Today's Links

1) Alan Blinder on the importance of maintaining current monetary and fiscal policy

2) Krugman reacts to David Leonhardt's article on Sino-American economic relations. Krugman brings up an insightful point about our (flawed) emphasis on the bilateral nature of trade.
The argument that a reduction in China’s dollar purchases would be contractionary for America because it would drive up interest rates is equivalent to the argument that fiscal expansion is contractionary for the same reason — and equivalently wrong.
But what if China doesn’t spend more, but just reallocates its reserves from dollars to, say, euros? The answer is, that’s also good for us: a weaker dollar will help our exports, at Europe’s expense.


3) Niall Ferguson's refreshing historical account on financial regulation

Today's Links

The Brink of Foreclosure

The Times has a stunning account of one man's credit crisis. It's hard not to envision similar situations playing out all across the country. The closing paragraphs of the story are just as troubling, it seems that JP Morgan's mortgage management process is backward and overwhelmed. Cleaning up this mess will continue to be a herculean task.

The Plan: Is it enough?

My initial reaction to the Geithner plan is mixed. The plan will improve the current situation substantially, but I fear it isn’t large or bold enough

The Good – I like that the plan:
1) provides (cheap) government financing/leverage
2) encourages private investors to determine asset values (although these prices are actually subsidized, and are not actually true market prices)
3) requires private investors to put skin in the game (although some doubt they are putting in enough to make their private incentives work)
4) removes SOME of the legacy assets, which increases banks’ ability to lend
5) clarifies (hopefully) the situation facing banks and provides transparency into what they are actually holding
6) doesn’t require new action by congress. Who knows what kind of compramises have to be made to get nationalization passed.

The Bad:
One of Krugman's strongest points is that we are delyaing the inevitable - fixing insolvent banks b/c these legacy assets aren't worth enough to compensate for liabilities - and that each month we delay, we lose 600,000+ jobs, credit doesnt flow, businesses dont invest and confidence deteriorates. Many estimate that the losses are in the 4 trillion range, and collectively these programs only address about 2 trillion. While Geithner points out that his plan could reduce uncertainty about what banks are holding and stimulate private investment into banks (which optimistically would go the rest of the way to 4 trillion at no cost to the taxpayer), I fear that we aren’t being bold enough and delays - not addressing the full scope of the 4 trillion dollar problem - are frighteningly costly in terms of jobs, investment, and confidence.

Inefficient Government Spending

Today's NY Times front page features an article about how funds from the stimulus were distributed to school districts across the country. The article highlights the inefficiencies that come with having the government spend a lot of money quickly. Consider this portion of the article:

In pouring rivers of cash into states and school districts, Washington is using a tangle of well-worn federal formulas, some of which benefit states that spend more per pupil, while others help states with large concentrations of poor students or simply channel money based on population. Combined, the formulas seem to take little account of who needs the money most.
As a result, some districts that are well off will find themselves swimming in cash, while some that are struggling may get too little to avoid cutbacks.

The article goes on to explain that taking efficiency -optimizing who gets education spending - into consideration would take months and require negotiations. While I appreciate and understand that point, this article reminded me how hard it is for the government to spend a lot of money in a short amount of time in an effective manner.

For more, check out one of my favorite articles on the larger issue of public versus private ownership by Andrei Shleifer

What have you been watching? How TV can influence behavior

This week's Economist features two interesting articles by Eliana La Ferrara, one of my favorite economists.

I agree with Andrew Samwick on AIG

He makes 3 points on the AIG bonus story


1) Bonus: My understanding is that a bonus is related to performance. At a company that needed a federal bailout to remain afloat, what metric is being used to assert that the bonus payment is positive? If there is no metric, then why is it called a bonus at all?
2) Retention: The bonus payments are sometimes referred to in the context of retaining these employees. In what universe have the talents of those at AIG Financial Products just become more valuable? Are there other financial firms just lining up at the door of AIG FP, begging these folks to come wreck their companies like they wrecked AIG?
3) Ownership: The article notes that for its $170 billion, the government has an 80% ownership stake in the company. And the "owners" are being told by the CEO that they cannot determine compensation levels of the "workers?" This is yet another reason why the government should not "own" corporations.

Nasty Cycles of An Economic Avalanche - McArdle Update

Here is more from Megan McArdle

First, their credit disappears from the market, which shrinks the economic pie by making it more difficult to trade goods and services between our current and future selves. The economic pie shrinks.

Second, the shrinkage of the current economic pie changes peoples' estimation of the future. Much of economic forecasting is, after all, trend extrapolation. To make matters worse, we are basically hard-wired to over-weight recent events when predicting what will happen next.

Third, the changed expectations shrink even further the amount of future trade that people are willing to do between current and future selves. No one wants to defer consumption now and lend some business the money on the wan hope that Snozzleberry soda is the Next Big Thing. The economic pie shrinks further.



Note: Her post also links the role of trade, the role of money and finance, and confidence

Nasty Cycles of an Economic Avalanche

From the Remarks of Larry Summers at Brookings:
It was a central insight of Keynes’ General Theory that two or three times each century, the self-equilibrating properties of markets break down as stabilizing mechanisms are overwhelmed by vicious cycles. And the right economic metaphor becomes an avalanche rather than a thermostat. That is what we are experiencing right now.

Declining asset prices lead to margin calls and de-leveraging, which leads to further declines in prices.

Lower asset prices means banks hold less capital. Less capital means less lending. Less lending means lower asset prices.

Falling home prices lead to foreclosures, which lead home prices to fall even further.

A weakened financial system leads to less borrowing and spending which leads to a weakened economy, which leads to a weakened financial system.

Lower incomes lead to less spending, which leads to less employment, which leads to lower incomes.

Weekend Reading

1) The Economist on highly skilled immigrants - "Give me your scientists..."
2) The Economist on efficient markets
3) Larry Summers at Brookings