Worth reading

[ghariton]

Let's just call it revisiting moral hazard:

Indeed.

We have to find a way to let the large financial institutions fail, without pulling down the rest of the economy.

My instinct s to compensate the depositors, etc, and if necessary assign the accounts, etc, to another bank -- or pool of banks. In any case, shareholders should assume their residual responsibility -- and lose their money. As for the executives, that should be between them, the shareholders, and the debt holders.

George

[parvus]

I wonder whether it would have made a difference if, instead of being allowed to grow so large, Fannie and Freddie had been forced by the government to split into, say, four corporations apiece. (Had they been purely private entities, the regulator otherwise might have required something approaching a 10% capital base.)

At least with an integrated bank, no matter how large, there are various bits of the business that could be sold off to competitors: brokerage, wealth management, merchant banking, capital markets, retail branch networks and so on. Who could take over Freddie and Fannie's monoline portfolios? Countrywide?

Anyway, I'm just thinking aloud.

Added: before I think aloud, I really should google.

How to Privatize Fannie Mae and Freddie Mac
Presented by
Bert Ely
to the
40th Annual Bank Structure Conference
Sponsored by the
Federal Reserve Bank of Chicago
May 7, 2004
<snip>
This paper will address two complementary yet mutually independent proposals -- privatizing the three housing-related government-sponsored enterprises (GSEs) and authorizing banks and thrift institutions to own largely unregulated mortgage housing subsidiaries (MHS). MHS will enable banks and thrifts to retain the ownership of long-term, fixed-rate mortgages they have originated or purchased in a special-purpose subsidiary (an MHS) that will be funded in the capital markets, not by deposits.

The first section of the paper will outline the American housing finance problem. The paper's second section will explain the relatively straight-forward manner in which the three housing finance GSEs -- Fannie Mae, Freddie Mac, and the Federal Home Loan Banks (FHLBs) -- can be fully privatized. The third section of the paper will describe the MHS concept, explain why it is a complement to fully privatizing the housing GSEs, and describe how, in many cases, it will produce lower "all-in"1 mortgage interest rates than Fannie Mae and Freddie Mac (F&F) can produce.

<snip>
Despite appearances to the contrary, the American housing finance system is hardly the bastion of efficiency. It suffers from high mortgage transaction costs, an excessive reliance on the secondary mortgage market, inefficient funding mechanisms, and excessive taxpayer risk stemming largely from F&F's undercapitalization for the interest-rate risks they have assumed. The underlying causes of this inefficiency are a public policy tilt towards the secondary mortgage market, through the GSEs, and a companion public policy tilt against depository institutions holding mortgages in portfolio.

The solution to these underlying causes is relatively straight-forward and easy to implement -- privatize the three housing GSEs while authorizing the MHS concept, which will enable depository institutions to profitably and safely hold long-term, fixed-rate mortgages in portfolio, by selling the mortgages they originate to MHS they own and control. This proposal has moved to a crucial stage in public policy development -- legislation to implement both pieces of this proposal -- privatizing the GSEs and authorizing the MHS. With the AEI having sponsored the drafting of that legislation, the GSE privatization/MHS authorization proposal is now ready for implementation.

Given growing concerns about the systemic risk F&F pose, trumpeted by Chairman Greenspan in his February testimony to the Senate Banking Committee, this legislation has been drafted not a moment too soon.

[parvus]

Man in the News: Bill Gross

Mr El-Erian, who appears positioned to succeed Mr Gross, describes the investing culture as one of “constructive paranoia”: Mr Gross created a system where a shadow investment committee questions every move made by the real one. “Most fund managers say if you put on 10 trades, and six or seven do well, that’s a good day. Bill doesn’t think that way. He wants all 10 to do well.”

[Norbert Schlenker]

I don't think anyone's ever linked this site before. It is well written and usually comedic genius a la The Onion for finance.

http://www.dealbreaker.com/

[parvus]

[url=http://online.wsj.com/article/SB122151242235938477.html?mod=special_coverage]Old-School Banks Emerge
Atop New World of Finance[/url]

More than 200 years after it was born at the base of a buttonwood tree, Wall Street as we have known it is ceasing to exist.

The rapid demise of 158-year-old investment bank Lehman Brothers Holdings Inc., together with the takeover of 94-year-old Merrill Lynch & Co., represent a watershed in the banking industry's biggest restructuring since the Great Depression.

For decades, the world of banking was divided largely into two kinds of businesses. Commercial banks took deposits and made loans, eking out a decent return under the burden of heavy regulations designed to protect depositors. Standalone securities firms such as Lehman, Merrill and the now-defunct Bear Stearns Cos. took no deposits and were lightly regulated, freeing them to take big risks and make fat profits at the cost of occasional losses. More recently, some of the biggest institutions, such as UBS AG and Citigroup Inc., combined the two.

Now, as many securities firms are consumed in the wake of a disastrous foray into financial wizardry, the balance of power is shifting. On the wane are the heavy borrowing and complex securities that financiers embraced in recent years. On the rise is a more old-fashioned business of chasing customer deposits and building branch networks, conducted with the backing of federal insurance programs to keep depositors from pulling out en masse.

Of the five major independent investment banks that existed a year ago, only two -- Goldman Sachs Group Inc. and Morgan Stanley -- remain standing. Two others, Merrill and Bear Stearns, have been acquired by big deposit-taking institutions, Bank of America Corp. and J.P. Morgan Chase & Co. Other giant commercial-banking players, such as Wells Fargo & Co. in the U.S., as well as Germany's Deutsche Bank AG and Spain's Banco Santander SA, have emerged as some of the most powerful players in an industry that is likely to be safer but less lucrative for shareholders.

Banks are heading "back to basics -- to, if you like, the core purpose of the system with less bells and whistles," says Douglas Flint, finance chief at HSBC Holdings PLC and co-chair of the Counterparty Risk Management Policy Group, a task force of finance executives working on a framework to prevent systemic financial shocks. "There is a recognition that when the dust settles...the construct of the industry will be different."

After 73 years: the last gasp of the broker-dealer

It sometimes feels as though my two decades as a financial journalist have been spent, first in London and then in New York, watching investment banks either collapse or be acquired: Barings, SG Warburg, JPMorgan, Bear Stearns, and now Lehman Brothers and Merrill Lynch.

This Sunday was different, however, because it marked not simply the end of Lehman and surrender of Merrill, but the last gasp of the independent investment bank itself. Morgan Stanley opened on Wall Street on Monday September 16 1935 and, 73 years later, almost to the day, the institution of the broker-dealer died.

Goldman Sachs and Morgan Stanley are the last hold-outs among Wall Street’s independent investment banks (although even Morgan Stanley sold out once before, to Dean Witter, in 1997). How long these two will spurn the capital backing of a commercial bank remains to be seen.

There will, of course, be investment banks in future. But they will be smaller, specialist institutions, like the merchant banks of old. There are plenty of advisory firms, hedge funds and private equity funds and this Wall Street crash will create more. All of those unemployed financiers will need something to do.

The full-service investment bank, buying and selling shares and bonds for customers as well as advising companies and trading with its own capital, is doomed. In order to generate the revenues needed to match larger institutions, banks such as Lehman scurried into risk-taking that eventually sunk them.

Stockbrokers such as Morgan Stanley were pushed out on their own by the 1933 Glass-Steagall Act, which enforced the separation of banks and investment banks. Their fate was probably sealed on May 1 1975, when fixed commissions for trading securities were abolished, setting off a squeeze on broking revenues.

“To stockbrokers, May Day means nothing less than the abolition of the system that has enriched them in good times and pulled many of them through during long periods of market slack,” Time magazine noted that year. Investment banks had relied on these commissions during the financial doldrums following the 1973 oil crisis.

Investment banks went on to enjoy 30 years of prosperity. They grew rapidly, taking on thousands of employees and expanding around the world. The big Wall Street firms swept through the City of London in the 1990s, picking up smaller merchant banks, such as Warburg and Schroders, on their way.

<snip>
Banks insisted that their safeguards to stop inside information from their customers leaking to their proprietary traders were strong. But there was no doubt that being “in the flow” gave investment banks’ trading desks an edge. Goldman Sachs’ trading profits came to be envied by rivals.

Investment banks also expanded into the underwriting and selling of complex financial securities, such as collateralised debt obligations. They were aided by the Federal Reserve’s decision to cut US interest rates sharply after September 11 2001. That set off a boom in housing and in mortgage-related securities.

The catch was that investment banks were taking what turned out to be life-threatening gambles. They did not have sufficient capital to cope with a severe setback in the housing market or markets generally. When it occurred, three (so far) of the five biggest banks ended up short of capital and confidence.

The Demise of the Shadow Banking System and of the Broker Dealers: Some Media Appearances

I discussed in detail over the weekend the Lehman and Merrill crisis and explained why - as I argued months ago - the remaining broker dealers (now only Morgan Stanley and Goldman Sachs being left) will go bust unless they merge with a financial institution that has a stable base of insured deposits. The business model of broker dealers is fundamentally broken and cannot be fixed. I elaborated in detail in a series of interviews yesterday and today on these views. Here are below the links to these interviews.

[George$]

PBS and Bill Moyers ---[url=http://www.pbs.org/moyers/journal/09192008/watch2.html]BILL MOYERS: If you read only one book on the route to this financial meltdown, I recommend this one: BAD MONEY: RECKLESS FINANCE, PBS video -- FAILED POLITICS, AND THE GLOBAL CRISIS OF AMERICAN CAPITALISM. The author, Kevin Phillips, has a history of being way ahead of the curve. As a young man working for Richard Nixon, he wrote THE EMERGING REPUBLICAN MAJORITY, a book that uncannily predicted how the GOP would regain power in Washington. Kevin Phillips saw our current crisis coming a long time ago. And in one book of historical insight after another, laid out the clues he was tracking. As recently as last spring in the AMERICAN PROSPECT magazine, Phillips wrote that what he thought was about to happen would be "unusual and potentially tragic."

In the preface of his book, he has written that these things usually come to fruition in August and September. And sure enough, here we are coping in September with the effects of bad money. Kevin, it's good to see you again .... [/url]

[George$]

Another PBS and Bill Moyers video interview on the current financial crisis
More about the Wall Street crisis With Gretchen Morgenson and Floyd Norris from the New York times. Re AIG bailout etc

[WishingWealth]

Keep Wall Street Out of the Retirement Business
Should we trust the folks who brought us Lehman and AIG with a privatized Social Security system? Should we trust them with our 401(k)s?

by Chris Farrell [at Business Week]

Remember the Bush Administration's push to partially privatize Social Security? The privatization advocates warned that insolvency loomed unless dramatic changes were made to the system. Social Security was also labeled a terrible investment. The Bush team's argument: Let people invest a portion of their payroll tax money with the financial wizards of Wall Street in an account reminiscent of a 401(k). Workers would get a higher rate of return on their Social Security money, and the economy would benefit from a higher rate of savings.

"We heard the fear that Social Security will go bankrupt and the solution is privatize it," says Zvi Bodie, a finance professor at Boston University. "Yeah, right! It was a self-serving proposal from industry."

Imagine Bear Stearns, Lehman Brothers (LEH), American International Group (AIG), and other titans of finance managing Social Security? The late economist Robert Eisner told me during an interview in the early 1990s that "Social Security was not meant to be a get-rich scheme or a competitor to go-go funds." He was right.

http://www.businessweek.com/print/inves ... 216336.htm

WW

[WishingWealth]

From Edge 258.
http://www.edge.org/documents/archive/e ... tml#dysong

ECONOMIC DIS-EQUILIBRIUM
Can you have your house and spend it too?

"What remedy is there if we have too little Money?" asked Sir William Petty (the author of Political Arithmetick, designer of an ill-fated high-speed sailing catamaran, and cofounder of the Royal Society) in his brief Quantulumcunque Concerning Money in 1682. His answer, amplified by the founding of the Bank of England in 1694, resonates to this day: "We must erect a Bank, which well computed; doth almost double the Effect of our coined Money: And we have in England Materials for a Bank which shall furnish Stock enough to drive the Trade of the whole Commercial World."
...

WW

[WishingWealth]

In Dissent magazine.

http://dissentmagazine.org/article/?article=1232

What Would Jefferson Do?: How Limited Government Got Turned Upside Down.
...
For the “New Right” movement inspired by Goldwater and Reagan after 1964, attacking the welfare state was a political reenactment of the American founding—a revival, they claimed, of “Jeffersonian democracy.” When they cut taxes, they talked about the Boston Tea Party. When they opposed campaign finance reform, they argued that giving money to politicians is a form of protected speech under the First Amendment: limiting such money is no better than shutting down newspapers or throwing people in jail for calling King George III a tyrant. Even Milton Friedman joined the “founding principles” crusade, arguing in his 1980 bestseller Free to Choose that the modern Democratic Party is the “greatest threat” to everything Thomas Jefferson believed in.

What these modern-day Jeffersonians hated most of all was government redistribution. In his Independence Day oration at the Jefferson Memorial in 1987, Reagan called for a new “economic bill of rights” to liberate the people by privatizing government services and by reducing taxes, regulation, and social spending. Charles Murray recapitulated this theme in his Clinton-era jeremiad What It Means to Be a Libertarian (1997), which begins with a long excerpt from Jefferson’s First Inaugural Address and calls for the elimination of “all governmental social-service programs and all income transfers in cash or kind.”

The Cato Institute, Washington’s leading free-market think tank, is perhaps the most conspicuous new claimant to the founders’ vision. According to the mission statement on its Web site, its agenda of privatizing federal entitlement programs, flattening the tax code and exempting wealth from taxation, deregulating industry and finance, and slashing federal discretionary spending by 30 percent (for a start) is inspired by a “Jeffersonian philosophy” of limited government.

Such thinking sounds right to many people because it is rarely challenged on its own historical merits. Most progressives seem to accept the conservative argument that our modern, active government, resting on political foundations laid in the New Deal era, goes far beyond what the founders could have contemplated or their principles allowed. For example, Michael Tomasky’s much-discussed American Prospect essay “Party In Search of a Notion” (April 2006) advises a return to the notion of the “common good.” But he goes no further than the New Deal in defining what this means, as if it is strictly a modern invention.
...

and to lower the blood pressure.

http://dissentmagazine.org/article/?article=1229

The Legacy of the Clinton Bubble
...
THE CONVENTIONAL wisdom has held that economic policy was a great success under Bill Clinton in the 1990s and a failure ever since. Hillary Clinton has made the comparison often, promising to end “the seven year detour” and “attack poverty by making the economy work again.” In January, in response to the president’s State of the Union Address, Barack Obama stated that it was “George Bush’s Washington that let the banks and financial institutions run amok and take our economy down this dangerous road.”

Perhaps this reading of history makes for good politics in an election year, and it is certainly better for the Clintons than for anyone else. The only problem is that the story line is flawed. One could even say that it’s a bit of a fairy tale.

For six of eight years, Bill Clinton governed with Republican majorities in Congress. Not surprisingly, there was much continuity between the Clinton and Bush administrations. Both embraced the so-called Washington Consensus, a policy agenda of fiscal austerity, central-bank autonomy, deregulated markets, liberalized capital flows, free trade, and privatization.

On each of these crucial issues, the most significant differences between Clinton and Bush were differences in timing and degree, not in direction. Both administrations were willfully asleep at the wheel. Clinton was fortunate to preside over the early stages of a bubble economy. Bush has had the misfortune of presiding as a lame duck through the final stages of the same bubble and, thanks to the deregulation of the Clinton years, without a regulatory structure capable of containing today’s speculative fevers.

In 1992, Bill Clinton campaigned on the promise of a short-term stimulus package. But soon after being elected, he met privately with Alan Greenspan, chair of the Federal Reserve Board, and soon accepted what became known as “the financial markets strategy.” It was a strategy of placating financial markets. The stimulus package was sacrificed, taxes were raised, spending was cut—all in a futile effort to keep long-term interest rates from rising, and all of which helped the Democrats lose their majority in the House. In fact, the defeat of the stimulus package set off a sharp decline in Clinton’s public approval ratings from which his presidency would never recover.
...

WW

[lilbit]

From Sy Harding, September 26th:

Are you suspicious of market-manipulation when, for apparently no reason, the Dow shoots up from negative territory in the last hour of the day, especially on a Friday, and closes up triple-digits all by itself?

You should be. Because that's what it is. Especially on low volume days, the program-trading firms can move the Dow wherever they want with their big automated computer buy and sell programs. As a former manager at such a firm said several years ago in a book which I cannot locate now, "We can't control it all day, and can't hold it at a specific level for a long period of time. But tell me where you want it for a few minutes and give me half an hour and we can put it there within a few points."

I've been ranting about this for 20 years, and finally gave up. The manipulation of the program-trading firms is so obvious regulators must be aware of it. They have certainly received enough complaints from me. But totally ignore the situation.

Who are the big trading firms? They are the large brokerage firms and banks trading for their own account and those of a few of their largest customers. The top ten for largest trading volume this week were Goldman Sachs, Credit Suisse, Morgan Stanley, Merrill Lynch (now a division of BankAmerica), Deutsche Bank, RBC Capital (Royal Bank of Canada), BNP Paribas, SIG Brokerage LP, UBS Securities, and Bear Stearns.

Between them they accounted for 39% of all the trading on the NYSE, a typical week. There was no 'directional' conviction. As usual there were 789 million shares in buy programs and 755 million in sell programs.

So back to yesterday's market:

The Dow closed up, as noted surging up from negative territory in the last hour of the day. It's easier to manipulate enough of the 30 stocks of the Dow to move it and to some extent the S&P 500 on which the same stocks appear. But look at how the rest of the market closed.

The NYSE Composite closed down .5%, the Nasdaq down .2%, the Nasdaq 100 down 1%, the DJ Transportation Avg down .3%, the DJ Utilities down .9%. Market breadth was even more revealing. There were more than twice as many stocks down as up on the NYSE, and 650 more stocks down than up on the Nasdaq. But the Dow closed up, and investors coming home from work would therefore hear that "the market" closed up for the day. Wall Street is reforming its misleading ways of always keeping investors bullish and buying what they're selling??? Sure they are.

By the way, with the changed landscape of the last few months, with those same financial firms now so beholden to the Fed and Treasury for hundreds of billions of bailout money, and easy access to all the money they want to borrow from the Fed's discount window, do you doubt the Fed's ability to make a few phone calls and ask for help in closing the market positive to avoid panic, or to start a day off positive when bad news comes out?



This was an ugly week.

[chiaroscuro]

In Dissent magazine.

http://dissentmagazine.org/article/?article=1232

What Would Jefferson Do?: How Limited Government Got Turned Upside Down.

and to lower the blood pressure.

http://dissentmagazine.org/article/?article=1229

The Legacy of the Clinton Bubble
...

WW

As always Libertarians spin things to free themselves of any association from any form guilt. Next they put all the blame for any crisis on government. That is a given.

Surprise us and show us the the Libertarian rag or article where they take on any responsibility in the smallest quantity. You will never see it. Religions can never be wrong.

[patriot1]

http://www.aif.ru/number/number/number_id/99#

Caption: "Will the world sustain the financial adventure of the USA? Russia has avoided the crisis"

Ad at the bottom of the page is for Brooke Bond Tea. Only in Canada, you say?

[TrueMrP]

In Dissent magazine.

http://dissentmagazine.org/article/?article=1232

What Would Jefferson Do?: How Limited Government Got Turned Upside Down.

and to lower the blood pressure.

http://dissentmagazine.org/article/?article=1229

The Legacy of the Clinton Bubble
...

WW

As always Libertarians spin things to free themselves of any association from any form guilt. Next they put all the blame for any crisis on government. That is a given.

Surprise us and show us the the Libertarian rag or article where they take on any responsibility in the smallest quantity. You will never see it. Religions can never be wrong.

Was it Libertarians that flooded the market with cheap credit?
Let it fall and don't print money. We all pay for it in the end.

[patriot1]

Was it Libertarians that flooded the market with cheap credit?

Well yes, or more exactly pseudo-libertarians - those who want the state to stay out of the way unless it's needed to clean up the mess they make.

Amid all the coverage of Alan Greenspan's memoir, The Age of Turbulence (disappointment with the current administration, dodging responsibility for the real estate bubble, novelistic and engaging treatment of his jazz filled youth and rise to economic sage and but limited insight into personal philosophy and thinking) there was an interesting article in The New York Times on his devotion to Ayn Rand. As a member of Rand's inner circle he was deeply influenced by her free-market philosophy and defense of individual rights. The NYTimes online features a 1957 Letter to the Editor written by Alan Greenspan in response to a negative review of Rand's Atlas Shrugged.

http://blog.fortefinancial.com/2007/09/index.html

[parvus]

Norm might appreciate this one:
This Economy Does Not Compute

Financial crises may emerge naturally from the very makeup of markets, as competition between investment enterprises sets up a race for higher leverage, driving markets toward a precipice that we cannot recognize even as we approach it. The model offers a potential explanation of why we have another crisis narrative every few years, with only the names and details changed. And why we’re not likely to avoid future crises with a little fiddling of the regulations, but only by exerting broader control over the leverage that we allow to develop.

Another example is a model explored by the German economist Frank Westerhoff. A contentious idea in economics is that levying very small taxes on transactions in foreign exchange markets, might help to reduce market volatility. (Such volatility has proved disastrous to countries dependent on foreign investment, as huge volumes of outside investment can flow out almost overnight.) A tax of 0.1 percent of the transaction volume, for example, would deter rapid-fire speculation, while preserving currency exchange linked more directly to productive economic purposes.

Economists have argued over this idea for decades, the debate usually driven by ideology. In contrast, Professor Westerhoff and colleagues have used agent models to build realistic markets on which they impose taxes of various kinds to see what happens.

So far they’ve found tentative evidence that a transaction tax may stabilize currency markets, but also that the outcome has a surprising sensitivity to seemingly small details of market mechanics — on precisely how, for example, the market matches buyers and sellers. The model is helping to bring some solid evidence to a debate of extreme importance.

A third example is a model developed by Charles Macal and colleagues at Argonne National Laboratory in Illinois and aimed at providing a realistic simulation of the interacting entities in that state’s electricity market, as well as the electrical power grid. They were hired by Illinois several years ago to use the model in helping the state plan electricity deregulation, and the model simulations were instrumental in exposing several loopholes in early market designs that companies could have exploited to manipulate prices.

Similar models of deregulated electricity markets are being developed by a handful of researchers around the world, who see them as the only way of reckoning intelligently with the design of extremely complex deregulated electricity markets, where faith in the reliability of equilibrium reasoning has already led to several disasters, in California, notoriously, and more recently in Texas.

Sadly, the academic economics profession remains reluctant to embrace this new computational approach (and stubbornly wedded to the traditional equilibrium picture). This seems decidedly peculiar given that every other branch of science from physics to molecular biology has embraced computational modeling as an invaluable tool for gaining insight into complex systems of many interacting parts, where the links between causes and effect can be tortuously convoluted.

Something of the attitude of economic traditionalists spilled out a number of years ago at a conference where economists and physicists met to discuss new approaches to economics. As one physicist who was there tells me, a prominent economist objected that the use of computational models amounted to “cheating” or “peeping behind the curtain,” and that respectable economics, by contrast, had to be pursued through the proof of infallible mathematical theorems.

[TrueMrP]

Was it Libertarians that flooded the market with cheap credit?

Well yes, or more exactly pseudo-libertarians - those who want the state to stay out of the way unless it's needed to clean up the mess they make.

Amid all the coverage of Alan Greenspan's memoir, The Age of Turbulence (disappointment with the current administration, dodging responsibility for the real estate bubble, novelistic and engaging treatment of his jazz filled youth and rise to economic sage and but limited insight into personal philosophy and thinking) there was an interesting article in The New York Times on his devotion to Ayn Rand. As a member of Rand's inner circle he was deeply influenced by her free-market philosophy and defense of individual rights. The NYTimes online features a 1957 Letter to the Editor written by Alan Greenspan in response to a negative review of Rand's Atlas Shrugged.

http://blog.fortefinancial.com/2007/09/index.html

Influence?, Certainly his actions were the opposite. I quote here:
"Greenspan was expected to follow his predecessor's aversion to jockeying the money supply in response to economic twitches. Perhaps he did for a while. But cautious monetarism did not last long. By the 1990s, his foot alternated between the monetary gas and brake pedals like any Keynesian. Economy growing after 1991 recession? Double the Fed Funds target to 6 percent. A little slowing in late 1995? Back to 4.75 percent. Stock market bubble still bubbling? Back up to 6.5. Too much? Down all the way to 1 percent."
Bernake is doing the same. It just hurts more this time.

[NormR]

Norm might appreciate this one:
This Economy Does Not Compute

Good fun. Similar stuff can be found in Critical Mass.

Some rather simple models / toys have provided surprisingly robust results. Still many models remain surprisingly primitive.

[WishingWealth]

In Chronicle.
http://chronicle.com/temp/reprint.php?i ... 4hy9z83x18

The Real Great Depression

The depression of 1929 is the wrong model for the current economic crisis

By SCOTT REYNOLDS NELSON

As a historian who works on the 19th century, I have been reading my newspaper with a considerable sense of dread. While many commentators on the recent mortgage and banking crisis have drawn parallels to the Great Depression of 1929, that comparison is not particularly apt. Two years ago, I began research on the Panic of 1873, an event of some interest to my colleagues in American business and labor history but probably unknown to everyone else. But as I turn the crank on the microfilm reader, I have been hearing weird echoes of recent events.

When commentators invoke 1929, I am dubious. According to most historians and economists, that depression had more to do with overlarge factory inventories, a stock-market crash, and Germany's inability to pay back war debts, which then led to continuing strain on British gold reserves. None of those factors is really an issue now. Contemporary industries have very sensitive controls for trimming production as consumption declines; our current stock-market dip followed bank problems that emerged more than a year ago; and there are no serious international problems with gold reserves, simply because banks no longer peg their lending to them.

In fact, the current economic woes look a lot like what my 96-year-old grandmother still calls "the real Great Depression." She pinched pennies in the 1930s, but she says that times were not nearly so bad as the depression her grandparents went through. That crash came in 1873 and lasted more than four years. It looks much more like our current crisis.

The problems had emerged around 1870, starting in Europe. In the Austro-Hungarian Empire, formed in 1867, in the states unified by Prussia into the German empire, and in France, the emperors supported a flowering of new lending institutions that issued mortgages for municipal and residential construction, especially in the capitals of Vienna, Berlin, and Paris. Mortgages were easier to obtain than before, and a building boom commenced. Land values seemed to climb and climb; borrowers ravenously assumed more and more credit, using unbuilt or half-built houses as collateral. The most marvelous spots for sightseers in the three cities today are the magisterial buildings erected in the so-called founder period.

...

WW

[ghariton]

This Economy Does Not Compute

Sadly, the academic economics profession remains reluctant to embrace this new computational approach (and stubbornly wedded to the traditional equilibrium picture).

Not the discipline of economics I'm familiar with. Perhaps there is a shadow world

Computational General Equilibrium (CGE) models are the workhorse of current macroeconomics. And the approach is also widespread in microeconomics.

An example, at random, from 2002:

This article outlines the ideas of general equilibrium and of computational general equilibrium models. In the process, strengths and limitations are discussed.

Another example, at random, from 1983.

FWIW, Google returned over 2 million hits for "computational general equilibrium".

George

[WishingWealth]

More from Edge.

http://www.edge.org/documents/archive/e ... html#globe

+ A few good links to other articles.

And webtv done right.
http://bloggingheads.tv/diavlogs/14756? ... &out=64:51

WW

[parvus]

This Economy Does Not Compute

Sadly, the academic economics profession remains reluctant to embrace this new computational approach (and stubbornly wedded to the traditional equilibrium picture).

Not the discipline of economics I'm familiar with. Perhaps there is a shadow world

Well, there is Kevin Hassett and Dow 36,000.

Computational General Equilibrium (CGE) models are the workhorse of current macroeconomics. And the approach is also widespread in microeconomics.
An example, at random, from 2002:

This article outlines the ideas of general equilibrium and of computational general equilibrium models. In the process, strengths and limitations are discussed.

Another example, at random, from 1983.
FWIW, Google returned over 2 million hits for "computational general equilibrium".

Interesting references. Thank you. Too bad (sigh) they're not available for the impecunious public (and the IMF, of all organizations)!

Questions for you George: let's assume equilibrium as the ideal-type (or perhaps just as the mean). How useful is that in representing extended periods of historical disequilibrium (1874, 1929. And, from the article I cited, to what extent is it possible with CGE to model Bernanke's financial accelerators, which I think is what the author is hinting at.

Apologies for showing my ignorance (but that's never stopped me before; indeed, I have found it a most useful way to attract instruction from those who are learned).

[Bylo Selhi]

<OT>

Well, there is Kevin Hassett and Dow 36,000.

Currently serving as "senior economic adviser to John McCain’s 2008 presidential campaign."

Be afraid. Be very afraid.
</OT>

[Shakespeare]

Individual identity vs. the financial crisis

The real reason is that the roots of the current crisis are tied to the fundamental nature of the postwar model of economic development called "Fordism." That model drew a tight connection between assembly-line mass production and mass consumption - ultimately fuelled by massive suburbanization....

As one leading blogger, Yves Smith at Naked Capitalism, recently put it: "Since consumption has come to depend on growth in indebtedness, a reversal, however painful, is necessary. Our excesses have been so great that there is no way out of this that does not lead to a general fall in living standards."

There you have it. The financial crisis is in reality a much deeper crisis of our underlying economic model and our way of life. It's a crisis of the way we have come to define ourselves....

How will we define ourselves when we can't get a quick self-defining "makeover" at the dealership, the electronics store or the mall? How will we rebuild our way of life and our very identity? Those are the questions that many of us, and our society as a whole, will be confronting long after the financial markets have been restored.

(Most FWF posters do not define themselves by product consumption. But most of Canada and the US does.)

[parvus]

<OT>

Well, there is Kevin Hassett and Dow 36,000.

Currently serving as "senior economic adviser to John McCain’s 2008 presidential campaign."

Be afraid. Be very afraid.
</OT>

Or, as Brad Delong opines:

As I understand it, originally Douglas Holtz-Eakin was supposed to debate Austan Goolsbee. Then Doug dropped out (I am not sure whether the statement that he had to go brief Sarah Palin was a joke or not). Kevin Hassett replaced him. Then Austan dropped out. And I replaced Austan.

Then Kevin said that he wouldn't come out of his hotel room if I were in the building.

I think this is a substantial mistake on Kevin's part.

(A) The topic is not his 1999 book Dow 36000: The New Strategy for Profiting from the Coming Rise in the Stock Market. The topic is Obama vs. McCain in the presidential election.

(B) Even if the topic were his 1999 book Dow 36000: The New Strategy for Profiting from the Coming Rise in the Stock Market, every time he hides from critics he does himself damage. If he still thinks that his late-1999 forecast that the Dow was about to triple in the next three-to-five years, he should defend it as the best forecast that could have been made at the time--and tell us why it did not come true. If he thinks that his late-1999 forecast that the Dow was about to triple in the next three-to-five years was not a good forecast then, he should recant. But hiding is never good.

And now that the issue is on the table again...

To be brief, the problems with Dow 36000: The New Strategy for Profiting from the Coming Rise in the Stock Market were:

Hassett got the math of the Gordon equation for valuing the stock market simply wrong. It's not the earnings yield that shows up in the numerator, it's the dividend yield. The book should have been called Dow 22000.

Hassett got the math of the equity premium wrong. The weighted average of the returns on bonds and stocks is the return on capital. The equity premium is a wedge between the rate of return on stocks and the rate of return on bonds. If the equity premium falls, the rate of return on stocks falls and the rate of return on bonds rises. Hassett calculated the effect of a fall in the equity premium by fixing the rate of return on bonds. The book should have been called Dow 15000.

The argument that the equity premium ought to go away is one you can make. The argument that the equity premium will go away in the next three to five years drastically understates uncertainty.

To argue toward the end stages of a bubble--when all standard indicators of fundamentals are blinking red and forecasting five-year equity returns of zero or less--that your readers should double up on their stock portfolios to "take advantage of the coming rise in the stock market" does not strike me as what my nursury school teacher used to call "playing well with others." It's kind of like treating your readers the way John-John Crummell treated the guests at my fifth birthday party when he lit the tablecloth on fire.

This does have a bearing on the presidential election. John McCain is holding himself out as the scourge of Wall Street. He is doing so while standing beside Ms. Carly "Golden Parachute" Fiorina and while sending out Mr. Kevin "Bubbles" Hassett as an advisor-surrogate. Something is wrong with this picture.