The Ultimate Risk: Capital Flight from the Dollar

The analysis by Floyd Norris in the New York Times is so wrongheaded it is difficult to know where to begin. I could complain about his focus only on banks rather than the shadow banking system, or his conflation of liquidity and solvency threats, or his comparing apples and oranges in measurements of leverage across countries. But the most important error is his claim that the US, by virtue of issuing the world’s reserve currency, has unlimited resources to throw at its financial system:

As the banking system quaked this week in many countries, and various governments took steps to bail out their banks or at least guarantee deposits, one question was asked quietly: Can the governments afford it?

That is not a question for the United States, which can print dollars and has a banking system that is the largest in the world but is small in relation to the national economy.

The last part of that sentence is about the confusion between banks and financial intermediaries (how could a Times columnist make this mistake after all that has happened during the past year?), but it is the first half I want to discuss.



Something like a trillion dollars (give or most likely take a couple of hundred billion) has been spent thus far in the pursuit of a bailout. How is it being financed? Not with money creation. The Fed can, if it wishes, treat its purchase of troubled assets (and institutions) like ordinary open market operations, simply crediting the accounts of sellers held as Fed liabilities. Indeed, it has done some of that in recent weeks, as the following chart shows.

M1 and M2 growth, 3rd quarter 2008 (index, July 7 = 1.00)


Indeed, an expansion of over 10% in M1 within the space of two weeks might be considered extravagant, except that during this same period M2 was up only about a tenth of that. In other words, the Fed is largely offsetting the contractive effects of the credit crunch, slightly erring on the side of greater liquidity. In absolute terms, the Fed’s additional injection comes to about $150B. The remainder of its bailout finance comes from a variety of sources, but essential is the global demand for treasuries, which has jumped by over $2T on an annualized basis in the first two quarters of this year compared to pre-crisis levels. It is difficult to disentangle the official from the private flows, but the latter by all accounts has been dramatic, as the herd rushes to “quality”.

The constraint faced by the Fed is the willingness of wealth holders to continue to skew their portfolios so strongly toward dollars. In an earlier post (“reverse tsunami”), I simplified by assuming that rebalancing will occur only after the crisis is over. Actually, it is entirely possible that this rebalancing (aka “capital flight”) could occur at any time. If it happens it will be triggered by a change in perceptions, that the dollar is not the rock in a raging sea that it previously seemed to be. Some of the factors that could cause this are beyond the control of Bernanke’s crew (such as one or more high profile nonfinancial defaults), but the perception that the US intends to inflate its way out of the crisis would have a similar effect and is clearly related to the “print dollars” option that Norris takes for granted. In other words, open market-style purchases of bad assets is effectively limited by private sector credit contraction. The bad assets are a stock (size unknown) and the contraction a flow, hence no match can be assumed.

A closing word of paranoia: it is difficult to overstate the significance of the financing constraint on bailout strategies. The lesson here is not 1929, but 1931-32, when a series of national currency runs whiplashed the global system and prevented any individual country from taking effective action. A change in sentiment on the dollar, if it occurs, will be sudden, unexpected and massive. An outflow of funds would stop the Fed/Treasury strategy in its tracks and mark the end of any meaningful program to restore financial markets. No one knows what the tipping point could be, or even whether the most enlightened policy can avert it. (In that respect our financial imbroglio resembles the risk of catastrophic climate change.) But its shadow looms over the entire operation, and this is constraint that policy-makers should keep firmly in mind, assuming they are not as clueless about the existential risks we face as current journalistic coverage.

Peak Toil

by the Sandwichman

In 1936, M. King Hubbert, the prophet of "Peak Oil" (Hubbert's Peak) and at that time a leader in the Technocracy organization, wrote a pamphlet on Man-Hours and Distribution.

The period since 1929 has been one of the most unique and one of the most disturbing in the history of North America. The events that have occurred since the stock market crash of that year have provoked more competent social thinking on the part of the American people, and have demolished more fixed tenets of our American social and economic faith than those of any preceding half century.

Up until the year 1929 the American public had been brought up in the belief that any child with ambition and a willingness to work would automatically be rewarded with material gain in direct proportion to the effort and ingenuity displayed; that any office boy might become the president of his corporation in due time provided he displayed the proper virtues of industriousness, honesty, respectfulness and thrift; that every boy had an equal chance of becoming President some day; that the pathway to success was to be found in part through proper education, and that educational facilities were equally available to all; that work could be had by all who were willing; and, conversely, that unemployment and lack of material success were themselves indicative of the lack of those cardinal virtues of industriousness, thrift, honesty, and the like.

In 1929 and the years that have followed, these tenets of our American folk-lore have been rudely shattered, for during that time one-quarter to one-third of all those willing and able to work have found it impossible to obtain employment and have consequently been forced to depend upon their relatives and friends for support, or else upon public governmental relief. During those years as many as one-quarter of the entire population have been dependent upon the funds of the federal government for food and clothing. Even the most independent and rugged of our remaining individualists, the American farmer, has found it increasingly necessary to rely upon the funds of the federal government. Corporate business has likewise had to be bolstered up.

The Risk of a Positive Feedback Loop

The current financial crisis is the result of very large declines in asset prices, whose epicenter is the housing market. We had a bubble, trillions of dollars in bets were made on the assumption it would continue, and it didn’t. The ultimate cost of a bailout (and therefore its feasibility given limited resources) is, at this point, determined by the volume of net asset deflation minus pre-existing equity of financial intermediaries (which, due to their extreme leverage, was minimal). So far so bad.

But it could get much worse. The world has almost certainly entered into a recession. The current decline in US consumer spending, the first since the sharp V-slump of the early 1990s, is a bad sign. As the downturn picks up speed, it will add to the quantity of distressed assets: new corporate paper gone bad, further declines in equities, even greater distress in housing. This could increase the amount of implicit writeoffs and expose even more counterparties to default risk. The price tag of a bailout would lurch further out of reach.

Consider, for instance, the effect of an announcement by General Motors that it is filing for bankruptcy. For some time the markets have told us this is a 50-50 possibility; with car sales plunging and the apparent desperation of GM management in its merger maneuvers, it has to be an even greater possibility today. This would be taken as a sign by almost everyone that a positive feedback loop from the real sector to the financial sector is beginning to take form, and the consequences would not be pretty.

Of course, no one knows what the future holds in store. We may yet waltz out of this with only a trillion or two in losses to show for our fears of impending doom. That looks like the best-case scenario. As for me, I’m worried about positive feedback and the risk that even the best-designed bailout (better than what is now on the table) will not be enough. This is why I think that what I originally called Plan B, and now stands as Plan C or D—public banking—ought to be given immediate consideration. Why should we pin all our hopes on a bailout that may fail to catch up with its moving target?

The Second Shoe, part III

by the Sandwichman

In earlier installments I discussed the non-parliamentary, non-democratic and accounting error dimensions of the current crisis. I indicated that in the next posting I would address "accounting for labor power." Before doing so, I would like to comment on the crackpot title of a feature in this week's Newsweek, "How to save capitalism." What an absurd way to frame the question! The point is not "saving" or "abolishing" capitalism. The point is getting on somehow with life and livelihood. If there are indeed elements of capitalism that we might want to retain, they must withstand some reasonable tests of usefulness and durability.

Having previously cited Engels and Lenin on book-keeping, I now will cite Marx, himself:

After the abolition of the capitalist mode of production, but still retaining social production, the determination of value continues to prevail in the sense that the regulation of labour-time and the distribution of social labour among the various production groups, ultimately the book-keeping encompassing all this, become more essential than ever.

Thus, for Marx, the key to determining value is the regulation of labor time and the distribution of social labor. This is regardless of whether one is intent on saving or abolishing capitalism. But how does capitalist book-keeping encompass the regulation of labor time? By compiling a payroll that records wage rates and hour worked by employees.

Is that how post-capitalist book-keeping with regard to labor time would also work? No. According to Moishe Postone, Marx analyzes four distinct elements of labor time. Necessary and surplus labor time from the perspective of the individual worker, socially necessary labor time from the global perspective and superfluous time, a fourth category that arises as labor time itself ceases to be the primary source of material wealth. Although this labor time is superfluous to the production of material wealth, under capitalism it remains a prerequisite for the performance of necessary labor time to the extent that labor time remains the source and measure of value. The material wealth that results from this fourth kind of labor time needs to be destroyed. War is the accustomed method for destroying this superfluous material wealth. But anything that promotes conspicuously wasteful consumption helps. After capitalism, this superfluous labor time (in theory!) could be converted to time free from labor.

I like Postone's interpretation but the categories may be a bit too abstract for book-keeping purposes. That's because he starts out from marxist theory rather than accounting practice. My own approach is to begin from an instance of accounting practice that is uniquely relevant to the analysis of labor time: the costing of collective bargaining proposals by unions and employers.

It so happens that unions and employers evaluate working time differently in their costing models. Unions typically use "paid hours" as the divisor for evaluating hourly labor rates. Employers use "hours actually worked". Neither side explicitly recognizes the productivity effects of different working time arrangements although the union approach does implicitly and very imprecisely. It's not difficult to build a spreadsheet model that reconciles the union and employer perspective while incorporating an explicit productivity factor. I've done it. What has proven difficult is convincing unions, employers or governments of the urgency of doing a more responsive costing of labor time.

Necessity, nonnecessity, freedom

"...according to Marx, historical necessity cannot, in and of itself, give rise to freedom. The nature of capitalist development, however, is such that it can and does give rise to its immediate opposite -- historical nonnecessity -- which, in turn, allows for the determinate historical negation of capitalism." -- Moishe Postone, Time, Labor and Social Domination

The Last Hurrah

by the Sandwichman

In 1995, following several years of "jobless recovery", Jeremy Rifkin's The End of Work was published and became a short-lived sensation. There was nothing new in Rifkin's central thesis of intractable technological unemployment. But the timing of his book seemed impeccable. For a while. Then a funny thing happened. The fantastic American job-creating machine fired up and talk about the end of work receded.

That "job-creating machine" was a centralized policy response to stagnation, not some inherent dynamic feature of free-market capitalism. The following graph by Paul Krugman shows the timing and effect of the Greenspan bubble machine.


Absent a new bubble, the collapse of the house price bubble brings us back to the question of technological unemployment or "the end of work" as Rifkin put it. Apologists for capitalism will be rooting for a new bubble. But is a new bubble even feasible? I say no, at least not for a considerable period of time. Bubbles are a confidence game. That is, they rely on widespread confidence that they are not bubbles. Too much learning has occurred over the past year for a new bubble to be able to take hold. Maybe after several years of forgetting...

Economic and Social Importance of the Eight-Hour Movement

"The end and object of produc­tion is consumption. Nothing but the de­sire for a commodity and a willingness to give an equivalent for it will cause it to be produced."

Update: For a contemporary survey with a great deal of relevance to the matters being raised here, please see: Fear of fallowing: the specter of a no-growth world published in the March 2008 Haper's magazine.

The employer represents capital, and capital represents the means of production; hence, the employing class represents pro­duction.The end and object of produc­tion is consumption. Nothing but the de­sire for a commodity and a willingness to give an equivalent for it will cause it to be produced. Production is universally the economic response to, and consequence of consumption. No one will continuously produce a commodity unless he can find consumers for it. To the extent that he ignores this fact, he pays the penalty in loss and bankruptcy. The market is the basis of the workshop and the warehouse, and the habitual daily consumption of wealth by the community is the basis of the mar­ket. Thus, economic production abso­lutely depends upon social consumption, and the success of the employing class de­pends upon the extent of the consuming class.

Sorting Through the Bubbles and the Crashes

Now that we have seen a full bore, global panic and crash, it might be worth sorting out how many bubbles there have been, and which of the three patterns identified by Minsky and Kindleberger (and first formally modeled by me, dating back to 1991) each has followed.

So, the first and most fundamental has been the housing bubble. This seems to have followed the pattern of gradually up and then gradually down, with no crash. The peak was end of 2005, and if one believes the various Shiller indexes, it still has a good 10-40% to go or so. Of course real estate bubbles rarely crash, unless they are for vacant land as in Florida in the 1920s, as people will generally not dump their own homes in a panic.

The next was the derivatives bubble. Whereas the housing bubble fairly clearly started around 2000 or 2001 after the tech stock crash, the beginning of the derivatives bubble is shrouded in mist, still much about it is not well known. However, it looks to have followed the peak followed by a period of financial distress and then a crash pattern, the most common pattern for major bubbles. The peak would appear to have been August, 2007, and the crash was the outright financial market panic on Sept. 17, 2008, after Lehman Brothers was allowed to fail and AIG nearly went under, with Treasury yields dropping to 0.06% at one point. This crash ended with the announcement of the bailout of AIG and that there would be a broader bailout, although clearly the credit and derivative markets have not really recovered from that crash.

Then there was the oil bubble, which looks more like the theoretically preferred one that goes up, peaks, and then pretty much crashes, which happened in July, although it has continued to sink since, and very rapidly in recent days.

Finally there is the behavior of the stock markets. While there was a bubble in US stocks in the 1990s, the more recent behavior has not been particularly bubbly. The sharp crash of the last few days has been a negative bubble, an epiphenomenon emanating from the crashes of the derivatives and credit markets, collateral damage, although quite serious, and threatening to take down the real economy as well (bankruptcy for General Motors anybody?).

Looking Ahead: A Reverse Tsunami

This afternoon I co-led a forum on the financial crisis with my Evergreen colleague Peter Bohmer. I had a flash as I was preparing: at some future point we could be in for a reverse tsunami.

Here’s the idea: A real tsunami begins with an outward flow of water. If you’re standing on the beach and suddenly the water line retreats 10 or 20 meters, it’s time to race for higher ground. Now consider the opposite phenomenon. The massive Fed/Treasury spending spree to hold the crisis at bay, thus far unsuccessful, is being financed by a massive capital inflow. Some of this comes from foreign CB’s eager to do their part, but a big part is the result of global capital flight to the supposedly least risky currency. Suppose we get out of this alive and calm returns to the markets. Most of those people are going to want to bring their money back—that’s the reverse tsunami. How do we finance that? The Fed’s balance sheet will be wall-to-wall junk.

OK, just getting to that moment will be a big victory.

"Revulsion" and the Minsky Moment

The two hour drop of the Dow leading to the second largest decline in percentage terms in a single day ever looks like we have finally come to the end of the period of financial distress described by Minsky and Kindleberger that we have been in since August, 2007, the move to panic and crash, the drop off the cliff. Which brings to mind another old fashioned term (like "fictitious capital," brought up here recently by michael perelman). This would be "revulsion," also a term liked by Minsky (for his "moment") and Kindleberger, which happens at the worst point of the panic and crash stage.

How to Think about the Crisis

My piece on How to Think About the Crisis was just published in Radical Notes
http://radicalnotes.com/content/view/73/39/

The Corrosive Qualities of Inequality: The Roots of the Current Meltdown.

My article was just published in Challenge Magazine.

"The Corrosive Qualities of Inequality: The Roots of the Current Meltdown." Challenge, Vol. 51, No. 5 (September-October, 2008): pp. 40-64.

McCain’s Mortgage Subsidy: Incidence to Homeowners or to Bankers?

Mike Allen reports:

Sen. John McCain (R-Ariz.) made an overnight change in the homeowner bailout he proposed at Tuesday’s presidential debate, making it more generous to financial institutions and more costly for taxpayers. McCain's staff says it was always meant that way. When McCain sprung his surprise idea at the start of the debate in Nashville, his campaign posted details online of his American Homeownership Resurgence Plan, which would direct the government to buy up bad home mortgages, allowing strapped people to keep their property. The document posted and e-mailed by the McCain campaign on Tuesday night says at the end of its first full paragraph: “Lenders in these cases must recognize the loss that they’ve already suffered.” So the government would buy the mortgages at a discounted rate, reflecting the declining value of the mortgage paper. But when McCain reissued the document on Wednesday, that sentence was missing, to the dismay of many conservatives. That would mean the U.S. would pay face value for the troubled documents, which was the main reason Sen. Barack Obama (D-Ill.) gave for opposing the plan. A McCain campaign official explained the change: “That language was mistakenly included in the initial draft and it’s been corrected. It doesn’t reflect the intentions of the initiative, which necessitated the correction and the removal of the sentence. A simple mistake.” Obama Campaign Economic Policy Director Jason Furman said in the campaign statement opposing McCain's plan: "John McCain wants the government to massively overpay for mortgages in a plan that would guarantee taxpayers lose money, and put them at risk of losing even more if home values don’t recover. The biggest beneficiaries of this plan will be the same financial institutions that got us into this mess, some of whom even committed fraud."

When I posted this, Barkley suggested that the McCain proposal wasn’t quite so bad. He – like me – was assuming that most of the incidence of this subsidy would go to homeowners. Brad DeLong, however, seems to be saying that most of this subsidy would go “to the shareholders and managers of banks with troubled assets”. If that’s the case, I agree that this is a really bad proposal.

Voluntary Debt for Government Equity: the Mankiw-Paulson Bank Bailout Plan

Greg Mankiw wrote yesterday:

Some economists have proposed forcing these firms to go raise more capital from private sources. But how exactly can the government do that? It is not entirely clear how, as a legal matter, that can be accomplished. Perhaps regulators can twist the arms of the financial institutions. Call it the Tony Soprano approach. “Nice bank you have here. I wouldn’t want anything bad to happen to it.” Other economists have suggested that the government inject capital itself. That raises several questions. First, which firms? The government does not want to put taxpayer money into “zombie” firms that are in fact deeply insolvent but have not yet recognized it. Second, at what price should the government buy in? Third, isn’t this, kind of, like socialism? That is, do we really want the government to start playing a large, continuing role running Wall Street and allocating capital resources? I certainly don't. Here is an idea that might deal with these problems: The government can stand ready to be a silent partner to future Warren Buffetts. It could work as follows. Whenever any financial institution attracts new private capital in an arms-length transaction, it can access an equal amount of public capital. The taxpayer would get the same terms as the private investor. The only difference is that government’s shares would be nonvoting until the government sold the shares at a later date. This plan would solve the three problems. The private sector rather than the government would weed out the zombie firms. The private sector rather than the government would set the price. And the private sector rather than the government would exercise corporate control. Why would an undercapitalized financial firm take advantage of this offer? Because it would need to raise only half as much capital from private sources, that financing should be easier to come by. With Warren Buffetts in scarce supply, the government can in effect replicate them, by pigging backing on what they do.

Today, we learn:

The Bush administration is considering taking ownership stakes in certain U.S. banks as an option for dealing with a severe global credit crisis ... A decision to inject capital directly into financial institutions in return for ownership stakes would be similar to a plan announced Wednesday by Britain ... Treasury Secretary Henry Paulson told reporters that Treasury was moving quickly to implement the $700 billion rescue effort and he specifically mentioned reviewing ways to bolster the capital of banks.

My concern with Mankiw’s idea starts with the Akerlof demand for lemons problem where insiders may have information about the health of their company that the public or the government does not have (the asymmetric information problem). When this information is positive, they would be less likely to accept new equity infusion. Those willing to accept equity infusion may possess negative inside information about the health of their companies. The case against forced debt for equity swaps is not quite as air tight as Greg Mankiw suggests.

Villains and a Heroine

Today's Times has an article on Greenspan's role in the crisis, focusing on his rabid opposition to any regulation of derivatives. Along with Rubin and Summers, he shut down the attempt by Brooksley Born at the CFTC to do something. In retrospect, Rubin claims he wanted to regulate derivatives, but failed to do so because "the industry certainly didn't want any increase in these requirements. There was no potential for mobilizing public opposition." That's leadership, Bob! And Summers called Born and told her that trying to regulate would cause a financial crisis. When Congress finally made it official with Gramm taking the lead - as has been pointed out often-- the fix was already in, thanks to Rubin, Summers and Greenspan. Bipartisanship! An Obama administration should hire Brooksley Born and shun Summers and Rubin like the plague. For shame!

An Addition to Krugman’s Minimal Model

Paul Krugman has given us a first stab at a leverage-constrained intermediary-driven model of financial contagion. Its point is well-taken, but in my view it misses a very large piece.

I won’t reproduce the math (all basic algebra), but will make the argument verbally: Krugman’s model captures the effect that a falling asset price has on intermediaries’ portfolio capacity for this asset, assuming a fixed capital requirement: the price goes down, so holdings have to decline too in response to diminished equity. This assumes that the extent of leverage is externally imposed, for instance by a responsible regulator.

As we know, however, such regulators have been in short supply. Rather, desired leverage can be viewed as endogenous, a function of perceived risk. A falling asset price can therefore generate a potential double-whammy: for any given degree of leverage it reduces holdings, and it can also increase perceived risk exposure, reducing desired leverage still more.

If this is correct, one potential irony in renewed regulatory vigor (such as demanding more prudent policies on the part of institutions the government acquires an equity stake in) is that it intensifies deleveraging and puts further downward pressure on assets. Such an effect would not arise in interventions that touched a small corner of the global financial system, like Sweden’s in the early 90s, but it would have to be taken into account in the emerging global rescue. This would be an argument for public banking, as I’ve advocated here before, since such a system could be scaled up to whatever level of finance is deemed necessary, rather than relying on private sector willingness to lend and take positions.

Twenty-Five Years of Eight-Hour Propaganda

by the Sandwichman

"Why, of all possible immediate demands of the working class, was the eight-hour day chosen to be the special demand of labor's hosts on the from now on eventful May day?" Hubert Langerock asked in an article published in the May 1914 International Socialist Review.

Langerock, presumably a Marxist, had just spent six paragraphs dismissing what he referred to as the "simplism" and "bourgeois spirit" of Ira Steward's eight-hour theory. Without skipping a beat, he then delivered a panegyric to the demand for a reduction of hours as, "the only one which is not susceptible of a capitalistic interpretation." So which is it bourgeois simplism or unyielding revolutionary program?

It was not entirely on account of historical or national precedents but, because of all the demands which labor make under capitalism, a reduction of the hours of labor is the only one which is not susceptible of a capitalistic interpretation, the only one which unequivocally strikes at the root of the system. A reduction of the hours of labor embodies the experimental logic of facts and therefore it remains independent in its results from the words or formulas wherein it is expressed, it forces the most conservative craft-union man into an attitude which is revolutionary, whether he likes it or not.

No other demand of labor under capitalism is susceptible of the same interpretation, whether it be minimum-wage, or old-age pensions or unemployment benefits or feeding of school children or many more all such measures, unless backed up by a strong revolutionary feeling which makes them indisputable conquests of a forward-moving proletariat, become mere philanthropies of the bourgeois, surface measures of the master class. The bourgeois of today knows that he can recede from the orthodoxy of his old Manchesterianism without pecuniary loss, if he can prevent the birth of an efficient working class economic organization, which would cut the cost of his social emotionalism out of his profits.

Such was the reason for which eight hours became the specific demand of the marchers on May day.

Correction: Great Minds Think Simultaneously

On Oct. 3 I posted a piece that pointed out the similarities between my proposal for public banking and Andrew Feldstein’s. Not only was the general idea roughly the same, we both proposed the same figure for initial capitalization, $300B. Since my proposal appeared three days earlier, I harbored suspicions. I couldn’t find contact information for Feldstein, so I posted my doubts on the website of Joe Nocera, the New York Times columnist who was the source for AF’s proposal. After waiting for two days and not seeing any response, I went public about my suspicions here. I tried to make it clear that I had nothing to go on but coincidence, but in retrospect my writing could be interpreted as leaving a different impression.

What I’ve learned since: (1) Nocera and the Times are justifiably concerned about apparent accusations of plagiarism against one of their quoted sources. (I was contacted today.) (2) Feldstein privately communicated his proposal to Nocera on the same day I posted mine three minutes earlier. Talk about an idea being in the air!

So to set the record straight: the similarity and simultaneity of Andrew Feldstein’s suggestion and mine are entirely and remarkably coincidental. Whatever the truth content of my philosophical musings on the difference between academic and commercial conceptions of intellectual property, they do not apply in any way to this particular episode. And if Feldstein’s investment strategies are as farsighted as his policy proposals, you might want to take a look at his hedge fund.

McCain’s Expensive Mortgage Rescue Plan

Lauren Kornreich reports on McCain’s contradictory claims last night:

Does John McCain recommend a spending freeze to help stabilize the economy, or want the government to purchase bad mortgages from struggling homeowners? Well, according to his answers during Tuesday night’s debate, both. Early in the debate, McCain recommended that the federal government buy up bad mortgages from landowners and replace them with lower cost, fixed-rate mortgages, which he said would help keep Americans in their homes.

How expensive will this be? CalculatedRisk notes his own and the WSJ’s estimates of how many households have negative housing equity – something close to 12 million. He also notes what he calls a bad policy proposal from Glenn Hubbard and Chris Mayer. Whether or not the following proposal is a good idea or a bad one – it’s going to add to the Federal debt:

Housing starts are at their lowest level since the early 1980s, while there are more vacant houses than at any time since the Census Bureau started keeping such data in 1960. Millions of homeowners owe more on their mortgage than their house is worth. Foreclosures are accelerating. House prices continue to fall, weakening household balance sheets and the balance sheets of financial institutions. But this can stop. The price of a home is partially dependent on the mortgage rate -- a lower mortgage rate raises house prices. We propose that the Bush administration and Congress allow all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25% (matching the lowest mortgage rate in the past 30 years), and place those mortgages with Fannie Mae and Freddie Mac.

Details of McCain's proposal can be found here:

The new mortgage would be an FHA-guaranteed fixed-rate mortgage at terms manageable for the homeowner. The direct cost of this plan would be roughly $300 billion, because the purchase of mortgages would relieve homeowners of “negative equity” in some homes.

Something tells me that this proposal would cost a LOT more than $300 billion. If anyone has a credible analysis of what this proposal would likely cost – that would be most appreciated.

Update: Brad DeLong places his estimate at only $100 billion but that’s because he views the McCain plan as not buying that many bad mortgages:
Democrats want to prevent depression and support the financial markets by investing taxpayer money in banks with troubled assets. Republicans want to give taxpayers money away to the shareholders and managers of banks with troubled assets.

Economic and Social Importance of the Eight-Hour Movement

"That the labor movement is a natural phase of modern society is too obvious for any careful observer of social phenomena and student of economic history to question."

There is nothing more conclusively demonstrated in the history of society than the fact that industrial reform is an inseparable part of social evolution. Activity is the evidence of life and discontent is the first indication of progress. The division of labor, and the specialization of economic functions constantly tend to make a readjustment of industrial and social relations necessary. The concentration of capital and the use of labor-saving and wealth-cheapening methods, which are the indispensable instruments of modern civilization, tend to produce two results. One is the division and concentration of industrial power; the other is the addition and diffusion of social and political power. The first tends to specialize and limit the laborer's economic function, and the latter to generalize and extend his social function. While the first tends to diminish his industrial individuality, the second tends to increase his social and political individuality. Thus, in proportion as the laborer becomes an economic automaton, and loses the power to employ himself, he becomes a social unit, and gains political power over his employer. Therefore, just n proportion as the division of labor, the concentration of capital, and wage conditions increases—which are the infallible evidence of progress—the laborer's social power becomes the chief means of promoting his industrial well-being.

Consequently, the labor movement, which is the organized social force of the laboring class, instead of being a relic of the simple conditions of the past, is an essential part of the complex social institution of the present. It is the natural outcome of the industrial growth of the present century, and can neither be coaxed nor coerced into silence. If wisely directed, it may be made an invaluable aid to progress; if perverted, it may become a perpetual menace to society.

Whether this movement shall become a help or a hindrance to progress, will largely depend upon the treatment it receives at the hands of the intellectual classes. If it is snubbed as an "alien intrusion," and its propositions refused a respectful hearing, it may be expected to incite passion and lead to class warfare. But if it is recognized as a legitimate phase of modern society, and its propositions treated with the careful consideration to which all vital problems are entitled, it may easily become the strong arm of national safety, social peace and progress. It is therefore no longer a question whether or no we shall have a labor movement, but whether by increasing the opportunities for developing the laborer's intelligence, and advancing his material well being, we shall promote social evolution, or whether by opposing the movement, we shall force it along the line of revolution.

The Fed Takes a Step Toward Public Banking

So now the Fed will directly purchase unsecured commercial paper, something a “real” financial institution does as a matter of course (except during a panic). Because even its resources are limited, it is acting on the liability side of the ledger as well, for the first time offering to pay interest on the deposits of commercial banks. (This also encourages banks to be less than fully lent, offsetting the credit creation implications of the Fed’s buying binge.)

If you put these two items together, you have the beginning of what I called Plan B in my earlier post on the subject. There is no need to bail out the private sector: it is possible to create a publicly owned and operated financial entity to carry on the normal tasks of issuing credit, pooling risk and supporting long-term investment. To go further down this road, the Fed would (a) expand the range of assets it would consider buying, and (b) offer competitive returns on deposits and shares of investment funds. Of course, it would be much better for this operation to be spun off to a new entity to avoid conflicts of interest and operational overload.

The overall situation is still in flux, and in particular it is not clear whether it will be possible to unfreeze private financial channels. It may be that, not only is public banking the best strategy—it may be the only one.

FED to Purchase Commercial Paper as an Offset to the Credit Crunch

Today’s 3-month LIBOR stands at 4.32% while yield on 3-month Treasury bills is less than 0.8%. While we thought Friday’s bail-out legislation would alleviate the credit crunch – the TED spread still exceeds 3.5%. Dean Baker says the FED has found a plan B:

It turns out that the Fed can buy commercial paper directly from non-financial corporations needing credit to maintain operations. This will keep the credit markets working even if the zombie banks aren't up to the task. In other words, the threat of a complete meltdown in the absence of a bailout was nonsense and the media once again got taken for a ride by the Bush administration.

The Federal Reserve reports interest rates both for 3-month nonfinancial commercial paper and for 3-month financial commercial paper. As of October 1 (latest date reported), the interest rate on the former (what Dean seems to be discussing) was only 2.27% while the interest rate on financial commercial paper was 3.81%.

The NY Times article that Dean relies on states:

The Fed plan is intended to renew the flow of credit on which the economy depends. Under its plan, the central bank would buy unsecured commercial paper, essentially short-term i.o.u.’s issued by banks, businesses and municipalities.

Given the spread between interest rates on financial commercial paper and nonfinancial commercial paper, it would be interesting to see which sector the FED’s plan B will focus on.

Crisis Commentary Overview

I have tried to integrate the commentaries into a coherent whole, before I go on to new ones.

Some people have complained about the Word format. I tried to use open office, but it lost all my formatting. Help will be appreciated

http://michaelperelman.wordpress.com/2008/10/07/crisis-commentary-overview/

Me on Italian TV

So, folks, just back from two conferences in Europe. The first one, in Urbino, Italy, on Dynamic Modeling in Economics and Finance, was held in honor of me turning 60. There was a report from it that appeared on Italian TV. The announcer described me as "volcanic," and the co-organizer described some of my early work on bubbles and crashes as relevant to the current situation (accurate). One of the participants, Frank Westerhoff from Germany, presented a model discussed last week in a NYTimes column by Mark Buchanan on Tobin taxes stabilizing speculative markets. The link to see about the conference and get to the video of the Italian TV story is
http://www.econ.uniurb.it/bischi/MDEF2008.html.

McCain’s Health Care for the Well To Do But Maybe Not for You

Paul Krugman makes one definitive claim and speculates on McCain’s plan for Medicare:

Conservative Republicans still hate Medicare, and would kill it if they could — in fact, they tried to gut it during the Clinton years (that’s what the 1995 shutdown of the government was all about). But so far they haven’t been able to pull that off. So John McCain wants to destroy the health insurance of nonelderly Americans instead. Most Americans under 65 currently get health insurance through their employers. That’s largely because the tax code favors such insurance: your employer’s contribution to insurance premiums isn’t considered taxable income, as long as the employer’s health plan follows certain rules. In particular, the same plan has to be available to all employees, regardless of the size of their paycheck or the state of their health. This system does a fairly effective job of protecting those it reaches, but it leaves many Americans out in the cold. Workers whose employers don’t offer coverage are forced to seek individual health insurance, often in vain. For one thing, insurance companies offering “nongroup” coverage generally refuse to cover anyone with a pre-existing medical condition. And individual insurance is very expensive, because insurers spend large sums weeding out “high-risk” applicants — that is, anyone who seems likely to actually need the insurance.

The speculation had to do with Palin’s closing remarks during the VP debate and her tribute to Ronald Reagan. Laura Meckler assures us that this speculation is well founded:

John McCain would pay for his health plan with major reductions to Medicare and Medicaid, a top aide said, in a move that independent analysts estimate could result in cuts of $1.3 trillion over 10 years to the government programs. The Republican presidential nominee has said little about the proposed cuts, but they are needed to keep his health-care plan "budget neutral," as he has promised. The McCain campaign hasn't given a specific figure for the cuts, but didn't dispute the analysts' estimate.

As a member of the deficit hawk wing of the Democratic Party, I think fiscal neutrality is a good thing. But I also think this type of a move is really bad policy from an income distribution perspective.

Update: Jonathan Cohn does a nice job of explaining how the McCain position has evolved over time:

First McCain said he would elimin[at]e the entire tax deduction for health insurance, in order to pay for his new tax credit. This would have paid for itself, but it would have done so by raising taxes on a lot of people. Then McCain decided he was keeping part of the deduction after all. While he would be raising taxes on a very few people, he'd be lowering them for most. Of course, that would also have meant running much bigger deficits. Now McCain is saying, no, no, he's not going to increase the deficit with his health care plan. Instead, he's going to pay for it by cutting Medicare and Medicaid--which, at the levels he's discussing, might seriously weaken the program. I can't wait to see what they come up with next.

The usual GOP playbook – playing fast and loose with how their fiscal proposals are supposed to be paid for (if at all).

Economic and Social Importance of the Eight-Hour Movement

The opposition of the employing class to this measure has not risen so much from an aversion to improving the laborer's condition as from a misconception of their economic relation to the community, and especially to the laboring classes.... For nearly a century the colleges have taught, and the employing classes have believed, that an increase of wages always means a decrease of profits—that their income moves inversely with that of the laborer's, or, in the language of the economic instructors, that "profits rise as wages fall, and fall as wages rise."

This proposition has been periodically discussed for more than three-quarters of a century. The characteristic feature of the controversy is that the measure has always been favored by the laboring class and their sympathizers, and as uniformly opposed by the statesmen, economists and employers. This opposition, however, is not, as is commonly assumed, all due to abnormal selfishness on the part of the employing class. The average employer is not more unsympathetic and indifferent to the welfare of society than is any other citizen. There is nothing in the mere fact of being an employer that necessarily destroys one's interest in the social well-being of others. The opposition of the employing class to this measure has not risen so much from an aversion to improving the laborer's condition as from a misconception of their economic relation to the community, and especially to the laboring classes. Nor are they responsible for this misconception; but as we have elsewhere shown, it is mainly due to the erroneous teachings of political economy. For nearly a century the colleges have taught, and the employing classes have believed, that an increase of wages always means a decrease of profits—that their income moves inversely with that of the laborer's, or, in the language of the economic instructors, that "profits rise as wages fall, and fall as wages rise." With this conviction it is not surprising that they should regard every effort to improve the laborer's economic and social condition— which always involves an increase of wages—as inimical to their interests.

From this point of view the more clearly it could be shown that a reduction of the hours of labor would tend to increase wages, the more imperative seemed the necessity for the employers to oppose it. This attitude has been further strengthened by the fact that hitherto the subject has been presented on sympathetic and philanthropic rather than economic grounds. Appeals to sentiment rather than to science have been made for it. The employing class have been asked to grant a reduction of the hours of labor, not as an act of wise statesmanship, but as a boon to the laborer, out of sympathy for the "unfortunate classes." To this they have with some degree of consistency replied, that "factories are business and not charitable institutions," and have accordingly resisted all efforts in this direction as an unwarranted attempt to compel them to make involuntary contributions to the laborers—to force them to give something for nothing—all of which they regard as a violation of their rights as free citizens. In short, through the influence of these conclusions they have come to regard the labor movement as an unwarranted agitation against the best interests both of the employing class and the whole community.

This view of the subject being generally shared by the leading journalists, essayists and statesmen, who reflect the teachings of the colleges—we naturally find the daily press, the magazines and the legislatures averse to every proposition for reducing the hours of labor. Among the objections usually urged against this measure are, that it would increase dissipation among the masses, that it would diminish production, and make smaller profits, and lower wages or higher prices inevitable, and thus be injurious alike to the employer, the laborer and the consumer. If these views were correct, the opposition which they incite to this measure would be entirely warranted, and the movement for the general establishment of an eight-hour system should be abandoned. But are they correct? In order to give a comprehensive answer to this question, the subject must be removed from the domain of philanthropy to that of philosophy, and science must be substituted for sentiment as the guide to action.

Power is never having to say you are sorry

Citing a Greenspan interview: "The majority of lawyers, in my experience, seek to regulate -- that is, to contain certain activities with little weight given to the lost benefits of such activities," he says. "The question is: What do you lose? In this case, a very valuable instrument [credit default swaps, the derivatives at the core of the current mess] for the diminution of systemic risk. You can stop the system dead and eliminate speculative losses. But you will also get significantly reduced economic activity and ultimately lower standards of living."

Barrett, Paul. 2008. "Wall Street Staggers." Business Week (17 September): pp.

Recent Interview on the Crisis

I was on Realnews yesterday. The interview begins with a montage of congressional talks on the bailout, then a discussion with me for the final 3 minutes or so.

LINK to video

Economic and Social Importance of the Eight-Hour Movement

"There is nothing new or novel in the proposition for a general reduction of the hours of labor."

There is nothing new or novel in the proposition for a general reduction of the hours of labor. It introduces no new principle into society. It proposes no arbitrary interference with economic and social relations; it disturbs no existing interests; it does not change the relation of buyers to sellers, or laborers to employers; in fact, it does not in any way arbitrarily disturb existing economic and social institutions. All it asks for is that the laborer shall have more leisure; that the development of his social character may be commensurate with the increase of his productive power and the comfort and culture of his home may grow apace with the wealth-cheapening capacity of the factory.

4th Crisis Commentary: Capitalism 101

This commentary deals more with the nature of the efficiency of market investment.

commentary-4

Have you no sense of decency, madam Governor, at long last? Have you left no sense of decency?

by the Sandwichman

Senator Joe McCarthy: I perform this unpleasant task because the American people are entitled to have the coldly documented history of this man who says, "I want to be your President."

Strangely, Alger -- I mean, Adlai [laughter] -- But let's move on to another part of the jigsaw puzzle. Now, while you think -- while you may think there can be no connection between the debonair Democratic candidate and a dilapidated Massachusetts barn, I want to show you a picture of this barn and explain the connection.

Here is the outside of the barn. Give me the pictures of the inside, if you will. Here is the outside of the barn up at Lee, Massachusetts. It looks as though it couldn't house a farmer's cow or goat from the outside. Here's the inside: a beautifully panelled conference room with maps of the Soviet Union. Well, in what way does Stevenson tie up with that?

My -- my investigators went out and took pictures of the barn after we had been tipped off of what was in it -- tipped off that there was in this barn all the missing documents from the Communist front -- IPR -- the IPR which has been named by the McCarran Committee -- named before the McCarran Committee as a coverup for Communist espionage.

Now, let's take a look at a photostat of a document taken from the Massachusetts barn -- one of those documents which was never supposed to see the light of day. Rather interesting it is. This is a document which shows that Alger Hiss and Frank Coe recommended Adlai Stevenson to the Mount Tremblant Conference which was called for the purpose of establishing foreign policy (postwar foreign policy) in Asia. And, as you know, Alger Hiss is a convicted traitor. Frank Coe has been named under oath before congressional committees seven times as a member of the Communist Party. Why? Why do Hiss and Coe find that Adlai Stevenson is the man they want representing them at this conference? I don't know. Perhaps Adlai knows.

The Second Shoe, Part II

by the Sandwichman

"I hate to sound like a Marxist about this, but…" -- Doug Muzzo, Political Science Professor, Baruch College, commenting on Michael Bloomberg’s decision to seek a third term as mayor of New York City.

Hate it or not, in the context of a really, really big economic crisis, making sense of the conjuncture may indeed require that we occasionally "sound like a Marxist."

In his introduction to the 1891 edition of Marx's Wage Labor and Capital, Frederick Engels stressed the importance of the distinction that Marx subsequently made (years after writing WL&C) between labor and labor power. Engels called this distinction, "one of the most important points in the whole of political economy."

Engels framed his discussion of this most important point by remarking on the relationship between political economy and book-keeping:

Classical political economy took over from industrial practice the current conception of the manufacturer, that he buys and pays for the labor of his workers. This conception had been quite adequate for the business needs, the book-keeping and price calculations of the manufacturer. But, naively transferred to political economy, it produced there really wondrous errors and confusions.

Twenty-six years later, on the eve of the Russian Revolution these "wondrous errors and confusions" had been miraculously resolved, at least in the eager imagination of V.I. Lenin:

The accounting and control necessary for [the socialization of industry] have been simplified by capitalism to the utmost, till they have become the extraordinarily simple operations of watching, recording and issuing receipts, within the reach of anybody who can read and write and knows the first four rules of arithmetic.

Nothing had changed. Book-keeping still offered a wondrously erroneous and confused approach to political economy. Lenin simply didn’t know what he was talking about.

Then in the 1930s along came Oskar Lange and Ludwig von Mises and their debate about economic calculation under socialism. Lange won the debate at the time -- in theory. But, with the collapse of the Soviet system in the early 1990s, von Mises came to be seen as the winner on the ground. The dysfunctional Soviet accounting system, inspired by Lange’s arguments, had played an important role in that collapse. The unspoken assumption is that it was the Langian amendments to the accounting system -- not some intrinsic flaw in accounting-in-general -- that led to that collapse.

The joker in this deck is that the calculation debate revolved around comparing centralized state planning with some hypothetical competitive market. There is no such thing. In the real world, domination of markets by a few key players (bond rating agencies, the Federal Reserve, banks too-big-to-fail) and the principal-agent problem engendered by the separation between corporate shareholder ownership and management render the competitive scenario moot.

Oskar Lange wasn't alone in recognizing how the latter separation distorted economic incentives. Adolph Berle and Gardiner Means stipulated that the separation of risk and control in the modern corporation left a choice between conservatively protecting the assets of shareholders but thereby ['possibly'] inhibiting enterprise or granting free rein to the controlling group and risking "corporate oligarchy" and "corporate plundering". Berle and Means’s analysis was influential in establishing the securities regulatory policies of the Roosevelt New Deal. And guess what? The deregulation mania of the last three decades did indeed unleash enterprise, oligarchy and plundering.

But there’s no returning to the New Deal regulatory security blanket. In offering their fixes of financial regulation, on the one hand, and socialist calculation, on the other, Berle and Means and Oskar Lange ignored the old critique of political economy Engels had highlighted.

"Labor" may be a perfectly coherent book-keeping category from the limited perspective of the individual firm, but it is the source of error and confusion when brought over into political economy. National economic statistics rely heavily on the collection and collation of firm-level data based on accounting conventions. If firm-level data are silent on social costs than so will be national statistics.

Soviet accounting failed because state owned enterprises carried unsold goods on their books at official prices. It made no difference whether those goods were even salable. That created a perverse managerial incentive to produce shoddy goods.

Capitalist accounting fails because private firms are oblivious to the social cost of their labor and raw materials inputs. Those 'inputs' include byproducts of waste, pollution and worker health impacts. That has created a perverse managerial incentive to subsidize their input costs through off-the-book social and environmental "externalites".

The capitalist accounting fault is the mirror image of the Soviet one but the end result is the same. Accounting incentives encourage managers to count the destruction of value in the wider world as a plus for their own narrow enterprises.

Next: Accounting for labor power

The unemployed, the gambler and the whore

by the Sandwichman

I'm sure I'm not the only male in America who, when Palin dropped her first wink, sat up a little straighter on the couch and said, "Hey, I think she just winked at me."

"The 'keep smiling' on the job market adopts the behavior of the whore who, on the love market, picks up someone with a smile." -- Walter Benjamin, The Arcades Project

In the past decade, he has played on Mississippi riverboats, on Indian land, in Caribbean craps pits and along the length of the Las Vegas Strip. Back in 2005 he joined a group of journalists at a magazine-industry conference in Puerto Rico, offering betting strategy on request. "Enjoying craps opens up a window on a central thread constant in John's life," says John Weaver, McCain's former chief strategist, who followed him to many a casino.

"The capitalist who gives himself over to fate at the gaming table is replicating in his leisure his activity of gambling on the stock market during the 'work' day, but this parallel is for Benjamin less revealing than the characteristic 'futility, the emptiness, the inability to complete something' which connects the gambler and the machine laborer..." -- Susan Buck-Morss, "The Flaneur, the Sandwichman and the Whore"

Jobs are vanishing at the fastest pace in more than five years with pink slips likely to keep stacking higher in the months ahead, an urgent signal the country may be careening toward a deep and painful recession just as Americans prepare to elect a new president.

"The closer work comes to prostitution, the more inviting it is to describe prostitution as work -- as has long been true in the argot of prostitutes. The convergence here proceeds with giant steps under the sign of unemployment; the 'keep smiling' on the job market adopts the behavior of the whore who, on the love market, picks up someone with a smile." -- Walter Benjamin, The Arcades Project

Key words: unemployed, gambler, whore. Google the title of this posting and at the top of the list is a JSTOR file of Susan Buck-Morss's 1986 New German Critique essay, "The Flaneur, the Sandwichman and the Whore: The Politics of Loitering." This is not some clever google-bomb. It simply reflects that the deep connection between financial speculation, John McCain's craps addiction, unemployment and Sarah Palin's ostentatious winking is nothing new.

Meanwhile, A Lube Job

While attention was elsewhere, congress voted to give lend GM, Ford and Chrysler a $25B bailout all their own. I can remember a time not so long ago when that would have been considered real money. Critics protest: why should we prop up Detroit? What about Toyota and Honda, for instance: they produce in this country too, no?

But this misses the point. Toyota and Honda don’t need the money; they’ve been designing and building fuel-efficient vehicles for years. We should reward the Big 3 for binging on SUV’s and starving their research engineers.

It’s Not Over

It’s official: Henry Paulson is now authorized to begin shelling out the first tranche in his $700B plan to refloat financial markets. Don’t pull your money out from under your mattress just yet, however.

1. This is just a beginning. The writedowns in the mortgage market are estimated at $2 trillion and the bubble is still unwinding. The losses in derivative assets will be greater still. The bailout buys time but it does not constitute a solution.

2. The problem of pricing assets will be enormous. There is a technical problem, of course, in determining the price of something that no one currently bids for, but a deeper issue lurks. The plan was sold on the basis of highly ambiguous wording. It was stated for public consumption that the only problem is liquidity, and that the Fed/Treasury can solve it by offering to buy assets at their hold-to-maturity value. Everyone knows, however, that the real problem is solvency, and that the unspoken intention is to overpay in order to slip cash to players who might otherwise go under. No doubt it is possible to do this quietly, a few billion at a time, like the US military does in Iraq, but this is not big enough or fast enough to rescue the markets. There will need to be big, big overpayments, and in their search for congressional votes the plan’s backers couldn’t hope to ask for such a mandate. This means that everyone connected with the operation will be looking over their shoulders, worrying that, if they follow the unstated intent of the law, they will be held personally accountable.

But look on the bright side: mental illness will now be covered under more private health insurance plans (for those dwindling few that have them), and small timber-dependent communities out here in the Pacific northwest will be able to keep their schools open. So the bill will have some successes to crow about.

What Would a Scientific Economics Look Like?

This is the title of piece of mine just published in the Post-Autistic Economics Review. I happen to be a fan of science (I’m so pre-postmodern) and would like economics to move in that direction. Let me know what you think.

Is it Plagiarism or Normal Business Practice?

As loyal readers of EconoSpeak know, on Sept. 24 I posted a relatively substantial proposal that I headlined “Plan B: How to Restore Financial Markets Without a Bailout”. Three days later, I was surprised to see almost the same plan referred to in a New York Times column, but attached to the name of Andrew Feldstein, the director of a hedge fund. What struck me is that, not only were the two key general ideas—the public financial intermediary, the window to acquire distressed assets at market prices—the same, even the initial capitalization was pegged at an identical $300B. (Some of the details revealed in a followup Times blog were different and, honestly, not as good.) In my line of work, this is a prima facie case of plagiarism.

What this probably represents, however, is a difference in culture. In the academic world that I inhabit, there is a strong expectation that all borrowed words or ideas will be attributed to their source. Failure to do this constitutes an intellectual scandal; on the positive side, we try to impress our peers with a bottomless pile of citations. (This is called “scholarship”.)

The business world is different. There the rule is, if it ain’t nailed down you can take it. Having a bright idea and getting mentioned in the Times is worth real money. I can imagine that Feldstein’s fund may get an extra investor or two (or dissuade an existing investor from fleeing) by the halo effect of this publicity. I was dumb enough not to copyright my idea, so what do I expect?

Actually, while I like to have my ego stroked every now and then, and while I would come down hard on any student who submitted a paper that plagiarized, I don’t really care about attribution in this case. I would like this idea to be given a fair hearing, and someone with a hedge fund is likely to have a wider audience than me. In fact, I rather like the notion that an obscure economist can release an idea on some little corner of the web, it can bounce around for a while, and then reappear dressed up in real money.

The Problem with Trickle-Up

I’ve been hearing a lot recently about a so-called “trickle-up” approach to straightening out the financial system. The idea is that, rather than forking over hundreds of billions of dollars to speculators, we should give it instead to distressed homeowners. The government could issues grants or subsidized loans to folks having trouble making their mortgage payments; this would serve two purposes, to keep people in their homes and, by greatly reducing the default rate, validating the financial assets derived from mortgages.

Nice try, but it won’t work.



First, there is a nasty problem of equity vs cost: the program is affordable only if you give the money to the subset of owners falling behind in their payments, but why should they be the only ones to get a price break. Speaking just for myself, I own a house and have not skipped a payment yet, although not without occasional struggle. Why them and not me? Multiply this by a few million and you have a real question.

Second, and much more to the point financially, the underlying problem is a housing bubble. Prices overshot by about 30% or so on a national average, and a mountain of securities were piled on top. How will helping people make onerous payments correct this? Answer: you can only prevent the deflation of the bubble by permanently (or at least indefinitely) blowing more air into it. To sustain the overvaluation of a house, you not only have to subsidize its current financing, you have to subside new buyers so that the old ones can sell at the inflated price. If you don’t, the house drops in value and you are back to square one as far as derivative assets are concerned. The real point is that it is futile for the government to try to hold back the deflation of the bubble by throwing money at it. The prices have to come down one way or another.

This is why I like Dean Baker’s approach. He would let the mortgages fail but allow people to stay in their homes as renters. From a progressive point of view I see no particular value in mass home ownership. (Why should people concentrate their savings into a single asset, their home, rather than diversify? Or rather than own their own job, which could provide a greater measure of income security?) What needs to be prevented, however, is mass eviction.

Sandwichman Doubts the Work Ethic!

by the Sandwichman

PGL writes "No one doubts the work ethic of Americans..."

Nobody expects the Spanish Inquisition, maybe. But no one doubts the work ethic? What am I? Chopped liver?

Sandwichman doesn't doubt that there are endless panegyrics to hard work in American folklore. But Sandwichman doubts that what American politicians and pundits call the work ethic -- striving for financial success (or just survival), willingness to put in extra hours on the job in exchange for more income -- constitutes a genuine work ethic.

Sandwichman's argument continues to be that the conventional misconception about the work ethic is at the root of the economy's inability to generate sufficient demand to sustain full employment.

The revised American standard version of the work ethic falsely ties higher income to longer hours on the job. Well, if one takes that as an unquestionable article of faith, then there's no point in considering the Stewardian critique and alternative summed up in the ditty, "whether you work by the piece or work by the day, decreasing the hours increases the pay."

That ditty, by the way, expressed the founding philosophy of organized labor in the United States. Today's unions have strayed far from that idea, which may account in part, for their declining influence. But no one doubts? What does that mean? Doesn't it really frame the discussion in such a way as to exclude us nobodies who fundamentally questions the conventional wisdom about the connection between longer hours and higher income?

As long as "no one doubts the work ethic", the debate about how to "stimulate" the necessary demand can continue to go around and around in the same circles: "Reduce taxes" "No, increase government spending (on worthwhile things)" "No, reduce taxes" "No... No... No..."

To use a tired cliche: been there, done that.

The Employment Situation for September & Sarah Palin on the Fundamentals of the US Economy

Last night - Sarah Palin argued:

John McCain saying our economy was strong, he was talking to and about the American workforce, and the American workforce is the greatest in this world, with the ingenuity and the work ethic that is just entrenched in our workforce, that is a positive, that is encouragement, and that is what John McCain meant.

BLS reported this morning:

Nonfarm payroll employment declined by 159,000 in September, and the unemployment rate held at 6.1 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Employment continued to fall in construction, manufacturing, and retail trade, while mining and health care continued to add jobs.

No one doubts the work ethnic of Americans. The problem is that the economy is not generating sufficient aggregate demand to fully utilize this work ethnic.

Payroll employment has declined by 760 thousand since December 2007. While the unemployment rate did not further increase last month, that’s not because of any good news from the household survey of employment which showed a 222 thousand decline last month alone. We should note that the employment-population ratio fell from 62.1% to 62.0% but that was accompanied by a decline in the labor force participation rate from 66.1% to 66.0%. Palin does not seem to be attributing this decline to less work ethic and she’s likely correct as this decline is more likely due to a discouraged worker effect.

Our graph shows both the employment-population ratio (EP) and the labor force participation rate (LF) from October 1998 to September 2008. From early 2001 to September, the employment-population ratio fell from its 64% plus level to only 62.0% as of September 2003 but then partially recovered to 63.4% by December 2006. Since then, this ratio has plummeted with the September 2008 level being as bad as the September 2003 level. While the rise in the unemployment rate sounds bad, the drop in the employment-population ratio has been worse since the labor force participation rate has also declined from around 67% as of the end of 2000 to only 66% now.

The next Administration needs to recognize that these hard working Americans want new job opportunities. Alas, I did not hear very much from Governor Palin last night as to how a McCain Administration would go about accomplishing this goal.

Update: John McCain has responded to the labor market news and proposes that we cut government spending as a means for increasing employment. Lord Keynes must be rolling over in his grave!

The 1960s - the subversive current continues

If somebody doesn't bring an end to this suicidal thrust that we see in the world today none of us are going to be around because somebody's going to make the mistake through our senseless blundering, with the dropping of a nuclear bomb somewhere, and then another one's going to drop, and don't let anybody fool you, this can happen within a matter of seconds....But this is were we have drifted, and we are drifting there because nations are caught up with the drum major instinct, 'I must be first. I must be supreme. Our nation must rule the world!' And I am sad to say that the nation in which we live is the supreme culprit. And I'm going to continue to say it to America, because I love this country too much to see the drift that it has taken. God didn't call America to do what she's doing in the world now. God didn't call America to engage in a senseless, unjust war as the war in Vietnam! And we are criminals in that war, we have committed more war crimes almost than any nation in the world, and I'm going to continue to say it! And we won't stop it because of our pride and our arrogance as a nation, but God has a way of putting nations in their place! The God that I worship has a way of saying 'Don't play with me!'

If we are to go forward, we must go back and rediscover those precious values -- that all reality hinges on moral foundations and that all reality has spiritual control.
Martin Luther King, Jr. 1929-1968, Baptist civil-rights leader in the US



Hidden conclusion here.

Crisis Commentary: Third Installment

I just posted a short third installment.

http://michaelperelman.wordpress.com/2008/10/03/crisis-commentary-third-installment/

The Second Shoe, Part I

by the Sandwichman

John Gray of the London School of Economics has evocatively compared Monday's bailout defeat and the events leading up to it to the fall of the Soviet Union. To fully comprehend the aptness of that comparison, one needs to take into account two factors: 1. the exceptional nature of the American post-World War II "bipartisan" national security state and 2. the failure of an ideologically-rigged accounting system.

In parliamentary democracies, governments get defeated from time to time on votes of non confidence. The government falls and there is an election to form a new government. In the US, a defeat of the government on a vote in the House ordinarily has no political significance. Business as usual slouches on. In short, the US is not a parliamentary democracy. It never has been.

Following the second world war, however, the two-party presumption was grafted onto the already un-parliamentary system. But even that duopoly was further constrained by a bipartisan foreign policy and an anti-Communist ideology. In effect, the US became a one-party state with an imperial presidency and a politically-impotent legislature. The essence of democratic political power resides in the possibility that an opposition may bring down -- not merely obstruct -- the government.

Monday's defeat of the bailout bill occurred at a propitious time and under extraordinary circumstances. The coincidence of an already scheduled election made the vote a de-facto no confidence vote. And the fact that the bill was supported by the leadership of both parties made it explicit who the ruling party actually was -- not the Democrats, not the Republicans but the center-right bipartisan party. That governing party suffered a humiliating defeat. The Republican contingent of the BPP suffered an even more profound defeat. A leadership that is repudiated by two-thirds of its constituents has no legitimacy.

"Lame" duck is not the anatomically accurate metaphor for what remains of George W. Bush's administration. Castrated is. The Republican House leadership is walking dead. Congressional Democrats have no mandate, a situation Speaker Pelosi conceded two years ago.

The government has fallen. But the one-party bipartisan non-parliamentary system, which has so successfully insulated itself from political consequences for 60 years virtually assures that this political crisis will not be resolved through the upcoming elections. Resolving the crisis will require dismantling that non-parliamentary regime, the American counterpart to the failed Soviet state.

Next: The Accounting Debacle.

Bailed out with what!

"The Federal Reserve System was the crucial anomaly at the very core of representative democracy, an uncomfortable contradiction with the civic mythology of self-government."

This is what William Greider wrote in the first chapter of his book 'Secrets of the Temple - how the Federal Reserve runs the country." His book arrived yesterday in the mail. Here's a quick summary - and my extrapolation from - the first 6 pages.

The western capitalist system depends on 'deeper transactions' than elections. Central banks are inconsistent with representative forms of government. They are, in fact, more powerful than elected governments because they possess the power to answer the main questions of political economy - who shall fail and who shall prosper. Central banks are both directors of the private economy and the protector of the most powerful players within it.

The co-emergence of concentrated political and economic power in the hands of the modern global corporation has meant that these entities have been able to accumulate profits at a greater rate than the development of wealth on the planet. As a result, inflation became a permanent feature of the world economy. If the central banks had implemented policy to put the breaks on this dangerous development it would have worked against the narrow self-interest of these multinationals. Inflation was, instead, addressed by increasing dangerous forms of 'productivity'. Forests were no longer given time to regenerate. People in third world nations (in particular) were forcibly evicted from their lands and conscripted into low-wage manufacture for TNCs. Environmental regulation was dismantled and dangerous forms of industrial agriculture were expanded everywhere. Wages were kept low across the globe.

Profits for the global corporation continued to expand at an even faster rate and now exceeded any relation to real wealth. It became truly fictional. Having brought the planet beyond the brink of reversible climate change and increasing impoverishment of humanity everywhere there is now very few places left to 'invest'.

The role of the US Fed had been to ensure that debtors would be rewarded over savers because such action was the corollary of ensuring the profits continued to flow to big business.

In 2008 the debtors can no longer pay their installments. It should be game over but the global corporations want to be bailed out yet again. Bailed out with what?!

Term Auction Facility - TAF

[Readers' comments would be most helpful here. I'm not at all sure whether I've missed detail or misrepresented some facts relating to the Term Auction Facility. Here's what I've pieced together today.]

The Term Auction Facility is an emergency provision implemented by the US Federal Reserve last December to address the freezing up of interbank lending during the so-called 'credit crisis'. The banks weren't - and aren't - using the existing 'discount window', which is the emergency facility traditionally provided. This was happening even after the Fed had dropped the rate charged. There was a lack of liquidity and something had to be done quickly.

"Lenders [were] hoarding cash and shunning their peers as if they were all lepers." [1] Banks had failed to mark their securities to market and there didn't appear to be any practical way to assess the real value of their assets and liabilities. Suspicions were very high after many years of unregulated/deregulated and lax lending practices. At that stage it appeared that all the good collateral of the banks had been pledged and what was left to lend against wasn't worth having.

"In the Federal Funds market the Fed, along with the Bank of Canada, Bank of England, the European Central Bank and the Swiss National Bank, decided to implement a new monetary instrument.... This program, known in the US as the Term Auction Facility, enables the Fed to auction a set amount of funds to depository institutions, against a wide range of collateral."[2] The financial press reassured the public that the 'collateral' was of good quality and had triple A ratings from respectable firms such as Standard and Poors and Moodys. The trouble was that the rating agencies themselves had given over to the free-for-all spirit and their standards had plummeted also.

In the middle of February this year - for the first time ever - "the banking system showed negative net non-borrowed reserves" in the US [3]. The banks were exploiting the Term Auction Facility as much as they could for a range of reasons. This was a sign of continuing distress in the financial market. The funding was cheaper than elsewhere provided. There were continuing difficulties raising funds from other sources. The collateral problems were bad and appeared to be getting worse under this new program. The bankers' greater reliance on government support resulted in the central banks increasing the amount of money they were using to fund the facility to the tune of hundreds of billions of dollars. The system lacks transparency. The public don't know who submitted the collateral. The banks are distorting their behaviour; they appear to have long begun to create Residential Mortgage-Backed Securities "and keeping them on the banks books as a quick way, in another liquidity squeeze like August [2007], to access ECB/FED liquidity." [4]

The trouble is that the assets involved in these auctions have still not been appropriately valued. The solvency of the institutions involved is unknown. The true situation appears to be coming to light only after the bank is formally declared bankrupt. The public are left liable and extremely vulnerable as the Fed and other central banks accrue more and more worthless or low-value collateral.

Last night the US Fed announced that TAF "will expand by $300 billion to $450 billion." [5] Under the circumstances described above this is, in effect, a massive bailout of these institutions by stealth.


“If all the bank loans were paid up, no one would have a bank deposit, and there would not be a dollar of currency or coin in circulation. This is a staggering thought. We are completely dependent on the commercial banks for our money. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money, we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp upon the picture, the tragic absurdity of our hopeless position is almost incredible - but there it is. It (the banking problem) is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it is widely understood and the defects remedied very soon.” - Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta



[1] Crisis may make 1929 look a 'walk in the park'. By Ambrose Evans-Pritchard. Last Updated: 11:02pm GMT 23/12/2007. http://www.telegraph.co.uk

[2] Term auction facility
From Wikipedia, on 29th September 2008
http://en.wikipedia.org/wiki/Term_auction_facility

[3] Term Auction Facility: Confirmation of Financial Stress? Tuesday, February 19, 2008. http://www.nakedcapitalism.com/2008/02/term-auction-facility-confirmation-of.html

[4] [3] A resonder to 'Term Auction Facility: Confirmation of Financial Stress?' Naked Capitalism. Tuesday, February 19, 2008. http://www.nakedcapitalism.com/2008/02/term-auction-facility-confirmation-of.html

[5] Fed Pumps Further $630 Billion Into Financial System (Update2)
By Scott Lanman and Craig Torres. 29th September 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=ahwz_k5JvuB8&refer=home

Crisis Commentary: Second Installment

I just posted the second installment on my crisis commentary. Again, I would appreciate any comments, since it still needs more work.

Thanks.

http://michaelperelman.wordpress.com/2008/09/30/crisis-commentary-second-installment/

What was it about 1995 and the US Federal Reserve?

1990 – 1992 era. The changes began then that led to the elimination of the reserve requirement.

1992 The Fed Reserve ratios were lowered.

1995 – The US Federal Reserve effectively eliminated the fractional reserve ratio. Banks were no longer required to back assets that largely corresponded with “broad money” (M3) with cash reserves. The consequence was that banks could effectively create money without limitation. From early 1994 to late 1996, most of the remaining reserve deposits disappeared. "This transformation of banking practices seems to have started small, but really picked up steam by 1996 and 1997, likely due to competitive pressures among banks; those banks that used these methods could easily out-compete those that did not."[1]

1995 – US Fed and other central banks printing money like confetti….It is reasonable to suppose that such a gigantic increase in money supply would produce price rises in assets, housing and commodities BUT consumer price inflation remained under control. Why? Rapid growth of India and China (source of cheap labour)? Internet and telecommunications revolution rapidly improved the cost structures of existing products? Labour-free productivity of manufacturing. The stepping up of the rate of environmental rape (mining of raw materials and forests) associated with industrial production? The WTO established.

1995 Dow First close above 5000. Stock Market Keynesianism. Never before had a US economic expansion become so dependent on the ascent of the stockmarket.

Mid 1990s – the collapse of the First Italian Republic. It involved large-scale criminal influence in government and originated as an American parapolitical operation.

1995 – 1999 – The vice president of the Bank of New York sets up illegal accounts to facilitate the movement of funds into and out of Russia. Her crimes of money laundering did not result in a sentencing for her.

1995 – 2001 – the dot com speculative bubble.

1990 – 2005 – doubling of the global workforce

1995 – 2005 – about 3.2 million US homeowners bought houses on the basis of subprime mortgages or similar credit terms

1995 – 2005 Global ‘Savings’?? Glut. “..a remarkable reversal in the flows of credit to developing and emerging-market economies, a shift that has transformed those economies from borrowers on international capital markets to large net lenders…” (Ben Bernanke in 2005)

[1] What (Really) Happened in 1995? How the Greenspan Fed Screwed Up in the Mid-90s and set the stage for the Greatest Financial Bubble in the History of the World. By Aaron Krowne

Also see: ‘Made in U.S.A. 1995’ by Eric Janszen. March 22, 2006
http://www.itulip.com/forums/showthread.php?p=1495

Bailout can WORSEN things: top US budget director.

The Washington Post reported the following a few days ago.

A financial bailout could worsen the crisis, be insufficient to restore trust and cost ‘a few’ billion dollars a year to administer said Peter R Orszag, US Congressional Budget Office Director, in his testimony before the House Budget Committee. The key question he said what “What are we buying and what are we paying for it?" Orszag feared that the bailout as it stands might reveal that the large financial corporations are inflating prices of assets on their books. “Suppose a company has Asset X, whose value is recorded on the books as $100. Because of the current economic decline, Asset X's real value has dropped to $50. If the company takes part in the government bailout and sells Asset X for $50, the company has to report a $50 loss on its books. On a scale of millions of dollars, such write-downs could ruin a company.” Such corporations "look solvent today only because it's kind of hidden” [but they] “actually are insolvent".

Here's what I don't understand: Because short-term lending by the banks had almost completely shut down Treasury is acting as a go-between in short-term lending between banks. "Instead of Bank A lending directly to Bank B, as is customary, Bank A [purportedly] no longer had confidence that Bank B could repay the loan. So Bank A would give the money to the Treasury, which issued a security that was put into the Federal Reserve, which then issued the cash to Bank B." [That action implies that the US Government is already guaranteeing the debt of insolvent firms; already bailing them out. Is that correct?]

Bailout Could Deepen Crisis, CBO Chief Says
Asset Sales May Lead to Write-Downs, Insolvencies, Orszag Tells Congress
By Frank Ahrens, Washington Post Staff Writer. Thursday, September 25, 2008; D04
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/24/AR2008092402799_pf.html

How to afford a new pair of trousers

No need to scrimp when money is short. Just grab a piece of grandma's quilt, cut out a rectangle, double it over and sew up the seams. Viola! A new pair of trousers.



Takes about half an hour on the sewing machine.

Debate Post-Mortem: The Limits of Framelessness

Both McCain and Obama are effectively running against Bush, but neither is able to frame his argument in a coherent way. That is, we have criticisms of this policy or that one, but no general position that ties them together and makes them look like anything more than random corrections. McCain’s problem is obvious—he’s really running against his party (the “maverick” trope)—but what about Obama?

Republicans have put forward different frames over recent years, but two are central to actual policy: free-market economics and the unrestricted, hegemonic use of police and military power (“standing tall”, “keeping us safe”). You could say that the current financial crisis blows away the first and that Iraq discredited the second. So this is an opportunity for the Democrats to engage in a little frame replacement to their own advantage. Instead, what do we get?



Obama talks about the Iraq disaster in an apolitical fashion, as a simple error in judgment. As one who saw through the bs from the beginning, he claims to have superior judgment compared to someone like McCain. What’s missing, however, is how his rejection of Bush’s war reflects a broader position on military and foreign policy. No doubt he is afraid of being labeled “soft”, and this explains his reckless belligerence regarding Pakistan. Yet it would not be very difficult to construct a politically saleable alternative to the shoot’em up philosophy of Bush/McCain.

You’d think he would do better on the economic side. The lessons of the financial mess are straightforward and lend themselves to a reframing of the public role in directing the economy. Still, Obama goes only halfway. He talks repeatedly of the “failed philosophy of the last eight years”, but he says nothing about what the new philosophy should be.

A failure to frame is politically disabling on multiple levels. It cedes too much of the political turf from the outset, and does nothing to predispose the voters to support you. It means that every policy initiative has to start from zero, with no ideological headstart. Above all, it represents an abandonment of the leadership role of politics, the struggle to change the political center of gravity. If one side hammers relentlessly on its frames and the other talks about competence and judgment—well, we know what you get.

There is no evidence at this point that the Democrats are prepared to conduct a political fight in broad daylight to change the direction of this country.