were saved. And now have our money to gamble again.

  25. I am consistently impressed by StatsGuy’s comments. Nklein, you too. A good read on the depressingly repetitive history of finance is “The Ascent of Money” by Niall Ferguson. We do not learn from the past. Ever.

  26. “Deficits don’t matter.” Eventually deficits matter – the fiscal costs incurred in saving our financial system mean higher taxes, relative to what would otherwise have been the case, for you and your children.”

    Is that necessarily so? Assuming that we do, in fact, pay for the increased spending with future taxes, does that mean higher taxes? It means more revenue, but that is not the same thing. Just as, when conditions are right, lower taxes can increase revenue by stimulating the economy (the Laffer Curve argument), can’t increased spending increase revenue by stimulating the economy? And, when conditions are right, the revenue to pay for that spending could even come from lower taxes?

    Besides, the Laffer Curve argument is usually something of a gamble, since we typically don’t know where we are on it. But now we know that the economy is in the doldrums, and that reducing unemployment will stimulate the economy.

  27. IXLNXS wrote”

    “Seems alot of politicians believe they are too big to fail as well.”

    That’s what happens when you dance with the devil. :-)

  28. oregano wrote:

    “I am consistently impressed by StatsGuy’s comments.”

    Stand on the shoulders of giants, you’ll see further.

  29. Min wrote March 9, 2010 at 5:10 pm:

    “Besides, the Laffer Curve argument is usually something of a gamble, since we typically don’t know where we are on it. But now we know that the economy is in the doldrums, and that reducing unemployment will stimulate the economy.”

    Laffer Curve – excerpts

    “It is used to illustrate the concept of Taxable Income Elasticity (that taxable income will change in response to changes in the rate of taxation). The curve is constructed by thought experiment.

    David Stockman, President Ronald Reagan’s budget director during his first administration and one of the early proponents of supply-side economics, was concerned that the administration did not pay enough attention to cutting government spending. He maintained that the Laffer curve was not to be taken literally — at least not in the economic environment of the 1980s United States. In The Triumph of Politics, he writes: “[T]he whole California gang had taken [the Laffer curve] literally (and primitively). The way they talked, they seemed to expect that once the supply-side tax cut was in effect, additional revenue would start to fall, manna-like, from the heavens.

    Since January, I had been explaining that there is no literal Laffer curve.” Stockman also said that “Laffer wasn’t wrong, he just didn’t go far enough” (in paying attention to government spending).”

    http://en.wikipedia.org/wiki/Laffer_curve

  30. (1) “Listening to US officials, talking to legal experts, and waiting for an intense Senate debate on financial reform to begin, you can easily form the impression that “too big to fail” adequately describes our most serious future systemic banking problems. It does not.”
    (2) “The biggest banks in some European countries today are already too big to save. Unless we take immediate and real action to reduce the power – and size – of our largest banks, we are heading in exactly the same direction.”

    ??

  31. That is to say, if they craft a solution to (1), they will also have solved (2), ne?

  32. Intriguing post StatsGuy.
    ‘To save the economy, the government had to save the financial system directly – indeed, finance is the ONLY industry that is so important to the economy that it merits direct salvation’

    You imply there is another solution available and that it does not include public debt escalation and/or TBTF bank reduction action?

    What is your solution?

  33. How about save the country from depression with some strings attached, like renewal of Glass Steagall, and the other regulations that kept us safe for 50 years after the great depression 1.0 ??

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  35. Is the Senate finally ready to address this issue? In a word, no. The Plutocracy is alive and well, and now, with the Supremes speaking recently, there will be either (a) enough incumbents to keep the status quo, or (b) enough newly elected Senators sponsored into office to make up the difference.

    Anyone holding their breath for change at this point, will turn blue and die long before it gets near, because first this country will fail. We are reliving lots of world history, and nothing in the human political animal has changed. We will fail and we may be speaking a difference language before we’re done.

  36. The use of language is quite important in the bailout arguments as lots of the commenters have pointed out rather eloquently. What I find quite comical is the use of the word ‘implicit’ when referring to a government guarantee that banks will not fail. There is nothing implicit about it. The guarantee is quite explicit. Before the stress tests were even given the President of the United States stated that all banks would pass the test and that no bank would be allowed to fail. Hard to get much more explicit than that.

  37. I don’t think I have ever heard an economist argue that higher spending will pay for itself in higher taxes resulting from the growth. In particular because Keynesian fiscal stimulus is usual mean to fill a gap in demand, rather than to boost GDP to a higher potential. At least that is my understanding.

  38. I think Simon is saying that if the solution to (1) is merely resolution authority, without a break up or other restriction of size, we could easily blow through the current problem to reach (2). Actually, I think he is saying we will blow through the current problem.

    That said, I’m not sure it is right to compare the European bank’s to the home member state’s GDP. That’s kind of like comparing Citi to New York’s GDP, although Europe doesn’t have “federal” regulators or “federal” resolution authority, is it isn’t entirely wrong.

  39. Tony Foresta

    Too much has been taken from fartoomany, to buttress and/or bailout waytoofew.

    If the USG did in fact seize the assests and annul the charters of the predatorclass den of vipers and thieves in the TBTF oligarchs, and formed a resolutiontrustlike substance to keep money (finance) flowing and foreign counterparties at bay, – and committed 1/3 of the 14 Trillion US dollars forked over to the TBTF oligarchs, and redirected that other 4.66 Trillion dollars toward infrastructure projects, green technologies, education, and other programs that directly benefit the PEOPLE and NOT the predatorclass alone, – I submit that the crisis would have been much less severe for the people, and the ends much more just toward the predatorclass den of vipers and thieves that conjured, cloaked, aided, and abetted the worst financial crisis since the great depression.

    It’s a question of priorities. Purchased leadership has their respective priorities wildly misaligned.

    The people, not the oligarchs, or the predatorclass are the heart and engine of America.

  40. “2) To save the economy, the government had to save the financial system directly – indeed, finance is the ONLY industry that is so important to the economy that it merits direct salvation”

    Well that and the auto industry. And housing.

  41. James Gornick

    Here We Are Again

    An Article posted by Michael Panzner on March 9, 2010.

    “Well, here we are again: on one side, a rapidly growing contingent of optimists; on the other, a shrinking cadre of pessimists. According to USA Today’s Adam Shell, writing in “As Bull Market Turns 1, Is it Time to Party, or Worry?” below are just a few of the reasons why now is the time to buy stocks.

    •Major roadblocks still absent. Two of the biggest rally killers — interest rate hikes by the Federal Reserve and a big spike in inflation — “simply are not present yet,” says James Paulsen, chief investment strategist at Wells Capital Management.

    Many investors are worried that the Fed’s so-called exit strategy, in which the U.S. central bank drains cheap money from the financial system and boosts borrowing costs in an effort to stave off inflation, will put what Bernanke dubs the nascent economic recovery in jeopardy. But Paulsen argues that even if the Fed starts to raise short-term interest rates, currently near 0%, it won’t spell the end of the stock rally. The rally is not at risk, he argues, until sometime after the Fed begins to raise rates.

    •Investor fear still present. Typically, stock rallies run into trouble when investors get too optimistic, too complacent and too convinced that profiting in the stock market is a sure thing. But despite the big gains in the first year of the bull, sentiment is anything but ebullient.

    And from a contrarian standpoint, that is bullish.

    Not only are stocks climbing the “Wall of Worry,” they are also dealing with more daunting “Cliffs of Concern,” says Citi’s Levkovich.

    “There is all this stuff to worry about,” Levkovich says. “Debt problems in Greece. China tightening its monetary policy (or its property bubble bursting). Commercial real estate woes. What about the banking sector? What about jobs? What about underfunded pension plans? It goes on and on.

    “I am not saying these problems are not out there, or that they are irrelevant,” Levkovich says. “We do have reason to worry.”

    But investors must recognize, Levkovich adds, that all these risks get priced into the market. More important, investors must realize that if any better- than-expected news surfaces, the markets have room to go higher.

    •Earnings power is underappreciated. Optimists such as Federated’s Auth are betting that the economic recovery will be stronger and last longer than the current consensus opinion on Wall Street. Most economists are calling for a subpar recovery due to banks cutting back on credit and the ongoing process of individuals paying down debt after years of spending beyond their means.

    If Auth is right, and manufacturing is in the early stages of recovery, and job growth is about to turn positive and U.S. companies with major foreign operations continue to reap big profits in faster- growing emerging markets, corporate profitability should be better than analysts are now predicting.

    Profits will also benefit from the fact that most companies prepared for a depression that never happened by cutting costs and headcounts. So when sales pick up, the profits will pile up more quickly on the bottom line.

    “We have earnings rebounding substantially in the next couple of years,” Auth says.

    How big a rebound? Analysts’ consensus estimate for 2010 earnings for S&P 500 companies is roughly $76 per share,and Auth is estimating closer to $85 to $90, which puts the current market price-to-earnings ratio at around 12.7, which is below the long-term average of 15.

    •Cash on sidelines still piling up. “We still have a ton of sidelined cash, or dry powder, sitting on the sidelines,” says Paulsen. By his estimates households have upwards of $7 trillion sitting in cash or cash equivalents. Because most of Americans have bought into the “new normal” thesis of less spending, less risk-taking and lower returns, Paulsen says there could be a lot of “potential converts” who might have to switch to a more aggressive strategy and buy stocks if the recovery is better than economists think.

    Ever since the financial crisis began, money flows into domestic stock funds have been woefully small, as investors have flocked to the perceived safety of bond funds.

    That trend continued in the week ended Feb. 24, the most recent data available, as domestic stock funds had inflows of just $151 million, vs. nearly $8 billion going into bond funds, according to the Investment Company Institute.

    Some would disagree with the bullish case, of course, including yours truly:

    But bears such as Michael Panzner, who writes the blog Financial Armageddon, say bulls are “blind to the worsening economic reality all around them,” and in danger of getting hurt again by falling asset prices.

    Headwinds are plentiful, Panzner says.

    There has been little improvement in bank lending or credit availability, he says. The “long-term unemployment situation is getting worse” and economic data, which had been pointing up, have flattened out recently, suggesting a growing risk of a double dip, or economic relapse, he says.

    The banking system also remains weak, as is the financial position of sovereign states such as Greece as well as states such as California.

    He predicts a not-too-pretty fallout.

    “In my view, the effect will be, at the least, a retest of what we saw last March,” Panzner says. “At worst, much lower lows. It may not happen in 2010. However, it could be over the next couple of years.”

    Who do you believe?” (Panzner).

    In Every Season, the decay of mans social order brings new meaning to why God is in charge; Now and Forever, over what will be mans desire to bring the full hit of inviting the ultimate Armageddon(s)…

    From: Whenitcountsnow Far-fetched James Gornick | March 09, 2010 |

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    The miracles of Healing, and your concerns are made whole within the risen Christ that had been sent as a ransom for all from the time of Easter and the revealing of “I am” to the Living and the Dead spanning from all ages.

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  42. “Fantastic fears of inflation were expressed. That was to cry, Fire, Fire in Noah’s Flood … It is after depression and unemployment have subsided that inflation becomes dangerous.”

    –Ralph M. Hawtrey, Secretary of the British Treasury, 1933

  43. That’s offensive bungalowbill.

  44. Modern government and religion have a lot in common these days! For instance, you petition and petition somebody more powerful than you to help you out and stop screwing you over, and things continue to slide downhill anyway with no concern for your troubles. The problem is that neither God nor honest politicians exist.

    Keep pushing the mystical thinking that keeps the majority of the population unable to try and solve problems though logic, though. It’s obviously been a great help to us over the past 30 years as its gained in power.

  45. StatsGuy has been very clear about his proposed solutions over the past year or so he has contributed to this blog. Among other things, he calls for a permanent injection of several hundred billion dollars of new money (without any corresponding debt issuance as I understand it) into the economy. That money would be parceled out in block grants to the states who would use it on approved infrastructure, education, and other projects. StatsGuy also believes the TBTF issue is important and certainly needs to be addressed, but more important than this is gaining back control over the nation’s money supply from the large banks. Aggressive regulation of bank activity coupled with stricter capital requirements will surely lead to a rather large decline in the velocity of money. To counteract that a corresponding increase in base money is necessary. to avoid debt-deflation. Sticking it to the bankers feels good to write about, but in reality the political reaction to a collapse in aggregate demand will just undo whatever reforms to the bank sector so-called progressives can come up with. Also, the idea that even a substantial injection of new money into the economy will “inevitably,” lead to inflation is frankly absurd.

    If you’re interested in the evolution of StatsGuy’s thought process I recommend simply typing his name into the search box on the right hand side of the screen. I highly recommend doing this as you probably won’t find a more thoughtful commentator than StatsGuy anywhere on the web. As you can tell, I’m a StatsGuy groupie and have been ever since I read this fantastic post by him almost one year ago:

    http://baselinescenario.com/2009/04/26/guest-post-too-big-to-fail-and-three-other-narratives/

    *StatsGuy, if I’ve misrepresented any of your views I apologize and feel free to correct me.

  46. And if you don’t live in Connecticut read his “Seven Deadly Innocent Frauds:”

    mosler2012.com/wp-content/uploads/2009/03/7deadly.pdf

  47. The argument that we will inevitably pay higher taxes to finance government spending is bogus. Operationally, taxation and spending are separate and independent processes. That’s just the way it is.

    http://bilbo.economicoutlook.net/blog/?p=1229

  48. Tony Foresta

    Mystical thinking has it’s place, thank the goddess, – but obviously not on Wall Street. Wall Street is bent on thievery and illgotten gain comewhatmay, no matter how many families are tossed into oblivion, no matter how many gifted children are deprived of futures because they suffer the great misfortune of NOT being born predatorclass. Amerika today is commandeered by ruthless heartless monsters in the predatorclass whose only singular and exclusive interests are imponderable wealth at any cost. They do not care if America crumbles and burns. They do not care if millions of American families and many more millions of children are thrust into rank poverty and enslavement; – in fact the predatorclass den of vipers and thieves that owns and kontrols Amerika, are bent, (as in are insatiable in their desire) to see the poor and middleclass Americans stomped into poverty, oppression, slavery, and oblivion.

    All the erudite experts chitter chatter about this or that problem, or this or that visionary dim hope for resolution to these monstrous problems and all the while, – most of us – IGNORE the hideous fanged blood dripping dragon in the room – CRIMES were, and are being committed. NOTHING HAS CHANGED!!!

    Excuses, statistics, blah blah blah. CRIMES were and are being committed!!!

    We either right these horrible wrongs, and that will require accountability, culpability, and in some circumstances long jail sentences or worse for the predatorclass den of vipers and thieves who conjured, cloaked, aided, and abetted, and profited wantonly from the worst economic crisis since the Great Depression, – or we don’t. If we don’t – then woe to us, for we are headed for a real horrorshow catastrophe that will make the previous crisis seem like a Disney movie. If we do, – then the predatorclass and the socalled TBTF oligarchs are accountable, culpable, and must be put back in the keep.

    Riddle me this economics and finance experts??? What is the basis, what is the root and substance of the 70% climb in the dow since the halcyon days of November 2008. Fundamentals? Confidence? Speculation? Criminal activity? I challenge anyone here to explain why on earth, and upon what math, or analytics is driving the dow to 10,500? How long is this fiction sustainable? What could possibly explain the markets exuberance?

    From my pedestrian perspective, Amerika is heading for a real horrorshow correction, when all the false fictional mythical numbers and profits and mathematics
    confront the reality of a dead and dying American middleclass.

    Please, I beg of you? Upon what ground can anyone base the exuberance of Wall Street? Inquiring minds want to know!

  49. “The only limit is real out-put capacity. Going beyond that will result in inflation.”

    Interesting way to look at it that I hadn’t before. Thanks for the insight.

  50. I need enlightenment! The article you link seems to argue that increases in revenue in the good times will pay off the deficits in bad times. If so, will it? What if the good times are short and the bad times long? No data or sources are given to support the argument. It doesn’t seem to be arguing that we should just print money as we need it. Additionally, Presidents from Kennedy to Bush have argued to cut taxes in good times to eliminate the surpluses. Seems that would cut the ground out from under the articles first argument. By the way, the article didn’t mention that taxation and spending are separate and independent processes. Separate I get. But independent? Seems that, eventually, the money for spending has to come from somewhere other than borrowing.

  51. Oops, forgot to check “notify me . . .”

  52. AJ: “I don’t think I have ever heard an economist argue that higher spending will pay for itself in higher taxes resulting from the growth.”

    I don’t think that’s what I am saying may be a possibility. Rather, it is that even if the spending is paid off by future taxes, that may not necessitate a higher tax rate (which is how laymen interpret the ambiguous term, “higher taxes”).

  53. JS: “Seems that, eventually, the money for spending has to come from somewhere other than borrowing.”

    It ought to. Unfortunately, the way we have set things up in the U. S., that is, in effect, where it comes from. The government is the ultimate source of our money, including the taxes it receives. It does not create money by printing it, but by spending. But then it borrows, so that the numbers come out the same as if it spent what it borrows or received in taxes. So, in effect, money is created by borrowing, in a way that is analogous to how bank money is created by borrowing.

    That is not the whole story, because the Fed has been delegated the authority to spend money without borrowing. That is something that the Fed avoids doing, unless it is necessary.

    The U. S. has not paid off the national debt since 1836. (And there was a depression in 1837!) Given that, the proposition that we have to pay off current spending by future taxes is dubious. We have not done so for 174 years. Why start now?

    In the modern era, IIUC, the effective tax rate has been fairly stable, at around 20%. So taxes seem to depend more on current income than on past expenditure.

    Now, if we had debts to pay off in gold or some other currency, things could get nasty. But fortunately, we don’t. :)

  54. Since you collect 0 at both a 0% tax rate and a 100% tax rate, and you do not collect negative taxes, there must be an intermediate tax rate where you collect the maximum amount of revenue. If that amount is greater than 0, there must be a tax rate such that increasing it will reduce revenue, and decreasing it will increase revenue.

    But where is it? ;)

  55. At least, we don’t have a significant level of debt in anything but dollars. :)

  56. Well in that case, of course growth (and inflation) can close the gap on it’s own.

  57. Thank you. When evaluating a given U.S. federal budget position you should always keep two things in mind: the productive potential of the U.S. economy and the price level.

    There are any number of metrics used to gauge the price level, but some of the most common are:

    Government statistics:

    1) The CPI
    2) “Core,” inflation
    3) Median or trimmed inflation

    Market based indicators:

    1) Long-term (10 year and out) bond yields
    2) TIPS spreads
    3) The CPI futures market

    Different economists use different measures for different purposes so there are actually many, many more metrics than I’ve mentioned here. I’m sure someone more knowledgeable than me could add to this list if they were so inclined.

    Estimating the productive potential of the U.S. economy is rather more difficult and controversial than measuring the price level, but here are some possible proxies:

    1) The unemployment and underemployment rates
    2) Capacity utilization rates
    3) Business inventories
    4) Trend GDP growth rates

    That’s all I can think of off the top of my head. My advice is to never listen to anyone who talks about debt/GDP ratios without also mentioning at least some of the metrics presented here. Nothing occurs in a vacuum, anyone who tries to tell you differently is trying to sell you something.

  58. My opinion is that strong economies occur for reasons other than tax rates. Both tax cuts and periods of progressive tax rates, seem to be more or less the same in their correlation to strong job and income growth.

    They diverge on correlation with deficits. Tax cuts strongly correlate with growing deficits.

    Therefore I think we’re watching the wrong ball(s) for understanding what is really going on. Strong job and income growth seem to be triggered by very large changes. Game changing innovation for one example. Population growth for another.

    Another historically strong driver is government. Governments occasionally decide to back one reform or another aimed at boosting one or more industries.

    We subsidize corn and get cheap meat. It may be toxic as Hell, but it’s cheap. We built an interstate highway system and auto sales boomed. We subsidize the pharma and medical device industries through academic (primarily) pure research. That’s worked pretty well, but not without several serious “bad” unintended consequences.

    We subsidize Wall Street. It sure has grown, hasn’t it?

    That we don’t instead subsidize organic food, clean energy and universal health care is a crying shame. But there’s no questioning that government can be a huge driver of growth.

    Our stagnation today is due to the philosophy that government can’t boost economies. That’s a relatively recent ideology and can only be believed if one first tosses out the window more than a century of American history.

    As for the tea baggers (partiers?) may I propose a solidarity greeting they can use? Bend over from the waste and grab your ankles.

    Their flag? “Don’t Tread On My Stockholm Syndrome.”

  59. oops, waist, not waste.

  60. James Gornick

    3-D:

    First, it’s a foregone conclusion that politics and religion are hot seats for many to enter a discussion.

    The similarities, as you eluded to, are only the same in one reflection. This reflection is the, “petition somebody more powerful than you to help you out”(3-D).

    The certain difference between the presence of God or to question the lack of presence is the more critical view you have raised.

    In comparisons of God and the existence of honest politician(s) was far-reaching in the context we have no hope. Hope is the key word in this message.

    The hope and prayers of are forefathers in placing their faith in the One Living God. In a God Who We Trust was the line drawn in the sand for the whole world to come to know. To know that this sovereign nation is led by the spirit of Gods social order of principles from the beginning of time.

    This is where the politician is somewhat separated from the comparison you gave.

    Man and/or woman who are given the privilege and called to serve at the election of their fellow men and women. These elected given the privilege to serve, have the moral and ethical call to do the right things.

    Your comments can ring true; many fall away from the path of what is right and choose wrong when given power.

    This is where your comments also move toward apathy, and forgetting the ultimate ending has already been told in the final chapters of the “Greatest Book Ever Written”, this if you believe in the One Living God.

    Many a politician has found their ruins to follow the deceptions and deceit of falling to the temptations of the 7 Grave Sins of Man.

    There are many good men and women that stand for the rights and moral codes and principles of life.

    The list would be long throughout our great nations history; of these men and women who have answered this call to serve.

    The problem now seems a select few have decided to push the “One World Order” through the assemble of “The BuliderBerg Group” and the “Tri-Lateral Commission”, on the back of oppressing many to become captive by the very nature of the fall of keeping a social order. To run with power to think they will control the choices of a nation under God.

    The call sounded now is for the ones to hear “Gods Will” for keeping a true social order. Social order based upon the principals of “I am”. You can ask me another day who “I am” happens to be…

    I happen to be a God fearing Man that will stay on his knees and continue to pray and serve and answer the call. Many proud Marines and all that have served in the armed forces and our nation know this honor of God and Country well…

    Far-fetched, Not Anymore!
    James Gornick

  61. Wow! That sounds like a Ponzi scheme. And you think investors will be comfortable with that forever? I noticed in prior posts, you hedged on this theory. Is Johson’s statement that deficits do matter conflict with it, or just seems to?
    Somewhere I read we have to borrow several billion a day, but I also read that China is not growing its stockpile of U.S. debt. Wonder who is picking it up?

  62. You got through writing that entire wall of text without putting together a single logical thought or saying anything substantive at all. Quite typical when Jesus Speak gets rolling. I’m not going to debate the truth of the Bible or the existence of God as stated in it. Even if he DOES exist (and the easier explanation by Occam’s Razor is that he doesn’t), he allowed all this to happen already, so obviously appealing to him is a waste of time even if you believe in him. He clearly doesn’t care.

    What I will debate is how useless the “Use prayer!” line of “helping” is. At best, it’s just a waste of time. At worst, it’s an excuse for apathy after claiming “Well I’ve put it in God’s hands, so it’s all gonna work out now and I don’t have to think about it!”

    How about instead of suggesting people get on their knees and start begging your invisible man for help, you encourage people to get off their knees (and butts) and start making things happen? What we need right now isn’t prayer, wishful thinking, and platitudes as doled out by the local religion. We need actual people giving actual thought towards solving actual problems instead of assuming an ancient book (which repeatedly contradicts itself in an orgy of tragically flawed logic) has already foretold that imaginary mystical forces will fix a REAL problem for us if we just trust them.

    Apologies to the other posters if I seem to be ranting, but this drivel is just… mind blowing.

  63. If not seeking prayer, than folks need to bring logic of what is true and has stood the times of so many generations of change…

    Times of Classical and Contemporary Virtue Theories:

    Plato (c.428-347 B.C.) Aristotle (384-322 B.C.) are good places to start in what makes the character of foundational change…

    “All the gold which is under or upon the earth is not enough to give in exchange for virtue” (Plato).

    “All men are by nature equal, made all the same earth by one Workman; and however we deceive ourselves, as dear unto God is poor peasant as the mighty prince” (Plato).

    “We are what we repeatedly do. Excellence, then, is not an act, but a habit” (Aristotle).

    “What lies in our power to do, lies in our power not to do” (Aristotle).

    “It is possible to fail in many ways…while to succeed is possible only in one way” (Aristotle).

    When you bring in the world of skeptics and others who would challenge creation over evolution, you find that so many occurrences of logic has also confirmed the existence of a Living God that refute the existence…

    I am one that did not right these famous words uttered throughout the centuries. But logic to come to bring action is brought about by passion of ones soul to achieve greater things in the service of his or her fellow man.

    The logic is simple; Occam’s Razor was known for simplicity. His challenge was to intellectually challenge the very nature of faith.

    The challenge you are asking for, is for people to make solutions and resolve problems.

    This is done my friend by the very nature of the call to rise and bring the voice and ability for a world reeling with uncertainty, and struggling with the very nature of moral and ethical loss of what is to keep a social order.

    This occurs when you try to make God absent from the equation.

    Add the God factor and the desire of, “Knock and it will be open, Ask and it will be granted unto thee”, holds true if the prayer is truly offered by inviting Gods Will to intervene.

    It does get mind blowing when the absolute challenge that stems greed, consumption, and lack of social order that broke eventually the society and the Roman Emperor.

    This is the signal today sent by many countries challenged with debt by accursed leverage and derivatives sold by the concerns such as Goldman Sachs and other Market Makers.

    The sorry statement in all this dialect; is the eventual collapse and fall of our modern society can happen over and over again, if the lessons are not learned…

    Call this, our modern colleges of teaching theory as I have had the pleasure over these past years attending…

    Keeping with the season… For those who do pray and know works and prayers are the ultimate answer… Enjoy!

    Far-fetched, Not Anymore!
    James Gornick

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  65. Ted Kaminski

    I don’t see where either unemployment or depression of the economy have subsided at this time. The inflation hawks should stay sleeping in their nests.

  66. Ted Kaminski

    Actually the article cuts the ground out from under the Bush tax cuts which increased our debt prior to an economic shock.