The Great Recession

Justin Fox posted this chart yesterday showing job losses (so far) during the current recession compared to job losses during the Great Depression.  It's a pretty good panic corrective, showing just how far away we are from the problems of the 30s.

It's also, I think, a tribute to how much more we know about the economy these days than we did back then.  Sure, it often seems as if we're still so far in the dark we can barely see our own hands in front of our faces, but the fact is that we're doing pretty well despite the fact that our underlying problems are probably every bit as severe as the imbalances that caused the Great Depression.

Consider, after all, that our response to the Depression appears to have been 180 degrees wrong.  We literally did almost everything possible to make it worse: we tightened the money supply, balanced the budget, raised interest rates, passed protectionist legislation, and allowed banks to fail by the hundreds.  It escalated a panic into a Depression.

And this time around?  Just the opposite: interest rates are close to zero, we're running an enormous budget deficit, protectionism has largely been kept at bay, money is being pumped into the economy prodigiously, and with the notable exception of Lehman Brothers banks are being saved right and left.  These actions have reduced a panic to a severe recession.

If we had taken the same policy actions that Hoover and Mellon took in the 30s, does anyone doubt that the results would have been another Great Depression?  I don't.  We may still be doing a lot of dumb things, but we're an awful lot smarter than we were 80 years ago.

More on Crises

This subject is admittedly a little arcane, but here's Matt Yglesias arguing, contra Ezra Klein and me, that the United States is indeed unsuited to dealing with short-term crises:

The U.S. political system, with its high number of veto points, is arguably unsuited to taking decisive action in response to a crisis compared to alternative models, such as the Westminster system in play in the United Kingdom and Canada or to the multiparty coalition systems of northern Europe. It’s hard to know how to evaluate that claim. There is, however, a political science literature indicating that American-style systems are more prone to total constitutional breakdown in a crisis.

I can't comment on the political science literature, but it seems to me that the U.S. doesn't do any worse than other developed countries on this score.  You can argue about whether our historical responses to immediate crises have been correct, but they certainly seem to have been as decisive as anyone else.  To pick the example of our current economic meltdown, which countries have done better?  Japan?  Germany?  China?  Iceland?

There's a pretty good case to be made that these countries have all acted both more slowly and with less sense of genuine urgency than the U.S.  At the very least, it's safe to say that almost no one has done demonstrably better.  We do indeed have a large number of veto points in our political system, but in practice it's not clear that this has prevented decisive action during a genuine emergency.

Revenge of the Spurned

So what happens if we manage to wrest all those retention bonuses away from the AIG traders who destroyed the company?  Maybe this:

Company officials contend that the uproar is scaring away the very employees who understand AIG Financial Products' complex trades and who are trying to dismantle the division before it further endangers the world's economy.

"It's going to blow up," said a senior Financial Products manager, who spoke on condition of anonymity because he was not authorized to speak for the company. "I have a horrible, horrible, horrible feeling that this is going to end badly."

That would be bad.  But Andrew Ross Sorkin thinks it might be even worse:

A.I.G. employees concocted complex derivatives that then wormed their way through the global financial system. If they leave — the buzz on Wall Street is that some have, and more are ready to — they might simply turn around and trade against A.I.G.’s book. Why not? They know how bad it is. They built it.

So as unpalatable as it seems, taxpayers need to keep some of these brainiacs in their seats, if only to prevent them from turning against the company.

Now that's a lovely thought, isn't it?  If they don't get their bonuses, these guys might not only leave AIG, but turn around and do their best to make things even worse.  That's just speculation, of course.  But would it surprise anyone if that started to happen?

Dealing With Crises

Noam Scheiber says "our political system isn't ideally suited to dealing with financial and economic crises."  Ezra Klein begs to differ:

Indeed, I think our political system is actually fairly well-designed for short-term crises. The problem is long-term crises like global warming or health costs. As Peter Orszag wrote back on his CBO blog, "our political system doesn’t deal well with gradual, long-term problems" that require "trading off up-front costs in exchange for long-term benefits." Few Congressmen want to raise taxes tomorrow to reduce carbon a decade from now. Lots of Congressmen don't want the economy to collapse if they have to run for reelection next year. For that reason, I'm much more confident in the system's ability to react agilely and seriously to the economic crisis than global warming. The economic crisis, after all, threatens their reelection. Incumbents often don't survive depressions. Conversely, I think conventional wisdom is that it's fixing global warming, rather than global warming itself, that poses the largest political threat to incumbent legislators.

I think that's right.  In fact, I'd go further: not only can we respond fairly well to short-term crises, we actually have responded fairly well to the current economic meltdown.  There have been plenty of miscues and half measures along the way, but in the space of 18 months the Fed has created an alphabet soup of term lending facilities; Fannie Mae, Freddie Mac, and AIG have been nationalized; interest rates have been reduced to near zero; TARP was passed and hundreds of billions of dollars pumped into the banking system; the Fed has launched plans to rescue the commercial paper market, the money market, and the consumer loan market; FDIC insurance has been raised to $250,000; Detroit has been bailed out; and an $800 billion stimulus measure has been passed.  Some of these actions might have been late or misguided — it could hardly be otherwise considering the depth and freakishness of the financial implosion — but all things considered, the willingness of our political system to deal with this crisis hasn't been all that bad.  If we could muster half this much energy, mistakes and all, on behalf of global warming I'd be ecstatic.

European Banks

Paul Krugman thinks Europe is in worse shape than the United States:

On the fiscal side, the comparison with the United States is striking. Many economists, myself included, have argued that the Obama administration’s stimulus plan is too small, given the depth of the crisis. But America’s actions dwarf anything the Europeans are doing.

The difference in monetary policy is equally striking. The European Central Bank has been far less proactive than the Federal Reserve; it has been slow to cut interest rates (it actually raised rates last July), and it has shied away from any strong measures to unfreeze credit markets.

....Why is Europe falling short? Poor leadership is part of the story. European banking officials, who completely missed the depth of the crisis, still seem weirdly complacent. And to hear anything in America comparable to the know-nothing diatribes of Germany’s finance minister you have to listen to, well, Republicans.

There's a third side to this too: fixing the banking system.  I'm not quite sure what's going on here, though.  Back in September and October we heard a lot about how European banks were even more highly leveraged than American banks: leverage of 40:1 or even 60:1 wasn't uncommon among some of Europe's largest banks.  This suggested that their banks were headed for even worse trouble than ours and might very well need even bigger bailouts.

But since then, nothing.  Britain's banks are falling like flies, and Eastern Europe is in big trouble, but I've been reading very little about the big Western European banks that compares with the drumbeat of calls for nationalizing Citigroup or Bank of America.  (Though here's a recent example of just that.)  Is this because European banks, despite their astronomical leverage, are in better shape than American banks?  Or is it because European regulators have their heads in the sand and don't want to deal seriously with their bad banks any more than ours do?

I'm not sure, and I'm going to dig around a bit and see if I can get up to speed on this.  But any way you look at it, this needs to be on the agenda too.

Zombie Banks

Over at our main site, I've got a piece up that I think of as "Nationalization 101."  (The official title is "Real Capitalists Nationalize," a phrase I stole from Steve Randy Waldman.) It's a quick overview of how banks work, why toxic assets have frozen the credit market, and what the options are for dealing with it.  Option #4 is the Swedish solution: selective, temporary nationalization of the weakest banks:

President Obama clearly has considered the Swedish experience: "They took over the banks," he said on Nightline last month, "nationalized them, got rid of the bad assets, resold the banks, and a couple years later, they were going again. So you'd think looking at it, Sweden looks like a good model." Yet, he went on, the United States has a "different set of cultures" than Sweden, and Americans would find nationalization a hard pill to swallow.

Unsaid but implicit in Obama's statement, though, is that Americans could likely be persuaded to accept nationalization if they understand that all the alternatives are worse. In fact, this may have been exactly the point of the bank rescue plan Obama's treasury secretary, Timothy Geithner, announced shortly after that interview. A key element of the plan involves a mandatory "stress test" for the country's biggest banks, which sounds remarkably similar to Hempton's third-party auditor and Sweden's Bank Support Authority. It could turn out to have been a smart PR move as much as anything: Get everyone talking about the stress tests, worrying about the stress tests, gossiping about the stress tests — and by the time the results become public, it's hard to imagine any recourse other than nationalization for the banks that don't pass.

The stress test is also a way to address both of the two big problems with nationalization. Not only can it fairly decide which banks are solvent and which ones aren't, but it also addresses the dreaded "contagion" problem: Since investors are wiped out when a bank is nationalized, the mere fear of nationalization can scare private investors away from every bank, even the good ones. But if stress tests are done on every bank and the bad ones are all nationalized at once, the good banks are freed from fears that they might be next on the government chopping block.

You'll notice that in this piece I'm still holding out hope that Geithner's stress tests are basically designed to give him an excuse for selective nationalization.  I'm still hoping that's true, I think, but it's hard to say what's really going on.  Last night, for example, Ben Bernanke was asked on 60 Minutes if all the big banks the Fed regulates are solvent, and he answered flatly, "I believe they are, yes."  But then he followed up by mentioning the stress tests and suggesting that if a big bank is insolvent, they'd  "try to wind it down in a safe way." What's that supposed to mean?

Add to that the fact that Citigroup and Bank of America, the two banks most often mentioned as basket cases, have recently sworn on stacks of Bibles that their capital position is rock solid.  No more bailouts for them!  And considering that their toxic asset pool was guaranteed by the government a few months ago, which limits their downside losses, they might even be right.  Or, they might be lying through their teeth.  Who knows?

In any case, the full Swedish solution will be a tough sell.  Not only would it involve temporary nationalization of one or two big banks, but it would also feature a systemwide guarantee of all bank obligations.  But that's basically what we did for AIG, and bailing out all of AIG's counterparties hasn't exactly gone down well in the heartland.  Doing the same thing for the rest of the financial system, nationalized or not, would certainly help restore confidence in the banking system, but getting Congress to agree won't be easy.

Quote of the Day - 03.16.09

From Fareed Zakaria, himself a Very Serious Person in good standing, breaking ranks with the Very Serious People who have a chokehold on American foreign policy:

The problem with American foreign policy goes beyond George Bush. It includes a Washington establishment that has gotten comfortable with the exercise of American hegemony and treats compromise as treason and negotiations as appeasement.

On a related note, I think this partly accounts for one of my pet peeves: the popularity of the "carrot and stick" metaphor that gets used so often when politicians and pundits talk about how we should deal with foreign powers.  Most national leaders are comfortable with the idea of negotiating with us based on competing interests, but I don't think there's a leader in the entire world who doesn't bristle at the idea of being bribed like a schoolboy into cooperation with the United States.  It's a fantastically counterproductive way of publicly describing foreign relations, but nobody on this side of the Atlantic even seems to notice how fundamentally demeaning and offensive it is, or how difficult it makes it for foreign leaders to avoid the charge that they're "caving in" if they come to terms with us.

A better description of the bargaining process is simple: we have things we want, they have things they want, maybe we can strike a deal.  That's the way adults negotiate.  It's time for the carrot and the stick to be buried for good.


Last year California decided to raise taxes on "alcopops," sweet alcoholic drinks that are largely designed to appeal to teenagers.  But guess what?  No new taxes have flowed into state coffers:

Beverage makers admit they aren't paying the new taxes. They say they don't have to because they have reformulated the drinks — more than 6,000 varieties — to transform them into simple beers by limiting the amount of distilled spirits they contain.

They won't explain how. The formulas, they say, are trade secrets. And beverage-industry officials and federal regulators say there are no tests to determine how much distilled spirits the drinks contain.

....Board member Bill Leonard, who voted against the initial tax hike, said that although he is curious about how the industry managed to change thousands of drink formulas in a year, "it is probably impossible for us to ever figure out whether the formula is what they say it is."

I have to admit that my first reaction when I read this story was to laugh.  I know, I know: that's totally inappropriate.  It's a serious issue.  Etc.  But the brazenness on display here is really something, isn't it?  If the alcopop business ever fizzles out, maybe industry executives can all find jobs at AIG instead.

AIG Fesses Up

So where has all that taxpayer cash that's been shoveled into AIG gone?  Today they revealed their largest counterparties, and the top 5 — drum roll, please — are:
  • Goldman Sachs: $12.9 billion
  • Bank of America + Merrill Lynch: $12.0 billion
  • Société Générale: $11.9 billion
  • Deutsche Bank: $11.8 billion
  • Barclays: $8.5 billion
So it looks like everyone was right: Goldman did have enormous exposure to AIG and foreign banks did get massive dollops of aid from the bailout.  No wonder Lloyd Blankfein and Christine Lagarde took such a keen personal interest in AIG's fortunes.

UPDATE: The AIG memo contains four appendices that list amounts paid out to various creditors.  I just added them up to get the numbers above, but Felix Salmon says that amounts to adding up apples and oranges.  The real action, he says, is solely in Appendix 2, which gives us a different top 5:
  • Société Générale: $6.9 billion
  • Goldman Sachs: $5.6 billion
  • Merrill Lynch: $3.1 billion
  • Deutsche Bank: $2.8 billion
  • UBS: $2.5 billion
There's more to it than this, though.  Read Felix for more details on why further transparency is still needed.

Bay Bleg

Marian and I are coming up to San Francisco in a couple of weeks and we're going to have all day Sunday free for sightseeing and whatnot.  Do any of my Bay Area readers have any nonobvious suggestions for things to do and see?  Anything accessible by foot or transit is OK.  Thanks!