About a year ago, I sketched a plan to get the banks back into health.  Its principle was simple:  Instead of handing out massive amounts of cash to the banks with tons of toxic assets clogging their balance sheets, in the hope that that they restart lending, hand the money directly to the so-called “subprime” borrowers so that they continue to service their mortgages.   At the time, it sounded utopian, even silly — because the political clout to push for it, let alone to force its implementation was non-existent.  Even now, the political force that is required to place this plan in the agenda is still in its embryonic stages, but I believe it is gradually building up.

In this post (in my otherwise neglected blog), I just want to report that — aside from Joseph Stiglitz — there’s another reputed economist just coming around to my approach: Steve Keen.   The neat thing is that, unlike me, who only enunciated a principle and sketched the idea, Keen has taken the trouble to model and calibrate carefully the effects of the alternative plan.

And, in regards to the build up of the political force referred above, I will refer you to Arianna Huffington’s review of Michael Moore’s new movie, Capitalism: A Love Story.

[Image borrowed from The Black Commentator: http://www.blackcommentator.com.]

Arthur Schlesinger, Jr. tells the story of FDR approached by people who wanted the U.S. to increase its involvement in confronting Hitler in Europe.  FDR replied to them:

“I agree with you, I want to do it, now make me do it.”

This is how the president tacitly assigned to them the task of bringing their case directly to the U.S. people, at the time hesitant about taking a bigger part in the European conflict.  If the national attitude towards the conflict shifted, FDR would “follow” suit.

If we check our hopes and illusions at the door, it is far from clear at this point the extent to which Obama is truly committed to promoting a progressive agenda in the U.S. and the globe.  The opportunity is definitely there.  But, consider — for example — his choice of economic cabinet.   The people he’s recruited are, to put it mildly, not known as strong reformers.  In the management of the economy, people like Austan Goolsbee, Tim Geithner, Larry Summers, and — in the background — Robert Rubin, people who have advocated the type of policies associated with the lead to the current economic disaster, have been tapped and are actively shaping up Obama’s economic plan.

Others, like Joseph Stiglitz, Paul Krugman, James Galbraith, and Dean Baker, have been largely ignored, in spite of the fact that they were critical of the policy climate that led to the current crisis, and that they have been forceful advocating measures to fight the crisis that place the broader public interest, the interest of working- and middle-class people, at the center of these policies.

In today’s New York Times, Paul Krugman continues to speak his mind about the timidity of Obama’s plans, in stark contrast with the urgency of his words.  Basic arithmetic indicates that, in the current conditions, a less than 1 trillion dollar “stimulus” is insufficient to move a 15-trillion dollar economy and tax cuts (especially tax cuts for large businesses) are largely wasted resources, because their “bang for the buck” is significantly smaller than that of a dollar directly spent.  (Apparently, even strongly pro-establishment Democrats of the Nancy Pelosi type oppose Obama’s intention of not phasing out the tax cuts for the rich that W. Bush passed!)  Yes, there’s uncertainty, but — precisely — the nature of economic uncertainty during a crisis is such that timidity in the response is the greater evil.

The excuse, as Krugman suggests, seems to be political.  Like Krugman, I’m deeply skeptical of Obama’s alleged approach.  It seems, for what we know, that Obama wants to have a large majority behind his actions, including a solid support in Congress, which requires compromising with staunch Republicans.  By temperament — the press has been telling us — Obama prefers a pragmatic focus on solutions, rather than political confrontation.

That is fine as long as the interest of the majority of working- Americans is truly the top priority.  As a tactical stance at this point, there’s nothing wrong in principle with opening the tent to more people.  But, if history is any guide, the special interests that oppose the economic security of working Americans, the reform of our disfunctional health care system, the reform of our foreign policy, etc. won’t be pacified with friendly gestures.

If Obama begins to compromise to them, always at our expense, they will only confirm that stiffening their opposition works.  Just like in economics, tax incidence is avoided by those more willing to walk away from a market deal, and falls on those forced to take it; in politics, the stubborn prevails and the compromising paints himself into a corner.  This is not an argument in favor of partisanship for partisanship’s sake.  It’s an argument in favor of partisanship to advance the public interest.

Ultimately, it is not an ideological disagreement, but the clash of their vested interests against the needs and interests of the majority of Americans which makes the right wingers so stubborn that only the effective derailment of the popular effort that gave Obama his victory, can pacify them.

Obama has said that he’ll listen to the people.  During his campaign, he emphasized that his election was not about him, but about us, rank-and-file Americans.  We need to test his claim continuously, from the get-go.  Let’s press on.  After all, we’re fired up and ready to go.  So, let’s bring the discussion to our relatives, friends, neighbors, coworkers, and everybody willing to engage in a conversation with us.  Let’s use all means at hand to impress upon the new administration that we’re stubborn in demanding satisfaction to our needs as working- and middle-class Americans.

Let’s make him do it!

[UPDATE 1/10/2009: Christina Romer and Jared Bernstein, from Obama's economic team, have estimated the impact of Obama's plan (AARP) on employment.  Since they admit that the impact of the plan as presented is rather underwhelming, they seem to be asking us to make them do more.]

[UPDATE 1/13/2009: John Nichols, a The Nation correspondent, has followed Obama closely.  Here's his view on how to push him to the left: http://www.commondreams.org/view/2009/01/12-9]

In an October 2008 paper, V.V. Chari, Lawrence Christiano, and Patrick J. Kehoe (Fed Minneapolis, CCK) found no evidence of a crunch affecting interbank credit or borrowing by Main Street.  They argue that Main Street’s cost of borrowing is not as high as a quick look at spreads would suggest; that we should look at the levels instead.

In a November 2008 paper, Ethan Cohen-Cole, Burcu Duygan-Bump, Jose Fillat, and Judit Montoriol-Garriga (Fed Boston, CDFM) replied in detail to the arguments in the CCK paper and concluded that Main Street is indeed being hit by a credit crunch.  I am just starting to read the latter, but I didn’t find the CCK view convincing to begin with.  I’ll say why below.

My sixth sense tells me that the political implications of what CCK are arguing are relevant.  What they are really suggesting with their paper is that large public efforts to get the economy moving are not called for, especially those directed to support employment.  It’s the old let-the-markets-sort-things-out shibboleth.

From my standpoint, the main issue is the net (dynamic) distributional effect of the measures taken and to be taken (by the new administration) with the alleged aim of shoring up the financial and non-financial sectors of the economy.   Among the different possible ways in which the financial sector can be rescued, I believe that, on equity as well as on efficiency grounds, it can be argued that the best approach is the direct relief to working- and middle-class borrowers via methods that put the public interest first at the expense of the captains of finance that drove us into the ditch.

I’ll just say, to be more specific, that I favor the outright nationalization of, at least, the weakest banks, followed by the re-negotiation and direct extension of new loans to lower income individuals and small businesses by the nationalized banks.  With Fannie and Freedie re-nationalized, the mortgage market can be fixed and revived provided the political will is there.

Following Michael Moore, I also favor a similar type of nationalization of troubled industries, like car making, and the realignment of priorities  of those companies to serve the public interest, particularly in the areas of environmental sustainability and workers’ interests.

Having said that about the politics of the issue, I now return to the empirical debate mentioned above.

In the CCK paper, I find one argument utterly unconvincing, namely that spreads (the difference between the interest rates at which banks, business, or people borrow and the baseline interest rates, those of assets deemed relatively risk-free by the markets, like the federal funds rate or LIBOR) are not informative of the existence of a credit crunch.

It seems to me that  the exact opposite is true. I expect all rate levels to be dragged down to some extent by the monetary policy reactions to the crisis: lower federal funds rate and discount (the latter being the rate at which U.S. banks can borrow from the Fed). The issue is how the risk, term, liquidity, and information structures of the interest rate react to monetary policy moves.  And, at that, the spreads tell the story.  And spreads for the credit instruments available on Main Street have gone through the roof.  The flight to quality (i.e. the flight to Treasuries) is the credit crunch!

A credit crunch doesn’t mean that liquid wealth (money) won’t find any parking spot at all.  It simply means that all regular parking spots are suddenly deemed unbearable by lenders and that the hurdle rates at those spots vis-a-vis the seemingly riskless rate increase accordingly.  Parked in Treasuries, wealth will earn the baseline interest as small as it may be now.   So, it’ll be like cash (not entirely, because it’s not fully liquid, but almost), except that it will earn some token interest.

On the other hand, loaning wealth to yours truly would be an act of unbelievable foolishness.  Evidence of the credit crunch is not that the overall rate at which I’d be borrowing now is relatively low (assuming that the market where I can borrow exists, a rather heroic assumption nowadays), but the difference between what I’d have to pay in interest and what the federal government does pay in interest.

In any case, if the tons of base money (the additional reserves the Fed loans to banks via discount window or that end up in the banks whenever the Fed buys Treasuries in the open market) that the Fed has been injecting into the banking system as of late had already translated into streams of credit to average Joes like me, then we’d be observing them in the data on deposits or measures of the money stock (M1 or M2).  Here, I only see a minuscule jump in deposits, M1 and M2 in September and October.

http://www.federalreserve.gov/releases/h8/current/

http://www.federalreserve.gov/releases/h6/Current/

On the other hand,  take a look at what happened to bank reserves:

http://www.federalreserve.gov/releases/h3/Current/

In words, in September and October 2008, bank reserves went straight up.  More specifically, they more than doubled and more than tripled, respectively.  On the other hand, total deposits and M measures in the same periods only experienced a tiny increase.  Up to the latest data point available, reserves have been building up much faster than total deposits or Ms have gone up.   That does it for me.

I understand that businesses have other ways to raise cash than issuing commercial paper or knocking on a banks’ door.  But these aggregate data show clearly, to my lights, that banks have not been lending at anything near the pace at which they have expanded their reserves.  Have other forms of cash raising picked up the slack left by debt?  The state of the stock markets in the last few months doesn’t suggest that.  So, chances are, Main Street businesses are under strife while banks have frozen lots of new credit lines, and recalled old ones, as fast as they have been able to, and now sit on a bunch of idle base money.

How can this be?  Don’t banks lose the “risk-free” federal funds rate by holding reserves beyond what they are required to hold, since reserves are just electronic credits recorded on the Fed banks?  Well, a zero interest rate still beats the negative returns that banks fear if they were to loosen their purse.

To translate into new deposits (money in the economy), the base money injected by the Fed needs to be loaned, thus expanding total deposits and the Ms via the multiplier mechanism. It didn’t happen. It’s not happening.  The money multiplier has dropped.  And since credit is the lifeblood of the “real” economy nowadays, this situation must be having “real” effects as documented by the press on real time.

Conclusion: There was, back in the fall of 2008, and — although it’s eased a bit since the fall — there continues to be a credit crunch.

Michael Moore offers a plan to deal with the auto industry troubles in ways that would advance the public interest.  I find it well-informed and sensible.

I know that, because he’s Michael Moore, a “controversial” documentary maker, serious economists and journalists — that is, economists and journalists under serious pressure to feign objectivity (objectivity of the type that is in fact impossible in a society as unequal as ours) — would have to find some fault in Moore’s logic or facts, or else.  Well, I couldn’t find anything objectionable in Moore’s plan.  Readers are of course welcome to voice their own objections (or agreement) in the Comments section.

Here is Michael Moore’s plan to deal with the auto industry disaster:

http://www.michaelmoore.com/words/message/print.php?messageDate=2008-12-03

This is an old lecture delivered by Salih Neftci at the New School on credit risk and the crisis.  (Click the tab labeled  “Play Full Program” to see the entire lecture.)  It’s still a very useful presentation when looking back at what triggered this mess.

I took all of Salih’s courses in econometrics, macroeconomics, finance, and financial engineering at the CUNY GC.  Excellent instructor.  Nice man.  Funny jokes.  Full disclosure: He once wrote a great letter of recommendation for me that got me a finance professorship.  So, I’m very grateful to him.

In a class, I once asked him point blank: “If you are so smart, how come you are into finance and making bucks?  How come you’re not into politics, trying to change the world for good?”  That rattled him a bit.  He babbled about how some women in his family, including his mother, had all been into politics at great cost.  He then said that politics only rarely improves on things.  He then stopped himself, unhappy with his own answers, and continued the class.

That is a propos of this passage in Krugman’s latest column:

Meanwhile, how much has our nation’s future been damaged by the magnetic pull of quick personal wealth, which for years has drawn many of our best and brightest young people into investment banking, at the expense of science, public service and just about everything else?

I agree with Paul Krugman.  What a waste of our society’s dearest resources!

Krugman’s Nobel lecture is on here (Windows Media Player):

http://nobelprize.org/mediaplayer/index.php?id=1072

His slides are here (pdf):

http://www.princeton.edu/~pkrugman/nobelslides.pdf

Do not miss Salon.com’s interview of Paul Krugman.  A quick comment:

Krugman is good at clarifying for the general public what I regard as Keynes’ main insight in the General Theory, namely that specific disproportions in the economy, e.g. sectoral bubbles, dislocations in particular markets caused by unexpected shocks in technology or policy, etc., can turn into nasty economy-wide crises only because, as a result of widespread, self-reinforcing fears about future business conditions, there’s a sudden, generalized flight to liquidity.

This is a massive coordination problem.  Coordination problems are common to capitalist markets, not only — as in this case — to financial markets.  They are a manifestation of the inherent conflict at the root of every capitalist society between an increasingly interdependent economy and private ownership.  Keynes’ genius was to realize that, like other coordination problems facing the capitalists, the Gordian knot could be cut by the decisive action of the government.

In this interview, Krugman paraphrases Keynes’ “magneto” metaphor in the Great Slump — “If you’ve got electrical problems with your engine, that doesn’t mean you should junk the whole car” (I think Keynes referred to a ‘wagon’).  And then he throws this one-two punch:

It’s true that classical economics says that we should let market forces do the work; but classical economics also says that severe recessions can’t happen.  This idea that we must not intervene is based on a worldview that is refuted by the very fact that the economy is in the mess it’s in.

Insisting on this point is called for, not only because regular people have for long been bombarded with the Austrian view that recessions (and depressions) are necessary to purge or clear the dead wood that has cluttered the system, but also because some people in the left apparently buy into the argument.

Last Thursday, in a panel discussion at New York University, Doug Henwood and Anwar Shaikh offered their views on the ongoing economic crisis.  Their presentations were both excellent and largely complementary.  I hope the organizers of the discussion upload the video on the web for others to watch it directly.  Meanwhile, I will share a few impressions/comments on the issues involved:

[12/8/2008 UPDATE: The audio file is already available at: http://nyusociology.org/blogs/radical/2008/12/08/the-deepening-economic-disaster/]

1. Doug had an understandably skeptical view of the political opportunities opened to the left by the crisis.  One of his remarks, was that an economic crisis — with its sequels of joblessness and insecurity — could tilt people towards solidarity and collective struggle just as well as to the kind of misanthropic despair that strengthened Fascism.  This is a valid warning.  I’d just add the qualification that the very fact that, as a result of a crisis, things might tip from one extreme to the other suggests that the moment is pregnant with political opportunities for the left: the U.S. and global left.  At times like these, the actions of the left — especially actions that are thoughtfully conceived — can have large positive consequences.

2. In his introductory remarks, Doug referred to the discontent among leftists towards Paulson’s bailout plan when it was initially announced.  Doug said that, not taking some sort of action to bail out the banks, even if it involved handing money out to Wall Street, could have triggered even worse consequences to working people than the alternative.  The collapse of banks entailed serious risks for everybody.  Doug aptly alluded to the debate between Bernanke and Friedman/Schwartz on the causes and propagation mechanisms of the Great Depression of the 1930s (Anwar reminded us that we should be specific when we refer to the Great Depression, since the U.S. experienced a few of them in the late 19th century).

3. Bernanke’s reputation as an academic, which in turn led him to the Fed chairmanship, was based on his famous 1983 paper, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression,” (AER, 73-3).   In his essay, Bernanke questioned prevailing views, because they implicitly assumed perfect (neutral) financial markets.   The banks’ collapse simply echoed the fall in output or — as claimed by Friedman & Schwartz — fed the fall in output as a result of wealth effects or (in tandem with tone-deaf monetary policy moves) via the shrinkage of the money supply.  Instead, Bernanke argued compellingly, bank bankrupticies led to a credit freeze with real output negative effects.

4. At this point, Doug failed to make the crucial distinction between the collapse of banks and the collapse of banking — or the collapse of the banking system as a whole.  Even if we rule out socialism as a feasible alternative in the short run, under capitalism, existing banks and banking are by no means the same thing.  By failing to draw this distinction, Doug leaves unquestioned a key article of faith of the neoliberal doctrine, namely that banking is a business to be left to private interests.

5. As I’ve written previously on this blog, it is entirely feasible — within the confines of the U.S. capitalist economy — to dampen the effects of the credit freeze on the economy by providing direct relief to mortgage debtors.  That can be duly complemented  with alternative ways to get credit flowing into the economy, e.g. by nationalizing at least some banks (buying a controlling interest and, using the current laxity in monetary policy to expand credit to well directed social goals).  My back-of-the-envelope estimations tell me this approach would be significantly more economical and effective than the favored ones.  (In all fairness to Doug, a questioner moved him to entertain the possibility of credit unions, development banks, and other forms of banking under greater public control, but he made these remarks with due skepticism.)

6.  This leads me back to the issue above. In fluid times, when its inherent instability and antagonisms sow doubts in people’s minds on the social efficiency and equity, rationality and desirability of capitalism, Marx’s famous epigram becomes more operational than under normal conditions: Ideas become a material force when they grip the minds of the masses.   How can the proposals of the left grip the minds of the masses if we don’t even dare to entertain them publicly in the first place?  The first task of the left is to articulate the needs of people, frame them in ways compelling enough to enligthen their actions when they set themselves in political motion.  The realm of political feasibility is being expanded by the crisis.  When the reigning economic ideology (e.g. neoliberalism) has exhausted itself, people otherwise impermeable to the ideas of the left are more ready to regard them.

7. In his closing statement, Anwar remarked that we shouldn’t view the ongoing crisis as a U.S. crisis, but as a crisis of capitalism.   Today’s capitalism continues to be largely an alienated phenomenon, without a central manned direction, subject to its own inherent, spontaneous laws above and beyond the control of the so-called “Masters of the Universe.” I don’t disagree with his statement as a general methodological, abstract proposition.  In fact, just the other day, I was going to write critical comment to a recent paper by Samir Amin using an argument similar to Anwar’s.   If it weren’t for views as those espoused by Amin and others, I’d have said that Anwar’s statement was unnecessary.

8. Having said that,  there’s clearly a dimension in which this is a crisis of national hegemony — a crisis of U.S. imperialism.  The view that global capitalism is driven by spontaneous social laws doesn’t have to exclude the recognition that, on a more concrete level, some nations, states, classes, groups, and individuals wield a much greater amount of social power than the rest of the human race — and that they use it to exploit others less fortunate.    (In fairness to Anwar, he also said in his reply to a questioner that he didn’t deny that national policies significantly altered the operation of the “pure” laws of capitalism, although the latter would wind up asserting themselves, usually in the form of sudden crises.)  This asymmetry of power is at the root of capitalism and imperialism.  The issue of international hegemony is a real political dimension that the left has to ponder.  Although no given nation state exercises absolute global social control or can impunely violate the laws of motion of capitalism, the U.S. continues to dominate the world economically and politically.   As I’ve tried to argue elsewhere, imperialism is nowadays the weakest link of the capitalist chain.  Imperialism, as a form of forceful extra-economic appropriation of the social labor of poor countries for the benefit of rich countries, is in a terminal crisis.

Anna J. Schwartz is one of those human beings whose charm nobody who meets her personally can resist.

For more years than I’d like to admit, I took classes in the CUNY Grad Center building located on the northeastern corner of 5th Avenue and 34th Street in Manhattan.  The economics department office was located on the 5th floor, sandwiched between the offices of the National Bureau of Economic Research and the Howard Samuels Center.  So, rather frequently, one would run into this beautiful woman in her late 80s/early 90s, on the halls or at the commons.  Invariably, she’d be dressed up, elegant, and serious.   I doubt she ever missed a day of work at the NBER since she joined it at some point during WWII.

Traditionally, as it continues to do, the economics department would jointly organize a weekly-session seminar along with the NBER.  A few times, Anna would attend the sessions.  And if you took the course in American economic history, she’d occasionally lecture, particularly on the monetary history of the Great Depression.   Anna and Milton Friedman wrote what a few (the latest being perhaps Hugo Kaufmann), a bit too obsequiously for my taste, have called “the definitive monetary history of the U.S.”

I don’t think anybody ever writes any definitive history of anything.  And it’s always seemed to me that Friedman and Schwartz significantly overestimated the role of monetary policy in leading to, and failing to prevent, the Great Depression.   That, of course, doesn’t take away that Anna has the most impressive, encyclopedic knowledge of these events, knowledge that she projects splendidly in the fluency of her speech and in the surprising volume of her voice.

Yesterday evening, the European Union Studies Center organized a lecture by Anna Schwartz on the origins of the ongoing crisis.  I attended, took notes, and then, at the end, during the Q&A period, I kindly objected to one of Anna’s claims.  I expected the lecture to be an elaboration of thoughts she expressed on her well publicized October 18 Wall Street Journal’s interview blaming the Fed (Greenspan) for ushering the financial crisis and criticizing the Fed (Bernanke) for handling it the wrong way — while praising Paulson’s initial TARP.   And that’s exactly what she did in the lecture.

But I’ll share all that tomorrow, when I update this blog post.

Krugman or Mankiw?  Mankiw or Krugman?

I say Krugman.  And here’s my argument (awaiting moderation as a comment on Krugman’s NYT blog):

With all due respect, what did Greg Mankiw and Glenn Hubbard accomplish under Bush, not for them personally, but for society? What’s the economic record of the Bush administration measured in social welfare terms? Isn’t economics ultimately about optimizing the welfare of society? Shouldn’t that criterion trump citations, publications, or “academic accomplishments” as determined by fellow economists? I can list two remarkable accomplishments by Paul Krugman off the top of my head that, in welfare terms, go much longer than any increasing-returns trade or urban economics story. Krugman opposed the invasion of Iraq. And Krugman opposed the tax cuts for the rich.

UPDATED: 12/1/2008

I’m getting a few readers linked from Greg Mankiw’s blog.  For their sake, I’ll expand on my argument just a little.

Assume arguendo that the economists’ talent is a resource with a positive value.  Since their productivity is not infinite (which, in conventional economics translates as, the economists’ talent is a scarce resource), then it is incumbent upon the economists — as the public guardians of social efficiency — to see to it that their talent is allocated to its best possible use.

(This is, by the way, an idea that Robert E. Lucas made famous with his remark on why macro economists should spend more of their thinking time on growth economics and less on business cycles.)

Which was — by far — a better way to spend the scarce talent of the economists in question, say, in the last 8 years?  Was it better to spend it promoting or opposing the war, the tax cuts for the rich, the deregulation of financial markets, the dismantling of the social safety net, etc.?

According to Stiglitz and Bilmes, the war is costing us $2 trillion plus.  That’s the conservative estimate.  To the extent the deregulation of financial markets is a factor leading to the current mess, that’s to be added to a problem that is requiring an emergency public injection of $.7 trillion plus.   I don’t have handy figures for the total cost (on social welfare) of the increase in social inequality caused by the tax cuts for the rich, social insecurity, etc. but I am sure it’s not zero.

I’m not saying that Mankiw alone did all that.  He contributed to it, willingly and knowingly.

I’m not saying that Krugman alone managed to reverse all that.  But he contributed to it with his well argued opinion.

Krugman served the public interest with his critique of the way things were mismanaged by Bush.  Mankiw, on the other hand, did a big disservice to the public by throwing his academic and intellectual weight to the sad task of propping up Bush.

Conclusion: To the extent they owe anything to society (since they both for sure stand on the shoulders of giants), we got an excellent return on Krugman.  Mankiw, on the other hand, has been a toxic asset on our balance sheet.  Let’s hope that Paulson buys it — and keeps it.