The Latest, Greatest Depression

I don’t have a lot to say about the recent US financial upheavals. I’m not a student of the financial markets at the best of times, and for the last few months my focus has been almost exclusively inward. I don’t feel remotely qualified to do even an armchair analysis.

Instead, I thought I’d pass on some articles on the topic that I’ve found interesting.

First, the author of Freakonomics, when asked for his anaylsis, punts and asks two of his economist friends, resulting in the most layman-accessible overview of the situation that I’ve read: Diamond and Kashyap on the Recent Finance Upheavals. Addressing what the events will mean for the man-on-the-street, they say:

As their own funding dries up, the remaining financial firms will be much more cautious in extending credit to normal firms and individuals. So even for people whose own circumstances have not much changed, the cost of the credit is going to rise. For an individual or business that falls behind on payments or needs an increase in short-term credit because of the slowing economy, credit will be much harder to obtain than in recent years.

One section of their analysis in particular caught my eye, the discussion of the Fed’s experimentation with new powers, and the questions it raises about where they will draw the new line about intervention.

One is where to draw the line. A.I.G. was an insurance company, not a bank or a broker dealer, so the Fed had no special relationship with A.I.G. Presumably, if a very large airline or automaker had been involved in the C.D.S. market, the same reasoning that led to the rescue would apply.

A second challenge comes with defining the acceptable level of chaos. We will never be able to find out what would have happened if A.I.G. had been allowed to fail. Furthermore, there are some reasons to believe that even if A.I.G. continues to operate, the fundamental stress in the financial system will remain. If the rescue does not mark a turning point, the bailout may be viewed quite differently down the road.

Should the government intervene if it merely postpones an inevitable adjustment? Creditor runs can make adjustment too fast; blanket bailouts can make adjustment too slow. Has the Fed found the speed that is just right?

In her reanalysis of the Great Depression, journalist Amity Shlaes found that the Depression had been exacerbated and prolonged by the unpredictability of Federal intervention. From an interview:

Scholars have overlooked the cost of uncertainty in an economy, what we would now call the “unknown unknowns.” Both the Hoover and Roosevelt administrations (but especially the Roosevelt administration) were so unpredictable. That hurt the economy very much, and when I went back and saw the extent I was astounded. Uncertainty is a factor that I thought needed to be explored. There were lots of people who said, “I will not invest ’til I know what’s going to happen.”

During the Depression, you heard the phrase “bold, persistent experimentation” all the time. We’ve been taught that was good. Somebody had to do something, was what we learned. But what I saw was this enormous cost, especially during the second half of the 1930s.

My impression is that the Fed’s intervention has not yet reached the level of "bold, persistent experimentation". But they’ve already introduced a certain amount of uncertainty by bailing out Bear Sterns, Fanny and Freddie, and A.I.G. while letting Lehman fail. I hope that whatever strategy the Fed settles on, it is well-defined, consistent, and firm. The market, like most games, only works so long as the rules stay the same.

Another take on the subject that caught my eye is this one, from an actual rich person. Mark Cuban addresses the Democratic and Republican presidential candidates:

Dear Sen. McCain […] after the events on Wall Street this past week, my hope is that you will completely retract your economic strategy and do the prudent thing, which is to say that your strategy of tax cuts is no longer viable when the government is about to take on what could be anywhere between 500Billion and 1 Trillion dollars in debt to support retaining liquidity in our financial system and in turn keep our economy running smoothly.

Dear Sen. Obama […] The trillion plus dollars of market valuation that have been lost in the stock market has come from primarily those you would like to increase taxes for. […] I know many people who have lost much if not all of their networth, and during my trip to NY this past week, met several who have been completely wiped out. Their entire life savings, gone because they owned stock in the several financial institutions that have gone bankrupt or sold at pennies on the dollar and their jobs were lost as a result as well. My hope is that you will completely retract your economic strategy and do the prudent thing, which is to say that your strategy of tax cuts for the middle range of earners, and tax increases for those earning 250k is no longer viable when the government is about to take on what could be anywhere between 500Billion and 1 Trillion dollars in debt to support retaining liquidity in our financial system and in turn keep our economy running smoothly.

[…]

Senators McCain and Obama, failure to recognize that what the financial markets went through changed the fabric of our economic model and in turn the impact of your economic policy is completely irresponsible.

Finally, if anyone’s interested, here’s an Austrian analysis that’s a little on the wonky side for my comprehension, but raises some interesting questions about the potential effectiveness of the Fed’s plan:

But why should pumping more money do the trick? It seems that, for most experts, money is an agent for economic growth. Money however is just a medium of exchange and cannot create real wealth as such. On the contrary, monetary expansion results in the squandering of real wealth and economic impoverishment (look at Zimbabwe). If the pool of real savings is declining, then real economic growth will follow suit regardless of how much money the Fed is going to pump.

One Comment

tricstmr September 22, 2008 at 21:31

I too..

.. liked the Frekanomics thinger… Nicely done..

For my part–I don’t understand the finances enough to completely understand what’s up.. but I do have a sense now that the bailout plan, as it is presently conceived, seems a bit dangerous.

Not the amount–yes, scary, huge, whatever–but as it currently stands, it is so worded that:

1. Give Treasury secretary 700 billion.
2. He can do whatever he wants, hire whomever he wants to help
3. You don’t get to understand or ask questions or oversee any of his actions
4. Haha.

Such a method of doing things hasn’t seemed to lead to good things in this administration with regard to say Iraq or the patriot act or anything else.. so I find such an idea quite nasty…

Also.. from what I’ve been reading–this idea of the government just buying the bad debt doesn’t seem all that clever. When the S&L’s went down the tubes 2 decades ago–the gov’t bought the banks–and then sold the assets off later—recovering a good chunk of their expenditures.. This sounds like a better solution for the taxpayers… rather than just having the losses be “socialized”–while rewards remain privatized–the exchange should be more equitable.. (basically, if we were expecting the private sector to work this out on their own–no private individual would ever just agree to buy up the debt without getting some equity.. so why should the gov’t do it differently…)

That’s about all I have to add tho.. Basically transparency needs to be pushed further and the current bailout isn’t structured to be transparent at all.
Bad.

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