A realistic discussion about the financial crisis and how to deal with it?

A discussion with: Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros, Robin Wells, with Jeff Madrick as moderator.

http://www.nybooks.com/articles/22756

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Jeff Madrick: It was six months ago now that the Lehman debacle occurred, that AIG was rescued, that Bank of America bought Merrill Lynch; it was about six months ago that the TARP funds started being distributed. The economy was doing fairly poorly in much of 2008, and then fell off a cliff in the last quarter of 2008 and into 2009, shrinking at a 6 percent annual rate—an extraordinary drop in our national income. It is now by some very important measures the worst economic recession in the post–World War II era. Employment has dropped faster than ever before in this space of time.

We have a three-front problem: a housing market that went crazy as the housing bubble burst; a credit crisis, the most severe we've known since the early 1930s; and now a sharp drop in demand for goods and services and capital investment, leading to a severe recession. What gives us the jitters is that all of these are related. We have seen some deceleration in the rate of economic decline, and many people are saying that "green shoots" are showing. What is the actual state of the economy, and do we need a serious mid-course correction on the part of the Obama administration?

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Bill Bradley: How far are we along in a recovery? When the market price of Citicorp drops from 60 to 1, and then comes back to 3, I don't think that's a recovery. Warren Buffett buys Goldman Sachs, and after he buys, the price drops 45 to 50 percent, and if he's going to break even on the investment he's got to earn 9 percent for the next twelve years, I don't think that's a recovery. The administration has put in place measures that, if they were to work, could offer some hope.

What I'd like to suggest is that if they don't work, there's an alternative. The national government has now made about $12.7 trillion in guarantees and commitments to the US financial sector, and we've already spent a little over $4 trillion in this crisis. Some institutions such as Citicorp, for example, received about $60 billion in direct assistance, and $340 billion in guarantees. So US taxpayers are into Citicorp for around $400 billion. If we look out to June, July, and if we see that the PPIP is not succeeding, that the bank assets aren't being bought at levels that they should be bought from the books of banks, then there is an alternative.

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Niall Ferguson: This is the end of the age of leverage, which began, I guess, in the late 1970s, and saw an explosive rise in the ratio of debt to gross domestic product, not only in this country, but in many, many other countries. Once you end up with public and private debts in excess of three and a half times the size of your annual output, you are Argentina. You know, it's funny that people refer all the time back to the collapse of Lehman last September. Let's remember that this crisis actually began in June 2007. It fully became clear in August of 2007 that major financial institutions were almost certainly on the brink of insolvency to anybody who bothered to think about the impact of subprime mortgage defaults on their balance sheets.

But we were in denial. And we stayed in denial until September, more than a year later, of last year. Then we had the breakdown. Notice how psychological terms are very helpful when economics fails as a discipline. After the breakdown, we came out of denial and we realized that probably more than one major bank was insolvent. Then in September and October the world went into shock. It was deeply traumatic.

Now we're in the therapy phase. And what therapy are we using? Well, it's very interesting because we're using two quite contradictory courses of therapy. One is the prescription of Dr. Friedman—Milton Friedman, that is —which is being administered by the Federal Reserve: massive injections of liquidity to avert the kind of banking crisis that caused the Great Depression of the early 1930s. I'm fine with that. That's the right thing to do. But there is another course of therapy that is simultaneously being administered, which is the therapy prescribed by Dr. Keynes—John Maynard Keynes—and that therapy involves the running of massive fiscal deficits in excess of 12 percent of gross domestic product this year, and the issuance therefore of vast quantities of freshly minted bonds.

There is a clear contradiction between these two policies, and we're trying to have it both ways. You can't be a monetarist and a Keynesian simultaneously—at least I can't see how you can, because if the aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the Keynesian policy must be to drive interest rates up.

.... much more

George Soros: "There are two features that I think deserve to be pointed out. One is that the financial system as we know it actually collapsed. After the bankruptcy of Lehman Brothers on September 15, the financial system really ceased to function. It had to be put on artificial life support. At the same time, the financial shock had a tremendous effect on the real economy, and the real economy went into a free fall, and that was global.

The other feature is that the financial system collapsed of its own weight. That contradicted the prevailing view about financial markets, namely that they tend toward equilibrium, and that equilibrium is disturbed by extraneous forces, outside shocks. Those disturbances were supposed to occur in a random fashion. Markets were seen basically as self-correcting. That paradigm has proven to be false. So we are dealing not only with the collapse of a financial system, but also with the collapse of a worldview."

..........more

Krugman said, "The other thing not to miss is the importance of a strong social safety net. By most accounts, most projections say that the European Union is going to have a somewhat deeper recession this year than the United States. So in terms of macromanagement, they're actually doing a poor job, and there are various reasons for that: the European Central Bank is too conservative, Europeans have been too slow to do fiscal stimulus. But the human suffering is going to be much greater on this side of the Atlantic because Europeans don't lose their health care when they lose their jobs. They don't find themselves with essentially no support once their trivial unemployment check has fallen off. We have nothing underneath. When Americans lose their jobs, they fall into the abyss. That does not happen in other advanced countries, it does not happen, I want to say, in civilized countries.

And there are people who say we should not be worrying about things like universal health care in the crisis, we need to solve the crisis. But this is exactly the time when the importance of having a decent social safety net is driven home to everybody, which makes it a very good time to actually move ahead on these other things."

then Bradley noted: "B.B.: As we look at the future, we also have to look at the mistakes policymakers made in the last ten years. It's not news that people are greedy. But we made conscious decisions not to put limits on that natural human impulse. What were the mistakes? In 1999, we allowed investment banks, banks, insurance companies to combine: we eliminated the Glass-Steagall Act, which prohibited commercial banks from operating as investment banks. Why was Glass-Steagall put into law? Because the last time we didn't limit greed we got into trouble, the Great Depression.

The second mistake was in 1999, the explicit decision by the Clinton administration and Congress not to regulate derivatives, in particular credit default swaps. In 2002 they were worth $1 trillion and today they're worth $33 trillion, and that decision not to regulate derivatives created the following sequence: you have mortgages; then a thousand mortgages are packaged and sold as a mortgage-backed security; a thousand mortgage-backed securities are packaged and sold as a collateral debt obligation ; then a thousand collateral debt obligations are packaged and sold as a CDO squared; and insuring each one of those bundles are credit default swaps, which are a part of that $33 trillion. And our government deliberately decided not to regulate this chain of investments."

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.....read it all if you get the chance. I know that long articles are not realy popular on discussion boards.

in a dark alley, would you? This Friedmanite acolyte was depressed at the mention of such measures as higher taxes (evidently on the wealthier, who have profited the most from the rapacious Friedmanite lunacy that led to this crisis. Even diagnosing DENIAL as one of the features of the way in which this dire situation was being viewed, then the "breakdown". He rather likes the psychological terminology.

If Ferguson sees a connection between Friedman's fantasies and this incipient depression, he evidently thinks the benefits "afforded"(!) by the former to a grateful populace (extending usurious credit to them, in lieu of a living wage) were well worth the world suffering the latter, the depression. Well, the world's poorer folk, of course.

Heck, where will all that high-octane, Gordon Gecko dynamism go, with a socialised state, (rightly described by Krugman as a minimal requirement for qualification of a country as civilised). Hasn't it historically been the engine of growth, of profit? Well, in a limited sense, yes. But for whom? For mutt economisificists like him, as well as Mr Gekko's tribe who've been feeding them, of course. For the rest, this has been a Gadarene rush by them over the prostrate bodies of the people, and then over this precipice. No wonder Nassim Taleb is so withering about the myrmidon scholars of that dismal science. "Science!" That's a good one.

Economics is the study of the effects of human greed, and its polar opposite, socio-economic responsibility and the synergies it creates, period. Statistics can, of course, be very helpful, but Nassim Taleb was surely right on the mark when he stated what should have been obvious to anyone with an ounce of common-sense, namely: mathematical models to measure human behaviour cannot but be absolute tosh. I mean it follows inexorably from the pellucidly true insight of John K Galbraith that "the modern conservative is engaged in one of man's oldest exercises in moral philosophy; that is, the search for a superior moral justification for selfishness."

A little ironically, perhaps, the arch-capitalist, George Soros, "cut to the chase" in the clearest terms:

"There are two features that I think deserve to be pointed out. One is that the financial system as we know it actually collapsed. After the bankruptcy of Lehman Brothers on September 15, the financial system really ceased to function. It had to be put on artificial life support. At the same time, the financial shock had a tremendous effect on the real economy, and the real economy went into a free fall, and that was global.

The other feature is that the financial system collapsed of its own weight. That contradicted the prevailing view about financial markets, namely that they tend toward equilibrium, and that equilibrium is disturbed by extraneous forces, outside shocks. Those disturbances were supposed to occur in a random fashion. Markets were seen basically as self-correcting. That paradigm has proven to be false. So we are dealing not only with the collapse of a financial system, but also with the collapse of a worldview."

George, give Nails a nudge, will you. He's fallen asleep.

He was worried about going back to the bad ol' 70's... I think the 70's will be viewed like a picnic by the time this crisis is over?

you remember another truth, verbalised by that truly great thinker, Galbraith:

"In economics, hope and faith coexist with great scientific pretension and also a deep desire for respectability."

Conceptual leaps are not the way to get ahead in Academe, that is, unless, Friedman-like, they're plum crazy and support the deepest, darkest desires of the super-rich. Then it's a different story.

it escapes me at the moment..

have been tried."

Here's a couple more, though I expect you're familiar with them all:

"If you feed enough oats to the horse, some will pass through to feed the sparrows (referring to "trickle down" economics)."

And how prophetic is this!

"...the process by which wants are now synthesized is a potential source of economic instability. Production and therewith employment and social security are dependent on an inherently unstable process of consumer debt creation. This may one day falter."
— John Kenneth Galbraith