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December 25, 2007

Economist's View - 5 new articles

Nouriel Roubini: Too Little, Too Late

Nouriel Roubini sees a hard landing ahead (though Jim Hamilton says "The bears must wait another quarter"):

The Global Economy's Inevitable Hard Landing, by Nouriel Roubini, Project Syndicate: In recent weeks, the global liquidity and credit crunch that started last August has become more severe. ... To be sure, major central banks have injected dozens of billions of dollars of liquidity into the commercial banking sector, and the US Federal Reserve, the Bank of England, and the Bank of Canada have lowered their interest rates. But worsening financial conditions prove that this policy response has failed miserably.

So it is no surprise that central banks have become increasingly desperate... The recent announcement of coordinated liquidity injections by the Fed and four other major central banks is, to be blunt, too little too late.

These measures will fail ... because monetary policy cannot address the core problems underlying the crisis. The issue is not just illiquidity – financial institutions with short-term liabilities and longer-term illiquid assets. Many more economic agents face serious credit and solvency problems, including millions of households in the US, UK, and the Eurozone with excessive mortgages, hundreds of bankrupt sub-prime mortgage lenders, a growing number of distressed homebuilders, many highly leveraged and distressed financial institutions, and, increasingly, corporate-sector firms.

At the same time, monetary injections cannot resolve the generalized uncertainty of a financial system in which globalization and securitization have led to a lack of transparency that has undermined trust and confidence. When you mistrust your financial counterparties, you won't want to lend to them, no matter how much money you have.

The US is now headed towards recession, regardless of what the Fed does. ... Other economies will also be pulled down as the US contagion spreads.

To mitigate the effects of a US recession and global economic slump, the Fed and other central banks should be cutting rates much more aggressively... The Fed's 25-basis-point cut in December was puny relative to what is needed; similar cuts by the Bank of England and Bank of Canada do not even begin to address the increase in nominal and real borrowing rates that the sharp rise in Libor rates has induced. Central banks should have announced a coordinated 50 basis-point reduction to signal their seriousness about avoiding a global hard landing.

Likewise, the European Central Bank's decision not to cut rates ... is mistaken..., the ECB is virtually ensuring a sharp euro-zone slowdown.

In any case, the actions recently announced by the Fed and other central banks are misdirected. Today's financial markets are dominated by non-bank institutions – investment banks, money market funds, hedge funds, mortgage lenders that do not accept deposits, so-called "structured investment vehicles," and even states and local government investment funds – that have no direct or indirect access to the liquidity support of central banks. All these non-bank institutions are now potentially at risk of a liquidity run.

Indeed, US legislation strictly forbids the Fed from lending to non-depository institutions, except in emergencies. But this implies a complex and cumbersome approval process and the provision of high-quality collateral. And never in its history has the Fed lent to non-depository institutions.

So the risk of something equivalent to a bank run for non-bank financial institutions, owing to their short-term liabilities and longer-term and illiquid assets, is rising – as recent runs on some banks (Northern Rock), money market funds, state investment funds, distressed hedge funds suggests. There is little chance that banks will re-lend to these non-banks the funds they borrowed from central banks, given these banks' own severe liquidity problems and mistrust of non-bank counterparties.

Major policy, regulatory, and supervisory reforms will be required to clean up the current mess and create a sounder global financial system. Monetary policy alone cannot resolve the consequences of inaction by regulators and supervisors amid the credit excesses of the last few years. So a US hard landing and global slowdown is unavoidable. Much greater and more rapid reduction of official interest rates may at best affect how long and protracted the downturn will be.

"Sinte Klaas"

The transformation of St. Nicholas:

St. Nick in the Big City, by John Anthony McGuckin, Commentary, NY Times: St. Nicholas was a super-saint with an immense cult for most of the Christian past. There may be more icons surviving for Nicholas alone than for all the other saints of Christendom put together. So what happened to him? Where's the fourth-century Anatolian bishop who presided over gift-giving to poor children? And how did we get the new icon of mass consumerism in his place?

Well, it's a New York story.

In all innocence, the morphing began with the Dutch Christians of New Amsterdam, who remembered St. Nicholas from the old country and called him Sinte Klaas. They had kept alive an old memory — that a kindly old cleric brought little gifts to the poor in the weeks leading up to the Feast of the Nativity. While the gifts were important, they were never meant to overshadow the message of Jesus's humble birth.

But today's chubby Santa is not about giving to the poor. He has had his saintly garb stripped away. The filling out of the figure, the loss of the vestments, and his transformation into a beery fellow smoking a pipe combined to form a caricature of Dutch peasant culture. Eventually this Magic Santa (a suitable patron saint if there ever was one for the burgeoning capitalist machinery of the city) was of course popularized by the Manhattanite Clement Clarke Moore published in "A Visit From St. Nicholas," in The Troy (New York) Sentinel on Dec. 23, 1823.

The newly created deity Santa soon attracted a school of iconographers: notable among them were Thomas Nast, whose 1863 image of a red-suited giant in Harper's Weekly set the tone, and Haddon Sundblom, who drew up the archetypal image we know today on behalf of the Coca-Cola Company in the 1930s. This Santa was regularly accompanied by the flying reindeer: godlike in his majesty and presiding over the winter darkness like Odin the sky god returned.

The new Santa also acquired a host of Nordic elves to replace the small dark-skinned boy called Black Peter, who in Christian tradition so loved St. Nicholas that he traveled with him everywhere. But, some might say, wasn't it better to lose this racially stereotyped relic? Actually, no, considering the real St. Nicholas first came into contact with Peter when he raided the slave market in his hometown and railed against the trade. The story tells us that when the slavers refused to take him seriously, he used the church's funds to redeem Peter and gave the boy a job in the church.

And what of the throwing of the bags of gold down the chimney, where they landed in the stockings and little shoes that had been hung up to dry by the fireplace? Charming though it sounds, it reflected the deplorable custom, still prevalent in late Roman society when the Byzantine church was struggling to establish the supremacy of its values, of selling surplus daughters into bondage. This was a euphemism for sexual slavery — a trade that still blights our world.

As the tale goes, Nicholas had heard that a father in the town planned to sell his three daughters because his debts had been called in by pitiless creditors. As he did for Black Peter, Nicholas raided his church funds to secure the redemption of the girls. He dropped the gold down the chimney to save face for the impoverished father.

This tale was the origin of a whole subsequent series of efforts among the Christians who celebrated Nicholas to make some effort to redeem the lot of the poor — especially children, who always were, and still are, the world's front-line victims. Such was the origin of Christmas almsgiving: gifts for the poor, not just gifts for our friends.

I like St. Nicholas. You can keep chubby Santa.

"Preventing the Next Bout of Looting"

Menzie Chinn is worried that the regulatory effort to prevent problems in mortgage markets from reemerging is failing to adequately address part of the problem:

A Thought on the Sub-prime Debacle, by Menzie Chinn: Most of the NYT's recent coverage of the subprime mess focused on Greenspan and the Federal Reserve System. However, it's clear that regulation was deficient along other fronts. From the NYT:

... The Fed was hardly alone in not pressing to clean up the mortgage industry. When states like Georgia and North Carolina started to pass tougher laws against abusive lending practices, the Office of the Comptroller of the Currency successfully prohibited them from investigating local subsidiaries of nationally chartered banks.

Virtually every federal bank regulator was loathe to impose speed limits on a booming industry. But the regulators were also fragmented among an alphabet soup of agencies with splintered and confusing jurisdictions. Perhaps the biggest complication was that many mortgage lenders did not fall under any agency's authority at all. ...

Ms. Bair was an exception, especially for the deregulation-minded Bush administration. As a former assistant secretary of the Treasury in 2001 and 2002, she had worked with Mr. Gramlich to raise concerns about abusive lending practices. Indeed, she tried to hammer out an agreement with mortgage lenders and consumer groups over a tough set of "best practices" that would have covered subprime mortgages.

But that effort largely stalled because of disagreement. Though some big lenders did endorse a broad code of conduct, she recalled, they soon began loosening standards as competition intensified. ...

I think that as we learn more and more about the run-up to current situation, we will find out that "looting" was the relevant phenomenon. From George Akerlof and Paul Roemer's 1993 discussion of the S&L crisis, in the Brookings Papers in Economic Activity:

"Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.

Bankruptcy for profit occurs most commonly when a government guarantees a firm's debt obligations. The most obvious such guarantee is deposit insurance, but governments also implicitly or explicitly guarantee the policies of insurance companies, the pension obligations of private firms, virtually all the obligations of large or influential firms. ...[B]ankruptcy for profit can easily become a more attractive strategy for the owners than maximizing true economic values. ...

Unfortunately, firms covered by government guarantees are not the only ones that face severely distorted incentives. Looting can spread symbiotically to other markets, bringing to life a whole economic underworld with perverse incentives. The looters in the sector covered by the government guarantees will make trades with unaffiliated firms outside this sector, causing them to produce in a way that helps maximize the looters' current extractions with no regard for future losses...."

Now instead of arguing against Fed intervention to try to mitigate the credit crunch, on the grounds of discouraging "moral hazard", (in Krugman's lexicon, that horse is already out the barn door) I would say we need to think now about how to prevent the next bout of "looting".

That involves a much more complicated and difficult task of insulating the regulatory authorities from political pressures (see "avoiding regulatory capture"). It also probably requires expanding and integrating regulatory charters.

I'm not sure how one would do that. But I know how not to do it. From the WSJ:

Regulators appointed by President Bush often have been more sympathetic to industry concerns about red tape than their Clinton administration predecessors. When James Gilleran, a former California banker and bank supervisor, took over the OTS in December 2001, he became known for his deregulatory zeal. At one press event in 2003, several bank regulators held gardening shears to represent their commitment to cut red tape for the industry. Mr. Gilleran brought a chain saw.

He also early on announced plans to slash expenses to resolve the agency's deficit; 20% of its work force eventually left. When he left in 2005, Mr. Gilleran declared that the OTS had "exercised increased diligence in its review of abusive consumer practices" while reducing thrifts' regulatory burden. ...

So, let's think constructively about preventing the next bout of looting, even as we deal with the after-effects of the current bout.

One of These Things is Not Like the Others

Dean Baker on the similarities and differences among Democratic presidential candidates:

Challenging the powers that be, by Dean Baker, Comment is Free: It would be difficult to identify much difference between the three leading Democratic presidential candidates' positions on major economic issues. They have come forward with comparable positions on taxes, healthcare and trade. ...

On taxes, all three candidates have said they want the wealthy to pay a larger portion of the bill, which starts with taking back the Bush tax cuts on families earning more than $200,000 a year. All three have proposed eliminating various loopholes that primarily benefit the wealthy. Edwards has gone the furthest in this respect, calling for raising the capital gains tax rate back to the pre-Clinton level of 28%. This tax increase almost exclusively affects the wealthy. ...

All three contenders have proposed a national healthcare system... Both Clinton and Edwards would impose a mandate that everyone buy into this system. Obama has claimed that he would not require a mandate. As a practical matter, the healthcare system that any of them are able to put in place will depend on the arms they twist and the pressure they can bring to bear against the insurance companies, the pharmaceutical industry and other powerful actors who will be hurt by real reform.

Any serious plan will require a mandate - this directly follows from its requirement that insurers take all comers. Without a mandate, no one would buy insurance until they had serious bills. This would be like letting people buy car insurance after an accident, and then sending the company the bill. That doesn't work.

All three contenders have said that they want to break with the Bush-Clinton-Bush trade agenda. ... What their position means in practice remains to be seen. ... As a practical matter, the country has already gone about as far as it can in placing its manufacturing workers in competition with low-wage workers in the developing world. The impact of any future trade deals on the US economy will be almost imperceptible.

A decline of the dollar by an additional 10% against the currencies of our trading partners would swamp the impact of all currently pending trade deals. On this issue there are likely to be substantial differences among the candidates. Former Treasury secretary Robert Rubin is likely to be the guiding light for economic policy in a Clinton or Obama administration. Rubin was the architect of the high dollar policy of the 1990s... He remains an enthusiastic supporter of a high dollar. Therefore Clinton or Obama would be more likely than Edwards to sacrifice the jobs and wages of manufacturing workers in order to prop up the dollar.

Rubin's Wall Street agenda would also apply to other areas of economic policy, most importantly the budget. Rubin places balanced budgets and even budget surpluses at the centre of his economic vision. A push to a balanced budget will seriously curtail the ability to extend healthcare coverage, promote access to childcare, promote clean technologies and address other neglected priorities. By contrast, Edwards has clearly stated that he does not view a balanced budget as a priority... The willingness to accept deficits may prove especially important in the context of an economy that could be in recession when the next president takes office.

In short, Edwards has set himself apart from the other two top candidates by indicating a clear willingness to challenge an agenda set on Wall Street. If a President Edwards actually carried through with this course, he would pursue a very different economic agenda than his two leading rivals.

links for 2007-12-25

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