Kevin Drum

Asset Bubbles

| Wed Oct. 15, 2008 1:59 PM EDT

ASSET BUBBLES....Should the Fed (and other central banks) try to prick asset bubbles before they get out of hand? In theory, sure, but as Mark Thoma points out, the problem is that we're not very good at recognizing bubbles in the first place: "If we didn't identify one of the largest bubbles in memory, and for the most part people didn't, I'm not confident we will be able to come to any kind of consensus about 'ordinary' sized bubbles before it's too late. And if that's the case, waiting until we are certain we are observing a bubble will delay policy beyond the point where it can be helpful."

So what to do? Mark suggests a simple solution: the Fed already reacts to ordinary inflation, which is calculated as a complex weighted average of the prices of various goods and services. When these prices rise faster than long-run fundamentals dictate — creating micro-bubbles, if you will — the Fed reacts by raising interest rates. But the Fed's definition of inflation is incomplete:

There is one set of prices, however, that theory says ought to be part of the rate-setting decision, but they are missing. And interestingly, and perhaps only coincidentally, the one set of prices that are not monitored and responded to just happen to be the place where bubbles erupt — asset prices. But if we include these prices in the Fed's policy rule so that whenever asset prices rise the Fed responds by increasing the target interest rate, and if we weight the asset prices properly so that some prices, e.g. housing prices, receive more weight (house prices are notoriously sticky, so theory says they ought to receive a lot of weight), then perhaps it's much less likely that a little bubble turns into a big bubble. Asset price inflation will be stopped by increases in the federal funds rate (and if it isn't stopped by interest rate hikes, then other measures can be implemented). With this approach, you don't have to debate whether a particular price run is a bubble or not; if it is creating asset price inflation, then there will be an automatic response of the federal funds rate to temper the increase. To me, not having to know if it is a bubble or not is an attractive feature.

This might just be an example of the recency effect on my part, but it sure seems as if the last couple of decades have produced more than the usual number of asset bubbles. What's more, they've become steadily more dangerous. On a proportionate scale, the U.S. subprime bubble wasn't actually any bigger than either the Japanese or Swedish real estate bubbles of the late 80s/early 90s, but a combination of derivative speculation and the absolute size of America compared to either Sweden or Japan magnified it into a global disaster that previous bubblemeisters could hardly dream of.

So yes: it's time to pull our heads out of the sand and start giving asset inflation some weight in Fed anti-inflation policy. It doesn't have to dominate Fed policy, it merely needs to be a factor in it. Remember: the point isn't to eliminate asset bubbles, only to try to tame them a bit. I imagine Ben Bernanke has other things on his mind at the moment, but this seems like something worth a serious rethink once the current crisis calms down a bit.

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From the Annals of Airport Security

| Wed Oct. 15, 2008 12:31 PM EDT

FROM THE ANNALS OF AIRPORT SECURITY....Jeffrey Goldberg and Bruce Schneier explain why the no-fly list is not just a gargantuan monster that's gotten completely out of hand and made the lives of uncounted innocent people miserable, but a useless gargantuan monster that's gotten completely out of hand and made the lives of uncounted innocent people miserable:

To slip through the only check against the no-fly list, the terrorist uses a stolen credit card to buy a ticket under a fake name. "Then you print a fake boarding pass with your real name on it and go to the airport. You give your real ID, and the fake boarding pass with your real name on it, to security. They're checking the documents against each other. They're not checking your name against the no-fly list — that was done on the airline's computers. Once you're through security, you rip up the fake boarding pass, and use the real boarding pass that has the name from the stolen credit card. Then you board the plane, because they're not checking your name against your ID at boarding."

What if you don't know how to steal a credit card?

"Then you're a stupid terrorist and the government will catch you," he said.

What if you don't know how to download a PDF of an actual boarding pass and alter it on a home computer?

"Then you're a stupid terrorist and the government will catch you."

I couldn't believe that what Schneier was saying was true — in the national debate over the no-fly list, it is seldom, if ever, mentioned that the no-fly list doesn't work. "It's true," he said. "The gap blows the whole system out of the water."

Other tips: you can carry all the liquid on board a plane that you want as long as you put it in a bottle marked "saline solution." Or hide it on your person in a Beerbelly™. Just don't look too nervous while you're doing it, OK?

Pakistan Update

| Wed Oct. 15, 2008 12:06 PM EDT

PAKISTAN UPDATE....McClatchy reports on an upcoming U.S. intelligence assessment on Pakistan:

A U.S. official who participated in drafting the top secret National Intelligence Estimate said it portrays the situation in Pakistan as "very bad." Another official called the draft "very bleak," and said it describes Pakistan as being "on the edge." The first official summarized the estimate's conclusions about the state of Pakistan as: "no money, no energy, no government."

Juan Cole adds some perspective to the report and ultimately suggests that it's off base: "People who know Pakistan well are more afraid of the right wing elements in the Pakistani military (whom the CIA has long funded and coddled) than they are about an elected civilian government being weak or corrupt." To be honest, both of these assessments sound about right to me.

There are also intelligence reports on Iraq and Afghanistan coming down the pike, and McClatchy reports that they are "intended to support the Bush administration's effort to recommend the resources the next president will need for Iraq, Afghanistan and Pakistan at a time the economic crisis is straining the Treasury and inflating the federal budget deficit." Unfortunately, it appears that the intelligence community plans to say that we need more troops and more resources in all three areas, which doesn't sound all that helpful. Hopefully President Obama and his team are already working on assessments of their own.

McCain's Headwinds

| Wed Oct. 15, 2008 11:32 AM EDT

McCAIN'S HEADWINDS....Via Ezra, Matt Taibbi and Byron York have an IM conversation for New York magazine:

B.Y.: I've just finished an article for National Review — the actual magazine — about the headwinds McCain faces. I was going to look at three, and then I started to list them. I stopped at ten. New Gallup numbers out today show that George W. Bush's job approval rating remains at 25 percent, while his disapproval rating has ticked up to 71 percent. How hard is it to succeed a two-term president of your own party who is at 25-71? We don't know because it's never been done.

M.T.: Yeah, that's a damned shame, too. I feel really badly for the guy. I suppose you think the media coverage is also a headwind?

B.Y.: Actually, I did not list media coverage among the headwinds. I listed the succeed-a-two-term-president problem, the right-track/wrong-track problem, the Republican-Democrat-enthusiasm gap problem, the Republican-Democrat-I.D.-gap problem, the financial meltdown, Iraq, Republican gloom on Capitol Hill, Obama's fund-raising advantage, and McCain's historical problems with the GOP base.

M.T.: But all of those "headwinds," or almost all of them, are the direct result of McCain having supported policies that are now unpopular. There is absolute justice in his facing a "headwind" from the financial meltdown, from the unpopularity of the Iraq war, and so on. How is that a "headwind"? That's just self-created unpopularity.

The rest of the conversation is even more entertaining as York tries to insist that Fannie Mae and CRA are the real causes of the credit crisis. Live by the smear, die by the smear.

Gamma Quadrant Update

| Tue Oct. 14, 2008 11:26 PM EDT

GAMMA QUADRANT UPDATE....What's that, you say? Barack Obama is palling around with terrorists? That is so last week. Here's a more recent tour of the Gamma Quadrant:

One: Bill Ayers really wrote Obama's book, Dreams From My Father. Two: Obama had an underage, gay affair with a pedophile. Three: It's entirely possible that Obama was involved with bombing the South African rugby team while he was at Columbia in the 80s. Four: Obama, Bill Ayers, and Jeremiah Wright (via a chain of associations too Rube Goldbergesque to summarize) were engaged in a conspiracy to teach Pan-African "cultural nationalism" to Chicago schoolkids during the 90s. Five: Obama was having an affair with one of his fundraiser babes in 2004 until Michelle found out and banished the woman to a "little Caribbean island."

There's no evidence yet that Obama was actually the secret love child of Malcolm X, but I'm sure we'll find it soon enough if we just keep digging.

Playing Pattycake?***

| Tue Oct. 14, 2008 8:31 PM EDT

PLAYING PATTYCAKE?....The stock market was down today, but shares in banks that got capital infusions yesterday are up, up, up. The LA Times reports:

Investors' verdict on the Treasury's $250-billion plan to buy stakes in banks: They love it.

That may make taxpayers even more suspicious about these deals. If there was supposed to be some pain involved for shareholders in this partial nationalization, it's not showing up in the stocks. Of the nine big banks expected to get the largest cash infusions, most saw their shares surge today — the third straight advance — even as major market indexes slipped.

Sure, maybe this means less than meets the eye. Maybe the details don't matter, and investors just figure bailout = good and therefore it's time to buy. But check out this tick-tock from the Wall Street Journal about how yesterday's meeting at the Treasury Department went:

A final deal between regulators was hashed out in Mr. Paulson's office Sunday afternoon....The top bankers were then told to show up for a meeting Monday at 3 p.m., but were given few details. Expecting an uproar over the plan, government officials secretly planned to break off the first meeting, giving CEOs time to vent, talk to their boards, clear their heads, and reconvene at 6:30 p.m.

In Mr. Paulson's call with Morgan Stanley's Mr. Mack, the CEO asked the Treasury secretary the reason for the meeting, according to people familiar with the matter. Mr. Paulson responded, according to a person familiar with the matter: "Come on down, we'll tell everyone at the same time," adding, "I think you'll be pleased."

....U.S. officials argued the plan represented a good deal for the banks: The government would be buying preferred shares, and thus wouldn't dilute their common shareholders. And the banks would pay a relatively modest 5% in annual dividend payments.

The meeting ended at about 4 p.m. By 6:30 p.m., all of the [term sheets] had been turned in and signed by the CEOs. No second meeting was held.

It sure doesn't sound like the bankers put up much of a fight, does it? They've shown precious little willingness to sacrifice for the common good before now, so my guess is that they decided this was indeed a pretty good deal. Count me among those taxpayers who are more suspicious about this deal than I was yesterday.

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The Revolution Lives

| Tue Oct. 14, 2008 4:43 PM EDT

THE REVOLUTION LIVES....Conservatives have been mostly at sea over the banking crisis, and I figure one of the reasons is that even modern movement conservatives have been unable to argue with a straight face that the solution to a systemic global credit crisis is the right wing's usual economic cure-all: tax cuts. This isn't entirely true, of course, as we saw a couple of weeks ago when the wingnuts in the Republican Study Committee held up the bailout bill because they thought that eliminating the capital gains tax ought to be a part of the package. Still, that one desultory effort aside, there's just been no way to plausibly pretend that extending the tax cut revolution was a serious answer to preventing financial meltdown.

Until now! Check out my abridged version of John McCain's latest economic plan:

Lower Taxes On....Suspend Tax Rules That....Accelerate The Tax Write-Off For....Reduce Capital Gains Taxes For....Eliminate Taxes On....

There's nothing like that old time gospel, is there? You name a problem, and the answer is tax cuts for the well-off. For more detail and less snark, Robert Gordon and James Kvaal have you covered here.

The Recession Cometh

| Tue Oct. 14, 2008 2:22 PM EDT

THE RECESSION COMETH....Atrios points us to the latest from Nouriel Roubini, the Cassandra of the banking crisis:

Nouriel Roubini, the professor who predicted the financial crisis in 2006, said the U.S. will suffer its worst recession in 40 years, causing the rally in the stock market to "sputter.''

"There are significant downside risks still to the market and the economy,'' Roubini, 50, a New York University professor of economics, said in an interview with Bloomberg Television. "We're going to be surprised by the severity of the recession and the severity of the financial losses.''

The economist said the recession will last 18 to 24 months, driving unemployment to 9 percent, and already depressed home prices will fall another 15 percent. The U.S. government will need to double its purchase of bank stakes and force lenders to eliminate dividends to save them from bankruptcy, Roubini added.

This actually sounds about right to me. Another round of recapitalization strikes me as at least a 50-50 probability; forcing banks to suspend dividends sounds like a painful but necessary move; and there's really no question that we're headed into a fairly deep recession. In fact, what really surprises me is that it's only in the past week or so that newspapers have stopped running fatuous headlines along the lines of "Is U.S. Slipping Into Recession?" Of course the U.S. — and the rest of the world — are slipping into recession. Frankly, I think that's been obvious for months, but certainly nobody sentient could have doubted it anytime after mid-September.

And my arcane concerns about the current account deficit notwithstanding, massive stimulus is pretty obviously the right fiscal response to this now that monetary policy has been mostly played out. Along those lines, check out Steve Teles for some good ideas on what a stimulus package should look like. "Right now the Democrats are in danger of doing the obvious," he warns, "which will be bad economics, bad government, and bad politics. Someone needs to get them thinking bigger." Get to work, blogosphere!

The Coming Conservative Backlash

| Tue Oct. 14, 2008 12:47 PM EDT

THE COMING CONSERVATIVE BACKLASH....In today's column, David Brooks is already predicting a conservative backlash against upcoming liberal overreach. Sheesh. Can we please have our liberal overreach first? I'm looking forward to it.

Personally, though, I'm skeptical. I hope I'm just being my usual pessimistic self, but I'm skeptical anyway. Take this from Ezra Klein, for example, about the new Paulson bailout plan:

The liberals were right. Not the Democrats. The liberals. They were right that deregulation had gone too far....They were right that government intervention on a massive scale was needed to stabilize the capitalist system. They were so right, in fact, that Hank Paulson and George W. Bush couldn't hold the line, and will now sign into law the most profoundly socialist measure this country has seen since the 1930s.

Maybe. And this is basically what prompts Brooks to predict a social democratic renaissance hellscape, which will eventually degenerate into....something....and then produce an inevitable backlash.

But, really, is this bailout the most profoundly socialist measure this country has seen since the 1930s? In a technical sense, maybe it is (though conservatives would probably argue the case for Medicare), but I have my doubts that it's a harbinger of social revolution. The government isn't nationalizing banks, after all. They're taking what amounts to roughly 20% nonvoting stakes. And my guess is that in a couple of years, when the markets have settled down, they'll sell those stakes off and everything will return to normal. Hopefully it will be a more tightly regulated normal, but it won't necessarily have an enormous impact beyond the financial sector.

I hope I'm wrong about this. I'd like to see the social democratic renaissance that Brooks is so itchy about. But although I know that comparisons to Japan and Sweden aren't really fair since both countries are already pretty socially democratic compared to ours, it's still the case that massive bank failures in those countries in the early 90s didn't fundamentally change their characters. I have my doubts that it will happen here, either, unless Barack Obama turns out to be a far more dynamic leader than I expect him to be. I sure hope he proves my skepticism wrong, and if he does I'm perfectly willing to accept the conservative backlash in 2024 that goes along with it. We could get a lot done in the meantime.

Robot Cars

| Tue Oct. 14, 2008 12:14 PM EDT

ROBOT CARS....Matt Yglesias, riffing off a Tim Lee piece, says that self-driving cars could free up lots of parking spaces. Which is true, I guess, but seems sort of like saying that cold fusion would be great because it would allow us to build smaller cooling towers. If we ever do build a genuinely self-driving car, it means we're only a stone's throw away from nearly human-level artificial intelligence. More efficient parking will be the least of our worries at that point.