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May 21, 2009

Economist's View - 5 new articles

"Near Sighted Stress Tests"

Lucian Bebchuk argues that banks "could well be in much worse shape than has been suggested by the stress tests" because the tests only looked at losses through the end of 2010. Anticipated losses after that date, which could be big enough to matter, were not included:

Near-Sighted Stress Tests, by Lucian Bebchuk, Forbes: Buoyed by the results of the "stress tests" conducted by banks' supervisors, markets now appear optimistic about the capital positions of U.S. banks. Unfortunately, however, this renewed optimism has a shaky foundation. By design, the stress tests have avoided estimating the declines in the value of many toxic assets owned by banks. As a result, U.S. banks could well be in much worse shape than has been suggested by the stress tests.

The report announcing the results of stress tests stresses that supervisors conducted "a deliberately stringent test" and examined the ability of banks to absorb losses even under an "adverse" scenario... The report concludes that, with a modest aggregate addition of $75 billion in common equity, the banks will be well capitalized at the end of 2010 even under the adverse scenario. ...

However, for a bank that has "troubled assets" ... that do not become due until after 2011, supervisors did not attempt to come up with a precise estimate of the extent to which, at the end of 2010, the economic value of the troubled assets will fall below the $1 billion face value.

This approach overlooks a substantial amount of economic damage imposed on banks by the crisis. Indeed,... even if banks are able to avoid recognizing these declines in value on their financial statements until after 2010, there will still be such economic losses. A bank may be an economic zombie even if its financial statements do not yet show it.

The report acknowledges this major problem in a footnote, noting that its estimated losses "are not full lifetime losses … because the projections are for a two-year forward horizon and thus do not capture losses occurring beyond the end of 2010." ...

To get a full picture of the banks' situation, bank supervisors should estimate also the decline in the economic value of banks' positions with longer maturities. Only then will the stress tests be able to deliver reliable figures for the additional capital necessary to make the banking sector healthy and vigorous. Until such an analysis is done, it would be important to avoid the premature conclusion that the U.S. baking system is largely out of the woods.

"Will the Stimulus Stifle Recovery?"

More people tired of hearing criticisms of the economic stimulus package that are wrong due to the "Great Forgetting":

Will stimulus spending stifle recovery?, by James W Dean and Richard G Lipsey, Economists Forum: The enormous stimulus packages hastily put together by governments in most large economies encounter two sorts of criticisms from many conservative economists. Both criticisms are wrong.

The first is that spending will either be hurried and wasteful, or that it won't come on stream until employment has recovered, and will therefore be inflationary.

The second is that deficit-financed government spending merely replaces spending by consumers and firms dollar for dollar; so-called 100 per cent 'crowding out'. Critics often fail to point out that these two arguments cannot both be true. If government spending merely replaces private spending dollar for dollar, it does not affect total demand. As a result, it cannot be inflationary. ...[...continue reading...]

On the first point, they conclude that:

To be sure, stimulus programmes should target projects with productive potential. Economies from the US to China are in dire need of new physical and social infrastructure. But even "unproductive" projects are better than none at all if the alternative is to leave labour and capital unemployed.

And if stimulus spending for infrastructure comes into effect after the end of recession, when real resources and financial markets are re-employed, there are adequate monetary tools to contain such pressures. In other words, long-term plans for infrastructure planning can stand on their own merit.

And on the second:

...arguments that deficit-financed stimuli will be crowded out are far-fetched in the extreme...

Greenspan's Capital Idea

Yves Smith:

Greenspan Says Banks Need More Capital, by Yves Smith: You have to give former Fed chairman Alan Greenspan credit for having no shame. Well, he did once look a bit rattled before Congress for about five minutes and 'fessed up it never occurred to him that people would be so greedy as to run companies so as to leave burned hulks in their wake.

Did he utterly miss reading the news during Enron and the 2002 accounting scandals?

Greenspan also made life difficult for Bernanke in early 2007 more than once. Indeed, prior to Greenspan, no former Fed chairman made frequent pronouncements. This is unseemly, but having a sense of propriety went out of fashion in America some time ago.

Now Greenspan is saying the banks are not OK (if they need a lot more capital, then by definition, they are undercapitalized now) when the powers that be have a full court press on to present precisely that image. And whose responsibility might it be that the banks are in such sorry shape? Might the Greenspan Fed's extreme laissez faire stance have had a wee bit to do with it? ...

This also goes along with his self-exonerating claim that the housing bubble was not caused by Fed policy under his watch, and that the problems could have been avoided if financial firms had larger capital buffers (and, according to Greenspan, all that is needed in terms of regulation is larger reserves against losses, no other regulation is needed, his often noted surprise at the failure of deregulated markets is that firms did not accumulate sufficient reserves on their own).

links for 2009-05-21

"Anatomy of Thatcherism"

Robert Skidelsky assesses Thatcherism:

Anatomy of Thatcherism, by Robert Skidelsky, Project Syndicate: Thirty years ago this month, Margaret Thatcher came to power. Although precipitated by local conditions, the Thatcher (or more broadly the Thatcher-Reagan) revolution became an instantly recognizable global brand for a set of ideas that inspired policies to free markets from government interference. ... But 30 years of hindsight enable us to judge which elements of the Thatcher revolution should be preserved, and which should be amended in the light of today's global economic downturn. ...

[B]y the 1970s the pre-Thatcher political economy was in crisis. The most notorious symptom of this was the emergence of "stagflation"... Something had gone wrong with the system of economic management bequeathed by John Maynard Keynes. In addition, government spending was on the rise, labor unions were becoming more militant, policies to control pay kept breaking down, and profit expectations were falling. It seemed to many as though government's reach had come to exceed its grasp...

Thatcherism emerged as the most plausible alternative to state socialism. ... Yet, despite all the "supply side" reforms introduced by Thatcherite governments, unemployment has been much higher since 1980 than in the 1950s and 1960s...

What about inflation targeting? Here, too, the record since 1980 has been patchy... Nor has Thatcherite policy succeeded in one of its chief aims ― to reduce the share of government spending in national income. The most one can say is that it halted the rise for a time. ...

In de-regulating financial markets worldwide, the Thatcher-Reagan revolution brought about the corruption of money, without improving on the previous growth of wealth ― except for the very wealthy. ... Furthermore, in unleashing the power of money, the Thatcherites, for all their moralizing, contributed to the moral decay of the West.

Against these formidable minuses are three pluses. The first is privatization. By returning most state-owned industries to private ownership, the Thatcher revolution killed off state socialism. The British privatization program's greatest influence was in the former communist states, to which it gave the ideas and techniques needed to dismantle grossly inefficient command economies. ...

Thatcherism's second success was to weaken trade unions. Set up to protect the weak against the strong, labor unions had become, by the 1970s, enemies of economic progress, a massive force of social conservatism. It was right to encourage a new economy to grow outside these congealed structures.

Finally, Thatcherism put paid to the policy of fixing prices and wages by central diktat or by tripartite "bargains" between governments, employers, and trade unions. These were the methods of fascism and communism, and they would, in the end, have destroyed not just economic, but political, liberty.

Political pendulums often swing too far. In rebuilding the shattered post-Thatcherite economy, we should be careful not to revive the failed policies of the past. ...

As long as central government takes responsibility for maintaining a high and stable level of employment, Keynes thought, most of the rest of economic life can be left free of official interference. Building a proper division of responsibility between state and market from this insight is today's main task.

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