What happened to the global economy and what we can do about it
Author: James Kwak
At the request of several readers, I’ve printed entire months of blog posts to PDFs for download. There is also a “Download the Blog (PDF)” link in the sidebar under navigation. This might be useful for new readers who want to catch up on a plane, or something like that.
I did this in a very low-tech way (explained after that link) so if you have suggestions for how to do it faster or more elegantly please post them there.
By James Kwak
Simon and I wrote on op-ed in the New York Times today, trying to debunk the idea that, as we put it, “A.I.G.’s traders are the people that we must depend on to save the United States economy.” The AIG bonus fiasco, as I’ve written earlier, has been particularly useful in raising the political cost of the administration’s current bailout strategy. But, as I said then, “$165 million, of course, is less than one-tenth of one percent of the total amount of bailout money given to AIG in one form or another.” And as far as the cost to the taxpayer is concerned, the big bill is for bailing out AIG’s creditors. In his op-ed in the Wall Street Journal today, Lucian Bebchuk wants to know why.
Now, the government has not explicitly guaranteed AIG’s liabilities. But the main reason for bailing out AIG in the first place was the fear that an uncontrolled failure would have ripple effects that would take down many other financial institutions who were dependent in some way on AIG; most commonly, they had bought insurance, in the form of credit default swaps, from AIG and were counting on being paid. And a major usage of bailout money has been to make whole AIG’s counterparties holding those credit default swaps, primarily investment banks trading on their own account or on behalf of their hedge fund customers.
Occasionally we get personal finance questions. Actually, we’ve gotten fewer of those questions lately, perhaps because readers realize we don’t have much to offer on that score, and that we try to avoid anything that might sound like investment advice.
Zvi Bodie, whose name you may have seen here before, has thought a lot about personal investing, and agrees with some of the positions I’ve offered here: notably, that most information about personal finance available on the market is not worth listening to. Bodie recently posted a series of 3-minute webcasts to the Boston University School of Management website where he lays out some basic advice on saving for retirement, including some of the implications of the current economic crisis. I didn’t watch all of them, but I liked how accessible they were.
By James Kwak
We are going to start experimenting with Twitter. I’m not sure how we’re going to use it, but our handle is baselinescene and you can find it here. Simon and I are sharing one account and, if we remember, will put our initials at the end of updates so you can tell who is who. We will probably use it to announce new posts (but probably not all of them, since right now I don’t know how to do it automatically), link to articles we find interesting but don’t have time to blog about, and broadcast random thoughts about the economy. (Don’t expect to find what we ate for lunch – unless it’s really good.) If this doesn’t turn into something useful, we’ll stop using it.
I’m not going to explain what Twitter is and how to use it, because I don’t really know. If you don’t know and you’re curious, ask someone under the age of 30.
Update: Thanks to the reader who pointed out twitterfeed, our new blog posts are now automatically added to our Twitter updates.
Also, for those who may be worried: If you ignore Twitter, you won’t be losing out on anything important; there’s nothing we do on the blog today that we are moving to Twitter.
Email updates
Several people have pointed out that our automated email updates do not include the name of the author for each post. This is a problem with Feedburner (the service we use to generate and send these updates) and there is no known solution.* So we have decided to start manually adding our names at the end of posts from now on. Since this is manual, we may forget from time to time; you can always find out who the author is by visiting the post itself on the web.
* We can’t use FeedFlares because we use WordPress.com, which doesn’t allow Javascript.
By James Kwak
In the past, several of our readers have asked if we could help organize some sort of popular political movement to protest some of the policies that we have criticized. That isn’t anything we have any experience or expertise in, however.But in case you are interested, I wanted to let you know about a new group called A New Way Forward that is organizing rallies on April 11. Their platform is pretty straightforward:
NATIONALIZE: Experts agree — Insolvent banks that are too big to fail must incur a temporary FDIC intervention – no more blank check taxpayer handouts.
REORGANIZE: Current CEOs and board members must be removed and bonuses wiped out. The financial elite must share in the cost of what they have caused.
DECENTRALIZE: Banks must be broken up and sold back to the private market with new antitrust rules in place– new banks, managed by new people. Any bank that’s “too big to fail” means that it’s too big for a free market to function.
A New Way Forward is being organized by two people from the Participatory Politics Foundation, although the two groups are not officially related.
By James Kwak
$165 million, of course, is less than one-tenth of one percent of the total amount of bailout money given to AIG in one form or another. Yet it may turn out to be the $165 million that broke the camel’s back.
The AIG bonus saga neatly encapsulates many of the problems that we have identified with the financial system and with the bailout to date.
Adam Davidson at Planet Money recently asked, “Who Do We Blame?” Which, I think, is a perfectly legitimate question. While the most important things are getting ourselves out of this crisis and reducing the chances of another one happening, asking who is at fault for this one is a reasonable exercise, for at least two reasons: first, it responds to our basic human curiosity; second, since many of the parties involved care only about their reputations (Bush, Clinton, Greenspan, Paulson, etc. have enough money for several lifetimes), going after people’s reputations is one of the few ways to create some measure of accountability. Politicians who inveigh against “pointing fingers” usually have something to hide.
I started writing a comment on the Planet Money thread, but they have a character limit on comments, and it’s hard for me to write anything in fewer than 1250 characters. So I emailed them my response and, what do you know, they put it up as a post on their blog. To save you any suspense, I think that if you are going to blame any individual (as opposed to, say, a whole category of activity, like “lax loan underwriting”), it should be Alan Greenspan, for reasons described further in that post.
Update: My friend Dave Sohigian blames an entire generation.
More extra-credit reading while on spring break: Sanjiv Gupta has an article at The Huffington Post about the relationship between the financial crisis, our banking sector, and democracy. The central question, as I see it, is an old one: how to ensure that a democratic political system is not undermined by a non-democratic economic system. Gupta suggests, as one possible step, a national credit union to compete with private-sector banks. To think about this in detail, we’d have to think about why we (most of us, including me) instinctively think that the following the profit motive is generally the right way to allocate capital. That’s something I hope to devote more space to later.
My school is on break this week, so I’m taking some time off from now through Wednesday or Thursday. I probably won’t write anything very involved, but I will try to point out a few things I’ve been reading.
On that note, I finally read Amartya Sen’s essay “Capitalism in Crisis” from The New York Review of Books. The article meanders through a variety of topics, but two of the broad themes are: the economic systems we call “capitalist” involve much more intertwining of free markets and nonmarket goods and services (education, health care, pensions, etc.) than most people realize; and we need less to invent a new form of capitalism than to understand better the one we already have.
This is my last post on nationalization for at least a week, and hopefully a lot longer than that. I’m tired of writing about it. But I was listening to Raghuram Rajan on Planet Money, and things became a little more clear to me.
Rajan was saying that he had some concerns about nationalization and didn’t think it was necessary to fix the banking system. His concerns were sensible, I have counter-arguments for them, and I don’t want to get into a detailed debate here. More importantly, he agreed with the nationalizers that the system is broken, hasn’t been fixed, and needs to be fixed – he just thinks you could do it a different way.
As Bernie Madoff goes to his reward today, we should be asking how this could have happened. Not only Madoff and Allen Stanford, but also dozens of “mini-Madoffs” have been unearthed since the market collapse in September and October, which seems to have reminded the SEC that it has an law enforcement function. Not surprisingly, regulators are ramping up their enforcement divisions, and Congressmen are planning legislation to increase enforcement budgets.
A little late to close the barn door.
While Christopher Cox, SEC chairman from 2005 until this January, makes an obvious target, there is a deeper phenomenon at work than just the Bush administration’s hands-off attitude toward corporate fraud (an attitude largely shared by the Clinton administration). That is the general tendency of people – investors and officials alike – to underestimate the risk of fraud during a boom and overestimate the risk of fraud during a bust.
Move over, Bill Moyers.* Simon is going to be on Stephen Colbert tonight.
If you have predictions about what Colbert is going to want to talk about, or ideas for witty comebacks, please post them. I believe Simon is traveling but will check in around 6 pm Eastern.
* Just kidding. Bill Moyers is one of our finest public servants.
A week ago, Simon wrote his “Confusion, Tunneling, and Looting” post, which argued that the confusion created by crises helps the powerful and well-positioned siphon assets out of institutions and out of the government. The revelations that much of the AIG bailout money has gone straight to its large bank counterparties in the form of collateral could fall under this heading.
The looting theme has gone mainstream, with David Leonhardt in The New York Times. I think Leonhardt’s article is good, but it describes looting (taking advantage of implicit government guarantees to take excessive risks) as a cause of the mess we are now in – and as something we’ll need to worry about in preventing crises in the future. But, as Simon argued, it’s also something to worry about right now. As long as the Too Big To Fail doctrine holds, the banks’ implicit government guarantee is more explicit than it ever has been. So whatever perverse incentives helped bring on the crisis are even stronger today.
As Simon wrote this morning, the administration strategy is to wait and see if the economy turns around, lifting banks out of the mess they created. How can you tell if this is working? One way is to look at bank bonds.
If the administration is right and the banks are healthy (and to the extent they aren’t healthy, their capital will be topped up with convertible preferred shares), then bank bonds are safe. Even subordinated bonds (the ones that get paid off after senior bonds and insured deposits) are protected by the bank’s capital – both common and preferred shares. So if the administration is correct that the banking system is adequately capitalized, and will be even more adequately capitalized after the stress tests and capital infusions, then banks will be able to pay off all of their bonds.
Even if the administration is wrong and the banks are not adequately capitalized, bondholders are only in danger if the administration decides not to protect them. This could happen in one of two ways. First, the administration could request, as a condition of a future bailout, that bondholders exchange some of their debt for equity. There is no law that says that bondholders have to exchange their bonds for equity just because the government asks, so the threat would be that the government would not bail out the bank otherwise (forcing it into bankruptcy or conservatorship).* Second, the administration could take over the banks; in that case, the regulator might decide not to pay back all of the bondholders – but it certainly could decide to pay them back. It’s just a question of whether losses are borne by the bondholders or the taxpayer (assuing the equity holders have been wiped out).
So what does the bond market think?
(For a complete list of Beginners posts, see Financial Crisis for Beginners.)
If you want to get caught up on the financial and economic crisis in a hurry (and get a quick refresher on first-year macroeconomics), Charles Jones has a drafted a new chapter on the crisis for his macroeconomics textbook. (If you’ve already read all of our Beginners posts, though, hopefully you won’t need to get caught up.) It’s 43 pages long (not very many words per page, though) and includes a relatively standard account of how the crisis came about (with a focus on the U.S. housing bubble), the impact on the real economy, and the thinking behind monetary policy, the fiscal stimulus, and the main proposals to fix the banking system. (Perhaps wisely, he doesn’t say which proposal – buying toxic assets, recapitalization, or reorganization – he recommends.) There is a discussion of what the crisis looks like in IS-LM terms – the main change from the standard version being the jump in the risk premium, which undermines the Fed’s ability to reduce effective interest rates. He also discusses the “zero bound” on nominal interest rates, in case you were wondering what that meant.
I think there should be a lot more on the crisis outside the U.S., for two reasons: first, it’s hitting harder in most other countries; and second, with so many countries being affected in so many different ways (Eastern Europe bubbles collapsing, China and Japan losing demand for exports, Russia hit by falling commodity prices, Iceland crashing under a hypertrophied banking sector), there would be lots to write about.
Jones even closes with a note of optimism:
Whatever happens in the coming years, it is worth remembering a key fact about the Great Depression, in evidence on the cover of the macroeconomics textbook . . . Even something as earth-shaking as the Great Depression essentially left the long-run GDP of the United States largely unaffected.
Update: I meant, but forgot, to add that Jones does not attempt to address the question of whether macroeconomics as a field needs to be revised in the light of the crisis. Mark Thoma has several posts on this question: a few are here, here, and here.
The Baseline Scenario 