Author: James Kwak

Yet More on GM

My two earlier posts on the auto industry and GM have been among the most-commented-on posts in our brief history. For those who want a crash course on GM’s problems and whether or not bankruptcy is a possible solution, I strongly recommend two podcasts from Planet Money.

  • Kimberly Rodriguez, an economist, talks about the importance of the industry, but also the problems with simply giving GM an operational loan.
  • Steve Jakubowski, a bankruptcy lawyer, explains the risks of GM entering Chapter 11 (if you’re curious about the market for debtor-in-possession financing, listen to this), but also explains how a “prepackaged” bankruptcy, possibly funded by the government, could work.

Simon also tells me he talked through the arguments on both sides of the GM issue in his latest installment for the MIT Sloan podcast. (I haven’t had time to listen to it yet.)

If there’s a consensus between them, I’d say it’s that some kind of brokered solution is better than either simply leaving GM alone or simply handing them a loan without strings attached. (It is possible, however, that a loan might be necessary just to buy enough time to broker the solution.)

The New York Times is reporting that it could all be academic, since Senate Republicans and President Bush are opposed to doing anything for GM, and GM could be unable to pay its bills by the time Obama takes office.

Other Good Sources of Information and Perspectives

Since the article about Simon in the WSJ earlier today, we’ve been getting a large number of first-time visitors. On the chance that some of you are new to the economics blogs, I wanted to suggest a few other sites you might also want to check out. We are nowhere close to the be-all and end-all of information about the global economy or the current crisis, and in any case the more perspectives you get, the better.

  • Planet Money is an excellent, excellent podcast for people who are relatively new to the world of economics and the financial crisis, and for people who commute and can listen to it in their cars. I listen to it for fun.
  • Real Time Economics (Wall Street Journal) gives you rapid coverage of economic issues as they arise.
  • Calculated Risk and naked capitalism are good sources for near-real-time news about the crisis and the economy in general. Calculated risk has a particular focus on housing and mortgages; naked capitalism has incisive commentary from one side of the political spectrum.
  • Econbrowser is more technical and data-oriented; more advanced readers will like this one.
  • Economist’s View and Marginal Revolution provide in-depth articles applying economics to broad range of phenomena.
  • And James Surowiecki has a blog!

Of course, we would love it if you would come back here often (or sign up for email subscriptions). But I wanted you to know some of your options.

(Feel free to add other suggestions in the comments.)

America Is Best Country

When I was in college, the college humor magazine did a brilliant spoof of USA Today, complete with a silly poll in the lower-left-hand corner of the front page. According to their mock poll, Americans thought that the United States was the best country in the world, with about 92% of the vote.

I was reminded of this today by President’s Bush’s speech today, which the Wall Street Journal summarized as “Bush Defends American Capitalism.” The thrust of the speech was, indeed, that American-style capitalism is the best economic system there is, and that the current global crisis should not lead to a reaction against free markets.

I consider the second half of that sentence a fairly unobjectionable position. Saying that we need transparency, cooperation, and economic growth are also fairly unsurprising. However, I wouldn’t say Bush’s arguments that American capitalism – our curious mix of free-market ideology, lobbyist-driven politics, and widespread private sector capture of regulatory agencies – is the best possible expression of free markets is very convincing. Look at what he compares us to:

Meanwhile, nations that have pursued other models have experienced devastating results. Soviet communism starved millions, bankrupted an empire, and collapsed as decisively as the Berlin Wall. Cuba, once known for its vast fields of cane, is now forced to ration sugar. And while Iran sits atop giant oil reserves, its people cannot put enough gasoline in its — in their cars.

It’s also curious how Bush trots out those red herrings, like “authorities in every nation should take a fresh look at the rules governing market manipulation and fraud.” Sure, I’m against market manipulation and fraud, too, but saying they were a significant part of the global crisis is misdirection akin to calling the corporate scandals of the beginning of the decade (Enron, WorldCom, etc.) the fault of “a few bad apples.” The vast majority of the behavior of people who were selling mortgages, securitizing mortgages, rating securities, and trading credit default swaps was completely, 100%, tell-it-to-Santa-Claus legal.

Then there’s the disingenuous argument par excellence:

History has shown that the greater threat to economic prosperity is not too little government involvement in the market, it is too much government involvement in the market. (Applause.) We saw this in the case of Fannie Mae and Freddie Mac. Because these firms were chartered by the United States Congress, many believed they were backed by the full faith and credit of the United States government. Investors put huge amounts of money into Fannie and Freddie, which they used to build up irresponsibly large portfolios of mortgage-backed securities. And when the housing market declined, these securities, of course, plummeted in value. It took a taxpayer-funded rescue to keep Fannie and Freddie from collapsing in a way that would have devastated the global financial system.

The idea that Fannie and Freddie were the cause of the crisis is simply false, at least in the form it usually takes, and one I’d hoped I’d heard the last of once the Presidential campaign was over. During the peak of the subprime boom, Fannie and Freddie were buying a smaller and smaller share of subprime loans in comparison to private sector institutions. Fannie and Freddie got into trouble because they were private companies using their implicit government guarantee to fund risky investments in search of higher profits; the problem was not too much government, but management and shareholders making a quick buck off the government.

For the record, I’m for free markets, not socialism. But I’m not for a lame-duck president making campaign speeches when what we need are real solutions.

Update: Hey, Felix Salmon agrees with me on this. He even uses the word “disingenuous” in roughly the same place that I do.

India in the Global Economy

One of our commenters pointed out that we have failed to say anything about India, despite its large and growing importance in the global economy. Simon’s colleague Arvind Subramanian (whom we have linked to before, including this morning) has a new opinion piece, originally posted at the Peterson Institute.

India and the G-20

The upcoming G-20 summit meeting in Washington provides an opportunity for India to help shape the new global economic architecture in line with its strategic and economic interests. India should propose short-term, crisis response actions to help limit the economic downturn; advance a clear, medium-term agenda; and push for a political commitment by all countries to keep markets open and prevent trade barriers from going higher.

Although the G-20 has been in existence for nearly a decade, this is the first G-20 summit meeting, and many participants will be looking to Prime Minister Manmohan Singh, a respected economist in India and throughout the world, for a particular contribution.

What does India bring to the G-20 table? As a long-time spokesperson for the G-77, India has a record of assuming a leadership role. But in the past, this role was often used to assert India’s right to retain sovereignty. In the words of Strobe Talbott, the former diplomat who now leads the Brookings Institution, India has been on many issues a “sovereignty hawk,” protecting its own interests at the expense of global cooperation on issues ranging from nuclear proliferation to trade. But with India’s growth, and in an era of globalization, its interests—and its perception of its interests—have changed. India now has a keen stake in sustaining an open global trading system. Accordingly, its leadership should now be harnessed for a different cause. Moreover, India has begun to realize that it needs to contribute to sustaining this system rather than assuming that the status quo can be taken for granted. But trading partners are wary of India, viewing India’s role in the trade negotiations as unhelpful. It would be a singular achievement if India can manage to reassure G-20 participants on this score. In short, leadership comes naturally to India. The question is going to be the cause for which India harnesses this leadership role.

As Aaditya Mattoo of the World Bank and I have argued [pdf], for India the medium-term agenda should include: First, reforming the financial architecture, including by strengthening the International Monetary Fund’s capacity to respond to crises and enhancing its legitimacy through radical governance reform to give greater say to the emerging powers. Second, securing the future openness of the trading system, which would require a commitment to go beyond completing the current Doha agenda in two ways: deepening rules in existing areas (especially services) and developing rules in new areas (to deal with undervalued exchange rates, cartelization of oil markets, investment restrictions and environmental protectionism). Third, reforming the makeup of the bodies involved in global decision-making, including the creation of a more representative membership than the G-7.

Arvind Subramanian is a Senior Fellow, Peterson Institute for International Economics and Center for Global Development, and Senior Research Professor, Johns Hopkins University

The Quest for Global Balance

Even with all the chaos in the US economy these days, the G20 summit approaching this weekend is bringing the global financial system to the top of the agenda, at least for the few days. One of the issues of the past few weeks has been volatility in currency prices as (most) countries with overvalued currencies and large current account deficits see their currencies fall. The flip side of this situation is countries with undervalued currencies and large current surpluses – most notably, China. Arvind Subramanian presents one solution in the Financial Times: treat undervalued currencies as a form of trade barrier and manage them through the WTO.

Not with a Bang but a Whimper

Two days ago, in my post about AIG, I had the following passage:

In mid-October, Treasury committed $250 billion to explicit recapitalization, but to all intents and purposes seems committed to using some of the other $450 billion to buy those same toxic assets – at what price is still unclear. (Why they would still bother doing this is also unclear, for that matter.)

I meant to expand on that throwaway parenthesis, but I was busy all day today and didn’t get around to it. By the time I got home, I found out that Henry Paulson had scrapped the idea of buying troubled assets altogether (something we’ve favored for a while), saving me the effort of arguing against it.

Unfortunately, after reading Bloomberg, The New York Times, the Wall Street Journal, and the text of Paulson’s remarks, I can’t figure out what they’re doing with the remaining money instead. The main emphasis of the news articles was on the new idea to create a new entity, seeded by TARP money, to lend money against consumer loans, in order to stimulate demand for those loans and hence consumer lending. But this was just one of three possibilities that Paulson mentioned: the others were additional recapitalizations (potentially with a public-private structure, or expanded to a broader range of financial institutions) and a loan-modification program.

While I agree with Andrew Ross Sorkin that it’s a good thing Paulson was able to change his mind about buying illiquid assets, I would feel better if he knew what he was changing his mind to.

Russia Tries to Stop Ruble from Falling, Gives Up

The emerging markets rout continues: Russia, she of the $500 billion war chest of foreign currency reserves, spent 19% of those reserves trying to fight off a currency devaluation. Today, Russia didn’t quite give up the fight, but conceded some ground, widening the allowed trading range and at the same time increasing interest rates. Just goes to show: fighting those nasty currency speculators rarely works, if ever.

(Thanks to Free Exchange for catching this.)

An Economic Strategy for Obama

Barack Obama has been getting a mountain of unsolicated economic advice; here’s one selection. In case he needs more to read, we posted our long-term recommendations on the WSJ Real Time Economics blog today. In short, we see a long-term challenge – and opportunity – to shift resources from the financial sector and into what is colloquially called the “real economy.” This will require, among other things, investment in education, openness to immigration, consolidated financial regulation, and assistance for workers affected by restructuring.

Why Not Let GM Go Bankrupt?

GM is mounting a massive PR campaign to convince Washington that a GM bankruptcy would be catastrophic to the national economy, resulting in the loss of millions of jobs, costing taxpayers over $100 billion, and plunging the economy into a depression (whatever that is). In addition to Nancy Pelosi and Harry Reed, Barack Obama has now called for an auto bailout.

I don’t want the US auto industry to go away. Yes, if GM and every one of its suppliers and dealers stopped operating tomorrow, that would cost hundreds of thousands or millions of jobs. But it’s not clear to me why bankruptcy would have the same effect. Ordinarily, when a company goes bankrupt – especially a big one – it goes right along doing whatever it was doing before, except now it doesn’t have to pay off all its creditors, and its operations are monitored by a court. The bankruptcy process is intended to find a reasonable outcome for all of the stakeholders that reflects the order of priority of their claims, but also (in the case of a company as big as GM) reflects the public interest. Airlines, for example, have been going in and out of bankruptcy for years in order to force their unions to negotiate long-term cost reductions, and even use the threat of bankruptcy as a negotiating tool.

Continue reading “Why Not Let GM Go Bankrupt?” →

Baseline Scenario, 11/10/08

Baseline Scenario, November 10, 2008
By Peter Boone, Simon Johnson, and James Kwak, copyright of the authors

The Baseline Scenario is our periodic overview of the current state of the global economy and our policy proposals. It includes two sections:

  1. Analysis of the current situation and how we got here
  2. Policy proposals

Please note that we do not currently publish our upside and downside risk scenarios in detail.

_______________________________________________________________
ANALYSIS

The roots of the crisis

For at least the last year and a half, as banks took successive writedowns related to deteriorating mortgage-backed securities, the conventional wisdom was that we were facing a crisis of bank solvency triggered by falling housing prices and magnified by leverage. However, falling housing prices and high leverage alone would not necessarily have created the situation we are now in.

Continue reading “Baseline Scenario, 11/10/08” →

The Overpayment Begins

Way back in the heady days of September, we criticized the original version of TARP because it seemed designed to ensure the government would overpay for toxic assets. Instead, we recommended splitting the transaction into two parts: (a) buy the assets at market (cheap) prices, and (b) explicitly recapitalize the banks. In mid-October, Treasury committed $250 billion to explicit recapitalization, but to all intents and purposes seems committed to using some of the other $450 billion to buy those same toxic assets – at what price is still unclear. (Why they would still bother doing this is also unclear, for that matter.)

Until now.

Today’s government re-re-bailout of AIG (WSJ article; Yves Smith commentary) can be hard to follow, but one provision is the creation of a new entity with $5 billion from AIG and $30 billion from the government to buy collateralized debt obligations (CDOs). The goal is to buy CDOs that AIG insured (using credit default swaps), because if those CDOs are held by an entity that is friendly to AIG, that entity will no longer demand collateral from AIG. The theory is that in the long run these CDOs will not default and that the new entity will make money on the deal.

The rub is that this entity is planning to pay 50 cents on the dollar for these CDOs. This has two problems. First, 50 cents is almost certainly more than these CDOs are worth on their own (hence the title of this post). If they were really worth 50 cents on the dollar, AIG wouldn’t be having the problems it is having posting collateral; like the original TARP plan, this is an unfounded bet that the market is mispricing these assets. Second, and more bafflingly, the CDS contract is presumably separate from the ownership of the CDO; that is, buying the CDO from the counterparty doesn’t eliminate AIG’s obligation to pay if the CDO defaults, and hence doesn’t serve its stated purpose. If, on the contrary, the CDS contract is contingent on the counterparty holding the CDO, then the CDO is worth a lot more than 50 cents to the counterparty, because it is insured for 100 cents by AIG – and we all know the government isn’t going to let AIG default on those swaps. And no sane counterparty would sell for 50 cents.

Supposedly Treasury had enough time to think about how AIG should be bailed out and this is a better bailout than the original. If it is, I must be missing something.

If You’ve Got It, Flaunt It

Other countries can only drool with envy. China today announced a $586 billion stimulus package – that’s 17% of 2007 GDP. Spread through the end of 2010, it’s still more than 7% of GDP per year. By comparison, the US stimulus package earlier this year was just over 1% of GDP, and after causing a small uptick in spending in Q2 it vanished into the sea of bad news; our recent proposal was for 3% of GDP, and that was at the higher end of the range.

Of course, the stakes for China are very high. GDP growth ranged between 11 and 12% in 2006 and 2007, but the IMF recently cut its estimate for 2009 to 8.5% (down from the 9.3% estimate just a month ago), and according to the New York Times article the annualized rate for this quarter could be as low as 5.8%. While these are growth rates that the developed world hasn’t seen for decades, the huge population migration from countryside to city requires high growth simply to keep unemployment in check. So the Chinese government brought out the heavy economic artillery.

The current crisis has proven, if it needed any proof, that even China is susceptible to the fortunes of the global economy. If it can lead to greater participation by China in the global financial system, including institutions like the IMF, that would be one positive outcome.

Simon on FLYP

FLYP, which I can only describe as an online multimedia magazine, has a “cover story” entitled “Now What?” on the challenges the country faces and various perspectives on what the Obama administration should do about them. Simon is interviewed (in video) for “pages” 7 (domestic economy) and 10 (global financial system), but there are also sections on foreign policy, energy, the environment, health care, and so on.

(I should add that FLYP is very slick and well-produced – you might enjoy browsing around the other stories and issues, although the user interface is not particularly intuitive.)

The Paulson Legacy

With the footsteps of a new Treasury Secretary audible around the corner, Henry Paulson’s days running the country are essentially at an end. The best he can do now is delay whatever changes the Obama administration will make.

Looking back over the last two months, Paulson’s record (and that of the rest of the Bush administration) in combating the greatest financial crisis of our lifetimes is poor, though not catastrophic. The one thing that can be said in his favor is that the financial system did not completely collapse and Ben Bernanke’s supposed warning in the dark hours of September 18 that “we may not have an economy on Monday” did not come to pass. We have said on this site that stabilizing the financial system was job one, and the patient is stable.

Continue reading “The Paulson Legacy” →