There's something happening in the economics profession. Everywhere I go, on all the blogs and sites I visit related to economics, economists are having their "I'm mad as hell and I cant take it anymore" moment. Normally mild-mannered, dry, boring, people usually more interested in stuff like dynamic vs. static equilibrium models, or the proper application of obscure financial rules are now vigorously exercised about bank bailouts, the stimulus and more. Join me below.
Paul Krugman is mad. In a post entitled: How Many Banks, Krugman takes Obama to task about his response to the financial crisis. Obama opposes a Swedish-style temporary nationalisation of the banking system because Sweden has only 4 banks while the USA has many more. However, Krugman continues by quoting Martin Wolf from the FT, stating that the largest 4 banks in the US have 64% of the assets of all commercial banks. Krugman concludes:
So as far as this discussion is concerned, we’ve got, like, four banks. The "thousands of banks" line is just a diversion.
Maybe the economic adviser who said this to Obama needs some retraining?
Additionally, in a post entitled All your downsides are belong to us, Krugman notes that the taxpayers have basically been covering all of AIG's losses on credit default swaps (CDS).
In effect, then, we’ve already nationalized a large part of the financial industry’s potential losses.
So at the very least, we have a right to know who the counterparties are: who are we subsidizing, here? And beyond that, shouldn’t there be some quid pro quo? Shouldn’t the US government get something in return for taking on so much of the risk?
Martin Wolf (Chief Economics correspondent at the Financial Times) is positively shrill about the financial situation in the UK. In this article, the normally considered and calm Wolf questions the government bailouts to banks.
The UK government looks increasingly like a python that has swallowed a hippopotamus. In acting as insurer of last resort to the British-based banking system, it is taking on huge risks on behalf of taxpayers. If this turned out to be a global depression, with huge losses for British-based banks, fiscal solvency might even come into question. Can this make sense? I doubt it.
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Implicitly, the UK government is guaranteeing the liabilities of the swollen UK banks. Explicitly, it seems likely to guarantee at least £600bn of toxic assets of RBS and Lloyds under its "asset protection scheme". I am no populist. Yet when I think of the sums earned by those responsible for dumping this mess on to the UK taxpayer, even my blood boils.
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The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. The UK cannot afford it.
Phew! This is the voice of a radical demanding radical reform and change, not the voice of an associate editor and Chief Economics commentator of a respected and mainstream broadsheet like the FT!
There's more to come. Willem Buiter, Professor of Political Economy at LSE comments on the UK asset protection scheme at his blog on the FT:
Like its American and Dutch counterparts, this toxic asset insurance scheme is without redeeming social value: it is inefficient, unfair and expensive to the tax payer. Apart from that it is great. There also are superior alternatives available: full nationalisation and, best of breed, the ‘good bank’ solution.
Buiter adds in another entry on the recent testimony of the Vice-Chairman of the Fed to the Senate Banking Committee:
The reports on the evidence given by the Vice Chairman of the Federal Reserve Board, Don Kohn, to the Senate Banking Committee about the Fed’s role in the government’s rescue of AIG, have left me speechless and weak with rage.
Buiter discusses a Wall Street Journal Report about where the AIG bailout money has ended up.
nearly three-quarters was reported to have gone to a group of banks, including Société Générale SA ($4.8 billion), Goldman Sachs Group ($2.9 billion), Deutsche Bank AG ($2.9 billion), Credit Agricole SA’s Calyon investment-banking unit ($1.8 billion), and Merrill Lynch & Co. ($1.3 billion). With the US government (Fed, FDIC and Treasury) now at risk for about $160 bn in AIG, a mere $19 bn may seem like small beer. But it is outrageous. It is unfair, deeply distortionary and unnecessary for the maintenance of financial stability.
Don Kohn himself is concerned about this because, as he states in his testimony, moral hazard is maximised. In the future, counterparties will not have learnt their lessons because they will bet that the US taxpayer, via the US government, will cover their losses in full. Buiter goes even further than this:
Unless the counterparties pay the full price for their hubris and recklessness, they will be back for more. It is therefore tragic that central banks and governments everywhere are going out of their way to protect and shelter the unsecured creditors of the banks (holders of junior and senior debt among them), by raiding the tax payer or the credit and reputation of the central bank. Significant mandatory debt-to-equity conversions and large write-downs of (haircuts on) the claims of other unsecured creditors should be an integral part of any financial assistance package.
Buiter ends his blog entry with:
The logic of collective action teaches us that a small group of interested parties, each with much at stake, will run rings around large numbers of interested parties each one of which has much less at stake individually, even though their aggregate stake may well be larger. The organised lobbying bulldozer of Wall Street sweeps the floor with the US tax payer anytime. The modalities of the bailout by the Fed of the AIG counterparties is a textbook example of the logic of collective action at work. It is scandalous: unfair, inefficient, expensive and unnecessary.
Not your typical staid university professor but someone ready to storm the barricades!
Yves Smith from http://www.nakedcapitalism.com/ continues this story with the latest revelations from the WSJ outlining the largesse banks received from the taxpayer and mentioning the reluctance of Fed Vice-Chair Kohn to reveal any futher information about recipients to the Senate Banking Committee. She notes that AIG basically perpetrated a scam by writing all these unhedged credit default swaps by assuming that there would be little risk of default and therefore they didn't need any capital to back it up. She also notes that counterparties to AIG swaps like Goldman Sachs were represented at the talks about the AIG bailout and that firms like Goldman Sachs ultimately benefited from the bailout by having their CDS paid out in full (Cronyism, much?). Furthermore,
Another reason for the bailout was that AIG's guarantees allowed European banks to circumvent minimum capital requirements, which means the AIG salvage operation was a backstop to European financial firms.
So basically the central players on Wall Street and in European banks made sure that they stayed operating and got a big hit of free government money. Yves ends her entry with:
Wake up and smell the coffee. The public purse is being looted and we the great unwashed are being fed pablum. Just because the perps work for once esteemed institutions and are typically treated with deference does not change the nature of the undertaking.
Yves is not known for pulling her punches but this is incendiary stuff. Yves wants to round 'em up and throw away the key!
Dean Baker at the American Prospect is usually always angry because his Beat the Press blog is devoted to uncovering the rank stupidity in the coverage of economic issues by the MSM. But he's also mad about the welfare for banks like Citi.
The NYT piece on bailout III for Citigroup looks like it was written by Citi's lobbyists. The piece never once points out that the government has handed tens of billions to Citigroup for almost nothing. Let me say that about six more times: the NYT article on the latest Citi bailout never once points out that the government has handed tens of billions to Citigroup for almost nothing. The NYT article on the latest Citi bailout never once points out that the government has handed tens of billions to Citigroup for almost nothing. The NYT article on the latest Citi bailout never once points out that the government has handed tens of billions to Citigroup for almost nothing.I suppose tens of billions for Citi doesn't deserve as much attention as $50 million for the National Endowment for the Arts or $25 million for the Smithsonian.
...It's time that the media stopped covering up for Wall Street.
In another entry Baker asks why the government doesn't just own Citigroup outright.
The coverage of the negotiations over switching the government's preferred shares in Citigroup to common shares has been awful. It treats this issue as a purely technical question. It isn't. It is a question about handing taxpayer dollars to Citigroup's shareholders and top executives...
I was just at a White House conference listening to a lot of people talking about cutting Social Security and Medicare benefits for retirees. How can the same government that hands tens of billions of dollars to Citi's shareholders and top executives cut key benefits for the retirees? Why aren't the news reports calling attention to this massive give away to some of the nation's richest people?
When I head over to Economist's View it seems like every second post there is about how the stimulus is inadequate. This comes from many economists from all over the spectrum: Joseph Stiglitz, Nicholas Stern (both former Chief Economists of the World Bank) Paul Krugman, Robert Barro and Ricardo Caballero all have articles on the front page of the blog basically saying that governments need to over-react to this crisis. Robert Barro gives a 20% chance of a Great Depression-style economic path in the next several years.
Not only are economists asking for more spending, they are also asking for capital controls on a national level (Krugman, Dani Rodrik) and international capital regulation (Kenneth Rogoff in the NYT).
Not so long ago it would have been anathema for anyone to state support for capital controls, as Krugman pointed out in this post about his limited support for capital controls in some circumstances. Support for international financial regulation would have been even harder to find, yet a respected former IMF economist and current Harvard Econ professor is supporting just that.
So why the outrage, why the radical calls for change, the demands for greater actions? I could show you more graphs about the falls in global trade, the declines in 2008 Q4 GDP around the world, the huge increases in the unemployed. Part of it is because we are in a huge mess and everyone is scared. Another part of it is that calls for equity and fairness in economic policy and its application are starting to be just as important, or even more important, than calls for efficiency. Since Reagan, academics and policymakers have been pushing economic ideas that relate to efficiency in the market. Now the ideas being pushed into the public arena still include efficiency, but equity is getting a hearing too.
Not just that, I also think that there will be profound changes in our economic, financial and regulatory architecture in the futureas a result of this outrage. As we push aside the ideological neo-classical idolatory in economic policy that has dominated the last 30 years and look at our regulatory and other institutions with more intellectual honesty, I think we'll being to make major changes in them. And then maybe we'll be safe for another generation or two.
It's also kinda comforting that so much of the outrage sounds just like what you would read here on dailyKos. It seems that in our social concerns, we're not that far apart from many of the world's more respected economists.
Update: Just wanted to add that in the short-term unless Obama and those around him can get their heads around a decent response to the financial crisis, I fear that it will undo all the good they have done in other areas (like the stimulus) by giving us a good decade of lost growth and economic opportunity.