Brad DeLong's Egregious Moderation

Menzie Chinn: "Stuff Happens": the Bush Administration's Economic Stewardship

From <>:

Econbrowser: "Stuff Happens": the Bush Administration's Economic Stewardship: The White House has recently tangled with the NYT regarding what got us into the current economic crisis [0] (see also [1]). This comes on the heels of the Paulson argument that he would not have done anything different, had he known the full extent of the looming crisis. This leads me to wonder how we should view the Bush Administration's stewardship of the economy.

In particular, when one examines the mixture of policies and events that have led us to the brink of possibly the deepest and most persistent downturn since the Great Depression, one can see several suspects listed.

• Fannie and Freddie
• Community Reinvestment Act
• CDO's and CDS's
• Global saving glut
• Monetary policy
• Deregulation
• Criminal activity and regulatory disarmament
• Tax cuts and fiscal profligacy
• Tax policy
• Red Herrings

I've already dealt with the first two "betes noire" -- favorite villains in the fevered commentary of certain noneconomists -- in this post, so we can dispense with these as key drivers (Jim attributes some blame, here, although I don't think he attributes central blame here either). I don't think CDO's and CDS's in and of themselves caused the crisis, although they certainly obscured the primary problem of overleveraging (CDO's) and lack of transparency (CDS's). And the saving glut -- well, the saving glut was a worldwide phenomenon, but I think it safe to say the countries that did and didn't borrow from the Chinese have suffered in the current crisis (here is my critique from 2005; CFR report [pdf]).

Synergy

So what I want to think about is the toxic mixture of the last five items, which interacted in a synergistic manner to place us in the situation we are now in.

First, monetary policy. While there seems to be a widespread consensus that it was too lax in 2002-04, this is a viewpoint made with the benefit of hindsight. As Orphanides and Wieland (2007) [pdf] have pointed out, according to the Greenbook forecasts, monetary policy was not -- according to a Taylor rule framework -- overly lax.

Second, deregulation. On this front, I think it's important to not indict all deregulation (eliminating the Glass-Steagall barriers makes sense to me, while the Phil Gramm-sponsored Commodity Futures Modernization Act exemption of regulation of CDS's does not). I outline some empirical research on what factors were important in this crisis in this post.

Third, regulatory disarmament/nonenforcement and "criminal activity". I would have discounted this item in the absence of clear evidence, but now that we know about how the OTS "helped out" IndyMac [2] [3], I think we can be reasonably confident that we'll hear a lot more about how deregulatory zeal [4] [5] metastatized over into criminal activities on the part of regulators and the regulated.

Fourth, fiscal profligacy via tax cuts. I think it's important to focus on profligacy (because it pushed the economy more into a boom exactly at a time when not needed) and on tax cuts (because it made people feel like they had more discretionary income than reasonable), thereby pushing the asset boom.

Fifth, tax policy. In particular, I have been thinking about the tax deductibility on second homes, a provision dating back to 1997 [6] [7] [8]. (I've been thinking about this in part because mortgage deductibility on a second home never made sense to me, let alone on a first home). Capital Games and Gains has pointed out this provision, citing a NYT article. But even this last article doesn't locate primary blame here; rather it's cited as a contributing factor. I suspect that on its own, this provision wouldn't had a big impact, but in combination, it might have. My caveat here is that I haven't found much empirical work backing a big role for this factor.

Typically, in my academic work, I would think of these factors adding up in a linear fashion, so that each of the impulses would sum to the total effect. But (departing from a model, and with no econometric work to back up the hypothesis interactive effects), I think it's worthwhile to think about lax monetary policy, deregulatory zeal and criminal activity/regulatory disarmament, and tax cuts and tax policy changes, all combining to lead to the "bubble" (in a nontechnical sense) we've witnessed, the deflation of which has been associated with the ongoing financial crisis.

Consider one example of a pernicious synergy: the 2001 and 2003 tax cuts were aimed at higher income households, while the second home mortgage deductibility benefited mostly higher income households [9]; with regulatory oversight absent, and low interest rates, well the stage was set.

Prescient, or Not

I won't claim to have foreseen the full enormity of the crisis we're now undergoing. As I indicated when I posted my first blogpost some three years ago, I thought the sheer irresponsibility of the fiscal policy being pursued, against a backdrop of overconfidence in largely nontraded derivatives, would lead to grief in the form of a "sudden stop" of net capital flows to the US. In this respect, I was wrong -- what we've achieved instead is a sort of "global sudden stop" where the process of deleveraging proceeded in a discrete (and "disorderly") fashion. So, unlike some, I was only partially -- not completely -- blindsided. (And, I'm sure Akerlof and Romer were completely aware of what was coming...)

I believe history will look critically on the Bush Administration's economic stewardship, in particular how the policies propelled an unsustainable bubble, and tied our hands in the use of fiscal policy tools. In sum, I think Kevin (Dow 36,000) Hassett's view "Bush's Legacy May End Up Better Than You Think" will not prove true.

Dan Froomkin: Pack of Liars

Dan Froomkin - Pack of Liars: Yesterday's bipartisan Senate report on the abuse of detainees in U.S. custody at Guantanamo, Abu Ghraib and elsewhere doesn't just lay out a clear line of responsibility starting with President Bush, it also exposes the administration's repeated explanation for what happened as a pack of lies.

"The abuse of detainees in U.S. custody cannot simply be attributed to the actions of 'a few bad apples' acting on their own," the report finds. "The fact is that senior officials in the United States government solicited information on how to use aggressive techniques, redefined the law to create the appearance of their legality, and authorized their use against detainees. Those efforts damaged our ability to collect accurate intelligence that could save lives, strengthened the hand of our enemies, and compromised our moral authority."

The report notes that in early 2002, not long after the Defense Department legal counsel's office started exploring the application of the sorts of abhorrent practices later documented at Abu Ghraib, Bush signed a memo exempting war-on-terror detainees from the Geneva Conventions. "[T]he decision to replace well established military doctrine, i.e., legal compliance with the Geneva Conventions, with a policy subject to interpretation, impacted the treatment of detainees in U.S. custody," the report states.

And the report concludes: "The abuse of detainees at Abu Ghraib in late 2003 was not simply the result of a few soldiers acting on their own. Interrogation techniques such as stripping detainees of their clothes, placing them in stress positions, and using military working dogs to intimidate them appeared in Iraq only after they had been approved for use in Afghanistan and at [Guantanamo]. Secretary of Defense Donald Rumsfeld's December 2, 2002 authorization of aggressive interrogation techniques and subsequent interrogation policies and plans approved by senior military and civilian officials conveyed the message that physical pressures and degradation were appropriate treatment for detainees in U.S. military custody. What followed was an erosion in standards dictating that detainees be treated humanely."

In a statement, Committee Chairman Sen. Carl Levin voiced his contempt for what was essentially an administration cover-up: "Attempts by senior officials to portray [the bad apples scenario] to be the case while shrugging off any responsibility for abuses are both unconscionable and false. Our investigation is an effort to set the record straight on this chapter in our history that has so damaged both America's standing and our security. America needs to own up to its mistakes so that we can rebuild some of the good will that we have lost."

As examples of false statements, Levin offered: "In May 2004, just after the pictures from Abu Ghraib became public, Deputy Secretary of Defense Paul Wolfowitz said that the abuses depicted were simply the result of a few 'bad apples' and that those responsible for abuse would be held accountable. More than seven months later, then-White House Counsel Alberto Gonzales testified before the Senate Judiciary Committee. Asked about accountability for detainee abuses, Gonzales said 'we care very much about finding out what happened and holding people accountable.' Neither of those two statements was true."

But Levin could have gone much higher. Bush himself repeatedly and sanctimoniously blamed Abu Ghraib on a small number of low-level perpetrators, even while trying to get credit for what he insisted was a transparent system that held those who were responsible accountable.

Bush, on May 24, 2004, described what happened at Abu Ghraib as "disgraceful conduct by a few American troops who dishonored our country and disregarded our values."

On June 1, 2004, he told a reporter: "Obviously, it was a shameful moment when we saw on our TV screens that soldiers took it upon themselves to humiliate Iraqi prisoners -- because it doesn't reflect the nature of the American people, or the nature of the men and women in our uniform. And what the world will see is that we will handle this matter in a very transparent way, that there will be rule of law -- which is an important part of any democracy. And there will be transparency, which is a second important part of a democracy. And people who have done wrong will be held to account for the world to see.

"That will stand -- this process will stand in stark contrast to what would happen under a tyrant. You would never know about the abuses in the first place. And if you did know about the abuses, you certainly wouldn't see any process to correct them."

In a May 18, 2004, interview, Bush told an Iraqi journalist: "I want to know the truth, too. . . . [Y]ou've just got to know that I'm interested in the truth, as well, just like you're interested in the truth."

And by April 6, 2006, after seven soldiers had been convicted, Bush made it clear that his quest was over: "I'm proud to report that the people who made that decision are being brought to justice, and there was a full investigation over why something like that could have happened."

By contrast, yesterday's Senate report suggests that those responsible for the abuse have emphatically not been brought to justice, and that there's more investigating to be done. Among the issues still to be addressed: the CIA interrogation program, which even more overtly included techniques commonly considered to be torture, such as waterboarding. There's also the obvious question that comes to mind after considering the sequence of events: How are these not war crimes?

John Lippert on the Chicago School

Bloomberg: Dec. 23 (Bloomberg) -- John Cochrane was steaming as word of U.S. Treasury Secretary Henry Paulson’s plan to buy $700 billion in troubled mortgage assets rippled across the University of Chicago in September. Cochrane had been teaching at the bastion of free-market economics for 14 years and this struck at everything that he -- and the school -- stood for. “We all wandered the hallway thinking, How could this possibly make sense?” says Cochrane, 51, recalling his incredulity at Paulson’s attempt to prop up the mortgage industry and the banks that had precipitated the housing market’s boom and bust.

During a lunch held on a balcony with a view of Rockefeller Memorial Chapel, Cochrane, son-in-law of Chicago efficient-market theorist Eugene Fama, and some colleagues made their stand. They wrote a petition attacking Paulson’s proposal, sent it to economists nationwide and collected 230 signatures. Republican Senator Richard Shelby of Alabama waved the document as he scorned the rescue. When Congress rejected it on Sept. 29, Cochrane fired off congratulatory e-mails. The victory was short-lived. Lawmakers approved the plan four days later, swayed by what Cochrane calls a pinata of pork-barrel amendments.

“We should have a recession,” Cochrane said in November, speaking to students and investors in a conference room that looks out on Lake Michigan. “People who spend their lives pounding nails in Nevada need something else to do.”

At the University of Chicago, once ascendant free-market acolytes are finding themselves in an unusual role: They’re battling a wave of government intervention more sweeping than any since the Great Depression as the U.S. struggles with the worst recession in seven decades. By the end of November, the government had committed $8.5 trillion, or more than half the value of everything produced in the country in 2007, to save the financial system. The European Union had ponied up more than $3 trillion to guarantee bank loans and provide capital to lenders. And China had unveiled a $586 billion stimulus plan and its biggest interest-rate cut in 11 years.

The intrusion is anathema to the so-called Chicago School of economics and its patriarch, the late Milton Friedman. For half a century, Chicago’s hands-off principles have permeated financial thinking and shaped global markets, earning the university 10 Nobel Memorial Prizes in Economic Sciences starting in 1969, more than double the four each won by Columbia University, Harvard University, Princeton University and the University of California, Berkeley. Chicago’s laissez-faire imprint underpins everything from U.S. President Ronald Reagan’s 1981 tax cuts and the fall of communism that decade to quantitative investment strategies. In 1972, Friedman helped persuade U.S. Treasury Secretary George Shultz, former dean of Chicago’s business school, to approve the first financial futures contracts in foreign currencies. Such derivatives grew more complex after Chicago economists created the mathematical formulas to price them, helping spawn a $683 trillion market that’s proved to be a root of today’s financial system breakdown. On Dec. 16, the U.S. Federal Reserve cut its target lending rate to as low as zero for the first time and said it will buy mortgage- backed securities.

Friedman, who died in 2006 at age 94, defined the Chicago School in 1974 as he spoke to a board of trustees dinner. “‘Chicago’ stands for a belief in the efficacy of the free market as a means of organizing resources, for skepticism about government intervention into economic affairs,” he said. Friedman was explaining a movement that had taken hold in the U.S. and was percolating in Europe and South America. “By the mid-1970s, there was a whole generation in government and academia who’d trained at Chicago or places influenced by it,” says Ross Emmett, a Michigan State University professor who’s written three books on the school. Today, 10 percent of Chicago undergraduates study economics. Alumni of Chicago’s graduate business school, now called the Booth School of Business, run states and companies. Jon Corzine, the former chief executive officer of Goldman, Sachs & Co. who earned his MBA in 1973, is governor of New Jersey. Peter Peterson, who graduated with an MBA in 1951, co-founded Blackstone Group LP, the world’s largest private equity firm. David Booth, a 1971 MBA graduate for whom the school is now named, donated $300 million in November, the largest endowment given to the university.

Booth, who founded Dimensional Fund Advisors Inc., bases his funds on Fama’s theory that a market digests information affecting prices so well that even professional investors can’t outsmart it for long. Even with his U.S. Micro Cap Portfolio fund down 40 percent in 2008 through Dec. 22, Booth says quantitative investing is less vulnerable during a slump than stock picking that relies on human judgment. “This supports our theory in that predicting the market is even more difficult than we expected,” he says. Unlike Booth, 62, much of the academic world is reassessing Chicago School hallmarks. That’s true even in the limestone buildings on the 211-acre (85-hectare) Hyde Park campus in which professors teach Friedman’s theories.

On Oct. 14, about 250 students and professors debated an administration-backed plan for a $200 million research center to be named for Friedman. The protesters argued that the institute would enshrine policies that have brought economies near collapse. “When Friedman’s Platonic ideas of free-market virtues are put into practice, they have too often generated a systemic orgy of competitive greed -- whose remedies, ironically, entail countermeasures of nationalization,” Marshall Sahlins, an emeritus professor of anthropology, said during the debate, speaking in a room adorned with murals of female students parading through the campus in medieval gowns. Sahlins, 77, noted a few weeks later socialist and capitalist countries alike are regulating or nationalizing financial institutions in a rebuff to Friedman. Off campus, the global meltdown is stirring anti-Chicago economists, who were voices in the wilderness during decades of lax government oversight of markets. Joseph Stiglitz, who won one of Columbia’s economics Nobels, says the approach of Friedman and his followers helped cause today’s turmoil.

“The Chicago School bears the blame for providing a seeming intellectual foundation for the idea that markets are self- adjusting and the best role for government is to do nothing,” says Stiglitz, 65, who received his Nobel in 2001. University of Texas economist James Galbraith says Friedman’s ideology has run its course. He says hands-off policies were convenient for American capitalists after World War II as they vied with government-favored labor unions at home and Soviet expansion overseas. “The inability of Friedman’s successors to say anything useful about what’s happening in financial markets today means their influence is finished,” he says. Instead, Galbraith, 56, says policy-makers are rediscovering the ideas of his father, Harvard professor John Kenneth Galbraith, and economist John Maynard Keynes of the University of Cambridge. Keynes, who died in 1946, argued that governments should spend to combat the unemployment that free markets tolerate. Galbraith, who died in 2006, rejected mathematical models and technical analyses as divorced from reality....

Already, some of the university’s top economists have abandoned hard-line Friedmanism for the middle ground. Douglas Diamond, a finance professor at Chicago since 1979, declined to sign Cochrane’s petition damning Paulson’s bailout. Diamond says he knew the Sept. 29 vote against the rescue would spur investors to pull assets from banks. He says governments have no choice but to provide safety nets for banks and tougher oversight. “The vote was the beginning of people believing crazy stuff, like the U.S. might find it politically expedient to let its financial system go,” Diamond, 55, says.

Robert Lucas, a Chicago economist who won a Nobel in 1995 for a theory that argued against governments trying to fine-tune consumer demand, says deregulation may have gone too far. Depression-era laws that separated commercial and investment banks helped depositors decide if they wanted secure accounts or riskier investments. Today, without these distinctions, people can’t be sure if their investments, or those of their customers, are safe. “I’m changing my views on bank regulation every week,” Lucas, 71, says. “It was an area I saw as under control. Now I don’t believe that.” Lucas says he voted for Obama, the only Democrat besides Bill Clinton he’d supported in 44 years. He concluded the candidate was comfortable talking with professional economists. He describes Goolsbee, whom he has met in faculty workshops, as a serious scholar....

The university got its start in 1892 as a haven for researchers, not would-be managers. William Rainey Harper, a Bible scholar who taught at Yale, attracted oil magnate John D. Rockefeller as his benefactor. Harper broke with then prevailing Ivy League practices by hiring Jews, finance professor Fama says. By 1946, Chicago was luring stars such as Enrico Fermi, father of the self-sustaining nuclear reaction. Friedman’s parents were Jews who emigrated from what’s now Ukraine. When he joined the faculty in 1946, he allied with Friedrich Hayek, a London School of Economics professor who later transferred to Chicago. They sought to discredit Keynes, who argued that deficits in government budgets could revive demand in recessions. They viewed rising government power as a step toward left-wing totalitarianism and wanted to stop it, says Philip Mirowski, a University of Notre Dame economist....

Fama, 69, who favors casual shirts and chinos on campus, joined the Chicago faculty in 1963. When he opened his financial theory class on Sept. 29, the day Congress voted down Paulson’s bailout, he placed efficient-market equations from his 1976 textbook on an overhead projector. Fama says he never denied the possibility of unexpected events even though he’d spent a lifetime showing that markets effectively digest information. He was stunned that American International Group Inc., once the world’s largest insurer, sold $441 billion in unhedged and undercapitalized insurance on securitized debt, much of it tied to mortgage values. “No one expected a player like AIG to take a long position and not hedge themselves,” Fama says. He says the government may have been able to stabilize the U.S. financial system at a lower cost by letting AIG collapse...

Matthew Yglesias: Republicans: The “Magic Negro” Party

Matthew Yglesias » The “Magic Negro” Party: Back during the Republican presidential primaries, there was a lot of sentiment that sure Rudy Giuliani was a baby-killer and didn’t hate gays, and sure he lacked relevant qualifications for the presidency, and sure he seemed to be involved in a bit of corruption and cronyism, but, hey, he pissed off a lot of liberals so he must be doing something right. I think that’s the spirit in which you have to understand the boost being given to RNC Chair candidate Chip Saltsman by the fact that he’s a bit racist:

The controversy surrounding a comedy CD distributed by Republican National Committee chair candidate Chip Saltsman has not torpedoed his bid and might have inadvertently helped it.

Four days after news broke that the former Tennessee GOP chairman had sent a CD that included a song titled “Barack the Magic Negro” to the RNC members he is courting, some of those officials are rallying around the embattled Saltsman, with a few questioning whether the national media and his opponents are piling on.

One of the distinguishing characteristics of modern American conservatism is that it believes in a curious concept of “color blindness.” In this view, racism is bad. But absent truly egregious behavior, it’s not something you’d really get all that upset about nor is it something you should be really attuned do. But so-called “political correctness” — meaning something like anti-racism that’s gone too far — is a really serious problem.

Matthew Yglesias: Question of the Day

Matthew Yglesias » Question of the Day: Spencer Ackerman asks the tough questions:

Is comparing Bush to Sarah Palin more insulting to Bush or to Palin?

I’m going to say “more insulting to Palin.” Palin’s something of a laughingstock, but Bush is a villain. I mean, he wrecked the world economy, he led to millions of Iraqis being forced to flee their homes, he’s a total disaster and a disgrace. Palin gave bad answers in TV interviews. There’s no real comparison.

Mark Thoma: Was Risk Misperceived, Misrepresented, or Misallocated?

Economist's View: Was Risk Misperceived, Misrepresented, or Misallocated?: We know that excessive risk taking was a factor in the financial crisis, but why people were willing to take on excessive risk?

There are several explanations for this. In one class of models, misperception of risk generates excessive demand for risky assets, housing and financial assets in particular. There are a variety of stories about why risk is misperceived, ratings agencies failed to do their jobs, risk assessment models turned out to be wrong, people believed that housing prices would continue to go up, and so on. The key is that in this class of models the misperception of risk gives people a false sense of security, and induces them to take on more risk than they can handle.

In another class of models, risk is misrepresented. Here, there is out and out fraud or other practices where, essentially, people know that the house is made of cards, but advertise it as being made of bricks anyway, and assure people that it is perfectly safe. Fraud could cause the victim to misperceive risk, so this is related to the first class of models, but I am trying to separate excessive risk taking brought about by intentional misrepresentation from excessive risk taking brought about by errors in judgment (or, perhaps more accurately in some cases, from negligence).

In a third class of models risk is misallocated, and there are two strands of risk misallocation models. In one, the mechanism that causes people to take excessive risk is knowledge that the government will step in and cover any potential catastrophic losses (risk is reallocated from the private to the public sector). This is the moral hazard problem, and the claim that government intervention led to excessive risk taking has been leveled pretty much wherever government has played a role in housing and financial markets, even when the role has not been very large.

In the second strand of risk misallocation models, the cause of excessive risk taking is market failure due to principal agent problems (e.g. when mortgage brokers are paid according to the number of loans that pass through their hands rather than according to the quality of the loans, and hence have no incentive to monitor risk). Market failures of this type can cause excessive risk taking because the person taking the risks does not face the full consequences of their decisions when the risky decisions turn out to be wrong. Why not take a big risk if you win on the upside, but you don't have to pay the full cost (or any of the costs) on the downside? However, unlike the first strand of risk misallocation models where there is too much government intervention, here the problem can arise when government fails to regulate markets properly, so the problem is often the result of too little government intervention rather than too much.

In a final class of models government is also blamed, but this time government is a bully that forces banks - through regulation or moral suasion - to make loans that are overly risky. The very thoroughly discredited models blaming the Community Reinvestment Act for the financial crisis fit into this class, and the models blaming the CRA are the most prominent member of this category. For that reason, I'll call these models "misguided" and set them aside.

So which was it, misperception, misrepresentation, or misallocation? In the following, Tyler Cowen focuses on the misallocation of risk due to government induced moral hazard. My own view is that misallocation of risk did play a role, but I think risk misallocation due to market failures, i.e. the failure of regulation, was more important in generating the crisis than moral hazard brought about by implicit or explicit government guarantees. I also think the misperception of risk was important, perhaps even more important than the misallocation of risk

David Beckworth: What Happened to the 1,911,000 Lost Jobs?

Macro and Other Market Musings: What Happened to the 1,911,000 Lost Jobs?: Mark Thoma directs us to a stunning claim made by Casey Mulligan in the New York Times:

[T]he decreased employment is explained more by reductions in the supply of labor (the willingness of people to work) and less by the demand for labor (the number of workers that employers need to hire).

If true, this claim means most of the 1,911,000 jobs lost since December 2007 are the result of voluntary choices made by employees. This interpretation probably strikes most observers as ridiculous, but before we dismiss it out of hand let's take a look at the employment data. The place for data on this question is the BLS's Job Opportunity and Labor Turnover Survey (JOLTS). This survey provides data on job openings, hires, and separations, and goes back to December 2000.

Let's first take a look at the JOLTS data on "quits" and "layoffs & discharges". The quits category is defined as "employees who left voluntarily" and does not include retirees or transfers to other locations.... Note that the number of voluntary quits has actually declined over the past two years, indicating workers are not leaving their jobs en masse as suggested by Mulligan. So much for the labor supply contraction. Layoffs & discharges, on the other hand, show a upward trend over the past two years. The increase in layoffs & discharges, however, is quite modest and that may be surprising to some observers given the large number of lost jobs this year. The modest increase in layoffs & discharges, though, is more than made up for with the lack of new job openings and hires... an interesting point raised by Robert Hall: employment typically falls during a recession not because of a huge increase in job losses, but because new jobs are harder to find. Either way, weakened labor demand is the source of the employment reduction. The JOLTS data show this to be the case for the current U.S. recession.

Paul Krugman: Fifty Herbert Hoovers

Op-Ed Columnist - Paul Krugman - Fifty Herbert Hoovers - NYTimes.com: No modern American president would repeat the fiscal mistake of 1932, in which the federal government tried to balance its budget in the face of a severe recession. The Obama administration will put deficit concerns on hold while it fights the economic crisis.

But even as Washington tries to rescue the economy, the nation will be reeling from the actions of 50 Herbert Hoovers — state governors who are slashing spending in a time of recession, often at the expense both of their most vulnerable constituents and of the nation’s economic future.

These state-level cutbacks range from small acts of cruelty to giant acts of panic — from cuts in South Carolina’s juvenile justice program, which will force young offenders out of group homes and into prison, to the decision by a committee that manages California state spending to halt all construction outlays for six months.

Now, state governors aren’t stupid (not all of them, anyway). They’re cutting back because they have to — because they’re caught in a fiscal trap. But let’s step back for a moment and contemplate just how crazy it is, from a national point of view, to be cutting public services and public investment right now.

Think about it: is America — not state governments, but the nation as a whole — less able to afford help to troubled teens, medical care for families, or repairs to decaying roads and bridges than it was one or two years ago? Of course not. Our capacity hasn’t been diminished; our workers haven’t lost their skills; our technological know-how is intact. Why can’t we keep doing good things?

It’s true that the economy is currently shrinking. But that’s the result of a slump in private spending. It makes no sense to add to the problem by cutting public spending, too.

In fact, the true cost of government programs, especially public investment, is much lower now than in more prosperous times. When the economy is booming, public investment competes with the private sector for scarce resources — for skilled construction workers, for capital. But right now many of the workers employed on infrastructure projects would otherwise be unemployed, and the money borrowed to pay for these projects would otherwise sit idle.

And shredding the social safety net at a moment when many more Americans need help isn’t just cruel. It adds to the sense of insecurity that is one important factor driving the economy down.

So why are we doing this to ourselves?

The answer, of course, is that state and local government revenues are plunging along with the economy — and unlike the federal government, lower-level governments can’t borrow their way through the crisis. Partly that’s because these governments, unlike the feds, are subject to balanced-budget rules. But even if they weren’t, running temporary deficits would be difficult. Investors, driven by fear, are refusing to buy anything except federal debt, and those states that can borrow at all are being forced to pay punitive interest rates.

Are governors responsible for their own predicament? To some extent. Arnold Schwarzenegger, in particular, deserves some jeers. He became governor in the first place because voters were outraged over his predecessor’s budget problems, but he did nothing to secure the state’s fiscal future — and he now faces a projected budget deficit bigger than the one that did in Gray Davis.

But even the best-run states are in deep trouble. Anyway, we shouldn’t punish our fellow citizens and our economy to spite a few local politicians.

What can be done? Ted Strickland, the governor of Ohio, is pushing for federal aid to the states on three fronts: help for the neediest, in the form of funding for food stamps and Medicaid; federal funding of state- and local-level infrastructure projects; and federal aid to education. That sounds right — and if the numbers Mr. Strickland proposes are huge, so is the crisis.

And once the crisis is behind us, we should rethink the way we pay for key public services.

As a nation, we don’t believe that our fellow citizens should go without essential health care. Why, then, does a large share of funding for Medicaid come from state governments, which are forced to cut the program precisely when it’s needed most?

An educated population is a national resource. Why, then, is basic education mainly paid for by local governments, which are forced to neglect the next generation every time the economy hits a rough patch?

And why should investments in infrastructure, which will serve the nation for decades, be at the mercy of short-run fluctuations in local budgets?

That’s for later. The priority right now is to fight off the attack of the 50 Herbert Hoovers, and make sure that the fiscal problems of the states don’t make the economic crisis even worse.

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Gershom on Samuel Huntington

[A]s some ideas do, [Huntington's] seeped into popular culture, ready to be quoted when the need arose even by people who couldn't quite recall the source. September 11 created the need. … The problem is that Huntington's thesis is intellectually fuzzy, factually incorrect - and likely to become a self-fulfilling prophecy.

In his original essay, Huntington defined a civilization as a "cultural entity" - "the broadest level of cultural identity people have, short of that which distinguishes humans from other species." Since "culture" itself is a slippery concept, so is "civilization." A civilization, he said, is defined by common language (though the only civilization on his list with a common tongue is Japanese), a common history (though Indonesians hardly share a history with Iranians) and most importantly, by religion (though he places Catholic Italians in one civilization and Catholic Argentinians in another).

The lines between religions, Huntington asserted, are sharper than those between nations. Apparently he never spoke to a scholar of religion. In fact, we live in an era of unparalleled religious mixing. Charismatic Catholics copy Pentecostal Protestants and speak in tongues. Islamic preachers of the End cite the New Testament. New Age Jews borrow from Buddhist meditation. The liberals of sundry faiths often find it easier to speak to each other than to the conservatives of their own religions.

While drawing some lines too sharply, Huntington ignored others. His essay skipped the war between secular, Arab, Sunni-ruled Iraq and theocratic, Persian, Shi'ite-ruled Iran. It offered no framework for understanding the genocidal wars that have afflicted Central Africa. On a global level, he recast the economic tensions between poor nations and wealthy ones - between those who make the shoes and those who wear them - as tensions between "the West and the rest," though that left him not quite knowing what to do with Japan. He described fundamentalism as a force uniting civilizations from within and sharpening the borders between them. Yet the divisions between fundamentalists, mainstream believers, and secularists slice through America itself, Islamic countries, Hindu India and the Jewish state, and opposition to fundamentalism creates a common cause across the supposed borders of civilizations.

For the West, Huntington sometimes substituted "Western Christianity." That erased the differences between Catholics and Protestants, and required ignoring the protracted agony of Northern Ireland. His passing references to Jews and Israel appeared to place them in the West. Perhaps Judaism is an honorary Protestant denomination.

In the real world, Jews identify with the West precisely to the extent that it excludes religion and history as conditions for full membership in society. This is an ideological partnership, not a "civilizational" one. We can happily sign on the Bill of Rights. We cannot identify with Western history as a package deal; that history includes Nazism, the Inquisition and the Crusades. When George W. Bush refers to America's current war effort as a "crusade," he reminds us to be queasy about Western civilization. In Jewish historical memory, "crusade" means the same thing as "jihad," and neither is healthy for us....

Defining today's conflict as the West against Islam satisfies the desire for a large, easily identified enemy. Yet framing this battle as a clash of civilizations invites every Muslim from Morocco to Indonesia to take the side of the men who crashed the planes. It labels every Muslim who opposes fundamentalists, every Muslim leader willing to work with the U.S., as a traitor. It risks turning a misconception into a political fact.

Michael Mackenzie: US stocks cap dismal year

FT.com / Markets - US stocks cap dismal year: Stocks in the US are on course for their worst annual falls since the Great Depression when trading closes today, while in Asia some markets ended the year on Tuesday by notching up their worst performance since records began.

The S&P 500 has already fallen 39.3 per cent on the year, its worst run since a drop of 47.1 per cent in 1931, while the Dow has lost 34.7 per cent, its worst annual decline since it fell 52.7 per cent in the same year.

In Japan, the Nikkei 225 index ended 2008 on Tuesday by recording a 42.1 per cent fall, well above its last biggest annual loss of 38.7 per cent in 1990, while Korea’s Kospi index ended the year with a loss of 40.7 per cent.

It was a similar story in Europe. In London, the FTSE 100 was heading for its worst annual fall since it was created in 1985, having already lost 32.4 per cent to date, well above its previous biggest yearly loss of 24.5 per cent in 2002.

In the rest of Europe, the FTSE Eurofirst 300 has already suffered an annual decline of 45.7 per cent, its worst year since the index was constituted in 1986, a result that is not expected to improve before the last day of trading ends today.

The falls follow a dismal 12 months for stocks that saw them start under pressure from the credit squeeze that began in 2007, and then suffer a raft of grim financial events ranging from the stock trading scandal at Société Générale in January to the near collapse of Bear Stearns, the US investment bank in March and the collapse of Lehman Brothers in September.

As the banking system froze, the credit crunch pushed the global economy into its worst recession since the 1970s, while oil prices soared to as much as $150 a barrel. The value of leading equity markets ended up tumbling by nearly half, in spite of a drop of more than $100 a barrel in crude oil since July and aggressive central bank rate cuts.

“There has been a global flight to safety into government bonds, and everything else has been left behind,” said Jay Mueller, port-folio manager at Wells Capital Management.

An index of US Treasuries has recorded a real return of 14.5 per cent so far in 2008, the best year since 1995 according to Barclays Capital.

The performance of emerging market equities has been far worse, with the MSCI tumbling by a record 55 per cent in dollar terms this year. A collapse in commodity prices intensified the rout for emerging markets.

In a sign of further gloom in the world’s largest economy, new figures published on Tuesday showed US consumer confidence fell to a record low in December in the face of the economic downturn and rising job losses.

The consumer confidence index fell to 38, down from 44.7 in November and much worse than economists had expected. A year ago the index was at 90.6. House prices in big US cities plummeted a record 18 per cent on the year in October, also defying forecasts, according to the closely watched Case-Shiller index.