Five Questions for Christy Romer

Christy Romer, chair of the President’s Council of Economic Advisers, will appear before the Joint Economic Committee tomorrow. (Details, background, and links to Christy’s relevant recent work will appear on The Hearing shortly; update, now posted).

I suggest Committee members consider pursuing the following lines of questioning.

  1. Please explain precisely how the U.S. will avoid the type of “balance sheet” recession seen in Japan during the 1990s? Building on that, kindly elaborate on why this kind of recession is not an issue at the global level. Related to this, what is your view of the IMF’s latest global forecast, for example for Western Europe?
  2. Larry Summers argues that growth in the recent past was overly based on the financial sector and there is now a need to rebalance the economy, led by public investment.  Do you agree with this view and which public investments – and related private sector activities – exactly would you have in mind?  How /why will resources move out of the financial sector, given the level of bailouts (i.e., insurance for bankers’ bonuses) today and promised for the future?
  3. The Administration indicates that it wants to reform the way finance is regulated.  Regarding the past two decades, would you agree that the financial sector has proved able to “capture” regulators and to resist rules (e.g., on derivatives) that would restrict potential profitability?  If yes, how exactly do you think future regulators (e.g., the system regulator now under discussion) will resist similar capture?
  4. Do you support the idea of applying and updating antitrust principles to banks that are “too big to fail”?
  5. What other approaches make sense for dealing with big banks in the future?  Do you agree that controlled financial system risk creates serious potential for huge unpleasant fiscal surprises?  Could Pecora-type hearings be one way to examine how best to bring down these risks?

Feel free to add more questions here or at The Hearing at  The JEC is definitely interested in what you have to say.

By Simon Johnson

51 thoughts on “Five Questions for Christy Romer

  1. Simon, with regards to question #1, can you do an in-depth analysis compare the US today vs. Japan in the 90s?

    Please include:

    1. Structural analysis of the 2 economies as whole
    2. Structural analysis of the 2 financial systems in particular
    3. Structural analysis of the 2 societies that underlies their economy
    4. Analysis of the handling of the 2 cresses

    Hopefully, a careful look at the vast differences in the initial conditions should offer some clue to the first question you post. Granted, no one can predict with certainty what will happen tomorrow.

    On the other hand, I don’t really expect you to do any of these analyses. You have never done any so far. It is a lot of work after all. It is much easier to pontificate on a soapbox.

    To rally populist support, you don’t need to do the careful analyses anyway! Populists are incapable of critical independent thoughts and will be happy do your bidding if you press the right buttons!

  2. Speaking of regulatory capture, did everyone see this in the Washington Examiner?

    One nation, under Goldman!

    Former Barney Frank staffer now top Goldman Sachs lobbyist
    Examiner Columnist
    04/28/09 5:30 PM
    Goldman Sachs’ new top lobbyist was recently the top staffer to Rep. Barney Frank, D-Mass., on the House Financial Services Committee chaired by Frank. Michael Paese, a registered lobbyist for the Securities Industries and Financial Markets Association since he left Frank’s committee in September, will join Goldman as director of government affairs, a role held last year by former Tom Daschle intimate, Mark Patterson, now the chief of staff at the Treasury Department. This is not Paese’s first swing through the Wall Street-Congress revolving door: he previously worked at JP Morgan and Mercantile Bankshares, and in between served as senior minority counsel at the Financial Services Committee.
    Politico reported this last week based on an anonymous source, and Bloomberg confirmed it today.

  3. Mr. Silly

    Sounds like your solution to the current financial crisis is not to attempt to solve it by asking meaningful questions of those with the power to fix it, but to accuse those trying to ask meaningful questions of pontificating.

  4. How does the administration hope to solve the moral hazard problem regarding capital provision to banks? Given recent government decisions, is there any reason for private investors not to believe that the capital structure of banks will be protected up through quite junior levels? If investors provide capital on terms that are not sufficiently attendendant to risk, is current policy then not simply setting up the next round of failures and bailouts?

  5. Quick point on your question number 2 – much has been said recently on the growth of the financial sector as a percentage of national GDP, and how it was obviously unsustainable. However, if you rewind 4 or 5 years, many people were noticing the same thing, but it wasn’t restricted to finance – rather, manufacturing’s share of GDP was declining as the service sector’s was picking up. Surely finance sits within services, and surely, the justifications that were used 5 years ago (globalisation leading to a decreasing marginal cost of labor + transportation in developing economies vs. ours) are still relevant. I’m not saying that finance took a fair share (it probably was over-inflated), I’m just saying that trying to recalibrate our economy to resemble the 1950s mix of businesses is probably ill-advised. Remember, back then GM was the pinnacle of corporate efficiency.

    Questions I would add:

    1) Given the level of stimulus and bailouts that have been pledged, how do you plan to protect the credit-worthiness of the US Treasury going forward?

    2) For all this talk of spending on education – will you pledge to include a credible economics education to high school curricula?

    3) Does your vision of a viable financial system include the possibility for bankruptcy for financial entities? Or are some institutions going to continue to be “too big to fail.”

    4) Will government sponsorship of debt financing (both at the corporate level and at the mortgage level) continue?

    4 a) What will happen to Fannie Mae and Freddie Mac? How about Ginnie Mae? Sallie Mae?

    5) Fed governors have been loathe to try and “pop” asset bubbles for fear of causing deflation…this has resulted in the famous macroeconomic “put.” What is your vision of monetary policy going forward, is it 1) the same as it was, 2) more counter-cyclical, or 3) less interventionist all together, allowing the economy to fell the full effects of its excesses along with the full benefits of its efficiencies.

    I’m sure I will think of more…

  6. Some of my questions for the experts:

    1) We were told last September that if the government did not act by paying out massive sums of money to the financial firms on Wall Street, the nation’s economy could collapse completely. How has our economy been served by having billions of the bailout dollars going to bonuses for executives at the firms that brought us to the point of collapse?

    1A) What solutions have been proposed by those heavily bonused executives that will help us as a nation get out of this mess? (Their solutions have not been as publicized nearly as much as their bonuses, leaving much of the country to wonder what they’re doing to help solve the crisis, other than collect a paycheck.)

    2) What role will campaign finance reform play in the new regulatory environment to be developed?

    3) How will business executives who presided over the over-leveraging of their business to the point of collapsing the global economy be held accountable for their business failures? Or has the government taken the view that leaders of companies that require trillions in federal support to survive are not at all accountable for the failures of their companies?

    4) How can companies with massive amounts of toxic assets on their books declare profits this quarter? Shouldn’t those profits go to alleviate the burden of the bad debt on their books, instead of to bonuses for employees?

    5) Why does the US taxpayer need to get involved with eliminating the toxic assets from the books? This has not been adequately explained in a manner that makes sense to those outside of Wall Street.

    6) What progress have we seen as a result from the capital injection program that began under Paulson’s reign?

    7) Under Paulson’s TARP, capital was distributed to a large number of banks, regardless of whether they were healthy or sick. Does this mean that the financial system is so interconnected that no bank can fail? If not, how long will the government prop up “zombie banks”?

    8) And just how many zombie banks do we have within the US financial system? How many healthy banks remain?

    9) Can you please explain in a clear, succinct manner how people who got paid millions of dollars in compensation had no clue that their asset sheets had turned into a towering mountain of debt? Business people outside of Wall Street would like to know how this can happen on the watch of highly compensated, highly educated leaders.

    10) Can you address the lingering notion that with this crisis, we’ve revised American capitalism so that we now socialize the losses of the wealthiest firms in the country while continuing to privatize their profit? It is not clear to most outside of Wall Street how this is helping the nation.

    In all honesty, Simon, I would revise your question #4 to read: How will the government update and apply antitrust principles to banks that are “too big to fail”?

    OR, better yet: What regulations and antitrust principles can be developed and applied to these “too-big-to-fail” institutions to protect them (and thus, the global economy) from ever again failing in such a catastrophic manner?

  7. What will you do if the US government fails to sell the T-bills it will have to issue to cover its expenses?

  8. Questions for Chairman Romer:
    1. What specific productive activities do you believe can lead us out of this economic crisis? Explain.
    2. What specific steps can government take to foster these productive activities?
    3. What steps, if any, should government take to moderate income disparity and wealth disparity in the U.S.?

  9. Do you believe that pre-privatization should be off the table for all of the large banks subject to the “stress test”? If so, why should we treat these banks different from the majority of banks in the US? Is there another economic explanation for the differing treatment besides the To Big To Fail Policy? Do you believe that a pre-privatizing a large bank could lead credit to seize up again or would the impact be felt more directly in the stock market and confidence measures?

  10. Thank you for listing the debt crisis / balance sheet recession as #1.

    If I could add one question, that perhaps Dr. Romer may have some passion to answer, this would be the one:

    How successful has the recapitalization of banks been at stimulating monetary supply growth through debt-expansion (lending)? Recent reports suggest that banks are hoarding extensively and building up liquidity.

    Are these reports credible? Are the stress tests inducing banks to hoard capital, as the banks claim? Is the real reason for bank balance sheet contraction that there is a scarcity of quality borrowers seeking credit, as some banks claim?

    Do you still believe this is a liquidity crisis driven by inadequate bank capitalization, or is it mostly a debt/demand crisis now?

  11. I would ask Romer (or anyone else among these growth technocrats), given the facts of Peak Oil and resource depletion, environmental constraints including the necessity for carbon mitigation, the implosion of exponential debt, and the hollowing out of the productive parts of the economy in favor of the financialized pseudo-economy which has now collapsed, what are you proposing as the realistic basis for the resumption of debt-based “recovery” and restored “growth”?

    Or are you really just thinking in terms of boom-bust bubbles ad nauseum, from here on, for as long as the capacity for delusion and the dwindling resource base render them possible?

    Related to my first question, do you believe American food and farm policy, based on massive fossil fuel inputs, industrial monocropping, horrendous economic and social barriers to would-be small farmers, and just-in-time distribution, is sustainable?

    If the answer to these is the affirmative, is there any real basis for the answer beyond fundamentalist relgious faith in how “technology will save us”?

  12. I can’t seem to figure out how to post questions as suggested to the WP site, however my two questions are:

    1) Who on the President’s Council of Economic Advisers represents the outside viewpoints as espoused by the likes of Simon Johnson and Paul Krugman? Is there any diversity here?

    2) Who on the President’s Council of Economic Advisers has never been employed in the financial industry and thus does not potentially have a vested interest in maintaining the status quo?

    Simple questions.

  13. I realize my question is not in line with the general consensus, but here is my preferred line of questioning:

    1. Do you agree that people generally tend to repeat behaviors that are rewarded, and avoid behaviors that have negative consequences (operant conditioning)?

    2. Do you agree that at both a personal and organizational level, our policies have been rewarding irresponsible behavior (borrowing too much, taking unwise risks, etc) and punishing responsible behavior (saving, delaying unwise purchases, having a high income due to high productivity/value)?

    3. What do you believe the long term consequences are of rewarding irresponsible behavior, and punishing responsible behavior? If you believe these problematic incentives are necessary now, do you have any plans to try to fix these incentives in the future?

  14. I believe he is allowing Ms. Romer to answer those questions you have posited. The point is to find out the administrations view, not Simon’s.

    Pehaps your questions are best referred to Professor Krugman. He has already covered the questions you are asking. I’m sure Simon is aware of his work.

  15. James, “better never than late!” Here are some questions.

    What is the administration’s disposition toward:

    1. A regulatory authority looking out for systemic risk? Should such authority rest with the SEC (focused on individual corporations as they report and as their securities trade) or should it rest with an agency that has a more global perspective such as the Fed or the FDIC?

    2. Expansion of FDIC authority to step in and intervene in the affairs of financial institutions other than commercial banks?

    3. Current levels of bank credit in the US? Can these expand while the process of global “de-leveraging” continues? Has any determination been made as to an optimum (safety consistent with growth) level of leverage might be? What benchmarks are used to indicate an optimum level? In other words, do we have any idea where we are with respect to contraction and expansion?

    4. Intermediation on a global scale? Is the IMF viewed as the logical agent to distribute credit from nations with surpluses to nations with deficits? Is a radical restructuring of present allocations within the IMF called for?


  16. “Move Over Adam Smith: The Visible Hand of uncle Sam”, found at the noted web address, is an essay which gives a strong case for one to believe that the federal reserve has agents acting in the market buying equities and futures and anything else they desire.

    This doesn’t sound so scandalous since people for a long time have “suspected” that there is a “PLUNG PROTECTION TEAM” acting through Goldman and other primary dealers. And, since we all know that at this point, we are ALMOST clueless to what kind of collateral is being taken on behalf of the US Taxpayer for all of the loans out on TARP.

    But, indeed it is a serious problem, if this is true, for the credibility of our capital markets. If we the people are to accept that it is OK for the Federal Reserve/ Treasury to step in for national security, shouldn’t our government have it’s own trading desk to prevent insider problems–many would say that this has been going on forever, and that Goldman is an arm of the Government–even if this is the way it works, we all know that it is not OK to allow this to continue if we wish to maintain the integrity of our capital markets.

  17. I would second Matt Fahrner’s post about scouting out former financial professionals who don’t have a vested interest in the current system. Specifically, I would seek out any flow traders…preferably those who trade their own account (or are locals), but maybe even flow traders who worked at I-banks.

    For all talk about greedy traders bringing the world to collapse, in my experience, the most bearish, cynical people tend to be flow traders who’ve seen the market’s irrational crowd mentality firsthand. Whereas the academics and quants whose job it was to model esoteric default risk and warehouse it before attempting to sell it on to others had never seen black swan events (in house prices, corporate bond defaults, etc.), any flow trader who has to mark his book to market every second knows how irrational and fat-tailed the world really is. (In fact, if you look at recent bank profits, its flow trading which has pushed them back in the black).

    Anyone can buy the parts of a CDO for 98 and sell it for 100 if they dress it up with words like “gaussian copula” and “postive carry.” Its these guys who leveraged themselves up to make that 2 cents profit that brought the world to collapse. The option trader on the floor of the CME knows much more how crazy and irrational the world is, and because they bear the full brunt of their losses, understand just what it means to “risk manage.” To me, the are some of the best psychologists and sociologists in the world (not to mention investors). Unfortunately, the economic elite in Washington was educated by the same doctrine that churned out the quants at S&P who’s home price model couldn’t deal with house price declines.

    In summary…Nassim Nicholas Taleb needs to be on the President’s council.

  18. This is extremely normal. Through a combination of circumstances, I happen to know a highly-placed Washington lobbyist for an important firm in a regulated industry. Before taking this job, my acquaintance worked long and hard in a series of staff positions for Democratic Senators. Surely we cannot deprive talented, hardworking, and knowledgeable people of the chance to contribute their efforts on either side of the government/industry partnership, just on the off chance that the little people are being screwed?

  19. As an antitrust lawyer, I’m not sure why Simon thinks that antitrust law is the appropriate tool to solve the too big to fail problem (if there is such a problem). There are a few examples of using antitrust law to break up monopolies (most notably the phone monopoly), but the banking system is nowhere near a monopoly.

    Moreover, the banking industry doesn’t appear to even be particularly concentrated by modern antitrust standards. The current crisis has added significant additional concentration, but even if we focus on a segment of the very large domestic institutions (which there is no obvious reason to do), the “market” is not particularly concentrated. And such a market would ignore the signification competition from foreign banks and other non-bank institutions. I am not aware of any precedent for using antitrust law to restructure any non-monopoly industry, and there are many that are far more concentrated than banking.

    The too big to fail “problem” (I am skeptical that anyone outside the GSEs ever actually believed that they were too big to fail) is also not the sort of thing antitrust laws are designed to deal with. Antitrust policy focuses on the benefits to consumers, in the form of price, quality and innovation competition, not question of which products should be offered, who should be able to offer and buy them, and how best to assure the stability of the system. The latter questions more properly belong in the much more robust arena of banking and financial services regulation. As long as the regulators can be somehow insulated from capture.

  20. Looks like most of my questions are already covered…however, I didn’t see anything related to the PPIP. My questions would be:

    1. How would you protect against banks offloading “legacy” assets at a price they’re willing to sell at and then buy back that same asset (via a SPE or other shady agent) at a much lower price and with much greater upside potential due to the leverage component inherent and fundamental to the plan? Oh, and due to the fact that that leverage is non-recourse.

    2. Do you or anyone you know (other than Geithner) actually think this is a fair plan for the taxpayer?

  21. Those questions are so great, they should be turned back to you.

    Could you provide us with your suggested answers? Any chance you could do a quick run-through of what you think Romer’s best answers would be – from the Administration’s perspective and not yours?


  22. I don’t know if she’s the right person to be asking but I’d like more clarification of the bank stress tests. Specifically, I’d like to know if there was a full audit of these so called toxic assets. Do we now have a clearer picture of the nature and quantity (If not the value) of the derivative assets that are out there? Surely this kind of assessment is the first step in cleaning up that mess and I don’t see how the financial sector can recover until it’s been addressed.

  23. Unfortunately I will give you the questions that are more likely to be asked,

    “Ms. Romer, when I’m asked by a single mom who is recently out of work when the economy is going to turn around, what should I tell her?”

    “The great state of Tennessee is suffering along with the rest of the country, but we feel it’s wrong to burden our children with so much debt, and that’s why we’ve refused to take the stimulus money – except for the funds that we feel are actually stimulative. Could you tell us how this massive debt build up is going to starve our grandchildren and create more gay marriage?”

    “When in your view will the housing market turn around?”

    “my constituants want to know when they are getting their baiout, how do you respond?”

    “I have to appear on CNBC as one of twelve talking heads in a box on Kudlow’s show in five minutes, so I yeild my time to the chairman.”

    And of course she will try and answer each questions truthfully, but using as few works as humanly possible and tossing in an anecdote or two to distract the committee from the fact that she didn’t answer the question.

    Another hard six hour day for our elected officials.

  24. From Robert Peston on the BBC:

    “This is a nod to an idea that the chancellor is planning to float in a couple of weeks in a white paper on reforming regulation of the banking system (and the US authorities are moving in the same direction).

    For what it’s worth, there are two reasons why it might make sense to force our biggest and most complex banks to hold more capital than their smaller, simpler peers: if big super-banks have the privilege of knowing that we as taxpayers would always bail them out in a crisis, surely they’ve got to put in place treble protection against the risk that they’d call on us for such help; also the costs of holding the extra capital might encourage them to slim down and simplify their operations.

    That said, such a regime could achieve the precise opposite of what would be intended.

    The public imposition of a higher capital requirement on, for example, Barclays than on smaller, simpler banks would be a public declaration that Barclays would never in any circumstances be allowed to collapse.

    And, paradoxically, that could give an unfair competitive advantage to Barclays – because safety-conscious depositors might well choose to give Barclays a disproportionate amount of wonga in the belief that there are no circumstances in which that wonga could be lost.

    Which is partly why some, like the Liberal Democrats, are in favour of the forced break-up of the likes of Barclays and Royal Bank of Scotland into so-called narrow banks, so that these sorts of competitive distortions are minimised and so that banks don’t abuse ordinary depositors’ cash by gambling it in the supposed casinos of wholesale markets.

    As I’ve recently noted, the Tories have also come out in favour of dismantling the big banking conglomerates – and Mervyn King, the governor, has said it’s an idea he would like explored properly.

    Even so, Lord Turner isn’t in favour of the prohibition of Barclays-style universal banks, and nor are the chancellor and prime minister. They believe that delineating wholesale banking and retail banking in a clean way is easier said than done.”

    Given that Narrow Banking has been taken up by the Liberal Democrats in the UK, and even the Tories are exploring such ideas, would the US government consider the idea of a Narrow/Limited Banking System?

    After all, even though the Turner Report didn’t accept Narrow Banking, it did note that it’s worth being considered.

  25. In the category of now you know so you can’t say that you didn’t see it coming (e.g. demographic trends) here are some questions:

    1) Could Dr. Romer confirm that she is aware of the much-larger-than-subprime Alt-A and prime option-ARM default wave (which is just getting started and will not crest until summer 2011*)? Can she confirm that President Obama is also aware of this new default wave?

    2) Does she have an estimate of how many of these Alt-A and prime option-ARMs are too underwater to be refinanced? (My guess is that these option-ARMs were taken out at the peak of the bubble in the hope of making a quick speculative buck by flipping the properties: i.e., Minsky’s ponzi financing.)

    3) Assuming that these Alt-A and prime option-ARMs have yet to default because they have yet to reset, could banks get rid of these now-performing-but-soon-to-be-toxic mortgages (and CDOs) with the Private Public Investment Program (PPIP)?

    4) Under PPIP the default risk of these Alt-A and prime option-ARMs will be transferred to the FDIC. Who should be politically accountable if the FDIC has to raise insurance fees on deposit accounts to replenish its funds? Will Bush-appointee FDIC Chair Sheila Bair be the scapegoat and sacrificial lamb?

    5) How could this impact President Obama’s reelection campaign in 2012 should the American people see their skyrocketing monthly banking service fees as a “backdoor tax”? Is spreading this pain around to banks that had prudent lending practices during the bubble fair to their shareholders and depositors?

    Do David Axelrod and Valerie Jarrett know about this Alt-A and prime option-ARM default tsunami? Just as Bush’s decision to invade Iraq led to a failed presidency, will Obama’s decision to go forth with a wholesale transfer of default risk to the FDIC under PPIP lead to another failed presidency?

    6) What are the policy alternatives to PPIP (e.g., create ultra-clean new banks by recapitalizing old insolvent banks under the resolution authority auspice of “prompt corrective action”), and why is PPIP (with the FDIC on the hook to absorb default risk instead of old bank shareholders and unsecured creditors) the best policy?

    Note that under the Fed’s 10% reserve ratio, a $100 billion capitalization will create $1 trillion in fresh lending capacity overnight! — in which case ultra-clean new banks will have absolutely ZERO excuses not to lend to creditworthy borrowers.

    7) Congressional Oversight Panel Chair Elizabeth Warren said on Monday** that the “adverse scenario” used for Geithner’s stress test was “disturbingly close” to current economic conditions; do you agree with her call for a more-adverse second stress test?

    *Uhlfelder, Eric, “More Mortgage Meltdown Misery,” Financial Times, February 7, 2009 (google article; see chart).

    “A Second Mortgage Disaster On The Horizon?”, CBS 60 Minutes: New Wave Of Mortgage Rate Adjustments Could Force More Homeowners To Default, December 14, 2008 (google for video).

    ** “TARP Cop Sees Unstressful Bank Tests,” Reuters, April 27, 2009.

  26. MK:

    Thank you so much for that bit of comic relief.

    A perfect rendition of “our government at work for C-Span viewers” … and probably the essence of “our government at work” period.

    So sad. So scary.

  27. I’ve made many serious comments on this board in the past, but like the CIA guy from “Charlie Wilson’s War” said… “There’s no reason this can’t be fun you know.”

  28. On point #3 (Regulatory Capture), I would draw Prof. Romer’s attention to the October 1999 GAO report on the LTCM Collapse entitled “Long-Term Capital Management: Regulators Need to Focus Greater Attention on Systemtic Risk”.

    That report highlighted the contribution of important regulatory gaps between the SEC, FRB and the CFTC, as well the problems posed by the lack of netting and transparency of OTC derivatives.

    I would ask Prof. Romer whether she saw similarities between the GAO’s proposals in 1999 and Mr. Geithner’s proposals in March for regulatory reform. I would also ask her why she felt the GAO’s proposals were not acted upon.

  29. It already happened, and the solution was to buy back the treasuries offered for sale that day, with cash printed the day before, and flood the market with “cash”…a term you need to start using with a snicker. It’s very painful watching America, a once-great and respected nation, dying a slow and ugly death. I believe the death certificate should read: Cause Of Death: Greed, Stupidity, a “bought” government, and taxpayers too busy watching American Idol, too care what happened…until the TV went blank.



  30. Here’s a good question:

    “when government officials are caught taking bribes in China, they are given a trial, and if found guilty, they are immediatly executed. Do you think if we execute a few of the Politicians and Lobbyists in Washington who are clearly on the take, maybe the massive theft will stop?”


  31. StatsGuy,

    The questions you raised are the key questions.

    Why are banks, including the healthy banks, hording cash instead of lending more? The possibilities I gathered are as follow (hope I didn’t miss any):

    1. Lack of quality borrowers
    2. Fear of bank run
    3. Hedge against “unpredictability of how the government has dealt with troubled banks”

    Notice this is completely opposite of “gambling on redemption” that Simon Johnson suggest would happen to zombie banks. If anything the banks are too hunkered down because they are still alive and want to stay that way!

    1) Lack of quality borrowers

    I don’t have any data on this. However, there is not a whole lot the banks can do about it. The lack of quality borrowers issue has to be addressed by our government (by stimulating demand) and the market place (sellers have to face reality). We definite do not want to force banks to make bad loans.

    2) Fear of bank run

    Most evidences suggest the “fear of bank run” issue is over for healthy banks. At the end of last year, this was a very acute issue when people didn’t know the financial condition of most banks. However today, even without the government stress test, we do know (at least know enough) the conditions of all the banks. Most banks are healthily capitalized. This is on top of the government guarantee backing all the banks! This is clearly showed here:

    3) Hedge against being wipe out by government

    The banks are understandably afraid of being put into receivership, nationalization, preprivatization etc. Let’s pause and consider the irony here! The commentariates argue for “pre-privatization” so the resulting healthy banks can lend and support the economy’s recovery. Unfortunately, this ended up putting the banks (most banks are already healthy) into a survival defense mode! They aren’t lending so that they can increase their capitalization level. They do this is so that they can past any external scrutiny with flying color. No bank wants to end up like WaMu or Wachovia! Now consider the amount of money horded and not getting multiplied by our fractional banking system. Painful irony.

    A word on cyclical policies:

    We should increase capital requirement during boom times and relax capital requirement during recession. Now is absolutely the wrong time to wag our fingers at the banks and say they need more capital. In fact, now is the time to out right tell the banks we’ll *relax* their capital requirement!

    By the way, China’s bank system is an excellent demonstration of this counter cyclical policy in action. Last few years, China had the biggest economic boom on earth. However, their central bank ratchet up reserve requirements and limited lending. Now their banks are well capitalized. Their central bank is now following a relaxed lending policy and lending is breaking all records.

    What is even more painfully ironic is the biggest shareholders of US banks are average US citizens with their 401K, IRA and pension plans!! When existing bank shareholders are wiped out and new investors buy the “clean up banks” pennies on the dollar is when real wealth is transferred from someone’s pension plan to the new investor’s portfolio holding! With pre-privatization, the average investor gets to ride the crash down but doesn’t get to ride it back up when the economy recovers. This may also suggest #1 above is not true and that there are qualify borrowers.

  32. StatsGuy, the last paragraph in my post above is a cut and paste error. I didn’t want to cause you any confusion.

  33. AJ,

    Thanks for the input. I stronglhy suspect you are right. 19 Banks is an oligopoly, but the number is just too large. However, is it possible to come up wiht some sort of model of anti-competitive behavior that operates even with such a large number? Some people are convinced that the main actors all belong to the same club. It’s a stretch, but would some sort of cartel theory have a chance. How about Mastercard and Visa as a duopoly?

  34. Thanks Ted. I hope this will shed some light on the root of the issue.

    Simon has made his view clear. He is suggesting to his ill informed audience that we are likely to repeat Japan’s lost decade. What I like to know is what is his prediction base on.

    Just at a high level, we are talking about two countries with vastly different characteristics and societal structures. Furthermore, the two financial systems cannot be more different. The Japanese financial system took one blow after their asset bubble crash during the early 90s and has not recover it’s formal glory ever since. On the other hand, the US financial system was knocked down repeatedly during the last century through depression, recessions and wars. Through every crisis, the US financial system fixed its weakness and became stronger than before. The US financial system exemplified “what doesn’t kill you makes you stronger”. The US financial system has earned the #1 position in the world for a century.

    The US economy today and the Japanese economy in the 90s are two vastly complex systems. Furthermore, the initial conditions are also vastly different. So given 2 complex systems with 2 different initial conditions, yet Simon is still confidently predicting US will follow Japan! Well, I am open to that! Given the extraordinary claim, I expect to see some serious hardcore intellectual justification that goes beyond superficial similarities.

    Having said the above, if Simon cannot then I do have a real beef with Simon. If there is a fire, instead of helping to put out the fire, someone pours gasoline on it; I definitely have a problem with that. Fear mongering during a crisis is pouring gasoline on fire.

    Regarding Krugman, I don’t believe Krugman is an expert on Japan’s lost decade. Furthermore, his blog at NYTimes is for general consumption and grossly lacking in depth and detail. Others such as Brad Delong ( do a much better job than Krugman by far. By the way, Brad Delong did recently discuss Japan, among other topics, during an hour long interview with Bloomberg (available on podcast).

  35. My question for Christina Romer is as follows:
    Do you agree that banks, which want to continue relying on the financial support by the federal government, must disclose details of stress tests to the public?

    The definition of fiancnial government support here includes both the Capital Purchase Program, which under the TARP provided preferred equity to banks, and various liquidity programs, such as CPFF, TALF, TLGP, PPIP, and others, which are putting public funds at risk.

    Banks will then have two options:

    1) Some banks may choose not to disclose their stress test results. In this case, these banks will be given a certain amount of time to return funds they received under the TARP and stop using any of the liquidity programs which can potentially result in losses to the Federal Reserve, Treasury or the FDIC, or ultimately, losses to the taxpayers.

    2) Banks that choose to maintain access to these programs have to publish detailed results of their stress tests. A public oversight body, say, the Joint Economic Committee of the Congress, will need to decide on case by case basis if these banks have to strengthen their capital base to retain access to programs posing potential risk to the Federal Reserve, Treasury or the FDIC. Moreover, the public oversight body will be responsible for deciding if and when stress tests must be repeated, should the economy deteriorate further, beyond the “more adverse scenario” used in the stress tests.

    Support by the taxpayers requires full transparency for the taxpayers!

  36. Ms. Romer,

    Why don’t we do what the Italians have done?
    Why not charge the leading executives of these banks and AIG with fraud? They told their customers that various derivatives and credit default swaps and so on were as liquid and safe as T bills. They hid their fees. They knew precisely what they were doing and I am sure documentation is abundant and a good prosecutor can motivate witnesses to testify to the criminal intent.

    Why protect a criminal combine that involved much more money than the Mafia ever dreamed of stealing?

    Bob Eisenberg

  37. I won’t try to speak for Simon, but the distinctions between Japan and the USA, and the claim that the US will be ok in 2009, because it has weathered past financial crises miss the point and/or assume that if something happens a few times, it will always happen. The crucial similarity between Japan 1990 and the US 2008, is that when financial crisis came, the political class and the captains of (the finance) industry could not bring themselves to deal with the crisis in a transparent fashion. Read Professor J. Galbraith’s “Due Diligence, Damn it” from February on this. Read Prof. J Peek’s 1999 analysis of Japan in the New England Economic Review. The common thread is that in both countries, the representatives of the people worked on the basis that if no-one actually said the banks were insolvent, they would be solvent – witness Geithner’s weasel words “currently the vast majority of banks have more capital than they need to be considered well capitalized by their regulators”. This is deceitful and mad and as such means that any recovery will be based on perception, not objective fact.

    I’ve noticed, recently, that a lot of posts on baselinescenario are getting bogged down in minutiae and technocratic argument. The crucial issues are incredibly straightforward: there has been massive fraud in the US financial system, and the political class has responded to this with spin. Concentrate on that and America may come out of this crisis ok; bicker amongst yourselves and Adios Amigos will be right – you will be finished.

  38. Looks like you missed my point. We have two different and complex systems with different initial conditions. Simon is making a casual prediction that the two systems will behave similarly. Under pretty much any context, this is foolish self-deception at best, fear mongering during a crisis at worse.

    As for looking for a villain to blame, you should try to be comprehensive. Otherwise, the villain that you missed will likely come back! Let me start you off:

    1. US regulators has relaxed banking regulations for decades.
    2. US Fed under Greenspan keep interest rate too low. This is the most direct cause to the housing bubble.
    3. US consumers spent beyond their means
    4. US banks participated in the sub-prime lending

    So, the US government, US consumers and US financial institutions are all to blame. I am leaving out international imbalances in trade. This is because no one forced us to spend like there is no tomorrow. But others may want to include our trading partners in the above list.

    You know, what really annoys me is most people don’t think critically and independently. They accept what they are spoon-fed on face value. You could add this to the list above. After all, it seems silly now, but some people used to believe house price will never go down! This isn’t just the consumer either. This included banks that made subprime loans and buy and sell mortgage based securities.

    By the way, I didn’t make any public prediction that US will be OK or not OK in 2009. My take is to hope for the best, prepare for the worst. Luckily the last few months have been very encouraging.

  39. Some questions for Christina Romer:

    A) About the PPIP:

    You were quoted as saying, “What we’re talking about now are private firms that are kind of doing us a favor, right, coming into this market to help us buy these toxic assets off banks’ balance sheets.”

    1) Assuming “private firms” includes hedge funds and “us” refers to taxpayers, why don’t hedge funds renounce their “carried interest” tax treatment if they want to do taxpayers a favor?

    2) Are these private firms going to do us a favor in their purchases of “toxic assets” by paying more than the bid side of the current market?

    3) If the answer to 2) is yes, will their bids exceed the bid side by more than the value of the PPIP’s below-market financing and put option?

    4) If the answer to 3) is no, how does the plan help taxpayers, who are providing the below-market financing and put option?

    5) If the answer to 3) is yes, why haven’t the private firms bought the assets from the banks without benefit of the PPIP?

    6) If the answer to 3) is yes, what will allow the private firms to pay more: superior asset valuation or management skills?

    7) If the answer to 6) is superior valuation skills, does this imply that the banks will succeed in selling only their most under-valued assets? Will this improve their solvency?

    8) If the answer to 6) is superior management skills, how can the private firms influence the cash flows of the “toxic assets,” which depend on their underlying mortgages, which in turn are a function of house prices, interest rates, unemployment and income levels, and underwater homeowners’ taste for avoiding default?

    B) About Wall Street and the administration:

    1) During this crisis, the government and the media have tended to lump together commercial and investment banks and treat “the banks’” return to health as a necessary prerequisite to the real economy’s revival. Despite the repeal of Glass-Steagal, even firms that engage in both types of banking maintain this organizational division. What essential functions do investment banks (whether standalone or part of a universal bank) perform in the U.S. economy?

    2) Given Wall Street’s history of misconduct, both proven (e.g., municipal yield-burning and Nasdaq market-maker violations) and never-investigated (e.g., front-running in the Treasury market, described at, what resources is the administration devoting to investigating and prosecuting fraud in the mortgage securitization market?

    3) President Obama and others in the administration have been critical of Wall Street during the crisis. Which members of the administration were critical of Wall Street prior to the crisis?

    4) Tim Geithner and Larry Summers are frequently described as being “close to Wall Street,” yet neither has ever worked at a (for-profit) bank. What are their sources of information on how Wall Street works?

  40. I would hope Ms. Romer would follow the form you ask in answering the question #1. Also are there any lessons that can be learned even though there are differences in the economies and the financial sectors?

    My question to you would be can we learn anything from any other “event” because each and every country effected is unique to themselves? If not then is there any hope for the study of economics?

    Thank you for the reference to Brad Delong. I believe he agrees that Krugman has the facts correct as to the history of the crisis. He does disagree with Krugman’s “answers” concerning the need for modest inflation and its implications. Some of Mr. Krugman’s books have more depth than his column and blog.

  41. We definitely should study history and apply what we’ve learned. However, I am saying we should do a serious analysis before making an extraordinary claim.

    Simon just casually predicts US will follow Japan.

    We already have many signs suggesting this is not the case. For example, the US’ monetary policies and fiscal policies are way ahead of Japan in the 90s. This is definitely credit to Obama and his team. Or look at how we are handling the toxic assets vs. Japan. Here I haven’t even touch on structural differences like Japanese keiretsus and their relationships with banks and etc. If you dig below the surface you’ll find many of the problems that plagued Japan that doesn’t affect US.

    No one can say for sure we won’t have an L shape recovery. But if we do, my bet is that we’ll face many different challenges than what Japan experienced.

  42. I’d like to suggest that you should look at the total aggregate cost of this recession in financial terms and in human suffering. This is the crucial issue of the highest priority right now.

    There serious systemic problem with our financial system. However, let’s put out the house fire first. Let’s address the fire codes and it’s enforcement second.

    Does that make sense?

  43. I’m sure there are enough “talented, hardworking, and knowledgeable people” to fill those positions without the revolving door between industry and politicians. You should not be allowed to leave a position with a politician and immediately work for groups trying to influence said politician.

    That is clearly unethical.

  44. And something that was supposed to change? Of course being the life-long victim of both Illinois parties’ politics, I have long been suspect of hope, change, our time, etal.

  45. I fully support suggestion #2. However, it should be restricted to educating students in the US Capitalist economy. Otherwise it might start to become an indoctrination class for an “Animal Farm” agenda.

  46. Simple answer on lack of borrowers. Check out current rates on loans on mortgage refinances and new car loans outside of highly credit worthy customers. These rates are very unattractive. Also, prior to the credit collapse, the vast majority of Americans considered the largest component of personal wealth to be home equity which in some cases has either disappeared or turned negative, the inverse of a “wealth effect.” With 401K declines mostly in the double digits, it appears consumers behavioral response to avoid borrowing is quite rational. I read somewhere the drop in consumer credit demand was around 29%.

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