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May 26, 2009

Economist's View - 5 new articles

Feldstein: Has the US Recovery Begun?

Martin Feldstein says don't get your hopes up for the economy just yet:

Has the US Recovery Begun?, by Martin Feldstein, Commentary, Project Syndicate: ...[M]y reading of the evidence does not agree with that of those who claim that ... a sustained cyclical recovery is likely to begin within the next few months. ... But, although the recent news is not as encouraging as some have claimed, I expect that the next few months will see some real improvements that will reduce the rate of overall economic decline, or even produce a temporary rise in the GDP growth rate, owing to the Obama administration's fiscal stimulus measures. ...

But the key thing to bear in mind is that the stimulus effect is a one-time rise in the level of activity, not an ongoing change in the rate of growth..., there is nothing to make that higher growth rate continue in the following quarters. So, by the end of the year, we will see a slightly improved level of GDP, but the rate of GDP growth is likely to return to negative territory.

The positive effect of the stimulus package is simply not large enough to offset the negative impact of dramatically lower household wealth, declines in residential construction, a dysfunctional banking system that does not increase credit creation, and the downward spiral of house prices. The Obama administration has developed policies to counter these negative effects, but, in my judgment, they are not adequate to turn the economy around and produce a sustained recovery.

Having said that, these policies are still works in progress. If they are strengthened in the months ahead – to increase demand, fix the banking system, and stop the fall in house prices – we can hope to see a sustained recovery start in 2010. If not, we will just have to keep waiting and hoping. [...more...]


Starve the Beast (Recession Edition)

John Taylor plays Starve the Beast. First, he calls for permanent tax cuts - and only permanent tax cuts - to stimulate the economy, tax cuts that will make the long-run budget picture worse. (Paul Krugman: "You've got John Taylor arguing for permanent tax cuts as a response to temporary shocks, apparently oblivious to the logical problems.") Then, he tells a "scary" inflation story and argues that deficits are a bigger threat than the financial crisis and must be reduced through reductions in the size of government:

Exploding debt threatens America, by John Taylor, Commentary, Financial Times: ...Under President Barack Obama's budget plan, the federal debt is ... is rising – and will continue to rise – much faster than ... America's ability to service it. ...

I believe the risk posed by this debt is systemic and could do more damage to the economy than the recent financial crisis. To understand the size of the risk, take a look at the numbers..., a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. ... A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. ...

The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised. ... And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. ... This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating. ...

The time for ... excuses is over. ... Good government should be a nonpartisan issue. I have written that government actions and interventions in the past several years caused, prolonged and worsened the financial crisis. The problem is that policy is getting worse not better. ...[G]overnment is now the most serious source of systemic risk. ...


"Credit Crisis Cassandra"

This explains a lot. Brooksley Born, head of the Commodity Futures Trading Commission from 1996-1999, wanted to regulate the financial markets that have caused us so much trouble, but Greenspan, Rubin, Summers, and Levitt stood in the way and would not allow it. I wonder if they patted her on the head as they explained "that they understood finance better than she did."

I have argued that the attitudes toward regulation were the biggest problem in creating this crisis, and this article reinforces that view. The people in charge of the regulatory agencies were convinced that unregulated markets were self-correcting, and that regulation was not needed and would more likely do harm than good. As this shows, no amount of convincing from people who weren't as smart as the smartest guys in the room was going to change that. The question for me is whether those in charge now, Summers for example, have learned their lesson and the humility to be derived from it, or whether they will be defensive of their own role to the extent that it affects the type of regulation they can support. I'd very much like to believe they have learned their lesson, though humility seems to be lacking, but watching Summers and others argue that the private sector and the market is preferable to temporary government takeover of banks (i.e. his and the administration's opposition to temporary nationalization), - the continued faith that the market always knows best - makes me wonder if they have.

One more note on Summers. I wasn't in favor of him when he was picked to be part of the administration because I thought he carried far too much political baggage. If he has value, it is not as a spokesperson for the administration. But again and again I heard that he was the only one smart enough to do this job. I don't believe that and never will, but if it's true, fine, put him in an office somewhere, let him be smart and helpful, but above all keep him out of the public eye. He does not help as a spokesman for the administration, he hurts the cause every time he opens his mouth. At first it seemed like he was going to be the key spokesperson on financial matters and as I said, I thought that was a mistake. But lately I haven't heard much from him, most of his work appears to be behind the scenes, and as far as I'm concerned, that's a very good development in terms of the public presentation of the administration's views:

Credit Crisis Cassandra, by Manuel Roig-Franzia, Washington Post: Friends ... want Brooksley Born to say four words, four simple words: "I told you so." Ah, but she won't... Not even in a quiet moment in her living room, giving her first interview with a major news organization...

A little more than a decade ago, Born foresaw a financial cataclysm, accurately predicting that exotic investments known as over-the-counter derivatives could play a crucial role in a crisis much like the one now convulsing America. Her efforts to stop that from happening ran afoul of some of the most influential men in Washington, men with names like Greenspan and Levitt and Rubin and Summers...

[F]rom 1996 to 1999, when Born was the chairman of the Commodity Futures Trading Commission, the U.S. economy was roaring and she was getting nowhere with predictions of doom. ... She woke repeatedly "in a cold sweat," agonizing that a financial calamity was coming, she recalled one recent afternoon. "I was really terribly worried," she said.

Before taking office, Born had been a high-octane attorney... But ... she... was taking on Beltway pros... She marched into congressional hearing after congressional hearing -- pin neat, always with a handbag -- but no one really wanted to listen.

The Wall Street Journal declared that "the nation's top financial regulators wish Brooksley Born would just shut up." The Bond Buyer newspaper compared her to a salmon "swimming against raging currents." ... Now ... she ... may be closer than ever to vindication...

Born's baptism as a new agency head in 1996 came in the form of an invitation. Federal Reserve Chairman Alan Greenspan ... wanted her to come over for lunch.

Greenspan had an unusual take on market fraud, Born recounted: "He explained there wasn't a need for a law against fraud because if a floor broker was committing fraud, the customer would figure it out and stop doing business with him."

This made no sense to her. She'd spent much of the 1980s defending clients caught up in a vast conspiracy by two wealthy brothers, Nelson and William Hunt, who duped investors while trying to corner the world silver market. "After all," Born said, looking back, "I'm a lawyer, and I think the existence of fraud prohibitions is critically important."

But Greenspan was insistent, she said. Finally, he said, "Well, Brooksley, I guess you and I will never agree about fraud." ...

That was just the beginning. By early 1998, Born had also tangled with Treasury Secretary Robert Rubin, his deputy, Summers, and Securities and Exchange Commission head Arthur Levitt, not to mention members of Congress, financial industry heavyweights and business columnists. She wanted to release a "concept paper" -- essentially a set of questions -- that explored whether there should be regulation of over-the-counter derivatives. ...

They warned that if she did so, the market would implode and predicted tidal waves of lawsuits. On top of that, Rubin told her, she didn't have legal authority to regulate the derivatives anyway. She wasn't buying any of it, and she wasn't backing down. ...

Based on her lunch with Greenspan, Born knew she would run into heavy resistance. ... In early 1998, Born's plan to release her concept paper was turning into a showdown. Financial industry executives howled, streaming into her office to try to talk her out of it. Summers, then the deputy Treasury secretary, mounted a campaign against it, CFTC officials recalled. ...

In one call, Summers said, "I have 13 bankers in my office and they say if you go forward with this you will cause the worst financial crisis since World War II," recounted Greenberger, a University of Maryland law school professor who was Born's director of the Division of Trading and Markets. ...

The discordant notes crescendoed in April 1998 during a tension-filled meeting of the President's Working Group, a gathering of top financial regulators that periodically met behind closed doors at the Treasury Department. At that meeting, Greenspan and Rubin forcefully opposed Born's plans, Waldman said. "Greenspan was saying we shouldn't do it," Waldman recalled. "Rubin was saying we couldn't do it."

The next month, Born released her concept paper anyway. Within weeks, she was under attack. ... Greenspan, Rubin and Levitt jointly urged Congress to pass a moratorium on the CFTC regulating over-the-counter derivatives.

With emotions running high, Born was summoned to the office of House Banking Chairman Jim Leach, a Republican from Iowa, to meet with top officials from the Fed and the Treasury. ...

"The feelings in the room were very tense," recalled Leach... "There were some very profound personality clashes between Rubin and [Born], and Greenspan and her," Leach said. "They felt, I think, that they understood finance better than she did." ...

"If you could fault her for anything, it's not recognizing the politics," Waldman said. "She assumed the force of her ideas were going to be sufficient."

But then, in September 1998, a huge hedge fund that had bet heavily on derivatives -- Long-Term Capital Management -- nearly failed and had to be bailed out by a group of banks. Here was a living example of Born's prophecy. Even Leach, who supported the moratorium on CFTC regulatory action, introduced Born at a hearing by saying, "You're welcome to claim some vindication, if you want."

Born responded: "I certainly will not do so." But she went on to tell the committee that the Long-Term Capital debacle "should serve as a wake-up call about the unknown risks in the over-the-counter derivatives market."

No one woke up. That same month, Congress passed the moratorium. Born says they were "muzzling an independent agency." Two months later, Born announced that she would not seek reappointment to a second term. ...

Last week,... she traveled to Boston to receive the John F. Kennedy Profiles in Courage award. Finally, though perhaps too late, everyone wanted to listen to Brooksley Born. She once again warned about the danger of Dark Markets... "If we fail now to take the remedial steps needed to close the regulatory gap," Born said, "we will be haunted by our failure for years to come." ...


Comment Troubles?

A couple of people have reported that their comments are being rejected by the TypePad system. I have no idea why -- they are not being tagged as spam so I cannot restore them -- all I can recommend for now is to keep trying (some people send the rejected comments to me by email, and that will work if there aren't too many, but I won't always be able to post them right away). I am looking into this. [I should probably add that not every missing comment is TypePad's doing...]


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