Bernanke, Stiglitz, Minsky -- Who was right?

Today on the podcast, continuing with our series on listening to those who were right with Hyman Minsky, who perhaps predicted better than anybody because he described the capitalism in which we live and identified the sources of instability.

I just listened to the Brookings conference on Lehman Brothers one year later and the remarks of Fed Chairman Ben Bernanke, whom regular listeners will remember I often call Baffled Ben. Mr. Bernanke's remarks were essentially a litany of all the dominoes in the financial sector's collapse and the special and extraordinary measures he and others have taken to prop them up again.

My impulse during it all was to say out loud again and again, "And you didn't see it coming."

This was indeed a collapse of epic dimensions. The imposing facade of Wall Street was made of glass. And they were bowling inside. One of the balls got loose, as they tend to do when constraints are minimal, it hit the glass and the entire thing cracked and began to chip out.

The Fed has spent trillions on duct tape, so a good chunk of the facade is still standing. It doesn't look very good. In the places where clear glass has replaced the opaque variety, we can see that those who work behind the walls are more clowns or grifters than titans or geniuses, but they still rake in the big bucks. Unfortunately the stability of the wall of glass, even taped up as it is, does not help the real economy. It ratifies a lot of bad decisions, keeps the authors of the debacle from reaping their just desserts and keeps up pretenses.

It reminds me of Bernanke's predecessor, Maestro Magoo Greenspan, who spent most of his career at the Fed as the acknowledged genius of economics and only when the philosophy of nonregulation and the tactic of ever more liquidity blew up the economy was he relegated to his rightful place. Still, there are plenty of voices advocating going slow on regulation, and heavens, don't do anything fundamental, and let's try to find a new bubble to blow up. Greenspan was as close as anybody to the man who knows all. Now we see him as the befuddled Wizard of Oz. Yet Oz itself, Wall Street, is considered the heart of the economy, and now that it is seemingly rescued, it is assumed that the rest will follow. No.

Beneath it all is a fever to keep asset prices from further collapse. This is working to some extent in the stock markets, where more easy money is buoying up the S&P. When financial assets are valued on the basis of casino markets and the ability to find buyers, we are in deep do-do. Assets need to be valued on the basis of the stream of value one obtains by owning them.

In any event, I would have played Mr. Bernanke's rendition of all that went wrong, except that it was his entire speech. To some extent he is the fireman who saved Oz from burning to the ground and his heroic deeds are oft repeated. One only wishes he had not provided the arsonists with the gasoline. Ah, well.

As to forecasting, Mr. Bernanke admits to not being very good, and properly includes the majority of academic and Wall Street forecasters with him in not being very good, before announcing that the Great Recession is over and although the next period will be the Great Stagnation, some day things will get back to normal. Of course, he does not mention those who did predict the calamity, nor the fact that many of these are not satisfied either with the remedies in place, those in prospect, nor with the outlook going forward.

We'll get to Hyman Minsky in a moment, but let's get to another who is writing contemporaneously. Joseph Stigltiz. In our view the greatest living economist. We'll introduce his latest piece this way.

Recession and Recovery. It may surprise the listener that one can have higher employment, GDP and other economic activity in a recession than in a recovery, even if they are separated only by a year or so. That is no doubt what we will have this time around. Recession and Recovery are designations of the direction of economic activity, most often represented by the statistic GDP. As we said, Ben Bernanke and others predict the period going forward will be the Great Stagnation, with very weak and probably falling employment, very weak, but likely rising growth, and a very weak investment climate.

This is a flat line, particularly if you take into consideration that the population is rising and the projected growth is likely not to even match the growth in population. Yet because it is up, it is recovery. We will not be recovered in the sense of returning to any form of health, but the economic designation by the sages at the NBER will be quote recovery unquote.

By these lights it is obviously time to introduce new designators, and we at Demand Side, never shy, are stepping up to the challenge. We hereby offer the following designations for economic health: Strong Economy, Weak Economy, Failing Economy. We are in a Failing Economy, on account of the critically deficient employment of labor and capital and the failed and essentially insolvent financial system.

Joseph Stiglitz, writing recently on Project Syndicate looked at it this way, under the title.

GDP Fetishism

NEW YORK – Striving to revive the world economy while simultaneously responding to the global climate crisis has raised a knotty question: are statistics giving us the right “signals” about what to do? In our performance-oriented world, measurement issues have taken on increased importance: what we measure affects what we do.

If we have poor measures, what we strive to do (say, increase GDP) may actually contribute to a worsening of living standards. We may also be confronted with false choices, seeing trade-offs between output and environmental protection that don’t exist. By contrast, a better measure of economic performance might show that steps taken to improve the environment are good for the economy.

Eighteen months ago, French President Nicolas Sarkozy established an international Commission on the Measurement of Economic Performance and Social Progress, owing to his dissatisfaction – and that of many others – with the current state of statistical information about the economy and society. On September 14, the Commission will issue its long-awaited report.

The big question concerns whether GDP provides a good measure of living standards. In many cases, GDP statistics seem to suggest that the economy is doing far better than most citizens’ own perceptions. Moreover, the focus on GDP creates conflicts: political leaders are told to maximize it, but citizens also demand that attention be paid to enhancing security, reducing air, water, and noise pollution, and so forth – all of which might lower GDP growth.

The fact that GDP may be a poor measure of well-being, or even of market activity, has, of course, long been recognized. But changes in society and the economy may have heightened the problems, at the same time that advances in economics and statistical techniques may have provided opportunities to improve our metrics.

For example, while GDP is supposed to measure the value of output of goods and services, in one key sector – government – we typically have no way of doing it, so we often measure the output simply by the inputs. If government spends more – even if inefficiently – output goes up. In the last 60 y ears, the share of government output in GDP has increased from 21.4% to 38.6% in the US, from 27.6% to 52.7% in France, from 34.2% to 47.6% in the United Kingdom, and from 30.4% to 44.0% in Germany. So what was a relatively minor problem has now become a major one.

Likewise, quality improvements – say, better cars rather than just more cars – account for much of the increase in GDP nowadays. But assessing quality improvements is difficult. Health care exemplifies this problem: much of medicine is publicly provided, and much of the advances are in quality.

The same problems in making comparisons over time apply to comparisons across countries. The United States spends more on health care than any other country (both per capita and as a percentage of income), but gets poorer outcomes. Part of the difference between GDP per capita in the US and some European countries may thus be a result of the way we measure things.

Another marked change in most societies is an increase in inequality. This means that there is increasing disparity between average (mean) income and the median income (that of the “typical” person, whose income lies in the middle of the distribution of all incomes). If a few bankers get much richer, average income can go up, even as most individuals’ incomes are declining. So GDP per capita statistics may not reflect what is happening to most citizens.

We use market prices to value goods and services. But now, even those with the most faith in markets question reliance on market prices, as they argue against mark-to-market valuations. The pre-crisis profits of banks – one-third of all corporate profits – appear to have been a mirage.

This realization casts a new light not only on our measures of performance, but also on the inferences we make. Before the crisis, when US growth (using standard GDP measures) seemed so much stronger than that of Europe, many Europeans argued that Europe should adopt US-style capitalism. Of course, anyone who wanted to could have seen American households’ growing indebtedness, which would have gone a long way toward correcting the false impression of success given by the GDP statistic.

Recent methodological advances have enabled us to assess better what contributes to citizens’ sense of well-being, and to gather the data needed to make such assessments on a regular basis. These studies, for instance, verify and quantify what should be obvious: the loss of a job has a greater impact than can be accounted for just by the loss of income. They also demonstrate the importance of social connectedness.

Any good measure of how well we are doing must also take account of sustainability. Just as a firm needs to measure the depreciation of its capital, so, too, our national accounts need to reflect the depletion of natural resources and the degradation of our environment.

Statistical frameworks are intended to summarize what is going on in our complex society in a few easily interpretable numbers. It should have been obvious that one couldn’t reduce everything to a single number, GDP. The report by the Commission on the Measurement of Economic Performance and Social Progress will, one hopes, lead to a better understanding of the uses, and abuses, of that statistic.

The report should also provide guidance for creating a broader set of indicators that more accurately capture both well-being and sustainability; and it should provide impetus for improving the ability of GDP and related statistics to assess the performance of the economy and society. Such reforms will help us direct our efforts (and resources) in ways that lead to improvement in both.


Now at last, on to Hyman Minsky, another voice who has been right, and I see we are running long, so we will continue some of our look at Minsky next week.


Hyman Minsky wrote in the 1970s and 1980s, and was as close as anybody to being the direct line of succession from Keynes.

[At this point I was googling for a more complete bio, the first signs of instability in my computer appeared, and between now and then has been difficult. Always back up your stuff. Continuing.]

Minsky's work that I have looked at are the two books John Maynard Keynes and Stabilizing an Unstable Economy. Both are profoundly coherent and both are difficult reads.

Postwar financial sector instability began in the 1960s with the backstopping of the commercial paper market, according to Minsky. Prior to that banks dealt primarily in government securities when "making their positions." There was an ample supply of these government securities left as a legacy of World War II. As the years have progressed, the innovation of financing instruments has progressed, and also the periodic backstopping of these instruments by the government or a consortium of banks organized by the government or Fed.

We've looked at that before, and the fact that it continuously adds another stratum to the financial sector, making the system ever more topheavy. Now we've arrived at the point where the government is behind the banking institutions and whatever they do in their entirety. No matter how egregious or massive, they are too big too fail. If this system is not materially altered soon, the outcome is inevitable and catastrophic.

Now let's turn to a line of Minsky's thought which follows from the work of the great Polish economist Michal Kalecki. We brought this up a couple of weeks ago in our observations on the 70-30 historically stable split between labor and capital.

Kalecki observed that with not-too-heroic assumptions, including that workers consume all their income, it followed that, among other things, investment equals profit in a simple economy. I was surprised and delighted to find in my reading of Stabilizing an Unstable Economy, that Minsky has taken this line and developed it fully, or more fully, for economies with a government, a large government, trade and where workers save some of their income and capitalists consume some of theirs.

The simplest useful equation in Minsky, which is derived directly from Kalecki's insights has to do with prices.

P_c = W/A_c (1 + N_I/N_C)

The formula states that the price level is positively related to the wage rate and the ratio of labor in the investment goods sector to labor in consumption goods sector -- that is, the balance of the economy toward investment. It gets more complicated as government and trade is introduced, but one key connclusion does not change. To quote Minsky:

"Explanations of inflation are usually in terms of either too rapid an increase in money, a budget deficit, or wages rising too fast."

But, he continues,

"The money supply does not appear in the price level equation. The quantity theory is not visible."

Minsky goes on,

"Money appears in teh subsystems that determine realized investment and the financing of government deficits. In particular, money affects total demand and the course of prices through the banking mechanism that finance activity and control over (sic) capital and financial assets."

[Now we begin a long digression.]

The quantity theory of money PQ = MV has been treated as a key to unlocking inflation by many and even most economists. The quantity theory is a fallacy not because it is not true, but because it does not explain anything. V, velocity, varies radically in alignment with other parameters. V is a wild card. Monetarists want PQ = M, and Milton Friedman's famous "Inflation is always and everywhere a monetary phenomenon" is based on PQ = M, not PQ = MV. V can be one or a hundred or one one-hundredth. This being so, it washes away any significance of M.

It is like saying the total height you can jump is based on your strength times the gravitational pull. Well, your mass affects that pull and so does the planet you are on. If you can vary these at your pleasure, your strength is not a determining factor. To make the height you can jump relevant to strength, you need to set the conditions much more explicitly than a simple equation. So it is with velocity, which carries he sum of a dozen other indicators. The interaction of these indicators is expressed in velocity and it is these indicators that determine PQ.

[This digression is not from Minsky. Returning to him now, and his simple elegant algebra... After introducing governments and deficits, he shows that when the dust settles

You know, I'm sorry we didn't get more into this earlier. Next week, we'll go deeper, including the eye-opening discovery that in some very substantial way, government deficits arise in the absence of private investment. That is, it is useful to think of the two as substitutes, and the fact that substantial private investment is not on the table for years to come is a good sign that government deficits are.

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We can't carry the big banks forever

We can keep feeding the big banks. It may keep them alive. Not as useful citizens. But alive. To get credit back in the economy and get the financial sector's huge mistakes off our backs, we will need to cut them down to size and make the lenders as well as the borrowers suffer.

Stiglitz calls for cutting them up, Kuttner posits a transactions tax, but the New Deal remedy of forced negotiations to reduce principle has not been effectively tried. It needs to be done. Here are two more reports on how and why.

Cramdown Is Back: Banks Against Homeowners, Round 2
Ryan Grim
Huffington Post
First Posted: 09- 8-09 11:01 PM

House Financial Services Committee Chairman Barney Frank (D-Mass.) tells the Huffington Post he plans to revive the effort to give bankruptcy judges the authority to renegotiate home mortgages -- by making it part of this fall's much-anticipated financial regulatory reform bill.

Wall Street banks scored an overwhelming victory in April when they soundly defeated a cramdown measure in the Senate. Only 45 Democrats voted with homeowners, dealing the measure the kind of defeat that often sends legislation off into the wilderness for years, if not for good.

Frank and Senate Majority Whip Dick Durbin (D-Ill.), who led the bill in the upper chamber, both said after its defeat that it was finished. Frank was dismissive when, about a week after the vote, HuffPost asked if cramdown might come back. "Excuse me, what planet were you on last week? The vote was 45 to 51. Why would you ask that? Do I think there's a likelihood we could overturn 45-51? No," said Frank. "I wish it weren't the case."

But since then, foreclosures have continued unabated and the unemployment rate has continued to climb, increasing to 9.7 percent last month. Both forces feed on each other and create a drag on the economy.

The Obama administration had high hopes for the law Congress passed intended to encourage mortgage modifications. The law is all carrot, however, and no stick. Cramdown is the stick. If banks think they could get hit in bankruptcy court, they're more likely to bargain.

On Tuesday, Frank was asked by HuffPost if he had plans to readdress cramdown. "Yes, as I will announce tomorrow, and I told this to bankers, given the slow pace of modifications, for whatever reason: they're not putting enough people on it, they're not taking it seriously, there are legal obstacles. As of now my intention would be to include the bankruptcy on primary residences in the reg reform."

Frank said that he met in Boston recently with Senate Majority Leader Harry Reid (D-Nev.), Charles Schumer (D-N.Y.), Jack Reed (D-R.I.) and Tim Johnson (D-S.D.); the latter three are all on the Senate Banking Committee. They told him, he said, that they were ready to make a serious push at major financial regulatory reform before the year was out. Frank guessed the House would act by October.

President Obama needs a win against the financial sector to blunt the populist anger rising about bailouts and bonuses. Frank thinks the must-pass reg reform could be the perfect vehicle to attach cramdown to.

He acknowledged that cramdown hadn't been able to pass on its own, but said that "it could be that the eagerness to get the bigger picture, gets that one done."

Regulatory reform could wind up being a major boon to consumers, with a chunk of credit card reform thrown in, too. Frank said that if credit card companies continue to jack up rates in advance of the effective date of the reform bill recently passed, "we could move that effective date up a few months in the reg reform bill." Other possibilities include a consumer financial protection agency and a provision that would mandate an audit of the Federal Reserve.

Frank said that as the foreclosure crisis has stretched on, Democrats who were skeptical of the need for cramdown authority have approached him to say that they now see the argument.

Rep. Brad Miller (D-N.C.), a lead proponent of cramdown in the House, said he ran into Durbin about two months ago and thanked him for his efforts. Durbin, he said, was hopeful that he'd get another crack at it before too long. Miller said Durbin may now get that chance because he banks were given an opportunity to reform and they haven't lived up to their end of the deal.

"Barney's really angry that we've done all this stuff, that the industry helped draft, and they said, 'If you do it this way, and you hold your mouth, and you stand on just your left leg, if you do all that, we'll have lots of modifications.' And nothing - nothing - has happened," Miller said.



For a history of mortgage Cram Downs, and why they are needed, see Tanta's Just Say Yes To Cram Downs .

Just Say Yes To Cram Downs
by Tanta on Calculated Risk
10/07/2007 11:09:00 AM

A lot of people have raised questions in the comments regarding proposed changes to federal bankruptcy law to accommodate modifications of mortgage loans.

Here's the issue, in a nutshell. Until the 2005 bankruptcy reform, insolvent homeowners could choose Chapter 7 (liquidation) or Chapter 13 (repayment plan) bankruptcy. After the reform bill, for practical purposes most homeowners are limited to Chapter 13.

Chapter 7 filings usually do not result in borrowers keeping their homes, although they can (if the borrower reaffirms the mortgage debt, the court accepts the reaffirmation, and the borrower has the financial capacity to continue to make mortgage payments). In most cases, the BK stay is lifted and the loan is foreclosed.

You can think of Chapter 13 as itself a kind of loan modification: the court establishes a 3-5 year repayment plan for all the borrower's debts, with the unpaid remainder discharged at the end of the repayment plan period. In Chapter 13, the debtor can keep a mortgaged home, as long as he continues to make mortgage payments throughout the plan period, and makes up any past-due amounts (including fees) during the repayment period as determined by the repayment plan. If the borrower does not or cannot continue to pay the mortgage, the stay is lifted and the lender can foreclose.

However, secured debts can be restructured or modified in a Chapter 13 bankruptcy, and secured creditors, except the mortgage lender on a principal residence, can be subject to what is called a "cram down." This happens when the amount of the debt is greater than the value of the collateral securing it; the court reduces the value of the secured debt to the market value of the collateral, with the remainder being treated as unsecured (and subject to the same repayment plan/discharge terms as any other unsecured debt). The prohibition of court-ordered modifications for mortgages on principal residences was created in 1978; between 1978 and 1993 most bankruptcy courts interpreted the law to mean that while interest-rate reduction or term-extension modifications were not allowed, home mortgages could still be crammed down.

In 1993, with Nobleman v. American Savings Bank, the Supreme Court held that the prohibition on modifications of principal-residence mortgage loans also included cram downs. The result is that borrowers who are upside down and who have toxic, high-rate mortgages are simply, in practical terms, unable to maintain their homes in Chapter 13.

According to the Center for Responsible Lending:

The language we seek to change was enacted in 1978, a time when virtually all home mortgages were fixed-interest rate instruments with low loan-to-value ratios. The loans were rarely the source of a family’s financial distress. As originally introduced, the House legislation permitted a plan to modify any secured indebtedness, including that represented by a home mortgage.21 During Senate hearings on the proposed legislation, advocates for secured lenders suggested that home-mortgage lenders were “performing a valuable social service through their loans,” and “needed special protection against modification.” At their urging, the original proposal was subsequently amended to insert the exception for mortgages on primary residences. 22 This claim likely succeeded through effective lobbying since, as described below in section III, the merits of the argument are groundless. Whatever the merits of this claim in 1978, however, when home mortgage loans were responsibly underwritten thirty-year fixed rate loans, it plainly does not apply to the practices of subprime mortgage lenders during the last decade.

As far as I'm concerned, if you believe that prior to 1978, when modifications of home mortgages were unrestricted, and in the period of 1978-1993, when term modifications were restricted but cram downs were widely practiced, mortgage lenders offered higher-rate (relative to prevailing market), higher-LTV mortgage terms than they have in the post-1993 period, when they are safe from any restructurings, I would like to discuss a bridge purchase with you. Nonetheless, that reliable source of comic relief, the Mortgage Bankers Association, wants you to think that allowing cram downs or other kinds of loan restructuring would, um, ruin the party:

“Giving judges free rein to rewrite the terms of a mortgage would further destabilize the mortgage backed securities market and will exacerbate the serious credit crunch that is currently hindering the ability of thousands of Americans to get an affordable mortgage,” said Kurt Pfotenhauer, Senior Vice President for Government Affairs and Public Policy for MBA. “The current legislation gives no guidance as to the proper parameters for judges to modify existing loan contracts.”

By allowing judges to rewrite loan contracts and provide whatever relief they individually deem appropriate, HR 3609 would cast doubt on the value of the asset against which the mortgage loan is secured. As a result, lenders and investors would likely demand a higher premium for offering these loans. This premium could come in the form of higher fees, a higher interest rate or the requirement for a larger downpayment, all of which would serve to make the American dream of homeownership less attainable for many Americans.

In other words, the MBA implicitly admits that in the post-1993 era lenders have made low- or no-down loans at interest rates that, while high enough in terms of the blood they extract from strapped borrowers, are still lower than what they would have been if the lenders had had a healthy fear of BK court restructurings. Of course it's beyond ludicrous to argue that being forced to take what they can reasonably get by a BK judge is the "destabilizing" factor here, but you can count on the mortgage industry be ludicrous when dollars are on the table.

In fact, I have some sympathy with the view that mortgage lenders "perform a valuable social service through their loans." That's why, when they stop doing that and become predators, equity strippers, and bubble-blowers instead of valuable social service providers, I like seeing BK judges slap them around. Everybody talks a lot about moral hazard, and the reality is that you're a lot less likely to put a borrower with a weak credit history, whose income you did not verify and whose debt ratios are absurd, into a 100% financed home purchase loan on terms that are "affordable" only for a year or two, if you face having that loan restructured in Chapter 13. If you are aware that your mortgage loan can be crammed down, I'm here to tell you that you will certainly not "forget" to model negative HPA in your ratings models, and will probably pay more than a few seconds' attention to your appraisals. You might even decide that, if a loan does get into trouble, you're better off working it out yourself, via forbearance or modification or short sale, rather than hanging tough and letting the BK judge tell you what you'll accept. That would be a major bummer, right?

But I think my favorite part of the MBA lament is this: "HR 3609 would cast doubt on the value of the asset against which the mortgage loan is secured." Translation: lenders mark to model, but if you let them, BK judges will mark to market.

Is it possible that BK judges would use the lowest plausible "distressed liquidation value" to determine the secured part of the mortgage loan? Sure it is. BK judges don't have parts of their job descriptions that refer to supporting home values or keeping those comps up or controlling "price discovery." The cram down is, precisely, the "mark to market" you don't want to get, which is why the risk of it used to function as a brake on lender stupidity.

I am fully in favor of removing restrictions on modifications of mortgage loans in Chapter 13, but not necessarily because that helps current borrowers out of a jam. I'm in favor of it because I think it will be part of a range of regulatory and legal changes that will help prevent future borrowers from getting into a lot of jams, which is to say that it will, contra MBA, actually help "stabilize" the residential mortgage market in the long term. Any industry that wants special treatment under the law because of the socially vital nature of its services needs to offer socially viable services, and since the industry has displayed no ability or willingness to quit partying on its own, then treat it like any other partier under BK law.

Big banks getting bigger

Economic Policy Institute

Economic Snapshot for September 9, 2009

by Nancy Cleeland

Total assets held by the nation’s banks have grown dramatically in recent years, from $8.4 trillion at the end of 2002 to $13.3 trillion as of the end of June 2009. Within that rapidly expanding universe, a handful of mega-banks have grown even faster, taking an ever-larger share of the total. As of this summer, the four largest bank holding companies—Bank of America Corp., JPMorgan Chase & Co, Citigroup Inc., and Wells Fargo & Co.—accounted for nearly half of all bank assets held in the United States. That’s significantly higher than in late 2002, when their share was a mere 27%.

With some 8,000 small to mid-sized banks, the U.S. financial sector remains far more diverse than those of most European countries, where a few large banks have long dominated the financial sector. But at the upper levels of finance, the trend toward consolidation is clear. It was made possible by a series of regulatory changes in the 1990s that eliminated geographic restrictions and the separation of commercial and industrial banking, in the hope of achieving greater efficiencies and competitive advantages in a global environment. Today, that philosophy is being reevaluated and policy makers are looking at a variety of approaches to keep the big banks at a more manageable size.

Kuttner seconds the Tobin Tax

Slow down economically destructive speculation and at the same time generate big new revenues for government, without touching the real economy? Step right up.

Demand Side has long supported the Tobin Tax for currency transactions, to slow down the hot money that has burned up so many developing economies. Capital as investment is good, but free markets often mean capital is simply speculation searching for tiny arbitrage opportunities. A small tax is a big tax if the same money is being used time and again, as it is in international currency speculation. "Hot money" is defined as that resting only a week in a particular way. Hardly enough time to build .... well, anything.

The same principle could apply to all transactions, as pointed out in better detail below by Robert Kuttner.

A Virtuous Tax
by Robert Kuttner
Huffington Post
September 13, 2009

One prime cause of the financial collapse is that financial trading markets have become speculative worlds unto themselves. Instead of adding efficiency to the real economy, they mainly add risk that the rest of us now have to pay for.

There are many ways to damp down financial speculation, but a very effective strategy is to tax it. Given the huge costs of the clean-up (now being borne mainly by taxpayers) it would make a lot more sense to require financial markets to pay for their own bailout.

One very neat way of doing this is through a very small tax on all financial transactions. Ordinary retail sales are taxed, as are wages. But oddly enough, financial transactions are exempt from tax.

This idea was first proposed in modern form by the Nobel Laureate James Tobin in 1972, after the collapse of fixed exchange rates led to massive increase in currency speculation. Tobin proposed a small tax on short term currency trades to make extreme speculation less profitable.

Since them, short term speculation and the invention of exotic securities that lend themselves to speculation has become the dominant activity of Wall Street. So a Tobin-style tax on all financial transactions has three big things going for it.

First, a very small tax in all kinds of financial transactions, say one tenth of one percent, would not be felt by legitimate long-term investors. But in the case of traders who get in and out of exotic derivatives minute by minute, making huge numbers of quickie trades, it would add up to a lot of money and would cut into both their profits and their entire socially destructive business strategy. So a universal financial transaction tax would discourage purely speculative activities and encourage investing for the long term.

Second, such a tax could pull in hundreds of billions of dollars a year, at a time when large deficits are giving the political right (and center) an excuse to cut social spending, and no form of taxation is popular. But this tax would be the least unpopular. It would not just fall primarily on the very, very wealthy. It would fall on the least socially defensible part of Wall Street, the people who make their billions from speculative short term trades. And that raises the third benefit.

What's missing from the entire debate about financial reform is a progressive brand of populism. Regular people know that they got done in by excesses on Wall Street, and they see a Democratic administration shoveling trillions of dollars to the same Wall Street banks that caused the mess. No wonder people are confused about whether government is on their side. What is overdue is a little bit of populist retribution against the people who brought down the system -- and will bring it down again if the hegemony of the traders is not constrained.

Do we have a shot of injecting the case for a Tobin Tax into the debate? In the past few weeks, Adair Turner, the head of Britain's Financial Service Authority, cautiously expressed support for the general idea.

Peer Steinbrueck, Germany's finance minister, explicitly called for such a tax last week, as did the AFL-CIO. In an unguarded moment early in his career, even Larry Summers, President Obama's market-friendly chief economic adviser, embraced the idea, as throwing some salutary sand in the gears when financial markets "worked too well."

The Group of 20 meetings next week in Pittsburgh are not likely to produce very much in the way of real reform, because even after the disgrace of Wall Street, the usual suspects are still making policy in most nations. But a global campaign for a Tobin Tax should begin in earnest now. It could bear early fruit, as speculative excess continues and as government finds itself searching for defensible taxes.

Stiglitz points out that banking problems have not been fixed, only increased

Can you say Meltdown Part II?

The remedies for the banking system's instability have not been tried. Instead we have fed the fat guys. Joseph Stiglitz says not a good idea.

Stiglitz Says Banking Problems Are Now Bigger Than Pre-Lehman
By Mark Deen and David Tweed
Sept. 13 (Bloomberg)

Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.

“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview today in Paris. “The problems are worse than they were in 2007 before the crisis.”

Stiglitz’s views echo those of former Federal Reserve Chairman Paul Volcker, who has advised President Barack Obama’s administration to curtail the size of banks, and Bank of Israel Governor Stanley Fischer, who suggested last month that governments may want to discourage financial institutions from growing “excessively.”

A year after the demise of Lehman forced the Treasury Department to spend billions to shore up the financial system, Bank of America Corp.’s assets have grown and Citigroup Inc. remains intact. In the U.K., Lloyds Banking Group Plc, 43 percent owned by the government, has taken over the activities of HBOS Plc, and in France BNP Paribas SA now owns the Belgian and Luxembourg banking assets of insurer Fortis.

While Obama wants to name some banks as “systemically important” and subject them to stricter oversight, his plan wouldn’t force them to shrink or simplify their structure.

Stiglitz said the U.S. government is wary of challenging the financial industry because it is politically difficult, and that he hopes the Group of 20 leaders will cajole the U.S. into tougher action.

G-20 Steps

“We aren’t doing anything significant so far, and the banks are pushing back,” he said. “The leaders of the G-20 will make some small steps forward, given the power of the banks” and “any step forward is a move in the right direction.”

G-20 leaders gather next week in Pittsburgh and will consider ways of improving regulation of financial markets and in particular how to set tighter limits on remuneration for market operators. Under pressure from France and Germany, G-20 finance ministers last week reached a preliminary accord that included proposals to claw-back cash awards and linking compensation more closely to long-term performance.

“It’s an outrage,” especially “in the U.S. where we poured so much money into the banks,” Stiglitz said. “The administration seems very reluctant to do what is necessary. Yes they’ll do something, the question is: Will they do as much as required?”

Global Economy

Stiglitz, former chief economist at the World Bank and member of the White House Council of Economic Advisers, said the world economy is “far from being out of the woods” even if it has pulled back from the precipice it teetered on after the collapse of Lehman.

“We’re going into an extended period of weak economy, of economic malaise,” Stiglitz said. The U.S. will “grow but not enough to offset the increase in the population,” he said, adding that “if workers do not have income, it’s very hard to see how the U.S. will generate the demand that the world economy needs.”

The Federal Reserve faces a “quandary” in ending its monetary stimulus programs because doing so may drive up the cost of borrowing for the U.S. government, he said.

“The question then is who is going to finance the U.S. government,” Stiglitz said.

Asteroid hits computer

The blog and podcast are down for a bit as the shards of the computer are recovered from the vicinity

Robert Reich reminds us of the history of efforts on health care

The Lessons from History on Health Care Reform
September 8, 2009
by Robert Reich


With Congress returning from recess to consider health care legislation and the President set to deliver a major address on the subject to both houses of Congress tomorrow, a bit of history may be in order. An excellent starting place David Blumenthal's and James Marone's "The Heart of Power," which I reviewed for the New York Times this past weekend. Here are the major points:

Universal health care has bedeviled, eluded or defeated every president for the last 75 years. Franklin Roosevelt left it out of Social Security because he was afraid it would be too complicated and attract fierce resistance. Harry Truman fought like hell for it but ultimately lost. Dwight Eisenhower reshaped the public debate over it. John Kennedy was passionate about it. Lyndon Johnson scored the first and last major victory on the road toward achieving it. Richard Nixon devised the essential elements of all future designs for it. Jimmy Carter tried in vain to re-engineer it. The first George Bush toyed with it. Bill Clinton lost it and then never mentioned it again. George W. expanded it significantly, but only for retirees.

All the while, the ideal of universal care has revolved around two poles. In the 1930s, liberals imagined a universal right to health care tied to compulsory insurance, like Social Security. Johnson based Medicare on this idea, and it survives today as the “single-payer model” of universal health care, or “Medicare for all." The alternative proposal, starting with Eisenhower, was to create a market for health care based on private insurers and employers; he locked in the tax break for employee health benefits. Nixon came up with notions of prepaid, competing H.M.O.’s and urged a requirement that employers cover their employees. Everything since has been a variation on one or both of these competing visions. The plan now emerging from the White House and the Democratic Congress combines an aspect of the first (the public health care option) with several of the second (competing plans and an employer requirement to “pay or play”).

Devising a plan is easy compared with the politics of getting it enacted. Mere mention of national health insurance has always prompted a vigorous response from the ever-vigilant American Medical Association; in the 1930s, the editor of its journal equated national health care with “socialism, communism, inciting to revolution.” Bill Clinton’s plan was buried under an avalanche of hostility that included the now legendary ad featuring the couple Harry and Louise voicing their fears that the Clinton plan would substitute government for individual choice — “they choose, we lose.”

One lesson is that a new president must move quickly, before opponents have time to stoke public fears. After his 1964 landslide, Johnson warned his staff to push Medicare immediately because “every day while I’m in office, I’m going to lose votes. I’m going to alienate somebody. We’ve got to get this legislation fast.” George W. Bush started planning what became the Medicare drug benefit months before he was elected.

Clinton, by contrast, suffered from delay. Right after his election, national health insurance looked so likely that even some Republicans began lining up behind various plans. A year later, it was dead. In the interim, battles over Clinton’s budget and Nafta drained his political capital, gave his opponents ample time to rouse public concerns about government-sponsored health care and soured key allies like organized labor and the AARP.

Congress can be just as much of an obstacle: one lesson from history is that a president must set broad health reform goals and allow legislators to fill in the details, but be ready to knock heads together to forge a consensus. “I’m not trying to go into the details,” Johnson repeatedly said of his Medicare bill, yet he flattered, cajoled, intimidated and bluffed recalcitrant members until they agreed. “The only way to deal with Congress is continuously, incessantly and without interruption,” he quipped.

Carter, on the other hand, poured endlessly over his incipient health care plan, scribbling opinions in the margins about every detail, and dealt with Congress at arm’s length. And Clinton delivered a plan so vast and complex that even a Democratic Congress chose simply to ignore it. Republicans, meanwhile, decided that a defeat of Clinton’s health care bill would be seen as a repudiation of the new administration and might give them a shot at retaking the House and Senate.

Presidents who have been most successful in moving the country toward universal health coverage have disregarded or overruled their economic advisers. Plans to expand coverage have consistently drawn cautions or condemnations from economic teams in every administration, from Harry Truman’s down to George W. Bush’s. An exasperated Lyndon Johnson groused to Ted Kennedy that “the fools had to go to projecting” Medicare costs “down the road five or six years.” Such long-term projections meant political headaches. “The first thing, Senator Dick Russell comes running in, says, ‘My God, you’ve got a one billion dollar [estimate] for next year on health. Therefore I’m against any of it now.” Johnson rejected his advisers’ estimates and intentionally lowballed the cost. “I’ll spend the goddamn money.” An honest economic forecast would most likely have sunk Medicare.

It’s not so much that presidential economic advisers have been wrong — in fact, Medicare is well on its way to bankrupting the nation — but that they are typically in the business of thinking small and trying to minimize risk, while the herculean task of expanding health coverage entails great vision and large risk. Economic advice is important, but it’s only one source of wisdom.

Yet since Johnson, presidents have found it increasingly difficult to keep their economists at bay, mainly as a result of the growth of Washington’s economic policy infrastructure. Cost estimates and projections emanating from the White House’s Office of Management and Budget and the Congressional Budget Office, both created during the Nixon administration, have bound presidents within webs of technical arguments, arcane rules and budget limits. To date, Democratic presidents have felt more constrained by this apparatus than Republicans, perhaps because they have felt more of a need to prove their cost-cutting chops.

President Obama seems to have anticipated many of these lessons. He’s moved as quickly on the issue as this terrible economy has let him, and he has not been too rattled by naysaying economists (although the cost estimates of the Congressional Budget Office set him back). But although he outlined his goals but left most details to Congress, the lesson from history is that he may have waited too long to force a deal on that disorderly body (especially disorderly when Democrats are in charge). The question remains whether, in the weeks and months ahead, he can knock Congressional heads together to clinch it, and overcome those who inevitably feed public fears about a “government takeover” of health care and of budget-busting future expenditures. He needs to work fast, and be tough as nails.

But even if Obama fails, there is an art to losing, too — in a way that can tee up the issue for future presidents. Truman lost but nonetheless redefined the terms of debate, setting the stage for Medicare (which is why Johnson honored Truman when he signed it into law). Compare him with Clinton, who walked away from the wreckage of his health care plan and rarely mentioned the subject again. This allowed opponents to gain control over the spin and history, so that the Democrats’ signature cause slipped out of political sight for a decade.

Any history of the fight for universal care in America contains a subplot with a supporting actor who, although he never became president, is repeatedly heard from offstage — goading, pushing, threatening and pulling presidents of both parties toward universal coverage. Ted Kennedy first introduced his ambitious national health insurance proposal 40 years ago, and he never stopped promoting the cause. A deal he reached with President Nixon was the closest this country has ever come to universal care. Even before Kennedy’s death last month, his illness had tragically sidelined him just when his powerful voice was most needed. Yet when and if America ever achieves universal coverage, it will be due in no small measure to the tenacity and perseverance of this one remarkable man.

Nouriel Roubini v. the V-shapers

A double dip recession would really be just a L-shaped recession with a bump off the bottom to account for a stimulus package. Nouriel Roubini has been right in predicting the housing and mortgage crash, the financial sector systemic meltdown, and now he is right to say there is no substance to the claims the economy is in a V-shaped recovery process.

A Phantom Recovery?
by Nouriel Roubini
August 22, 2009

NEW YORK – Where is the American and global economy headed? Last year, there were two sides to the debate. One camp argued that the recession in the United States would be V-shaped – short and shallow. It would last only eight months, like the two previous recessions of 1990-1991 and 2001, and the world would decouple from the US contraction.

Others, including me, argued that, given the excesses of private-sector leverage (in households, financial institutions, and corporate firms), this would be a U-shaped recession – long and deep. It would last about 24 months, and the world would not decouple from the US contraction.

Today, 20 months into the US recession – a recession that became global in the summer of 2008 with a massive re-coupling – the V-shaped decoupling view is out the window. This is the worst US and global recession in 60 years. If the US recession were – as most likely - to be over at the end of the year, as is likely, it will have been three times as long and about fives times as deep – in term of the cumulative decline in output – as the previous two.

Today’s consensus among economists is that the recession is already over, that the US and global economy will rapidly return to growth, and that there is no risk of a relapse. Unfortunately, this new consensus could be as wrong now as the defenders of the V-shaped scenario were for the past three years.

Data from the US – rising unemployment, falling household consumption, still declining industrial production, and a weak housing market – suggest that America’s recession is not over yet. A similar analysis of many other advanced economies suggests that, as in the US, the bottom is quite close but it has not yet been reached. Most emerging economies may be returning to growth, but they are performing well below their potential.

Moreover, for a number of reasons, growth in the advanced economies is likely to remain anemic and well below trend for at least a couple of years.

The first reason is likely to create a long-term drag on growth: households need to deleverage and save more, which will constrain consumption for years.

Second, the financial system – both banks and non-bank institutions – is severely damaged. Lack of robust credit growth will hamper private consumption and investment spending.

Third, the corporate sector faces a glut of capacity, and a weak recovery of profitability is likely if growth is anemic and deflationary pressures still persist. As a result, businesses are not likely to increase capital spending.

Fourth, the re-leveraging of the public sector through large fiscal deficits and debt accumulation risks crowding out a recovery in private-sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth.

Domestic private demand, especially consumption, is now weak or falling in over-spending countries (the US, the United Kingdom, Spain, Ireland, Australia, New Zealand, etc.), while not increasing fast enough in over-saving countries (China, Asia, Germany, Japan, etc.) to compensate for the reduction in these countries’ net exports. Thus, there is a global slackening of aggregate demand relative to the glut of supply capacity, which will impede a robust global economic recovery.

There are also now two reasons to fear a double-dip recession. First, the exit strategy from monetary and fiscal easing could be botched, because policymakers are damned if they do and damned if they don’t. If they take their fiscal deficits (and a potential monetization of these deficits) seriously and raise taxes, reduce spending, and mop up excess liquidity, they could undermine the already weak recovery.

But if they maintain large budget deficits and continue to monetize them, at some point – after the current deflationary forces become more subdued – bond markets will revolt. At this point, inflationary expectations will increase, long-term government bond yields will rise, and the recovery will be crowded out.

A second reason to fear a double-dip recession concerns the fact that oil, energy, and food prices may be rising faster than economic fundamentals warrant, and could be driven higher by the wall of liquidity chasing assets, as well as by speculative demand. Last year, oil at $145 a barrel was a tipping point for the global economy, as it created a major income shock for the US, Europe, Japan, China, India, and other oil-importing economies. The global economy, barely rising from its knees, could not withstand the contractionary shock if similar speculative forces were to drive oil rapidly towards $100 a barrel.

So the end of this severe global recession will be closer at the end of this year than it is now, the recovery will be anemic rather than robust in advanced economies, and there is a rising risk of a double-dip recession. The recent market rallies in stocks, commodities, and credit may have gotten ahead of the improvement in the real economy. If so, a correction cannot be too far behind.