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March 7, 2009

Economist's View - 6 new articles

Blinder: Nationalize?

Alan Blinder is not a fan of nationalization:

Nationalize? Hey, Not So Fast, by Alan S. Blinder, Commentary, NY Times: ...When philosophical conservatives like Alan Greenspan start talking about nationalizing banks, you know you've passed into some kind of parallel universe. ... Like Ben Bernanke ... and Timothy Geithner,... I am not convinced that nationalization is the only, or even the best, way out. ...

[D]idn't Sweden pull this off with great success in the early 1990s? Yes... But this is not Sweden. Let's think about some of the downsides to nationalizing banks in America.

Where to draw the line? First and foremost, the Swedish government had to deal with only a handful of banks; we have more than 8,300. ... Presumably, no one wants to nationalize all the banks, thousands of which are healthy. But where do you stop, once you start?

Suppose we nationalized four banks. Bank Five would then find itself at a severe disadvantage in competing for funds... Forced to pay higher interest rates... Bank Five might start looking like a candidate for nationalization, too — followed by Banks Six, Seven and so on. ...

The Management Challenge The Swedes ... never had to deal with institutions of the size and complexity of our banking behemoths. Mr. Geithner has emphasized that governments are ill-suited to manage businesses. I'd take the point a step further: Overseeing the management of dozens, or hundreds, or maybe even thousands of nationalized banks is a daunting task.

Political Obstacles The process of nationalization and reprivatization ... in Sweden ... was remarkably free of political interference. Would that happen here? You decide. My bet is no.

The Confidence Question Finally, because nationalization runs counter to deeply ingrained American traditions and attitudes,... it might undermine rather than bolster confidence. ... The Treasury, of course, would never use "nationalization" in public; it would invent some nice euphemism. But the commentariat would not be so constrained.

All of that said, there are arguments in favor of nationalization. Or are there?

One is that financial firms are careening off track, thereby costing taxpayers more and more bailout money. (Think A.I.G.) That's a ... major reason to seek quick closure. But ... the government already owns shares in many banks, and ... the Fed can pretty much dictate to the banks right now, what additional powers would nationalization bring?

Another argument is that banks' dodgy assets are hard to value, making it impossible to know how much capital they need — and probably very expensive to provide it. True again. But nationalization doesn't make these problems disappear.

If the government takes over a bank, the taxpayers ... inherit... all the uncertainties over valuation. And if a bank has negative net worth when it is nationalized, who do you think fills the hole? ...

Worse yet, even talk about nationalization can be harmful if it puts bank stocks under further selling pressure. After all, who wants to own a stock whose value is heading toward zero? Which is why Mr. Bernanke and Mr. Geithner have taken pains to beat down rumors that nationalization is coming.

Unfortunately, their denials can never be categorical. If worst really does come to worst, the other options may evaporate, leaving the government no choice but to nationalize some banks. ... But, please, let's not rush there. Let's first at least explore what is called the "good bank, bad bank" approach.

What's that? While there are many variants, the basic idea is to break each sick institution into two. The "good bank" gets the good assets... As a healthy institution, it can presumably raise fresh capital and go on its merry way as a private company.

The "bad bank" inherits the bad assets and the rest of the capital — which, after appropriate markdowns of the assets, will not be enough. So, again, someone must fill the hole. And, realistically, given the mess we're in, much of that new capital would likely come from the taxpayers.

Here's a prediction: We will get to the good-bank, bad-bank solution sooner or later. Wouldn't it be nice if it was sooner?

Blinder's colleague at Princeton, Paul Krugman:

How many banks?, by Paul Krugman: One objection you keep hearing to nationalization pre-privatization as part of a bank restructuring effort is that the US financial system is just too big and complex. ... But are we really thinking about thousands of banks? Here's Martin Wolf, today:

The four biggest US commercial banks – JPMorgan Chase, Citigroup, Bank of America and Wells Fargo – possess 64 per cent of the assets of US commercial banks (see chart) [chart not available online]. If creditors of these businesses cannot suffer significant losses, this is not much of a market economy.

So as far as this discussion is concerned, we've got, like, four banks. The "thousands of banks" line is just a diversion.


The truth is that the Bernanke-Geithner plan — the plan the administration keeps floating, in slightly different versions — isn't going to fly. ...

Think of it this way: by using taxpayer funds to subsidize the prices of toxic waste, the administration would shower benefits on everyone who made the mistake of buying the stuff. Some of those benefits would trickle down to where they're needed, shoring up the balance sheets of key financial institutions. But most of the benefit would go to people who don't need or deserve to be rescued.

And this means that the government would have to lay out trillions of dollars to bring the financial system back to health, which would, in turn, both ensure a fierce public outcry and add to already serious concerns about the deficit. (Yes, even strong advocates of fiscal stimulus like yours truly worry about red ink.) Realistically, it's just not going to happen.

Quick Note

I will be on the Mark Martinez radio show today at 3:00 p.m. PST (streaming audio). The call-in number is 661 631-1230.

Will Fiscal Policy Pass the Test?

This won't be the last downturn in the history of the world, I'm pretty sure of that, and how monetary and fiscal policymakers react and the difference it makes - if any - will be studied carefully and used to guide our response the next time something like this happens.

So we need to do this right. With respect to monetary policy, I think we have learned that monetary policy loses its punch as interest rates get stuck at or near zero. Not everyone agrees - some people argue that unconventional monetary policy can still be used effectively - but even if that's true, I don't think that monetary policy alone can stop the downturn and turn things around.

That leaves fiscal policy. I believe that fiscal policy can help people during downturns like we are in now. I could be wrong about that, the evidence just isn't there to say for sure. But of the two errors, not helping people when help would have mattered, and trying to help but failing to do any good, I'd rather make the second mistake.

But as we try to help, there are two ways in which we could make fiscal policy less attractive as a stabilization tool in the future.

First, the political process could render fiscal policy too weak to be effective. If tax cuts and government spending are directed mostly toward political goals, that could water the policy down so much that it does little good.

In the stimulus package just enacted, politicians did direct tax cuts and spending towards political ends, and they had enough success to make the policy far less effective than it might have been. But let's hope there's enough useful policy measures left to make a difference, and I think there are, and that the evidence is clear enough so that we are able to learn what works and what doesn't. That way, the lesson going forward will be about how to do fiscal policy better next time - which mix of policies works best - rather than that politicians can't be trusted to do it at all.

Second, we could fail to reduce the budget deficit once the economy turns around. Done correctly, stabilization policy does not add to the long-term budget problems of an economy. During the bad times, the troughs of the business cycle are filled by running deficits (either tax cuts or increased government spending), and during the good times the peaks of the cycle are shaved as these policies are reversed. By filling the troughs during the bad times with the shaved peaks from the good times, the economy is more stable since we are moving resources from times when the economy is overheated to times when it is running cold. And since the peak to trough transfers are one-to-one, there is no net change overall in the size of the government debt (the size of government could go up or down in the process, or it could stay the same, that depends upon the particular mix of tax and government spending changes that politicians choose, it has nothing to do with stabilization).

We're pretty good at giving away the goodies when things get bad, and I'm glad we are generous enough to do that, but we haven't been as good at paying the bills when times get better. If we are going to try fiscal policy, and as I said above I don't think we have any choice but to run a budget deficit right now, we have to find a way to pay the deficit off once things improve (but not before). If we don't, if this ends up adding substantially to our long-run debt, then the lesson will be that changes in taxes or government spending are too sticky to be used effectively as a stabilization tool. Taxes can be cut easily, but raising them again later is a lot harder, and the same goes for spending - it's easier to add to spending than to cut it back. If the lesson is that we cannot overcome this resistance to paying for stabilization policy, and there are plenty of people who cannot wait to make that point - in many cases the same people who are all too ready to argue that the increased debt necessitates cuts in key social programs - then fiscal policy will not look very attractive the next time the economy goes into a recession so deep that monetary policy alone is not enough to save the day.

In the short-run, the first problem is the worry, i.e. that the bill that was enacted is too watered down to be effective (and that another round won't be possible if things don't turn around), but over the longer run it's the second problem that is of concern. If it was up to me - and many of you will be happy it isn't - I'd put parts of fiscal policy in the hands of an independent Fed like structure and charge it with stabilizing fluctuations in the economy over the business cycle while retaining a long-run balanced budget (perhaps even implementing Andrew Samwick's idea of having a predetermined list of infrastructure projects on the shelf and ready to go if a recession hits). But that's not going to happen, so it's up to the political process to make fiscal policy work as a stabilization tool and, while there have been some good signs from the administration along these lines, I can't say I'm overly confident that politicians are up to the task.

"Put Earmarks in Perspective"

Thomas Mann of the Brookings Institution says that "hyperbolic attacks on earmarks do a disservice to the public":

Put Earmarks in Perspective, by Thomas E. Mann, Senior Fellow, Brookings: It is hard to take seriously a political opposition whose major antidote to the most serious and frightening financial and economic crisis since the Great Depression is a rhetorical crusade against congressional earmarks.

Sen. John McCain took to the Senate floor Monday to unleash his fury at the 9,000 earmarks — "wasteful, disgraceful, corrupting ... pork barrel spending" — that are included in a $410 billion omnibus spending bill for the current budget year. ... But dramatic calls for an abolition of earmarks, by law or presidential veto, are futile and counterproductive. Congress has the constitutional power of the purse and legitimately defends its authority to allocate public resources. Given the enormity of the economic and financial problems facing the country, Obama would be foolish to engage Congress in a battle over earmarks.

Earmarks constitute less than 1 percent of the federal budget. In most cases, they don't add to federal expenditures but merely allow Congress to direct a small fraction of program funding that would otherwise be allocated by formula or grant competition. Abolishing all earmarks would therefore have a trivial effect on the level of spending and budget deficits. While earmark reform and reduction is a worthy cause, it is a relatively minor one. It would do nothing to slow the rate of federal spending or improve our long-term budget outlook. Moreover, hyperbolic attacks on earmarks do a disservice to the public, encouraging people to concentrate way too much attention and energy on a largely symbolic issue and ignore the critical decisions that we face in the months and years ahead. In an effort to stimulate an economy threatened by deflation and severe recession, federal spending will increase dramatically over the next several years. The challenge is to see that these new funds are expended in the most responsible way possible. Beefing up our public management capacity — in contracting, financial accountability, program evaluation — and developing oversight systems are the highest priorities. Same with efforts under way to stabilize the financial markets. Then there are the daunting challenges of designing and implementing new systems to restrain the cost and increase the coverage of health care and to shift to a low-carbon economy, to say nothing of grappling with a huge, long-term fiscal imbalance. In this most threatening and challenging policy environment, it is time for earmarks to be put in their proper perspective and for politicians in both parties to get serious with the public about what really lies ahead.

Here's a graph I made during the election illustrating the same point.

Fractured Fairy Tales

The M1 multiplier is less than one:

The Demise of Fractional Reserve Banking, by Athenian Abroad: Fractional reserve banking -- the system under which banks hold only a fraction of their deposits in reserve, and lend the rest -- is a bĂȘte noire of a certain segment of the economic and political blogosphere. There's something about it that seems dizzyingly insubstantial, self-referential, unnatural, unearthly, and unholy: it's the Financial System from Yuggoth! I don't get it myself, but the metaphysical loathing can be quite intense. So, for these folks: good news! We don't have fractional reserve banking anymore. In statistics-speak, since last November, the monetary base has exceeded M1, which means, more or less, that bank reserves (plus surplus vault cash) exceed liquid deposits. So everything's OK now, right?

links for 2009-03-07

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